TaxTMI 
TaxTMI 
2016 (5) TMI 145
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.... Dispute Resolution Panel (DRP) which in turn were passed on the objections filed by the assessee against the draft assessment order of the Assistant Commissioner of Income Tax-the AO which in turn was in accordance with the order of the TPO-Additional Commissioner of Income Tax. The Assessing Officer (AO) had made a reference to the TPO for determining the arm's length price (ALP) of certain international transactions entered into by the assessee with its associated enterprises (AEs). 2. The assessee's appeal was admitted by an order dated 11.09.2014 on the following substantial questions of law raised in paragraph-15 of the appeal:- "A. Whether on a true and correct interpretation of section 92C(1) r/w 92CA(3) of the Income Tax Act the Tribunal was right in law in upholding an adjustment to the declared value of following International Transactions: (i) Professional consultancy of Rs. 1,52,07,206/- (ii) Management fee for support services of Rs. 1,40,56,800/-. B. Whether, the order of the Tribunal is perverse for nonconsideration of relevant material, the evidence placed on record and submissions made by the Appellant and reaching a conclusion that the services ava....
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....no alternative but to remand the matter to the Tribunal for fresh consideration in light of our findings on the questions of law. 4. The assessee is a wholly owned subsidiary of Knorr- Bremse Asia Pacific (Holding) Limited (KBAP). KBAP was formally known as Knorr-Bremse Far East Limited. It carries on business inter alia of manufacturing air brake sets for passenger cars and wagon coaches, shock absorbers for passenger cars and locomotives, distributor or valves, computer control break system, tread break units and brake accessories. The assessee's business is segregated into two parts, namely, manufacture and distribution. During the assessment year, it entered into various international transactions with its AEs. We will refer to these transactions shortly. The assessee had prepared a transfer pricing report which adopted the Transactional Net Margin Method (TNMM) considering it to be the most appropriate method for the purpose of benchmarking its activities under the manufacturing and distribution segments separately. The assessee has described its manufacturing and distribution functions as follows:- Manufacturing functions: The manufacture of the products, referred to ea....
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.... 2.69 Aggregated with Manufacturing & Trading Function 13. SAP License Fees - 1.41 14. Software license fees - 0.27 15. Advance license fees - 0.48 No Benchmarking required 16. Recovery of expenses 0.86 - 17. Materials/Products imported free of costs as replacement/samples during the warranty period NIL 18. Use of technical know-how - NIL 19. Supply of materials at free of costs as samples/warranty NIL" The main grievance of the assessee is that item Nos.3,8,11 and 13 were valued separately by the authorities by the Comparable Uncontrolled Price Method (CUP Method). The assessee's contention is that the entire matter ought to have been determined by the TNMM. 6. While benchmarking the international transactions in its manufacturing segment, the assessee selected five independent comparable companies, the mean profit level indicator (PLI) of which was 8.47% against the assessee's margin of 9.01% from its manufacturing operations. With reference to its distribution activities, the assessee se....
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....from its said AE KBAP which acted as a regional service centre for providing management and operational support services to its group companies in the Asia Pacific Region. These services are provided under a management support agreement dated 01.01.2003 and includes business development, marketing, project management services, human resource support services, accounting, financial support and controlling services and IT support services. Service fee was paid by the assessee to KBAP computed on the basis of the expenses incurred by the KBAP. The assessee's case is that the expenses were based on the time spent and expenses actually incurred. Documentary evidence in this regard was also produced before the authorities and in these appeals. 9. The assessee's case is that these transactions were inextricably linked to the manufacturing and distribution functions performed by it and they were, therefore, aggregated and analyzed with the assessee's manufacturing and distribution functions. According to the assessee, there is no direct comparable as per the CUP Method for transactions of this nature. Further, the transactions being closely and intrinsically linked with the core busines....
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.... also the basis on which such payments are paid. 11. If the AE has rendered services to more than one entities including you, then the basis of allocation amongst various entities. Also furnish the basis of choosing a particular allocation key. Please note that in the event of your being unable to provide these details in a satisfactory manner, the arms length price in respect of all these transaction amounting to Rs. 7,29,00,346 shall be reduced to 'nil'." The assessee furnished the details and filed a reply dated 18.10.2010. 11. Before dealing further with the order of the TPO, it would be convenient to set out the following provisions of the Act and the Income Tax Rules. The relevant provisions of the Act are as follows:- "92-B. Meaning of International Transaction.-(1) For the purposes of this section and Sections 92, 92-C, 92-D and 92-E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, i....
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....price so determined: Provided that no deduction under Section 10-A or Section 10-AA or Section 10-B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section: Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm's length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XVII-B, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm's length price in the case of the first mentioned enterprise." 12. The relevant Rules are as follows:- "10A. For the purposes of this rule and rules 10B to 10E,- (a) "uncontrolled transaction" means a transaction between enterprises other than associated enterprises, whether resident or non-resident; (b) "property" includes goods, articles or things, and intangible property; (c) "services" include financial services; (d) "transaction" includes a number of closely linked transact....
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....e manufacturing segment, the assessee had selected the TNMM as the most appropriate method with Net Profit Margin (NPM) as the PLI. From the major international transactions tabulated above, the TPO segregated the ones at serial nos.3, 8, 11, 12 and 13 and tabulated the same separately. For the purpose of this appeal it will be convenient to set out this table as well which also indicates the payments against each of the services. "Professional consultancy 15,207,206 Management fee for support services 14,056,0800 SAP consultancy charges and other expenses 26,893,871 SAP License Fees 14,064,063 Software 2,678,406 Total 72,900,346" The TPO noted that under the above provisions of the Act and the Rules each class of transaction has to be examined having regard to the ALP by applying the most appropriate method. He held that the said services are a class of transactions of their own and, therefore, require separate analysis. He, therefore, analysed the said segregated services/transactions separately under the CUP Method observing that the Act does not preclude the TPO from applying the appropriate method for each class of transaction l....
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...., the allocation method chosen must lead to a result that is consistent with what comparable independent enterprises would have been prepared to accept." Therefore, the assessee cannot escape its responsibilities of having to show the actual benefit it has received. The assessee will also have to demonstrate that independent parties would be inclined to make such a payment in similar circumstances." We will deal with these observations later. The TPO thereafter proceeded to deal with each of the segregated services that he considered separately. Regarding the professional consultancy services, the TPO observed that formal training sessions were not held for the assessee's employees; that the cost accruing to the AE in this regard would be very small; that this kind of training would be picked up by the employees on the job and that it is not as if the employees were being given training in respect of all the maritime laws and other regulations that are prevalent all over the world; that the documents do not evidence "formal training"; that the invoices do not contain a description of the services and that the assessee had only relied upon some minutes of the meeting and mo....
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....f as to the complex problems that the AE had solved which the assessee would have been unable to; that the support services related to creation of codes, solving initial problems on account of implementation of SAP and that the implementation of hotline services and ongoing support were expected from the AE without any charge. The correspondence was held to be merely routine day-to-day correspondence which does not establish the services and any tangible benefits having been derived therefrom. The TPO concluded that no independent party would pay such huge amounts for the said services. (E) With respect to SAP consultancy services, the TPO observed that the assessee has mentioned that the expenses had been capitalised during the year but that during the discussion with the assessee's authorized representative, it had been observed that depreciation was being claimed and charged to the profit and loss account during the year. The TPO held that since depreciation was being claimed, this item had a bearing on the profitability of the assessee and, accordingly, the claim with respect to the capitalised nature of assessee fees did not have any force and that the transaction had to be....
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....of the assessee by the amounts debited to Profit & Loss Account and shall disallow the depreciation on the items, on which the depreciation is being claimed. The Assessing Officer may examine the feasibility of initiating penalty proceedings u/s 271(1)(c) of the Act in accordance with Explanation 7 of the same. In respect of other transactions no adverse inference is drawn." 14. The Assistant Commissioner of Income Tax - AO accordingly prepared a draft assessment order dated 20.12.2010 and assessed the assessee's income at Rs. 6,25,65,160/-together with interest and also initiated penalty proceedings. 15. The assessee filed its objections on 01.09.2011 to the draft assessment order before the DRP. The DRP by its order dated 03.09.2011 issued directions under Section 144C(5) of the Act. With respect to the TPO having rejected the assessee's approach of aggregating the closely linked transactions, the DRP merely held that it found the reasoning of the TPO to be logical and agreed with him. Nothing further was stated. With regard to the assessee's objection to the TPO having used the CUP Method for benchmarking certain services only, the DRP observed that the SAP licenc....
