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TMI Blog2011 (11) TMI 194X X X X Extracts X X X X X X X X Extracts X X X X ..... PEAL NO. 3829 (DELHI) OF 2010 - - - Dated:- 30-11-2011 - R.P. TOLANI, SHAMIM YAHYA, JJ. G.C. Srivastava and Mononut Dalal for the Appellant. N.K. Chand for the Respondent. ORDER R.P. Tolani, Judicial Member This is assessee's appeal against the Addl. CIT's order dated 14-10-2009, passed u/s 92 CA(3) of the Income-tax Act, 1961, relating to A.Y. 2006-07. 1.1 Following grounds are raised: "1. On the facts and in the circumstances of the case and in law, the Hon'ble Dispute Resolution Panel (DRP) erred in confirming order under section 92CA(3) the Income Tax Act, 1961 ("the Act") passed by the learned Transfer Pricing Officer ("TPO") and thereby confirming the draft order passed by learned Assessing Officer ("AO"); 2. On the facts and in the circumstances of the case and in law, the Hon'ble DRP/TPO erred in confirming rejection of the transaction by transaction analysis carried out by the appellant and by applying Transactional Net Margin Method ("TNMM") on a company wide basis. 3. Without prejudice to the above ground, on the facts and in the circumstances of the case and in law, the Hon'ble Dispute Resolution Panel (DRP) erred in not directing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... '. The assessee is also engaged in the business of providing buying services to the associated enterprise for sourcing of garments, handicrafts, leather products, etc. in India. The assessee during the relevant previous year entered into the international transactions and their method of evaluations with the associated enterprises, as under: Sl. No. Name of the Associated Enterprise International transactions Amount (Rs.) Method Used (i) Bencom S.r.l., Benind S.p.A, Benetton Australia Pty. Ltd, Benetton Asia Pacific Ltd. Purchase (Import) of garments accessories as samples 12,490,798 CUP (ii) Benind S.p.A, Benetton Asia Pacific Ltd. Purchase (Import) of raw-material 14,993,923 CUP (iii) Benind S.p.A Purchase of fixed assets 3,559,485 CUP (iv) Bencom S.r.l. Payment of Royalty 29,517,706 CUP (v) Bencom S.r.l., Benind S.p.A. Italy, Benetton Asia Pacific Ltd, Benetton Group, S.p.A. Reimbursement of expenses (paid) 5,851,440 CUP (vi) Bencom S.r.l., Benetton Asia Pacif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3% (ii) The copy of approval granted by the Central Government approving the rate of royalty. Hence, since the average of royalty paid by the abovementioned companies was higher than the royalty paid by the assessee company, the international transaction of payment of royalty is to be regarded as being at arm's length applying CUP method. (d) Reimbursement of expenses (paid and received): CUP method was also found suitable for benchmarking international transactions of reimbursement made to and received from the associated enterprises in respect of expenses incurred as the same were merely reimbursement of expenses incurred by AEs for/on behalf of assessee. For benchmarking, such transactions were adequately supported by third party evidences. Since, such transactions do not have any element of income, hence it was considered to be at arm's length applying CUP method. (e) Export of finished goods: For benchmarking the transaction of exports, there was no internal comparable available to apply CUP method as the assessee and the AEs did not enter into similar transactions with unrelated parties. Hence, for determining the arm's length price of international tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the international transactions entered into by the assessee with the associated enterprises have been satisfactorily evaluated separately by applying the most appropriate method for determining the arm's length price of the various international transactions. 2.3 In order to arrive at the most precise approximation of fair market value, the ALP should be determined on a transaction by-transaction basis and only in case when the separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis, that such transactions may be evaluated together. 2.4 Combining all transactions together, was not in conformity with the Income tax rules, OECD commentary and any internationally accepted benchmarking principles. All segments cannot be evaluated together as each activity will result in completely different functions and there is no basis for undertaking the benchmarking analysis combining all international transactions whereby a rate of operating profit margin is applied on the entire sales of the assessee company which is largely domestic sale not involving any international transaction. 