9911796707
TMI Blog2012 (9) TMI 766X X X X Extracts X X X X X X X X Extracts X X X X ..... credit based which the suppliers have to extend to GAP, USA entities and assessee bears no risk. The assessee' role, functions and activities are limited to scrupulously follow the handbook and other instructions provided by the parent group. These facts and circumstances indicate lack of authority or discretion with assessee in deviating or changing from the policies and procedures prescribed by the parent company. Therefore, it is unable to be agreed with the view that assessee incurred any significant risk in its functions. Development of substantial human resources intangibles by assessee - Held that:- There is no supporting material available on record to hold it against assessee. Except generalized assertions nothing reliable is placed on record to support these observations - Assessee had 230 employees on its payroll engaged in execution of preordained support nature activities as per the guidelines. Department has failed to demonstrate that any or few of employees were any acclaimed personalities or indispensable in garment procurement trade so as to constitute any human intangibles as alleged. With no decision making or entrepreneurial role embedded in their work profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her based on any cogent reasoning nor factual reliability, the assessments as framed give an impression of being work of adversarial approach in tax liability determination - No hesitation to accept a candid proposal given by the assessee and hold that assessee TP adjustments be made by adopting the 32% cost plus mark up of the assessee for AY 2006-07 and 2007-08. The mark-up proposal of assessee is higher than mark-up over total cost earned by all comparables placed on record. The assessments should be framed accordingly. Depreciation on computer peripherals, printers and UPS @ 15% instead of 60% as allowable under the Income Tax Rules - Held that:- Rate of depreciation it is by now settled that the computer peripherals are eligible for 60% depreciation which should be allowed to the assessee. - IT Appeal Nos. 5147 (delhi) of 2011 & 228 (Delhi) of 2012 - - - Dated:- 18-9-2012 - R.P. TOLANI AND T.S. KAPOOR, JJ. ORDER R.P. Tolani, Judicial Member - These are two appeals filed by the assessee against assessment orders passed consequent to directions of the Dispute Resolution Panel-II, New Delhi U/s 144C(5) of the Income-tax Act, 1961, relating to A.Y. 2006-07 2007-0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the detailed submissions and extensive analysis to demonstrate that the said adjustment(made by the Ld. TPO) results into an operating profit/ value added expenses (OP/VAE) ratio of 830.95% for the appellant, which is unrealistic, impractical and absurd. 7. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in applying the decision of the Hon'ble Delhi Tribunal rendered in the case of Li Fung (India) Pvt. Ltd. v. DCIT in the case of the appellant without appreciating that the FAR profile of the appellant was entirely different than the assessee involved in the said case; and accordingly, the said decision could have no application in the instant case of the appellant. 8. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in holding that the profit level indicator (PLI) adopted by the appellant for setting the price and also testing the arm's length aspect of the international transactions entered into by the appellant with its associated enterprise, being OP/VAE was not a valid PLI for the purposes of the Indian Transfer Pricing regulations. 9. The Ld. DRP and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oods sourced directly by the AEs of the appellant from third party vendors in the cost base of the appellant, for the purpose of computing the arm's length profit margin of the appellant on the alleged ground that it created supply chain and human asset intangibles in India and generated location savings in India which have not been factored into in its remuneration model. 2.4 in upholding the Ld. TPO's stance of rejecting the appellant's reliance on relevant international judicial precedents on absolutely irrelevant, inconsistent and extraneous reasons. 2.5 in disregarding the detailed submissions and extensive analysis to demonstrate that the said adjustment(made by the Ld. TPO) results into an operating profit/ value added expenses (OP/VAE) ratio of 830.95% for the appellant, which is unrealistic, impractical and absurd. 3. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on the principles of natural justice to pass a proper and speaking direction under section 144C of the Act: 3.1 in disregarding the various submissions and extensive/ voluminous documentary evidence filed by the appellant during the course of the DRP/ assessment p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nation of Arms Length Price "ALP". TPO, however looking at the FAR and other factors which are mentioned herein below, rejected assessee's cost plus 15% ALP and held that commission @ 5% on the FOB value of goods sourced by the foreign enterprise through Indian Vendors was the most appropriate PLI for determining ALP. TPO's report has been accepted by DRP. Thus apart from other issues main issue for our adjudication is, whether PLI based on cost plus mark-up or 5% of commission on FOB value of goods facilitated by the assessee for outsourcing is the most appropriate in given circumstance. 