TaxTMI 
TaxTMI 
2014 (3) TMI 891
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....s performing KPO functions should be considered as comparable ? (2) Whether, in the facts of the assessee's case, companies earning abnormally high profit margin should be included in the list of comparable cases for the purpose of determining the arm's length price of an international transactions?" 2. The assessee in the present case is a company incorporated in India on 19-11-2003. It is a wholly owned subsidiary of Maersk GSC Holdings A/S, which in turn is a downstream subsidiary of APMM Group ("Maersk Group). It is engaged, inter alia, in the business as shared service centre and renders transaction processing, data entry, reconciliation of statements, audit of shipping documents and other similar support services. It also renders I.T. services such as process support, process optimization and technical support services. The return of income for the year under consideration was filed by it on 30-9-2008 declaring total income of Rs. 34,14,980/- under the normal provisions of the Act and book profit of Rs. 12,29,06,881/- computed u/s 115 JB of the Act. In the said year, it had carried out, inter alia, the international transactions of provi....
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....estic operations as well when the taxpayer's ITES segment is mainly an export oriented. Sl. No. Name of the company 1. Informed Technologies India Ltd. 2. Shreeji Info Hubs Ltd. 5. As discussed above, some of the taxpayer's comparables do not stand scrutiny of FAR analysis. 6. Some companies like Eclerx Services Ltd., though is into KPO services and qualify all the filters applied by the tax payer based on the data pertaining to the FY 2007-08, have not been selected." 5. Keeping in view the above material defects pointed out by him, the TPO rejected the TP report submitted by the assessee treating the same as un-reliable and in-correct and proceeded on his own to determine the ALP of the relevant international transactions entered into by it. In this regard, he noted that the assessee company was operating with more than 2000 employees out of the State of Art facility and was providing support services to its AEs such as documentation, finance, operations, logistics, global information systems etc. According to him, these services were in the nature of knowledge based services and thus were liable....
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....ssional services include both software development services and IT enabled services. Sub-segmental results are not submitted. Thus the same is not considered as a comparable. 7. Informed Technologies India Ltd. The company has exports to the extent of 66.52% of its revenues for the FY 2007-08 (RPTs on income and expense side combined). Thus the company fails 75% export filter applied by the TPO and is not considered as a comparable. 8. KPIT Commins Global Business Solution Ltd. The company is a subsidiary of KPIT Cummins Infosystems Ltd. As per the information and annual report submitted by the company for the FY 2007-08, the company fails 25% RPT filter. 9. Maple E- solutions Ltd. The company is not into KPO services and thus the same is not considered as a comparable. 10. R System International (segmental) The company is not into KPO services and thus the same is not considered as a comparable. 10. Shreejal Info Hubs Ltd. The company was earlier known as Ask Me Info Hubs Ltd. The company fails 75% export earning filter as it does not have any export for the FY 2007-08. Thus the company is not considered as a comparable. 11. Spanc....
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....were selected as companies. This is an appropriate filter as this is the stage which will determine the correct comparability. 5. Companies not disclosing segmental financials, whose services appeared different from that of taxpayer This is considered an appropriate filter since this filter will help to identify companies which are similar in function (IT enables service) to arrive at appropriate comparables. Wherever segmental information is available, the same is considered as a comparable. 6. Companies excluded for other reasons (based on information contained in the product profile, Director's report and other information available in the database) This is to be seen case by case. TPO tried to obtain maximum information using powers u/s 133(6). If sufficient information is not obtained, the decision is taken based on the information available in the Public domain. 8. In addition to some of the filters found to be appropriate by him as discussed above, the TPO considered some additional filters or criteria which, according to him, would lead towards selecting proper comparables and finally applied the following filters or criteria in searching for ....
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....nufacturing clients. To its Financial Services clients, it offers realtime capital markets, middle and back office support, portfolio risk management services and various critical data management services. 6. Mold-Tek technologies Ltd. The company is mainly engaged in Engineering design services 7. Triton Corp Ltd. The company is mainly engaged in knowledge process outsourcing and legal process outsourcing services. 9. The TNMM adopted by the assessee for benchmarking the relevant international transactions with OP/TC as PLI was accepted by the TPO. Accordingly, he considered the profit before interest and tax for computing the operating margins but treated only the income and expenses related to the operations of the relevant financial year for the computation of operating margins of the comparables. Accordingly, certain income and expenses of non-operating nature having nothing to do with the operations of the comparables were excluded by him for the purpose of considering the operating revenue and operating expenses. Similarly, extra-ordinary expenses/income which were non-recurring in nature such as donations, preliminary expenses etc. were not considered b....
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....ys Technologies Ltd. 1565300000 112110000000 44420009000 39.62% 12. KALS Information Systems Ltd. (Application Software Segment) 20540685 14471510 6069175 41.94% 13. LOS Global Ltd. (Formerly Lanco Global Systems Ltd.) 1366627613 1080643805 285983808 26.46% 14. Mindtree Ltd. (Earlier Mindtree Consulting Ltd.) 7415894045 6429612469 986281576 15.34% 15. Persistent Systems Ltd. 4069810000 3186990000 882820000 27.70% 16. Quintegra Solutions Ltd. 898876034 819057389 79818645 9.75% 17. R Systems international Ltd. (Software Development & Customization Segment) 1445601636 1253790215 191811421 15.30% 18. Sasken Communication Technologies Ltd. (Software Services Segment) 3358007000 2976115000 381892000 12.83% 19. Softsol India Ltd. 189940746 165165066 69906590 42.33% 20. Tata Elxsi Ltd. (Software Development & Services Segment) 3420535000 2881806000 538729000 18.69% 21. Thirdware Solutions Ltd. (Software Development Services Segment) 509558000 414099000 95459000 23.05% 22. V.G.L Softech Ltd. 4....
