KIRLOSKAR TOYOTA TEXTILE MACHINERY PRIVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH : BANGALORE BEFORE SHRI N. V. VASUDEVAN, VICE PRESIDENT AND SHRI B. R. BASKARAN, ACCOUNTANT MEMBER IT(TP)A No.197/Bang/2015 Assessment Year : 2009-10 M/s. Toyota Industries Engine India Pvt. Ltd., Vs. DCIT, (formerly known as Kirloskar Toyota Textile Circle – 11(5), Machinery Pvt. Ltd.,) Bengaluru. Plot No.09, 2nd Phase, Jigani Industrial Area, Bengaluru – 560 105. PAN : AAACK 7425 Q ASSESSEE RESPONDENT Assessee by : Shri. Ajit Tolani, CA Revenue by : Shri. Sumer Singh Meena, CIT(DR)(ITAT), Bengaluru Date of hearing : 24.02.2022 Date of Pronouncement : 28.02.2022 O R D E R Per N V Vasudevan, Vice President

This is an appeal by the assessee against Order dated 19.12.2014, passed by CIT(A)-4, Bengaluru, in relation to Assessment Year 2009-10. 2. The first issue that requires adjudication in this appeal is with regard to correctness of the orders of the Revenue authorities in so far as it relates to determination of Arm’s Length Price (ALP) in respect of an international transaction of material handling equipment distribution service rendered by the assessee to its Associate Enterprise (AE). 3. The assessee imports Material Handling Equipment (MHE) from Toyota Industries Corporation, Japan (TICO) for resale and is engaged in

IT(TP)A No.197/Bang/2015 Page 2 of 15 the trading activity and it does not undertake any value addition to the import of MHE, which are resold to unrelated parties. Based on the activities carried out by assessee and the functions, assets and the risk analysis ('FAR'), assessee carried out the economic analysis, primarily to identify companies that are broadly similar to the FAR of the assessee. Assessee applied Resale Price Method (RPM) and computed assessee’s Margin at 15,39% and Comparables Margin at 18%. However, during the assessment proceedings, TPO held that RPM cannot be used in the instant case, owing to the fact that there is no information in the public domain of the comparables to compare the functionality of the comaprables selected by the assessee. The TPO however considering the very same comparable companies in his search process and made an upward adjustment of Rs. 225,70,105/- based on arm's length markup of the comparables at 2.43% on sales using Transaction Net Margin Method (TNMM) as most appropriate method. The CIT(A) confirmed the action of the Ld. TPO and sustained the application of TNMM method and rejected RPM Method.

IT(TP)A No.197/Bang/2015 Page 3 of 15 i. Rule 10B(1)(b)(i) - "the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated, is identified ...." ii. OECD Guidelines — "2.29 An appropriate resale margim is easiest to determine where the reseller 1101'N 110i odd substantially to the value of the product. In contrast, it mot, be more difficult to use the resale price method to arrive o arm's length price where, before resale, the goods are further processed or incorporated into a more complicated product so that their identity is lost of transformed….” UN Guidelines - "....The resale price method measures the iii. value of functions performed, and is ordinary used in cases involving the purchase and resale of tangible property in which the reseller has not added substantial value to the tangible goods by physically altering the goods before resale..." ICAI Guidance Note - "The resale price method is to be iv. adopted only when goods purchased from an associated enterprises are resold to unrelated parties". Further there are various judicial pronouncements which holds that RPM is the best method in the distribution segment. Learned Counsel for the assessee placed reliance on the decision of the ITAT, Bengaluru Bench, rendered in the case of Element 14 India Pvt. Ltd., Vs. DCIT in IT(TP)A No.351/Bang/2016 for Assessment Year 2011-12, order dated 16.09.2020. wherein all the decisions on the issue have been discussed. It was a case of a pure distributor who does not carry out any value addition for products carried out by it. The Tribunal had to consider the appropriateness of adopting RPM as the most appropriate method for determining ALP. The Tribunal followed the decision rendered by the ITAT, Bengaluru Bench, in the case of Acer India Pvt. Ltd., IT(TP)Nos.2837/Bang/2017 and 3391/Bang/2018 dated 05.03.2020 and held that RPM is the Most

IT(TP)A No.197/Bang/2015 Page 4 of 15 Appropriate Method (MAM) in the case of distribution of products. The learned DR however placed reliance on the order of the CIT(A).

