Subject:- application infrastructure, unloading and correction of data on servers.
Referred Sections:
Sections 143(2) and 142(1) of the Income Tax Act,
Section 92CA(3) of the Act.
Section 143(3)
Section 144C of the Act
section 92B of the Act
Section D.1.2
Referred Cases / Judgments
Ameriprise India (P.) Limited vs. ACIT in ITA
CIT v. Kusum Health Care Pvt. Ltd.
Rampgreen Solutions (P) Ltd v. CIT
Rushabh Diamonds v. ACIT
Sony Ericsson Mobile Corporation Pvt Ltd v. ACIT
Mumbai International Airport Private Limited v. Golden Chariot
Rampgreen Sales Pvt. Ltd. v. CIT
Ors. v. Commissioner of Income Tax-III
Fung India Private Limited v. CIT
Software Services Pvt. Ltd. v. ACIT
Maersk Global Centres (India) Private Limited v. ACIT
Ameriprise India Pvt. Ltd. v. ACIT
e-Serv (India) Pvt. Ltd. v. ITO,
Fung India Private Limited v. CIT
IN THE HIGH COURT OF DELHI AT NEW DELHI
Reserved on: 07.02.2018
Pronounced on: 09.08.2018
+ ITA 461/2017
M/S. MCKINSEY KNOWLEDGE CENTRE INDIA PVT.
LTD. ..... Appellant
Through: Mr. Porus Kaka, Sr. Advocate with Mr.
Divesh Chawla & Mr. Harpreet Singh Ajmani,
Advocates.
versus
PR. COMMISSIONER OF INCOME TAX, DELHI-6 ..... Respondent
Through: Mr. Rahul Chaudhary with Ms. Vibhooti
Malhotra, Advocates
+ ITA 526/2017
MCKINSEY KNOWLEDGE CENTRE INDIA PVT. LTD.
..... Appellant
Through: Mr. Porus Kaka, Sr. Advocate with Mr.
Divesh Chawla & Mr. Harpreet Singh Ajmani,
Advocates.
versus
PR. COMMISSIONER OF INCOME TAX, DELHI-6 ..... Respondent
Through: Mr. Rahul Chaudhary with Ms. Vibhooti
Malhotra, Advocates.
+ ITA 590/2017
PR.COMMISSIONER OF INCOME TAX-6 ..... Appellant
Through: Mr. Rahul Chaudhary with Ms. Vibhooti
Malhotra, Advocates
ITA 461/2017 & connected matters Page 1 of 38
versus
MCKINSEY KNOWLEDGE CENTRE INDIA PVT.LTD.
..... Respondent
Through: Mr. Porus Kaka, Sr. Advocate with Mr.
Divesh Chawla & Mr. Harpreet Singh Ajmani,
Advocates.
+ ITA 82/2018
PR. COMMISSIONER OF INCOME TAX-6 ..... Appellant
Through: Mr. Rahul Chaudhary with Ms. Vibhooti
Malhotra, Advocates.
versus
MCKINSEY KNOWELEDGE CENTRE INDIA PVT LTD
..... Respondent
Through: Mr. Porus Kaka, Sr. Advocate with Mr.
Divesh Chawla & Mr. Harpreet Singh Ajmani,
Advocates.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE A.K. CHAWLA
MR. JUSTICE S. RAVINDRA BHAT
%
1. This judgment will dispose of four cross appeals (ITA 461/2017, ITA
590/2017 and ITA 82/2018, ITA 526/2017), two filed by M/s. McKinsey
Knowledge Centre India Pvt. Ltd. (the Assessee), and the respective
ITA 461/2017 & connected matters Page 2 of 38
opposing two by the Revenue, as they address the same questions of law.
The following question of law arises in ITA 461/2017 & ITA 526/2017:
(1) Did the ITAT commit an error in law in holding that the
assessee was engaged in knowledge management systems and
international transactions/activities in respect of one of the
services rendered to its associated enterprises, i.e. AE."
2. In ITA 461/2017 & ITA 526/2017, the other question urged with
respect to the notional interest attributed to the assessee and for which
adjustment was made by the Transfer Pricing Officer (TPO), was finally
affirmed by the ITAT. By the order dated 07.02.2018, this Court considered
the submissions of the parties and was of the opinion that having regard to
the considered view in the case of Pr. CIT v. Kusum Health Care Pvt. Ltd.
[ITA No.765/2016, decided on 25.04.2017], the matter requires further
examination/scrutiny; the reasons for the credit or delay in payment needs to
be examined.
3. The matter was, therefore, remitted to the ITAT with directions to file
a report, if deemed necessary. All the rights of the parties were reserved.
The following question of law arises in ITA 590/2017 & ITA 82/2018:
"Did the ITAT fall into error in excluding the relative
comparables which were held to be irrelevant for the purpose
of ALP determination in the circumstances of the case?"
4. The assessee is a company incorporated under the Companies Act,
1956 and is a wholly owned subsidiary of McKinsey Holding Inc., USA.
The business operations of the Assessee can be broadly divided into two
divisions, namely:
ITA 461/2017 & connected matters Page 3 of 38
(a) Research and Information Services Division
The Research and Information (R&I) Services Division can be further
divided into through 3 sub-groups- (a) Knowledge On Call Group - provides
journalistic research information support. The services offered include
financial analysis. (b) Practice Research Group - focuses on domain specific
research support. The services provided include sector data and analysis,
capital market insights, perspectives and industry trends and (c) Analytics
Group - focuses primarily on time intensive analysis requiring expertise and
analytical tools and techniques. The services provided include data analysis,
model/tool development, proprietary database management, practice
specialized analytics.
(b) IT Support Services Division
The IT Support Division provides services which include data-based
administration support for maintenance of application infrastructure,
unloading and correction of data on servers.
5. ITA 461/2017 (by the assessee), challenges an order of the Income
Tax Appellate (ITAT) dated 15.12.2016, for assessment year (hereinafter
referred to as "AY") 2011-12. The revenues appeal ITA No. 590/2017
questions the same order. By the impugned order dated 15.12.2016, the
ITAT partly allowed the assessees appeal and directed ex clusion of four
comparables, namely Aditya Birla Capital Advisors Pvt. Ltd., Birla Sunlife
Asset Management Company Limited, ICRA Limited and Ladderup
Corporate Advisory Pvt. Ltd, by applying stringent standards of
comparability analysis to comparables selected under the Transaction Net
Margin Method (also referred to as "TNMM") to determine arms length
price ("ALP") in the transfer pricing process.
ITA 461/2017 & connected matters Page 4 of 38
6. During the relevant previous year, the assessee entered into certain
international transactions with its associated enterprises, in which TNMM
was the chosen method used for determination of ALP. It filed return of
income on 28.11.2011, which were picked up for scrutiny and notices under
Sections 143(2) and 142(1) of the Income Tax Act, 1961 ("the Act") and
questionnaires were issued on 06.08.2012 and 16.04.2013, respectively. The
Assessing Officer (AO) referred the case to the Transfer Pricing Officer
(TPO) for determination of ALP under section 92CA(3) of the Act. The TPO
accepted TNMM as the most appropriate method for determining Arms
Length Price,selected by the assessee. Operating Profit (OP)/Operating Cost
(OC) was accepted as the Profit Level Indicator (PLI) by the TPO. However,
out of 16 companies selected by the assessee as comparable companies, the
TPO rejected 14 (including non-Indian companies). A final list of 8
comparable companies, including two companies chosen by the Assessee
was finally drawn up by the TPO. On 28.01.2015, the TPO passed an order
under Section 92CA(3) of the Act proposing upward adjustment of
`l,02,66,664/- in respect of provision of IT Support Services and
`27,33,96,137/- in respect of provision of Research and Information
Services. Further, the TPO also proposed addition of `8,89,039/- in respect
of account of receivables. The AO passed the Draft Assessment Order on
24.02.2015 after proposing an addition of `28,45,51,840/- on account of
transfer pricing adjustment.
