9911796707
TMI Blog2022 (2) TMI 1446X X X X Extracts X X X X X X X X Extracts X X X X ..... e before the Transfer Pricing Officer wherein the profile of the assessee company has been described it is relevant to note that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the fact rather there is an categorical affirmation that the assessee is engaged in the business of manufacture and export of colored stones and studded jewellery and has manufacturing units in Jaipur and Mumbai. It has the necessary manufacturing set up with requisite assets and infrastructure in place which are employed. The associated enterprises perform substantial part of marketing, sales and distribution functions. The assessee takes all types of risk such as inventory risk, credit collection Risk, product risk, manpower risk, market risk (to limited extent), technology risk, general business risk and foreign exchange risk. Therefore, we donot find any infirmity in assessee being classified as a manufacturer performing all the entrepreneurial functions. It is again noted that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the functions performed, the asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an appropriate PLI is not justified in the instant case. Cost Plus Method as the most appropriate method confirmed for determining the arms length and Gross Profit/COP as the appropriate Profit Level Indicator Selection of comparables and application of the PLI (i.e. Gross Profit margin / Cost of production) - Taking into consideration the comparables so selected by the TPO where the median OP/COP comes to 12.90% and given that the assessee has reported OP/COP of 13.51%, we find that the assessee s transactions with its associated enterprises meets the arms length requirements and no adjustment is warranted. Therefore following the approach so suggested by OECD/UN transfer pricing guidelines the transfer pricing adjustment is hereby directed to be deleted. Decided in favour of assessee. - SHRI SANDEEP GOSAIN, JUDICIAL MEMBER AND SHRI VIKRAM SINGH YADAV, ACCOUNTANT MEMBER For the Assessee : Shri Vijay Mehta, C.A., Shri S.R. Sharma, C.A. For the Revenue : Shri B.K. Gupta, Pr.CIT ORDER PER VIKRAM SINGH YADAV, ACCOUNTANT MEMBER: This is an appeal filed by the assessee against the order dated 30.06.2021 passed u/s 143(3) read with section 144C(13) of the Income Tax Act, 1961 ( the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Appellant, established legal principles and internationally accepted transfer pricing guidelines. 4.4 On facts and in law, without prejudice to the other grounds, even if TNMM is adopted as the Most Appropriate Method in the given case, then the Ld. TPO, Ld. AO and the Hon'ble DRP erred in not adopting Operating Profit /Operating Cost ('OP/OC') as the most appropriate PLI and instead incorrectly applied the Berry Ratio. 5. On facts and in law, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) of the Rules by rejecting certain functionally comparable companies identified by the Appellant in its TP documentation. 6. On facts and in law, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in arbitrarily applying new filters and introducing new companies in the comparable set without sharing the entire search process with the Appellant. 7 On facts and in law, without prejudice to the above grounds, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in disregarding the Appellant's submissions for considering the correct computation of OP/ VAE under the Berry Ratio for the Appellant as well as the alleged comparable companies. 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l not be an appropriate PLI and as against the same, OP/VAE has been stated to be the appropriate PLI by the TPO. Further, referring to the comparables for benchmarking the international transactions, rejecting most of the comparables except few as selected by the assessee and selecting fresh set of comparables, the TPO stated that the median OP/VAE of the comparables is proposed to be taken at 55.27% and using the same, arms length revenues of the assessee were determined at Rs.389,85,63,762/- as against reported operating revenues of Rs. 360,60,46,377/- resulting in a difference of Rs.29,25,17,385/- which was proposed as an adjustment u/s 92CA of the Act. Thereafter, the Transfer Pricing Officer passed an order u/s 92CA(3) of the Act dated 25.10.2019 proposing an adjustment of Rs.29,25,17,385/- and taking into consideration the adjustment so proposed by the Transfer Pricing Officer, the draft assessment order u/s 143(3) read with section 144C(13) of the Act was passed by the Assessing officer on 13.11.2019 wherein adjustment on account of transfer pricing as proposed by the Transfer Pricing Officer was made and the assessed income was determined at Rs.57,36,47,429/-. 