Maersk Global Centres (India) (P.) Ltd. v. Asstt. CIT

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The Tax Publishers2014 TaxPub(DT) 1484 (Mum-Trib) : (2014) 147 ITD 0083 : (2014) 161 TTJ 0137 : (2014) 101 DTR 0001 : (2014) 031 ITR (Trib) 0001 Maersk Global Centres (India) (P) Ltd. v. Asstt. CIT INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALPBenchmarking of comparable companies--Assessee was a wholly owned subsidiary of Maersk, GSC it was engaged, inter alia in 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 rendered IT services such as process support, process optionization and technical support services. In the TP study report submitted by the assessee, the ALP of international transactions representing IT enabled services provided to the AEs was determined by applying TNMM and adopting operational profit to total cost (OP/TC) as profit level indicator (PLI). The OP/TC was worked out at 12.82 per cent while overage OP/TC of 13 companies selected by assessee was worked out price at 13.90 per cent since the profit margin of the assessee company after claiming working capital adjustment at 4.79 per cent and risk adjustment at 7.46 was higher than average profit was comparable, it was claimed in its TP study report that the price charged by assessee-company to its AEs was at ALP. TPO stated that assessee did not use current financial year data, i.e., assessment year 2007-08 and three companies were related party transaction and two companies were functioning as domestic operations as well as export of ITES. Having held that services rendered by the assessee-company to its AEs were in the nature of knowledge process outsounding (KPO) service, the TPO rejected twelve, out of thirteen comparables selected by the assessee. However, TNMM adopted by the assessee four benchmarking international transactions with OP/TC was accepted by TPO. Thus, by the TPO accordingly the arithmetic mean of OP/TC of seven comparables selected by him was worked out at 47.74 per cent and after allowing working capital adjustment at 2 per cent he worked out adjusted mean margin at 75.74 per cent as such, for difference adjustment of certain amount was made by AO/TPO. Further, for TP adustment for IT services was also made. DRP, however, selected 10 companies as comparables. The question before Special Bench of Tribunal is whether BPO or KPO would be selected as comparability test. *Held:* Assessee was a BPO services and not KPO services and if two companies objected are tested these were not relatively equal degree of comparability hence liable to be excluded and after excluding the same assessee-company was in safe harbour limit of +/- 5 per cent the AO is directed to not to make any TP adjustment. Sub-rule (3) of rule 10B clearly provides for further exclusion of the comparables selected by applying the test/criteria given in sub rule (2) of rule 10B 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. [Para 67] 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. [Para 68] Keeping in view the large number of services falling under ITES, the difficulty in classifying these services either as low end BPO services or high end KPO services, the difficulty in creating a third category of entities falling in between BPO and KPO and lesser degree of comparability even within BPO and KPO sector, the ITES services cannot be further bifurcated or classified as BPO and KPO services for the purpose of comparability analysis. There could exist significant overlap between the ITES activities or functions with some activities/functions being very fact-sensitive and introducing an artificial segregation within ITES may lead to creation of more problems in the comparability analysis than solving the same. [Para 75] Having held that ITES services cannot be further bifurcated as BPO and KPO services for the purpose of comparability analysis, the next question that arises is what could be the basis of such dissection, bifurcation or classification of ITES services to facilitate relatively equal degree of comparability when the broad functional analysis based on ITES sector is taken into account by applying TNMM. This purpose of attaining a relatively equal degree of comparability can be achieved by taking into consideration the functional profile of the tested party and comparing the same with the entities selected as potential comparables on broad functional analysis taken at ITES level. The principal functions performed by the tested party should be identified and the same can be compared with the principal functions performed by the entities already selected to find out the relatively 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. [Para 76] Potential comparables of ITES sector level can be selected by applying Broad functional test at first stage and although the comparables so selected can be put to further test, depending on facts of each case, by comparing the specific functions performed in the international transactions with that of uncontrolled transactions to attain the relatively equal degree of comparability as discussed above, the classification of ITES into low-end BPO services and high-end KPO services for comparability analysis would not be fair and proper. [Para 78] The answer to 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. [Para 78] There are ten entities which are finally selected as comparables in the present case by the AO/TPO as per the direction of the DRP and the assessee has mainly disputed the inclusion of only two comparables namely MT Technologies Ltd. and eCS (P.) Ltd. on the ground that they are functionally different