9911796707
TMI Blog2009 (5) TMI 600X X X X Extracts X X X X X X X X Extracts X X X X ..... ot been rebutted even in proceedings before the CIT(A). For the sake of record, however, the grounds of appeal taken by the Revenue are reproduced below: That the learned CIT(A) erred in law and on facts in allowing relief of Rs. 56,35,952 on the ground that there is no necessity of manipulating assessee's income as the unit is a 100 per cent EOU ignoring that the facts and circumstances of the case prove to the contrary. That the learned CIT(A) erred in law and on facts in allowing relief of Rs. 56,35,952, the adjustment of which was made by the TPO on the basis of comparable cases which were not rebutted in appeal. That the learned CIT(A) erred in law and on facts in allowing relief of Rs. 56,35,952, ignoring the report of the TPO and further ignoring the method adopted by the TPO which was the most appropriate method best suited to the facts and circumstances of the case for determining ALP. 3. The taxpayer before us is a 100 per cent export oriented undertaking (EOU) engaged in the business of manufacturing and supplying high quality kits of components to european original equipment manufacturers (OEMs) and power engineering customers in gulf and Asia pacific region. The ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on that the raw material, which mainly consists of copper and lead, are charged by the AE on the basis of rates prevailing at London Metal Exchange, and certain mark up thereon. This mark up ranging between 2 per cent to 6 per cent, according to the assessee. was quite insignificant and it was charged for services rendered by the AE in connection with purchases. The assessee also submitted that it is neither practical nor desirable for the assessee company to directly deal with third party suppliers in UK-particularly when the assessee has an AE, with several decades of experience in this line, in UK. The fact that the assessee is a vendor to OEMs in Europe, which necessarily requires top quality input material, and that the assessee needs only small quantities of several items, which need to be consolidated and shipped together by the AE in order to make the imports economical and feasible, also requires the involvement of AE in the entire import process. While the TPO did not find any defect in the above submissions of the assessee, the TPO also noted that the assessee has not given any material to support the contention that the service charges paid by the assessee to the AE are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed profits. It was also noted that the profit before taxes (PBT), as a ratio to sales, shown by the assessee for the financial years 1999-2000 to 2004-05 was 11.51 per cent, 6.59 per cent, 17.27 per cent, (-) 2.35 per cent, 10.34 per cent and 15.05 per cent respectively. The TPO thus noted that except for the year before us, Le., financial year 2002-03, the assessee has shown a positive PBT/sales ratio in every year. It was also noted that the assessee has not been able to give any reasonable explanation for incurring the loss in this year. The turnover of the assessee has gone up from Rs. 3.38 crores in the immediate preceding year to Rs. 5.62 crores in the present year, and yet the assessee has suffered a loss. The TPO thus inferred that "the loss in the present year can be explained only by way of same extraordinary expenses, which pertains only to the current year or the transactions with the AEs have not been at arms length". On further examination of data relating to this year, the TPO found that the material consumption to sales ratio in the current year has been 76.24 per cent as against 46.75 per cent in the immediate preceding year. The TPO observed that "In view of the i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ersity between the controlled and the uncontrolled parties is acceptable" and that "in this case, comparables chosen are having the product connectors which is similar to the product made by the assessee". The TPO thus adopted average of PBT/cost ratio of these three companies, which worked out to 7.23 per cent, and computed the arms length operating profit at Rs. 42,68,141. Accordingly, the arms length operating revenue was computed by the TPO at Rs. 6,33,01,901. On this basis, an adjustment of Rs. 56,35,952 was made to the total income disclosed by the assessee. 8. Aggrieved by the ALP adjustment so made, the assessee carried the matter in appeal before the CIT(A). In the course of appellate proceedings, a remand report was also called from the TPO. Vide remand report dt. 21st Dec., 2006, a copy of which was also placed before us at pp. 42-44 of the paper book, TPO reiterated his stand. With regard to import of raw material from AEs, the TPO noted assessee's stand that the Authorised Representative purchases raw material on behalf of the assessee and exports the same to the assessee company on bulk basis. The assessee's submission was that the AE is allowed a mark up of 2 per ce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 92CA(3) of the Act. The assessee was able to explain the losses during the financial year 2002-03 stating that there was substantial increase in material consumption (70 to 75 per cent) due to low end-products. The assessee also explained that the losses were due to lower capacity utilization. I also agree with the assessee's argument that there is no necessity for manipulating the export prices in view of the fact that theirs is a 100 per cent EOU. Thus, the assessee was able to explain the low profitability with facts and figures but the TPO rejected the assessee's argument without any reasonable and strong basis. Even the comparables adopted by the TPO for the purpose of adjustment are not really comparable in view of assessee's objections. Even as per r. 10C of the IT Rules, the TPO should adopt the most appropriate method which is best suited to the facts and circumstances of each particular international transaction which provides most reliable measures of ALP in relation to international transaction. The TPO totally ignored the intent behind these rules and carried out the adjustments on a strong presumption that the increase in costs have not been passed to the AEs