TaxTMI 
TaxTMI 
2016 (9) TMI 1650
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.... heard together and deem it appropriate to dispose of them by this common order. First we take up Revenue's appeal ITA No.181/Kol/2010 for A.Y 04-05. 3. Revenue has raised following grounds as under:- "1. That on the facts and in the circumstances of the case, Ld. CIT(A) erred in deleting the addition of Rs. 50,15,212/- made by the TPO due to adjustment of arm's length price adopting RPM method being the most appropriate having regard to the facts and circumstances of each particular transaction after giving reasonable opportunity to the assessee. 2. On the facts and in the circumstances of the case, Ld. CIT(A) erred in directing not to include service charge amounting to Rs. 90 lakhs in total turnover while computing deduction u/s. 80HHC of the IT Act. 3. That on the facts and in the circumstances of the case, Ld. CIT(A) erred din allowing deduction of customs duty of Rs. 11,77,331/- which was adjusted against advance license benefit available to the company rather than payment thereby violating the provision of sec. 43B of the IT Act. 4. That on the facts and in the circumstances of the case, Ld. CIT(A) erred in accepting additional evide....
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.... than 5%, therefore TNMM is not the most appropriate method. The AO also observed that the assessee for the AY 2003-04 used the CPM method for the export to AE and RPM method for the Export from AE. So the AO adopted the CPM method and worked out the ALP for the exported goods as under:- The manufacturing details submitted by the assessee are as under:- Total Domestic sales Export to AEs Export to non-AEs Net sales 2,288,221,250 2,024,504,485 37,986,395 80,760,331 Other income 45,519,716 Raw material consumption 1,616,195,407 1,400,627,381 32,271,826 63,842,458 Gross profit 672,025,843 623,877,104 5,714,569 16,917,873 GP on sales 29% 31% 15% 21% GP on cost 42% 45% 18% 26% It was observed that the overall GP margin is 42% on total costs of the assessee. However on export to AEs, the GP on cost is only 18% as compared to 26% earned on the export to non-AEs. The AO further observed that the functions performed by the assessee are similar in both the cases of exports to AE and non-AE. Therefore the GP margin should be similar. The assessee objected on ....
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....a essential. Under the RPM, the similarity of the function is necessary which is matching i.e. in both the cases of imports from AE and non AE, the functions performed are trading only. Besides the there is no substantial value addition by the assessee in the trading goods. Hence, RPM is the most appropriate method in the given facts. In view of the above, the AL GP margin on sales in respect of imports is considered as 23%. After giving 5% relief, adjusted ALPO is 18% only. The GP margin shown by the assessee is only 13%. 5. Aggrieved, assessee preferred an appeal to ld. CIT(A) whereas assessee submitted that the TPO rejected the transfer pricing study without finding out any deficiency in it. The finding of the AO that the assessee has used the CPM method in the AY 2003-04 is incorrect as the assessee has used only TNMM method for that year. The justification given by the AO for adopting the CPM method that the transaction with AE is less than 5% of the total volume of the business is not tenable as his logic is not based on any provision of law or any precedent of case. He has applied this logic on his own whimsy, conjecture, premises. Without prejudice to above the TPO ha....
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....be adopted in all cases. If the circumstances so demanded, the TPO was competent to examine the application of alternate method for determining ALPs. However, before making departure from a method adopted in the earlier year; it was incumbent upon the TPO to establish with cogent reasons that earlier accepted method was not appropriate. In the appellant's case the TDPO rejected the assessee's reliance on TNMM method on the ground that in the immediate preceding year the assessee had adopted CPM & RPM methods for determining ALP with AEs whereas in the year under consideration assessee had adopted TNMM method to justify its transactions with AEs. In the light o these observations TPO proposed adjustments to ALP by adopting CPM & RPM methods which according to him were followed by the assessee in the earlier year. In other words TPO justified adoption of CPM & RPM methods on the rule of consistency & thereby rejected assessee's TP report which was based on TNMM method. In my opinion the TPO was not justified in rejecting TNMM method for the reasons set out in his order because in the immediately preceding year also, assessee had adopted the same method; justifying its international t....
