ITAT Bangalore Rules On Turnover Filters And COVID-Driven Employee Cost Adjustment In Costrategix Technologies Pvt. Ltd. Vs DCIT
The Bangalore Bench of the Income Tax Appellate Tribunal has, in the case of Costrategix Technologies Pvt. Ltd. Vs DCIT (ITAT Bangalore), delivered a significant ruling for captive software service providers on two core transfer pricing issues for AY 2021-22:
- Application of an upper turnover filter and exclusion of high-turnover and functionally dissimilar comparables; and
- Grant of an economic adjustment for extraordinary employee costs attributable to COVID-19–related underutilisation of manpower.
The appeal arose from a final assessment order dated 11/10/2024 for Assessment Year 2021-22, in which the Assessing Officer, following the Transfer Pricing Officer’s proposals and Dispute Resolution Panel directions, made a transfer pricing adjustment of ₹2,83,35,615 in respect of international transactions with the Associated Enterprise (AE).
Background: Business Profile And Transfer Pricing Methodology
Costrategix Technologies Pvt. Ltd. is a private company rendering Software Development and Support Services (delivery services in Digital and Data Analytics) to its AE, CoStrategix Inc., USA. During the relevant year:
- Value of international transaction with AE: ₹10,11,49,530
- Nature of transaction: Provision of captive software development and support services
- Method adopted: Transactional Net Margin Method (TNMM)
- Profit Level Indicator (PLI): Operating Profit/Operating Cost (OP/OC)
In its transfer pricing documentation:
- The assessee computed its adjusted operating margin at 13.54% on OP/OC basis, after claiming an economic adjustment for underutilisation of manpower.
- A set of 6 comparable companies was selected, and on that basis, the assessee asserted that its margin was at arm’s length.
The Transfer Pricing Officer (TPO), however:
- Recomputed the assessee’s PLI at -2.28% (negative margin);
- Rejected the assessee’s comparable set by applying various filters (export, FAR, persistent loss, employee cost, etc.);
- Selected 18 comparable companies, with a weighted average median margin of 25.09%; and
- Suggested a transfer pricing upward adjustment of ₹2,83,35,615.
The Dispute Resolution Panel (DRP) largely upheld the TPO’s approach, including refusal to apply an upper turnover cap, following which the AO passed the final assessment order including the full transfer pricing adjustment.
The assessee then approached the ITAT challenging, inter alia:
- Inclusion of very large companies (turnover > ₹200 crores) as comparables;
- Inclusion of certain functionally dissimilar companies;
- Inclusion of a company with high related party transactions (RPT); and
- Denial of a COVID-19–linked employee cost adjustment of ₹1,51,77,750.
Dispute On Turnover Filter: Exclusion Of High-Turnover Comparables
Assessee’s Stand On Upper Turnover Filter
The assessee emphasised that its operating revenue from the international transaction was ₹10,11,49,530, making it a relatively small captive service provider. It contended that:
- An upper turnover filter of ₹200 crores must be applied,
- Only companies having turnover in the range of ₹1 crore to ₹200 crores should be treated as comparable, and
- Companies far larger in size and scale, enjoying economies of scale and brand-related advantages, cannot be reliably compared with a small captive service provider.
Out of the 18 comparables selected by the TPO, the assessee pointed out the following nine companies as having turnover exceeding ₹200 crores:
- 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
- Cybage Software Pvt Ltd
In support of its position, the assessee relied upon:
- Autodesk India Private Limited Vs. DCIT, 96 taxmann.com 263 (Bangalore-Tribunal)
- CIT Vs. M/s. Pentair Water India Pvt. Ltd., Tax Appeal No. 18 of 2015 dated 16.09.2015
- The coordinate Bench decision in Dotgo Private Limited Vs. DCIT, IT(TP)A No. 2096/Bang/2024
- Earlier Bangalore Tribunal decisions such as Genisys Integrating Systems (I) (P.) Ltd.
- Other decisions cited in Autodesk such as Willis Processing Services, Capgemini India (P.) Ltd., NTT Data, Societe Generale Global Solutions, LSI Technologies, etc.
Tribunal’s Analysis On Turnover Criterion
The Tribunal revisited the legal position on turnover-based filters, relying heavily on the ratio in Autodesk India Private Limited Vs. DCIT, 96 taxmann.com 263. In Autodesk, the Bangalore Bench had:
- Noted that the issue of high profit margins in Chryscapital Investment Advisors (India) Pvt. Ltd. Vs. DCIT, 56 taxmann.com 417 (Delhi) did not directly decide turnover as a comparability criterion, and the remarks on turnover were obiter;
- Followed the binding ratio of Pentair Water India (P.) Ltd. (Bombay High Court), which recognised turnover as a valid parameter for selecting comparables in transfer pricing;
- Affirmed that, in the absence of jurisdictional High Court authority to the contrary, and with conflicting non-jurisdictional views, the interpretation favourable to the assessee must prevail; and
- Held that companies with significantly higher turnover than the tested party can be excluded on that ground.
The Tribunal in the present case also noted that:
- The decision in Genisys Integrating Systems (I) (P.) Ltd. was one of the earliest Bangalore Tribunal rulings on turnover filters;
- Later decisions of some benches which did not follow Genisys and Autodesk were considered per incuriam, as they ignored earlier coordinate Bench rulings; and
- The coordinate Bench decision in Dotgo Pvt Ltd had recently reaffirmed the application of an upper turnover filter and excluded high-turnover companies such as Mindtree Ltd, Nihilent Ltd, Larsen & Toubro Infotech Ltd, Wipro Ltd, Tata Elxsi Pvt. Ltd., Infosys Ltd, Tata Consultancy Services and Cybage Software Pvt Ltd.
In Dotgo, reliance was also placed on: