2014 (10) TMI 702 - AT - Income Tax

Correctness of ALP adjustment - The nature of assessee s trading activity Applicability of berry ratio - Held that - Even with respect to the trading transactions, which were claimed by the assessee to be in the nature of a service rather than a trading activity, the assessee will only be compared with such entities which are similarly placed as the assessee including in respect of their functional and risk profile as well as working capital exposure would be chosen as comparables - the unique intangible of sogo shosha business model, even if that can be treated as a unique intangible asset, belongs to the MCJ group and not the MCI individually - neither the assessee has performed any functions on or with respect to the goods traded by it, beyond holding flash title for the goods in some of the cases, nor has the assessee borne any significant risks associated with the goods so traded - All the functions, assets and risk of the assessee are quite reasonably reflected by the operating costs incurred and the value of goods traded does not have much of an impact on its analysis of FAR - The cost of goods sold would be relevant if and only if the assessee would have assumed any significant risks associated with such goods sold and when monetary impact of such risks is not reflected in operating expenses of the assessee - GAP International Sourcing India Pvt Ltd Vs ACIT 2012 (9) TMI 766 - ITAT DELHI - a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. There is neither anything inappropriate in the use as such of berry ratio per se, nor there are any real issues with respect to accounting policies of the assessee vis- -vis accounting policies of the comparables finally selected there is nothing wrong in principle in use of berry ratio in the case of an assessee, though, in the absence of any specific comparables before us, it is not possible to visualize and deal with the difficulties with regard to variations in, and impact of, accounting policies in such cases - the use of berry ratio as PLI is appropriate to the facts and circumstances of this case, the objections taken by the authorities below to the use of berry ratio are unsustainable in law, and the adjustments for use of intangibles and locational savings are unwarranted - the computation of ALP so far as buy sell segment of assessee s activities are concerned stands restored to the assessment stage thus, the matter is to be remitted back for fresh examination. Service fee/commission segment of assessee s activities Held that - It is impermissible to make notional additions in the cost base and thus take into account the costs which are not borne by the assessee following the decision in LI And Fung India Pvt. Ltd. Versus Commissioner of Income Tax 2014 (1) TMI 501 - DELHI HIGH COURT - It is no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by the AEs, in respect of which services are rendered, in its reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms length price - the adjustments carried out in the cost base of ALP computation, in respect of service fee/commission segment, are indeed devoid of legally sustainable merits the AO is directed to delete these adjustments. Correctness of disallowance u/s 40(a)(i) Payments made to the foreign entities No permanent establishment in India - Held that - once it is an undisputed position that the recipient entities did not have any permanent establishment in India and the transactions are of purchases simplictor, the payments made to entities cannot give rise to any income taxable in India - It is so for the reason that it is only when the recipient has a PE in India under article 5 of India Japan tax treaty, it s income from trading can be brought to tax in India only when such an income is directly or indirectly attributable to such a PE relying upon GE Technology Center Pvt Ltd. v. CIT 2010 (9) TMI 7 - SUPREME COURT OF INDIA - unless the non-resident has a tax liability in respect of income embedded in the payment, tax deduction obligation under section 195 cannot come into play as the assessee did not have any obligation to deduct tax at source from these payments, the very foundation of disallowances ceases to hold good in law - The disallowances of payments to MC Metal Services Asia (Thailand), Metal One Corporation (Japan) and to Metal One (Asia) Pte Ltd Singapore is to be deleted. Payment made to foreign entities TDS not deducted Held that - There is no failure on the part of the assessee in deducting tax at source u/s 195 and there is no cause of action for disallowance u/s 40(a)(ia) - the AO is directed to delete the disallowance u/s 40(a)(ia) in respect of payment to Mitsubishi Corporation Singapore, MC Tubular Inc USA, Thai MC Co Ltd, Thailand, and Peto Diamond Corporation, Japan. Payment made without deducting TDS PE in India Held that - As decided in Daimlerchrysler India (P) Limited. Versus Deputy Commissioner Of Income-Tax 2009 (1) TMI 339 - ITAT PUNE-B so far as payments made to Japanese non-residents is concerned, there cannot be any discrimination so far as deductibility of the payments in the hands of the person making the payment is concerned - If appropriate tax withholding by the person making the payment is a sine qua non for business deduction so far as payments to non-residents are concerned, unless there is a similar pre-condition for deductibility of related expenses to the payments to residents as well, that disabling provision cannot be enforced in respect to payments made to non-residents either - no disallowance can be made in respect of payments made to a resident assessee, even without applicable deduction of tax at source, as long as related payments are taken into account by the recipients in computation of their income, and taxes in respect of such income are duly paid and related income tax returns are duly filed by the resident recipients u/s 139(1). Section 40(a)(i) does not have an exclusion clause similar to second proviso to Section 40(a)(ia), so far as payments made to nonresidents, without deduction of applicable tax deduction at source, are concerned, such payments will be disallowable even in a situation, as is the admitted factual position in this case, even when the non-resident recipient has taken into account such payments in computation of his income, has paid taxes on the same and duly filed, under section 139(1), related income tax return - so far examining discrimination to the non resident Japanese taxpayers is concerned, the right comparator will be a resident Indian taxpayer - it will be contrary to the scheme of the tax treaties in question that if rigour of disallowance of a payment, on account non-deduction of tax at source from the related payment, is to be relaxed in the situations in which the resident recipient has taken the said amount into account in computation of income, paid taxes on the income so computed and filed, under section 139(1), related income tax return, and yet the rigour of disallowance in respect of payments made, without appropriate deduction of tax at source, to the non-residents are concerned, is not relaxed in the cases in which the non-resident recipient has taken such receipts into account in computation of income, paid taxes on the income so computed and filed, under section 139(1), related income tax return - the AO was in error in making a disallowance Decided in favour of assessee.

