THE PRINCIPAL COMMISSIONER OF INCOME TAX, VADODARA 1 vs. GULBRANDSEN CHEMICALS PVT. LTD.

C/TAXAP/751/2019 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD R/TAX APPEAL NO. 751 of 2019 With R/TAX APPEAL NO. 752 of 2019 With R/TAX APPEAL NO. 753 of 2019

FOR APPROVAL AND SIGNATURE:

HONOURABLE MR. JUSTICE J.B.PARDIWALA and HONOURABLE MR. JUSTICE BHARGAV D. KARIA

================================================================ 1 Whether Reporters of Local Papers may be allowed to see the judgment ? NO 2 To be referred to the Reporter or not ? NO 3 Whether their Lordships wish to see the fair copy of the judgment ? NO 4 Whether this case involves a substantial question of law as to the interpretation of the Constitution of India or any order made thereunder ? NO ================================================================ THE PRINCIPAL COMMISSIONER OF INCOME TAX, VADODARA 1 Versus GULBRANDSEN CHEMICALS PVT. LTD. ================================================================ Appearance: MR.VARUN K.PATEL(3802) for the Appellant(s) No. 1 MR S.N. SOPARKAR, SR. ADV WITH MR B S SOPARKAR(6851) for the Opponent(s) No. 1 ================================================================ CORAM: HONOURABLE MR. JUSTICE J.B.PARDIWALA and HONOURABLE MR. JUSTICE BHARGAV D. KARIA

Date : 03/02/2020

ORAL JUDGMENT (PER : HONOURABLE MR. JUSTICE BHARGAV D. KARIA) Page 1 of 71

C/TAXAP/751/2019 JUDGMENT (PER : HONOURABLE MR. JUSTICE BHARGAV D. KARIA) 1.These Tax Appeals under Section 260A of the Income   Tax   Act,   1961   (for   short   ‘the   Act, 1961’) are at the instance of the Revenue and are directed against the orders passed by the Income Tax Appellate Tribunal, Ahmedabad ‘D’ Bench, Ahmedabad (for short ‘the Tribunal’). 2.Tax Appeal No. 751 of 2019 is arising out of the order of the Tribunal dated 12.02.2019 in ITA No. 2276/AHD/2013 for A.Y. 2008­09. 3.Tax Appeal Nos. 752 of 2019 and 753 of 2019 are arising out of the common order of the Tribunal dated 12.02.2019 for A.Y. 2007­08 in ITA No. 760/AHD/2012 filed by the revenue and ITA No. 874/AHD/2012 filed by the assessee. 4.Since   common   issues   are   arising   in   these appeals, the same were heard analogously and are being disposed of by this common order. For the sake of convenience, Tax Appeal No. 753 of 2019 is treated as the lead matter. 5. The revenue has proposed the following three questions of law as substantial questions of law for the consideration of this Court so far as Tax Appeal Nos. 752 of 2019 and 753 of Page 2 of 71

C/TAXAP/751/2019 JUDGMENT 2019   are  concerned,  which  pertains  to  A.Y. 2007­08: (a) Whether   in   the   facts   and circumstances   of   the   case,   the   learned ITAT has erred in law and on facts in deleting   the   upward   adjustment   of Rs.2,78,02,502/­ made by the AO/TPO and confirmed   by   CIT   (A)   on   account   of Transfer Pricing adjustments in respect of international transactions of sale of chemical products by the assessee to its Associated Enterprises (Aes)? (b) Whether   in   the   facts   and circumstances   of   the   case,   the   learned ITAT has erred in law and on facts in rejecting   the   TPO’s   approach   of rejecting   the   Transactional   Net   Margin Method   (TNMM)   and   adopting   Comparable Uncontrolled Price (CUP) Method as Most Appropriate Method (MAM)? (c) Whether   in   the   facts   and circumstances   of   the   case,   the   learned ITAT has erred in law and on facts in allowing

following

appropriate adjustments claimed by the assessee for material   differences   in   contractual term,

underlying

commercial circumstances, functions, risk and other economic   factors   between   assessee’s transactions

with

AEs

vis­à­vis assessee’s   transactions   with   non   AEs while

applying

the

Comparable Uncontrolled Price (CUP) method: vi. Adjustment on account of business volumes difference. vii. Adjustment   for   advance   payment received from AE. Page 3 of 71

C/TAXAP/751/2019 JUDGMENT viii. Adjustment   for   marking   and selling   expenses   not   required   to   be incurred for AE sales vis­à­vis non AE sales. ix. Adjustment   for   credit   risk   not required to be borne by the assessee for AE sales vis­à­vis non AE sales. x. Adjustment for interest free ECB loan received from AE? 6.   Brief facts of the case are as under: 6.1. It   appears   from   the   material   on   record that the respondent – assessee  filed his return   of   income   for   A.Y.   2007­08   on 05.11.2007   declaring   the   income   at Rs.99,43,677/­.   The   case   of   the   assessee was selected   for scrutiny assessment and a notice under Section 143(2) and 142 (1) of the Act, 1961 were issued. 6.2. The Assessing Officer referred the case to the   Transfer   Pricing   Officer   (TPO)   under Section 92CA(1) of the Act, 1961. The TPO passed   an   order   dated   19.10.2010   under Section   92CA   (3)   of   the   Act,   1961 determining   the   total   transfer   pricing adjustment

Rs.3,91,40,456/­

by discarding   the   Transactional   Net   Margin Method   (TNMM)   and   adopted   Comparable Uncontrolled   Price   (CUP)   method   as   Most Page 4 of 71

C/TAXAP/751/2019 JUDGMENT Appropriate   Method   (MAM)   by   the   assessee in

respect

the

international transactions. 6.3. On the basis of the order passed by the TPO,   the   Assessing   Officer   adopted   the upward transfer pricing calculated by the TPO and passed the assessment order. 6.4. The   Assessing   Officer   adopted   the   CUP method   as   Most   Appropriate   Method   (MAM), due   to   following   reasons   as   recorded   by the Tribunal in the impugned order: “5. 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 Page 5 of 71

C/TAXAP/751/2019 JUDGMENT its   AEs,   namely   Gulbrandsen   Chemicals Inc,   USA,   and   Gulbrandsen   EU   Limited, UK.   During   the   course   of   assessment proceedings,   the   matter   regarding 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 Page 6 of 71

C/TAXAP/751/2019 JUDGMENT 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   vis­à­vis 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 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”.   It   was   thus submitted

that

the

economic circumstances in which sales have taken place   with   the   AEs   are   not   at   all Page 7 of 71

C/TAXAP/751/2019 JUDGMENT comparable

with

the

economic circumstances in which non AE sales have taken place. It was also explained that the AEs, to which the assessee has sold the products, are resellers whereas non AEs   are   end   consumers,   and   that   while these AEs are located in US and UK, the non AE customers are in Asia and Middle East.   Emphasis   thus   was   placed   on   the fact that the geographical location of markets was different and the comparison was   thus   inappropriate.   It   was   also highlighted that the volume of sales to the   AEs   was   substantially   higher   than sales to non AEs. The attention was also invited to the fact that while AEs make, on an average, 17 months advance payment for   the   purchases   while   non   AEs   are extended   60­90   days   credit   period.   It was   thus   contended   that   there   was   no credit   risk   to   AE   sales.   The   assessee further   pointed   out   that   the   AEs   also reimburse   the   assessee   the   basic research and development costs with 110% mark   up   under   long   term   business arrangement,   over   and   above   the   sale price,   and   that   the   assessee   has   also benefited from interest free ECB loans from the AEs. None of these submissions impressed   the   TPO.   The   TPO   noted   the objections   of   the   assessee   for   the application of Internal CUP but rejected the   same   mainly   on   the   ground   that “since 2003­04, the assessee company has been   using   internal   CUP   as   the   most appropriate   method”   and   “the   assessee company   has   shifted   from   internal   CUP method to internal TNMM without giving any   appropriate   reasons.   So   the contention of the assessee is rejected”. As regards the justification of TNMM on the ground that the volume of sales to the AEs is several times higher than the Page 8 of 71

C/TAXAP/751/2019 JUDGMENT sale to non AEs, the TPO observed that “it   means   that   the   assessee   has   sold huge volume to AEs at a lower rate and shifted the huge profits from India to other   countries”   and,   therefore,   “the contention   of   the   assessee   is   not acceptable”.   As   regards   the   credit period   and   advance   payments,   the   TPO observed, on a superficial note again, “contention   of   the   assessee   is considered but is not acceptable because in USA and UK market, the price of TTC, MBTC   and   DBTC   are   higher   than   non   AE price   rate”.   As   regards   guaranteed purchase   of   50%   production,   the   TPO observed   that   “it   is   seen   that   the assessee has been earning profits only from   the   non   AE   transactions   (and)   at least 50% guaranteed selling to AEs mean that   the   assessee   is   making   loss   and shifting the profits from India to other countries”.   On   reimbursement   of   R&D costs   also,   the   Assessing   Officer   did only observe, in rather general terms, that the plea is “not acceptable because the   assessee   has   sold   the   products   to its AEs at very lower rate and shifted the profits from India to outside India” The same was the comment in respect of interest free ECB loans from the AEs. As for the need of adjustment on account of various factors, the TPO simply observed that   “the   assessee   has   charged   very nominal   margin   to   its   AEs   (and) therefore, there is no any issue for any adjustment”. He then proceeded to make the adjustment by observing as follows: 10. Computation of Arm’s Length Price Product Sales to AE Quantity (kgs) Sales   to AE:   Avg. rate Sales

to non­AE Uncontrolled price rate Difference Adjustment TTC 113800 227 253 26 2958800 Page 9 of 71

C/TAXAP/751/2019 JUDGMENT MBTC 351036 371.41 465.18 93.77 32316646 DBTO 56852 351.84 409.27 57.43 3265010 Total Transfer Pricing Adjustment Rs.3,91,40,456/­ 6.5. Being aggrieved by the upward Arm’s Length Price   adjustment   (ALP)   made   by   the Assessing   Officer   on   the   basis   of   the order   passed   by   the   TPO,   the   assessee carried   the   matter   in   appeal   before   the CIT (A). 6.6. However,   CIT   (A)   confirmed   the   order passed by the Assessing Officer observing that,

‘regardless

merits

into adjustments   made   by   the   appellant,   the fact   remains   that   adjustment   to   make control   and   uncontrolled   transactions comparable   were   possible   in   appellant’s case. It was also observed that, “further, it is an accepted position that CUP is a superior   method   to   other   methods,   if available.” The CIT (A) relying upon the decision of the Tribunal in case of Serdia Pharmaceuticals India Pvt. Ltd. v. ACIT by Mumbai ITAT reported in (2011) 44 SOT 391 (Mum.)  and held that the adjustments were possible   but   same   were   rejected   on   the merits   including   in   respect   of   volume discount,   credit   terms,   marketing   and selling   function   and   consequent   costs, Page 10 of 71

C/TAXAP/751/2019 JUDGMENT credit risk, reimbursement of R & D costs, interest   from   ECB   loan   and   all   such factors. As the TPO observed that there is a huge difference  between the sale price of  Meno N Butyl Trichloride i.e.  MBTC to its USA based AE and UK based AE, inasmuch as the same product was sold to USA based AE for Rs.412.95 and to UK based AE for Rs.370.13.  According  to the CIT (A) such difference   indicated   that   sales   to   USA based AE was much above the ALP. The CIT (A)   therefore,   observed   that,   ‘the appellant   has   not   explained   the   vast difference between the prices charged for the same chemical from two AEs in the same period.’   And   therefore,   ‘the   adjustment claimed   by   the   appellant   and   the calculation   done   by   the   appellant   to arrive   at   ALP   after   adjustments   is   not acceptable’ and ‘determination by the TPO of ALP of transactions to be average sale price   to   non­AEs   over   the   year,   without carrying out adjustments is upheld’.   The CIT   (A)   however,   reduced   the ALP adjustment

