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TMI Blog2018 (8) TMI 592X X X X Extracts X X X X X X X X Extracts X X X X ..... ion urged with respect to the notional interest attributed to the assessee and for which adjustment was made by the Transfer Pricing Officer (TPO), was finally affirmed by the ITAT. By the order dated 07.02.2018, this Court considered the submissions of the parties and was of the opinion that having regard to the considered view in the case of Pr. CIT v. Kusum Health Care Pvt. Ltd. [ITA No.765/2016, decided on 25.04.2017], the matter requires further examination/scrutiny; the reasons for the credit or delay in payment needs to be examined. 3. The matter was, therefore, remitted to the ITAT with directions to file a report, if deemed necessary. All the rights of the parties were reserved. The following question of law arises in ITA 590/2017 & ITA 82/2018: "Did the ITAT fall into error in excluding the relative comparables which were held to be irrelevant for the purpose of ALP determination in the circumstances of the case?" 4. The assessee is a company incorporated under the Companies Act, 1956 and is a wholly owned subsidiary of McKinsey Holding Inc., USA. The business operations of the Assessee can be broadly divided into two divisions, namely: (a) Research and Information S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccepted as the Profit Level Indicator (PLI) by the TPO. However, out of 16 companies selected by the assessee as comparable companies, the TPO rejected 14 (including non-Indian companies). A final list of 8 comparable companies, including two companies chosen by the Assessee was finally drawn up by the TPO. On 28.01.2015, the TPO passed an order under Section 92CA(3) of the Act proposing upward adjustment of Rs. 1,02,66,664/- in respect of provision of IT Support Services and Rs. 27,33,96,137/- in respect of provision of Research and Information Services. Further, the TPO also proposed addition of Rs. 8,89,039/- in respect of account of receivables. The AO passed the Draft Assessment Order on 24.02.2015 after proposing an addition of Rs. 28,45,51,840/- on account of transfer pricing adjustment. 7. The assessee, being aggrieved, went before the Disputes Resolution Panel (DRP), which allowed part relief to the Assessee. The DRP by order, dated 02.11.2015, rejected the assessee's objection as regards functional comparability of (a) M/s Aditya Birla Capital Advisors Pvt. Ltd., (b) Birla Sunlife Asset Management Company Ltd, and (c) ICRA Ltd. selected by the TPO held as comparable for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g ALP. The TPO pursuant to examination of the transfer pricing documents passed order dated 29.01.2016 under section 92CA(3) of the Act and proposed an upwards adjustments of Rs. 34,19,39,145/- in respect of Provision for Research & Information Services. Further, the TPO also proposed an adjustment on account of outstanding receivables and interest thereon amounting to Rs. 14,90,875/-. 10. In respect of the research and information services, the assessee had selected 18 comparables companies whose average of adjusted operating margins was 14.50% on operating cost. According to it, the PLI was 15.17%, and was higher than the average of adjusted operating margins of the comparables. However, the TPO rejected foreign companies as comparables and finally selected 8 comparables computing average PLI of 36.48%. Accordingly, the TPO made an order dated 29.01.2016 under section 92CA(3) of the Act and proposed an upwards adjustments of Rs. 34,19,39,145/- in respect of provision for Research & Information Services. Further, the TPO also proposed an adjustment on account of outstanding receivables and interest thereon amounting to Rs. 14,90,875/-. 11. The AO passed the Draft Assessment Orde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee for enabling them to service their clients. The Assessee carries out research from the internet based database or other source and then compiles the data, which is further customized according to the requirement of the requestor before transmission to the overseas group companies so that McKinsey group entities could consider them for providing consultancy services. 15. Further, it was submitted that under the R&I segment, it has rendered data processing services which are in the nature of Business Process Outsourcing (BPO). The assessee contests the ITAT's order stating that while holding it to be a KPO, it has overlooked the fact that it has established that to carrying on research from the internet based databases or other sources to compile data, which is then customized/processed in accordance with the requirements of the requesting party. The assessee also submitted that the ITAT in its previous case (in AY 2006-07) observed that the services rendered by it were in the nature of customization of data/data processing and that the assessee acts as a "back office" providing "support services" to its parent company, thereby, essentially accepting that the Assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es to be prospectively applicable. The Assessee is, thus, challenging the impugned order of the ITAT on the ground that the nature of services provided by the Appellant under the R&I segment are not in the nature of KPO services, and the ITAT order holding otherwise is contrary to the material on record and perverse in law. 18. The Assessee cited Rushabh Diamonds v. ACIT, Mumbai [2016] 48 ITR(T) 707 (Mumbai- Trib.), where it was held as follows: "12. In our considered view, even if we proceed on the basis that Explanation to Section 92B is indeed retrospective in effect and it does cover delay in realization of debts, as long as sale is benchmarked on TNMM basis, as in this situation before us, there cannot be any occasion to make a separate adjustment for delay in realization of debts. The reason is that the interest income is an integral part of the PBIT inasmuch as interest income, in cases other than finance companies, is required to be included in the 'other income' and thus affects the profit before interest and taxes. While profit before interest and taxes does not take into account 'interest expenditure', it does take into account 'interest income' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fic anti abuse rule), and that every anti abuse legislation, whether SAAR (specific anti abuse rule) or GAAR (general anti abuse rule), is a legislation seeking the taxpayers to organize their affairs in a manner compliant with the norms set out in such anti abuse legislation. An anti-abuse legislation does not trigger the levy of taxes; it only tells you what behaviour is acceptable or what IS not acceptable. What triggers levy of taxes IS noncompliance with the manner in which the anti-abuse regulations require the taxpayers to conduct their affairs. In that sense, all anti abuse legislations seek a certain degree of compliance with the norms set out therein. It is, therefore, only elementary that amendments in the anti-abuse legislations can only be prospective. It does not make sense that someone tells you today as to how you should have behaved yesterday, and then goes on to levy a tax because you did not behave in that manner yesterday. ****************************************************************** 39. It is for this reason that the Explanation to Section 92B, though stated to be clarificatory and stated to be effective from 1st April 2002, has to be necessarily treated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpugned order of ITAT erred in law and on facts in rejecting high profit margin comparables by disregarding broad similarity between functions performed, assets used and risk undertaken by the assessee and the comparables excluded by the Tribunal by ignoring the findings of facts recorded by the TPO. The decision of Mumbai International Airport Private Limited v. Golden Chariot (2010) 10 SCC 422 was also highlighted, wherein, it has been held by the Apex Court with regard to "doctrine of election" and "doctrine of approbation and reprobation" that the litigant cannot change and choose its stand to suit its convenience. In the facts of the present case, it was asserted that the assessee could not change their stand that stringent standards of comparability analysis should not be applied to low profit margin comparables while it should be applied to high profit margin comparables to suit its convenience. It was asserted that the Assessee, as well, as the companies selected by the TPO as comparables are engaged in the business of providing advisory services in various fields and these advisory services were in the form of knowledge services which required not only analysis but interpr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tax any notional income but to ensure that the real income is brought to tax under the Act. This has also been explained by a Division Bench of this Court in Sony Ericsson Mobile Communications India Pvt. Ltd. and Ors. v. Commissioner of Income Tax-III and Ors. 374 ITR 118 in the following words:- "77. As a concept and principle Chapter X does not artificially broaden, expand or deviate from the concept of "real income". "Real income", as held by the Supreme Court in Poona Electricity Supply Company Limited versus CIT, [1965] 57 ITR 521 (SC), means profits arrived at on commercial principles, subject to the provisions of the Act. Profits and gains should be true and correct profits and gains, neither under nor over stated. Arm's length price seeks to correct distortion and shifting of profits to tax the actual income earned by a resident/domestic AE. The profit which would have accrued had arm's length conditions prevailed is brought to tax. Misreporting, if any, on account of non-arm's length conditions resulting in lower profits, is corrected." 14. The substratal rationale of the transfer pricing regulations is to ensure that the true income of an Assessee is brou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s as the board may prescribe; read with Rule 10B of the Income Tax Rules, 1962 which provides for calculation/determination of ALP. Where more than one price is determined by the most appropriate method, the Arm's Length Price shall be taken to be arithmetical mean of such prices. Rule 10B(2) describes the grounds on which the comparability of an international transaction (or a specified domestic transaction) with an uncontrolled transaction should be based on. This sub-rule reads as follows: "Determination of arm's length price under section 92C 10B(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ule 10B(2) expressly indicate that the specific characteristics of the services provided and the functions performed would be factors for considering the comparability of uncontrolled transactions with controlled transactions." 26. Examining the analysis of the functions of the assessee in the ITAT orders, reference can be made to the Master Services Agreement entered into by the Assessee with McKinsey and Co. Inc., USA w.e.f. 1st April, 2010. It is a common agreement between the Assessee and McKinsey, USA for providing both the 'Research and information services' and also 'IT support services'. The preamble part of this agreement provides as follows: "WHEREAS: (A) The Client is in need of assistance in the development, maintenance and service software and information/research related products and services. Further, the Client requires assistance with respect to knowledge management systems and infrastructure related issues like server problems, hosting of Notes databases, problems with documents in the Notes databases." 