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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 ..... affect the amount of gross profit and the resultant ALP under the RPM - since the TPO has not made any separate adjustment on account of AMP expenses and has given effect to the same under TNMM, the incurring of higher advertisement and marketing spend would not affect the calculation of ALP under the RPM - RPM prima facie appears to be the most appropriate method. Selection of comparables – M/s Media Video Ltd. - Held that:- If any company though functionally comparable, but, has more than a specific percentage of the RPTs, then, it should be ignored by treating it as a controlled transaction - the percentage of RPTs to make a company as ineligible for comparison, should be taken as more than 25% and not 15% as suggested on behalf of the assessee - The view adopting more than 25% RPTs making a company incomparable has been taken in Actis Advisers Pvt. Ltd. VS. DCIT (2012) [2012 (10) TMI 779 - ITAT, DELHI] - a company can be considered as incomparable if its RPTs exceed 25% - transactions which do not impact the profitability, such as loan given or taken or other items finding place in the balance sheet, can have no place either in the numerator or the denominator of this formu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat their profit is abnormally higher - There can be no justifiable reason to exclude such high or low profit companies unless it is shown that such high or low profit was due to abnormal factors - The mere fact that a company has a high or low turnover can be no reason to justify its exclusion if it is otherwise functionally comparable - The exclusion of companies on such a rationale runs contrary to the express provisions of the Act. The assessee’s turnover under this segment amounted to less than ₹ 10 crore - The TPO has applied the turnover filter by setting a lower limit of turnover at ₹ 5 crore without setting any upper ceiling of turnover - law does not permit a person to both approbate and reprobate - as the TPO has himself applied the lower limit at half of the assessee’s turnover, there is justification in applying some upper limit as well – the order of the CIT(A) is upheld by fixing the upper limit of turnover filter at ₹ 50 crore - when the three sets of companies are held to be rightly excluded, the price charged by the assessee from its associated enterprises in this segment of international transactions comes within (+)/(-) 5% range as per provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on a multiple year data basis, of 9% in respect of 23 comparable companies chosen by the assessee. The assessee s list of 23 comparables with the business description and the ratio of GP/sales has been tabulated on pages 3 and 4 of the Transfer Pricing Officer s (TPO) order. That is how, it was claimed that the international transactions under this segment were at arm s length price (ALP). The TPO observed that the companies chosen by the assessee were engaged in altogether different nature of business. Some were distributing food products, while others were trading in electronic goods or textiles etc. On being called upon to explain as to why RPM adopted by the assessee be not rejected on account of high degree of functional and economic divergence among the comparables and the assessee, it was stated that all the comparables performed the basic function of trading and distribution. Unconvinced with the assessee s submissions, the TPO held that such a method was not capable of application because apart from dissimilarity of the products dealt with by the assessee vis-a-vis the so-called comparables, even the data of the comparables chosen by the assessee was not appropriately ava ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vii) Gold Rock Investments Ltd. Out of these seven companies, the ld. CIT(A) excluded Procal Electronics India Ltd. which had a high negative margin of (-) 39.58% during the financial year relevant to the assessment year under consideration, primarily due to excess depreciation cost along with significant drop in the sales as compared to the previous year. He further excluded Redington (India) Ltd. on the premise that it had very high turnover in comparison with the assessee. That is how, the ld. CIT(A) was finally chose five companies as comparable with their respective OP/Sales margin as hereunder:- (i) Compuage Infocom Ltd. 2.25% (ii) Media Video Ltd. 6.77% (iii) Amzel Automotive Ltd. 3.88% (iv) Business Link Automation (India) Ltd. 2.81% (v) Gold rock Investments Ltd. 0.35% Average 3.21% He held that only the current year s data should have been considered. He further held that the TPO was not justified in benchmarking the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng 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(1) at the material time. Second is that such computation can be done only in the manner as is prescribed under the rule. The instant controversy narrows down to examining and deciding as to whether RPM or TNMM is the most appropriate method in the present circumstances. 