Rs.2,78,02,502/­

by observing as under: “3.3.2 Appellant’s   contentions   in para 3.2.2 of its submissions regarding Page 11 of 71

C/TAXAP/751/2019 JUDGMENT mistakes in quantification of transfer pricing   addition   under   CUP   method   by Id. TPO are now taken up. It is pointed out   by   the   appellant   that   for   the products   MBTC   and   DBTO,   TPO   compared consolidated average price for both the AEs   with   non­AE   average   price.   Each sale transaction to the AEs constituted a   separate   international   transaction, arm’s   length   price   of   which   was required to be determined in accordance with   Section   92   of   the   I.T.   Act.   The Comparable Uncontrolled Price (CUP) for each of the 4 chemicals was determined by the TPO to be the average sale price charged   by   appellant   to   non­AEs.   Each transaction of sale of chemicals to the AEs   needed   to   be   benchmarked   with reference   to   the   CUP   and   if   the   CUP exceeded   the   sale   price   to   AE   for   a particular   transaction,   only   then transfer

pricing

adjustment

was warranted.   TPO’s   approach   in   working out   adjustment   on   the   basis   of consolidated   average   sale   price   for both AEs for MBTC & DBTO was therefore erroneous;   AE­wise   aggregation   of transactions for each chemical for the purpose of benchmarking and working out transfer pricing adjustment is however acceptable in this case, since it does not   result   into   an   outcome   different from   transaction­wise   benchmarking. Thus, only AE­wise segregation of sale transactions for each chemical needs to be   done.   Appellant’s   submissions   in respect   of   DBTA   sale   also   have   merit and are accepted. Accordingly, transfer pricing   adjustment   of   Rs.2,78,02,502/­ worked out by the appellant is directed to   be   substituted   in   place   of adjustment   of   Rs.3,91,40,456/­   worked out by TPO subject  to verification  by Page 12 of 71

C/TAXAP/751/2019 JUDGMENT the   AO   of   arithmetical   correctness   of the working done by the appellant.” 6.7. The

assessee

being

aggrieved

and dissatisfied   by   the   order   passed   by   the CIT   (A)   carried   appeal   before   the Tribunal, whereas, the Revenue also filed a   cross­appeal   for   the   reduction   of   ALP adjustment   made   by   the   CIT   (A).   The Tribunal   considered   the   question   as   to which  is the most appropriate  method  for ascertainment of Arm’s Length Price in the facts of the case. The Tribunal considered the   well   established   principle   that   as long as it is reasonably possible to apply direct   method   of   ascertaining   the   Arm’s Length   Price   of   a   transaction,   such   a direct   method   will   have   an   edge   over application   of   an   indirect   method   of ascertaining   the   Arm’s   Length   Price.   The Tribunal relied  upon the decision  of the coordinate  Bench of the Tribunal in case of  ACIT   v.   MSS   India   Ltd.    reported   in (2009)   32   SOT   132   (Pune)  and   Serdia Pharmaceuticals   India   Pvt.   Ltd.   (supra) and has observed as under: “…Going   by   this   principle,   all   other things being equal, a direct method like Comparable   Uncontrolled   Price   (CUP) Page 13 of 71

C/TAXAP/751/2019 JUDGMENT 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 straight­jacket 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   most appropriate method “which is best suited to the facts and circumstances of each particular   transaction”   and   “which provides   the   most   reliable   measure   of arm’s length price of the international transaction”.   Rule   10C(2)   further provides   that   in   selecting   the   most appropriate method as specified in rule 10C(1), certain factors are to be taken Page 14 of 71

C/TAXAP/751/2019 JUDGMENT into account: (a)   the   nature   and   class   of   the international transaction; (b) the class or classes of associated enterprises

entering

into

the transaction and the functions performed by   them   taking   into   account   assets employed   or   to   be   employed   and   risks assumed by such enterprises; (c) the   availability,   coverage   and reliability   of   data   necessary   for application of the method; (d) the degree of comparability existing between   the   international   transaction and   the   uncontrolled   transaction   and between   the   enterprises   entering   into such   transactions;   (e)  the   extent   to which reliable and accurate adjustments can be made to account for differences, if   any,   between   the   international transaction

and

the

comparable uncontrolled transaction or between the enterprises

entering

into

such transactions; (f)  the  nature,  extent  and reliability of   assumptions   required   to   be   made   in application of a method [Emphasis,   by   underlining,   supplied   by us] 10.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

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 Page 15 of 71

C/TAXAP/751/2019 JUDGMENT 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. 11.  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 intra­AE 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 Page 16 of 71

C/TAXAP/751/2019 JUDGMENT 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: The way this rule works, the benchmark gross  profit   is to be applied  on each transaction   with   the   AEs   ,   while,   for computing the benchmark, one could take into account a series of same or similar transactions.   In   other   words,   while setting the benchmark, one can take into account   several   transactions   with unrelated   enterprise   on   what   can   be termed as 'global basis', essentially in respect of same or similar property or services   though,   the   benchmark   so arrived   at   cannot   be   applied   on   the global basis i.e. the average of gross profit   earned   from   same   or   similar transactions   with   AEs.  The   application of  CPM has  to be on transaction  basis rather   than   on   global   basis,   and   this fundamental  scheme  of cost plus  method is also evident from the plain wordings of Rule 10 B as well. Any other view of the matter will result in incongruities. For example, if our average mark up to unrelated   enterprises   is   20   per   cent. and we charge a mark­up of 2 per cent in one transaction with AE and 38 per cent in another transaction with the AE, both these transactions, by applying the mark up on global basis, will meet the test of  ALP whereas   in the first  case,  the mark up charged is certainly not a mark­ up   resulting   in   an   ALP.   In   this particular case, for example, the normal Page 17 of 71

C/TAXAP/751/2019 JUDGMENT mark   up   in   transactions   with   has   been computed   at   16.31   per   cent.   and   the average   of   mark   up   on   sales   to   AEs having   been   taken   at   17.08   per   cent. entire   sales  to AEs has  been  taken  at ALP, but, the mark up in the many cases is clearly less than benchmark. To give one example, at page 221 of the paper­ book,   margin   of   14.15   per   cent   (4 invoices),   13.95   per   cent.   13.81   per cent.   14   per   cent   (4   invoices),   14.14 per   cent   (2   invoices),   and   14.16   per cent   is   given   by   assessee's   own computation, and, on the same page, on one   invoice,   the   assessee   has   shown   a margin as high as 27 per cent. The cost plus   method,   therefore,   has   not   been correctly applied. In any case, one of the most important input, i.e. diamond, has been imported at a price for which no   ALP   documentation   is   available   and the   price   of   imports   have   been   taken into account in computation of costs as well. The costs of inputs have not been verified either. No efforts are made to show that the terms of sale to the AEs and   all   other   relevant   factors   are materially

similar

vis­a­vis

the transactions

with

independent enterprises.   The   CPM   is   applied   by comparing gross profit on sales, whereas the  method  requires  comparison  of mark up   on   costs   on   transactions   with   AEs vis­a­vis   mark   up   on   costs   on transactions with non AEs [Emphasis, by underlining, supplied by us now] 12. 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 Page 18 of 71

C/TAXAP/751/2019 JUDGMENT 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. 13.   When   comparing   the   prices   of products  sold in intra AE transactions vis­à­vis   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 Page 19 of 71

C/TAXAP/751/2019 JUDGMENT service   transferred;   (ii)   Functions performed   by   the   parties   taking   into account   assets   employed   and   risks assumed,   in   short   referred   to   as   the “functional analysis” (iii) Contractual terms; (iv) Economic circumstances; and (v)   Business   strategies   pursued”. Clearly,   therefore,   the   significant variations in economic circumstances and contractual   terms   can   take   seemingly comparable   transactions   outside   the ambit of comparability.” 6.8. After

considering

the

aforesaid principles, the Tribunal applied the same to the facts of the case, as under: “14.   We   have   noted   huge   and   crucial variations   in   payment   terms   of   the transactions   with   the   AEs   vis­a­vi 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   non­AEs   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 Page 20 of 71

C/TAXAP/751/2019 JUDGMENT 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. 15. 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 Page 21 of 71

C/TAXAP/751/2019 JUDGMENT is huge variations in quantities sold to the AEs vis­à­vis the quantities sold to the non­AEs 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 Page 22 of 71

C/TAXAP/751/2019 JUDGMENT 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 made, he rejects the adjustments on merits. That is   clearly   incongruous.   When   he   admits that   no   adjustments   can   be   made   on merits,   the   very   foundation   of   his decision   to   uphold   application   of   CUP method ceases to hold good. In any case, having   perused   the   material   on   record, we   are   of   the   considered   view   that accurate   adjustments   cannot   be   made   to nullify   the   impact   of   absolutely fundamental   variations   in   the   terms   of the   intra   AE   and   non   AE   transactions, and since accurate adjustments cannot be made, for this reason alone, CUP method ceases   to   be   workable   on   the   facts   of this   case.   The   contradiction   in   the approach is also evident from the fact that   the   CIT(A)   has   upheld   application of   CUP   method   on   the   sole   basis   that accurate adjustments can be made to take care of variations in the intra AE and independent transactions but then one of the   points   made   before   us,   in   the written   submissions,   is   that   “if   total adjustment of 36% claimed in those years was allowed, prices would come down to such unrealistic levels that one of the international   transaction,   including sales   to   non   AEs,   were   made   anywhere neat them”. Clearly, there is no meeting ground   between   these   diametrically opposed   stands   by   the   authorities.   As regards the decision of coordinate bench in   the   case   of   Serdia   Pharmaceuticals (supra),   that   was   a   case   in   which   no dispute was raised with respect to the comparables   cases   except   on   account   of quality   for   which   suitable   adjustment Page 23 of 71

C/TAXAP/751/2019 JUDGMENT was allowed. This precedent, therefore, does not offer any help to the case of the revenue. 16. 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 do not   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.”

6.9. The   Tribunal   thereafter   referred   to   the decision of the Coordinate Bench relied on behalf of the assessee in the case of DCIT v.   Dishman   Pharmaceuticals   &   Chemicals Page 24 of 71

C/TAXAP/751/2019 JUDGMENT Ltd. reported   in  45   SOT   37   (2011), wherein,   the   Tribunal   considering   the factors   relating   to   the   determination   of Most Appropriate Method for computing ALP adjustments   and   came   to   the   conclusion that CUP method cannot be applied in each and   every   case.   The   Tribunal,   therefore, in the facts of the case, held as under: “19. 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

compared

with

the independent transactions  entered into by the assessee. We, therefore, reject the stand of the authorities below on this issue. 20.   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 Page 25 of 71

C/TAXAP/751/2019 JUDGMENT 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.   We,   therefore,   delete the   impugned   ALP   adjustment   of   Rs 2,78,02,502.” 6.1. Learned   Standing   Counsel   appearing   for   the revenue Mr. Varun K. Patel submitted that the Tribunal has committed an error in law and on facts in rejecting the approach of the TPO of adopting Comparable Uncontrolled Price (CUP) method as Most Appropriate Method (MAM) and Page 26 of 71

C/TAXAP/751/2019 JUDGMENT further erred in allowing various adjustments claimed   by   the   assessee   for   material differences   in  contractual   term,   underlying commercial circumstances, functions, risk and other

economic

factors

between

the transactions of assessee with AEs vis­à­vis the transactions of the assessee with non­AEs while applying the CUP method as under: i.

