Costrategix Technologies Pvt. Ltd. Vs DCIT (ITAT Bangalore)
Summary: The Bangalore Bench of the Income Tax Appellate Tribunal considered the assessee’s appeal for Assessment Year 2021-22 against the assessment order dated 11 October 2024, under which a transfer pricing upward adjustment of ₹2,83,35,615 was made. The assessee, Costrategix Technologies Pvt. Ltd., was engaged in providing Software Development and Support Services, being delivery services in Digital and Data Analytics, to its Associated Enterprise, CoStrategix Inc., USA. The value of the international transaction was ₹10,11,49,530.
The assessee had benchmarked the international transaction using the Transactional Net Margin Method (TNMM), adopting Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator. In its transfer pricing study, the assessee reported a PLI of 13.54% and selected six comparable companies. The TPO revised the assessee’s PLI to -2.28%, rejected the assessee’s comparables on various filters and selected 18 comparable companies with a weighted average median margin of 25.09%. The TPO consequently proposed an upward adjustment of ₹2,83,35,615. The Dispute Resolution Panel (DRP) rejected the assessee’s objection concerning the absence of an upper turnover filter, following which the AO finalised the assessment with the transfer pricing adjustment.
The assessee challenged, among other matters, the inclusion of companies having turnover exceeding ₹200 crore. It submitted that, considering its own turnover of ₹10,11,49,530, comparable companies should fall within the ₹1 crore to ₹200 crore range. The assessee identified nine companies with turnover exceeding ₹200 crore: Mindtree Ltd., Great Software Laboratory Pvt Ltd., Nihilent Ltd., Larsen and Toubro Infotech Ltd., Wipro Ltd., Tata Elxsi Pvt Ltd., Infosys Ltd., Tata Consultancy Services Ltd. and Cybage Software Pvt Ltd. The Tribunal considered the turnover-filter issue in light of its earlier decision in CIT Vs. M/s. Pentair Water India Pvt. Ltd. and the decision in Autodesk India Private Limited Vs. DCIT, reported in 96 taxmann.com 263. The Tribunal also considered the coordinate Bench decision in Dotgo Pvt Ltd.
Following the reasoning set out in the order, the Tribunal held that companies having turnover exceeding ₹200 crore were to be excluded from the comparable set and directed the TPO/AO to exclude the nine companies identified by the assessee while calculating the arm’s length price.
The assessee further sought exclusion of five companies on functional-dissimilarity grounds: Orion India Systems Ltd., Net4Nuts Ltd., CG-VAK Software & Export Ltd., Aptus Software Labs Pvt Ltd. and Consilent Technologies Pvt Ltd. The Tribunal relied upon the findings recorded by the coordinate Bench in Dotgo Pvt Ltd. It held that Orion India Systems Ltd. was engaged in diversified BPO/KPO and technology-related activities rather than the captive software-development services provided by the assessee. Net4Nuts Ltd. was engaged in diversified enterprise-wide solutions, ERP, cloud computing, custom software development and other activities. Aptus Software Labs Pvt Ltd. was engaged in infrastructure management, cloud computing, content management, network operations and various testing services. Consilient Technologies Pvt Ltd. was involved in diversified software algorithms, digital communication, video signal processing and performance optimisation services. These companies were therefore held functionally different and directed to be excluded. In relation to CG-VAK Software & Export Ltd., the Tribunal relied upon Aptean India Pvt Ltd., reported in 132 taxmann.com 253, noting that the company had revenue from software services and BPO services and was also engaged in product manufacturing, unlike the assessee’s SWD services.
The Tribunal also considered Sagarsoft (India) Ltd. The assessee submitted that its related party transactions exceeded 85% of operating revenue, based on trade receivables of ₹35.07 crore and consultancy service transactions of ₹60 lakh against operating revenue of ₹41.86 crore. The Tribunal referred to Atlas Healthcare Software India Pvt. Ltd., reported in 120 taxmann.com 115, where Sagarsoft had been excluded because its RPT level was 54% in the relevant year. In the present case, the Tribunal found that the RPT exposure was even higher and held that Sagarsoft could not be regarded as an uncontrolled comparable. It therefore directed the TPO/AO to exclude Sagarsoft (India) Ltd. from the final comparable set.
On these turnover, functional-comparability and RPT issues, the Tribunal allowed the assessee’s grounds.
