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TMI Blog2017 (7) TMI 996X X X X Extracts X X X X X X X X Extracts X X X X ..... e order dated 01.09.2015 of CIT(A)-44, New Delhi which is assailed in the said year. It was a common stand of the parties before the Bench that the facts, circumstances and the issues in all the years are identical. Accordingly, Grounds from ITA No.960/Del/2014 are reproduced hereunder:- 1. "That on the facts and in the circumstances of the case and in law, the order passed by the Ld. Assessing Officer ("AO") is bad in law and void ab-initio. 2. The Ld. AO/Ld. Transfer Pricing Officer ("TPO") erred on facts and circumstances of the case in determining the arm's length adjustment to the Appellant's international transaction from Associated Enterprises ("AEs"), thereby resulting in the enhancement of returned income of the Appellant by Rs. 14,29,24,000. 3. That the reference made by the Ld. AO suffers from jurisdictional error as the Ld. AO has not recorded any reasons in the draft assessment order based on which he reached the conclusion that it was "expedient and necessary" to refer the matter to the Ld. TPO for computation of the arm's length price, as is required under section 92CA(1) of the Income Tax Act, 1961 ("Act"). 4. The Ld. AO/ TPO erred on facts an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... years' data as used by the Appellant in the TP documentation and holding that current year (i.e. FY 2008-09) data for the comparable companies should have been used despite the fact that the same was not available to the Appellant at the time of preparation of its TP documentation. 9. That the Ld. AO/ TPO /DRP erred in facts and in law in being inconsistent by rejecting the transfer pricing methodology for this financial year when the same was accepted in the prior years despite there being no change in facts and circumstances over the two years (i.e. financial year 2007-08 and 2006-07). 10. That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 274 read with section 271 of the Act mechanically for furnishing inaccurate particulars without recording any adequate satisfaction for such initiation 11. That the Ld. AO erred in facts and in law in charging and computing interest under section 234B of the Act. The above grounds of appeal are mutually exclusive and without prejudice to each other. The Appellant craves leave to add, alter, amend or vary any of the above grounds either before or at the time ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f a routine distributor like market risk, price risk, customer credit risk, product liability risk, foreign exchange risks etc. The major international transaction undertaken by the assessee which is a subject matter for consideration in the present proceedings, it was submitted, is purchase of finished goods. The assessee it was submitted has selected Resale Price Method (hereinafter referred to as "RPM") as the most appropriate method. It was submitted that the gross margins of the assessee have remained healthy consistently over the years when compared with the prior years. It was also submitted that it is a matter of record that for the two previous years i.e. 2007- 08 and 2008- 09 assessment years identical international transactions of the assessee after detailed TP scrutiny analysis the transaction on an identical set of facts has been accepted to be at arm's length. It was submitted that there was no change in either the FAR profile of the assessee or of the comparables it had selected. The method adopted for benchmarking methodology followed in the year under consideration, it was submitted, also remains the same. 2.3. Referring to the facts on record, it was submitted th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of the ITAT in ITA No.7367/MUM/2012 in the case of M/s Carlyle India Advisors Pvt. Ltd. vs DCIT. Specific attention was invited to page 9 para 12 of the same wherein Motilal Oswal Investments Advisors Pvt. Ltd. had been rejected as a comparable with an extreme OP margin of 72.33% from the final set of comparable selected by the TPO on the grounds that it was engaged in diversified activities and the segmentals were not available. 2.5. Apart from the said fact, it was also his submission that Modi Care Ltd. should not be considered as a comparable especially on a standalone basis since on a perusal of its financials, it would be evident that apart from the direct selling Model Modi Care Ltd. also includes service income in the nature of AMC and once its service income is excluded its TP/sales would be 69.66%. The fact that Modi Care Ltd. recognises service income, it was submitted is evident from the fact that the TPO in 2010-11; 2011-12; and 2012-13 assessment years has admitted that Modi Care Ltd. recognises service income in its Profit & Loss A/c and has accordingly removed service income from the competition of margins. It was his submission that the assessee is not praying ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or otherwise the results would become unreliable. Oriflame India Ltd., it was submitted recorded sales net of discounts/incentive paid to its agents/consultants and hence shows a lower gross margin as per its accounting treatment. 