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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’, NEW DELHI
Before: MS. SUSHMA CHOWLA & SH. PRASHANT MAHARISHI
PER PRASHANT MAHARISHI, AM:
This appeal is filed by Motorola Mobility Chennai Private Limited { assessee} against the order of The Deputy Commissioner Of Income Tax, Circle – 2, Gurgaon (the learned AO) passed under section 144C read with section 143 (3) of The Income Tax Act, 1961 (the Act) dated 25 January 2016 assessing the income at Rs 44328564/– against the returned income of ₹ 1 5174900/– passed in pursuance of direction under section 144C (5) of the act by The Dispute Resolution Panel – 1, New Delhi (the learned DRP) dated 18th of November 2015 on the draft assessment order dated 27/2/2015 passed by the learned assessing
officer wherein the transfer pricing adjustment to the international transactions of the assessee of Rs. 29153664/– were incorporated pursuance to order under section 92CA (3) of the income tax act of The Additional Commissioner Of Income Tax, Transfer Pricing Officer –II (2) New Delhi dated 28/1/2015 restricting the transfer pricing adjustment to Rs. 29153664/–.
The assessee has raised the following grounds of appeal :-
That on the facts and circumstances of the case, and in law, the Assessment Order dated January 25, 2016 passed under section 143(3) read with section 144C of the Income Tax Act, 1961 (“the Act” pursuance to the directions issued by Hon’ble Dispute Resolution Panel (“DRP”) is bad in law. 2. That the Hon’ble DRP erred on facts and in law in confirming the additions/ disallowance proposed the draft order passed by the assessing officer without judiciously considering the factual and legal objections to the draft assessment order. 3. The Ld. TPO/ AO and Hon’ble DRP erred in enhancing the income of the Appellant by INR 29,153,664 holding that the international transaction of receipt of services do not satisfy the arm’s length principle envisaged under the Act and in doing so have grossly erred in not appreciating that none of the conditions set out in section 92C (3) of the Act are satisfied in the present case. Also, the Ld. TPO and Hon’ble DRP have grossly erred:
in holding that neither the Appellant has received any 3.1. service and/ or benefit in lieu of the payment made by it for services availed nor was there any need for such services/ payments; thereby challenging the commercial wisdom of the Appellant in making such payments while passing the order in contrast with the recent judicial pronouncements in this regard;
in holding that the activities for which the Appellant is 3.2. 3-5- paying are also performed by it and thereby recommending that the services and/ or benefits received are incidental and duplicative in nature which 3-6. have not resulted in any economic and commercial benefit to the Appellant; in holding that the Appellant has not furnished 3.3. 3-7- substantial documentary evidence/ furnished only some third party invoices to demonstrate the benefits received from the AEs, ignoring the submissions and documents submitted by the Appellant during the 3-8. assessment proceedings, thereby holding that the Appellant has failed to substantiate that any service in this regard has actually been availed by it; in holding that the Appellant has not furnished any cost 3.4. benefit analysis with respect to cost of services and benefits received from AE vis-a-vis independent parties and that no independent verification was conducted by the Appellant to substantiate the costs incurred by the AE; 3.5. in holding the Appellant has not furnished any basis for the cost allocated to it; 3.6 In holding that the services received by the Appellant are in the nature of shareholder services; 3.7 in undertaking Comparable Uncontrolled Price (“CUP”) analysis for the said transaction when it was already benchmarked under Transactional Net Margin Method(“TNMM”) 3.8 in holding that the benchmarking done by the Appellant in respect of international transaction relating to payment for receipt of services is not in accordance with the law and in doing so have further grossly erred in: a. disregarding the arm’s length price, as determined by the Appellant in the Transfer Pricing documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Rules; b. not appreciating that payment towards intra group service fees is closely linked to the primary business 3
segments/ functions of the Appellant and erred in analyzing the transaction separately for the determination of arm’s length price; c. inappropriately rejecting TNMM adopted by the Appellant, as the most appropriate method for benchmarking the said transactions; 4. The Ld. TPO and Hon’ble DRP erred, on the facts and circumstances of the case and in law, in re-determining the arm’s length price of transaction relating to receipt of services assuming that no advantage has been conferred upon the Appellant from such payment. In doing so, The Ld. TPO erred in rejecting the transfer pricing method and 4.1. analysis of the Appellant. Further, the Ld. TPO has not undertaken the best method analysis for selection of most appropriate method; The Ld. TPO erred in determining the arm’s length price of the 4.2. international transaction without following the manner of applying CUP Method prescribed under Rule 10B(i)(a) of the Rules; 5. That on a without prejudice basis, if the expenditure pertaining to the receipt of intra group services is disallowed, the operating income of the Appellant must be reduced by the same amount plus the mark-up as the revenue model of the Appellant is a cost plus basis model and the revenue earned on amount of cost disallowed has already been offered to tax. 6. That the Ld. AO/TPO and Hon’ble DRP has erred in disregarding sound TP principles and judicial pronouncements in India in undertaking the TP adjustment. 7. That the Hon’ble DRP erred in proposing to alternatively disallow the expenses under section 37(1) of the Act on the grounds that such expenses have not been incurred for the purposes of the business.