27. From the Agreement, it appears that the assessee's functions are also inclusive of 'Knowledge management systems and infrastructure issues which wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n Incentive Scheme for BPO Centers and KPO Centers, 2011". The said scheme is for providing incentives to promote ITeS and to generate further employment opportunities. In terms of the said scheme, "Business Process Outsourcing (BPO)" is defined to mean "the transfer of an organization's entire noncore but critical business process/function to an external centre which uses an IT based service delivery" and "Knowledge Processing Outsourcing (KPO) "has been defined to mean "allocation of relatively high-level tasks to an outside organization or a different group (possibly in a different location) within the same organization. KPO is, essentially, high-end Business Process Outsourcing (BPO)". *************************************************** ************************** 33. ...The Special Bench of the Tribunal held that even though there appears to be a difference between BPO and KPO Services, the line of difference is very thin. The Tribunal was of the view that there could be a significant overlap in their activities and it may be difficult to classify services strictly as falling under the category of either a BPO or a KPO. The Tribunal also observed that one of the key succ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Master Service Agreement, sample copies of service requests, as well as the McKinsey India website (as quoted from, above), concluded that it was undeniable that the assessee was providing knowledge-based research and information services. There is clearly a form of knowledge intensive analysis that is rendered by the Assessee which is a more nuanced and involved service than that which is provided by a BPO. A similar conclusion was arrived at in New River Software Services Pvt. Ltd. v. ACIT Circle- 13(1) (27.03.2015 - ITAT Delhi), which ruled that: "...The employee actually undertaking these services was required to analyse various datas by employing his special knowledge and then only it could provide its AE with necessary support. It cannot be denied that these were high end services, requiring strategic decision making before arriving at final conclusion. We, therefore, are not inclined to accept the assessee's submissions that it was mere a BPO. The various decisions relied upon by ld. counsel for the assessee are primarily with reference to BPO and not KPO. The distinction elucidated in Safer Harbour Rules is also in same lines. 30. Likewise, in Maersk Global Cent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;...." This explanation was explained in Ameriprise India Pvt. Ltd. v. ACIT (supra) as follows: "22. On going through the relevant part of the Explanation inserted with retrospective effect from 1.4.2002, thereby also covering the assessment year under consideration, there remains no doubt that apart from any long-term or short-term lending or borrowing, etc., or any type of advance payments or deferred payments, 'any other debt arising during the course of business' has also been expressly recognized as an international transaction. That being so, the payment/nonpayment of interest or receipt/non-receipt of interest on the loans accepted or allowed in the circumstances as mentioned in this clause of the Explanation, also become international transactions, requiring the determination of their ALP. If the payment of interest is excessive or there is no or low receipt of interest, then such interest expense/income need to be brought to its ALP. The expression 'debt arising during the co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a redundant contention, because as has been highlighted by the ITAT, by a plain reading of the (retrospectively applicable) amendment that introduced the Explanation to section 92B of the Act by Finance Act, 2012, it is determinable that if there is any delay in the realization of a trading debt arising from the sale of goods or services rendered in the course of carrying on the business, it is liable to be visited with transfer pricing adjustment on account of interest income short charged/uncharged. Hence, the assessee's contention that the ITAT erred in concluding that charging of interest on delayed receipt of receivables is a separate international transaction which requires to be benchmarked independently, is incorrect. 34. In the revenue's appeals, it is important to notice that the significance of the similarity of comparables in the determination of the ALP was been highlighted in Rampgreen (supra) by citing the "Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations" (OECD Guidelines) published in 2010, that indicates the "comparability factors" which are important while considerin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices can have an effect on the price and would require an appropriate adjustment to be considered (see in particular paragraph 2.15). Under the resale price method and cost plus method, some differences in the characteristics of property or services are less likely to have a material effect on the gross profit margin or mark- up on costs (see in particular paragraphs 2.23 and 2.41). Differences in the characteristics of property or services are also less sensitive in the case of the transactional profit methods than in the case of traditional transaction methods (see in particular paragraph 2.69). This however does not mean that the question of comparability in characteristics of property or services can be ignored when applying these methods, because it may be that product differences entail or reflect different functions performed, assets used and/or risks assumed by the tested party. See paragraphs 3.18-3.19 for a discussion of the notion of tested party. 