from the assessee company. In order to appreciate the stand of the assessee on this issue, it is necessary to identify the principle functions performed by the assessee and compare the same with the principle functions performed by the entities selected by the AO/TPO. The claim of the assessee right from the beginning was that there are two types of services mainly provided by it to its AEs and they were classified under two heads 'provision of IT enabled services' and 'provision of IT services'. Although this claim of the assessee has not been accepted by the DRP which treated both these services under one broad head of 'IT enabled services', the functions performed by it in relation to both these types of services were separately given by the assessee company in its TP study. [Para 79] A perusal of the functional profile of the assessee company shows that although the services claimed to be provided by it to the AEs as IT services such as process support, process optimization and technical support are not in the nature of low end services such as voice or data processing as they require some degree of special knowledge and domain expertise in the concerned field, the revenue generated from these services was only about 10% of the total revenue generated during the year under consideration. There were also some other services rendered by the assessee company to its AEs as IT enabled services such as reconciling the difference between equipment management system and transfer plan in global custom services study, contract drafting, various audit functions based on different business strategy, tender handling etc. which, as rightly submitted by the DR, cannot be strictly considered as low-end services as they involved some degree of special knowledge and expertise in the relevant field. However, these services again were only incidental to the main services rendered by the assessee involving information collation from shipper/customer/AE and populating the same into various processes and systems provided by the AE. These main services rendered by the assessee to its AEs thus involved primarily data entry, transcription, consolidation, co-ordination, preparation, processing and review of shipping documents and such other similar support services which were mainly comprising of back office support services rendered by the assessee to its AEs in the nature of low-end services. The profile of work-force employed by the assessee during the year under consideration comprised of 96 per cent of graduates and postgraduates whereas only 4 per cent work-force was professional such as CA, B.Tech etc. which again goes to show that the functions performed by the assessee company to its AEs were mainly in the nature of providing back office support services of low-end nature. Going by the functions performed by the assessee to its AEs during the year under consideration, 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. [Para 80] Keeping in view information available in the annual report of MT as well on its website, the said company is mainly involved in providing high-end services to its clients involving higher special knowledge and domain expertise in the field and the same cannot be taken as comparable to the assessee company which is mainly involved in providing low-end services. It may be pertinent to note here that the financial year 2007-08 was a unique year for MT Technologies Ltd. as the scheme of arrangement involving amalgamation between Tekmen Tool (P.) Ltd. and MT Technologies Ltd. and de-merger between MT Technologies Ltd. simultaneously was sanctioned by the Hon'ble AP High Court by 15-7-2008 with the appointed date for amalgamation and de-merger being 1-10-2007 and 1-4-2007 respectively. It is also pertinent to note that while working out the operating margin of the said company, provision for derivative loss of Rs. 6.43 crores made by MT technologies Ltd. was excluded by the A.O. treating the same as non-operating expenses whereas in the case of Rushabh Diamonds (supra), it was held by the Division Bench of this Tribunal that the gain or loss arising from the forward contract entered into for the purpose of foreign currency exposure on the export and import has to be taken into consideration while computing the operating profit. [Para 81] Keeping in view the nature of services rendered by M/s.eCS (P.) Ltd. and its functional profile, this company is also mainly engaged in providing high-end services involving specialized knowledge and domain expertise in the field and the same cannot be compared with the assessee company which is mainly engaged in providing low-end services to the group concerns. [Para 82] For the reasons given above, if the functions actually performed by the assessee company for its AEs are compared with the functional profile of M/s. C S (P.) Ltd. and M T Technologies Ltd., it is difficult to find out any relatively equal degree of comparability and the said entities cannot be taken as comparables for the purpose of determining ALP of the transactions of the assessee company with its AEs. Therefore, these two entities are directed be excluded from the list of 10 comparables finally taken by the AO/TPO as per the direction of the DRP. [Para 83] The AO directed to recompute the ALP of the transactions of the assessee-company with its AEs applying the average profit margin of the remaining eight comparables. If the difference between the ALP so recomputed and the price actually charged by the assessee is within the safe harbour limit of (+) or (-) 5 per cent, the A.O. is directed not to make any TP adjustment as per the second proviso to section 92C(2). [Para 84] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2014 TaxPub(DT) 1484 (Mum-Trib) : (2014) 147 ITD 0083 : (2014) 161 TTJ 0137 : (2014) 101 DTR 0001 : (2014) 031 ITR (Trib) 0001

