9911796707
TMI Blog2014 (10) TMI 460X X X X Extracts X X X X X X X X Extracts X X X X ..... y the Assessee in its grounds of appeal reads thus: "The learned Assessing Officer, learned Transfer Pricing Officer and Honourable Dispute Resolution Panel have erred in Gr.No.12: not appreciating that the trading and manufacturing segments are intertwined and inter-related warranting a "combined Transaction Approach" in arriving at the arm's length price. Gr.No.22: doing separate evaluation of royalty payment, technical fees and other payments by adopting CUP method without justifying how the same was most appropriate method. Gr.No.23: Concluding that arm's length price of royalty payment, technical fees and other payments as NIL without brining on record any comparable; Gr.No.24: Concluding that the taxpayer has not been able to show that it derived any economic benefit from the alleged know-how received from the associated enterprises ignoring the evidence supporting the same, which were on record;" 4. The assessee is a company. It is in the business of manufacture and selling Multi Utility Vehicles under the model name 'Innova' and passenger cars under the model 'Camry' and 'Corolla'. For the A.Y. 2007-08, it filed a return of income on 19.10.2007, which was revised on 3. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) adopted was cash profit to sales. The Assessee arrived at the cash and operating profit margin of the 7 comparable and arrived at an arithmetic mean of 5.28% and 2.87% respectively of cash profit margin and operating profit margin of the 7 comparable. The Assessee's cash profit margin and operating profit margin were arrived at 11.36% and 8.84% respectively. It was submitted by the Assessee that on a comparison at the entity level, the profit margins of the Assessee was much higher than the arithmetic mean of the comparable and therefore the international transaction with the AE should be considered as at Arm's Length. 8. The TPO was of the view that segmental financials demarcating Manufacturing segment and Trading segment are important for transfer pricing analysis at the segmental level. The segmental result as given by the Assessee as enclosure to one of the letter dated 27.1.2011 of the Assessee to the TPO was accepted by the TPO. Thereafter the TPO was of the view that while computing the operating margin in the manufacturing segment, the following items were not considered as part of operating revenues. i. Interest from banks; ii. Interest from others; iii. Profit on s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arms length price in relation to the international transaction. (2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely: (a) the nature and class of the international transaction;" According to the TPO, the most appropriate method is to be applied keeping in view the nature and class of transaction. Thus each class of' international transaction is to be analysed separately by applying the most appropriate method. 12. The TPO also held that the law provides for comparative analysis of the international transactions in TNMM on the basis of the net margin realized by the taxpayer during the year from the international transactions and not based on enterprise level earnings and in this regard referred to Sub clause (i) of clause (e) of Rule 10B(1) of the Income Tax Rules, 1962 (the Rules) is extracted below:- "(i) the net profit margin realized by the enterprise from an international transaction entered into within associated enterprise is computed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... segments:- * Manufacture and sale of passenger cars * Trading in auto components 14. Thereafter, the TPO arrived at the results of the trading segment as well as manufacturing segment of the assessee. The PLI adopted was operating profit on sales. As far as trading segment is concerned, the AO arrived at the following segmental results:- The TPO was satisfied that the international transactions in the trading segments were at Arm's Length as the Assessee's profit margin was better compared to the profit margin of the comparable companies (in its trading segment) selected by the Assessee in it's TP study. No adjustment whatsoever was therefore suggested by the TPO in so far as it relates to the trading segment is concerned. 15. As far as manufacturing segment is concerned, the TPO as we have already seen had arrived at the operating profit margin on sales at 1.94% in the chart given at para-9 of this order. The taxpayer had identified 7 comparables at the enterprise level by taking manufacturing segment as well as trading segment results. The 7 comparables chosen by the assessee were as follows:- 16. The TPO accepted 5 companies as comparables. One of the filters applied by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ualized. Otherwise, the comparability exercise would be distorted. Adjustments have to be made for the differences in operational efficiency levels between the taxpayer and the comparable company. Thereafter the TPO drew the following conclusion with regard to the operational efficiency of the Assessee and that of the comparable companies. The TPO concluded that the operative efficiency of the Assessee vis-â-vis the comparable companies is higher by 3.57%. This difference according to the TPO was material as the margins of the comparable companies in this sector varied only from 3.52% on sales to 9.35% on sales for the FY 2006-07. The TPO therefore proposed to increase the margins of the comparable chosen i.e., he revised the profit margins of the comparables so that they would be on par with the Assessee. 