The remaining substantive issue concerned the assessee’s claim for an economic adjustment of ₹1,51,77,750 on account of extraordinary employee cost arising from underutilisation of manpower during FY 2020-21. The assessee explained that it was a captive service provider whose billing was based on a pre-agreed hourly rate fixed at the beginning of the year. It claimed that it had undertaken capacity-building measures and retained employees because of expected demand, but the COVID-19 outbreak caused a slowdown and reduced utilisation. The assessee submitted that it consequently incurred higher employee costs without a corresponding increase in revenue.
The DRP rejected the claim on the reasoning that the COVID-19 pandemic had affected the assessee and comparable companies similarly. Before the Tribunal, the assessee relied upon Rule 10B(3) of the Income Tax Rules, the OECD Guidance on Transfer Pricing issued on 18 December 2020, and decisions including Mentor Graphics, Phillips Software and Demag Cranes.
The Tribunal examined the assessee’s employee headcount, billed hours and hours worked. It noted that headcount was 74 in FY 2018-19, 85 in FY 2019-20 and 76 in FY 2020-21, before increasing to 102 in FY 2021-22 and 113 in FY 2022-23. Billed hours were 89,959, 83,332 and 85,424 respectively for FYs 2018-19 to 2020-21, followed by substantial increases in subsequent years. Hours worked declined from 1,56,304 in FY 2019-20 to 1,47,176 in FY 2020-21. The resulting per-hour cost increased from ₹546 to ₹643, approximately 18%. Average CTC also increased from ₹76,648 in FY 2019-20 to ₹92,204 in FY 2020-21 and ₹1,13,127 in FY 2021-22.
The Tribunal found that the assessee had demonstrated extraordinary circumstances, quantified the extraordinary cost with reasonable accuracy and established a material impact on its PLI. It further observed that the TPO had not shown that the comparables had suffered the same level of underutilisation or salary pressure. The Tribunal therefore held that the adjustment was allowable under Rule 10B(3). It directed the AO/TPO to grant the employee-cost adjustment of ₹1,51,77,750 and recompute the PLI.
Accordingly, the grounds concerning the employee-cost adjustment were allowed. The appeal was ultimately **partly allowed**.
Cases Discussed
- CIT Vs. M/s. Pentair Water India Pvt. Ltd., Tax Appeal No. 18 of 2015 dated 16.09.2015 — considered on the relevance of turnover as a criterion for selecting comparable companies in transfer pricing proceedings.
- Chryscapital Investment Advisors (India) Pvt. Ltd. Vs. DCIT, 56 taxmann.com 417 (Delhi) — referred to in the discussion concerning whether high turnover can by itself justify exclusion of a comparable.
- Autodesk India Private Limited Vs. DCIT, 96 taxmann.com 263 (Bangalore-Tribunal) — followed for the turnover-filter issue and the view that turnover is a relevant criterion in determining comparability.
- Dotgo Private Limited Vs. DCIT, IT(TP)A No. 2096/Bang/2024 — relied upon for exclusion of high-turnover and functionally dissimilar companies and for the analysis of Sagarsoft (India) Ltd.
- Genisys Integrating Systems (I) (P.) Ltd. — considered in the turnover-filter discussion and referred to as the earlier Bangalore Tribunal decision concerning turnover-based comparability.
- Dell International Services India (P) Ltd. Vs. DCIT, (2018) 89 Taxmann.com 44 (Bang-Trib) — referred to in the turnover-filter discussion.
- Sysarris Software Pvt. Ltd. Vs. DCIT, (2016) 67 Taxmann.com 243 (Bangalore-Trib) — referred to regarding conflicting views on the turnover filter.
- Willis Processing Services — referred to in Autodesk in the discussion of decisions concerning turnover comparability.
- Capgemini India (P.) Ltd. — referred to in Autodesk in the discussion of decisions concerning turnover comparability.
- NTT Data — referred to in Autodesk in the discussion of later decisions concerning turnover comparability.
- Societe Generale Global Solutions — referred to in Autodesk in the discussion of later decisions concerning turnover comparability.
- LSI Technologies — referred to in Autodesk in the discussion of later decisions concerning turnover comparability.
- Continental Automotive Components (India) (P) Ltd. Vs. DCIT, 167 taxmann.com 433 (ITAT Bangalore) — referred to in Dotgo concerning application of the upper turnover filter.
- Marvell India Pvt. Ltd. Vs. DCIT, IT(TP)A No. 115/Bang/2023 — referred to in Dotgo concerning the upper turnover filter.
