TaxTMI 
TaxTMI 
2014 (3) TMI 891
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....ered 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 providing I.T. enabled services to its Associated En....
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....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 to be characterised as Knowledge Process Outsourcing (KPO) services. He noted that the asses....
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....me 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. Spanco Telesystems and Solutions Ltd. (Segmental) Now the company is known as Spanco Ltd. The Annual Report is available for the FY 2007-08. This BPO segment is not into KPO s....
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....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 comparables:- "- Companies whose data is not available for the FY 2007-08 were excluded and the data for the FY 2007-08 has been considered for the period from 01-04-2007 to 31-03-2008. &n....
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.... 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 by him as operating expenses or operating income. Accordingly, the arithmetic mean of OP/TC of seven comparables selected by him was worked out by the TPO at 47.74% and after allowing the working capital adjustment at 2%, he worked out the adjusted arm's length mean margin at 45.74%. Applying ....
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....0 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. 42437512 36812017 5625495 15.28% 23. Wipro Ltd. (Wipro Technologies Segment) 112762000000 87713000000 25049000000 28.56% 11. The arithmetic mean of the OP/TC of the above comparables selected by him was worked out by the TPO at 24.99% and after applying the same as average profit margin of the comparables, without allowing any working capital adjustment, to the operating cost of Rs. 12,05,35,098/- as submitted by the assessee in the TP study report, he determined the ALP of international transactions of the assessee company with its AEs involving p....
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....ix 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 taken by the TPO was there in the list of comparables selected by the assessee itself. As regards the remaining four comparables selected by the TPO, which were objected by the assessee, the DRP accepted the objection of the assessee in respect of two comparables namely Acropetal Technologies Limited and Coral Hubs Limited and directed exclusion of the same from the comparables for the following reasons :- "Acropetal Technologies Ltd.- It has been pointed out by the assessee in its submission wherein the Annual Reports of the comparables have been filed, that this ....
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.... 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 not clear how the assessee has stated that it has controlled transactions or if it violates the RPT limit. In conclusion, this company is found to be comparable." 15. The three comparables selected by the TPO namely Mold-Tek Technologies Ltd., M/s Coral Hubs Ltd. and M/s eClerx Services Limited were also objected by the assessee before the DRP on the basis of their high profitability. This objection of the assessee was not found sustainable by the DRP observing that high and low margins both reflect the industry profitability especially when they are acceptable on functional similarity. It was also ob....
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....p; 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 adjustment to the margins of the comparables selected by him as required u/r 10-B(l)(e)(iii) of the Income Tax Rules, 1962, the DRP discussed the claim of the assessee in respect of various risks as under:- "Market Risk/Business Risk: The taxpayer's claim that it does not bear market risk as it renders services exclusively to its group company is not acceptable. In fact, the taxpayer bears a much bigger market risk viz., single customer risk. As the taxpayer is dependent on its AE its entire existence is dependent on it. If the AE runs out of business or if AE's business gets reduced substantially, th....
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....ributing 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 organization may be lost when an employee leaves the organization. The assessee is in a business which requires skilled manpower to run its business. There are judicial pronouncements which confirm that a trained and assembled workforce has a measurable, identifiable value. One example is Ithica Industries Inc. V. CIT 97 TC 253 where the Appellate Tax Court, USA has reached the conclusion that an in-place work force was an intangible asset with an ascertainable value." 19. After the above discussion, the DRP also referred to the various decisions of the Tribunal wherein a similar claim of the assessee for risk adj....
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.... 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 Assessee 20.41 (5.27) 15.14 4. R Systems International Limited- Segmental Assessee 11.87 (9.27) 8.90 5. Spanco Telesystems & Solutions Limited -Segmental Assessee 7.22 (4.23) 2.99 6. Triton Corp Limited Common 23.81 (4.46) 19.35 7. Mold-Tek Technologies Limited Department 96.66 (13.35) 83.31 8. Crossdomain Solutions Limited Department 26.96 (1.25) 25.71 9. Datamatics Financial Services Limited Segmental Department 34.87 (0.97) 33.90 10. eClerx Services Limited Department 65.88 (2.82) 63.06 Average 32.07 (4.02) 28.04 22. The adjusted average profit margin of comparables at 28.04% was applied by the A.O./TPO to the combined total operating co....
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....k 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 questions specifically referred for the consideration of this Special Bench and answers to these questions thus will decide the issue raised in ground No. 2 of the assessee's appeal as agreed by the ld. Representatives of both the sides. 25. While opening his arguments on the issue involved in question No. 1, the ld. Counsel for the assessee Shri Porus Kaka referred to the relevant portion of the TPO's order for the earlier year at page 5 of his paper book wherein the nature of work performed or services rendered by the assessee company was discussed. He then invited our attention to the specific finding recorded by the A.O. in his final order for the year under consideration clearly accepting that there was no material change in the activities undertaken by the assessee company during the year under consideration. He submitt....