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..... On such consideration, the DRP held that the assessee could not be considered only as a low-end service provider. It was also held by the DRP that the activities of the assessee, at the same time, could not be considered as that at the high end of the spectrum to be qualified as KPO. It was noted by the DRP that the assessee had been considered as I.T. enabled service provider generally in earlier years and there being no segmental division between the different services and their profitability, the DRP considered it proper in the facts of the case to compare the assessee with the mix selection of comparables of I.T. enabled service sector in order to provide reasonable and appropriate comparability. Accordingly, the objection of the assessee regarding the rejection by the TPO of the five comparables selected by it merely on the ground that they are not KPO service provider was held to be sustainable by the DRP. 13. As regards the seven comparables selected by the TPO, the assessee apparently did not raise any material objection in respect of two comparables namely Crossdomani Solutions and Datamatics Financial Services Limited while one comparable namely Triton Corpn. as take....
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....cline from 27.98% to (13.95%) in the relevant year this is certainly not normal in terms of results. This is very different from the case of Mold-Tek, where a restructuring has taken place and demerger happened of an entirely different business segment, that too in October, 2006 and accounts restructured as on 1-4-2007 i.e., the beginning of previous year relevant to the assessment year under consideration. This has brought the comparable closer to the same line of ITES business as the assessee. That the company is comparable is clear from its functional profile. As far as not taking provision for derivative losses as an operating expense is concerned, reliance can be placed upon the decision of ITAT, Pune in the case of Honeywell Automation India Ltd. Vs. DCIT, (2009-TIOL-104-ITAT-PUNE in ITA No. 4/PN/08 dated 10-02-2009) wherein it was held that the provisions made for future losses cannot be considered while computing the operating profit of the relevant year. We also find that TPO/AO has taken this view consistently i.e., in the case of other comparables and assessee. From the Annual Report submitted by the assessee it is ....
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....as ITES and accordingly directed the A.O./TPO to bench mark these transactions by taking the following ten entities as final comparables:- 1. Caliber Point Business Solutions Ltd. 2. Cosmie Global Ltd. 3. Maple E Solutions Ltd. 4. R. Systems International (Segmental) 5. Spanco Telesystems and Solutions Ltd. 6. Triton Corp. Ltd. 7. Mold-Tek Technologies Ltd., 8. Crossdomain Solutions Limited 9. Datamatics Financial Services Limited (segmental) 10. eClerx Services Ltd." 17. As regards the objection of the assessee that the TPO has not allowed the working capital adjustment to the margins of the comparables selected by him, the DRP directed the TPO to allow such adjustment based on the final comparables selected by following the same method and basis as adopted in assessee's own case in the earlier years. 18. As regards the objection of the assessee that the TPO has not allowed appropriate risk adjus....
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....in and has been mentioned earlier also in the context of the manpower costs vis a vis total costs. It has to collect and nurture pool of talented manpower so that it can carry out its functions efficiently. In this day of high attrition rates, all enterprises face this risks especially these like the assessee. Hence, in the event of the assessee being unable to do so, its position will be compromised. In the 21st century, corporations have become increasingly reliant on human capital, at a time when this resource is becoming more difficult to retain. With the globalization of trade, many new opportunities are available to skilled staff, contributing to the already prevalent breakdown of bonds between employers and employees. A soaring employee turnover across many economic sectors has resulted in enormous losses to employers and has in turn enhanced the value of securing and retaining a stable, skilled workforce. Many MNEs are currently investing considerable resources in efforts to retain their employees, although such expenditures do not create 'assets' in the traditional sense. Corporations are still coming to terms with the fact that the most valuable information in the....
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....le year data instead of multiple year data of the companies selected by him u/r 10B(4) of the Income Tax Rules, 1962, the DRP overruled the same by observing that the assessee has not given any details as to how earlier years data have the impact on the profit of the current year of the assessee or of the comparables. The DRP in this regard relied on OECD Transfer Pricing Guidelines as revised on 22nd July, 2010 wherein it was cautioned that use of multiple year data does not necessarily imply the use of multiple year average for the purpose of bench marking. 21. The DRP thus issued directions u/s 144-C(13) of the Act on the objections raised by the assessee vide its order dtd. 7-9-2012 and directed the A.O./TPO to give effect to the said directions. Accordingly, the margins of final set of comparables after giving working capital adjustment were worked out by the A.O./TPO as under:- Sr. No. Company Name Assessee/Department FY 2007-08 NCP Adjustment FY 2007-08 Revised NCP 1. Caliber Point Solutions Limited Assessee 9.67 (2.50) 7.17 2. Cosmic Global Limited Assessee 23.30 (2.43) 20.87 3. Maple Esolutions Limited Asses....
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....elected by the DRP: 1. Caliber Point Business Solutions Ltd. 2. Cosmic Global Ltd. 3. Maple E-Solutions Ltd. 4. R Systems International (Segmental) 5. Spanco Telesystems and Solutions Limited 6. Triton Corpn. Ltd. 7. Mold-Tek Technologies Ltd. 8. Crossdomain Solutions Limited 9. Datamatics Financial Services Limited (segmental) 10. eClerx Services Ltd. 24. As submitted by Sr. Advocate Shri Porus Kaka, the ld. Counsel for the assessee, the assessee is disputing the inclusion of two entities out of ten comparables finally selected by the DRP namely Mold-Tek Technologies Ltd. and eClerx Services Ltd. on the ground that firstly they are KPO service providers who cannot be compared with the assessee company, which is basically a BPO service provider and secondly both these entities earning abnormally high profit margins should not be included in the list of comparables. Both these issues are raised in the que....