and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der s. 10A of the Act, the transfer pricing provisions ought not to be applied to the assessee. He submits that the Bangalore Bench has duly considered the impact of decision in Aztec Software & Technology Services Ltd. by the Five Member Bench of the Tribunal, and yet the Division Bench was of the considered view that the transfer pricing provision cannot be applied in a case where profits of the assessee are fully exempt from tax under s. 10A. It is contended that, once a Co-ordinate Bench comes to a conclusion on a set of material facts, it cannot be open to another Co-ordinate Bench of equal strength, on materially identical facts, to come to any other conclusion. We are thus urged to confirm the order of the CIT(A) for this short reason and decline to interfere in the matter. While learned counsel for the assessee made elaborate arguments on merits, he also submitted that all these arguments may not be necessary to deal with in view of the fact that the assessee did not stand to gain by distorting the transfer prices, and, for this reason alone, transfer pricing adjustments could not be made. When asked to reconcile between the views of the Five Member Bench vis-a-vis the Divi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tside India, and the assessee is claiming benefit under s. 10A of the Act, the transfer pricing provisions ought not to be applied to the assessee", but then this view of the Division Bench is diametrically opposite to the views of an earlier Five Member Special Bench of this Tribunal in the case of Aztec Software & Technology Services Ltd. wherein this Larger Bench, inter alia, observed as follows: "21. It is abundantly clear that legislature while introducing the enactment did comprehend a situation requiring investigation and addition on account of computation of ALP in cases of the assessee entitled to benefit under s. 10A/10AA or s. 10B of the Act. In the light of specific provision, it is difficult to contend that ALP cannot be determined under s. 92C or 92CA where assessee is entitled to benefit of above sections. 22. In the light of above discussion, we hold that although Chapter X has title 'Special provision relating to avoidance of tax' and aim of various sections under Chapter X is to check avoidance of taxes, diversion of income and funds by non-residents from India, it is not necessary that AO must demonstrate such avoidance and diversion of tax before invoking prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... below has to give way to the higher wisdom of the tier above. It is in this backdrop, we are unable to follow the decision of the Bangalore Division Bench in Philips Software Centre (P) Ltd.'s case, so far as the question of applicability of transfer pricing provisions in a case in which assessee is eligible for tax exemption under s. 10A is concerned, and we respectfully follow the Five Member Special Bench decision in the case of Aztec Software & Technology Services Ltd., and adopt the reasoning of the said decision. 17. We, therefore, uphold the objection raised by Shri Kaushal. The conclusion of the CIT(A) to the effect that the transfer pricing provisions could not have been invoked on the facts of this case, as the assessee did not have any tax avoidance motive, is hereby vacated. 18. Ground No. 1 is thus allowed in principle, but having regard to the fact that the learned CIT(A) has also decided the issue in favour of the assessee, on merits of the ALP adjustments made by the AO, it is necessary to deal with the issue of ALP adjustments on merits. 19. That takes us to the second set of grievances raised in the appeal, i.e., by grounds of Appeal Nos. 2 and 3, to the effec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te that, on the given facts of the case, a particular method will be more appropriate vis-a-vis the method adopted by the assessee, and such an appropriateness of method must be shown on the touchstone of the factors set out in r. 10C(2) above. The ALP adjustments are counter measures to ensure that the prices at which international transactions are entered into by the AEs are not so contrived as to adversely affect the domestic tax base, and, therefore, most appropriate method should be decided in the light of this basic governing principle alone. The consideration as to which method will be more beneficial to the Revenue authorities is certainly not germane to the selection of most appropriate method. While there is no particular order or priority of methods which the assessee must follow, and no method can invariably be considered to be more reliable than others, on a conceptual note, transactional profit methods (i.e., TNMM and profit split method) are treated as methods of last resort which are pressed into service only when the standard methods. which are also termed as 'traditional methods' (i.e. CUP method, resale price method and cost plus method) cannot be reasonably appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence of one method over the other method must be justified by the TPO on the basis of cogent material and sound reasoning. Let us, in the light of this factual position, revert to the facts of this case. 23. It is an undisputed position that the imports of raw material, which mainly consist of copper and lead, are charged by the AE on the basis of rates prevailing at London Metal Exchange. and certain mark up thereon. This mark up ranging between 2 per cent to 6 per cent, according to the assessee, was quite insignificant and it was charged for services rendered by the AE in connection with purchases. The assessee was asked to submit the details of mark up and, on the details of mark up having been furnished by the assessee, the TPO observed that, "it is seen that mark up charged is around 2 per cent to 6 per cent in most of the cases and this mark up includes freight and insurance which is paid by the AE". The TPO himself observes that "in view of the above (submissions), it can be seen that the AE has rendered significant service in procuring the raw material but the assessee has not been able to give any comparable to suggest that service charges are at arms length". In the rem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aw