2.9. The Revenue recognition policy of the two companies it was submitted, was also divergently different. Referring to paper book page 433 of volume 2, the assessee it was submitted has a policy of allowing 20% of discount on MRP to its consultants which is equal to margin of 25% of sales for the consultants. When this position is compared with the discount given to the consultants/agents which is categorised as incentives by Modi Care Ltd, it was submitted that it is a below the line in Profit & Loss A/c as a part of operating expenses. Accordingly, it does not form part of the computation of gross profit margin of Modi Care Ltd. The incentive pay to the agents and consultants works out to be around 30% of the sales over and above the said discount the assessee also pays incentives to the tune of Rs. 3,032,04/- as would be evident from paper book page 44 31 of volume11 of the paper book filed before the ITAT. Accordingly, it was his submission that it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the information available on the said company's website itself, it was submitted it has been stated that Modi Care Ltd manufactures its own products thus the value added expenses are high because of these manifestly high expenses and it cannot be considered as comparable to the assessee. It was submitted that even if the evidence of the website description for a moment is not considered, the incidence of such high operating expenses demonstrated that the said company having substantial value adding expenses unlike the assessee cannot be deemed to be comparable to the assessee. 2.13. It was also submitted that significant advertising, marketing and promotion expenses spend when compared to its sales of 7.32% when compared to 0.49% of the assessee, would also show that functionally the companies cannot be said to be comparable and thus for an apple to apple comparison and economic adjustments for the said facts, should also be factored into and once a revised GP/sales post the said investments are carried out it would be seen that the GP is 65.95%. 2.14. Inviting attention to paper book page 19 of the Annual Report for financial year 2008 - 09 paper book page 73 volume1, it was su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was submitted that it is true that the assessee is a direct seller and hence may be considered to perform extra functions of carrying inventory for a longer duration at high-risk vis-a-vis an ordinary trader who may sell its inventory to another wholesaler, retailer but the said difference it was submitted can easily be accounted for by making an adjustment for higher working capital levels. A direct reseller would have a higher working capital requirement on account of higher inventory levels such an approach it was submitted is widely accepted by the OECD and the UN and has been endorsed by the ITAT also in a catena of cases. 2.18. The TPO and the DRP/CIT(A) in the respective years, in the circumstances, it was submitted has failed to appreciate that for applying RPM product comparability is necessary and since the comparables chosen by the assessee deals in cosmetics thus during the benchmarking analysis, the assessee has necessarily focused on the companies which are:- a) primarily traders i.e. engaged in buying and selling activities; and/or b) deal in the category of cosmetics 2.19. The business description of the comparable companies, it was submitted has been provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eration. The basic of TP report of the appellant laying emphasis on the profile of Oriflame Group is reproduced as under:- 2.1 Profile of Oriflame Group The Oriflamme Group was founded in Sweden in 1967. Oriflame is a global cosmetic group with direct selling operations. This means that independent sales personnel sell products directly to the end consumers, without any involvement of various retail chains. 4.2.1. Functions performed by Oriflame Group. The Oriflame group provides some 900 products in the field of skin care, make up, fragrances and toiletries through direct sales. 