2022 (12) TMI 542 - AT - Income Tax

Tribunal directs deletion of certain additions, upholds expense adjustment, and emphasizes international transaction benchmarking.

The Tribunal partially allowed the appeal, directing the AO to delete additions made for the purchase of raw materials and components, data management and ... TP Adjustment - proposed downward adjustment made by the AO/TPO on account of raw materials and components purchased from the AEs which was not in accordance to the arm’s length principles - whether the action of the TPO was correct to adopt the comparable selected by the assessee for its contract manufacturing activity for the purpose of comparing the margin with the PLI of the assessee to determine the ALP? - HELD THAT:- The answer stands in negative. It is for the reason that the comparable selected by the assessee were based on the import of raw materials whereas the comparable used by the TPO were based on sale of finished goods. As such the basis/methodology for selection of comparables with respect to purchase of raw materials and components viz a viz sale of finished goods cannot be the same. Thus, the entire basis adopted by the TPO for comparing the PLI of the assessee with respect to the import of purchases of raw materials and components viz a viz sales of finished goods is baseless and devoid of any merit. It is for the reason that both the transactions are different and independent to each other and therefore no nexus of whatsoever between them could be established. This fact was very much brought to the notice of the TPO during the assessment proceedings by the assessee vide letter dated 25th January, 2021. The action taken by the TPO which was subsequently confirmed by the Ld. DRP is not maintainable in the given facts and circumstances. Whether the TPO was right in rejecting the comparables selected by the assessee with respect to its transactions of purchases of raw materials and components from the AE’s? - In the absence of any specific defect pointed out by the authorities below with respect to comparable selected by the assessee, we are not in agreement with the decision of the authorities below for selecting the other comparable which were chosen by the assessee for its sale of finished goods of its contract manufacturing unit. In holding so, we draw support and guidance from the judgment of Frigoglass India (P.) Ltd[2014 (4) TMI 556 - ITAT DELHI] Admittedly the assessee has categorized its segments in four compartments which have been discussed in the preceding paragraph. The assessee further has made two compartments under the category of license manufacturing which was based on the basis of purchases for raw materials and components from associated enterprise and non-associated enterprise. All these segments were duly reported under the transfer pricing study report and this fact can be verified from - This fact was also accepted by the TPO in his order that there exists a separate AE Segment under license manufacturing. As per the judgment of Virtusa Consulting Services Pvt. Ltd.[2021 (2) TMI 378 - MADRAS HIGH COURT]the transfer pricing report is considered as one of the authentic document which cannot be ignored while determining the ALP until and unless some adverse material is available on record. As assessee, has applied the internal TNMM method as most appropriate and from the aforesaid rule we note that the rule 10B of the rules has to be apply to select the method for the purpose to determine the ALP and TNMM method could be applied as internal as well as external. Whether the margin shown by the assessee under the contract manufacturing can be compared with the license manufacturing? - We find that the risk involved under contract manufacturing is less and the assessee is also not required to maintain the inventory at its own risk whereas in the case of license manufacturing the assessee has to maintain its own inventory and greater risk is attached under this segment. Thus, we are of the view that the profit margin of the contract manufacturing segment cannot be compared with the license manufacturing. As such an apple can be compared with another apple that is the underlying theory/ concept of the transfer pricing provisions. In this connection we draw our attention to the order in the case of ACIT Vs. Ishwar Manufacturing Co. Pvt. Ltd. [2016 (3) TMI 535 - ITAT CHANDIGARH] wherein it was held that For making a comparative analysis, apples are to be compared with apples and not with oranges. We are not convinced with the order of the authorities below for adopting the margin of the contract manufacturing as comparable to determine the ALP with respect the purchase of raw materials from the AE’s under the activity of license manufacturing. Once we have accepted the transaction shown by the assessee for the import of raw materials and components at the arm length price, no adjustment with respect to other transactions aggregated with the transactions in dispute is required to be made. In other words, the impugned transactions discussed above have to be treated at arm length price as applicable for the purchase of raw materials and components. As contended before us by the learned AR for the assessee that whatever adjustments needs to be made by the revenue authorities should be with respect to the international transactions with the AE which are in dispute - We find force in the argument of assessee and accordingly direct the revenue to make the adjustments with respect to the international transactions with the AE’s which are in dispute. However, we are conscious to the fact that the direction at this stage will not make any difference to the assessee for the reason that the appeal has been decided in favour of the assessee. However, we have recorded this observation for the statistical purposes. Enhancing the income in relation to receipt of data management and other related service fees paid by the Appellant to its AEs by rejecting the TP documentation maintained by the Appellant and arbitrarily determining arm’s length price as ‘Nil’ by applying Comparable Uncontrolled Price Method(“CUP”) Method - It is pertinent to mention here that there is no dispute on the legal proposition that if the TPO finds that the method applied by the assessee is not appropriate, it can carry out his own analysis however he has to follow the methodology as provided in Chapter-X of the Income-tax Act. Starting point for applying the CUP method as per the transfer pricing provisions is availability of the price of the same product or service in uncontrolled conditions and according to that the ALP of the product or service can be ascertained. Thus, the action of the TPO of applying CUP method and at the same considering the value of such transaction as Nil in absence of comparable uncontrolled transactions, is