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TMI Blog2019 (4) TMI 1786X X X X Extracts X X X X X X X X Extracts X X X X ..... f the assessee are Ceat, J.K. Industries, MRF Ltd. & Good Year. The assessee filed its return declaring certain international transactions. The AO referred the determination of the arm's length price (ALP) of such international transactions to the Transfer Pricing Officer (TPO). Instantly, we are concerned with the international transaction of "Import of raw material" with transacted value at Rs. 75,02,50,825/-. The assessee applied the Cost Plus method as the most appropriate method for showing this international transaction at ALP. For doing so, the assessee selected seven foreign/AEs situated in China, Belgium, Spain and Brazil collectively as tested party. Certain comparables qua each of the foreign/AEs were considered. The Transfer Pricing Officer (TPO) required the assessee to furnish Annual Reports and Financial statements of the seven tested parties selected by the assessee, which it did not on the premise that such documents were in respective regional language. Further, the assessee itself demonstrated that these foreign/AEs were engaged in many activities other than supply of material to the assessee, as was the international transaction under consideration before the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... foreign/Associated Enterprise(s) can be considered as tested party or only the Indian entity, which has recorded the transaction in its books of account, can be so considered? 6. For this purpose, we need to visit the provisions of the Chapter X of the Act with the caption "Special Provisions Relating to Avoidance of Tax" dealing with the computation of income from international transactions having regard to ALP. Section 92(1) of the Act provides that : 'Any income arising from an international transaction shall be computed having regard to the arm's length price'. Thus, this provision applies to income of an enterprise from an international transaction, which is chargeable to tax under the Act. The term "international transaction" has been defined in section 92B to mean 'a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase ... of tangible .... property.....'. The methodology for computation of arm's length price of an international transaction has been set out in section 92C(1) of the Act to be as per any of the prescribed methods, including the TNM method. The TPO adopted this method as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional transaction.' 7. A cursory look at the above provisions indicates that firstly, a transaction between two or more associated enterprises is called an international transaction; secondly, any income from such an international transaction is required to be determined at ALP; thirdly, the ALP in respect of such an international transaction should be determined by one of the prescribed methods, which also includes the TNMM. 8. The term `enterprise' under the TNM method, and for that matter all other methods, has been used to indicate the assessee in whose hands the benchmarking of the international transaction is done and the term `associated enterprise' has been used to denote the foreign/AE, being the other related party to the international transaction. It is so borne out from rule 10B(1)(b)(i) under the Resale price method, which provides that : `the price at which property purchased .... by the enterprise from an associated enterprise is resold...is identified'. As this method is usually applied in the hands of the party purchasing the goods and then reselling it, there remains no doubt that the term `enterprise' has been used for the Indian assessee purchasing the go ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e ALP of the international transaction of the Indian enterprise with its foreign AE. Scope of transfer pricing addition under the Indian taxation law is limited to transaction between the assessee and its foreign/ AE. We fail to comprehend as to how the profit realized by the foreign/AE can be relevant, when the profit of the Indian enterprise is sought to be ensured at ALP. The underlying object of the transfer pricing provisions is, inter alia, to see that there is no profit shifting from the Indian taxation base by means of the foreign/AE charging more than that charged by comparable independent cases, which fact is ensured by determining the ALP of the international transaction. If foreign AE has, in fact, charged more, then its profit rate will shoot up and the corresponding profit of the Indian enterprise will be squeezed. In that scenario, a comparison of the profit rate of the foreign/AE will run contrary to the mandate of the provisions. Whereas, we were required to determine if the profit charged by the foreign AE is not more than that charged by uncontrolled comparables by seeing the profit rate of the Indian enterprise, we will end up doing a futile exercise of rather ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenses Operating 40 expenses Operating 48 Profit Operating 42 Profit Total 208 208 Total 300 300 Operating profit to sales of Foreign/A.E. - 23% Operating profit to sales of assessee/Indian enterprise-14% 10. It can be seen from the above that because of showing higher transfer price in the hands of the assessee/Indian enterprise, OP/Sales of the assessee/Indian enterprise has come down to 14%, which in arm's length situation should have been 20%. If we apply TNM method by taking the assessee as a tested party, it would call for making transfer pricing addition to the extent of reduction in the price mutually manipulated by the Foreign/AE and the assessee/Indian enterprise because of their association. On the other hand, if we take the foreign/AE as a tested party, it would show a rosy picture of its OP/Sales at 23%, being higher than that of foreign or Indian comparables, not necessitating any transfer pricing addition. In fact, it is this arrangement between the related parties which is sought to be curbed by the transfer pricing legislation. Going with the foreign/AE as a tested party in non-arm's length situation, would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orities below in rejecting foreign/Associated Enterprises as a tested parties. 