M/s. Mckinsey Knowledge Centre India pvt. Ltd. Vs PCIT (Delhi High Court)
The revenue urged that a stringent application of the comparability test was unnecessary as was also provisioned in Chapter-6 of United Nations Practical Manual on Transfer Pricing, Edition 2013, and some flexibility in conducting this comparison was urged to be allowed.
However, from the above analysis, in the present appeals, even if due consideration is given to a certain level of dissimilarity between the Assessee and the comparable companies, it can be observed that the nature of services provided by the above mentioned comparable companies do not demonstrate even a degree of similarity with the services rendered by the Assessee that would be sufficient to qualify under rule 10B(2) of the Income Tax Rules, since, as established above, the Assessee‟s services under its R&I segment are in the nature of services provided by a KPO and they are functionally dissimilar from the comparable companies, in terms of their services as well as their risk profiles.
Relevantly reading what was highlighted in Rampgreen (supra) that 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, inter alia, the difference in services/products offered has no material bearing on the profitability, and do not have functional differences or any differences in their risk profiles. Thus, it can be concluded that the ITAT was correct in excluding the above-mentioned comparable companies.
FULL TEXT OF THE HIGH COURT ORDER / JUDGMENT
1. This judgment will dispose of four cross appeals (ITA 461/2017, ITA 590/2017 and ITA 82/2018, ITA 526/2017), two filed by M/s. Mc Kinsey Knowledge Centre India Pvt. Ltd. (the Assessee), and the respective opposing two by the Revenue, as they address the same questions of law. The following question of law arises in ITA 461/2017 & ITA 526/2017:
(1) Did the ITAT commit an error in law in holding that the assessee was engaged in knowledge management systems and international transactions/activities in respect of one of the services rendered to its associated enterprises, i.e. AE.”
2. In ITA 461/2017 & ITA 526/2017, the other question 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 Services Division
The Research and Information (R&I) Services Division can be further divided into through 3 sub-groups- (a) Knowledge On Call Group – provides journalistic research information support. The services offered include financial analysis. (b) Practice Research Group – focuses on domain specific research support. The services provided include sector data and analysis, capital market insights, perspectives and industry trends and (c) Analytics Group – focuses primarily on time intensive analysis requiring expertise and analytical tools and techniques. The services provided include data analysis, model/tool development, proprietary database management, practice specialized analytics.
(b) IT Support Services Division
The IT Support Division provides services which include data-based administration support for maintenance of application infrastructure, unloading and correction of data on servers.
5. ITA 461/2017 (by the assessee), challenges an order of the Income Tax Appellate (ITAT) dated 15.12.2016, for assessment year (hereinafter referred to as “AY”) 2011-12. The revenue‟s appeal ITA No. 590/20 7 questions the same order. By the impugned order dated 15.12.2016, the ITAT partly allowed the assess e‟s appeal and directed exclusion of four comparables, namely Aditya Birla Capital Advisors Pvt. Ltd., Birla Sunlife Asset Management Company Limited, ICRA Limited and Ladderup Corporate Advisory Pvt. Ltd, by applying stringent standards of comparability analysis to comparables selected under the Transaction Net Margin Method (also referred to as “TNMM”) to determine arms‟length price (“ALP”) i the transfer pricing process.
6. During the relevant previous year, the assessee entered into certain international transactions with its associated enterprises, in which TNMM was the chosen method used for determination of ALP. It filed return of income on 28.11.2011, which were picked up for scrutiny and notices under Sections 143(2) and 142(1) of the Income Tax Act, 1961 (“the Act”) and questionnaires were issued on 06.08.2012 and 16.04.2013, respectively. The Assessing Officer (AO) referred the case to the Transfer Pricing Officer (TPO) for determination of ALP under section 92CA(3) of the Act. The TPO accepted TNMM as the most appropriate method for determining Arm‟s Length Price,selected by the assessee. Operating Profit (OP)/Operating Cost (OC) was accepted 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 `l,02,66,664/- in respect of provision of IT Support Services and `27,33,96,137/- in respect of provision of Research and Information Further, the TPO also proposed addition of `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 `28 ,45 ,5 1,840/- 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 02.1.2015, rejected the asessee‟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 the Research and Analysis Segment, and directed the TPO to apply the export filter and exclude the comparables which fail the export filter. As per the directions of the DRP, the TPO by its order dated 08.12.2015 revised the original adjustment down to `25,94,83,195/-. On 10.12.2015, the AO passed the final assessment order making an addition of `25,94,83,195/- on account of transfer pricing adjustment to the price determined by the Assessee. Aggrieved, both the assessee and the revenue appealed to the ITAT against the final assessment order passed by the AO. The ITAT by its order, dated 15.12.2015 directed the exclusion of the following comparables on the grounds of functional dissimilarity:
(a) Aditya Birla Capital Advisors Pvt. Ltd.