7. The assessee, being aggrieved, went before the Disputes Resolution
Panel (DRP), which allowed part relief to the Assessee. The DRP by order,
dated 02.11.2015, rejected the assessees objection as regards functional
comparability of (a) M/s Aditya Birla Capital Advisors Pvt. Ltd., (b) Birla
ITA 461/2017 & connected matters Page 5 of 38
Sunlife Asset Management Company Ltd, and (c) ICRA Ltd. selected by the
TPO held as comparable for the Research and Analysis Segment, and
directed the TPO to apply the export filter and exclude the comparables
which fail the export filter. As per the directions of the DRP, the TPO by its
order dated 08.12.2015 revised the original adjustment down to
`25,94,83,195/-. On 10.12.2015, the AO passed the final assessment order
making an addition of `25,94,83,195/- on account of transfer pricing
adjustment to the price determined by the Assessee. Aggrieved, both the
assessee and the revenue appealed to the ITAT against the final assessment
order passed by the AO. The ITAT by its order, dated 15.12.2015 directed
the exclusion of the following comparables on the grounds of functional
dissimilarity:
(a) Aditya Birla Capital Advisors Pvt. Ltd.
(b) Birla Sunlife Asset Management Company Ltd.
(c) ICRA Ltd.
(d) Ladderup Corporate Advisory Pvt. Ltd.
8. In its appeal the revenue impugns the ITATs order on the ground that
it erred by excluding (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Birla
Sun life Asset Management Company Ltd., (c) ICRA LTD. and (d)
Ladderup Corporate Advisory Pvt. Ltd. from the list of comparables on the
grounds of functional dissimilarity by ignoring the fact that these companies
were engaged in similar line of business and were functionally comparable
under TNMM. Likewise, in ITA No. 82/2018, the revenue challenged the
order dated 11.05.2017 passed by the ITAT for AY 2012-13 for the
exclusion of (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Axis Private
Equity Ltd., and, (c) Credit Information Bureau India Ltd. from the list of
ITA 461/2017 & connected matters Page 6 of 38
comparables on the grounds of functional dissimilarity by ignoring the
functions performed, assets used and risk assumed (FAR), as the profiles of
these comparables were similar to the Assessee.
9. The Assessee, in its appeal, ITA No. 526/2017 declared income of
`31,91,40,070/-. Notices for scrutiny alongwith questionnaire were issued
and served upon the assessee. During the relevant AY, the assessee
submitted (by Form 3CEB) that it had entered into international transactions
with its associated enterprises for provision of research and information to
the tune of `1,78,84,76,202/- and IT support services to the tune of
`64,77,91,811/-. The AO referred the case to the TPO for determination of
ALP under section 92CA(3) of the Act. The TPO accepted TNMM as the
most appropriate method for determining ALP. The TPO pursuant to
examination of the transfer pricing documents passed order dated 29.01.2016
under section 92CA(3) of the Act and proposed an upwards adjustments of
`34,19,39,145/- in respect of Provision for Research & Information Services.
Further, the TPO also proposed an adjustment on account of outstanding
receivables and interest thereon amounting to `14,90,875/-.
10. In respect of the research and information services, the assessee had
selected 18 comparables companies whose average of adjusted operating
margins was 14.50% on operating cost. According to it, the PLI was 15.17%,
and was higher than the average of adjusted operating margins of the
comparables. However, the TPO rejected foreign companies as comparables
and finally selected 8 comparables computing average PLI of 36.48%.
Accordingly, the TPO made an order dated 29.01.2016 under section
92CA(3) of the Act and proposed an upwards adjustments of
`34,19,39,145/- in respect of provision for Research & Information Services.
ITA 461/2017 & connected matters Page 7 of 38
Further, the TPO also proposed an adjustment on account of outstanding
receivables and interest thereon amounting to `14,90,875/-.
11. The AO passed the Draft Assessment Order on 14.03.2016
determining the total income of the Assessee at `66,25,70,090/- against the
returned income of `31,91,40,070/- proposing a transfer pricing adjustment
amounting to `34,34,30,020/-. Aggrieved, the assessee preferred appeal to
the DRP. The DRP by its order dated 29.09.2016, rejected the assessees
objection with respect to exclusion of the three comparable companies
namely Aditya Birla Capital Advisors Pvt. Ltd., Axis Private Equity Ltd.,
and Credit Information Bureau India Ltd. The DRP observed that the
assessee had taken an objection before the DRP that the TPO had resorted to
cherry picking of comparables, however, the assessee had failed to give any
specific instance of in that regard.
12. Pursuant to DRPs directions, the TPO by its order, dated 10.11.2016
revised the original adjustment from `34,34,30,020/- down to
`12,66,07,828/-. Consequently, the AO passed final assessment order under
section 143(3) read with section 144C of the Act on 25.11.2016 wherein the
returned income of the Assessee of `31,91,40,070/- was assessed at
`44,57,47,898/- incorporating therein addition as per the transfer pricing
adjustment of `12,66,07,828/-. Thus, being aggrieved, the assessee preferred
an appeal before the Tribunal who by order dated 11.05.2017 directed for the
exclusion of (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Axis Private
Equity Ltd., and, (c) Credit Information Bureau India Ltd. from the list of
comparables on the grounds of functional dissimilarity.
13. The Assessee challenges the ITATs impugned order of 11.05.2017 in
ITA No. 526/2017 assailing the order on the ground that the ITAT erred in
ITA 461/2017 & connected matters Page 8 of 38
concluding that nature of services provided by it under the R&I segment was
in the nature of KPO services, whereas, according to their assertion, it
functions more like a BPO.
Contention of parties
14. Learned senior counsel, Mr. Porus Kaka, on behalf of the Assessee
assailed the impugned orders of the ITAT on the ground that the ITAT erred
in concluding that the nature of services provided by the Assessee under the
R&I segment are in the nature of KPO services which is contrary to the
material on record. Mr. Kaka submitted that the McKinsey group of
companies is engaged in providing management consulting services. These
companies during the course of executing consultancy services with third
parties seek assistance of the assessee for enabling them to service their
clients. The Assessee carries out research from the internet based database or
other source and then compiles the data, which is further customized
according to the requirement of the requestor before transmission to the
overseas group companies so that McKinsey group entities could consider
them for providing consultancy services.
15. Further, it was submitted that under the R&I segment, it has rendered
data processing services which are in the nature of Business Process
Outsourcing (BPO). The assessee contests the ITATs order stating that
while holding it to be a KPO, it has overlooked the fact that it has established
that to carrying on research from the internet based databases or other
sources to compile data, which is then customized/processed in accordance
with the requirements of the requesting party. The assessee also submitted
that the ITAT in its previous case (in AY 2006-07) observed that the
services rendered by it were in the nature of customization of data/data
ITA 461/2017 & connected matters Page 9 of 38
processing and that the assessee acts as a "back office" providing "support
services" to its parent company, thereby, essentially accepting that the
Assessee acts as a back office and provides support services; in light of its
present position that is unchanged in terms of facts, the Assessee avers that it
should be considered as a BPO and not a KPO.