13. Notwithstanding the above legal position, even if we presume for a moment on a hypothetical basis that the stand of the assessee of having foreign/AEs as a tested party is correct, the assessee still cannot be said to have successfully established the particulars of the so called seven foreign/AEs simultaneously as tested party. Not only the assessee failed to furnish the basic information of the foreign/AEs, such as, Annual Reports and Financial statements etc., the assessee categorically admitted before the TPO that these foreign/AEs were engaged in many activities other than supply of material to the assessee. Similar is the position of foreign comparables chosen by the assessee qua each of the seven foreign/AEs. It is trite that if an assessee has chosen a comparable, onus is on him to prove that the said company is comparable to the international transaction. Adverting to the facts of the instant case, we find that the assessee chose certain foreign companies as comparable, but on being called upon by the TPO, failed to lead any evidence to show that they were comparable. Ergo, we accord our im ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sed for the purpose of making comparison with the net profit margin realized by the assessee from its international transaction as per sub-clause (i). 18. There can be no dispute on the principle that calculation of 'Operating profit' as envisaged under Rule 10B(1)(e) embraces cumulative effect of all the items of income and expenses which are of operating nature. Ordinarily, there can be no question of considering each item of such operating expenses or income in isolation de hors the other expenses/income to claim adjustment on the ground of such expenditure or income of the assessee on the higher or lower side seen individually or as a percentage of other operating expense/incomes in comparison with its comparables. The reason is obvious that when we consider the operating profit margin, the effect of all the individual higher or lower items of expenses or incomes is subsumed in the overall operating profit margin, ruling out the need for any adjustment on comparison of one-to-one items resulting into the determination of the operating profit margin. One company may have taken a building on rent for carrying on its business, in which case, it will pay rent which will find place ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... permissible, the assessee cannot also seek an exclusion or inclusion of a company on the ground that the ratio of its depreciation to total expenses or sales etc. is more or less in comparison with comparables. It is so for the reason that such higher percentage of depreciation to total expenses is marginalized by the lower percentage of repairs and other incidental costs of the assets and vice versa. 19. However, the position may be different when there is a difference in the rates of depreciation charged by two companies on similar category of assets. One company may adopt the policy of charging depreciation on its assets in conformity with the rates prescribed in Schedule XIV of the Companies Act and other company may adopt a policy of charging depreciation at the higher rates than those prescribed under Schedule XIV. This can be demonstrated with the help of an example. Other things being equal, if the operating profit of company A, after claiming depreciation of Rs. 10 on the value of asset worth Rs. 50 with rate of depreciation 20%, is Rs. 100, the operating profit of company B with everything same including the value of assets at Rs. 50, but with rate of depreciation 30%, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the assessee, then suitable adjustment should be made to the profits of the comparables. We order accordingly. 21. Now we turn to first ground of the Revenue's appeal by which the decision of the AO in restricting the transfer pricing adjustment only to the international transactions and not to the entity level, based on the direction of the DRP, has been challenged. 22. Briefly stated, the facts of the case are that the TPO computed transfer pricing adjustment with reference to the entity level transactions of the assessee, that is, with both the associated enterprises and non-associated enterprises. The assessee challenged such a decision before the DRP by contending that the transfer pricing addition should have been restricted only to the international transactions, which got concurrence of the Panel. The Revenue is aggrieved by such a decision. 23. After considering the rival submissions and going through the relevant material on record, we find that no exception can be taken to the decision of the DRP in directing that the transfer pricing addition should be restricted only to the international transactions and not the non-international transactions of the assessee. Firs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the issue raised on this score is two-fold. First is the application of most appropriate method and the second is the deletion of addition on merits. We espouse the first issue. The assessee admittedly imported steel cord from its AEs and sold the same to the non-AEs without any value addition or further processing. The Resale price method, as the name itself suggests, is preferably used when the goods are `resold'. The mechanism for the computation of the ALP under this method is based on this foundation. In our considered opinion, the RPM is the most appropriate method for determining the ALP in case of distribution of goods. In other words, if the goods purchased are sold as such without any further processing or value addition, then the RPM is the most appropriate method. Our view is fortified by the judgment of the Hon'ble Jurisdictional High Court in CIT Vs. L'oreal India Pvt. Ltd. (2015) 276 CTR 0484 (Bom). We, therefore, countenance the impugned order on this score and hold that the RPM is the most appropriate method for benchmarking the international transaction. 27. The second aspect of the issue is about the deletion of addition by application of the RPM. The ld. AR fa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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