5. As per page-24 of TP report:- 5.2.1 Functions performed by Oriflame India Oriflame India is a routine distributor which carries out routine functions and assumes normal risks associated with carrying out such business. The main business activity for Oriflame India is the distribution and sales of the cosmetic products through direct sales channel. As per Page -34 of TP report:[ The company: Oriflame India faces the risk of adverse sales conditions due to increase competition in the market place. The company faces dual competition from both the cosmetics companies and direct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us adjustment sought by the Ld. AR. (i) Adjustment on account of cost of goods sold (COGS): Ld. AR has sought adjustment in COGS on the basis of average cost of goods sold and other expense by the appellant as well as other comparable such as J K Helene Curtis Ltd and M/s. Rama Vision Ltd. etc. If the adjustment on account of COGS is allowed which is the main cost to compute gross margin of M/s. ModiCare.the entire purpose of computing Gross Profit Margin for the purpose of RPM analysis is lost. Tinkering of Gross Profit Margin of the comparable on the basis of other comparables which are not considered as comparable is not proper. Further, at gross margin level major cost is COGS is adjusted on the basis of appellant's result then gross margin is itself adjusted then there is no meaning of taking gross margin as profit level indicator. Accordingly, this adjustment is rejected. (ii) Adjustment on the basis of Service Income: Ld. AR has sought exclusion of service income for the computation of Gross Margin for its trading segment. As the service income is not related to attain the direct selling activities. I have perused the financials of M/s. ModiCare Ltd. It has declared se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 07 Legal, Professional & Consultancy Charges 8,287,372 7,755,203 Repair & Maintenance Others 4,428,456 5,016,559 Auditor's remuneration -audit fee 425,000 425,000 Tax audit fee 75,000 75,000 Electricity & water charges 2,326,068 2,208,565 Provision for doubtful advances - 952,220 Advances written off 3000 855,533 Fixed assets written off 1,198,152 - Loss on disposal of fixed assets 293,194 - -net of gain Rs. 75,430(previous year NIL) Franchise expenses 22,499,788 20,308,572 Marketing & sales promotion expenses 44,213,293 29,552,604 Freight & cartage 16,711,545 11,637,296 Freight exchange difference (net) - 123,971 MISC Expenses 6,744,486 5,618,955 Total 255,913,960 227,071,179 A perusal of this schedule reveals that there are no item apparently of advertisement expenses as such. In any case, expenses related to marketing and sales promotion expenses effects net profitability of the business and in my view they did not affect gross margin. Accordingly, no adjustment of these alleged AMP expenses is allowed while arriving at Gross Profit Margin. (iv) Claim of adjustment on account of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method for benchmarking the International Transaction and has consider average net PLI (OP/OI) 12.7% being average of PLI of JK Helene Curtis Ltd and M/s. Rama Vision Ltd and Modi Care Ltd. I do not agree with the arguments of Ld. AR. The appellant is a trader, therefore, the most appropriate method is RPM for benchmarking International Transaction and therefore the Profit Level Indicator has to be considered at Gross Profit Level only. Accordingly, I confirm the approach of the TPO for benchmarking the international transaction of the appellant on the basis of RPM. Hence, this ground of appeal is dismissed." 3.1 The arguments, it was submitted, would remain the same for each of the years despite the differences in amounts and the minor variations of the names of the companies proposed by the tax payer as principally the most appropriate method; methodology; selection of comparables and the reasons for rejecting the objections of the assessee continue to remain the same. 4. Countering the submission of the ld. CIT DR, the ld AR relying upon the synopsis filed, submitted that the objections have not been considered on facts. Inviting attention to the synopsis filed for 2010-11 as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lected as a standalone comparable on a gross basis under RPM. Table no. 2: Diversified product portfolio as per annual report of Modicare Ltd. S.No. Products Sales (INR) % of the total product turnover 1. Laundry & Home Care 78,765,810 14.34% 2. Personal Care 120,292,729 21.89% 3. Agriculture 79,718,481 14.51% 4. Tea 8,045,875 1.46% 5. Jewellery 53,766,590 9.79% 6. Cosmetics 86,129,350 15.68% 7. Healthcare 88,886,747 16.18% 8. Others 33,819,599 6.16% Total 549,425,182 Case laws relied upon: M/s Carlyle India Advisors Pvt. Ltd. vs. DCIT (ITA no. 7367/ Mum/2012) (Page 9. para 12): Hon'ble Mumbai CIT rejected a comparable Motilal Oswal Investment Advisors Pvt Ltd with an extreme OP margin of 72.33% from the final set of comparables selected by the Ld. TPO since it was engaged in diversified activities and segmental was not available. 9.2. Diverse functional profile (Please refer to Page 35 of the Annual Report for FY 2010-11) Modicare Ltd. recognizes service income in its profit and loss account to the extent of 9.66% of its total revenue (including service income). This as per its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... care Limited (INR) Rama Vision Ltd.