9911796707
TMI Blog2011 (9) TMI 204X X X X Extracts X X X X X X X X Extracts X X X X ..... a company incorporated under the Companies Act, 1956. The assessee is a subsidiary company of Li & Fung (South Asia) Limited, a company incorporated in Mauritius, which is a part of the Li & Fung Group. Li & Fung Group world wide which has a network world over in export trading. The assessee is providing buying / sourcing services to clients located world over. During the financial year 2005-06 relevant to assessment year 2006-07, the assessee entered into the international transactions for its affiliated Li & Fung (Trading) Limited, Hong Kong. As declared, the assessee received service charges for providing buying services as cost plus mark up of 5%. As per the provisions of section 92D of the Income-tax Act read with Rule 10B of Income-tax Rules, the assessee maintained and determined Arms Length Price (hereinafter referred to as ALP) of the international transaction of provision of buying services applying Transactional Net Margin Method (hereinafter referred to as TNMM) and assessee identified this method as the most appropriate method for such transactions. 3. On the reference to the Transfer Pricing Officer (hereinafter referred to as TPO), the TPO held that cost plus compen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... form they are given. The relevant portions of the OECD guidelines issued on 22.07.2010 are as below: [QUOTE] 1.67. Associated enterprises are able to make a such greater variety of contracts and arrangements than can independent enterprises because the normal conflict of interest which would exist between independent parties is often absent. Associated enterprises may and frequently do conclude arrangements of a specific nature that are not or are very rarely encountered between independent parties. This may be done for various economic, legal, or fiscal reasons dependent on the circumstances in the particular case. Moreover, contracts within an MNE could be quite easily altered, suspended, extended, or terminated according to the overall strategies of the MNE as a whole, and such alterations may even be made retroactively. In such instances tax administrations would\ have to determine what the underlying reality is behind a contractual arrangement in applying the arm's length principle. 1.68 In addition, tax administrations may find it useful to refer to alternatively structured transactions between independent enterprises to determine whether the controlle ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rnational transaction of Provision of Buying Services on the basis of the order passed under section 92CA(3) of the Act by the Transfer Pricing Officer ("the TPO"). 1.2 That the assessing officer erred on facts and in law in arbitrarily determining the arm's length price of rendering of buying services undertaken by the appellant at 3% of the FOB value of export made by unrelated party vendor. 1 .3 That the assessing officer! TPO erred on facts and in law in not appreciating that the international transaction of Provision of Buying Services was at arm's length and no adjustment to the price thereof was called for being made. 1.4 That the assessing officer/ TPO erred on facts and in law in arbitrarily including the FOB value of exports in the cost base (i.e. sales made through the appellant) of the appellant, for the purpose of computing the arm's length profit margin of the appellant. 1.5 That the assessing officer/ TPO erred on facts and in law in not appreciating that in terms of rule 10B(1)(e) of the Income-tax Rules, it was impermissible to consider the cost incurred by unrelated enterprise to compute net profit margin of the appellant while applying TN ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... law in not appreciating that the appellant has received nearly 80% of the entire consideration received by the associated enterprise for rendering sourcing services and the associated enterprise has retained only 20% of the total consideration on account of functions performed, assets utilized and risks assumed at their own, there could not be any allegation as to transfer of profit from India. 1.14 Without prejudice that the assessing officer / TPO erred on facts and in law in not appreciating that while the appellant has earned operating profit margin of 5.46%, the associated enterprise had earned a meager profit margin of 0.99% and, therefore, addition on account of alleged difference in arm's length price of international transactions is not warranted. 1.15 Without prejudice that the assessing officer / TPO erred on facts and in law In not appreciating that the adjustment on account of the alleged difference in arm's length price could not exceed the total amount of revenue retained by the associated enterprise in respect of such international transactions of rendering buying services after reducing the appropriate cost in relation thereto. 