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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 ..... method shall be the method which is best suited to the facts and circumstances of each particular international transaction or specified domestic transaction, and which provides the most reliable measure of an arm’s length price in relation to the international transaction or the specified domestic transaction, as the case may be. Thus though the issue may be of academic interest in the present proceedings we deem it appropriate to clearly and ambiguously set out that on the selection of the most appropriate method there is no finding given as the issue is not under challenge in the present proceedings. In view of the above detailed reasoning and the conclusion the issues are remitted back to the TPO in the respective years to comply with the aforesaid directions set out hereinabove. - I.T.A .No.-960/Del/2014 And 184/Del/2016 And 271/Del/2016 - - - Dated:- 24-3-2017 - SMT DIVA SINGH, JUDICIAL MEMBER AND SH.ANADEE NATH MISSHRA, ACCOUNTANT MEMBER For The Assessee : Sh.Himanshu S.Sinha, Adv. Sh. Yeshu Arora, CA For The Revenue : Sh. Amrendra kumar, CIT DR Sh. Neeraj Kumar, Sr.DR ORDER PER DIVA SINGH, JM The present appeals have been filed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 92D of the Act read with Rule 10D of the Income Tax Rules, 1962 and its submissions and substituting the same with his own methodology without providing any cogent evidence or back up documentation in support of his statements used to reject the TP methodology adopted by the Appellant by 4.2.1 rejecting companies whose revenues are less than ₹ 5 crores without taking cognizance of the Appellant's submissions. 4.2.2 rejecting companies whose data is not available for FY 2008- 09. 4.2.3 holding that the quantitative filter of ratio of R D expenses to sales more than 3% is an inappropriate filter. 4.2.4 applying the threshold limit of 25% for the related party transactions based on subjective grounds and without any rational justification and by disregarding various judicial pronouncements. 4.3. not following a detailed search methodology for the arm's length analysis, demonstrating cherry picking of companies, thus also reflecting a single minded intention of making an addition to the returned income of the Appellant. 5. The Ld. AO/ TPO/ DRP erred in facts and in law by considering direct selling companies to be the only appr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... und Nos. 4 and 5, it was submitted the issues agitated therein may be considered to be agitated before the ITAT. However, the specific grievance which the assessee wants to highlight is addressed by Ground No. 6 which is also addressed in Ground No. 4.1. Ground No. 7, it was submitted is also an argument in support of the prayer and vide Ground No. 9, reliance is being placed on the Rule of Consistency Ground Nos. 10 and 11 it was submitted may not require any specific adjudication. 2.1. In the light of the above submissions, it was submitted that the specific grievance of the assessee is primarily retention of Modi Care Ltd. as a standalone comparable rejecting the comparables selected by the assessee. The retention is also assailed as it has been done without making appropriate adjustments keeping in mind the peculiar business model of the assessee. The assessee, it was stated, is engaged in a direct sales business model the TPO wrongly rejected the comparables selected by the assessee ignoring the objection to retaining Modi Care Ltd. as a single comparable company, which has wrongly been selected and retained. The DRP in the two years and the CIT(A) in 2010-11 A.Y., it was s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .62%; 29.70% and 32.62% respectively in the 3 years. The transaction accordingly was still very much at arm slength. However, the TPO rejected all the comparable companies selected by the assessee on the grounds that none of these companies were engaged in direct selling and thus selecting a single comparable i.e. Modi Care Ltd. on the basis of its TP/sales of 76.47% and without making any adjustments in order to make it comparable as provided under Rule 10 B(2) proceeded to make adjustments. The issue, it was submitted had been agitated before the DRP on this ground however it did not meet with success resulting in filing of the present appeal before the ITAT. Reiterating the submissions made before the DRP and relying upon the synopsis filed it was the prayer of the assessee that Modi Care Ltd. as the sole comparable selected by the TPO and retained by the DRP was an incorrect comparable. In support of the said submission, it was stated that Modi Care Ltd. had a diverse product portfolio which included diverse products like auto care, agricultural products, tea, jewellery, healthcare etc. and even if the personal care products of Modi Care Ltd. are aggregated with cosmetics even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es from annual maintenance contracts and other service contracts. It was his submission that it is quite possible that Modi Care Ltd. may be deriving franchise service fee from its franchisees. These factors, it was submitted admittedly demonstrate that the said company was functionally different from that of the assessee. 