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Income Tax Appellate Tribunal, DELHI BENCH ‘I-1’ : NEW DELHI
Before: SHRI N.K. BILLAIYA & SHRI KULDIP SINGH
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, DCIT, Circle 16 (1), New Delhi. (hereinafter referred to as ‘the Revenue’) by filing the present appeal sought to set aside the impugned order dated 29.10.2015 passed by the AO in consonance with the orders passed by the ld. DRP/TPO under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) qua the assessment year 2011-12 on the grounds inter alia that :-
“1. Whether on the facts and circumstances of the case, the Dispute Resolution Panel (DRP) was right in disagreeing with the description of the activity carried out by the assessee as that of being akin to trading? 2. Whether on facts and circumstances of the case, the Dispute Resolution Panel (DRP) was right in law in rejecting the primacy of functions carried out by the assessee and basing its decision on the ground that risks were minimal in the case of the assessee? 3. Whether on facts and circumstances of the case, the Dispute Resolution Panel (DRP) was right in law in rejecting the TPO's analysis without going into the agreements the assessee has entered into with AE being the final fact finding authority? 4. Whether on facts and circumstances of the case, the Dispute Resolution Panel (DRP) erred in directing acceptable of a PLI that does not include cost of goods among expenses, when all the functions performed assets utilized and risk undertaken were in that context only?”
Briefly stated the facts necessary for adjudication of the controversy at hand are : M/s. Marubeni Itochu Steel India Pvt. Ltd. (MIIP) (hereinafter referred to as ‘the taxpayer’) is a service and trading company and also providing liaisoning support services to its parent and affiliates for purchase and sale of goods from/in India. It is working as communication channel between its parent/affiliates companies and third parties in India. The taxpayer during the year under assessment engaged in two types of transactions with its group companies viz. :-
(a) Provision of support services to its Group Companies – Service Segment; and (b) Purchase of steel products from its Group Companies for the purpose of resale in India Trading Segment.
During the year under assessment, the taxpayer entered into international transactions with its Associated Enterprises (AE) as under:-
Marubeni India Comparables International Segment Transfer Profit Total value Margin Arithmetic Transaction Name Pricing level of mean Method indicator transactions (PLI) (INR) Import of Trading TNMM OP/Sales 324,256,873 2.17% 0.78% finished goods Provision of 119,080,510 support services Indent TNMM OP/VAE 17.19% 12.17% Reimbursements 25,111,289 payable Reimbursements Cost-to- NA NA 4,598,098 NA NA receivable cost
The taxpayer in its TP study applied Transactional Net Margin Method (TNMM) as Most Appropriate Method (MAM) with OP/Sales as Profit Level Indicator (PLI) for trading and OP/VAR for service transaction to benchmark its international transactions. The taxpayer selected 12 comparables engaged in distribution of steel projects with average OP/Sales at 0.78% using multiple year data as against its own OP/Sales at 2.17% for AE trading segments. In service segment, the taxpayer carried out TP analysis with 7 comparable companies engaged in identical services with average OP/VAE at 12.17% using multiple year data as against OP/VAE of the taxpayer at 17.19% for AE indent segment for the year under assessment and found its transaction at arm’s length.
Transfer Pricing Officer (TPO) rejected the taxpayer’s approach and benchmarked the international transactions afresh with regard to indent segment by rejecting taxpayer’s approach, the TPO recharacterized the commission/service of the taxpayer as trading business on the ground that the taxpayer is owner of supply chain management and human intangibles and also proceeded to conclude that compensation model of the taxpayer does not account for the profit attributable to location savings and thereby added the value of Rs.895 crores i.e. value of the goods on which the taxpayer has earned commission to the cost base of service fees and commission segment pertaining to AE. TPO by conducting a fresh search of the companies engaged in steel trading activities used 2.68% as the benchmark for making the enhanced cost of the taxpayer and thereby made an adjustment of Rs.22,51,55,093/- to the total income of the taxpayer.