Adjustment   on   account   of   business volumes difference. ii. Adjustment for advance payment received from AE. iii. Adjustment   for   making   and   selling expenses not required to be incurred for AE sales vis­à­vis non AE sales. iv. Adjustment for credit risk not required to be borne by the assessee for AE sales vis­à­vis non AE sales. v. Adjustment   for   interest   free   ECB   loan received from AE. 6.2. Mr.   Varun   Patel   further   submitted   that, Indian Transfer Pricing Regulations as well as   OECD   guidelines   state   that   the transactional profit method should ideally be applied   on   a   transaction   to   transaction basis,   but   in   appropriate   situation transactions may be grouped or aggregated. It was submitted that, the relevant controlled Page 27 of 71

C/TAXAP/751/2019 JUDGMENT transactions may best be aggregated if it is impractical  to  analyze  all  profits  of  each individual

transactions

such transactions are so inter­related that this is  the  most  reliable   means  of  benchmarking the  outcome  of  the  transaction  against  the arm’s length outcome. Reference was made to Rule 10A (d) of the Income Tax Rules, 1962 (for   short   ‘the   Rules’),   wherein,   it   is defined that “transaction” includes a number of   closely   linked   transactions.   It   was therefore submitted that if the appropriate method  adopted  by  the  assessee  by  applying TNMM is to be given any credence then in case of   any   enterprise   all   its   international transaction   would   be   closely   interlinked because all the transaction of an enterprise in one way or the other are connected to the overall   operation   and   objective   of   the company, and the basis of comparability and analysis   on   a   transaction   to   transaction basis would lose its meaning. 6.3. It  was  further  submitted   that  by  following the   TNMM   and   by   clubbing   all   the international   transactions   for   all   the products, the assessee has failed to follow the Letter and Intent of TNMM as described in law. Page 28 of 71

C/TAXAP/751/2019 JUDGMENT 6.4. Learned advocate for the Revenue, in support of his submission referred to the decision of the   ITAT   Ahmedabad   ‘D’   Bench   in   case   of Effective   Teleservices   (P.)   Ltd.   v.   Deputy Commissioner   of   Income   Tax reported   in (2019) 19 taxman.com 98 (Ahmedabad­Trib.). He relied upon the following observations made by the Tribunal as under: “6. We have heard the rival contentions of   both   the   parties   and   perused   the materials   available   on   record.   At   the outset we note that similar issue related to   internal   CUP   method   was   raised   in assessee’s   own   appeal   in   Effective Teleservices   (P.)   Ltd.   v.   Asstt.   CIT (2019)   90   taxman.com   390   (Hyd.­   Trib.) where   issue   was   decided   in   favour   of assessee by the ITAT vide order dated 16­ 01­2018 by observing as under: “10.

have

given

thoughtful consideration   to   the   orders   of   the authorities   below.   We   find   that   the assessee is eligible for tax holiday u/s. 10A of the Act, therefore, we do not find any   merit   in   holding   that   the   assessee manipulated   the   prices   and   shifted   the profits to the overseas jurisdiction for avoiding   taxes   in   India.   Moreover,   the taxes rates in the USA are higher than the   tax   rates   prevailing   in   India. Moreover, the AE of the appellant company has incurred losses in providing end to end   services   to   third   parties.   If   the assessee

had

directly

undertaken contracts with the third parties in USA, it   would   also   have   incurred   operating losses   as   against   operating   profits Page 29 of 71

C/TAXAP/751/2019 JUDGMENT earned   while   undertaking   transactions with AEs. 11.   We   find   that   the   appellant   company has earned average hourly rate from its AE business at Rs. 274.39 per hour. As against the same, the average hourly rate from Non AE business was Rs. 108.82 per hour.   Thus,   the   average   hourly   rate earned from AE business was more than Non AE   business.   The   only   reason   for rejecting   the   assessee’s   contention   is that the pricing mechanism in case of AE as   well   as   Non   AEs   was   different; therefore, CUP is not applicable. In our considered   opinion,   merely   because pricing mechanism is different, internal CUP should not have been rejected. 12. We find that the TPO has mentioned in the order that the risk profile of AE and non   AE   is   entirely   different.   In   our considered   opinion,   reasonable   accurate adjustment cannot be made for such risk differences and if the risk adjustment is made, the same would further reduce the average hourly rate charged from AE which is,   as   mentioned   elsewhere,   lower   than the average hourly rate charged from AE. Therefore,   in   our   understanding   of   the facts,   internal   CUP   should   have   been accepted as most appropriate method.” 6.1   Similarly,   the   identical   issue related to internal TNMM method was also raised   in   assessee’s   own   appeal   of assessment   year   2009­10   in   Effective Teleservices   (P.)   Ltd.   (supra)   where issue was decided in favour of assessee by the ITAT vide order dated 16­01­2018 by observing as under: “13. For the sake of completeness of the adjudication, rejection of internal TNMM analysis   undertaken   by   the   appellant during   the   course   of   transfer   pricing assessment should not have been rejected. Page 30 of 71

C/TAXAP/751/2019 JUDGMENT We   find   that   the   appellant   company   has provided identical services to AE as well as   non   AEs   and   functions   performed, assets used and risks assumed in AE as well   as   non   AE   business   were   similar. Therefore,   in   our   considered   opinion, even internal TNMM can be considered as most appropriate method. We find that the operating   margin   of   the   appellant   from the AE segment was derived at 30.90% and the   operating   margins   in   the   non   AE segment was derived at Rs. 74.92%. 14.   The   TPO   rejected   the   internal   TNMM analysis   on   the   basis   that   as   the appellant has made operating loss in non AE   business,   the   transactions   with   non AEs are not at independent rates and they have   been   undertaken   only   to   increase capacity utilization. The total turnover of   Non   AE   segment   of   Rs.   5.67   lacs   as against the turnover of Rs. 1909.60 lacs in the case of international transactions with   AE.   The   ld.   CIT(A)   confirmed   the rejection by holding that the turnover of the third party segment is very much less compared to that with AE. The ld. CIT(A) further held that the appellant has not proved the allocation of the common cost between AE and non AEs and whether they are   scientific   and   at   arm’s   length.   We find   that   the   TPO   has   nowhere   disputed the   common   cost   allocation   made   by   the appellant.   We   also   find   that   the   ld. CIT(A) has also never raised any doubt on the allocation. Insofar as the difference in   the   turnover,   we   find   that   the Tribunal   Delhi   Bench   in   the   case   of Lummus   Technology   Heat   Transfer   BV   Vs. DCIT   42   taxmann.com   342   has   held   as under:­ 5.   Rule   10B(l)(e)   of   the   Income   Tax Rules, which deals with the Transactional Net Margin Method, provides requires that Page 31 of 71

C/TAXAP/751/2019 JUDGMENT "the   net   profit   margin   realised   by   the enterprise   (i.e.   the   assessee)   from   an international   transaction   entered   into with an associated enterprise is computed in   relation   to   costs   incurred   or   sales effected   or   assets   employed   or   to   be employed   by   the   enterprise   or   having regard   to   any   other   relevant   base"   is compared   with   "   the   net   profit   margin realised   by   the   enterprise   (   i.e.   the assessee) or by an unrelated enterprise from

comparable

uncontrolled transaction   or   a   number   of   such transactions is computed having regard to the same base" ­ of course, subject to comparability   adjustments   which   could affect the amount of net profit margin in uncontrolled conditions. It is not at all necessary, as the authorities below seem to   suggest,   that   such   net   profit computations,   in   the   case   of   internal comparables (i.e. assessee's transactions with   independent   enterprise),   are   based on the audited books of accounts or the books of accounts regularly maintained by the assessee. hi our considered view, all that   is   necessary   for   the   purpose   of computing arm's length price, under TNMM on the basis of internal comparables, is computation of net profit margin, subject to   comparability   adjustments   affecting net   profit   margin   of   uncontrolled transactions, on the same parameters for the transactions with AEs as well as Non AEs, i.e. independent enterprises, and as long as the net profits earned from the controlled transactions are the same or higher   than   the   net   profits   earned   on uncontrolled

transactions,

ALP adjustments are warranted. It is not at all   necessary   that   such   a   computation should be based on segmental accounts in the   books   of   accounts   regularly Page 32 of 71

C/TAXAP/751/2019 JUDGMENT maintained by the assessee and subjected to audit. We are, therefore, of the view that the authorities below were in error in rejecting the segmental results on the ground that the segmental accounts were not   audited   and   that   these   segmental accounts   were   not   maintained   in   the normal   course   of   business.   As   regards vague generalizations by the TPO to the effect

that

these

accounts

are manipulated,   that   allocation   basis   of expenses   is   unfair   and   that   these accounts   conceal   true   profitability,   we find   that   these   observations   are   too sweeping and generalized the observations to have any merits. In any event, learned counsel

for

the

assessee

has painstakingly   taken   us   through   the segmental accounts, pointed out the basis of   allocation   of   the   expenses.   We   have noted that the allocation of expense is on   the   man   hour   basis,   which   is   quite fair   and   reasonable,   and   that   every person   has   to   punch   in   hours   on   a specific project. We have also noted that all these details and expense allocation basis were also before the TPO and even then,   no   specific   defects   were   pointed out by the TPO. Taking into account all these   factors,   as   also   entirety   of   the case, we are of the considered view that the   TPO   indeed   erred   in   rejecting   the segmental accounts and thus declining to accept   the   internal   comparable.   We   are also   of  the  view   that   the   size   of   the uncontrolled transaction or transactions being smaller, by itself, does not make these transactions incomparable with the transactions   in   controlled   conditions. Size   of   the   comparable   does   matter   in entity level comparison because scale of operations substantially vary and so does the underlying profitability factor, but Page 33 of 71

C/TAXAP/751/2019 JUDGMENT in a transaction level comparison within the same entity, mere difference in size of the uncontrolled transactions does not render   the   transaction   incomparable.   If the size of uncontrolled transaction is too big, it may call for an adjustment for volume business. If the size of the uncontrolled transaction is too small, it may   provoke   an   inquiry   by   the   TPO   to ensure   that   it   is   not   a   contrived transaction outside the normal course of business   or   with   regard   to   other significant factors surrounding smallness of   such   transaction.   However,   in   our considered view, in none of these cases, a comparable can be rejected on the basis of its size per se. In this view of the matter,   the   authorities   below   were clearly   in   error   in   rejecting   the internal   comparable,   i.e.   profitability of assessee's transactions with non AEs, on the ground that the volume of business with   non   AEs   was   too   small   vis­a­vis business   with   AEs.   In   view   of   these discussions,   as   also   bearing   in   mind entirety   of   the   case,   the   assessee   was quite justified in adopting internal TNMM and   comparing   the   profit   earned   on   its transactions with AEs with profit earned with   non­AEs.   Accordingly,   the   ALP adjustment of Rs. 2,72,42,940/­ deserves to be deleted. We order so. The assessee gets   the   relief   accordingly.   15.   The Tribunal Hyderabad Bench in the case of NTT   Data   Global   Delivery   Services Limited.   63   taxmann.com   92   had   taken   a similar   view   and   followed   the   findings given   in   the   case   of   Lummus   Technology Heat Transfer BV (supra).” 6.2   Respectfully   following   the   same   we are   of   the   view   that   assessee   rightly benchmarked   the   transaction   by   choosing the   internal   CUP   method   as   most Page 34 of 71

C/TAXAP/751/2019 JUDGMENT appropriate method and alternatively also rightly   benchmarked   the   internal   TNMM method   as   most   appropriate   method   to determine   the   ALP.   Accordingly,   the appeal of the assessee is allowed.” 6.5. It was also submitted that the Tribunal has failed to consider that the assessee has not taken into account very important factor for determination of the ALP on the basis of the determination   of   the   price   in   different geographies as compared to sale of products to associate enterprise of the assessee, then non­associated   enterprises   of   the   assessee situated in the different parts of the world. It   was   submitted   that,   non­AE   situated   in non­developed countries or charge at a lesser price in the sale of products to AE situated in  countries,  viz.  USA  which   are  developed countries.   The   difference   on   this   account needs to be considered, which has not been taken into account by the assessee. It was further   submitted   that,   in   economics, Purchasing Power Parity (PPP) is a condition between  countries  where  an  amount  of  money has  the  same   purchasing  power  in  different countries.   Considering   the   PPP,   instead   of making any reduction in Non­AE price due to adjustments,   the   assessee   was   required   to increase the Non­AE price which is not being Page 35 of 71