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..... The activities primarily involves the information collation from the shippers/customers/AE and populating the same in various processes and systems provided by the AE. The work requires limited domain expertise and no analytical skills. These activities are performed by low skilled employees who are primarily graduates by qualification. For ease of reference, we have attached herewith the available data of employees during FY 2007-08 and their qualification along with their birth date and in Exhibit 2. Broad classification of employees, based on their qualification is diagrammatically presented as under:- On perusal of above, your goodself would appreciate that since majority of employees are only graduates, activities of the Assessee cannot be qualified to be high end in nature. Following are some of the key features of the Assessee's business which are worth noting: * Assessee's business activities are performed by graduates and freshers with limited experience. Average age of employees is around 26-27 years; * Activities of the Ass....
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....bsp; (please refer IT enabled Services definition as provided in the CD,) (Please refer Exhibit 3) We respectfully submit that we object to the characterization of the Assessee as a KPO. Merely because the services performed by the Assessee pertain to the logistics industry we request your goodself not to conclude that the services performed by the Assessee can be categorized as KPO. A KPO industry is significantly higher on the value chain and involves processes that demand advanced information analysis as well as some judgment and decision making. Further the main concern of the KPO is the quality of the service provided as the same would involve strategic decision making. Thus a KPO industry is extremely sensitive and absorbs higher risks involving; confidentiality, quality, decision making etc. As discussed in above paragraphs, the Assessee in turn is a captive entity engaged in the provision of data processing services merely to its AE, which inter alia involves activities such data entry, transcription, reconciliation, consolidation, co-ordination,....
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....e TPO himself on page 2 of his order. 28. Our attention was invited by Shri Porus Kaka to the relevant portion of the submissions made by the assessee before the DRP at page No. 116 & 117 of the paper book to point out that the erroneous categorization of the assessee as KPO was challenged by the assessee by making the following submission: Erroneous categorization as KPO • The Assessee's back office support services primarily comprises of low end data entry, transcription, consolidation, co-ordination, preparation, processing and review of shipping documents and such other similar support services * The activities primarily involves information collation from shipper/customer/AE and populating the same into various processes and system provided by AE. • Activities are mechanical application of systems provided by AE and hence Assessee does not have authority to make any decisions * Carries limited low end functions based on instruction, standardised processes, data specification, process note and statement of work all of which have alway....
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...., held that the assessee could not be considered as KPO going by the qualification and profile of its workforce. He contended that the objection of the assessee for inclusion of two comparables on the basis of functional difference, however, was not considered by the DRP specifically. 30. Shri Porus Kaka submitted that none of the services rendered by the assessee is in the nature of logistics outsourcing services and business analytic services and the finding given by TPO to this effect is contrary to the business profile of the assessee company given by the TPO himself on page No. 2 of his order. He contended that even the qualification and profile of the workforce employed by the assessee established the fact that the assessee is providing low end services which cannot be characterized as KPO services. 31. Shri Porus Kaka contended that ITES sector as a whole is taken as functionally similar by the TPO as well as by the DRP for the purpose of comparability analysis, which is not as per the procedure prescribed in the relevant Rules. Relying on the decision of Hon'ble Delhi High Court in the case of Li and Fung (I) Pvt. Ltd. dtd. 16-12-2013, he contended that arbitrary ....
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....3 of his paper book and submitted that the contents thereof clearly make out the distinction between BPO and KPO. The said contents are extracted below:- "Knowledge Process Outsourcing (KPO) The global business environment is becoming increasingly information and knowledge intensive. In such an environment, business entities have realized the importance of and opportunity in assimilating data, analyzing trends, creating knowledge and harnessing this knowledge for running business operations efficiently thereby contributing to growth and profits. The evolution and maturity of the Indian BPO sector gave rise to Knowledge Process Outsourcing (KPO). The term KPO has generally come to refer to such activities and process solutions supplied by the service provider that essentially involve information searching, analyzing, interpreting and require significant domain expertise on part of the service provider. A KPO firm requires substantially more domain expertise than BPO firm. Professionals continue to learn: and undergo continuous training to learn new procedures and newer int....
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....ffice operations and support centre, which are the services rendered by the assessee company in the present case. He then referred to the definition of "knowledge process outsourcing services" given in clause (g) of Rule IOTA to mean certain specified business process outsourcing services which are provided mainly with the assistance or use of information technology requiring application of knowledge and advanced analytical and technical skill. He contended that the services so specified by the CBDT do not include back office support services as rendered by the assessee company in the present case. He contended that the services rendered by the assessee also do not require application of knowledge and/or advance analytical and technical skill. He contended that these provisions given by the CBDT in safe harbour rules thus clearly show that there is a clear distinction between KPO services and BPO services and the back office support services rendered by the assessee fall within the category of BPO services. 35. Shri Porus Kaka submitted that before the decision of the Mumbai Bench of Tribunal in the case of Willis Processing Services (I) Pvt. Ltd. Vs. DCIT (supra), several Bench....
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....e comparability for this purpose has to be seen on the basis of FAR analysis and the relevant Rule 10B(3)(ii) allows only reasonably accurate adjustment to be made to eliminate the differences, if any. He contended that in the transfer pricing exercise, analysis has to be qualitative and not quantitative. He also contended that the broad characterisation of BPO and KPO services made by the Tribunal in the case of Willis Processing Services (I) P. Ltd. (supra) as ITES, based on the larger size of sample, is not in accordance with the TP regulations prescribed in the relevant Rule and thus the view taken in the said case has not been followed even by the other co-ordinate Benches of the Tribunal. 37. Reference was made by Shri Porus Kaka to section B.3.1 of the OECD transfer pricing guidelines issued in July, 2010 and our attention was drawn to paragraph Nos. 2.68 to 2.75 contained therein explaining the comparability standard to be applied when TNMM is followed. The said paragraphs read as under:- "2.68 A comparability analysis must be performed in all cases in order to select and apply the most appropriate transfer pricing method, and the process for ....
