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TMI Blog2016 (4) TMI 1447X X X X Extracts X X X X X X X X Extracts X X X X ..... 2014 - AY 2009-10 : 1. That on facts and in law the TPO/AO/DRP erred in making/upholding an addition to total income of '106,86,60,627 under Chapter- X of the Income Tax Act, 1961[hereinafter referred as "the Act"] in the order of assessment. 1.1 That on facts and in law, the AO/TPO/DRP jurisdictionally erred in virtually rewriting the accounts of the appellant, including therein transactions which did not belong to it and in changing its functional profile. 1.2 That on facts and in law the DPR/AO/TPO without any cogent, acceptable material on record erred in: i. Completely misunderstanding the business model, functional and risk profile of the tested party. ii. Re-characterizing the service and commission segment as equivalent to its trading segment. iii. Rejecting the use of "Berry Ratio" and using OP/TC (including cost to others) as a Profit Level Indicator (PLI) in order to Benchmark appellant's international transactions. iv. Using the data not existing at the time of preparation of Rule 100 documentation by the assessee. v. Using single year data as against multiple year data used by the assessee in order to compute the arm's length price of its i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... referred as the "AO"] / Dispute Resolution Panel [herein above referred as the "DRP"] / Transfer Pricing Officer [hereinabove referred as the "TPO"] are bad in law and void ab-initio. That the appellant prays for leave to add, alter, amend and/or vary the ground(s) of appeal at or before the time of hearing." "Grounds of appeal qua ITA No.1795/Del/2015 - AY 2010-11: 1. That on facts and in law the TPO/AO/DRP erred in making/upholding an addition to total income of Rs. 98,70,26,791/-under Chapter- X of the Income Tax Act, 1961 [hereinafter referred as "the Act"] in the order of assessment. 1.1 That on facts and in law, the AO/TPO/DRP jurisdictionally erred in virtually rewriting the accounts of the appellant, including therein transactions which did not belong to it and in changing its functional profile. 1.2 That on facts and in law the DPR/AO/TPO without any cogent, acceptable material on record erred in: i. Completely misunderstanding the business model, functional and risk profile of the tested party. ii. Re-characterizing the service and commission segment as equivalent to its trading segment. iii. Rejecting the use of "Berry Ratio" and using OP/TC (inclu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at on the facts and circumstances of the case, the learned AO/DRP has erred, both on facts and in law in making/upholding a disallowance of an amount of Rs. 1,10,01,931/- on account of expenditure on logistics and warehousing support services. 8. That on the facts and circumstances of the case, the learned AO/DRP has erred, both on facts and in law in making/upholding a disallowance of an amount of Rs. 5,93,513/- on account of non-deduction of withholding tax on purchases from Mitsui & Co. Ltd., Japan under section 40(1)(i) of the Income Tax Act. 9. That on the facts and circumstances of the case and in law, the AO/DRP erred in charging interest u/s 234A, 234B and 234C of the Act. 10. That on facts and in law the orders passed by the Assessing Officer [herein above referred as the "AO"] / Dispute Resolution Panel [herein above referred as the "DRP"] / Transfer Pricing Officer [hereinabove referred as the "TPO"] are bad in law and void ab-initio. That the appellant prays for leave to add, alter, amend and/or vary the ground(s) of appeal at or before the time of hearing." ITA NO.813/Del/2014 (AY 2009-10) : 3. Briefly stated facts of this case are : the assessee c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6,791/- on account of difference in arms length price (ALP) for the combined Associated Enterprises (AEs) segment determined by the TPO. 9. During the assessment proceedings, it has come on the record that assessee has paid service fee of Rs. 40,78,906/- to its related parties, namely, M/s. West Japan Logistics Division of Mitsui & Co. Ltd., Japan amounting to Rs. 6,40,000/- and M/s. Mitsui & Co. (Asia) Pte Ltd., Singapore amounting to Rs. 34,38,906/-. Finding the explanation filed by the assessee not tenable, TPO/DRP disallowed the same u/s 37 (1) being the expenditure not incurred wholly and exclusively for the purpose of business and considered the same as related party transaction. The AO thereby made an addition of Rs. 40,78,906/- to the total income of the assessee. 