1.16 Without prejudi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e appellant 5.17% Having regard to the aforesaid analysis, such international transactions entered into by the appellant are considered to be at arm's length as per the Transactional Net Margin Method, which is identified as the most appropriate method for such transactions in terms of section 92 of the Act. The Transfer Pricing Officer ("TPO") in his order dated 28.10.2009, however, held that the cost plus compensation @ 5% of cost of the appellant is not at arm's length because it does not include profit attributable to the appellant due to the following reasonsa) The appellant has performed all the critical functions, assumed significant risks and used both tangibles and unique intangibles developed by it over a period of time. b) There is no evidence that the AE has either technical capacity or manpower to assist the appellant and that in the absence of any credible evidence, such general remarks to somehow prove the involvement of the AE cannot be accepted (Refer page. c) The appellant has developed several Unique intangibles which have given an advantage to the AE in the form of the low cost of the product, quality of the product and enhanced the profitabil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endent on the circumstances in the particular case. Moreover, contracts within an MNE could be quite easily altered, suspended, extended, or terminated according to the overall strategies of the MNE as a whole, and such alterations may even be made retroactively. In such instances tax administrations would have to determine what the underlying reality is behind a contractual arrangement in applying the arm's length principle. 1.68 In addition, tax administrations may find it useful to refer to alternatively structured transactions between independent enterprises to determine whether the controlled transaction as structured satisfied the arm's length principle. Whether evidence from a particular alternative can be considered will depend on the facts and circumstances of the particular case, including the number and accuracy of the adjustments necessary to account for differences between the controlled transaction and the alternative and the quality of any other evidence that may be available. [UNQUOTE] Therefore, the assessee's claims that it does not bear the risks of a normal trader have to be tested in this light. Accordingly, we are inclined to accept the TPO's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the inter national transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. " TNMM examines the net profit margin relative to an appropriate base (e.g. cost, sales, assets) that a taxpayer realizes from a controlled transaction (or transactions that are appropriate to aggregate under the transfer pricing principles). The method compares the profitability of either of the controlled parties with the profitability of the uncontrolled comparable(s). For application of TNMM in terms of Rule 10B(I)(e) of the Income-tax Rules ("the Rules"), net profit margi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is with regard to the method of computing profit/TC margin whether on gross basis as done by the TPO or net basis as worked out by the assessee. In this case the assessee has applied TNM method to determine arm's length price, which has also been accepted by the revenue authorities. The comparables cited by the assessee has also been accepted by the TPO as appropriate. It is also found by us that in the regular financial accounts maintained by the comparable companies, the com parables recognize revenue on a net basis. The assessee has also recognized revenues on a net basis in its financial account, which had been duly audited by the auditor. The assessee has computed the margin of operative profit on the total cost on the basis of net revenue by way of markup received from the associate concern. The payment made by the assessee to third party vendor/media agencies for and on behalf of the principal has not been included in the total cost for determining the profit margin, though, on the other hand, the TPO has included the payment reimbursed by the assessee's associate enterprise to the assessee on account of payment made to third party vendor/media agencies. It is not in disput ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cost of agency function itself, or alternatively, depending on the type of comparable data being used, the mark-up on the cost of services should be lower than would be appropriate for the performance of the services themselves. In this type of cases, it will be appropriate to pass on the cost of rendering advertising space, to the credit recipient without a mark up and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function. These guidelines are as under:- 3.41 In applying the transactional net margin method, various considerations should influence the choice of margin used. For example, these considerations would include how well the value of assets employed in the calculations is measured (e.g. to shat extent there is intangible property the value of which is not captured on the books of the enterprise) and the factors affecting whether specific costs should be passed through, marked up, or excluded entirely from the calculation. 