2019 (4) TMI 1866 - AT - Income Tax

TP Adjustment - Selection of MAM - Selection of comparable Modi Care Ltd. - TNMM method v/s Resale price Method - HELD THAT - Simply because Modicare Ltd. is also involved in direct selling, cannot be taken as a good comparable, especially in the light of the observation and finding of the Hon'ble High Court in Chryscapital Investor Advisors (India) Pvt. Ltd. 2015 (4) TMI 949 - DELHI HIGH COURT - Apart from that, we agree with the contention of the learned counsel that, Modi Care Ltd. had a huge diversified product portfolio ranging from personal care, agriculture, Tea, Jewellery, Healthcare, cosmetics, etc. which had different profitability depending upon market factors. Different product items would involve different level of assets, risks and market which may affect gross margins. Though it is not always necessary under resale price analysis that each product line distributed should be examined, but there should be broadly similar products so that gross compensation of the functions performed, that is, marketing and selling functions can be analysed. If reliable data for the various product and marketing strategy is not available, then accurate comparability adjustments would be very difficult to carry out. Because of the difference in accounting treatment, there is a gap between gross profit margin and net profit margin disclosed by the Modicare Ltd., which can be seen from the annual account that the gross profit margin of Modicare Ltd has been shown at 76.47%, whereas the net profit margin is at only 2.25%. Thus, there is substantial variance in the gross and net profit margin levels, which indicates that Modicare Ltd. is incurring heavy operating expenses and also substantiates heavy functions at the operating level. Further, Modicare Ltd. has significant AMP expenses of 7.32% which in the case of the assessee is only 0.94%. If a distributor is incurring substantial AMP expenses then it cannot be compared with routine distributor under RPM as it tantamount to value addition. This also goes to show Modicare Ltd. has different functions as compared to the assessee. There is also difference in the case of goods sold ratio and value-added expenses which is apparent from the fact that in case of Modi Care Ltd. the cost of goods sold ranges from 22% to 28% of its total operating cost and value-added expenses/operating expenses are more than 70%. Modicare Ltd. has also recorded franchisee expenses and hence it cannot be inferred wholly as a direct seller. Service fee earned by the assessee is on account of renewal fees and handling fees received from the individual consultants, engaged in distribution of assessee s product and directly related to assessee s business. Whereas, the service fee earned by Modi Care Ltd. is on account of annual maintenance contract (AMC). This factor also vitiates the comparability analysis. We are thus in tandem with the contention raised by the learned counsel that due to non-comparable product profile and other differences and lack of data for various factors, reasonably accurate adjustment cannot be made. as was directed by the Hon'ble High Court. Hence Modi Care Ltd. cannot be taken as a comparable company under RPM. Service fee earned by the assessee is on account of renewal fees and handling fees received from the individual consultants, engaged in distribution of assessee s product and directly related to assessee s business. Whereas, the service fee earned by Modi Care Ltd. is on account of annual maintenance contract (AMC). This factor also vitiates the comparability analysis. We are thus in tandem with the contention raised by the learned counsel that due to non-comparable product profile and other differences and lack of data for various factors, reasonably accurate adjustment cannot be made. as was directed by the Hon'ble High Court. Hence Modi Care Ltd. cannot be taken as a comparable company under RPM. The differences in the functions performed between the enterprises are often reflected in variations in operating expenses. Though this may lead to wide range of gross profit margin but still broadly similar levels of net operating profit indicators. Under the TNMM standard of comparability is relaxed relative to other methods with only broadly similarity of functions required. Thus, in our opinion as observed by the Hon ble High Court, TNMM can be adopted as most appropriate method. Accordingly, we direct the TPO to apply TNMM on the comparable selected by the assessee with suitable working capital adjustment. Appeals of the assessee are allowed.

Summary

Issues Involved:
1. Transfer Pricing Adjustment
2. Inclusion or Exclusion of Comparable Company (Modicare Ltd.)
3. Adoption of Resale Price Method (RPM) vs. Transactional Net Margin Method (TNMM)
4. Functional and Product Differences
5. Availability of Segmental Data
6. Comparability Adjustments

Detailed Analysis:

1. Transfer Pricing Adjustment:
The appeals were filed by the assessee against the orders for the Assessment Years 2009-10 to 2012-13, challenging the transfer pricing adjustments in the distribution and sales of cosmetic products. The adjustments were substantial, ranging from ?14.29 crores to ?48.90 crores across the years.

2. Inclusion or Exclusion of Comparable Company (Modicare Ltd.):
The primary issue was whether Modicare Ltd. should be included as a comparable company for the assessee, Oriflame India Pvt. Ltd. The Tribunal initially included Modicare Ltd. but was directed by the High Court to reconsider this decision due to significant differences between the two companies. The High Court observed that the Tribunal's findings were inconsistent and remanded the issue back to the Tribunal for a detailed examination.

3. Adoption of Resale Price Method (RPM) vs. Transactional Net Margin Method (TNMM):
The assessee adopted RPM to justify its arm’s length margin, selecting five comparable companies. However, the TPO rejected these comparables and included Modicare Ltd. as the sole comparable. The High Court directed the Tribunal to consider the applicability of TNMM as the most appropriate method if RPM could not be reliably applied.

4. Functional and Product Differences:
The assessee argued that Modicare Ltd. had a diversified product portfolio and different business models, making it incomparable. Modicare Ltd. dealt in various products like personal care, agriculture, tea, jewelry, healthcare, and cosmetics, unlike the assessee, which dealt only in cosmetics. The Tribunal noted these differences and highlighted the significant variance in gross and net margins, indicating heavy operating expenses and functional differences.

5. Availability of Segmental Data:
The High Court directed the Tribunal to examine the availability of data for various product segments of Modicare Ltd. The TPO's remand report confirmed that segmental data for Modicare Ltd. was not available, making it difficult to carry out accurate comparability adjustments.

6. Comparability Adjustments:
The Tribunal observed that due to the lack of segmental data and significant differences in product and functional profiles, accurate comparability adjustments were not feasible. The Tribunal highlighted that Modicare Ltd. had different accounting treatments for incentives/discounts and incurred substantial AMP expenses, which were not comparable to the assessee.

Conclusion:
The Tribunal concluded that Modicare Ltd. could not be considered a comparable company under RPM due to the lack of necessary data and significant differences. Consequently, the Tribunal directed the TPO to apply TNMM on the comparables selected by the assessee with suitable working capital adjustments. The appeals of the assessee were allowed, and the findings were applied mutatis mutandis for all the appeals.