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....et profit indicators can be influenced by some of the same factors, such as competitive position, that can influence price and gross margins, but the effect of these factors may not be as readily eliminated. In the traditional transaction methods, the effect of these factors may be eliminated as a natural consequence of insisting upon greater product and function similarity. Depending on the facts and circumstances of the case and in particular on the effect of the functional differences on the cost structure and on the revenue of the potential comparables, net profit indicators can be less sensitive than gross margins to differences in the extent and complexity of functions and to differences in the level of risks (assuming the contractual allocation of risks is arm's length). On the other hand, depending on the facts and circumstances of the case and in particular on the proportion of fixed and variable costs, the transactional net margin method may be more sensitive than the cost plus or resale price methods to differences in capacity utilisation, because differences in the levels of absorption of indirect fixed costs (e.g. fixed manufacturing costs or fixed distribution cos....
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....h a case, the range may not include points representing the profits of independent enterprises that are affected in a similar manner by a unique factor. The use of a range, therefore, may not always solve the difficulties discussed above. See discussion of arm's length ranges at paragraphs 3.55-3.66. 2.74 The transactional net margin method may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences of the type referred to above. The transactional net margin method should not be used unless the net profit indicators are determined from uncontrolled transactions of the same taxpayer in comparable circumstances or, where the comparable uncontrolled transactions are those of an independent enterprise, the differences between the associated enterprises and the independent enterprises that have a material effect on the net profit indicator being used are adequately taken into account. Many countries are concerned that the safeguards established for the traditional transaction methods may be overlooked in applying the transactional net margin method. Thu....
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....d pointed out that as per para 3.56 of the guidelines, where it is possible to determine that some uncontrolled transactions have a lesser degree of comparability than others, they should be eliminated. He also referred to para 3.57 of the guidelines wherein it is stated that if the range of comparables includes a sizeable number of observations, statistical tools that take account of central tendency to narrow the range (e.g. the interquartile range or other percentiles) might help to enhance the reliability of the analysis. He also referred to para 3.59 of the OECD guidelines wherein it is suggested that where the application of the most appropriate method produces a range of figures, a substantial deviation among points in that range may indicate that the data used in establishing some of the points may not be as reliable as the data used to establish the other points in the range or that the deviation may result from features of the comparable data that require adjustments. It is suggested that further analysis of those points in such cases may be necessary to evaluate their suitability for inclusion in any arm's length price. 40. Reference was made by Shri Porus Kaka to....
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....rendered by the two entities should be compared in order to treat the same as comparables for the purpose of transfer pricing analysis. He relied on the decision of Hon'ble Supreme Court in the case of DIT (International Taxation) v. Morgan Stanley and Co. Inc. [2007] 292 ITR 416 wherein the Hon'ble Apex Court emphasized the significance of functions performed and risks assumed by the enterprise in undertaking the transfer pricing analysis. He contended that comparability should be based on the conclusion drawn from the functional analysis of the enterprise and it should be a backdrop of benchmarking and determining the arm's length price. He argued that the parameters for taking an un-controlled transaction as comparable to international transaction are provided in Rule 10-B(2) and as held by the Bangalore Special Bench of ITAT in the case of Aztec Software and Technology Services Ltd. v. ACIT 107 ITD 141 (Bang.)[SB], this criteria should form a basis for judging the comparability, whatever be the methodology chosen for the purpose of determination of ALP. He also relied on the decision of Delhi Bench of ITAT in the case of Mentor Graphics (Noida) Pvt. Ltd. v. DCIT, 18....
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....een KPO & BPO 1. Process: It' is s not a simple case of the 'K' replacing the 'B'. KPO involves high-end processes like valuation and, investment, research, patent filing, legal and insurance claims processing, amongst others. 2. Focus: Unlike conventional BPO where the focus is on process expertise, in KPO, the focus is on knowledge expertise. 3. Specialisation: The difference lies in domain specialization. BPO employees do not generally require specialized knowledge. Customer care executives at a BPO require good knowledge of the English language, the ability to be articulate and possess basic computer kills. On the other hand, a KPO organisation specializing in equity or financial analysis for example, can employ highly qualified professionals who possess high-end knowledge of accounts and finance. S/he should hold MBA or a CA qualification. 4. Driving Force: While KPO organizations are knowledge-driven, BPOs are process-driven. 5. Activities: KPO involves off shoring of knowledge intensive business processes that demand ....
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....e various back office support services as ITES, Shri Ajay Vora submitted that the said notification is issued in the context of section 10A, 10B and 80 HHE of the Act to explain and define the term "computer software" for the purpose of Explanation 2(1)(b) of section 10A, Explanation 2(1)(b) of section 10-B and Explanation (b) of section 80HHE of the Act and the same cannot be extended or applied to treat the BPO as KPO. He contended that the said notification is to be read in the context in which it is issued and the same, issued on 26-9-2000 by the CBDT, cannot be applied to decide the issue relating to transfer pricing as the provisions relating to transfer pricing were not even in the statute when the said notification was issued by the CBDT. 47. The ld. CIT (DR) Shri Ajeet Kumar Jain submitted in his reply that the characterisation of the services rendered by the assessee company is required to be done in order to ascertain whether it is a BPO or KPO or something in between. In this regard, he invited our attention to the executive summary given in the TP study report submitted by the assessee at page 62 of the paper book and pointed out that the services provided by the as....