The brief facts of the case shows that assessee is a subsidiary of Motorola Mobility Incorporation, engaged in the business of law and manufacturing/assembly of handsets and other telecom products using 4
the critical raw materials components sourced from holding company. It also procured certain raw materials Components, consumables accessories from third party vendors locally in India. It also undertook testing and quality assurance services in respect of the product manufactured. For its manufacturing operations, assessee is a contract manufacturer remunerated at cost plus profit margin in respect of all operational costs incurred.
The assessee filed its return of income on 30 November 2011 declaring income of ₹ 15174900/–. During the course of assessment proceedings on examination of form No. 3CEB , it was found that assessee has entered into six different types of international transactions which were aggregated and adopting the most appropriate method as the Transactional Net Margin Method, taking the assessee as a tested party, the profit margin of the assessee of 6.95% was tested against the comparable companies profit margin of 1.53% and the transfer pricing study stated that all the international transactions entered into by the assessee are at arm’s length.
The learned transfer pricing officer accepted all other international transaction but the disputed the arm’s length price of international transaction of receipt of services of Rs. 291,53,664/–. He held that assessee has not received any benefit from the payments made for receipt of services to associated enterprise and he determined the arm’s length price of cost contribution reimbursement paid by the appellant amounting to that international transaction as Nil by applying the Comparable Uncontrolled Price (CUP) method. The learned AO passed the draft assessment order on 27/2/2015 making addition of that amount to the returned income of the assessee of ₹ 1 5174900 and determined the total income of the assessee at RS. 44328564/–. 5
The assessee filed its objection before the Dispute Resolution Panel, who upheld the order of the learned transfer-pricing officer determining the arm’s price of the above service at Rs. Nil and further it directed the learned AO to alternatively disallow the above expenditure under section 37 (1) of the act as those expenses have not been incurred wholly and exclusively for the purposes of the business.
Consequently the learned assessing officer passed an assessment order under section 144C read with section 143 (3) of the Act on 25/1/2016 determining the total income of the assessee at Rs 44328564/–. Aggrieved by that order assessee has preferred this appeal before us.
Ground number one and two of the appeal was said to be general in nature and therefore same are dismissed.
