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TMI Blog2013 (12) TMI 594X X X X Extracts X X X X X X X X Extracts X X X X ..... ith the associated enterprises is to be benchmarked, the same should be done with indent/ commission transaction with non-associated enterprises - Decided against the assessee. Legal and professional charges – Held that:- The assessee-company employs foreign nationals for the purpose of its business, as they have requisite expert knowledge of the markets outside India - The assessee-company has many of the foreign nationals, on its rolls, working at various managerial positions - As per the general policy of the assessee-company and the market wide practice, the company at the time of the departure of such foreign assignees, after completion of their assignments, bears the cost of their return journey to their respective home countries - The expenditures were incurred by the assessee on its employees who were returning to their home countries, after completion of the assignments. The expenditures were charges in connection with passenger baggage clearing – Decided in favour of assessee. Disallowance of deduction of deposits written off – Held that:- The assessee has debited an amount to the profit and loss account under head "Deposits written off - The AO misread the profit and los ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose, whether at the proposal or the approval stage; (d) As no initial opinion was formed under section 92C(3) of the Act which is a jurisdictional precondition ; (e) By not furnishing the letter of reference ("LOR") to appellant. 3.1 That since the reference by the learned Assessing Officer was bad in law and void ab initio, consequentially the entire proceedings by the learned Transfer Pricing Officer, order of the learned Transfer Pricing Officer, directions of the learned Dispute Resolution Panel and, also the impugned addition of Rs. 55,26,16,748 is vitiated, invalid, illegal and hence, a nullity. 4. The order of learned Assessing Officer and directions of the learned Dispute Resolution Panel along with the learned Transfer Pricing Officer's order under section 92CA(3) of the Act is based on complete disregard of the facts of the case of the appellant and the statutory provisions of law. 4.1 The learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has in fact erred in their orders by disregarding the following objections apparent on facts and in law on the facts and circumstances of the case of the appellant : (a) That the learned Assessing Offic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the commission amount and not to the gross amount of sales ; (g) That the learned Assessing Officer/Transfer Pricing Officer/ Dispute Resolution Panel has overlooked that in respect of indent based transactions, service tax is applicable and in respect of principal based transactions, sales tax is applicable. Thus, apparently, the two transactions are different class of transactions ; (h) The learned Dispute Resolution Panel erred in stating that the appellant has not provided conclusive evidence to show that the principal transactions and indent transactions are significantly different. The learned Dispute Resolution Panel further erred in completely overlooking the additional evidences filed by the appellant before the learned Dispute Resolution Panel on January 21, 2011 along with Form 35A. Thereby, the learned Dispute Resolution Panel operated with a pre-determined mindset to retain the adjustment made by the learned Transfer Pricing Officer without adhering to the critical evidences furnished by the appellant ; (i) The learned Dispute Resolution Panel erred in stating that the lease agreement dated January 5, 2007 between Omega Global Logistic Pvt. Ltd. and the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has erred in holding that the appellant has created human and supply chain intangibles for which it is not being adequately compensated by the associated enterprises. 7. That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has erred in adopting a transfer pricing approach that is different from the earlier year despite there being no change in the facts and circumstances of the case of the appellant. 8. That the learned Assessing Officer/Dispute Resolution Panel has grossly erred both in law and on facts in proposing a disallowance of a claim of expenditure of Rs. 3,72,560 representing legal and professional charges incurred wholly and exclusively for the purpose of business of the appellant-company. 8.1 That the learned Assessing Officer and the Dispute Resolution Panel has failed to appreciate that, mere fact that, such expenditure had been disallowed in the preceding years could not be a basis much less valid basis to hold that, expenditure incurred towards writer relocations was a personal expenditure. In fact, they have failed to appreciate that, it is wells ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oles is that of a mere service provider. On these transaction, Sumitomo India earns income in the form of commission, generally based on the total invoice price or quantity of merchandise. Most of Sumitomo India's commission receivable on these transactions are from Sumitomo Corporation. It was stated in the transfer pricing report that Sumitomo India provides marketing support services for facilitating both exports and imports in India through Sumitomo Corporation. The support services include gathering information about customer requirements, products, local prices, market trend, etc. During the financial year 2006-07, the assessee undertook the following international transactions : Sl. No. Type of International transaction Method selected Total value of transaction (Rs.) 1 Purchase of goods TNMM 10,28,25,122 2 Sale of goods TNMM 12,94,773 3 Rendering of support services TNMM 30,45,25,711 4 Interest earned TNMM 7,22,621 5 Services received TNMM 1,03,35,041 6 Reimbursement