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....co Telesystems and Solution Ltd. (segmental) selected by the assessee company as comparables, on the other hand, were providing low end BPO services such as call centers. He contended that the assessee company had rightly selected BPO as well as KPO as comparables in its own TP study since the distinction between BPO and KPO would not have much impact for comparability where TNMM is followed particularly when the services rendered by the assessee have attributes of KPO also. 49. Reference was made by Shri Ajeet Kumar Jain, ld. CIT (DR) to the order of the Tribunal passed in assessee's own case for A.Y. 2007-08 placed at page 28 to 40 of his paper book (ITA No. 8558/Mum/2011 dtd. 29-2-2012). It was pointed out from the relevant portion of the said order of the Tribunal at page 33 of the paper book that eClerx Services Pvt. Ltd. having 90.43% OP/TC was taken by the TPO as comparable and the same was not disputed by the assessee. He pointed out that one of the thirty comparables taken by the TPO was M/s Mod-Tek Technogies Ltd. and although the said entity having 113.49% OP/TC was disputed by the assessee, inter alia, on the ground of abnormal profits, the Tribunal finally resto....
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.... harbour rules are applicable to the assessee who exercises a valid option for application of safe harbour rules. He contended that the assessee in the present case has not exercised this option and therefore it cannot take a shelter under safe harbour rules by relying on the definition given therein in support of its case that the BPO and KPO services are different and there is no similarity between them. He also contended that the safe harbour rules are framed by the CBDT vide circular dtd. 18-9-2013 and they cannot be applied in the present case involving A.Y. 2008-09. A reference was made by him to the Circular dtd. 20-12-2013 issued by the CBDT wherein it is clarified that if the safe harbour rules are not opted by the assessee, they cannot be relied upon and referred to by him. Relying on the decision of Hon'ble Supreme Court in the case of ITO v. M.C. Ponnoose and Others - ITO v. Excel Productions and Others [1970] 75 ITR 174 and in the case of Govinddas and Others vs. ITO [1976] 103 ITR 123, he contended that the safe harbour rules cannot be applied retrospectively to support the case of the assessee that there is a difference between BPO and KPO. 52. Shri Ajeet Kuma....
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.... in the comparability analysis. 54. Shri Ajeet Kumar Jain submitted that there are five methods prescribed to determine the ALP in relation to the international transaction and the requirement for comparability analysis are method specific as given in sub rule (1) of Rule 10-B. He referred to the said Rule and submitted that price charged or paid for the property transferred or service rendered in the comparable transaction is relevant in case of CUP and re-sale price method while the cost of production incurred in respect of property transferred or services provided is relevant for cost plus method. He submitted that there is, however, no mention or reference to any property transferred or services provided in case of TNMM which is specifically there in case of other method. He contended that the relevant Rule thus makes it clear that specific characterization of the property transferred or services is not relevant for TNMM and this position is in conformity with the relevant OECD guidelines which suggest that broad comparability of functions to be done for TNMM. He contended that there is thus no need to make any distinction between BPO and KPO for TNMM and the broad category ....
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.... economic activities in the country gave rise to new and complex issues emerging from transactions entered into between two, or more enterprises belonging to the same multinational group. The profits derived by such enterprises carrying on business in India could be controlled by the multinational group, by manipulating the prices charged and paid in such intra-group transactions, thereby, leading to erosion of tax revenues. With a view to provide a statutory framework which could lead to computation of reasonable, fair and equitable profits and tax in India, in the case of such multinational enterprises, the Finance Act, 2001 substituted the then existing section 92 of the Income-tax Act by new sections 92 and 92A to 92F. As provided therein, income arising from an international transaction between associated enterprises shall be computed having regard to the arm's length price. The term 'associated enterprise' has been defined in section 92A. Section 92B defines an 'international transaction' between two or more associated enterprises. The provisions contained in section 92C provide for methods to determine the arm's length price in relation to an internat....
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....od referred to in sub section (1) shall be applied for determination of ALP in the manner as may be prescribed. The manner in which the ALP in relation to an international transaction is to be determined by any of the methods, being the most appropriate method, for the purposes of sub section (2) of the section 92-C of the Act has since been prescribed in Rule 10-B of the Income Tax Rules, 1962 which reads as under:- "Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely:- (a) comparable uncontrolled price method, by which,- (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled tr....
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....ed enterprise; (c) cost plus method, by which,- (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; &nbs....
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....market returns achieved for similar types of transactions by independent enterprises, and thereafter, the residual net profit remaining after such allocation may be split amongst the enterprises in proportion to their relative contribution in the manner specified under sub-clauses (ii) and (iii), and in such a case the aggregate of the net profit allocated to the enterprise in the first instance together with the residual net profit apportioned to that enterprise on the basis of its relative contribution shall be taken to be the net profit arising to that enterprise from the international transaction or the specified domestic transaction ; (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction or a specified domestic transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit ma....
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.... 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. (3) An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction or a specified domestic transaction shall be the data relating to the financial year in which the international transaction or the specified domestic transaction has been entered....
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....lity of property or services is the strictest for the CUP method whereas differences in characteristics of property or services are less sensitive in case of transactional profit methods than in case of traditional transaction methods. It further clarifies, in para 1.41, that the comparability analysis for method based on gross or net profit indicator often puts more emphasis on functional similarity than on product similarity and, depending on the facts and circumstances of the case, it may be acceptable to broaden the scope of comparability analysis to include un-controlled transactions involving products that are different, but where similar functions are undertaken. 61. Chapter II of the OECD transfer pricing guidelines (July, 2010) deals with selection of the transfer pricing method and Part III thereof deals with transactional profit methods. Section B-2 of this part discusses about strengths and weaknesses of Transactional Net Margin Method (TNMM) and one of the strengths of TNMM, as explained therein, is that the net profit indicators (e.g. operating income) are less affected by transactional differences than is the case with price as used in the CUP method. It is furthe....