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....nbsp; 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 Assessee arc based on instructions, standardized processes, data, specifications, process notes and statement of work provided by its AE; * Team size generally vary from 17-18 employees with one Team Leader; * Quality or output is generally measured in terms of number of documents / transactions processed, number of punching errors, number of queries, etc.; * Assessee normally operates in three shifts (8 hours each). In contrast, KPO services generally would not have the above characteristics and primarily comprise high end research and analytical services such as software development, Research and Development in pharmaceuticals, Engineering Design services and other such high end value adding services. Qualifications of the employees, Team size and Qu....
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...., 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, preparation, processing and review of shipping documents such as bills of lading, etc and similar support services, following pre-defined procedures and adhering to the set standards and criteria as laid down by the AE and routinely sending the same to the AE as required by them. The Assessee does not have authority to make any decisions (as would he required to be made by an independent KPO) and operates as per the directions and instructions provided by its AE. The activities performed by the Assessee are merely preparatory and auxiliary in nature. Thus the Assessee's role does not involve any judgment or decision making skills and thereby the services provided do not face the risks arising there-from, as in the case of a KPO. Based on the above, it is evident that the environment within which the services are provided b....
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....d 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 always been provided by it's AE * These activities are performed by low skilled employees who are primarily graduate by qualifications, with minimum / no shipping industry knowledge. * Minimum training required to perform the activities * Jobs vacancy advertisement clips by the Assessee appearing in newspaper attached as Annexure 1 for giving a view on how Assessee portrays itself to the job seekers Erroneous categorization as KPO (Cont...) * Assessee providing low end back office support services has been accepted by revenue authorities in earlier years * There has been no change in Assessee's FAR during year under consideration * Employee cost broadly similar in FY 2006-07 and FY 2007-08 (Paper book Page No. 231) * In contrast, KPO services are significantly higher on the value chain and involves processes tha....
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.... 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 exercise of TP adjustment is not permissible and this exercise has to be done following the Rules prescribed. 32. Shri Porus Kaka then proceeded to explain the nature of functions performed by two entities namely Mold-Tek Technologies Limited and eClerx Services Ltd., with the help of relevant documents. He invited our attention to the relevant portion of the annual report of Mold-Tek Technological Services for financial year 2007-08 at page 139 of the paper book wherein the said entity was described as "pioneers in structural engineering services". He also invited our attention to page 140 and 144 of his paper book to point out that almost the entire sales of the said entity for the financial year 2007-08 was on account of export of KPO division. He also brought to our notice the relevant portion at page 145 & 146 of his paper book wherein it was clearly stated that Mold-Tek Technologies Ltd. is providing only structural engineering services and it has suitably enlarged its HRD Deptt. to handle the increasing number of manpower in the KPO ....
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....ain expertise than BPO firm. Professionals continue to learn: and undergo continuous training to learn new procedures and newer interpretations. Consequently, a good KPO firm is likely to be judged more by the depth of knowledge and experience of its professionals than just its Size. India is a preferred destination for KPO because of its large English speaking labour pool, inherent domain expertise due to a large and developed domestic services industry and knowledge and application of internationally accepted quality standards and processes. The country adds more than three million graduates and professional degree and diploma holders annually. It is home to the world's second largest reservoir of engineers and scientists, and the second largest pool of IT manpower. The knowledge services provided by this industry include Investment Research, Legal Research, Sourcing Management, Information Management, Market Research and Analytic Services. Some of the key sectors it services include Banking and Financial Institutions, Legal, Paralegal and Intellectual Property, Contract Research Organizations and the Bio-Pharma Industry. &....
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....of the Mumbai Bench of Tribunal in the case of Willis Processing Services (I) Pvt. Ltd. Vs. DCIT (supra), several Benches of the Tribunal took a view in favour of the assessee, accepting the distinction between BPO and KPO and holding that the BPO service provider cannot be compared with the KPO service provider. He cited two of such decisions one rendered by Hyderabad Bench of ITAT in the case of Capital IQ Information Systems (India) (P.) Ltd. DCIT (I.T.A No. 1961/Hyd.2011 dtd. 23-11-2012 and other rendered by Mumbai Bench of ITAT in the case of Lloyds TSB Global Services Pvt. Ltd Vs. DCIT (ITA No. 5928/Mum/2012 dtd. 21-11-2012). He submitted that even after the decision in the case of Willis Processing Services (I) Pvt. Ltd. rendered on 1-3-2013 taking a view against the assessee, the Tribunal has decided this issue in favour of the assessee in the various decisions rendered thereafter. He filed the copies of such orders of the Tribunal passed in the following cases:- 1. Zavata India Pvt. Ltd. v. DCIT - ITA 1781/Hyd/2011 dtd. 2-7-2013 (2013) 35 taxmann.com 423) 2. PTC Software (I) Pvt. Ltd. v. ACIT ITA 1605/PN/2011 dtd. 30-4-2013 3. Cognizant Technology Services Pvt. Ltd....
