2013 (6) TMI 550 - AT - Income Tax

Arms length price adjustment - addition on account of understatement of arm s length price in respect of commission income earned from its Associated Enterprises (AE) - whether TPO erred in altering the business model of the Appellant by re-characterizing the commission transactions as trading transactions and by applying the Gross Profit margin earned from trading transactions with non-associated enterprises on the value of goods on which commission income has been earned by the Appellant - Whether the TPO on facts was justified to treat the indenting activity at par with the trading activity - Held that - On a consideration of the business profile of the assessee as available on record and the nature of services rendered and the risk profile of the assesse TPO erred in considering that the activity of a service provider is similar to the activity of a trader. The unrebutted facts available on record is that the assessee is a service provider to the extent of 88.67% of its total earnings. As per the contracted terms and the unrebutted stand of the assessee it is merely providing indenting services. At no point of time the title in goods or possession of the merchandise is in assessee s hands. The contract is entered into by SCJ and Indian customers directly whether for export or import. The negotiations are directly done by SCJ and the Indian customers and the assessee merely functions as a facilitator. Looking at the nature of services rendered and the arguments advanced which also remain unrebutted and as such are taken to be correct the assessee does not need to incur cost either for maintaining or storing the inventory or for the transportation as the title in goods is never held by the assessee for its indenting activity as a service provider. Consequently the assessee is not exposed to any credit risk in maintaining the inventory nor is the assessee exposed to price risk or the risk linked with offering credit sales. From the nature of the risk profile of the assessee and on considering the functions performed and the assets deployed it can be safely concluded to be that of a low risk business which has also been the claim of the assessee. It is a matter of record that in these years the assessee has also shown profits on its own trading with non AEs. In the facts available on record nothing has been brought on record by the TPO to either justify that the assessee has made a wrong claim on facts while claiming to be engaged in indenting activities or was infact performing all or some of the functions of a trader in which eventuality the TPO would have been well within his rights to re-characterize the assessee s indenting activities as a trading activity. It is an accepted economic principle that the trader acting as an entrepreneur is exposed to price risk cost risk credit risk warranty risk etc which would necessitate the contract being entered into and negotiated by assessee. In its indenting activity these facts are not evident There is no reasoning and justification for applying the margins earned in trading activity to indenting activity as the two are distinct and separate. Merely because the assessee was also having a small level of trading activity in its own name there is no reason available on record either justifying the action of re-characterizing the nature of assessee s activity from a service provider to that of a trader. As observed neither the TPO has lead any discussion nor has the DRP cared to throw any light on the aspect for upholding the action of the TPO. Where all the critical functions were being performed by the AE the services provided as a facilitator by the assessee cannot be treated as a trading activity. The record shows that at no point of time the assessee was ever exposed to any of those risks as such the two activities could not be treated at par and thus invited a similar treatment. Thus unable to agree with the TPO who chose to re-characterize the activities of the service provider and treated them at par with the activities of a trader since the nature of the activities of a trader and service provider are materially distinct and different. The costs referred to in Rule 10 B (1)(e)(i) does not suggest that in the facts of a case like the present case the costs would mean the FOB value of goods. The assessee demonstrably is a low risk entity as a service provider functioning as a facilitator who is not exposed to price risk warranty risk inventory risk etc. whose funds are not locked in the cost of goods title in goods never vests with the assessee contracts are entered in the name of SCJ and its affiliates at one end and the customers in India also in their own names. In these unrebutted facts on record the TPO was not correct in holding that the costs as per the Rule were FOB value of goods. The unrebutted fact on record is that the assessee has been able to render services utilizing the network of the AE and all intangibles and patents etc. utilized internally belong to the AE and the level and degree of the qualification required of the personnel of the assessee is low and skill requirement is so low that no specific skills are required by the personnel who replace the existing personnel who may choose to move on for better options. The assessee does not need to and cannot restrain the leaving personnel from utilising any skills which they may have acquired during employment as no specific skills for indenting are required for indenting and acting as a facilitator. It is not the case of the department that the assessee is performing critical functions which admittedly are performed by the AE or that the assessee is contributing by way of analysis reports and opinions being provided as such value added services are being performed wherein the analysis/opinions may turn out to the correct or grossly wrong as such due to the high risks of both eventualities occuring the personnel are necessarily highly qualified sought after experts commanding high salaries.The simple performance of a low risk activity of facilitator does not lead to the conclusion that a human intangible is being created. It is seen that there is no material on record as to how supply chain intangibles are being created as the assessee is using the network and intangibles of its AE. There was no justification for TPO to apply trading margins to assessee s indenting activity under TNMM Thus it would necessitate re-iterating the distinctions in the two separate sets of activities and the conclusions on the detailed FAR analysis. Accordingly relying on the same there is no justification to apply the margins of trading activity to indenting activity in the facts of the present case. Since in the facts of GAP International Sourcing the assessee had applied cost plus 15 % ALP and the entire commission of Li & Fung Group to Li & Fung India was worked out as per the calculations provided by the assessee s counsel his suggestion that the OP/TC of Li & Fung India worked out of 32.43 % be applied. The said proposal of the assessee was accepted and 32% cost plus mark up was accepted in GAP International. As the assessee has assailed the action of the TPO upheld by the DRP in limiting depreciation to 15% in regard to the computer peripherals as opposed to the 60 % as per assesses claim. It is seen that the issue is no longer res integra as the same stands covered by the judgment of the jurisdictional High Court in assessee s favour in the case of CIT v. BSES Rajdhani Limited 2010 (8) TMI 58 - DELHI HIGH COURT - AO is directed to grant necessary relief. Assessee s appeal allowed for statistical purposes.

