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TMI Blog2012 (5) TMI 317X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod adopted by the TPO cannot be called TNMM prescribed under the Act and Rules, we have to necessarily uphold the Order of the first appellate authority, though for different reasons. - Decided in favor of assessee. - IT Appeal No. 5272 (Mum.) of 2007 - - - Dated:- 16-5-2012 - B.R. MITTAL, J. SUDHAKAR REDDY, JJ. ORDER J. Sudhakar Reddy, Accountant Member This is an appeal filed by the Revenue directed against the Order of the Commissioner of Income Tax (Appeals)-10, Mumbai dated 8-5-2007 for the assessment year 2004-2005. 2. Facts in brief. The assessee is a company and engaged in the business of manufacturing and export of pharmaceutical products. It filed its return of income for assessment year 2004-2005 on 27-10-2004 declaring total income at Rs. 2,12,88,722/-. Along with return of income, the assessee-company filed audit report under section 92E in the prescribed Form No.3CEB in relation to international transactions along with other audit reports and Forms. 3. The assessee has entered into international transactions with Associated Enterprises for (a) export sale of pharma products and (b) reimbursements of business promotion expenses. The matter ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arried the matter in appeal before the first appellate authority. The first appellate authority deleted the addition on the following grounds : ( a ) There are no defects in respect of information and documents kept under section 92D and as prescribed under Rule 10B(b). ( b ) In the previous year the total amount paid to AE for advertisement was Rs. 6,43,58,749/-, which corresponded to 30.92% of total sales and these transactions of the earlier years were accepted by the Assessing Officer. The TPO's assumption to restrict advertisement and marketing expenses to 10% of total sales of Rs. 54 crores is not supported with any logic. ( c ) That operating margins to sales and operating profit to cost were not comparable with the study of 17 units carried out by TPO. ( d ) Even the study carried out for those companies, the advertising and marketing expenses vary between 5.27% to 31.89% and taking mean of all companies for benchmarking is not justified. ( e ) That Assessing Officer has not pointed out any defects in the bill for reimbursement supported with vouchers. ( f ) That the remittance bear approval of RBI and other monitoring agencies. ( g ) That TPO has accep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee had no control over them, without verifying the genuineness of the factum of transfer." 7. Learned D.R. Mr. Ajit Kumar Jain submitted that the TPO order should have been upheld by the Commissioner of Income Tax. He took this Bench through the Order of the TPO passed under section 92CA(3) of the Act on 8-12-2006 specifically finding at para-5. He pointed out that the TPO recorded that, for the export sale of Rs.50.12 crores, the advertisement expenses are at Rs.32.58 crores which is 60.33% of total sales. He pointed out that assessee's net profit before tax was 5.8% of the sales. He submitted that the assessee has incurring unusually high expenditure on advertisement abroad. He submitted that though the assessee has produced all details, the TPO was not able to decipher the documents in foreign language or actually carry-out the physical verification of the expenses. He submitted that it is evident that two of the assessee's AEs are located in Cyprus which is a tax heaven. He supported the finding of the TPO that the transactions prima facie appear to be doubtful. 7.1 Thereafter, he took this Bench to the finding of the TPO wherein arms length price has been det ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessment year 2003-2004 dated 9-3-2006 and submitted that the reimbursement of expenses for marketing and advertisement was accepted and no adjustment was suggested. He argued that Cyprus is not a tax heaven and due to the fact that the banking system in Ukraine and other such countries, was not accepted by the Government, Cyprus was the place where AEs were located. He pointed out the assessee adopted CUP method and the Assessing Officer has not rejected the same. He relied heavily on the Order of the CIT(A). 9. In reply, the learned DR submitted that the fundamental issue to be decided is whether the expenditure on marketing and advertisement, is to be borne by the assessee or the AE ? 10. Rival submissions heard. On a careful consideration of the facts and circumstances of the case and a perusal of the papers on record and the Orders of the authorities below we hold as follows : 10.1 Assessee has used cost plus method to justify that the transactions are at arms length. The assessee ultimately sold products in Ukraine but routed the same through its Associated Enterprise located in Cyprus. Reason given by the assessee is that Ukraine is politically and economi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s established is then taken into account to arrive at an arm's length price in relation to the international transaction." 10.4 A plain reading of this Rule demonstrates that the methodology adopted by the Assessing Officer is against the law. It is not right to pick-up 17 pharmaceutical companies, look into the percentage of expenditure incurred by each one of them on marketing and advertisement and then arrived at a average or mean and hold that this average percentage is the industry average and apply the same as the arms length percentage of expenditure to be incurred by the assessee. Mean of percentage of a certain type of expenditure cannot be "arms length price". The method followed by TPO is not "TNMM". 10.5 This Tribunal in the case of UCB India (P.) Ltd. v. ACIT [2009] 121 ITD 131 held as follows : 68. We now consider the second limb of invoking provisions of section 92C, i.e., the adoption of TNMM by the assessee. The assessee has adopted the TNMM by comparing the overall operating profits of the assessee company with the overall operating profits of certain other organizations or companies which were the comparable companies selected by it, from out of dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices because it is on the basis of rate of return on sales or cost or operating assets that transactional margin is computed. These parameters generally available in the case of a party providing services." 69. Under the Transfer Pricing Regulations the following steps are to be taken to determine the TNMM : Step 1 : The net profit margin realized by an enterprise from an international transaction entered into with an AE 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. Step 2 : The net profit margin realized by the enterprise or by an unrelated enterprise, form a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base. Step 3 : The net profit margin referred to in step 1 arising in comparable uncontrolled transactions is adjusted taking into account the differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprise entering into such transactions, which would materially affect the amount of net profit margin in the open market. Step 4 : The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise." 71A. The arguments of Shri Rajan Vora that entity level comparison is permitted both by the OECD commentary as well as by the commentaries by eminent authors like Robert T. Cole, J. Harold Mc Lure and others, in our considered opinion is not correct. In the book "Transfer Pricing Note Book Third Edition Robert T. Cole at Chapter XXV ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ability is compared, the assessee has shown greater profitability margins than these 17 pharma companies. Expenditure incurred by the 17 companies on other heads such as "salaries, raw material, establishment etc.," are not compared. The nature of product are different. The markets are different. Nothing common has been brought-out. This is not the way the "TNMM" is to be applied under the Income Tax Act and the Rules framed therein. At best what can be said is that the TPO has adopted an adhoc method to disallow capital expenses under the guise of Transfer Pricing provision. 10.7 The learned DR submits that the most important aspect to determine is as to who should bear the expenditure and who is getting the benefit out of this marketing and advertisement expenditure. The assessee is the manufacturer of the product and as recorded by TPO at page 3, the assessee is selling products which are high in demand and cater the niche market. The expenditure is of the assessee. Ofcourse the primary benefit would be that of the assessee. In any event, in our opinion, this is not the primary issue. The primary issue is, whether the TPO has arrived at the "arms length price" in accordance ..... X X X X Extracts X X X X X X X X Extracts X X X X
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