10. The AO in pursuance to the order passed by the TPO/DRP made addition of Rs. 5,93,513/- on account of making purchases of Rs. 7,19,40,901/- from M/s. Mitsui & Co. Ltd., Japan during FY 2009-10 on account of non-deduction of TDS on the business profit on the aforesaid payment on the ground that M/s. Mitsui & Co. Ltd., Japan has a PE in India and is regularly filing its return of i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of paid/payable expenses 143,461,810/- 13. Assessee company is wholly owned subsidiary of MCJ, the general trading company playing an important role in linking buyers and sellers for products in a variety of industrial segments. Assessee company is considered to be a low risk activity and the primary source of activity is in the nature of commission earned on the traded goods. 14. The assessee company has used TNMM as the most appropriate method for bench marking its international transaction and PLI selected as GP/OC i.e. Berry ratio. Assessee company chosen 29 comparables and by using 3 years data adjusted average Berry ratio at 1.08 and assessee company has claimed its 3 years average Berry ratio at 1.17. 15. However, TPO after analysis of the assessee's transfer pricing approach and after issuing show cause notice selected 31 comparables and taken average at 4.66 %. Assessee raised objection to the comparables chosen by the TPO inter alia that in the absence of computation of correct margin certain parties are having related party transaction more than 25% and that the financial of some comparable are indicating manufacturing activity. 16. TPO disposed of the objections ra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 51 27. Varun Industries Ltd. 5.47 5.16 28. Vigneshwara Exports Ltd. 8.58 8.58 29. Welspun trading Ltd. 0.04 0.04 4.75 2.58 8. Calculation of arm's length price Based on above, it is concluded that the assessee has not been able to substantiate its arguments with valid documentary evidences. Following the discussion in the preceding paras, the FOB value of goods sourced from India, being Rs. 4591 Crores shall be taken as part of the cost base to calculate the remuneration of the assessee. Computation of arm's length profit for the combined AE segment (computation of profit of AE segment is attached as Annexure 1) is given below:- Cost base of AE segment (AE-service segment) FOB Value 50,570,000,000 Operating cost of AE segment (Commission + Service segment) (805,292,495+63,512,277) 868804,772 Total (A) 51,438,804,772 Mean of OP/TC of comparables (Arm's length OP/TC) (B) 2.16% Operating profit reported before including value of goods on which commission is earned (114,982,857 + 9,068,535) (C) 124,051,392 Arm's length profit (D)= (A) x (B) 1,111,078,183 Deficit D-C 987,026,791 The dif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yers in India, the Mitsui Japan has a contract with the Japanese suppliers and Mitsui Japan also enters into contract with the buyers in India. Similarly for exports from India, Mitsui Japan enters into a contract with Indian supplier directly for the purchase and sales transactions. Thus the role of Mitsui India, the assessee company is a mere facilitator, a mere service provider. Mitsui India does not take title or possession of the merchandise at any moment and bears no price risk. Mitsui India does not take inventory risk, it does not take warranty risk, it does not take credit risk. It does not employ its capital. In purchase and sale, inventory, advances, debtors, Mitsui India's main function is to maintain contact with the suppliers to ensure timely delivery of merchandise to the customers in the quality and grade desired, communicating with Mitsui India or its affiliates, gathering information on demand and supply conditions of the commodities. The above functions are entirely different than the trading business. In trading activities, one ventures himself. Buys and sells goods in it's account. It takes price risk, inventory risk, it deploys capital in inventory, debtors. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ivalent to its trading segment. 24. Now, the question arises for determination is, "as to whether TPO/DRP has inflated the total cost (TC) of assessee by Rs. 4541 crores qua AY 2009-10 and Rs. 5924.87 crores qua AY 2010-11 respectively by ignoring the fact that the said value was recorded sale/purchase by the AEs and was never a cost to the assessee"? 