- Sun Tec Business Solutions P. Ltd. Vs. ACIT, IT(TP) No. 01/Coch/2021 — referred to in Dotgo concerning the upper turnover filter.
- Aptean India Pvt Ltd., 132 taxmann.com 253 — relied upon for the functional differences of CG-VAK Software & Export Ltd.
- Atlas Healthcare Software India Pvt. Ltd., 120 taxmann.com 115 — referred to regarding exclusion of Sagarsoft (India) Ltd. on account of related party transactions.
- Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT, ITA No. 120/PN/2011 — relied upon by the assessee in support of adjustments for material differences in transfer pricing analysis.
- Mentor Graphics (Noida) (P) Ltd., 109 ITD 101 — relied upon by the assessee for the proposition that material differences should be adjusted while applying TNMM.
- Phillips Software Centre Pvt. Ltd. Vs. DCIT, 26 SOT 226 — relied upon by the assessee for the proposition concerning adjustment of material differences in transfer pricing analysis.
FULL TEXT OF THE JUDGMENT/ORDER OF ITAT BANGALORE
This is an appeal filed by the assessee against the assessment order passed by the IT Department vide order dated 11/10/2024 in DIN No. ITBA/AST/S/143(3)/2024-25/1069609792(1) for the assessment year 2021-22.
2. The assessee has raised as many as 9 Grounds in the appeal memo. The Ground Nos. 1 and 2 of the assessee’s appeal are general ground, not requiring any separate adjudication. Hence, the same is hereby dismissed as infructuous.
3. The Ground No. 3 of the appeal of the assessee is that the TPO and Ld. DRP erred in rejecting the comparables selected by the assessee.
4. At the outset, we note that the learned AR of the assessee before us submitted that at the instruction of the assessee this ground is not pressed. Hence, we dismissed the same as not pressed.
5. The assessee through Ground Nos. 4 & 5 of the appeal has challenged the comparable companies selected by the TPO.
6. The facts in brief are that the assessee, a private company, is engaged in the business of providing Software Development and Support Services (being delivery services in Digital and Data Analytics) to its AE namely CoStrategix Inc. US. During the year under consideration, the assessee has provided services to the said AE for a value of Rs. 10,11,49,530/- only.
7. The assessee benchmarked the impugned international transaction by adopting TNMM as most appropriate method. In the TP study the PLI was taken as operating profit / operating cost (OP/OC) at 13.54%. To compare the PLI, the assessee company selected set of 6 comparable companies whose weighted average margin was being 35th percentile and 65th percentile was at 5% and 29.79%. Accordingly, the assessee claimed that its international transaction is at ALP.
7.1 However, the TPO during the assessment proceedings revised the working of the PLI and as per revised working, the PLI (Op/Oc) of the assessee was computed – 2.28%. Further, the TPO rejected the comparables companies selected by the assessee by holding that those companies fails either on export filter, FAR filter, persistent loss filter, employee cost filter etc. Thereafter, the TPO applying its own filter in the Data base Namely AceTP and Prowess, selected a set of 18 comparables companies which weighted average margin median arrived at 25.09%. The list of the proposed comparable companies selected by the TPO and their margin computation is available at page 17 to 18 of the TPO’s order.
7.2 The assessee against the proposed set comparables companies filed objections. The assessee company submitted that in the process of selection of comparable the upper turnover filter was not applied. Accordingly, the assessee claimed there were certain companies which cannot be a comparable as their turnover are very high as compared to the assessee’s turnover of Rs. 10,11,49,530/-. Those companies are as under:
1. Mindtree Ltd
2. Great Software Laboratory Pvt Ltd
3. Nihilent Ltd
4. Larsen and Toubro Infotech Ltd
5. Wipro Ltd
6. Tata Elxsi Pvt Ltd
7. Infosys Ltd
8. Tata Consultancy Services Ltd
7.3 However, the TPO rejected the objection of the assessee. As the median of the weighted average margin of the 18 comparables companies as selected by the TPO was computed at 25.09 and the assessee PLI at -2.28%, the TPO proposed upward adjustment of Rs. 2,83,35,615/-. Based on same, the AO finalised the draft assessment order under section 144C(1) of the Act.
8. The aggrieved assessee preferred to file objection before the learned DRP.
9. Before the learned DRP, the assessee again raised objection regarding not applying the upper limit turnover filter and prayed that the comparables companies having abnormally higher turnover than the assessee’s turnover should be excluded. However, the learned DRP rejected the objection of the assessee and confirmed the action of the TPO. Accordingly, the AO finalised the assessment order by making addition on account of TP upward adjustment for Rs. 2,83,35,615/- to the total income of the assessee.
