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TMI Blog2014 (9) TMI 266X X X X Extracts X X X X X X X X Extracts X X X X ..... ethods enumerated in Rule 10B(1) of the rules - even in relation to the present situation whereby the comparability analysis has been carried out by adopting the CUP method, the adjustments to the uncontrolled comparable transaction which are permissible and justifiable in law and on facts of the case, in order to facilitate comparability of the international transaction with the uncontrolled comparable transactions deserve to be allowed – so far as adjustments proposed by the TPO on account of the international transaction of export of finished goods to the associated enterprises is concerned, it shall be scaled down to ₹ 36,91,536/- as against ₹ 71,01,810/- determined by the TPO – Decided partly in favour of Assessee. The comparable transaction picked-up by the TPO, namely, agreement between assessee and Henkel USA is a transaction between two related/associated enterprises and therefore it is a controlled transaction and not an "uncontrolled transaction" - Such a transaction undertaken between two controlled entities, in our view cannot be considered as a 'comparable uncontrolled transaction', as envisaged in clause (a) of sub-rule (1) of rule 10B of the Rules - t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in short 'the Assessing Officer') passed u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (in short the Act ) dated 25.10.2011, which is in conformity with the directions given by the Dispute Resolution Panel, Pune (in short 'the DRP') dated 20.05.2011. 2. In this appeal, the Grounds of Appeal raised by the assessee read as under: 1. General: The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in making an adjustment amounting to INR 78,43,090/- to the value of international transactions entered into by the Appellant pertaining to import of raw materials, export of finished goods and drop shipment commission rejecting the analysis undertaken by the Appellant in the Transfer Pricing Study Report to determine the arm's length price for its international transactions. 2. Non-consideration of the aggregation approach adopted by the appellant in the Transfer Pricing Study Report. 2.1 The learned DCIT erred in rejecting the aggregation approach followed by the appellant for three of its international transactions relating to import of raw materials, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n and application of internal Comparable Uncontrolled Price (CUP) method as the most appropriate method. 5.1 The learned DCIT erred on the facts and in circumstances of the case by rejecting Transactional Net Margin Method (TNMM) for benchmarking drop shipment commission without providing justifiable reasons for such rejection and selecting Comparable Uncontrolled Price (CUP) method as the most appropriate Method. 5.2 The learned DCIT erred in comparing controlled transactions which is clearly not as per TP regulations as well as OECD guidelines. 5.3 The learned DCIT ought to have considered that reduction of royalty from drop shipment commission by one of the associated enterprises is tax neutral transaction. 6. Transfer pricing adjustment without giving benefit of +/- 5 per cent as available under proviso to section 92C(2) of the Act. The learned DCIT erred on the facts and in circumstances of the case and in law in making the transfer pricing adjustment from the arm's length price without giving the benefit of the option available to the Appellant under proviso to section 92C(2) of the Act of adopting as arm's length price, a price wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... before us can be understood as follows. The appellant company had entered into international transactions with its associated enterprises on account of : (i) import of raw materials, packing materials, and finished goods; (ii) drop shipment commission receipts; and, (iii) export of finished goods. In the Transfer Pricing Study conducted by the assessee, it aggregated the aforesaid international transactions into two broad segments for the purposes of benchmarking it with the comparables. The international transactions comprising of import of raw materials packing materials, and export of finished goods were aggregated under Manufacturing segment, and the residual international transactions on account of the import of finished goods for re-sale and receipts by way of drop shipment commission, were grouped together under Trading segment. The assessee chose to aggregate the transactions into the respective segments for the reason that the transactions of import of raw materials packing materials, and export of finished goods were relating to the manufacturing functions whereas the import of finished goods for re-sale and receipts by way of drop shipment commission related to trad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll as furnished written submissions in support of the case of the Revenue. The rival submissions have been heard and the relevant material perused. 7. The first and foremost plea raised by the assessee is against the approach of the TPO in selecting CUP method as the most appropriate method instead of the TNM method adopted by the assessee in order to benchmark its international transactions. According to the learned counsel, the TPO erred in rejecting the aggregation approach adopted by the assessee for three of its international transactions relating to import of raw materials, export of finished goods and import of packing raw materials and benchmarking it by applying the TNM method. Justifying the aggregation approach, it has been explained that the three activities of the assessee are closely linked to the manufacturing process. According to learned counsel, the TPO has not given any justifiable reasons for rejection of the aggregation approach and has merely stated that each of the transaction is different in its nature and scope. The learned counsel pointed out that the imported raw material and the packing material are used in the manufacturing process and the finished g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e purposes of comparability analysis. The learned CIT(DR) also pointed out that the aggregation approach is justified in case where it is impracticable to analyse the profitability from each individual transactions or where such transactions are so interrelated that the only reliable means of benchmarking is the aggregate approach. According to the learned CIT-DR, the instant was not one such case. 9. Firstly, we may consider the addition of ₹ 71,01,810/- with respect to the international transactions of export of finished goods to the associated enterprises which has been made by the TPO by invoking CUP method after rejecting the TNM method adopted by the assessee. In para 8 (A)(iii) of the order, the TPO noticed that assessee exported goods to its associated enterprises, namely, Henkel Korea, Henkel China, Henkel Thailand and Henkel Singapore amounting to ₹ 17,80,512/-. In respect of exports to Henkel Singapore, it was found that it was made at the same price which was charged from the third parties; and, therefore no adjustment was made by the TPO. Similarly, with regard to exports to Henkel Thailand, it was noticed that there was no third party sale of the same p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year assessee has incurred ₹ 10.70 crores on this score which translates to 28% of the sales made to third parties in India. Further, assessee has to bear the credit risk in relation to sale to third parties, whereas there is no such risk in case of export of goods to associate enterprises. Further, assessee