25. This issue has again been dealt with by the coordinate Bench in the judgment (supra), operative part thereof is reproduced for ready reference as under :- "28. We have considered the arguments advanced by the parties and gone through the orders of the authorities below as well as the judgments relied upon. On going through the order of TPO in the case of the assessee and the order passed by the ITAT in the case of Mitsubishi Corporation India (P) Ltd., we note that the facts of the two cases are almost similar. In this regard we note that the ITAT in Para 7 of its order has recorded the FAR analysis carried out by the TPO. It may be relevant to quote para 7 of the order passed by the ITAT in the case of Mitsubishi Corporation India (P) Ltd. (supra) as under:- "7. As the Transfer Pricing Officer rightly noted, the m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tics. -Accounting and administration. -Developing long term strategic policies. -Dealing with finance, accounting, IT and legal issues. -Human Resource Management: (b) risks assumed by the assessee: -bears volume risk -bears foreign exchange risk -bears manpower risk (c) assets used by the assessee: -Fixed asset" 29. In the order passed by the learned TPO in the case of the assessee before us, the FAR analysis stated by the TPO in para 5.2.1 is exactly the same as stated hereinabove in the case of Mitsubishi Corporation India (P) Ltd.. The conclusion drawn by the TPO and quoted in the judgment of the Mitsubishi Corporation India (P) Ltd. in para 9 of the order are also exactly the same as in para 5.3 of the TPO's order in the case of the assessee company. Thus we are of the view that the facts of the present case are similar to the facts of the Mitsubishi Corporation India (P) Ltd. In the Mitsubishi Corporation India (P) Ltd.(supra), the ITAT has held that it is impermissible to make notional addition in the cost base and then take into account the cost which are not borne by the assessee. The ITAT while giving the above finding has relied upon the jud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tered into by the assessee company as transaction that of trading activity. The ITAT has examined this issue and has held as under:- "12.18 In the aforementioned background we are of the view that in order to adjudicate upon the issues it would be appropriate for us to formulate the questions as under:- (a) Whether the TPO on facts was justified to treat the indenting activity at par with the trading activity ; (b) If the answer to the query posed in (a) is "yes" then were the margins earned in the trading activity by the assessee with non AEs correctly applied to the indenting activity with AEs ; (c) If the answer to the query posed in (b) is "yes" then would the 'costs' referred to in Rule 10B (1) (e) (i) be the FOB value of goods on the facts of the present case or would it be the operating cost of the assessee; (d) If the answer posed to the query in (a) is "no" then is there any justification on facts in applying the margins earned in the trading activity to the profits of indenting activity for working out the Arms Length Price. 12.19. On a consideration of the business profile of the assessee as available on record and the nature of services rendered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ranty risk etc, which would necessitate the contract being entered into and negotiated by assessee. In its indenting activity these facts are not evident. Accordingly the question posed in (a) is answered in the negative. 12.21 Considering the next question posed, even if the answer in (a) is in the negative, we see that there is no reasoning and justification for applying the margins earned in trading activity to indenting activity as the two are distinct and separate. Merely because the assessee was also having a small level of trading activity in its own name, there is no reason available on record either justifying the action of re-characterizing the nature of assessee's activity from a service provider to that of a trader. As observed, neither the TPO has lead any discussion nor has the DRP cared to throw any light on the aspect for upholding the action of the TPO. Where all the critical functions were being performed by the AE, the services provided, as a facilitator, by the assessee cannot be treated as a trading activity. The performance of the critical functions, like decisions to enter into contract, to negotiate the terms of the contract, to decide the level and e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the FAR analysis shows that there is no comparison in the two activities 12.25. Accordingly on account of these facts, we are unable to agree with the TPO who chose to re-characterize the activities of the service provider and treated them at par with the activities of a trader since the nature of the activities of a trader and service provider are materially distinct and different. 