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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 ..... 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 to make suitable adjustment to the margins of the appellant to adjust for material differences between the appellant and comparable companies, while applying TNMM on a company wide basis. 4. Without prejudice to the above ground, on the facts and in the circumstances of the case and in law, the Hon'ble DRP/TPO erred in not selecting appropriate comparables for benchmarking the international transactions of the appellant. 4.1 The Hon'ble DRP/TPO erred in accepting Page Industries Limited and Microtex India Limited which earned significant revenues from non-comparable products as comparable companies. 4.2 The Hon'ble DRP/TPO erred in accepting Raymond Apparel Limited which has significant related party transactions, as comparable company. 4.3 The Hon'ble DRP/TPO erred in accepting Kewal Kiran Clothing Company and Koutons Retail India Limited which underwent major restructuring changes during the relevant year as comparable companies. 5. On the fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) 5,851,440 CUP (vi) Bencom S.r.l., Benetton Asia Pacific Ltd. Reimbursement of expenses (received) 270,145 CUP (vii) Benind S.p.A, Benetton Asia Pacific Ltd, Benetton Retail Hongkong Ltd. Export of garments 124,923,684 TNMM (viii) Benind S.p.A Receipt of commission 7,611,367 TNMM (ix) Benind S.p.A, Bencom S.r.l. Payment of expatriates' cost 33,822,175 Cost Plus Method 2.1 According to assessee, the ALP was determined on a "transaction by-transaction" basis for applying arm's length price on above method, using the most appropriate method having regard to functional analysis and availability of the comparable uncontrolled benchmark. 2.2 AO referred the report to ld. TPO for determination of ALP. Assessee submitted following justification for "transaction to transaction" basis and methods adopted for its TP report. (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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applying TNMM, operating profit to total sales was considered as the base or the profit level indicator. 46 companies in readymade garment business were identified based on selection criteria, which were considered functionally comparable to the business activity of the assessee. The result of TNMM analysis for transactions other than buying services is summarized as under: Average OP/ OC % of comparable companies 8.73% OP/ OC % of the assessee 17.41% Since the operating profit ratio of the assessee for exports made to related parties @17.41% is higher than the average of operating profit ratio of 8.73% of comparable companies, the international transaction of export of finished goods was therefore, considered being at arm's length using TNMM. Operating profit margin of the assessee company in respect of international transactions of export of manufactured goods 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%). (f) Receipt of commission: For determining the arm's length price of international transaction of receipt of commission, Transactional Net Margin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... how room, creating presence in the various parts of the country, large demonstration, marketing and selling expenses, etc. In other words, the low profitability of the assessee company is not on account of the international transactions as would be evident from the following: (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. The profitability of the assessee is not impacted on account of the international transaction of imports, which is, in any case, only 2.54% of the total turnover. (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 worked out at 20.41% (OP/Sales %) as against 15.29% in case of the comparable companies identified the TPO. 2.7 In other words, low profitability of the assessee company could be largely attributed to the expenses incurred by the assessee to establish and promote itself in the domestic market and has nothing to do with the various international transactions undertaken by the associated enterprise. 3. The TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by AO who proposed this addition to assessee's income. Aggrieved, assessee approached DRP where following contentions were raised: (1) The TPO has undertaken entity level benchmarking analysis applying TNMM combining all the international transactions as against transaction by transaction analysis as provided in the Transfer Pricing Regulations recommended by OECD guidelines (in paragraph 1.42). Reliance is also placed on the following decisions, wherein, determination of arm's length price of international transactions on transaction by transaction basis is upheld: - Development Consultants (P.) Ltd. v. Dy. CIT [2008] 23 SOT 455 (Kol.) - ACIT v. Star India Limited [IT Appeal Nos. 3585 & 3846 (M) of 2006] - Aztec Software & Technology Services Ltd. v. Asstt. CIT [207] 107 ITD 141 (Bang.) (SB) - UCB India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 95 (Mum.) In the case of UCB India (P.) Ltd. (supra), relied upon by the TPO, too, the Hon'ble Mumbai Bench of the Tribunal upheld the determination of the arm's length price by considering segmental margin on a stand alone basis. In view of the aforesaid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n criteria as considered by the TPO himself. d. Koutons Retail India Limited: The financial statements of Koutons Retail India Limited are not available on any public domain for financial year 2005-06. Secondly, the company has undergone major restructuring during the previous year 2005-06 as Koutons retail India Limited was incorporated by acquiring, Charlie creations, which was a partnership firm. Evidently, the profit of the company has considerably increased due to such restructuring and hence should not be considered as a comparable for the relevant assessment year. 4.1 Assessee contended that the following companies should be excluded from the set of comparable companies considered by TPO, applying TNMM: S.No. Companies Reason for rejection (i) Raymond Apparel Limited Substantial related party transactions to the extent of 26%. (ii) Microtex India Limited Does not satisfy turnover criteria considered by the TPO. (iii) Kewal Kiran Clothing Ltd. Major restructuring during the relevant previous year resulting in abnormally high sales and operating profit margin. (iv) Koutons Retail India Ltd Major restructuring during the relevant previous year and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... invalidity in aggregating international Transactions of exports of finished goods and rendering of buying services which are functionally different International transactions undertaken with different associated enterprises. Assessee has summed up his arguments in the table below in which the reasons for rejections are also given S.No. Companies Reason for rejection (i) Raymond Apparel Limited Substantial related party transactions to the extent of 26%. (ii) Microtex India Limited Does not satisfy turnover criteria considered by the TPO. (iii) Kewal Kiran Clothing Ltd. Major restructuring during the relevant previous year resulting in abnormally high sales and operating profit margin. (iv) Koutons Retail India Ltd. Major restructuring during the relevant previous year and financial statements not available on any public domain. The assessee company deals in high-end ready-made garment products in comparison to Koutons and the economic/ market scenario of the assessee company so far as well assessee's product is concerned is completely different and is not comparable to that of Koutons. Assessee has also tried to submit that l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ioned 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. (c) 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 transaction of export of finished goods, Transactional Net Margin Method (TNMM) was selected as the most appropriate method. For the purpose of applying TNMM, operating profit to total sales was considered as the base or the profit level indicator. 