2015 (8) TMI 931 - HC - Income Tax

HC overturns transfer pricing adjustments, rules selected comparables not functionally similar under TP rules

The HC set aside the ITAT's confirmation of transfer pricing adjustments involving two comparables, e-Clerx Services Ltd. and Vishal Information ... Transfer pricing adjustment - wholly owned subsidiary of vCustomer, USA, (an Associated Enterprise -‘AE’) - Determination of Arm's Length Price (ALP) using Transactional Net Margin Method (TNMM) - TP Adjustments made in respect of the consideration for the services rendered to overseas holding company - selection of comparable as according to the Tribunal, no differentiation could be made between the entities rendering ITeS - functionally comparable companies - Did the ITAT fall into error confirming the transfer pricing adjustment upholding the inclusion of two comparable, i.e., e-Clerx Services Limited and Vishal Information Technologies Limited, now called as Coral Hub Ltd.? - Held that:- We find it difficult to accept ITAT view as it is contrary to the fundamental rationale of determining ALP by comparing controlled transactions/entities with similar uncontrolled transactions/entities. ITeS encompasses a wide spectrum of services that use Information Technology based delivery. Such services could include rendering highly technical services by qualified technical personnel, involving advanced skills and knowledge, such as engineering, design and support. While, on the other end of the spectrum ITeS would also include voice-based call centers that render routine customer support for their clients. Clearly, characteristics of the service rendered would be dissimilar. Further, both service providers cannot be considered to be functionally similar. Their business environment would be entirely different, the demand and supply for the services would be different, the assets and capital employed would differ, the competence required to operate the two services would be different. Each of the aforesaid factors would have a material bearing on the profitability of the two entities. Treating the said entities to be comparables only for the reason that they use Information Technology for the delivery of their services, would, in our opinion, be erroneous. See Maersk Global Centers case [2014 (3) TMI 891 - ITAT MUMBAI]. Both Vishal and eClerx could not be taken as comparables for determining the ALP. Vishal and eClerx, both are into KPO Services. E-Clerx is engaged in data analytics, data processing services, pricing analytics, bundling optimization, content operation, sales and marketing support, product data management, revenue management. In addition, eClerx also offered financial services such as real-time capital markets, middle and back-office support, portfolio risk management services and various critical data management services. Clearly, the aforesaid services are not comparable with the services rendered by the Assessee. Further, the functions undertaken (i.e. the activities performed) are also not comparable with the Assessee. even Vishal could not be considered as a comparable, as admittedly, its business model was completely different. Admittedly, Vishal’s expenditure on employment cost during the relevant period was a small fraction of the proportionate cost incurred by the Assessee, apparently, for the reason that most of its work was outsourced to other vendors/service providers - Decided against the Revenue Issues Involved:1. Transfer Pricing Adjustments (TP Adjustments)2. Inclusion of eClerx Services Ltd. and Vishal Information Technology Ltd. as comparables3. Application of Rule 10B(2) for functional comparability4. Determination of Arm's Length Price (ALP) using Transactional Net Margin Method (TNMM)5. Functional dissimilarity between Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO)Detailed Analysis:1. Transfer Pricing Adjustments (TP Adjustments):The Assessee challenged the TP Adjustments made by the Assessing Officer (AO) based on the Transfer Pricing Officer (TPO)'s report, which included eClerx Services Ltd. and Vishal Information Technology Ltd. as comparables. The adjustments were made to align the consideration for services rendered by the Assessee to its overseas holding company with the Arm's Length Price (ALP).2. Inclusion of eClerx Services Ltd. and Vishal Information Technology Ltd. as comparables:The Assessee argued that eClerx and Vishal were not suitable comparables due to significant functional differences. The Tribunal upheld their inclusion, stating that both companies provided Information Technology Enabled Services (ITeS) and no further sub-classification was permissible. However, the Court disagreed, noting that eClerx and Vishal were engaged in Knowledge Process Outsourcing (KPO) services, which involve higher skill levels and knowledge compared to the Assessee's voice call services, a lower-end ITeS.3. Application of Rule 10B(2) for functional comparability:Rule 10B(2) mandates that comparability should consider the specific characteristics of services provided and functions performed. The Court emphasized that for reliable benchmarking, the entities selected as comparables must be functionally similar and subject to similar business environments and risks. The Tribunal's approach of not differentiating between various ITeS was found to be erroneous.4. Determination of Arm's Length Price (ALP) using Transactional Net Margin Method (TNMM):The Assessee used TNMM to justify its pricing, which the TPO accepted but rejected the Assessee's benchmarking report. The Court highlighted that for TNMM to be effective, the comparables must be similar in all material aspects affecting profitability. The inclusion of KPOs like eClerx and Vishal, which have different functional profiles and business models, was deemed inappropriate for determining the ALP of the Assessee's transactions.5. Functional dissimilarity between Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO):The Court noted that KPO services involve advanced skills and knowledge, unlike BPO services, which are more routine. The Tribunal's view that no distinction could be made within ITeS was rejected. The Court stressed that comparables must be selected based on functional similarity, and the inclusion of KPOs for benchmarking a BPO's transactions was flawed.Conclusion:The Court set aside the Tribunal's order and the final assessment order, ruling that eClerx and Vishal could not be considered comparables due to their functional dissimilarity with the Assessee. The appeal was allowed, emphasizing the need for accurate functional comparability in transfer pricing analysis.