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TMI Blog2014 (11) TMI 101X X X X Extracts X X X X X X X X Extracts X X X X ..... for phone operators and internet service providers; manufacturing and distributing mobile phones; providing strategic inputs for business developments; and providing R&D support to the group entities for maintaining its technological leadership and competitiveness. The assessee has four distinct business segments. The major segment is Nokia Mobile Phones Sales Division or the Trading segment. Under this segment, the assessee acts as a distributor of mobile phones imported from Nokia affiliates throughout India, mainly through HCL Infosystems (third party distributor). To be more specific, the assessee acts as a trader of Nokia phones which are sold mainly to single customer, HCL Infosystems, after importing from its Associated enterprises (AEs). HCL Infosystems further distributes the phones through its own network of dealers. The assessee declared sales of Rs. 59 crore and operating loss of Rs. 13.9 crore under this segment. In benchmarking this international transaction, the assessee selected Resale Price Method (RPM) as the most appropriate method. Gross profit margin under this segment at 11% was stated to be more than the arithmetic mean of such margin, on a multiple year dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was not capable of application as it was difficult to compute gross margin by analyzing costs and then establish the functional comparability of the comparables chosen by the assessee. He upheld the TPO's action in employing TNMM as the most appropriate method. He further noticed that both the assessee as well as the TPO were not justified in not using the current year data. Relying on certain decisions, it was held that only the current year's data was required to be employed. Then, he proceeded to examine the comparable companies as offered by the assessee and also those chosen by the TPO. Out of 23 comparables chosen by the assessee, the ld. CIT(A) shortlisted four companies as functionally comparable under the TNMM. From the companies chosen by the TPO as comparable, the ld. CIT(A) accepted four companies as comparable, one of which is common to both the assessee as well as the TPO. That is how the ld. CIT(A) initially shortlisted the following seven companies:- (i) Compuage Infocom Ltd. (ii) Media Video Ltd. (iii) Business Link Automation (iv) Procal Electronics India Ltd. (v) Redington (India) Ltd. (vi) Amzel Automotive Ltd. (vii) Gold Rock Investments Ltd. Out of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... regard to the nature of transaction or class of transactions or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe." Five specific methods have been given, which include, RPM and TNMM. The sixth method is general as may be prescribed by the Board. There is no quarrel on the point that the sixth method, now prescribed under rule 10AB, is not applicable to the assessment year under consideration as the same is operative from the A.Y. 2012-13. Sub-section (2) of section 92C provides that the most appropriate method referred to in sub-section (1) shall be applied for determination of ALP in the manner as may be prescribed. Rule 10B sets out the procedure under the above referred five methods. Sub-rule (1) of Rule 10B reiterates that the ALP in relation to an international transaction shall be determined by any of the prescribed methods being the most appropriate method. When we read section 92C in juxtaposition to Rule 10B, two things become vivid. First is that the ALP of an international transaction is required to be determined by a most appropriate method which has to be either of the five given in section 92C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng of services ; (iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market ; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise ; 9. Sub-clause (i) of clause (b) of Rule 10B(1) deals with identifying the price at which the goods purchased from an AE is resold. Sub-clause (ii) of clause (b) of Rule 10B(1) talks of reducing the amount of normal gross profit margin of comparable uncontrolled transactions from such resale price of the assessee. Sub-clause (iii) states that the result of sub-clause (ii) is further reduced by the expenses incurred in connection with the purchase of goods and sub-clause (iv) provides that the amount so deduced under sub-clause (iii) is adjusted on account of differences in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Revenue. The obvious reason for this is that the incurring of high advertisement and marketing expenses by the assessee vis-a-vis the other comparable companies does not in any manner affect the determination of ALP under the RPM. When we consider gross profit in numerator and net sales in denominator, all the expenses debited to the Profit & loss account automatically stand excluded. It is but natural that only those expenses can have bearing on the gross profit that are debited to the Trading account. As the amount of advertisement and marketing expenses falls 'below the line' and finds its place in the Profit and loss account, the higher or lower spend on it cannot affect the amount of gross profit and the resultant ALP under the RPM. If the assessee has incurred more expenses on advertisement and promotion, which, in the opinion of the ld. DR went on to brand building for an AE, then, the transfer pricing adjustment on account of such AMP expenses was separately called for. Since the TPO has not made any separate adjustment on account of AMP expenses and has given effect to the same under TNMM, we hold that the incurring of such higher advertisement and marketing spend would no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) provides for calculation of gross profit margin as a percentage of sales in respect of comparable uncontrolled transactions. This primarily contains two things, viz., first, the selection of comparables and second, the availability of their data enabling computation as prescribed. 