46 companies in readymade garment business were identified based on selection criteria, which were considered functionally comparable to the business activity of the assessee. The result of TNMM analysis for transactions other than buying services is summarized as under: Average OP/ OC % of comparable companies 8.73% OP/ OC % of the assessee 17.41% Since the operating profit ratio of the assessee for exports made to related parties @17.41% is higher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntained (III) For the purpose of determining the arm's length price in relation to international transactions, in terms of sub-section (2) of section 92C of the Act, Rule 10B of the Rules provides the manner of application of the various prescribed methods. Clause (e) of sub-rule (1) of Rule 10B of the Rules provides for application of Transactional Net Margin Method as under: "(e) Transactional Net Margin Method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd the risks assumed, by the respective parties to the transactions." (VI) Similar convtroversy came up before Mumbai Bench of the ITAT in the case of Star India Ltd. (supra). In this case TPO has ignored the detailed analysis of the various international transactions individually entered into by the assessee in respect of its two principal business activities namely the export business and buying services business. The TPO treated all the activities as one and determined the arms length price at an entity level ignoring that one cannot compare a distributor with a principal and an agent at the same time, as each activity will result in completely different functions and reasons analysis. The ITAT upholding the contention of the assessee, held as under in this behalf: "63. We have carefully examined all the activities of the assessee and we find that the assessee is in fact involved in three independent activities, i.e. (a) distribution activity for which assessee has to pay the license fee for the right to distribute the Star channels to Asian Broadcasting Corporation Ltd also based in Dubai and Indian Region Broad Casting Ltd., a company based in Hong Kong. This distribu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... activities, assessee's assets were utilized and the risks were assumed. This activity is also an independent activity and could not be linked up with the other two remaining activities. Since all the three activities of the assessee are not inter related or interlinked, the Arms Length Price for all the activities should have been determined independently, in the light of comparable case. But. the TPO has consolidated and treated all the three activities as one activity and has determined a common Arms Length Price, having adopted Arithmetic Mean of operating cost margins of six comparable cases., which are not involved in all the activities as involved by the assessee. 64. We have thoroughly examined the order of the Special Bench in the case of Aztec Software and Technologies Ltd. (supra) and we find that the Tribunal has examined the Chapter-X of the Income-tax Act, relating special provisions relating to avoidance of tax in detail and the Tribunal has held that ideally in order to arrive at the most precise approximation of fair market value arms length principle should be applied on transaction to transaction basis. However, there are often situations where separate transact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... keting risk - Domestic Significant Insignificant (iv) Foreign Exchange risk Significant Insignificant (v) Technology risk Significant NA (vi) R & D risk Insignificant NA (vii) Manpower risk Significant Significant (viii) Price risk Significant NA (ix) Capacity utilization risk Significant NA III Assets Employed (i) Tangible Assets Significant Insignificant (ii) Intangible Assets Acquired NA (iv) The two business activities require performing different functions, utilization of assets and risks are entirely separate and different activities. (v) There is a separate team of people for the two business segments. Reliance is placed on the judgment of ITAT in the case of UCB India (P.) Ltd. (supra) where ITAT while examining the applicability of TNMM of entity level or on a transaction by 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 transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that: "We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors" The TPO, however, disregarded the contention of the assessee that the above company having related party transaction should not be considered as part of the comparable companies. TPO erroneously held that since the 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 compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able companies. The said company, it would be appreciated, does not satisfy the selection criteria as considered by the TPO himself. The said company for that reason is to be excluded from the set of comparable companies. v. The financial statements of Koutons Retail India Limited are not available on any public domain for financial year 2005-06. Besides, as per various news reports on the internet, in public domain, the company has undergone major restructuring during the previous year 2005-06. On 07.02.06, Koutons retail India Limited was incorporated by acquiring, Charlie creations, which was a partnership firm. As a result of the restructuring, as reported, the total income of Koutons Retail India Limited 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean." (emphasis supplied) 5.3 Reliance is placed on the decision of Calcutta Bench of 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 ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se, designs quality control, handling etc. The FAR analysis in each of the activity will have distinct and separate considerations. 7.2 We, find merit in the argument of the learned counsel that the TPO should have accepted the method of assessee's benchmarking analysis on the basis of transaction 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. (s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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