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....Transfer Pricing Guidelines in section B.3.1. of Chapter II wherein it is stated that a comparability analysis performed for selecting and applying a transactional net margin method should not be less reliable than for other methods. At the same time, we have to take note of the fact that the relevant financial data is not available in the public domain in respect of many ITES service providers as they are private limited companies. Moreover, many of the ITES providers, which are listed public limited companies and whose financial data is available in public domain, are captive service providers and they, therefore, cannot be considered as comparables having substantial related party transaction. Keeping in view these problems as well as other problems discussed in the remaining portion of this order, which are peculiar to the ITES industry, our endeavor is to find out a practical solution which can help to perform a comparability analysis in the cases belonging to ITES sector. In our opinion, this problem can be solved by splitting the exercise of comparability analysis in two steps in order to attain relatively equal degree of comparability, the first being to select the potentia....
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....nsactions have a lesser degree of comparability than others, they should be eliminated. 67. As already observed, the comparability of an international transaction with uncontrolled transaction for the purpose of determining the ALP of an international transaction by following TNMM is required to be judged with reference to the functions performed as per sub Rule (2)(b) of Rule 10B read with Rule (l)(e) thereof and there is no bar in the TP regulations in India to exclude certain entities selected as potential comparables on broad functionality test by applying the functional test at narrow or micro level to attain the relatively equal degree of comparability. On the other hand, Rule 10-B(3) provides that the uncontrolled transaction selected/judged as per Rule 10-B(2) shall be comparable to an international transaction only if none of the differences, if any, between the transactions being compared, or between enterprises entering into such transactions are likely to materially affect the price or cost charged or paid or the profit arising from such transaction in the open market or reasonably accurate adjustment can be made to eliminate the effects of such difference. In our op....
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.... move up the value chain through KPO service offerings. In para 4.3 of the report, it is stated that the ITES industry is likely to see an increasing share of penetration from KPOs. It is also stated that while the BPO sector would contribute large volumes, the KPO sector would be a "value play". It is further stated that a lot more areas are likely to witness KPO activity spanning patent advisory, high end research and analytics, online market research and legal advisory. 70. Shri Ajay Vora has also placed on record a copy of Article "KPO -An Emerging Opportunity for Chartered Accountants" published in 2006 in the Journal "The Chartered Accountants" to highlight the distinction between BPOs and KPOs. As stated in the said Article, KPO, simply put, is the upward shift of the BPO industry in the value chain. It is explained that the KPO is a new industry with high growth rate in India and older BPO companies that provided basic back-end or customer care support service are moving up this value chain. It is stated that unlike conventional BPO, where the focus is on process expertise, the focus in KPO is on knowledge expertise. It is explained that KPO involves business process req....
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....TA 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;" 73. On a careful study of the material placed before us to highlight the distinction between BPO services and KPO services, we are of the view that even though there appears to be a difference between the BPO and KPO services, the line of difference is very ....
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....O sector, we are of the view that the ITES services cannot be further bifurcated or classified as BPO and KPO services for the purpose of comparability analysis. In our opinion, there could exist significant overlap between the ITES activities or functions with some activities/functions being very fact-sensitive and introducing an artificial segregation within ITES may lead to creation of more problems in the comparability analysis than solving the same. 76. Having held that ITES services cannot be further bifurcated as BPO and KPO services for the purpose of comparability analysis, the next question that arises is what could be the basis of such dissection, bifurcation or classification of ITES services to facilitate relatively equal degree of comparability when the broad functional analysis based on ITES sector is taken into account by applying TNMM. In our opinion, this purpose of attaining a relatively equal degree of comparability can be achieved by taking into consideration the functional profile of the tested party and comparing the same with the entities selected as potential comparables on broad functional analysis taken at ITES level. The principal functions performed ....
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.... the selection of comparables would not be feasible but much can be done to increase objectivity and ensure transparency in the application of subjective judgments. Keeping in mind all these factors, it is necessary in the present context that all the relevant facts peculiar to ITES sector should be taken into account including particularly the problems discussed by us in para 73 to 75 of this order and accordingly the relatively equal degree of comparability should be sought to be achieved by taking into consideration the functional profile of the tested party and comparing the same with functional profile of the potential comparables selected at ITES level. 78. To sum up, we hold that the potential comparables of ITES sector level can be selected by applying broad functional test at first stage and although the comparables so selected can be put to further test, depending on facts of each case, by comparing the specific functions performed in the international transactions with that of uncontrolled transactions to attain the relatively equal degree of comparability as discussed above, the classification of ITES into low-end BPO services and high-end KPO services for comparabil....
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....s under:- "4.1.1 - Provision of I.T. enabled services. MGSCIPL is engaged in providing back office support services to AE. Activities undertaken by MGSCIPL are essentially IT enabled services such as data entry, transcription, reconciliation, consolidation, co-ordination, preparation, processing and review of shipping documents such of hills of lading, etc. Broad activities carried on by MGSCIPL as directed by AL from time to time are as follows: Export/Import documentation - Log, review and process shipping instructions to produce draft transport documents; - Receive, log and process amendments to shipping instructions: - Publish Transport Documents to the Web; - Perform data quality checks and updates; Reconcile differences between Equipment Management System (RKEM - Rederiets Kontainer Equipment Management) and the Transport Plan in Global Customer Service System (GCSS):- Identify and correct manifest er....