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.... and apply the most appropriate transfer pricing method, and the process for selecting and applying a transactional net margin method should not be less reliable than for other methods. As a matter of good practice, the typical process for identifying comparable transactions and using data so obtained which is described at paragraph 3.4 or any equivalent process designed to ensure robustness of the analysis should be followed when applying a transactional net margin method, just as with any other method. That being said, it is recognised that in practice the level of information available on the factors affecting external comparable transactions is often limited. Determining a reliable estimate of an arm's length outcome requires flexibility and the exercise of good judgment. See paragraph 1.13. 2.69 Prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but net profit indicators are less adversely affected by such differences. As with the net margin method resembles, this, however, does not mean that a mere similarity of functions between two enterprises necessarily lead to....
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....ect fixed costs (e.g. fixed manufacturing costs or fixed distribution costs) would affect the net profit indicator but may not affect the gross margin or gross mark-up on costs if not reflected in price differences. See Annex I to Chapter II "Sensitivity of gross and net profit indicators". 2.71 Net profit indicators may be directly affected by such forces operating in the industry as follows: threat of new entrants, competitive position, management efficiency and individual strategies, threat of substitute products, varying cost structures (as reflected, for example, in the age of plant and equipment), differences in the cost of capital (e.g. self financing versus borrowing), and the degree of business experience (e.g. whether the business is in a start-up phase or is mature). Each of these factors in turn can be influenced by numerous other elements. For example, the level of the threat of new entrants will be determined by such elements as product differentiation, capital requirements, and government subsidies and regulations. Some of these elements also may impact the application of the traditional transaction methods. 2.72 As....
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....e overlooked in applying the transactional net margin method. Thus where differences in the characteristics of the enterprises being compared have a material effect on the net profit indicators being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method. See discussion of comparability adjustments at paragraphs 3.47-3.54. 2.75 Another important aspect of comparability is measurement consistency. The net profit indicators must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences in the treatment across enterprises of operating expenses and non-operating expenses affecting the net profits such as depreciation and reserves or provisions that would need to be accounted for in order to achieve reliable comparability." 38. Referring to the relevant portion of the OECD guidelines, Shri Porus Kaka submitted that determining a reliable estimate of arm's length outcome requ....
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....ngth price. 40. Reference was made by Shri Porus Kaka to section A.7.3 of the OECD guidelines dealing with "extreme results in the context of comparability considerations" to point out that extreme results might consist of losses or unusually high profits. It is suggested that extreme results can affect the financial indicators that are looked at in the chosen method and where one or more of the potential comparables have extreme results, further examination would be needed to understand the reasons for such extreme results. He submitted that if the relevant data is secured, further analysis is required to find out the reliability of such data as suggested in the OECD guidelines. He contended that this vital aspect was not considered by the Tribunal in the case of Willis Processing Services (I) Pvt. Ltd. (supra) and the decision was rendered without further analysis or investigation to find out any abnormality and to nullify the effect of such abnormality by applying suitable statistical method. He submitted that even the comparison of functions made by the Tribunal in para 30.10 of its order passed in the case of Wills Processing Services (I) Pvt. Ltd. is very generic which is do....
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....e case of Mentor Graphics (Noida) Pvt. Ltd. v. DCIT, 18 SOT 76 (Delhi) wherein it was held that the first step in the determination of ALP is to analyse the specific characteristics of the controlled transaction so as to make meaningful comparison with the comparables possible. 42. Shri Ajay Vora contended that there are basic and fundamental differences in the characteristics of BPO as compared to KPO. In support of this contention, he relied on the report prepared by the National Skill Development Corporation (NSDC) on Human Resource and Skill Requirements in the IT and ITES Industry Sector (2022) placed at page 7 to 45 of his paper book and took us through the relevant portion thereof. He invited our attention to page 12 of the said report to point out that the expression "ITES" and "BPO" are used interchangeably. He invited our attention to page 19 of the report wherein it is stated that customer interaction and finance and accounting services form a significant portion of BPO services. He contended that the BPO thus is involved in rendering mainly voice and data processing services which are in the nature of low end services. He contended that the KPO services on the other ha....
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....tensive business processes that demand specialised expertise. This delivers high value to organisations by providing much required business expertise. A few examples of KPO businesses are online' teaching, patent filing, legal and insurance claims processing, valuation research, investment research and media content supply. BPO on the other hand, involves a predefined way of handling a business process, which is taught to agents or employees. BPO services normally include transaction processing, setting up a bank account, selling of insurance policies, technical support and voice and email-based support. 6. Contact with clients: Unlike BPOs, KPO employees tend to have greater direct contact both with international clients and with their teams overseas, once again underscoring the need for specialised skills. This could mean establishing direct channels of communication with a team member overseas to seek clarifications in the midst of completing work. If the work involved is complicated, direct communication with the client may also be needed, as seen in several cases of filing tax returns." 44. Shri Ajay Vora contended that even the CBDT now has reco....
