TaxTMI 
TaxTMI 
2022 (2) TMI 1446
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....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 not appreciating that CPM has consistently been accepted by the revenue auth....
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....d 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 international transactions undertaken by the assessee during financial year relevant to the impugned assessment year. On going through the transfer....
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....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 applied and the Dispute Resolution Panel has upheld the application of Berry ratio with Operating Profit/Value Added Expenses (OP/VAE) as the PL....
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....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 appropriate PLI for the assessee since Berry Ratio only reflects value adding activities performed by the entity and excludes any purchases and manufacturing related expenses in the cost base. It was fur....
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....n 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 summarily disregarded. 12. It was further submitted that if GP/COP as the PLI is applied on the comparable companies selected by the TPO, the international transaction of the assessee will meet the arm's length requir....
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.... 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 that in several judicial pronouncements, noteworthy being the case of Sumitomo Corporation India Pvt Ltd 2016-T1I-38-HC-DEL-TP, the Hon'ble Delhi High Court upheld the use of berry ratio in certain situations even though the Income Tax Act does not specifically provide for either the berry ratio, or th....
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....ue 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 of Hon'ble Supreme Court and other High Courts, it is held that the principle of consistency is a rule in general but for cogent reasons or on justifiable ground, the Revenue has got right to depart from its earlier practice and take a different view which shall be determined upon the facts and circumstances of each case. iii) Comments on Berry's ratio is ....
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....red 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 pricing report and financial statements and in this regard, our reference was drawn to the following facts and figures as contained in its financial statements: "10. Fixed Assets Name of Assets As at 31.03.2016 A. Tangible Assets Freehold land 48,94,908 Leasehold Land 3,51,56,343 Building 21,50,47,894 Plant & Machinery 18,79,50....
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....dopted 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: "B. 3.5 Berry ratios 2.106 "Berry ratios" are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability. 2.107 The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination o....
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....al 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 activities. The ROA and ROCE divide operating profit by a balance sheet figure. These PLIs are based on assets actively employed in the business. Such tangible assets consist of all assets minus investments (e.g. in subsidiaries), minus cash and cash equivalents beyond the amount needed for working capital. In the case of the ROA a deduction is also made for intangible assets such as goodwill. These two PLIs may, for example, be used for leasing companies. This type of PLI maybe the most reliable if the tangible operating assets have a high correlation, to profitability. For example, a manufacturer's operating assets such as property, plant, and equipment could have more impact on profitability than a distributor's operating assets, since often the primar....
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....ry 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 undertaken by the Assessee. Thus, in cases where an Assessee uses intangibles as a part of its business, Berry ratio would not be an apposite PLI as the value of such tangibles would not be captured in the operating cost and, therefore, it would not be appropriate to compute the ALP based on net profit margin having regard to the operating cost as a relevant base. Similarly, Berry ratio would not be an appropriate PLI for determining ALP in cases of Assessees who have substantial fixed assets since the value added by such assets would not be captured in Berry ratio. 46. It can be seen from the above that the Berry ratio can be used only in very limited circumstances and the limitations that we have listed above are by no means exhaustive. There is also a view expressed that use of Berry ratio as a PLI r....
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....rldwide, 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: 2.100 "Berry ratios" are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability. 2.101 The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.76. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.92 in relation to the use of cost-based indicators in general. One common difficulty in the determin....
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....en 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 all these tests. We are in agreement with the approach adopted by the OECD document in this regard. Going by this approach, and, applying the tests laid down above, it does indeed seem that berry ratio could be appropriate in the present case. 48. Berry ratio is increasingly finding specific acceptance in many jurisdictions. While it is use in US for long, in Japan, even as berry ratio was used in APAs earlier as well, the 2013 amendment to the transfer pricing regulations, with effect from 1st April 2013, now specifically list berry ratio as acceptable in appropriate cases. In India, there have been several recent judicial precedents, which we will deal with a little later, upholding the use of berry ratio as a PLI. 49. Lets take a pause here and take a look at the circumstances in which berry ratio came into existence and its common usage in the TP analysis. 50. In the landmark ca....
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....e 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 inventory levels, and particularly as it does not involve any unique intangibles or value addition to the goods traded. 52. The answer to the fundamental question of whether a taxpayer should be entitled to a return on the value of goods handled by it, would actually depend on the functions performed and the related risks borne by it, with respect to the goods; and not on whether the taxpayer has taken title to the goods, shorn of the assessee's FAR profile. 53. Clearly and undisputedly, on the facts of this case, neither the assessee has performed any functions on or with respect to the goods traded by it, beyond holding flash title for the goods in some of the cases, nor has the assessee borne any significant risks associated with the goods so traded. All the functions, assets and risk of the assessee are quite reasonably reflected by the operating costs incurred and the value of goods traded does not have much of an i....
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....ontended 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 operating expenses incurred to distribute products as analogous to the firm's total costs, then the ratio of gross margin to operating expenses would capture the mark-up on operating expenses that is afforded to the distributor. 6.6 The Berry ratio can also be applied to service providers, as it can be conceptualized as the mark-up earned on the costs of provision of services, by subtracting one from the Berry ratio expressed in unit terms as follows:- Berry ratio - 1 = GP/VAE - 1 = (GP-VAE)/VAE = OP/VAE wherein GP = gross profit; OP = operating profit; and VAE = value adding (operating) expenses. 55. In the case before the coordinate bench, it was noticed that the berry ratio is used for distributorship functions, though, as a variant of the berry ratio, its application could also be related to the service providers. This decision, however, is important for the short reason that it recognizes and upholds application of berry ratio in the situations i....
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....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 there is sufficient lead time between order being received and the actual procurement activity. There are no other factors, in addition to the operating costs, which affect direct relationship between operating costs and operating profits. Therefore, except in a situation in which significant trade or marketing intangibles are involved or in a situation in which there is further processing of the goods procured before selling the same or in a situation which necessitates employment of assets in infrastructure for processing or maintenance of inventories, the use of berry ratio does seem to be quite appropriate. 59. As we make the above observations, we also make it clear that in case the assessee is not able to find other comparables with significantly low or zero inventory levels, it does not prejudice the interests of the revenue authorities in any manner. The reason is this. When a comparable has an additional risk associated with inventories, which is not present in the case of the assessee, the profits achieved by th....
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....assets employed by both of them is very relevant. In our view Id. TPO/AO did not properly appreciated the functions performed, risk assumed and bassets employed by the AE and appellant. 6.7 In this year, only 20 vessels were chartered by AE to the appellant, where large number of employees are not required. The number of employees quoted by TPO in the comparable company as 216 to 5056 is not relevant as these companies were having their own vessels and are also engaged in other allied business activities with wider assets base. The least number of employees is 48 in case of Sanyan Group Limited. Considering the size and the assets employed, the number of employees in such comparable cases may be higher as compared to the case of AE. 6.8 We are of the considered opinion that Berry ratio is not applicable in this case and therefore, appropriate profit indicator in this case is operating profit to total cost i.e. OP/TC. In case of pure distributor, only value added expenses are considered and Berry ratio can be applied. The AE made value addition, assumed various risks of business and also incurred damages and losses in the business, as discussed by me in detail earlier. As per TN....
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....sources, it imports raw material like Stones, Rough Gems Stones, Chains, Findings, Diamond, Mounting and Preform, etc. The raw materials imported undergoes through various stages of processing (like cutting calibrating, polishing, etc.) and is used captively for the manufacturing of studded jewellery which is then exported. At VGL manufacturing infrastructure is most contemporary and significant by making full use of CAD, CAM system and equipment such as Laser soldering machines. Besides this, the company has a modern, extensive computer network, and implemented an ERP solution to integrate all its operations. 1. Adarsh Nagar, Jaipur - It has Gems Stones and diamond-processing unit for processing rough gems stone to finished gems stone, which are either directly exported to Associated Enterprises or Independent party or used as captive consumption in manufacturing studded jewellery. 2. Sitapura, Jaipur - Sitapura is 100% EOU. It has Chain Division and Jewellery Division, manufacturing chains and studded Jewellery. Company required to purchase gold from banks locally and gems stones from Adarsh Nagar, Jaipur. These are processed together or manufactured studded jewellery, which ....