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....71,826 63,842,458 Manufacturing cost (as per list attached) 206,499,457 3,874,612 8,237,554 Royalty 2% on sales 40,490,090 1,615,207 Sales commission 34,806,318 3,541,431 Adjusted cost 1,696,557,274 36,146,438 77,236,649 Gross profit 327,947,211 1,839,957 3,523,682 Gross profit margin 16.20% 4.84% 4.36% 10. from the comparative analysis, it is noted that if incidence of manufacturing cost, royalty on sales & commission was taken into account then assessee's profit margin in respect of exports to AEs was higher at 4.84% against profit margin of 4.36% in respect of exports to non AEs. It appeared that in his order the TPO took into account only the direct material consumption cost but failed to consider the proportionate manufacturing cost, royalty & commission payments. From the facts as are brought on record I find force in the A/R's argument that profit margin in Exports to AEs was higher than the profit margin in exports to Non AEs. In his report u/s 92CA(3) TPO failed to consider the cost & manufacturing sales overheads. I have therefore no hesitation in holding that TPO di....
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....as Annexure-I. 13. From the comparative chart of the trading operations furnished it appeared that assessee imported printing ink from AEs at a cost of Rs. 7,06,70,14/- and sold to local parties for Rs. 8,09,41,169/- and earned margin of Rs. 1,02,71,025/- which in percentage term was 13%. The cost of purchases effected from unrelated parties (domestic and import) was ascertained by TPO at Rs. 4,20,47,002/-. These purchases inter alia included 3 products viz., press chemicals, blankets & machines. The products procured from unrelated parties & sold to unrelated parties were other than printing ink. It appeared from the comparative statement that purchases from unrelated parties were imported as from the comparative statement that purchases from unrelated parties were imported as well as sourced locally. Profit margins varied substantially form product to product and also depending whether the product was sourced locally or imported. For example, in the case of sale of press chemicals, the assessee earned profit margin of 32% from locally sourced press chemicals whereas in the case of imported press chemicals profit margin was only 14%. In the case of imported blankets sold ....
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....or the TPO brought on record any other material or evidence to justify the downward adjustments in the cost of printing inks imported from AEs. On the other hand, in the reports furnished before the AO; the appellant justified its transactions with AEs by adopting TNMM method and no infirmity in the working of ALP; made by adopting TNMM method was proved by the AO or the TPO. In absence of any other adverse material or infirmity in the report furnished by the assessee before AO; I find no justification in the adjustments carried made by the TPO in respect of material imported from AEs and sold to unrelated parties. The addition of Rs. 40,47,058/- is therefore ordered to be deleted. 14. Since on the facts of the case I have held that adjustments carried out by AO to the ALP with AEs were unjustified & the relief is allowed; the objections raise by the appellant against reference made to TPO for determination of ALP without complying the conditions prescribed in the Act; are now of academic interest only. I therefore do not deem it necessary to adjudicate the grounds challenging the AO''s reference for determination of ALP by the TPO." Being aggrieved by the order of the ....
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....ew on the ground that the TPO thought that the assessee itself had used CPM and RPM to justify the ALP in earlier year and that is why he rejected TNMM on ground of consistency. He found that the assessee has used TNMM in its analysis and not CPM or RPM. This assertion is not correct. As mentioned above, the TPO did not consider the TNMM as the most appropriate method in the circumstances of the assessee as its international transactions were less than 5% of the turnover. Further, he intended to analyze the two segments viz. manufacturing and trading segments, separately. This is clearly mentioned in the last Para of page 2 of the TPO's order. The reference to the use of CPM and RPM in earlier year was not made in the context of rejection of the TNMM. It was made while justifying these two methods as the most appropriate method for the two respective functions of the assessee. To appreciate this distinction, it is felt necessary that the whole process of arriving at the ALP of an international transaction in the case of the assessee be summarized. Section 92D requires any person who has entered into an international transaction to keep and maintain such information and docum....
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.... the Board may prescribe. 7. Further, Section 92C(2) provides that the most appropriate method mentioned in section 92C(1) is to be applied in the manner as may be prescribed. In this context, Rule 10B describes the manner in which the each Method prescribed in Section 92C(1) is to be applied and Rule 10C further provides that the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular transaction. It also mentions the factors which have to be taken into account while selecting the most appropriate method. As mentioned earlier, duty has been cast on the assessee to analyse the Methods and show the working of ALP. In Part-V of the Report mentioned above, the Methods prescribed by the Act have been analyzed. The assessee has rejected CUP and the PSM and even the TPO does not have any information or document in his possession to apply these methods. Thus, the only Methods left for analysis are the CPM, RPM and TNMM. As per Rule 10B(1)(C), CPM has to be applied to an entity which is involved in production of some property or services. As the assessee has a manufacturing function, this Method can be applied for internat....
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....wever, the assessee has not applied the TNMM by taking into consideration the nature of transactions (import of raw materials for manufacturing, import of finished goods for trading, export of finished goods for trading, payment of royalty), the class of transactions (export, import), the class of associated persons (manufactures, traders, technical knowhow providers) or the functions performed (manufacturing, trading). The assessee has also not taken into account the comparability factors prescribed in Rule 10B(2) which requires taking into account (in respect to both controlled and uncontrolled transactions): i. Characteristics of the property transferred ii. Functions performed, assets used etc iii. Contractual terms iv. Conditions prevailing in the markets in which the parties to both controlled and uncontrolled transactions are operating. It needs to be mentioned here that, these requirements are common to all the Methods described in Rule 10BB(1). Thus, the assessee failed to draw any distinction between the international transactions carried out under the manufacturing function taking into account assets used and risks assumed on one....
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....ejection of the TNMM. In Para 8 to 10 of his appellate order, Ld. CIT(A) has next taken up the actual application of CPM in the context of the manufacturing function. It is seen that on the basis of details furnished by the assessee, Ld. CIT(A) has arrived at a view that various costs, including royalty and commission payments were not included while computing the cost of production under the CPM. After allowing for these costs, Ld. CIT(A) found that the margins would not lead to any adjustments in the ALP. In this context, it has already been mentioned above that the details of gross margins for the two segments were called from the assessee itself. The sheet supplied by the assessee to the TPO in this regard is enclosed as Annexure 2 to this submission. If additional details were submitted by the assessee with regard to computation of gross margins, the same should have been remanded to the AO /TPO for comments. Thus, the nature of these additional manufacturing costs remained un-examined from the TPO's side. Further, it is seen that royalty and commission payments are included in the cost side for sales to unrelated parties. These are operational costs and not costs of....
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....#39;AEs'). Sl No. Nature of transaction Amount (in INR) Method used (a) Import of products for trading 40.44 million TNMM (b) Import of materials for manufacturing 27.40 million TNMM (c) Export of manufactured goods 37.63 million TNMM (d) Commission received 0.24 million TNMM (e) Royalty paid 30.68 million TNMM All the above transactions were benchmarked applying the TNMM Method prescribed in Section 92C of the Income-tax Act, 1961. In the order passed u/s 92CA(3) the TPO found the transactions mentioned at SI. No. (b), (d) & (e) benchmarked applying the TNMM Meth to be "at arm's length" (ALP). However as regards the export of manufactured products & import of various goods for trading, the TPO rejected the assessee's computation and evaluation of arm's length pricing. The TPO without pointing out any defect in the benchmarking exercise or in the reasons stated by the transfer pricing auditor in the transfer pricing report for taking the TNMM Method to be the most appropriate method baldly alleged that since the volume of import & export transactions with the AEs was not substantial (being less t....
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....ed for benchmarking the assessee's transactions with AEs and has justified the application of TNMM Method. Therefore the contention of the TPO & argument of the D/R that benchmarking exercise carried by the assessee was not reliable since the volume of the import & export transactions were not substantial is erroneous and bad in law. It is imperative to mention that the TPO did not dispute the benchmarking of commission income & royalty payment under the TNMM method adopted by the assessee; justifying to be ALP. The commission proceeds represented only a faction of the total turnover of the assessee. The TPO however did not dispute the application of TNMM Method for benchmarking the commission income. Similarly royalty payment of Rs. 30.68 million to AE was only 1.21% of the total expenses debited to P&L AI c. Even this transaction was benchmarked applying TNMM Method. The TPO accepted the assessee's benchmarking exercise and the application of TNMM Method in respect of royalty payment was accepted as well. In the circumstances the assessee fails to understand that if the application of TNMM was found justifiable by the TPO in respect of commission received and royalty p....
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....) for AY 2003-04 is at Page 226 of Paper book. It will be noted from Pages 154 to 161 of the Paper Book [Pages 24 to 31 of TP study] that even in the AY 2003-04 the TP auditor had justified TNMM to be the most appropriate method and in the TP order for AY 2003-04 no adjustment was proposed. It is therefore submitted that the rejection of TNMM Method applied by the assessee on the ground that the volume of import & export transactions with the AEs were not substantial is totally unwarranted and incorrect. The assessee further submits that both the TPO and the D/R have singularly failed to explain as to why and on what basis any of the other four methods prescribed in Section 92C( 1) was found or considered more suitable or for that matter more reliable than the TNMM Method. It appears from the TO Order that the TPO proceeded to arbitrarily apply the "Cost Plus Method" for benchmarking "Export of manufactured goods" and "Resale Price Method" for "Trading of various goods". The TPO made factually incorrect statement in the impugned order for holding that "CP Method" and the "RP Method" were the most suitable methods for benchmarking "Export of manufactured goods" and "Trading of va....
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....as reiterated that the assessee had adopted the CP Method & RP method in the immediate preceding AY 2003-04. This shows that even the D/R failed to take note of the basic jurisdictional documents of AY 2003-04 which were admittedly before him in the form of Pages Nos. 126 to 225 of the Paper book. The Id. D/ R also did not care to take note of the categorical findings of the Id. CIT(Appeals) at Pages 18 & 19 of his order where he had clearly stated that in the earlier year the assessee had justified ALP of his transactions with AEs on TNMM Method. This shows the non-application of mind by the D/R to the facts involved in the present case. The assessee therefore submits that the basic premise of the TPO's contention which is supported by the D/R in his arguments are factually incorrect and patently wrong. The assessee reiterates that it had applied TNMM Method to justify the arm's length price in AY 2003- 04 and not the CP or RP Method as alleged. 9. At page 2 of his written arguments by the D/R; has further stated that the TPO did not reject the TNMM Method on the ground that CP Method & RP Method was used by the assessee in earlier year. In D/R's view therefore the ....
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....TPO is only required to firm opinion that the price charged by the assessee is not in accordance with relevant provisions and / or methods and then he can straightaway proceed impute the correct arm's length price. The D/R in his submission has argued that the AO or the TPO were not obliged to discharge the responsibility call them by the specific provisions of Section 92D read with Rule 10D. In his missions the Id. D/R has tried to make out a case that the AO or TPO are required to justify the arm's length price with reference to the correct facts transactional documents of the assessee. Going by D/R's logic, the AO 01: TPO has unlimited, unspecified and unbridled powers to reject the bench-making exercise carried out by the assessee without even the need to substantiate it with reference to the true facts, details & documents of the asses Such argument of the D/R is blatantly erroneous and contrary to the provisions of law and also the principles of natural justice. Before the Id. CIT(Appeals), the assessee without prejudice to its primary contention that TNMM Method was in most appropriate method had successfully made out the case that even the CP Method & RP Meth....
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....f cost of raw materials consumed. The TPO did not cite any reasons for which he had sought these details. In compliance with the directions of the TPO the assessee furnished the break-up of sales made in the manufacturing & trading operations to both related & unrelated parties. Corresponding details of the cost of materials consumed vis-a-vis value of finished goods exported were also furnished in response to TPO's requisition. The TPO never informed the assessee that he had decided to apply CP Method nor he required the assessee to furnish relevant data to compare the gross profit margins. In fact even after obtaining the details of sales & cost of raw materials, the TPO never issued any "show cause" notice requiring the assessee to furnish the statement giving details of direct & indirect costs, factory overheads and post manufacturing expenses incurred in relation to its exports to AEs & non-AEs. The TPO also never show caused the assessee to explain as to why TNMM should be rejected or for that matter why CPM should not be applied to its case. The assessee was kept in complete dark and was never informed by the TPO that he was proposing to benchmark the ALP applying CP Met....
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....tanding & calculation and application of CP Method by the TPO was wholly erroneous and incorrect. Aggrieved by the same, the assessee challenged it before the CIT(Appeals). In the appellate proceedings, the assessee disputed the mode & the manner in which the TPO had applied the CPM Method. It was explained that in order to apply CP Method, the gross profit margin had to be computed as the difference between 'value of sales' and the 'cost of goods sold'. Unlike in case of traded goods, the 'cost of goods sold' of manufactured products is determined by aggregating cost pertaining to raw materials, labour, factory overheads, direct & indirect expenses etc. All the aforesaid cost heads are included for determination of the 'cost of goods sold'. It was explained before the CIT(A) that the AO& TPO had erroneously considered only the cost of raw materials and omitted to consider the other relevant expenses/ overheads for the purposes of computing the "cost of goods sold". It was in this background that the assessee furnished a statement before the CIT(Appeals) containing its version of computation of gross profit margin on export of manufactured good....
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....een the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise." From bare perusal of the above Rule, it is evident that for applying CP method, one has to compute the cost of production which shall include both direct & indirect costs. The TPO was therefore clearly wrong in considering only the "cost of raw materials" as the complete "cost of production". Before the CIT(Appeals), errors committed by the TPO were pointed out. The assessee also furnished the correct computation of "gross profit" margin which should have been applied by the TPO himself in the context of CP Method for benchmarking export of manufactured products. Comparing the calculation of the profits margin as done by the TPO and by the assessee, the Ld. CIT(A) found merit in as....
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....ve certainly taken it up by raising specific ground of appeal. Even in the order u/s 92CA(3) the TPO has nowhere alleged that the assessee did not file details pertaining to cost break- up of manufactured goods though requisitioned by him. These facts therefore support the assessee's contention that it had never filed additional evidence before the CIT(A). The TPO had consciously computed gross profit margin by deducting from the value of export Sales; only the Cost of raw materials consumed for applying the CP Method. In the circumstances it is submitted that the Ld. DR has tried to twist the actual facts to give a misleading picture that the assessee had either filed additional details or two sets of statements before the TPO and CIT(A).; 9.2 It is also imperative to note that even though in his order the CIT(A) has pointed out specific infirmities & mistakes committed by the TPO in determining ALP of non-AE transactions the D/R in his written arguments has nowhere even attempted to justify the manner in which CP Method was applied by the TPO. In fact the D/R conceded that Rule 10B required inclusion of both direct & indirect cost of production for application of CP method....
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....y shall operate. Even if for a moment the D/R's logic is accepted at its face value that the gross profit can be computed without the sales value, even then the gross profit would be NIL. In such an eventuality entire "cost of production" debited on the debit side would be reflected as cost of unsold stock and will accordingly reflect on the credit-side of the P&L a/c. In the circumstances the gross profit would be NIL. The Ld. D/R has further argued that the royalty & commission expenses are not "cost-side" related expense but "sales-related" expense and hence could not form part of "cost of production". In this regard we submit the Ld. D/R has properly understood the true meaning of the assessee's submissions made before the CIT(A). It was never the assessee's case that these 2 expenses were to be considered as part of production cost. In the first instance it is submitted that the assessee never included the royalty & commission as part of manufacturing costs of the assessee. Instead the same were excluded from value of export sales made to unrelated parties to make them comparable to the sales made to AEs and accordingly ascertain the arm's length value of an....
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....ontrolled transactions. In the facts involved the present case the assessee made export sales to AEs and also to unrelated parties. In respect of export to AEs the assessee had no obligation to pay royalty nor was any commission paid. In respect of export sales to unrelated parties, the assessee paid royalty to its parent company as well as paid commission to agents who procured export ordeRs. As such the export sales price of unrelated parties was materially higher than the export sale price charged from AEs. In terms of Rule 10C & 10B(3)(ii) it was therefore necessary to make suitable adjustment to the sale price realized in uncontrolled transactions so as to make them comparable with the transactions with AEs. The assessee therefore excluded the royalty & commission paid on sales to unrelated parties so as to arrive at the comparable arm's length value of uncontrolled transactions in conformity with Rule 10B & Rule 10C of IT Rules, 1962. Accordingly the normal gross profit mark-up was computed only after excluding the royalty & commission costs. The D/R however failed to appreciate the foregoing facts of the case and wrongly alleged that the assessee treated commission & roy....
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.... be compared and not otherwise. The D/ R in fact concurred with the assessee's contention as well as the Id. CIT(A) findings that the only press chemicals was comparable to printing inks. Both the assessee as well the Id. CIT(A) had compared the profit margin earned from sale of imported printing inks to unrelated parties with the profit margin earned by the assessee from sale of imported press chemicals to unrelated parties. In the facts involved in the present case the Id. CIT(A) noted that the assessee had imported printing inks from AEs worth Rs. 7.06 crores which was sold to unrelated parties for Rs. 8.09 crores resulting in gross profit margin of 13%. Correspondingly the assessee had imported press chemicals from unrelated parties worth Rs. 1.75 crores which was sold to unrelated parties for Rs. 2.02 crores yielding profit margin of 14%. Without prejudice to the assessee's contention that the aforesaid margins would require turnover adjustment and working capital adjustment, it is submitted that the margin was 13% earned from transactions with related parties was found comparable to margin of 14% earned from uncontrolled transactions and was therefore held to be at ar....
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.... the rejection. We also further find that the TPO has considered only cost of raw materials consumed and no other associated costs was considered in arriving at the G.P. margin. The TPO in order to apply CP Method cost pertaining to raw materials, labour, factory overheads, direct & indirect expenses etc should take into consideration. All the aforesaid cost heads are included for determination of the 'cost of goods sold' as per Rule 10B of the I.T. Rules, 1962 which lays down the manner in which the CP method is to be applied. The relevant part of the said Rule provides as follows: "cost plus method, by which,- (i) The direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) The amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii) The normal gross ....
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....e service charge amounting to Rs 90 lakhs in the total turnover while computing deduction u/s 80HHC of the Act. The assessee claimed the deduction u/s. 80HHC for the profit of the business. The AO during the course of assessment proceedings observed that the profit of the business is inclusive of fees for services for an amount of Rs. 90 lakhs. The assessee did not deduct 90% of such fees of services in terms of this provision of the Explanation of (baa) to Sec. 80HHC of the Act. Accordingly, the AO has reduced the profit of the assessee's business by 90% of Rs. 90 lakhs being fees for services. 13. Aggrieved, assessee preferred an appeal before Ld. CIT(A), whereas assessee submitted that the fees for services i.e. Rs. 90 lakhs should also be reduced from the total turnover of the assessee to the extent of 90%. Ld. CIT(A) accordingly, directed the AO to exclude the 90% of fees for services from the total turnover of the assessee by observing as under:- "..... I however find that the identical questions were considered by the Income Tax Appellate Tribunal, Kolkata in the assessee's own case for AY 2003-04 in ITA No. 499/Kol/2007 & MA No. 73/Kol/2008 dated 30th April, ....