19. The Assessee however vehemently opposed such a course of action being adopted by the TPO. According to the Assessee adjustment on account of operating efficiency is not contemplated in law at all. In this regard the Assessee pointed out that there could be adjustments made for transaction level difference or an enterprise level difference. These differences can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies cannot be compared at all. We are not going into the other elaborate submissions made by the Assessee in this regard as the issue raised in Gr.No.12 proceeds under the assumption that even if the adjustment on account of operating efficiency is given even then the margins of the Assessee if compared at entity level rather than at segmental level, will be well within the permitted (+) (-) 5% range of arithmetic mean PLI of the comparable companies chosen by the TPO. 20. The TPO did not agree with the submissions of the Assessee regarding upward adjustment of the margins of the comparable for the purpose of comparability and accordingly arrived at the margin of the comparables after making adjustments towards operational efficiency as follows:- 21. The TPO thereafter compared the net margin earned by the Assessee as computed by him in para-9 of this order on segmental basis for manufacturing segment to the Adjusted Net Margin earned by the comparable companies as follows: The TPO held that the margin earned by the Assessee was much less than the arithmetical mean margin earned by comparable enterprises and was beyond +/- 5% range from the price charged by the Assessee in its i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... penses Rs. 3,21,80,558 * Royalty Rs. 78,13,84,839 Total cost incurred with AEs In the mfg segment Rs. 1171,99,324,137 the TPO also took up the individually the four categories of international transactions comprised in the manufacturing segment for individual analysis. He was of the view that each of the aforesaid individual transactions were at arm's length except the transaction of payment of royalty. In this regard the TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action and hence was subsumed into the expenditure and accordingly already considered. 25. The Assessee elaborated on the above main contentions by pointing out that it was set up in India to manufacture and sell MUV under the model name "Innova" and passenger car under the model name "Corolla". The Assessee has license to manufacture "Innova" and "Corolla" from Toyota Motor Corporation, Japan(TMC), which owns the above brands. The Assessee also imports Camry and sports utility vehicle (SUV) Land Cruiser Prado as (completed brought unit) CBU and sells the same in the Indian market. The Assessee also purchases various spares and components from TMC, which forms part of the MUV and passenger car. The Assessee received various support services from TMC. The Assessee also purchase certain parts and components locally and exports the same to associated enterprises. The Assessee submitted that it had applied TNMM at the entity level for the following reasons: 1. The transactions between the Assessee and its associated enterprises are two way i.e., purchase as well as sale of parts and components. The transactions are linked and interdependent; 2. The international transactions between ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties or services, 2. rights to use intangible property, and 3. pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing or manufacturing know-how and the supply or vital components to an associated manufacturer,' it may be more reasonable to assess the arm's length terms {or the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method or methods". (emphasis supplied) 27. The Assessee also drew the attention of the DRP to para 150 of OECD Guidelines on Transaction Profit Methods wherein it is observed as follows: "In particular, sales revenue that is derived from uncontrolled activities (purchase from unrelated parties, sales to unrelated parties) should not be included in the determination or testing of the remuneration for controlled activities, unless the controlled and uncontrolled activities are so closely linked that they cannot be evaluated adequately on a separate basis. One example of the latter situation can sometimes occur in relation to unco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... If the independent dealings being considered as possible comparables cannot be disaggregated, it would generally be appropriate to group all the relevant transactions between associated enterprises so comparability to the uncontrolled party package deal transaction can be properly determined." 30. Based on the above submissions, the Assessee submitted that in its case it would be appropriate to aggregate all the transactions and adopt TNMM using the combined transaction approach at the entity level. 31. The Assessee reiterated that TNMM considers the net profit margin earned by an organization. Adjustments are made to the net profits to factor in the differences at the transaction level or the enterprise level. Adjustments are also made for difference in the accounting methodology. TNMM makes a comparison at the entity / global level and not at the transactional level. The merit of this method is that it is resilient to minor functional differences. As a result of this characteristic, examination is not made at the individual component level of income or expenditure that has been reckoned in arriving at the net profit. When a comparison is made at the macro (global) level, where ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee was engaged in various activities other than AE transactions. The Tribunal also rejected the application of CUP method on the ground that it suffers from various deficiencies, infirmities and lack of information on comparability. 33. Similarly in case of Star India, the assessee was engaged in three distinct businesses viz distribution of star channels, marketing for advertisement sales and content development for television programmes. The TPO in that case clubbed the three distinct businesses and determined ALP. It was not demonstrated by the TPO that the activities are closely linked. The assessee demonstrated that the activities are independent activities. In that context it was held that ALP is to be determined for each segment separately. In this case, the Tribunal relying on the Bangalore Special Bench Decision in the case of Aztec Software and Technologies Limited 107 ITD 141 (SB)(Bang.) held that where transactions are closely linked that have to be evaluated together. The relevant observations are extracted below: "64. We have thoroughly examined the order of the Special Bench in the case of Aztec Software and Technologies Ltd. (supra) and we find that the Tri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreement, royalty at 6% on manufacture of licenced products and 3% on accessories, spares and components was to be paid by the assessee. This is a standard agreement adopted by the TMC for calculation of royalty payable for use of know-how. The assessee, however, paid only 5% which is less than the standard rate charged. The assessee submitted that the TPO proceeded ignoring the business realities. It was submitted that the assessee's very existence was based on know-how provided by the AE and there was no alternative source from which automobile technology could be sourced or obtained. The assessee also placed reliance on the decision of the Mumbai ITAT in the case of Dresser Rand (India) Pvt. Ltd. v. ACIT, ITA No.8753/MUM/2010, wherein the Tribunal held that the TPO cannot compute ALP at NIL on the ground that no real services were received by the assessee or that the assessee has not received any benefit under cost contribution arrangement. The following observations were brought to the notice of the DRP. "We find that the basic reason of the Transfer Pricing Officer's determination of ALP of the services received under cost contribution arrangement as & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. The authorities below have been swayed by the considerations which are not at all relevant in the context of determining the arm's length price of the costs incurred by the assessee in cost contribution arrangement." 