3. Against t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... racterized as a routine manufacturer performing all the entrepreneurial functions and accordingly, the assessee applied the GP/COP as the PLI and choose CPM as the most appropriate method for the purpose of benchmarking analysis in the TP documentation. It was stated that the TPO failed to appreciate that the assessee is engaged in manufacturing activities in complete disregard to the facts of the case, functional profile of the assessee, established legal principles and internationally accepted transfer pricing guidelines. Thereafter, the TPO rejected assessee s benchmarking approach and applied Berry Ratio by observing the following in the TP order as under: In this case the Appellant is purchasing from related parties and selling to related parties. So, both cost and revenue sides are tainted. In this scenario, OP/Cost of Production will not be an appropriate PLI. OP/VAE has been chosen as PLI 7. In this regard, the Ld AR submitted that nowhere it is mentioned in either the Indian TP regulations, OECD Guidelines or the UN TP Manual that Berry Ratio is an appropriate method when both sales and cost sides are tainted. In fact, as per the aforementioned rules, regulations and guide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rry Ratio is mostly used with low-risk procurement and distribution service providers, which have no funds blocked in inventories and employ no intangible assets. The Ld. AR drawn our attention to the financial statements of the assessee at Page 47-72 of the Paper Book for a detailed break up of inventories and other assets of the assessee and stated that the aforesaid analogy is considered under UN TP manual (2017) as well, extract of which is enclosed on Page 379 of the Paper Book. It was stated that a similar view has been adopted in the OECD guidelines (2017) and relevant extract of the same is submitted at Page 376-378 of the Paper Book. The Ld. AR also relied upon the following judicial precedents which clearly states that Berry ratio can be effectively applied in cases of stripped-down distributors, which have no financial exposure and risk in respect of goods distributed by them: Delhi ITAT's decision in case of Mitsubishi Corporation India Pvt. Ltd (ITA number 5042/Del/l1 dated 21st October 2014) Delhi High Court's decision in the case of Sumitomo Corporation India Private Limited (ITA number 381/2013 dated 22nd July 2016) Ahmedabad ITAT Bench decision in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s AEs have made very nominal or no profit during the year under consideration as per details below: Sr.No. Name of AE OP/OR(%) 1. STS Gems Limited, Hong Kong -3.88% 2. Jewel Gem USA Inc., USA 2.30% 3. STS Gems Thai Limited, Thailand 4.70% 4. The Jewellery Channel Limited, UK 3.67% 5. The Jewellery Channel Inc., USA -1.34% 6. STS Gems Limited, Japan - 7. STS Jewels Inc., USA 4.20% 14. It was submitted that the fact that VGLs operating margin (9.72%) is significantly higher than that of the AEs and there is no motive for the assessee to shift profits outside India and therefore, no adjustment is warranted. Further, any transfer pricing adjustment to the aforesaid transaction of VGL with its AEs would lead to double taxation. 15. Per contra, the Ld. PCIT DR has drawn our reference to the findings of the TPO as well as the DRP. The findings of the TPO are already noted above. As far as the findings of the DRP are considered, the contents thereof read as under: 4.1.1 Ground number 1 is related to the overall proposed TP adjustment of Rs. 29,25,17,385/- on account of application of Berry ratio as PLI by the TPO. As all the sub grounds 1.1 to 1.10 are concerned with this same issue, they ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the order of the AO/TPO on this issue. 16. The ld PCIT/DR also referred to the report of the Transfer Pricing Officer dated 16.11.2011 and contents thereof read as under: 2. In the above context, point wise reply to the contentions raised by Ld. AR was sought from this office. The point wise replies to the contentions are given below:- i) Comments on show cause notice was not considered. In the last paragraph of show cause notice dated 15.10.2019, it was dearly stated that if the Taxpayer does not attend hearing on the said date i.e. 18.10.2019 or any other date communicated by the TPO, it is presumed that the tax payer does not want to avail the opportunity of hearings and in that case, the proceedings would be continued or decided based on the written submission made and/or material available on record. Again, the noticed 16,10,2019 was issued providing the last opportunity to submit the reply of above-mentioned show cause notice by 18.10.2019. However, the reply of the assessee or any other intimation had not been received in this office till 24,10.2019 and the TP proceedings had been concluded with the materials on record and order u/s 92 CA(3) of the income Tax Act 1961 w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7. Further drawing our reference to the Annual Financial Statements of the assessee company, it was submitted that the assessee is an international electronic retailer of fashion jewellery and in year 2015-16 through its e-stores represented by US and UK TC channels and supported by ecommerce platform, it had sold 8.1 million products and generated Rupees 1276 crores in revenues. It was accordingly submitted that the assessee is basically a retailer where it buys goods from its related entities and has substantially sold to its related entities and, therefore, the TPO has rightly applied Operating Profit/Value Added Expenses as an appropriate PLI and rejecting the Gross Profit/Cost of Production as adopted by the assessee. It was accordingly, submitted that there is no infirmity in the order of the DRP which has rightly confirmed the adoption of Operating Profit/Value Added Expenses as an appropriate PLI and, therefore, the transfer pricing adjustment has been rightly confirmed by the DRP which may kindly be affirmed and no interference is called for in the impugned so passed by the Assessing officer. 