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TMI Blog2011 (7) TMI 177X X X X Extracts X X X X X X X X Extracts X X X X ..... be construed strictly and the method adopted by the tax authorities for making transfer pricing adjustments is reasonable in the circumstances of the case - Decided against the assessee. - IT APPEAL NO. 825 (MUM.) OF 2010 - - - Dated:- 22-7-2011 - D. MANMOHAN, R.K. PANDA, JJ. Ramesh Iyer for the Appellant. Vatsalya Saxena for the Respondent. ORDER D. Manmohan, Vice-President. Assessment made by the Assessing Officer under section 143(3) of the Act read with section 92C(4) of the I.T. Act for the assessment year 2005-06, having been confirmed by the learned CIT(A), assessee is in appeal before us. Though several grounds were urged before us, all the grounds are directed against the correctness of the transfer pricing adjustment made by the TPO as against the profit/losses declared by the assessee under Transactional Net Margin Method (hereinafter referred to as "TNMM"). 2. Facts of the case are as follows :- Assessee-company was set up in Santacruz Electronics Export Processing Zone (SEEPZ). This was incorporated on 25-1-1984 as a wholly owned subsidiary (99.95 per cent) of Cherokee International, USA. The prime goal of the company was to act as a subsidi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d a questionnaire to the assessee-company and requested to submit detailed explanations to support the arm's length price computed in this case. 2.4 Assessee submitted that 95 per cent of the raw materials were supplied by AE on free of cost basis and the assessee-company does not have to pay for the raw materials and components received from AE nor is it required to take any other risks and merely has to incur the basic running expenditure to manufacture the end-product to enable it to export the same to AE. As per the arrangement stated to have been entered into with the AE, the assessee charged a mark-up of 6 per cent on the 'standard cost'. In otherwords, assessee is rewarded for the value addition made to the raw materials procured from the AE. Assessee being a captive manufacturer of transformers etc., it does not bear any risk of business related to marketing inventory or of capital in which event the method followed by the assessee i.e., mark-up of 6 per cent on the standard cost, is reasonable. In otherwords, TNMM is the most appropriate method and the assessee furnished certain comparables. 2.5 The TPO observed that if the assessee does not have to bear any risk of bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontrolled comparable companies. 2.8 The TPO observed that even if TNMM is considered as most appropriate method to benchmark the transactions with the AE, the issue herein is not mainly with regard to mark-up of 6 per cent on costs but centres around the question of nature of mark-up i.e., whether the assessee has actually shown to have charged the mark-up of 6 per cent on costs. Having regard to the circumstances i.e., (a) assessee is making net loss despite charging mark-up on the costs (b) claimed to have charged 6 per cent on cost, as per the agreement, but actual working thereof is not reflected in the accounts (c) there is absence of details regarding the standard cost (d) agreement is not placed on record, the TPO concluded that the assessee should be entitled to charge a markup as per TNMM on the total cost so incurred. In the instant case, the cost of exports were shown at Rs. 15,91,07,755 and with a mark-up of 6 per cent on costs the arm's length value of the sales of finished goods is taken to be Rs. 16,21,17,599. Accordingly, TPO suggested for an adjustment of Rs. 30,09,844. 3. Assessing Officer, accordingly, completed the assessment which was challenged by the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been reduced by Rs. 1,32,04,176 (Rs.5,01,64,176 - Rs. 3,69,60,000) thus making it liable for adjustments. The TPO on the facts of the case, characterization of transaction and functions performed as correctly applied the mark-up of 6 per cent on actual cost." 4.1 He also observed that once parent company is holding 99.95 per cent holding it has to compensate its subsidiary on actual cost even if the local company is inefficient and thus, cost-plus method has to be adopted. At any rate, assessee-company having not taken the actual cost into consideration and charged mark-up of 6 per cent on estimated cost, this itself would have lead to adjustments under TNMM also. Learned CIT(A) thus, supported the Order of the TPO/Assessing Officer by observing that even under TNMM adjustment made by the TPO is in accordance with law. In this regard, he observed that when a taxpayer intends to dispute Transfer Pricing Method adopted by the tax authorities, the burden of proof is upon the assessee to prove that the method followed by the assessee is reasonable. No doubt the transfer pricing regulations do not question the intent and purpose of parties of setting the contract price by the taxpaye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia Pvt. Ltd. the assessee has not discharged his obligation of proving the correctness of the method followed by it. Adverting our attention to rules 10B, 10C and10D of the I.T. Rules learned D.R. submitted that every person, who enters into an international transaction, has to maintain certain documents. In the instant case, the assessee being a contract manufacturer, the mode of sharing of costs and agreement there-for can be verified only if the agreement to that extent is placed on record, as no prudent businessman would have suffered loss. In the instant case, 5 per cent of the raw materials were purchased by the assessee apart from investing in plant and machinery etc., and for such risks undertaken the assessee would not allow itself to be at the mercy of AE and would have certainly entered into a written agreement. Since assessee failed to produce the document and having admitted that it had marked-up its profit on the estimated cost only, the tax authorities were justified in accepting the mark-up on the total cost rather than on estimated cost-either under cost-plus method or under TNMM. Learned Counsel relied upon the decision of ITAT, Delhi Bench in the case of Mentor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gic of arriving at "standard cost". Since assessee is a contract manufacturer and 5 per cent of the raw materials are purchased on its own to manufacture the end-product, there is some element of risk involved, having invested on the plant and machinery, infrastructure etc., to carry on the activity of manufacture. While considering the reasonableness of the reward all these factors have to be cumulatively taken note of. As rightly pointed out by the tax authorities, in the case of a contract manufacturer it is unthinkable for a manufacturer to agree, in writing, to carry on the business so as to end up in losses. Assessee having not taken actual cost into consideration, TPO/Assessing Officer, as well as the learned CIT(A), have correctly noticed that either under TNMM or under cost-plus method the cost of goods supplied should be taken into consideration. It also deserves to be noticed that the mark-up of 6 per cent has not been disputed by the tax authorities. 9. Learned Counsel, appearing on behalf of the assessee, submitted before us that in order to disregard the method followed by the assessee, the burden is upon the TPO to prove that the uncontrolled transactions are not c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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