TaxTMI 
TaxTMI 
2022 (2) TMI 1446
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.... TPO') has erred in proposing and the Ld. AO has erred in confirming and thereafter, the Hon'ble Dispute Resolution Panel, New Delhi ('the DRP') has further erred in upholding the transfer pricing adjustment of INR 29,25,17,385 in respect of Appellant's international transactions of sale and purchase of goods to/ from its Associated Enterprises ('AEs'), alleging the same to be not at arm's length in terms of the provisions of section 92C of the Act read with Rule 1OD of the Income-tax Rules, 1962 ('the Rules'). 3. On the facts and in law, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in rejecting the economic analysis carried out by the Appellant in the Transfer Pricing ('TP') documentation prepared and maintained in compliance with Section 92D of the Act read with Rule 10D of the Rules. In doing so, the Ld. TPO, Ld.AO and the Hon'ble DRP erred in: 4.1 rejecting Cost Plus Method ('CPM') considered by the Appellant as the Most Appropriate Method with Gross profit margin/ Cost of production ('GP/COP') as the Profit Level Indicator ('PLI'), without giving any cogent reason 4.2 no....
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....ransfer pricing adjustment, and the Hon'ble DRP further erred in rejecting the Appellant's objections on this ground without appreciating the facts of the case thereby denying the Appellant the principle of natural justice. 10. On the facts and in the circumstances of the case, the Ld. AO erred in levying interest under section 234A/234B/234C of the Act. 11. That in view of the facts arid circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under Section 274 read with Section 271(l)(c) of the Act for concealment / furnishing inaccurate particulars of income." 2. Briefly, the facts of the case are that the assessee is carrying on the business of manufacturing and export of gold jewellery studded with precious and semi-precious stones. It filed its return of income declaring total income of Rs.28,11,20,040/- which was selected for scrutiny and notices u/s 143(2) and 142(1) were issued and served on the assessee. During the course of assessment proceedings, a reference was made by the Assessing officer to the Transfer Pricing Officer u/s 92CA(1) of the Act on 31.10.2018 for determination of arms' length price of internat....
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....y the Assessing officer on 30.6.2021 considering the adjustment so confirmed by the Dispute Resolution Panel and making an addition of Rs.29,25,17,385/- to the returned income so filed by the assessee. 4. Being aggrieved with the final assessment order so passed by the Assessing officer on 30.6.2021 considering the adjustment confirmed by the Dispute Resolution Panel and making of an addition of Rs.29,25,17,385/- to the returned income by the Assessing officer, the assessee is now in appeal before us. 5. During the course of hearing, the Ld. AR submitted that the transfer pricing adjustment of Rs.29,25,17,385/- has been upheld by the Dispute Resolution Panel in respect of the assessee international transactions of sale and purchase of goods to/from its Associated Enterprises. In doing so, it has disregarded the economic analysis carried out by the assessee in its transfer pricing documentation and has rejected the Cost Plus Method, with gross profit margin/Cost of Production (GP/COP) as the profit level indicator, which is the most appropriate method for the impugned transactions without giving any cogent reasons. It was further submitted that the Transfer Pricing Officer has....
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....lds no water since it is the sales transactions of VGL which is primarily undertaken with the AEs and so called tainted in the words so used by the TPO and only a small proportion of the purchases are attributable to the AEs. In this regard, our reference was drawn to sales and purchases with the AE's/Non-AEs as under: Sales to Amount (in INR) % of sales total Aes 3,18,54,77,750 88.34% Other Parties/Non-Aes 42,05,68,627 11.66% Purchases from Amount (in INR) % of total purchases AEs 59,47,42,920 21.09% Other Parties/Non-Aes 2,22,53,31,523 78.91% 8. The Ld. AR submitted that the purchases made by the assessee from its AEs are undertaken on a Cost-to-Cost basis since the AEs only facilitate in sourcing materials from these jurisdictions occasionally on need basis. Our reference was drawn to the detailed submissions made before the DRP along with relevant evidences in form of invoices and confirmations, placed at page No. 179 of the Paper Book regarding the cost-to-cost nature of the purchases made by the assessee from its AEs. 9. It was further submitted by the Ld AR that Berry Ratio cannot be considered as an appro....