10. Being aggrieved by the final assessment order, the assessee is in appeal before us.
11. The learned AR of the assessee before us filed paper book running from pages 1 to 122, notes, case laws etc which are on record. The learned AR before us reiterated that turnover viz a viz the international transaction of the assessee company stands at ₹ 10,11,49,530/- only. Therefore, the assessee company is a small size company and accordingly the comparable company should have turnover between ₹ 1 crore to ₹ 200 crores only. Accordingly, the comparable outside the said range of turnover should be excluded. There were 18 companies selected by the TPO and out of 9 companies having turnover exceeding ₹ 200 crores, hence these 9 companies should not be considered as comparable for working out the ALP of the assessee. In contending so, the ld. AR relied on the order coordinate bench of this Tribunal in the case of Dotgo Private Limited vs DCIT bearing IT(TP)A No. 2096/Bang/2024. Such lists of the comparable companies having turnover more than 200 crores with the associated enterprises is reproduced as under:
1. Mindtree Ltd
2. Great Software Laboratory Pvt Ltd
3. Nihilent Ltd
4. Larsen and Toubro Infotech Ltd
5. Wipro Ltd
6. Tata Elxsi Pvt Ltd
7. Infosys Ltd
8. Tata Consultancy Services Ltd
9. Cybage Software Pvt Ltd.
11.1 Likewise, the learned AR submitted that there were comparable companies selected by the TPO which are functionally dissimilar to the assessee and accordingly, these should be excluded from the list of the comparable. Those companies are as under:
1. Orion India Systems Ltd.
2. Net4Nuts Ltd
3. CG-VAK Software & Export Ltd
4. Aptus Software Labs Pvt Ltd
5. Consilent Technologies Pvt Ltd
11.2 The ld. AR to this effect has again placed reliance on the decision of the Tribunal in case of Dotgo Private Limited vs DCIT (supra).
11.3 Furthermore, the learned AR submitted that one the comparable company namely Sagarsoft (India) Ltd have related party transaction over 85%. The learned AR drawn attention to financial statement of the said company as per which the revenue from the operation stands at Rs. 41.86 crore whereas related party transaction in the form of trade receivable stand at Rs. 35.07 crores and in the form of consultancy services stand at Rs. 60 lakhs. Accordingly, the learned AR argued that the impugned party fails on RPT filter and should be excluded from the list of comparables. The learned AR also submitted the impugned company was excluded by the Kolkata ITAT in the case of Atlas Healthcare Software India Pvt Ltd reported in 120 taxmann.com 115 from the comparable list because impugned company has RPT of 54% in the relevant year.
12. On the contrary, the learned DR before us vehemently supported the order of the authorities below.
13. We have heard the rival contentions of both the parties and perused the materials available on record. The facts of the case have been elaborated in the preceding paragraph which are not in dispute, therefore for the sake of brevity and convenience, we are not inclined to repeat the same. The 1st controversy arises whether the companies having turnover exceeding ₹ 200 crores should be excluded while calculating the ALP of the assessee. In this regard, we find pertinent to refer the order of this tribunal in the case of Autodesk India Private limited vs. DCIT reported in 96 taxmann.com 263 wherein it was held as under:
17.7 We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt. Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon’ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon’ble Bombay High Court in the case of Pentair Water India (P.) Ltd. (supra) has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon’ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee.
17.8 In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating Systems (I) (P.) Ltd. (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating Systems (I) (P.) Ltd. (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating Systems (I) (P.) Ltd. (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India (P.) Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).
13.1 Similar view also taken by the coordinate bench of this tribunal in the case of Dotgo Pvt Ltd (supra) where it was held as under:
21. In respect of nine (9) comparables viz.,
i. Great Software Lab. Pvt Ltd,
ii. Nihilent Ltd,
iii. Mindtree Ltd,
iv. Larsen & Toubro Infotech Ltd.,
v. Wipro Ltd,
vi. Tata Elxsi Pvt. Ltd.,
vii. Infosys Ltd,
viii. Tata Consultancy Services,
ix. Cybage Software Pvt Ltd ;
21.2 The assessee submitted that these companies failed the upper turnover filter test, which the lower authorities refused to apply stating further that a newly incorporated company having turnover of only Rs.10.23 crores and therefore it is wholly inappropriate to compare the same with giant software companies having diversified services, valuable intangibles and better margins. Reliance in this regard was placed on the following decisions wherein the application of upper turnover filter was adopted; Hon’ble Tribunal in the following cases rejected such comparables.
