No Addition for R & I Segment in the Nature of Services Provided by KPO, Functionally Dissimilar from Comparable Companies: Delhi HC [Read Judgment]

The Delhi High Court in the case of M/S. McKinsey Knowledge Centre India Pvt. Ltd. v. Pr. CIT held that 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.

The assessee is a company incorporated under the 1956 Companies Act and is a wholly owned subsidiary of McKinsey Holding Inc., USA. The business operations of the assessee can be divided into two divisions i.e. Research and Information Services Division (including financial analysis, research support and time intensive analysis) and IT Support Services Division (including data based administration support for maintenance of application infrastructure). The Income Tax Appellate Tribunal (ITAT) by its order dated 15.12.2016 directed the exclusion of four comparables after applying comparability analysis selected under the Transaction Net Margin Method (TNMM) to determine arms’ length price (ALP) in the transfer pricing process. The Transfer Pricing Officer (TPO) passed an order u/s 92CA(3) of the Act proposing an upward adjustment in respect of provisions of IT Support Services, Research and Information Services and transfer pricing adjustment. Furthermore, the Dispute Resolution Panel (DRP) upon being reached directed the TPO to apply the export filter to exclude the comparables which fail the export filter after which the additions were reduced. Aggrieved, the assessee approached the ITAT which identified 4 comparables on the ground that they were engaged in similar line of business and were functionally comparable.

The issue before the Hon’ble Court was whether the ITAT committed 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.

The assessee contended that the nature of services provided by it Research and Information segment are in the nature of Business Process Outsourcing (BPO) and not Knowledge Process Outsourcing (KPO) services. These companies (comparables) seek assistance of 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. Furthermore, 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 revenue, on the other hand, contended that the ITAT failed to appreciate that application of the TNMM does not require the stringent standard of comparability analysis as required while applying the CUP method because, under the TNMM methodology, the net profit margin of the comparable are compared with the tested party. Accordingly, the method is more tolerant to small differences between the comparable and tested party. The Revenue also argued that the assessee being a knowledge centre is engaged in the business of high skilled advisory services which requires not only analysis of specialized data but also involves analysis, processing, customization, interpretation of data and creation of knowledge bank.

The division bench comprising of Justice Ravindra Bhat and Justice A.K Chawla after analyzing the contentions of both the parties was of the opinion that according to the 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. Further, 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.