Transfer Pricing Adjustment - IT Services GCC, Hyderabad

The Problem

A Hyderabad-based IT services GCC, functioning as a captive development centre for its UK parent, was engaged under a cost-plus contract — the Indian entity was reimbursed for all costs plus a markup of 12%. This arrangement had been in place for four years.

The Transfer Pricing Officer (TPO) initiated proceedings under Section 92CA and proposed an upward adjustment of ₹1.2 Cr, alleging that the 12% markup was below the arm's length range of 17–22% benchmarked against comparable companies identified by the TPO.

Why This Happens

Transfer pricing disputes arise because the "right" markup for captive IT service centres is not a fixed number — it depends on the functions performed, assets owned, and risks assumed (the FAR analysis). TPOs typically use publicly available databases like Prowess or CapEx to identify comparables, but their shortlists often include companies that are not truly comparable — they may own proprietary products, bear market risk, or have different workforce compositions. The dispute is almost always about which companies should be in the comparable set.

What We Did

FAR Analysis of the Indian Entity We prepared a detailed Functions, Assets, and Risks (FAR) analysis documenting that the Indian GCC:

• Performed routine development and testing functions only
• Owned no intellectual property (all IP vested with UK parent)
• Bore no market, credit, or business risk
• Was a "limited-risk service provider" in TP terminology

This positioned the entity at the lower end of the arm's length range for routine captive IT service providers.

Rejecting TPO's Comparables Of the 14 companies in the TPO's comparable set, we challenged 9 on the following grounds:

• 3 companies owned proprietary software products (not pure IT services)
• 3 companies had related-party transactions exceeding 25% of turnover (functionally different)
• 2 companies had abnormal profitability due to one-time IP licensing
• 1 company operated in a different geographic market with different cost structures

After exclusion, the TPO's comparable set reduced to 5 companies with a median TNMM margin of 13.8%.

Fresh Benchmarking We identified 8 additional comparable companies from CMIE Prowess and international databases, all of which were pure captive IT service providers with no IP ownership. The combined comparable set (our 8 + TPO's 5) showed an arm's length range of 10–15.4% with a median of 12.2% — placing the client's 12% markup squarely within the range.

DRP Proceedings We filed a detailed objection before the Dispute Resolution Panel (DRP) with the full TP benchmarking study. The DRP granted partial relief, accepting exclusion of 7 of the 9 challenged comparables and adopting a final arm's length range of 11.5–16%. At 12%, the client's markup fell within this range.

The Result

The DRP reduced the transfer pricing adjustment by 80% — from ₹1.2 Cr to ₹24L. The residual adjustment of ₹24L arose from two comparables the DRP declined to exclude. The client accepted this outcome to avoid further litigation at ITAT.

Key Takeaway: GCCs under cost-plus arrangements must maintain an updated Transfer Pricing study (Form 3CEB) every year. The annual TP documentation is not just a compliance requirement — it is the primary defence in a TPO proceeding.