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TMI Blog2018 (11) TMI 43X X X X Extracts X X X X X X X X Extracts X X X X ..... is held, RPM to be the most appropriate method, comes the turn of AO/TPO/DRP to satisfy himself that not only correct method has been applied by assessee but also that proper data for determination of a repeat under such method has been made available. Admittedly, comparables proposed by assessee and used by Ld.TPO/AO/DRP for purposes of analysis, do have significant intensity functions, as compared to that of assessee. AO/TPO/DRP overlooked these huge differences between low risk function performed by assessee vis-a-vis high intensity functions performed by comparables which is not acceptable when RPM is used as MAM. We are thus of opinion that Ld.AO/TPO erred in not conducting fresh search of comparables which would have strict functional similarity while using RPM as MAM. TPO erred in not conducting fresh search of comparables for purposes of determining the comparability of the arm’s length price by using RPM as MAM. Further before DRP even after assessee having submitted additional evidence in relation to fresh comparables for determining ALP by using RPM as most appropriate method was rejected. Adjustment on account of difference in the ALP of the international tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the purpose of benchmarking the international transaction of import of finished goods. 2.3 That the DRP/TPO erred in not appreciating the functional profile of the assessee and applying the RPM for the purpose of benchmarking the international transaction of import of finished goods undertaken by the appellant, a limited risk distributor. 2.4 That the DRP/TPO erred on facts and in law in not appreciating that having regard to the fact and circumstances of the case and due to lack of data of the comparable companies for computation of gross profit margin, RPM could not be applied as the most appropriate method for the purpose of benchmarking the international transaction of import of finished goods. 2.5 That the DRP/TPO erred on facts and in law in ignoring the fact that reliable gross profit margin cannot be computed in case of the comparable companies due to differences in classification of expenses as direct and indirect expenses in the audited accounts. 2.6 That the DRP/TPO erred on facts and in law in rejecting two comparable companies, namely, Sri Aruna Auto..Service Ltd. and PAE Ltd. considered by the appellant in the Transfer Pricing Documentation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons applying TNMM as the most appropriate method in the assembly segment, wherein, no adverse inference has been drawn by the TPO. 3.3. That the DRP/TPO erred on facts and in law in allegedly holding payment of localization support charges as duplication of expenditure incurred by the appellant and ignoring the fact that royalty payment, technical fee and localization charges are paid entirely for different purposes and are clearly distinguishable. 3.4 That the DRP/TPO erred on facts and in law in not appreciating that the expenditure incurred on account of receipt of localization support was wholly and exclusively for the purpose of business of the appellant. 3.5 That the DRP/TPO erred on facts and in law in computing adjustment on account of difference in the arms length price of international transaction of receipt of localization of support without reasonably applying any of the prescribed methods, thereby, violating the requirements of the Transfer Pricing regulations. 4. That the DRP/assessing officer erred on facts and in law in treating expenditure incurred on account of payment of royalty of ₹ 2,57,43,018 as capital expenditure. 4.1. Tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n its TP study: 4. For the purpose of application of TNMM, the assessee considered the following six comparable companies with an average operating profit margin of 4.91%: Sl. No. Company Name Weighted Average 1. George Oakes Ltd 4.04 2. India Motor Parts Accessories Ltd 7.95 3. Jullundur Motor Agency [Delhi] Ltd 4.56 4. Speed-A-Way Pvt Ltd 5.90 5. Sri Aruna Auto Service Ltd 1.83 6. PAE Ltd 5.16 Arithmetic Mean 4.91 5. Since operating profit margin earned by assessee from trading segment was 3.71%, therefore, it was submitted to be within arm s length range +/-5% of mean operating profit margin of the comparable companies which was at 4.91%. Assessee thus treated international transaction in trading segme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uring transfer pricing assessment proceedings, Ld.TPO noticed that assessee debited localisation expenses of ₹ 52,22,479/-. Such expenses were claimed as reimbursement by assessee on cost to cost basis to its AE. Ld.TPO was of the opinion that assessee has already entered into royalty agreement with AE and was paying royalty, therefore, there was no need to pay such localisation expenses. Ld.TPO was of opinion that no independent party in similar situation would have paid and, therefore, such payments tantamount to duplication of expenditure in independent circumstances of uncontrolled nature and, therefore, this kind of transaction will have no value and CUP for this transaction will be NIL . Accordingly, assessee was asked to show cause as to why ALP of the localisation support services be not determined at NIL . 11. Vide reply dated 13.12.2013, the assessee strongly contended that these are different activities and are not relatable to royalty. It was submitted that assessee is responsible for localisation of imported components/products having regard to the Indian customers requirements. It was further submitted that assessee had to adhere to the strict quality me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... whereas that of assessee is 16.89%. It was further submitted that unlike normal risk taking distributor who is compensated on gross margin basis, assessee is not engaged in performing significant selling and distribution function, addition/identification of new customers, inventory management etc. Therefore, assessee is not entitled to profits arising from favourable prices movement, new customer additions or better inventory management etc. 20 . Ld.Counsel stated that recharacterisation is inconsistent with the functional profile of assessee because, being a limited risk distributor, assessee is compensated on gross margin basis. It may incur losses at net level due to factors such as market conditions, efficiency/inefficiency of operations and inventory management etc. Therefore, such a compensation model would not be consistent with its functional characterisation of a limited risk distributor. 21 . Ld.Counsel further pointed out that Ld.TPO has ignored the fact that significant functional and risk differences between assessee and full-fledged distribution companies considered for purpose of comparability and such differences cannot be eliminated by RPM. Therefore, TNMM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ks assumed in performing the activity of purchase and Import of product from A.E. to resell, there is no dispute that assessee is incurring no inventory risk and very little market risk. Assessee places orders on its AE for purchase of goods against confirmed orders received from unrelated domestic customers and assessee does not perform any critical function such as advertisement, marketing, management of inventory etc. There is also no quarrel that customers of assessee could have purchased directly from the AE, Japan. However, Indian customers wanted to procure these goods locally from assessee rather than buying the same from their group companies. Since information relating to prices of such products is already available with Indian customer, it is difficult for assessee to charge significantly different prices. 