2.5 The company in the relevant previous yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .6 of the transfer pricing order and computed the operating profit margin as follows: S. No. Name of the company OP/Sales OP/OC 1. Raymond Apparel Limited 12.14% 12.99% 2. Arvind Brands Limited -16.64% -13.91% 3. Lux Hosiery Industries Limited 2.44% 2.49% 4. Koutons Retail India Ltd. 15.44% 18.26% 5. Page Industries Ltd. 18.51% 22.51% 6. Kewal Kiran Clothing Ltd. 22.32% 28.28% 7. Nash Fashion (India) Ltd. 7.16% 7.04% 8. Oswal Knit India 5.42% 5.73% 9. Microtex India Limited 10.51% 11.71% Arithmetic Mean 8.59% 10.57% 3.3 The average mean of the comparable at 10.57% being more than the operating profit margin of the entity @2.57%, the TPO proposed an adjustment in the arm's length price as per computation as follows: Value of international transactions 189,537,478.00 OP/OC of comparables 10.57% Arm's lengt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ces activities cannot be disregarded. (2) The following companies have been unjustifiably included in the list of comparable companies by the TPO: a. Raymond Apparel Limited: The company had substantial high related party transactions of 26.22%, which is beyond the limit of 10% to 15% as laid down by the Hon'ble Delhi Bench of the Tribunal in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448. b. Kewal Kiran Clothing Limited The company has undergone major restructuring during the relevant previous year by way of bringing forth an Initial Public Offer; acquisition of substantial assets of Kewal Kiran Enterprises, a partnership firm and the cessation Kewal Kiran Retail India Private Limited and Kornorstone Retail Limited to be its subsidiaries. Since, the relevant previous year was abnormal; the operating result of the said company cannot be taken into account for the purpose of benchmarking analysis. The TPO, however, rejected the contention of the assessee holding that the impact of business restructuring on profit margin of a company, always reduces profit margin of the restructured company in initial years. The contention of the TPO is incorrec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Page Industries Ltd. 22.51% 4. Lux Hosiery Industries Limited 2.49% 5. Arvind Brands Limited -13.91% Average 4.77% 4.3 Since the operating profit margin of the assessee from the international transactions of exports @17.41% was higher than the average of operating profit ratio of 3.38% of comparable companies, the international transaction of export of goods, therefore, considered being at arm's length applying TNMM. (3) The low profitability of the assessee was entirely on account of the expenses incurred on establishing new show rooms, creating presence in the various parts of the country, large demonstration, marketing and selling expenses, etc. They were not on account of the international transactions under taken by the assessee due to following factors: (i) The gross profit margin of the assessee company is worked out at 44.53% as against 31.76% in the case of the comparable companies identified by the TPO. (ii) The operating profit margin of the assessee company after excluding some of the expenses, such as, rent, advertisement, shop running and guarantee charges, etc., is w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ra 6.7, 6.8 and 6.9. Taking in view brand value of assessee company discussed, no directions are being issued regarding the arm's length price of international transactions determined by APO. Aggrieved, assessee is before us. 5. Learned counsel for the assessee vehemently contends that: (1) The benchmarking undertaken by the assessee on the following international transactions has not been disputed by the TPO - Purchase of fixed assets - Reimbursement of expenses (paid) - Reimbursement of expenses (received) - Payment of expatriates' cost The assessee had undertaken the benchmarking of the following international transactions as follows: (a) Import of garments/ accessories/ raw material - CUP method: For benchmarking the abovementioned international transactions, the assessee filed the invoices raised by the AE on the unrelated third parties as CUPs along with the standard price list at which such garments were sold to unrelated parties. On the basis of such comparison, it was concluded that the payment made to the AEs was at arm's length applying the CUP method. (b) Payment of Royalty: The assessee pays royalty @ 4.8% on domestic sales exclu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 17.41% was higher than the operating profit margin of comparable companies identified in the notice at 8.59% (determined by the assessee at 3.38%). (d) Receipt of commission: For determining the arm's length price of international transaction of receipt of commission, Transactional Net Margin Method (TNMM) was selected as the most appropriate method. For the purpose of applying TNMM, operating profit to operating cost was considered as the base. After considering various criteria, comparable companies were identified. The results of TNMM analysis for buying services are summarized as under: Average OP/ Sales % of comparable companies 9.68% OP/ Sales % of assessee from