IT(TP)A No.197/Bang/2015 Page 5 of 15 products. For the sake of convenience, we extract below the relevant observations made by the Tribunal in the case of A.O Smith India Water Heating P Ltd (supra):- “14. Now the assessee is before us with the submission that it is an accepted principle that the computation of ALP based on a direct method like RPM, which tests the results at gross level unlike the TNMM which tests the results at net level, extinguishes the requirement o making adjustment in relation to the difference in operating expenses, which could be different from enterprise to enterprise. It was further contended that as provided in Rule l0B, under RPM price of international transaction needs to be computed on the basis of gross profit margin earned in uncontrolled Bangalore transactions, while under TNMM price of international transaction is computed on the basis of net profit margin of uncontrolled transactions. As per Rule 100(1), the most appropriate method for determining the ALP depends upon the facts and circumstances of each case. Similarly, the operating expenses incurred by the assessee is different from the operating expenses incurred by comparable companies. The learned counsel for the assessee has highlighted that incurs certain expenses which does not affect sale/purchase price of the goods sold. Therefore, in a situation where incurrence of item expenses affects only the net profit of the entity without corresponding effect of gross profit or price of transactions, the TNMM will not provide the most reliable arms length results. The selection of TNMM would require making reliable adjustment to arrive at the operating profit i.e., adjustment for expenditure incurred in the current year, the benefit of which will be received in the future year. In the absence of reliable adjustment, the selection of TNMM will not result in arriving at the ALP of the international transaction. In transactions method like RPM or Cost Plus method, the effect of these factors may be eliminated as natural consequences of insisting upon greater product of function similarity. Depending upon the facts and circumstances of the case and particular on the effect of functional differences on the cost structure and the revenue of the potential comparables, the net profit indicators can be less sensitive

IT(TP)A No.197/Bang/2015 Page 6 of 15 than the gross margin to the difference in the extent of complexity of function and difference in the level of risk. 15. It was further contended that comparability should not be interpreted in isolation because of the conditions and circumstances of the controlled transactions should be taken into consideration while comparing the net margin. Under the facts and circumstances of the assessee, the net margin comparability is more volatile than the gross margin comparable. In the light of the facts, it was contended that if the cost structure is such that costs are effecting in net profit directly without affecting the price or gross margin, then there can be no two opinions that RPM should be preferred over the TNMM method. In support of these contentions, he placed reliance upon the following judgments-.- (1) Horiba India Pvt. Ltd., v. OCIT, 81 taxmann.com 209 (2) Bose Corporation Pvt. Ltd., v. ACIT, Circle 3(1), New Delhi, 77 taxmann.com 194 (3) ITO v. L'Oreal India Pvt. Ltd., (2015) 24 taxmann.corn 192 (Born) (4) Mattel Toys India Pvt. Ltd., v. DOlT in ITA No.2476/Mum/2008. The Id. DR placed reliance upon the order of the AO and the DRP. 16. Having heard the rival submissions and from a careful perusal of the record, we find that undisputedly the assessee is a trading company and carries out distribution and marketing of products of AOS group in India. It imports water filters from AO Smith China and sells them in India. AO Smith India is, according to the TP document, a distributor of AOS Water Heaters in India. The Tribunal has examined the most appropriate method in the case of distributor to determine the ALP for the international transactions. In the case of Horiba India Pvt. Ltd. (supra), the Tribunal has held that in the case of a distributor where the goods are purchased from the AE and resold to other independent entities without any value addition, then the resale price method should be reckoned as most appropriate method. One of the main reason given by the TPO as well as the DRP is that the assessee is full fledged/full risk distributor and performing host of functions, therefore

IT(TP)A No.197/Bang/2015 Page 7 of 15 RPM should not be taken as the most appropriate method, because all these functions require huge cost which may not represent the gross profit margin. This contention of the revenue was rejected by the Tribunal and it was held that in comparable controlled transaction scenario, a normal distributor will undertake all kinds of functions which are related to sales of the product. The things like market research, sales & marketing, warehousing, controlled quality and also risks like market risk, credit risk, etc. are undertaken by any distributor for the sale of the products. The Tribunal further held that what is important to see is whether there is any value addition or not on the cost purchased for resale. If there is no value addition to the finished goods purchased from the AE are sold in the market as it is, then gross profit margin earned on such transactions become determining factor to analyse the gross compensation after the cost of sales. Accordingly the Tribunal held that the RPM is the most appropriate method. 17. Similarly, in the case of Bose Corporation Pvt. Ltd. v ACIT (supra), the assessee company was engaged in the business of distribution of sound and audio assistant for individual customers and public places. It was a wholly owned subsidiary of Bose Corporation, USA. During the relevant year, assessee purchased furnished goods from its AE and resold the same in India to unconnected parties. The assessee adopted resale price method (RPM) as most appropriate method (MAM) for determining the ALP of the said international transactions. The profit level indication (PLI) adopted by the assessee was gross profit/sale and the assessee has made itself tested party for the purpose of international transactions. The TPO rejected the transfer pricing study of the assessee and opined that transactional net margin method was to be applied for determining ALP of international transactions under question. While determining the issue as to which is the most IT(TP)A No.351/Bang/2016 appropriate method in case of distributor, the Tribunal has held that the resale price method (RPM) is the most appropriate method and directed the TPO to calculate margin of the comparables by using RMP. The relevant observation of the Tribunal is extracted hereunder for the sake of reference:

IT(TP)A No.197/Bang/2015 Page 8 of 15 "8.1 At this juncture, we note the mandate of Rule 10C which defines the 'Most appropriate method'. Sub-rule (1) of Rule 10C states that: "For the purposes of sub- section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arm's length in relation to the international transaction." Sub-rule (2) of Rule 10C lists certain factors which should be taken into account in selecting the most appropriate method as specified in sub-rule (1). These factors, inter olio, include ©, the availability coverage and reliability of data necessary application of the method'; and (d) the degree of comparability existing between the international transaction and the uncontrolled transaction...........' 8.2 An overview of the factors prescribed for choosing the most appropriate method indicates that firstly, the data necessary for application of the given method should be available and secondly, the uncontrolled transactions should be functionally similar, if not identical. A company, in order to be ranked as comparable under the RPM, should preferably be engaged in doing similar activity as that of the assessee or at least of the some genus of the activity, with a different product. The Ld. TPO himself has categorized the corn parables chosen by the assessee as traders akin to computer industry or engaged in trading of instruments. As the basic requirements under rule 10(c)(1) are fulfilled by these corn parables and that the Ld. TPO has not brought on record any evidence to prove material difference between the assessee and the corn parables so selected, we direct the Ld. TPO to calculate the margin of the comparables by using RPM." 18. In the case of CIT Vs. L'Oreal India Pvt. Ltd., similar dispute was raised before the Hon'ble High Court of Bombay. In that case, assessee had business in 2 segments viz., manufacturing and distribution, In respect of business of distribution, the TPO suggested transfer pricing adjustment by applying the TNMM and rejected the resale price method

IT(TP)A No.197/Bang/2015 Page 9 of 15 (RPM) adopted by the assessee because the TPO found that assessee was incurring loss consistently and hence the price police was not at arm's length. The Hon'ble High Court, having examined all aspects have finally concluded that RPM is the most appropriate method. The relevant observation of the Hon'ble High Court is extracted hereunder for the sake of reference: "7. After having perused the relevant part of the order passed by the Commissioner and this Tribunal on this question, we are in IT(TP)A No.351/Bang/2016 agreement with Pardiwalla that the Tribunal did not commit any error of law apparent on the face of the record nor can the findings can be said to be perverse. The Tribunal has found that the TPO has passed an order earlier accepting this method. The Tribunal has noted in para 19 of the order under challenge that this method is one of the standard method and the OECD (Organization of Economic Commercial Development) guidelines also state in case of distribution or marketing activities when the goods are purchased from associated entities and there are soles effected to unrelated parties without any further processing, then, this method can be adopted. The findings of fact are based on the materials which have been produced before the Commissioner as also the Tribunal. Further, it was highlighted before the Commissioner as also the Tribunal that the RPM has been accepted by the TPO in the preceding as well as succeeding assessment years. That is in respect of distribution segment activity of the Assessee. In such circumstances, and when no distinguishing features were noted by the Tribunal, it did not commit any error in allowing the Assessee's Appeal. Such findings do not raise any substantial question of law. The Appeal is devoid of merits and is, therefore, dismissed. There would be no orders as to costs." 19. Copy of the order of the Tribunal in the case of L'Oreal India Pvt. Ltd., is also placed on record to demonstrate as to under what circumstances the RPM was considered to be most appropriate method. Similarly, in the case of Mettal Toys India Pvt. Ltd., v. DCIT (supra), the Tribunal again reaffirmed its

