HUHTAMAKI PPL LTD.[AS A SUCCESSOR TO POSITIVE PACKAGING INDUSTRIES LTD],MUMBAI vs. DY CIT 14 (2)91), MUMBAI

4.1. The various international transactions carried out by the assessee are tabulated in page 2 of the order of the ld. Transfer Pricing Officer (TPO) in para 3. Out of the seven transactions listed thereon, the issues in dispute before us are only with regard to item Nos. 1 & 2 thereon i.e. export of manufactured finished goods to Associated Enterprises (AEs) – Rs.88,98,56,779/- and to export of raw materials and consumables to AEs- Rs.4,93,45,415/-.

4.2. The ld. TPO observed in para 4 of his order that assessee is primarily engaged in the business of manufacture and sale of flexible packaging materials, rotogravure printing cylinders, CPP films, labels and metalized films. During the period 01/04/2014 to 30/01/2015, the assessee has manufactured and sold finished goods to its AEs which are tabulated hereunder:-

Name of the AE Amount (in INK) Positive Packaging Middle East (LLC) 12,98,375 Positive Packaging United (M.E.) FZCO 14,45,42,038 Positive Packaging Industries South 53,45,90,515 Africa (Pty) Ltd. Primetech M.E. FZCO 3,13,51,654 Positive Packaging Industries Nigeria 16,83,20,543 Ltd. Gravics Systems South Africa (Pty) Ltd. 88,41,632 9,12,022 Purechem Manufacturing Limited, Nigeria Total 88,98,56,779 4.3. Further during the year, the assessee has exported raw materials and consumables to its AEs on a need basis totalling to Rs.4,93,45,415/-.

4.4. The assessee in its transfer pricing study report benchmarked the above international transactions by applying Internal TNMM as the Most Appropriate Method. The Profit Level Indicator adopted (PLI) adopted by the assessee was operating profit / operating cost (OP/OC). In the above analysis, the operating margin on cost of HPPL from the sale of manufactured finished goods to unrelated parties was -0.78% vis a vis profit of 3.31% from its AEs. Since the margin of goods sold to AEs was higher than the margin earned from sale of manufactured goods to non- AEs, the said transaction was considered to be at arm’s length price (ALP) using Internal TNMM as the MAM.

4.5. The assessee, however, as a matter of abundant caution, also benchmarked the aforesaid transactions by using External TNMM as the MAM. The assessee’s margin as stated supra was 3.31% of operating cost from export of manufactured finished goods and raw materials / consumables to AEs. The assessee compared its margins with 12 comparable companies listed in pages 4 & 5 of the order of the ld. TPO whose margin were in the range of 2.84% to 7.06%. The median of the aforesaid comparables was arrived at 5.55% and since the assessee’s margin was 3.31%, the said transaction was treated to be at arm’s length as assessee’s margin fall within the range of the comparables. The segmental results of the comparable companies were furnished by the assessee before the ld. TPO. However, the ld TPO rejected the same by stating that the same is not on actual basis. Finally, the ld. TPO rejected 9 comparable companies from the chosen list of 12 comparable companies by the assessee and took only 3 comparable companies of the assessee i.e. Packaging India Pvt. Ltd., Umax Packaging Ltd., and TCPL Packaging Ltd., and arrived at the average margin thereon at 8.5%. The ld. TPO by applying 8.5% sought to make an upward adjustment of Rs.8,63,57,985/- on account of export sales made to AE in the following manner:-

Particulars In.Rs In.Rs In.Rs 821,20,83,465 Total revenue Less :- Interest Income 388,79,952 817,32,03,513 Total Operating Income Total Operating expenses 84540,22,171 Less :- Finance cost 1879,70,955 Less :- Amotisation 167,39,909 Less :- Loss on sale of fixed assets 39,65,589 2086,76,453 Total Operating expenses 82453,45,718 Total Operating Profit / (Loss) (721,42,205)

OP/OC -0.87% Comparables OP/OC 8.50% Difference 9.37% Total entity level Adjustment 72,99,65,910

Adjustment restricted on sales made ' 8,63,57,985 to AE's 4.6. One of the main objections raised by the assessee before the ld. DRP was that Internal TNMM should be the most appropriate method in the instant case which was rejected by the ld. TPO. However, on without prejudice basis, the assessee had even resorted to benchmark its international transaction by using External TNMM wherein 12 comparable companies have been chosen by the assessee and segmental data thereon were duly provided by the assessee and that the similar data furnished were accepted by the ld. TPO in earlier years. The assessee also pointed out that it had determined profitability of each of the sales segment namely, AE exports, non-AE exports and non-AE domestic, by preparing segmental profitability statement and got the same certified by an independent Chartered Accountant. The assessee also submitted that for the purpose of determining the profitability under each of the segment, all the direct costs were identified and directly attributable to the concerned sales segment. However, with respect to other costs which were not readily identifiable in relation to particular sale segment, the same were allocated to each segment using “sales as the most appropriate cost allocation key”. Further since AE export and non-AE export segment were functionally comparable in every respect to the assessee by applying Internal TNMM as the Most Appropriate Method and compared the profitability earned in both the segments to establish arm’s length nature of impugned international transactions with its AEs.

