2012 (9) TMI 766 - AT - Income Tax

Transfer pricing ( TP ) adjustment u/s 92CA(3) - as assessee performs the functions of a risk bearing agent and therefore, cost plus PLI adopted by the assessee for ALP determination is not the most appropriate - Held that - No supporting material has been brought on record that assessee GIS India has borne any business risks arising from its activities with GAP USA. There are no adverse facts, material or evidence on the basis whereof Ld. TPO has made arrived at such a conclusion. The TPO has not given any examples or comparables whatsoever to demonstrate which major business risks much less any risk are borne by GIS India and how. In a sweeping manner it has been held that as functions follow risks, and since, in his wisdom GIS India undertakes key functions, therefore it must also be bearing the consequent risks. The observation is flawed as from the handbook and guidelines it clearly emerges that assessee had no wisdom or discretion in these terms. As it is common trend in garment that goods are generally supplied on credit based which the suppliers have to extend to GAP, USA entities and assessee bears no risk. The assessee role, functions and activities are limited to scrupulously follow the handbook and other instructions provided by the parent group. These facts and circumstances indicate lack of authority or discretion with assessee in deviating or changing from the policies and procedures prescribed by the parent company. Therefore, it is unable to be agreed with the view that assessee incurred any significant risk in its functions. Development of substantial human resources intangibles by assessee - Held that - There is no supporting material available on record to hold it against assessee. Except generalized assertions nothing reliable is placed on record to support these observations - Assessee had 230 employees on its payroll engaged in execution of preordained support nature activities as per the guidelines. Department has failed to demonstrate that any or few of employees were any acclaimed personalities or indispensable in garment procurement trade so as to constitute any human intangibles as alleged. With no decision making or entrepreneurial role embedded in their work profiles, it is not clear how the TPO or DRP can arrive at such a conclusion that these routine activities led to creation/development of any valuable supply chain or human asset. TPO has theoretically relied on a Hindustan Times news paper report published in 2008 in respect of cost of procurement services in various countries which is not acceptable as this news paper report by itself cannot partake the character of a comparable data - Location savings to developing economy arise to the industry as a whole, there is nothing on record that assessee on standalone basis was sole beneficiary - The intent of sourcing from low cost countries for a manufacturer/retailer is to survive in stiff competition by providing a lower cost to its end-customers the advantage of location savings is passed onto the end-customer via a competitive sales strategy. The arm s length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus no separate/additional allocation is called for on account of location savings. Transactional Net Margin method ( TNMM ) - use of Net Profit/Total Cost OR percentage of FOB value of goods procured by parent as PLI - Held that - All the significant directions relating to procurement of goods from third party vendors in India, namely (a) designs & trends of apparel (b) quality parameters of materials (c) terms & conditions for dealing with vendors, etc, are all provided by GAP US to the appellant through the voluminous vendor handbook & other correspondences which are placed on record and have not been controverted by the department. It emerges that assessee follows and executes them as a service provider. For such preordained support services, the assessee cannot be held to be entitled to remuneration in terms of Li & Fung case 2011 (9) TMI 204 - ITAT, NEW DELHI on FOB value of goods procured by GAP US from third party vendors in India. In the case of Li & Fung India, assessee actually carried out significantly value added functions in India, which is not the case - thus the appropriate PLI will be net profit/total cost and not the % of FOB value of goods sourced by AE Looking at the sweeping observations of the TPO and DRP which are neither based on any cogent reasoning nor factual reliability, the assessments as framed give an impression of being work of adversarial approach in tax liability determination - No hesitation to accept a candid proposal given by the assessee and hold that assessee TP adjustments be made by adopting the 32% cost plus mark up of the assessee for AY 2006-07 and 2007-08. The mark-up proposal of assessee is higher than mark-up over total cost earned by all comparables placed on record. The assessments should be framed accordingly. Depreciation on computer peripherals, printers and UPS @ 15% instead of 60% as allowable under the Income Tax Rules - Held that - Rate of depreciation it is by now settled that the computer peripherals are eligible for 60% depreciation which should be allowed to the assessee.

Summary

Issues Involved:
1. Transfer Pricing (TP) Adjustment
2. Functional, Asset, and Risk (FAR) Profile
3. Benchmarking Approach
4. Inclusion of Goods Sourced Directly by AEs
5. Reliance on International Judicial Precedents
6. Operating Profit/Value Added Expenses (OP/VAE) Ratio
7. Application of Li & Fung Case
8. Profit Level Indicator (PLI)
9. Creation and Ownership of Intangibles
10. Depreciation Rate on Computer Peripherals
11. Penalty Proceedings

Detailed Analysis:

1. Transfer Pricing (TP) Adjustment:
The core issue was the enhancement of the appellant's income by substantial amounts due to TP adjustments made by the Transfer Pricing Officer (TPO). The TPO's stance was that the appellant's cost-plus 15% remuneration model was not at arm's length and instead used a commission-based model on the FOB value of goods sourced.

2. Functional, Asset, and Risk (FAR) Profile:
The authorities below assumed that the appellant performed significant functions, owned substantial assets, and assumed considerable risks, thereby justifying a TP adjustment. However, the Tribunal found no supporting material for this assumption and concluded that the appellant was a low-risk sourcing support service provider.

3. Benchmarking Approach:
The appellant's conservative benchmarking approach, which included full-fledged distributors converted into service providers after working capital adjustments, was disregarded by the TPO. The Tribunal found this approach appropriate and held that the TPO's rejection was based on unsustainable theoretical assumptions.

4. Inclusion of Goods Sourced Directly by AEs:
The TPO included the value of goods sourced directly by the AEs from third-party vendors in the cost base of the appellant. The Tribunal found this inclusion unjustified as the appellant's role was limited to providing liaisoning support services.

5. Reliance on International Judicial Precedents:
The TPO rejected the appellant's reliance on relevant international judicial precedents. The Tribunal found that the TPO's reasons for rejection were irrelevant and inconsistent.

6. Operating Profit/Value Added Expenses (OP/VAE) Ratio:
The TPO's adjustment resulted in an OP/VAE ratio of 830.95%, which the Tribunal found unrealistic, impractical, and absurd. The Tribunal emphasized that the arm's length pricing should reflect commercial and economic realities.

7. Application of Li & Fung Case:
The Tribunal noted that the facts of the appellant's case were different from the Li & Fung case. In Li & Fung, the Indian entity performed all significant functions, whereas in the appellant's case, all significant directions were provided by GAP US. The Tribunal held that the Li & Fung case was not applicable to the appellant's case.

8. Profit Level Indicator (PLI):
The Tribunal upheld the use of Net Profit/Total Cost as the appropriate PLI instead of the percentage of FOB value of goods procured by the parent. The Tribunal found that the TPO's PLI resulted in absurd and distorted results.

9. Creation and Ownership of Intangibles:
The TPO assumed that the appellant created and owned valuable intangibles. The Tribunal found no supporting material for this assumption and concluded that the appellant did not create any valuable intangibles.

10. Depreciation Rate on Computer Peripherals:
The Tribunal held that computer peripherals are eligible for 60% depreciation, aligning with judicial pronouncements favoring the appellant.

11. Penalty Proceedings:
The Tribunal did not specifically address the penalty proceedings under section 271(1)(c) read with section 274 of the Act, but the decision to partly allow the appeals suggests that the penalty proceedings may not stand.

Conclusion:
The Tribunal concluded that the appellant is a low-risk sourcing support service provider and upheld the cost-plus 15% remuneration model. The Tribunal directed the TP adjustments to be made by adopting a 32% cost-plus mark-up for the appellant for AY 2006-07 and 2007-08. The Tribunal also allowed 60% depreciation on computer peripherals. The appeals were partly allowed.