(INR) J K Helene Curtis Ltd. (INR Lakhs) Incentives/Discount 3,974,543 110,428,823 2,126,923 91.40 Incentives/Discount/Total operating Cost % 0.18% 18.21% 1.26% 0.58% Without prejudice, for an apple to apple comparison economic comparability adjustments have to be undertaken to compute the PLI for this company to account for the significant dissimilarities in the function and revenue streams, between Modicare Ltd. and the Appellant. Hence sales of Modicare Ltd should be reduced by the amount of incentives paid as appearing in operating expenses in its financials since for an "apple to apple" comparison with the Appellant and other comparables acceptable to the Appellant, so as to keep the accounting treatment similar (Page no. 123 of ITAT paperbook). The revised GP/ Sales of Modicare Limited would be 48%. 9.6 Medicare Ltd, has substantial variation between gross margin and net margin The Appellant would like to state that Modicare Ltd has a gross margin of 66.77% (as per Ld. TPO) whereas, its net margins are -9.94%. The substantial variance in the gross and net level margins establishes the fact that the company is incur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of operating expenses An economic adjustment for differences in the cost profile of Modicare Ltd, and the Appellant should be carried out. This adjustment has been computed by bringing the VAE of Modicare Limited to the level of VAE of the independent distributors of Cosmetics. As can be seen from the analysis below the ratio of COGS to VAE in case of a trader is 60:40 approximately. Modicare Limited is incurring heavy expenditure at the operating level for instance its freight outward expenses, incentives and franchisee expenses are very high in proportion to the purchase cost that it is incurring. If the VAE adjustment is carried out then the gross margin of Modicare Ltd. is25.02% (Page no. 119 of ITAT paperbook) 16 The companies chosen by the Appellant in the TP documentation/ fresh search are comparable to the Appellant in terms of their products, functions, assets and risks and should be considered while computing the arm's length margin. 17 If these companies are considered, then the results of the benchmarking analysis would be: (Page no. 113 of ITAT paperbook) Table no. 9: GP/Sales margins of comparables engaged in trading of cosmetic products S.No. Name of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stries Ltd in 2009-10 assessment years, it was concluded that compared to the unadjusted average margin of 3 years as 29.95%, the tax payer's margin of 45.58% did not warrant any adjustment as the transaction was admittedly at arm's length. It has also been argued that the PLI of 2010-11 assessment year was 46.79% and in 2011-12 assessment year it was 48.72%, which was much higher than that of the comparables. On the basis of these facts, it was claimed that the transactions with its AE over the years were at arm's length. Since the unadjusted average margin of 3 years was not accepted by the TPO, the taxpayer was required to carry out a fresh search of the comparable companies for the respective years, even then the GP margins were 36.62%; 29.70% and 37.47% respectively and it was again claimed that no adjustment was warranted. It has also been argued before the tax authorities and repeated before us that the gross margins of the assessee have remained healthy and consistent over the years. 5.2 It has also been argued by the ld AR that identical international transactions of the assessee in the immediately preceding two assessment years namely 2007 - 08 and 2008 - 09 assessment ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sale policy of the foreign AE. We, thus, do not deem it appropriate to address the issue as we find that the selection of the most appropriate method is an accepted fact as the method adopted by the assessee has been accepted by the TPO. It goes without saying that the product which is purchased by the assessee admittedly falls in the category of cosmetic and personal care. The product is stated to be competing in a highly competitive socio economic market segment in the country with many domestic and international players competing for attention in the limited segment. The assets stated to be employed by the taxpayer are routine assets like computers, office paraphernalia etc. Qua the risks also the taxpayer is stated to be reasonably cushioned as the market risk; capital risk etc. are risks borne by the foreign AE. The taxpayer is stated to be exposed to normal inventory risk and limited credit risk. We find that the tax authorities have noted in passing that the risk of unsold inventory is entirely borne by the taxpayer. We find that such an observation without addressing the sale policies of unsold inventory of the foreign AE cannot be of any relevance. Accordingly if inventor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining 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 55a[or the specified domestic 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." 