Continental Automotive Components (India) (P) Ltd. Vs. DCIT (167 taxmann.com 433) [ITAT Bang] [Pg 62 to 68 of the Legal PB]
Marvell India Pvt. Ltd. Vs. DCIT (IT(TP)A No. 115/Bang/2023) [ITAT Bang] [Pg 69 to 83 of the Legal PB]
Sun Tec Business Solutions P. Ltd. Vs. ACIT (IT(TP) No. 01/Coch/2021) [ITAT Coch] [Pg 50 to 61 of the Legal PB]
21.3 In view of the turnover Filter as discussed above, the TPO’s failure to apply an upper turnover filter is not justified. The absence of such a filter, despite applying a lower limit, leads to inconsistency and affects the reliability of the comparability analysis.
13.2 Based on the above finding of the ITAT, we are inclined to exclude the companies having turnover exceeding ₹ 200 crores as comparable (which are detailed in preceding paragraph vide learned submission of the assessee) while calculating the ALP for the transactions international transactions carried out by the assessee with the AE. Hence, we direct the TPO/AO to exclude the companies stated above from the list of comparable while calculating the ALP with respect to the international transaction carried out by the assessee with the AE.
Now coming to the next argument of the learned AR regarding the companies being functionally different.
13.3 We note that the coordinate bench of this Tribunal in case of Dotgo Pvt Ltd (supra) has found that the “Orion India Systems Ltd” is engaged in the business of “providing technology solutions such as cloud services, mobility, system integration; business solutions such as BPTO business solution, business inteligence, strategic outsourcing and application development. This company is therefore engaged in a diversified business of providing business and technology solutions and not in the development of software”. Hence in our considered view this company which is engaged in the business of providing BPO & KPO services is vastly different from the assessee company which is providing captive SWD services to its AEs
13.4 Similarly, the Tribunal in case of Dotgo Pvt Ltd (supra), has found that the “Net4Nust Ltd” is engaged in the business of providing enterprisewide solutions across multiple industries, ERP, cloud computing, custom software development, off-shore engineering services, designing, architecting developing and maintenance of high availability software products / solutions, mobile value-added services. Hence, we hold that the company which engaged in such divers activity cannot be a comparable to the assessee which is providing Software development services.
13.5 Likewise the Tribunal in case of Dotgo Pvt Ltd (supra) has found that the “Aptus Software Labs Pvt. Ltd.” is engaged in several diversified businesses which vastly differ from those of the assessee, i.e. infrastructure management, cloud computing, content management systems, network operations center, quality assurance services such as functional testing, security testing, performance scalability reliability testing, test automation. Therefore, we hold that the impugned company is functionally different and cannot be a comparable to the assessee which is providing Software development services.
13.6 Further the Tribunal in case of Dotgo Pvt Ltd (supra) has found that the “Consilient Technologies Pvt Ltd” is providing optimized software algorithms involved in voice, data, fax, solutions of speech processing, digital communication and video signal processing, high performance loud-based solutions, performance optimization services. Thus, it is not exclusively into software development, and the provision of its services is diversified than the SWD services provided by the assessee. Therefore, we hold that the impugned company is functionally different and cannot be a comparable to the assessee which is providing Software development services.
13.7 Now coming to the company CG-VAK Software & Export Ltd, in this regard, we note that the coordinate bench of this Tribunal in Aptean India Pvt Ltd reported in 132 taxmann.com 253 has found that the company CG-VAK Software & Export Ltd is having revenue from both software services and BPO services. Further the said company is not only engaged in the business of computer software development but also engaged in product manufacturing process. On the contrary the assessee company on hand is providing SWD services and not engage in product manufacturing. Hence, in our considered opinion this company is functionally different and therefore, the same should be excluded from the comparable list.
13.8 Regarding the Sagarsoft (India) Ltd, the primary contention of the assessee is that the company has exceptionally high related party transactions (“RPT”), which renders it functionally and economically unreliable for benchmarking the assessee’s international transactions. From the financial statements referred to by the learned AR, it is evident that the company has reported revenue from operations of Rs. 41.86 crore, whereas its related party exposure comprises trade receivables of Rs. 35.07 crore and consultancy service transactions of Rs. 60 lakhs. The aggregate RPT thus exceeds 85% of the revenue. Such a high level of related party involvement clearly fails the RPT filter which has been consistently applied by this Tribunal and other coordinate benches while selecting uncontrolled comparables.
