GULBRANDSEN CHEMICALS PRIVATE LIMITED,,BARODA vs. THE DY.CIT.,CIRCLE-1(1),, BARODA

By way of this appeal, the assessee appellant has challenged correctness of the order dated 11th June 2013, in the matter of assessment under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961, for the assessment year 2008-09.

Grievances raised in the appeal are as follows: 1. In the facts and circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) ('CIT(A)') grossly erred in confirming the addition u/s 92 of the Income-tax Act made by the Learned Assessing Officer ('AO')/Transfer Pricing Officer (‘TPO’) of Rs.5,55,56,963/- to the income of appellant in respect of the international transactions of sale of chemical products viz. ANH and MBTC by appellant to its Associated Enterprises ('AEs') Gulbrandsen Chemicals Inc., USA and Gulbrandsen EC Limited, UK.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in upholding the Ld. TPO/AO's approach of rejecting the Transactional Net Margin Method ("TNNM") as the most appropriate method.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in upholding the Ld. TPO/AO's approach of adopting the

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in not allowing following comparability adjustments claimed by the appellant for material differences in contractual terms, underlying commercial circumstances, functions, risks and other economic factors between appellant's transactions with AEs vis-a-vis appellant's transactions with non-AEs, while applying the CUP method.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in upholding Ld. TPO/AO's approach of notionally increasing the sales realization from National Titanium Dioxide Company Limited by 10% on account of volume factor for establishing the comparability for benchmarking international transactions of sale of ANH under CUP method.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in upholding that under CUP method the Ld. TPO/AO has correctly made the comparison of prices in US dollar instead of Indian rupees.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in not allowing the benefit of arm's length price range of +/- 5% provided in proviso to section 92C(2) of the Act and thereby ignoring making of the transfer pricing adjustment with reference to lower end of aforesaid +/- 5% range.

In the facts and circumstances of the case and in law, the Ld. CIT (A) grossly erred in not considering the foreign exchange gain or loss arising on account of business transactions as operating income for computation of operating margin in Ld. TPO's alternative and without prejudice working in his transfer pricing order u/s 92CA(3).

In the facts and circumstances of the case and in law, the Ld. CIT(A) grossly erred in not quashing the Ld. AO’s action of initiating the penalty proceedings u/s 274 r.w.s. 271(1)(c) of the Act.

When this appeal was taken up for hearing, learned representatives fairly submitted that whatever we decide on the cross appeal for the assessment year 2007-08, which were heard along with this appeal, will apply mutatis mutandis on this appeal as well.

Vide our order of even date, we have allowed the appeal of the assessee, for the assessment year 2007-08, and observed as follows:

The material facts and circumstances of the case are like this. The assessee company is a wholly owned subsidiary of EW Limited, Mauritius- a group entity of Gulbrandsen Inc, USA and Gulbrandsen EU Limited UK inasmuch as the shareholders of EW Limited, i.e. Peter Gulbrandsen and Donald Gulbrandsen, are also majority shareholders of Gulbrandsen Inc, USA and Gulbrandsen EU Limited UK. The assessee is engaged in the manufacturing of chemicals for its divergent industrial customers, its product range includes Aluminium Chloride Anhydrous (ANH), Meno N Butyl Trichloride (MBTC), Stannic Chloride (TTC), Dibutyl Tin Oxide (DBTO)/ Dibutyl Tin Tin Dilaurate (DBTAA) and Tri Chloro Benzene and these products are supplied to the industries including petrochemical industry, pharmaceutical and chemical intermediate users. The assessee has also sold these products to its AEs, namely Gulbrandsen Chemicals Inc, USA, and Gulbrandsen EU Limited, UK. During the course of assessment proceedings, the matter regrading ascertainment of arm’s length price was referred to the Transfer Pricing Officer. The Transfer Pricing Officer noticed that the assessee had, deviating from the stand taken in the earlier years in which internal CUP method was adopted for benchmarking the sale to the AEs, computed the arm’s length price of these transactions on the basis of Transactional Net Margin Method (TNMM). In effect thus, the assessee moved, in the current year, from internal CUP to TNMM. This, however, did not find favour with the TPO. The TPO was of the view, for the detailed reasons set out in his order, that, given the facts of the case, the internal CUP was the most appropriate method and it has been used all along in the earlier years. The reasoning adopted by the TPO was like this. It was noted that the assessee had sold 40% of its products to the associated enterprises, and earned margin of PBIT/Cost at 2.07%, as against the sale of 70% of its products in the immediately preceding year and earning margin of PBIT/Cost at -3.26%. The TPO computed the total cost per kg for each type of chemicals and compared it with average sale rate to AEs so as to compute the GP/Cost (%) and noted that “the assessee has charged very nominal margin to the AEs”. Coming to the Internal TNMM adopted by the assessee and the TPO’s view that the basis of allocating the overheads was not clear, it was explained by the assessee that revenue and expenses have been allocated on actual basis wherever these are directly allocable, and wherever these are not directly allocable, the allocation has been done on the basis of appropriate allocation key such as ration of sales quantity, sales revenue, total revenue. It was also explained that the segmental details have been reconciled with entity level audited accounts. The assessee further submitted that “in case if in your view there are any inappropriate cost allocations, we would appreciate if you can kindly let us know which cost allocations are not appropriate and why these are not appropriate so that we can accordingly clarify and explain on those aspects”. While the TPO did not have any specific comment on this request, he simply rejected the explanation of assessee as “not accepted”. It was also explained to the TPO that the CUP method is not really appropriate to the facts of this case as the assessee has long term business arrangements with the AEs, whereas there are no such long term arrangements with non AEs and that the contractual, economic, commercial, functional and risk profile differences, between the AE transactions vis-à-vis non AE transactions, make the comparison of prices irrelevant. The attention was invited to the fact that, as also stated in OECD Guidelines for Multinational Enterprises and Tax Administrators, application of CUP method “requires

It was in this backdrop that the impugned ALP adjustment was made by the Assessing Officer. Aggrieved by the arm’s length price adjustment, assessee carried the matter in appeal before the CIT(A) but without any success. The CIT(A) observed that “regardless of merits in the adjustments made by the appellant, fact remains that adjustments to make uncontrolled and controlled transactions comparable were possible in appellant’s case” and went on to add that “further, it is an accepted position that CUP is a superior method to other methods, if available” as “was also held in the case of Serdia Pharmaceuticals India Pvt Ltd by Mumbai ITAT (2011) 44 SOT 391 (Mum)”. Even as the learned CIT(A) held that adjustments were possible, he rejected the same, on the merits, including in respect of volume discount, credit terms, marketing and selling function and consequent costs, credit risk, reimbursement of R&D costs, interest free ECB loans, and all such factors. The TPO also observed that there is a huge difference between sale price of MDTC to its USA based AE and UK based AE inasmuch as the same product was sold to US based AE for Rs 412.95 and to UK based AE for Rs 370.13. This, according to the CIT(A), indicated that the sale to USA based AE was much above the arm’s length price. Learned CIT(A) observed that the “appellant has not explained the vast difference between the prices charged for the same

The assessee is aggrieved and is in further appeal before us. 8. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of applicable legal position. We have also perused the detailed written submissions filed by the learned DR.

It is by now a reasonably well-established legal proposition that as long as it is reasonably possible to apply a direct method of ascertaining the arm’s length price of a transaction, such a direct method will have an edge over application of indirect method of ascertaining the arm’s length price. This principle has been reiterated in a large number of decisions of the coordinate benches, such as in the case of ACIT Vs MSS India Ltd [(2009) 32 SOT 132 (Pune) and Serdia Pharmaceuticals India Pvt Ltd VS ACIT [(2011) 44 SOT 391 (Mum)]. Going by this principle, all other things being equal, a direct method like Comparable Uncontrolled Price (CUP) method will have an edge over an indirect method like Transactional Net Margin Method (TNMM). That does not, and cannot, however mean that whatever be the fact situation, CUP is always a preferred method because of one of the essential prerequisite for application of any method of ascertaining the ALP is the inputs necessary for that purpose. Whatever may be inherent edge of the direct methods of determining arm’s length price of an international transaction over indirect methods of determining the arm’s length price of international transactions, selection of the most appropriate method for determining arm’s length price under the transfer pricing provisions, in a particular fact situation, is not an academic exercise which can be decided de hors the peculiar facts of that situation, and, therefore, there cannot be any straight-jacket formulas holding application of a particular method in case of a particular type of product or service. While rule 10B(1) of the Income Tax Rules 1962, provides that arm’s length price in relation to an international transaction shall be determined by any of the methods, “being the most appropriate method”, set out therein, Rule 10 C(1) provides the mechanism for selecting the

What is clear from the above analysis is that a method of determining arm’s length price, to be held as a ‘most appropriate method’ (MAM), should be, as provided in rule 10C(1), a method “which is best suited to the facts and circumstances of each particular transaction” and a method and “which provides the most reliable measure of arm’s length price of the international transaction”. Under rule 10C(2)(c), “the availability, coverage and reliability of data necessary for application of the method” is one of the crucial factors determining suitability of a method of determination of arm’s length price in a particular fact situation. Similarly, it is also important to determine whether accurate adjustments can be made for the differences between the international transactions and the comparable uncontrolled transactions, and unless such adjustments can be made the related method cannot be said to be most appropriate method. We have already seen as to how, in the CIT(A)’s analysis, suitable adjustments could not be made even though in his opening observations in the operative portion of the order, he stated that suitable adjustments can indeed be made. The inability to make suitable adjustments, therefore, does take the method outside the ambit of most appropriate method. Quite clearly, therefore, unless suitable reliable data inputs necessary for application of a particular method, as CUP in this case, are available, CUP method cannot be said to be most appropriate methods on the facts of this case. Let us, therefore, first examine whether sufficient inputs were indeed available.

