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TMI Blog2016 (8) TMI 1433X X X X Extracts X X X X X X X X Extracts X X X X ..... disallowed by the Learned AO by invoking the provisions of section 43B(f) of the Act. The same was also upheld by the Learned Dispute Resolution Panel (DRP in short). Aggrieved, the assessee is in appeal before us. 2.1. We have heard the rival submissions. At the outset, we find that the CIT(A) confirmed the disallowance as made by the Ld. AO on account of claim for provision for leave encashment. Ld. counsel for the assessee stated that the deduction on account of provision for leave encashment was made on the basis of the judgment of Hon'ble jurisdictional High Court in the case of Exide Industries Ltd. Vs. Union of India (2007) 292 ITR 470 (Cal) but he fairly conceded that subsequently Hon'ble Supreme Court has stayed this judgment of Hon'ble jurisdictional High Court vide order 08-05-2009 by following observations:- "Pending hearing and final disposal of the Civil Appeals, Department is restrained from recovering penalty and interest which has accrued till date. It is made clear that as far as the outstanding interest demand as of date is concerned, it would be open to the Department to recover that amount in case Civil Appeal of the Department is allowed. We ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of sale (both domestic and export) of such software along with related services. Research and development expenses were incurred in the said business. Mr Gandhi and his personnel through their technical intelligence and expertise developed know-how for producing metering related softwares. Since TECRES possessed the requisite know-how, a key to survival in the market for static meters, the assessee entered into Business Transfer Agreement for acquisition of business of TECRES. Theo entire team of the said TECRES along with their developed codes and domain repository had joined the assessee pursuant to the Business Transfer Agreement. The intellectual property rights acquired by the assessee consisted of designs, software, data base, research and development material and facility, technical know-how, process know-how, confidential information, basic and detailed drawings, operation and maintenance manuals relating to the business carried out by TECRES. The ld AO observed that the Income Tax Rules recognizes intangible assets such as knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature and these assets m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... share of the consideration was attributed towards the intellectual property the said business possessed. The entire team together with the domain knowledge had been transferred to the assessee pursuant to the agreement. The same had been used by the assessee for its very survival in the business of static meters to be in line with the regulations of the Central Electricity Authority and hence the use of intellectual property for the purpose of business had been duly demonstrated by the assessee and it is not a colourable device as alleged by the Learned DRP. He argued that the allegation of the Learned DRP is without any basis by ignoring the fact that the knowhow in the instant case has been actually acquired by paying a consideration of Rs. 4.92 crores (pursuant to independent valuation by an expert) to Mr Gandhi pursuant to business transfer agreement. He argued that the provisions of the Act in more than one section had, in its wisdom, had defined intangible assets as knowhow, patents, copyrights, trade marks, licences , franchises or any other business or commercial rights of similar nature. Hence knowhow is an independent item of intangible asset. Similarly patent is an indep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Installation and operation of meters) Regulations, 2006 (pages 47 to 66 of paper book) with regard to this issue. We find that the assessee had capitalized the following assets under intellectual properties:- a. Low cost single phase static meter IP for domestic segment. b. Low cost single phase static meter IP for South Asian market like Vietnam, etc. c. RF AMR Radio frequency accelerated meter reading IP d. Salem 3T Metering Module IP e. Salem 1G HVDS IP f. PL Comm Evaluation Modem IP 3.3.1. It was argued that the intellectual property rights acquired by the assessee consisted of designs, software, data base, research and development material and facility , technical know how, process know how , confidential information, basic and detailed drawings, operation and maintenance manuals relating to the business carried out by TECRES. The valuation of the same was carried out by an independent expert and valuation report is enclosed in pages 25 to 82 of paper book. We find that the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued in July 2010 (enclosed in pages 67 to 73 of Part A of Paper Book) provides that the term 'intangi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the form of knowhow is not required to be registered. 