buying services 23.96% Since the operating profit ratio of the assessee @ 23.96% was higher than the average of operating profit ratio of 9.68% of comparable companies, the aforesaid international transactions was considered having been entered at arm's length price, using TNMM. 5.1 Ld. counsel contends that the TPO proceeded to apply TNMM on entity wide basis disregarding the aforesaid benchmarking undertaken by the assessee. The adjustment proposed by the TPO i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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." (IV) For application of TNMM the net profit margin (over an appropriate base) realised by the enterprise from an international transaction entered into with the associated enterprise is to be compared with that from comparable uncontrolled transaction by an unrelated enterprise. The net profit margin arising in comparable uncontrolled transactions is adjusted to take into account the difference, if any, between the international transaction(s) and the comparable uncontrolled transaction(s) or between the enterprise entering into such transaction which would materially affect the amount of net margin profit. The OECD guidelines provide that in order to arrive at the most precise approximation of fair market value, the arm's length principle should, ideally be applied on a transaction-by-transaction basis. Your Honour's attention is invited to paragraph 1.42 of the OECD guidelines which provide that "Ideally, in order to arrive at the most precise approximation of fair market value, the arm's length principle should be applied on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment sales to the satellite television channels broadcast by them in India. The contract for advertisement is directly entered into between the advertisers, advertising agencies and Star Ltd and NGC Asia, as the case may be. These entities directly raise the invoice on the advertisers and the advertisement agencies and for the services rendered by the assessee, it receives commission at 10% of the advertisement revenue collected by it from Star Ltd in respect Star channels. In the case of NGC Asia, the assessee recovers 15% commission in respect of advertisement sales revenue of NGC. The assessee collects the dues from the advertisement agencies on behalf of Star Ltd. or NGC Asia as the case may be, but out of the advertisement commission at a maximum of 15% of the gross billing and applicable income-tax withholding. The assessee is entitled to the agreed commission on the net billed amount, and deduct its own commission at the time of realisation and the rest of the amount is paid to the principal. In the light of these facts, commission on advertisement sales arises out of an independent activity, which cannot he linked up with the other activities of the assessee, i.e. distribut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erent and distinct from the buying service segment as: (i) In manufacturing export segment, the international transactions related to export of finished goods, viz., garments manufactured by the assessee, buying service segment involves undertaking source related services, such as, identifying of the vendors, merchandize, undertakings, design, quality control, handling, co-ordination and logistics, etc. These two activities are entirely different. (ii) Manufacturing export activities and buying service activities are independent of each other and are not interconnected or inter-related. (iii) Manufacturing export segment and buying services segment involve the following different functions, assets and risk: S. No. Description Manufacturing Export Buying Services I Functions performed (i) Strategic Planning Significant Significant (ii) Sourcing and supply chain management Significant NA (iii) Manufacturing/Trading Significant NA (iv) Marketing Brand Building - Dome ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y transaction basis held that under TNMM, an international transaction or class of transaction should be evaluated on a standalone basis by computing the segmental margins - (VIII) The TPO has adopted a combined analysis of manufacturing transactions and buying services, undertaken by the assessee, and considered comparable companies engaged in manufacturing of garments on entity level basis. The comparison of manufacturing enterprises for bench marking of the buying services by the assessee. Therefore, it would be erroneous and inconsistent with fundamental test of comparability as provided in the Transfer Pricing regulations. Having regard to the functional analysis of the transactions, it would be inappropriate and in consistence with the accepted transfer pricing convention and practices to evaluate manufacturing exports and buying service segment together on an entity level for determining the arm's length price. Therefore, benchmarking analysis carried out by the assessee separately considering