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TMI Blog2011 (9) TMI 204X X X X Extracts X X X X X X X X Extracts X X X X ..... crucial and critical function to fulfill the conditions to execute 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. AO as well as the DRP has proceeded on a wrong footing which have given absurd results of adjustments. In view of the fact that majority and crucial services rendered by assessee, the distribution of compensation received by AE @ 5% of the FOB value of the exports between the assessee and the associated enterprise should be in the ratio of 80 : 20. The assessee must get 80% of the total receipt by AE from the ultimate purchasers. AO is directed to compute the arm’s length price in the above manner. - Decided in favor of assessee partly. - ITA No.5156/Del./2010 - - - Dated:- 30-9-2011 - SHRI C.L. SETHI, SHRI B.C. MEENA, JJ. ASSESSEE BY : Shri Ajay Vohra Neeraj Jain, Advocates RE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 profitability of the AE. These intangibles have increased profit potential of the AE though cost for development and use of intangibles was not taken for computations of routine markup of 5% considered by the appellant. d) The appellant has developed the supply chain management which manages the link between and organization and its suppliers and customer to achieve strategic and pricing advantage. e) The appellant has developed and owned human capital intangible at its own cost and all the related risks in creation and maintenance of human intangible are borne by the appellant. f) The AE has recognized that India offers both cost and operational advantage such as lower salaries fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 conclusion that the FOB value of goods should form part of the cost base for calculating the remuneration that should accrue to the assessee. That leads to the next question as to what should be the correct markup that should be applied. The TPO has applied the markup of 5% because the assessee is operating on a cost plus 5% model. However, when we are increasing the cost base manifold, the application of a markup of 5% will be excessive. We accordingly hold that given the facts and circumstances of the case a markup of 3% will be reasonable. This will adequately cover the valuable intangibles that have been developed and used by the assessee as also the location saving that the assessee is passing on to its AE." 4. After considering the assessee s pleadings before the DRP, they uphold the TPO s conclusion that FOB value of goods exported should form part of the cost base for calculating the remuneration that should accrue to the assessee. However, the DRP considered the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the international transactions of rendering buying services. 1.7 That the assessing officer/ TPO erred on facts and in law in holding that the appellant has borne all the major risks associated with the functions performed by the appellant and that since significant value added benefit and strategic advantages have been provided to the AE by the appellant, the appellant should be allowed to share the benefit in the cost plus arrangement. 1 .8 That the assessing officer/ TPO erred on facts and in law in holding that the appellant is the owner of supply chain management and human asset intangibles in India and was entitled to a return/ mark-up including cost of goods sourced by it, cost of development and use of intangibles. 1.9 That the assessing officer! TPO erred on facts and in law in holding that no evidence has been proved that the AE has either technical capacity or manpower to assist the appellant without appreciating that the functions of the AE were elaborated in the Transfer pricing Documentation. 1.10 That the assessing officer/ TPO erred on facts and in law in disregarding the functional, asset and risk profile of the appellant as submitted in its Transfe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing buying and sourcing services to the customers abroad. The appellant is a subsidiary company of Li Fung (South Asia) Ltd., a company incorporated in Mauritius and is a part of the Li Fung Group, which is one of the world leaders in export trading, having a worldwide network, substantial experience, know-how and market presence. The appellant provides buying/sourcing services to the group companies for supply of high volume, time sensitive consumer goods. The appellant is paid service charges for the buying/sourcing services rendered to the group companies at cost plus markup of 5%. For the previous year relevant to assessment year 2006-07, the appellant filed it's return of income on 01-12- 2006, declaring income of Rs.3,08,26,448. The assessment was, however, completed, vide order dated 08.10.2010 passed under section 143(3) read with section 144C of the Income Tax Act, 1961 (the 'Act'), at an income of Rs.36,67,95,634, after making an addition of Rs.33,59,69,186 on account of difference in the arm's length price of the international transactions undertaken by the appellant. He further submitted that during the financial year 2005-06, the appellant entered into the internat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... developed and owned human capital intangible at its own cost and all the related risks in creation and maintenance of human intangible are borne by the appellant. f) The AE has recognized that India offers both cost and operational advantage such as lower salaries for the employees, low cost material and low cost manufacture. Accordingly, the appellant has neither quantified locational saving nor the AE has attributed any part of the additional profit on account of locational saving to the appellant, in India. On account of the aforesaid, the TPO applied the mark-up of 5% to the FOB value of exports being 1202.96 crores and accordingly computed an addition of Rs.57,65,61,186 to the income of the appellant, as under: Description Rupees Net operating income (5% on the FOB value of exports Rs.1,202.96 crores) A 601,480,000 Operating income shown by the assessee B 24,918,814 Difference A-B 576,561,186 The Dispute Resolution Panel, however, vide order dated 30-09-2010 issued following directions in terms of section 144C(5) of the Act: "International transactions h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the cost base manifold, the application of a markup of 5% will be excessive. We accordingly hold that given the facts and circumstances of the case a markup of 3% will be reasonable. This will adequately cover the valuable intangibles that have been developed and used by the assessee as also the location saving that the assessee is passing on to its AE." Accordingly, the addition on account of the alleged difference in the arm's length price of international transactions of provision of buying / sourcing services was computed at Rs.33,59,69,186, as follows: Description Rupees Net