3.3.2. We find that the assessee had filed a copy of the Business Transfer Agreement (BTA) entered into with Mr. Gandhi as an additional evidence. It was submitted by the ld AR that the said agreement was never called for by the lower authorities and hence there was no occasion for the assessee to file the same and it was also submitted that the acquisition of business from Mr Gandhi by the assessee was never a subject matter of debate. In these circumstances, we deem it fit and appropriate to admit the said additional evidence for better appreciation of the facts to resolve the issue under dispute before us. 3.3.3. We find force in the argument advanced by the ld AR that the transfer of employees would also result in transfer of knowhow also. We find that the Explanation 4 to section 32(1) of the Act defines 'knowhow' as any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil-well or other sources of mineral deposits (including searching for discovery or testing of deposits for the winning of access thereto). Section 32(1)(ii) of the act provides fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith anti-tampering and other communication facilities. We find that the reliance placed by the ld AR on the Co-ordinate bench decision of Pune Tribunal in the case of Modular Infotech P Ltd vs DCIT reported in 131 TTJ 243 (Pune) is well founded. In the said case, the assessee company was engaged in the business of software development and also licensing of software. It had taken over the business of a firm namely M/s Modular Systems and claimed depreciation @ 25% on an amount of Rs. 4,27,00,000/- pertaining to the value of IPR paid to the firm. The AO disallowed the claim of depreciation on IPR against which assessee filed appeal before the ld CITA. During the appellate proceedings with the CITA, the assessee pointed out that the amount of Rs. 4.27 crores included composite consideration in respect of all the intangible assets of the firm namely IPRs and the goodwill and submitted a fresh valuation of the assets including that of the goodwill at Rs. 79,50,000/-. The CITA disallowed depreciation on goodwill of Rs. 79,50,000/- and allowed assessee's claim of depreciation in respect of balance IPR payment. On appeal filed before the Tribunal, it was held that where assessee company to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r 2008-09. The ld AO is also directed to rework the opening WDV of this asset in the subsequent year and rework the allowability of depreciation on the same pursuant to this order. In view of this decision, we are not inclined to entertain the alternative claim of the assessee vide ground no. 1(a) that the consideration so paid in the sum of Rs. 4,92,00,000/- has to be construed as Goodwill and depreciation has to be granted accordingly. 3.3.6. With regard to the additional ground raised by the assessee vide ground no. 1(b) and 1(c ) on the allowability of depreciation on goodwill amounting to Rs. 93,41,680/- for Asst Year 2007-08 and Rs. 81,73,970/- for Asst Year 2008-09, we find that the Hon'ble Apex Court in the case of CIT vs Smifs Securities ltd reported in 348 ITR 302 (SC) had held that the assessee is entitled for depreciation on goodwill. It is not in dispute that the assessee had paid consideration towards acquisition of Goodwill. This issue is now well settled and not with any dispute. We find lot of force in the argument advanced by the ld AR that the benefit of decision of the apex court supra was not available during the pendency of proceedings before the ld AO and ld ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tic' and 'Trading Segment' by imputing a downward adjustment of Rs. 43,27,604/- and Rs. 51,29,012/- respectively. All other international transactions of the assessee have been determined to be at arm's length. 5.1 Trading Segment The transactions encompassed under the Trading Segment have been summarized below:- a) Purchase of Finished Goods - Rs. 3,93,62,040/- b) Payment of consultancy charges for EMPS - Rs. 9,25,716/- The assessee had justified the Arm's Length nature of its international transactions under the trading segment by considering itself as the tested party, wherein it benchmarked the profitability of its trading segment using Resale Price Method (RPM) against third party companies engaged in comparable activities. Accordingly, GP / Sales was considered to be the appropriate Profit Level Indicator (PLI). Accordingly, 11 comparable companies were identified by the assessee. The arithmetic mean of the PLI for all the 11 comparable companies considering 'mul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tronics Ltd NA 5.1.3. The ld AR argued that, as per paragraphs 2.23 and 2.24 of 'Chapter II : Transfer Pricing Methods' of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations - 2010 , with regard to the extent of product comparability when RPM is considered as MAM, broader differences are more likely to be reflected in differences in functions performed between the parties to the controlled and uncontrolled transactions. Hence, less product comparability is to be compared while using the RPM while more emphasis should be laid on the functional comparability of the comparables. 5.1.4. The ld AR argued that in any case, the margins of the comparable companies selected by the ld TPO should be computed from the audited financials which has more authenticity and if it is considered, then the international transactions of the assessee would be at Arm's Length on account of 5% tolerance limit permitted u/s 92C(2) of the Act. He submitted the following table in support of his contentions:- Name of the Company GP / Sales for FY 2006-07 Gemini Traze Rfid Pvt Ltd 23.47% Media Video Ltd 11.29% Tak Machinery & Leasing Ltd 27.98% Average ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vailable on record including the paper book comprising of relevant extract of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued in July 2010 (pages 67 to 73) ; relevant extract of OECD / G20 Base Erosion and Profit Shifting (BEPS) Report on Actions 8-10 (2015) - Aligning Transfer Pricing Outcomes with Value Creation (pages 74 to 79) among others. The facts stated hereinabove remain undisputed and hence the same are not reiterated for the sake of brevity. There is no dispute with regard to the Most Appropriate Method (in the instant case Resale Price Method) chosen by the assessee for its trading segment. There is no dispute with regard to the identification of Profit Level Indicator. The dispute is only on account of selection of related comparables and adoption of single year margins based on audited financials. In view of the detailed submissions made hereinabove , we deem it fit and appropriate, to set aside this issue to the file of the ld TPO / ld AO to accept the comparable companies who are engaged in the related field as that of assessee and adopt the single year margins based on audited financials of those comparable companies fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd considered net margins [operating profit / sales (OP / Sales) ] of the assessee as well as the comparables instead of the gross margins [Gross Profit / Direct and Indirect Cost of Production (GP / DICOP) ]. As a result, the ld TPO arrived at results which showed that the international transactions undertaken by the assessee under the manufacturing (domestic) segment were not at Arm's Length. Accordingly, the ld TPO made a downward adjustment of Rs. 43,27,604/- to the international transactions. This action of the ld TPO was approved by the ld Dispute Resolution Panel (DRP). Aggrieved, the assessee is in appeal before us. 5.2.1. The ld AR argued that in transfer pricing analysis a transaction by transaction approach should be undertaken for bench marking analysis to determine the arm's length price of the international transactions being entered into. The principle of undertaking transaction by transaction analysis for determination of arm's length price has been embedded under the Indian Transfer Pricing Regulations, OECD Transfer Pricing Guidelines, 2010 updated via Base Erosion and Profit Shifting Action Plan 8-10, 2015 (herein referred to as 'OECD TP Guidel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Where transactions are so closely interrelated or continuous that application of the arm's length principle on a transaction-by-transaction basis would become unreliable or cumbersome, transactions are often aggregated for the purposes of the analysis ... 5.2.5. The ld AR argued that it could be observed from the above readings of International Guidelines that both OECD TP Guidelines and UN TP Manual have given primary preference to undertake a transaction by transaction analysis. It is only under certain exceptional circumstances, where separate transaction level analysis could not be undertaken or separate transactions are so closely inter-linked, that aggregation of transaction approach has been warranted. However, in the instant case, each of the transactions undertaken by the assessee on which TP adjustment has been imputed were distinct, independent and warrant separate analysis to determine the arm's length price. Like for instance, payment for royalty is in relation to technology received from AE to enable to manufacture the product for the purpose of business, whereas, with respect to purchase of components, the assessee needs to ensure that those are appropriat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ass of transaction based on various factors and analysis. In the case of Star India Ltd. (supra), also the TPO treated all the activities of the assessee as one and determined the ALP at entity level without appreciating that one cannot compare the FAR of a principal and agent on same footing. 7.4. In our view, in the assessee's case there are different segmental activities, which are independent of each other. They are required to be analyzed on transaction to transaction basis and not by combining all activities. Consequently, we uphold the assessee's method of ALP. Consideration of transaction by transaction approach for determination of the arm's length price has also been upheld in the following mentioned judicial precedents: * Ankit Diamonds ( 2011) 43 SOT 523( Mumbai Trib.) * Avineon India (P) Ltd, TS-308-ITAT-2013(Hyd)-TP * DCIT -vs- M/s Starlite (133 TTJ 425) (Mumbai Trib.) * Symantec Software Solutions (P) Ltd., (2011) 46 SOT 48 (Mumbai Trib) * Tecnimount ICB (P) Ltd., (2011) 11 taxmann.com 49 (Mumbai Trib.) Accordingly, he argued that the 'transaction by transaction approach' adopted by the assessee should be considered for benchmarking the inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in USA and Greece which are engaged in the sale of parts and components/ semi finished goods similar to that sold by the assessee's AE based in USA and Greece. The ld AR also submitted a brief note on each of the transactions and benchmarking methodology adopted by the assessee to determine the arm's length price. 5.2.8. Purchase of raw materials & components - Manufacturing Domestic segment With respect to the above, an adjustment computed as a percentage of transaction value to the total costs of the Manufacturing Segment was undertaken by the Ld. TPO. We find that the assessee is trying to justify its Arm's length price by following transaction-bytransaction approach, encompassed in its 'Manufacturing - Domestic' segment, selecting itself as the tested party wherein it bench marked the gross profitability of its manufacturing segment using Cost Plus Method (CPM) against third party companies engaged in comparable activities. Accordingly, Gross Profit/Direct & Indirect Cost of Production (GP/DICOP) was considered to be the appropriate Profit Level Indicator (PLI). A search for uncontrolled comparable companies were undertaken and PLI was determined for comparison wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hod (traditional transaction method or transactional net margin method) may be applicable in cases where one of the parties makes all the unique contributions involved in the controlled transaction, while the other party does not make any unique contribution. In such a case, the tested party should be the less complex one. See paragraphs 3.18-3.19 for a discussion of the notion of tested party. 