2.6. Apart from the above, it was also his submission that Modi Care Ltd. has fluctuating margins, the intensive fluctuation in the sales for Modi Care Ltd. it was submitted shows that it is assuming significant business and market risks whereas in the case of the assessee there is a consistent increasing trend and there is no such risk exposure of the assessee. Table 3: Sales trend of Oriflame India vis- -vis Modicare Limited (INR) Sales Oriflame India Year on Year change Modicare Limited Year on Year change FY 2006-07 656,303,028 - 344,886,627 - FY 2007-08 968,658,047 47.59% 36 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion that it is improper to compare the gross margins of Modi Care Ltd.with the assessee. 2.10. Addressing the comparables selected by the assessee, it was submitted that for J.K. Helene Curtis Ltd., Wipro and Yardley the sales is net of incentives. Thus for an apple to apple comparison it was submitted economic comparable adjustments had to be undertaken to compute the PLI for this company to account for the significant dissimilarities in the functions and revenue streams of Modi Care Ltd. and the assessee. Accordingly it was submitted the sales of Modi Care 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 assessee, the factors imparting comparability have to be given similar treatment. The accounting treatment similar between the comparables it was submitted needs to be kept acceptable on facts. Thus the revised GP/sales of Modi Care Ltd after accounting for this adjustment and after excluding the service income it was submitted would be 40% and the GP sales of the assessee, it was submitted is 45.6% therefore even on without prejudice basis if Modi Care Ltd. is to be ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 73 volume1, it was submitted would show that Modi Care Ltd in its annual report for the aforementioned financial year has recorded franchisee expenses of ₹ 20,308,572/- which is 5.09% of total operating expenses. Thus, Modi Care Ltd. admittedly is not wholly a direct seller as it has franchise business also. 2.15. Attention was again invited to paper book page 131 volume1 of the paper book filed. It was also submitted that the cost of goods sold i.e. COGS as per the financial statements for Modi Care Ltd. is only 22.56% of its total operating costs, its value, added expenses i.e.( VAE) are 77.44% of total costs. It was submitted its position admittedly is unlike the trading Co where COGS should be the dominant component of total costs as can be seen from the financials of Oriflame India Ltd. as a percentage of its total operating cost is 50.71% and the said position is in alignment with the description of a distributor hence the cost profile of Modi Care Ltd., it was submitted is also not similar to the assessee. 2.16. Without prejudice to these arguments, it was submitted that in case selection of Modi Care Ltd. as a comparable is retained as a stand-alone comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... panies, it was submitted has been provided in the TP documentation. Attention was invited to paper book page 550 of volume II. Reliance was placed upon M/s Tupperware India Pvt.Ltd. vs DCIT (C.O.No.191/Del/2011 168/Del/2012): Tupperware India Pvt.Ltd., it was submitted, is a part of IDSA s list of direct selling companies. However as can be read from the said decision, the ITAT, it was submitted, has not rejected non-direct resellers from the comparable set of companies to determine the arm s length gross margin for M/s Tupperware India Pvt.Ltd. Attention was also invited to Mattel Toys (I) Pvt. Ltd. vs DCIT (ITA No.2476/Mum/2008), ITA No.2801/mum/2008) (Para 39, page 22): It was submitted that RPM is the most appropriate method in case of distribution activities without any value addition. Hence functional and operational comparability has been defined as a necessary component and admittedly. According all comparables selected by the Appellant should also be considered for an arm s length analysis. 3. The ld. CIT DR heavily relying on the orders of the DRP and the CIT(A) submitted that all the arguments of the assessee have already been considered in detail and have been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lace. The company faces dual competition from both the cosmetics companies and direct sales companies. The company s business is also subject to adverse demand conditions. In view of the appellant profile it would not be appropriate to treat the appellant as a routine distributor though marketing channels i.e. whole seller, retailer, show room etc. The appellant is the undisputedly member of Indian Direct Selling Association (IDSA). This Association is an autonomous body which acts as an interface between the industries and policy making body of the Government. Oriflame and Modi Care are the members of Indian Direct Selling Association. The TPO has taken the members profile from IDSA site and reproduced in the order. In view of the functionality being direct sales in my view if the comparable exists in the same segment i.e. direct selling model, then other distributors there the chains of whole selling, distributing and show rooms should not be considered. The reasons behind this conclusion is that the FAR of direct sellers or through the chain of distributing network or through show rooms are bound to be different. Risk in the case of direct selling is different as sal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the direct selling activities. I have perused the financials of M/s. ModiCare Ltd. It has declared service income of ₹ 5,47,26,523/- in its Profit Loss A/s for the Financial Year ending 31.03.2010. I have also perused the working of Gross