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....e services provided by the assessee were broadly categorized therein as Information Technology Enabled Services (ITES) and Information Technology Services (ITS). He submitted that the ITES services provided by the assessee were stated to be that of transaction processing, data entries, reconciliation of statements, audit of shipping documents and other similar support services. He submitted that this nature of services rendered by the assessee again was repeated in the relevant portion of the TP study report appearing on page 65 of the paper book. He also invited our attention to the information relating to the functions performed by the assessee in connection with provision of I.T. enabled services to its AE as given in the relevant portion of the TP study report appearing at page 76 and 78 of the paper book and pointed out that the services performed by the assessee included, inter alia, to reconcile the differences between Equipment Management System and the Transport Plan in Global Customers Service Systems, tender handling, contract drafting and data quality. He contended that all these services rendered by the assessee are clearly in the nature of KPO services and not routine....
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....he Tribunal finally restored the matter to the file of the A.O. with a direction to recompute the ALP margin on the basis of profit margin of all the thirty comparables. He contended that both the entities having higher profit margin thus were finally included and taken as comparables for transfer pricing analysis in assessee's own case for A.Y. 2007-08. 50. As regards the dispute raised by the assessee in respect of filters applied by the TPO for the selection of comparables, Shri Ajeet Kumar Jain contended that different filters are required to be applied in order to find a suitable comparable transaction. He submitted that the objective of such search for comparable companies, as stated in the TP study report submitted by the assessee (relevant portion of the paper book page 88), is to identify a group of independent companies with publicly available data that perform broadly similar functions, operate in broadly similar market and bear broadly similar risk to that of tested party. He invited our attention to the reasons given by the TPO on page 3 & 4 of his order for rejecting the filters applied by the assessee and contended that the same are sufficient to show that the f....
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....52. Shri Ajeet Kumar Jain invited our attention to para 1.38 of the OECD Transfer Pricing Guidelines issued in July, 2010 wherein it is stated that the information on product characteristics might be more important if the method applied is a comparable uncontrolled price method than if it is TNMM. He also relied on para 1.40 of the said guidelines wherein it is stated that the factor of characteristic of property or services must be given more or less weight depending on the transfer pricing method. It is explained that under CUP method, any material difference in the characteristics of property or services can have an effect on the price whereas such difference in the characteristics of property/services is less sensitive in the case of TNMM. It is suggested in para 1.41 that in comparability analysis for method based on gross or net profit indicators, it may be acceptable depending on the facts and circumstances of the case to broaden the scope of comparability analysis to include uncontrolled transactions involving products that are different but where similar functions are undertaken. He submitted that the assessee himself took call centers as well as KPO as comparables and the....
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....broad category of ITES can be taken for the purpose of comparability analysis. In support of this contention, he relied on the decision of Delhi Bench of ITAT in the case of ACTIS Advisors (P.) Ltd. (supra) wherein neither the assessee nor the TPO had gone into functional line horizontal test within ITES inasmuch as the comparables were selected from ITES without applying specifically any qualitative filter and the contention of the assessee seeking further dissection of these comparables was not accepted by the Tribunal observing that there will not be any end in that way and it is a very subjective exercise. Shri Ajeet Kumar Jain contended that the assessee in the present case has also not done any horizontal classification since it has taken call centers and KPO as comparables and since the broad comparability at ITES level is quite fair and proper in the facts and circumstances of the case, the claim of the assessee for further dissection in the form of BPO and KPO should not be accepted. 55. In the rejoinder, Shri Porus Kaka submitted that Rule 10B(2) of the Income Tax Rules, 1962 is applicable in case of all the methods applied for determining the ALP of an international tra....
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....an international transaction, and the most appropriate method to be followed out of the specified methods. While the primary responsibility of determining and applying an arm's length price is on the assessee, sub-section (3) of section 92C empowers the Assessing Officer to determine the arm's length price and compute the total income of the assessee accordingly, subject to the conditions provided therein. The Board has prescribed rules 10A to 10E in the Income-tax Rules, 1962, giving the manner and the circumstances in which different methods would be applied in determining arm's length price and the factors governing the selection of the most appropriate method. These provisions have been enacted with a view to provide a statutory framework which can lead to computation of reasonable, fair and equitable profit and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by altering the prices charged and paid in intra-group transactions leading to erosion of tax revenues. 57. During the course of hearing before us, the ld. Representatives of both the sides have referred to and relied on the OECD Transfer Pricing Guidelines for multina....