14. Espousing the first issue of selection of comparables, it is seen that the assessee chose the RPM as the most appropriate method by selecting 23 companies as comparable in its TP study report. A cursory look at the functional profiles of these companies transpires that some of them are in entirely different line of business. Obviously, such companies cannot be considered as comparable. The ld. AR was fair enough to concede this position by admitting that the companies which are not comparable should be excluded from the list of comparables. To cut short the controversy, it was stated by the ld. AR that he was agreeable with the four companies chosen by the ld. CIT(A) as comparable with the exception of Media Video Ltd. whose exclusion was assailed. Apart from that, the ld. AR further requested for the inclusion of Procal Electronics India Ltd., which was included by the ld. CIT(A) in the initial li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of transactions with the associated enterprises (numerator) vis-a-vis the total of transactions (denominator). In order to decide that what should constitute the contents of numerator and denominator for the purposes of finding out the percentage of RPTs, it is relevant to note the logic behind applying this filter. It is manifest that the aim of the transfer pricing regime is to ensure that the international transactions are recorded at arm's length price. This is done under the TNMM by comparing the profit earned from the international transaction with that earned by the comparable independent parties in an uncontrolled situation. Thus, while choosing comparables, it must be ensured that the profit earned by them correctly reflects true profit as is earned by an enterprise from an independent third party. If such a chosen company, though functionally comparable, has also entered into international transactions beyond a particular percentage with the related parties, it is quite possible that its overall profit may have been distorted due to such transactions rendering it as incomparable. That is why, this filter is applied to make certain that a company sought to be considere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come can be combined to find out the percentage of RPTs with the total of sales and job income taken together. In a given case, similar to what is prevailing before us, where the RPTs comprise of purchase, sales, small non-operating expenses and service income, we can preferably find out two percentages of RPTs by ignoring the RPT of payment of non-operating expense of rent, which does not directly affect the profit earned from trading activity. First percentage of RPT purchases with total purchases and second of RPT sales and service income as one unit with the total of sales and service income again as one unit. The decision as to whether such a company be included in the list of comparables by applying the filter of more than 25% RPT, would depend on the outcome of two such percentages of RPTs. If either of the two breaches the 25% threshold, then the company will cease to be comparable. If however, both the percentages are less than 25%, then the company would be liable for inclusion in the list of comparables. We want to make it clear that the above discussion about the components of RPT formula is relevant only in the case of an assessee who is a Trader/Distributor and not a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Video Ltd., in accordance with our above discussion for ascertaining whether this company should continue in or be excluded from the final list of comparables drawn by the ld. CIT(A). If the percentage of RPTs as discussed above finally comes to more than 25%, then, this company should be excluded from the list of comparables. In the otherwise situation, the inclusion of this company in the list of comparables is justified. 22. Now, we turn to M/s Procal Electronics India Ltd., which the ld. AR insists for inclusion in the list of comparables. The ld. DR, on the perusal of the Annual accounts of this company, submitted that this company was engaged in manufacturing as well as trading and, hence, the same cannot be included in the list of comparables. There is no dispute on the fact that the assessee is simply engaged in the trading activity under this segment. In such a situation, a company can be included in the list of comparables only if either it is not engaged in manufacturing or the segmental results, if any of its trading segment are available. The ld. AR was fair enough to concede that if the segmental results of this company from the trading segment are not available, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his so far secret company is not comparable, then the same be excluded and vice versa. This disposes of the aspect of selection of companies as comparable. 25. Having dealt with the first component of sub-clause (ii) of rule 10B(1)(b) about the selection of comparables companies, now we move on to the second component about the availability of their data enabling computation as prescribed. On being called upon to explain the working given by the assessee under the RPM in respect of companies chosen by it as comparable, the ld. AR took us through such calculation, which brought out that the calculation of gross profit has been wrongly made by reducing purchases from the figure of sales with the adjustment on account of difference of inventory, wherever applicable. It goes without saying that the calculation of gross profit encompasses the consideration of not only the figure of purchase as well as inventories, but also of the direct expenses which are debited to the trading account. The ld. AR admitted that the figure of gross profit was computed by the assessee in the manner as demonstrated, i.e., without the effect on direct expenses incurred by the comparable companies. Such an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 10B(1)(b) be applied. If the figures of gross profit of the comparable companies are not available, then, the RPM cannot be considered as the most appropriate method. In such