TaxTMI 
TaxTMI 
2021 (8) TMI 1443
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....er tool-manufacturing contract in Haridwar. The assessee filed its return declaring total income of Rs. 27,72,90,010/-. Fifteen international transactions totaling Rs. 484,29,35,354/- were reported in Form No. 3CEB. The AO made a reference to the Transfer Pricing Officer (TPO) for determining the Arm's Length Price (ALP) of the international transactions, who computed transfer pricing adjustments of - Rs. 22,37,81,961 under the international transaction of allocation of RHQ costs; Rs. 82,34,00,000 under the Manufacturing activity segment; and Rs. 5,27,44,000 under the international transaction of payment of global software charges. We will espouse these transfer pricing additions ad seriatim for consideration and decision. A. PAYMENT OF R.H.Q. FEE 3. The assessee paid Rs. 22,37,81,961/- towards its share as the Regional Head Quarter (RHQ) fee. The TPO observed that Lear Shanghai provided certain support services to the worldwide Lear group entities including those situated in Asia Pacific Region covering the assessee, for which it was charged this fees. The assessee selected the Transactional Net Margin Method (TNMM) as the most appropriate method and considered the AE, i.e.,....
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....ral accounting consulting services, including US GAAP reconciliation services; 8) Treasury consulting services and financial analysis services; 9) Implementation of capital expenditure process; 10) Tax consulting services; 11) Legal consulting services, including contract review and administration; 12) Board administration services; 13) Dealing with administrative authorities relating to joint venture contract administration; 14) Human resource consulting services; 15) Environmental analysis and consulting services; 16) Access to Lear IT systems and services." 6. To buttress the contention of having availed the services from Lear Shanghai, the ld. AR referred to page 378 onwards of the paper book, being, correspondence between the assessee and Lear Shanghai in respect of various services. There is a detailed elaboration of various services provided by Lear Shanghai through e-mails to the assessee and other group entities. A summary of such services has been given at page 537 of the paper book. There is a reference to numerous audit services, account services, budgeting services, sale services, engin....
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.... of a `tested party' has been given in the Indian Transfer pricing provisions. The OECD guidelines in this regard emphatically provide that: `As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis.'. Two illustrations have been given to identify a tested party, as under: "Two illustrations Choice of the tested party: illustration Assume that company A manufactures two types of products, P1 and P2, that it sells to company B, an associated enterprise in another country. Assume that A is found to manufacture P1 products using valuable, unique intangibles that belong to B and following technical specifications set by B. Assume that in this P1 transaction, A only performs simple functions and does not make any valuable unique contribution in relation to the transaction. The tested party for this P1 transaction would most often be A. Assume now that A is also manufacturing P2 products for which it owns and uses valuable unique intangibles such as valuable patents and trade....
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.... of usage of its intangibles in addition to other costs of procuring product P1 for determining its profit level indicator, A will need to account for only the cost incurred by it in manufacturing product P1. In the second illustration given by the OECD guidelines, where the company A manufactures P2 products by using its own patents and trademarks and sells them to B, the tested party is B. It is so for the reason that now the functions of B are relatively simple as that only of distributor. It is A whose intangibles are being used. Whereas A will have to account for the usage of its intangibles in addition to other costs incurred by it in manufacturing product P2 for determining its profit level indicator of the transaction, B will have to account for directly the cost of goods purchased and the computation of PLI for the international of purchase of product P2 will be relatively simple in its hands. 12. It, ergo, clearly transpires that selection of a tested party primarily depends upon two factors, viz., the least complex entity and availability of suitable comparables. This coincides with the normal ALP determination process envisaged under the Act, as per which we find out....
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....recipients or the Beneficiaries have been grouped under five categories, 1. WOFE manufacturer located in China (China WOFE); 2. Joint Venture manufacturers located in China (China JV); 3. Non-China entities located in Asia-Pacific region (Asia Non China) [The assessee has been included in Asia Non-China] 4. Lear Corporation (US) related; and 5. LCM and Lear RHQ 15. There are 90 cost centres involved in the provision of the services, which have been gathered in 7 Cost pools, vis., China-SSD; China-EPMS; APO-CS; APO-CSD; APO-EPMS; LCM & Lear HQ; and Direct Cost. As per Table of Abbreviations given on page 609 of the Paper book, SSD stands for Seating System; EPMS for Electrical Power Management System; APO for Asia Pacific office; LCM for Lear Corporation (Mauritius) Limited; and Lear RHQ for Lear (China) Holding Limited, which at the material time was Lear Shanghai, the service provider. These cost pools are incurring costs in providing the RHQ services. On a pertinent query, the ld. AR submitted that all the seven cost pools are divisions of Lear Shanghai and no other Lear group company has contributed in any manner to the pr....