IT(TP)A No.197/Bang/2015 Page 10 of 15 view that in the case of distributor, the RPM is the most appropriate method by holding that ultimate aim of the transfer pricing is to examine whether price of the margin arising from the international transactions with a related party is at ALP or not. The determination of the approximate ALP is a key factor for which most appropriate method is to be followed. Therefore, if at any stage of the proceedings, it is found that by adopting one of the prescribed method other than choosing earlier, the most appropriate ALP can be determined, the assessing authorities as well as the appellate authorities should take into consideration such a plea raised before them provided it is demonstrated as to how a change in the method will produce better or more appropriate ALP on the facts of the case. The Tribunal accordingly rejected the contention of the Revenue and directed the TPO to adopt RPM instead of TNMM for computing the ALP. 20. Turning to the facts of the case, we find that undisputedly, assessee is a distributor of AO Smith China which is involved in the manufacture of water heaters and sells the water heater imported from AO Smith China in India without making any value addition to the product in a similar type of case, it has been repeatedly held by the Tribunal and the Hon'ble High Court of Bombay that in case of IT(TP)A No.351/Bang/2016 distributor, whether the product is being sold to the uncontrolled entities without making any value addition RPM is the most appropriate method and should be preferred over TNMM. Accordingly, we set aside the order of the AO, passed consequent to the direction of the DRP in this regard and direct the AOITPO to adopt the RPM as the most appropriate method." 11. Since the facts are identical in this case, we hold that the Resale Price Method is most appropriate method in the facts and circumstances of the present case. Accordingly we direct the AO/TPO to adopt Resale Price Method as most appropriate method and determine the ALP of the transactions accordingly." 6. In the instant case, the assessee has claimed that it has not carried out any value addition to the products imported by it from its Associated

IT(TP)A No.197/Bang/2015 Page 11 of 15 Enterprises. It is also submitted that the functions to be performed by the assessee as a "distributor", which is highlighted by the TPO is normal functions performed in the trade circles even by a non-related party. We notice that the revenue has not negated both these submissions of the assessee. The TPO has rejected RPM for the reason that the details and information necessary for computing margins of comparable companies was not available. The absence of details and information can be no ground to reject RPM as the MAM, as the TPO has powers to call for the necessary details from the comparable companies to ascertain the Gross Profit margin that has to be compared under RPM. Accordingly, we are of the view that RPM is the most appropriate method in the facts and circumstances of the case. Accordingly, we direct the AO/TPO to adopt Resale Price Method as most appropriate method and determine the ALP of the transactions accordingly. We are of the view that the facts and circumstances, we set aside the order of the CIT(A) and direct the AO/TPO to adopt RPM as the MAM and determine the ALP of the transactions accordingly after affording assessee opportunity of being heard.

IT(TP)A No.197/Bang/2015 Page 12 of 15 8. Section 115JB of the Act provides that notwithstanding anything contained in any other provision of the Act, where in the case of an assessee, being a company, the income-tax, payable on the total income as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April,2007, is less than ten per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income-tax at the rate of ten per cent. The assessee being a company the provisions of Sec.115JB of the Act were applicable. It is also not in dispute that the income tax payable on the total income as computed under the Act in respect of the previous year relevant to AY 2007-08 was less than 10% of its book profits and therefore book profit should be deemed to be the total income of the assessee and tax payable by the assessee on such total income shall be 10% of such total income. Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956). In so preparing its book of accounts including profit and loss account, the company shall adopt the same accounting policies, accounting stand and method and rates for calculating depreciation as is adopted while preparing its accounts that are laid before the company at its annual general meeting in accordance with provisions of Sec.210 of the Companies Act. Explanation below Sec.115JB of the Act provides that for the purposes of section 115JB of the Act, "book profit" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by— certain items debited in the profit and loss account in arriving at the net profit and as reduced by- certain items that are credited in the profit and loss account. In other words, all that one has to do, while computing book profits is to

IT(TP)A No.197/Bang/2015 Page 13 of 15 take the profit as per profit and loss account prepared in accordance with Companies Act, 1956 and make additions or subtraction as is given in the explanation to Sec.115JB(2) of the Act.

IT(TP)A No.197/Bang/2015 Page 14 of 15 payment of Bonus Act, 1965. The said provision is being estimated with reasonable certainty thereby making it ascertained and not unascertained: The following judicial pronouncements support the plea of the assessee wherein it was held that provisions estimated as per the Payment of Bonus Act, 1965 is an ascertained liability and cannot be added for the purpose of computing book profit u/s.115JB of the Act. (i) Stanley Black & Decker India Limited Vs DCIT-3(1) Mumbai (2017 (11) TMI (1147)-ITAT Mumbai (ii) DOT -11, Bangalore Vs M/s L & T Valdel Engineering P Ltd 2015 (6) TMI 934- ITAT Bangalore.

IT(TP)A No.197/Bang/2015 Page 15 of 15 13. In the light of the judicial pronouncements referred to above, we are of the view that the provision for bonus as well as provision for long term service are both ascertained liability and cannot be added to book profit under section 115JB of the Act. We hold and direct accordingly. The other grounds were not pressed and are dismissed as not pressed.

Pronounced in the open court on the date mentioned on the caption page. Sd/- Sd/- (B. R. BASKARAN) (N.V. VASUDEVAN) Accountant Member Vice President Bangalore, Dated: 28.02.2022. /NS/*

Copy to: 1. Appellants 2. Respondent 3. CIT 4. CIT(A) 5. DR 6. Guard file By order

Assistant Registrar, ITAT, Bangalore.