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TMI Blog2015 (12) TMI 1758X X X X Extracts X X X X X X X X Extracts X X X X ..... erely on the basis that the value of international transactions exceeded Rs. 5 Crores was unlawful and not in accordance with section 92CA(1) of the Act. 3. That the Commissioner of Income- Tax (Appeals) erred on facts and in law in not appreciating that reference made by the assessing officer to the TPO under section 92CA(1) of the Act without recording satisfaction that it was necessary or expedient so to do was unlawful and adjustment made by the TPO/ assessing officer on the basis of such reference was invalid. 4. That the Commissioner of Income-tax (Appeals) erred on facts and in law in not holding that the international transactions entered into with the associated enterprise were at arm's length and no adjustment to the price thereof was called for being made. 5. That the Commissioner of Income-tax (Appeals) erred on facts and in law in disregarding the adjustment made to the prices of international transaction of export to Glyphics Media inc. (GMI) on account of geographical difference, for determining the arm's length applying Comparable Uncontrolled Price (CUP) method holding that such adjustment were not correctly made. 6. That the Commissioner of Income-tax (App ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment on account of geographical difference was made on the basis of instance of purchase of similar product by an unrelated party in Europe and USA during the relevant previous year. 14. That the Commissioner of Income-tax (Appeals) erred on facts and in law in upholding the adjustment on account of selling and distribution expenses incurred by the appellant at Rs. 0.27 per CD allegedly being selling and distribution expenses incurred in distributing the products in non US locations. 15. That the Commissioner of Income-tax (Appeals) erred on facts and in law in holding that the appellant failed to come up with documentation to show that it treats that US and European market differently. 16. That the Commissioner of Income-tax (Appeals) erred on facts and in law in holding that appellant did not produce adequate documentation for claiming adjustment on account of purchasing power priority considering the various variables, such as, interest rate, exchange rate, price level, etc. 17. That the Commissioner of Income-tax (Appeals) erred on facts and in law in disregarding prices paid for purchase of CDs in European and US by imation allegedly on the ground that the same p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant craves leave to add, after, amend or vary from the above grounds of appeals before or at the time of hearing." 3. All the grounds relate to adjustment of Rs. 54,62,582/- to the international transaction of the assessee with its AE Glyphics Media Inc. USA (hereinafter referred to as "GMI") 4. The facts emanating from the orders of authorities below are that for the instant in an order was passed by the Dy. CIT, Circle 5(1), New Delhi on 28.7.2004 u/s 143(3) of the Act, whereby he determined the assessed loss at Rs. 3,21,14,948/- after making an addition of Rs. 54,62,582/- on account of the difference between the arm's length price of international transaction and the book value of the transaction, to the returned loss of Rs. 3,75,77,530/-. 5. During the assessment proceedings, the AO noticed that the assessee had sold 4,39,40,400 CDs and 67,23,400 floppies to its AE GMI, a company incorporated in USA for a sum of Rs. 42,12,03,955/-. As per the economic analysis carried out by the assessee, internal comparable uncontrolled price method was found to be the most appropriate method for benchmarking international transaction of exports to GMI as assessee company had entered into s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... USA prices were 10-20% lower than the European prices. Accordingly, on a conservative basis, 10% of export price has been loaded on the wholesale price charged by MBI from GMI. iv) The adjusted price of sale to GMI was compared with the average sale price of comparable uncontrolled enterprises. v) The result of such comparison is charted (Table-2) as follows; Table2 Sr. No. Name of Packing Average wholesale price to AE (in US $) Add Specific cost factor (in US $) Add 10% mark up due to difference in US and Europe markets (in US$) Adjusted average wholesale price to GMI (in US$) Average retail price [Arm's Length price] (in US$) Difference in average price [Col. 7- Col. 6] (in US$) 1 2 3 4 5 6 7 8 1 CDR Cake Box - Rotterdam 0.18 0.02 0.02 0.22 0.18 -0.04 2 CDR Cake Box-Direct 0.18 0.02 0.02 0.22 0.19 -0.03 3 CDR Cake Box- Total 0.18 0.02 0.02 0.22 0.18 -0.04 4 Jewel case- Rotterdam 0.26 0.02 0.03 0.31 0.30 -0.01 5 Jewel case- Direct 0.33 0.02 0.04 0.39 0.32 -0.07 6 Slim case- Total 0.27 0.02 0.03 0.32 0.31 -0.02 7 Slim case- Rotterdam 0.28 0.02 0.03 0.33 0.29 -0.04 8 Slim case- Direct 0.27 0.02 0.0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transfer pricing adjustments. ii) The TPO had no objection to the adjustment made on account of freight differential, though he had reservations about the other two adjustments. iii) The adjustment for selling & distribution was made by adding a figures of Rs. 1.11/- per CD, to the average wholesale price charged from the GMI, to all the three categories of packaging. The value of Rs. 1.11/- was arrived at by dividing the total expenses of GMI for the period 01.04.2001 to 31.03.2002 