2016 (7) TMI 15 - AT - Income Tax

Tribunal directs fresh examination of comparables & allows conversion charges as business expenditure

Gap International Sourcing (India) Pvt. Ltd. Versus DCIT, Circle 10 (1), New Delhi

The Tribunal partly allowed the appeal, directing the Transfer Pricing Officer (TPO) to re-examine comparables and benchmark international transactions ... Transfer pricing adjustment - valid remuneration model for benchmarking the TP adjustment - cost plus form of remuneration v/s commission based remuneration - Held that:- As relying on assessee’s own case qua the assessment years 2006- 07 and 2007-08 and case from Li & Fung India Pvt. Ltd. vs. DCIT [2011 (9) TMI 204 - ITAT, New Delhi] wherein remuneration model of markup of 5% on the operation cost without considering the value of the cost procured by the AE directly from the third party vendors in India has been held as a valid remuneration model for benchmarking the TP adjustment. So, we are of the considered view that the assessee is not into buy and sell rather it is a facilitator/service provider and its compensation model at ALP would not be commission of FOB cost of goods sourced from India, rather assessee company is entitled to cost plus remuneration and not a commission based remuneration. Bench marking the international transaction by using appropriate comparables - Held that:- TPO has not made a fair analysis of the comparables, though chosen by the assessee in its TP study for the AY 2007-08, rather relied upon his own finding for the earlier years which have undisputedly been set aside by the Tribunal. So, we are of the further opinion that the ld. TPO to benchmark international transactions afresh by examining the suitable comparables by providing opportunity of being heard to the assessee. So, file is ordered to be restored to the TPO to benchmark the international transactions in the light of the observations made hereinbefore. Disallowance of rent expenses being conversion charges paid to the Municipal Corporation of Delhi (MCD) - Held that:- DRP/AO have erred in disallowing the expenses of conversion charges claimed by the assessee and then added the same to the total income of the assessee company which are not to be considered as capital expenditure as the same have been expended for business purpose and without conversion of the property, the business would not have been started even and as such, allowable for deduction 1. ISSUES PRESENTED AND CONSIDERED 1. Whether the remuneration for provision of sourcing support services to associated enterprises satisfies the arm's length principle and whether the appropriate remuneration model is cost-plus (markup on operating cost) or commission on FOB value of goods sourced. 2. Whether the Transfer Pricing Officer/Dispute Resolution Panel correctly rejected the assessee's benchmarking (comparables, multiple-year data and OP/TC PLI) and correctly selected alternate comparables and applied an OP/OC margin on total FOB exports to compute ALP. 3. Whether the value of goods sourced directly by associated enterprises from third-party vendors should be included in the assessee's cost base or FOB export value for computing ALP on sourcing services (i.e., whether location savings, supply-chain and human asset intangibles attributable to the assessee justify treating it as owner of intangibles and applying commission on FOB value). 4. Whether earlier coordinate Tribunal and High Court findings in the assessee's own matters and in Li & Fung support the cost-plus model and/or preclude the revenue's contrary approach; and whether those precedents were properly considered. 5. Whether conversion/municipal ('MCD') charges paid through a consultant and claimed as rent/administrative expense are capital in nature or are allowable business expenditure. 6. Ancillary questions: whether interest under s.234B and penalty under s.271(1)(c) were wrongly levied (raised but not finally determined by the Tribunal in the present order). 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Appropriate transfer pricing remuneration model for sourcing support services (cost-plus v. commission on FOB). Legal framework: Arm's length principle under domestic TP provisions requires selection of the most appropriate transfer pricing method based on FAR (functions, assets, risks). Cost-plus is appropriate for routine service providers performing low-risk support functions; profit-split or commission on transaction value may be invoked where unique intangibles, significant integrated functions or interlinked transactions exist. Precedent treatment: Coordinate Tribunal decisions in the assessee's own earlier years accepted the assessee as a service/facilitator entitled to cost-plus remuneration; the jurisdictional High Court/Li & Fung authority (as applied) upheld remuneration measured as markup on operating cost without including the value of goods procured directly by AEs. Interpretation and reasoning: The Tribunal examined the assessee's FAR and earlier coordinate-bench findings and concluded the assessee performs routine, low-risk liaisoning and coordination for sourcing - it does not procure title, create supply-chain intangibles or bear major risks, nor does it develop unique intangibles or capture location savings warranting a commission on FOB. The Tribunal found the TPO/DRP's characterisation (that assessee controls critical merchandising, quality, logistics and owns human/supply-chain intangibles) inconsistent with earlier undisputed findings and with the documentary record as interpreted by the Tribunal. Ratio vs. Obiter: Ratio - where an entity functions as a sourcing facilitator performing routine, low-risk functions without creation or ownership of unique intangibles, cost-plus remuneration is the appropriate ALP method. Obiter - comments on commercial advantage to AE by low cost goods and general statements about intangibles not specifically established on evidence. Conclusion: The Tribunal held the assessee is entitled to cost-plus remuneration and rejected the TPO/DRP conclusion that commission on FOB was the correct ALP model; direction given to remit benchmarking to TPO consistent with this method where necessary. Issue 2 - Selection and treatment of comparables, use of multiple-year data, and correctness of TPO's benchmarking applying OP/OC on FOB exports. Legal framework: Selection of comparable uncontrolled enterprises must reflect similarity in functions, assets and risks; PLI must be appropriate (OP/TC or OP/OC) and statistical measures (mean median, use of multi-year data) are subject to reasoned justification and consistency with TP documentation. Precedent treatment: The assessee used six comparables with OP/TC PLI and multi-year data yielding an OP/TC mean of 13.28%; TPO substituted a different set of retail/trading comparables yielding OP/OC