material, it is expected that the assessee should have charged correspondingly higher figure for its sale to the AE, which has not been done and this is one of the major reasons for the assessee making the loss in the this financial year". He then added that "in other words, the assessee has absorbed the increase in cost of raw material instead of passing it on to the AE" and, therefore, "an adjustment is required and the same is done as per TNMM". The TPO has also observed that "the assessee has not been able to rebut the non-passing of unabsorbed costs to the AE". It is on the strength of this reasoning that the TPO has rejected the cost plus and CUP method advocated by the assessee, and proceeded to adopt TNMM as method for determining the ALP. 24. In our considered view, once it is not in dispute that the billing by the AE for raw materials supplied to the assessee is done on the basis of the London Metal Exchange prices plus certain mark up, there is no further need of the internal comparables since London Metal Exchange, being an independent organization entering into transparent and arm's length transactions with a number of other organizations, provides the most reliabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cent range is available to the taxpayers in all the cases and the TP adjustment should be restricted only on the net amount remaining after allowing the benefit of 5 per cent range provisions. Therefore, even if we were to assume that, what the TPO himself terms as 'significant services provided in procuring the raw material' were worth nothing-an unrealistic assumption anyway, at best an adjustment could be made in the cases of uncontrolled transaction price, i.e., LME price, was found to be less than 5 per cent of the international transaction price minus freight and insurance costs. When admittedly the maximum mark up is 6 per cent and the freight and insurance costs far in excess of 1 per cent, obviously no such adjustments are really possible. We have noted that the TPO, in his remand report, observed that "While determining the prices, the AE considers its own prices but does not consider the return that the assessee should have earned", but then we are unable to understand relevance of this observation in deciding the ALP. As long as the assessee has entered into raw material purchase transaction with the AE at an ALP, it is of no consequence whether or not the assessee mak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anner as to ensure that the AEs are allowed to make a reasonable profit margin. As long as the prices at which international transactions are entered into are ALPs, it is hardly relevant whether or not the AE has ensured that the assessee makes reasonable profits. As much as hypothetical independence of the transactions it does not permit artificially low profits by manipulating prices at which transactions are entered into by the AEs, it does not also require that the transactions must also be entered into such a manner as to ensure that the assessee must make reasonable profits. The question of reasonableness of profits is relevant only when transaction profit methods are applied, but such a situation arises only when standard or traditional methods fail. That is not the situation before us. We are in sesisn of a situation in which traditional method is not properly faulted with and the parameters necessary for application of the same are available. The consideration about lower profits having been earned by the assessee, even if that be so, are not at all germane to the occasion. 26. In any event, the assessee has given reasonable explanation for higher consumption of raw mater ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ii), inter alia, provides for determination of the amount of normal gross profit mark up to direct and indirect costs, computed according to the same accounting norms as followed in the transaction with AE, by the enterprise in a comparable uncontrolled transaction. In the present case the assessee has entered into export transactions with the unrelated parties and the assessee's mark up on such transactions is admittedly comparable with the exports to related parties. 28. We have also noted that the TPO had rejected the cost plus method on the ground that "the basis of gross profit margin is not clear" and that "while distributing various costs, it is always difficult to exactly find out the correct ratio in which all these costs should be allocated and if the distribution of these costs is not done correct, it may give undesirable results", but then merely because a method of ALP determination presents complexity in approach, it cannot be discarded. That apart, as we have noted above, r. 10B(1)(c)(ii) requires that the mark up has to be computed according to the same accounting norms as followed in the transaction with AE, and, therefore, when internal comparison is being made, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ters were to be applied to the gross profit margin on uncontrolled comparable transactions and therefore the difficulties perceived by the TPO were not of much consequence. Having regard to these discussions, and bearing in mind entirety of the case, we are of the considered view that the TPO did indeed err in applying the TNMM on the facts of this case and thereby disturbing the ALP determined by the assessee. We agree with the assessee that, on the facts of the present case, the ALP could be best determined by the CUP and cost plus method. We, therefore, agree with the learned CIT(A) that the facts and circumstances of the case did not warrant or justify any ALP adjustments. 29. We have noted that the assessee has himself given certain comparables but as is evident from the perusal of records these comparables were given by the assessee without prejudice to his argument that TNMM was not the most appropriate method of determining ALP on the facts of this case and when the TPO insisted that the assessee must furnish some comparable cases anyway. Now that we have held that TNMM was indeed not the appropriate method of determining ALP on the facts of this case, these comparables ar ..... X X X X Extracts X X X X X X X X Extracts X X X X
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