18. In his rejoinder, the ld AR submitted that the ld PCIT DR has referred to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,23,34,698 20 a. Cost of Materials Consumed Particulars Year ended 31st March, 2016 (Rs.) Materials Consumed Opening Material-inprocess 72,68,15,922 Add: Purchases 2,69,18,74,749 3,41,86,90,671 Less: Closing Material-inprocess 1,14,71,78,872 2,27,15,11,799 2,27,15,11,799 20 b. Particulars of Material Consumed Particulars Year ended 31st March, 2016 (Rs.) Gem Stones 1,46,47,89,128 Alloys 55,98,204 Diamond 12,57,03,250 Gold 14,06,08,480 Platinum 69,98,367 Silver 41,34,12,926 Parts Findings 9,36,19,065 Others Metal 2,07,82,379 2,27,15,11,799 25 Other Expenses a. Manufacturing Expenses Particulars Year ended 31st March, 2016 (Rs.) Job Work Charge 29,71,74,362 Stores and Consumables 5,64,85,051 Power and Fuel 3,57,87,155 Repairs and Maintenance # 1,22,48,322 Other Manufacturing Expenses 1,32,81,415 41,49,76,305 19. We have heard the rival contentions and perused the material available on record. As contended by the ld AR during the course of hearing, the principle dispute which arises in the present case is adoption of appropriate PLI for benchmarking and determining the arms length nature of the international transactions undertaken by the assessee company with its associated enterpris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... another method or financial indicator. 2.108 A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. 21. Further, we refer to the United Nation Practical Manual on Transfer Pricing for developing countries (2017) wherein the relevant discussion reads as under: B.3.3.7.3. Although all of the above PLIs are possible, the three PLIs: (i) return on capital emplo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by distributors and service providers in situations where their value-added functions can be considered to be reflected in the operating expenses. Consequently, it may be appropriate to use the Berry Ratio if the selling or marketing entity is a service provider entitled to a return on the costs of the provision of its services. However, some key limitations of the Berry Ratio are: The Ratio is very sensitive to functions and classifying of cost as operating cost; It misses values of cost needed to maintain the intangible property of an entity; and Its reliability diminishes if asset intensities (the efficiency with which assets are used) of the entities differ. 22. Further, the Hon'ble Delhi High Court in the case of Sumitomo Corporation India Private Limited Vs. CIT (Supra) had an occasion to examine the applicability of Berry ratio and the relevant findings reads as under: 45. Traditionally, the denominator of the ratio only comprised of selling, general and administration expenses. However, the Treasury Legislation of USA also included depreciation as a part of the Operating Expenses used as a denominator in the berry ratio. As is apparent, Berry ratio has limited applicab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pect of the goods distributed by them. 23. Further, we refer to the Coordinate Delhi Benches decision in the case of Mitsubishi Corporation India Private Limited Vs. DCIT (Supra) and the relevant discussion and findings are contained at paras 44 to 59 of its order which read as under: Berry ratio: connotations and its background 44. Simply put, berry ratio is ratio of gross profit to the operating expenses. 45. Unlike in Indian TP regulation, wherein no specific ratios are prescribed, US Regulation 4825(b)(ii)(4)(B) accepts this PLI as one of the financial ratios that may be appropriate to measure the arm s length price, even though it puts a rider that, reliability under this profit level indicator also depends on the extent to which the composition of tested party s operating expenses is similar to that of the uncontrolled comparables . So far as Indian TP provisions are concerned, the PLIs set out in rule 10B(1)(e)(i) are only illustrative inasmuch as it ends with the expression or having regard to any other relevant base but there is no prohibition as such on the use of this ratio. However, having regard to the use of this ratio worldwide, and for the reasons we will set out in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. 