of US$ 11,84,410, by the total number of CDs sold to GMI and then by multiplying the same with the appropriate foreign exchange rate to arrive at average selling & distribution (S&D) expenses per CD. iv) According to the TPO, the correct way of doing this adjustment would be to reduce average selling & distribution expenses incurred by MBIL from the prices charged by it from unrelated parties. This was accepted, by the A.R.s during the hearing on 15.3.2004. However, the TPO was of the view that certain adjustments are to be done before coming up with the correct arm's length price. v) The appellant had furnished details of selling & distribution expenses incurred by MBIL amounting to Rs. 76,22, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 75 crores Domestic turnover @ 5% to 7% of the total turnover : Rs. 50 crores. Export turnover to Non- US Destination : Rs. 625 crores. Ratio between Export turnover to Non- Us destination and total turnover : 625/675=93% Apportionment of selling & distribution expenses to Non- US destinations: Rs. 8,45,62,531/- x 0.93= Rs. 7,86,43,165/-. Total Number of CDs and Floppies exported to UREs in Non- US destinations = 29,00,26,730 (while working out the corresponding adjustment in GMI's wholesale price, the appellant had used this number) Selling & distribution expenses per CD for export sales to Non- US destination = Rs. 0.27/-. The value of Rs. 0.27/- was accordingly used by the TPO as selling & distribution expenses per CD for export sales to Non- US destination that needs to be subtracted from the export prices charged to UREs in accordance with Rule 10B(3) of the IT Rules. vii) The appellant had claimed that European customers were willing to pay more than US customers (para 5.10 of the T.P. Report). To substantiate this, an example was given of the prices an independent party (Emtec) was prepared to pay to GMI in USA and to MBIL in Europe for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for geographical market differences. Hence, adjustment on account of geographical differential was not accepted by the TPO while computing Arm's length price." 9. On the basis of the aforesaid TPO computed the ALP as the average of various transactions prices for each of three categories of CD packing viz. Jewel Box Slim case and Cake box and adjustments were made to these average prices for freight differential and selling and distribution expenses in the manner stated hereunder :- Jewel Case Packing Average price charged from UREs for export Rs. 14.4 Adjustment as per Rule 10B for freight differential Add: Freight Differential Rs. 0.28 Rs. 14.68 Less: Selling and Distribution expenses as worked out above Rs. 0.27 Arm's Length Price Rs. 14.41 95% thereon Rs. 13.69 Slim case packing Average price charged from UREs for export Rs. 13.21 Adjustment as per Rule 10B for freight differential Add: Freight Differential Rs. 0.17 Rs. 13.38 Less: Selling and Distribution expenses as worked out above Rs. 0.27 Arm's Length price Rs. 13.11 95% thereof Rs. 12.45 Cake Box Packing Average price cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 02 Rs. 13.02 Rs.13.11 Rs. 12.45 35800 @ Rs. 13.11 = Rs. 4,69,338/- The book price in the invoice is less than 95% of the ALP. Hence TP adjustment is called for as per proviso to section 92C(2) of the Act. 7 S.2-13-S.1 Slim Box invoice from Rotterdam 186400 CDRs for Rs. 2410224 @ Rs. 13.02 Rs.13.02 Rs.13.11 12.45 186400 @ Rs. 13.11 = Rs. 2443704/- The book price in the invoice is less than 95% of the ALP. Hence TP adjustment is called for as per proviso to section 92C(2) of the Act. 8 S.2-13-S.1 Slim case invoice from Rotterdam Rs. 12.16 Rs.13.11 Rs. 12.45 10800 @ 13.11= Rs. 14115880 The book price in the invoice is less than 95% of the 1080000 CDRs for Rs. 1313746.112 @ Rs. 12.16 ALP. Hence TP adjustment is called for an amount of Rs. 1,02,134/- on account of difference between the ALP Value of the transaction and the invoice value. 11. The TPO on the basis of his comparison of book price in various invoices with the ALP for each of the three categories as per the tabulation given above, proposed a total addition of Rs. 54,62,582/- as per the details given below: S. No. of above Table No. 4 Transaction value (Rs.) Arm's Length Price (Rs.) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elated parties in Europe. The adjustment so made by the assessing officer does not recognize the business realities that much higher expenses/cost is required to be incurred for selling the products in USA, where the appellant does not have a substantial market presence as compared to the expenditure required to be incurred by appellant in Europe. The TPO while making the adjustment has not taken into account the most significant factor influencing the prices of export to GMI. Hence the TPO has erroneously computed the selling and distribution expenses @ Rs. 0.27 per CD instead of Rs. 1.11 per CD as computed by the appellant. It is respectfully submitted, that for the purpose of determining the arm's length price applying the CUP method, comparison of international transactions with GMI have to be made with that of unrelated parties in a similar situation, i.e., the two parties are to be placed in similar situation to make comparison of like with like possible. Reliance n this regard is placed on the following case laws: Egain Communication (P) Ltd. vs DCIT 118 ITD 243 (Kol) Schefenacker Motherson Ltd. vs. ITO 123 TTJ 509 (Del) Honeywell Automation Pvt. Ltd. vs. DCIT 108 