31. In our considered opinion, a normal risk taking distributor undertakes necessary decisions and performs functions related to market strategy, pricing operation and inventory management and at the same time, bears risk only relating to fluctuations in market. A normal risk taking distributor may earn high profits and incur losses whereas, limited risk distribut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 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; Sub-clause (i) of clause (b) of Rule 10B(1) deals with identifying price at which goods are purchased from AE is resold; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1.36 A tax administration's examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III. In other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured. 1.37 However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties' characterization of the transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ttained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm's length. 36 . At this juncture, we note mandate of Rule 10C which defines the 'Most appropriate method'. Sub-rule (1) of Rule 10C states that: For the purposes of sub-section (1) of section 92C, most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides most reliable measure of an arm's length in relation to the international transaction. 37 . Now once again at the cost of repetition, we advert to functions performed by assessee. It is admitted fact that assessee simply purchase products from its AE's and is resold without any further value addition. Assessee has cataragorised itself to be low risk bearing entity. There is no dispute regarding very minimal risk/no risk withstood by assessee on the basis of low intensity function performed by it. The product imported from AEs representing international transaction, is neither processed further, nor used as raw material for manufacturing any other product. Thus on the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from arguing for application of TNMM as most appropriate method, assessee vide Ground 2.9 has taken alternate plea to consider the fresh search of comparables submitted by assessee as additional evidence for applying RPM. While doing so, Ld.Counsel referred to page 139 of appeal sets wherein gross profit margin of new comparables selected by assessee for applying RPM as most appropriate method has been listed. It was submitted by assessee before DRP that these comparables have similar functional intensity as that of assessee and are operating in Automation industry. It has also been submitted that the margin ranges between 2.72% to 6.26% with an arithmetic mean of 4.71% vis-a-vis the gross profit margin of assessee at 5.69%. It has been submitted therein that the functions of these comparables are similar to that of assessee and does not assume any risks subject to any kind of adjustments that may be required. None of the above has been verified by DRP. 45. We therefore set aside this issue to Ld.TPO/AO with following directions: (1) To adopt RPM as most appropriate method for determining ALP of transaction relating to Import of products from A.E. (2) To admit additional ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ial or business expediency of incurring any expenditure is to be seen from the assessee s point of view. Ld.Counsel concluded by stating that it is not correct to hold that payment of localisation support charges is duplication of expenditure. 51. On the contrary, Ld.CIT DR strongly supported the findings of the TPO and read the relevant observations of the TPO. 52. We have perused the submissions advanced by both the sides in the light of the records placed before us. 53. It is observed that the Ld. TPO while making adjustment on this issue, held that no separate compensation is required as these services are included in technology transfer and patent licence agreement and, therefore it is duplication of expenditure. The assessee has not been able to prove that the services were actually received and has grossly failed to satisfy need, benefit and evidence of the services. In our view it is a settled law that a businessman has prerogative to organise his affairs in the manner best suited to its functioning, commercial or business expediency. Revenue authorities cannot step into their shoes. Thus assessee cannot be directed by the revenue authorities, of how to condu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rused the material placed before us. We find that the Revenue has accepted the royalty as revenue expenditure in the preceding as well as subsequent years. Thus, there would be no justification for treating the same to be capital expenditure in some of the intervening years. Hon'ble Apex Court in the case of Radhasoami Satsang Vs. CIT - [1992] 193 ITR 321 held as under:- Held, reversing the decision of the High Court, on the facts, (i) that property given to the Satguru was intended for the common purpose of furthering the purpose of the institution. The central council had authority to manage the properties of the institution and, on revocation of the trust, the property was not to go back to the Satguru, and, at the most, in the place of the trust, the central council would exercise authority. The Tribunal was justified in holding that the properties were subject to a legal liability of being used for the religious or charitable purposes of the Satsang. ( ii) That, in the absence of any material change justifying the Department to take a different view from that taken in earlier proceedings, the question of the exemption of the assessee assessee should not hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urther rights in favour of third parties. What is accorded is purely access to technical knowledge which is for the tenure of the agreement. DRP has also noted a recent decision of the Advanta India Ltd. (TS 590-HC-2015 (TEL AP) wherein the Hon'ble High Court has distinguished Alembic Chemical Works and held in favor of capitalization 6 ITA-1267 5884/D/2014 of of payment for know how only as capital in nature, on facts where the taxpayer acquired a living organism germplasm used to produce revenue generating products. But, even here the royalty paid was confirmed as a revenue expense. Having examined the Agreement governing Royalty, and the terms of its payment in light of the principles laid down by the Supreme Court and High Court and in due deference to decisions in the case of Alembic Chemical Works Co Ltd v CIT, 177 ITR 377 (SC) supra and Delhi High Court in the case of CIT v JK Synthetics Ltd 309 ITR 371, Shri Refrigeration Industries Ltd v CIT 127 ITR 746, Triveni Engr Works Ltd v CIT 136 ITR 340 Ciba of India 69 ITR 692 Hon'ble Supreme Court and other DRP concludes that royalty paid is revenue in nature. AO is directed to allow it accordingly. 9. The ..... X X X X Extracts X X X X X X X X Extracts X X X X
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