Ground number three of the appeal raising several issues contested the determination of the arm’s length price of the international transaction of receipt of services of Rs. 29153664/– at Rs nil. The learned authorised representative submitted the details of entity wise and service -wise bifurcations of the amount paid by assessee to its associated enterprise. He submitted that the above summary presented reimbursement of cost incurred by Motorola incorporation i.e. landline cost, InterCall charges and long-distance charges incurred by it while conducting business with its associated enterprise globally. It was further stated that these reimbursements were made without any Mark up. He submitted that assessee has made payment of ₹ 20997079/– to Motorola incorporation which is supported by the multilateral services agreement. He referred to the agreement titled as Multilateral Service Agreement at page number 149 of the paper book and referred to several invoices placed at page number 140 – 143 of the paper book. He 6
further referred that other payments were made to other entities amounting to ₹ 8176565/–. He submitted that assessee had received certain services from a Singapore entity in the nature of supply chain planning and monitoring services where assessee acts as a contract manufacturing entity and it manufactures products according to orders provided by the group entities. Since Singapore entity is the regional headquarter, the regional supply chain manager was placed at Singapore and this centre was involved in provision of assistance in the entire supply chain of the assessee. He further stated that the above services were requisitioned by the assessee and availed them from time to time, the cost arising for availing such services; the above payment has been made. He further stated that the payment of above services has brought synergies in overall operations, technical support in order to maintain a high level of efficiency and quality in carrying out its business operations in India. He further submitted that assessee has availed services that are required for running the appellant’s business operation smoothly and efficiently. Such services availed by the appellant from its associated enterprise through confidential reports, electronic mails, calls et cetera and he referred to certain documentary evidences in the nature of sample invoices to substantiate that these services have actually been received by the appellant. He stated that the above expenditure is in the nature of cost to cost reimbursement and no Mark up was paid on the same when it is paid to the Motorola incorporation and when it is paid to Motorola Singapore and other group entities, it is cost +5%. With respect to the benefit achieved, he stated that by paying the above cost the assessee achieved economies of scale by centralization and compliance with consistent operating policies, procedures and standards developed by Motorola mobility group within the group. He therefore submitted that there is a benefit which is been received by the assessee by availing the services. He further referred to the OECD guidelines; 2010-para number 7.2 to 7
support his contentions. He also referred to UNTP manual para number 10.4.9.1. He further submitted that the need for services is a commercial business decision taken by the company and the services are actually required by assessee in the course of its business operation. He submitted that the learned TPO/AO could not question the commercial decision of the businesspersons. He further submitted that that the associated enterprises perform integral functions for supply chain management of the assessee company and the services provided by them are directly linked to the business of the assessee in the services received from Singapore entity in other group entities pertain exclusively to the business requirement of the assessee. He further pressed into service the argument that intra group services is construed as a shareholder service only when the recipient does not require the services, however in the present case the appellant has repetitively mentioned in its submission that the services are required and resulted in direct benefit of assessee in India, He further submitted that the international transaction of receipt of services is closely interlinked to the manufacturing operations of the appellant and thus these transactions are not evaluated on a transaction by transaction basis but for the purpose of determining ALP, the international transactions were aggregated for benchmarking the manufacturing operations of the assessee in India. He stated that the learned transfer pricing officer has not alleged that overall transactional net margin method should not have been applied, however the TPO has applied the CUP method for justifying the arm’s-length price of intra group services only without recording any reason to show as to how CUP method provides a more reliable result than transactional net margin method.
Coming to the ground number five, he submitted that assessee has undertaken low-end manufacturing and assembly of handset pertaining to which it received services from its associated enterprise. He stated 8
that assessee has earned an arm’s length margin for performing contract manufacturing functions and in turn such services already forms part of the cost base for the manufacturing functions. He stated that it is not in dispute about the overall benchmarking of the transaction on transactional net margin method as no adjustment has been proposed thereon. Alternatively, he submitted that if expenditure pertaining to the receipt of intragroup services is disallowed the operating income of the appellant must be reduced by the same amount plus the markup as the revenue earned on amount of cost disallowed has already been offered to tax. Otherwise, it will lead to double taxation in the hands of the appellant. He referred to the decision of coordinate bench in case of MERCER CONSULTING INDIA PRIVATE LIMITED in ITA number 1085/2016.
On coming to ground number seven, about the disallowance of the above expenditure under section 37 (1) of the act on the ground that such expenses have not been incurred for the purposes of the business as directed by the learned dispute resolution panel, He submitted that in order to run its business operation smoothly and efficiently, the company had availed certain services from its group entities and accordingly incurred expenses which were in the nature of cost and such expenditure were incurred wholly and exclusively for the purpose of the business operations of the assessee. The assessee company had debited such expenses to the profit and loss account and claimed the same as deduction. He submitted that the learned transfer-pricing officer has merely alleged that the company has not received any benefit from the payments made for receipt of the services to its associated enterprise, however, it did not say at anywhere that such expenses have not been incurred wholly and exclusively for the purposes of the business. He also referred to the draft assessment order passed by the 9
learned assessing officer and stated that nowhere the above expenditure were held to be not incurred wholly and exclusively for the purposes of the business and therefore the direction of the learned dispute resolution panel is erroneous and without any basis. He placed reliance on the decision of the honourable Delhi High Court in case of the CIT versus DLF Hilton hotels 69 taxman.com 300 stating that no such disallowance can be made. He further referred to the decision of the honourable Supreme Court in case of SA builders Ltd versus CIT 288 ITR 1 as well as the decision of the coordinate bench in case of Quantum Advisers Private Limited Versus Deputy Commissioner Of Income Tax (2016) 73 taxman.com 233. In the end, he submitted that the adjustment proposed by the learned transfer-pricing officer deserves to be deleted. He further submitted that such expenditure cannot even otherwise be disallowed under section 37 (1) of the income tax act.