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....ss of manufacturing and selling of coloured gemstones and studded jewellery. The assessee procures raw material from both AEs and Non-AEs and subsequently manufactures and sells the finished goods and accordingly, based on the detailed FAR analysis, VGL was characterized as a routine manufacturer performing all the entrepreneurial functions and for ascertaining the arm's length price of the international transactions of Sale/ Export of goods to AEs and Purchase of material from AEs, a methodical benchmarking search was undertaken, applying CPM as the most appropriate method (with OP/COP as the PLI) to identify independent third party comparable companies in India that are engaged in manufacturing of studded jewellery, i.e. gemstones/colored stones, diamonds, and Silver/ Gold studded jewellery. 11. It was further submitted that in rejecting the economic analysis of the assessee, the TPO and the DRP did not appreciate that CPM has consistently been accepted by the Revenue authorities in the prior years as the most appropriate method and there being no change in the facts and circumstances of current year vis-à-vis prior years, the 'Rule of consistency' cannot be....
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....o the assessee dated 15.10.2019 wherein he gave detailed reason for rejecting the TP analysis of the assessee as the assessee was purchasing and selling to related parties and the reason why OP/Cost of production would not be an appropriate PLI, The TPO has clearly noted in his order that the assessee did not give the reply to the show cause letter. Thereafter the TPO had no option but to proceed with the determination of ALP in accordance with the facts of the case as submitted by the assessee in its TP analysis as well as the analysis as per Berry ratio. In view of this fact the Ground number 1.1 is rejected, 4.1.2 In Ground number 1.2, 1.7, 1.8 and 1.9 the assessee has contended the action of the AO/TPO in applying Berry ratio i.e. OP/VAE as the appropriate PLI and rejection of CUP as MAM 4.1.2.1 The Panel has noted the submission of the assessee given on 01.12.2020 and 13.12.2020 as well as the reasoning giving by the AO/TPO in the draft order dated 13.11.2019. In several judicial decisions it has been held that in cases where operating expenses are considered as a relevant base, then application of Berry ratio as PLI is most appropriate. The Panel also notes ....
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....s submission through email dated 29,10.2019 before the Hon'ble DRP. ii) Comments on Consistency is to be followed. The then TPO at Para No, 03 (Page No, 3} of TP order had rejected the method adopted by the assessee and stated that the assessee is purchasing from related parties and selling to related parties. So both cost and revenue sides are tainted. In this scenario, OP/Cost of Production will not be an appropriate PLI, OPA/AE has been chosen as PL!. The TPO had provided the justifiable ground for change in his approach and following mentioned judgments also cited that change in approach should be based on the justifiable ground. In this regards, the decision of Hon'ble Apex Court in the case of Radhasoami Satsang Vs. Commissioner of Income Tax decided on dated 15.01.1991 is imperative to mention here. In the above mentioned case, Apex Court held that each assessment year being a unit, what is decided in one year may not apply in the following year. The same question had been dealt in length by ITAT in the case of Anjala Exhibition Pvt. Ltd. Vs. ACIT in ITA No.162/DEL/2012 dated 31.05.2013. In that case, after referring various pronouncement o....
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....ted financial statements of the assessee company which includes its subsidiaries. On a standalone basis, the assessee company has reported revenues of Rs 367.99 crores as disclosed in its financial statements submitted at pages 47-72 of the paperbook which the ld PCIT DR has failed to take into consideration. It was further reiterated that the assessee is a manufacturer and exporter of colored gemstones and studded fashion jewellery and sells its products through the retail stores network of its associated enterprises and non-associated enterprises across various countries. It was submitted that e-stores represented by US and UK TV channels are that of its associated enterprises and the detail profile of its associated enterprises were also submitted as part of the transfer pricing report. It was accordingly submitted that the ld PCIT DR was not correct to state that the assessee is a retailer of fashion jewellery and functional profile of the assessee company is that of manufacturer and exporter of coloured gemstones and studded jewellery having all the characteristics of a routine manufacturer performing all the entrepreneurial functions which is duly corroborated by its transfer....