16. On behalf of the Assessee, the cases of Ameriprise India (P.) Limited
vs. ACIT in ITA No. 2010/Del/2014, where on similar facts the ITAT had
held that collection and processing of data received/sourced and sending
reports to the AE after analyses, evaluation and processing of such data into
specific formats is providing back office support services, and Rampgreen
Solutions (P) Ltd v. CIT 60 Taxmann.com 255 (Del) wherein the Delhi High
Court, in the context of distinguishing BPO and KPO services, held that
"...The expression "KPO" indicates the involvement of domain knowledge in
providing ITeS. Typically, KPO includes involvement of advance skills; the
services provided may include analytical services, market research, legal
research, engineering and design services, intellectual management etc..... ",
were also cited. The assessee further submitted that the definition of BPO
services has been provided by the Central Board of Direct Taxes by
Notification dated 18.09.2013 under Rule 10TA of the Income Tax Rules,
1962, based on which the activities performed by the Assessee under the
R&I segment fall under the categories of back office operations/data
processing/support center/data search, integration and analysis.
17. Moreover, with regard to the notional interest on overdue receivables,
(where the ITAT held it to be separate and an international transaction), the
assessee submitted that early or late realization of sale/service proceeds is
incidental to the transaction of sale/service, and thus, if the ALP in respect of
ITA 461/2017 & connected matters Page 10 of 38
an international transaction is determined, then there can be no question to
benchmark the interest separately. It was submitted that any separate
adjustment on the pretext of outstanding receivables while accepting the
comparables and transfer price of underlying transaction by application of
TNMM was unjustified. To substantiate this point, the Assessee highlighted
the amendment brought under Explanation to section 92B of the Act vide
Finance Act, 2012, w.e.f. 01.04.2012 whereby clause (c) of the Explanation
(i) to section 92B of the Act recognizes ,,capital financing as a deemed
international transaction being an anti-abusive legislation deserves to be
prospectively applicable. The Assessee is, thus, challenging the impugned
order of the ITAT on the ground that the nature of services provided by the
Appellant under the R&I segment are not in the nature of KPO services, and
the ITAT order holding otherwise is contrary to the material on record and
perverse in law.
18. The Assessee cited Rushabh Diamonds v. ACIT, Mumbai [2016] 48
ITR(T) 707 (Mumbai- Trib.), where it was held as follows:
"12. In our considered view, even if we proceed on the basis
that Explanation to Section 92B is indeed retrospective in effect
and it does cover delay in realization of debts, as long as sale is
benchmarked on TNMM basis, as in this situation before us,
there cannot be any occasion to make a separate adjustment for
delay in realization of debts. The reason is that the interest
income is an integral part of the PBIT inasmuch as interest
income, in cases other than finance companies, is required to
be included in the 'other income' and thus affects the profit
before interest and taxes. While profit before interest and taxes
does not take into account 'interest expenditure', it does take
into account 'interest income' because the interest income is
part of the 'other income', under preamended as well as post
amended schedule VI to the Companies Act, which is duly taken
ITA 461/2017 & connected matters Page 11 of 38
into account into computation of PBIT. In a way PBIT is a
misnomer, as while PBIT does not take into account interest
expenditure, it does take into account interest income
appearing in the other income. Once the profitability, as per
PBIT, is found to be comparable, there cannot be a separate
adjustment for interest income on delayed realization which is
an integral part of the PBIT figure.
13. It is in this background that we may refer to the
observations made by a coordinate bench of this Tribunal, in
the case of Micro Ink Ltd (supra), as follows:
'7. We find that, as evident from audit report on form 3CEB
(pages 39 to 52 of the paper-book), the arm's length price of
exports to the AEs, including Micro USA, has been determined
on the basis of the transactional net margin method (TNMM).
By way of a note at page 51, it is specifically stated that
"further, the said amount of Rs 2428.26 millions has also been
determined/ computed by the assessee having regard to the
arm's length price on application of Transactional Net Margin
Method (TNMM), on aggregation of transactions, as prescribed
under section 92C of the Income Tax Act, 1961". In this
backdrop, we can usefully refer to the decision of Hon'ble Delhi
High Court, in the case of Sony Ericsson Mobile Corporation
Pvt Ltd v. ACIT [(2015) 374 ITR 118 (Delj] wherein Their
Lordships had, inter alia, observed as follows:
"Where the Assessing Officer/TPO accepts the comparables
adopted by the assessed, with or without making adjustments,
as a bundled transaction, it would be illogical and improper to
treat AMP expenses as a separate international transaction, for
the simple reason that if the functions performed by the tested
parties and the comparables match, with or without
adjustments, AMP expenses are duly accounted for. It would be
incongruous to accept the comparables and determine or
accept the transfer price and still segregate AMP expenses as
an international transaction.
***************************************************
**************************
ITA 461/2017 & connected matters Page 12 of 38
36. It is very important to bear in mind the fact that right now
we are dealing with amendment of a transfer pricing related
provision which is in the nature of a SAAR (specific anti abuse
rule), and that every anti abuse legislation, whether SAAR
(specific anti abuse rule) or GAAR (general anti abuse rule), is
a legislation seeking the taxpayers to organize their affairs in a
manner compliant with the norms set out in such anti abuse
legislation. An anti-abuse legislation does not trigger the levy
of taxes; it only tells you what behaviour is acceptable or what
IS not acceptable. What triggers levy of taxes IS noncompliance
with the manner in which the anti-abuse regulations require the
taxpayers to conduct their affairs. In that sense, all anti abuse
legislations seek a certain degree of compliance with the norms
set out therein. It is, therefore, only elementary that
amendments in the anti-abuse legislations can only be
prospective. It does not make sense that someone tells you
today as to how you should have behaved yesterday, and then
goes on to levy a tax because you did not behave in that manner
yesterday.
***************************************************
***************
39. It is for this reason that the Explanation to Section 92B,
though stated to be clarificatory and stated to be effective from
1st April 2002, has to be necessarily treated as effective from at
best the assessment year 2013-14. In addition to this reason, in
the light of Hon'ble Delhi High Court's guidance in the case of
New Skies Satellite BV (supra) also, the amendment in the
definition of international transaction under Section 92B, to the
extent it pertains to the issuance of corporate guarantee being
outside the scope of 'international transaction', cannot be said
to be retrospective in effect. The fact that it is stated to be
retrospective, in the light of the aforesaid guidance of Hon'ble
Delhi High Court, would not alter the situation, and it can only
be treated as prospective in effect i.e. with effect from 1st April
2012 onwards."
ITA 461/2017 & connected matters Page 13 of 38
19. Ms. Vibhooti Malhotra, on behalf of the Revenue challenged the
orders of the ITAT further, stating that it failed to appreciate that application
of the TNMM does not require stringent standard of comparability analysis
as required while applying the CUP method because under the TNMM
methodology, net profit margin of the comparable are compared with the
tested party. Accordingly, the method is more tolerant to small differences
between comparable and tested party, thereby, not appreciating the relevant
stipulations under the guidelines as extracted from Chapter-6 of United
Nations Practical Manual on Transfer Pricing, Edition 2013, the relevant part
of which reads as follows:
"6.3.9.1. Product comparability is most important in applying
the CUP method, as differences in products will result in
difference prices. The Cost Plus Method and the Resale Price
Method are less dependent on product comparability and focus
on functional comparability because differences in functions
that are reflected in differences in operating expenses may lead
to a broad range of gross margins.
However, the TNMM is even less dependent on product
comparability and functional comparability than the traditional
transaction methods, because net margins are less influenced
by differences in products and functions. The TNMM focuses on
broad product and functional comparability.