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....cation: owner's expenses; monthly disbursements; RKDS pay-at; purchase order creation: Maersk Logistics Import Processing System (MIPS) web; Hyperion Financial Management (HFM) controlling tasks. Other services - Tender Handling: Prepare tenders by updating Maersk - Product Catalogue (MEPC) details; - Contract Drafting: Draft all lanes in MARS awarded to Maersk Line; and - Data Quality: Various audit functions based on different business units' strategy (Global invoice audit, (Container billing count, DSL Audit. GBR dispute team). L 4.1.2 Provision of IT services MGSCIPL provides IT services such as process support, process optimization and technical support to its A Is. MGSCIPL provides technical support services to users of corporate systems. Functions performed by MGSCIPL under IT services segment could be categorised under following headings: DL Process support MGSCIPI, provides first line proce....
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....n. There were also some other services rendered by the assessee company to its AEs as IT enabled services such as reconciling the difference between equipment management system and transfer plan in global custom services study, contract drafting, various audit functions based on different business strategy, tender handling etc. which, as rightly submitted by the ld. D.R., cannot be strictly considered as low-end services as they involved some degree of special knowledge and expertise in the relevant field. However, these services again were only incidental to the main services rendered by the assessee involving information collation from shipper/customer/AE and populating the same into various processes and systems provided by the AE. These main services rendered by the assessee to its AEs thus involved primarily data entry, transcription, consolidation, co-ordination, preparation, processing and review of shipping documents and such other similar support services which were mainly comprising of back office support services rendered by the assessee to its AEs in the nature of low-end services. The profile of work-force employed by the assessee during the year under consideration co....
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.... and the same cannot be taken as comparable to the assessee company which is mainly involved in providing low-end services. It may be pertinent to note here that the financial year 2007-08 was a unique year for Mold-Tek Technologies Ltd. as the scheme of arrangement involving amalgamation between Tekmen Tool Pvt. Ltd. and Mold-Tek Technologies Ltd. and de-merger between Mold-Tek Technologies Ltd. simultaneously was sanctioned by the Hon'ble AP High Court by 15th July, 2008 with the appointed date for amalgamation and de-merger being 1st October, 2007 and 1st April, 2007 respectively. It is also pertinent to note that while working out the operating margin of the said company, provision for derivative loss of Rs. 6.43 crores made by Mold-Tek technologies Ltd. was excluded by the A.O. treating the same as non-operating expenses whereas in the case of Rushabh Diamonds (supra), it was held by the Division Bench of this Tribunal that the gain or loss arising from the forward contract entered into for the purpose of foreign currency exposure on the export and import has to be taken into consideration while computing the operating profit. 82. In so far as M/s eClerx Services Limite....
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....ee of comparability and the said entities cannot be taken as comparables for the purpose of determining ALP of the transactions of the assessee company with its AEs. We, therefore, direct that these two entities be excluded from the list of 10 comparables finally taken by the AO/TPO as per the direction of the DRP. 84. As submitted by the ld. Counsel for the assessee, if these two entities are excluded from the comparables and the ALP of international transactions of the assessee company with its AEs is recomputed by taking into consideration the arithmetic mean of the margins of the remaining eight comparables, the difference between such ALP and the price charged by the assessee would be within the safe harbour limit of 5% requiring no TP adjustment. We accordingly direct the A.O.to recompute the ALP of the transactions of the assessee company with its AEs applying the average profit margin of the remaining eight comparables. If the difference between the ALP so recomputed and the price actually charged by the assessee is within the safe harbour limit of (+) or (-) 5%, the A.O. is directed not to make any TP adjustment as per the second proviso to section 92C(2) of the Act. ....
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....he normal course as mentioned by CBDT in para 55.10 of the Notification. He contended that this clearly indicates the expectation of the legislature that there would not be any significant diversion between various ALPs if the different sets of comparable data are equally reliable. 87. Shri Porus Kaka submitted that there are several cases decided by the different Benches of the Tribunal wherein it is held that the comparables earning super normal or abnormal profits should be excluded. He placed on record the copies of orders passed by the Tribunal in the following such cases:- Sr. No. Decision Citation 1. CES (P.) Ltd. v. DCIT ITA No. 1445/Hyd./20I0 2. DCIT v. Hellosoft India (P.) Ltd. [2013] 32 taxmann.com 101 (Hyd.) 3. BA Continuum India (P.) Ltd. v. ACIT ITA No. 1154/Hyd./2011 4. Avineon India (P.) Ltd. v. DCIT ITA No. I989/Hyd./2011 5. Market Tools Research (P.) Ltd. v. DCIT ITA No. 181l/Hyd./2012 6. Google India (P.) Ltd. v. DCIT [2013] 29 taxmann.com 412 (Bang.) 7. Capital IQ Information Systems (India) (P.) Ltd. v. DCIT [2013] 32 taxmann.com 21 (Hyd.) 8. Sap Labs India (P.) Ltd. v. ACIT [20....
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....e common thread running through these entities so as to include them in the list of final comparables. Our attention was drawn to the decision of Chandigarh Special Bench of ITAT in the case of Quark Systems Pvt. Ltd. wherein the issue of super normal profit was considered by the Tribunal and it was held that when the profit margin is abnormally high, the matter may be investigated further. Mr. Porus Kaka also relied on the decision of Mumbai Bench of ITAT in the case of Symantec Software Solutions (P.) Ltd. (supra) and pointed out that the entities earning super normal profits were excluded by the Tribunal in this case on the ground that there was failure on the part of the A.O./TPO to prove that the higher profits shown by these entities were normal. He contended that super normal profits thus certainly is a trigger which at least should invoke further investigation or enquiries to ascertain and decide whether the entities earning such super normal profits should be included in the list of final comparables or not. 89. Shri Ajay Vora, the ld. Counsel for the intervener also put forth his argument on the issue relating to the exclusion of entity earning super normal or abnormal....