37. The DRP on the issue of conclusions of the TPO that the trading and manufacturing segment of the assessee are distinct and not inter-related warranting combined transaction approach, held as follows:- "The facts, arguments and contentions of the Eligible Assessee have been considered and deliberated upon in great detail after giving due opportunities in a speaking manner by the Transfer Pricing Authority. For economy of words, the same are not being replicated in this order. However there is no reason for any deviation from the position taken by the Transfer Pricing Officer in the given context. Moreover, the context of the eligible assessee before the Dispute Resolution Panel are mere repetition of those put forth before the Transfer Pricing Officer. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B(1)(d) of the Rules advocate profit split method of determining ALP where international transactions involve transfer of unique intangible or in multiple international transactions which are so inter-related that they cannot be evaluated separately for the purpose of determining ALP of any one transaction. It thus appears that the Act and the Rules contemplate determining ALP by aggregating international transactions which are multiple, interlinked or inter-related to each other and cannot be evaluated separately. To this extent the conclusions of the TPO regarding determination of ALP by taking segmental results without looking into as to whether the two segments are interlinked or inter-related cannot be sustained. As to what would be the most appropriate method in such cases is again dependent on Rules 10B(2) and (3) of the Rules. 42. The OECD guidelines as well as the Australian Tax Officer (ATO) Taxation Rule 97/20 on International Transfer Pricing para.2.74(1) referred to by the assessee before the Revenue authorities which have been set out in the earlier part of this order seems to support 'combined transaction approach' where the transactions are closely linked or contin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unction, assets and risks of the trading and manufacturing segments generally differ, however circumstances may warrant combining both of them. It is only in the specific facts of the case that the combining of both segments is advisable. In the instant case of the assessee, the sale of spare parts is triggered as a result of the manufacturing activities, including warranty commitments. Therefore, we are of the view that it would not be in the fitness of things for the sale of spare parts and components to be considered in isolation from the sale of manufactured vehicles. This view is supported by the OECD T.P. Guidelines, 2010, relied on by the assessee. This view is also buttressed by the fact that the comparable companies are also trading in spare parts and components. On a overall consideration, it can be concluded that trading in spare parts is closely inter-linked with the manufacturing segment of the assessee. We are of the view that no meaningful purpose would be served in segregating the trading and manufacturing segments, particularly when the assessee and the comparable companies are at par with regard to the nature and scale of combined activities. Needless to add that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o a conclusion that the ALP of an international transaction is nil because no services were rendered or that the assessee did not derive any benefit from the AE for which payments were made, we have considered the submissions of the learned counsel for the assessee. This issue is purely academic because we have already held that the conclusions of the TPO/DRP that the trading and manufacturing segment of the Assessee are distinct and not inter related warranting combined transaction approach is not correct and that a combined transaction approach has to be adopted and that on the basis of combined transaction approach the price paid for the international transaction is at Arm's Length. We may also that legally the TPO should adopt the ALP as nil. On similar approach by TPO adopting ALP at Nil the ITAT, Bangalore Bench, in the case of M/s.Festo Controls Pvt. Ltd. vs. DCIT in ITA No.969/Bang/2011 (AY: 2007-08) dated 4-1-2013, the Tribunal examined the question as to whether the TPO can determine the ALP at nil on the ground that no services were rendered. The Tribunal, on the above issue followed the decision of the Mumbai Bench of the ITAT in the case of Castrol India Ltd. v. ACIT i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me. In light of the aforesaid decisions, we are of the view that the stand taken by the assessee in this regard deserves to be accepted. It is clear from the decisions referred to above that the TPO has to work out the ALP of the international transaction by applying the methods recognized under the Act. He is not competent to hold that the expenditure in question has not been incurred by the assessee or that the assessee has not derived any benefits for the payment made by the assessee and therefore he cannot consider the ALP as NIL. We hold accordingly. 49. Besides the above, even on facts the determination of ALP at NIL in respect of royalty payments cannot be sustained. In this regard, it was brought to our notice by the ld. counsel for the assessee that similar payment made in A.Y. 2009-10, the DRP in its directions dated 19.11.2013 was pleased to hold that the payment of royalty was supported by the services rendered by the AE and was justified. The aforesaid order of the DRP was considered by the CIT(A), LTU, Bangalore in A.Y. 2005-06 and in her order dated 20.3.2014, the CIT(A) held as follows:- "10.3 The above mater had come up for adjudication before the DRP in the appe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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