of expenses (payment) 6,28,502 7 Reimbursement of expenses (receipts) TNMM 1,40,36,868 The assessee has benchmarked its international transaction relating to provision of renderi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of the tested party margin, it was noticed that the entire international transactions relating to sales and purchase of goods and commodities had remained out of computation of profit level indicator. Most importantly, the cost of sales was not included in the denominator of profit level indicator used. The Transfer Pricing Officer asked the assessee to furnish the FOB value of goods on which commission had been received for the purpose of determination of cost of goods sold. The assessee was also required to explain as to why Berry ratio was used to benchmark international transaction of the tested party. The Transfer Pricing Officer noted that the Income-tax Act or Income-tax Rules do not permit the use of "operating expenses" in the base which do not include the cost of sales. In accordance with the provision of rule 10B(1)(e)(i) the net profit margin realised by the enterprise from an international transactions entered into with the associated enterprise is computed in relation to "cost incurred" or "sales effected" or "assets employed" or "to be employed" by the enterprise. He further observed that the provisions of the Income-tax Act and the Income-tax Rules do not recog ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rive at the numerator of your profit level indicator, i.e., gross profit on sales. This numerator has then been divided by "operating expenses" to arrive at computation of profit level indicator of Berry ratio. On examination of the computation in the case of comparable companies, it is found that profit level indicator has not been computed in the same manner as that of the tested party. 4. However, on examination of the computation of the tested party margin of the tested party margin, it is noticed that the entire international transactions relating to sales and purchase of goods and commodities have remained out of computation of profit level indicator. Most importantly, the cost of sales is not included in the denominator of the profit level indicator used. For the purposes of determination of cost of goods sold, you were required to furnish the FOB value of goods on which commission has been received vide this office letter dated May 26, 2010. You were also required to explain the adoption of Berry ratio to benchmark international transactions in the case of the tested party. You were also required to explain as to how 'gross profit' has been arrived in the case of the teste ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 46,304 Sales Commission -- -- 32,36,83,588 -- 32,36,83,588 Other income 2,73,93,863 2,73,93,863 Total (A) 10,80,20,767 14,81,25,537 32,36,83,588 2,73,93,863 60,72,23,755 Direct expenses Cost of materials 10,28,25,123 13,78,61,103 -- -- 24,06,86,226 Change in stock -- 36,65,508 -- -- 36,65,508 Total (B) 10,28,25,123 14,15,26,611 -- -- 24,43,51,734 Gross profit (C)=A-B 51,95,644 65,98,926 32,36,83,588 2,73,93,863 36,28,72,021 Segmental gross profit margin (as calculated) 4.80% 4.45% 1.61% Operating expenses Employee remuneration 6,15,22,635 Admin and other expenses 13,74,55,343 Interest and finance charges 3,43,331 Depreciation 61,99,011 Total operating expense (D) 20,55,20,320 Operating profit (E)=C D 15,73,51,701 8. From an analysis of the above computation, it is seen that in your trading transaction with your associated enterprises, you have earned a gross profit margin of 4.80 per cent. In the segment relating to trading with non-associate enterprises, you have "earned a gross profit margin of 4.4, per cent. However, with respect to commission income earned of Rs. 32,36,83,588 on FOB value of goods traded through you of R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion to associated enterprise with respect to prospective supplier/ customer economic and business conditions, custom clearance and communication channel between supplier and buyer. The assessee submitted that these are very low-end services and decision making authority is the associated enterprise who is exposed to risks such as foreign exchange risk, debtors risk, quality risk, etc. The assessee earns a service fee for the services it renders in the form of commission. The assessee has listed out the factors on which commission rate is decided. It is stated that commission rate depends upon business segments and market conditions. It was further submitted that in few cases, where volume involved is very small, the assessee has taken title of goods. It was submitted that with respect to this small volume, it takes title to the goods which is flash title. The assessee has been characterised as facilitator and coordinator for the financial year 200607 and the very small quantity of trading business does not change the true identity of the company as above. The assessee classified transactions wherein trading takes place as principle transactions and the transactions in which it rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of 4.45 per cent earned in the non-associated enterprise trading segment should be adopted to compute the margin that the assessee should have earned on FOB value of goods on which it has earned commission/service income : * Lack of comparability between the two segments makes this approach completely untenable. * Higher margin in the non-associated enterprises trading segment arises from different functions, costs, assets and risks and other factors like difference in volume. * No justification in re-characterising transactions entered into by the assessee without any reason in disregard to the business model adopted by the assessee. The assessee has selected service fee and commission model as one of its business models which constitute 95 per cent of its business based on commercial