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....nsaction, or a number of such transactions, is identified; (ii) such price is adjusted to account for 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 the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or services provided in the international transaction or the specified domestic transaction ; (b) resale price method, by which,- (i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterp....
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....nbsp; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise; (d) profit split method, which may be applicable mainly in international transactions or specified domestic transactions involving transfer of unique intangibles or in multiple international transactions or specified domestic transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining the arm's length price of any one transaction, by which- (i) the combined net profit of the associated enterprises arising from the international transaction or the specified domestic transaction in which they are engaged, is determined; (ii) the relative contribution made by each of the associated enterprises to the earning of such combined net pro....
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....ted enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the 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 the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction 55c [or the specified domestic transaction; (f) any other method as provided in rule 10AB. &n....
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....that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." 59. The manner in which the ALP in relation to an international transaction is to be determined is prescribed in Rule 10B and it is relevant in this context to take into account the specific method followed for determining the ALP in relation to an international transaction. In the present case, the method followed for determining the ALP of an international transaction by the assessee as well as by the A.O./TPO is Transactional Net Margin Method (TNMM) and the comparability of an international transaction with an uncontrolled transaction has to be judged with reference to the functions performed, taking into account the assets employed or to be employed and the risks assumed by the respective parties to the transaction as per Rule 10B(2)(b). The specific characteristics of the property transferred or services provided as envisaged in Rule 10-B(2)(a) in either transactions may not be that relevant to judge the comparability of....
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....tional differences between the controlled and uncontrolled transactions than gross profit margins as the differences in functions performed between enterprises are often reflected in variations in operating expenses leading to wide range of gross profit margin but broadly similar levels of net operating profit indicators. 62. At the time of hearing before us, Shri Porus Kaka has relied on the guidelines given by the OECD in section B-3.1 (para 2.68 to 2.75) in respect of the comparability standard to be applied to the Transactional Net Margin Method. However, as rightly pointed out by the ld. D.R., these guidelines are issued by the OECD as a caution to overcome the number of weaknesses of the TNMM, as clearly mentioned in para 2.64. In any case, we will deal with these guidelines, given by the OECD, subsequently at an appropriate stage. Suffice it to say at this stage that the net profit indicators such as operating profit to operating cost or total cost or total sales are less affected by transactional differences and the same being more tolerant to some functional differences between controlled and uncontrolled transactions, broad functionality can be taken into consideration f....
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....ing held that all the entities providing IT enabled services can be taken as potential comparables by applying a broad functionality test, the next issue that arises is whether further dissection or bifurcation of ITES is possible for rejecting or selecting the potential comparables. 65. A useful reference in this regard can be made to the OECD transfer pricing guidelines. Section A-1 of Chapter III of these guidelines narrates the typical process that is considered as an accepted good practice which can be followed while performing the comparability analysis. One of the steps involved in this process stated as step 2 is "broad-based analysis of the tax payer's circumstances". It is explained in section A-2 (para 3.7) that the "broad-based analysis" is an essential step in the comparability analysis which can be defined as an analysis of the industry, competition, economic and regulatory facts and other elements that affect the tax payer and its environment, but not yet within the context of looking at the specific transactions in question. Section A-5 of Chapter III of the OECD guidelines deals with "selecting or rejecting potential comparables" and suggests that there are ba....
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....s selected by applying the test/criteria given in sub Rule (2) of Rule 10-B if there is any difference found between the enterprises entering into the transactions which materially affects the cost charged or the profit arising from such transaction in the open market. 68. Keeping in view the relevant portion of the OECD T.P. Guidelines discussed above and having regard to the relevant TP regulations as contained in Rule 10-B(3) of Income Tax Rules, 1962, we are of the view that further dissection or classification of ITES services can be done depending on the facts and circumstances of each case so as to select the entities having a relatively equal degree of comparability. 69. Having held that further dissection, bifurcation or classification of IT enabled services may be required to be done to bring into relatively equal degree of comparability, the next question that arises is whether such classification can be done into BPO & KPO services so as to say that the BPO & KPO services have a lesser degree of comparability and cannot be compared with each other. During the course of hearing before us, Shri Ajay Vora has filed a copy of report prepared by National Skill Development ....
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....ant degree or other highly skilled professional qualifications. It is further explained that KPO requires moving away from the simple execution of standardized processes to the implementation of processes that demand advanced analytical and technical skills together with some decision making. The difference between KPO and BPO is also highlighted with particular reference to process, focus, specialization, driving force, activities etc. 71. Shri Porus Kaka and Shri Ajay Vora have relied on the Notification No. SO 2810(E) issued by the CBDT on 18th September, 2013 making Rules 10-TA to Rule 10-TG as Safe Harbour Rules. In clause (e) of Rule IOTA, the term "information technology enabled services" is defined as under:- "'(e) "information technology enabled services" means the following business process outsourcing services provided mainly with the assistance or use of information technology, namely:- (i) back office operations; (ii) call centres or contact centre services; (iii) data processing and data mining; (iv) Insurance claim p....
