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TMI Blog2016 (7) TMI 1055X X X X Extracts X X X X X X X X Extracts X X X X ..... rry ratio can only be applied where the value of the goods are not directly linked to the quantum of profits and the profits are mainly dependent on expenses incurred. The fundamental premise being that the operating expenses adequately represent all functions performed and risks undertaken. For this reason Berry ratio is effectively applied only in cases of stripped down distributors; that is, distributors that have no financial exposure and risk in respect of the goods distributed by them. In the present case, the Assessee asserts that its business comprises of two segments, trading segment and indenting segment and the functional risk and the reward in the two segments are different. In the trading segment, the Assessee earns a higher profit margins (calculated on the value of the goods traded) while in the indenting segment its profit margins are lower. Plainly, the use Berry ratio would give unreliable results if the product mix of the comparables is different from the product mix of the Assessee. This would make the task of finding a set of comparables fairly difficult. - Decided in favour of assessee. - ITA 381/2013, ITA 738/2015, ITA 382/2013, ITA 702/2014, - - - Dated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Transfer Pricing Officer? (2) Whether the Income Tax Appellate Tribunal has disregarded the assessee s claim that they had followed Transactional Net Margin Method? (This question will include the submission of the appellant that the Transfer Pricing Officer s order does not adopt any specified method) 4. For the purposes of addressing the above questions, only the facts obtaining in ITA No. 381 relevant to AY 2007-08 (ITA No.381/2013) are referred herein. 5. The Assessee was incorporated in 1997 and has its offices in Delhi, Mumbai and Chennai. The Assessee is a subsidiary of Sumitomo Corporation Japan (hereafter the SCJ ) which is one of the largest general trading companies (Sogo Shosha) of Japan. SCJ is the flagship company of the Sumitomo group which is a large conglomerate of companies. The Assessee has seven operating divisions and deals in various products. 6. The Assessee filed its return of income for AY 2007-08 on 25.10.2007 declaring a total income of ₹ 15,35,40,749/-. 7. The Assessee reported the following international transactions for FY 2006-07:- S. No. Type of International transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sted using data for financial years 2004-05, 2005-06 and 2006-07) of the PLI of these comparable companies was computed at 1.18%. Proceedings before the TPO/AO 11. The TPO noticed that the Assessee's transactions could be classified into two types - Indent sales and Proper sales . In respect of Indent sales , the Assessee merely indents for the goods which are supplied directly by the supplier to the purchaser; the Assessee only receives commission on the value of the invoice or the quantity of goods supplied. In case of Proper sales , the Assessee purchases the goods and sells the same. The purchases made are against confirmed orders and thus, the transactions of purchase and sale are back to back. The Assessee acquires the title to goods only for a brief moment; this is described as a flash title . Such sale transactions are on a profit margin. 12. The TPO examined the transfer pricing report submitted by the Assessee and noticed that the PLI used by the Assessee did not take into account the cost of sales. The TPO held that the use of such ratio (Berry ratio) as the PLI was not permissible under Rule 10B(1)(e) of the Rules which contained provisions for c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cted enhancement of Assessee's income by an amount of ₹ 55,26,16,748/- after reducing the commission of ₹ 30,42,28,035/- as declared by the Assessee. 16. Pursuant to the order dated 28th October, 2010 passed by the TPO, the AO issued a draft assessment order on 23rd December, 2010. The Assessee filed objections against the draft assessment order before the Dispute Resolution Panel (hereafter 'DRP') which were not accepted and the DRP issued its directions on 27th September, 2011. The AO passed the final assessment order on 25th October, 2011 pursuant to the DRP s directions. Proceedings before the Tribunal 17. Aggrieved by the final assessment order, the Assessee preferred an appeal before the Tribunal urging several grounds. The Assessee, inter alia, contended that the functions performed and the risks undertaken in respect of principal to principal transactions with Non-AEs were not similar to the indent based transactions with AEs and that the TPO had erred in proceeding on the basis that the said transactions were comparable. The Assessee claimed that in respect of indent transactions, the credit risks and foreign exchange fluctuation risks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the case, no adjustment as to the extent of volume was necessary as the Assessee had entered into separate contracts for each transaction and it was not the Assessee's case that each of such separate transaction with an AE was greater in volume as compared to a similar transaction in the Non-AE segment. The Tribunal then proceeded to direct that the commission computed at the rate of 2.26% (i.e. the rate of commission in respect of transactions with Non-AE s) be taken as the bench mark for determining the ALP for commission earned in the AE segment. 22. The Assessee has impugned the above decision before us in ITA 381/2013. Submissions 23. Mr C.S. Aggarwal, learned Senior Advocate, appearing for the Assessee contended that the fundamental issue in these appeals related to the determination of the most appropriate method to be adopted for determining the ALP. He submitted that the Assessee in its TP studies found TNMM to be the most appropriate method for determination of the ALP and this method was also accepted in the preceding years. However, the TPO had rejected the same and made the ALP adjustment without reference to any particular method. He contended that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent on account of volume of transactions between AE and Non-AEs segment and in support of its claim had produced the brokerage rates for transactions in the security markets. The Tribunal had rejected the same as it found that each transaction was a separate transaction in terms of a separate contract and, therefore, any discount on volumes was not warranted. 