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TMI Blog2011 (6) TMI 449X X X X Extracts X X X X X X X X Extracts X X X X ..... with the working results of a concern which was not comparable at all - Decided against the revenue With respect to purchase of finished goods - Held that:- Assessee has committed two fundamental mistakes in working out the ALP based on resale price method. It went by its internal gross profit rate averaged over two years, that too without excluding the purchases and sales from the associated enterprises. Neither the A.O. nor the TPO went into this aspect but simply applied TNM method, that too based on a single comparable, which as already mentioned by us was not comparable at all. Matter set aside to AO - Decided in favor of Revenue for statistical purposes. - IT APPEAL NOS. 703 & 951 (MDS.) OF 2009 - - - Dated:- 17-6-2011 - ABRAHAM P. GEORGE, GEORGE MATHAN, JJ. M. Viswanathan for the Appellant. Shaji P. Jacob for the Respondent. ORDER Abraham P. George, Accountant Member These are appeals filed by the assessee and Revenue respectively, for assessment year 2004-05, both directed against an order dated 27.3.2009 of Commissioner of Income Tax (Appeals)-XI, Chennai. 2. Assessee in its appeal has raised only one issue which is against the direction of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 13th November, 2009, as under:- "2.17 In the facts and circumstances of the case, when the royalty payments shall be computed at a particular percentage of sales priced, and if there was no sales, no royalty would be payable. Merely because goods were produced in India by the assessee acquiring the technical process from the foreign collaborator, it cannot be said that the royalty payment is referable to the production house/manufacturing of the products. The technical know-how for the manufacturing process was acquired by the assessee against a lump sum payment of royalty and subsequent to that, if there is no sale of the product manufactured by the assessee, then there would be no royalty payable. Thus, the running royalty payable has no nexus or direct connection with the manufacture of the product. The liability to pay the royalty arises only when there is a sale. Therefore, we are of the view that the running royalty cannot be said to be a capital expenditure. We do not find any rationale in bifurcation of the running royalty and treating one part as capital and the other part as revenue by the learned Commissioner of Income Tax (Appeals) without any basis. The decision r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lone from COCL, France. It had also effected sale of finished goods to COCL, Singapore. In addition, it was having certain transactions with COCL, Singapore for liaison activities, and also transactions relating to royalty and technical service with COCL, USA. Purchase of raw materials from COCL, Singapore, was of the value of Rs. 13,55,90,154, which was in addition to purchase of finished goods Rs. 4,66,66,369/- from the same associated enterprise. Purchase of finished goods from COCL, France came to Rs. 63,48,769/-. These together, totalled to Rs. 18,86,05,292/-. As per the assessee, the purchase of raw materials from COCL, Singapore of Rs. 13,55,90,154/- consisted of two specific items on which comparables existed and arms length price was computed and given in Form No. 3CEB filed. It had worked out arms length price vis- -vis the above purchase of Rs. 13,55,90,154/- at Rs. 18,16,05,784/- based on comparable third party transactions listed in Annexure - 2(B) of the said Form. The comparison of price of these two raw materials, were with purchase effected by M/s Herdilla Schenectady and M/s Lubrizol India Pvt. Ltd. Thus, in so far as these two raw materials were concerned, assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ls of its ownership and for ascertaining possibility of any transaction with its associated enterprises, whereupon M/s IIP replied that it was an independent company held by Indian promoters and had no related parties transactions at all. Nevertheless, it was also confirmed by M/s IIP that in the relevant previous year, it had only small customers and only one major customer was M/s Bennet Colman Co. Ltd., Mumbai. The TPO rejected the contention of the assessee that its turnover could not be compared with that of M/s IIP, for, according to him, this was not a criteria to be adopted for selecting a comparable concern. Thereafter he made the following comparison between financial results of assessee and M/s IIP:- INDIAN ADDITIVES LTD.