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....Having rendered these findings, the Tribunal observed that there is no guidance in India regarding the criteria for choosing a particular method and that the law does not provide for priority for any particular method to be applied. The tribunal, however, observed that the OECD and certain other countries considered the CUP Method to be the most direct method for determining the ALP. The Tribunal, therefore, rejected the TNMM in respect of the said three transactions and upheld the TPO and DRP's adoption of the CUP Method in respect thereof. With respect to the evidence produced by the assessee, the Tribunal merely held as under:- "9.2. After hearing the parties with reference to material on record, we find that the authorities below have not conclusively held that the assessee could not enter into such a transaction nor had they disallowed the same by holding that such an expenditure is not assessee's business expenditure. The DRP as well as the authorities below have merely elucidated that the payments are reimbursement in respect of Ms. Rita Ricken and other personnel's case to serve the interest of share holders. By saying so they have only described the circumstance under w....
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....he grounds raised in appeal by the assessee. 20. A reading of the orders of the TPO, the DRP and of the Tribunal makes it clear that one of the main reasons for not accepting the assessee's case was that the assessee had not been able to substantiate that the payment for the services had actually increased its profits. As we noted earlier, the TPO, in fact, further held that the assessee should have been able to show the level of increase in profit post the said transactions. 21. We are unable to agree with this finding. The answer to the issue whether a transaction is at an arm's length price or not is not dependent on whether the transaction results in an increase in the assessee's profit. This would be contrary to the established manner in which business is conducted by people and by enterprises. Business decisions are at times good and profitable and at times bad and unprofitable. Business decisions may and, in fact, often do result in a loss. The question whether the decision was commercially sound or not is not relevant. The only question is whether the transaction was entered into bona fide or not or whether it was sham and only for the purpose of diverting the profits....
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..... The factors that are involved in achieving this objective are the means of achieving this end. Absent any special term in the contract, the seller of goods or the provider of services is not concerned whether its purchaser profits from the use that the goods or services are put to. It is concerned with the same only in so far as the usefulness of its products and services enhances the value thereof and consequently furthers its own commercial interests. Merely because an assessee profits by the use of the goods supplied or the services rendered, it does not follow that the same were sold or supplied at an arm's length price. Conversely, merely because an assessee does not profit from the use of the goods or services it does not follow that they were not sold at an arm's length price. 26. A view to the contrary would cause considerable confusion and lead to arbitrary, if not illogical, results. A view to the contrary would then raise a question as to the extent of profitability necessary for an assessee to establish that the transaction was at an arm's length price. A further question that may arise is whether the arm's length price is to be determined in proportion to the exte....
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....or authorised. We are in respectful agreement with these observations. 28. The absence of profit may at the highest be a factor while considering whether the transactions were genuine or not. That would depend upon the facts of each case. However, mere absence of profit would not be a ground for holding that the transactions are not genuine and ought not to be taken into consideration in the assessment proceedings. 29. We hasten to add that in the case before us the assessee has, in fact, contended that it has benefited from the international transactions entered into by it with its AEs. However, even assuming that this has not been established, it would make no difference. 30. Mrs. Suri relied upon a judgment of the Delhi High Court in Commissioner of Income-Tax vs. Cushman and Wakefield (India) Pvt. Ltd., [2014] 367 ITR 730 (Delhi). The Division Bench held:- "35. The Transfer Pricing Officer's report is, subsequent to the Finance Act, 2007, binding on the Assessing Officer. Thus, it becomes all the more important to clarify the extent of the Transfer Pricing Officer's authority in this case, which is to determining the arm's length price for international transactions....
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....pendent parties would be inclined to make such a payment in similar circumstances." The TPO's conclusion in the last but one sentence does not follow from the OECD Guidelines quoted by him. The OECD Guidelines merely state that the result must be consistent with what comparable independent enterprises would have been prepared to accept. We do not see how from this observation it follows that the assessee cannot escape its responsibility of having to show the actual benefits it had received. 32. The Tribunal has also held in paragraph 7.2 that the assessee has failed to show whether there has been any real or tangible benefits by entering into the said transactions. 33. It is obvious, therefore, that this aspect weighed considerably with the authorities in rejecting the assessee's case even on merits. Considering these observations, we would presume that had the assessee established that the transactions had resulted in increased profitability, the assessee's contention on merits also would have been accepted. In any event, they would have enhanced the assessee's ability to establish the case on merits. The DRP and the Tribunal had rejected the assessee's contention regardi....
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....uted separately under the CUP Method while retaining the assessment of the remaining transactions under the TNM Method. She submitted that this approach would lead to skewed results. She submitted that assuming that the TNM Method was not the appropriate method in respect of the said transactions and the arm's length price thereof ought to be assessed by the CUP Method, all the other transactions also must be assessed by the CUP Method. 37. We will assume that the various international transactions were entered into with respect to the final commercial venture undertaken by the assessee, be it the manufacture and the sale of goods or the provision of services by it. The AO or the TPO, as the case may be, is required to determine the arm's length price in relation to "an international transaction". The acquisition of various items/components in the assessee's venture could indeed be telescoped into and form a single transaction. For instance, in the case of a package deal where each item of the package is not separately valued but all the components thereof are given a composite price, the transactions form but one composite transaction. An assessee may enter into one composite t....
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....ve that although each sale and each provision of service is priced separately, they were all provided under one composite agreement which constitutes an international transaction. 40. We are, however, unable to agree with Mrs. Suri's contention that as the services and goods are utilized by the assessee for the manufacture of the final product they must be aggregated and considered to be a single transaction and the value thereof ought to be computed by the TNMM. Merely because the purchase of each item and the acceptance of each service is a component leading to the manufacture/production of the final product sold or service provided by the assessee, it does not follow that they are not independent transactions for the sale of goods or provision of services. The end product requires several inputs. The inputs may be acquired as part of a single composite transaction or by way of several independent transactions. In the latter case, the sale of certain goods and/or the provision of certain services from out of the total goods purchased or services availed of by an assessee together can form part of a separate independent international transaction. In such an event, the AO/TPO mu....
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....l things get taken into account and stand reconciled when computing the net profit margin. Once the comparables pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the comparables would result in affirmation of the transfer price as the arm's length price. Then to make a comparison of a horizontal item without segregation would be impermissible." It is obvious that the Division Bench considered the expenditure towards AMP as part of the overall transaction in respect whereof the TNM Method was adopted and, therefore, held that it could not be segregated and valued as a separate international transaction. The judgment, therefore, does not assist the assessee. 43. It follows, therefore, that if the TPO had correctly come to the conclusion that the said five items were not connected to the rest, he was justified in determining the arm's length price thereof separately from and independent of the others. It would be neither logical nor rational in that event to club several independent and unconnected transactions for the purpose of determining the arm's length price. If, on the other hand, it is established that ....
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....ansactions with the group entities. Prima facie at least, it appears, therefore, that each transaction was separate and independent of the other. As we intend remanding the matter, it will be open to the assessee to contend otherwise. It is for the assessee to establish that though these services were provided by different entities they formed a part of an international transaction and were not separate independent international transactions. 46. There is yet another issue of law which, in our view, is important and requires consideration. The TPO referred to the management support services. The same fell within four categories, namely, business development, human resource services, accounting, financial support and controlling services and IT services. With regard to the same, the TPO held that the assessee had sufficient local help to allow it to overcome the legal challenges at the local level. The TPO held that there was no reason to believe that the AEs provided assistance that the assessee could not obtain at the local level in India. Mr. Joshi, the learned counsel appearing on behalf of the respondent, submitted that for these and other services, the appellant could alway....
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....ave been given the same weightage. Further, this would be so not merely in computing the quantum but also the very question as to whether the services were rendered by the AEs and availed of by the assessee. These are issues of fact which must, in the first instance at least, be determined by the authorities under the Act. 51. As we are remanding the matter, it is not necessary to deal with the voluminous evidence produced and relied upon by the assessee. The authorities have come to the conclusion that the same did not reflect that any valuable services were in fact rendered. As we are remanding the matter, we do not wish to make any observation in this regard, least it prejudices either of the parties while considering the matter upon remand. Suffice it to state that the assessee has relied upon voluminous evidence which cannot be ignored. The same must be considered and analyzed. It cannot by any stretch of imagination be held that the evidence is irrelevant. For instance, the assessee has produced all the invoices and proof of payments including in respect of services rendered by the employees of the AE's. The assessee has also established that such employees of the AE had a....
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....her. The TPO, for instance, held that the description in the invoices of the work done by the AEs' representatives/employees did not really convey anything, that there was no description of the services actually rendered and that the correspondence/other documents did not prove the delivery of services nor the benefits derived therefrom. In this regard, it is also pertinent to note Mrs. Suri's grievance that the TPO did not even seek any explanation or particulars regarding the details mentioned in the invoices and in the correspondence regarding the nature of assistance rendered by the employees of the AEs. Thus, on the one hand, commercial expediency is recognized but on the other it is held that the transactions were really not for the benefit of the assessee. The matter would have to be considered/re-considered in view of the observations in this judgment. 54. This brings us to the appeal filed by the Revenue/respondent in ITA-182-2013. The Revenue is aggrieved by the decision of the Tribunal directing the AO to delete the addition with respect to the SAP Consultancy charges in the sum of Rs. 2,68,93,871/- to the assessee's income. The Tribunal found that the DRP had r....