13.9 We also note that the Kolkata Bench of the Tribunal, in the case of Atlas Healthcare Software India Pvt. Ltd. (120 taxmann.com 115), has already examined the comparability of this company and held that Sagarsoft (India) Ltd. should be excluded, as its RPT level was 54% in the relevant year. The present case reflects an even higher RPT percentage. In view of the above factual position and in line with judicial precedent, we hold that M/s Sagarsoft (India) Ltd. cannot be regarded as an uncontrolled comparable. The company stands vitiated by significant related party influence, and therefore its margins cannot be used for arm’s length analysis. Accordingly, we direct the TPO/AO to exclude M/s Sagarsoft (India) Ltd. from the final set of comparables for benchmarking the assessee’s international transactions.
13.10 In view of the above detailed discussion the ground of appeal raised by the assessee for exclusion of certain comparable companies selected by the TPO on account of upper turnover filter, functionality difference and RPT filter is hereby allowed.
14. The Ground No. 6 of the assessee is that the TPO and Ld. DRP erred in computing the Margin of the comparables selected by the TPO. At the outset, we note that the learned AR of the assessee before us submitted that at the instruction of the assessee this ground is not pressed. Hence, we dismissed the same as not pressed.
15. The last issue raised by the assessee through Ground Nos. 7 to 9 of the appeal is that the TPO erred in not considering the economic adjustment of employee cost for the sum of Rs. 1,51,77,750/- only.
16. The necessary facts are that assessee while computing PLI has computed its operating profit in the following manner:
| Revenue From Operation | Rs. 10,11,49,530/- |
| Less: Operating Cost | Rs. 10,24,56,258/- |
| Total Expenses | Rs. 10,45,60,628/- |
| Less: Finance Cost | (Rs. 9,55,652) |
| Less: Depreciation | (Rs. 11,48,718) |
| – |
–
| A. Operating Profit | Rs. 13,06,728/- |
| B. Underutilisation of Manpower | Rs. 1,51,77,750/- |
| Adjusted Operating Profit (A + B) | Rs. 1,38,71,022/- |
| PLI (Adjusted OP/OC) | 13.54% |
16.1 However, the TPO revised the computation of Operating profit and operating cost in the following manner:
| A. Revenue From Operation | Rs. 10,11,49,530/- |
| B. Operating Cost | Rs. 10,35,13,587/- |
| Total Expenses | Rs. 10,45,60,628/- |
| Less: Finance Cost | (Rs. 9,55,652/-) |
| Less: Rates & taxes | (Rs. 91,389/-) |
| C. Operating Profit (A – B) | – Rs. 23,64,057/- |
| D. PLI (OP/OC) | – 2.28% |
16.2 Hence, the TPO in the computation of PLI has not allowed the adjustment on account of underutilisation of Manpower for the sum of Rs. 1,51,77,750/- only. The non- allowance of adjustment on account of Depreciation is not in dispute. However, the assessee being aggrieved by non-allowances of adjustment on account underutilisation of the Manpower raised objection before the learned DRP.
17. The assessee before the learned DRP submitted that it has made recruitment of certain number of employees anticipating increase in revenue. But due to covid situation and thereby slowdown of economy the anticipated revenue not realised. Hence, it sought adjustment on account of increase cost of the employee which has impacted its operational performance. Therefore, to make its operational performance comparable with other it is necessary to make adjustment of such increased cost of employee. Accordingly, the assessee prayed to the learned DRP issue direction for allowances of impugned adjustment for sum of Rs. 1,51,77,750/-.
17.1 The plea of the assessee was rejected by the learned DRP by observing that the Covid-19 pandemic has impacted the assessee as well as the comparables companies in the similar manner. Hence no adjustment is required to be done for such universal impact of the Covid-19 pandemic. Accordingly, the AO passed final assessment order in conformity with the learned DRP direction.
18. Being aggrieved by the direction of the learned DRP and the assessment order the assessee is in appeal before us.
19. The learned AR before us submitted that the assessee is a captive service provider rendering IT services only to its AE. The billing is done on the basis of a pre-agreed hourly rate. This rate is fixed before the start of the year after considering budgeted employee cost, overheads, and a profit mark-up. Once the rate is agreed, neither the assessee nor the AE can change it during the year. The assessee tracks the actual hours worked through time sheets. Billing is periodic and is based on these hours. This method has been consistently followed and has always given fair compensation to the assessee.
