TaxTMI 
TaxTMI 
2016 (3) TMI 718
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....hases made from Associated Enterprises (AE). ii) The Ld. assessing Officer /TPO/DRP had erred in not applying any of the prescribed Method for determining the ALP. iii) The Ld. Assessing Officer /TPO/DRP had erred in adopting Berry ratio as profit level indicator (PLI) while computing the ALP. iv) The Ld. Assessing Officer /TPO/DRP had erred in considering routine normal expenses such as employee cost, general and administration cost, selling and distribution cost, and depreciation as Value Added Expenses (VAE) while computing the PLI. v) The Ld. Assessing Officer/TPO/DRP has failed to appreciate that the losses incurred by the appellant were on account of start-up phase of the company. vi) The Ld. A.O/TPO/DRP failed to appreciate that market research activity were rendered under a separate agreement which is distinct from distribution activity of the appellant and therefore cannot be considered as a part of value added expenses forming part of trading activity. vii) The Ld. A.O/TPO/DRP has failed to appreciate that the appellant & its AE are two independent parties in joint venture and therefore would not allow inflation of pur....
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....n of market research services Market Research Transactional Net Margin Method (TNMM) Net cost plus margin 16.05% 6.36% Accordingly, the assessee concluded that the international transactions entered into with the AE, were at arm's length. However, the TPO has not accepted the method adopted by the taxpayer and adopted TNMM as MAM along with Berry Ratio as PLI for the purchase of finished goods. The TPO determined the ALP of purchase of goods from AEs as Rs. 23.65 crores as against Rs. 36.48 crores recorded in the books of accounts and thereby has made a downward adjustment of Rs. 12.83 crores to purchase price of goods from A.E.s." 4. Aggrieved by the order of the Ld. DRP and the DCIT dated 19.11.2014 & 28/01/2015 respectively, the assessee is now in appeal before us. 5.1 Ground Nos.(i) to (vii) - Rejection of the Resale Price Method as the Most Appropriate Method (MAM) and acceptance of Berry ratio as a the MAM:- The assessee has applied RP Method because it is applicable in situations where selling and distribution operations carried out by the reseller/distributor does not add substantial value to the "product" through use of t....
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....of which are accounted and included in the operating expenses. iii) In the Indian context the Delhi Bench of the Tribunal in the case of GAP International Sourcing (India) Pvt. Ltd., Vs. ACIT in ITA No.5147/Del/2011 had held that "for non-risk bearing requirement facilitating functions which are preordained contract or hand book the appropriate PLI would be the net profit /total cost". Further, in the case DCIT Vs. Cheil Communications India Pvt Ltd in 137 TTJ 539, the Delhi Bench of the Tribunal held that Operating profit /Value added expenses is to be applied where the appellant performs agency functions to its AE. iv) In the case of the assessee, the assessee company renders many functions to its AEs other than routine trading activity and therefore, reasonable markup on cost has to be accounted. The assessee company had widely advertised the trade mark and the brand legally owned by the assessee's AEs and had incurred substantial cost. The assessee company had also widely established the distribution net work and rendered marketing support services. Therefore it is essential for the assessee company and its AEs to set up contractual terms to ensure reasonable ....
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....o the needs of the AE to distribute the products manufactured by the AE. Therefore, the aggregate profit has to be shared by both the assessee company and the AEs considering the ALP. xiv) During the relevant assessment year, the assessee company had claimed warranty expenses to the tune of Rs. 28,60,589/- in its P&L A/c which shows that the assessee company had assumed the risk of providing warranty. 5.3 The Ld. A.R. had objected to the Berry ratio as PLI before the Revenue because of the following reasons:- i) On plain reading of the Section-92C of the Act, the Berry Ratio is not a method prescribed under the Act for determining PLI. ii) The activity of the assessee is to buy finished goods from its AEs and resale the same to the third party in India without any value addition to the products, thus undertaking a limited risk. Therefore, RPM will be more suitable. iii) During the relevant financial year, it was a beginning phase of the business; therefore the assessee had to incur huge expenditure which would not be a regular feature. iv) The assessee neither bears any significant risk nor deploys significant assets other than the ro....
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....rguments, it is necessary to analyse the definition of Berry Ratio. As the same had not been defined in the domestic Law, it is necessary to see the other guidelines. Para 2.100 of OECD Guidelines defines the Berry Ratio as: "Berry Ratios" are defined as ratio of Gross profit to Operating expenditures. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortization may or may not be included in the operating expenses, depending in particular on the possible uncertain they can create in relation to valuation and comparability. This panel upholds the action of the TPO as he has taken uniform stand while computing the operating/value added expenses in the case of assessee and comparable companies. This panel finds that the contention of the assessee in respect to value added cost i.e, that only advertisement, marketing and promotion expenses are to be considered as value added expenses and other expenses such as employee cost, general & administration, selling & distribution and depreciation should not be considered as value added expenses, has no force as the definition of Berry Ratio clearly defines that all the opera....
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....formed in the controlled transaction (taking account of assets used and risks assumed) is not materially affected by the value of the products distributed, i.e. it is not proportional to sales, and * The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator." As evident from the OECD approach, Berry Ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade, the value of services performed by the entity is adequately reflected by operating expenses, the value of functions performed and assets employed In the controlled transactions is not proportionate to sales and when the entity does not perform any significant operations such as manufacturing or processing. Typically, a low risk high volume trading business involving back to back trading without any value addition to the goods traded, which is what AE is engaged in and the assessee is contributing to, satisfies all these tests. We are in agreement with the approach adopted by the OECD document in this regard. Going by this appr....
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.... have been separately compensated for by the AEs. vi) Filters adopted by the TPO is incorrect and not comparable to the case of the assessee. vii) Proper segmental accounting was made by the assessee with respect to market research and distribution activities. viii) The assessee had only established a dealer network for selling the products procured from the AEs directly to the end customers and therefore there was no Value Addition made to the products of the AEs. ix) The market research activities conducted by the assessee were restricted to data collection from the potential customers of the assessee and the same was dealt as separate business segment from which the assessee was remunerated separately. x) The warranty expense was borne by the AEs and not by the assessee. xi) Business promotion expenses incurred by the assessee was routine in nature such as trade fair/exhibitions/road-shows/promotion of products, dealers meeting and travels cost and therefore these expenses cannot be treated as value added activities. xiii) Pricing decisions were taken by the assessee and not by the AEs. xiv) Since the AEs an....
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....ies is unquestionable. vi) The Berry ratio is the ratio of gross profit to operating expenses and is named after American economist Professor Charles Berry, who first applied in the transfer pricing court case E.I du Pont de Nemours & Co. v. U.S.,608 F.2d 445(Ct.Cl.1979). The du Pont case involved a distributor which also performed related marketing services. When evaluating the performance of the distributions, Professor Berry compared the ratio of gross profit to operating expenses to third party comparable companies ratios of gross profits (less unrelated other income) to operating costs (excluding interest and depreciation). In this way, Professor Berry was able to evaluate the return the du Point distributor earned on its purely value adding distribution activities, though with an important underlying assumption that the cost of these activities were fully captured in the distributor's operating expenses. The Berry ratio has been recognized in the U.S transfer pricing regulations since the early 1990s. Generally, the berry ratio should only be used to test the profits of limited risk distributors or service providers that do not own or use any intangible assets. This ....
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....le etc., the benefit of which is directly enjoyed by the AEs without producing any significant profit to the assessee for the relevant assessment year. xi) The argument of the Ld. A.R. that the assessee had incurred loss on account of start-up phase is also not appreciable because the expenses incurred by the assessee is abnormal compared with a normal start-up phase. xii) Market research activities performed by the assessee company is inter linked with the distribution activities of the Assessee Company and inseparable. Further, we also find that proper segmental accounting is also not carried out by the assessee. xiii) It is pertinent to mention that the assessee company not only established a dealer network for selling the products of the AEs to the end customers but also made tremendous awareness of the existence of the assessee's AEs and their products in the Indian markets. xiv) Even if the warranty expenses were borne by the assessee's AEs, considering the other functions performed by the assessee company the Berry ratio would be the most appropriate method in determining the ALP in the case of the assessee company. xv) The abnorm....
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....m of derivative losses/gains is independent to the extent of the services rendered and is determined entirely outside the parameters of the service provider's actual business. The Ld. DRP further observed that as far as the adjustment on account of foreign exchange fluctuations, the assessee claimed that the foreign exchange fluctuations which are inbuilt in the purchase from AEs to arrive at the margin of the assessee. The Ld.DRP further opined that the essence of transfer pricing is in the arm's length principle which requires the determination of transfer prices between AEs to reflect terms in a hypothetical scenario where it is required to assume "as if" the transaction takes place between two unrelated parties. Under the basic principles of contracting, the costs which would be reimbursed with a markup should be ones which are controllable and can be monitored, i.e. at the time of entering into the agreement. Any cost that may arise out of the future uncertain movement of the nominal exchange rate is not predictable and hence non-contractible. Hence it was upheld by the Ld.DRP that the assessee will not be eligible for adjustments on account of foreign exchange fluctuations. B....