3. Ld. counsel for the assessee Shri Rahul Mitra FCA, vehemently argues that as a facilitator for sourcing of apparel merchandise from India by the Associated Enterprises ('AEs'), the Appellant operates as a limited risk bearing sourcing support service provider. In respect of this activity, the Appellant is remunerated on a cost plus 15% mark-up basis for acting as a co-ordination arm facilitator/ interface between the third party vendors in India and its overseas AEs. There is a marked difference between a risk bearing agent and low risk facilitator, the later amounts to a service provider onl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the exportation of purchased products; - Purchasing support services relating to identifying and evaluating new vendors; and - Act as a liaison between GIS Inc. and local vendors. (ii) The services are same as undertaken by earlier liaison office, where ALP working at cost + 15% basis has been accepted. In performance of the above mentioned services, the necessary inputs i.e. specifications and designs of the products to be sourced, names and addresses of vendors/ manufacturers, detailed information on potential or new vendors, operating softwares, training material, operating and process know-how etc., were all provided by the AEs. The assessee has inherited the set up enjoyed by L/A. (iii) Besides, as per the "Intangible property" clause of the service and support agreement, GAP Group provides the following information to the assessee : - Vendor list containing business information relating to the on-going sourcing of merchandise, yarn, fabrics, trim and packaging, which includes name of manufacturers or vendors, items, production capacity, price, production lead time, and quality; information on branded labels, zippers, buttons, plastic notions, snap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion/ voluminous documents to substantiate its arguments which have been summarily overlooked. (vi) Goods sourced by the AEs from India are directly sold by the third party vendors to the overseas AEs. The Appellant's role in the entire process is limited to provision of liaisoning support services. (vii) The authorities below have failed to appreciate the crucial points that GIS Inc. and not the assessee has no role to play in several key and critical activities in the Group's value chain such as: - Develop global sourcing strategies; - Deliver global cost of goods targets and savings; - Develop global sourcing policies, procedures and standards; - Develop global sourcing organization and operating structure; - Manage global sourcing organization; - Own and maintain vendor relationships; - Authorize and negotiate contracts with freight forwarders, carriers, delivery and other logistics companies; - Factory and mill relationship management, including building and developing strategic relationships; - Long-range planning with vendors and mills for capacity planning; - Vendor level placement decisions for samples and b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bric supplier lists, sampling procedures/ techniques/ processes, quality control standards, etc., are owned by the overseas GAP group companies and not GIS India. The assessee has to carry out its functions strictly as per the service agreement between GIS India and GIS Inc. Thus, GIS India performs a limited role and bears limited / minimal risks as a result of its standalone liaisoning and co-ordination activities, undertaken on the detailed guidelines, standards, manuals, polices and procedures developed / created by the overseas group companies. 5. The relevant documents submitted by the Appellant to support its contentions include: - Vendor handbook/ manual which demonstrate the policies/ processes developed/ set by the GAP Group, which is a part of the core intangible property developed by the GAP Group over the years. - Vendor Compliance Agreement entered into between the GAP retail companies and the Indian vendor describing in the clause IV ("Vendor's representation and warranty of originality of product design supplied by vendor") and clause V ("product performance standards and procedures") that the vendor bears the warranty and liability of the product in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions (includes the entire cost of Indian sourcing operations) under the head 'Cost of Goods Sold and Occupancy Expenses' which is different from the cost of design and development which is classified as value added expense, demonstrate the fact that the design/ development function is carried out entirely in USA. - Sample copies of memos/ documents/ designs created by GAP US and sent to the Appellant (over e-mails) evidencing the fact that the key activities in the value chain, namely product designing, taking all vendor and sourcing related decisions, setting quality control norms etc., are performed by the overseas group entities. - Document presenting/ depicting the entire product process (from concept to line-freeze), again evidencing that all key decisions are performed/ undertaken in the US by the relevant GAP US employees/ personnel. - Documents setting out the in-season/ pre-season meeting schedules clearly evidencing that all key decisions are performed/ undertaken in the US by the relevant GAP US employees/ personnel. - List of employees working in US for GAP Group's design, production and technical service teams. These lists amply demonstrate the fac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted by GAP Group from low raw material costs are passed on to end customers. In no circumstances, GIS India gets a return for the manufacturing activity or is entitled to a return on account of location savings as it only functions as a mere support service provider and a watch dog ensuring that the right quality of goods reaches at right place at the right time, and operates strictly within the confines of the standards prescribed by the overseas GAP Group. 5.4 GIS India and GIS Inc. have entered into a legally binding agreement which defines the role, responsibilities and remuneration of both the parties to the agreement. It should have been duly considered and appreciated by the Ld. TPO as well as Ld. DRP and in the absence of any adverse material is to be accepted on commercial principles. 