41. In the proposed revision of Chapter I-Ill of the Transfer Pricing Guidelines issue don 9th September, 2009 - 9th January, 20 I 0 by GECD, it has been provided in Para 2.134 as under:- &nbs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndering advertising space on behalf of its associate enterprises. We further find that the method adopted by the assessee while submitting transfer pricing study based on net revenue has been accepted by the department in earlier year and, therefore, there is no reason to depart from that stand already accepted by the department in earlier year. In the light of the view we have taken above, we therefore, uphold the order of the learned CIT(A) on this issue and reject the ground raised by the revenue." The value of export by the third party vendors to third party customers does not provide any benchmark or basis for determining the arm's length price. The TPO for computing the remuneration for buying services rendered by the appellant on a cost plus basis, has sought to include in the cost of the services rendered by the appellant the entire cost of goods sold / exported by such third party exporters / vendors. Learned AR further submitted that this would artificially enhance the cost base of the appellant for applying the OP/TC margin. It would be appreciated that the compensation model of the appellant should be based on functions performed by it and the operating costs in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... do with the manufacture and export of garments by the unrelated party vendors. The appellant has merely rendered buying / sourcing support services in relation to such exports. The remuneration received by the appellant on a cost plus mark-up of 5% adequately represents the functions performed, assets utilized and risks assumed by the appellant. If the TPO's contention is to be considered it would amount to treating the appellant as partner of the venders / exporters in their manufacturing business which is certainly not the case. Learned AR pleaded that the above basis of determining the arm's length price of international transactions applying TNMM was accepted in the Transfer Pricing assessment consistently year after year. The TPO in the earlier years, it is respectfully submitted, did not dispute the aforesaid functional analysis undertaken by the appellant. In the relevant previous year, too, the facts with regard to the operations of the appellant and the functions performed, assets utilized and risks assumed by the appellant remain the same as in the earlier years. It is the respectful submission of the assessee that although there is no res judicata in Income-tax p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd: 200 CTR 426 (Del.) * CIT vs. A.KJ. Security Printers: 264 ITR 276(Del) * MIS Escorts Cardiac Diseases Hospital: 2007-Tiol-52-Del- Hc-It * Vesta Investment & Trading Co. (P) Ltd: 70 ITD 200 (Chd.) * Udaipur Distillery Co. Ltd V. JClT: 100 ITD 422 (Jodh.) In view of the aforesaid, the application of TNMM by the TPO by enhancing the cost base of the appellant by considering FOB value of export by unrelated party vendors is inconsistent with the Transfer Pricing regulations and addition made on this account, therefore, is liable to be deleted. Learned AR also pleaded that no agreements entered by the appellant with the vendors from whom goods are sourced. The TPO, while observing that for computation of OP/TC margin of the appellant the total cost component should also include cost of the sales, did not appreciate the facts of the case of the business of the appellant. The appellant, it is reiterated, is an offshore service provider and rendering buying / sourcing services to the third party customers of the associated enterprise, viz., Li & Fung (Trading). Under the arrangement, goods and merchandize are sourced by third party customers fro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the export of goods, viz. garments, by the exporters to the overseas customers. Such advantage on account of location saving is, therefore, at best be attributed to the vendors / exporters and the third party overseas customers. In the US Regulations, too, the location saving is applied between the buyer and the seller located in different jurisdiction, as would be appreciated from the US Regulations [1.482-(1)(d)(4)(ii)(C)], which read as under: "(C) Location savings. If an uncontrolled taxpayer operates in a different geographic market than the controlled taxpayer, adjustments may be necessary to account for significant differences in costs attributable to the geographic markets. These adjustments must be based on the effect such differences would have on the consideration charged or paid in the controlled transaction given the relative competitive positions of buyers and sellers in each market. Thus, for example, the fact that the total costs of operating in a controlled manufacturer's geographic market are less than the total costs of operating in other markets ordinarily justifies higher profits to the manufacturer only if the cost differences would increase the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the 3rd party customers in lieu of facilitating the export of finished goods as follows: FOB value of exports 1202.96 crores Amount received by the assessee ..... A 48.19 crores (i.e. 4% of the FOB value) Adjustment proposed .................. B 33.60 crores Total amount to be received by the assessee 81.79 crores (i.e. 6.8% of the FOB Value) Total amount received by the AE 5% of 1202.96 crores 60.148 crores It would also be noted that the AE on the entire export of Rs.1202.96 crores has retained nearly I % of the FOB value of export, i.e. Rs.12.46 crores. [ Rs.1202.96 crores X 5% = Rs.60.15 crores (-) Rs.47.69 crores received by the assessee = Rs.12.46 crores]. The TPO erroneously made adjustment of Rs.33,59,69,186 on account of alleged difference in the arm's length price of international transactions of