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....generation of services, whose description is given in the next column and then there is a list of Lear group beneficiary entities availing the services. The ld. AR explained the auditor's certificate by submitting that in the first row under the first column of `Cost pool', China -SSD (China Seating system) incurred costs in rendering the services mentioned in next column and the beneficiaries of such services are China SSD manufacturers, US, LCM & RHQ and Asia Non-China. Similarly, in the third row, the `Cost pool' of APO-CS (Asia Pacific Officer - Corporate Services) incurred the costs; the services generated by such costs are Corporate services; and the Beneficiaries of such services are Asia Pacific manufacturers, US, LCM and RHQ. Similarly, in the fourth row, the Cost Pool of APO-SSD (Asia Pacific Seating System) incurred the costs; the services generated are Sales and Business development, Program management, Engineering, Finance and Human Resources etc.; and the beneficiaries of such services are Asia Pacific SSD manufacturers, US, LCM & RHQ and Asia Non-China. The `Cost pool' in the second last row is LCM & Lear RHQ; and the beneficiaries are also LCM & Lear RHQ. The last r....
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....below, this information was not even shared with the auditor, who has reported immediately above the Table of time allocation of 50% and 20% on page 614 of the paper book that: `Accordingly to the information provided by the Lear RHQ management, the percentage of the cost allocated to the five categories, accordingly to the work time and effort spent on the relevant regions are listed as below.' Thus, it is graphically clear that the entire exercise of cost allocation to the respective zones is based on the time spent by Staff and Dep. Headers and there exists no basis except `the information provided by the Lear RHQ Management'. Since the foundational figures of allocation of costs to Asia-Non -China, that have been sub-allocated to the assessee in India, is itself open to question and is not based on any authentic document/evidence, we are unable to appreciate as to how such cost allocation can be considered as proper. 19. It is in the above manner that costs with code 31 have been allocated at 37% to Asia Non-China region by taking Staff costs at 29% (50% of 58%) and Dep. header costs at 8% (20% of 42%). Costs under code 61 have been allocated accordingly at 47% to Asia-Non-C....
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....erlooks proper allocation of the cost base. We have noted above that there is no reliable rationale of the cost allocation to the Asia Non-china zone at 37% under the concerned code. The percentages of 50% of Staff and 20% of Dep. Headers, which form the basis for the cost allocation, are just the words of mouth of the management de hors a proper substantiation by any evidence capable of examination. The improper cost allocation has jeopardized the benchmarking of the transaction resulting into profit shifting from India by booking higher expenses and thus taking away the rightful tax due to the Indian exchequer. 22. The Auditor's certificate, which is the self claimed evidence of proper cost allocation, is itself riddled with several disclaimers. Para 1.1 with the `Limitation' heading starts by stating that: `This study relies upon substantial input and information provided by Lear RHQ. EY China assumes no responsibility for the accuracy and completeness of such information'. EY China is the auditor firm which has issued Cost allocation certificate. It is further pertinent to note that the auditor has made the following disclaimers reading as under: "Lear RHQ has repre....
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....ces at Sl.No.1 to 3, 4, 6, 7, 8, 10, 11, 14 and 15 are in the nature of consulting services thereby leaving five non-consulting services. Two out of such five services given at Sl. Nos. 5 and 16 are relating to "Access to Lear Cost and Technology Optimization services" and `Access to Lear IT systems and services'. Lear Shanghai is not owning any global IT System, which implies that the same is owned by some other major Lear Group entity. Giving the assessee an `Access to Lear IT systems' would thus mean that Lear Shanghai first got access to the same by paying some consideration. The same holds good for allowing the assessee an access to Lear Cost and Technology optimization. In order to verify as to what were the costs incurred by the assessee for availing access to the Lear IT systems and Lear cost and technology optimization, the ld. AR was asked to place on record the annual accounts of Lear Shanghai. On perusal of the "Income and profit appropriation statement" of Lear Shanghai, it can be seen that there is a composite figure of cost of sales at Rs. 15,87,01,208/-. There is no Note appended to the cost of sales which could show the cost at which Lear Shanghai obtained access t....
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....three comparables, namely, Business Brain SHOWA-OTA-INC; S.Pool Inc; and Temp Holdings Company Ltd. All the three companies chosen as comparable are located in Japan as against Lear Shanghai located in China. We have tabulated above the nature of international transaction of rendering RHQ services. The first company taken as comparable is Business Brain SHOWA OTA INC., whose consolidated report has been placed at page 2247 onwards of the paper book. This company situated in Tokyo, Japan has shown its nature of business under the nomenclature of "Business Services". However, the details of its activities have been set out at page 2249 of the paper book giving certain codes under which it rendered services - Code 737 represents `Computer programming, data processing and other computer related services'; Code 7379 represents `Computer related services, not elsewhere classified'; Code 6209 covers `Other information technology and computer service activities'; Code 5415 covers `Computer Systems design and Related services'; Code 541519 represents `Other Computed Related services'. On going through the nature of services provided by this company, it is clear that these are in the nature ....
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.... to geographical location of comparables as is manifest from Rule 10B(2). It provides that the comparable of an international transaction with an uncontrolled transaction shall be judged with reference to four sub-clauses and clause (d) states : "conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail". On going through Rule 10B(2), which deals with the determination of ALP under section 92C, it gets absolutely evident that the condition prevailing in the markets in which the respective parties to the transaction operate, including the geographical location, is an important factor to judge an uncontrolled transaction. Thus, it is overt that the Indian transfer pricing regulations attach necessary importance to geographical location of the comparable entities vis-avis the transaction under consideration. 31. It is clear that not only all the three comparables chosen by the assessee for benchmark....
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.... order passed by the Tribunal for the assessment year 2007-08, a copy of which has been placed at page 101 onwards of the paper book. Relevant discussion has been made at para 2.2 onwards of the order and eventually the matter has been sent back in line with the view taken by the Tribunal in its order for earlier years, namely, 2005-06, 2006-07 & 2008-09. Both the sides are in agreement that the facts and circumstances of this ground are similar to those of earlier years. Respectfully following the precedents, we set-aside the impugned order on this score and remit the matter to the file of the AO/TPO for re-deciding it in accordance with the directions given by the Tribunal in its aforenoted earlier orders. C. MANUFACTRURING ACTIVITY SEGMENT 36. The AO made transfer pricing addition of Rs. 82,34,00,000/- under the Manufacturing activity segment. The assessee, inter alia, had three international transactions viz., `Export of seating components' amounting to Rs. 47,63,29,917/-; `Import of CKD components' amounting to Rs. 66,09,76,639/-; and `Import of raw materials and components' amounting to Rs. 27,62,33,311/-, all of which were benchmarked by the assessee independently. The....
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....82,34,00,000/- was recommended. The assessee remained unsuccessful before the Dispute Resolution Panel (DRP), which led to the making of transfer pricing addition of Rs.82.34 crore in the impugned order on this score. Aggrieved thereby, the assessee has come up in appeal before the Tribunal. 38. The assessee is engaged in manufacturing and assembling of automotive seating and electrical systems. The assessee maintained a composite set of books of account with one Profit and loss account. Its total revenue for the year stood at Rs. 1942.19 crore, out of which the major portion (more than 95%) was contributed by the manufacturing activity at Rs. 1862.52 crore. Out of such manufacturing revenue, the assessee made sales to non-Associated Enterprises under the head "Other Manufacturing" at Rs. 1701.69 crore, which is more than 91% of the total sales, meaning thereby that the sales to Associated Enterprises are less than 4%. It is only for the purpose of benchmarking that the assessee divided its financials into separate segments, inter alia, Export of seating components (hereinafter called SC-AE), Import of CDK units (hereinafter called CDK-AE) and Other manufacturing of domestic sal....
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....ities below were justified in jettisoning the assessee's point of view and determining the ALP of the three international transactions under the overall Manufacturing activity segment as one unit. 40. Operating revenues in the above Table have been given under the above three segments pertaining to the manufacturing activity at gross as well as net of excise duty levels. On a specific query, the ld. AR submitted that the allocation of costs to the three segments was done by booking direct costs to the related segments and common costs by way of allocation in the ratio of their Revenues on net basis. Net revenue from the SC-AE segment stands at Rs. 47.60 crore; CKD-AE segment at Rs. 100.09 crore; and DS-Non AE segment at Rs. 1515.46 crore. The first major item in the above Table under the head 'Operating expense' is `Cost of raw material and components consumed' that has been shown at Rs. 28.87 crore; Rs. 86.20 crore; and Rs. 1182.00 crore respectively. The ld. AR submitted that the figure under the CKD-AE segment at Rs. 86.20 crore was on actual basis pertaining solely to the CKD components and the balance cost of raw materials at Rs. 1210.87 crore (Rs. 1297.07 total cost of raw....