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....ces rendered by the ITES sector is so wide that a classification of all these services either as low end or high end is always not possible. On the one hand, KPO segment is referred to as a growing area moving beyond simple voice services suggesting thereby that only the simple voice and data services are the low end services of BPO sector while anything beyond that are KPO services. The definition of ITES given in the safe harbour rules, on the other hand, includes inter alia data search integration and analysis services and clinical data-base management services excluding clinical trials. These services which are beyond the simple voice and data services are not included in the definition of KPO services given separately in the safe harbour rules. Even within KPO segment, the level of expertise and special knowledge required to undertake different services may be different. 74. One of the key success factors of the BPO industry is stated to be its ability to move up the value chain through KPO service offering. While KPO is termed as an upward shift of the BPO industry in the value chain, it is also stated that the evolution of majority of Indian BPO sector has given rise to KPO....
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....ively equal degree of comparability. If it is possible by this exercise to determine that some uncontrolled transactions have a lesser degree of comparability than others, they should be eliminated. The examination of controlled transactions ordinarily should be based on the transaction actually undertaken by the AE and the actual transaction should not be disregarded or substituted by other transaction. 77. A useful reference in this regard can be made to the OECD guidelines on Transfer Pricing (including paragraph No. 2.68 to 2.75 thereof relied upon by Shri Porus Kaka) to establish the comparability. As suggested therein, determining a reliable estimate of arm's length outcome requires flexibility and the exercise of good judgment. It is to be kept in mind that the TNMM may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences. When the comparable uncontrolled transactions being used are those of an independent enterprise, a high degree of similarity is required in a number of aspects of the AE and the independent enterprise involved in the transactions in order for the....
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....ternational transactions of the assessee company providing back office support services to their overseas associated enterprises, companies performing KPO functions should be considered as comparable ?. In our opinion, the answer to this question will depend on the facts and circumstances of each case inasmuch as if the assessee company, on the basis of its own functional profile, is found to have provided to its AE the low-end back office support services like voice or data processing services as a whole or substantially the whole, the companies providing mainly high-end services by using their specialized knowledge and domain expertise cannot be considered as comparables. 79. In so far as the present case is concerned, we now proceed to do an exercise of comparability analysis keeping in view the observations made in para 76 to 78 in order to attain relatively equal degree of comparables by taking into consideration the functional profile of the assessee company and comparing the same with that of the entities selected as comparables by TPO/DRP on broad functional analysis taken at ITES level. There are ten entities which are finally selected as comparables in the present case b....
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....by Maersk Automated Rating System (MARS), reports required by local authorities and customs, submit vessel port omission notifications, issue arrival notices, manual entry of surcharges not covered by MARS, confirm and collect invoice details, etc. Agency Operation: - Prepare vessel load and discharge lists; - Clearance of Electronic Data Interchange (EDI) errors in the tracking system; - Update of various operations systems including Global Schedule Information System (GSIS): - Prepare Hazardous and special cargo manifests and lists: - Maintenance and update of the transport plan in GCSS; - Verify and index dangerous good declarations in Global Hazardous Declaration Electronic Replacement (GHDER) system: - Approve hazardous cargo on Maersk Line vessels, etc. Logistics Export/Import handling - Update Shipment details in Maersk logistics Operations and Documents (MODS) system; - Check MODS updates to e....
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....stems and provide support to system implementation. If the problem is not resolved, then the same is escalated to second level support. Process Optimisation Second level support is provided by technical personnel who are expert in specific modules within the corporate systems and provide solutions through remote access control. Employees who are involved in rendering these services require in depth understanding of the system for analyzing system utilization and user behavior. MGSCIPL provides consultancy to Global IS portfolios and Area business teams in areas of deployment support and post implementation audits. MGSCIPL also carries out surveys, identifies the gaps in the process and bridges the same. Technical support MGSCIPL provides following technical support services: * Service desk support which includes desktop and telephony systems, mobility solutions and server support (including setting up of server and optimizing its utilisation): *Resolution to incidents raised by users, including technical set up of devices (PC, l....
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....ces of low-end nature. Going by the functions performed by the assessee to its AEs during the year under consideration, we are of the view the assessee was a captive contract service provider mainly rendering back office support services and such services rendered by it to its AEs involving some degree of special knowledge and expertise formed only small portion of the services rendered by it which essentially were in the nature of incidental services. 81. In so far as the case of Mold-Tek Technologies Ltd. is concerned, it is observed from the annual report of the said company for the financial year 2007-08 placed at page 139 to 151 of the paper book that the said company was pioneer in structural engineering KPO services and its entire business comprised of providing only structural engineering services to various clients. Further information of Mold-Tek Technologies Ltd. available on their Website is furnished in the form of printout at page 158 to 165 of the paper book and a perusal of the same shows that it is a leading provider of engineering and design services with specialization in civil, structural and mechanical engineering services. It is stated to have a strong team o....
