9911796707
TMI Blog2015 (7) TMI 915X X X X Extracts X X X X X X X X Extracts X X X X ..... and adjustment for use of intangibles was unwarranted. the use of berry ratio as PLI is appropriate to the facts and circumstances of this case, the objections taken by the authorities below to the use of berry ratio are unsustainable in law, and the adjustments for use of intangibles and locational savings are unwarranted. With these observations, the computation of ALP so far as buy sell segment of assessee’s activities are concerned stands restored to the assessment stage. The matter will be examined afresh in the light of the above observations which we respectfully concur with that laid by the co-ordinate bench in Mitsubhishi Corporation India Pvt. Ltd. (supra) and the matter is remanded back to be examined afresh at the assessment stage. Service fee segment which the TPO treated as trading segment - Held that:- The same issue cropped in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein held that it is impermissible to make notional additions in the cost base and thus take into account the costs which are not borne by the assessee – following the decision in LI And Fung India Pvt. Ltd. Versus Commissioner of Income Tax [2014 (1) TMI 501 - DELHI HIGH COURT] - It is no lon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as the ownership control of Marubeni Singapore which, inturn holds 99% share capital & Marubeni Japan holds remaining 1% of Marubeni India. 4. The appellant/assessee, Marubeni-Itochu Steel India Private Limited ("MIIP") / "the Appellant") brought to the notice of the TPO that assessee is a service and trading company and provides liaisoning support services to its parent and affiliates for purchase and sale of goods from India. It acts as a communication channel between its parent/affiliates companies and third parties in India. 5. The assessee states that it is engaged in undertaking two types of transactions with its Group Companies : a) Provision of support services to its Group Companies - Service Segment - where sales and purchases in relation to the import and export is recorded in the books of AE. The services include the following : • Furnishing information regarding steel products and Indian steel market; • Providing information concerning transportation, customs clearance and any other information as required by the AEs; • Receiving and delivering of relative documents required in the contracts and shipping documents as required by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 09-10)( page 102 of P.B.). The appellant computed its own OP/VAE at 7.91 % for the financial year 2009-10 ( page 118 of the Paper Book).Since the OP/VAE (7.91%) of the appellant is better than the OP/VAE (7.52%)of the comparables, as such, indenting transaction entered with the AE was claimed to be at Arm's length. Further, similarly to benchmark the international transaction in the trading segment, appellant selected 17 comparables by applying appropriate search filters and average OP/Sales of these comparable companies was computed at 0.61 % (using multiple-year data i.e. data for financial years 2007-08, 2008-09 and 2009-10) (page 93 of P.B.). The appellant computed its own OP/Sales at 0.80% for the financial year 2009-10 (page 118 of P.B.) and since the margin of profit of the appellant is better than the mean margin of the comparables, as such, trading transaction entered with the AE was claimed to be at Arm's length. 10. However, the Transfer Pricing Officer (herein after referred to as "TPO") re-characterized the indent based transactions as trading transactions. That vide an order dated 24.01.2014 (pages 145-174 of appeal documents), the TPO rejected the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed comparable companies to the aforesaid cost base and accordingly, made upward adjustment to the total income of the assessee; (e) The assessee is reimbursed based on cost plus model; (f) The commission business of the assessee is equivalent to the trading business and accordingly compared the assessee with trading companies and also the companies involved in manufacturing activities; (g) The assessee as part of this network and the synergy created by the same should be deriving income commensurate to the intangibles involved. The network of which assessee is a part consists of wholesaler, manufacturer, chemical dealers, paper traders etc. It is doing procurement and as well as sourcing for manufacturers and also of wholesaler. On this basis, the assessee can be compared with all the comparables confronted to him, wherein the receipts are from the trading of commodities irrespective of the type of the commodity or the way in which it is produced; (h) That appellant company has developed unique intangibles like supply chain management intangibles and human asset intangible for which it is not being adequately compensated; (i) The compensation model of the assessee does n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ving at this conclusion has been stated in the said order. No evidence or material has been brought on record by the TPO/ AO to reach the aforesaid conclusion. As per the Ld counsel, the TPO has acted outside his jurisdiction by challenging the compensation model of the assessee. In this regard, the Ld counsel submits that it is a settled principle in tax jurisprudence that the business model method/ transaction chosen by a taxpayer has to be respected and it not open to the revenue to dictate the business model. According to him, the TPO has only contended that trading transactions and service/ commission transactions are equivalent without assigning any reason to arrive at this conclusion. However, the Ld counsel pointed out that the assessee