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TMI Blog2011 (2) TMI 99X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee as well as the TPO considered ‘CUP method’ as the most appropriate method for determining ALP of the aforesaid international transactions. The approach of the ld. CIT(A) in the AY 2002-03 and the TPO in the AY 2003-04 in comparing a controlled transaction with another controlled transaction is nowhere prescribed the Act or in Rule 10B(a) of the IT Rules,1962 and is against the spirit of CUP method. - Matter remanded back. X X X X Extracts X X X X X X X X Extracts X X X X ..... , pricing strategy, market etc. (d) The Commissioner of Income-tax (Appeals) ought to have appreciated that besides same functions, Arvind Worldwide Inc. (Mauritius) operated on larger scale with branches in many parts including in the important European market whereas the scale of operation was lower in case of Arvind Worldwide Inc. which mostly operated in the US market and therefore determining arm's length price for comparison between both Associated Enterprises without making any adjustment to eliminate said material difference will never give correct picture. (e) The Commissioner of Income-tax (Appeals) determined the arm's length price by following internal CUP method but while doing so failed to appreciate that even under internal CUP, the controlled transaction need to be compared with uncontrolled transaction. III. (a) In the facts and circumstances of the case, the Commissioner of Income-tax (Appeals) erred in rejecting the claim of write off of Rs. 102.25 crores made by the appellant company during the course of assessment proceedings. (b) The Commissioner of Income-tax (Appeals) ought to have appreciated that in view of Circular No 14(XL-35) dated 11-4-1955, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [TPO]. Inter alia, the assessee paid commission of Rs. 8,38,02,080 @ 4.2% to its Associated Enterprise, Arvind Worldwide Inc., Mauritius and Rs. 20,60,842 @.6.2% to Arvind Worldwide Inc., USA while the TPO noticed that the assessee paid commission @ 2.8% to non-related parties. To a query by the TPO, the assessee, vide letter dated 3-01-2005 explained the nature of services rendered by the Associated Enterprises and other non-related parties and contended that they paid commission to the AE @ 2.8% only for procuring orders while additional amount of commission @ 1% was paid to AEs for identifying product market segment & requirements of major customers and information besides 0.5% for collecting market related data and informing key buying factors, market strategy to be followed,1% for canvassing of textile products manufactured by parent company and del-credere commission @ 1%. It was also pointed out that the commission to AE was paid at the higher rates (which is lower than the arms length rate) Arvind Worldwide Inc., USA in view of small amount of business and to incur fixed overheads to maintain the office. In nut-shell, the assessee contended that : (i) comprehensive servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "6. I have gone through the contention of the assessee and the main contentions of the assessee are as follows: (a) The services rendered by the non-related party are limited to the procurement of orders and forwarding it to the assessee for execution. (b) The AE has done comprehensive services which include exploring the new materials, make efforts to enhance market share, procure orders, negotiating terms of orders, collection of payments, inform best practices followed by competitors, inform about market sharing, carry out market research/survey and canvassing the textile products through various techniques. (c) AE do not receive commission if the sales amount of the order procured by it are not realized. Non related party paid commission irrespective of the fact that the sales amount is realized or not. (d) Commission payments are governed by the FEMA and also monitored by RBI, so if the rate of commission is excess, the RBI could not have allowed the assessee to remit the same. (e) Major communication with the AE were through E-mail or telephonic conversation and no corporate keeps the hard copy of E-mails. However, the assessee has produced some sample corresponde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmation & documents to be maintained by every person who enters into international transaction. The relevant sub-rules is reproduced below: 10D(1)(e) - a description of the functions performed, risks assumed and assets employed or to be employed by the assessee and by the associated enterprises involved in the international transaction; 10D(1)(f) - a record of economic and market analyses, forecasts, budgets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately, which may have a bearing on the international transactions entered into by the assessee. 