The learned departmental representative vehemently supported the order of the learned transfer pricing officer in the direction of the learned dispute resolution panel stating that the assessee, when it is availing the intragroup services must satisfy the need test, benefit test, shareholder test, rendition test, shareholders activity test and duplicative test to show that such services are for the purposes of the business. She further submitted that when the assessee does not have any benefit from the services received by it, there is no reason that any independent party would pay for such services if no benefit were received from them. She therefore submitted that when the assessee has failed to show that what kind of benefit it has earned, received on availing of the services, the learned TPO has correctly assume that arm’s-length price of the above services is nil.
We have carefully considered the rival contention and perused the orders of the lower authorities. Admittedly, the assessee has entered into six kind of international transactions. It has sold goods worth ₹ 1557968990, purchased raw material components of ₹ 1367508767, sold components of ₹ 1470615/– and purchased goods worth ₹ 30235663. There is also cost recharge paid by the assessee of ₹ 1849439/–. The assessee has received the services of Rs. 29153664/- from its associated enterprise. All these transactions were benchmarked together by the assessee by adopting the most appropriate method as the transactional net margin method. The tested party’s [ assessee taken as tested party] profit margin i.e. assessee’s profit margin was 6.95% and the comparable companies profit margin was 1.53% and therefore the assessee stated that all the international transactions taken together by the assessee are at arm’s-length. The learned TPO accepted the five transaction but disputed the ALP of the sixth transaction of receipt of services amounting to Rs. 29153664/– holding that assessee has not received any benefit by availing the services. He further held that universally such payments are being treated at arm’s- length only when it is proved substantially by the taxpayer that such services were actually received and further proving that such services have benefited it. Therefore, he held that the assessee has not been able to prove any tangible benefit derived from such services and has not been able to demonstrate that an independent party would have made a payment of such a magnitude for intragroup services as the assessee has made. Therefore, he held that the arm’s-length price of such international transaction is at nil. The learned dispute resolution panel upheld the finding of the learned TPO and further directed the learned assessing officer to disallow the above expenditure under section 37 (1) of the income tax act as the above expenditure has not wholly and exclusively incurred for the purposes of the business. To analyze the findings of the contesting parties it is necessary to look at the Mobile 11
Device Contract Manufacturing Agreement place to page number 331 of the paper book, entered into by the assessee on 31 July 2010 with Motorola mobility LLC. According to that agreement, the assessee was to engage into manufacturing of mobile devices. According to clause number 2.05 of that agreement as per the guidelines set by Motorola mobility incorporation the assessee was responsible for the procurement of parameters, including assemblies gets piece parts necessary to manufacture the product. The compensation was agreed at section 3 of that agreement which says that Motorola Mobile incorporation shall purchase the goods manufactured by assessee at the poor unit cost. The power unit cost has been defined separately in section 1. According to that, the profit markup percentage has to be applied to the total cost of sales as well as the expenses are allocated to the manufacturing activity of the assessee. Now we come to the multilateral service agreement entered into by the assessee along with several other companies. According to that description of services as mentioned in section 1 relates to product information, marketing, field engineering services, administration, legal matters, labour law and employee relations, transportation, financial services, secondment of employees and other services. The compensation is to be provided according to section IV of the agreement which provides that the services shall be billed to the recipient and suppliers cost and expenses incurred with respect to such services taking into account all the cost of expenses which are directly or indirectly related to the services performed and calculated in accordance with the internationally accepted accounting principles under the accrual method. In addition to the above cost, the supplier will add a profit markup of 5% on all related cost incurred internally but not on disbursement for services provided solely by third parties. On looking at the both agreements, it is apparent that they are independent of each other. Therefore, the action of the assessee in benchmarking it together along with other activities 12
and other international transactions is not proper as these classes of services is covered in multilateral service agreement is a class of transaction of its own. Hence, aggregation of those transactions together is not proper for their benchmarking. Therefore, we do not find any infirmity in the order of the learned transfer-pricing officer in adopting cup method is the most appropriate method for benchmarking of the transaction of receipt of the services.
