Vol. 11 Issue 9.4 September 18, AshitaSud. Ganesh Krishnamurthy

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1 Vol. 11 Issue 9.4 September 18, 2015 The Delhi High Court rules on a controversy surrounding use of Knowledge Process Outsourcing companies as comparable for benchmarking information technology enabled services providers In the case of Rampgreen Solutions PvtLtd 1 (hereinafter referred to as taxpayer ), the Delhi High Court ( HC ) has given its verdict and addressed the controversies surrounding the use of Knowledge Process Outsourcing ( KPO ) companies as comparable for benchmarking Information Technology Enabled Services ( ITES ) providers. AshitaSud Ganesh Krishnamurthy The HC in its judgment expressed its reservation against the ruling of the Special Bench of the Income tax Appellate Tribunal, Mumbai in a matter involving similar issues in the case of Maersk Global Centres (India) Pvt Ltd vs ACIT 2 ( Maersk ). The Special Bench in the case of Maersk had held that due to the overlapping nature of Business Process Outsourcing ( BPO ) and KPO services, ITES cannot be further bifurcated between BPO and KPO services. The HC taking a contrary view has ruled that BPO services constitute lower end of ITES whereas KPO services involve high value added processes requiring advanced skills, domain knowledge and experience of the persons carrying on such processes. KPO services would therefore fall at the higher end of the ITES hence it will be important to identify comparable companies based on similarity of services (i.e. BPO or KPO) rather than selecting a broad set of ITES companies. Further, placing emphasis on the similarity of business model of the company being chosen as comparable, the HC has ruled that only companies having functions, business model, assets and resources employed and risks undertaken similar to that of the tested party should be considered as comparable for determining the arm s length nature of the international transaction. MukeshButani, New Delhi mukesh.butani@bmrlegal.in Ajit Kumar Jain, Mumbai ajit.jain@bmradvisors.com AmodKhare, Mumbai amod.khare@bmradvisors.com SanjivMalhotra, New Delhi sanjiv.malhotra@bmradvisors.com SuchintMajmudar, Bangalore suchint.majmudar@bmradvisors.com Background and brief facts of the case The taxpayer was engaged in rendering voice based customer care services,

2 which was classified by the taxpayer as low end ITES rendered to its Associated Enterprises ( AE ). The taxpayer had benchmarked the international transactions of rendering these services adopting Transactional Net Margin Method ( TNMM ) and using Profit Level Indicator ( PLI ) of operating profit / total cost ratio. The Transfer Pricing Officer ( TPO ) made adjustments to the transfer price by modifying the set of comparable companies chosen by the Taxpayer for benchmarking its international transaction of rendering ITES to its AEs. The Dispute Resolution Panel ( DRP ) accepted the contentions of the Assessee and rejected certain comparable companies additionally chosen by the TPO. However, in the case of one of the comparable companies - eclerx Services Ltd ( eclerx ), the DRP held that although there were functional dissimilarities between eclerx and the Assessee i.e. eclerx was involved in providing KPO services, the differences were not significant enough to warrant rejection of eclerx as a comparable. Further, in the case of another comparable - Vishal Information Technology Ltd ( Vishal ) it held that the difference in the business model of Vishal would not materially affect the profit margin and thus the same does not need to be rejected. On further appeal, the Income Tax Appellate Tribunal ( ITAT ), New Delhi ruled that both eclerx and Vishal were engaged in providing ITES and once a service fell within the category of ITES then the sub-classification of the segment was not permissible. Aggrieved by the order of the ITAT, the Assessee filed an appeal with the HC. Key issue for consideration before the HC: Whether a KPO service provider could be considered as a comparable company for benchmarking the international transaction of rendering ITES Ruling of the HC: The HC opined that the expression KPO indicates the involvement of domain knowledge in providing ITES. Typically, KPO includes involvement of advanced skills; the services provided may include analytical services, market research, legal research, engineering and design services, intellectual management etc. The HC drew reference to the definition of KPO services under the Safe Harbour rules issued by the Central Board of Direct Taxes ( CBDT ). In addition, it relied upon the report referred to in the Special Bench Ruling, National Skill

3 Development Corporation 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 and KPO services are likely to span activities such as patent advisory, high-end research and analytics, online market research and legal advisory. The HC observed, while entities rendering Call Center services and KPO services may be employing IT-based delivery systems, the characteristics of services, the functional aspects, business environment, risks and the quality of human resource employed would be materially different and all these factors have a material bearing on the profitability of the entities. As a result, benchmarking international transactions on the basis of comparing the PLI of high-end KPO service providers with the PLI of a company performing Call Center services would be unreliable and possibly flawed. The HC on this basis, disagreed with the opinion of the Tribunal on the issue that once a service falls under the category of ITeS, then there is no subclassification of segment and ruled that the services segments of low-end ITES and KPO would be very different. Based on these differences, the HC excluded eclerx as a comparable company for the voice based ITES provided by the Assessee. Further, the HC rejected Vishal as a comparable company to the voice based ITES provided by the Assessee on account of the outsourcing business model adopted by Vishal. BMR Comments This is a welcome HC ruling as it seems to have set at rest the debate on the differentiation between generic ITES services and KPO/BPO services by asking for an evaluation of services domain of the tested party vis-à-vis functional comparability of comparable companies in a transfer pricing analysis. The ruling may have an impact on the choice of comparable companies in ongoing transfer pricing audits as well as during the filing and negotiation process for taxpayers involved in Advance Pricing Agreement discussions with the Indian revenue. The HC has taken a view different from the decision of the Special Bench of the ITAT Mumbai in the case of Maersk and has ruled on matters of law. Hence, it is expected that this decision will override the ruling of the Special Bench and is expected to have a binding effect for

4 cases pending with the ITAT on similar issues. The ruling is in line with the globally accepted transfer pricing principles which place focus on significant people functions and function-assetrisk analysis for the purpose of characterization of an enterprise and selection of comparable companies. It further emphasizes the business model comparability in addition to the function-asset-risk comparability. While the HC ruling theoretically lays down the principles of comparability, the challenge is to strike a balance between tolerance towards functional comparability while using TNMM as the most appropriate method and the choice of most comparable companies. In addition, practically it may be a challenge to identify the function-assetrisk parameters of the comparable companies based on data available in the public domain. In practice, a stricter comparability approach as proposed by this HC ruling may result in fewer comparable companies which in turn may result in some cases in lower than 9 comparable companies a minimum threshold that has been proposed in the draft rules issued by the CBDT for taxpayers to avail of the benefit of a range and multiple year data for determination of arm s length price. 1 ITA 102/2015, High Court of Delhi 2 ITA 7466/Mum/2012

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