manufacturing export activities and buying services activities provide an ideal benchmark for the respective international transaction and cannot be disregarded. (IX) The TPO f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... filter of substantial related party transactions was not applied by the assessee in the Transfer Pricing documentation, the said contention could not be raised by the assessee at this stage. The assessee did not undertake benchmarking analysis in the Transfer Pricing documentation applying TNMM. The assessing officer for the first time in the show cause notice has applied TNMM to determine the arm's length price of the international transaction and identified the aforesaid companies as comparable companies. Consequently, there was no occasion for the assessee to apply the substantial related party filter in the Transfer Pricing documentation. Therefore, Raymond Apparel Ltd. having substantial related party transactions calls for being excluded from the list of comparables. (ii) Kewal Kiran Clothing Limited The company has undergone major restructuring during the relevant previous year. As given in its annual report, the company brought an IPO of 31,00,037 Equity shares of Rs. 10/- and became a public limited company w.e.f. from 02.11.05. The sales and operating income increased from Rs. 261.19 mn to Rs. 859.64 mn during the year. The net profit before tax also increased to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mited has increased to Rs. 21,270.78 lakhs in financial year 2005-06 as against 986.6 lakhs in financial year 2004-05 (Source: Capitaline). (X) It has been consistent stand of the Revenue that the companies with major restructuring should not have been accepted as a comparable, Koutons Retail India Limited should not be included as a comparable company. The TPO without basis has observed that the business restructuring reduces the profit margin of the company in the initial years. The comparative statement of profitability of the Koutons is as under: Year Sales % increase PBT % increase PAT % increase 31.03.2005 96.33 3.05 1.93 31.03.2006 158.34 64.37% 20.93 586.23% 13.62 605.70% 31.03.2007 402.40 154.14% 52.59 151.27% 33.95 149.27% 31.03.2008 793.46 97.18% 105.15 99.94% 69.49 104.68% 31.03.2009 1046.68 31.91% 120.82 14.90% 79.56 14.49% Thus, the profit of the company increased due to restru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the ITAT in the case of Development Consultants (P.) Ltd. (supra), wherein the aforesaid contention of the assessee has been upheld by the Hon'ble Tribunal. 5.4 The benefit of +/(-) 5% as per proviso to section 92C(2) of the Act has been held to be admissible as standard deduction while computing the arm's length price of the international transactions in the following decisions: - Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 /(Bang.) - Sony India Ltd.'s case (supra) - Skoda Auto India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 319 (Pune) - Development Consultants (P.) Ltd.'s case (supra) 5.5 Assuming even if assessee's other arguments are not accepted, in view of the clear provisions of proviso to section 92C (2) of the Act No adjustment is called for as assessee ALP is not less than 95% of the average operating profit margin of the comparable uncontrolled enterprises determined applying TNMM method. 5.6 In any case the assessee company during the relevant previous year has incurred substantial expenses to promote and establish its business in the domestic market. Low profitability of the assessee is mainly on account of the expenses i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction to transaction basis in respect of different segments of assessee's international transactions with associated enterprises. In our view, assessee's functions, risk and assets FAR considerations, which are given in the above table, deserves to be merited. TPO did not appreciate the assessee's transactions correctly and applied entity level benchmarking on TNMM method by combining assessee's all international transactions with associated enterprise without justification. 7.3 Our view is supported by ITAT judgments - Mumbai Bench in the cases of UCB India (P.) Ltd. (supra); and Star India Ltd. (supra); and Kolkata Bench in the case of Development Consultants (P.) Ltd. (supra). All these cases clearly lay down that ALP would be determined based on the nature of service provided by assessee for each class of transaction based on various factors and analysis. In the case of Star India Ltd. (supra), also the TPO treated all the activities of the assessee as one and determined the ALP at entity level without appreciating that one cannot compare the FAR of a principal and agent on same footing. 7.4 In our view, in the assessee's case there are different segmental activities, w ..... X X X X Extracts X X X X X X X X Extracts X X X X
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