Now we come to the reason of holding that arm’s-length price of these international transaction of receipt of services is nil as no benefit has been derived by the assessee is incorrect. This issue has already been considered by the honourable Delhi High Court in CIT versus Cushman and Wakefield India private limited 46 taxman.com 317 (2014) wherein it has been held that TPO cannot determine arm’s length price of payments made by the assessee to its associated enterprise at nil taking a view that assessee did not derive any benefit from services rendered by the associated enterprises. Further in that case the court held that the emails also provide a sufficient basis to hold that the benefit of accrued to the assessee. Further, the court also held that this determination remains unclear and inchoate and that devil lies in the details. Honourable High Court remanded the matter back to the file of the concerned assessing officer for determination of an arm’s length price in that particular case. In this case, also the learned transfer pricing officer as well as the learned dispute resolution panel has held that assessee has not derived any benefit from those services. As held by the honourable High Court, the duty of the learned transfer pricing officer is just to determine the arm’s length price of the services rendered for which the payment have been made by the assessee.
Further, the honourable High Court also held with respect to the allowability of expenditure under section 37 of the income tax act that 13
reference by the assessing officer to the transfer-pricing officer is only for the limited purpose of determining the arm’s length price based on a prima facie view that such referral is necessary. It does not imply a can create view as to the existence of services all the accrual of the benefit (such that allowance under section 37 must be permitted). However, in the present case the assessee has shown that the appellant has entered into in company service agreement for receipt of various services and some of the key benefits derived by the assessee are achieving economies of scale by centralization and compliance with the consistent operating policies, procedures and standards developed by Motorola mobility group within the group. The nature of the benefit derived by the assessee is to be looked at from the perspective of the assessee. Therefore, respectfully following the decision of the honourable High Court we reject the argument of the learned transfer-pricing officer and the learned dispute resolution panel that the arm’s length price of the services received by the assessee is nil. The learned TPO is duty bound to determine the arm’s length price. In view of this, we set aside the whole issue back to the file of the learned transfer pricing officer for determination of the arm’s length price of receipt of services by the assessee amounting to Rs. 29153664/–. Accordingly, ground number three of the appeal of the assessee is allowed subject about directions.
In view of our decision in ground number three of the appeal, ground number four, five and six of the appeal are also set aside to the file of the learned transfer-pricing officer accordingly.
Coming to the ground number seven, where the learned Dispute Resolution Panel has proposed alternatively to disallow the above expenses under section 37 (1) of the income tax Act on the ground that such expenses have not been incurred for the purposes of the business. Looking at the order of the learned assessing officer, no such 14
disallowance alternatively has been made by the learned assessing officer on reading para number three of his order where the addition of Rs 29153664/– has purely been made on the aspect of determination of arm’s length price of such services at nil. As the learned assessing officer has not disallowed the above expenditure under section 37 (1) of The Income Tax Act, ground number seven of the appeal of the assessee is premature, hence dismissed. 18. The ground number eight is with respect to the initiation of penalty under section 271 (1) ( C ) of the income tax act. We find that above issue is premature at this particular stage, hence it is dismissed. 19. Ground number nine is with respect to the chargeability of interest under section 234C and 234D of the income tax act as well as withdrawal of interest under section 244A of the income tax act that is consequential in nature and hence it is dismissed.
In the result, appeal of the assessee is partly allowed with about directions for statistical purposes. Order pronounced in the open court on 20/02/2020 -Sd/- -Sd/- (SUSHMA CHOWLA) (PRASHANT MAHARISHI) JUDICIAL MEMBER ACCOUNTANT MEMBER *NEHA* Date: 20/02/2020 . Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(Appeals) 5. DR: ITAT ASSISTANT REGISTRAR ITAT NEW DELHI