(b) Birla Sunlife Asset Management Company Ltd.
(c) ICRA Ltd.
(d) Ladderup Corporate Advisory Pvt. Ltd.
8. In its appeal the$rHve ue$iHpuX s $tLe $ITXJT‟s$order$H $t7e $7rou d$that $ it erred by excluding (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Birla Sun life Asset Management Company Ltd., (c) ICRA LTD. and (d) Ladderup Corporate Advisory Pvt. Ltd. from the list of comparables on the grounds of functional dissimilarity by ignoring the fact that these companies were engaged in similar line of business and were functionally comparable under TNMM. Likewise, in ITA No. 82/2018, the revenue challenged the order dated 11.05.2017 passed by the ITAT for AY 2012-13 for the exclusion of (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Axis Private Equity Ltd., and, (c) Credit Information Bureau India Ltd. from the list of comparables on the grounds of functional dissimilarity by ignoring the functions performed, assets used and risk assumed (FAR), as the profiles of these comparables were similar to the Assessee.
9. The Assessee, in its appeal, ITA No. 526/2017 declared income of `3 1,91,40,070/-. Notices for scrutiny alongwith questionnaire were issued and served upon the assessee. During the relevant AY, the assessee submitted (by Form 3CEB) that it had entered into international transactions with its associated enterprises for provision of research and information to the tune of `1,78,84,76,202/- and IT support services to the tune of `64,77,9 1,811/-. The AO referred the case to the TPO for determination of ALP under section 92CA(3) of the Act. The TPO accepted TNMM as the most appropriate method for determining 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 `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 `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 `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 `14,90,875/-.
11. The AO passed the Draft Assessment Order on 14.03.2016 determining the total income of the Assessee at `66,25,70,090/- against the returned income of `31,91,40,070/- proposing a transfer pricing adjustment amounting to `34,34,30,020/-. Aggrieved, the assessee preferred appeal to the DRP. The DRP by its order dated 29.09.2016, rejected the assessee‟s objection with respect to exclusion of the three comparable companies namely Aditya Birla Capital Advisors Pvt. Ltd., Axis Private Equity Ltd., and Credit Information Bureau India Ltd. The DRP observed that the assessee had taken an objection before the DRP that the TPO had resorted to cherry picking of comparables, however, the assessee had failed to give any specific instance of in that regard.
12. Pursuant to DRP‟s directions, the TPO by its order, dated 10.11.2016 revised the original adjustment from `34,34,30,020/- down to `12,66,07,828/-. Consequently, the AO passed final assessment order under section 143(3) read with section 144C of the Act on 25.11.2016 wherein the returned income of the Assessee of `31,91,40,070/- was assessed at `44,57,47,898/- incorporating therein addition as per the transfer pricing adjustment of `12,66,07,828/-. Thus, being aggrieved, the assessee preferred an appeal before the Tribunal who by order dated 11.05.2017 directed for the exclusion of (a) Aditya Birla Capital Advisors Pvt. Ltd., (b) Axis Private Equity Ltd., and, (c) Credit Information Bureau India Ltd. from the list of comparables on the grounds of functional dissimilarity.
13. The Assessee challenges the ITAT‟s impugned order of 11.05.2017 in ITA No. 526/2017 assailing the order on the ground that the ITAT erred in concluding that nature of services provided by it under the R&I segment was in the nature of KPO services, whereas, according to their assertion, it functions more like a BPO.
Contention of parties
14. Learned senior counsel, Mr. Porus Kaka, on behalf of the Assessee assailed the impugned orders of the ITAT on the ground that the ITAT erred in concluding that the nature of services provided by the Assessee under the R&I segment are in the nature of KPO services which is contrary to the material on record. Mr. Kaka submitted that the McKinsey group of companies is engaged in providing management consulting services. These companies during the course of executing consultancy services with third parties seek assistance of the assessee for enabling them to service their 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 paren company, thereby, essentially ac epting that the Assessee acts as a back office and provides support services; in light of its present position that is unchanged in terms of facts, the Assessee avers that it should be considered as a BPO and not a KPO.