on the contrary has pointed out extensive dissimilarities in detail and took our attention to the chart which reflects the summary of functions & risks of service segment & trading as provided in TPO report is reproduced below for quick reference : 19. A perusal of the chart below shows the Summary of risk borne by MIIP& Group Companies 20. Further, the assessee also demonstrated before the TPO/DRP by way of highlighting the difference bet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y to be stocked, insurance and other incidental activities. Yes No Inventory Risk : Inventory risk relates to the losses associated with carrying finished product inventory. Losses include obsolescence, shrinkage, or market collapse, such that products are only saleable at prices that produce a loss Yes No Inventory carrying cost like warehouse rent and insurance cost Yes No Customer Credit Risk: Customer credit risk is borne by a firm when it supplies products or services to a customer. Yes No Foreign Exchange risk: Foreign exchange risk occurs when purchases of materials, resources, or services are denominated in one currency, while sales of finished product are denominated in another currency. Yes Limited to service fee/ commission to be received. Lesser foreign exchange risk as compared to trading business. 21. So, the Ld counsel contented that there is no justification of recharacterizing the transactions entered into by the assessee without any cogent reasons in complete disregard of the business model adopted by the assessee. In the commercial world there are various types of business models which are selected by the entities based on commercial factors and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .406, was also to be included in cost base of the service/commission segment and then ALP was recomputed. So far as this aspect of the matter is concerned, the issue is now covered in favour of the assessee by Hon'ble jurisdictional High Court's decision in the case of Lt & Fung wherein Their Lordships have, inter alia, observed as follows : "...........This Court is of opinion that to apply the TNMM, the assessee's net profit margin realized from international transactions had to be calculated only with reference to cost incurred by it, and not by any other entity, either third party vendors or the AE. Textually, and within the bounds of the text must be AO/TPO operate, Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assessee's net profit margin for application of the TNMM. Rule 10B(1) (e) recognizes that "the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise.. (emphasis supplied). It thus c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ;s service/commission segment. Cost incurred by the assessee in providing such sales support and coordination services are already built in the profit and loss account and does not warrant any addition to the cost base of the assessee. 26, The Ld counsel submits that the AO has proposed to apply a set of trading and manufacturing companies to determine the arm's length price of the international transactions of the assessee. Herein, the ld counsel, submitted that the law provides the use of comparable data of uncontrolled transactions with reference to the functions performed, assets employed and the risks assumed by the tested party and the comparable companies. Based on the functional analysis in the TP Report, it is evident that the assessee is engaged in provision of commission and services to its AEs in relation to its indent segment. Thus, according to Ld counsel, the application of a set of steel trading companies that assume all entrepreneurial risks is unjustified. Over and above this, the Ld counsel submitted that selecting manufacturing companies as part of the comparable set is a gross misapplication of the Transfer Pricing provisions in India. 27. The Ld counsel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the TP Report Transportation of the goods to the port of departure The assessee is not involved in transportation of the goods to the port of departure. Further, this function is also not mentioned in the TP Report. Random quality check prior to shipping The assessee is not involved in Random quality check prior to shipping. Further, this function is also not mentioned in the TP Report. 29. It was pointed out by the Ld counsel that in addition, the TPO alleged that the assessee is bearing single customer risk wherein the assessee could not work with any other unrelated party as per agreement with the AE. This allegation according to Ld counsel is based on assumption and contrary to the evidences furnished by the assessee that it is dealing with many customers and does not undertake any single customer risk. The Ld counsel wondered as to how the TPO came to such a conclusion and stated that if he has arrived at such a conclusion based on any agreement then the TPO did not share the said agreement which he has relied upon while alleging that the assessee bears single customer risk. 30. Further, the Ld counsel submitted that the TPO also alleged that the assessee is bearing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. In fact the very basis on which the TPO has concluded that location savings should be attributed to the assessee is wrong. It is the AEs which procure goods from suppliers in India or sells goods to buyers in India. The terms and conditions of such sales/purchases are determined between the AEs of the assessee and the Indian suppliers/buyers. According to Ld counsel, it is purely a business decision between Indian buyers/seller and the AEs and they deal at arm's length. Further, it was emphasised by the Ld counsel that the assessee does not identify the contract manufacturer as alleged by the TPO and it is a matter of fact that Indian suppliers, from whom the AEs buys various commodities are not captive manufacturers of the AEs. It was pointed out by the Ld counsel that the assessee is not a captive service provider as it is not bound to provide services to its AEs only. 34. Strong reliance was placed by the Ld counsel on the Hon'ble Delhi High Court ruling of Li & Fung India Pvt. Ltd. (ITA 306/2012) wherein the Hon'ble High Court has rejected the application of principles of location savings and human and supply intangibles without any basis. The Hon'ble High Court has als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been laid down for the purpose of drawing up a comprehensive Transfer Pricing Study. 