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TMI Blog2020 (10) TMI 240X X X X Extracts X X X X X X X X Extracts X X X X ..... lity and to deprive the settled principles in question of all relevant purpose. - ITA No. 2051/MUM/2016 - - - Dated:- 9-9-2020 - Shri Saktijit Day (Judicial Member) And Shri N.K. Pradhan (Accountant Member) For the Assessee : Mr. Dhanesh Bafna /Mr. Arpit Agrawal, AR For the Revenue : Mr. Anand Mohan/Mr. Michael Jerald, DR ORDER PER N.K. PRADHAN, A.M. This is an appeal filed by the assessee. The relevant assessment year is 2011-12. The appeal is directed against the order dated 29.01.2016 passed by the Dy. Commissioner of Income Tax- 15(1)(1), Mumbai (hereinafter AO ) u/s 143(3) r.w.s. 144C(13) of the Income Tax Act 1961, (the Act ). 2. The grounds of appeal filed by the assessee read as under: 1. On the facts and in the circumstances of the case and in law, the DRP and AO erred in partly upholding the action of the TPO by making transfer pricing adjustment in relation to the international transaction of purchase of finished goods at ₹ 6,62,46,133. 2. On the facts and in the circumstances of the case and in law, the DRP and AO erred in rejecting comparables namely, P L Enterprise Ltd. and PAE Ltd. from the economic analysis of the Appel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee s objections 1. Kusam Electrical Industries Ltd. The Company is involved in manufacturing and trading of electrical electronic measuring testing instruments. The TPO has observed that the company is involved in manufacturing and trading of electrical measuring and testing instruments. The TPO has failed to appreciate and take cognisance of the detailed explanation submitted by the assessee vide Annexure C along with supporting document i.e. extract of Annual report of the Company as Annexure C1 (yellow highlighted paras) vide submission dated January 19, 2015. The assessee would like to reiterate that, . on perusal of this, you would appreciate that the company is involved in the trading/distribution of electrical and electronics measuring instruments . Further, it can also be observed that the company only deals in trading of goods. It is evident from the cost of sales and indirect expenses incurred are mainly in the nature of packaging, transport and administrative expenses. Hence, this company can be considered as comparable to ETPL's distribution business of measuring and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The TPO has observed that the company is involved in supply of fire alarms. The TPO has failed to appreciate and take cognisance of the detailed explanation submitted by the assessee vide Annexure C along with supporting document i.e. extract of Annual report of the Company as Annexure C4 (yellow highlighted paras) vide submission dated January 19, 2015. The assessee would like to reiterate that, .... on perusal of this, you would appreciate that the company is involved in purchase and supply of fire alarm and detection equipments, control panels and related components or spare parts. Further, from the extract of Annual report, it can be clearly observed that company is involved in only in one segment of purchase and supply of fire alarm and detection equipments, control panels and related components or spare parts. Inventory of the company also consists of trading goods. Hence, this company can be considered as comparable to ETPL's distribution business of measuring and surveying equipments. 5. Adtech Systems Ltd. - The Company is involved in the business of supplying, installation, commissioning ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gration of Electronic Security Systems. Though not strictly necessary, the Company has, for as a measure of providing greater understanding, divided this segment into two viz the Electronic Article Surveillance Systems (EAS) used for providing security to the retail segment and the Commercial Industrial (C/l) for providing security solutions for industrial use. Hence, it can be observed that the company primarily operates in single segment viz Supply and integration of Electronic Security Systems and its functions are broadly same in EAS and C/l segments. Accordingly, the TPO's contention to reject this company as comparable to ETPL based on (i) this company provides installation and AMC services; and (ii) assessee has erred in not using segmental data available in the financials are erroneous and needs to be quashed. Hence, this company can be considered as comparable to ETPL's distribution business of measuring and surveying equipments. The DRP observed that functionally AE and non-AE business are not comparable. In respect of non-AE business, the assessee is required to assess the specific needs of the clients, select suitable hardware and softwa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appellant is engaged into the business of trading in surveying and measurement equipments. During the year under consideration, the appellant purchased finished goods from its AE for trading amounting to ₹ 54,22,80,618/-. The appellant chose Resale Price Method ( RPM ) as most appropriate method ( MAM ) to benchmark the impugned international transaction and selected Gross Profit/Sale as profit level indicator . The appellant earned a GP Margin of 29.50% (entity level). The appellant chose a set of 5 comparables and arrived at an arithmetic mean of 28.28%. Since, the appellant s GP margin was higher than that of the comparables and hence, it was concluded that the impugned international transaction was at arm s length. The TPO applied internal RPM and compared AE s margin of 28% with Non AE margin 39.92% and accordingly, made an upward TP adjustment of ₹ 9,33,15,374/-. The DRP rejected the internal RPM applied by the TPO and directed to apply external RPM. However, while dealing with the comparable selected by the appellant, the DRP excluded PL Enterprises Ltd. and PAE Ltd. as comparable for the reasons stated in para 2.6.6 (page 22) of the DRP Or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... within the +/-5% range as provided under section 92C(2) of the Act. Hence, the transaction is at arm s length Thus the Ld. counsel submits that under RPM, only gross margins are seen with reference to items purchased and sold or earned by an independent enterprise in comparable uncontrolled transactions vis- -vis the one in the controlled transactions, therefore, the nature of products has not much relevance; the focus is more on same or similar nature of functions rather than similarity of products. Also it is stated by him that if the above contention of the appellant is accepted and PAE Ltd. is included in the final list of comparable, then arithmetic mean of the gross margin of the comparable will work out to 29.78% which will fit within +/-5% of the appellant s gross margin of the AE segment (i.e. 28%). Thus, the Ld. counsel argues for inclusion of PAE Ltd. in the final set of comparables. The working as submitted by the Ld. counsel