Maersk Global Centres (India) (P) Ltd. v. Asstt. CIT

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALPBenchmarking of comparable companies--Assessee was a wholly owned subsidiary of Maersk, GSC it was engaged, inter alia in 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 rendered IT services such as process support, process optionization and technical support services. In the TP study report submitted by the assessee, the ALP of international transactions representing IT enabled services provided to the AEs was determined by applying TNMM and adopting operational profit to total cost (OP/TC) as profit level indicator (PLI). The OP/TC was worked out at 12.82 per cent while overage OP/TC of 13 companies selected by assessee was worked out price at 13.90 per cent since the profit margin of the assessee company after claiming working capital adjustment at 4.79 per cent and risk adjustment at 7.46 was higher than average profit was comparable, it was claimed in its TP study report that the price charged by assessee-company to its AEs was at ALP. TPO stated that assessee did not use current financial year data, i.e., assessment year 2007-08 and three companies were related party transaction and two companies were functioning as domestic operations as well as export of ITES. Having held that services rendered by the assessee-company to its AEs were in the nature of knowledge process outsounding (KPO) service, the TPO rejected twelve, out of thirteen comparables selected by the assessee. However, TNMM adopted by the assessee four benchmarking international transactions with OP/TC was accepted by TPO. Thus, by the TPO accordingly the arithmetic mean of OP/TC of seven comparables selected by him was worked out at 47.74 per cent and after allowing working capital adjustment at 2 per cent he worked out adjusted mean margin at 75.74 per cent as such, for difference adjustment of certain amount was made by AO/TPO. Further, for TP adustment for IT services was also made. DRP, however, selected 10 companies as comparables. The question before Special Bench of Tribunal is whether BPO or KPO would be selected as comparability test. Held: Assessee was a BPO services and not KPO services and if two companies objected are tested these were not relatively equal degree of comparability hence liable to be excluded and after excluding the same assessee-company was in safe harbour limit of +/- 5 per cent the AO is directed to not to make any TP adjustment.

Sub-rule (3) of rule 10B clearly provides for further exclusion of the comparables selected by applying the test/criteria given in sub rule (2) of rule 10B 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. [Para 67] 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. [Para 68] Keeping in view the large number of services falling under ITES, the difficulty in classifying these services either as low end BPO services or high end KPO services, the difficulty in creating a third category of entities falling in between BPO and KPO and lesser degree of comparability even within BPO and KPO sector, the ITES services cannot be further bifurcated or classified as BPO and KPO services for the purpose of comparability analysis. There could exist significant overlap between the ITES activities or functions with some activities/functions being very fact-sensitive and introducing an artificial segregation within ITES may lead to creation of more problems in the comparability analysis than solving the same. [Para 75] Having held that ITES services cannot be further bifurcated as BPO and KPO services for the purpose of comparability analysis, the next question that arises is what could be the basis of such dissection, bifurcation or classification of ITES services to facilitate relatively equal degree of comparability when the broad functional analysis based on ITES sector is taken into account by applying TNMM. This purpose of attaining a relatively equal degree of comparability can be achieved by taking into consideration the functional profile of the tested party and comparing the same with the entities selected as potential comparables on broad functional analysis taken at ITES level. The principal functions performed by the tested party should be identified and the same can be compared with the principal functions performed by the entities already selected to find out the relatively 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. [Para 76] Potential comparables of ITES sector level can be selected by applying Broad functional test at first stage and although the comparables so selected can be put to further test, depending on facts of each case, by comparing the specific functions performed in the international transactions with that of uncontrolled transactions to attain the relatively equal degree of comparability as discussed above, the classification of ITES into low-end BPO services and high-end KPO services for comparability analysis would not be fair and proper. [Para 78] The answer to 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. [Para 78] There are ten entities which are finally selected as comparables in the present case by the AO/TPO as per the direction of the DRP and the assessee has mainly disputed the inclusion of only two comparables namely MT Technologies Ltd. and eCS (P.) Ltd. on the ground that they are functionally different from the assessee company. In order