...
6.3.11.1. The strengths of the TNMM include the following:
Net margins are less affected by transactional differences than
price and less affected by functional differences than gross
margins. Product and functional comparability are thus less
critical in applying the TNMM"
20. Ms. Malhotra contended that the impugned order of ITAT erred in law
and on facts in rejecting high profit margin comparables by disregarding
broad similarity between functions performed, assets used and risk
ITA 461/2017 & connected matters Page 14 of 38
undertaken by the assessee and the comparables excluded by the Tribunal by
ignoring the findings of facts recorded by the TPO. The decision of Mumbai
International Airport Private Limited v. Golden Chariot (2010) 10 SCC 422
was also highlighted, wherein, it has been held by the Apex Court with
regard to "doctrine of election" and "doctrine of approbation and
reprobation" that the litigant cannot change and choose its stand to suit its
convenience. In the facts of the present case, it was asserted that the assessee
could not change their stand that stringent standards of comparability
analysis should not be applied to low profit margin comparables while it
should be applied to high profit margin comparables to suit its convenience.
It was asserted that the Assessee, as well, as the companies selected by the
TPO as comparables are engaged in the business of providing advisory
services in various fields and these advisory services were in the form of
knowledge services which required not only analysis but interpretation of
various data, and hence in no way different from each other in terms of their
functional profiles.
21. The Revenue also argued that, the assessee being a knowledge center
is engaged in the business of high skilled advisory services which requires
not only analysis of specialized data but also involves analysis, processing,
customization, interpretation of data and creation of knowledge bank.
Similarly, it was submitted that the companies selected by the TPO as
comparables, engaged in the business advisory services were in the form of
knowledge centers which required not only analysis but interpretation of
various data and therefore, the Tribunal erred in holding that the functional
profile of the comparables excluded by the Tribunal were different from the
assessee.
ITA 461/2017 & connected matters Page 15 of 38
Analysis and Conclusions
22. The assessees primary contention is that it functions as, and hence
seeks to be identified as a BPO and not as a KPO. Before examining this
contention, it would be useful to look at the legislative history and purpose
of introducing transfer pricing adjustment in the Income Tax Act, 1961 (the
"Act"), as highlighted in Rampgreen Sales Pvt. Ltd. v. CIT (supra) as
follows:
12. At the outset, it is necessary to bear in mind that the
object and purpose of introducing provisions relating to
transfer pricing adjustment in the Act. By virtue of Finance Act,
2001, Section 92 of the Act was substituted by Sections 92 to
92F of the Act with effect from 1st April, 2002. Section 92 of the
Act, as was in force prior to 1st April, 2002, enabled the AO to
bring the correct profits to tax in relation to certain cross-
border transactions. However, with a large number of multi-
national companies establishing operations in India, either
through their subsidiaries or through other related ventures, a
need was felt to provide a statutory framework to ensure that
there is no avoidance of tax by transfer of income from India to
other tax jurisdictions. Circular no. 14 of 2001 issued by the
CBDT indicates that the provisions of Section 92 to 92F of the
Act were introduced "With a view to provide a detailed
statutory framework which can lead to computation of
reasonable, fair and equitable profits and tax in India".
13. The heading of Chapter X also clearly indicates that it
contains "special provisions relating to avoidance of tax". The
object of Chapter X of the Act is not to tax any notional income
but to ensure that the real income is brought to tax under the
Act. This has also been explained by a Division Bench of this
Court in Sony Ericsson Mobile Communications India Pvt. Ltd.
and Ors. v. Commissioner of Income Tax-III and Ors. 374 ITR
118 in the following words:-
ITA 461/2017 & connected matters Page 16 of 38
"77. As a concept and principle Chapter X does not
artificially broaden, expand or deviate from the concept of
"real income". "Real income", as held by the Supreme Court in
Poona Electricity Supply Company Limited versus CIT, [1965]
57 ITR 521 (SC), means profits arrived at on commercial
principles, subject to the provisions of the Act. Profits and
gains should be true and correct profits and gains, neither
under nor over stated. Arm's length price seeks to correct
distortion and shifting of profits to tax the actual income earned
by a resident/domestic AE. The profit which would have
accrued had arm's length conditions prevailed is brought to tax.
Misreporting, if any, on account of non-arm's length conditions
resulting in lower profits, is corrected."
14. The substratal rationale of the transfer pricing
regulations is to ensure that the true income of an Assessee is
brought to tax under the Act and there is no avoidance of tax by
transfer of income from India to any other tax jurisdiction by
virtue of the influence exercised by the associated enterprises.
The aim of the provisions of Chapter X of the Act is to compute
the income in relation to a controlled transaction between an
Assessee and its associated enterprise having regard to ALP, in
order to nullify the effect of transfer of income to a jurisdiction
outside India, if any, in respect of the controlled transactions.
15. The exercise of determining the ALP in respect of
international transactions between the related enterprises is
aimed to determine the price, which would have been charged
for products and services, as nearly as possible, in case such
international transactions were not controlled by virtue of them
being executed between related parties. The object of the
exercise is, thus, to remove the effect of any influence on the
prices or costs that may have been exerted on account of the
international transactions being entered into between related
parties. It is, at once, clear that for the exercise of determining
ALP to be reliable, it is necessary that the controlled
transactions be compared with uncontrolled transactions which
are similar in all material aspects."
ITA 461/2017 & connected matters Page 17 of 38
23. In light of the above objective of introduction of transfer pricing
provisions in the law, this court will proceed to examine the nature of the
assessees activities to decide whether it is a KPO or a BPO. As discussed
above, the computation of the income in relation to a controlled transaction
between an assessee and its associated enterprise having regard to the ALP,
is in order to nullify the effect of transfer of income to a jurisdiction outside
India, if any, in respect of the controlled transactions. In the present case, the
method used for determination of the ALP was the TNMM.
24. Section 92C (1) of the Act contains provisions in relation to various
methods of calculation of ALP, it envisages five methods, namely (a)
comparable uncontrolled price method, (b) resale price method, (c) cost plus
method, (d) profit split method, (e) transactional net margin method, (f) any
such other method as may be prescribed by the board, with regard to the
nature of transaction or class of transaction or class of associated persons or
functions performed by such persons or such other relevant factors as the
board may prescribe; read with Rule 10B of the Income Tax Rules, 1962
which provides for calculation/determination of ALP. Where more than one
price is determined by the most appropriate method, the Arms Length Price
shall be taken to be arithmetical mean of such prices. Rule 10B(2) describes
the grounds on which the comparability of an international transaction (or a
specified domestic transaction) with an uncontrolled transaction should be
based on. This sub-rule reads as follows:
"Determination of arm's length price under section 92C
10B(2) For the purposes of sub-rule (1), the comparability of
an international transaction [or a specified domestic
ITA 461/2017 & connected matters Page 18 of 38
transaction] with an uncontrolled transaction shall be judged
with reference to the following, namely:--
(a) the specific characteristics of the property
transferred or services provided in either
transaction;
(b) the functions performed, taking into account assets
employed or to be employed and the risks
assumed, by the respective parties to the
transactions;
(c) the contractual terms (whether or not such terms are
formal or in writing) of the transactions which lay
down explicitly or implicitly how the responsibilities,
risks and benefits are to be divided between the
respective parties to the transactions;
(d) conditions prevailing in the markets in which the
respective parties to the transactions operate,
including the geographical location and size of the
markets, the laws and Government orders in force,
costs of labour and capital in the markets, overall
economic development and level of competition and
whether the markets are wholesale or retail."