C/TAXAP/751/2019 JUDGMENT taken   into   account   for   the   purposes   of calculation of ALP. 6.6. It was therefore submitted that, the ALP of sales to the AE in respect of ANH and MBTC are benchmarked using CUP as Most Appropriate Method by the TPO. 6.7. It was further submitted that, the assessee has failed to discharge the onus by carrying out   the   benchmarking   in   using   the   most appropriate method and in such scenario; the benchmarking   carried   out   by   the   TPO represents the best possible approach. 7.1. On  the  other   hand,  learned  Senior  Advocate Mr.   S.N.   Soparkar   assisted   by   learned advocate   Mr.   B.S.   Soparkar   submitted   that, the questions of law proposed by the revenue are in realm of questions of facts and as the Tribunal   being   the   final   fact   finding authority has arrived at a conclusion on the basis of the material produced before it that the TNMM applied by the assessee is the Most Appropriate Method (MAM) for the purpose of computation   of   ALP,   and   therefore,   no interference is required to be made in the findings given by the Tribunal. 7.2. It   was   further   submitted   by   the   learned Page 36 of 71

C/TAXAP/751/2019 JUDGMENT Senior Advocate appearing for the assessee – respondent that the Tribunal on the facts of the present case has held that the assessee has applied TNMM by comparing the profits on transactions with the AE and the Non­AEs 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,   and   in such circumstances, the method adopted by the assessee was considered as Most Appropriated Method.   It   was   also   submitted   that   the Tribunal has also given a finding that the application of CUP method was not justified on   the   facts   of   the   present   case,   as   the intra   AE   transactions   were   fundamentally different

character

economic circumstances and contractual terms and these cannot   be   compared   with   the   independent transactions entered into by the assessee. 7.3. It   was   therefore   submitted   that,   the difference   of   opinion   between   the   Tribunal and   that   of   CIT   (A)   and   TPO   as   to appropriateness   of   one   or   other   methods cannot  per­se  be  a ground  for  interference because appropriateness of the method unless shown   by   the   contrary   to   Rules,   specially Rule   10B   and   10C   of   the   Rules,   the   same Page 37 of 71

C/TAXAP/751/2019 JUDGMENT cannot be considered as substantial question of law under Section 260A of the Act, 1961. In support of his submissions, learned Senior Advocate placed reliance upon the decision of the   Delhi   High   Court   in   the   case   of Principal   Commissioner   of   Income­Tax­6   v. Make   My   Trip   India   (P.)   Ltd.  reported   in (2017) 399 ITR 297 (Delhi). 7.4. Learned Senior Advocate further relied upon the decision of the Coordinate Bench of this Court in the case of  Principal Commissioner of   Income­tax,   Gandhinagar   v.   Tudor   India (P.) Ltd.  reported in  (2019)  11 taxman.com 450   (Gujarat)  to   submit   that     the   entire scheme   of   the   transfer   pricing   has   been considered   by   this   court   and   as   such   the Tribunal has come to the conclusion on the basis of the material on record as per the provision   for   the   transfer   pricing   in   the act,1961. It was therefore submitted that no interference is required to be made in the impugned   order   of   the   Tribunal   as   no substantial   question   of   law   arises   there from. 8. Having heard the learned advocates appearing for   the   receptive   parties   and   having   gone through   the   material   on   record,   it   appears from the facts of the case that the Tribunal Page 38 of 71

C/TAXAP/751/2019 JUDGMENT considering the material on record has given the finding of fact that the TNMM applied by the   assessee   is   the   correct   method   and   the application of CUP method was not justified, in view of the fact that intra AE transactions were fundamentally different in character in economic   circumstances   and   contractual   terms and   these   cannot   be   compared   with   the independent transactions entered into by the assessee. 9. The Tribunal has further discarded the view of the TPO dealing with the internal TNMM adopted by the assessee with regard to the basis of allocating the overrates being not clear, by observing that the revenue and expenses have been   allocated   on   actual   basis   wherever  the same were directly allocable and wherever the same were not directly allocable, allocation was   made   on   the   basis   of   the   appropriate allocation   key   such   as   ratio   of   sales quantity, sales revenue and total revenue. The Tribunal also found that the segmental details have been reconciled with entity level audited accounts. It was also found that the TPO did not   have   any   objection   with   regard   to   the allocation   made   by   the   assessee,   but explanation given by the assessee was simply rejected as “not accepted”. The CIT (A) also Page 39 of 71

C/TAXAP/751/2019 JUDGMENT did not refer to any flow to the allocations made in the segmental accounts and discussed the   issue   on   generalities   only.   In   such circumstances, the Tribunal after considering in detail the facts of the case as stated in paras­14   and   15   of   the   impugned   order reproduced   hereinabove,   has   come   to   the conclusion that the internal TNMM adopted by the assessee is just and proper. 10.   In   decision   of  Principal   Commissioner   of Income­tax,   Gandhinagar   v.   Tudor   India   (P.) Ltd.  (supra)   this   Court   has   considered   the entire scheme of the transfer pricing and has observed as under: “11. The Karnataka High Court, in the case of Pr. Commissioner of Income Tax, Bangalore & Ors. vs. Softbrands India P. Ltd., reported in (2018) 406   ITR   513   had   the   occasion   to   consider   the special provisions relating to the Avoidance of Tax   in   Chapter­X   of   the   Act   comprising   of Sections   92   to   94­B   with   regard   to   the assessment   to   be   done   for   the   computation   of income   from   international   transactions   on   the principles of “Arm's Length Price” (ALP) and the relevant   Rules   for   computation   of   such   income under the aforesaid provisions of Chapter­X in the form of Rule 10­A to 10­E in the Income Tax Rules, 1962. We may quote the relevant portion of the judgment; “Perspective   of   International   Trade   and Transactions: 4. With   the   ever   increasing   international Trade and transactions, particularly, in the Software Industries and Bangalore, being the Silicon   Valley   of   India   where   many   big, small   and   medium   size   Software   Industries have   their   Offices   and   Units   in   this Software Industry, and Bengaluru is a hub of Page 40 of 71

C/TAXAP/751/2019 JUDGMENT this   Service   Industry   and   essentially   the Indian Companies have business linkages with large

Companies

spread

worldwide particularly   in   the   Western   Hemisphere   of the Globe. 5.   The   implementation   of   the   Tax   laws   in this   field   in   a   smooth,   clear   and   quick manner is of utmost importance to build an image   of   an   efficient   Tax   Administration both  at Departmental  level and in Judicial Courts so that the economic activity in such borderless  trade  thrives  and enures  to the benefit of the Indian economy at large and Software Industry in particular. While the special provisions have been made for  computation  of 'Arm's  Length  Price'  to arrive   at   a   fair   assessment   of   income taxable in the hands of the Indian Resident Companies and these special provisions also provide   for   an   elaborate   and   in­depth analysis   of   huge   data   of   the   comparable cases of other similarly situated Companies to arrive at a fair 'Arm's Length Price' and for   that,   Special   Cells   and   designated Authorities   have   been   created   under   the Income   Tax   Act,   1961,   but   still   retaining the   normal   provisions   for   assessments   of appeals in the  Indian Income Tax Act  about the remedial Forums or the appeal mechanisms and   the   Income   Tax   Appellate   Tribunal constituted   under  Section   253  of   the   Act continues to be the final fact finding body under   the   Act   even   with   regard   to   the assessments

the

international transactions under the Special Chapter X as aforesaid

and

the

appeal

the Constitutional Courts as provided in Section 260­A  to High Court and  Section 261  to the Hon'ble   Supreme   Court   are   applicable   to these special assessments under Chapter X as well. “ 12.  In   para­11   of   the   judgment,   the   Hon'ble Court   diluted   upon   the   following   three questions; “[I] The analysis of the provisions relating to the   Transfer   Pricing/   determination   of   the 'Arm's Length Price'; Page 41 of 71

C/TAXAP/751/2019 JUDGMENT [II] The Scheme of procedure of assessment and appeals to the Tribunal and High Court/Supreme Court. [III] The scope  of interference  by High Court under Section 260­A of the Act in these type of cases. “ 13.  The Court, thereafter, expressed its prima facie   opinion   as   regards   the   transfer   pricing adjustments. “Prima Facie Opinion: 15.  We   are   of   the   considered   opinion   that this   entire   exercise   of   making   Transfer Pricing   Adjustments   on   the   basis   of   the comparables   is   nothing   but   a   matter   of estimate of a broad and fair guess­work of the   Authorities   based   on   relevant   material brought before the Authorities including the Appellate   Tribunal,   but   nonetheless   the Tribunal  being the final  fact finding  body remains so for this Special Chapter X also and   therefore, unless   this   Court   is satisfied   that   a   substantial   question     of law   is   arising   from   the   order   of   the Tribunal,   the   appeal   under  Section   260­A cannot   be   entertained   at   the   instance   by either the Revenue or the Assessee and the exercise   of   fact   finding   or   'Arm's   Length Price'   determination   or   'Transfer   Pricing Adjustments'   should   be   allowed   to   become final   with   a   quietus   at   the   hands   of   the final fact finding body, i.e. the Tribunal.” 14. The   Court,   thereafter,   undertook   a comparative   analysis   of   Section   260­A   of   the Act, 1961, Section 100 and Section 103 of the CPC and proceeded to observe as under: “16.   We   would   analyze   the   provisions   of Section  260­A  of the Act in a little  more detail but we are of the firm opinion that the entry into the High Court under  Section 260­A  of the Act is locked  with  the  words "Substantial  questions  of law" and the key to   open   that   lock   to   maintain   such   appeal can only be the perversity of the findings of the Tribunal in these type of cases and the   perversity   in   the   findings   not   only Page 42 of 71

C/TAXAP/751/2019 JUDGMENT averred  by the appellant  before  this  Court but,   established   on   the   basis   of   cogent material   which   was   available   before   the Authorities below including the Tribunal and the findings arrived at by the Tribunal can be so held to be perverse  within  the well settled parameters for determining the same as perverse. It is not allowed to either of the   parties,   i.e.   the   Assessee   or   the Revenue  to invoke  the jurisdiction  of this Court under  Section 260­A  of the Act merely because   the   Tribunal   comes   to   reverse   or modify   the   findings   given   by   the   lower Authority,   viz.   Transfer   Pricing   Officer (TPO)   or   Dispute   Resolution   Panel   (DRP) which   comprises   of   three   Commissioners   and the   Revenue   or   the   assessee   may   feel dissatisfied,   because   of   the   reversal   or modification   of   such   findings   by     the Tribunal resulting in leaving out of certain comparables   or   adding   on   of   certain comparables   for   determining   the   'Arm's Length Price' in the hands of the Assessee Company. 17.  Unless  such  perversity  in the findings of the Tribunal is established we are of the opinion that the appeals under Section 260­A of   the   Act   cannot   and   should   not   be entertained at the instance of either of the parties and the present cases before us, we find   that   the   Tribunal   has   given   cogent reasons

and

detailed

findings

upon discussing each case of comparable corporate properly   and   therefore,   we   find   ourselves unable to call such findings of the Tribunal perverse in any manner so as to require our interference under Section 260­A of the Act. 18. We now take up the analysis of  Section 260­ A of the Act which we have already said is in pari materia with Sections 100 and 103 of the Civil Procedure Code. 19. The said provisions are quoted below for ready reference and comparison. Section 260­A of the Income Tax Act, 1961 reads as under: "260A ­ Appeal to High Court: (1) An appeal shall lie to the High Court from every order passed in appeal by the Appellate   Tribunal   [before   the   date   of Page 43 of 71