Summary

Issues Involved:
1. Arms' Length Price (ALP) Adjustment
2. Re-characterization of Transactions
3. Method of Computing ALP
4. Creation of Intangibles
5. +/-5% Relief under Section 92C(2)
6. Depreciation Rate on Printer
7. Penalty Proceedings under Section 271(1)(c)
8. Interest under Section 234B

Issue-wise Detailed Analysis:

1. Arms' Length Price (ALP) Adjustment:
The primary issue in both assessment years (2007-08 and 2008-09) is the adjustment of the ALP concerning the commission income earned by the assessee from its Associated Enterprises (AEs). The assessee used the Transaction Net Margin Method (TNMM) with Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI). However, the Transfer Pricing Officer (TPO) rejected this method, arguing that the assessee's PLI did not capture the cost of goods transacted. The TPO applied a gross profit margin from the trading transactions with non-AEs to the value of goods on which commission was earned, leading to significant adjustments in the assessee's declared income.

2. Re-characterization of Transactions:
The TPO re-characterized the commission/indent transactions of the assessee as trading transactions. This re-characterization was based on the belief that the assessee created human and supply chain intangibles, which were not adequately compensated by the AE. The Tribunal found that the TPO erred in treating the indenting activity at par with the trading activity. The Tribunal noted that the assessee was a service provider and not a trader, and the functions, assets, and risks involved in the two activities were distinct and different.

3. Method of Computing ALP:
The Tribunal held that the TPO's method of computing the ALP was not in accordance with the methods specified in Section 92C(1). The TPO's approach of applying the gross profit margin from trading transactions to the commission income was not justified. The Tribunal emphasized that the costs referred to in Rule 10B(1)(e)(i) should be the operating costs of the assessee and not the FOB value of goods.

4. Creation of Intangibles:
The TPO's finding that the assessee created human and supply chain intangibles was not supported by evidence. The Tribunal observed that the assessee was merely a facilitator using the network of its AE and did not possess or develop any intangibles. The Tribunal concluded that the TPO's assumption of the creation of intangibles was incorrect.

5. +/-5% Relief under Section 92C(2):
The assessee's claim for relief under the proviso to Section 92C(2) was not granted by the TPO. The Tribunal did not specifically address this issue in detail, but the overall decision favored the assessee, indicating that the adjustments made by the TPO were not justified.

6. Depreciation Rate on Printer:
In the 2008-09 assessment year, the assessee contested the AO's decision to allow depreciation on a printer at 15% instead of the claimed 60%. The Tribunal ruled in favor of the assessee, directing the AO to grant the higher depreciation rate, as supported by the jurisdictional High Court's judgment in CIT v. BSES Rajdhani Limited.

7. Penalty Proceedings under Section 271(1)(c):
The issue of penalty proceedings under Section 271(1)(c) was deemed premature and dismissed by the Tribunal for the 2007-08 assessment year.

8. Interest under Section 234B:
The Tribunal did not specifically address the issue of interest levied under Section 234B in the detailed analysis, but the overall decision suggests that the adjustments leading to the interest calculation were not upheld.

Conclusion:
The Tribunal allowed the appeal for the 2007-08 assessment year and partly allowed the appeal for the 2008-09 assessment year for statistical purposes. The Tribunal found that the TPO's adjustments and re-characterizations were not justified, and the assessee's method of computing the ALP using TNMM with OP/TC as PLI was appropriate. The Tribunal also ruled in favor of the assessee on the issue of depreciation rate for the printer.