47. As evident from the underlined portion of the OECD approach, highlighted above, berry ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade intermediary, the value of services performed by the entity is adequately reflected by operating expenses, the value of functions performed and assets employed in the controlled transactions is not proportionate to sales and when the entity does not perform any significant operations such as manuf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sks, though certainly much more risks than in a back to back trading, associated with inventories or with uncertainties of normal trading. The key contribution to the economic activity was recognized as performing the distributorship function rather than the value of goods sold. Accordingly, distributors must achieve a particular gross profit in order to compensate them for their services, the costs of which are accounted for, almost entirely, in their operating expenses. To reflect the reality of distributors' economic significance and to provide an arm's length return to DuPont's Swiss subsidiary, Berry utilized a ratio that has since been named in his honor and is computed as gross profit to operating expenses. There are some variants to this ration but that aspect of the matter is not really relevant for the present purposes. 51. The underlying assumption for applicability of berry ratio is that the return to the tested party should be commensurate with his operating expenses and the value of goods dealt in was irrelevant for this purpose. While this proposition so laid down was in the case of a limited risk distributor without any value addition to the goods or sig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ds, is irrelevant. Distributors must achieve a particular gross profit in order to compensate them for their value-adding services, the costs of which are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr. Berry on this aspect reads as under:- Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is a measure of the activities of the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the product distributed, or the value of the exposure provided by radio, television or print media . 6.5 It is contended that the Berry ratio is merely a variant of the cost plus method. If one were to think ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... DIRECT AND IS DILUTED BY USE OF MORE FUNCTIONS (SUCH AS PROCESSING), MORE ASSETS (SUCH AS SIGNIFICANT CURRENT ASSETS OR UNIQUE INTANGIBLES) AND MORE RISKS (SUCH AS RISKS ASSOCIATED WITH INVENTORIES); APPLICATION OF BERRY RATIO IS NOT JUSTIFIED 57. In our considered view, to sum up, in a situation in which a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. In such a situation, no other costs are relevant since (a) the cost of goods sold, in effect, is loses its practical significance, (ii) there is no value addition, and, accordingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 58. In typical cases of pure international trading, there is neither any processing of goods involved nor is there use of any significant trade or marketing intangibles. The inventory levels are also extremely low, at least with respect to the goods traded, since the nature of activity does not re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een outsourced by the AE to one M/s R. M. Martine, since inception of the AE. The AE had its own funds, undertook business risk and many instances of such risk which actually borne by AE pertaining to various vessels have been proved with evidence. The payment of hire charges, bunker charges, port charges have been made by the AE from its own funds evidenced by cash flow statement could not be controverted by revenue. In our studied and considered view the AE has performed proper business functions, assumed business risks by employing its own funds independently without help of appellant and, therefore, in no way AE can be considered as pure distributor. In view of these facts and circumstances, the Berry ratio is not at all applicable in the present case. Our view is fortified by Hon'ble Delhi High Court judgment in the case of Sumitomo Corpn. (supra) 6.6 In Transfer Pricing study, it is imperative to employ proper understanding of business, business practice, functions performed by AE and the appellant, risks assumed by both the parties and the assets employed by both of them is very relevant. In our view Id. TPO/AO did not properly appreciated the functions performed, risk a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... way of its subsidiaries. VGL is one of the largest exporters of colored gemstones from India also one of the largest exporters of studded Jewellery. VGL processes gems and raw materials into rings, bracelets, pendants, etc. and export it to its associated company in U.S.A and other overseas countries, in financial year 2005-06, VGL become an Indian MNC, perhaps the first in the Indian gems and Jewellery sector by extending its operations in more than 10 countries through the acquisition of Companies of STS Group and extending its Retail Stores network at major holiday destination of the world from 12 to 19. It has also launched operation through TV channels by its associates i.e., The Jewellery Channel Ltd, UK and Jewellery Channel, USA. VGL is professionally managed, end-to-end vertically integrated gems and jewellery business organization. It is one of the eight world-wide 'sight holder' in Tanzanite and is the leader in processing other popular gemstones such as Fire Opal, Apatite