C/TAXAP/751/2019 JUDGMENT establishment   of   the   National   Tax Tribunal], if the High Court is satisfied that   the   case   involves   a   substantial question of law. (2) [The [Principal Chief Commissioner or] Chief   Commissioner   or   the   [Principal Commissioner   or]   Commissioner   or   an assessee aggrieved by any order passed by the Appellate Tribunal may file an appeal to the High Court and such appeal under this sub­ section shall be­] (a)   filed   within   one   hundred   and   twenty days   from   the   date   on   which   the   order appealed   against   is   [received   by   the assessee   or   the   [Principal   Chief Commissioner   or]   Chief   Commissioner   or [Principal Commissioner or] Commissioner]; (b) [*******] (c) in the form of a memorandum or appeal precisely stating therein the substantial question of law Involved. [(2A) The High Court may admit an appeal after   the   expiry   of   the   period   of   one hundred   and   twenty   days   referred   to   in Clause  (a) of sub­section  (2), if it is satisfied that there was sufficient cause for not filing the same within that period.] (3) Where the High Court is satisfied that a substantial question of law is involved in   any   case,   it   shall   formulate   that question. (4) The appeal shall be heard only on the question

formulated,

and

the respondents shall, at the hearing of the appeal, be allowed to argue that the case does not involve such question: Provided that nothing in this sub­ section shall  be deemed  to take  away  or abridge the   power   of   the   Court   to   hear,   for reasons to be recorded, the appeal on any other   substantial   question   of   law   not formulated by it, if it is satisfied that the case involves such question. (5)   The   High   Court   shall   decide   the question of law so formulated and deliver such   judgment   thereon   containing   the grounds on which such decision is founded Page 44 of 71

C/TAXAP/751/2019 JUDGMENT and may award such cost as it deems fit. (6) The High Court may determine any issue which ­ (a)   has   not   been   determined   by   the Appellate Tribunal; or (b)   has   been   wrongly   determined   by   the Appellate   Tribunal,   by   reason   of   a decision   on   such   question   of   law   as   is referred to in sub­section (1). [(7)   Save   as   otherwise   provided   in   this Act, the provisions of the Code of Civil Procedure, 1908 (5 of 1908), relating to appeals to the High Court shall, as far as may be, apply in the case of appeals under this Section.] Sections 100 and 103 of the Code of Civil Procedure, 1908 read thus: "Section 100 ­ Second Appeal. (1) Save as otherwise expressly provided in the body of this Code or by any other law for the time being in force, an appeal shall   lie   to   the   High   Court   from   every decree   passed   in   appeal   by   any   Court subordinate to the High Court, if the High Court is satisfied that the case involves a substantial question of law. (2) An appeal may lie under this section from an appellate decree passed ex­ parte. (3) In an appeal under this section, the memorandum of appeal shall precisely state the substantial  question of law involved in the appeal. (4) Where the High Court is satisfied that a substantial question of law is involved in   any   case,   it   shall   formulate   the question. (5)   The   appeal   shall   be   heard   on   the question so formulated and the respondent shall,  at the hearing  of the appeal,  be allowed  to argue  that the case does  not involve such question: Provided that nothing in this sub­ section shall  be deemed  to take  away  or abridge the   power   of   the   Court   to   hear,   for Page 45 of 71

C/TAXAP/751/2019 JUDGMENT reasons to be recorded, the appeal on any other   substantial   question   of   law,   not formulated by it, if it is satisfied that the case involves such question." Section   103  ­   Power   of   High   Court   to determine issues of fact ­ In any second appeal, the High Court may, if   the   evidence   on   the   record   is sufficient, determine any issue necessary for the disposal of the appeal, ­ (a) which has not been determined by the lower Appellate Court or both by the Court of first instance and the lower Appellate Court, or (b) which has been wrongly determined by such   Court   or   Courts   by   reason   of   a decision   on   such   question   of   law   as   is referred to in section 100." What is a Substantial Question of Law? 20. From a bare comparison of the provisions quoted   above   and   as   discussed   in   various judgments   of   the   Constitutional   Courts, which we will refer in brief herein below, it is clear that the Scheme of both Section 260­A  in  Income   Tax   Act,   1961   and  Section 100  r/w.  Section  103 of the  Code  of Civil Procedure   are   in   pari   materia   and   in   same terms. 21. The existence of a substantial question of law is sine qua non for maintaining  an appeal   before   the   High   Court.   While   the appeal to High Court under  Section 260­A  of the Act may be a First appeal in the sense from the order of final fact finding by the Tribunal under the  Income Tax Act, whereas the   Second   Appeal   on   substantial   question of law before High Court under  Section 100 would lie against the Judgment and Decree of the   first   Appellate   Court   disposing   of   an appeal against the Judgment and Decree of a Trial Court, but nonetheless it is the third round of consideration at the level of the High   Court,   where   the   facts   and   law   both have   been   screened,   discussed   and   analyzed by the Authorities or the Courts below and therefore the tenor and color of the words "substantial question of law" in both these Page 46 of 71

C/TAXAP/751/2019 JUDGMENT enactments remains the same. 22.   The   High   Court   has   power   to   not   only formulate   the   substantial   questions   of   law and rather it has the duty to do so and can also frame additional  substantial  questions of   law   at   a   later   stage,   if   such   a substantial  question  of law  is involved  in the appeal before it under these provisions and the appeal should be heard and decided only   on   such   substantial   questions   of   law after allowing the parties to address their arguments   on   the   same.   The   extended   power given to the High Courts to decide even an issue under Sub­ section (6) of Section 260­ A  of the Income Tax Act, which is in pari materia   with   Section   103   of   the   Civil Procedure Code and which says that the High Courts may determine any issue which (a)has not been determined by the Tribunal or (b) has been wrongly determined by the Tribunal, can be so determined by the High Court, only if   the   High   Court   comes   to   the   conclusion that   'by reason   of   the   decision   on substantial question of law rendered by it', such a determination of issue of fact also would   be   necessary   and   incidental   to   the answer   given   by   it   to   the   substantial question   of   law   arising   and   formulated   by it. 23.   The   argument   raised   by   the   learned counsel   for   the   Respondent   Assessee   before us by making a disjuncted reading of Clause (a)  and  Clause  (b) of Sub­ Section  (6) of Section 260­A of the Income Tax Act, 1961 to submit   that   the   High   Court   can   touch   upon the issues of facts also in an appeal under this   provision   bereft   of   substantial question of law, is a misconceived argument. 24. In our opinion, both the Clause (a) and Clause   (b)   of   Sub­Section   (6)   of  Section 260­A  of   the   Act   are   circumscribed   by   the words   'by   reason   of   the   decision   on   such question  of law  as is referred  to in Sub­ section   (1)'.   Therefore,   even   if   an   issue which   has   not   been   determined     by   the Tribunal,   which   was   required   to   be   so determined   in   terms   of   the   answer   to   the Page 47 of 71

C/TAXAP/751/2019 JUDGMENT substantial   question   of   law   given   by   the High Court, such an issue not determined by the   Tribunal   could   also   be   decided   by   the High  Court with reference to Clause (a) and more so, if such an issue has been wrongly decided according to the answer given by the High Court to such a substantial question of law,   then   also   the   High   Court   can   set   it right to fall in line with the answer given by   the   High   Court   to   such   a   substantial question   of   law   raised   before   it   and determined   by   it   in   terms   of   Clause   (b) thereof. 25. Sub­section (6) of  Section 260­A  of the Act,  therefore,  does  not give any extended power,   beyond   the   parameters   of   the substantial   question   of   law   to   the   High Court to disturb the findings of fact given by the Tribunal below. 26. Sub­section (7) inserted in Section 260­ A of the Act by the Finance Act of 1999 with effect   from   01/06/1999   after   a   period   of about   8   months   of   substituting   the   new provisions   of  Section   260­A  to   the   Act   as they now stand by Finance Act of 1998, with effect  from  01/10/1998  was only  to clarify and support that the parameters of Sections 100  & 103 of the Civil Procedure  Code and other   provisions   of   Civil   Procedure   Code relating   to   appeals   of   High   Court   shall apply to the appeals under  Section 260­A  of the Income Tax Act also. 27.   The   insertion   of   Sub­section   (7)   in Section 260­A  of the Act does not give any new or extended powers to the High Court and the pre­existing provisions from Subsection (1) to Sub­section (6) in  Section 260­A  of the   Act   already   had   all   the   trappings   of Sections 100 and 103 of the Civil Procedure Code. Case Laws on Substantial Question of Law: 28.   In   the   leading   and   the   first   and foremost   case   on   the   interpretation   of Section 100 of the Code of Civil Procedure Code, the Constitution Bench of the Hon'ble Supreme Court in the case of Sir Chunilal V. Mehta and Sons Limited Vs. Century Spinning and   Manufacturing   Co.   Limited   AIR   1962   SC Page 48 of 71

C/TAXAP/751/2019 JUDGMENT 1314, held in para.6 as under: "6.   We   are   in   general   agreement   with the view taken by the Madras High Court and we think that while the view taken by   the   Bombay   High   Court   is   rather narrow the one taken by the former High Court of Nagpur is too wide. The proper test for determining whether a question of   law   raised   in   the   case   is substantial   would,   in   our   opinion,   be whether   it   is   of   general   public importance   or   whether   if   directly   and substantially affects the rights of the parties and if so whether it is either an open question in the sense that it is not finally settled by this Court or by the Privy Council, or by the Federal Court or is not free from difficulty or calls   for   discussion   of   alternative views.   If   the   question   is   settled   by the   highest   Court   or   the   general principles to be applied in determining the question are well settled and there is   a   mere   question   of   applying   those principles  or that the plea  raised  is palpably absurd the  question would not be a substantial question of law." 29.   In   the   case   of   Santosh   Hazari   Vs. Purushottam   Tiwari   (Deceased)   by   LRs., [2001]   3   SCC   179,   another   Three   Judges' Bench of the Honble Supreme Court explained the meaning of the substantial questions of law   in   paras.11   and   12   in   the   following manner. "11. Even under the old Section 100 of the   Code   (pre­1976   amendment),   a   pure finding   of   fact   was   not   open   to challenge   before   the   High   Court   in second   appeal. However   the   Law Commission   noticed   a   plethora   of conflicting judgments. It noted that in dealing with second appeals, the courts were devising and successfully adopting several   concepts   such   as,   a   mixed question   of   fact   and   law,   a   legal inference   to   be   drawn   from   facts proved,   and   even   the   point   that   the Page 49 of 71

C/TAXAP/751/2019 JUDGMENT case   has   not   been   properly   approached by the courts below. This was creating confusion in the minds of the public as to   the   legitimate   scope   of   second appeal   under Section   100 and   had burdened   the   High   courts   with   an unnecessarily   large   number   of   second appeals.  Section   100  was,   therefore, suggested   to   be   amended   so   as   to provide that the right of second appeal should   be   confined   to   cases   where   a question   of   law   is   involved   and   such question  of law  is a substantial  one. (See Statement of Objects and Reasons.) The   Select   Committee   to   which   the Amendment   Bill   was   referred   felt   that the  scope  of second  appeals  should  be restricted so that litigations may not drag on for a long period. Reasons, of course,  are  not  required  to be stated for   formulating   any   question   of   law under sub­section (4) of Section 100 of the Code; though such reasons are to be recorded   under   proviso   to   sub­section (5)  while  exercising  power to hear on any other substantial question of law, other   than   the   one   formulated   under sub­section (4). 12. The phrase "substantial question of law",   as   occurring   in   the   amended substantial, as qualifying "question of law",   means   ­   of   having   substance, essential,   real,   of   sound   worth, important or considerable. It is to be understood

something

in contradistinction  with ­ technical,  of no   substance   or   consequence,   or academic   merely.   However,   it   is   clear that the legislature has chosen not to qualify   the   scope   of   "substantial question of law" by suffixing the words "of   general   importance"   as   has   been done  in many  other provisions  such as Section   109   of   the   Code   or  Article 133(1)(a) of   the   Constitution.   The substantial question of law on which a second  appeal  shall  be heard  need not necessarily   be   a   substantial   question of law of general importance.  In Guran Page 50 of 71

C/TAXAP/751/2019 JUDGMENT Ditta   v.   T.   Ram   Ditta",   the   phrase "substantial question of law" as it was employed in the last clause of the then existing Section 110 CPC (since omitted by the Amendment Act, 1973) came up for consideration  and their Lordships held that   it   did   not   mean   a   substantial question   of   general   importance   but   a substantial   question   of   law   which   was involved   in   the   case   as   between   the parties.   In   Sir   Chunilal   V.   Mehta   & Sons Ltd. v. Century Spg. And Mfg. Co. Ltd.   the   Constitution   Bench   expressed agreement with the following view taken by   a   Full   Bench   of   the   Madras   High Court in Rimmalapudi Subba Rao v. Noony Veeraju." 30. In the case of Hero Vinoth (Minor) Vs. Seshammal  [2006]5  SCC 545, the Two Judges' Bench of the Hon'ble Supreme Court following the   earlier   precedents,   summarises   the principles in the following manner. The relevant portion of the said judgment at para.24 is quoted below for ready reference: "24. The principles relating to Section 100 CPC relevant for this case may be summarized thus: (i)   An   inference   of   fact   from   the recitals or contents of a document is a question of fact.