At the outset, it is important to note that what has been relied upon by the TPO is Internal CUP data but then rather than taking the comparable uncontrolled price of the transaction, the TPO has compared average of intra-AE transactions and independent transactions. This approach, though in the case of application of Cost Plus Method, has been rejected by a coordinate bench of this Tribunal in the case of ACIT Vs Tara Ultimo Pvt Ltd [(2012) 143 TTJ 91 (Mum)], though the same reasoning will be equally applicable in respect of the CUP as well as the computation mechanism, in that respect, is materially similar. In this case, speaking through one of us (i.e. the Vice President), the coordinate bench had observed as follows:

It is also important to note that the TPO has justified application of internal CUP on the basis of deviations in prices at which products are sold to different AEs and, by implication, using one intra AE price to bench the other intra AE price. That is wholly incorrect. It is well settled in law that it is only an uncontrolled price which can be compared with controlled price and used for any benchmarking. This position has been well summarized in a coordinate bench decision in the case of Sabic Innovative Plastic India (P.) Ltd. v. Dy. CIT [2013] 59 SOT 138/35 taxmann.com 177 (Ahd.), and we are in considered agreement with the same.

When comparing the prices of products sold in intra AE transactions vis-à-vis independent transactions, it is not sufficient to compare the prices de hors the economic circumstances in which the respective AE and non AE transactions take place. This principle is beyond any doubt or controversy. In the OECD Guidelines for Multinational Enterprises and Tax Administrators, it is clearly stated that application of CUP method “requires high degree of comparability not only in the products sold and services provided but also in the economic circumstances in which the respective AE and non AE transactions take place”. In the UN Transfer Pricing Manual, it is observed that “degree of comparability between controlled and uncontrolled transactions is typically determined on the basis of a number of attributes of the transactions or parties that could materially affect prices or profits and the adjustment that can be made to account for differences” and then it is observed that “these attributes, which are usually referred to as the five comparability factors, include: (i) Characteristics of the property or service transferred; (ii) Functions performed by the parties taking into account assets employed and risks assumed, in short referred to as the “functional

We have noted huge and crucial variations in payment terms of the transactions with the AEs vis-a-vi transactions with non AEs. The CIT(A) has rejected the adjustments in this respect on account of irrelevant factors such as assessee claiming only 8% adjustment in the financial year 2005-06, as against 20% adjustment sought in this year, even though the transactions were under the same agreement. That is immaterial. What is material is that there is huge difference in the payment terms. The CIT(A) has also noted the deviations in the advance payment terms of 120 days under the agreement and the actual advance payment of 17 months on average. He has also noted that in three invoices on non-AEs the credit period was 60 days but then he declines to treat these evidence as support for the claim that in all cases similar credits were given. However, what is clear that there is clearly significant variation in payment terms. As a matter of fact, at page 29, learned CIT(A) himself notes that “as per the agreement, advance payment was to facilitate appellant’s purchases, working capital etc which, in turn, ensured uninterrupted supply to the AE”. He does accept that he was given analysis sheet showing 17 months advance payment but rejects it as agreement refers to only 120 days advance payment. That does not belittle the fact that whatever may have been payment terms under the intra AE agreement, the payment was actually received substantially in advance. The question we must ask ourselves is that whether such substantial advance payments, which ensure availability of working capital to the assessee, can be compared with normal business transactions allowing, on the contrary, credit period to the customers. The answer is clearly in negative as the economic circumstances in which these two sets of transactions operate are substantially different. The very character of these transactions is different.