and Emerald. Procuring directly from the sources, it imports raw material like Stones, Rough Gems Stones, Chains, Findings, Diamond, Mounting and Preform, etc. The raw materials imported underg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee while carrying out its manufacturing activities, it is noted from the transfer pricing report and the financial statements placed on record that the assessee performs the functions of purchases, product conceptualization and designing, manufacturing/processing of final product, sales and marketing and after sales services. It has the necessary manufacturing set up with requisite assets and infrastructure in place which are employed. The associated enterprises perform substantial part of marketing, sales and distribution functions. The assessee takes all types of risk such as inventory risk, credit collection Risk, product risk, manpower risk, market risk (to limited extent), technology risk, general business risk and foreign exchange risk. Therefore, we donot find any infirmity in assessee being classified as a manufacturer performing all the entrepreneurial functions. It is again noted that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the functions performed, the assets employed and the risk undertaken (nature and extent thereof) by the assessee while carrying out its business of manufacture ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sts of production incurred by the enterprise in respect of the goods transferred to an associated enterprise are determined. To this, a normal gross profit mark up in the same or similar comparable uncontrolled transactions by the enterprise or an unrelated enterprise is added. The price so arrived at is then adjusted to take into account the functional and other differences between the international transactions and comparable uncontrolled transactions which could materially affect the amount of gross profit margin in the open market to arrive at the ALP. The CPM method is used to test transfer price of manufacturers, assemblers and others that add value. Determination of comparability under the CPM depends in particular on similarity between functions employed. In the instant case, as VGL during the year has mainly exported Gold / Silver Studded Jewellery, we have determined CPM as the most appropriate method due to following reasons: - a. Comparability between international transactions and comparable transactions: VGL's export to AE's mainly consists of Gold/Silver/Other Metal Studded Jewellery which forms more than 80% of the total turnover of the VGL. Since in current ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /VAE as the appropriate PLI. 33. The reasoning adopted by the TPO is that as the assessee is purchasing from related parties and selling to related parties, both cost and revenue sides are tainted and in such a scenario, OP/COP will not be an appropriate PLI and OP/VAE has then been adopted by him. The DRP has upheld the reasoning so adopted by the TPO drawing reference to the decision of Hon ble Delhi High Court in case of Sumitomo Corporation (Supra) where use of berry ratio in certain situations has been upheld even though the Income Tax Act doesn t specifically provide for either the Berry ratio or the bright line test. 34. Firstly, referring to the decision of the Hon ble Delhi High Court in case of Sumitomo Corporation (Supra), in that case, it was held that Berry ratio can be used effectively where the value of goods have no role to play in the profits earned by the assessee and the profits earned are directly linked with the operating expenditure incurred by the assessee. It has been held that where the assessee uses intangibles or has substantial fixed assets, the value of such intangibles or value addition by such assets would not be captured in the operating cost and thu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d expenses and quantum thereof in the face of these undisputed facts and circumstances of the case ignoring the manufacturing functions and risk so undertaken and the asset employed by the assessee. We therefore find that the decision of the Hon ble Delhi High Court doesn t support the case of the Revenue rather its supports the contentions advanced by the ld AR on behalf of the assessee. 35. Now, coming back to the reasoning adopted by the TPO where he says that since the assessee is purchasing from related parties and selling to related parties, both cost and revenue sides are tainted and in such a scenario, OP/COP will not be an appropriate PLI and OP/VAE has then been adopted by him. It appears that the TPO seems to be guided by some misconception that the assessee is in the business of trade intermediary where it buys from its associated enterprises and then, sells to its associated enterprises. As we noted above, the undisputed facts are that the assessee is a manufacturer and exporter and as part of its activities, it procures certain goods from its associated enterprises which constitute merely 21.09% of its total purchases besides purchases from other entities, process the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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