But the legal effect of the terms of a document   is   a   question   of   law. Construction   of   a   document   involving the   application   of   any   principle   of law,   is   also   a   question   of   law. Therefore,

when

there

is misconstruction of a document or wrong application  of a principles  of law in construing a document, it gives rise to a question of law. (ii) The High Court should be satisfied that   the   case   involves   a   substantial question   of   law,   and   not   a   mere question   of   law.   A   question   of   law Page 51 of 71

C/TAXAP/751/2019 JUDGMENT having   a   material   bearing   on   the decision   of   the   case   (that   is,   a question,   answer   to   which   affects   the rights of parties to the suit) will be a substantial question of law, if it is not covered by any specific provisions of   law   or   settled   legal   principle emerging   from   binding   precedents,   and involves   a   debatable   legal   issue.   A substantial   question   of   law   will   also arise   in   a   contrary   situation;   where the legal position is clear, either on account of express provisions of law or binding precedents, but the Court below has decided the matter, either ignoring or   acting   contrary   to   such   legal principle. In the second type of cases, the substantial question of law arises not because the law is still debatable, but because the decision rendered on a material question, violates the settled position of law. (iii)   The   general   rule   is   that   High Court   will   not   interfere   with   the concurrent   findings   of   the   courts below. But it is not an absolute rule. Some of the well­recognised  exceptions are   where   (i)   the   courts   below   have ignored   material   evidence   or   acted   on no evidence; (ii) the courts have drawn wrong   inferences   from   proved   facts   by applying the law erroneously; or (iii) the courts have wrongly cast the burden of   proof.   When   we   refer   to   "decision based   on   no   evidence",   it   not   only refers to cases where there is a total dearth of evidence, but also refers to any case, where  the evidence,  taken  as a whole, is not reasonably capable of supporting the finding." 31.  In the case  of Vijay Kumar  Talwar  Vs. Commissioner of Income Tax, Delhi, [2011] 1 SCC 673, comparing the provisions of Section 260­A  of   the   Act   with   Section   100   of   the Civil   Procedure   Code,   the   Hon'ble   Supreme Court   held   that   in   the   absence   of demonstrated   perversity   in   the   findings   of Page 52 of 71

C/TAXAP/751/2019 JUDGMENT the Tribunal, the Court cannot interfere and a   finding   of   fact   may   give   rise   to   a substantial question of law, only if it is perverse. Paragraphs 23 and 25 of the said judgment is quoted below for ready reference:­ "23. A finding of fact may give rise to a   substantial   question   of   law,   inter alia,   in   the   event   the   findings   are based   on   no   evidence   and/or   while arriving at the said finding, relevant admissible evidence has not been taken into   consideration   or   inadmissible evidence   has   been taken   into consideration  or legal principles have not   been   applied   in   appreciating   the evidence, or when the evidence has been misread.   (See   Madan   Lal   v.   Gopi Narendra   Gopal   Vidyarthi   V.   Rajat Vidyarthi,  Commr.   Of   Customs   v.   Vijay Dasharath   Patel,  Metroark   Ltd.   v.   CCE and

W.B.

Electricity

Regulatory Commission v. CESC Ltd.). 25.   We   are   of   the   opinion   that   on   a conspectus   of   the   factual   scenario, noted   above,   the   conclusion   of   the Tribunal   to   the   effect   that   the assessee has failed to prove the source of the cash credits cannot be said to be   perverse,   giving   rise   to   a substantial   question   of   law.   The Tribunal   being   a   final   fact­finding authority,

the

absence

of demonstrated perversity in its finding, interference therewith by this Court is not warranted." 15. The Court, thereafter, proceeded to explain the scheme of assessment of the Transfer Pricing Cases. “Scheme   of   Assessment   of   the   Transfer Pricing Cases: 32. Let us briefly now discuss the Scheme of assessment   under   Chapter   X   relating   to Transfer   Pricing   cases   of   International Taxation   under   these   provisions   in   income arising   from   international   transactions which shall be computed having regard to the Page 53 of 71

C/TAXAP/751/2019 JUDGMENT 'Arm's Length Price' (Sec.92). 33. Section   92­A defines   an   'Associate Enterprise'   viz.,   the   Company   which participates   directly   or   indirectly,   or through  one  or more  intermediaries,  in its Management   or   control   or   Capital   of   the other Enterprise by holding more than 26% of the share holding in such other Enterprises and satisfy the other criterias as stated in Section 92­A of the Act. 34. The word 'International Transaction' is defined in Section 92­B of the Act. 35. The most important provision concerning us in this batch of cases is Section 92­C of the  Act  which  provides  for 'Computation  of Arm's  Length  Price'  and  the  said  provision stipulates that the 'Arm's Length Price' in relation   to   the   international   transactions shall   be   determined   by   following   any   of these methods enumerated in  Section 92­C  of the Act which is considered to be the 'Most Appropriate Method' by the Authorities under the Act. The methods provided are: Clause

(a):

Comparable

Uncontrolled Principles Method (CUP); Clause (b): Resale Price Method (RP) Clause (c): Cost Plus Method (CP) Clause (d): Profit Split Method (PS) Clause (e): Transactional Net Margin Method (TNMM); and Clause   (f):   such   other   Method   as   may   be prescribed by the Board. 36.  It appears  from  the  true  facts of the various cases before us and the arguments of the   learned   counsels   that   the   TNNM   Method appears   to   be   the   most   popular   and   widely adopted   Method   for   determining   the   'Arm's length price' in which the Operating Profit Margin of comparable Companies are considered by the Authorities and applied to the cases of the Assessees to determined the 'Arm's Length Price' and make Transfer Pricing Adjustments. Rules 10­A, 10­AB, 10­B, 10­C & 10­CA of the Page 54 of 71

C/TAXAP/751/2019 JUDGMENT Income Tax Rules, 1962 prescribe the manner for  working  out  'Arm’s  Length  Price'  under aforesaid prescribed Methods. 37.  Section 92­CA  of the Act envisages that the   Assessing   Authority,   if   he   considers necessary or expedient so to do, he can with the   previous   approval   of   the   Principal Commissioner,   refer   the   computation   of 'Arm's   Length   Price'   to   Transfer   Pricing Officer

(TPO),

another

Departmental Authority   only,   who   is   supposed   to   have special knowledge and training for computing the

'Arm's

Length

Price'

the international   transactions.   The   Report   of the  Transfer  Pricing  Officer  is binding  on the Assessing Authority as per Section 92­CA (4)   of   the   Act,   but   where   the   Assessee raises   an   objection   against   the   Draft Assessment Order of the Assessing Authority based on such Report of the Transfer Pricing Officer, the Assessee Company within 30 days can   either   accept   the   said   Draft   Order   or file   its   objections   before   the   Dispute Resolution   Panel   (DRP)   and   the   Assessing Officer  as per  Section  144­ C  of the Act. The said Dispute Resolution Panel comprises of   a   Collegium   of   three   Principal Commissioners or Commissioners of Income Tax constituted   by   the   Board   as   defined   in Section 144­C (15) of the Act and it has to comply   with   the   principles   of   natural justice by giving an opportunity of hearing to   the   Assessees.   The   order   passed   by   the Assessing   Authority   in   pursuance   of   the directions   of   the   Dispute   Resolution   Panel (DRP)  is directly  appealable  to the  Income Tax   Tribunal   under  Section   253  (1)   (d)   of the Act. Section 254 of the Act empowers the Appellate   Tribunal   to   pass   such   orders   on the appeals 'as it thinks fit' after giving an   opportunity   of   hearing   to   both   the parties. 38. From the aforesaid Scheme of assessment with   regard   to   international   transactions, it   is   clear   that   the   process   of determination of 'Arm's Length Price' has to be   undertaken   by   the   Expert   Wing   of   the Income   Tax   Department   which   is   manned   by Page 55 of 71

C/TAXAP/751/2019 JUDGMENT Transfer Pricing Officer (TPO) and at the higher level by a Collegium of   three   Commissioners   in   the   form   of Dispute Resolution Panel (DRP) whose orders on questions of facts are appealable before the   highest   fact   finding   body,   viz.,   the Appellate Tribunal. 39.  The  process  of determination  of 'Arm's Length Price' as observed above, necessarily takes  into account  the comparable  cases  of other similarly situated or nearly similarly situated   Corporate   Entities   whose   data   are in public domain or on the Data Bases like Prowess and Capital Line Data Base etc. “ 16. The Court, thereafter, proceeded to discuss whether any substantial question of law could be said to be involved in the matter. “No   Substantial   Question   of   Law   Arises   in these Cases: 40. The dispute essentially before us is the pairing   and   matching   such   comparables   with the Transfer Pricing Analysis of the profit margins given by the Assessee himself during the  course  of determination  of such  'Arm's Length Price'. 41. The shades of arguments raised by both the   sides   before   us   in   these   appeals   and most of which have been filed by the Revenue are that either the wrong Filters have been applied   or   Filters   have   been   wrongly applied,   particularly   qua   Turnover   Filter giving a far too wide or narrower range of comparables   or   even   though   comparable Entities

were

functionally

different entities   from   the   Entities   in   the   list   of Departmental   comparables,   as   against   the comparables   sought   to   be   provided   by   the assessees   but   the   Revenue   Department generally insists on their inclusion to get high profit ratio leading to higher Transfer Pricing   adjustments,   whereas   the   assessee would   like   to   keep   the   comparables   in   a narrower   range   to   justify   its   Transfer Pricing Analysis and profits declared. Page 56 of 71

C/TAXAP/751/2019 JUDGMENT 42. In sum and substance, we find that such an   exercise   having   been   undertaken   by   the Authorities below may have resulted not only in high pitched Transfer Pricing Adjustments in the declared profits of the Assessee, but a   flood   of   such   appeals   go   before   the Tribunal itself where finally the inclusion or   exclusion   of   comparables   has   been determined  by the Tribunal  on due analysis giving its own reasons. 43. The contention raised before us that in view   of   some   different   views   taken   by   the Tribunal   by   different   Benches   at   different places,   the   present   appeals   under  Section 260­A  of the Act deserve to be entertained and admitted by this Court for laying down certain Guidelines about the Filters or Most Appropriate   Method   to   be   adopted   for determination   of   the   'Arm's   length   price', does   not,   in   our   considered   opinion   falls within   the   parameters   of   the   substantial question of law. None of the sides was able to point out any perversity in the Orders of the Appellate Tribunal in this regard.

finding

exercise.

Neither

the sufficient Data nor factual informations nor any   technical   expertise   is   available   with this   Court   to   undertake   any   such   fact finding  exercise  in the  said  appeals  under Section 260­A of the Act. This Court is only concerned with the question of law and that too   a   substantial   one,   which   has   a   well defined connotations as explained above and findings of facts arrived at by the Tribunal in these type of assessments like any other type   of   assessments   in   other   regular assessment   provisions   of   the   Act,   viz. Sections   143,  147  etc.   are   final   and   are binding   on   this   Court.   While   dealing   with these   appeals   under  Section   260­A  of   the Act,   we   cannot   disturb   those   findings   of fact under  Section 260­A  of the Act, unless such   findings   are   exfacie   perverse   and unsustainable

and

exhibit

total Page 57 of 71

C/TAXAP/751/2019 JUDGMENT nonapplication   of   mind   by   the   Tribunal   to the relevant facts of the case and evidence before the Tribunal. 45.  Otherwise   if   the   High   Court   takes   the path  of making  such  a comparative  analysis and   pronounces   upon   the   questions   as   to which Filter is good and which comparable is really comparable case or not, it will drag the   High   Courts   into   a   whirlpool   of   such Data analysis defeating the very purpose and purport of the provisions of  Section 260­A of the Act. Therefore what we observed above appears   to   us   to   be   the   sustainable   view that the key to the lock for entering into the jurisdiction of High Court under Section 260­A  of   the   Act   is   the   existence   of   a substantial question of law involved in the matter.   The   key   of   ex­facie   perversity   of the   findings   of   the   Tribunal   duly established   with   the   relevant   evidence   and facts. Unless it is so, no other key or for that   matter,   even   the   in­consistent   view taken   by   the   Tribunal   in   different   cases depending upon the relevant facts available before it cannot lead to the formation of a substantial   question   of   law   in   any particular case to determine the aspects of determination of 'Arm's Length Price' as is sought to be raised before us. “ 17. The Court, thereafter, expressed its concern for giving primacy to the Tribunal in the area of fact finding. “46. Undoubtedly, the Income Tax Tribunal is the   final   and   highest   fact   finding   body under   the   Act.   It   is   manned   by   Expert Members (Judicial Members are selected from District Judges or Advocates and Accountant Members   selected   from   practicing   Chartered Accountants or persons of CIT level in the Department).   Therefore   this   quasi­judicial forum is expected and as some of the nicely articulated   Judgments   and   Orders   from   the Tribunal   would   indicate,   the   Orders   passed by the Tribunal should normally put an end and   quietus   to   the   findings   of   facts   and factual   aspects   of   assessment.   The   lower Revenue   Authorities   cannot   be   allowed   to Page 58 of 71

C/TAXAP/751/2019 JUDGMENT make it their prestige issue, if their stand is   not   upheld   by   the   Tribunal   and   agitate against   their   Orders   before   the   higher Courts by resort to Section 260­A or Section 261  of   the   Act   merely   because   they   are dissatisfied  with the findings  of facts  by the Tribunal. 47. In the case before us now, the pick of comparables, short­listing of them, applying of   filters,   etc.,   are   all   fact   finding exercises   and   therefore   the   final   Orders passed   by   the   Tribunal   are   binding   on   the lower Authorities of the Department as well as High Court. 48.   The   Tribunal   of   course   is   expected   to act   fairly,   reasonably   and   rationally   and should   scrupulously   avoid   perversity   in their   Orders.   It   should   reflect   due application of mind when they assign reasons for returning the particular findings. 49. For   instance,   while   dealing   with comparables   or   Filters,   if   un­equals   like Software Giant Infosys or Wipro are compared to   a   newly   established   small   size   Company engaged   in   Software   service,   it   would obviously   be   wrong   and   perverse.   The   very word   "comparable"   means   that   the   Group   of Entities  should  be in a homogeneous  Group. They   should   not   be   wildly   dissimilar   or unlike or poles apart. Such wild comparisons may  result  in the best judgment  assessment going haywire and directionless wild, which may land up the findings of the Tribunal in the

realm

perversity

attracting interference under Section 260­A of the Act. “ 18. In the last, the Court concluded as under: “The procedure of assessment under Chapter X relating   to   international   transactions   as indicated above is already a lengthy one and involves   multiple   Authorities   of   the Department. A huge, cumbersome and tenacious exercise of Transfer Pricing Analysis has to be undertaken by the Corporate Entities who have  to comply  with  the  various  provisions of the Act and Rules with a huge Data Bank and   in   the   first   instance   they   have   to satisfy that the profits or the income from transactions  declared  by them is at 'Arm's length' which analysis is invariably put to Page 59 of 71

C/TAXAP/751/2019 JUDGMENT test and inquiry by the Authorities of the Department   and   through   the   process   of Transfer   Pricing   Officer   (TPO)   and   Dispute Resolution  Panel  (DRP) and the Tribunal  at various   stages,   the   assessee   has   a cumbersome task of compliance and it has to satisfy  the  Authorities  that  what has been declared by them is true and fair disclosure and   much   of   the   Transfer   Pricing Adjustments   is   not   required   but   the   Tax Authorities have their own view on the other side and the effort on the part of the Tax Revenue   Authorities   is   always   to   extract more   and   more   revenue.   This   process   of making   huge   Transfer   Pricing   Adjustments results   in   multi­   layer   litigation   at multiple Fora. After the lengthy process of the   same,   the   matter   reaches   the   Tribunal which also takes its own time to decide such appeals.   In   the   course   of   this   dispute resolution,   much   has   already   been   lost   in the   form   of   time,   man­hours   and   money, besides   giving   an   adverse   picture   of   the sluggish Dispute Resolution process through these   channels.   If   appeals   under  Section 260­A of   the   Act   were   to   be   lightly entertained   by   High   Court   against   the findings of the Tribunal, without putting it to a strict scrutiny of the existence of the substantial  questions  of law, it is likely to open the flood­gates for this litigation to   spill   over   on   the   dockets   of   the   High Courts   and   up   to   the   Supreme   Court,   where such further delay may further cause serious damage to the demand of expeditious judicial dispensation in such cases. Conclusion: 55.   A   substantial   quantum   of   international trade and transactions depends upon the fair and   quick   judicial   dispensation   in   such cases.   Had   it   been   a   case   of   substantial question of interpretation of provisions of Double   Taxation   Avoidance   Treaties   (DTAA), interpretation   of   provisions   of   the  Income Tax Act or Overriding Effect of the Treaties over   the   Domestic   Legislations   or   the questions like Treaty Shopping, Base Erosion and   Profit   Shifting   (BEPS),   Transfer   of Page 60 of 71

C/TAXAP/751/2019 JUDGMENT Shares  in Tax Havens  (like in the case of Vodafone etc.), if based on relevant facts, such  substantial  questions  of law could  be raised  before the High Court under  Section 260­A  of   the   Act,   the   Courts   could   have embarked  upon such exercise  of framing  and answering such substantial question of law. On   the   other   hand,   the   appeals   of   the present tenor as to whether the comparables have been rightly picked up or not, Filters for   arriving   at   the   correct   list   of comparables   have   been   rightly   applied   or not, do not in our considered opinion, give rise to any substantial question of law. 56.   We   are   therefore   of   the   considered opinion   that   the   present   appeals   filed   by the   Revenue   do   not   give   rise   to   any substantial   question   of   law   and   the suggested   substantial   questions   of   law   do not meet the requirements of  Section 260­A of the Act and thus the appeals filed by the Revenue are found to be devoid of merit and the same are liable to be dismissed. 57. We   make   it   clear   that   the   same yardsticks   and   parameters   will   have   to   be applied, even if such appeals are filed by the  Assessees,  because,  there  may be cases where   the   Tribunal   giving   its   own   reasons and   findings   has   found   certain   comparables to   be   good   comparables   to   arrive   at   an 'Arm's   Length   Price'   in   the   case   of   the assessees  with which  the assessees  may not be   satisfied   and   have   filed   such   appeals before this Court. Therefore we clarify that mere   dissatisfaction   with   the   findings   of facts arrived at by the learned Tribunal is not   at   all   a   sufficient   reason   to   invoke Section 260­A  of the Act before this Court. “ 19. The Delhi High Court, in the case of CIT vs. EKL  Appliances Ltd., reported in (2012) 345 ITR 241 (Delhi), in context with Section 92CA of the Act, had observed as under: “It seems to us that the decision taken by the Tribunal is the right decision. The TPO applied the CUP method while   examining the payment   of   brand   fee/   royalty.   The   CUP Page 61 of 71

C/TAXAP/751/2019 JUDGMENT method which in its expanded form is known as "comparable uncontrolled price" method is provided for in Rule 10B(1)(a) of the Income Tax  Rules,  1962.  It is one of the methods recognised   for   determining   the   ALP   in relation   to   an   international   transaction. Rule   10B(1)   says   that   for   the   purposes   of Section 92C(2), the ALP shall be  determined by   any   one   of   the   five   methods,   which   is found to be the most appropriate method, and goes   on   to   lay   down   the   manner   of determination of the ALP under each method. The five methods recognized by the rule are (i)   comparable   uncontrolled   price   method (CUP), (ii) re­sale price method, (iii) cost plus   method,   (iv)   profit   split   method   and (v)   transactional   net   marginal   method (TNMM).   The   manner   by   which   the   ALP   in relation to an international transaction is determined   under   CUP   is     prescribed   in clause (a) of the sub­rule (1) of Rule 10B. The   following   three   steps   have   been prescribed: ­ "(a)   comparable   uncontrolled   price   method, by which, (i) the price charged or paid for property transferred   or   services   provided   in   a comparable   uncontrolled   transaction,   or   a number of such transactions, is identified; (ii) such price is adjusted to account for differences,

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; (iii)   the   adjusted   price   arrived   at   under sub­   clause   (ii)   is   taken   to   be   an   arm's length   price   in   respect   of   the   property transferred   or   services   provided   in   the international transaction;" The   Organization   for   Economic   Co­operation and   Development   (“OECD   ,   for   short)   has  ‟ laid down "transfer pricing guidelines" for Multi­National

Enterprises

and

Tax Administrations.   These   guidelines   give   an introduction   to   the   arm’s   length   price Page 62 of 71

C/TAXAP/751/2019 JUDGMENT principle and explains article 9 of the OECD Model Tax Convention. This article provides that   when   conditions   are   made   or   imposed between two associated enterprises in their commercial   or   financial   relations   which differ   from   those   which   would   be   made between   independent   enterprises   then   any profit   which   would,   but   for   those conditions,   have   accrued   to   one   of   the enterprises,   but,   by   reason   of   those conditions,   if   not   so   accrued,   may   be included  in the  profits  of that  enterprise and taxed accordingly. By seeking to adjust the profits in the above manner, the arm’s length   principle   of   pricing   follows   the approach of treating the members of a multi­ national   enterprise   group   as   operating   as separate entities rather than as inseparable parts   of   a   single   unified   business.   After referring   to article   9 of   the   model convention   and   stating   the   arm’s   length principle,   the   guidelines   provide   for "recognition   of   the   actual   transactions undertaken"   in   paragraphs   1.36   to   1.41. Paragraphs   1.36   to   1.38   are   important   and are   relevant   to   our   purpose.   These paragraphs are reproduced below: ­ "1.36

tax

administration's examination of a controlled transaction ordinarily   should   be   based   on   the transaction actually  undertaken by the associated   enterprises   as   it   has   been structured   by   them,   using   the   methods applied   by   the   taxpayer   insofar   as these   are   consistent   with   the   methods described   in   Chapters   II   and   III.   In other   than   exceptional   cases,   the   tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate   business   transactions   would be   a   wholly   arbitrary   exercise   the inequity   of   which   could   be   compounded by   double   taxation   created   where   the other tax administration does not share the   same   views   as   to   how   the transaction should be structured. 1.37 However, there are two particular circumstances   in   which   it   may, exceptionally,  be both appropriate and Page 63 of 71