5.2.11. We find that the concept of overseas tested party and foreign comparable companies is well recognized and acknowledged by Indian Revenue as could be seen from India's commentary in United Nations Practical Manual on Transfer Pricing for Developing Countries which were placed on record by the ld AR, wherein, the following has been stated:- 10.4.1. Transfer Pricing Regulations in India 10.4.1.3. The Indian Transfer Pricing administration prefers Indian comparables in most cases and also accepts foreign comparables in cases where the foreign associated enterprise is the less or least complex entity and requisite information is available about the tested party and comparables. In the instant case, all the requisite information was available for undertaking overseas benchmarking stu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntention of the Act or OECD Guidelines. Hence with regard to correct application of CPM or TNMM, the Associated Enterprises of the assessee should be selected as tested party to the transaction, as being the least complex entity. Subsequently, an analysis of gross margin or net margin by applying either CPM or TNMM retained by AEs should be undertaken for benchmarking the transaction price pertaining to purchase of materials and components. In this regard, we find that the assessee had submitted the economic analysis for the consideration of ld DRP and ld TPO in the course of proceedings wherein AEs were selected as tested party for the analysis and profitability retained by them were benchmarked. The assessee provided the ld TPO with the group transfer policy wherein it was stated that the supplier of the components would retain a maximum margin of 5% on costs on supply of materials to members of the group (vide page 215 of the paper book). Accordingly, the comparable companies were identified and arithmetic mean was computed. The prices of such transfer of materials and components were determined to be at Arm's Length. The detailed benchmarking analysis as submitted before the ld ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quent years, the assessee got access to a database named RoyaltyStat which has repository of royalty agreements entered into between the parties around the world. The details about RoyaltyStat database has been provided by the assessee in Page 1 of the Paper Book as Additional Evidence. Consequently, the assessee undertook a separate benchmarking study for payment of royalty, considering Comparable Uncontrolled Price (CUP) method as the Most Appropriate Method. The details of the benchmarking study has been provided as Exhibit A of the paper book relating to additional evidence filed before us. The ld AR provided the summary of benchmarking study as below:- Rate of royalty paid by the assessee to its AE - 4% Arm's Length rate of royalty as determined from benchmarking study - 4.34% 5.2.15. We have gone through the rival submissions and we deem it necessary to admit the additional evidences filed by the assessee together with the relatable paper book for better appreciation o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment to Arm's Length Price - ITA NO. 1623/Kol/2012 - Asst Year 2008-09 The assessee is a closely held company engaged in the business of manufacturing and distribution of electric meters and related components. In the course of its business operations, the assessee has entered into certain international transactions. For the purpose of benchmarking the prices of the international transactions, the assessee in its transfer pricing report, segregated the above transactions into two broad segments- 'Manufacturing' and 'Trading'. The international transactions entered into by the assessee under each of the above depicted segments, have been summarized below: International Transactions of the assessee with its associated enterprises Segment of the assessee Amount (Rs.) Export of Finished Goods Manufacturing Segment - Export 7,06,66,978 Import of raw materials & components Manufacturing segment Domestic Sales 2,53,18,093 Payment of Royalty 2,14,28,538 Payment of Management Fees 2,76,66,442 Purchase of Finished Goods Trading of Finished Goods 6,73,03,783 Purchase of capital asset Others 1,53,118 Reimbursement of expenses 22,95,649 Payment of bank gu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the materials available on record including the paper book filed by the assessee and the written submissions of the ld DR. We would like to give our findings in respect of each of the international transactions entered into by the assessee during the financial year 2007-08 as under:- 6.3.1. Sale of finished goods - Manufacturing (Export) Segment During the Financial Year 2007-08, the assessee manufactured and sold electric meters and components worth Rs. 108.35 crores out of which goods worth Rs. 7.35 crores were exported to AE. The details of the same are enclosed in page 306 of the Paper Book. For the purpose of determination of Arm's Length Price, the assessee