10D(1)(m) - any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of arm's length price. The Rule 10D(3) states that the information in sub-rule (1) shall be supported by authentic documents which include (f) letters & other correspondence documenting any terms negotiated between the assessee and the associated enterprise and (g) documents normally issued in connection with various transaction under the accounting practices followed. In the light of the aforesaid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orm as per the agreement and whether transactions with them are comparable with the transactions undertaken with associated enterprises. The authorized representative of the Arvind Mills Limited submitted sample copies of agreements with both associated enterprises and non-related parties considered for comparison, and the copy of e-mails exchanged with associated enterprises. In respect of the e-mails the assessee stated: "... in respect of documentary evidence in support of services performed by the AEs, we wish to inform you that the major communications with the Associated Enterprises were through E-mail or telephonic conversation ……. We are fortunate that we were able to retrieve some E-mail's from the archive database and therefore able to produce some sample E-mails out of the mails retrieved for your kind perusal. Your honour will please note that these sample mails produced covers majority activity defined in the agreement viz. order/new order booking, market trend, fashion trend, technical support, payment follow-up, new customer, interaction with foreign Government authorities, follow-up of insurance claim etc." In the preceding year the TPO had made sp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons that the assessee has compared with are those where the Parties to whom commission is being paid are performing lesser functions than those performed by its AEs. So the transaction of the AEs, as far as the intra AE rates are concerned, cannot be compared with transactions of any other parties, as there is no similarity in functions of the AE and the functions of other parties. Thus it is not explained why the assessee has compensated both the AEs differently for performing the same functions. As there is no uncontrolled transaction to compare with, for this transaction, the comparable transaction exists, in the form payment of lower rates of commission to a controlled entity of the group On the issue of use of controlled transaction, paragraph 1.70 of the 1995 OECD Report indicates that evidence from enterprises engaged in controlled transactions with associated enterprises may be useful in understanding the transaction under review or as a pointer to further investigation. The dealings between associated enterprises, for comparison, can also be used in the cases of last resort where: (1) There is sufficient data available to demonstrate their reliability; and (2) Relat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 59. The AO will be required to make an addition of Rs. 43,07,259 to the income of the assessee on the basis of discussion in the preceding paras. In respect of remaining transactions no adjustment is made to the value of international transactions entered into by the assessee. This order is in response to specific reference under section 92CA(1) received and will apply to the case of the assessee for AY 2003-04 only." 2.4. In terms of the aforesaid order of the TPO, the AO added an amount of Rs. 43,07,259 in the AY 2003-04. 3. On appeal, the learned CIT(A) reduced the addition to Rs. 7,47,310 in the AY 2002-03 in the following terms:- "2.3 I have considered the submission for the appellant, facts of the case and order u/s. 92CA(3) of the Act passed by Addl. CIT (Transfer Pricing-3), Mumbai. The Addl. CIT(TPO) has applied CUP method for considering arms length price of commission paid to Arvind Worldwide Inc. Mauritius and Arvind Worldwide Inc. USA. The total commission paid to Arvind Worldwide Inc. Mauritius comes to 4.2% while to Arvind Worldwide Inc. USA it comes to 6.2%. The TPO has taken total average commission of large number of non-related enterprises and has made adjus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. After execution by AML of order procured by AE, it is the sole responsibility of AE to collect payments of said orders and failing which it would not be entitled to any commission. AE would also have to help the company to realize the proceed of the order which the company has procured itself or through other agents. AE would identity product market segment, quality requirements of the major customers in the international market. It would inform the AML about the best practices followed by similar textile manufacturers in the international market It would also inform the AML about the marketing strategy adopted by other suppliers of similar product, collect market related data, information on key buying factors. The AE would also carry out market research/survey from time to time The AE would canvass for the textile products of the parent company through various promotion techniques and bear the expenditure for such promotion and marketing. And for which the parent company shall have to provide specifications and marketing material like design, brochures, samples etc. free of charge to the AE. 2.3.1 These AEs were not agent simplicitor and not simply obtaining the orders ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ell as both the AEs are incurring huge losses and therefore there was no; intention of the appellant to transfer part of profit to the AEs. 2.3.2. From the above facts and considering the reply of the appellant I find that the services rendered by the AEs are definitely much wider and comprehensive than what have been provided by the non-related parties and even non-related parties have been paid commission @ 5% and more in many cases. Considering these facts and legal position, TPO was not justified in restricting the commission payment to 2.8% which was the average of commission paid to all non-related parties taken together. However, I find that the services rendered by both AEs are similar and agreements are also similar. Therefore, there was no justification for giving higher commission @ 6.2% to Arvind Worldwide Inc. USA than to Arvind Worldwide Inc. Mauritius, which was given @ 4.2%. Therefore, following the internal CUP method it will be justifiable to make adjustment in respect of commission paid to Arvind Worldwide Inc. USA and the commission paid in excess of 4.2% will be disallowed. Such disallowance will come to Rs. 7,47,310. Therefore, the upward adjustment cost of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll. In view of this, I do not find any justification in the adjustment made by the Transfer Pricing Officer and the same is deleted." 