7. Before ascertaining the most appropriate method as may be applicable in the factual scenario obtaining instantly, it is crucial to have a look at the functions performed and the nature of activity undertaken by the assessee under this segment. At the cost of repetition, we are mentioning that the assessee purchased mobile phones and accessories from Nokia group companies situated outside India and sold the same to local independent customers, mainly, HCL Infosystems. The TPO has also admitted this fact that the international transactions under this segment involve import of mobile phones and accessories from foreign AEs which are resol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h 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 the international transaction and comparable uncontrolled transactions which materially affect the amount of gross profit margin in the open market. Finally, sub-clause (v) provides that the adjusted price found under sub-clause (iv) is taken as arm s length price in respect of purchase of goods from the AE. When we consider the methodology given under RPM, more specifically sub-clauses (i) and (v), it becomes patent that sub-clause (i) refers to property purchased by the enterprise is resold and sub-clause (v) refers to arm s length price in respect of the purchase of the property by the enterprise . A close scrutiny of the above two sub-clauses along with the remaining sub-clauses of rule 10B(1)(b) makes it clear beyond doubt that RPM is best suited for determining ALP of an international transaction in the nature of purchase of goods from an AE which are resold as such to unrelat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 not affect the calculation of ALP under the RPM. Ex consequenti, we hold that RPM prima facie appears to be the most appropriate method in the facts and circumstances of the instant case. 12. At this juncture, we note the mandate of Rule 10C which defines the Most appropriate method . Sub-rule (1) of Rule 10C states that: For the purposes of sub-section (1) of section 92C, the most appropriate method shall be 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 arm s length in relation to the international transaction. Sub-rule (2) of Rule 10C lists certain factors which should be taken into account in selecting the most appropriate method as specified in sub-rule (1). These factors, inter alia, include - (c), the availability, coverage and reliability of data necessary for applic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 list of seven comparables, but, was later on excluded by stating that it had high negative margin of 39.58%. 15. Now, we will examine as to whether M/s Media Video Ltd., was rightly included by the ld. CIT(A) in the list of comparables. The ld. AR contended that the related party transactions (RPTs) of this company were more than 40% and, hence, the same should be excluded from the list of comparables. To bolster this submission, the ld. AR invited our attention towards the Annual report of this company. He referred to a chart prepared by him on page 520 of the paper book deducing figures from the Annual report of Media Video Ltd. The percentage of RPTs at more than 40 of this company was demonstrated by taking in the numerator all the international transactions of (i) purchase of goods and material; (ii) sale of goods and raw materials; (iii) rend paid; and (iv) service income. A sum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered 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 considered as comparable should have its profit uninfluenced by the impact of the related party transactions. 18. In view of the foregoing discussion, it is manifest that the transactions which do not impact the profitability, such as loan given or taken or other items finding place in the balance sheet, can have no place either in the numerator or the denominator of this formula. However, any income or expenditure resulting/relating from/to or likely to result/relate from/to such items of assets or liabilities, should not be confused with the per se international transactions finding place in the balance sheet of the company calling for exclusion. 19. The numerator of this formula consists of all the related party transactions of a company sought to be chosen as comparable which affect the profit earned directly from operations. If, however a related party transaction is of such a n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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 Service provider/receiver or a Manufacturer. Since we are concerned in the extant case with the application of RPT filter in the case of a Trader, we have restricted ourselves only to a trader and have thus desisted from examining the contents and other relevant considerations in the application of this filter to a Service provider/receiver or a Manufacturer. 21. Turning to the facts of the instant case, it is seen that the assessee has computed the percentage of related party transactions of Media Video Ltd. by clubbing all the four types of international transactions in the numerator, viz., Purchase of goods and materials; Sale of goods and materials; Rent paid; and Service Income, all totaling ₹ 22,43,46,000 and the amount of net sales as denominator at ₹ 55,25,22,266. We fail to appreciate the rationale of the manner in which this exercise has been carried ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt. 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, then, it should not be included in the list of comparables. 23. We, therefore, set aside the impugned order on this issue and remit the matter to the file of the TPO/AO for examining as to whether the financial results of M/s Procal Electronics India Ltd. are available for the trading segment. If these are found to be available, then, such segmental results should be included. In the otherwise situation, the order excluding this company from the list of comparables is justified. 