5.5 Without prejudice to the above, it is pleaded that, even if it is assumed that location savings have indeed arisen in the instant case, then in that situation, the question of allocation truly needs to be addressed in light of the relative bargaining powers/ ownership of intangibles of the parties concerned and the competitive market position of the company based in the low cost juris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... egotiations (including talks on payment terms) with the suppliers. However, the operating companies were responsible for concluding and signing individual contracts and all other purchase related activities such as placing orders and making payments for the raw materials. The suppliers delivered the raw materials directly to the operating companies. Based on the above facts, the Supreme Court of Netherlands held that in respect of the procurement/ purchasing coordination/ support services provided, BCC is entitled to a return on its costs which was quantified to a 5% margin on costs. (b) The activities carried out by BCC are in fact substantially more than the limited risk routine services carried out by the assessee. BCC carried out price negotiations with the suppliers also whereas the assessee only performs routine activities within the confines of the instructions provided by the AEs. (c) Applying the ratio of this ruling, the remuneration model of charging a mark-up on the value adding costs incurred by the Appellant in its procurement/ purchasing coordination/ support services activity, should be accepted as the arm's length business model. Further, it may also be noted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ost in relation to price of goods. Therefore, the PLI used by the Appellant in its own case is actually OP/TC since the Appellant's VAE is equal to TC. The relevant Rule clearly suggests that based on the intensity of functions performed (which is measured by value added expenses), under TNMM, a relevant cost base i.e. VAE in the instant case, can be used. This concept is very well supported by the Ruling by the Hon'ble Delhi Tribunal in the case of DCIT v. Cheil Communications India Pvt. Ltd. (ITA No. 712/Del/2010) (137 TTJ 539), which holds as follows: "The rival contentions of both the parties have been considered and orders of the authorities below have carefully been perused. The only question that falls for our consideration is with regard to the method of computing profit/TC margin whether on gross basis as done by the TPO or net basis as worked out by the assessee. In this case the assessee has applied TNMM method to determine ALP, which has also been accepted by the Revenue authorities .. The payment made by the assessee to third party vendor/media agencies for and on behalf of the principal has not been included in the total cost for determining the profit margin, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the distribution services performed, measured as a percentage of the value-adding (operating) expenses incurred by them. The value of the products being distributed, in other words, is irrelevant. Distributors must achieve a particular gross profit in order to compensate them for their value-adding services, the costs of which are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr. Berry on this aspect reads as under:- "Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is a measure of the activities of the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the product distributed, o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ustomers for products sourced directly by such global customers from third party vendors in India. For such sourcing services, Li Fung HK received a commission of 5% from its global customers, on the value of goods procured by such customers directly from third party vendors in India. 7.2 The global customers of Li Fung HK procured products worth Rs 1202.96 crore directly from third party vendors of India and accordingly paid a commission of Rs 60.15 crore to Li Fung HK, computed @ 5%. Li Fung HK in turn paid a remuneration of Rs 47.69 crore to Li Fung India under a cost plus 5% model. The TPO challenged the cost plus 5% model of Li Fung India and held that Li Fung India should also receive a 5% profit on the value of products sourced from India. The DRP allowed partial relief by reducing it to 3%. On assessee's appeal, ITAT in short held as under: (a) The assessee could not refute that it had actually performed all critical functions, assumed significant risks and also developed significant supply chain intangibles in India and Li Fung HK did not have either any technical expertise or manpower to carry out the sourcing activities in HK. (b) In view of the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase rests on the peculiar facts of its case and does not have a general application for all sourcing companies/activities. The following comparative table will show how facts are different from GIS India's case. S. No. Li Fung India GIS India 1. Li Fung Group is one of the world's largest leaders in export trading. The Li Fung India (along with its overseas AE - Li Fung HK) is itself a sourcing company and is engaged in the business of providing sourcing services to third party buyers/retailers. The overseas AE of the tax payer is not the ultimate buyer of the products sourced from Indian vendors. (Paras 2, 6 8 of the Ruling and refer to pages 1401, 1408 and 1432 of the Paper book) GAP Group is an international specialty retailer offering apparel, accessories, and personal care products. GIS India is captive unit of GAP Group wherein, it is to be noted that the Group itself is not in the business of providing sourcing services but the same being performed by just an in-house arm, operating in India. 