factors. Therefore, the approach of thrusting the business model of principle business to service fee/commission model is not correct. * Assessee has stated that the associated enterprises perform more functions, assumes more risks and deploys more resources as compared to the assessee. * The factual analysis in the show-cause notice fortifies the assessee's stands of being at the arm's length i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /brokerage charged from low value/small customers is much higher on account of premium rate of commission charged from them. The assessee further submitted that two instances of discount offered on the basis of volume of business. It was submitted that these details have been collected from the information available in the public domain. For the purpose of computing the economic adjustment on account of volume difference, the assessee computes the average of the discount on the basis of said examples. The assessee came to conclusion that discount of 50 per cent was applied on non-associated enterprises segment commission percentage to arrive at the arm's length commission percentage: Non-associated enterprise commission percentage (A) 2.26 % Less: 50% of 2.26% (B) 1.13% Arm's length commission percentage (A B) 1.13% 6.1. It was claimed that the assessee has earned commission at 1.58 per cent as against the arm's length commission percentage of 1.13 per cent. Therefore, commission earned in the associated enterprise segment is at arm's length. The assessee further submitted that the analysis on the basis of transactional net margin method and Berry ratio to justify the arm's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,20,767 14,81,25,537 32,36,83,588 2,73,93,863 60,72,23,755 Direct expenses Cost of materials 10,28,25,123 13,78,61,103 -- -- 24,06,86,226 Change in stock -- 36,65,508 -- -- 36,65,508 Total (B) 10,28,25,123 14,15,26,611 -- -- 24,43,51,734 Gross profit (C)=A-B 51,95,644 65,98,926 32,36,83,588 2,73,93,863 36,28,72,021 Segmental gross profit margin (as calculated) 4.80% 4.45% 1.61% Operating expenses Employee remuneration 6,15,22,635 Admin and other expenses 13,74,55,343 Interest and finance charges 3,43,331 Depreciation 61,99,011 Total operating expense (D) 20,55,20,320 Operating profit (E)=C D 15,73,51,701 8. The Transfer Pricing Officer referred to that in the show-cause notice it was proposed that profit level indicator as demonstrated in the table above does not capture the cost-base on which the commission/service income has been earned whereas the gross profit margin of the trading segment contains cost of goods sold in the numerator. The cost base on which commission income has been earned, i.e., FOB value of goods traded through the assessee is Rs. 20,10,21,88,471 on which commission/service fee of Rs.32,36,83,588 had been earned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Officer mentioned that it was obvious that the assessee was performing identical transactions in both the segments. The Transfer Pricing Officer further observed that he had examined the compensation model along with the facts of the case and reached a conclusion, that in this case commission should be expressed as percentage of FOB price of goods sourced through the assessee for the following reasons : "(a) It is evident from the FAR analysis discussed earlier in this order that the assessee has played a major role in identifying suppliers, raw material, networking with buyers and suppliers, support in after sales services, business promotion, collection of market information, collection of accounts receivable on behalf of associated enterprise, handling of precuts and commodities, etc. has been in constant touch with the buyer. It has assumed significant risks and has used both its tangibles and unique intangibles. These facts clearly prove that value addition activities of the assessee can only be expressed as a percentage of FOB of goods sourced through the assessee. (b) The assessee is operating in a low cost country like India and its operating cost is so low that it is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pensated by the associated enterprises. The Transfer Pricing Officer further observed in this case the assessee has borne all the major risk associated with abovereferred to functions. In addition to this the assessee has also borne following major business risks such as single customer risk ; risk associated with development and use of intangibles. He observed that assessee has used its assets including human assets (technical manpower) to discharge the function. The Transfer Pricing Officer observed that on examining the compensation model in this case, it was noted that the assessee was allowed a very nominal and routine compensation of 1.6 per cent on the service it renders (which does not include cost of development and use of intangibles) without allocating any profit component for development and use of unique intangibles by the assessee which has resulted in huge commercial and strategic advantage to the associated enterprise in the form of low cost of goods, high profit margin and assured timely supply and demand of quality goods and orders, i.e., these intangibles have enhanced the profit potential of the associated enterprises, without any corresponding mark-up to the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sation model of the assessee was thus clearly linked to the FOB value of the goods transacted through it. The Transfer Pricing Officer further observed that the arguments of the assessee that volume of business in the case of indent segment is much larger than the trading segment, was also therefore, not found to be correct. He observed that assessee enters into a separate contract with respect to each and every transaction/trade, i. e., carried out through the assessee. The compensation basis is mentioned in that contract. The Transfer Pricing Officer observed that it is not the case of the assessee that the volume in single transaction is more than in similar transaction in the trading segment. Therefore, the Transfer Pricing Officer observed that the correct comparison was therefore, the gross margin that the assessee is making in the trading segment (principle transaction segment) with the commission/ service income earned in the indent segment. 