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....g the arithmetic mean. He submitted that as per the principles of statistical analysis, the size of sample is important inasmuch as higher the sample size, better or closure is the estimate. He referred to Chapter 5 "Measures of Central Tenancy" given in the book "Statistics for Economics" prescribed as text book for class XI and submitted that arithmetic mean as explained therein is the most commonly used measure of central tendency. It is defined as a sum of the values of all observations divided by number of observations. He pointed out from the example given therein that in case of extreme figures also, the arithmetic mean is used as a measure of central tendency. He contended that by adopting the arithmetic mean to work out the average profit margin of the comparables, Indian law has recognized the extreme values also for comparability. He submitted that the quartile method of central tendency removes the extreme results but by adopting the arithmetic mean and not quartile, the law makers want even the extreme results to be considered. 91. As regards the CBDT Circular No. 14 of 2011, para 55.10 referred by Shri Porus Kaka, Shri Ajeet Kumar Jain submitted that section 92-C o....
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.... such decisions cited by him are as under:- Sl No. Name of the case Date of decision Bench 1 Exxon Mobil Company India Pvt. Ltd. 10.06.11 Mumbai 2 BP India Services Pvt. Limited 23.09.11 Mumbai 3 Actis advisors Pvt. Limited 12.10.13 Mumbai 4 Nextlink India Pvt. limited ...10.12 Bangalore 5 24/7 Customer.Com. Pvt. Limited 09.11.12 Bangalore 6 Trilogy E-Business software India Pvt. Limited 23-11-12 Bangalore 7 Exxon Mobil Company India Pvt. Limited 19.12.12 Mumbai 8 Stream international Services Pvt. limited 11.01.13 Mumbai 9 Willis Processing Services (I) P. Limited 01.03.13 Mumbai 10 Vodafone India Services P. Limited 26.04.13 Mumbai 11 Rushabh Diamonds 26.04.13 Mumbai 12 Syscom Corporations 12.07.13 Mumbai 13 Chrys Capital Investment Advisors India Private limited 20.12.13 New Delhi 93. Shri Ajeet Kumar Jain pointed out that there were atleast eight decisions rendered by the Tribunal prior to the case of Willis Processing Services (I) P. Ltd. (supra) taking a view in favour of the assessee on this issue and it th....
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....erated by the Tribunal holding that there is no bar in the relevant Rule 10B(2) to consider the companies earning abnormal profits as comparable to tested party as long as they are functionally comparable. It was held that this question may not arise at all in the context of OECD guidelines and US TP regulations as they advocate a quartile method for determining ALP whereby the extreme results get automatically excluded. It was also held that the Indian regulations, however, deviate from OECD guidelines and provide arithmetic mean method for determining ALP whereby all companies that are in the sample are considered without exception and the average of all the companies is considered as ALP. It was held that the entity showing extreme results, however, can be excluded for comparability if it is found there are specific or special reason for such extreme results. In the case of Stream International Services (P.) Ltd. (supra) it was held by the Mumbai Bench of ITAT that comparability is judged primarily by seeing the functional similarity and then the capital employed and risks undertaken. Higher or lower profit rate is not and can never be a relevant criteria to judge the comparabil....
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.... consideration and any significant diversion such as abnormal high profit margin should not be included in the list of comparable cases for the purpose of determining the ALP of an international transaction. We find it difficult to accept this contention of Shri Porus Kaka. The arithmetic mean may be a mean number in the context of any arithmetic progression as given in the Concise Oxford Dictionary. However, in the context of measuring central tendency or averages like that of more than one price as contemplated in the first proviso to section 92C(2) of the Act, it is to be taken as the sum of the values of all observations divided by number of observations as rightly submitted by the Shri Ajeet Kumar Jain, the ld. CIT (DR) relying on the Text Book "Statistics for Economics". It, therefore, cannot be said that by using the term "arithmetic mean" in the said proviso, the legislature has envisaged existence of the comparable figures in a specific range as sought to be contended by Shri Porus Kaka. On the other hand, the arithmetic mean is a commonly used measure of central tendency after taking into consideration the sum of the values of all observations and then divided by the numb....
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.... 10B(2) and 10B(3) to make a case incomparable. The Tribunal observed that the profit rate in any case cannot be such determinative factor in itself as it is a consequence of the effect of the various factors. In the case of 24/7 Customer.Com (P.) Ltd. (supra), the Bangalore Bench of this Tribunal considered the relevant OECD guidelines in this respect and held that the exclusion of companies with abnormal profits from the comparables may be in line with the principles enumerated in the OECD guidelines, but the same cannot be said to be in tune with the Indian TP Regulations. The Tribunal noted that there was a deviation in the TP Rules specifically from OECD guidelines by specifying the arithmetic mean for determining the ALP as against the quartile method suggested in the OECD guidelines which excludes the companies that fall in the extreme quartiles for comparability. To the similar effect is another decision of Bangalore Bench in the case of Trilogy E-Business Software India Ltd. (supra) wherein it was held that the TP Regulations provide arithmetic mean method for determining the ALP wherein all companies that are in the sample are considered without exception and the average ....
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....cumstances of each case inasmuch as potential comparable earning abnormally high profit margin should trigger further investigation in order to establish whether it can be taken as comparable or not. Such investigation should be to ascertain as to whether earning of high profit reflects a normal business condition or whether it is the result of some abnormal conditions prevailing in the relevant year. The profit margin earned by such entity in the immediately preceding year/s may also be taken into consideration to find out whether the high profit margin represents the normal business trend. The FAR analysis in such case may be reviewed to ensure that the potential comparable earning high profit satisfies the comparability conditions. If it is found on such investigation that the high margin profit making company does not satisfy the comparability analysis and or the high profit margin earned by it does not reflect the normal business condition, we are of the view that the high profit margin making entity should not be included in the list of comparable for the purpose of determining the arm's length price of an international transaction. Otherwise, the entity satisfying the co....