16. On behalf of the Assessee, the cases of Ameriprise India (P.) Limited ACIT in ITA No. 2010/Del/2014, where on similar facts the ITAT had held that collection and processing of data received/sourced and sending reports to the AE after analyses, evaluation and processing of such data into specific formats is providing back office support services, and Rampgreen Solutions (P) Ltd v. CIT 60 Taxmann.com255 (Del) wherein the Delhi High Court, in the context of distinguishing BPO and KPO services, held that
“…The expression “KPO” indica es the involvement of domain knowledge in providing ITeS. Typically, KPO includes involvement of advance skills; the services provided may include analytical services, market research, legal research, engineering and design services, intellectual management etc ”,
were also cited. The assessee further submitted that the definition of BPO services has been provided by the Central Board of Direct Taxes by Notification dated 18.09.2013 under Rule 10TA of the Income Tax Rules, 1962, based on which the activities performed by the Assessee under the R&I segment fall under the categories of back office operations/data processing/support center/data search, integration and analysis.
17. Moreover, with regard to the notional interest on overdue receivables, (where the ITAT held it to be separate and an international transaction), the assessee submitted that early or late realization of sale/service proceeds is incidental to the transaction of sale/service, and thus, if the ALP in respect of an international transaction is determined, then there can be no question to benchmark the interest separately. It was submitted that any separate adjustment on the pretext of outstanding receivables while accepting the comparables and transfer price of underlying transaction by application of TNMM was unjustified. To substantiate this point, the Assessee highlighted the amendment brought under Explanation to section 92B of the Act vide Finance Act, 2012, w.e.f. 01.04.2012 whereby clause (c) of the Explanation (i) to section 92B of the Act recognize „capital financing‟ as a deemed international transaction being an anti-abusive legislation deserves 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’ because the interest income is part of the ‘other income’, under preamended as well as post amended schedule VI to the Companies Act, which is duly taken into account into computation of PBIT. In a way PBIT is a misnomer, as while PBIT does not take into account interest expenditure, it does take into account interest income appearing in the other income. Once the profitability, as per PBIT, is found to be comparable, there cannot be a separate adjustment for interest income on delayed realization which is an integral part of the PBIT figure.
13. It is in this background that we may refer to the observations made by a coordinate bench of this Tribunal, in the case of Micro Ink Ltd (supra), as follows:
‘7. We find that, as evident from audit report on form 3CEB (pages 39 to 52 of the paper-book), the arm’s length price of exports to the AEs, including Micro USA, has been determined on the basis of the transactional net margin method (TNMM). By way of a note at page 51, it is specifically stated that “further, the said amount of Rs 2428.26 millions has also been determined! computed by the assessee having regard to the arm’s length price on application of Transactional Net Margin Method (TNMM), on aggregation of transactions, as prescribed under section 92C of the Income Tax Act, 1961″. In this backdrop, we can usefully refer to the decision of Hon ‘ble Delhi High Court, in the case of Sony Ericsson Mobile Corporation Pvt Ltd v. ACIT [(2015) 374 ITR 118 (Delj] wherein Their Lordships had, inter alia, observed as follows:
“Where the Assessing Officer!TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction.
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36. It is very important to bear in mind the fact that right now we are dealing with amendment of a transfer pricing related provision which is in the nature of a SAAR (specific 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.
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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 as effective from at best the assessment year 2013-14. In addition to this reason, in the light of Hon ‘ble Delhi High Court’s guidance in the case of New Skies Satellite BV (supra) also, the amendment in the definition of international transaction under Section 92B, to the extent it pertains to the issuance of corporate guarantee being outside the scope of ‘international transaction’, cannot be said to be retrospective in effect. The fact that it is stated to be retrospective, in the light of the aforesaid guidance of Hon ‘ble Delhi High Court, would not alter the situation, and it can only be treated as prospective in effect i.e. with effect from 1st April 2012 onwards.”
19. Vibhooti Malhotra, on behalf of the Revenue challenged the orders of the ITAT further, stating that it failed to appreciate that application of the TNMM does not require stringent standard of comparability analysis as required while applying the CUP method because under the TNMM methodology, net profit margin of the comparable are compared with the tested party. Accordingly, the method is more tolerant to small differences between comparable and tested party, thereby, not appreciating the relevant stipulations under the guidelines as extracted from Chapter-6 of United Nations Practical Manual on Transfer Pricing, Edition 2013, the relevant part of which reads as follows:
“6.3.9.1. Product comparability is most important in applying the CUP method, as differences in products will result in difference prices. The Cost Plus Method and the Resale Price Method are less dependent on product comparability and focus on functional comparability because differences in functions that are reflected in differences in operating expenses may lead to a broad range of gross margins.
However, the TNMM is even less dependent on product comparability and functional comparability than the traditional transaction methods, because net margins are less influenced by differences in products and functions. The TNMM focuses on broad product and functional comparability.
6.3.11.1. The strengths of the TNMM include the following:
