TaxTMI 
TaxTMI 
2013 (12) TMI 594
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....have erred both in law and on facts in making an addition of Rs. 55,26,16,748 on account of alleged understatement of the arm's length price in respect of commission income earned by the appellant from its associated enterprises ("hereinafter referred to as AE"). The aforesaid findings and conclusions have been reached without any material and is a vitiated finding. 3. That in making the aforesaid addition the learned Assistant Commissioner of Income-tax had erred in referring the matter to the learned Transfer Pricing Officer under section 92CA of the Act on the following amongst other grounds, rendering the order of the Transfer Pricing Officer as unsustainable both in law and on facts : (a) As none of the pre-conditions laid down under section 92C(3) of the Act were satisfied, there was no occasion for determination of the arm's length price by the Assessing Officer and the value of the international transactions ought to have been accepted ; (b) As the reference made by the learned Assessing Officer to the learned Transfer Pricing Officer is not in accordance with the provisions of section 92CA(1....
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....ns of the appellant with its associated enterprises have same functions and, risks as the principal transactions with non-associated enterprises, the action of recharacterisation of indent business as trading business is based on no valid basis ; (d) That in absence of valid basis much less any valid material, the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has erred in holding that, indent based transactions of the appellant with associated enterprises are comparable to principal transactions of non-associated enterprises ; (e) That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel having found the transactions entered into with non-associated enterprises on identical circumstances are indent transactions, i.e., service based transactions, he has erred in holding transactions and therefore, addition is based on an inconsistent stand and, contradictory approach ; (f) That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has failed to appreciate the difference in risk profile of the indent and proper transactions. In particular, in the indent based transactions there are neglig....
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....cannot be compared to the proper sales transactions ; (l) That furthermore the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has erred in comparing indent based transactions of associated enterprises with principal based transactions of non-associated enterprises and not with indent transaction of non-associated enterprises after allowing appropriate adjustments and, hence the addition is misconceived, misplaced and unsustainable; (m) That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel has erred in not making adjustments to the uncontrolled transaction to account for the material impact of the economic differences between the controlled and uncontrolled transactions as mandated under rule 10B(3) of the Income-tax Rules, 1962 ; (n) That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel's method of computing the arm's length price is not in accordance with any of the methods specified in section 92C(1) ; (o) That the learned Assessing Officer/Transfer Pricing Officer/Dispute Resolution Panel's conclusions are arbitrary and based on conjectures and surmises ; and 5. That the lea....
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.... same is not tenable. 10. On the facts and circumstances of the case, the learned Dispute Resolution Panel has erred in not examining the validity of initiation of penalty proceedings under section 271(1)(c). 11. The above grounds of appeal are mutually exclusive and without prejudice to each other. The appellant craves leave to add, alter, amend or vary any of the above grounds either before or at the time of hearing as we may be advised. The arguments taken hereinabove are without prejudice to each other. Grounds Nos. 1 to 7-Transfer pricing issue 3. M/s. Sumitomo Corporation is a Japanese entity headquartered in Tokyo. Sumitomo Corporation is a main company of the Sumitomo group. It is one of the largest trading companies or sogo shosho in Japan. A sogo sosho is an integrated business enterprise with the fundamental role of facilitating trade between buyers and sellers market. Sumitomo Corporation undertakes its trading activities in India through Sumitomo India. In case of import of goods for buyers in India, Sumitomo Corporation has a contract with the Japanese suppliers. Sumitomo Corporation also enters into contract with the buyers in India. 3.1. Sumitomo I....
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....f comparable companies (from the business support segment) at 18 per cent. During the financial year 2006-07, the assessee had undertaken the following international transactions: (i) Import of goods from associated enterprises ; (ii) Export of goods to associated enterprise ; and (iii) Rendering of support services to associated enterprise. For benchmarking of the international transactions, the assessee had used transnational net margin method (TNMM) and profit level indicator of Berry ratio. When the calculation of tested party margin in the transfer pricing report was examined by the Transfer Pricing Officer, it was noticed that the transactions relating to sales made in the associated enterprise and non associated enterprise segment had been aggregated and "cost of sales" was deducted therefrom to arrive at "gross profit margin" with respect to the trading sales. With respect to other transactions, in which it was claimed that the assessee had only rendered services to associated enterprise, the commission and fee on such services has been calculated. The "gross profit margin" on the trading sales (associated enterprise and non associated enterprise segment) had....
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.... such division of incomes exists. Thus, the Transfer Pricing Officer found the calculation on profit level indicator in the case of the tested party and in the case of the comparables has not been carried out as per the provisions of the Income-tax Act and it was proposed to reject the profit level indicator adopted by the assessee to benchmark its international transactions. Based on the aforesaid facts, the Assessing Officer issued the detailed show-cause notice dated September 30, 2010. The relevant portion of the same as reproduced in the Transfer Pricing Officer order is as under : "2. During the financial year 2006-07, relevant to the assessment year 2007-08, you have undertaken the following international transactions : (i) Import of goods from associated enterprises, (ii) Export of goods to associated enterprises, and (iii) Rendering of support services to associated enterprise. 3. For benchmarking of the international transaction, you have used transnational net margin method (TNMM) and profit level indicator of Berry ratio. When the calcul....
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....puted in relation to 'cost incurred' or 'sales effected' or 'assets employed' or 'to be employed' by the enterprise. The provisions of the Income-tax Act and Income-tax Rules do not recognise the use of Berry ratio as an appropriate profit level indicator under transactional net margin method. 6. Vide your submission dated July 21, 2010, you have furnished the basis of computation of Berry ratio in the case of the tested party. However, it has not been explained as to how the "gross profit margin", i.e., the numerator has been arrived at in the case of the comparable companies. As has been analysed above, the numerator in the case of the tested party contains sales, cost of sales, commission and other income whereas in the case of comparables, no such division of incomes exists. It is therefore found that the calculation of profit level indicator in the case of the tested party and in the case of the comparables has not been carried out as per the provisions of the Income-tax Act and it is proposed to reject the profit level indicator adopted by you to benchmark your international transactions. 7. Vide your ....
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....of 4.80 per cent. In the segment relating to trading with non-associate enterprises, you have "earned a gross profit margin of 4.4, per cent. However, with respect to commission income earned of Rs. 32,36,83,588 on FOB value of goods traded through you of Rs. 20,10,21,88,471, which comes to 1.61 per cent. 9. On the basis of detailed examination of FAR analysis in your transfer pricing report, it is noticed that there is no significant difference between the functions performed, assets utilised and risks assumed by you in your trading transaction with your associated enterprises and other trading transactions vis-a-vis the transactions performed by you wherein you have purportedly earned only commission income or a fixed fee. While analysing the functions performed by you, it is also noticed that you are creating human intangibles and supply chain intangibles, for which apparently you are not being adequately compensated in your transactions with your associated enterprises. From the details mentioned in the transfer pricing report, it is found that Sumitomo India is creating following supply chain intangibles : (i) Sumitomo India maintains the relationship with the supplier o....
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....h is flash title. The assessee has been characterised as facilitator and coordinator for the financial year 200607 and the very small quantity of trading business does not change the true identity of the company as above. The assessee classified transactions wherein trading takes place as principle transactions and the transactions in which it receives commission as indent transactions. The assessee submitted that on the basis of FAR analysis it has applied Berry ratio, which measures the gross profit earned in relation to operating expenses. The assessee submitted that it does not trade in any goods while performing the service of facilitation. It merely provides support service to associated enterprise. It was claimed that it does not assume title to the goods. Risks related to indenting business are not borne by the assessee. The assets employed in assumption of title of goods are different from service transactions. The reason for not including COGS (cost of goods sold) in denominator was that the assessee has characterised itself as a support service provider based on FAR analysis. The assessee submitted that this means that the business of the assessee is predominantly that o....
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....g the business model of principle business to service fee/commission model is not correct. * Assessee has stated that the associated enterprises perform more functions, assumes more risks and deploys more resources as compared to the assessee. * The factual analysis in the show-cause notice fortifies the assessee's stands of being at the arm's length in respect of its international transactions. It has earned better margin in its trading transactions with its associated enterprise as compared to non-associated enterprise trading transactions. 5.1. The assessee submitted that the associated enterprise gross profit margin is lower than 4.45 per cent. even after performing more functions and more risks as compared to the assessee. 6. The assessee submitted that without prejudice to its stand in the transfer pricing study in regard to application of transactional net margin method and Beery ratio and above arguments to justify the arm's length nature of international transactions, the assessee has stated that it earns commission income from associated enterprises and non-associated enterprises and therefore by the approach suggested in the show-cause notice (without admitti....
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....tage (A B) 1.13% 6.1. It was claimed that the assessee has earned commission at 1.58 per cent as against the arm's length commission percentage of 1.13 per cent. Therefore, commission earned in the associated enterprise segment is at arm's length. The assessee further submitted that the analysis on the basis of transactional net margin method and Berry ratio to justify the arm's length nature of international transaction as per the transfer pricing report should be accepted. It was submitted that the assessee's business model nature of international transactions and transfer pricing methodology has remained unchanged since assessment year 2003-04 and the same has been accepted by the Revenue. It was further submitted that before the Revenue embarks upon disturbing the method adopted by the assessee, it was incumbent on it to demonstrate that one of the four condition specified in section 92C(3) was met. 7. The Transfer Pricing Officer considered the abovementioned replies of the assessee. The Transfer Pricing Officer observed that in understanding the business model of the assessee, it was essential to understand function performed ; assets utilised ; the risks undertaken ....
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....; Employee remuneration 6,15,22,635 Admin and other expenses 13,74,55,343 Interest and finance charges 3,43,331 Depreciation 61,99,011 Total operating expense (D) 20,55,20,320 Operating profit (E)=C D 15,73,51,701 8. The Transfer Pricing Officer referred to that in the show-cause notice it was proposed that profit level indicator as demonstrated in the table above does not capture the cost-base on which the commission/service income has been earned whereas the gross profit margin of the trading segment contains cost of goods sold in the numerator. The cost base on which commission income has been earned, i.e., FOB value of goods traded through the assessee is Rs. 20,10,21,88,471 on which commission/service fee of Rs.32,36,83,588 had been earned at 1.61 per cent. The Transfer Pricing Officer observed that the assessee was performing identical functio....
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....segments. The Transfer Pricing Officer further observed that he had examined the compensation model along with the facts of the case and reached a conclusion, that in this case commission should be expressed as percentage of FOB price of goods sourced through the assessee for the following reasons : "(a) It is evident from the FAR analysis discussed earlier in this order that the assessee has played a major role in identifying suppliers, raw material, networking with buyers and suppliers, support in after sales services, business promotion, collection of market information, collection of accounts receivable on behalf of associated enterprise, handling of precuts and commodities, etc. has been in constant touch with the buyer. It has assumed significant risks and has used both its tangibles and unique intangibles. These facts clearly prove that value addition activities of the assessee can only be expressed as a percentage of FOB of goods sourced through the assessee. (b) The assessee is operating in a low cost country like India and its operating cost is so low that it is a very poor proxy of the value ....
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....ntangible for which it is not being adequately compensated by the associated enterprises. The Transfer Pricing Officer further observed in this case the assessee has borne all the major risk associated with abovereferred to functions. In addition to this the assessee has also borne following major business risks such as single customer risk ; risk associated with development and use of intangibles. He observed that assessee has used its assets including human assets (technical manpower) to discharge the function. The Transfer Pricing Officer observed that on examining the compensation model in this case, it was noted that the assessee was allowed a very nominal and routine compensation of 1.6 per cent on the service it renders (which does not include cost of development and use of intangibles) without allocating any profit component for development and use of unique intangibles by the assessee which has resulted in huge commercial and strategic advantage to the associated enterprise in the form of low cost of goods, high profit margin and assured timely supply and demand of quality goods and orders, i.e., these intangibles have enhanced the profit potential of the associated enterp....
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.... the Transfer Pricing Officer observed that the compensation model of the assessee was thus clearly linked to the FOB value of the goods transacted through it. The Transfer Pricing Officer further observed that the arguments of the assessee that volume of business in the case of indent segment is much larger than the trading segment, was also therefore, not found to be correct. He observed that assessee enters into a separate contract with respect to each and every transaction/trade, i. e., carried out through the assessee. The compensation basis is mentioned in that contract. The Transfer Pricing Officer observed that it is not the case of the assessee that the volume in single transaction is more than in similar transaction in the trading segment. Therefore, the Transfer Pricing Officer observed that the correct comparison was therefore, the gross margin that the assessee is making in the trading segment (principle transaction segment) with the commission/ service income earned in the indent segment. 10.3. The Transfer Pricing Officer further observed that on the basis of FAR analysis it has been established that the assessee was performing identical function in both the ....
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....ernational transactions, the assessee has stated that it earns commission income from associated enterprise and nonassociated enterprise and therefore by the approach suggested in the show-cause notice (without admitting the same), commission earned by the assessee in the non-associated enterprise service/commission segment may, subject to economic adjustments mandated by law, be considered benchmark commission to compute arm's length commission from associated enterprise. The above stated stand taken in the letter dated October 19, 2010 has been considered. Herein the assessee has although without prejudice, but has admitted that for some minor transactions of Rs. 84.72 crores (as compared with total trading transaction of Rs. 2,010 crores) which the assessee has carried out with non-associated enterprise, the assessee has earned a higher margin of at 2.26 per cent as compared with commission at 1.58 per cent from associated enterprises transactions. However, the assessee has again without prejudice stated that 'volume' may impact the rate of commission. The assessee has stated that as the volume in non-associated enterprise segment was lower, it had earned a higher rate o....
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....se value of Rs.19,25,49,38,946 (the original figure of FOB value of goods given by the assessee in submission dated September 14, 2010 was Rs.20,10,21,88,471. However, the assessee in its submission dated October 19, 2010 has stated that this figure also contains certain nonassociated enterprise transactions on which it has earned commission income also. The correct FOB value of transactions with associated enterprise and rate of commission earned is as stated). The gross margin earned in the non-associated enterprise trading segment at 4.45 per cent. shall be taken to be the arm's length rate at which the assessee should have earned its commission income. Commission Income earned from associated enterprises at 1.58 per cent on Rs. 19,25,49,38,946 = Rs. 30,42,28,035 Arm's length commission income at 4.45 per cent on Rs.19,25,49,38,946 Rs. 85,68,44,783 Difference = Rs .55,26,16,748 Percentage of arm's length margin to international transaction = 181.64 per cent. The difference of adjustment required is more than 5 per cent. therefore the proviso to section 92C(2) is not attracted. The international transaction reported by the assessee is to be adjusted by Rs.55,26,16,....
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....ct that, in the report of the accountant under section 92D of the Act, nature of the transaction has been stated by the accountant to be the same functionally ; that transfer pricing study mentions that trading transaction are functionally similar to indent transactions ; that while stating so in the transfer pricing study, it had never been admitted that, they are comparable ; that though transactions of trading and, indent are in two different segments but since no separate meaningful analysis is required on account of miniscule volume, they were clubbed together for purpose of transfer pricing study. 16. It has further been submitted that the Transfer Pricing Officer committed an error when he compared the gross margin of negligible value of trading transactions of non-associated enterprises with high volume of indent transactions, genuineness of transactions of either indent/trading has not been disputed. That mere fact, that it was so reported by the accountant, it could not be held to be binding on the assessee and thus, the Transfer Pricing Officer could not have mechanically proceeded to determine the arm's length price on the perception of the accountant. It was further....
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....ome-tax Appellate Tribunal, Mumbai Bench in the case of Bayer Material Science P. Ltd. v. Addl. CIT [2012] 17 ITR (Trib) 275 (Mumbai) in I.T.A. No. 7977/Mum/2010. The abovesaid case laws were mentioned by learned counsel for the assessee for the proposition that trading and indenting segments are non-comparable. It has further been submitted that gross profit earned in trading transaction with associated enterprises is also comparable to the gross profit earned in the trading transactions with non-associated enterprises in uncontrolled circumstances. It has further been submitted that Assessing Officer has nowhere disputed that transactional net margin method adopted by the assessee is incorrect. Learned counsel for the assessee further submitted that the Transfer Pricing Officer has failed to appreciate many of the submissions of the assessee-company. 16.2. Further it has been submitted that without prejudice to the above (even if it is assumed without conceding) that, a segmental comparison of results of the assessee-company is warranted to determine the arm's length price, an appropriate comparison would be to compare the commission/service income earned from associate enterp....
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....as been submitted that if the Transfer Pricing Officer's approach is adopted to work out corresponding return on cost, it would be found, the same is absurdly high which is 345 per cent which is unrealistic and impractical. 18. The learned Departmental representative placed reliance on the orders of the Dispute Resolution Panel, Transfer Pricing Officer and the Assessing Officer. He submitted that it is found that the activities of indenting sales and proper sales are one and the same functionally. That when the assessee itself considers the indenting sales and proper sales to be one and the same, the preferred route of benchmarking was using the internal benchmark, which was available in the form of profit margin in third party sales made by the assessee itself. The internal benchmark is preferable to external benchmark has been laid down in plethora of rulings. In this regard, learned Departmental representative referred to the decision in the case of Birlasoft (India) Ltd. v. Deputy CIT [2011] 136 TTJ (Delhi) 505 and the decision in the case of UCB India P. Ltd. [2009] 317 ITR (AT) 292 (Mumbai). That where the associated enterprises is making profits or not is not relevant in....
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....3. We agree with the assessee's proposition that the nature of indenting transaction is different from the trading transactions. The trading transaction involves risks and finances, whereas in the indenting transaction the assessee has not to incur any such financial obligation or carry any significant risk. Moreover, we note that in respect of indenting transaction with non-associated enterprises, the average mean margin of profit of 2.26 per cent has been accepted by the Transfer Pricing Officer. We further find that the indent business of the assessee was nothing but trade facilitation and is purely of indent nature both in form and substance. No material has been brought on record to regard the indent transaction as trading transactions. 24. The assessee itself has agreed with the proposition that an appropriate comparison would be to compare the commission/ service income earned by the assessee from associated enterprises to that of the non-associated enterprises. This aspect of the assessee's submission has not been rebutted by the Revenue. However, the assessee has contended that the reason of difference between them was attributable to volume of business handled in assoc....
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....rcial practice that in highly competitive market condition, one can survive and sustain only by keeping low margin turnover. Thus, high turnover and low margin are necessity of the highly competitive market to survive. Similarly, low turnover does not necessarily mean high margin in competitive market condition. Therefore, unless and until it is brought to record that the turnover of such comparables has undue influence on the margins, it is not the general rule to exclude the same that too when the comparables are selected by the assessee itself." Similarly, in the case of Bayer Material Science P. Ltd. [2012] 17 ITR (Trib) 275 (Mumbai) in para 23 following proposition was laid down (page 294) : "Now, the question is whether these cases, which are otherwise comparables, should be disregarded simply on the ground of smallness of turnover when compared with that of the assessee. Considering the fact that the assessee did not come out with any comparable case to justify its price at arm's length and further the Transfer Pricing Officer found out these cases having functionally identical activities duly confronted t....
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....nd, on facts in proposing a disallowance of a claim of expenditure of Rs.3,72,560 representing legal and professional charges incurred wholly and exclusively for the purpose of business of the appellant-company. That the learned Assessing Officer and Dispute Resolution Panel has failed to appreciate that, mere fact that, such expenditure had been disallowed in the preceding years could not be a basis much less valid basis to hold that, expenditure incurred towards writer relocations was a personal expenditure. In fact, they have failed to appreciate that, it is well-settled position of law that, a company does not have any personal expenditure and as such, entire expenditure incurred ought to have been allowed as such. That the learned Dispute Resolution Panel has grossly erred both in law and on facts in directing the Assessing Officer to make the addition only if the Department has not preferred an appeal before the hon'ble Income-tax Appellate Tribunal against the addition deleted by the Commissioner of Income-tax (Appeals) in the assessment year 2006-07 on the similar ground. 32. On this issue, the Assessing Officer noted that from the details furnished, it was observe....
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....as under : Sl. No. Name of the payee Remarks Date Amount (Rs.) Page of PB 1 Writer Relocations Charges of unaccompanied passenger baggage clearing New Delhi to Tokyo, Japan Mrs. Keiko Mugikura 21.6.2006 1,33,000 605-607 2 -do- Charges of unaccompanied passenger baggage clearing New Delhi to Kobe, Japan Mrs. Chizuko Haruna 21.6.2006 34,000 608-610 3 -do Charges of unaccompanied passenger baggage clearing New Delhi to Japan Mrs. Rie Nagashima 30.3.2007 70,000 611-613 4 -do- Charges of unaccompanied passenger baggage clearing New Delhi to Tokyo, Japan Mrs. Rie Nagashima 31.3.2007 47,500 614-617 4. -do- Charges of unaccompanied passenger baggage clearing Mumbai to New Delhi Mrs. K. Nagashima 2.8.2006 23,200 618-619 5 -do Charges of unaccompanied passenger baggage clearing New Delhi to Chiba, Japan Mrs. K. Nagashima 23.11.2006 &nb....