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....nufacturing Expenses Particulars Year ended 31st March, 2016 (Rs.) Job Work Charge 29,71,74,362 Stores and Consumables 5,64,85,051 Power and Fuel 3,57,87,155 Repairs and Maintenance # 1,22,48,322 Other Manufacturing Expenses 1,32,81,415 41,49,76,305 19. We have heard the rival contentions and perused the material available on record. As contended by the ld AR during the course of hearing, the principle dispute which arises in the present case is adoption of appropriate PLI for benchmarking and determining the arms' length nature of the international transactions undertaken by the assessee company with its associated enterprises. The assessee has adopted Gross Profit Margin/Cost of Production as the PLI whereas the TPO has applied Operating Profit/Value Added Expenses as an appropriate PLI for benchmarking the international transactions with the associated enterprises. 20. Before we examine the applicability of both the ratios in the instant case, it would be relevant to refer to the OECD Transfer Pricing Guidelines (2017) wherein the relevant discussions are found at para B.3.5 and the relevant contents thereof read as under: ....
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....cable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above." 21. Further, we refer to the United Nation Practical Manual on Transfer Pricing for developing countries (2017) wherein the relevant discussion reads as under: "B.3.3.7.3. Although all of the above PLIs are possible, the three PLIs: (i) return on capital employed (ROCE) (ii) operating margin (OM) and (iii) return on total cost (ROTC) are most used in practice. The Berry Ratio may also be used, but subject to certain concerns about its inappropriate use.50 An OM is typically used for marketing, sales and distribution activities; a Berry ratio may sometimes be used for service of distribution activities; and full cost plus, ROCE or ROA are typically used for manufacturing activit....
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....s very sensitive to functions and classifying of cost as operating cost; > It misses values of cost needed to maintain the intangible property of an entity; and > Its reliability diminishes if asset intensities (the efficiency with which assets are used) of the entities differ." 22. Further, the Hon'ble Delhi High Court in the case of Sumitomo Corporation India Private Limited Vs. CIT (Supra) had an occasion to examine the applicability of Berry ratio and the relevant findings reads as under: "45. Traditionally, the denominator of the ratio only comprised of selling, general and administration expenses. However, the Treasury Legislation of USA also included depreciation as a part of the Operating Expenses used as a denominator in the berry ratio. As is apparent, Berry ratio has limited applicability; it can be used effectively only in cases where the: value of goods have no role to play in the profits earned by an Assessee and the profits earned are directly linked with the operating expenditure incurred by the Assessee. In other words, the operating expenditure incurred by the Assessed effectively captures all functions; performed and risks undert....
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.... 44. Simply put, berry ratio is ratio of gross profit to the operating expenses. 45. Unlike in Indian TP regulation, wherein no specific ratios are prescribed, US Regulation 4825(b)(ii)(4)(B) accepts this PLI as one of the "financial ratios that may be appropriate" to measure the arm's length price, even though it puts a rider that, "reliability under this profit level indicator also depends on the extent to which the composition of tested party's operating expenses is similar to that of the uncontrolled comparables". So far as Indian TP provisions are concerned, the PLIs set out in rule 10B(1)(e)(i) are only illustrative inasmuch as it ends with the expression "or having regard to any other relevant base" but there is no prohibition as such on the use of this ratio. However, having regard to the use of this ratio worldwide, and for the reasons we will set out in detail in a short while, the use of this ratio cannot be eliminated from the India transfer pricing practices altogether. 46. In the July 2010 version of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, berry ratio is specifically recognized as follows: ....
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....ds sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. 47. As evident from the underlined portion of the OECD approach, highlighted above, berry ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade intermediary, 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 MCJ is engaged in and the MCI is contributing to, satisfies....
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....zed as performing the distributorship function rather than the value of goods sold. Accordingly, distributors must achieve a particular gross profit in order to compensate them for their services, the costs of which are accounted for, almost entirely, in their operating expenses. To reflect the reality of distributors' economic significance and to provide an arm's length return to DuPont's Swiss subsidiary, Berry utilized a ratio that has since been named in his honor and is computed as gross profit to operating expenses. There are some variants to this ration but that aspect of the matter is not really relevant for the present purposes. 51. The underlying assumption for applicability of berry ratio is that the return to the tested party should be commensurate with his operating expenses and the value of goods dealt in was irrelevant for this purpose. While this proposition so laid down was in the case of a limited risk distributor without any value addition to the goods or significant risks associated with inventories, we are of the considered view that it is equally useful in a case in which the business entity is engaged in trading, with zero or low inventor....
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....are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr. Berry on this aspect reads as under:- "Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is a measure of the activities of the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the product distributed, or the value of the exposure provided by radio, television or print media". 6.5 It is contended that the Berry ratio is merely a variant of the cost plus method. If one were to think of the gross margins earned by a distributor as analogous to a firm's total revenues available to a distributor, and the operati....
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....AS PROCESSING), MORE ASSETS (SUCH AS SIGNIFICANT CURRENT ASSETS OR UNIQUE INTANGIBLES) AND MORE RISKS (SUCH AS RISKS ASSOCIATED WITH INVENTORIES); APPLICATION OF BERRY RATIO IS NOT JUSTIFIED 57. In our considered view, to sum up, in a situation in which a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio. In such a situation, no other costs are relevant since (a) the cost of goods sold, in effect, is loses its practical significance, (ii) there is no value addition, and, accordingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 58. In typical cases of pure international trading, there is neither any processing of goods involved nor is there use of any significant trade or marketing intangibles. The inventory levels are also extremely low, at least with respect to the goods traded, since the nature of activity does not require maintenance of inventories and....
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....d by the AE to one M/s R. M. Martine, since inception of the AE. The AE had its own funds, undertook business risk and many instances of such risk which actually borne by AE pertaining to various vessels have been proved with evidence. The payment of hire charges, bunker charges, port charges have been made by the AE from its own funds evidenced by cash flow statement could not be controverted by revenue. In our studied and considered view the AE has performed proper business functions, assumed business risks by employing its own funds independently without help of appellant and, therefore, in no way AE can be considered as pure distributor. In view of these facts and circumstances, the Berry ratio is not at all applicable in the present case. Our view is fortified by Hon'ble Delhi High Court judgment in the case of Sumitomo Corpn. (supra) 6.6 In Transfer Pricing study, it is imperative to employ proper understanding of business, business practice, functions performed by AE and the appellant, risks assumed by both the parties and the assets employed by both of them is very relevant. In our view Id. TPO/AO did not properly appreciated the functions performed, risk assum....
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....errnany, Thailand, Hong Kong, Japan, etc. by way of its subsidiaries. VGL is one of the largest exporters of colored gemstones from India & also one of the largest exporters of studded Jewellery. VGL processes gems and raw materials into rings, bracelets, pendants, etc. and export it to its associated company in U.S.A and other overseas countries, in financial year 2005-06, VGL become an Indian MNC, perhaps the first in the Indian gems and Jewellery sector by extending its operations in more than 10 countries through the acquisition of Companies of STS Group and extending its Retail Stores network at major holiday destination of the world from 12 to 19. It has also launched operation through TV channels by its associates i.e., The Jewellery Channel Ltd, UK and Jewellery Channel, USA. VGL is professionally managed, end-to-end vertically integrated gems and jewellery business organization. It is one of the eight world-wide 'sight holder' in Tanzanite and is the leader in processing other popular gemstones such as Fire Opal, Apatite and Emerald. Procuring directly from the sources, it imports raw material like Stones, Rough Gems Stones, Chains, Findings, Diam....
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....he order so passed by the TPO. 27. In terms of the functions performed, assets employed and the risk undertaken by the assessee while carrying out its manufacturing activities, it is noted from the transfer pricing report and the financial statements placed on record that the assessee performs the functions of purchases, product conceptualization and designing, manufacturing/processing of final product, sales and marketing and after sales services. It has the necessary manufacturing set up with requisite assets and infrastructure in place which are employed. The associated enterprises perform substantial part of marketing, sales and distribution functions. The assessee takes all types of risk such as inventory risk, credit & collection Risk, product risk, manpower risk, market risk (to limited extent), technology risk, general business risk and foreign exchange risk. Therefore, we donot find any infirmity in assessee being classified as a manufacturer performing all the entrepreneurial functions. It is again noted that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the functions performed, the assets empl....
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....The CPM examines the gross profit mark-up to direct and indirect cost that a taxpayer realizes from a controlled transaction. First, the direct and indirect costs of production incurred by the enterprise in respect of the goods transferred to an associated enterprise are determined. To this, a normal gross profit mark up in the same or similar comparable uncontrolled transactions by the enterprise or an unrelated enterprise is added. The price so arrived at is then adjusted to take into account the functional and other differences between the international transactions and comparable uncontrolled transactions which could materially affect the amount of gross profit margin in the open market to arrive at the ALP. The CPM method is used to test transfer price of manufacturers, assemblers and others that add value. Determination of comparability under the CPM depends in particular on similarity between functions employed. In the instant case, as VGL during the year has mainly exported Gold / Silver Studded Jewellery, we have determined CPM as the most appropriate method due to following reasons: - a. Comparability between international transactions and comparable transactions....
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....cost of production (GP/COP) and given its GP/COP of 15.62% has determined its sales transactions to its associated enterprises which constitute 88.34% of total sales at arm's length. The TPO however has not agreed with the PLI so adopted by the assessee company and has adopted OP/VAE as the appropriate PLI. 33. The reasoning adopted by the TPO is that as the assessee is purchasing from related parties and selling to related parties, both cost and revenue sides are tainted and in such a scenario, OP/COP will not be an appropriate PLI and OP/VAE has then been adopted by him. The DRP has upheld the reasoning so adopted by the TPO drawing reference to the decision of Hon'ble Delhi High Court in case of Sumitomo Corporation (Supra) where use of berry ratio in certain situations has been upheld even though the Income Tax Act doesn't specifically provide for either the Berry ratio or the bright line test. 34. Firstly, referring to the decision of the Hon'ble Delhi High Court in case of Sumitomo Corporation (Supra), in that case, it was held that Berry ratio can be used effectively where the value of goods have no role to play in the profits earned by the assessee and the profits ear....
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....hese costs have to be necessarily considered and which has been rightly considered by the assessee as part of its "cost of production" and based thereon, has adopted operating profit/cost of production as an appropriate PLI. We failed to understand how the TPO has worked out the value added expenses and quantum thereof in the face of these undisputed facts and circumstances of the case ignoring the manufacturing functions and risk so undertaken and the asset employed by the assessee. We therefore find that the decision of the Hon'ble Delhi High Court doesn't support the case of the Revenue rather its supports the contentions advanced by the ld AR on behalf of the assessee. 35. Now, coming back to the reasoning adopted by the TPO where he says that since the assessee is purchasing from related parties and selling to related parties, both cost and revenue sides are tainted and in such a scenario, OP/COP will not be an appropriate PLI and OP/VAE has then been adopted by him. It appears that the TPO seems to be guided by some misconception that the assessee is in the business of trade intermediary where it buys from its associated enterprises and then, sells to its associated enterp....