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TMI Blog2015 (1) TMI 193X X X X Extracts X X X X X X X X Extracts X X X X ..... therefore, we are disposing of all these appeals togetyher by this consolidated order. 2. One common issue in all the assessment years is the challenge to the correctness of arm's length price adjustment made to the billing for contrac t manufacturing by the assessee, to its associated enterprises based abroad. We will begin by taking up this common issue. The short question, as learned counsel for the assessee contends, that we have to adjudicate upon in this bunch of appeals is whether Cost Plus Method (CPM), with entrepreneurship profits derived from manufacturing and selling its products in India as the benchmark, would indeed be most appropriate method of determining the arm's length price (ALP)of contract manufacturing of its same products for its associated enterprises abroad. The background in which this question arises is as follows. 3. The assessee company (Wrigley India, in short) was set up in India in October 1993 as a wholly owned subsidiary of the legendry William Wrigley Jr Co, USA (Wrigley USA, in short) founded in 1891 and is thus part of a large network of business entities associated with Wrigley USA (collectively referred as Wrigley group) - world's largest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... less : fixed costs 91.97 72.11% Net Profit (45.34) (-) 39.17% P/V Ratio 32.94% BEP Sales [Fixed cost/ PV ratio] 218.91% Other things being equal, Wrigley India will need to achieve minimum capacity utilization of about 60% (of the present installed capacity) to achieve breakeven. 5. In the course of dealing with determination of arm's length price in respect of these transactions, the transfer pricing study noted that CUP method cannot be applied to the facts of this case as "Wrigley India does not export such products to any unrelated party outside India" and "even though Wrigley India sells chewing gums to unrelated parties in India, the terms and risk profile for such transactions differ significantly" from that of exports to Wrigley group companies". It was also noted that "there is no publicly available information on prices charged in independent transactions of similar or identical nature which reflect characteristics of the products exported to Wrigley group companies" . The use of Resale Price Method was ruled out on the ground that "the RPM is applicable in a resale situation where the property or service purchased from an associated enterprise is sold to u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ( -) 1.37% to 13.17%. The arithmetic mean of the above mentioned range is 6.44%..... Information provided by Wrigley India indicates that the net margin earmarked by Wrigley India on budgeted cost of exports was 10% of costs (excluding SGAi.e. Sales, General and Administrative Expenses). Hence, Wrigley India's budgeted net margin of the export transaction is within arm's range computed as defined above, and, therefore can be considered to be at arm's length. 6. The TP study then, as a corroborative analysis, justified this pricing by pointing out that the realization of export proceeds was in excess of the marginal or incremental costs to the assessee, and, as such, provided a net contribution to the fixed costs which was as high as 36% of sales. A reference was made to the OECD Transfer Pricing Guidelines in support of the contention that while 'margin costing method' is not recognized by the Indian TP regulations, the same may be considered in certain situations as a corroborative to primary analysis. 7. This approach to benchmarking the assessee's transactions with the AEs, however, did not find favour with the Transfer Pricing Officer . He rejected this analysis for the sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etermination in 2006- 07, mercifully the TP study abandoned the comparison with budgeted costs and noted that actual margin (OP/TC) of the Wrigley India was 3%, as against 8.07% in the selected comparables, but then since sales price, as per comparables, was to be 108.07 on a total cost of Rs. 100, and since sales price of Rs. 103, as achieved by the assessee, was within 5% range (up to Rs. 108.07), the price at which goods were exported by the assessee were within permissible range of arm's length price. The same TP approach, though for slightly different reasons, was adopted by the assessee. The TPO, however, following his stand for the earlier two assessment years, rejected this approach as well. Similar adjustments were held appropriate by the TPO for this assessment year as well. 9. It was in this backdrop that the AO made the ALP adjustments with respect to the arm's length price of assessee's export transactions with the AEs. Aggrieved by the adjustments so made by the Assessing Officer, on the basis of the TPO's order, the assessee carried the matter in appeal before the CIT(A) but without any success. Learned CIT(A) passed a common order for the assessment years 2003-04, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 's appeals against order of the learned CIT(A) for the assessment years 2003-04, 2004-05 and 2005-06 and the order of the Assessing Officer, read with directions of the Dispute Resolution Panel under section 144C(13), for the assessment year 2006-07. The assessee is aggrieved of these orders and is before us. 13. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. 14. The question that we must decide at the threshold is as to which is the most appropriate method of determining arm's length price on the facts of this case. On this aspect of the matter, the dispute is confined to even narrower a question, i.e. whether or not CPM is the most appropriate method on the facts of this case, because neither revenue authorities have justified any other method of determining the ALP, nor is it in dispute that, if the CPM fails, the TNMM, as canvassed by the assessee, is the only method which can be applied. 