25. Therefore, it becomes crucial to see that the entities chosen as
comparables are functionally similar to the assessee, in order to ensure a
correct estimation of the ALP that serves the true purpose of transfer pricing
legislation. This was also highlighted in Rampgreen (supra) [and further laid
down in Li & Fung India Private Limited v. CIT 361 ITR 85 (Delhi)] as
follows:
"20. In order for the benchmarking studies to be reliable for the
purposes of determining the ALP, it would be essential that the
entities selected as comparables are functionally similar and
are subject to the similar business environment and risks as the
tested party. In order to impute an ALP to a controlled
ITA 461/2017 & connected matters Page 19 of 38
transaction, it would be essential to ensure that the instances of
uncontrolled entities/transactions selected as comparables are
similar in all material aspects that have any bearing on the
value or the profitability, as the case may be, of the transaction.
Any factor, which has an influence on the PLI, would be
material and it would be necessary to ensure that the
comparables are also equally subjected to the influence of such
factors as the tested party. This would, obviously, include
business environment; the nature and functions performed by
the tested party and the comparable entities; the value addition
in respect of products and services provided by parties; the
business model; and the assets and resources employed. It
cannot be disputed that the functions performed by an entity
would have a material bearing on the value and profitability of
the entity. It is, therefore, obvious that the comparables selected
and the tested party must be functionally similar for
ascertaining a reliable ALP by TNMM. Rule 10B(2) of the
Income Tax Rules, 1962 also clearly indicates that the
comparability of controlled transactions would be judged with
reference to the factors as indicated therein. Clause (a) and (b)
of Rule 10B(2) expressly indicate that the specific
characteristics of the services provided and the functions
performed would be factors for considering the comparability
of uncontrolled transactions with controlled transactions."
26. Examining the analysis of the functions of the assessee in the ITAT
orders, reference can be made to the Master Services Agreement entered into
by the Assessee with McKinsey and Co. Inc., USA w.e.f. 1 st April, 2010. It
is a common agreement between the Assessee and McKinsey, USA for
providing both the ,,Research and information services and also ,,IT support
services. The preamble part of this agreement provides as follows:
"WHEREAS:
(A) The Client is in need of assistance in the development,
maintenance and service software and information/research
related products and services. Further, the Client requires
ITA 461/2017 & connected matters Page 20 of 38
assistance with respect to knowledge management systems and
infrastructure related issues like server problems, hosting of
Notes databases, problems with documents in the Notes
databases."
27. From the Agreement, it appears that the assessees functions are also
inclusive of ,,Knowledge management systems and infrastructure issues
which would encompass infrastructure support, application support,
application operations group and survey development center. Further, in
context of assessing whether the Assessee is characterized as a KPO or a
BPO, the ITAT observed as follows:
"16. Now coming to the functional profile of research and
information services provided by assessee, which is divided into
3 broad subgroups of knowledge on-call, practice research,
and analytics. This is in terms of agreement dated 01/04/2010
titled as Master service agreement dated 01/04/2010 between
assessee and its associated enterprise wherein assessee is
responsible for providing research and information services to
its associated enterprises.
i. In first subgroup of knowledge on-call assessee provides
research and information reports. The services offered includes
financial analysis, fact packs, press search, document search
etc by employing around hundred personnel with experience
scale of 0 to 2 years.
ii. In practice research group assessee is focused on domain
specific research support with team size of over 240 people,
which provides sector data and analysis, capital market
insights, perspectives and industry trends.
iii. In analytics group, assessee primarily focuses on data
intensive analysis requiring expertise in analytical tools and
techniques., database management, etc.
***************************************************
***************
Further, Ld. Transfer Pricing Officer made reference to
ITA 461/2017 & connected matters Page 21 of 38
McKinsey India website and noted what types of work and
employees does and what type of skill he should possess to get
employment with McKinsey India. Based on this he further
looked at employee profile and held that that companies
indulge in providing high-end services in terms of research and
information segment assessee is offering knowledge-based
services and hence it is required to be benchmarked with
comparables engaged in research-based services."
28. Rampgreen (supra) examined the distinction between a KPO and a
BPO observing as follows:
"26. A Knowledge Process is understood as a high value added
process chain wherein the processes are dependent on
advanced skills, domain knowledge and the experience of the
persons carrying on such processes.
27. The Government of Rajasthan (Department of Information
Technology & Communication) has also floated a scheme on
12th December, 2011 known as "The Rajasthan Incentive
Scheme for BPO Centers and KPO Centers, 2011". The said
scheme is for providing incentives to promote ITeS and to
generate further employment opportunities. In terms of the said
scheme, "Business Process Outsourcing (BPO)" is defined to
mean "the transfer of an organization's entire noncore but
critical business process/function to an external centre which
uses an IT based service delivery" and "Knowledge Processing
Outsourcing (KPO) "has been defined to mean "allocation of
relatively high-level tasks to an outside organization or a
different group (possibly in a different location) within the same
organization. KPO is, essentially, high-end Business Process
Outsourcing (BPO)".
***************************************************
**************************
33. ...The Special Bench of the Tribunal held that even though
there appears to be a difference between BPO and KPO
Services, the line of difference is very thin. The Tribunal was of
the view that there could be a significant overlap in their
ITA 461/2017 & connected matters Page 22 of 38
activities and it may be difficult to classify services strictly as
falling under the category of either a BPO or a KPO. The
Tribunal also observed that one of the key success factors of the
BPO Industry is its ability to move up the value chain through
KPO service offering. For the aforesaid reasons, the Special
Bench of the Tribunal held that ITeS Services could not be
bifurcated as BPO and KPO Services for the purpose of
comparability analysis in the first instance. The Tribunal
proceeded to hold that a relatively equal degree of
comparability can be achieved by selecting potential
comparables on a broad functional analysis at ITeS level and
that the comparables so selected could be put to further test by
comparing specific functions performed in the international
transactions with uncontrolled transactions to attain relatively
equal degree of comparability.
34. ... the expression 'BPO' and 'KPO' are, plainly, understood
in the sense that whereas, BPO does not necessarily involve
advanced skills and knowledge; KPO, on the other hand, would
involve employment of advanced skills and knowledge for
providing services. Thus, the expression 'KPO' in common
parlance is used to indicate an ITeS provider providing a
completely different nature of service than any other BPO
service provider. A KPO service provider would also be
functionally different from other BPO service providers,
inasmuch as the responsibilities undertaken, the activities
performed, the quality of resources employed would be
materially different...Rule 10B(2) (a) of the Income Tax Rules,
1962 mandates that the comparability of controlled and
uncontrolled transactions be judged with reference to
service/product characteristics. This factor cannot be
undermined by using a broad classification of ITeS which takes
within its fold various types of services with completely
different content and value. Thus, where the tested party is not
a KPO service provider, an entity rendering KPO services
cannot be considered as a comparable for the purposes of
Transfer Pricing analysis. The perception that a BPO service
provider may have the ability to move up the value chain by
offering KPO services cannot be a ground for assessing the
ITA 461/2017 & connected matters Page 23 of 38
transactions relating to services rendered by the BPO service
provider by benchmarking it with the transactions of KPO
services providers. The object is to ascertain the ALP of the
service rendered and not of a service (higher in value chain)
that may possibly be rendered subsequently."