TTJ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s that (i) the prices being offered by the competitors in the market; (ii) the duties and taxes on imports into the country and the resultant delivered cost to the customer; (iii) domestic capacity and domestic prices of local manufacturers; (iv) the standard of living and paying capacity prevailing in different countries; and (v) the prices for each country is determined considering the landed price in the hands of the customer. The net FOB price would always vary from country to country and in many cases within the same country on account of the difference in freight because of the distance, whether it is seaport of land locked country/city, to and fro container traffic and other factors. It is never possible that FOB value of sales make to two different destination would be same. It is further submitted that there are several factors influencing the pricing of any currency e.g. capital/current account inflows, trade deficit/surplus, monetary policy etc. For that reason, pricing of the product or commodity would vary from country to country based on the money supply situation and purchasing power parity, etc. Reference is also invited to the Big Mac Index usually referred to by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s used and risks assumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties. Sub-rule (2) of Rule 10B of the Rules refers to comparability of transactions. Following the lead of OECD guidelines, the following factors are prescribed in this regard: * Characteristics of the property or services; * Functions performed, assets employed and risks assumed; * Contractual terms of the transactions; * Market conditions - geographic allocation and size of the markets; * Cost of labor and capital; * Economic development; and * Level of competition. Further, for the purpose of applying CUP method, minor differences in contractual terms or economic conditions can materially affect the amount charged in an uncontrolled transaction. CUP method becomes less reliable substitute for arm's length dealings if not all significant characteristics of the uncontrolled transactions are comparable. Therefore, it would be appreciated that, if appropriate adjustment is not made for the significant differences between the controlled transaction and uncontrolled transaction, CUP method will not produce a reliable measure of an a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , therefore, for the distributor in USA is much higher. Further, the distributor in USA is dealing only in CDs exported by the appellant from India and is, therefore, incurring significantly higher selling expenses on distribution/resale of products in that country. The distributors in European countries, it would be appreciated, are generally dealing in several products/commodities and, therefore, the per unit cost of their operation is much lower than the cost of the distributors in USA. A part of the higher cost of operations in USA for the distributor, which would otherwise have been incurred by the appellant (if there was no distributor) translates in the lower prices for export of CDs to USA. The appellant for the aforesaid reasons, while applying the CUP method to determine the arm's length price, made adjustments, inter alia, on account of difference in price realization for sale of CDs in USA and Europe owing to geographical difference due to factors such as, difference in purchasing power parity, pricing, customers in USA being more price conscious, higher cost of distribution etc. The appellant based on instances of prices paid by an unrelated customer for similar pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions of export to the associated enterprises and the average prices of export to unrelated parties The Indian transfer pricing regulations provide for the evaluation of combined transactions. The Indian transfer pricing regulations provide for the evaluation of combined transactions. The term transaction has been defined in clause (v) of section 92F of the Act to include the arrangement, understanding or action in concert whether or not such arrangement, understanding or action is format or in writing. Further, Rule 10A(d) defines transactions to include a number of closely linked transactions. The OECD guidelines also provides that there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include pricing of a range of closely linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. It would be appreciated that prices of export of CDs to the associate enterprises as well as to unrelated parties would vary significantly during the year on account of the various factors, viz. timing of export, size of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arm's length price i.e. the amount received by the associated enterprise from the customer and the actual value of international transactions. The Ho'ble Jurisdictional High Court vide order dated 14.3.2013 (in ITA nos 1828/2010, 1829/2010 & 1254/2011) had dismissed the revenue's appeal against the said order of the Tribunal. The Special Leave Petition (SLP) of the revenue against the said order has also been dismissed by the Supreme Court vide order dated 2.1.2014 (CC No. 22166 of 2013)" e) Without prejudice, benefit of +(-)5% as per the proviso to section 92C(2) of the Income Tax Act, 1961 to be provided while computing the arm's length price: "It is respectfully submitted that, the TPO while computing the adjustment to the arm's length price applied CUP method by taking the difference between average of prices of export to unrelated parties and uncontrolled prices for each export to GMI." 15. The learned DR supported the adjustments made in the orders of authorities below. 