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....ntended that these expenses were bifurcated on actual basis. No record whatsoever has been placed before the authorities below or the Tribunal to demonstrate that the expenses recorded under these three segments were on actual basis. Be that as it may, we have noticed above that one factory at Chakan, Pune was producing goods meant for SC-AE as well as DS-Non AE segments. The raison d'etre given above qua the raw material cost applies to this cost as well. Similar is the position regarding the other expenses claimed by the assessee in determining the operating profit from the three segments under consideration. 41. The assessee has drawn SC-AE and CKS-AE segments to show that the three international transactions under the manufacturing activity were at ALP. We have noted above that there is a separate international transaction of `Import of raw material' with value of Rs. 27,62,33,311/-. On a pertinent query, as to how the ALP of the international transaction of Import of raw material was done, the ld. AR submitted raw material cost of Rs.2.16 crore pertaining to the SC-AE segment was absorbed along with the other raw material costs of the same segment and the remaining amount o....
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....wise profit rates and found out the average profit of all the major products manufactured at 5%. It was thus observed that as against the major product-wise `Operating profit' calculated by the assessee itself at 5% in such calculation sheet, it had shown `operating profit' only at 0.05% in the Manufacturing segment in the segmental profit sheet meant for transfer pricing purpose. This further substantiates that the working done by the assessee in calculating the operating profit from the three segments for benchmarking is misplaced. Por una parte, the assessee itself presented figures before the TPO giving average operating profit at 5% and por otra parte it again itself computed operating profit at 0.05%. in the segmental calculation. 44. The ld. AR tried to clarify the position by submitting that the profit rate of 5%, as submitted before the TPO, was exclusive of common expenses, whereas it was not so in the working done for benchmarking. From the working so given at page 445 and 446 of the paper book, it is seen that the assessee has taken 24 major products dealt with by it with volume, per unit sale price, per unit material cost, per unit variable overheads and per unit fi....
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...., Trading and Service. The ld. AR submitted that the TPO in that case also clubbed the transactions and when the matter finally came up before the Tribunal, the separate benchmarking of the three segments was countenanced. 48. The facts of that case are distinguishable from those of the assessee inasmuch as in that case there was no dispute about the allocation of expenses to different segments and further the transactions of that assessee were subject to benchmarking. In contrast, the allocation of expenses done by the assessee in this case is apparently not correct as has been discussed above and further its DS-NonAE segment, which has shown the least profit, is non AE segment requiring no benchmarking. As such, the ratio in the case of Kolkata Tribunal referred above is not applicable to the facts of the extant case. 49. In view of the foregoing discussion, we are satisfied that the authorities below were justified in rejecting the segregation approach adopted by the assessee and rightly combined the three international transactions under the overall `Manufacturing activity' for benchmarking. 50. Notwithstanding having found that the preparation of the segmental profita....
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....rged for the same or similar uncontrolled transactions as are between non-AEs under similar circumstances. In other words, this method requires firstly, identifying the international transaction of the assessee and then comparing it with some price charged or chargeable under similar uncontrolled situation. 54. The ld. AR took us through the Transfer pricing study report, which refers to four transactions within its ambit. The first transaction is import of raw materials and components from Lear Automotive, Malaysia amounting to Rs. 1.56 crore. It is mentioned in the Transfer pricing study report that raw material and components (sheet foam worth Rs. 1.56 crore) were imported from Lear Malaysia on specific directions from Volkswagon, India, its customer. It has further been mentioned that Volkswagon, India directed the assessee to procure the relevant raw material and components and the prices were mutually agreed between Volkswagon and Lear Malaysia and that the price at which it has been imported by the assessee and the price at which it sold the same to Volkswagon, India ensured that it earned a reasonable markup. It has still further been mentioned:"Accordingly the company b....
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.....46 crore was benchmarked under the guise of adoption of "any other method". 58. Without prejudice to the above submissions for approving the segregation approach, the ld. AR submitted that the TPO went wrong in computing the transfer pricing adjustment by considering the entity level figures under the manufacturing activity whereas he ought to have restricted the addition only to the international transactions under consideration. It was stated that if the transfer pricing adjustment is restricted only to the international transactions under consideration as against the entity level transaction under the Manufacturing activity, the amount of the transfer pricing adjustment would get reduced to around rupees five crore. 59. It is overt that the TPO determined the ALP by considering the entity level PLI of the assessee under the Manufacturing activity and chose certain comparables for working out the amount of transfer pricing adjustment. It is essential to note that the ld. AR did not point out anything amiss in the selection of comparables or the computation of PLI of the assessee or comparables. The grievance is confined only to the making of transfer pricing adjustment on ....