24. As far as the Revenue s ground against the exclusion of some of the companies chosen by the TPO is concerned, the ld. DR, except for relying on the order passed by the TPO, could not point out any cogent reason for including such disclosed companies in the final list of comparables which were chosen by the TPO, but, rejected by the ld. CIT(A). It can be seen that the ld. CIT(A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 approach is totally misplaced inasmuch as it is not possible to tinker with the modus operandi given in the formula for calculation of the ALP. The numerator in the formula under the RPM is gross profit. Obviously, such a numerator cannot be substituted with anything less or more than the gross profit. The Special bench of the tribunal in the case of L.G. Electronics India (P) Ltd. VS. ACIT (2013) 152 TTJ 273 (Del) (SB) has held that Rule 10B has specified a set procedure to be followed for determining the ALP distinctly under the five methods. It is not permissible to invent a new procedure and try to fit such procedure within any of the existing procedures prescribed as per these methods. No one is authorized to add one or more new steps in the prescribed procedure or to substitute any other mechanism with the one prescribed under the rule. It is n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 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 consequential which has to be considered in the fresh determination of profit rate of comparables as well as that of the assessee either under RPM or, alternatively, under TNMM. 28. Ground nos. 4 and 5 of the assessee s appeal are against the confirmation of disallowance of ₹ 26,19,816/- (after allowing depreciation @ 20% on total expenses of ₹ 34,93,088/-) towards marketing expenses incurred by the assessee on account of providing handsets to AMSC s, dealers and employees. 29. After considering the rival submissions and perusing the relevant material on record, we find that this issue is no more res integra inasmuch as the Tribunal has restored such issue to the file of AO by its order in the appeals for assessment years 2000-01 and 2001-02. Respectfully following the precedent, we set aside the impugned order and remit the matter to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5% 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 ₹ 85,20,942/-, which was added by the AO. The ld. CIT(A) accepted the TPO s action in not granting deduction of 5% on account of downturn. He, however, excluded three sets of companies from the list of comparables drawn by the TPO. After such exclusion and allowing (+)/(-) 5% adjustment, the ld. CIT(A) found that the price charged by the assessee from its associated enterprises was at ALP. Consequently, the addition so made by the AO came to be knocked down. The Revenue assails the deletion of this addition. 33. We have heard the rival submissions and perused the relevant material on record. It is observed that there is no dispute on any aspect other than the exclusion of three sets of companies by the ld. CIT(A), which were chosen by the TPO. We will take up these three sets of companies one by one for consideration and decision. 34. The first set contains thirtee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t 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 which ordinarily run in the opposite directions, there is no reason to discard an otherwise comparable case simply on the ground of higher or lower percentage of amount of depreciation allowance. As the higher amount of depreciation is usually coupled with the lower repair cost etc., and vice versa, there can be no justification in applying the filter of rejecting the companies with depreciation higher or lower than a particular percentage of total costs. 36. Be that as it may, it is noticed that the TPO ventured to apply this filter and by applying the same, excluded some of the companies which were not suitable to him. However, he forgot to exclude these thirteen companies, which were probably favoring the assessee s case. As this filter has been applied and acted upon by the TPO partially, we are unabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r 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 transaction shall be determined by any of the given methods, being the most appropriate method, having regard to certain factors. Proviso to sub-section (2), which assumes significance for the present purpose, states that : where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices . In contrast, some countries have adopted the interquartile range, which is also called the midspread or middle fifty, instead of arithmetic mean of all, as used in India. When arithmetic mean is taken of the all the otherwise comparables companies, it tends to iron out the differences due to higher or lower size of a company or vacillating profitability rates. A company otherwise found to be functionally c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g 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 applied the lower limit at half of the assessee s turnover, there is justification in applying some upper limit as well. Taking a holistic view of the matter, we approve the view taken by the ld. CIT(A) in the present peculiar facts and circumstances by fixing the upper limit of turnover filter at ₹ 50 crore. The situation would have been different if the TPO had either set no or a nominal lower limit of the turnover filter, leaving the upper limit open. In that situation, there would have been no reason to set any upper turnover filter as well. Ergo, we countenance the conclusion drawn by the ld. CIT(A) in the present unusual circumstances. 42. When the above three sets of companies are held to be rightly excluded, the price charged by the assessee from ..... X X X X Extracts X X X X X X X X Extracts X X X X
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