The taxpayer carried the matter before the ld. DRP by way of filing objections, who has partly allowed the objections no.3, 5, 6 & 9 by following the decision in AY 2010-11. Feeling aggrieved, the Revenue has come up before the Tribunal by way of filing the present appeal.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
At the very outset, ld. DR for the Revenue as well as ld. AR for the taxpayer brought on record the fact that similar adjustment was made by the TPO in taxpayer’s own case for AY 2010-11 which was set aside in appeal by the Tribunal in order dated 24.07.2015 to the AO. The issue involved is re-characterization of the business of the taxpayer, but ld. DRP by disagreeing with the AO/TPO rejected the conclusion that from the evidence on record, interference in the nature of the business of the taxpayer is not required as the Revenue cannot dictate the business model of the taxpayer and held that it was unwarranted on the part of the TPO to modify the character of the taxpayer in the commission / service segment as trading segment
However, perusal of the decision rendered by the coordinate Bench of the Tribunal in taxpayer’s own case bearing for AY 2010-11 (supra), at para 52 page 45 of the order, shows that it is applicable to the facts and circumstances of the case which has been confirmed by the Hon’ble High Court of Delhi vide order dated 05.05.2006 in ITA 129/2016, available on file. Coordinate Bench of the Tribunal decided the identical issue by restoring the matter back to the TPO by returning following findings :-
“52. Next issue is with report to service fee segment which the TPO treated as trading segment. As per the assessee, the assessee is involved in two segments i.e. trading segment and service fee/commission fee segment. In respect to the computation of ALP by the assessee reflected for trading segment is not disputed by the TPO. However, in respect to the other segment which was claimed by the assessee as income from service fee/commission fee segment, the TPO, however, disagrees with the assessee’s contention and treats it as income from trading activity. The same issue cropped in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein the Coordinate Bench following the order of the Hon’ble jurisdictional High Court decision in the case of M/s Li & Fung India Pvt. Ltd vs. CIT (361 ITR 85) has upheld the contention of the assessee that it is no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by its AEs, in respect of which services are rendered, in its reconstructed financial statements and then putting the hypothetical trading profits, so arrived in their reconstructed financial statements, to the tests for determining arms’ length price. The Coordinate Bench held as follows :-
“Service fee/ commission segment of assessee’s activities
Coming to the service fee/ commission segment, we have noted that as regards the service fee/ commission segment, the TPO has re-characterized the same as trading activities as he was of the view that the right course of action will be to treat the same as equivalent to trading segment, because what the assessee has disclosed as service/commission income is in fact trading income. Accordingly, the cost of goods sold by the AEs, which was Rs.2927,92,05,406, was also to be included in cost base of the service/commission segment and then ALP was recomputed. So far as this aspect of the matter is concerned, the issue is now covered in favour of the assessee by Hon’ble jurisdictional High Court’s decision in the case of Li & Fung wherein Their Lordships have, interalia, observed as follows:
“………..This Court is of opinion that to apply the TNMM, the assessee’s net profit margin realized from international transactions had to be calculated only with reference to cost incurred by it, and not by any other entity, either third party vendors or the AE. Textually, and within the bounds of the text must the AO/TPO operate, Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assessee’s net profit margin for application of the TNMM. Rule 10B(1)(e) recognizes that "the net profit margin realized by the enterprise 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 ..." (emphasis supplied). It thus contemplates a determination of ALP with reference to the relevant factors (cost, assets, sales etc.) of the enterprise in question, i.e. the assessee, as opposed to the AE or any third party. The textual mandate, thus, is unambiguously clear.
The TPO’s reasoning to enhance the assessee’s cost base by considering the cost of manufacture and export of finished goods, i.e., ready-made garments by the third party venders (which cost is certainly not the cost incurred by the assessee), is nowhere supported by the TNMM under Rule 10B(1)(e) of the Rules. Having determined that (TNMM) to be the most appropriate method, the only rules and norms prescribed in that regard could have been applied to determine whether the exercise indicated by the assessee yielded an ALP.” 81. Clearly, therefore, it is impermissible to make notional additions in the cost base and thus take into account the costs which are not borne by the assessee. It is so opined by Hon’ble jurisdictional High Court on a careful analysis of rule 10B(1)(e)(i). It is, therefore, no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by the AEs, in respect of which services are rendered, in its reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms’ length price. Respectfully following the esteemed views of Their Lordships, we hold that the adjustments carried out in the cost base of ALP computation, in respect of service fee/commission segment, are indeed devoid of legally sustainable merits. We direct the Assessing Officer to delete these adjustments. Once this notional adjustment is deleted, the ALP determination is to be done on the basis of the commission/service fees. As we have stated earlier in this order as well, in the course of proceedings before us, the assessee has filed fresh computation of the ALP which attempts to demonstrate that, if notional adjustments made by the TPO are deleted, no ALP adjustment will be warranted. However, we are not inclined to go into verifications which must take place at the assessment stage.’’
Respectfully following the ratio laid by the Hon’ble predicted High Court in Li & Fung out that of the co-ordinate bench in Mitsubishi (supra) we deem it appropriate to uphold the grievances of the assessee in principle, as the terms above, delete the notional adjustments by TPO’s adopting cost base of the AEs in assessee’s ALP determination, and remit the matter to the file of the TPO for the necessary factual verifications on impact of this corrections. Accordingly, the matter stands restored to the file of the TPO in this respect also.”
Following the order passed by the coordinate Bench of the Tribunal in taxpayer’s own case in AY 2010-11 (supra) confirmed by Hon’ble High Court of Delhi and order passed in taxpayer’s own case in in AY 2013-14 order dated 27.09.2017, we are of the considered view that the notional adjustment made by the TPO by adopting cost base of the AE in benchmarking the international transactions is not sustainable and the matter is required to be restored back to the TPO/AO for factual verification on impact of this correction in the same manner as directed by the Tribunal in AYs 2010-11 and 2013-14 and to decide afresh after providing adequate opportunity of being heard to the taxpayer in the light of the decision rendered by Hon’ble Delhi High Court. Consequently, the appeal filed by the Revenue is allowed for statistical purposes. Order pronounced in open court on this 30th day of October, 2019.