C/TAXAP/751/2019 JUDGMENT legitimate for a tax administration to consider   disregarding   the   structure adopted by a taxpayer in entering into a   controlled   transaction.   The   first circumstance arises  where  the economic substance of a transaction differs from its   form.   In   such   a   case   the   tax administration may   disregard   the parties'   characterization   of   the transaction   and   re­characterise   it   in accordance   with   its   substance.   An example   of   this   circumstance   would   be an   investment   in   an   associated enterprise   in   the   form   of   interest­ bearing   debt   when,   at   arm's   length, having

regard

the

economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In this case it   might   be   appropriate   for   a   tax administration   to   characterize   the investment   in   accordance   with   its economic substance with the result that the   loan   may   be   treated   as   a subscription   of   capital.   The   second circumstance   arises   where,   while   the form   and   substance   of   the   transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving  in a commercially rational   manner   and   the   actual structure   practically   impedes   the   tax administration   from   determining   an appropriate transfer  price. An example of   this   circumstance   would   be   a   sale under a long­term contract, for a lump sum   payment,   of   unlimited   entitlement to   the   intellectual   property   rights arising as a result of future research for   the   term   of   the   contract   (as previously   indicated   in   paragraph 1.10).   While   in   this   case   it   may   be proper to respect the transaction as a transfer   of   commercial   property,   it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to Page 64 of 71

C/TAXAP/751/2019 JUDGMENT those   that   might   reasonably   have   been expected   had   the   transfer   of   property been   the   subject   of   a   transaction involving

independent

enterprises. Thus,   in   the   case   described   above   it might   be   appropriate   for   the   tax administration, for example, to adjust the   conditions   of   the   agreement   in   a commercially   rational   manner   as   a continuing research agreement. 1.38   In   both   sets   of   circumstances described   above,   the   character   of   the transaction   may   derive   from   the relationship between the parties rather than be determined by normal commercial conditions as may have been structured by   the   taxpayer   to   avoid   or   minimize tax. In such cases, the totality of its terms   would   be   the   result   of   a condition that would not have been made if   the   parties   had   been   engaged   in arm's length dealings.  Article 9  would thus allow an adjustment of conditions to   reflect   those   which   the   parties would have attained had the transaction been structured in accordance with the economic   and   commercial   reality   of parties dealing at arm's length." The significance of the aforesaid guidelines lies   in   the   fact   that   they   recognise   that barring

exceptional

cases,

the

tax administration   should   not   disregard   the actual   transaction   or   substitute   other transactions for them and the examination of a   controlled   transaction   should   ordinarily be based on the transaction as it has been actually   undertaken   and   structured   by   the associated   enterprises.   It   is   of   further significance that the guidelines discourage re­structuring of   legitimate   business transactions.

The

reason

for characterisation of such restructuring as an arbitrary   exercise,   as   given   in   the guidelines, is that it has the potential to create   double   taxation   if   the   other   tax administration does not share the same view as   to   how   the   transaction   should   be structured. Page 65 of 71

C/TAXAP/751/2019 JUDGMENT Two   exceptions   have   been   allowed   to   the aforesaid  principle  and  they  are (i) where the   economic   substance   of   a   transaction differs   from   its   form   and   (ii)   where   the form   and   substance   of   the   transaction   are the  same  but arrangements  made in relation to   the   transaction,   viewed   in   their totality, differ from those which would have been   adopted   by   independent   enterprises behaving in a  commercially rational manner. There is no reason why the OECD guidelines should not be taken as a valid input in the present   case   in   judging   the   action   of   the TPO. In fact, the CIT (Appeals) has referred to   and   applied   them   and   his   decision   has been   affirmed   by   the   Tribunal.   These guidelines,  in a different  form,  have been recognized  in the tax jurisprudence  of our country   earlier.   It   has   been   held   by   our courts   that   it   is   not   for   the   revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure  the  assessee  can incur.  We may refer   to   a   few   of   these   authorities   to elucidate   the   point.  In   Eastern   Investment Ltd. v. CIT, (1951) 20 ITR 1, it was held by the   Supreme   Court   that   "there   are   usually many   ways   in   which   a   given   thing   can   be brought about in business circles but it is not  for  the  Court  to decide  which  of them should have been employed when the Court is deciding  a question  under  Section  12(2)  of the Income Tax Act". It was further held in this case that "it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned". In CIT v. Walchand & Co. etc., (1967) 65 ITR 381, it   was   held   by   the   Supreme   Court   that   in applying   the   test   of   commercial   expediency for determining whether the expenditure was wholly   and   exclusively   laid   out   for   the purpose   of   business,   reasonableness   of   the expenditure has to be judged from the point of view  of the businessman  and not of the Revenue.   It   was   further   observed   that   the rule that expenditure can only be justified if   there   is   corresponding   increase   in   the Page 66 of 71

C/TAXAP/751/2019 JUDGMENT profits   was   erroneous.   It   has   been classically   observed   by   Lord   Thankerton   in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that "expenditure in the course of the trade which is unremunerative is   none the less   a   proper   deduction   if   wholly   and exclusively made for the purposes of trade. It   does   not   require   the   presence   of   a receipt   on   the   credit   side   to   justify   the deduction   of   an   expense".   The   question whether an expenditure can be allowed as a deduction   only   if   it   has   resulted   in   any income or profits came to be considered by the Supreme Court again in  CIT v. Rajendra Prasad Moody, (1978) 115 ITR 519, and it was observed as under: ­ "We fail to appreciate how expenditure which is otherwise a proper expenditure can   cease   to   be   such     merely   because there is no receipt of income. Whatever is   a   proper   outgoing   by   way   of expenditure

must

debited irrespective   of   whether   there   is receipt of income or not. That is the plain  requirement of proper  accounting and   the   interpretation   of Section 57(iii) cannot   be   different.   The deduction of the expenditure cannot, in the   circumstances,   be   held   to   be conditional upon the making or earning of the income." It is noteworthy that the above observations were made in the context of  Section 57(iii) of   the   Act   where   the   language   is   somewhat narrower   than   the   language   employed   in Section   37(1)  of   the   Act.   This   fact   is recognised in  the judgment itself. The fact that the language employed in  Section 37(1) of the Act is broader than  Section 57(iii) of the Act makes the position stronger. In the case of  Sassoon J. David & Co. Pvt. Ltd.  v. CIT, (1979)  118 ITR 261 (SC),  the Supreme   Court   referred   to   the   legislative history and noted that when the Income Tax Bill of 1961 was introduced,  Section 37(1) required   that   the   expenditure   should   have been   incurred   "wholly,   necessarily   and Page 67 of 71

C/TAXAP/751/2019 JUDGMENT exclusively" for the purposes of business in order to merit deduction. Pursuant to public protest, the word "necessarily" was omitted from the section. The   position   emerging   from   the   above decisions   is   that   it   is   not   necessary   for the   assessee   to   show   that   any   legitimate expenditure   incurred   by   him   was   also incurred   out   of   necessity.   It   is   also   not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The  only  condition  is that the expenditure should   have   been   incurred   "wholly   and exclusively" for the purpose of business and nothing   more.   It   is   this   principle   that inter   alia   finds   expression   in   the   OECD guidelines, in the paragraphs which we have quoted above. Even   Rule   10B(1)(a)   does   not   authorise disallowance   of   any   expenditure   on   the ground that it was not necessary or prudent for the assessee to have incurred the same or   that   in   the   view   of   the   Revenue   the expenditure   was   unremunerative   or   that   in view of the continued losses suffered by the assessee   in   his   business,   he   could   have fared   better   had   he   not   incurred   such expenditure.

These

are

irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the   TPO   as   per   law   but   in   judging   the allowability

thereof

business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the   ground   that   the   assessee   has   suffered continuous   losses.   The   financial   health   of assessee can never be a criterion to judge allowability   of   an   expense;   there   is certainly   no   authority   for   that.   What   the TPO has done in the present case is to hold that the assessee ought not to have entered into   the   agreement   to   pay   royalty/   brand fee,   because   it   has   been   suffering   losses Page 68 of 71

C/TAXAP/751/2019 JUDGMENT continuously. So long as the expenditure or payment  has  been  demonstrated  to have been incurred   or   laid   out   for   the   purposes   of business,   it   is   no   concern   of   the   TPO   to disallow   the   same   on   any   extraneous reasoning.   As   provided   in   the   OECD guidelines,   he   is   expected   to   examine   the international   transaction   as   he   actually finds   the   same   and   then   make   suitable adjustment   but   a   wholesale   disallowance   of the expenditure, particularly on the grounds which   have   been   given   by   the   TPO   is   not contemplated or authorised. Apart from the legal position stated above, even   on   merits   the   disallowance   of   the entire   brand   fee/   royalty   payment   was   not warranted.   The   assessee   has   furnished copious material and valid reasons as to why it   was   suffering   losses   continuously   and these have been referred to by us earlier. Full   justification   supported   by   facts   and figures have been given to demonstrate that the increase in the employees cost, finance charges,

administrative

expenses, depreciation cost and capacity increase have contributed   to   the   continuous   losses.   The comparative   position   over   a   period   of   5 years   from   1998   to   2003   with   relevant figures   have   been   given   before   the   CIT (Appeals)   and   they   are   referred   to   in   a tabular   form   in   his   order   in   paragraph 5.5.1.   In   fact   there   are   four   tabular statements furnished by the assessee before the CIT (Appeals) in support of the reasons for   the   continuous   losses.   There   is   no material   brought   by   the   revenue   either before   the   CIT   (Appeals)   or   before   the Tribunal   or   even   before   us   to   show   that these are incorrect figures or that even on merits   the   reasons   for   the   losses   are   not genuine. We are, therefore, unable to hold that the Tribunal   committed   any   error   in   confirming the order of the CIT (Appeals) for both the years deleting the disallowance of the brand fee/   royalty   payment   while   determining   the ALP. Accordingly,  the substantial  questions of law are answered in the affirmative and Page 69 of 71

C/TAXAP/751/2019 JUDGMENT in   favour   of   the   assessee   and   against   the Revenue.   The   appeals   are   accordingly dismissed with no order as to costs.“ 11. We   are   of   the   view   that   in   view   of   above dictum of law the findings of fact recorded by the Tribunal in the impugned order cannot be termed as perverse or contrary to the evidence on   record.   The   Tribunal   has   taken   into consideration   the   voluminous   documentary evidence on record for the purpose of coming to the conclusion of adoption of TNMM by the assessee   as   the   Most   Appropriate   Method   of arriving at ALP. The Delhi High Court in the case of  Make My Trip India (P.) Ltd. (supra) has also held that difference of opinion as to the appropriateness of one or the other method cannot   be   gone   into   in   the   appeal   under Section 260A of the Act, 1961 by observing as under: “5. The Court is of the opinion that no   substantial   question   of   law arises.   The   difference   of   opinion between the CIT (A) and the TPO, as to the appropriateness of one or the other   methods,   cannot   per   se   be   a ground

for

interference;

the appropriateness  of the method  unless shown   to   be   contrary   to   the   Rules specially  Rules  10B  and 10C,  in the opinion   of   the   Court,   are   hardly issues   that   ought   to   be   gone   into under Section 260A of the Income­tax Page 70 of 71

C/TAXAP/751/2019 JUDGMENT Act.” 12.In   the   overall   view   of   the   matter,   we   are convinced that the decision of the Tribunal is correct  and  requires   no  interference   and   no question   of   law     much   less   any   substantial question   of  law  can  be   said  to   have  arisen from the impugned order of the Tribunal. In the result, these appeals fail and are hereby dismissed, with no order as to costs.

(J. B. PARDIWALA, J) (BHARGAV D. KARIA, J) Pradhyuman// Page 71 of 71