ITAT clarifies use of high-turnover comparables for captive ITeS providers under TNMM

The Income Tax Appellate Tribunal, Bangalore, in the case concerning Zyme Solution Pvt. Ltd., has delivered an important ruling on selection and rejection of comparables in TNMM-based transfer pricing analysis for captive ITeS service providers. The decision reiterates that while transfer pricing is not an exact science, a proper FAR (Functions, Assets and Risks) analysis is mandatory, and high-turnover IT and BPO majors cannot casually be benchmarked against low-risk captive units.

The Tribunal partly allowed both the Revenue’s appeal and the assessee’s cross-objection, setting aside portions of the order of the Commissioner of Income-tax (Appeals) [CIT(A)] and remanding certain issues for fresh examination, while simultaneously directing outright exclusion of some large comparables.

Background of the dispute

Profile of the assessee and its business model

Zyme Solution Pvt. Ltd. is an Indian company engaged in providing Information Technology Enabled Services (ITeS) to its foreign Associated Enterprise (AE), Zyme Solutions Inc., USA. The assessee operates as a captive service provider, with the following key features:

  • It renders data management and back-office support services solely to its AE.
  • It is remunerated on a cost-plus model, with an approximate markup of 10% on operating costs.
  • It bears limited business, market, and entrepreneurial risks, consistent with a low-risk captive arrangement.

For Assessment Year 2013–14, the assessee filed its return of income on 27.11.2013, declaring a total income of Rs.3,90,84,179. The case was selected for scrutiny assessment.

International transactions and TP documentation

During the relevant year, the assessee undertook international transactions amounting to Rs.35,60,90,650 with its AE, towards provision of ITeS. In compliance with Chapter X of the Income Tax Act 1961, the assessee:

  • Prepared a Transfer Pricing Study Report.
  • Selected Transactional Net Margin Method (TNMM) as the most appropriate method.
  • Adopted Operating Profit / Operating Cost (OP/OC) as the Profit Level Indicator (PLI).

The assessee computed:

  • Its own margin at 10.01%, and
  • The mean margin of its selected comparables at 2.73% (without working capital adjustment).

On this basis, the assessee claimed that its margin exceeded that of comparable companies and that its international transactions were at arm’s length.

Reference to TPO and proposed adjustment

The Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) under Section 92CA of the Income Tax Act 1961. The TPO:

  1. Rejected the assessee’s TP study.
  2. Performed an independent benchmarking exercise.
  3. Determined the assessee’s margin at 10.36%.
  4. Identified nine comparable companies and computed their average margin at 20.64%.
  5. After an adjustment of 1.41%, arrived at a final mean margin of 19.23% for the comparables.

Based on this, the TPO proposed a transfer pricing adjustment of Rs.2,87,20,804. A draft assessment order was issued on 15.11.2016.

As the assessee did not raise objections before the Dispute Resolution Panel, the Assessing Officer passed the final assessment order under Section 143(3) read with Section 144C(13) on 27.01.2017, determining total income at Rs.6,78,06,461.

Appeal before CIT(A) and partial relief

Aggrieved, the assessee approached the CIT(A), Bangalore. By order dated 26.07.2024, the CIT(A) partly allowed the appeal and excluded the following four comparables selected by the TPO:

  • Harton Communications Ltd.
  • Capgemini Business (India) Ltd.
  • Tech Mahindra Ltd.
  • Infosys BPO Ltd.

In doing so, the CIT(A) primarily relied on earlier orders of the Bangalore Bench of the Tribunal, notably in:

  • ISG Novosoft Technologies Ltd. for A.Y. 2013–14
  • GXS India Technology Centre Pvt. Ltd. for A.Y. 2013–14

The CIT(A) concluded that these entities were not appropriate comparables for a captive ITeS provider like the assessee.

Appeal by Revenue and cross-objection by assessee

The Revenue challenged the CIT(A)’s order before the Tribunal, contesting the exclusion of the four comparables.