2010 (9) TMI 682 - AT - Income Tax

Arms length price - International transaction Scrutiny - The TPO observed that the business of the company was organized under three distinct segments (i) Consumer Product Division CPD (ii) System Products Division SPD & (iii) Industrial Sales Division ISD - It was concluded in the TP report that the assessee had earned net profit margin of 6.15% which exceeded the arm s length profit margin of 2.48%, the outcome of NPIPL s international transactions satisfied the arm s length standard - In the present case, the appellant has combined all the transactions relating to the trading functions across the two divisions CPD & SPD - Even the reimbursement of advertisement expenses as revenue receipt was certified by its auditors as per the guidelines of the Institute of Chartered Accountants of India - Only because the comparable selected by the TPO was not in receipt of such reimbursement, the assessee s case cannot be said to be at par with those, when fact was on record that assessee has got huge reimbursement of such expenses - criteria used for segregation is incorrect and factually inaccurate, despite the fact that under the Transfer Pricing Regulations the only reason which can be used for segregation is the FAR analysis as provided in Rule 10B(2)(b) The segregation was totally artificial and uncalled for and the authorities below were not justified in segregating them - The trading functions having the same FAR and having closely linked transactions were to be taken as a whole and not separately, thereby creating artificial loss in one segment and profit in the other The assessee had to incur huge advertisement costs because the assessee operated in a highly competitive environment against the market leaders such as SONY, SAMSUNG, LG and many local brands of Indian origin such as Videocon etc - These international transactions are pure and simple financial help by a parent A.E. in Japan to its subsidiary A.E. ailing in India to cope up with the high costs of advertisement to survive in the local Indian highly competitive market and it has no other implications except that the larger part of the cost of advertisement has been shared by the parent company without any corresponding or reciprocal benefit to the parent company - The additions were, therefore, deleted by the CIT(A) following the assessee s own case decided by the Tribunal in AY 1998-99 onwards Regarding allocation of the unallocated expenses and income to the ISD division - The assessee appoints various service centres, distributes service manuals to these, provides technical support to these and administers supply of spare parts and it reports all the service activities of these centres, it deals with all complaints, questions and answers from customers, i.e. ISD Division is the service part of the assessee - It is purely a local service allocated to servicing goods sold by AEs to its customers in India plus commission on the goods sold by the AEs directly in India - It is, therefore, clear that no adjustment on the ISD Division is called for as the PLI for the three years average of assessee is higher than that of the comparables - the result appeal of the revenue is dismissed whereas appeal of the assessee is allowed in part

Summary

Issues Involved:
1. Segregation vs. Aggregation of Trading Functions (CPD and SPD)
2. Reimbursement of Advertisement Expenses as Operating Income
3. Allocation of Unallocated Expenses to ISD Division
4. Use of Single-Year Data vs. Multi-Year Data for Transfer Pricing Analysis
5. Reliance on Customs Valuation for Transfer Pricing

Issue-wise Detailed Analysis:

1. Segregation vs. Aggregation of Trading Functions (CPD and SPD):
The primary issue was whether the trading functions of Consumer Product Division (CPD) and System Product Division (SPD) should be aggregated or segregated for transfer pricing analysis. The assessee argued for aggregation, citing identical functions, risks, and assets employed across both divisions. However, the TPO and CIT(A) opted for segregation, citing differences in product lines, target customers, and marketing strategies. The Tribunal found that the functions performed, risks assumed, and assets employed were identical for both divisions, and aggregation was appropriate. The PLI of the consolidated trading functions was 3.95%, exceeding the arm's length margin of 2.48%, making the international transactions at arm's length.

2. Reimbursement of Advertisement Expenses as Operating Income:
The TPO and CIT(A) treated the reimbursement of advertisement expenses from the AE as non-operating income, arguing it did not form part of the core operations. The assessee contended that these reimbursements were integral to its business operations and should be considered operating income. The Tribunal agreed with the assessee, noting that the reimbursement was a regular feature, supported by historical data and formal agreements. The reimbursement was necessary for the assessee to compete in the market and should be included in the operating income for transfer pricing analysis.

3. Allocation of Unallocated Expenses to ISD Division:
The TPO allocated unallocated expenses of Rs. 6.05 crores to the CPD, SPD, and ISD divisions, which the assessee contested. The Tribunal found that the ISD division, being a commission and marketing agency, did not require head office support, and allocating Rs. 20,59,669/- to it was unreasonable. The Tribunal held that the allocation of expenses should be limited to the trading functions, and the ISD division's loss was due to lower business volume, not inefficiency or mismanagement.

4. Use of Single-Year Data vs. Multi-Year Data for Transfer Pricing Analysis:
The CIT(A) held that only current year data should be used for computing the arm's length price, rejecting the use of multi-year data. The Tribunal upheld this view, agreeing that the use of single-year data is consistent with the statutory provisions under Rule 10B(4) of the Income Tax Act. The Tribunal noted that the assessee's reliance on multi-year data was not justified in this case.

5. Reliance on Customs Valuation for Transfer Pricing:
The assessee argued that the valuation accepted by the Customs Department should guide the TPO's determination of the arm's length price. The Tribunal dismissed this argument, stating that customs valuation serves different purposes and criteria compared to transfer pricing regulations under Chapter X of the Income Tax Act. The Tribunal emphasized that specific rules under the Income Tax Act should govern transfer pricing analysis.

Conclusion:
The Tribunal allowed the assessee's appeal in part, holding that:
- The trading functions of CPD and SPD should be aggregated.
- Reimbursement of advertisement expenses should be included as operating income.
- Allocation of unallocated expenses to the ISD division was unreasonable.
- Single-year data should be used for transfer pricing analysis.
- Reliance on customs valuation for transfer pricing was not appropriate.

The Tribunal ordered the deletion of the additions made by the TPO and upheld by the CIT(A), concluding that the assessee's international transactions were at arm's length. The appeal of the revenue was dismissed.