10.3. The Transfer Pricing Officer further observed that on the basis of FAR analysis it has been established that the assessee was performing identical function in both the segments, it is utilising common assets (including supply cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterprise and therefore by the approach suggested in the show-cause notice (without admitting the same), commission earned by the assessee in the non-associated enterprise service/commission segment may, subject to economic adjustments mandated by law, be considered benchmark commission to compute arm's length commission from associated enterprise. The above stated stand taken in the letter dated October 19, 2010 has been considered. Herein the assessee has although without prejudice, but has admitted that for some minor transactions of Rs. 84.72 crores (as compared with total trading transaction of Rs. 2,010 crores) which the assessee has carried out with non-associated enterprise, the assessee has earned a higher margin of at 2.26 per cent as compared with commission at 1.58 per cent from associated enterprises transactions. However, the assessee has again without prejudice stated that 'volume' may impact the rate of commission. The assessee has stated that as the volume in non-associated enterprise segment was lower, it had earned a higher rate of commission. It has already been demonstrated above, in para 8.6.2 that 'volumes' do not impact the rate and amount of commission th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,10,21,88,471. However, the assessee in its submission dated October 19, 2010 has stated that this figure also contains certain nonassociated enterprise transactions on which it has earned commission income also. The correct FOB value of transactions with associated enterprise and rate of commission earned is as stated). The gross margin earned in the non-associated enterprise trading segment at 4.45 per cent. shall be taken to be the arm's length rate at which the assessee should have earned its commission income. Commission Income earned from associated enterprises at 1.58 per cent on Rs. 19,25,49,38,946 = Rs. 30,42,28,035 Arm's length commission income at 4.45 per cent on Rs.19,25,49,38,946 Rs. 85,68,44,783 Difference = Rs .55,26,16,748 Percentage of arm's length margin to international transaction = 181.64 per cent. The difference of adjustment required is more than 5 per cent. therefore the proviso to section 92C(2) is not attracted. The international transaction reported by the assessee is to be adjusted by Rs.55,26,16,748 to bring it at arm's length price. Since the price charged by the assessee varies by more than 5 per cent. from the arm's length price, an adjustment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that transfer pricing study mentions that trading transaction are functionally similar to indent transactions ; that while stating so in the transfer pricing study, it had never been admitted that, they are comparable ; that though transactions of trading and, indent are in two different segments but since no separate meaningful analysis is required on account of miniscule volume, they were clubbed together for purpose of transfer pricing study. 16. It has further been submitted that the Transfer Pricing Officer committed an error when he compared the gross margin of negligible value of trading transactions of non-associated enterprises with high volume of indent transactions, genuineness of transactions of either indent/trading has not been disputed. That mere fact, that it was so reported by the accountant, it could not be held to be binding on the assessee and thus, the Transfer Pricing Officer could not have mechanically proceeded to determine the arm's length price on the perception of the accountant. It was further been submitted the transfer pricing guidelines issued by the OECD also supports the assessee's submissions. In this connection, learned counsel of the assessee r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he abovesaid case laws were mentioned by learned counsel for the assessee for the proposition that trading and indenting segments are non-comparable. It has further been submitted that gross profit earned in trading transaction with associated enterprises is also comparable to the gross profit earned in the trading transactions with non-associated enterprises in uncontrolled circumstances. It has further been submitted that Assessing Officer has nowhere disputed that transactional net margin method adopted by the assessee is incorrect. Learned counsel for the assessee further submitted that the Transfer Pricing Officer has failed to appreciate many of the submissions of the assessee-company. 16.2. Further it has been submitted that without prejudice to the above (even if it is assumed without conceding) that, a segmental comparison of results of the assessee-company is warranted to determine the arm's length price, an appropriate comparison would be to compare the commission/service income earned from associate enterprises to that of the non-associate enterprises. Thus, it has been submitted that commission earned by the assessee in non-associated enterprises services/commission s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which is unrealistic and impractical. 