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TMI Blog2015 (8) TMI 931X X X X Extracts X X X X X X X X Extracts X X X X ..... der routine customer support for their clients. Clearly, characteristics of the service rendered would be dissimilar. Further, both service providers cannot be considered to be functionally similar. Their business environment would be entirely different, the demand and supply for the services would be different, the assets and capital employed would differ, the competence required to operate the two services would be different. Each of the aforesaid factors would have a material bearing on the profitability of the two entities. Treating the said entities to be comparables only for the reason that they use Information Technology for the delivery of their services, would, in our opinion, be erroneous. See Maersk Global Centers case [2014 (3) TMI 891 - ITAT MUMBAI ] Both Vishal and eClerx could not be taken as comparables for determining the ALP. Vishal and eClerx, both are into KPO Services. E-Clerx is engaged in data analytics, data processing services, pricing analytics, bundling optimization, content operation, sales and marketing support, product data management, revenue management. In addition, eClerx also offered financial services such as real-time capital markets, middle ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bles as the functions performed and the services rendered by the said companies were materially different from those performed by the Assessee. 3. This Court, by an order dated 27th February, 2015, admitted the present appeal and framed the following questions of law:- 1. Did the ITAT fall into error in the given circumstances of the case in confirming the transfer pricing adjustment to the extent of ₹ 5,92,07,428/- upholding the inclusion of two comparable, i.e., e-Clerx Services Limited and Vishal Information Technologies Limited, now called as Coral Hub Ltd.? 2. Did the ITAT fall into error in not appreciating the terms of Rule l0B (2) of the Rules in respect of the analysis of functionally comparable companies? 4. The factual context in which the aforesaid questions of law arise are briefly stated as under:- 4.1 The Assessee is a wholly owned subsidiary of vCustomer, USA, (an Associated Enterprise - hereafter AE ). The Assessee is engaged in providing voice-based customer care to the AE s clients. The Assessee renders Call Center services, which fall within the broad description of Information Technology Enables Services (hereafter ITeS ). The Assessee h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... im for any adjustment on account of working capital provided to the Assessee and/or risks borne by the AE. The TPO proceeded to identify a different set of comparable companies for the purposes of determining the ALP. The companies selected by the TPO which were considered to be comparables included eClerx and Vishal (subsequently known as Coral Hub Ltd.). The TPO computed the average operating profit margin of the comparable companies at 28.96% on the basis of the average operating profit margin of eleven companies selected by the TPO as comparables for the purposes of benchmarking the international transactions. On the aforesaid basis, the TPO computed the TP Adjustment at ₹ 11,00,35,400/-. The AO incorporated the aforesaid adjustment in the draft assessment order passed under Section 144C(1) of the Act on 20th December, 2011. The Assessee objected to the draft assessment order dated 20th December, 2011 before the DRP. The Assessee impugned the draft assessment order on several grounds including selection of certain companies as comparables and exclusion of other companies considered as appropriate comparables by the Assessee. 6. The DRP accepted the Assessee s contentio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he relevant year, the hire charges, vendor payments constituted almost 87% of the total costs. According to the Assessee, this evidenced that Vishal s business model was different and Vishal had outsourced significant part of its operations. 9. The Tribunal rejected the Assessee s contention and held that both eClerx and Vishal were engaged in providing ITeS and once a service fell within that category then no sub-classification of the segment was permissible. The Tribunal held that KPO is a term given to the branch of BPO Services where apart from processing of data, knowledge is also applied. The Assessee s objection that the said two companies had abnormally high profits and thus ought to be excluded as comparables was also rejected. 10. The learned counsel for the Assessee submitted that eClerx and Vishal were KPO service providers and could not be considered as comparables for the purposes of benchmarking the Assessee s international transactions with the AE. The learned counsel referred to the decision of the Special Bench of the Tribunal in Maersk Global Centers (India) Pvt. Ltd. v. ACIT, ITA 7466/Mum/2012, dated 7th March, 2014 and submitted that the issue of whether ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer profits, is corrected. 14. The substratal rationale of the transfer pricing regulations is to ensure that the true income of an Assessee is brought to tax under the Act and there is no avoidance of tax by transfer of income from India to any other tax jurisdiction by virtue of the influence exercised by the associated enterprises. The aim of the provisions of Chapter X of the Act is to compute the income in relation to a controlled transaction between an Assessee and its associated enterprise having regard to ALP, in order to nullify the effect of transfer of income to a jurisdiction outside India, if any, in respect of the controlled transactions. 