an eventuality, TNMM should be applied with the suitable PLI. 27. With the above directions for a fresh computation of ALP of the international transactions under the trading segment, the grounds raised by the assessee are allowed for statistical purposes. Ground No. 3 of the Revenue's appeal is dismissed inasmuch as we hold that only the current year's data should be applied for computation of PLI of the tested party as well as comparables. Ground No.5 of the Revenue's appeal in allowing relief on account of advertisement and marketing expenses cannot be decided at this stage because of our direction for firstly applying RPM. Only if RPM is found to be inapplicable, because of lack of data, etc., the TNMM will be applied. If such an eventuality arises, then, the TPO will consider the effect of advertisement and marketing expenses afresh as per law, after allowing a reasonable opportunity of being heard to the assessee. Ground No.6 of the Revenue's appeal in allowing adjustment of (+)/(-) 5% of ALP is conse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod for benchmarking these international transactions with PLI of OP/TC. The assessee selected 51 comparable cases to demonstrate that the international transactions under this segment, on a consolidated basis, were at ALP. The mean margin of these companies, by taking the weighted average for the years 1999-2000 and 2000-01, was taken at 20%. On account of economic downturn experienced in this year owing to 11th September disaster, a downward adjustment of 5% was made in such margin of the comparables. Another 5% downward adjustment was made to the mean margin on account of working capital adjustment. The TPO found that the mean margin by use of the current year data was 19.17%. He rounded it to 20%. No deduction on account of downturn, as claimed by the assessee at 5%, was allowed. He took arm's length margin at 15% after allowing adjustment of 5% on account of working capital difference. As against the assessee's list of 51 comparable cases, the TPO selected 60 companies as comparable, which have been tabulated on pages 17 and 18 of his order. This exercise done by the TPO resulted into transfer pricing adjustment of Rs. 85,20,942/-, which was added by the AO. The ld. CIT(A) a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic that higher amount of depreciation follows in the initial years of the installation of machinery or other assets because of the higher base. With the increase in the age of the asset, the written down value goes on decreasing, which results into downward sojourn of the annual amount of deprecation over the years. At the same time, it is equally true that when asset is new, there are low costs of repairs and other incidental expenses connected with the operation of the assets. Thus it is evident that the effect of higher amount of depreciation in the initial years is set off by the lower amount of the cost of repairs etc. But with the increase in the age of the asset, no doubt, the amount of annual depreciation allowance declines, but at the same time, repair costs etc. boost up. Operating cost includes not only the cost of repairs etc. but also the amount of depreciation allowance. Consequently, operating profit also carries the effect of both the depreciation allowance and repairs cost etc. Under the TNMM, the numerator is always the amount of operating profit. When the amount of operating profit embraces the effect of depreciation allowance and also repairs cost etc., both of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss than Rs. 5 crore without any upper cap. The assessee argued before the ld. CIT(A) that its turnover under this segment amounted to Rs. 9.72 crore and, as such, there was no justification in either excluding the companies with sales less than Rs. 5 crore or including the companies with turnover of more than Rs. 50 crore. After obtaining the remand report from the TPO, the ld. CIT(A) held that these seventeen companies with sales of more than Rs. 50 crore be excluded from the list of comparables. 39. After considering the rival submissions and perusing the relevant material on record, we find that the assessee's turnover under this segment is to the tune of Rs. 9.72 crore. The TPO excluded the companies with the turnover of less than Rs. 5 crore without applying any upper limit of the turnover. The preliminary question which looms large before us is whether the application of this filter is correct? In this regard, it is relevant to note that the computation of arm's length price under the Indian transfer pricing provisions is embodied in section 92C of the Act. Sub-section (1) of this section provides that the arm's length price in relation to an international transactio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, turnover, ownership of branded/proprietary products, onsite vs. offshore services, expenditure on advertisement and R&D etc. The higher turnover was only one of the criterion and not the sole criteria for the exclusion of this company. In view of the above discussion, we hold in principle that no potentially comparable company can be expelled from the list of comparables simply for the reason of high or low turnover. 41. Adverting to the facts of the instant case, it is seen that the assessee's turnover under this segment amounted to less than Rs. 10 crore. The TPO has applied the turnover filter by setting a lower limit of turnover at Rs. 5 crore without setting any upper ceiling of turnover. We fail to comprehend any legally sustainable reason for applying the filter setting a lower limit of turnover at around half of the assessee's turnover and leaving the upper limit uncapped. It is trite that law does not permit a person to both approbate and reprobate. This proposition has sanction of the Hon'ble Supreme Court in R. N. Gosain Vs. Yashpal Dhir (1992) 4 SCC 683. Under this rule, a person cannot be permitted to blow hot and cold in the same breath. As the TPO has himself app ..... X X X X Extracts X X X X X X X X Extracts X X X X
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