38. According to the Ld DR in the instant case it is worth noticeable that the Taxpayer has failed to follow the prescribed approach in the true sense, thereby hoodwinking the tax authorities for the purpose of adopting the method to be adopted as per Sub rule (l)(e). According to the Ld DR, TNMM method prescribes three bases namely, cost, assets and sales and also any other relevant base. This forms the denominator of the PLI which ultimately calculates the net profit margin. Applying the doctrine of ejusdem genereis, where particular words are followed by general words, the general words have to construed as limited to things of the same kind as those specified and hence the construction of the rules would include in the context of "any other relevant base", the FOB value in the instant case. 39. In the instant case, the according to the Ld DR, the TPO rightly rejected the Berry Ratio (PLI) adopted by the assessee and the TPO after rejecting the Berry ratio of the assessee, choose to follow OP/TC as the PLI for computing net profit margin in the support services segment. In order to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clear that the assessee has failed to consider the various factors enumerated there under in the rules for the purpose of conducting the TP study. Therefore the TPO was right in rejecting the TP approach of the assessee. 43. With regard to adding of FOB value to cost base of the PLI, and the assessee reliance upon LI & FUNG Judgment of the Delhi High Court the Ld DR pointed to us that the said order has been challenged by the department in the Hon'ble Apex Court and the SLP has been admitted and Leave granted and took our attention to the copy of the order of Hon'ble Supreme Court admitting the SLP of the department. However we note there is no stay granted by Hon'ble Supreme Court while admitting the SLP. 44. According to ld. DR, in LI and FUNG India, the assessee was a captive offshore sourcing provider and was merely a support service provider, whereas in the instant case, the assessee deals in both trading as well as support service (assessee 's admission in the TP study). So at the outset the segments in which the assessee deals in differ with the case of LI and FUNG. The difference is also evident in the specific categories of products transferred and services rende ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as base for computing net profit margins. On the said reasoning, the claim of the assessee for use of 'Berry Ratio' was not accepted by the TPO which, according to him, being contrary to Rule 10B(1)(e)(i). The same issue, we find, was before the Coordinate Bench in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein the Tribunal dealt with the same and negated the contention of TPO and upheld the assessee's action of use of berryratio, and we note that facts & circumstances of that case were identical & similar. 46. Before going to the berry-ratio, the Bench in Mitsubishi corporation (supra) went ahead to address the TPO's view that compensation model of assessee does not include the profit attributable to the assessee on account of location saving, which in the instant case also the TPO was of the same view, wherein the Bench observed as under :- "TPO's stand on locational savings not being accounted for 70. We have also noted that the TPO has also taken up a point regarding locational savings which, according to him, have accrued to the AEs but the compensation model, which provides for a mark up on costs, does not take into account the benefits from the locational savings ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der (i) whether location savings exist; (ii) the amount of any location savings; (iii) the extent to which location savings are either retained by a member or members of the MNE group or are passed on to independent customers or suppliers; and (iv) where location savings are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under similar circumstances would allocate any retained net location savings. We are in considered agreement with this approach but then no such exercise, as suggested in the above four step process, has been carried out in the present case, nor is there any concrete finding even about something as fundamental as existence of locational savings. The TPO has raised some murmurs of locational savings being present in this case but such vague generalities are devoid of legally sustainable foundation. The allocation of I.T.A. No.: 5042/Del/11 Assessment years 2007-08 Page 40 of 95 location savings comes into play only when these savings are not directly passed on to the independent customers and thus add to the profits of the group as a whole. However, in a situation in which the group is only a facilita ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ged to the AEs of the assessee. The value of intangibles created in the process of carrying out the business activity cannot be built in the compensation for carrying out the activity which leads to creation