29. The ITAT, based on examination of the Master Service Agreement,
sample copies of service requests, as well as the McKinsey India website (as
quoted from, above), concluded that it was undeniable that the assessee was
providing knowledge-based research and information services. There is
clearly a form of knowledge intensive analysis that is rendered by the
Assessee which is a more nuanced and involved service than that which is
provided by a BPO. A similar conclusion was arrived at in New River
Software Services Pvt. Ltd. v. ACIT Circle- 13(1) (27.03.2015 - ITAT Delhi),
which ruled that:
"...The employee actually undertaking these services was
required to analyse various datas by employing his special
knowledge and then only it could provide its AE with necessary
support. It cannot be denied that these were high end services,
requiring strategic decision making before arriving at final
conclusion. We, therefore, are not inclined to accept the
assessee's submissions that it was mere a BPO. The various
decisions relied upon by ld. counsel for the assessee are
primarily with reference to BPO and not KPO. The distinction
elucidated in Safer Harbour Rules is also in same lines.
30. Likewise, in Maersk Global Centres (India) Private Limited v. ACIT
[2014] 161 TTJ 137, the term "knowledge process outsourcing services" has
been examined as follows:
"71. The term "knowledge process outsourcing services" is
defined in clause (g) of10-TA (the Notification No. SO 2810(E)
ITA 461/2017 & connected matters Page 24 of 38
issued by the CBDT on 18th September, 2013 making Rules 10-
TA to Rule 10-TG as Safe Harbour Rules) as under:--
(9) "knowledge process outsourcing services" means the
following business process outsourcing services provided
mainly with the assistance or use of information technology
requiring application of knowledge and advanced analytical
and technical skills, namely:
(i) geographic information system;
(ii) human resources services;
(iii) engineering and design services;
(iv) animation or content development and management;
(iv) business analytics;
(v) financial analytics; or
(vi) market research,
but does not include any research and development services
whether or not in the nature of contract research and
development services."
31. Thus, a comparison of the assessees functions in the context of
previous decisions on what constitute the functions of a KPO as compared
with a BPO, this court is unpersuaded by the assessees assertion that it is
merely a BPO; the services rendered by it are specialized and require
specific skill based analysis and research that is beyond the more
rudimentary nature of services rendered by a BPO. Therefore it would be
incorrect to slot the services provided by the Assessee into that of a BPO,
when it is more akin to a KPO.
32. Further, to address the contention of the Assessee that early or late
realization of sale/ service proceeds is incidental to the transaction of sale/
service, and that there can be no question to benchmark the interest
separately, in calculating the ALP in an international transaction, we refer to
the amendment brought under Explanation to section 92B of the Act vide
Finance Act, 2012, w.e.f. 01.04.2012. Clause (i) of this Explanation, gives
ITA 461/2017 & connected matters Page 25 of 38
meaning to the expression ,,international transaction in an inclusive manner.
Sub-clause (c) of clause (i) of this Explanation, states as follows:
"Explanation.--For the removal of doubts, it is hereby clarified
that-
(i) the expression "international transaction" shall include-
(a) ............
(b) ...........
(c) capital financing, including any type of long-term or short-
term borrowing, lending or guarantee, purchase or sale of
marketable securities or any type of advance, payments or
deferred payment or receivable or any other debt arising
during the course of business;...."
This explanation was explained in Ameriprise India Pvt. Ltd. v. ACIT (supra)
as follows:
"22. On going through the relevant part of the Explanation
inserted with retrospective effect from 1.4.2002, thereby also
covering the assessment year under consideration, there
remains no doubt that apart from any long-term or short-term
lending or borrowing, etc., or any type of advance payments or
deferred payments, 'any other debt arising during the course of
business' has also been expressly recognized as an
international transaction. That being so, the payment/non-
payment of interest or receipt/non-receipt of interest on the
loans accepted or allowed in the circumstances as mentioned in
this clause of the Explanation, also become international
transactions, requiring the determination of their ALP. If the
payment of interest is excessive or there is no or low receipt of
interest, then such interest expense/income need to be brought
to its ALP. The expression 'debt arising during the course of
business' in common parlance encompasses, inter alia, any
trading debt arising from the sale of goods or services rendered
in the course of carrying on the business. Once any debt arising
during the course of business has been ordained by the
legislature as an international transaction, it is, but, natural
that if there is any delay in the realization of such debt arising
ITA 461/2017 & connected matters Page 26 of 38
during the course of business, it is liable to be visited with the
TP adjustment on account of interest income short charged or
uncharged. Under such circumstances, the contention taken by
the assessee before the TPO that it is not an international
transaction, turns out to be bereft of any force.
***************************************************
***************
25. The foregoing discussion discloses that non-charging or
undercharging of interest on the excess period of credit allowed
to the AE for the realization of invoices amounts to an
international transaction and the ALP of such an international
transaction is required to be determined."
33. It was similarly held in BT e-Serv (India) Pvt. Ltd. v. ITO, Ward- 5(2)
2017(60)ITR(Trib)618(Delhi) as follows:
"22...The argument that assessee is an interest free entity and
does not pay any interest and therefore no interest shall be
imputed in the outstanding invoices is also devoid of merit
because it is not a case of allowance of interest expenditure in
the hands of the assessee but an 'international transaction' to be
benchmarked at arm's length. It is a case of determination of
arm's length price of a transaction. Undoubtedly the receivable
or any other debt arising during the course of the business is
included in the definition of 'capital financing' as an
'international transaction' as per explanation 2 to section 92B
of the Act w.e.f. 01.04.2002 inserted by the Finance Act 2012.
Therefore, even the outstanding receivable partake the
character of capital financing and consequently, overdue
outstanding is an 'international transaction'. The natural
corollary would be of imputing interest on such 'capital
financing', if same is not charged at arm's length. Therefore, we
reject the contention of the assessee that outstanding receivable
is not an 'international transaction' and therefore, hence,
according to us, interest on it requires to be imputed."
ITA 461/2017 & connected matters Page 27 of 38
Thus, this is a redundant contention, because as has been highlighted by the
ITAT, by a plain reading of the (retrospectively applicable) amendment that
introduced the Explanation to section 92B of the Act by Finance Act, 2012,
it is determinable that if there is any delay in the realization of a trading debt
arising from the sale of goods or services rendered in the course of carrying
on the business, it is liable to be visited with transfer pricing adjustment on
account of interest income short charged/uncharged. Hence, the assessees
contention that the ITAT erred in concluding that charging of interest on
delayed receipt of receivables is a separate international transaction which
requires to be benchmarked independently, is incorrect.
34. In the revenues appeals, it is important to notice that the significance
of the similarity of comparables in the determination of the ALP was been
highlighted in Rampgreen (supra) by citing the "Organisation for Economic
Co-operation and Development (OECD) Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations" (OECD Guidelines)
published in 2010, that indicates the "comparability factors" which are
important while considering the comparability of uncontrolled
transactions/entities with the controlled transactions/entities. The relevant
OECD Guidelines (which are not conclusive, but are only to be seen as
guiding factors) as quoted in Rampgreen are as follows:
"1.36 As noted above, in making these comparisons, material
differences between the compared transactions or enterprises
should be taken into account. In order to establish the degree of
actual comparability and then to make appropriate adjustments
to establish arm's length conditions (or a range thereof), it is
necessary to compare attributes of the transactions or
enterprises that would affect conditions in arm's length
ITA 461/2017 & connected matters Page 28 of 38
transactions. Attributes or "comparability factors" that may be
important when determining comparability include the
characteristics of the property or services transferred, the
functions performed by the parties (taking into account assets
used and risks assumed), the contractual terms, the economic
circumstances of the parties, and the business strategies
pursued by the parties. These comparability factors are
discussed in more detail at Section D.1.2 below.
xxxxxxxxxxxxxxxx
1.39 Differences in the specific characteristics of property or
services often account, at least in part, for differences in their
value in the open market. Therefore, comparisons of these
features may be useful in determining the comparability of
controlled and uncontrolled transactions. Characteristics that
may be important to consider include the following: in the case
of transfers of tangible property, the physical features of the
property, its quality and reliability, and the availability and
volume of supply; in the case of the provision of services, the
nature and extent of the services; and in the case of intangible
property, the form of transaction (e.g. licensing or sale), the
type of property (e.g. patent, trademark, or know- how), the
duration and degree of protection, and the anticipated benefits
from the use of the property.