bears product liability risk and warranty risk for goods sold to the domestic third parties, while on export sales to the associated enterprises there is no such risk. The associated enterprises, who buy goods from the assessee, bear this risk as they in-turn sell to end-customers in their respective countries. Further, the difference in geographical location has also been highlighted inasmuch as sales to third parties are only in the domestic market whereas the associated enterprises are located in China, Singapore, Thailand and Korea. It is pointed out that such geographical differences have a material impact on the pricing of goods but no reliable data was available to make reasonably accurate adjustments in this regard; even there are differences in the level of market between the exports made to the associated enterprises on one hand and sales made to the domestic th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith respect to third party sales but the same may not be includible in the prices charged from the customers, which is determined on the basis of prices prevailing in the open market; and, is not dependent on the incurrence of marketing function alone. In the aforesaid manner, the action of the TPO in making an adjustment of ₹ 71,01,810/- on account of the international transaction of export of finished goods to the associated enterprises is sought to be justified. 12. We have carefully considered the rival submissions. As regards the method to be adopted for comparability analysis, at the outset we may say that the approach of the TPO and the DRP in this regard cannot be faulted. In our considered opinion, having regard to the facts and circumstances of the case, including the fact that internal comparable uncontrolled transactions are available, the adoption of CUP method as the most appropriate method for the purposes of comparability analysis, is liable to be upheld. The learned counsel for the assessee as well as the learned CIT(DR) have referred to certain decisions of the Tribunal in this regard in support of their respective stands. We are not inclined to discuss e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s that an uncontrolled transaction shall be comparable to an international transaction if none of the differences between the transactions being compared are likely to materially affect the price or cost charged or paid or the profit arising from such transactions in the open market. In fact, clause (ii) of Sub-rule (3) of Rule 10B permits making of adjustments to eliminate the material effects of differences, in order to facilitate a meaningful comparison between an uncontrolled transaction and the tested international transaction. There is nothing in the phraseology of Rule 10B(3) of the rules to suggest that the adjustment to an uncontrolled transaction is permissible only under the TNM method and not to the other methods enumerated in Rule 10B(1) of the rules. Therefore, the plea of the learned CIT(DR) that the implications of sub-rules (2) and (3) of rule 10B of the Rules are only in relation to the comparability analysis to be carried out in terms of TNM method and not in terms of CUP method, in our view, is not manifested by the legislative intent. Therefore, even in relation to the present situation whereby the comparability analysis has been carried out by adopting the CUP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price. In the absence of the onus having been discharged by the assessee to quantify the adjustments on this count on the basis of any reliable data, no adjustments on this score are permissible. 16. Therefore, in conclusion we hold that so far as adjustments proposed by the TPO on account of the international transaction of export of finished goods to the associated enterprises is concerned, the same shall be scaled down to ₹ 36,91,536/- as against ₹ 71,01,810/- determined by the TPO. Accordingly, assessee succeeds partly. 17. Now, we may consider the international transactions of receipt of drop shipment commission by the assessee of ₹ 62,26,352/-. In this connection, the TPO noticed that assessee had received such commission on services given to its associated enterprises, viz. Henkel Malaysia, Henkel USA and Henkel Singapore as per details in para 9.2 of his order. The assessee benchmarked the said international transactions on the basis of TNM method whereas the TPO has selected the CUP method as the most appropriate method. The assessee earns drop-shipment commission as per the commission agreements. The TPO noticed that the Henkel Malaysia was deduct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thod, which reads as under : (a) comparable uncontrolled price method, by which, (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified; (ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or services provided in the international transaction; 21. The aforesaid three steps would reveal that the action of the TPO in the present case is contrary to the prescription contained in sub-clause (i) of clause (a) of sub-rule (1) of rule 10B of the Rules. Ostensibly, in terms of sub- clause (i), the price charged or paid in a comparable uncontrolled transaction is to be identified for the purpose of determining the arm's length price of the international transaction being test ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tails placed at page 248 to 250 of the Paper Book, which was also before the TPO. The contention of the assessee is that the number of transactions with associated enterprises are less compared to non-associated enterprises, its timings are different and that such imports have been made for compelling business reasons. In this connection, a tabulation pointing out the business reasons, the frequency of imports and the timing differences has been furnished which is an under : Name of the Product Frequency of Import from AE Frequency of Import from Non-AE Business Reasons Azo Dyestuff/C.I. Part -I - solvent Once (27.12.2006) Thrice Air freight is a major component of cost in the price compared. Cabosil Ts - 720 (10 Lb Bag) Shortage in local market from Dec. 2006 to March 2007 hence imported from AE The business reason for import from AE is due to shortage and quality problems with the local source hence it was imported from AE. Cap/Noz 25/10/100 G New Design Only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparison to prices charged by the third parties, without considering the reasons for the same. In our considered opinion, the said approach of the TPO is quite flawed and is not justified. Moreover, in the tabulation noted above, assessee has explained reasons which prevailed with it to make imports from the associated enterprises of the 5 products, though the prices charged by associated enterprises were higher than the prices charged by the non-associated enterprises. The circumstances canvassed by the assessee have not been found to be lacking in bonafides by the TPO. He has merely brushed aside the same. In our considered opinion, it would meet the ends of justice, if the aforesaid action of the TPO is set-aside and the matter is remanded back for re-computation of the arm's length price by taking into consideration the international transaction of import of raw materials from the associated enterprises in its entirety and not merely in relation to 5 products and leaving out the other 5 products which are also imported from the associated enterprises. Thus, the TPO/Assessing Officer shall re-visit the controversy on this aspect after allowing the assessee a reasonable opp ..... X X X X Extracts X X X X X X X X Extracts X X X X
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