Routine fashion distributor held tested party; Resale Price Method u/s 92C upheld, transfer pricing adjustment on imports deleted

ITAT Delhi held that the assessee, engaged in fashion retail as a routine distributor of finished goods imported from its AE without any value addition, is the appropriate tested party for transfer pricing analysis. Classifying the AE as the principal assuming core entrepreneurial and business risks, the Tribunal ruled that Resale Price Method (RPM), not Transactional Net Margin Method (TNMM), is the most appropriate method for benchmarking the international transaction of import of finished goods. The assessee's gross profit/sales margin under RPM was accepted as correctly determining the arm's length price, and the TP adjustment was deleted.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether, for the international transaction of import of finished goods for resale without value addition by a routine distributor, the Resale Price Method or the Transactional Net Margin Method is the Most Appropriate Method for determination of arm's length price.

1.2 Whether incurring substantial advertisement, marketing and promotion and related brand-building expenses by a distributor precludes adoption of the Resale Price Method.

1.3 Consequential treatment of brought forward business loss and unabsorbed depreciation in light of the decision on transfer pricing adjustment.

1.4 Consequential levy of interest under section 234B of the Income-tax Act, 1961.

1.5 Sustainability of initiation of penalty proceedings under section 274 read with section 270A of the Income-tax Act, 1961, in view of the deletion of transfer pricing adjustment.

2. ISSUE-WISE DETAILED ANALYSIS

2.1 Most Appropriate Method for benchmarking import of finished goods for resale

Legal framework (as discussed)

2.1.1 The Court referred to Rule 10B(1)(b) of the Income-tax Rules, 1962, and the jurisprudence holding that the Resale Price Method is best suited where goods are purchased from an associated enterprise and resold as such, with no or insignificant value addition, to unrelated parties.

2.1.2 Reliance was placed on decisions holding that for pure distributors or traders, where no value is added to the goods before resale, Resale Price Method is the Most Appropriate Method, and that Resale Price Method loses accuracy where the reseller substantially adds value to the product or further processes it.

Interpretation and reasoning

2.1.3 The assessee was characterized as a "routine distributor" undertaking fashion retail operations in India, purchasing 100% of its finished goods inventory from associated enterprises and reselling the same through retail outlets without any value addition.

2.1.4 The assessee performed routine distribution functions: procurement based on local demand forecasts with associated market risk; inventory management including warehousing and stocking in its retail outlets at its own cost; sales, distribution and after-sales services; and pricing decisions in line with group policy but based on local market knowledge.

2.1.5 The Court found that the assessee assumed routine risks including market risk, limited inventory risk, product liability risk and limited bad debts risk, whereas the associated enterprise functioned as the principal undertaking manufacturing, headquarter and marketing functions and assuming entrepreneurial risks including shareholders' risk.

2.1.6 It was undisputed that the assessee did not make any value addition to the imported finished goods; it merely resold apparel, clothing, accessories and footwear as purchased.

2.1.7 The Transfer Pricing Officer rejected the Resale Price Method and applied the Transactional Net Margin Method on the premise that the assessee was not a mere routine distributor since it incurred costs mandated by the associated enterprise on brand building, promotion, marketing, advertising and creation of intangibles; however, the functional characterization of the assessee as a distributor and the set of comparables were otherwise accepted.

2.1.8 The Court, following coordinate bench and High Court precedents in similar factual situations of pure distributors/pure traders reselling products without value addition, held that the Resale Price Method is the appropriate method for such distribution/marketing activities where goods are purchased from associated enterprises and sold to unrelated parties without further processing.

Conclusions

2.1.9 The assessee, being a routine distributor reselling imported finished goods without value addition, is correctly considered as the tested party.

2.1.10 The Resale Price Method is held to be the Most Appropriate Method for benchmarking the international transaction of import of finished goods for resale, and not the Transactional Net Margin Method adopted by the Transfer Pricing Officer.

2.1.11 The assessee's margin computed using Gross Profit/Sales as the Profit Level Indicator under Resale Price Method is accepted as correctly reflecting the arm's length price for the impugned international transaction, and the transfer pricing adjustment made by substituting Transactional Net Margin Method is deleted.

2.2 Effect of substantial AMP and related expenses on applicability of Resale Price Method

Legal framework (as discussed)

2.2.1 The Court referred to tribunal precedent holding that high advertisement and marketing expenses, which are debited to the profit and loss account (below the gross profit line), do not impact the determination of arm's length price under Resale Price Method, which is based on gross profit/sales.

2.2.2 It was noted that where expenditure on advertisement and promotion is considered to create marketing intangibles for the associated enterprise, a separate transfer pricing adjustment on account of such AMP expenses may be warranted; however, this has no bearing on the computation of arm's length price under the Resale Price Method itself.

Interpretation and reasoning

2.2.3 The Dispute Resolution Panel had observed that the assessee incurred substantial AMP and other expenses in relation to its turnover and, on that basis, opined that the assessee is not a simple distributor for the purpose of applying Resale Price Method.

2.2.4 The Court, relying on the cited precedent, reasoned that since Resale Price Method uses gross profit on sales as the Profit Level Indicator, only expenses that affect gross profit (those debited to the trading account) are relevant; expenses such as AMP, being debited below the gross profit line in the profit and loss account, do not affect gross profit and therefore do not interfere with the appropriateness or application of Resale Price Method.

2.2.5 The absence of any separate transfer pricing adjustment specifically on account of AMP expenses by the Transfer Pricing Officer reinforced that AMP expenditure should not be used to displace Resale Price Method in favour of Transactional Net Margin Method.

Conclusions

2.2.6 Incurring substantial AMP and related brand-building or marketing expenses does not disqualify the assessee from being treated as a routine distributor for Resale Price Method purposes.

2.2.7 High AMP expenditure does not affect the determination of arm's length price under Resale Price Method and cannot be a valid ground for rejecting Resale Price Method in favour of Transactional Net Margin Method when the assessee resells goods without value addition.

2.3 Consequential issues: brought forward losses, interest under section 234B and penalty initiation

Interpretation and reasoning

2.3.1 In view of the acceptance of Resale Price Method and deletion of the transfer pricing adjustment (allowing the substantive ground on method selection), other transfer pricing-related grounds were treated as academic and left open.

2.3.2 The assessee sought set-off of brought forward business loss and unabsorbed depreciation of an earlier assessment year; this became relevant in light of the revised income position following deletion of the transfer pricing adjustment.

2.3.3 Levy of interest under section 234B was characterized as consequential, dependent on the finally assessed income after giving effect to the appellate decision.

2.3.4 Initiation of penalty proceedings under section 274 read with section 270A, being premised on the additions made (in particular the transfer pricing adjustment), was considered unsustainable where such core addition did not survive.

Conclusions

2.3.5 The Assessing Officer is directed to consider and allow, in accordance with law, the set-off of brought forward business loss and unabsorbed depreciation in light of the deletion of the transfer pricing adjustment.

2.3.6 Interest under section 234B is to be recomputed, if at all, only as a consequential matter based on the recomputed total income after giving effect to the appellate order.

2.3.7 The initiation of penalty proceedings under section 274 read with section 270A has no foundation in view of the deletion of the substantive transfer pricing adjustment and consequently cannot be sustained.

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