is as under : Sr. No. Name of Comparable Company Gross Margin in its TP Study 1. Adtech Systems Ltd. 36.27% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Name of the Company As per TP Report Single Year Margin 1. Kusam Electrical Inds. Ltd. 41.74% 41.46% 2. PAE Ltd. 9.76% 11.30% 3. Alert Fire Protection Systems Pvt. Ltd. 31.38% 33.63% 4. Adtech Systems Ltd. 36.27% 34.93% 5. Matra Kaushal Enterprises Ltd. (PL Enterprises) 22.24% 14.74% Mean 28.28% 27.21% The appellant submitted before the TPO that as its gross profit margin at the entity level is 29.50% which is better than the margin of comparables at 27.21%, therefore, the transactions are at ALP. However, the TPO was not convinced with the above explanation of the appellant and applied internal RPM and compared AE s margin of 28% with Non-AE margin of 39.92% and accordingly made an upward TP adjust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... edings, it is demonstrated by the assessee that most appropriate ALP can be determined by adopting a prescribed method than that chosen by it earlier, same should be considered and (iii) where internal comparables are available, they are preferred over external comparables. Having gone through the above decision, we may mention here that there is no dispute on the findings in the above case. We are concerned here only with the comparability of PAE Ltd. In the case of Kobelco Construction Equipment India Ltd . (supra), relied on by the Ld. counsel, the assessee imported finished goods manufactured by its AE, like earthmoving equipment, hydraulic excavators, etc. for resale in India. It undertook the entire function of a 'distributor'. It mainly sold finished goods directly to the customers at high sea sales and some of the finished goods were sold through network of dealers. For the sale of spare parts, the assessee imported and then sold them through the network of dealers to the customers. The assessee has chosen 'Resale Price Method' (RPM) as the 'Most Appropriate Method' (MAM) and PLI was taken as gross profit/operating income. The assessee had sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be considered as comparable to company X in the year in which the RPTs breach has occurred. Also, a company might have been treated as non-comparable due to the TPO adopting its entity level results for comparable with the segmental results of the case before him, but in the later case, the TPO may take only the related segment results. In such a later case, the company treated as non-comparable to the first company may become comparable to the second company. The comparability of each company needs to be ascertained only after matching the functional profile and the other relevant reasons of the other company. Functional analysis enables comparison of controlled transactions with uncontrolled transactions. The Hon ble Supreme Court in the case of Morgan Stanley Company Inc (2007) 292 ITR 416(SC) has placed significant emphasis on FAR (functions performed, assets owned and risks assumed by the associated enterprises involved) analysis for benchmarking exercise, also known as comparability analysis, for determination of arm s length price of a transaction between associated enterprises. Their Lordships have observed: Therefore, in each case the data placed by the taxp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trading of above related surveying and measurement equipments. PAE Ltd. During the financial year 2010-2011, PAE restructured operations and transitioned from a horizontal organization structure to a more defined, vertical structure. Under the revised organization layout, PAE's business will be divided into 5 business verticals for better internal monitoring: Auto Batteries Auto Parts Industrial Batteries Power Backup Systems Solar Each vertical will perform as an independent Strategic Business Unit (SBU), focused on growing sales and optimizing operations. D 6.4 What is the architecture of RPM? In this context, we seek guidance from (i) OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2017), (ii) United Nations Practical Manual on Transfer Pricing for Developing Countries (2017) and (iii) Guidance Note on Report u/s 92E of the Income-Tax Act, 1961 (Transfer Pricing) (Revised 2019), issued by the Institute of Chartered Accountants of India. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2017) mentions the following : 2.31 Although broader produ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sale Price Method, greater product similarity is likely to provide more reliable transfer pricing results. It is not always necessary to conduct a resale price analysis for each individual product line distributed by the sales company. Instead, the Resale Price Method can be applied more broadly, for example based on the gross margin a sales company should earn over its full range of broadly similar products. Guidance Note on Report Under Section 92E of The Income-Tax Act, 1961 (Transfer Pricing) (Revised 2019), issued by the Institute of Chartered Accountants of India states the following : 6.16 On application of RPM, the UN in the Practical Manual on Transfer Pricing has observed as under: 6.2.9.3 While product differences may be more acceptable in applying the Resale Price Method as compared to the CUP Method, the property transferred should still be broadly similar in the controlled and uncontrolled transactions. Broad differences are likely to reflect differences in functions performed, and therefore gross margins earned, at arm s length. 6.2.9.4 Example: The compensation for a distribution company should be the same whether it sells washing machines or drye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... compared with gross profit margin earned by unrelated parties from trading of Desktops. This is because, both are consumer durables and fall in within the same industry. RPM is unlikely to give accurate result, if there is difference in level of market, functions performed, or product sold. For example, Gross profit margin of a chocolate distributor cannot be compared with Gross profit margin of a cosmetics distributor even though both products fall under FMCG category. This is because, there are huge differences in the products which affect the Gross profit margin. The fact remains that prices for different products would tend to equalize only to the extent that those products were substitutes for one another. RPM is a GP margin based method. It is a traditional transaction method. It primarily compares controlled and uncontrolled transactions. Under RPM we can tolerate slight differences in the products distributed by the two types of distributors as long as the broad category of products distributed is the same. As mentioned earlier while product differences may be more acceptable in applying the RPM as compared to CUP method, the property transferred should still ..... X X X X Extracts X X X X X X X X Extracts X X X X
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