2. The Li Fung India performed all the critical functions, assumed signif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g India actually carried out all the significant functions relating to procurement in India; and that very little or virtually nil functions were carried out at the level of Hong Kong. 7.4 However, the facts in the appellant's case are completely different in the sense that all the significant directions relating to procurement of goods from third party vendors in India, namely - (a) designs trends of apparel; (b) quality parameters of materials: (c) terms conditions for dealing with vendors, etc, are all provided by GAP US to the appellant through the voluminous vendor handbook other correspondences from time to time; and the appellant merely executes the same with diligence. 7.5 The TNMM with cost plus mark-up as PLI is recognized by OECD guidelines, Berry ratio, Cheil communications propositions, as mentioned above. For mere non risk bearing facilitating functions, the appellant is not entitled to a share of FOB value of goods procured by GAP US from third party vendors in India. In the case of Li Fung India, the assessee had actually carried out significantly value added functions in India. In the light of the facts that Li Fung India carried out significantly hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the value chain, would in fact be entitled to a "buy-sell" margin. 7.9 It is reiterated that a proper analysis of the "intensity of FAR" is crucial before drawing any inferences regarding remuneration model, as different business models may undoubtedly warrant different remuneration models. GIS India is a limited risk service provider, which would logically ascertain its operating profitability by measuring the profits earned as a percentage of the value added expenses incurred (or total costs in case of GIS India). On this reasoning, the assessee searched for comparable sourcing support service providers from the databases but could not find any and therefore, it had to resort to an alternate search by identifying distributor companies and make suitable working capital adjustment, choosing OP/VAE as the PLI in order to make a closer and more like-to-like comparison of the operating profitability of GIS India with such distributor companies. Accordingly, for the chosen comparable companies as well, it was deemed appropriate to compute their operating profitability on a similar basis, i.e. with reference to the respective value added expenses incurred and not with reference to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e TPO in its search for commission agents during the TP assessment for AY 2008-09, as updated with the results relating to AY 2006-07, yielding 26.01%. and (d) Li Fung's result of 32.43%. - The arithmetic mean of all the above results yield an OP/ VAE of [(3 x 15.13) + (6 x 19) + (7 x 26.01) + 32.43] / [3 + 6 + 7 + 1] = 21.99% or 22%. - Thus, the maximum margin on operating costs would still hover around 32% in the case of the appellant, with 22% as the centre of all the data points, without prejudice to the primary contention that the appellant's original margin of 15% on operating costs remains uncontroverted by the TPO DRP. 8. Ld CIT(DR) Shri Piyush Jain on the other hand, vehemently supports the order of TPO, AO and DRP. At the outset it is pleaded that assessee is a wholly owned subsidiary of its foreign AE. Supporting agreements and similar documentary evidence are irrelevant for the purposes of determination of ALP as per the TP regulations laid down in IT Act in this behalf. TP authorities have statutory duty to evaluate such transactions on the basis of comparables and other relevant parameters and not on the basis of convenient agreements. 8.1 GIS India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tments working in coordination indicate that it has earned a significant amount of supply chain intangibles, goodwill and name in India. Thus, assessee has developed substantial intangibles in terms of supply chain, human resources and goodwill for which it is to be suitably remunerated. If GAP, USA allows the assessee to render similar type of functions for a third party, these intangible will give priority to assessee for soliciting such services to third parties, which constitutes advantage of intangibles. 8.5 In view of the facts of the case, assessee enjoys intangibles in terms of: - GIS India owns human asset intangibles - Goodwill as a procurement facilitator in garment trade. 8.6 The compensation model offered by the assessee lacks in proper valuation of use of such intangibles, which are availed by the AEs. TPO has correctly analysed assessee's FAR holding that it has developed a supply chain management intangible over a period of time which is all about having the right product in the right place, right price, right time and right conditions. In other words, the supply chain management as developed by the assessee is the management of the link between and or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ocation savings in garment industry is done by Werner International Management Consultants (WIMC), and published in the Hindustan Times, Delhi edition on 10-08-2010. This shows that the average cost per operator in 2008 for workers in the garment industry is like: (in USD) Japan 30.81 France 30.39 Germany 25.42 Spain 18.39 UK 17.7 US 17.41 Brazil 3.41 China 0.85 India 0.85 Pakistan 0.56 8.9 Ld. DR contends that assessee is not only availing lower procurement cost in India but also the lower prices of purchase of raw material from India. This arrangement at the first blush indicates that the cost plus formula has been devised by the GAP, Inc. to attribute lowest income to the Indian subsidiary. The WIMS details though is published in 2010, relate to market research in 2008 and a suitable adjustment to F.Ys. 2005-06 2006-07 should be considered. It is emphasized that the only appropriate remuneration model for compensation to Indian entity ought to be in terms of % of FOB and not the cost plus mark-up. Assessee exc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t are claimed. Assessee has developed substantial intangibles in the form of human