16. We have considered the rival submissions and perused the material placed on record. Taking up the first objection viz-avis selling and distribution expenses, the learned AR has contended that TPO/CIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd distribution expenses incurred by GMI, adjustments should have been made to the wholesale price charged by the appellant from GMI by a sum of Rs. 1.11 per CD. 9.4.6 It has already been held at Para 9.1 of this order that the correct way of making adjustment is to start from the export prices charged by the appellant from the unrelated parties in non- US destination s. therefore., the expenses incurred by GMI to develop a market for the appellant's product do not have any relevance for the purpose of making adjustment on account of selling and distribution expense. What is relevant for the purpose of this adjustment is the selling and distribution expenses incurred by the appellant for distributing its product in non- US locations. The TPO in his order has computed Rs. 0.27 per CD as the amount of adjustment that is required to be made on account of selling and distribution expenses. The appellant has not pointed out any defect in the analysis done by the TPO. Even if it is accepted, as alleged by the appellant that it did no t concur with the methodology adopted by the TPO for this adjustment, the fact remains that the TPO had computed this adjustment factor objectively. Under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d risks. In view of the above the contention raised by the counsel is held to be not maintainable and therefore rejected. 18. Now taking up the second contention of the learned counsel viz-a-viz adjustment on account of geographical differences, it is noted that CIT(A) had considered the above objection and held as under: "9.5.2 I have carefully considered the submissions made by the appellant and appraised the evidence on record. There is no doubt that geographical market is one of the major economic circumstances that must be examined before coming to a conclusion regarding comparability between two sets of transactions. In fact economic circumstances include the following other factors apart from the geographical location that need to be considered for comparing two sets of transactions.: * Geographic location * Size of the market * Competition and size and importance of competitors * Availability of substitute goods and services. * Levels of supply and demand * Consumer purchasing power * Government regulations * Costs of production (costs of local labor and raw materials) It two countries represent two different markets, adjustments have to be made by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or prices in two different countries. In any case, there is no product similarity between a burger and a CD for meaning comparison. The reliance on prices paid by Imation is also misplaced as it pertains to the subsequent year and do not reflect contemporaneous market situations. v) Adjustment relating to higher cost of performing distribution function in US compared to Europe has already been taken care of through selling and distribution expenses incurred by the appellant. Similarly, reference to higher labour cost is US is also misplaced as it refer to selling & distribution cost only. vi) One reason for claiming this adjustment for geographical difference is also on account of higher cost on printing & packaging for selling in Europe. Since the TPO has already allowed for adjustment on account of freight differential which include packing, freight and forwarding, there is no need to make adjustment for this factor under this head again. vii) There reference to lower prices of home electronics and household appliances in US is also misplaced as these belong to different product categories. viii) The issue relating to price difference on account of memory size is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g regard to the above we accept the claim of the assessee for adjustment. The CIT(A) or the TPO have not denied or disputed any of the above factual submission to the assessee. A rejection of a claim for general consideration for granting an economic adjustment which on the face of fit is tenable is not a correct way to disregard the facts brought on record. The revenue ought to have appreciated the business and the nature of the market. The observation of the TPO that the export price of 10.4-I-I-0 (Jewel-case CD box) to LG Electronics Inc. in USA was Rs. 13.59 per CD while sale prices of the same product in Poland and German, was Rs. 12.4 per CD is also found to be misconceived and therefore for the reasons stated above we allow the adjustment as claimed by the assessee. 21. Accordingly if the aforesaid adjustment is applied it is seen that the transaction of the assessee with the AE is at the higher than the arm's length price and therefore the adjustment so made and sustained is deleted. Consequently we are not inclined to take up remaining objection raised by the learned counsel other than to hold that we find merit the submission that since the AE (GMI) had incurred loss the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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