Supernormal profits making company should be excluded from the comparables set, as they have a tendency to skew the results and cannot be considered as general representative of the industry.

The taxpayer was an Indian company (‘ICo’). ICo was a
wholly-owned subsidiary of an American company. ICo was engaged in providing
software development services and marketing development services to its
Associate Enterprises (AE’s). In respect of financial year 2005-06, ICo had
earned operating margin (operating profits/operating costs) of 14.96%. Based on
transfer pricing study done by ICo, ICo contended that its profit was higher
than the margins earned by comparable uncontrolled companies and therefore its
international transactions were at arm’s length. The Transfer Pricing Officer (‘TPO’)
conducted fresh comparables search and determined operating margin at 24.91% by
including three comparables having profit margins of 91% to 160%. Further, the
TPO also used updated data for financial year 2005-06 as were available at the
time of assessment as against taxpayer’s data as of date of tax filing.

Being aggrieved, ICo filed its submissions before Dispute
Resolution Panel (‘DRP’). However, DRP upheld the adjustment proposed by the TPO.

ICo filed appeal with the Tribunal against TP adjustment.

The Tribunal held as follows :

The TPO had brushed aside the contention of the taxpayer
without giving any cogent reasons and ignoring the documents submitted by ICo.
The TPO had also not commented on objections of ICo against one of the
companies.

It was not in dispute that the three companies had shown
supernormal profits as compared to other comparables and there was merit in the
argument of ICo for exclusion of these three companies. If these companies were
excluded, the average margin would be 17.5%, which would be within ±5% range of
the margin of ICo.

The order passed by DRP was very cursory and laconic without
going into the voluminous submissions made by ICo and such approach was contrary
to the provisions of Income-tax Act.