12.26. As we have held on facts that the two sets of activities are distinct and different, consequently we are of the view that there is no justification for applying the margins earned in trading activity to those earned in the indenting services. As such, we find ourselves unable to agree with the reasoning and the decision of the TPO which has been upheld by the DRP. At the cost of repetition the consistent and unrebutted material available on record shows that in the trading activity, the assessee has entered into contracts with the parties in India in its own name. The title in goods has been held for these contracts in assessee own name as such the assessee as any other trader has exposed itself to the price risk, the credit risk and other related risks of inventory risk etc. The negotiati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely : (a) ** ** ** (b) ** ** ** (c) ** ** ** (d) ** ** ** (e) Transactional net margin method, by which- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; ** ** ** 12.31. In the facts of the present case which have been discussed at length while considering the action of the TPO in recharacterizing the transactions, we are of the view that on the basis of the detailed FAR analysis of the assesses, the "costs" referred to in Rule 10 B (1)(e)(i) does not suggest that in the facts of a case like the present case the 'costs' would mean the FOB value of goods. The assessee demonstrably is a low risk entity as a service provider functioning as a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such value added services are being performed wherein the analysis/opinions may turn out to the correct or grossly wrong as such due to the high risks of both eventualities occurring the personnel are necessarily highly qualified sought after experts, commanding high salaries. The simple performance of a low risk activity of facilitator does not lead to the conclusion that a human intangible is being created. It is seen that there is no material on record as to how supply chain intangibles are being created as the assessee is using the network and intangibles of its AE. 12.33 Coming to the final question (d), which we have posed to ourselves since the answer to question (a) is in the negative the question regarding justification on facts in applying margins earned in trading activity to the profits of indenting activity for working out the Arms Length Price requires to be considered. For the said purpose we are of the view that elaborate discussions are not necessary as it would necessitate re-iterating the distinctions in the two separate sets of activities and the conclusions on the detailed FAR analysis already done in the earlier paras especially while considering queries ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 65. As for the objection that use of berry ratio is not permitted under rule 10B(1)(e)(i) as it does not deal with costs incurred, sales effected or assets employed or to be employed, it proceeds on the fallacy that the basis of computation, as set out in rule 10B(1)(e)(i), is exhaustive whereas it is only illustrative and it ends with the expression "or having regard to any other relevant base". Just because a cost base is not of costs incurred, sales effected or assets employed, such a base does not cease to permissible under rule 10B(1)(e)(i) unless such a base can be held to be irrelevant. In view of the elaborate discussions earlier, justifying exclusion of inventory costs, the cost of base of the operating expenses is relevant. When cost of inventory is excluded from the cost base, for all practical purposes, cost bases consists only of the operational costs. In our considered in a situation in which trading is on back to back basis without anything actually going to the current assets and flash title of goods is held only momentarily, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Rules. Having determined that (TNMM) to be the most appropriate method, the only rules and norms prescribed in that regard could have been applied to determine whether the exercise indicated by the assessee yielded an ALP. 81. Clearly, therefore, it is impermissible to make notional additions in the cost base and thus take into account the costs which are not borne by the assessee. It is so opined by Hon'ble jurisdictional High Court on a careful analysis of rule 10B(1)(e)(i). It is, therefore, no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by the AEs, in respect of which services are rendered, in its reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms' length price. Respectfully following the esteemed views of Their Lordships, we hold that the adjustments carried out in the cost base of ALP computation, in respect of service fee/commission segment, are indeed devoid of legally sustainable merits. We direct the Assessing Officer to delete these a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO is TNMM. The arm's length price has been determined using more than one comparable as is evident from the TPO's order for both the assessment years. This arithmetical mean has been taken into consideration for determination of the arm's length price by the TPO as is evident from the TPO order and accordingly the proviso to section 92C will be applicable to the present case. Since in the present case such difference is less than 5% and hence no adjustment can be made. 35. Accordingly under the facts and the reason discussed hereinabove and respectfully following the order of the co-ordinate bench on an identical issue under almost similar facts, we are of the view that adjustment made by the Assessing Officer in the assessment order cannot be sustained and the same are directed to be deleted. Accordingly, Ground no.1 to 4 of both the assessment years i.e. 2007-08 and 2008-09 are allowed." 