19.1 The learned AR explained that in FY 2020-21 the assessee had planned a capacity-build programme. Job offers had already been rolled out. Workspace upgrades and infrastructure improvements were initiated. These plans were made based on the expected growth pipeline. However, the COVID-19 outbreak created a sudden slowdown. The market became uncertain. Because of this, the assessee had to take a conscious business decision to retain the employees and honour the commitments already made. It could not retract the job offers or reduce headcount midway. The customers were still engaging and the assessee expected work to revive. Therefore, the employees were kept on standby rather than retrenched.
19.2 The learned AR submitted that because of this decision, the assessee incurred higher employee costs without a corresponding increase in revenue in FY 2020-21. The assessee maintained a minimum bench strength so that ongoing deliveries were not affected. These decisions were necessary for continuity and to ensure that the assessee was ready when digital demand returned.
19.3 The ld. AR pointed out that the assessee also anticipated increased demand for digital services. Hence, the company hired more employees to meet this requirement. During this time, the labour market became very tight. Companies were paying significantly higher salaries to attract talent. The assessee also had to offer higher cost-to-company (CTC) to new hires and make salary adjustments for existing employees. Thus, employee costs rose sharply. The table filed before the lower authorities clearly shows the rising average CTC and headcount over the years.
19.4 The learned AR further submitted that even though the assessee retained the staff expecting more work, actual business did not increase. In fact, revenue fell in FY 2020-21. It recovered only in the next two financial years, as seen from the revenue and billed-hours chart.
19.5 Because of this mismatch, the employee cost per hour increased by around 18%. This created an abnormal cost impact of approximately ₹1.52 crores for FY 2020-21. The assessee demonstrated this through a detailed working comparing FY 2020-21 with FY 2019-20. This increase was extraordinary and unusual.
19.6 The learned AR argued that Rule 10B(3) of the Income Tax Rules applies when there are differences between controlled and uncontrolled transactions. If these differences materially affect price or cost, reasonable adjustments must be allowed. COVID-19 and its consequences created such material differences for the assessee. Therefore, the assessee’s request for an employee-cost adjustment of ₹1.52 crores falls clearly within Rule 10B(3) of the Income Tax Rules. The learned AR stressed that the assessee bears the entire manpower-utilisation risk. This can be seen from the billing model itself. The AE does not compensate separately for idle time or under-utilisation. Therefore, any abnormal cost due to COVID must be adjusted while computing the arm’s length margin.
19.7 The ld. AR placed reliance on the OECD Guidance on Transfer Pricing issued on 18 December 2020. This guidance recognises that COVID-19 created exceptional circumstances and extraordinary costs. It provides that such costs must be isolated and suitable adjustments should be made. The learned AR also relied on various Tribunal decisions, including those of Delhi ITAT in Mentor Graphics reported in 109 ITD 101, Bangalore ITAT in Phillips Software reported in 26 SOT 226, and Pune ITAT in Demag Cranes reported in 120/Pune/2011. These decisions hold that material differences must be adjusted while applying TNMM.
19.8 It was submitted that the TPO wrongly rejected the claim. The assessee cannot obtain details of employee-cost structures of comparable companies, because these are not publicly available. When full information is not available, reasonable approximations must be permitted. The assessee has computed the adjustment using a scientific and consistent methodology, by benchmarking employee-cost to operating-cost ratios of comparables.
19.9 The learned AR finally submitted that if the extraordinary cost of ₹1.51 crores is excluded, the assessee’s operating margin becomes 14.51%, which is at arm’s length. Therefore, the learned AR prayed that the adjustment should be allowed. The assessee’s claim is justified, supported by documents, and in line with Rule 10B(3), OECD guidelines, and judicial precedents. The extraordinary COVID-related employee cost should be excluded for determining the arm’s length margin.
20. On the other hand, the learned DR vehemently supported the order of the authorities below.
21. We have heard the rival contentions and perused the material available on record. We find that the core issue is whether the assessee is entitled to an economic adjustment on account of extraordinary employee cost arising in FY 2020-21. The assessee claims that its operating margin for the year is distorted because it had to retain more employees at a higher cost while the billed hours and revenue did not increase in the same proportion. The TPO and DRP have rejected the adjustment mainly on the ground that COVID-19 was a universal event.