rendering buying / sourcing services by the appellant without appreciating that out of the total service fee of 5% of FOB value of export received by the AE, only I % of FOB value of export, i.e. nearly Rs.12.46 crores was retained by the AE and Rs.47.69 crores being nearly 80% of the consideration received by the AE, is already paid to the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business profitability of the AE. These intangibles have increased the profit potential of the AE. The assessee has also developed a supply chain management which is crucial to manage the link between the ultimate customer and supply to achieve the various advantage like pricing advantage, strategic advantage, etc. etc. The assessee offers both cost and operational advantage to the AE which is possible on account of low salaries for employees in India, low cost of material and low cost of manufacturing. Further he also pleaded that since the AE is receiving 5% of the FOB value from the purchasers and assessee is performing crucial and critical functions with the help of tangible and unique intangibles develops during a period of time, the assessee must receive the majority of the receipts with regard to the execution of the work. Therefore, he pleaded that the mark up should be based on FOB value and majority of the same must come to the assessee in terms of the arm's length transaction and he pleaded to sustain the orders of the authorities below. 8. We have heard both the sides in detail. The following facts are undisputed. The assessee is a subsidiary company of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f cost plus 5%. The Learned AR's plea that no adjustment has been made in the earlier years. For this, he has submitted assessment order for AY 2002-03 to 2005-06 wherein the transaction net marginal method with operating profit over total cost (OP/TC) as a profit level indicator has been accepted. This TNMM method has been accepted in these years. Reliance is also placed on the decision of Hon'ble Supreme Court in the case of Radhasoami Satsang Vs. CIT, cited supra and CIT vs. New Poly Pack (P) Ltd., 245 ITR 492, other case laws. In this regard, we hold that the principle of res judicata is not applicable in the income-tax proceedings. Each assessment year is a separate unit and what is decided in one year shall not ipso facto apply in the subsequent years. We have gone through the orders passed in the earlier years which has been placed in the paper book at pages 293 to 305 and for all these assessment years starting from 2002-03 to 2004-05, we find that while accepting profit level indicator nothing has been said about the basis on which the compensation has been received by the associated enterprise on the goods exported from India through assessee. As we have already stated ea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ork related to these exports is performed by assessee itself. Associate enterprise had no capacity to execute the work. The associated enterprise is charging from the third party on the basis of FOB value of the exports made possible by assessee. Assessee is providing sourcing services through its tangible and intangible capacity to these third party clients in the form of low cost product resulting into profitability and pricing advantage. The assessee's reliance on DCIT vs. Cheil Communication India Pvt. Ltd., cited supra, is not of much help as in that case, the facts were different. In that case, the assessee was providing to their party/media agency for and on behalf of the principal. In that case, the advertising space has been let out to the third party vendor in the name of ultimate customer and the beneficiary of advertisement. The assessee in that case was simply acting as intermediary between ultimate customer and the third party vendor in order to placement of advertisement. In assessee's case, the associated enterprise has been receiving the mark up as 5% of the FOB value of exports effected by assessee by applying its tangible and intangible capacity. The critical and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xecute the agreements. Therefore, we find no merits in this plea. The other claim of the assessee that location savings attributable to the end purchaser is also not justified as the assessee has developed many unique intangibles and also human capital intangibles which gives the locational advantage to procure low cost goods which helps the associated enterprise to obtain/retain the business and also benefits the end purchaser. These tangibles and unique intangibles developed over the period of time and the developed supply chains of the management owned by assessee benefits the ultimate purchaser and also provide locational savings to the all including the associated enterprise. As we have already said that the amount of adjustment computed by the TPO cannot exceed the amount which could have been received by the associated enterprise. There is nothing on the record from where we could gather that the compensation @ 5% on FOB value received by AE is depressed or on lower side. In view of these facts, we are of the view that the amount of adjustment so computed should not exceed the amount received by the associated enterprise. In our considered view, the AO as well as the DRP has ..... X X X X Extracts X X X X X X X X Extracts X X X X
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