Summary

Issues Involved:
1. Correctness of Arm's Length Price (ALP) adjustment of Rs. 68,15,17,853 under section 92C.
2. Justification of disallowance of Rs. 102,17,16,483 under section 40(a)(i).

Detailed Analysis:

Issue 1: Correctness of ALP Adjustment of Rs. 68,15,17,853

Background:
The core issue pertains to the ALP adjustment of Rs. 68,15,17,853 for Mitsubishi Corporation India Pvt. Ltd. (MCI), a wholly owned subsidiary of Mitsubishi Corporation Japan (MCJ). The Transfer Pricing Officer (TPO) challenged the use of the Transactional Net Margin Method (TNMM) with Berry Ratio as the Profit Level Indicator (PLI), and the use of multiple year data.

Proceedings at the Assessment Stage:
The TPO rejected the use of Berry Ratio, stating it does not include the cost of sales in the denominator, and the legal provisions do not permit using operating expenses in the base. The TPO also re-characterized service/commission income as trading income and included the cost of goods sold by the AEs in the cost base of the service/commission segment.

Rival Contentions:
The assessee argued that the Berry Ratio is appropriate given their low-risk, high-volume business model without inventory risks. The revenue contended that the trading activities must be treated as normal trading, and the costs borne by the AEs must be included in the cost base.

Our Analysis:
The Tribunal noted that the assessee's business model as a sogo shosha (general trading company) is unique and involves low margins due to high-volume trading without inventory risks. The Tribunal held that the Berry Ratio is appropriate for such a business model and rejected the TPO's objections. The Tribunal also emphasized that the costs borne by the AEs should not be included in the cost base, following the decision in Li & Fung India Pvt Ltd v. CIT.

Conclusion:
The Tribunal restored the matter to the assessment stage for fresh adjudication, directing that the Berry Ratio be used as the PLI and excluding the costs borne by the AEs from the cost base.

Issue 2: Justification of Disallowance of Rs. 102,17,16,483 under Section 40(a)(i)

Background:
The disallowance pertains to payments made to non-resident entities for the purchase of goods without deducting tax at source. The Assessing Officer (AO) contended that these entities had a Permanent Establishment (PE) in India, making the payments taxable in India.

Rival Contentions:
The assessee argued that the payments were not taxable in India as the non-resident entities did not have a PE in India. The revenue contended that the business model indicated the presence of a PE, and thus, tax should have been deducted at source.

Our Analysis:
The Tribunal categorized the payments into three segments:
1. Payments to entities with no PE in India and judicial findings negating the revenue's claim of PE.
2. Payments to entities with no material to demonstrate the absence of PE and no judicial findings negating the revenue's claim.
3. Payments to entities with an established PE in India.

For the first segment, the Tribunal deleted the disallowance, as the entities did not have a PE in India. For the second segment, the Tribunal held that the onus of proving the existence of a PE is on the revenue, and in the absence of such proof, the disallowance cannot be sustained. For the third segment, the Tribunal applied the non-discrimination clause under the India-Japan DTAA, which ensures deduction parity between payments made to residents and non-residents. The Tribunal held that the second proviso to Section 40(a)(ia) should be read into Section 40(a)(i), allowing the deduction if the recipient has taken the payment into account in their income, paid taxes, and filed returns.

Conclusion:
The Tribunal deleted the disallowance of Rs. 102,17,16,483 under Section 40(a)(i), holding that the payments to non-residents should be treated similarly to payments to residents, ensuring deduction parity as per the non-discrimination clause in the India-Japan DTAA.