5.6. On a perusal of the above, we note that the legislature envisages in its wisdom in sub-clause (ii) of clause (b) of sub-Rule (1) of Rule ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iate comparable and has also canvassed that the comparables selected by the taxpayer have wrongly been rejected by the tax authorities. One of the many lines of arguments taken by the taxpayer is that firstly Modi Care Ltd. has a very limited cosmetic and personal care product category thus it lacks product similarity; secondly it also has income from franchisees, hence it is not a similar service; thirdly its discounts are below the line expense and Revenue recognition policies are also significantly incomparable; fourthly it has high AMP spend; fifthly it has fluctuating sales; its incentives schemes are different it has wide variation between its gross margins and net margins thereby giving weight to the allegation that heavy functions are being performed at the operating level. 5.10 We note that as per text book definitions RPM, pre-supposes that there is no value added services being provided by the distributor and since marketing and promotion are considered to be value adding services thus in order to make the selected companies comparable this activity also has to be factored in. The taxpayer has claimed that when the expense of advertising and marketing of Modi Care Ltd i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts, transportation costs, insurance and performing the warranty function as operating expenses or its costs of goods sold or the differences in inventory valuation methods these variations will also affect the gross margins. It is thus important that the analysis does not compare apples with oranges but rather apples with apples. Therefore there can be no escaping the undeniable conclusion that appropriate adjustments should be performed to the data used in computing the gross margin to make sure that similar gross margins are compared. Thus in order to ensure that the selected company and the comparable company perform a similar and a near identical function and is also a low-risk distributor of the product purchased from the foreign AEs, there is again no escaping the statutory requirements and thus there can be no two opinions to hold that it is imperative to consider the contractual terms and the risks undertaken the economic conditions and the class of asset or services in which the two companies operate. The said exercise is necessary undeniably as it is important to keep in mind the fact that the distributor is remunerated for its functions as it does not carry out any value ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iv) of clause (b) of sub-Rule (1) of Rule 10B ideally more comparables should have been selected. We note that there is sufficient guidance and clarity in the aforesaid statutory provisions to ensure that the grievance of the assessee can be addressed as it has amply been provided that wherever the gross margins are demonstrated to be impacted either with incomparable activities; functions; accounting practices; product dissimilarities; etc. then necessary adjustments should be made. Herein noting that the tax payer's first grievance is that with necessary adjustments, even if Modi Care Limited is taken as a standalone comparable as has been done by the tax authorities even then adjustments proposed by the tax payer on valid grounds namely incomparable activities, functions accounting and Revenue recognition policies etc. is necessitated. We are given to understand that service income has been excluded by the TPO himself in the subsequent years and in fact in one of the years in the present proceedings. It has been argued that if the adjustments are thus made then no adjustments to the arm's length price of the assessee would be necessitated. We note that the tax authorities have n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v. Atlantic Coast Line Railroad Co. 318 U.S. 54 (1943); "A phrase begins life as a literary expression; its felicity leads to its lazy repetition; and repetition soon establishes it as a legal formula, indiscriminatingly used to express different and sometimes contradictory ideas". (emphasis provided) 5.14 Though, in the facts of the present case as noted earlier also for the three years under consideration selection of most appropriate method is not in dispute, we deem it appropriate to refer to sub-Rule (2) of Rule 10C of the IT Rules, 1962 for the sake of clarity noting that since it is a recurring issue and that in the peculiar niche area of cosmetics there are multiple players in the limited market the persuasiveness of the arguments that the business model of direct sales or retail sales as far as the specific target customer base is concerned the business model of direct sales may not be a relevant criteria thus we make it clear that the issue has been left open to be decided as and when and if ever a challenged is posed to the application of RPM as the most appropriate method. In order to take guidance from the Rules we deem it appropriate to refer to Rule 10C of the I ..... X X X X Extracts X X X X X X X X Extracts X X X X
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