15. The exercise of determining the ALP in respect of international transactions between the related enterprises is aimed to determine the price, which would have been charged for products and services, as nearly as possible, in case such international transactions were not controlled by virtue of them being executed between related parties. The object of the exercise is, thus, to remove the effect of any influence on the prices or costs that may have been exerted on account of the international transactions being entered into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntral Government in the Official Gazette in this behalf, the price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm's length price : Provided also that where more than one price is determined by the most appropriate method, the arm's length price in relation to an international transaction or specified domestic transaction undertaken on or after the 1st day of April, 2014, shall be computed in such manner as may be prescribed and accordingly the first and second proviso shall not apply. Explanation.-For the removal of doubts, it is hereby clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, 2009. 19. It is also necessary to refer to Rule 10B of the Income Tax Rules, 1962 which provides for determination of ALP under Section 92C of the Act. Sub-rule(1) of Rule 10B contains provisions in relation to various methods of calculation of ALP as provided under Section 92C of the Act and reads as under:- 10B. (1) For the purposes of sub-section (2) of se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thod, 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 subclause (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; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under subclause (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 serv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 margin realised by the enterprise or by an unrelated 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 subclause (iii); (v) the net profit margin thus establish ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 22. In the facts of the present case, it is not disputed that Vishal and eClerx are entities engaged in Knowledge Process Outsourcing Services (KPO Services). Thus, the principal question to be addressed is whether a KPO Service provider could be considered as a comparable for benchmarking international transactions entered into by an entity rendering ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , Voice Call Centers are normally involved in customer support and processing of routine data. In the case of Maersk Global Centers (India) Pvt. Ltd. v. ACIT (supra) a Special Bench of the Tribunal had referred to a report prepared by National Skill Development Corporation (NSDC) on Human Resource and Skill Requirements in IT and ITES Sector (2022) and noted that the KPO sector has been described as a value play . The said report also indicates that KPO services are likely to span activities such as patent advisory, high-end research and analytics, online market research and legal advisory . 26. A Knowledge Process is understood as a high value added process chain wherein the processes are dependent on advanced skills, domain knowledge and the experience of the persons carrying on such processes. 27. The Government of Rajasthan (Department of Information Technology Communication) has also floated a scheme on 12th December, 2011 known as The Rajasthan Incentive Scheme for BPO Centers and KPO Centers, 2011 . The said scheme is for providing incentives to promote ITeS and to generate further employment opportunities. In terms of the said scheme, Business Process Outsourcin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n into account. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm s length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm's length transactions. Attributes or comparability factors that may be important when determining comparability include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties. These comparability factors are discussed in more detail at Section D.1.2 below. xxxx xxxx xxxx xxxx 1.39 Differences in the specific characteristics of property or services often account, at least in part, for differences in their value in the open market. Therefore, comparisons of these features may be useful in determining the comparability of controlled and uncontrolled transactions. Characteristics that may be important to consider include the following: in the case of transfers of tangible property, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er or not more reliable data are available. Before broadening the search to include a larger number of potentially comparable uncontrolled transactions based on similar functions being undertaken, thought should be given to whether such transactions are likely to offer reliable comparables for the controlled transaction. D.1.2.2 Functional analysis 1.42 In transactions between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, a functional analysis is necessary. This functional analysis seeks to identify and compare the economically significant activities and responsibilities undertaken, assets used and risks assumed by the parties to the transactions. For this purpose, it may be helpful to understand the structure and organisation of the group and how they influence the context in which the taxpayer operates. It will also be relevant to determine the legal rights and obligations of the taxpayer in performing its functions. 1.43 The functions that taxpayers and tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity of data in producing a sufficiently reliable analysis. See paragraphs 3.2, 3.38 and 3.46. 