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....isputed the functions performed, the assets employed and the risk undertaken (nature and extent thereof) by the assessee while carrying out its business of manufacture and export of colored stones and studded jewellery. 28. Moving further, if we look at the international transactions undertaken by the assessee which are subject matter of examination before us, the same relates to import of gems stones, rough diamonds and other raw material from its associated enterprises as well as export of gems stones and studded jewellery to its associated enterprises. For the purposes, the assessee has considered the Cost Plus Method as the most appropriate method for determining the arms' length and has adopted Gross Profit/COP as the appropriate Profit Level Indicator and accordingly has carried out the benchmarking analysis with independent third party comparables. 29. Regarding the purchases and adoption of Cost Plus Method, from the transfer pricing report, it is noted as under: "In the case of VGL, the associated enterprises are only facilitating the procuring or purchasing activities for and on behalf of VGL. The associated enterprises purchase Roughs, Color stones, Diamonds, Mountin....
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....e transactions: VGL's export to AE's mainly consists of Gold/Silver/Other Metal Studded Jewellery which forms more than 80% of the total turnover of the VGL. Since in current year 80% of the VGL transactions is of Gold/Silver/ Other Metal Studded Jewellery, the functional and product similarity between independent companies becomes quite reliable as the functions involved in manufacturing of Studded Jewellery is very much same across the industry which includes designing, mounting, setting, polishing, finishing etc. b. Extent to which reliable and accurate adjustments can be made: Once the functional and product similarity is established, under CP method not many adjustments are required except that of accounting and other differences. Since the comparables used in testing are from listed companies and are available publicly which are following ail Accounting Standards and are governed by the Companies Act. VGL also prepare its financial statements in compliance to applicable Accounting Standards and as per the Companies Act. Since, both the comparables and VGL are governed by Companies Act and follow accounting standards; no adjustment is warranted in respect of the ....
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....d by the assessee. It has been held that where the assessee uses intangibles or has substantial fixed assets, the value of such intangibles or value addition by such assets would not be captured in the operating cost and thus, Berry ration would not be an appropriate PLI. It has been held that the fundamental premise which needs to be examined before applying Berry ratio is that the operating expenses should adequately represent all functions performed and risk undertaken and for this reason, Berry ratio is effectively applied only in case of stripped down distributors which have no financial exposure and risk in respect of goods so distributed by them. Therefore, we agree that the Berry ratio can be applied in certain circumstances but in the facts of the present case, where the assessee is admittedly and undisputedly, a manufacturer and exporter of coloured gemstones and studded fashion jewellery and not a distributor, one wonder how the value of goods so manufactured and exported have no role to play in the profits earned by the assessee. The assessee performs significant manufacturing functions right from procurement of raw material in terms of rough diamonds and gemstones, pro....
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....ssee is a manufacturer and exporter and as part of its activities, it procures certain goods from its associated enterprises which constitute merely 21.09% of its total purchases besides purchases from other entities, process them in its manufacturing facilities and thereafter, export them to its associated enterprises. Therefore, it carries out significant manufacturing and processing operations and it is not a case of simpliciter purchase and sale activity which is being undertaken by the assessee. Only in a latter scenario, where it purchases from its associated enterprises and on-sells them to other associated enterprises, berry ratio can be held to be useful and appropriate PLI as stated in para 2.102 of the OECD guidelines. Following the same, the Coordinate Bench in case of Mitsubishi Corporation (supra) has also held that in case of a low risk high volume trading business involving back to back trading without any value addition to the goods traded, berry ratio could be appropriate PLI. However, in a situation in which there is further processing of the goods procured before selling the same or in a situation which necessitates employment of assets in infrastructure for pr....