4.7. It was submitted before the ld. DRP that the ld. TPO had rejected the cost allocation method adopted by the assessee in segmental data on the ground that they are not on actual basis. In this regard, the assessee had explained before the ld. DRP that with respect to direct costs, material cost has been allocated to AE export segment on actual basis and balance components forming part of cost of production (including depreciation of building and plant and machinery) has been done based on production cost per unit absorbed on the basis of exported sale quantity to AEs. Further, all of the balance cost of production has been allocated to non- AE segments based on sales of these non-AE segments.

4.8. With regard to independent Chartered Accountant certificate provided by the assessee for the segmental data which was rejected by the ld. TPO on the ground that the Chartered Accountant had merely conducted test checks, the assessee submitted that the same cannot be a valid reason for rejecting the certification done by an independent Chartered Accountant and the verification of test check basis has been generally accepted auditing practices. The assessee also placed reliance on the decision of the Delhi Tribunal in the case of Honda Trading Corporation India Pvt. Ltd., vs. DCIT reported in TS-81- ITAT-2014(DEL).

4.9. With regard to yet another observation made by the ld. TPO that “sales ratio” is not the appropriate allocation key for allocating the cost which are not directly attributable, the assessee submitted that the said allocation key is universally accepted allocation key and has been duly certified by an independent Chartered Accountant. The assessee also placed reliance on the decision of the Bangalore Tribunal in support of its contention in the case of 3D Networks PTE Ltd., (India Branch) vs. ACIT in IT(TP)A Nos. 544 & 622/ BANG/2011 and in the case of M/s. Allegis Service India Pvt. Ltd., vs. DCIT in IT(TP)A No.1370/BANG/2014. It was vehemently submitted by the assessee before the ld. DRP that the ld. TPO did not provide any alternate allocation which shall be appropriate on the given assessee’s case and thus, it could be rightly concluded that the ld. TPO had rejected the “sales ratio” without any cogent reason.

4.10. It was also submitted that the ld. TPO had noted certain discrepancies in the segmental working produced by the assessee but the same were not even informed to the assessee during the course of transfer pricing assessment proceedings and these were made known to the assessee only in the order of the ld. TPO. The ld. TPO had observed that basis for allocating “HO expenses” and “other expenses” were not provided by the assessee. This is factually incorrect as the same are allocated in the sales ratio. The ld. TPO had observed that basis for allocating the following income i.e. excess provision written back, HO income, sundry balance written back and insurance claim amount on the basis of sales ratio is incorrect. The assessee submitted before the ld. DRP that these incomes are not directly notified for particular segment and thus allocated on sales ratio. With regard to yet another observation made by the ld. TPO for depreciation related to building and plant and machinery is allocated on sales ratio as against cost of production which is allocated at actual, the assessee submitted that depreciation related to building and plant and machinery forms part of cost of production. The same has been allocated as under:-

Allocation to export segment has been done based on depreciation cost per unit absorbed on the basis of exported sale quantity to AEs and the balance depreciation has been allocated to non-AE segments based on sales of these non-AE segments.

4.11. With regard to yet another observation made by the ld. TPO that increase in depreciation on account of change in the life of plant and machinery is not allocated, is concerned, the assessee submitted before the ld. DRP that the said expenses may be allocated to all the segments in sales ratio. It was also specifically pointed out that the same will not result in impugned international transactions not to be at arm’s length as the impact of the segment margin will be very minimal.

4.12. Hence, it was pointed out that all the adverse observations made by the ld. TPO had been duly addressed by the assessee before the ld. DRP and hence, it was pleaded that added segmental results given by the assessee need to be accepted.

4.13. The ld. DRP held that AE segment and non-AE segment have to be FAR (Functions Performed, Assets Employed and Risks Assumed) compliant and hence, they cannot be compared using Internal TNMM. The ld. DRP however, observed that assessee has got very nominal risk involved in the transactions carried out with its AEs. It held that the imports and exports of raw materials / goods to / from the AEs can be compared only to the imports and exports of raw materials / goods to/from the AEs on different dates as that would be a proper Internal TNMM comparison. With these observations, the ld. DRP upheld the rejection of Internal TNMM as MAM.

4.14. The ld. DRP held that audited segmental accounts given by the assessee should be accepted after proper modifications / adjustments made by the assessee which has also been submitted before the ld. DRP. Accordingly, the ld. DRP observed that OP/OC of the AE export segment should be taken at 2.32%. The workings of these margins at 2.32% are enclosed in page 495 of the paper book filed before us. The assessee had even furnished the revised non-AE export segmental margins working wherein the PLI of OP/OC was arrived at -1.78%. When this is sought to be compared with assessee’s margin of 2.32% as per the revised AE export segment workings, still the assessee’s pricing would be at arm’s length.