31. In the present case, the Tribunal noted that Vishal and eClerx were both engaged in rendering ITeS. The Tribunal held that, once a service falls under the category of ITeS, then there is no sub-classification of segment . Thus, according to the Tribunal, no differentiation could be made between the entities rendering ITeS. We find it difficult to accept this view as it is contrary to the fundamental rationale of determining ALP by comparing controlled transactions/entities with similar uncontrolled transactions/entities. ITeS encompasses a wide spectrum of services that use Information Technology based delivery. Such services could include rendering highly technical services by qualified technical personnel, involving advanced skills and knowledge, such as engineering, design and support. While, on the other end of the spectrum ITeS would also include voice-based call centers that render routine customer support for their clients. Clearly, characteristics of the service rendered would be dissimilar. Further, both service providers cannot be considered to be functionally similar. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s as to the Tribunal s aforesaid view in Maersk Global Centers (India) Pvt. Ltd. (supra). As indicated above, the expression BPO and KPO are, plainly, understood in the sense that whereas, BPO does not necessarily involve advanced skills and knowledge; KPO, on the other hand, would involve employment of advanced skills and knowledge for providing services. Thus, the expression KPO in common parlance is used to indicate an ITeS provider providing a completely different nature of service than any other BPO service provider. A KPO service provider would also be functionally different from other BPO service providers, inasmuch as the responsibilities undertaken, the activities performed, the quality of resources employed would be materially different. In the circumstances, we are unable to agree that broadly ITeS sector can be used for selecting comparables without making a conscious selection as to the quality and nature of the content of services. Rule 10B(2)(a) of the Income Tax Rules, 1962 mandates that the comparability of controlled and uncontrolled transactions be judged with reference to service/product characteristics. This factor cannot be undermined by using a broad cl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... both Vishal and eClerx could not be taken as comparables for determining the ALP. Vishal and eClerx, both are into KPO Services. In Maersk Global Centers (India) Pvt. Ltd. (supra), the Special Bench of the Tribunal had noted that eClerx is engaged in data analytics, data processing services, pricing analytics, bundling optimization, content operation, sales and marketing support, product data management, revenue management. In addition, eClerx also offered financial services such as real-time capital markets, middle and back-office support, portfolio risk management services and various critical data management services. Clearly, the aforesaid services are not comparable with the services rendered by the Assessee. Further, the functions undertaken (i.e. the activities performed) are also not comparable with the Assessee. In our view, the Tribunal erred in holding that the functions performed by the Assessee were broadly similar to that of eClerx or Vishal. The operating margin of eClerx, thus, could not be included to arrive at an ALP of controlled transactions, which were materially different in its content and value. In Maersk Global Centers (India) Pvt. Ltd. (supra), the Special ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h, as the same is not provided for in the statutory framework. The OECD Guidelines suggest that a quartile method be adopted which excludes entities that fall in the extreme quartiles for comparability. However, neither Chapter X of the Act nor the Rules made by CBDT provide for exclusion for such statistical reason. 41. Having stated the same, it may be necessary to bear in mind that supernormal profits may in certain cases indicate a functional dissimilarity or dissimilarity with respect to a feature that has a material bearing on the profitability. In such circumstances, it would be necessary to undertake further analysis to eliminate the possibility of the high profits resulting on account of any material dissimilarity between the tested party and the chosen comparable. A wide deviation in the PLI amongst selected comparables could be indicative that the comparables selected are either materially dissimilar or the data used is not reliable. The Tribunal proceeded on the basis that an adjustment could be made only in cases where supernormal profits resulted from the factors indicated in Rule 10B of the Income Tax Rules, 1962. In our view, the factors mentioned in Rule 10B are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparability between controlled and uncontrolled transactions/entity. It would not be apposite to ignore functional dissimilarity only for the reason that its impact may be reduced on account of using arithmetical mean of the PLI. The DRP had noted that eClerx was functionally dissimilar, but ignored the same relying on an assumption that the functional dissimilarity would be subsumed in the profit margin. As noted, the content of services provided by the Assessee and the entities in question were not similar. In addition, there were also functional dissimilarities between the Assessee and the two entities in question. In our view, these comparability factors could not be ignored by the Tribunal. While using TNMM, the search for comparables may be broadened by including comparables offering services/products which are not entirely similar to the controlled transaction/entity. However, this can be done only if (a) the functions performed by the tested party and the selected comparable entity are similar including the assets used and the risks assumed; and (b) the difference in services/products offered has no material bearing on the profitability. 45. In view of the aforesaid, t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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