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....rgest brands in the world and is recognized as experts in chosen markets-financial services and retail and manufacturing. It is claimed to be providing complete business solutions by combining people, process improvement and automation. It is claimed to have employed over 1500 domain specialists working for the clients. It is claimed that eClerx is a different company with industry specialized services for meeting complex client needs, data analytics KPO service provider specializing in two business verticals - financial services and retail and manufacturing. It is claimed to be engaged in providing solutions that do not just reduce cost, but help the clients increase sales and reduce risk by enhancing efficiencies and by providing valuable insights that empower better decisions. M/s eClerx Services Pvt. Ltd. is also claimed to have a scalable delivery model and solutions offered that include data analytics, operations management, audits and reconciliation, metrics management and reporting services. It also provides tailored process outsourcing and management services along with a multitude of data aggregation, mining and maintenance services. It is claimed that the company has a t....
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....accordingly dismissed. However, keeping in view that the issue involved in Q No. 2 has been specifically referred for the adjudication by this Special Bench, we now proceed to consider and decide the same for the sake of completeness. 86. As regards the issue involved in question No. 2 as to whether in the facts and circumstances of the case, the company earning abnormal high profit margin should be included in the list of comparable cases for the purpose of determining ALP of an international transaction, Shri Porus Kaka referred to the provisions of section 92-C of the Act to point out that the word used therein is "Arithmetic mean" and not "mean" or "average". He contended that the arithmetic mean envisages existence of arithmetic progression meaning thereby that it expects the comparable figures in a specific range. He contended that anything beyond that range therefore should not be taken into consideration. In support of this contention, he relied on the meaning of the expression "arithmetic mean" given in the Concise Oxford Dictionary which says that it is a mean number of arithmetic progression. He relied on the Board Circular No. 14 of 2001 (252 ITR (St.) 103) explaining ....
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..... DCIT [2011] 44 SOT 105 (Mum)(URO) 14. ACIT v. Sonata Software Ltd. [2013] 29 taxmann.com 144 (Mum) 15. Meritor LVS India (P.) Ltd. v. ACIT ITA No. 405/Bang/2011 16. DCIT v. Mitsui O.S.K. Lines Maritime (India) (P.) Ltd. [2011] 48 SOT 155 (Mum.) 17. ITO v. Saunay Jewels (P.) Ltd. [2010] 42 SOT 4 (Mum.) 18. Lintas India (P.) Ltd. v. ACIT [2012] 27 taxmann.com 300 (Mum.) 19. ACIT v. D.A. Jhaveri [2012] 54 SOT 219 (Mum.) 20. Symantec Software Solutions (P.) Ltd. v. ACIT [2012] 25 taxmann.com 163 (Mum.) 21. Adaptec (India) (P.) Ltd. v. DCIT ITA No. 1801/Hyd./09 22. Market Tools Research (P.) Ltd. v. ACIT [2013] 32 taxmann.com 358 (Hyd.) 23. Brigade Global Services (P.) Ltd. v. ITO [2013] 33 taxmann.com 618 (Hyd.) 24. Zavata India (P.) Ltd. v. DCIT [2013] 35 taxmann.com 423 (Hyd.) 25. Cummins Turbo Technologies Ltd. v. Dy. DIT [2013] 35 taxmann.com 350 (Pun) 26. Cognizant Technology Services (P.) Ltd. v. ACIT ITA No. 2106 & 1864 /Hyd./ 2011 27. Sapient Corporation (P.) Ltd. v. Dy. CIT (2011) 11 taxmann.com 69 (Del) 28. Addl. CIT v. UBS Securities India (P.) Ltd. ITA No. 6451/Mum./2011 88. Shri Porus Kaka took us through the relevant portio....
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....ue to fluctuation in foreign currency rates etc. He contended that the consistency of high margin is also required to be seen to find out as to whether the high margin is a normal situation or abnormal. He submitted that in the case of Symantec Software Solutions (P.) Ltd. (supra), three out of thirteen comparables selected by the TPO were showing high magnitude of margin as compared to the remaining 10 entities and the Tribunal held that these three entities should not be taken as comparables on account of their super normal profit since the TPO did not establish on evidence that these super normal profits earned by them was in accordance with normal activities of their business. He contended that whether the high profit is normal or abnormal profit is required to be seen from the relevant facts of each case. He also relied on the decision of the Chandigarh Bench of ITAT in the case of Quark Systems (India) (P.) Ltd. (supra) wherein it was held by the Tribunal in para 13 that if one entity was not treated as comparable by the tax authority on the ground of heavy losses suffered by it, they also have to consider that another entity taken by them as comparable had earned extra ordin....
