Transfer-pricing comparability permits rational turnover filters and excludes functionally different software-product companies without reopening completed benchmarking.
Transfer-pricing comparables may be screened through a rational turnover filter where differences in scale materially affect pricing. Selection must consider functions, assets, risks and material turnover differences. A software-product developer that owns intellectual property or develops and markets products is functionally distinct from a captive software-development service provider and should be excluded from its comparable set. Where the transfer-pricing officer has completed the comparability analysis, directions excluding specified entities require effect to be given to those exclusions only; they do not require a fresh arm's-length-price or comparability exercise.
Issues: (i) Validity of applying a turnover filter of Rs. 1 crore to Rs. 200 crores for selecting transfer-pricing comparables; (ii) Whether a software-product company was functionally comparable to a captive software-development service provider; (iii) Whether exclusion of comparables required a fresh arm's-length-price and comparability exercise on remand.
Issue (i): Validity of applying a turnover filter of Rs. 1 crore to Rs. 200 crores for selecting transfer-pricing comparables.
Analysis: Section 92C(2) of the Income-tax Act, 1961 does not prescribe a turnover filter. However, the Rs. 1 crore to Rs. 200 crores filter had a rational basis because comparability must be assessed with reference to functional profile, assets, risks, and material differences in the size and turnover of the tested party and comparable entities. A substantial variation in turnover can affect transaction pricing.
Conclusion: The turnover filter was valid and the issue was decided in favour of the assessee.
Issue (ii): Whether a software-product company was functionally comparable to a captive software-development service provider.
Analysis: The assessee provided software-development services to its associated enterprise and neither owned intellectual property nor developed or marketed software products. The proposed comparable was engaged in software-product development and in providing technology solutions and consultancy; its functional profile was therefore materially different.
Conclusion: The software-product company was not a valid comparable and was rightly excluded, in favour of the assessee.
Issue (iii): Whether exclusion of comparables required a fresh arm's-length-price and comparability exercise on remand.
Analysis: The transfer-pricing officer had already completed the comparability exercise and selected the final set of comparables. The remand required effect to be given to the exclusions directed on the identified grounds, and did not warrant reopening the entire determination of the arm's-length price.
Conclusion: No fresh comparability exercise was required; the issue was decided in favour of the assessee.
Final Conclusion: The transfer-pricing computation must be given effect using comparables selected through a rational turnover and functional-comparability analysis, without reopening the completed exercise merely because specified entities are excluded.
Ratio Decidendi: Transfer-pricing comparables must be selected by reference to functional profile, assets, risks, and material scale; a rational turnover filter is permissible, and a software-product company cannot be compared with a captive software-development service provider where their functions materially differ.