operating income (3% of the FOB Value of exports, i.e. 3% of Rs.1202.96 crores) 36,08,88,000 Operating income shown by the assessee 2,49,18,814 Difference of the above 33,59,69,186 The addition of Rs.33,59,69, 186 made on account of difference in the arm's length price of international transactions of buying / sourcing services, as aforesaid, is unlawful and not sustainable for the reasons that the I.T.O. applied TNMM method against the T.P. regulations. For the purpose of determining the arm's length price in relation to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actions by the appellant, is to be computed only with reference to cost incurred by the appellant itself. There is no provision under Rule 10B(1)(e) of the Rules to consider or impute cost incurred by third parties or unrelated enterprises, to compute net profit margin of the appellant enterprise for application of TNMM. The TPO, in the impugned order enhanced the cost base of the appellant enterprise artificially by considering the cost of manufacture and export of finished goods, i.e., readymade garments by third party venders (which cost is certainly not the cost incurred by the appellant), which is clearly inconsistent with the manner of application of TNMM as provided in Rule 10B(1)(e) of the Rules. The TPO's contention of enhancing the cost base of the appellant artificially by considering the cost of manufacture and export of finished goods, i.e., readymade garments by third party venders (which cost is certainly not the cost incurred by the appellant), clearly amounts to imputing notional adjustment / income in the hands of the appellant on the basis of a fixed percentage of the FOB value of export made by unrelated party vendors. Therefore the value of exports by the third ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to make payment to third parties for rendering of advertisement space on behalf of its customers or associated enterprises. It is, thus, clear that the assessee's business is not sale of advertising slots to its customers or associate concern. For performing the functions for and on behalf of associated enterprises, the assessee is remunerated by its associated enterprises on the basis of a fixed commission/charges based on expenses or cost incurred by the assessee for release of a particular advertisement. It is also to be noted that advertising space (be it media, print or outdoor), has been let out by third party vendors in the name of ultimate customers and beneficiary of advertisement. We have gone through the invoices and purchase orders from third party vendors and find that they contain customers' name, and all the terms of advertisement are finalized after taking the approval from the customers. The assessee simply acts as an intermediary between the ultimate customer and the third party vendor in order to facilitate placement of the advertisement. The payment made by the assessee to vendors is recovered from the respective customers or associate enterprises. In the eve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e at arm's length to treat a significant portion of the taxpayer's costs as pass through costs to which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit margin indicator). This depends on the extent to which an independent party at arm's length would accept not to be remunerated on part of the expenses it incurs. The response should not be based on the classification of costs as "internal" or "external" costs, but rather on a comparability (including functional) analysis, and in particular on a determination of the value added by the tested party in relation to those costs." 42. Further, OECD in ITS 2009 Transfer Pricing Guidelines has laid down as under:- "7.36 When an associated enterprise is acting only as an agent or intermediary in the provision of services, it is important in applying the cost plus method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves. In such a case, it may not be appropriate to determine arm's length pricing as a markup on the cost of the services but rather on the costs of the agen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the international transactions by the assessee, is to be computed only with reference to cost incurred by the assessee itself. There is no provision under Rule 10B(1)(e) of the Rules to consider or impute cost incurred by third parties or unrelated enterprises, to compute net profit margin of the assessee enterprise for application of TNMM. It is also submitted that the contention of the TPO of enhancing the cost base of the assessee enterprise artificially by considering the cost of manufacture and export of finished goods, i.e., readymade garments by third party venders (which cost is certainly not the cost incurred by the assessee), is clearly inconsistent with the manner of application of TNMM as provided in Rule 10B(1)(e) of the Rules. The aforesaid action of the TPO, it would further be appreciated, amounts to imputing notional adjustment / income in the hands of the assessee on the basis of a fixed percentage of the FOB value of export made by unrelated party venders. The appellant has, in the Transfer Pricing documentation, established the international transactions of rendering buying services to be at arm's length price having regard to the operating profit margin ea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as under: "We are aware of the fact that, strictly speaking, resjudicata does not apply to income-tax proceedings. Again, each assessment year being a unit, what is decided in one year may not apply in the following year but where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year. " The Delhi High Court in the case of CIT vs. Neo Polypack (P) Ltd: 245 ITR 492 on the rule of consistency observed as under: "We are of the view that no fault can be found with the order of the Tribunal declining to make a reference on the proposed question. It is true that each assessment year being independent of the other, the doctrine of resjudicata does not strictly apply to income-tax proceedings, but where an issue has been considered and decided consistently in a number of earlier assessment years in a particular manner, for the sake of consistency, the same view should continue to prevail in subsequent years unless there is some material cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the associated enterprise nor the appellant is involved in the transaction of purchase or sale of such goods except to the extent of rendering buying / sourcing support services. In view of the aforesaid, it would be appreciated that the contract for purchase of goods and merchandize was between third party overseas customers and the vendors / exporters in India. The associated enterprise and also the appellant is engaged in rendering sourcing support services in relation to such export. There are no direct contracts entered into between the appellant and the third