TaxTMI 
TaxTMI 
2016 (8) TMI 1143
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....e with respect to the transfer pricing (TP) adjustment of Rs. 4.92 crores, which was ultimately confirmed by the Hon'ble Tribunal out of the original TP adjustment of Rs. 236.23 crores initially made by the AO, after granting relief for the balance part of the TP adjustment amounting to Rs. 231.31 crores. 2. The CIT(A) erred in invoking the provisions of Explanation 7 of section 271(1) (c) of the Act in confirming the aforesaid levy of penalty by holding that the Appellant had failed to prove before the AO and CIT(A) that the TP adjustment with reference to which the penalty had been levied, as referred to in Ground N0.1 above, did not arise due to any absence of good faith and due diligence on the part of the Appellant in computing the price of its international transactions with the foreign associated enterprises (AEs) in accordance with the provisions of section 92C of the Act. 3. The CIT(A) erred in holding that the TP adjustment, which was confirmed by the Hon'ble Tribunal amounting to Rs. 4.92 crores out of the initial TP adjustment of Rs. 236.23 originally made by the AO, having been computed with reference to a mark up of 32% on operational cost of the Appellant, ....
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....t there was no occasion or scope on the part of the Appellant to have not computed its arm's length price in accordance with the provisions of section 92C of the Act with reference to such derived figure of 32% as a mark up on its operating cost, since the said figure of 32%, being a mark up on operating cost, did not exist in the AOs order passed under section 143(3) of the Act read with section 144C of the Act or in any public database available either with the AO or the Appellant, namely Prowess and Capitaline Plus, with reference to which comparable benchmarking analysis was carried out whether during the course of preparing the return of income or even during the assessment proceedings; and therefore the CIT(A) further erred in confirming the levy of penalty as aforesaid, by invoking the provisions of Explanation 7 of 271 (1) (c) of the Act. 8. During the course of the proceedings of the quantum/ merit appeal before the Hon'ble Tribunal relating to the relevant assessment year, the authorised representative of the Appellant, while disputing the reliance placed by the DRP, the AO and the departmental representative on the judgement of the Hon'ble Tribunal rendered in the case....
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.... since the TPO, DRP and AO had all along proceeded to compute the arm's length price in the case of the Appellant as a 6.07% commission on the value of goods procured by foreign AEs from third party vendors in India and had not calculated the arm's length mark up of 32% on the operating cost of Appellant, being the remuneration policy which was finally approved by the Hon'ble Tribunal in the Appellant's case; and the said figure of 32% as a mark up on operating cost came up as a point in the data range only during the course of discussions before the Hon'ble Tribunal and that too in the context of a private company, whose financials were not available in the public database and whose reference was made by the AO, the DRP and the Departmental Representative to augment their arguments for the adoption of a commission based remuneration model. 11. Without prejudice to any other contentions of the Appellant preferred in grounds as above, even assuming but not admitting that the adoption of the said figure of 32% as the arm's length mark up on operating cost of the Appellant, arose due to a difference of opinion between the Hon'ble Tribunal and the Appellant, such difference of opinio....
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....me during the hearing of the quantum proceedings in assessee's case. It was submitted that since the order of the ITAT in Li and Fung India P. Ltd. (cited supra) was available before the ITAT as a result of the view expressed therein considering the fact that the ultimate impact on the assessee in the quantum proceedings was not so detrimental to the assessee thus for the sake of peace of mind, the concession was made before the ITAT. In the circumstances, it was his prayer that penalty may be quashed as it is not a case of concealment. It was also submitted that in the face of the decision of the Hon'ble High Court in the very case of Li and Fung India P. Ltd. (cited supra) penalty in the peculiar facts and circumstances of the case was not maintainable. 2.1. Referring to the facts it was submitted that the record would show that penalty u/s 271(1)(c) was initiated on account of the following additions/disallowances:- i) Addition on account of Transfer Pricing - Rs. 2,36,22,31,473/- ii) Excessive claim of depreciation - Rs. 27,02,896/- 2.2. In the quantum proceedings it was submitted the addition on account of excessive claim of depreciation was deleted by the ITAT in ITA No....
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.... total operating costs plus a 15% mark-up thereon and therefore the total operating cost does not include the value of goods sourced by GAP US from third party vendors. The cost plus model adopted by the assessee it was submitted was not accepted by the TPO and he applied a commission at the rate of 6.07% in AY 2006-07 on the value of goods procured by GAP US directly from third party vendors from India, leading to a TP adjustment of Rs. 236.22 crores. The TPO while proposing the addition it was submitted relied upon the order of the ITAT in the case of Li & Fung India Private Limited ('Li & Fung India'). It was submitted that by the time the quantum appeal came up before the ITAT considering the argument of the assessee that the facts in the case of Li & Fung in assessee's case were distinguishable which argument was accepted by the ITAT and the remuneration model of the assessee as disclosed in the TP study was accepted. The ITAT it was submitted held that the assessee was entitled to a mark-up on total operating costs of GIS India only (and not the value of goods sourced by GAP US) and thus commission based remuneration was held to be not applicable to the assessee. However, on ....
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....necessarily attract penalty. In support of the said proposition, reliance was placed on Boston Scientific India Pvt. Ltd [TS-73-ITAT- 20I6(DEL)-TP]; and Mitsui Prime Advanced Composites India . Ltd [TS-193-ITAT- 2016(DEL)-TP]. It was further submitted that for levying penalty there must be absence of good faith and due diligence as held by the ITAT in RBS Equities India Ltd (formerly known as ABN Amro Asia Equities India Ltd.) [ITA No. 2570/Mum/2010, 201 l-TII-91-ITAT-MUMTP, TS-492-ITAT-201 l(Mum)]; M/s Verizon Communication India Pvt. Ltd. vs. DC1T [ITA No: 5566/Del/2011]; Serdia Pharmaceuticals (India) Pvt. Ltd. (ITA No. 7215/Mum/2007); M/s Firmenich Aromatics (India) Pvt. Ltd [ITA No 4654/Mum/2009]. 2.9. Accordingly it was summed up that the assessee has conducted its transfer pricing study in a bona fide manner and the ITAT has upheld the selection of most appropriate method followed in the TP Documentation maintained by the Company has also accepted the PLI and the remuneration model/stands accepted and has merely adopted a different mark-up. Thus a mere difference in the mark-up adopted by the assessee it was submitted does not justify the levy of penalty for concealment or ....
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....ccordance with the provisions contained in section 92C and in the manner prescribed under that section, in good faith and with due diligence]." 4.1. A perusal of the above makes it clear that Explanation 7 of section 271(1)(c) is a deeming provision whereby it is deemed that in case of any addition or disallowance in the case of an assessee who has entered into an "international transaction" defined in Section 92B of the Act then for the purposes of sub-section (c) of section 271(1) the said amount added or disallowed would be deemed to represent such income in respect of which particulars have been concealed or inaccurate particulars have been furnished. Exception is carved out only in the case where the assessee proves that the price charged or paid in such transaction was computed in accordance with the provisions contained in section 92C; and in the manner prescribed under that section "in good faith" and "with due diligence". Thus in order to consider whether the said requirements of Explanation 7 have been met or not, it is necessary to consider the facts and circumstances leading to the addition having been made. The discussion on these facts is relevant and material in or....
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....h. Considering the Agreement of the assessee with the Foreign AE which has been reproduced in the TPO's order itself verbatim shows that full facts have been disclosed all along including the fee schedule which has also been reproduced by the TPO. On analyzing the same, the TPO held that the correct compensation model at arms length price would be commission on FOB cost of goods sourced from India and the addition was proposed. By the time, the issue in the quantum proceedings came up before the DRP the decision of the ITAT in the case of Li & Fung holding the same view was available and the assessee consequently failed to get any relief. It is a fact that the Co-ordinate Bench in the quantum proceedings did not approve the interference with the remuneration model of the assessee made by the TPO and upheld by the DRP. It would be appropriate to refer at this stage to the findings arrived at in the quantum proceedings. The relevant extracts from the order in the quantum proceedings are extracted hereunder:- 9.2. "Characterization of Assessee and its Associated Enterprises through Function, Assets and Risk (FAR) analysis of international transactions. The FAR analysis gives the ....
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....ocurement support service provider only." (emphasis provided) 4.4. The following extracts from the order of the Co-ordinate Bench would further be relevant to refer to in order to consider the conduct of the assessee vis-a-vis its claim of good faith and due diligence which is under scrutiny:- 9.4. Li & Fung Case and TPO / DRP Stand i. ............................. ii. ............................ iii. The department has heavily relied on the Li & Fung India's case (supra). In this case, the Delhi Tribunal held that on the facts of the said case, the procurement company in India was entitled to a revenue linked remuneration. The decision in the case of Li & Fung proceeded on the specific findings of the TPO that the assessee was not able to establish that the foreign principal in Hong Kong had any substance, which the assessee was also not able to substantiate before the Tribunal. In these peculiar facts Tribunal accepted the factual position that the Indian assessee had actually carried out all the significant functions relating to procurement in India; and that very little or virtually nil functions were carried out at the level of Hong Kong. iv. However, the facts in ....
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....cision making. The TP study relied upon by the assessee as far as the selection of most appropriate method and selection of comparables is concerned, has been upheld by the TPO himself. The remuneration model has been upheld by the ITAT. Thus, to this extent as per record there is no doubt that the TP study has been prepared with due diligence and in good faith. 4.6. The next issue which then arises for our consideration is can the acceptance of enhanced mark-up of 32% as against the mark-up of 15% in the TP study be so fatal as to attract the rigorous of the Act. The fact that the mark-up of 32% was an estimated markup is an accepted fact and has not been disputed by the Revenue. Admittedly the said mark-up has neither been considered by the assessee in its TP study nor has it been proposed by the TPO or for that matter by the DRP. The said issue admittedly surfaced for the first time before the ITAT where faced with the position where the assessee realizing and accepting its inability to persuade the Bench to take a view on the facts and not on precedent available in the case of LI & Fung, the facts of which case had been held to be distinguishable that the assessee finding itse....
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....e facts of the Li & Fung, the Co-ordinate Bench had held that the foreign AE admittedly lacked the peculiar domain knowledge necessary for carrying out the activities which knowledge and expertise exclusively vested with the Indian AE. The Co-ordinate Bench had also observed that the higher returns of this foreign AE who had no core competence vis-a-vis the Indian AE entity which had the core strength and did the entire legwork having demonstrative knowledge, expertise and capability for the tasks undertaken by it deserved a higher share in the profits. As opposed to this in the facts of the present case the entire decision-making on apparel specifications, fashions quality, colour design was well within the capability of the foreign AE who as per its handbook directly placed orders meeting requirements with the third-party Vendors and the assessee's role was only limited to providing services to facilitate these. Thus in the face of these clear-cut distinctions the Co-ordinate Bench in the quantum proceedings concluded that the assessee was a low-risk service provider. The remuneration model of cost plus method was held to be most appropriate. Hence the decision to accept an estim....
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....d and addressing the ingredients of section 271(1)(c) the selection of method by the TPO has not been upset. 4.10. Considering the overall factual matrix wherein the facts have been re-visited by us in great detail, we find ourselves unable to agree with the view taken by the tax authorities. No doubt the onus is placed by the Statute upon the assessee to demonstrate that its computation of price paid or charged was within the four corners of the manner prescribed u/s 92C and notwithstanding the addition made the exercise was undertaken in good faith and with due diligence. Having so demonstrated by the consistent explanation on record in the facts of the present case the onus shifts to the Revenue to demonstrate that by a specific act, fact or conduct the affairs of the assessee in regard to computation of price charged or paid was lacking in good faith and was done without due diligence. No such argument has been raised nor any fact has been brought to our notice to suggest otherwise. The view taken appears to be that simply because the addition is accepted the penalty is to be levied. 4.11. We find considering the judicial precedent and the peculiar facts of the present case t....
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....Allahabad High Court in the case of Kedar Nath v. State [AIR 1965 ALL 233] (at p. 236) while opining on the meaning of the said term, held "Good faith imports the exercise of due care and attention. A person can be excused for having committed an error of judgment only if he exercised due care and attention and his conduct makes it clear that there was no negligence according to reasonable standards. The standard of care required is that of a reasonably prudent man who acts with the care and caution required of a person in his position dealing with a matter of similar importance." 4.13. At the cost of re-iteration in order to decide and adjudicate upon the said issue, it is necessary to consider the conduct of the assessee and ascertain whether it can be said to have been governed and guided by good faith and due diligence or not. In the facts of the present case as per the TP study report made available by the assessee to the tax authorities the assessee operates as a procurement support service company for its foreign AE. The foreign AE directly sources the goods from third-party vendors in India and in respect of these the assessee renders sourcing support services. For the sai....