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20 August 2018

Transfer pricing - Functional comparability for computing ALP under TNMM

Delhi High Court has upheld the ITAT decision which in turn had upheld the exclusion of comparables observing that the nature of services provided by assessee under R&I segment were in nature of Knowledge Processing Outsourcing (KPO) and not of Business Processing Outsourcing (BPO), which is functionally dissimilar from some of assessee’s comparable companies in terms of services as well as their risk profiles.

The High Court in the case Mckinsey Knowledge Centre v. PCIT noted that the nature of services provided by the assessee’s comparable companies do not demonstrate even a degree of similarity with services rendered by the assessee that would be sufficient to qualify under Rule 10B(2) of Income Tax Rules.

Referring to the Courts’ decision in Rampgreen Solutions v. CIT, it noted that in Transactional Net Margin Method (TNMM), comparables which are offering services not entirely similar to controlled transaction, may be included only if difference has no material bearing on profitability and also when functional and risk profile differences are absent.

The business operation of assessee included Research and Information (R&I) Services division and IT Support Services division. In respect of R&I services, the assessee had selected 18 comparables companies whose average of adjusted operating margins was 14.50%.

The TPO rejected certain foreign companies as comparables as they were engaged in providing BPO services and finally selected 8 comparables computing average PLI of 36.48%.