2016 (1) TMI 855 - AT - Income Tax

Allocation of expenses relating to agency service activity in proportion to the turnover by the TPO - Transfer pricing adjustment - Held that - Following the decision for the assessment year 2003-2004 as concluded that aggregate indirect expenses common to both the functions should be done on the basis of gross margin of distribution function and commission income receipts and not on the basis of sales, as adopted by the TPO. Allocation of expenses in proportion to sales would amount to give equal weightage in terms of functions performed, assets utilized and risks assumed to both distribution function as well as agency service activity, which otherwise involves much lesser functions and utilization of assets and risk. - Decided in favor of assessee.

Issues Involved:
1. Completion of assessment under section 144C/143(3) of the Income Tax Act, 1961.
2. Addition on account of the alleged difference in the arm's length price of international transactions.
3. Aggregation and allocation of expenses between distribution and agency services.
4. Selection and rejection of comparable companies for benchmarking analysis.
5. Use of inappropriate quantitative filters.
6. Consideration of multiple year data.
7. Risk adjustment and working capital employed comparability.

Detailed Analysis:

1. Completion of Assessment under Section 144C/143(3):
The assessing officer completed the assessment at an income of Rs. 48,241,533 against the returned income of Rs. 34,719,813. The appellant contested this, arguing errors in the assessment process.

2. Addition on Account of Alleged Difference in Arm's Length Price:
The assessing officer made an addition of Rs. 13,521,720 based on the TPO's order under section 92CA(3). The TPO segregated the distribution and agency services for computing the arm's length price, leading to this addition.

3. Aggregation and Allocation of Expenses:
The appellant argued that the TPO erred in aggregating the international transaction of agency services with market support services instead of the distribution segment. The DRP/TPO did not appreciate that the distribution and agency segments relate to the same products and involve common functions performed by the same employees. The TPO allocated common expenses to the agency segment in the ratio of sales, which the appellant contended should be allocated based on the gross profit ratio. The Tribunal upheld the appellant's contention, directing that expenses should be allocated based on gross margin rather than sales.

4. Selection and Rejection of Comparable Companies:
The TPO selected Choksi Laboratories Ltd. and WAPCOS as comparables, which the appellant argued were functionally dissimilar. Conversely, the TPO rejected several companies identified by the appellant as comparables, including Educational Consultants India Ltd., Indian Tourism Development Corporation Ltd., and others, citing reasons such as functional differences and turnover thresholds.

5. Use of Inappropriate Quantitative Filters:
The appellant contended that the TPO used inappropriate quantitative filters, like selecting companies with sales more than five crore, without a rational basis. The Tribunal did not specifically address this issue in detail but focused on the broader issue of expense allocation.

6. Consideration of Multiple Year Data:
The appellant argued that the TPO erred by not considering multiple year data, which could iron out fluctuations caused by business/economic/product life cycles. The Tribunal did not delve deeply into this issue, as the primary focus was on the allocation of expenses.

7. Risk Adjustment and Working Capital Employed Comparability:
The appellant claimed that the TPO did not allow appropriate risk adjustment to establish comparability, given the appellant was a low-risk-bearing captive service provider. Additionally, the TPO did not address the comparability adjustment concerning working capital employed. The Tribunal's decision on expense allocation indirectly addressed these concerns by emphasizing the need for a more accurate method of allocation.

Conclusion:
The Tribunal decided that the allocation of indirect expenses common to both distribution and agency functions should be based on the gross margin rather than sales. This decision was consistent with the appellant's case for the assessment year 2003-2004. Consequently, the appeal was allowed for statistical purposes, and the Tribunal directed the TPO to reallocate expenses accordingly. All other issues raised were rendered academic by this decision.

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