in itself contradictory and without any basis/logic. Therefore, the contention of the TPO to apply CUP method as MAM is not tenable under the law. The entire grounds consists of two issues, whether in fact the services were rendered and availed by the assessee and if so, whether the mark-up of 6% can be considered as comparable with the market averages. Culling from the details filed and arguments of both the parties, we find that there is no dispute about availing of the services. The evidences include the invoices, agreements along with details of cost allocation submitted - Hence, it cannot be said that the services have not been provided to the assessee. With regard to the mark-up of 6% paid by the assessee, we find that the economic analysis submitted by the assessee in TPSR available in the paper book is acceptable. Hence, we hold that no adjustment is called for while determining the ALP on account of payment for Intra Group Services in the form of Data Management and Other Related Services. Reimbursement of expenses received from the AEs - DRP enhancing the income of the Appellant pertaining to reimbursement of expenses received from the AEs by re-characterizing “reimbursement of expenses received” as “provision of support services” thereby imputing a markup of 5% on the cost of the reimbursements without providing any detailed/cogent reason for the same - HELD THAT:- Before us no material has been placed by Revenue to demonstrate that value addition has been done by the assessee and is not in the nature of reimbursement of primary third party expenses which were initially incurred by the assessee. Admittedly, there was no value addition done by the assessee by incurring the cost on behalf of the AE which was subsequently reimbursed. However, such transaction falls within the definition of international transaction with the AE and therefore the same needs to be benchmarked. A non-associated party will not incur any cost without having any benefit from the party. Indeed, the assessee must have employed its resources in providing administrative services to the AE and therefore we are of the view that the assessee should have charged some amount of fees on account of such transaction. However, the assessee in the given case has not determined the ALP of the transaction in hand, therefore the same was benchmarked by the AO/TPO on reasonable basis. As such it was the onus upon the assessee to bench-mark the transactions in hand but it failed to do so. Hence, we do not find any infirmity in the order of the authorities below. Thus, the ground of appeal of the assessee is hereby dismissed. Issues Involved:1. Legality of the order passed by the AO under Section 143(3) read with sections 144C(13) and 144B of the Income Tax Act.2. Rejection of the economic analysis and selection of foreign AEs as tested parties in the Transfer Pricing (TP) documentation.3. Enhancement of income by INR 1,370,919,013 for purchase of raw materials and components.4. Enhancement of income by INR 218,597,391 for data management and related service fees.5. Enhancement of income by INR 102,686,415 and INR 44,956,472 for purchase of fixed and intangible assets.6. Enhancement of income by INR 150,838,054 for payment of trademark fees.7. Enhancement of income by INR 1,684,889 for reimbursement of expenses.8. Initiation of penalty proceedings under sections 274, 270A, and 271AA of the Act.Detailed Analysis:1. Legality of the OrderThe first and second issues raised by the assessee were deemed general and dismissed as infructuous.2. Economic Analysis and Selection of Tested PartiesThe Tribunal found that the assessee failed to provide sufficient documentary evidence, such as financial statements of the foreign AEs, to substantiate the margin. The Tribunal upheld the rejection of foreign AEs as tested parties due to the lack of reliable data and appropriate documentation. The Tribunal emphasized that the tested party should be the least complex entity with reliable data for comparison.3. Enhancement of Income for Purchase of Raw Materials and ComponentsThe Tribunal noted that the TPO rejected the ALP determined by the assessee due to various deficiencies, including the lack of financial data of AEs and improper selection of comparables. The Tribunal disagreed with the TPO's methodology of comparing the margin of the assessee with the comparables selected for contract manufacturing activity. The Tribunal held that the profit margin of contract manufacturing could not be compared with license manufacturing due to different risk profiles and operational complexities. The Tribunal directed the AO to delete the addition made.4. Enhancement of Income for Data Management and Related Service FeesThe Tribunal found that the TPO's application of the CUP method and determining the ALP as 'Nil' was arbitrary and not in line with the provisions of rule 10B(1)(a). The Tribunal accepted the economic analysis submitted by the assessee, showing that the mark-up of 6% was within the acceptable range. The Tribunal held that the services were indeed rendered and no adjustment was warranted.5. Enhancement of Income for Purchase of Fixed and Intangible AssetsThe Tribunal noted that the TPO aggregated the transactions of purchase of fixed and intangible assets with the purchase of raw materials and components. The Tribunal found no merit in the TPO's rejection of the economic analysis carried out by the assessee. The Tribunal directed the AO to delete the addition made.6. Enhancement of Income for Payment of Trademark FeesThe Tribunal found that the TPO's aggregation of the transaction of payment of trademark fees with the purchase of raw materials and components was not justified. The Tribunal held that the assessee had provided sufficient economic analysis to benchmark the transaction separately. The Tribunal directed the AO to delete the addition made.7. Enhancement of Income for Reimbursement of ExpensesThe Tribunal noted that the expenses incurred by the assessee on behalf of its AEs were reimbursed on a cost-to-cost basis. However, the Tribunal held that the transaction needed to be benchmarked as it fell within the definition of an international transaction. The Tribunal upheld the TPO's adjustment of a 5% mark-up on the reimbursement of expenses.8. Initiation of Penalty ProceedingsThe Tribunal did not provide a separate analysis for the initiation of penalty proceedings, as the primary issues were resolved in favor of the assessee.ConclusionThe Tribunal allowed the appeal of the assessee in part, directing the AO to delete the additions made for the purchase of raw materials and components, data management and related service fees, purchase of fixed and intangible assets, and payment of trademark fees. However, the Tribunal upheld the adjustment made for the reimbursement of expenses.