4.15. With regard to External TNMM being adopted as the MAM, wherein 3 of 12 comparables chosen by the assessee were accepted by the ld. TPO, the ld. DRP further accepted four more comparables chosen by the assessee as under: i) Ecoplast Ltd., ii) Orient Press Ltd., iii) Raj Packaging Industries iv) Uma Polymers Ltd., 4.16. The ld. DRP infact even accepts the fact that the remaining five comparable companies chosen by the assessee are also engaged only in packaging industry but not engaged in flexible packaging industry (which is the business in which assessee is engaged in). The ld. DRP observed that since segmental break-up of the remaining 5 comparables of flexible packaging and normal packaging were not available, hence five comparables were rejected.

4.18. We have heard rival submissions and perused the materials available on record. It is not in dispute that the revised segmental margins given by the assessee before the ld. DRP which are enclosed in pages 496 and 497 of the paper book were duly accepted by the ld. DRP.

The entire cost allocation base adopted by the assessee in the revised segmental workings have also been accepted by the ld. DRP. We find that the ld. DRP ultimately observed that date-wise analysis for comparison of transactions with AEs and non-AEs were not available in the instant case and accordingly Internal TNMM was rejected. We hold that date-wise comparison of data in respect of AE vis-a-vis non-AE transactions would be relevant only under Comparable Uncontrolled Price (CUP) method. In the instant case, the ld. DRP had duly accepted TNMM as the Most Appropriate Method. The only dispute is whether the Internal TNMM or External TNMM should be adopted in the instant case. The only reason for rejection of Internal TNMM by the ld. DRP is non-availability of date-wise analysis of comparison of AE transactions vis a vis non-AE transactions. As stated supra, the date wise analysis for comparison of AE and non-AE transactions would be relevant only when CUP is adopted as MAM. They are certainly not relevant when TNMM is adopted as MAM. Moreover, with regard to the FAR analysis between AE and non-AE, we find that there is absolutely no difference with Functions performed or Assets employed. With regard to the Risks assumed, the ld. DRP itself admits that in respect of transactions with AE, the assessee is having very minimal and low risk. The turnover with non-AE is much greater than turnover with AE which is evident from the workings available in page 497 of the paper book. Hence, the entire FAR is also duly complied with by the assessee in the instant case. Even with lower risk that AE segment as accepted by the ld DRP is having, as evident from the segmental workings available in page 497 of the paper book, we find that assessee had made higher margins with AE as compared to non-AE transactions. Hence, certainly, the assessee’s international transaction with AE using Internal TNMM as the MAM is at arm’s length, which has to be accepted in the instant case. We hold accordingly. Hence, the ground Nos. 2-6 raised by the assessee are allowed.

4.19. With respect to External TNMM method adopted by the ld. TPO, we find that the ld. DRP ultimately had accepted seven comparables out of the 12 comparables chosen by the assessee. The five comparables which were rejected by the ld. DRP were only for the reason that they are engaged in mere packaging industry whereas the assessee is engaged in flexible packaging industry and that segmental break-up was not available in respect of flexible packaging and normal packaging. In this regard, we hold that when TNMM is adopted, only broad functional comparability is required to be seen. Hence, even the regular packaging industry would become broadly functional comparable with flexible packaging industry in which assessee is engaged in. We find that the Co-ordinate Bench of this Tribunal in the case of Watson Pharma Pvt. Ltd., vs. DCIT reported in 168 TTJ 281 by placing reliance on the Bangalore Tribunal decision rendered in the case of GE India Technology Centre Pvt. Ltd., vs. DCIT reported in 141 TTD 245 had observed that TNMM requires only broadly functional end product / services comparability. We find that this decision of Mumbai Tribunal in Watson Pharma in 168 TTJ 281 referred supra has been fully approved by the Hon’ble Jurisdictional High Court in the case of PCIT vs. Watson Pharma Pvt. Ltd., reported in 257 Taxman 65. Hence, going by the broad functional comparability by placing reliance on the aforesaid decisions of Mumbai Tribunal which has been approved by the Hon’ble Jurisdictional High Court, we hold that even the five comparable companies which were rejected by the ld. DRP ought to be included in the final list of comparables. By this process, effectively all the 12 comparables chosen by the assessee, on without prejudice basis, for applying External TNMM gets approved. Hence, there is no scope for making any adjustment to arm’s length price even if External TNMM is adopted in the instant case. Accordingly, the ld. TPO is hereby directed to delete the entire transfer pricing adjustment made in the instant case. Hence, the ground No. 7 & 8 raised by the assessee are also allowed.