party vendors, therefore, it cannot be construed that the assessee is supposed to share the profit margin on the FOB value on export made by such vendors. In view of the aforesaid, it is respectfully submitted that the TPO's contention to compute the arm's length price of the appellant by allocating 5% of FOB value of exports made by third party vendors to the AE is inappropriate and not sustainable. Learned AR also pleaded that location savings are attributable to the end purchaser only. The TPO while holding that the arm's length prices of international transactions of running, buying / sourcing services by the app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gained any advantage on account of location saving in respect of such export of finished goods by the exporters / vendors, the adjustment made by the TPO on the ground of location saving, is not sustainable and is liable to be deleted. Learned AR also pleaded that the amount of adjustment computed by the TPO far exceeding the amount retained by the AE. He submitted that without prejudice it is respectfully submitted that the adjustment computed by the TPO in the order passed under section nCA(3) of the Act at best cannot exceed the net margin, i.e., gross revenue received from the end customers less amount paid to the appellant retained by the associated enterprises in respect of international transactions. The appellant company rendering sourcing support services has facilitated exports by the vendors/ suppliers of nearly (USD 273.40 million @ Rs.44/$) Rs.1,202.96 crores in the relevant previous year. The AE entered into the contract with the unrelated party customer for rendering buying services at 4% to 5% of FOB value of exports. The assessee has in turn received services fee (at cost + 5%) of Rs.47.69 crores which is nearly 4% of the FOB value of the export (by the vendor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s are performed by the AE and substantial assets are utilized and risks are assumed by the AE in relation to buying services rendered to the customers. In addition, the AE bears L/C opening charges and several other costs at its end. In other words, while the appellant is receiving 4% of FOB value of export for rendering of buying services, the AE is retaining only I % or less of the FOB value of export at their end. The TPO/assessing officer has erroneously held that the appellant has developed several unique intangibles and developed a supply chain management, human capital at its own risk without appreciating that the appellant was only a captive offshore service provider not undertaking any independent enterprise risk. Since the formation of the appellant company, entire cost were reimbursed by the associated enterprise, which was also bearing all enterprise risks with regard to operation undertaken by the appellant. Further, it is reiterated that substantial functions are performed by the AE and substantial assets are utilized and risks are assumed by the AE in relation to buying services rendered to the customers. The appellant company, it is respectfully submitted has receiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der consideration, the return of income was filed on 01.12.2006 declaring income at Rs.3,08,26,448/-. During the relevant period, the assessee has entered into international transaction of buying services for sourcing of garments/ handicrafts/ leather products, etc. in India for its affiliate Li Fund (Trading) Ltd., Hong Kong. The assessee has been paid service charges for providing these services, computed on the basis of cost plus mark up method. It was 5% of cost incurred by assessee. Assessee worked out the arm s length price of international transaction by applying TNMM (Transactional Net Margin Method) by company operating profit margin of 26 companies and assessee s OP/OC taken at 5.17%. The TPO did not consider the cost plus compensation @ 5% at arms length by holding that assessee is performing all critical functions, assuming significant risks and used both tangibles and unique intangibles developed by it over a period of time. The associated enterprise is not having technical capacity and manpower to assist the assessee in this regard. The assessee has developed several unique intangibles which has been given advantage in the form of low cost of product, quality ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enterprise was receiving the compensation on the basis of FOB value while the Indian associate (assessee) was compensated only by cost plus 5% mark up. When the associated enterprise are receiving the compensation at FOB value and the assessee which is providing critical functions with the help of tangible and unique intangibles developed over the years and with the help of supply chain management which are important to achieve the strategic and pricing advantage. All these help the associated enterprise to enhance and retain the business and also contributes towards the locational savings on account of low cost salary, low cost material and low cost manufacture in India. Therefore, in our considered view, the cost plus 5% mark up is definitely not on the arms length while working out the compensation for the services rendered by the assessee to the associated enterprise. In such a situation, mark up on the FOB value of the goods sourced through the assessee shall be the most appropriate method to work out the correct compensation at arms length price. Therefore, the rules of consistency cannot be applied forever when such facts have not been considered/discussed at all in the ear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of it cannot be said to be at arm s length. The AE is getting remuneration on FOB value of export for which critical and main functions are performed by assessee. We also uphold that the assessee has developed a technical capacity and owns manpower which had developed human intangibles to perform all the critical functions. These tangible and unique intangible have been developed over the years. In view of these facts, we hold that to arrive at arm s length of these transactions, the mark up must be on the basis of FOB (free on board) value of the exports. Since the AE is receiving 5% of FOB value then the total receipt by AE must be Rs.60.148 crores. Thus, the attribution between assessee and AE must be from this amount. AO made addition of Rs.33.60 crores. If it is added to the actual receipts of assessee then it is much more than the total amount received by associated enterprise regard to these exports. Thus, the way in which this adjustment has been made gives abnormal / absurd results which cannot be sustained. The assessee was performing critical functions with the help of tangible and unique intangibles developed over the period of time and with the help of supply chain man ..... X X X X Extracts X X X X X X X X Extracts X X X X
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