TaxTMI 
TaxTMI 
2012 (9) TMI 766
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....following the directions of the Ld. DRP), erred on facts and in law in upholding the Ld. TPO's stance of not appreciating that the appellant is a low risk sourcing support service provider and disregarding the functional asset and risk ('FAR') profit of the appellant, on the basis of pre-conceived notions, surmises and conjectures , and without any cogent evidence, facts or basis whatsoever. 3. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in upholding the Ld. TPO's stance of disregarding the conservative benchmarking approach adopted by the appellant in its TP Documentation report for the year (full fledged distributors converted into service providers after making suitable working capital adjustments) to substantiate the arm's length nature of its international transactions. 4. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in upholding the Ld. TPO's stance of including the value of the goods sourced directly by the AEs of the appellant from third party vendors in the cost base of the appellant, for the purpose of computing the arm's length profit mar....
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....ly erred in: - erroneously concluding that the printers, scanners, UPS etc. cannot be said to be part and parcel of computer system and hence higher rate of depreciation is not admissible; - disregarding judicial pronouncements (in favour of the assessee ) while making the proposed adjustment. 12. On the facts and in the circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under section 271(1)(c) read with section 274 of the Act." ITA no. 5147/Del/11 (A.Y. 2007-08): "1. The Learned Dispute Resolution Panel ("Ld. DRP') and the Ld. Assistant Commissioner of Income-tax ('Ld. A.O') (following the directions of the Ld. DRP), erred on facts and in law, in enhancing the income of the appellant by Rs. 2,628,618,693/- on account of the transfer pricing ('TP') adjustment u/s 92CA(3) of the Income Tax Act, 1961 ('Act') made by the Ld. Additional Commissioner of Income-tax, Transfer Pricing Officer -1(2) ('Ld. TPO'). 2. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law: 2.1 in upholding the Ld. TPO's stance of not appreciating that the appell....
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....appellant also filed on record with the DRP vide a letter dated July 27,2011 before passing of the final directions by the DRP. 1.1 This is the second round of proceedings before ITAT in respect of A.Y. 2006-07 and first round for A.Y. 2007-08. In original proceedings for assessment year 2006-07 similar adjustment were proposed by Transfer Pricing Officer (TPO) for the assessment year (AY) 2006-07, which were followed by AO and a draft assessment order was proposed accordingly. Assessee approached the Dispute Resolution Panel (DRP), which confirmed the order of AO by a non-speaking order. The Assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT) in this regard. The ITAT, restored the case back to the DRP for fresh adjudication with directions to pass a speaking and reasoned order after considering the evidence and submissions/ documents presented by the assessee. During the pendency of set aside proceedings for A.Y. 2006-07, DRP upheld similar adjustments for A.Y. 2007-08. Thereafter DRP re-heard the matter for A.Y. 2006-07 and upheld the entire TP adjustments and AOs order thereon. Aggrieved assessee is before us in both the years. 2. Brief facts are asses....
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....that on account of operating in a low cost economy, the assessee had generated location savings in India which have not been factored into in its remuneration model. TPO thus rejected the assessee's cost plus based remuneration model on the basis of theoretical assumptions, which are unsustainable and not based on any evidence. Accordingly, the Ld. TPO held the remuneration model of cost-plus 15% to be not in line with the arm's length standards. 3.2 TPO reconstructed the Profit & Loss account of the Appellant by notionally bringing the value of goods sourced by overseas AEs from India, which were neither fully sourced through it nor routed through its financial accounts and its Profit & Loss account. This resulted in phenomenally exorbitant TP adjustment of Rs. 2,362,231,473 in A.Y. 2006-07 and Rs. 2,628,618,693 in A.Y. 2007-08. 3.3 Assessee approached DRP where copious written submissions and arguments in support of its FAR profile as a limited risk bearing sourcing support service provider were submitted. It was claimed that assesses primary business activity comprised identification of vendors, provision of assistance to vendors in procurement of raw material, inspection ....
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....ply items, size of operations, production facilities, production capacity, and number of employees; - Information pertaining to sample development and confirmed sample orders, which includes records on sample developers, sample materials, seasonal samples, and samples of products that has been produced and shipped in accordance with GAP Group's instructions; - Software or other business processes used to order and track merchandise or used in any other way with sourcing activities; - Training materials developed either by GIS India or by GAP Group; - All know-how, processes and trade secrets relating to sourcing activities; - All confidential and proprietary information relating to sourcing activities; - Similar items as now exist or that may exist in the future that are developed either by GIS India, GAP Group or an affiliate of GAP Group in connection with sourcing activities. (iv) Thus the relevant, assets required for the business (including intangible assets) like vendor lists, business information, software, business processes, etc. are ....
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.... Exception management to resolve production issues. (viii) GIS Inc. also bears all the relevant risks in connection with undertaking the above activities and no risk is attributable to assessee which is a key factor in determining the FAR. In the sourcing value chain, the Appellant's role is limited to operating within the confines of the requirements/ standards prescribed by overseas AEs. It performs strictly routine/ low value-adding activities and does not bear any of the key business risks such as market risk, product liability risk, product design and development risk, credit risk, price risk, foreign exchange risk etc. (ix) There is neither any basis nor supporting factual data for TPO to reach the conclusion that the Appellant had created any valuable / non-routine intangibles, for which a return on value of goods sourced by overseas AEs was required as consideration. Ld. TPO merely made a bald assumption that the Appellant had created valuable supply chain and human asset intangibles without giving proper reasonings evidential data / proof whatsoever to suggest that any intangibles have been created. (x) It is erroneously presumed that the 210 peo....
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....nd requirements set and prescribed by GAP US. - Extract of Vendor Compliance Handbook/ Manual which contains a format of the vendor compliance agreement as well as conditions that in the event of failure to comply with any term or requirement of a Purchase Order, retail companies shall be entitled to cancel, reject shipments, insist on re-performance, withhold payments, recover cost, offset any amounts due, etc. This demonstrates that the product liability in case of defect rests with the vendors and GIS India does not have any role to play in this regard. Thus there is no risk involved on this account. - Sample documents to substantiate that all product liability claims are settled between GAP Group and the vendor and GIS India only acts as a coordinator with no financial impact whatsoever. - Sample documents to substantiate that GAP Group directly maintains all vendor relationships. - Sample documents to substantiate that GAP Group drives all quality control strategy, standard and management requirement, whereas GIS India simply follows the instructions given therein which belies the allegation that assesses employee....
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....for GAP Group's design, production and technical service teams. These lists amply demonstrate the fact that the design/ development function is carried out entirely outside India. - Memo from GAP US stating that the vendor handbook is created only by GAP US and only GAP US is authorized to make any changes to it. - Sample copies of Purchase Orders which clearly establish the fact that the goods are directly sold by GAP Inc. from the third party vendors. - Relevant extracts of the company's website clearly evidencing/ corroborating the fact that the design/ development function is undertaken essentially in US, but certainly not in India. - Process maps which document that design, specification development and fabric development all occur in the US while GIS India plays a limited liaison role. - Spreadsheets that contain the US design, merchandising and sourcing costs for years 2005 and 2006 as well as GIS India operating costs for the same period. The disparity in the costs incurred by US group entities vis-à-vis GIS India indicates the relative value addition done in the US vis-à-vis India....
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....ed in light of the relative bargaining powers/ ownership of intangibles of the parties concerned and the competitive market position of the company based in the low cost jurisdiction, i.e. GIS India. In the instant case, all the valuable intangibles are owned by overseas group companies. As a result, the relative bargaining power of the overseas group companies is significant and not of the assessee. On the contrary, GIS India is a routine support service provider that undertakes routine liaisoning and co-ordination activities. Its bargaining power is negligible as compared to its overseas group companies. 5.6 Given the fact that GIS India does not have any unique intangibles or any distinctive competitive advantage vis-à-vis other similar sourcing companies in the market, which could have led to GIS India wielding significant bargaining power vis-à-vis its overseas group companies, it cannot be entitled to any location savings. 5.7 The DRP, during the remanded proceedings, out of voluminous documents submitted by GIS India referred to only one of the email exchanged between the Appellant and its group company regarding fabric hedging and long term booking. With....
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....p on the value adding costs incurred by the Appellant in its procurement/ purchasing coordination/ support services activity, should be accepted as the arm's length business model. Further, it may also be noted that the Appellant has charged a mark-up of 15% on the costs incurred by it in connection with its service provision activity (Value Added Costs), which is three times the cost plus margin specified in the aforementioned Dutch Ruling for purchasing coordination/ support services, the scope of which is anyway broader than those provided by the Appellant. 6.1 Ld. TPO while working out adjustments, drew a totally irrelevant reference from the case of an out of court settlement between USA tax authorities & "Tommy Hilfiger". Tommy Hilfiger remunerated its buying agency affiliate on the basis of a commission (10% and subsequently 7.5%) on the value of goods sourced by it. The Ld. TPO thereby claimed that GIS India should also have been remunerated by a commission on value of goods sourced ignoring that the information was not in relation to a judicial pronouncement. The reliance on an out of court settlement between the US revenue authorities and Tommy Hilfiger has no persuasi....
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....epted by the Revenue authorities........ The payment made by the assessee to third party vendor/media agencies for and on behalf of the principal has not been included in the total cost for determining the profit margin, though, on the other hand, the TPO has included the payment reimbursed by the assessee's associate enterprise to the assessee on account of payment made to third party vendor/media agencies......... We have gone through the invoices and purchase orders from third party vendors and find that they contain customers' name, and all the terms of advertisement are finalized after taking the approval from the customers. The assessee simply acts as an intermediary between the ultimate customer and the third party vendor in order to facilitate placement of the advertisement. The payment made by the assessee to vendors is recovered from the respective customers or AEs. In the event customer fails to pay any such amount to the advertisement agency, the bad debt risk is borne by the third party vendor and not by the advertising agency i.e. the assessee. It is, thus, clear that the assessee has not assumed any risk on account of non-payment by its customers or AEs. At thi....
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....lus 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 of the gross margins earned by a distributor as analogous to a firm's total revenues available to a distributor, and the operating expenses incurred to distribute products as analogous to the firm's total costs, then the ratio of gross margin to operating expenses would capture the mark-up on operating expenses that is afforded to the distributor. 6.6 The Berry ratio can also be applied to service providers, as it can be conceptualized as the mark-up earned on the costs of provision of services, by subtracting one from the Berry ratio expressed in unit terms as follows:- Berry ratio - 1 = GP/VAE - 1 = (GP-VAE)/VAE = OP/VAE wherein GP = gross profit; OP = operating profit; and VAE = value adding (operating) expenses. The above concept and approac....
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....med all critical functions, assumed significant risks and also developed significant supply chain intangibles in India and Li & Fung HK did not have either any technical expertise or manpower to carry out the sourcing activities in HK. (b) In view of the above, the Tribunal agreed that Li & Fung India should also receive a remuneration based on a percentage of value of goods sourced by the global customers of Li & Fung HK directly from third party vendors in India. (c) However, the total amount of commission accruing for the Li & Fung Group as a whole, could not exceed 5% of the value of such goods, i.e. Rs 1202.96 crore. (d) Li & Fung HK had already paid remuneration to Li & Fung India under the cost plus 5% model, thus retaining, at its level, about 20% of the total receipts from the customer, i.e. Rs 60.15 crore. (e) The ITAT held that in view of the above factual matrix, Li & Fung India should receive 80% of the total commission given by the end-customer in favour of Li & Fung HK and the balance 20% would be retained by Li & Fung HK and accordingly asked the TPO to recompute the TP adjustment. 7.3 Analysing Li & Fung case further ld. couns....
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....Group itself is not in the business of providing sourcing services but the same being performed by just an in-house arm, operating in India. 2. The Li & Fung India performed all the critical functions, assumed significant risks and used both tangibles and unique intangibles developed by it over a period of time (Intangibles included supply chain management which is important to achieve the strategic and pricing advantage, as well as human intangibles in the form of technical capacity and owned manpower to perform the critical functions). All intangibles including trademarks, processes, know-how, technical data, operating/quality standards etc. are developed and owned by the overseas GAP Group companies. GIS India does not create any valuable/ non-routine intangible and does not undertake any activity on its account that leads to the development of non-routine intangibles. 3. There have been ample documents filed at various levels (TPO, DRP) to evidence the functional profile of the overseas GAP Group companies and the fact that they own perform critical functions in the supply chain and own significant intangibles and that GIS India p....
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....third party vendors in India. In the case of Li & Fung India, the assessee had actually carried out significantly value added functions in India. In the light of the facts that Li & Fung India carried out significantly high-end and value added functions in India, if the intensity of functions of Li & Fung India, are measured as a percentage of operating expenses or VAE of Li & Fung India to the value of goods procured, comes to 3.78%. In real terms, Li & Fung India had carried out virtually five times greater functions as compared to the appellant. The assessee's percentages VAE comes to 0.73% and 0.79% in the case of the appellant for AYs 2006-07 and 2007-08 respectively. Even if the entire commission of Li & Fung Group is assigned to Li & Fung India, then the OP/ VAE of Li & Fung India works out to 32.43%, as compared to 15% adopted by the appellant, which again, is within acceptable limits. looking at the insignificant FAR of the assessee. 7.6 Alternatively it is pleaded that, looking at the 5 times functional intensity of the Li & Fung group of the same can be estimated to a maximum of 1% of FOB value. The assessee's intensity of functions being less than one-fifth of Li & F....
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....butor companies. Accordingly, for the chosen comparable companies as well, it was deemed appropriate to compute their operating profitability on a similar basis, i.e. with reference to the respective value added expenses incurred and not with reference to their total costs, which would also have included COGS or input costs, the companies being distributors. 7.10 Ld. Counsel at the end of his arguments summarized the arguments as under: - Given the functional, asset and risk profile of the appellant, it is entitled to a remuneration model of a mark up or profit on only its operating expenses or VAE; and not on the value of goods sourced by GAP US from third party vendors in India. - Incidentally, on identical facts, the Dutch Supreme Court had also approved a cost plus remuneration model for a similar procurement company; and not a commission linked to volume of goods procured, as the latter option would have resulted in exorbitant profit margin accruing to the procurement company, namely in excess of 600%. - The appellant's mark up of 15% on operating costs have not been controverted by the TPO, who in fact, committed a grave erro....
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....ign AE. Supporting agreements and similar documentary evidence are irrelevant for the purposes of determination of ALP as per the TP regulations laid down in IT Act in this behalf. TP authorities have statutory duty to evaluate such transactions on the basis of comparables and other relevant parameters and not on the basis of convenient agreements. 8.1 GIS India used multiple year data instead of contemporaneous comparable data. Thus assessee on its part has failed to give proper comparables. In this situation rule 10B(4) empowers the TPO to apply proper comparables for determinations of ALP. GIS India has used the weighted average of the financial data for the last couple of years to benchmark the international transactions. The provisions of Rule 10B(4) of the Income-tax Act prescribe that for the purposes of benchmarking international transactions the data of comparables used shall be the data for the year in which transaction took place. 8.2 TPO has reasonable indicators that the assessee performed all the critical functions, assumed significant risks and used both tangibles and unique intangible developed by it over a period of time. The critical functions involve great ....
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....ibles, which are availed by the AEs. TPO has correctly analysed assessee's FAR holding that it has developed a supply chain management intangible over a period of time which is all about having the right product in the right place, right price, right time and right conditions. In other words, the supply chain management as developed by the assessee is the management of the link between and organization and its suppliers and customer to achieve strategic and pricing advantage. This supply chain management ('SCM') as developed by the assessee in India is a part of the global supply chain management of the GAP group of the companies. The SCM as developed by the assessee consists of following proprietary informations: - Knowledge of Vendors - Knowledge of products and design - Knowledge of acquisition and supply - Knowledge of quality control - Knowledge of storage - Knowledge of logistic involved in exports of the goods. 8.7 All these activities provide significant value added trade benefit and strategic advantage to the AE. However, the compensation model does not include the benefits a....
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....me to the Indian subsidiary. The WIMS details though is published in 2010, relate to market research in 2008 and a suitable adjustment to F.Ys. 2005-06 & 2006-07 should be considered. It is emphasized that the only appropriate remuneration model for compensation to Indian entity ought to be in terms of % of FOB and not the cost plus mark-up. Assessee except relying on its conservative method in earlier years with liaisoning office has failed to provide any justification to support its TP working based on cost plus markup. In these circumstances TPO was left with no choice but to hold ALP 5.22% on FOB value relying on arithmetic mean of following comparables and working. S. No. Name OP/TC(%) 1. Pantaloon Retail (India) Ltd. 6.70 2. Trent Ltd. 6.19 3. Jaypee Spintex Ltd. 2.77 Arithmetic Mean 5.22 Accordingly, the arms length price is worked out by TPO on FOB value of exports of Rs. 3963,38,34,240/- for A.Y. 2006-07; and Rs. 51,535,602,475/-for A.Y. 2007-08, resulting into respective additions. 8.10 It will be therefore just and proper that GIS India's commission is worked out in terms of percentage of the FOB price of goods so....
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.... has made arrived at such a conclusion. The Ld. TPO has not given any examples or comparables whatsoever to demonstrate which major business risks much less any risk are borne by GIS India and how. In a sweeping manner it has been held that as functions follow risks, and since, in his wisdom GIS India undertakes key functions, therefore it must also be bearing the consequent risks. The observation is flawed as from the handbook and guidelines it clearly emerges that assessee had no wisdom or discretion in these terms. iv. Beside it is common trend in garment that goods are generally supplied on credit based which the suppliers have to extend to GAP, USA entities and assessee bears no risk. The assessee' role, functions and activities are limited to scrupulously follow the handbook and other instructions provided by the parent group. These facts and circumstances indicate lack of authority or discretion with assessee in deviating or changing from the policies and procedures prescribed by the parent company. Therefore, we are unable to agree with the view that assessee incurred any significant risk in its functions. v. Coming to the issue about assessee having devel....
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....competitive sales strategy. The arm's length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus in our view, no separate/additional allocation is called for on account of location savings. viii. In view of all these facts we are unable to agree with the propositions of TPO that assessee works as a risk bearing agent of the AE and it possesses human resources intangibles along with supply chain resources. The facts and circumstances lead us to a conclusion that assessee is a low risk procurement support service provider only. 9.3 Most Appropriate Method i. From records it is clear that the assessee proposed the use of Transactional Net Margin method ('TNMM') as the Most Appropriate Method with Net Profit/Total Cost as a Profit Level Indicator ('PLI'). Further, the department has accepted the use of TNMM with a percentage of FOB value of goods procured by parent as PLI. Accordingly, we proceed on the basis of TNMM as the most appropriate method without goin....
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....r at the disadvantage with a significant advantage to service provider. vi. It is important to note that the irrespective of the model followed, both procurer and service provider will set the terms which work in serving the best interest of both the parties, meaning putting both the parties at a win-win situation. In percentage model if the procurer feels that the percentage agreed is resulting in very high profitability for service provider, then the procurer would proceed to re-negotiate the percentage for bringing it down to reasonable level. Similarly, under the cost plus model if the service provider feels that reasonable mark-up would be more than the agreed mark-up then the service provider will take appropriate steps to get it corrected. vii. The essence of above discussion is to the effect that market forces will interact in any business model and lead to reasonably acceptable profitability. Considering this we now proceed to decide the PLI which would result in reasonable profitability. 9.4 Li & Fung Case and TPO/DRP Stand i. The PLI of percentage of FOB value of goods procured by parent results in net profit/total cost of assessee at 830% a....
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....in terms of Li & Fung case on FOB value of goods procured by GAP US from third party vendors in India. In the case of Li & Fung India, assessee actually carried out significantly value added functions in India, which is not the case before us. v. Even if we overlook the factual dissimilarities between the Li & Fung India and assessee's case, the transactional profitability earned by Li & Fung India supports the case of assessee. The department has heavily relied on the fact that Li & Fung Hong' remuneration of 5% of value of goods procured should be used as benchmark rate by the assessee. The department overlooked the other extremely important fact of the profitability earned by Li & Fung through 5% procurement service model. The total remuneration earned by Li & Fung Hong Kong was Rs. 60.15 crores against cost incurred by Indian company of Rs. 45.42 crores and some minor costs incurred in Hong Kong. The ITAT bench held that considering the facts of the case, 80% of commission (Rs. 48.12 crores) earned by Li & Fung Hong Kong should be attributed to Indian company. This attribution resulted in profitability of Rs. 2.72 crores (Rs. 48.12 crores - Rs. 45.42 crores) for the In....