18. The learned Departmental representative placed reliance on the orders of the Dispute Resolution Panel, Transfer Pricing Officer and the Assessing Officer. He submitted that it is found that the activities of indenting sales and proper sales are one and the same functionally. That when the assessee itself considers the indenting sales and proper sales to be one and the same, the preferred route of benchmarking was using the internal benchmark, which was available in the form of profit margin in third party sales made by the assessee itself. The internal benchmark is preferable to external benchmark has been laid down in plethora of rulings. In this regard, learned Departmental representative referred to the decision in the case of Birlasoft (India) Ltd. v. Deputy CIT [2011] 136 TTJ (Delhi) 505 and the decision in the case of UCB India P. Ltd. [2009] 317 ITR (AT) 292 (Mumbai). That where the associated enterprises is making profits or not is not relevant in a transfer pricing situation. In this regard, the learned Departmental representative has placed reliance upon the order of the Income-tax Appellate Tribunal, Mumbai in the case of Symant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndenting transaction the assessee has not to incur any such financial obligation or carry any significant risk. Moreover, we note that in respect of indenting transaction with non-associated enterprises, the average mean margin of profit of 2.26 per cent has been accepted by the Transfer Pricing Officer. We further find that the indent business of the assessee was nothing but trade facilitation and is purely of indent nature both in form and substance. No material has been brought on record to regard the indent transaction as trading transactions. 24. The assessee itself has agreed with the proposition that an appropriate comparison would be to compare the commission/ service income earned by the assessee from associated enterprises to that of the non-associated enterprises. This aspect of the assessee's submission has not been rebutted by the Revenue. However, the assessee has contended that the reason of difference between them was attributable to volume of business handled in associated enterprises segment and non associated enterprises segment and credit risk associated in non associated enterprises segment. Therefore, it has been argued that economic adjustment is required to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n high margin in competitive market condition. Therefore, unless and until it is brought to record that the turnover of such comparables has undue influence on the margins, it is not the general rule to exclude the same that too when the comparables are selected by the assessee itself." Similarly, in the case of Bayer Material Science P. Ltd. [2012] 17 ITR (Trib) 275 (Mumbai) in para 23 following proposition was laid down (page 294) : "Now, the question is whether these cases, which are otherwise comparables, should be disregarded simply on the ground of smallness of turnover when compared with that of the assessee. Considering the fact that the assessee did not come out with any comparable case to justify its price at arm's length and further the Transfer Pricing Officer found out these cases having functionally identical activities duly confronted to the assessee, it is not possible to disregard such cases merely on the ground that the volume of turnover is lower in comparison to that handled by the assessee. One more important factor which cannot be lost sight of is that in the case of Rathi Brothers Madras Ltd. indenting commission is 5 per cent. to 6 per cent. with turnover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n disallowed in the preceding years could not be a basis much less valid basis to hold that, expenditure incurred towards writer relocations was a personal expenditure. In fact, they have failed to appreciate that, it is well-settled position of law that, a company does not have any personal expenditure and as such, entire expenditure incurred ought to have been allowed as such. That the learned Dispute Resolution Panel has grossly erred both in law and on facts in directing the Assessing Officer to make the addition only if the Department has not preferred an appeal before the hon'ble Income-tax Appellate Tribunal against the addition deleted by the Commissioner of Income-tax (Appeals) in the assessment year 2006-07 on the similar ground. 32. On this issue, the Assessing Officer noted that from the details furnished, it was observed that the assessee has claimed an expense of Rs.3,72,560 towards writer relocations under the head legal and professional charges. The assessee was required to explain as to why not disallowance be made in view of the facts mentioned in the assessment orders for earlier years. The Assessing Officer noted that the assessee did not furnish any explanati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 3 -do Charges of unaccompanied passenger baggage clearing New Delhi to Japan Mrs. Rie Nagashima 30.3.2007 70,000 611-613 4 -do- Charges of unaccompanied passenger baggage clearing New Delhi to Tokyo, Japan Mrs. Rie Nagashima 31.3.2007 47,500 614-617 4. -do- Charges of unaccompanied passenger baggage clearing Mumbai to New Delhi Mrs. K. Nagashima 2.8.2006 23,200 618-619 5 -do Charges of unaccompanied passenger baggage clearing New Delhi to Chiba, Japan Mrs. K. Nagashima 23.11.2006 61,360 620-622 Total 3,69,060 36. Learned counsel for the assessee further submitted that during the course of assessment, the assessee duly provided the details of such expenditure. However, the Assessing Officer held that the said expenditure is personal in nature. It is further submitted that for the assessment year 2006-07, the learned Commissioner of Income-tax (Appeals) had deleted the above disallowance by holding that such expenditure is not personal expenditure. Furthermore, for the assessment 2008-09 the Assessing Officer disallowed similar expenditure, he was directed to delete the same by the Dispute Resolution Panel. Accordingly, learned counsel for the assessee pr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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