2015 (7) TMI 915 - AT - Income Tax

Transfer pricing adjustment - addition on account of alleged understatement of arm s length price in respect of commission income earned by the appellant from its AEs - according to the Ld DR, the TPO rightly rejected the Berry Ratio (PLI) adopted by the assessee and the TPO after rejecting the Berry ratio of the assessee, choose to follow OP/TC as the PLI for computing net profit margin in the support services segment - Held that - As decided in Mitsubishi Corporation India Pvt. Ltd case 2014 (10) TMI 702 - ITAT DELHI tribunal negated the contention of TPO and upheld the assessee s action of use of berryratio, and we note that facts & circumstances of that case were identical & similar.We concur with the aforesaid view of the co-ordinate bench and so the adjustment for use of locational savings was unwarranted. We are of the view that use of intangibles cannot be inferred or assumed and needs to be demonstrated on the basis of cogent materials by the TPO/AO and adjustment for use of intangibles was unwarranted. the use of berry ratio as PLI is appropriate to the facts and circumstances of this case, the objections taken by the authorities below to the use of berry ratio are unsustainable in law, and the adjustments for use of intangibles and locational savings are unwarranted. With these observations, the computation of ALP so far as buy sell segment of assessee s activities are concerned stands restored to the assessment stage. The matter will be examined afresh in the light of the above observations which we respectfully concur with that laid by the co-ordinate bench in Mitsubhishi Corporation India Pvt. Ltd. (supra) and the matter is remanded back to be examined afresh at the assessment stage. Service fee segment which the TPO treated as trading segment - Held that - The same issue cropped in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein held that it is impermissible to make notional additions in the cost base and thus take into account the costs which are not borne by the assessee following the decision in LI And Fung India Pvt. Ltd. Versus Commissioner of Income Tax 2014 (1) TMI 501 - DELHI HIGH COURT - It is no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by the AEs, in respect of which services are rendered, in its reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms length price - the adjustments carried out in the cost base of ALP computation, in respect of service fee/commission segment, are indeed devoid of legally sustainable merits the AO is directed to delete these adjustments.

Summary

Issues Involved:
1. Re-characterization of service/commission transactions as trading transactions.
2. Use of Transaction Net Margin Method (TNMM) and Berry Ratio.
3. Adjustment for location savings and intangibles.
4. Inclusion of FOB value in the cost base for computing Arm's Length Price (ALP).

Detailed Analysis:

1. Re-characterization of Service/Commission Transactions as Trading Transactions:
The assessee, engaged in trading steel items and providing liaisoning support services, was subject to scrutiny where the Transfer Pricing Officer (TPO) re-characterized the indent-based transactions as trading transactions. The TPO's decision was based on the assertion that the assessee was the owner of supply chain management and human intangibles, and that the compensation model did not account for location savings. The TPO added Rs. 955.85 crores to the cost base of the service fee and commission segment, resulting in an upward adjustment of Rs. 209,893,288/-. The Dispute Resolution Panel (DRP) upheld the TPO's approach, leading to a final assessment order determining the income at Rs. 14,49,14,380/-.

2. Use of Transaction Net Margin Method (TNMM) and Berry Ratio:
The assessee applied TNMM using Operating Profit/Value Added Expenses (OP/VAE) for support services and Operating Profit/Sales (OP/Sales) for trading activities. The TPO rejected this approach, particularly the use of Berry Ratio, arguing it was contrary to Rule 10B(1)(e)(i) which prescribes net profit margins should be computed in relation to costs incurred, sales effected, or assets employed. The Tribunal, however, found that Berry Ratio is appropriate in cases where the business model involves minimal inventory and significant operational costs, aligning with the assessee's business model.

3. Adjustment for Location Savings and Intangibles:
The TPO argued that the assessee did not account for location savings and intangibles, asserting that the business model resulted in unique intangibles like supply chain management intangibles and human asset intangibles. However, the Tribunal found that the TPO's assertions were not based on concrete evidence. Citing the case of Mitsubishi Corporation India Pvt. Ltd., the Tribunal held that routine intangibles developed during the course of business do not warrant additional compensation unless they are unique and significantly different from those of comparable entities.

4. Inclusion of FOB Value in the Cost Base for Computing ALP:
The TPO included the FOB value of Rs. 648 crore in the cost base for computing ALP, treating the service/commission business as equivalent to trading. The Tribunal, referencing the Delhi High Court's decision in Li & Fung India Pvt. Ltd., held that it is impermissible to include costs not borne by the assessee in the cost base. The Tribunal directed the deletion of these notional adjustments and remanded the matter back to the TPO for necessary factual verifications.

Conclusion:
The Tribunal upheld the assessee's use of Berry Ratio and rejected the TPO's re-characterization of service/commission transactions as trading transactions. It also found the TPO's adjustments for location savings and intangibles to be unwarranted. The inclusion of FOB value in the cost base was deemed impermissible, and the matter was remanded back to the TPO for fresh examination in light of these observations. The appeal was partly allowed for statistical purposes.