1.40 Depending on the transfer pricing method, this factor must
be given more or less weight. Among the methods described at
Chapter II of these Guidelines, the requirement for
comparability of property or services is the strictest for the
comparable uncontrolled price method. Under the comparable
uncontrolled price method, any material difference in the
characteristics of property or services can have an effect on the
price and would require an appropriate adjustment to be
considered (see in particular paragraph 2.15). Under the resale
price method and cost plus method, some differences in the
characteristics of property or services are less likely to have a
material effect on the gross profit margin or mark- up on costs
(see in particular paragraphs 2.23 and 2.41). Differences in the
characteristics of property or services are also less sensitive in
the case of the transactional profit methods than in the case of
ITA 461/2017 & connected matters Page 29 of 38
traditional transaction methods (see in particular paragraph
2.69). This however does not mean that the question of
comparability in characteristics of property or services can be
ignored when applying these methods, because it may be that
product differences entail or reflect different functions
performed, assets used and/or risks assumed by the tested
party. See paragraphs 3.18-3.19 for a discussion of the notion
of tested party.
1.41 In practice, it has been observed that comparability
analyses for methods based on gross or net profit indicators
often put more emphasis on functional similarities than on
product similarities. Depending on the facts and circumstances
of the case, it may be acceptable to broaden the scope of the
comparability analysis to include uncontrolled transactions
involving products that are different, but where similar
functions are undertaken. However, the acceptance of such an
approach depends on the effects that the product differences
have on the reliability of the comparison and on whether or not
more reliable data are available. Before broadening the search
to include a larger number of potentially comparable
uncontrolled transactions based on similar functions being
undertaken, thought should be given to whether such
transactions are likely to offer reliable comparables for the
controlled transaction.
D.1.2.2 Functional analysis
1.42 In transactions between two independent enterprises,
compensation usually will reflect the functions that each
enterprise performs (taking into account assets used and risks
assumed). Therefore, in determining whether controlled and
uncontrolled transactions or entities are comparable, a
functional analysis is necessary. This functional analysis seeks
to identify and compare the economically significant activities
and responsibilities undertaken, assets used and risks assumed
by the parties to the transactions. For this purpose, it may be
helpful to understand the structure and organisation of the
group and how they influence the context in which the taxpayer
ITA 461/2017 & connected matters Page 30 of 38
operates. It will also be relevant to determine the legal rights
and obligations of the taxpayer in performing its functions.
1.43 The functions that taxpayers and tax administrations might
need to identify and compare include, e.g. design,
manufacturing, assembling, research and development,
servicing, purchasing, distribution, marketing, advertising,
transportation, financing and management. The principal
functions performed by the party under examination should be
identified. Adjustments should be made for any material
differences from the functions undertaken by any independent
enterprises with which that party is being compared. While one
party may provide a large number of functions relative to that
of the other party to the transaction, it is the economic
significance of those functions in terms of their frequency,
nature, and value to the respective parties to the transactions
that is important.
1.44 The functional analysis should consider the type of assets
used, such as plant and equipment, the use of valuable
intangibles, financial assets, etc., and the nature of the assets
used, such as the age, market value, location, property right
protections available, etc.
1.45 Controlled and uncontrolled transactions and entities are
not comparable if there are significant differences in the risks
assumed for which appropriate adjustments cannot be made.
Functional analysis is incomplete unless the material risks
assumed by each party have been considered since the
assumption or allocation of risks would influence the conditions
of transactions between the associated enterprises. Usually, in
the open market, the assumption of increased risk would also be
compensated by an increase in the expected return, although
the actual return may or may not increase depending on the
degree to which the risks are actually realised.
1.46 The types of risks to consider include market risks, such as
input cost and output price fluctuations; risks of loss associated
with the investment in and use of property, plant, and
equipment; risks of the success or failure of investment in
research and development; financial risks such as those caused
by currency exchange rate and interest rate variability; credit
ITA 461/2017 & connected matters Page 31 of 38
risks; and so forth.
xxxxxxxxxxxxxxxx
1.51 In some cases, it has been argued that the relative lack of
accuracy of the functional analysis of possible external
comparables (as defined in paragraph 3.24) might be
counterbalanced by the size of the sample of third party data;
however quantity does not make up for poor quality of data in
producing a sufficiently reliable analysis. See paragraphs 3.2,
3.38 and 3.46."
35. The Revenue had asserted that in the exercise of TNMM, the ITAT
erred by concluding on the dissimilarity of the comparables, since this
particular method of computing the ALP allows for a broader application as
opposed to the stringent level of exactitude that the ITAT applied, while
comparing the functional similarity of the Assessee with the (excluded)
comparable companies. The revenue asserted that the ITAT erred by
applying stringent standards of comparability analysis for selecting
comparables under TNMM by ignoring the fact that TNMM is less
dependent on product comparability and functional comparability because
net margins are less influences by differences in products and functions;
Revenue highlighted the relevant part under the United Nations guidelines as
well, as quoted above.
36. At this juncture, it will be relevant to refer to the following parts from
the decision in Rampgreen (supra):
"42. Before concluding, there is yet another aspect of the
matter that needs consideration. The Tribunal proceeded on the
basis that while applying TNMM method, broad functionality is
sufficient and it is not necessary that further effort be taken to
find a comparable entity rendering services of similar
characteristics as the tested entity. The DRP held that TNMM
allows flexibility and tolerance in selection of comparables, as
ITA 461/2017 & connected matters Page 32 of 38
functional dissimilarities are subsumed at net margin levels, as
compared to Resale Price Method or Comparable Uncontrolled
Price Method and, therefore, the functional dissimilarities
pointed out by the Assessee did not warrant rejection of eClerx
and Vishal as comparables.
43. In our view, the aforesaid approach would not be
apposite. Insofar as identifying comparable
transactions/entities is concerned, the same would not differ
irrespective of the transfer pricing method adopted. In other
words, the comparable transactions/entities must be selected on
the basis of similarity with the controlled transaction/entity.
Comparability of controlled and uncontrolled transactions has
to be judged, inter alia, with reference to comparability factors
as indicated under rule 10B(2) of the Income Tax Rules, 1962.
Comparability analysis by TNMM method may be less sensitive
to certain dissimilarities between the tested party and the
comparables. However, that cannot be the consideration for
diluting the standards of selecting comparable
transactions/entities. A higher product and functional similarity
would strengthen the efficacy of the method in ascertaining a
reliable ALP. Therefore, as far as possible, the comparables
must be selected keeping in view the comparability factors as
specified. Wide deviations in PLI must trigger further
investigations/analysis.