(ASSESSEE) Mar 2004 INTERFLON (INDIA) PVT. Ltd. 2004 Rs. Crore (Non-Annualised) 12 mths Income Sales 1203600000 Sales 1400227 Other income 5600000 Other income 220629 TOTAL INCOME 1209200000 TOTAL INCOME 1620856 Expenditure Expenditure R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee and hence, there was no question of any adjustment whatsoever. Further, as per the assessee, TPO had made adjustment on purchase prices of two raw materials on which comparables were existing, on a reasoning that there were no comparables for other raw materials purchased, which were proprietary in nature. In so far as purchase of finished goods was concerned, explanation of the assessee was that these were all proprietary goods manufactured by COCL, Singapore and France and never produced by any other company nor available in open market. Therefore, according to assessee, it had adopted resale price for finding the arms length price. Assessee pointed out before ld. CIT(Appeals) that resale of such finished goods were effected only to third parties and hence, reducing gross profit from such resale prices was a good and correct method for fixing arms length price. Vis- -vis comparison made by the TPO with M/s IIP, assessee pointed out that the said M/s IIP was 100% Indian company, whereas, assessee was an equal collaboration between a public sector undertaking and foreign company. Assessee also brought to the attention of ld. CIT(Appeals) that M/s IIP was only doing purch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inished goods purchased. As per the learned A.R., application of TNM method was uncalled for when the assessee had given the specific comparables and adopted CUP method. According to him, without rejecting the comparables given by the assessee, the TPO had arbitrarily adopted TNM method that too based on the financials of a small company not at all comparable with that of the assessee. Relying on the comparison table of financials, given at para 7.4 of TPO's order, learned A.R. submitted that if the other income of Rs. 2,20,629/- was excluded from the profits of M/s IIP, it would result in negative margin. According to him, not only was the turnover of M/s IIP negligibly small, but it was also catering to different industrial field. Learned A.R. argued that TPO had adopted the TNM method without making proper analysis and without rejecting the CUP and Resale price method adopted by the assessee. According to him, CIT(Appeals) was justified in deleting the addition made. 14. We have perused the orders and heard the rival contentions. TPO had relied on financials of M/s IIP which he considered to be a comparable company and worked out the profit margin which came to 7.87% and appli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of raw materials where the assessee could give specific comparables adopting CUP method. Even for those 13 items, assessee has specifically mentioned that these were not available in the market and no comparable were there at all. Thus, we do not find any proper reason why the TPO could reject the method adopted by the assessee and apply the TNM method based on the financial of M/s IIP. Again, if we look at financial of M/s IIP reproduced by us at para 9 above, its sales were of Rs. 14 lakhs and odd against the sales in excess of Rs. 120 Crores of the assessee. The said M/s IIP had not paid any excise duty and indirect taxes, but, had incurred only packing cost in addition to cost of materials. As against this, assessee had paid indirect taxes of about Rs. 60 lakhs. Obviously, M/s IIP was not engaged in any major manufacturing activity nor it had a comparable turnover. There were substantial differences in the financial data of the two companies which considerably eroded the degree of comparability between the two. Thus, the TPO not only adopted the TNM method without rejecting the CUP method followed by the assessee, but also made addition based on the financial results of an unco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... p when resale price method is adopted for determining the arms length price of purchases from associated enterprises is the reduction of gross profit margin from the resale price. Such gross profit margin can be determined in any of the two methods. First is the gross profit margin of the assessee itself. But when gross profit margin of the assessee itself is considered, then such gross profit margin has to be worked out excluding the purchases from the associated enterprises and sales thereof. Otherwise, as already pointed out by us, it will be meaningless. However, here more than 70% of assessee's sales were out of purchases sourced from associated enterprises, and hence working out the gross profit margin internally, after excluding such transactions, would be inappropriate due to negligible quantities of balance purchases and sales. Hence, in such cases, the gross profit margin should be taken from comparable uncontrolled transactions entered into by similarly placed concerns. Thus, the assessee has committed two fundamental mistakes in working out the arms length price based on resale price method. It went by its internal gross profit rate averaged over two years, that too wit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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