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....erein it is clarified that under the existing provisions contained in the proviso to the sub-section (2) of section 92-C of the Act, if the application of the most appropriate method leads to determination of more than one price, the arithmetic mean of such prices shall be taken to be the ALP in relation to the international transaction and with a view to allow a degree of flexibility in adopting the ALP, the Finance Act 2002 has amended the said proviso to provide that where the most appropriate method results into more than one price, the price which differs from the arithmetic mean by an amount not exceeding 5% of such mean can be taken to be ALP, at the option of the assessee. 92. As regards the orders of the Tribunal cited by Shri Pours Kaka in support of the assessee's case that the entities earning super normal or abnormal profits should be excluded from the comparables, Shri Ajeet Kumar Jain furnished a chart giving findings recorded by the Tribunal in those cases along with the remark of the Revenue thereon. Referring to the said chart, Shri Ajeet Kumar Jain contended that the Tribunal in the case of Adobe Systems India (P) Ltd. took a view on this issue without much ....
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....vant Rules and even the OECD guidelines have been taken into consideration by the Tribunal while passing the orders. He submitted that in the case of BP India Services (P.) Ltd. (supra), for instance, the fact of comparables earning extreme profits than the profits earned by other comparables was taken note of by the Tribunal and it was held that the very rationale of having average in case of more than one comparables is to iron out the effect of extreme cases and find out the profit margin as a representative of the whole lot. He submitted that even the relevant provisions of Rule 10B(2) and 10B(3) of the Income Tax Rules were taken into consideration by the Tribunal and it was held that nowhere in the said Rules, the higher or lower profit rate has been prescribed as the determinative factor to make a case incomparable. It was also held 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. 94. Reliance was placed by Shri Ajeet Kumar Jain on the decision of the Tribunal the case of 24/7 Customer.Com (P.) Ltd. (supra), wherein it was held by the Bangalore Bench that the exclusion of companies wi....
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....hat these paras are part of section A-7 of the OECD commentary dealing with arm's length range and it is suggested that if such range includes a sizeable number of observations, statistical tools that take account of central tendency to narrow the range (e.g. the inter-quartile range or other percentile) might help to enhance reliability of the analysis. He contended that there is no such arm's length range recognized by Transfer Pricing Regulations in India and the statistical tool to take account of central tendency to narrow the range in order to enhance reliability of the analysis in TP regulations in India is arithmetic mean and not inter quartile range or other percentile as suggested in the OECD guidelines. He contended that para 3.63 to 3.66 of the OECD guidelines dealing with extreme results in the context of the arm's length range thus are not relevant in the Indian context and the reliance of Shri Porus Kaka thereon is clearly misplaced. 96. We have considered the rival submissions on the issue involved in Question No. 2 referred to this Special Bench relating to exclusion of high margin comparables and also perused the relevant material available on record.....
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....ng five were in the range of 15 to 35% and their average profit margin by calculating the arithmetic mean was 28.04%. This working made in assessee's own case thus clearly shows that the extreme values in both the end of spectrum do not materially affect the arithmetic mean and such extreme values are taken care of when the arithmetic mean is used as the measure of central tendency. 97. At the time of hearing before us, both the sides have cited several decisions of the Tribunal in support of their corresponding stand taken on this issue. After going through all these decisions of the Division Benches of this Tribunal, we find that the issue relating to exclusion of high profit margin entities from comparables has been decided in favour of the assessee in the cases cited by Shri Porus Kaka without taking into consideration some vital aspects including the relevant TP Regulations in India. It is observed that the decision initially taken in one case without much meaningful discussion has been invariably followed by the Tribunal in other cases decided thereafter. On the other hand, it is observed that the Tribunal, in some of the cases cited by Shri Ajeet Kumar Jain, the ld. CIT....
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....e is deviation in this respect in T.P. Regulations in India which specify the Arithmetic Mean for determining the ALP. Neverthless, the OECD TP Guidelines have considered and dealt with the situation of extreme results in the context of comparability consideration in section A.7.3 of chapter III and it is ++++++ suggested in para 2.63 that where one or more of potential comparables have extreme results consisting loss or unusual high profits, further examination would be needed to understand the reasons for extreme results. After taking into consideration this guidance provided in OECD Transfer Pricing Guidelines and on analyzing the decisions rendered by the Division benches of this Tribunal on this issue after taking into consideration inter alia the T.P. Regulations in India as discussed above, we are of the view that the potential comparables cannot be excluded merely on the ground that their profit is abnormally high. In our opinion, the matter in such case would require further investigation to ascertain the reasons for unusual high profit and in order to establish whether the entities with such high profit can be taken as comparables or not. 99. The question No. 2 referred....