of these intangibles. In any event, the onus is on the revenue authorities to demonstrate and quantify, on the basis of cogent material and reasonable basis, the value of intangibles which has not been take into account in the arm's length price of the services so rendered. It is also important to note that not only that there should be intangibles in use but these intangibles should be unique intangibles which may not be possessed by the comparable entities. There is no unique intangible pointed out in this case. Any comparable involved in the similar activity will essentially have the same intangibles, and no adjustments can be justified or warranted in the cases of routine intangibles. In view of these discussions, as also bearing in mind entirety of this case, the action of the TPO is devoid of any legally sustainable merits on this count as well. 72. The particular business model which gives rise to this edge, assuming that there is indeed an edge, to the assessee is a r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ets employed or to be employed; (b) use of berry ratio is not appropriate to the facts of this case as there are unique intangibles like supply chain intangibles and human assets intangibles; and (c) use of berry ratio is unworkable due to adjustments for variations in accounting policies for recording costs. 64. None of these objections, for the reasons we will set out now, merits acceptance. Rule 10B(1)(e)(i) and use of berry ratio 65. As for the objection that use of berry ratio is not permitted under rule 0B(1)(e)(i) as it does not deal with costs incurred, sales effected or assets employed or to be employed, it proceeds on the fallacy that the basis of computation, as set out in rule 10B(1)(e)(i), is exhaustive whereas it is only illustrative and it ends with the expression "or having regard to any other relevant base". Just because a cost base is not of costs incurred, sales effected or assets employed, such a base does not cease to permissible under rule 10B(1)(e)(i) unless such a base can be held to be irrelevant. In view of the elaborate discussions earlier, justifying exclusion of inventory costs, the cost of base of the operating expenses is relevant. When cost of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO with regard to operational difficulties in the cases of selected comparables. The problem, thus, is hypothetical problem at this stage which may arise in case there are significant issues in the accounting policies of the comparables vis-àvis the assessee. That stage has not yet come as the comparables are yet to be finalized, and no such specific issues are raised with respect to the comparables used in the analysis so far. 68. In any case, when we are dealing with business entities engaged in the trading activities and all their operating expenses pertain to the trading activities only, the issue regarding classification of operating costs are somewhat academic. 69. There is, therefore, neither there is anything inappropriate in the use as such of berry ratio per se, nor there are any real issues with respect to accounting policies of the assessee vis-à-vis accounting policies of the comparables finally selected. Obviously, as final comparables are not yet selected, there cannot be any question of the accounting policies adopted by the comparables vis-à-vis accounting policies of the assessee being so significantly different that the very compara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the order of the Hon'ble jurisdictional High Court decision in the case of M/s Li & Fung India Pvt. Ltd vs. CIT (361 ITR 85) has upheld the contention of the assessee that it is no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by its AEs, in respect of which services are rendered, in its reconstructed financial statements and then putting the hypothetical trading profits, so arrived in their reconstructed financial statements, to the tests for determining arms' length price. The Coordinate Bench held as follows :- "Service fee/ commission segment of assessee's activities 80. Coming to the service fee/ commission segment, we have noted that as regards the service fee/ commission segment, the TPO has re-characterized the same as trading activities as he was of the view that the right course of action will be to treat the same as equivalent to trading segment, because what the assessee has disclosed as service/ commission income is infact trading income. Accordingly, the cost of goods sold by the AEs, which was ₹ 2927,92,05,406, was also to be included in cost base of the service/comm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms' length price. Respectfully following the esteemed views of Their Lordships, we hold that the adjustments carried out in the cost base of ALP computation, in respect of service fee/commission segment, are indeed devoid of legally sustainable merits. We direct the Assessing Officer to delete these adjustments. Once this notional adjustment is deleted, the ALP determination is to be done on the basis of the commission/service fees. As we have stated earlier in this order as well, in the course of proceedings before us, the assessee has filed fresh computation of the ALP which attempts to demonstrate that, if notional adjustments made by the TPO are deleted, no ALP adjustment will be warranted. However, we are not inclined to go into verifications which must take place at the assessment stage.'' 53. Respectfully following the ratio laid by the Hon'ble predicted High Court in Li & Fung out that of the co-ordinate bench in Mitsubishi (supra) we deem it appropriate to uphold the grievances of the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X
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