15. Rule 10B(1)(c) defines the cost plus method, i.e. CPM, as follows: Cost plus method, by which,- (i) the direct and indirect costs of production incurred by the enterprise in respec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the situation before us. What the assessee is doing for its AEs is manufacturing the products, and, as noted elsewhere in this order, it is an uncontroverted position that the assessee's AEs, collectively constituting Wrigley group, deal" in FMCG sector which is characterized by impulsive buying by the consumers, heavy expenditure is required to be made on planning and execution of sales promotion" and that "these expenditure were incurred by the Wrigley Group to penetrate new market as well as to retain share in the existing market". It is also an uncontroverted position that "in respect of sales promotion, both Wrigley India and the AEs carry out this function in their respective market". What in effect, thus, assessee does is that the assessee manufactures the products and sells those products to the AEs but sales promotion is required to be done by the respective AE in its respective market. To this extent, there is no dispute whatsoever on factual aspects by the parties before us. 18. The question that arises is whether these transactions can be compared with the sales of similar product to distributors or other entities in the domestic market and particularly in a situatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsactions under these business models cannot be "comparable transactions" for the purposes of transfer pricing. In the first business model, creation of market in the end users is not the responsibility of the vendor, but in the second business model, it is job of the vendor to create and maintain the market of end users as well. The product may be the same but the FAR profile is materially different and it is this FAR profile which governs the profitability. The basic notions of transfer pricing recognize the impact of FAR profiling on the profitability. When profitability levels in two business situations, due to significant differences in FAR profiles of two situations, are expected to be different, such transactions cease to be comparable transactions for the purposes of transfer pricing analysis. 20. In OECD Transfer Pricing Guidelines, this aspect of the matter, so far as comparability analysis is concerned, has been explained thus: 1.47 The functions carried out (taking into account the assets used and the risks assumed) will determine to some extent the allocation of risks between the parties, and therefore the conditions each party would expect in arm's length transactio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r differences. These attributes, which are usually referred to as the five comparability factors, include: Characteristics of the property or service transferred; Functions performed by the parties taking into account assets employed and risks assumed, in short referred to as the "functional analysis"; Contractual terms; Economic circumstances; and Business strategies pursued. [Emphasis, by underlining, supplied by us] 22. On the facts of the present case, however, the comparability analysis has been confined to the first segment itself, i.e. characteristic of the property transferred. Undoubtedly, the product comparability is an important factor but its certainly not the sole or decisive factor. The assessee was producing the same products for its AEs as it was producing for independent enterprises but that was all so far as similarities were concerned. The FAR profile was not the same, the contract terms were not the same, the economic circumstances were not the same and the business strategies were not the same. Viewed thus, necessary precondition for application of CPM, i.e. finding normal mark up of profit in comparable uncontrolled transactions, could not have been ful ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etic level of professional work relied upon by even the large corporate entities. If the tax judicial system is clogged by frivolous litigation today and if the tax finality still takes decades to reach, these saviours of taxpayers are as much to be blamed for this situation as anybody else. No purpose can be served in reporting by a chartered accountant when such reports do not even point out glaring infirmities in taxpayer's approach vis -à-vis the transfer regulation, in a comparison of budgeted profits margin with actual profit margins realized by the comparables which is stated to be ascertainment of ALP on the basis of the TNMM. It appears that in an alarming number cases, these audit reports, rather than painting a true and fair picture of the relevant facts, tend to epitomize the art of constant hedging and manoeuvring by the professionals so as they stay within the confines of permissible professional conduct and are yet able to sidestep the inconvenient realities. Of course, it will be much worse a situation if they are actually so naïve as to be oblivious of simple provisions of law, of their onerous responsibilities or of the legitimate public expectations. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and on the facts of this case in deleting the addition of Rs. 39,00,813 for the assessment year 2003-04,Rs 9,05,383 for the assessment year 2004-05, and Rs. 7,08,793 for the assessment year 2005-06, made by the AO "by treating the expenses incurred by the assessee on research and development as capital in the nature". It is also pointed out that the tax implication of the above issue is less than permissible threshold limit in two of the assessment years before us but then as the issue is repetitive in nature, it is covered by the exemption clause in the CBDT instructions in this regard. Learned counsel for the assessee does not dispute this position. 32. We have noted these expenses were disallowed by the AO on the basis that the expenses were treated as research and development expenses resulting in enduring benefit to the assessee and that these expenses pertained to the development of the new product. However, when mater travelled in appeal before the CIT(A) he deleted the disallowance on the ground that these expenses were incurred on "laboratory testing of the products" and were thus routine revenue expenses in nature. Learned CIT(A) had also noted that "incurring of these e ..... X X X X Extracts X X X X X X X X Extracts X X X X
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