5. The Revenue is now in appeal before us against the aforesaid findings of the learned CIT(A) in reducing the addition to Rs. 7,47,310 in the AY 2002-03 and deleting the addition in AY 2003-04 while the assessee is in appeal against upholding of the addition to the extent of Rs. 7,47,310 in the AY 2002-03.The learned DR while carrying us through the orders of the TPO and the AO supported their findings. On the other hand, the learned AR on behalf of the assessee contended that even though the learned CIT(A) in AY 2002-03 determined the payment of commission @ 4.2% to Arvind Worldwide Inc., USA as ALP on the ground that the commission at the rate of 4.2% was paid to Arvind Worldwide Inc., Mauritius, the TPO and AO themselves found that the payment of commission @ 4.93% to Arvind Worldwide Inc., USA to be at ALP in the AY 2003-04. Since nature of services rendered by AEs was same in the two assessment years, the learned CIT(A) was not justified in upholding the addition to the extent of Rs. 7,47,310 in the AY 2002-03. The learned AR pointed out that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vailable for comparison; determination of Arm's Length Price is an easy task. However, it is not so in most of transactions and rarely one is able to locate an identical transaction. In such cases, Arm's Length Price is determined by taking results of a comparable transaction in comparable circumstances and make suitable adjustments for the differences. The Legislature in India, in order to determine true income of the assessee, have prescribed certain universally accepted methodologies to compute arm's length price under the Act and the Rules made thereunder. The most appropriate method referred to in sub-section (1) of section 92C of the Act is applied, for determination of arm's length price, in the manner prescribed. In terms of provisions of sec.92F (ii) of the Act 'Arm's Length Price' means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. There is no dispute that in the instant case CUP method, one of the prescribed method, was considered to be the most appropriate method by the assessee and the TPO in determining the ALP in respect of international transactions relating to paymen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sales/services and is used to set prices in the controlled transaction in the same way that it is used by uncontrolled taxpayers in the industry; and the amount charged in the controlled transaction is adjusted to reflect product and service variations. 6.2. It is well settled that the burden is on the assessee to select the most appropriate method and has to be substantiated by the assessee by an appropriate documentation as also as to why the selected method is considered best suited to the facts and circumstances of the international transaction and as to how it provides the most reliable result of the ALP. Rule 10C(2) of the I.T. Rules,1962 lays down the factors to be considered in selection of most appropriate method. After selection of most appropriate method, the next step is to collect the inputs for computing arm's length price under that method. The question arises as to who has the onus of collecting and furnishing the requisite inputs for determining the ALP. In terms of provisions of section 92D of the Act, the assessee entering into international transaction is required to keep and maintain information and documents as are prescribed in the Rule 10D of the Income-tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (j) a record of the actual working carried out for determining the arm's length price, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any, which were made to account for differences between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions; (k) the assumptions, policies and price negotiations, if any, which have critically affected the determination of the arm's length price; (l) details of the adjustments, if any, made to transfer prices to align them with arm's length prices determined under these rules and consequent adjustment made to the total income for tax purposes; (m) any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of the arm's length price." 6.3. Having regard to the aforesaid statutory provisions, including provisions of sections 271AA & 271G of the Act, it is apparent that burden to establish that international transaction was entered in to at ALP is on the assessee. The assessee is duty bound t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essing Officer may intervene only if he is, on the basis of material or information or document in his possession, of the opinion that the price charged in international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D of the Income-tax Act and the rules made thereunder; or the information or data used in computation of the Arms length price is not reliable correct; or the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D. If anyone of such circumstances exists, the Assessing Officer may reject the price adopted by the assessee and determine the Arms length Price in accordance with the same rules." 