CIT vs. MARUBENI INDIA PVT LTD

The assessee is a private limited company incorporated in India under the Companies Act, 1956. It is a 100% subsidiary of Marubeni Corporation, Japan („MCJ‟, for short). It carries on mainly two types of business – (i) operations consisting of representation service, i.e., to liaise between the business divisions of MCJ and its various suppliers/ customers in India which includes import, export, off shore trade, project management, marketing of finished goods, market research and liaison work; and (ii) trading of a broad range of industrial, agricultural and consumer goods, commodities and natural resources.

We may first take up the appeal filed by the assessee in ITA No.1042/2011 relating to the assessment year 2002-03. The assessee filed a return of income on 31.10.2002 declaring “nil” income. It was revised but even in the revised return the income declared was ` nil; however, it was explained that the interest on bank deposit earlier treated as business income was being shown as “income from other sources” in the revised return, that the brought forward unabsorbed depreciation was being claimed as depreciation of the current year and that the expenses amounting to `11,23,440/- relating to construction project was being withdrawn. The return was scrutinised and an assessment order was passed under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the „Act‟) determining the total income at `2,35,01,470/-. Several additions were made in the assessment order. For the purpose of the present appeal, however, the assessee has proposed the following 7 questions, stated to be substantial questions of law, for our consideration: - “1. Whether the Income Tax Appellate Tribunal, was correct in law, in rejecting the claim of the Appellant that interest income which is Business Income of the Appellant is operating income, disregarding the decision of the ITAT in Assessee’s 2013:DHC:2072-DB

Whether the Income Tax Appellate Tribunal, was correct in law, in treating Interest income of `1.72 crore as non- operating income.

Whether the Income Tax Appellate Tribunal, was correct in law, in holding on an adhoc basis that only 10 percent of the interest income should be allowed as relatable expenses disregarding the actual amount of interest expenses duly quantified and worked out with respect to accounts attributable to earning such income.

Whether the Income Tax Appellate Tribunal, was correct in law, in not allowing the benefit of 5% range available to the Appellant under the express provisions contained in Proviso 92C(2) while computing the adjustment on account of transfer pricing.

Whether the Income Tax Appellate Tribunal, was correct in law, in considering only current year data and denying the use of data of previous two years in terms of Rule 10B(4) read with section 92(D) of the Act.

Whether the Income Tax Appellate Tribunal, was correct in law, in not treating “closure of business” expenses as abnormal expenses disregarding the facts that such expenses were wholly unrelated to the pricing of international transaction which was the issue before the Tribunal, and also because none of the Comparable Companies incurred cost of such or similar nature.

Whether, the order of the Income tax Appellate Tribunal is not vitiated in law for non-consideration of relevant material and evidence placed on record and submissions made by the Appellant.”

The first three questions proposed by the assessee may be now examined. In the course of the assessment proceedings, the assessee‟s case was referred to the transfer pricing officer („TPO‟, for short) as the 2013:DHC:2072-DB

The TPO was further of the view that in respect of the services rendered by the assessee, it should be remunerated on a cost-plus basis and the total costs should be made the basis of computing its earnings and not merely the commission and fixed fees paid to it. According to the TPO the commission rates and the fixed fees were determined by extraneous unascertainable factors which had no bearing with the corresponding costs incurred by the assessee. As the commission was paid on the basis of the value of the transactions put through because of the efforts of the assessee, the assessee is artificially made to bear the risks of the market which it was otherwise not meant to bear. In the proceedings before the TPO in its transfer pricing report which it was required to submit by section 92E of the Act, the assessee chose five comparable companies and the average margin came to 8.37%. The TPO computed the arm‟s length remuneration in the following manner: -

The assessee filed an appeal against the aforesaid addition before the CIT (Appeals) and raised several contentions. In particular, it was contended that the approach of the TPO/ AO in treating the interest income as non- operating income was flawed and it was pointed out that the short term interest of `1.72 crores received by the assessee was on account of a treasury function which represented its core function and, therefore, ought to have been taken as operating income. It was accordingly submitted that excluding the interest revenue from the computation of the arm‟s length price was not appropriate since the cost for earning the interest income was built into the operating cost of the assessee. It was also submitted that the demonstrative costs also include interest on account of income tax which was non-operating income and should be excluded from the computation of operating profit.

The CIT (Appeals) dealt with the assessee‟s submissions in detail. He noted that the assessing officer/ TPO had treated the interest income earned by the assessee as non-operating income and after doing so it was found by 2013:DHC:2072-DB

The submissions of the assessee before the CIT (Appeals) were mainly these. The parking of the surplus funds in interest bearing securities was an integral part of the assessee‟s operations, that one of the objects of the company was to invest the surplus funds in securities, deposits, units, shares, bonds, debentures, etc. and that according to its memorandum of association these activities were permitted and thus the business model of the assessee envisaged the utilisation of surplus funds from time to time to generate operating revenue. It was, therefore, contended that it was not proper or appropriate to exclude the interest income from the computation of the arm‟s length price since the costs for earning the interest income was built into 2013:DHC:2072-DB

These submissions were considered by the CIT (Appeals) in detail who held that it was a universal practice followed under transfer pricing regulations to exclude interest from the operating revenue for computing the net profit from the operating activity except where the earning of interest itself was the main activity. In this view he held that the interest income cannot be considered as the assessee‟s operating income. He also found that the interest income in the present case was not so interwoven with the international transaction that it cannot be separated. He also held that the commission rates and the fees by which the assessee was remunerated were in no way related to the interest earnings of the assessee. According to the CIT (Appeals) while evaluating the arm‟s length price, what was required to be seen was the return on costs; if interest is included as part of the operating revenue, it would amount to computing the return on investment which would be wholly inappropriate. It is also irrelevant, according to the CIT (Appeals) that the interest income was treated as business income in the assessment order. For these reasons, the CIT (Appeals) held that for the purpose of determining the arm‟s length price in respect of the controlled transaction of 2013:DHC:2072-DB

The assessee carried the matter in further appeal before the Income Tax Appellate Tribunal. After considering the rival contentions and examining the facts, the Tribunal agreed with the income tax authorities, recording the following findings: -

On the basis of the above findings, the Tribunal took the view that neither the interest income of `1.72 crores nor the interest expenditure of `1.22 crores can be taken into consideration in the computation of the arm‟s length price.

The assessee has framed the first three questions against the aforesaid findings of the Tribunal. It was fairly admitted on behalf of assessee that question No.3 did not arise out of the order of the Tribunal. So far as the first two questions are concerned, we are satisfied that essentially they are questions of fact and do not give rise to any substantial questions of law. Whether a particular activity of the assessee i.e. the interest generating activity in this case, should be taken into consideration in the determination of the ALP is a question which needs to be decided considering the nature of the business of the assessee, which is referred to as “business model” in the transfer-pricing jargon. The Tribunal has rightly noted that the fact that the 2013:DHC:2072-DB

So far as the fourth question proposed by the assessee is concerned, the controversy arises this way. It was the assessee‟s contention that in determining the ALP, it was denied the benefit of the proviso to section 92C(2). The proviso as it existed at the material time, read as under: -

The arithmetic mean of the PLI of the five comparable cases was 9.33%. If the benefit of + 5% is allowed on this figure then the arithmetic mean would be 14.8% and 3.8% respectively. The contention of the assessee 2013:DHC:2072-DB

This controversy need not detain us any more, as it has been put at rest by the amendment made to section 92C by the insertion of sub-section (2A) by the Finance Act, 2012 with retrospective effect from 01.04.2002. The said sub-section is as under: -

As regards question No.5 the contention of the assessee is that the data relating to the earlier two years was available when the matter relating to the applicability of the arm‟s length price was being considered by the TPO and therefore, he ought to have considered that date also in arriving at the ALP. Our attention was drawn to sub-rule (4) of Rule 10B of the Income Tax Rules, 1962 and the proviso thereto. The sub-rule and the proviso are as below :- “(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :

Question No.6 relates to the finding of the Tribunal that the expenses relating to the closure of the business were abnormal expenses and cannot be considered relevant while arriving at the ALP in respect of the international transaction. It also refers to the finding of the Tribunal that none of the comparable companies had incurred such expenses. The assessee had paid compensation for closure of its units, including the Delhi and Chennai offices, in an amount of `68,97,992/-. The assessee sought inclusion of the compensation in the operating costs, on the footing that the closure of the units does not benefit the associated enterprise. It was further submitted by the assessee that its Indian business was being run as a totally independent unit with authority to the management in India to take decisions regarding closure of the offices in India. According to the assessee, the associated enterprise is not allowed to interfere in such decisions which are administrative in nature. The payment of compensation for closure of the Indian units was an abnormal item of expense and therefore, ought to have been excluded from the operating costs while arriving at the ALP of the international transaction. The case made out by the income tax department was that since the assessee is a captive unit of its associated enterprise, it was actually the latter which undertook the entire risk, that the associated enterprise was paying the assessee at the rate of cost plus 10% that if the Indian units are closed then the operating costs would correspondingly be reduced and therefore, the compensation paid would form part of the operating costs and would thus be relevant for arriving at the ALP.

The aforesaid issues were considered by the Tribunal. It noted that despite a specific direction issued by the CIT(Appeals), the assessee was 2013:DHC:2072-DB

The contention of the counsel for the assessee before us is that the assessee was being compensated by way of a commission of fees by the associated enterprise and not on cost plus basis as erroneously held by the Tribunal. It was submitted that in this context, the compensation paid in connection with the closure of the Indian units represents abnormal costs which have to be excluded for determining the ALP. Counsel also posed the question whether the closure of the Indian units would benefit the associated enterprise and answered the same in the negative, and submitted that in such a 2013:DHC:2072-DB

It may not be possible to lay down a formula that would be applicable universally to determine whether a particular expenditure or cost incurred by the assessee is a normal or abnormal item of expense, in cases relating to transfer pricing. If as held by the Tribunal, the assessee is compensated for its service on the basis of cost plus 10% then again the question may arise as to whether the compensation paid for closure of the Indian units can be considered to be normal or abnormal cost, because the compensation would directly depend or vary according to the quantum of the costs. In such case it would be relevant to consider whether the compensation paid for closure of the Indian units would amount to normal or abnormal expense. But as rightly pointed out by the counsel for the assessee, the assessee is being compensated by a fee or commission which has no connection with the costs incurred. This has been referred to even in the assessment order at paragraph 6.3 as follows:- “For the agency and market support services, MIPL has received two kinds of remuneration :

Question No.7 is general in nature, challenging the decision of the Tribunal on the ground of non-consideration of relevant material and evidence placed before it. This question is answered against the assessee.

In ITA 1114/2011 the revenue has proposed the following questions as substantial questions of law: -

Whether on the facts and circumstances of case, the Income Tax Appellate Tribunal was correct in law in holding that the amount of `1,21,75804/- should be all allocated to trading of goods segment?

The Assessee has two segments, one pertaining to trading and the other pertaining to the services. In the course of the transfer pricing analysis, it was noticed by the TPO that the assessee, while computing the operating profit margin has considered the total operating expenditure at only `15,72,33,860/-, as against the total operating expenditure of `18,52,26,882/- shown in the audited profit and loss account. This difference was sought to be reconciled by the assessee and from the reconciliation it was noticed by the TPO that the difference of `2,82,50,502/- was claimed by the assessee against the revenues from the trading segment. When the TPO called for the details of the trading segment the assessee filed the same from which it was noticed that direct cost of `1,61,16,786/- and indirect costs of `1,21,75,804/- were claimed in the trading segment against the revenue by way of sales. It may be noted that the aggregate of these two figures accounts for the difference between the operating expenditure as shown in the audited profit and loss account and as considered by the assessee for the purpose of the transfer pricing study.

On a perusal of the figures relating to the trading segment, the TPO was of opinion that the direct costs of `1,61,16,786/- were nothing but indirect expenses pertaining to the trading transactions such as salary, travelling, communication, entertainment, staff welfare, taxes and fees, donation, warranty, rent, bed debts, repairs and maintenance, depreciation, etc. In other words, it was the view of the TPO that the figure of `1,61,16,786/- exhausted the entire costs relating to the trading segment – both direct and indirect – and there was no justification at all for further claiming indirect costs of `1,21,75,804/- on proportionate basis. In this view of the matter the TPO and the assessing officer concluded that the figure of `1,61,16,786/- which was claimed to be direct costs are actually inclusive of indirect costs also and, therefore, no separate deduction from the cost-base need be given for the figure of `1,21,75,804/- claimed separately as indirect costs, for the purpose of calculating the ALP of the commission income. The arm‟s length remuneration was accordingly computed at `17,36,71,139/- and in arriving at this figure, deduction was given only for the expenses of `1,61,16,786/- and no deduction was given in respect of the amount of `1,21,75,804/-.

Aggrieved, the assessee contested the adjustment in appeal before the CIT (Appeals). It was submitted by the assessee before the CIT (Appeals) that it was maintaining segment accounts for the trading and commission income, particularly the projects which are part of the trading segment, that apart from direct costs incurred on a project there were indirect costs also which are incurred on the overall supervision of the projects and such costs cannot be directly identified and allocated necessitating an allocation on the basis of the income. Accepting the submission of the assessee, the CIT (Appeals) directed it to furnish the basis and break-up of the computation and allocation of the indirect or overhead expenses to the trading segment. The 2013:DHC:2072-DB

The CIT (Appeals) accepted the above statement and directed the assessing officer to exclude the amount of `1,21,75,804/- from the commission segment. He thus allowed the appeal of the assessee on this point.

The revenue carried the matter in appeal before the Income Tax Appellate Tribunal. The Tribunal noted that after excluding the aforesaid amount, the arm‟s length remuneration came to `16,31,25,719/- which is less than the actual revenue of `16,38,07,933/- and, therefore, no adjustment was required to be made. As to the correctness of the decision of the CIT (Appeals), the Tribunal adverted to the assessee‟s contention that the two projects – TISCO and Purulia – had nothing to do with the agency support services rendered by the assessee to its associated enterprises and, therefore, the expenses amounting to `1,21,75,804/- are not to be considered while determining the arm‟s length remuneration. Eventually the Tribunal held, agreeing with the assessee, as under: -

The grievance of the revenue mainly is that neither the CIT (Appeals) nor the Tribunal has given any reasons in support of their respective conclusions. It was submitted that when the CIT (Appeals) had obtained a statement from the assessee, he ought to have called for a remand report from the assessing officer or the transfer pricing officer before acting upon the same. On the other hand, learned counsel for the assessee submitted that it 2013:DHC:2072-DB

On a careful consideration of the facts and the rival contentions, we are inclined to agree with the learned counsel for the assessee that no question of law or substantial question of law arises out of the decision of the Tribunal on this point. The discussion made above shows that the dispute related only to the allocation of overhead/ indirect expenses between two segments of the assessee‟s business. It is nobody‟s case that the expenses were not incurred. It is also not the case of the revenue before the Tribunal or before us that the bifurcation of the indirect expenses on the basis of revenues is not an appropriate “allocation key”. The decision of both the CIT (Appeals) and the Income Tax Appellate Tribunal, is based on the undisputed figures submitted by the assessee. These figures have also been scrutinised by the transfer pricing officer. There is, therefore, no perversity in the decision of the Tribunal because it is based on the evidence embedded in the books of accounts themselves. The charge of perversity raised by the revenue seems to us to be unjustified. There was evidence upon which the Tribunal could come 2013:DHC:2072-DB

In the result the appeal of the revenue in ITA No.1114/2011 is dismissed, whereas the appeal of the assessee in ITA No.1042/2011 is allowed in part. There shall be no order as to costs.