average 5.33% and applied it to FOB exports. The Tribunal noted earlier Tribunal orders accepting cost-plus approach and comparable selection for prior years and observed revenue had not successfully challenged those orders. Interpretation and reasoning: The Tribunal found the TPO's comparable selection and methodology relied on an inconsistent search criterion and on results from earlier years that had been set aside by the Tribunal. The TPO did not fairly analyze the comparables proposed in the assessee's TP study for the relevant year; the change in search criteria was not explained in TP study. Consequently, the Tribunal restored the file to the TPO to benchmark afresh, giving the assessee opportunity to be heard and to ensure comparables and PLI are appropriate to the correct FAR and the adopted cost-plus model. Ratio vs. Obiter: Ratio - benchmarking must be carried out afresh by TPO with reasons, consistent search criteria, and respect for prior unchallenged coordinate-bench decisions; use of comparables cannot be arbitrary or based on criteria inconsistent with the assessee's functions. Obiter - criticism of the TPO's reliance on earlier findings as if sitting in appeal on prior years. Conclusion: TPO's benchmarking and application of a 5.33% OP/OC on FOB exports was not sustained; matter remitted to TPO for re-benchmarking in light of the Tribunal's finding that the cost-plus model applies and consistent with appropriate comparable selection and PLI. Issue 3 - Inclusion of FOB value of goods sourced by AEs and attribution of intangibles/location savings to the assessee. Legal framework: Profits attributable to a service provider are determined by reference to functions performed and the value created; allocation of profits on account of location savings or intangibles requires evidence that the tested party created, owned or exploited those intangibles or captured location advantages beyond routine functions. Precedent treatment: Earlier Tribunal decisions in the assessee's own cases and relevant High Court authority rejected inclusion of FOB value when the tested party was a routine service provider and did not own the goods or unique intangibles. Interpretation and reasoning: The Tribunal held there was insufficient evidence that critical supply-chain or human asset intangibles were created or owned by the assessee; key commercial decisions (vendor selection, pricing, product design, quality parameters) were taken by overseas AEs. Therefore, inclusion of FOB values and treating the assessee as owner of intangibles to justify commission on goods was not warranted. Ratio vs. Obiter: Ratio - absent demonstration that the tested party creates/owns intangibles or captures location savings, the value of goods sourced by AEs should not be folded into the service provider's remuneration base. Obiter - general observations on how location savings are to be demonstrated. Conclusion: The Tribunal rejected TPO/DRP approach of including FOB value on grounds of alleged intangibles/location savings; affirmed cost-plus approach tied to operating cost base only. Issue 4 - Effect of prior Tribunal/High Court decisions and whether revenue's contrary treatment was permissible. Legal framework: Precedent of coordinate Tribunal and higher courts are relevant; revenue may reopen or differ only with valid legal basis. Undisturbed Tribunal orders in prior years bearing on same taxpayer and same FAR are persuasive and must be considered unless distinguishable by facts. Precedent treatment: Several prior Tribunal orders in the assessee's own case in earlier assessment years accepted cost-plus; High Court authority in Li & Fung supported mark-up on operating cost without including value of goods. Revenue had not successfully appealed those Tribunal orders to a higher forum. Interpretation and reasoning: The Tribunal applied and followed the coordinate-bench and High Court authorities, noting the TPO/DRP repeatedly relied on findings already set aside by the Tribunal. The TPO's attempt to re-characterize facts without distinguishing the prior decisions or adducing new evidence was rejected. Ratio vs. Obiter: Ratio - prior unchallenged Tribunal findings concerning FAR and appropriate remuneration are binding for assessment years with materially identical facts and must be respected unless cogent evidence of change exists. Obiter - commentary on TPO acting like appellate authority on earlier years. Conclusion: The Tribunal followed coordinate precedents and held revenue erred in disregarding those decisions; directed reconsideration consistent with precedents. Issue 5 - Allowability of conversion / MCD charges (claimed as rent expense). Legal framework: Expenditure incurred for enabling use of premises for business is allowable as revenue expenditure unless it falls within statutory/explanatory provisions rendering it capital; determination depends on nature, enduring advantage and connection with business operations. Precedent treatment: Coordinate Bench decisions (Kalinga International and others) held conversion charges paid to municipal authority for enabling use of premises for business are revenue in nature and allowable. Interpretation and reasoning: The Tribunal found conversion charges were necessary to enable use of premises for carrying on business; payment was not for construction, renovation or enduring improvement as contemplated by Expln.1 to s.32(1), and was therefore revenue in nature. The TPO/DRP/AO erred in classifying the payment as capital without establishing enduring advantage or breach of municipal law facts. Ratio vs. Obiter: Ratio - conversion charges paid to municipal authority to enable use of third-party premises for business are revenue and deductible where they do not create enduring advantage or constitute capital works. Obiter - reference to other favorable coordinate decisions. Conclusion: The Tribunal allowed the deduction of Rs.1,75,16,800 as revenue expenditure and set aside the disallowance. Issue 6 - Interest and penalty. Legal framework and treatment: Issues of interest under s.234B and penalty under s.271(1)(c) were raised by the assessee but not finally adjudicated in detailed terms in the present order. Interpretation and reasoning: The order indicates these grounds were asserted by the assessee ('without prejudice') but the Tribunal's operative directions relate to TP benchmarking remand and allowability of conversion charges; interest/penalty issues were not ultimately decided for determination in this order. Ratio vs. Obiter: Obiter - no substantive ratio given on interest/penalty as not finally determined. Conclusion: Interest and penalty contentions remain undetermined by the Tribunal in this order (no relief granted or refused on merits in the operative portion); appeal was partly allowed for statistical purposes with remand as recorded.