26. In view of what has been discussed above and by following the order passed by the coordinate Bench in assessee's own case on identical facts qua the AYs 2007-08 and 2008-09, we are of the considered view that the adjustment made by the AO in compliance to the order passed by TPO/DRP for b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DRP has confirmed the addition of Rs. 18,73,472/- for AY 2009-10 and Rs. 23,17,869/- qua AY 2010-11 by applying the decision of Special Bench rendered in case of Cheminvest vs. ITO - 317 ITR 86 on the ground that disallowance would be made irrespective of the fact that during the year, there is any exempt income or not. 28. Undisputedly, the aforesaid decision of Cheminvest (supra) rendered by Special Bench of ITAT has been overruled by the Hon'ble jurisdictional High Court in ITA No.749/2014 vide judgment dated 02.09.2015. 29. Ld. DRP confirmed the addition of Rs. 18,73,472/- for AY 2009-10 and Rs. 23,17,869/- for AY 2010-11 by returning the following findings :- "16.1 The assessee submitted that the outstanding balance in investment (in shares) was at Rs. 13,00,80,400 and Rs. 13,00,80,400 as, on 31st March 2009 and 2010 respectively. There has been no investment in shares during the year, the assessee earned no dividend income on the above investments and accordingly claimed no exemption under Section 10(33} of the Income Tax Act. Consequently provisions of Section 14A of the Income Tax Act are not applicable. Therefore, the same has been wrongly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the law laid down by the Hon'ble jurisdictional High Court in judgment cited as Cheminvest vs. ITO (supra) in the similar facts and circumstances of the case, when assessee has not earned any exempt income during the years under consideration, as is evident from the documents lying at pages 7 & 14 of the paper book i.e. profit & loss account and audited balance-sheet, section 14A would not be applicable in the instant case. Hence, the disallowance confirmed by the DRP is not sustainable in the eyes of law. So, ground no.5 in both the years are allowed in favour of the assessee. GROUND NO.6 OF ITA NO.813/DEL/2014 - AY 2009-10 33. The AO after noticing the fact that from the auditor's report that expenditure amounting to Rs. 11,11,510/- on account of leased rent, staff welfare and commission income adjustment relates to prior period and hence disallowed the same and added the same to the total income of the assessee company. Ld. AR contended that the assessee had in fact never claimed the said amount as deduction in the return of income. As in the computation of income, the assessee has taken the total figure of Rs. 5,03,90,040/- as net profit which was in fact without ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... warehousing support service during the FY 2009-10 having been paid to M/s. Auto Cars and M/s. Hitachi Transport System India Pvt. Ltd., which has been disallowed by the AO u/s 37 (1) on the ground that the same has not been incurred wholly and exclusively for the purpose of business and the assessee has failed to offer any justification for making the aforesaid payment on account of commercial expediency nor the assessee has furnished copy of agreement with M/s. Panasonic India Pvt. Ltd. and nor placed on record detailed computation of losses. However, the ld. AR, on the other hand, contended, that the amount in question has been incurred under terms of the outsourcing agreement with respective agencies, namely, M/s. Auto Cars and M/s. Hitachi Transport System India Pvt. Ltd. and placed on record the copy of agreement, lying at pages 7 onwards of the paper book. This fact has however been overlooked by the AO as well as DRP and as such, we are of the considered view that this issue is also required to be restored to the AO to decide afresh after providing an opportunity of being heard to the assessee to adduce evidence in this regard. So, this ground is also determined in favour o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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