2016 (7) TMI 15 - AT - Income Tax

Transfer pricing adjustment - valid remuneration model for benchmarking the TP adjustment - cost plus form of remuneration v/s commission based remuneration - Held that - As relying on assessee s own case qua the assessment years 2006- 07 and 2007-08 and case from Li & Fung India Pvt. Ltd. vs. DCIT 2011 (9) TMI 204 - ITAT, New Delhi wherein remuneration model of markup of 5% on the operation cost without considering the value of the cost procured by the AE directly from the third party vendors in India has been held as a valid remuneration model for benchmarking the TP adjustment. So, we are of the considered view that the assessee is not into buy and sell rather it is a facilitator/service provider and its compensation model at ALP would not be commission of FOB cost of goods sourced from India, rather assessee company is entitled to cost plus remuneration and not a commission based remuneration. Bench marking the international transaction by using appropriate comparables - Held that - TPO has not made a fair analysis of the comparables, though chosen by the assessee in its TP study for the AY 2007-08, rather relied upon his own finding for the earlier years which have undisputedly been set aside by the Tribunal. So, we are of the further opinion that the ld. TPO to benchmark international transactions afresh by examining the suitable comparables by providing opportunity of being heard to the assessee. So, file is ordered to be restored to the TPO to benchmark the international transactions in the light of the observations made hereinbefore. Disallowance of rent expenses being conversion charges paid to the Municipal Corporation of Delhi (MCD) - Held that - DRP/AO have erred in disallowing the expenses of conversion charges claimed by the assessee and then added the same to the total income of the assessee company which are not to be considered as capital expenditure as the same have been expended for business purpose and without conversion of the property, the business would not have been started even and as such, allowable for deduction

Issues Involved:

1. Arm's length principle for international transactions.
2. Benchmarking approach for international transactions.
3. Inclusion of goods sourced value in cost base.
4. Guaranteed profit margin and remuneration entitlement.
5. Decision-making authority in value chain.
6. Misinterpretation of documents.
7. Adverse inference under Section 114 of the Indian Evidence Act.
8. Judicial pronouncements on cost plus remuneration.
9. Change in facts for the year under consideration.
10. Economic analysis using profit split method.
11. Disallowance of rent expense for conversion charges.
12. Levying interest under section 234B.
13. Initiating penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Arm's Length Principle:
The Tribunal noted that the assessee, a sourcing support service provider, claimed that its international transaction of providing sourcing support services to associated enterprises (AEs) was at arm's length. The assessee used the Transactional Net Margin Method (TNMM) with Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI) and reported a margin of 15.52%. The TPO rejected this, arguing that the compensation model was not at arm's length and proposed an adjustment based on the FOB value of goods sourced, resulting in an addition of ?3,26,53,01,335.

2. Benchmarking Approach:
The Tribunal observed that the TPO disregarded the assessee's benchmarking approach and comparables. The Tribunal emphasized that the assessee's functional profile as a low-risk procurement support service provider was accepted in previous years. The Tribunal directed the TPO to re-examine the comparables and benchmark the international transactions afresh.

3. Inclusion of Goods Sourced Value:
The TPO included the value of goods sourced directly by the AEs from third-party vendors in the cost base, arguing that the assessee created supply chain and human asset intangibles. The Tribunal, following its earlier decisions, held that the assessee was a facilitator/service provider, not a buy-and-sell entity, and thus entitled to cost-plus remuneration, not commission-based remuneration.

4. Guaranteed Profit Margin:
The assessee argued that it operated on a guaranteed profit margin of 15% on its operating cost and did not perform significant functions related to the goods supplied by vendors directly to the AEs. The Tribunal upheld that the assessee's remuneration model was valid and should not include the value of goods sourced by the AEs.

5. Decision-Making Authority:
The assessee contended that key decisions in the value chain were made by the overseas AEs, and it merely performed low-risk liaisoning and coordination functions. The Tribunal agreed, noting that the assessee did not create intangibles or bear significant risks.

6. Misinterpretation of Documents:
The Tribunal found that the DRP and AO misinterpreted the extensive documents filed by the assessee, drawing vague inferences. The Tribunal emphasized the need for a fair analysis of the comparables and the assessee's functional profile.

7. Adverse Inference:
The Tribunal noted that the DRP and AO drew an adverse inference under Section 114 of the Indian Evidence Act, claiming the assessee failed to produce the best available evidence. The Tribunal found this approach flawed and directed a fresh examination.

8. Judicial Pronouncements:
The Tribunal highlighted that the DRP and AO disregarded relevant judicial pronouncements upholding cost-plus remuneration for procurement support service providers. The Tribunal followed its earlier decisions and the jurisdictional High Court's judgment in Li & Fung India Pvt. Ltd., validating the assessee's remuneration model.

9. Change in Facts:
The Tribunal rejected the DRP and AO's claim that the facts for the year under consideration had changed, noting that the facts remained consistent with prior years. The Tribunal found no documentary evidence to substantiate the claim of changed facts.

10. Profit Split Method:
The Tribunal criticized the DRP and AO for proposing an alternate economic analysis using the profit split method without appreciating that the assessee's business model did not involve unique intangibles or interlinked transactions warranting such analysis.

11. Disallowance of Rent Expense:
The Tribunal addressed the disallowance of ?1,75,16,800 as rent expense for conversion charges paid to the Municipal Corporation of Delhi (MCD). The Tribunal, following a coordinate Bench's decision, held that the conversion charges were not capital expenditure but were expended for business purposes and thus allowable for deduction.

12. Levying Interest:
The Tribunal did not provide a detailed discussion on the issue of levying interest under section 234B, as it was a consequential matter dependent on the final determination of the assessee's income.

13. Penalty Proceedings:
The Tribunal also did not delve into the initiation of penalty proceedings under section 271(1)(c), as it was contingent on the outcome of the primary issues in the appeal.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes, directing the TPO to re-examine the comparables and benchmark the international transactions afresh, while also allowing the deduction of conversion charges as business expenditure.

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