resources and supply chain. Besides location advantages available to assessee have not been factored in the ALP. ii. On these observations, and by putting reliance on the case of Li Fung India, it has been held that assessee performs the functions of a risk bearing agent and therefore, cost plus PLI adopted by the assessee for ALP determination is not the most appropriate. Thereby the cost plus PLI has been substituted by 5% on FOB value of goods outsourced by the entities of foreign enterprises which has been considered to be the TP value. iii. In our considered view, no supporting material has been brought on record that assessee; GIS India has borne any business risks arising from its activities with GAP USA. There are no adverse facts, material or evidence on the basis whereof Ld. TPO has made arrived at such a conclusion. The Ld. TPO has not given any examples or comparables whatsoever to demonstrate which major business risks much less any risk are borne by GIS India and how. In a sweeping manner it has been held that as functions follow risks, and since, in his wisdom GIS India underta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... news paper report published in 2008 in respect of cost of procurement services in various countries. In our view this news paper report by itself cannot partake the character of a comparable data. It is a fact the labor costs including procurement services are very low in India, Pakistan, Bangla Desh and China. But it does not impinge on the assesses profitability by drawing a assuming perceived location advantages. Location savings to developing economy arise to the industry as a whole, there is nothing on record that assessee on standalone basis was sole beneficiary. We find merit in the argument of Mr. Mitra that the intent of sourcing from low cost countries for a manufacturer/retailer is to survive in stiff competition by providing a lower cost to its end-customers. Generally, the advantage of location savings is passed onto the end-customer via a competitive sales strategy. The arm's length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus in our view, no separate/add ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st plus mark-up model depending upon the set of facts. iv. In percentage model the procurement service provider is remunerated only in the event of goods procured by the procurer; if the goods are not procured then the service provider will incur loss to the tune of costs incurred in the process and notional loss on account of time spent by the service provider which it would have spent on other profit generating activity. Accordingly, percentage model puts the procurer at significant advantage and the procurement service provider at significant market risk. v. The cost plus mark-up model is in absolute contrast to the percentage model whereby the service provider is assured of cost recovery along with a mark-up irrespective of the fact whether the procurer purchases any goods or not. This model puts the procurer at the disadvantage with a significant advantage to service provider. vi. It is important to note that the irrespective of the model followed, both procurer and service provider will set the terms which work in serving the best interest of both the parties, meaning putting both the parties at a win-win situation. In percentage model if the procurer feels that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing to procurement in India; and that very little or virtually nil functions were carried out at the level of Hong Kong. iv. However, the facts in the appellant's case are different in as much as all the significant directions relating to procurement of goods from third party vendors in India, namely (a) designs trends of apparel; (b) quality parameters of materials: (c) terms conditions for dealing with vendors, etc, are all provided by GAP US to the appellant through the voluminous vendor handbook other correspondences which are placed on record and have not been controverted by the department. It emerges that assessee follows and executes them as a service provider. For such preordained support services, the assessee cannot be held to be entitled to remuneration in terms of Li Fung case on FOB value of goods procured by GAP US from third party vendors in India. In the case of Li Fung India, assessee actually carried out significantly value added functions in India, which is not the case before us. v. Even if we overlook the factual dissimilarities between the Li Fung India and assessee's case, the transactional profitability earned by Li Fung India supports ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amed give an impression of being work of adversarial approach in tax liability determination. Hon'ble Finance Minister generally and recently in particular gave a clarion call that the income tax proceedings should be fair and non adversarial in nature. This is rightly so as it is a sine qua none of a tax administration which usher into a rule of law which is predictable and based on sound reasoning and is not fraught with the perils of uncertainties and adversities for the taxpayers. (iii) In view of the foregoing we have no hesitation to accept a candid proposal given by the assessee and hold that assessee TP adjustments be made by adopting the 32% cost plus mark up of the assessee for AY 2006-07 and 2007-08. The mark-up proposal of assessee is higher than mark-up over total cost earned by all comparables placed on record. The assessments should be framed accordingly. We may hasten to add that this mark we will be subjected to variation is subsequent years if the facts and circumstances of the case so warrant. 10. Coming to the issue about rate of depreciation it is by now settled that the computer peripherals are eligible for 60% depreciation which should be allowed to the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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