undertook a detailed functional analysis and determined itself to be a tested party to the transaction. The assessee undertook segmental level profitability analysis to determine the profit earned from export of finished goods. The assessee also submitted a certified copy of the segmental profitability analysis before the ld TPO and ld DRP which are enclosed in pages 305 & 306 of the Paper Book. On evaluation of the methods prescribed under the TP regulations, the assessee considered TNMM as the MAM and OP/Sales as the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s end customers. Further, the assessee also bears credit risk with respect to its domestic operations. While on the other hand, under 'Manufacturing - Export' segment, the assessee receives product specification from its AE and accordingly manufactures and supplies the product. It is not liable to end customers for product performance. Also, no royalty is paid by the assessee on export of products to its AEs. It is also not undertaking any marketing efforts in the export market to secure contracts and does not bear any credit risk as it receives payment from its AEs. He argued that however, the Ld. TPO and Ld. DRP has overlooked the functional and risk differences arising between under the relevant sub-segments of the Manufacturing segment. He further argued that it would be necessary to appreciate the fact that market dynamics and economic circumstances of the Export market and Domestic market cannot be compared due to varied factors. Further, the Export market is likely to have a different realization from the Domestic market and therefore the two sub-segments cannot be compared for analysis purposes. Further, it needs to be considered herein that the value of 'Manufa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icing, purchasing, distribution, marketing, advertising, transportation, financial and management activities. It is also necessary to examine as to what is the principal function of the entities. " [Emphasis added] We find that even for comparability purposes, the assessee has undertaken two distinct search strategies for benchmarking its international transactions encompassed under 'Manufacturing -Domestic Segment' and 'Manufacturing - Export Segment". The assessee has given due consideration to identify comparable companies having a reasonable export operation so as to have similar economic consideration for comparability analysis. The details of the same are enclosed in Pages 61-62 and 65-67 of the Paper Book. We find that the ld TPO had failed to decipher that FAR analysis is one of the critical factors in establishing the Arm's Length Price of the international transaction and forgetting the fact that functions undertaken and risks assumed for the international transactions within the two segments are completely different and hence a collective benchmarking analysis for the same would only distort the principles of transfer pricing and will render the comparison defective. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anufacturing Segment' profitability from the same. However, he did not consider the sub-segment profitability of Manufacturing Segment into Manufacturing (Domestic) segment and Manufacturing (Export) segment based on difference in FAR analysis to determine the profitability from sale of finished goods. The ld AR further stated that the ld TPO in the earlier years has considered prices of international transaction pertaining to export of goods to AEs to be at Arm's Length wherein the assessee followed the same economic analysis to determine the Arm's Length Price. In view of the aforesaid findings and in the facts and circumstances of the case and respectfully following the judicial precedents relied upon hereinabove, we direct the ld TPO / ld AO to consider the certified segmental profitability to determine the Arm's Length Price of the relevant international transactions and hereby reject the combined segment approach adopted by the ld TPO. 6.3.2. Purchase of raw materials & components - Manufacturing (Domestic) Segment The observations and findings given by us for the Asst Year 2007-08 in respect of purchase of raw materials & components in Manufacturing (Domestic) Segment wou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Paper Book. We find that the assessee had considered payment of management service fee to be a different class of transaction, distinct from other international transactions. Accordingly, based on functional analysis, AE was determined as the least complex party and accordingly determined to be the tested party for the purpose of the analysis. Further , TNMM was determined to be the MAM. We find that the assessee undertook to identify comparable companies rendering similar services and the international transaction was determined to be at Arm's Length. These are enclosed in Pages 295 -303 of the Paper Book. The ld TPO while passing the order u/s 92CA(3) of the Act ignored the separate transaction level analysis undertaken by the assessee for justifying the Arm's Length nature of the international transaction and instead went ahead and clubbed the transaction under the TNMM analysis undertaken by ld TPO with respect to manufacturing segment. Moreover, when the ld DRP remanded back the case to the file of the ld TPO for analysis of the separate transaction level analysis and providing ground wise observations for arguments raised by the assessee before the ld DRP, the ld TPO did no ..... X X X X Extracts X X X X X X X X Extracts X X X X
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