1.41 In practice, it has been observed that comparability analyses for methods based on gross or net profit indicators often put more emphasis on functional similarities than on product similarities. Depending on the facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t and equipment, the use of valuable intangibles, financial assets, etc., and the nature of the assets used, such as the age, market value, location, property right protections available, etc. 1.45 Controlled and uncontrolled transactions and entities are not comparable if there are significant differences in the risks assumed for which appropriate adjustments cannot be made. Functional analysis is incomplete unless the material risks assumed by each party have been considered since the assumption or allocation of risks would influence the conditions of transactions between the associated enterprises. Usually, in the open market, the assumption of increased risk would also be compensated by an increase in the expected return, although the actual return may or may not increase depending on the degree to which the risks are actually realised. 1.46 The types of risks to consider include market risks, such as input cost and output price fluctuations; risks of loss associated with the investment in and use of property, plant, and equipment; risks of the success or failure of investment in research and development; financial risks such as those caused by currency exchange rate and inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntrolled transaction/entity. Comparability of controlled and uncontrolled transactions has to be judged, inter alia, with reference to comparability factors as indicated under rule 10B(2) of the Income Tax Rules, 1962. Comparability analysis by TNMM method may be less sensitive to certain dissimilarities between the tested party and the comparables. However, that cannot be the consideration for diluting the standards of selecting comparable transactions/entities. A higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable ALP. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in PLI must trigger further investigations/analysis. 44. Consideration for a transaction would reflect the functions performed, the significant activities undertaken, the assets or resources used/consumed, the risks assumed. Thus, comparison of activities undertaken/functions performed is important for determining the comparability between controlled and uncontrolled transactions/entity. It would not be apposite to ignore functional dissimilarity only for the reason that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in such cases, clarify that any attempt to use the transactional net margin method should begin by comparing the net margin which the tested party makes from a controlled transaction with the net margin it makes from an uncontrolled one (an "internal comparable"). If this proves impossible, possibly if there are no transactions with uncontrolled parties, then the net margin that would have been made by an independent enterprise in a comparable transaction (an "external comparable") serves as a guide to determine the arm's length price. Here, the strict criterion is of an independent enterprise, carrying out a comparable transaction, with the caveat that this will be only a guide. Indeed, the emphasis is very clearly on finding a comparable transaction. In addition, a functional analysis of both the associated enterprise and the independent enterprise is required to determine if the transactions are comparable. It might of course be possible to adjust results for minor functional differences, provided that there is sufficient comparability to begin with. The standard of comparability for application of the transactional net margin method is not less than that for the application ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loan rating, corporate governance rating, stakeholder value and governance rating, rating of claims paying ability of insurance companies, project finance rating and also 'grading services' comprising of IPOs, micro financial institutions, construction entitles, real estate developers and projects, etc. The description of the nature of services rendered by this company makes it vivid that it has no proximity to the nature of services rendered by the Assessee under this segment, which is basically in the nature of carrying out research from the internet based databases for compiling the data, which is then customized/processed in accordance with the requirements of the requester and then organized into templates in excel, power point, etc., before transmitting outside India. There being no closeness with the functions performed by the assessee, this company is directed to be excluded from the list of comparables. Ladderup Corporate Advisory Pvt. Ltd. This company provides a one-stop financial advisory and fund raising solutions in Investment Banking, Capital Markets, Wealth Management Project Finance and Growth stage investing. On an overview of the nature of business carried out ..... X X X X Extracts X X X X X X X X Extracts X X X X
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