Profit Margin computed by the TPO in its show cause. The TPO has computed Gross Profit Margin at the rate of 73.68% and while computing this Gross Profit Margin the TPO has included service income. Further, after considering the reply of the appellant Gross Profit Margin has been reduced to 70.33%. I agree with the argument of the Ld. AR that the service income is not a part of direct sales and purchase of the goods, therefore, it should not be included while computing Gross Profit Margin. Accordingly, AO/TPO is directed to exclude the service income while computing PLI on the basis of Gross Profit 8s and reduce further if such adjustment exceeds the lowering of gross profit margin from 73.68% to 70.33%. ( iii) Adjustment sought on account of AMP:- The Ld. AR in her argument has argued that AMP expenditure in the case of Modi Care Ltd compared to sales is 10.06% and average of such expense for appellant is very low. Ld. AR has no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - 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 ₹ 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... finding of the TPO that contribution of similar product which is sold by Oriflame excess 65% of turnover, therefore the Modi Care Ltd is good comparable as its working on direct selling model and is having mostly similar profile of products. As a result all these grounds of appeal are dismissed except adjustment allowed on account of services charges. ----------------------------------------------- ----------------------------------------------- 9.2 Decision; I have considered the Transfer Pricing Order, Assessment Order, Written submission and argument of the Ld. AR. Ld. AR has opted for TNMM as alternative 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9 . 1 Diversified product portfolio ( Please refer to Page 54 - 55 of the Annual Report for FY 2010 - 11 ) Cosmetics comprised only 15 . 68 % of the total product portfolio of Modicare Ltd . Even if personal care is aggregated with cosmetics, then also the total share of these two categories is only 37 . 57 %. Therefore 62 . 43 % share comprises as diverse products like auto care, agricultural products, tea, jewellery, healthcare, etc . ( Please refer to Page 54 - 55 of the Annual Report for FY 2010 - 1 1 ) ( Page no . 114 - 115 of ITAT paperbook ) It may be noted that Oriflame India does not deal in any of these product categories . ( Page no . 115 of ITAT paperbook ) Different product items would involve different level of assets, risks and markets and accordingly this company cannot be selected 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 . ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accepted that Modicare Ltd is not comparable to the Appellant . However this adjustment is not appropriate as segmental information for Modicare Ltd is not available . 9 . 3 Fluctuating Sales Modicare Ltd . has highly fluctuating sales while the Appellant has a consistent increasing trend . The intensive fluctuation in sales for Modicare Ltd shows that it is assuming significant business and marker risks while the same is not the case for the Appellant . ( Page no . 115 - 116 of ITAT paperbook ) Table 3 : Sales Trend of Oriflame India vis - a - vis Modicare Limited ( INR ) Sales Oriflame India Year on Year Change Modicare Limited Year on Year change FY 2006 - 07 656,303,028 - 344,886,627 - FY 2007 - 08 968,658,047 47 . 59 % 363,303,749 5 . 34 % FY 2008 - 09 1,355,759,156 39 . 96 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 incurring heavy operating expenses, which substantiates heavy, functions at the operating level that are not comparable to Oriflame India . This gives support to the argument that Modicare Ltd, is not just a direct marketer and reseller . Oriflame India on the other hand does not undertake value addition functions . ( Page no . 117 of ITAT paperbook ) 9 . 8 Significant Advertising Marketing and Promotion ( AMP ) spend ( Please refer to Page 86 of the Annual Report for FY 2010 - 1 1 ) Modicare Ltd . has significant AMP / sales of 10 . 41 % as compared to Oriflame India which is only 0 . 85 %. This clearly shows that this company has significantly different functions as compared to the Appellant and is b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied 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 the Company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 00,35,592 5. Cost reimbursements paid 1,57,57,891 6. Cost reimbursements received 1,24,744 5.1. It is a matter of record that the taxpayer in the year under consideration selected Resale Price Method (hereinafter referred to as RPM ) as the most appropriate method selecting Gross Profit / sales as the Profit Level Indicator (hereinafter referred to as PLI ). Considering the adjusted average 3 years margin of Avon Beauty Products India Private Limited; Bodyline International Private Limited; JK Helene Curtis Ltd; Paramount cosmetics (India) Private Limited and Surya Vinayak Industries 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where data may not be very robust. However, since in the facts of the present case the tax payer has consistently proposed RPM as the most appropriate method and this method has been accepted by the TPO, the occasion to comment upon and proceed to decide the method in the absence of a dispute even on an oral request of the ld. AR has to be rejected. We also note that RPM is one of the traditional methods and is ideally the best suited method to a case like the present case