At the outset, we note that the assessee is a captive service provider. It works only for its AE. The billing is based on a pre-agreed hourly rate which is finalised at the start of the year. This rate is based on budgeted employee cost, overheads and a margin. Once agreed, neither party can revise the rate during the year. The assessee, therefore, bears the risk of higher employee cost and lower utilisation. These facts are not disputed.
21.1 We further observe that the headcount pattern shows a clear and specific trend. In FY 2018-19, the assessee had 74 employees. In FY 2019-20, this increased to 85. In FY 2020-21, the year under dispute, the headcount was 76. In the subsequent years, the number jumped significantly to 102 in FY 2021-22 and 113 in FY 2022-23. This shows that FY 2020-21 was a transition period where recruitment was already initiated but utilisation did not rise due to COVID-19. It is also clear that business picked up strongly after the pandemic. Therefore, the action of retaining employees was not unreasonable.
21.2 We also compare the billed hours. In FY 2018-19 the billed hours were 89,959. In FY 2019-20 they were 83,332. In FY 2020-21 the billed hours were 85,424. In the next years they increased sharply to 1,16,423 and 1,33,965. This shows that the assessee had created capacity expecting higher work. But due to the pandemic, the actual billed hours did not increase. In other words, the assessee had higher available manpower capacity but lower utilisation.
21.3 We also note the hours worked from the assessee’s computation. In FY 2019-20 the hours worked were 1,56,304. In FY 2020-21 they were 1,47,176. Thus, even though the employee strength remained high, the actual hours deployed declined. This resulted in lower productivity and higher per-hour cost. The per-hour cost increased from ₹546 to ₹643, an increase of about 18%.
21.4 We also consider the industry reality. The software development industry witnessed sharp salary inflation during 2020-21 and 2021-22. Hiring became expensive. Companies had to offer higher CTC to attract and retain talent. This is reflected in the assessee’s average CTC, which increased from ₹76,648 in FY 2019-20 to ₹92,204 in FY 2020-21, and further to ₹1,13,127 in FY 2021-22. Therefore, the increase in employee cost is not artificial. It is a result of external market conditions.
21.5 We also note that the assessee was bound by issued job offers and had already undertaken workspace upgrades. It could not cancel these commitments midway. Retrenchment was also not a viable option because customers still required services, and the assessee expected work to resume. Therefore, the assessee retained capacity at a cost. This decision appears commercially prudent and consistent with what many companies had to do during the pandemic.
21.6 The financial impact of this is well demonstrated. The assessee computed an abnormal employee-cost impact of ₹1.52 crores for FY 2020-21. This cost arose purely due to (i) lower utilisation, (ii) higher salary cost, and (iii) retention of bench strength. These conditions did not exist in earlier or later years. Hence, FY 2020-21 is clearly an extraordinary year.
21.7 Rule 10B(3) permits adjustments if differences materially affect the profit and reasonably accurate adjustments can be made. The assessee has benchmarked the employee-cost to operating-cost ratio of comparables and has computed the adjustment scientifically. The TPO has mechanically rejected it by stating that COVID-19 affected all companies. However, the impact of COVID-19 is not uniform across industries or companies. The comparables may not have had similar recruitment cycles, similar pre-committed hiring, or similar utilisation profiles. Therefore, the DRP’s observation that COVID-19 affected all companies equally is not acceptable.
21.8 The OECD Guidance of December 2020 also recognises that exceptional costs during COVID-19 may warrant adjustments. Several Tribunal decisions such as Mentor Graphics (supra), Phillips Software (supra) and Demag Cranes (supra) also support adjustments when there are differences in risk and cost structure.
21.9 In the present case, we find that the assessee bears the resource-utilisation risk. It also bears the risk of higher employee cost. The AE does not compensate for idle capacity because the billing rate cannot be changed mid-year. The extraordinary employee cost therefore directly depresses the assessee’s PLI. If this abnormal cost is not adjusted, the comparison with steady-state margins of comparables becomes distorted.
21.10 We therefore hold that the assessee has demonstrated (i) existence of extraordinary circumstances, (ii) quantification of extraordinary cost with reasonable accuracy, and (iii) material impact on PLI. We also find that the TPO has not shown that the comparables suffered the same level of underutilisation or salary pressure. Hence, adjustment is allowable. Accordingly, we direct the AO/TPO to grant the employee-cost adjustment of ₹1,51,77,750 as claimed by the assessee, and recompute the PLI. The grounds of the assessee are allowed.
22. In the result, the appeal of the assessee is partly allowed.
Order pronounced in court on 18th day of December, 2025