It is also important to bear in mind the undisputed fact that the AE had an obligation to buy at least 50% of its products and the assessee was reseller rather than an end user. These contractual terms and the difference in functions also seriously affect the comparability. The reasons given by the CIT(A) for rejecting these variations are wholly superficial and devoid of any legally sustainable merits. The variations in quantities between the AEs and the non AEs cannot be ignored either. There is no dispute that there is huge variations in quantities sold to the AEs vis-à-vis the quantities sold to the non-AEs but the CIT(A) has rejected the plea on the basis that “there is no consistent pattern or correlation between the volume and sale prices” and that “there is no reference to any volume discount in the agreement”. That is again a superficial approach. Whether there is a mention of the volume discount or not or whether there is always a direct relation between the prices and volumes, the fact remains that the transactions with such huge variations, as in this case, cannot be considered to be comparable transactions and that is the consistent approach in benchmarking analysis. The scale of transactions is an important economic factor affecting the comparability. We have also noted that the AEs have reimbursed R&D costs, with mark up, to the assessee. The AEs have also given interest free ECB loans. These are also equally important factors. When we take the transactions with the AEs in the light of these surrounding economic and contractual realities, in our considered view, the transactions with non AEs, on the facts of this case and as a whole, are not comparable at all. We cannot consider the price of the product in isolation with all these factors, and that is the reason why the comparability under CUP ceases to be relevant as these factors are clearly missing in non AE transactions. We have also noted that Rule10 B(1)(a)(ii) itself provides that “such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market” but then while CIT(A) uphold the application of CUP method on the ground that adjustments can indeed be

A lot of emphasis has been placed on the fact that the assessee on its own was using the Internal CUP method in past, and, there was, thus, no good reason to deviate from the same. It is for this main reason that the application of TNMM has been declined by the authorities below. Nothing, however, turns on this plea. What is before us is the question as to which method is most appropriate method for ascertaining the arm’s length in the present year. We donot see how this question is to be adjudicated simply on the basis of what has been accepted by the assessee, on his own, as the most appropriate method in the earlier years. Such a choice of method in the earlier years, in our humble understanding, cannot act as an estoppel against the assessee. In our considered view, the decision as to what is the most appropriate method on the facts of this case is to be taken in the light of the facts and material on record before us in the present year. The past conduct of the assessee, with regard to the selection of the most appropriate method for ascertaining arm’s length price for the present assessment year, is not really decisive. We, therefore, reject this plea of the revenue authorities as well. 17. As we do so, we may also add that one of the decisions relied upon by the assessee was in the case of DCIT Vs Dishman Pharmaceuticals & Chemicals Ltd and vice versa [(45 SOT 37 (2011)]. While dealing with a subsequent year’s appeal, for the assessment year 2010-11, and reiterating the stand earlier taken by the Tribunal, vide order dated 31st December 2018, the Tribunal has, inter alia, observed as follows

In view of the above discussions and following the consistent view being taken by the coordinate benches, in our considered view, the application of CUP method was indeed not justified on the facts of the present case. The intra AE transactions, on the facts of this case, were so fundamentally different in character in economic circumstances and contractual terms, that these cannot be compared with the independent transactions entered into by the assessee. We, therefore, reject the stand of the authorities below on this issue.

We have noted that the assessee has applied TNMM by comparing the profits on transactions with AEs and the non AEs and no specific defects have been pointed out in the allocation of costs in the segmental accounts which are duly reconciled with entity level consolidated accounts. We have also noted that dealing with the Internal TNMM adopted by the assessee the TPO had expressed the view that the basis of allocating the overheads was not clear, in response to which it was explained by the assessee that revenue and expenses have been allocated on actual basis wherever these are directly allocable, and wherever these are not directly allocable, the allocation has been done on the basis of appropriate allocation key such as ration of sales quantity, sales revenue, total revenue. It was also explained that the segmental details have been reconciled with entity level audited accounts. The assessee had further submitted that “in case if in your view there are any inappropriate cost allocations, we would appreciate if you can kindly let us know which cost allocations are not appropriate and why these are not appropriate so that we can accordingly clarify and explain on those aspects”. We have noted that the TPO did not have any specific comment on this request and he simply rejected the explanation of assessee as “not accepted”. In appeal also, no specific adjustments were suggested to the allocations made in the segmental accounts and the discussions were confined to generalities. In these circumstances, we see no reasons to disturb the internal TNMM adopted by the assessee. ………….

There are some variations in this year, such as the advance payment in this year is for 13.97 months on an average, as evident from the calculations at pages 149-150 of the paper book, and such as the fact that there have no sales of certain products to non AEs at all and yet internal CUP mechanism has been adopted. These variations will, however, not have any impact on the conclusions arrived at by us. We, therefore, see no reasons to take any other view of the matter for this assessment year. In any case, that approach is not even disputed by the parties before us.

We, therefore, uphold the plea of the assessee and delete the impugned ALP adjustment which was made by adopting Internal CUP method and rejecting the TNMM adopted by the assessee for benchmarking the sales to AEs. Once we hold so, all other issues raised in the appeal are rendered infructuous calling for no adjudication by us.

In the result, the appeal is allowed in the terms indicated above. Pronounced in the open court today on the 12th day of February, 2019.