27. With respect to the contention that the products dealt in the AE segment were different from those in the Non-AEs segment, Mr Manchanda, contended that there were only two product categories, namely, telecom and transport where there were no comparables in the Non-AEs segment. He urged that the commission earned by the Assessee in respect of these two segments was at the rate in excess of 5% which was above the average rate of commission of 2.26% in the Non-AE segment. He argued that if the said two product categories were excluded, the ALP adjustment would increase. He further submitted that in order for the Assessee to make good his claim that a comparison between AE segment and Non-AEs segment was to be made product wise, the Assessee was required to produce every contract/agreement and invoice in the two segments wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... after the 1st day of April, 2014, shall be computed in such manner as may be prescribed and accordingly the first and second proviso shall not apply. Explanation .-For the removal of doubts, it is hereby clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, 2009. 30. It is apparent from the above that ALP has to be computed by the most appropriate method as is referred to in Section 92C(1). Sub-rule (1) of Rule 10C of the Rules postulates that the most appropriate method would be one which is best suited to the facts and circumstances of each particular international transaction and which provides the most reliable measure of an ALP in relation to that transaction. It is, thus, necessary that before an exercise is undertaken for making an ALP adjustment, the Assessee/TPO must identify the most appropriate method for computation of ALP. Subrule (2) of Section 10C of the Rules that postulates that the following factors shall be taken into account for selecting the most appropriate method:- (2) In selecting the most appropriate meth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The said approach was rejected by the Tribunal - and, in our view, rightly so - as it was not permissible for TPO to re-characterize the tested transaction. 33. We find no infirmity with the Tribunal's finding that indenting transactions reported by the Assessee were plainly in the nature of facilitating trade where the Assessee was required to do nothing more than to follow up the customers for facilitation of the transaction. The Assessee was not required to raise any invoice for sale and purchase and its financial commitment and risk were inconsiderable. 34. However, we find that the Tribunal erred in proceeding to determine the ALP on the basis of the rate of commission reported by the Assessee in respect of indenting transactions with Non-AEs, without further examination as to the similarity between the two transactions. The Tribunal effectively used the CUP Method for imputing the ALP of Assessee's indenting transaction with AEs. This may well be the most appropriate method to be used for determining the ALP. However, if the Tribunal thought that this was the case, it was necessary for the Tribunal to conduct a further in-depth inquiry as to the relevant uncontr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to ALP is of a recent vintage and was introduced by the Finance Act, 2001. The provisions under Chapter X of the Act have undergone significant changes over a period of time. The principles for computation of ALP are also evolving and as such, we are not persuaded to accept that the TPO was required to simply follow the transfer pricing methodology adopted in the preceding years. It is also well settled that principles of res judicata do not apply in assessment proceedings as assessment for each year is a separate proceeding and inquiry into the ALP in respect of international transactions under Section 92 of the Act is in aid of assessing the income chargeable to tax for the year under consideration. 37. We may now also consider Mr Aggarwal's contention that Berry ratio had been accepted as the appropriate PLI in respect of Sogo Shosha establishments and, therefore, the same should also be accepted in the case of the Assessee. The term Sogo Shosha is used in respect of large general trading companies that include within their fold a large network of subsidiary and affiliated companies, thus, enabling the said companies to leverage their network for their business. It is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the PLI in terms of Rule 10B(1)(e)(i) of the Rules. 41. Insofar as the other two reasons are concerned, it is necessary to understand the substratal rationale of using Berry ratio as the PLI. The said ratio was used by the Internal Revenue Service (IRS) in the USA in the case of E.I. Du Pont DE Nemours Co. v. United States: 608 F.2d 445 (1979) to sustain their stand that substantial part of the profits of a subsidiary in Switzerland were rightly allocated to Du Pont. Charles H. Berry, an economist (since deceased) provided necessary evidence in support of IRS's stand by using the ratio of Operating Profits to Selling, General and Administration Expenses to show that more than fair share of profits had been transferred to Du Pont's Swiss subsidiary. This ratio came to be known by the name of the economist who had used it in the aforementioned case. The aforesaid case concerned the allocation of profits between Du Pont De Nemours, an American Company engaged in manufacture of chemicals, and its wholly owned subsidiary established in Switzerland (Du Pont International S.A. referred to as 'DISA'). The said subsidiary was established in 1959. At the material time, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hrust of defendant's proof. Defendant has shown that DISA made extraordinarily high profits which the Commissioner reallocated to an economically reasonable level. 44. Subsequently, in 1990, Berry ratio was included as an acceptable PLI in certain circumstances under the Treasury Regulations in USA. OECD Guidelines issued in July 2010 also accepted that Berry ratio to be apposite in certain circumstances. More recently, Japan has also accepted use of Berry ratio for purposes of transfer pricing in certain circumstances in its tax legislation reforms introduced in March 2013. 45. Traditionally, the denominator of the ratio only comprised of selling, general and administration expenses. However, the Treasury Legislation of USA also included depreciation as a part of the Operating Expenses used as a denominator in the berry ratio. As is apparent, Berry ratio has limited applicability; it can be used effectively only in cases where the value of goods have no role to play in the profits earned by an Assessee and the profits earned are directly linked with the operating expenditure incurred by the Assessee. In other words, the operating expenditure incurred by the Assessee e ..... X X X X Extracts X X X X X X X X Extracts X X X X
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