to appreciate the stand of the assessee on this issue, it is necessary to identify the principle functions performed by the assessee and compare the same with the principle functions performed by the entities selected by the AO/TPO. The claim of the assessee right from the beginning was that there are two types of services mainly provided by it to its AEs and they were classified under two heads 'provision of IT enabled services' and 'provision of IT services'. Although this claim of the assessee has not been accepted by the DRP which treated both these services under one broad head of 'IT enabled services', the functions performed by it in relation to both these types of services were separately given by the assessee company in its TP study. [Para 79] A perusal of the functional profile of the assessee company shows that although the services claimed to be provided by it to the AEs as IT services such as process support, process optimization and technical support are not in the nature of low end services such as voice or data processing as they require some degree of special knowledge and domain expertise in the concerned field, the revenue generated from these services was only about 10% of the total revenue generated during the year under consideration. There were also some other services rendered by the assessee company to its AEs as IT enabled services such as reconciling the difference between equipment management system and transfer plan in global custom services study, contract drafting, various audit functions based on different business strategy, tender handling etc. which, as rightly submitted by the DR, cannot be strictly considered as low-end services as they involved some degree of special knowledge and expertise in the relevant field. However, these services again were only incidental to the main services rendered by the assessee involving information collation from shipper/customer/AE and populating the same into various processes and systems provided by the AE. These main services rendered by the assessee to its AEs thus involved primarily data entry, transcription, consolidation, co-ordination, preparation, processing and review of shipping documents and such other similar support services which were mainly comprising of back office support services rendered by the assessee to its AEs in the nature of low-end services. The profile of work-force employed by the assessee during the year under consideration comprised of 96 per cent of graduates and postgraduates whereas only 4 per cent work-force was professional such as CA, B.Tech etc. which again goes to show that the functions performed by the assessee company to its AEs were mainly in the nature of providing back office support services of low-end nature. Going by the functions performed by the assessee to its AEs during the year under consideration, 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. [Para 80] Keeping in view information available in the annual report of MT as well on its website, the said company is mainly involved in providing high-end services to its clients involving higher special knowledge and domain expertise in the field and the same cannot be taken as comparable to the assessee company which is mainly involved in providing low-end services. It may be pertinent to note here that the financial year 2007-08 was a unique year for MT Technologies Ltd. as the scheme of arrangement involving amalgamation between Tekmen Tool (P.) Ltd. and MT Technologies Ltd. and de-merger between MT Technologies Ltd. simultaneously was sanctioned by the Hon'ble AP High Court by 15-7-2008 with the appointed date for amalgamation and de-merger being 1-10-2007 and 1-4-2007 respectively. It is also pertinent to note that while working out the operating margin of the said company, provision for derivative loss of Rs. 6.43 crores made by MT technologies Ltd. was excluded by the A.O. treating the same as non-operating expenses whereas in the case of Rushabh Diamonds (supra), it was held by the Division Bench of this Tribunal that the gain or loss arising from the forward contract entered into for the purpose of foreign currency exposure on the export and import has to be taken into consideration while computing the operating profit. [Para 81] Keeping in view the nature of services rendered by M/s.eCS (P.) Ltd. and its functional profile, this company is also mainly engaged in providing high-end services involving specialized knowledge and domain expertise in the field and the same cannot be compared with the assessee company which is mainly engaged in providing low-end services to the group concerns. [Para 82] For the reasons given above, if the functions actually performed by the assessee company for its AEs are compared with the functional profile of M/s. C S (P.) Ltd. and M T Technologies Ltd., it is difficult to find out any relatively equal degree of comparability and the said entities cannot be taken as comparables for the purpose of determining ALP of the transactions of the assessee company with its AEs. Therefore, these two entities are directed be excluded from the list of 10 comparables finally taken by the AO/TPO as per the direction of the DRP. [Para 83] The AO directed to recompute the ALP of the transactions of the assessee-company with its AEs applying the average profit margin of the remaining eight comparables. If the difference between the ALP so recomputed and the price actually charged by the assessee is within the safe harbour limit of (+) or (-) 5 per cent, the A.O. is directed not to make any TP adjustment as per the second proviso to section 92C(2). [Para 84]