6.4. In case revenue authorities are not satisfied with the ALP and the supporting documents/information furnished by the assessee, the authorities have ample power to determine the same and make suitable adjustments. In the process of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparison will have to be made with each transaction of similarly placed non-related party. According to the ld. CIT(A),the non-related enterprises were given commission ranging from 1% to 10% depending upon the volume of business, services rendered, location of party, country and various economic consideration and under the CUP method, the AO was required to examine the transaction with each of non-related party and if the services rendered and the economic consideration were same, only then that could have been taken as comparable uncontrolled transaction. But as already pointed out by us, onus is on the assessee to establish ALP of the transaction and not on the AO. The ld. CIT(A) concluded that the AEs have rendered much wider services than what have been provided by the non-related parties to the assessee and were paid commission @ 5% and the TPO has not brought any material on record to substantiate that all non-related parties have also rendered the same services which the AEs have rendered. Though the ld. CIT(A) observed that in order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm's length conditions, it is necess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... results of these international transactions were not inconsistent with results of similar uncontrolled transactions carried in similar circumstances. In the absence of relevant FAR analysis and economic analysis in the light of relevant data of comparable controlled or uncontrolled transactions carried in same or similar circumstances, we are of the opinion that the ALP furnished by the assessee did not meet the statutory requirements. The ld. C.I.T. (Appeals) also failed to consider that burden of proof to show that the International Transactions were Arm's Length transactions, was on the assessee and no such findings emerge as to whether the same was discharged. The ld. CIT(A),in fact, did not examine, on the touchstone of parameters set out in Rules 10C(2) and 10B(1) of the IT Rules,1962, as to which method should for determining the arms length price will be most appropriate method on the facts of this case. The nature and class of international transactions, and other relevant factors, were required to be looked into. None of these important aspects of the matter have been dealt with by the ld. CIT(A) at all. That certainly is not judicious approach in dealing with the issue a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x authorities can be deleted in appeal only if the appellate authorities are satisfied and record a finding that ALP submitted by the assessee is fair and reasonable. Merely by finding faults with the transfer price determined by the revenue authorities, addition on account of "adjustments" cannot be deleted. This is because the mandate of section 92(1) is that in every case of international transaction, income has to be determined having regard to ALP. Therefore, unless ALP furnished by the assessee is specifically accepted, the appellate authorities on the basis of material available on record have to determine ALP itself. Subject to statutory provisions, Appellate authorities can direct lower revenue authorities to carry this exercise in accordance with law. The matter cannot be left hanging in between and ALP of international transaction has to be determined in every case. Evaluation of transactions is the most important part of transfer pricing and the AO in this case failed to carry the same in accordance with law. It has vitiated determination of A.L.P. The CIT(A) also adopted similar approach and did not examine merits of the case from the right perspective, as discussed ab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... We may clarify that the assessee is free to submit fresh information and documentation and is free to chose any of the prescribed methods as most appropriate method. In nutshell, the ld. CIT(A) should by way of a speaking order bring out clearly as to how the price determined by him is ALP in respect of the transactions entered into by the assessee with its AE. Be that as it may, a fair and reasonable Arm's Length Price should be determined. Consequently, ground nos. I & II in the appeal of the assessee for the AY 2002-03 & ground no.1 in the appeals of the Revenue for the AYs 2002-03 & 2003-04 are disposed of. 7. As regards ground no. III in the appeal of the assessee for the AY 2002-03 relating to write off of Rs. 102.25 crores, there is no discussion in the assessment order. On appeal, the ld. CIT(A) found that neither the claim was made in the computation of income nor any revised return was filed. Since the issue did not emanate from the assessment order, the ld. CIT(A) did not entertain the ground. 7.1. Though the assessee has raised a ground in the appeal before us, the ld. AR did not even whisper before us about this ground. Since the ld. AR did not make any submissions ..... X X X X Extracts X X X X X X X X Extracts X X X X
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