where admittedly no value added services are performed by the taxpayer. The function performed is that of a routine low-risk distributor. The product is directly purchased from the foreign AE and resold at a specific price as per the 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 wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of sub-section (2) of section 92C, the arm's length price in relation to an international transaction 55a [ or a specified domestic transaction ] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- ( a) comparable uncontrolled price method, by which,- ( i) xxxxxxxxxxxxxxxxxx ( ii) xxxxxxxxxxxxxxxxxx ( iii) xxxxxxxxxxxxxxxxxxx ( b) resale price method, by which,- ( i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; ( ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the 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 pric ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the degree of comparability is insisted upon to the extent that it is likely to a materially effect the price or cost charged or paid in or the profit arising from such transactions or reasonable accurate adjustments can be made to eliminate the material facts of such differences. 5.7 For ready references we also reproduce sub-Rule (2) and (3) of Rule 5.14 Though, in the facts of the present 5.8 Thus when considered in the light of the aforesaid statutory Rules, we find that the tax authorities while considering the grievance of the tax payer admittedly have taken a position contrary to what has been envisaged under the Rules. 5.9. Having so addressed, we find that over the years primarily the taxpayer has raised the issue that Modi Care Ltd. as a stand-alone comparable was ideally not an appropriate 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable transactions appropriate adjustments are required to be made. In view of the fact that there are difficulties in identifying identical or near identical FAR profiles where Indian companies are not required to disclose gross margins earned in the financials, identification of gross margins based on limited disclosures in financials at times may make the method unsuitable in certain conditions. The insistence on accounting consistency cannot also be over emphasised as gross profit margins will not be comparable if accounting principles and/or practices differ between the controlled transaction and the uncontrolled transaction. As has been argued by the taxpayer, the comparable company differs from the assessee company in reporting certain costs. Thus where a comparable company reports certain costs, for example discounts, 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 escap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the tax payer be examined and required to satisfactorily demonstrate its claim. 5.12. Accordingly, in view of the above, we are of the considered view that ideally the tax authorities should not have selected Modi Care Pvt. Ltd. as a standalone comparable. The tax authorities should have carried out a search or directed the assessee to carry out a fresh search ensuring that the comparables selected were primarily engaged in direct sales with no meaningful value addition activities. To the extent possible product similarities should have been aspired for and if it was found in a particular year that it was not available then carrying out the necessary adjustments on the comparables selected attempted to approach near comparable FAR. Thus complying with the requirements of sub-Rule (2) and (3) of Rule 10B and sub-clause (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 inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acceptable basis either for retaining or rejecting a comparable. The selection and retention of a comparable should be justified on the basis of facts ex facie on record and not on the basis of omissions or mistakes of the parties. It would not be out of place to quote from the well celebrated judgment of the Hon ble Apex Court the oft repeated dictum that there is no heroism in perpetuating an error . Thus, shelter behind the rule of consistently for retaining the comparables selected by the assessee on this ground has to be rejected out rightly as it reeks of lazy repetition as considered and referred to by their Lordships and extracted in 29 31 Chryscspital Investment Advisors (India) Pvt. Ltd. Vs DCIT 2015-TII-13-HC-DEL-TP dated 27/4/2015 wherein their Lordships quote Justice Felix Frankfurter s following extract from Tiller 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises; ( c) the availability, coverage and reliability of data necessary for application of the method; ( d) the degree of comparability existing between the international transactions [or the specified domestic transaction] and the uncontrolled transaction and between the enterprises entering into such transactions; ( e) the extent of which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transaction or between the enterprises entering into such transactions; ( f) the nature, extent and reliability of assumptions required to be made in application of a method. 5.16. Thus though the issue may be of academic interest in the present proceedings we deem it appropriate to clearly and ambiguously set out that on the selection of the most appropriate method there is no finding given as the issue is not under challenge in the present proceed ..... X X X X Extracts X X X X X X X X Extracts X X X X
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