44. Consideration for a transaction would reflect the
functions performed, the significant activities undertaken, the
assets or resources used/consumed, the risks assumed. Thus,
comparison of activities undertaken/functions performed is
important for determining the comparability between controlled
and uncontrolled transactions/entity. It would not be apposite
to ignore functional dissimilarity only for the reason that its
impact may be reduced on account of using arithmetical mean
of the PLI. The DRP had noted that eClerx was functionally
dissimilar, but ignored the same relying on an assumption that
the functional dissimilarity would be subsumed in the profit
margin. As noted, the content of services provided by the
ITA 461/2017 & connected matters Page 33 of 38
Assessee and the entities in question were not similar. In
addition, there were also functional dissimilarities between the
Assessee and the two entities in question. In our view, these
comparability factors could not be ignored by the Tribunal.
While using TNMM, the search for comparables may be
broadened by including comparables offering services/products
which are not entirely similar to the controlled
transaction/entity. However, this can be done only if (a) the
functions performed by the tested party and the selected
comparable entity are similar including the assets used and the
risks assumed; and (b) the difference in services/products
offered has no material bearing on the profitability."
37. However, even if the court notices the functional comparability of the
Assessee with the comparable companies, it cannot be said that they are
similar enough to serve the purpose of computing an accurate ALP,
arguendo if a larger scope for allowing smaller dissimilarities is permitted.
This observation arises from a close examination of each of the comparable
companies by the ITAT in both the cases, where it scrutinized the nature of
services and activities engaged in by these companies and categorically
concluded how they are different from those engaged in by the Assessee. In
this regard, the decision in Li & Fung India Private Limited v. CIT (supra)
was also noted to emphasize on finding a comparable transaction where the
functional analysis of both the associated enterprise and independent
enterprise is required to be determined if the transactions are comparable.
Further, it was submitted that even in case of TNMM, the standard of
comparability for application is not less than application of any other transfer
pricing method, hence, for transfer pricing analysis comparables should be
selected who provide services of the same character performing similar
functions and having similar levels of assets and risks. The relevant part
ITA 461/2017 & connected matters Page 34 of 38
from the decision in Li & Fung India Private Limited v. CIT (supra) is as
follows:
"34. The OECD Guidelines, which are instructive in such
cases, clarify that any attempt to use the transactional net
margin method should begin by comparing the net margin
which the tested party makes from a controlled transaction with
the net margin it makes from an uncontrolled one (an "internal
comparable"). If this proves impossible, possibly if there are no
transactions with uncontrolled parties, then the net margin that
would have been made by an independent enterprise in a
comparable transaction (an "external comparable") serves as a
guide to determine the arm's length price. Here, the strict
criterion is of an independent enterprise, carrying out a
comparable transaction, with the caveat that this will be only a
guide. Indeed, the emphasis is very clearly on finding a
comparable transaction. In addition, a functional analysis of
both the associated enterprise and the independent enterprise is
required to determine if the transactions are comparable. It
might of course be possible to adjust results for minor
functional differences, provided that there is sufficient
comparability to begin with. The standard of comparability for
application of the transactional net margin method is not less
than that for the application of any other transfer pricing
method."
38. The ITATs conclusions with respect to each of the compa rables,
in brief, is as follows:
Company ITAT Verdict on Comparability
Aditya Birla This comparable is not engaged in business of
Capital Advisors raising of funds but is engaged in advising functions
of raising of funds and deploying same. Based on the
work profile of Assessee and details of services
provided, it cannot be stated that functions performed
by the Assessee in research and information services
ITA 461/2017 & connected matters Page 35 of 38
are anywhere similar to functions of a fund manager.
Axis Private It is apparent that this company has a different risk
Equity Ltd. profile too. As per the balance sheet abstract of the
company, services of the company are classified as
asset management services. Based on the work
profile of the Assessee and details of services
provided, it cannot be stated that the functions
performed by the Assessee in research and
information services are anywhere similar to the
functions of a fund manager. In view of our analysis
of the functions and risk profile of the Assessee vis-à-
vis the comparable, Axis Private Equity Limited
should be excluded for comparibility analysis.
Credit Information This company is engaged in the business of credit
Bureau India Ltd rating and for this reason only, the functions of this
company compared with the Assessee company are
quite distinct. Therefore, in view of the combined
facts of non-availability of the information of the
relevant year, the order of the coordinate bench in
earlier years holding a credit rating company
dissimilar to the Assessee functionally, we do not
have any option other than to direct the Ld. Transfer
Pricing Officer to exclude this comparable.
Sun Life Asset This companys operations mainly relate to providing
Management asset management services and portfolio
Company management services. Segment reporting is not
required as the companys business is restricted to
single segment, i.e., Asset Management Services. It is
discernible from the Annual report of this company
and the references made by the TPO in his order to
its nature of business that there is no similarity
whatsoever between its functional profile and the
Assessee. This company is also directed to be
eliminated from the list of comparables.
ICRA Limited This company, provides ,,rating services comprising
of credit rating, bank loan rating, corporate
governance rating, stakeholder value and governance
rating, rating of claims paying ability of insurance
ITA 461/2017 & connected matters Page 36 of 38
companies, project finance rating and also ,,grading
services comprising of IPOs, micro financial
institutions, construction entitles, real estate
developers and projects, etc. The description of the
nature of services rendered by this company makes it
vivid that it has no proximity to the nature of services
rendered by the Assessee under this segment, which
is basically in the nature of carrying out research
from the internet based databases for compiling the
data, which is then customized/processed in
accordance with the requirements of the requester
and then organized into templates in excel, power
point, etc., before transmitting outside India. There
being no closeness with the functions performed by
the assessee, this company is directed to be excluded
from the list of comparables.
Ladderup This company provides a one-stop financial advisory
Corporate and fund raising solutions in Investment Banking,
Advisory Pvt. Ltd. Capital Markets, Wealth Management Project
Finance and Growth stage investing. On an overview
of the nature of business carried out by this company,
it is manifest that the same is absolutely different
from the Assessees.
39. The revenue urged that a stringent application of the comparability test
was unnecessary as was also provisioned in Chapter-6 of United Nations
Practical Manual on Transfer Pricing, Edition 2013, and some flexibility in
conducting this comparison was urged to be allowed. However, from the
above analysis, in the present appeals, even if due consideration is given to a
certain level of dissimilarity between the Assessee and the comparable
companies, it can be observed that the nature of services provided by the
abovementioned comparable companies do not demonstrate even a degree of
similarity with the services rendered by the Assessee that would be sufficient
ITA 461/2017 & connected matters Page 37 of 38
to qualify under rule 10B(2) of the Income Tax Rules, since, as established
above, the Assessees services under its R&I segment are in the nature of
services provided by a KPO and they are functionally dissimilar from the
comparable companies, in terms of their services as well as their risk
profiles. Relevantly reading what was highlighted in Rampgreen (supra) that
while using TNMM, the search for comparables may be broadened by
including comparables offering services/products which are not entirely
similar to the controlled transaction/entity however, this can be done only if,
inter alia, the difference in services/products offered has no material bearing
on the profitability, and do not have functional differences or any differences
in their risk profiles. Thus, it can be concluded that the ITAT was correct in
excluding the abovementioned comparable companies.
40. The question of law framed in ITA 461/2017 & ITA 526/2017 is
answered against the assessee; its appeals, therefore, have to fail. Likewise,
the question of law framed in ITA 590/2017 & ITA 82/2018 is answered
against the revenue and in favour of the assessee; the revenues appeals, too,
have to fail. All the appeals (ITA 461/2017, ITA 590/2017, ITA 82/2018 &
ITA 526/2017) are consequently dismissed, without order on costs.
S. RAVINDRA BHAT
(JUDGE)
A.K. CHAWLA
(JUDGE)
AUGUST 9, 2018
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