CHANDNI BEDI,NEW DELHI vs. ACIT, NEW DELHI

O R D E R PER AMIT SHUKLA, JM: All the aforesaid appeals have been filed by the assessee against the separate impugned orders for the Assessment Years 2009-10, 2010-11, 2011-12 and 2012-13. In all the appeals, the assessee has challenged following transfer pricing adjustment in the distribution and sales of the cosmetics product, i.e., direct sale:-

Assessment Year 2009-10 Rs.14,29,24,000/- Assessment Year 2010-11 Rs.45,44,16,384/- Assessment Year 2011-12 Rs.41,77,85,066/- Assessment Year 2012-13 Rs.48,90,27,914/-

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4. The assessee for its trading of goods in its transfer pricing study report has shown gross profit margin of:- i) A.Y. 2009-10: 45.58% ii) A.Y. 2010-11: 46.79% iii) A.Y. 2011-12: 48.72% iv) A.Y. 2012-13: 45.31% To bench mark its gross profit margin, assessee adopted resale price method RPM to justify its arm’s length margin of its international transaction. In its T.P. Study report, assessee selected 5 comparable companies, viz., i) Avon Body Products Ltd.; ii) Bodyline International Pvt. Ltd.; iii) J.K. Helene Curtis Ltd.; iv) Paramount Cosmetics (India) Ltd.; and v) Surya Vinayak Industries Ltd. The average gross profit margin of five comparables was arrived at 29.95%, whereas assessee’s gross profit margin during the relevant financial year was at 45.58%, hence it was reported that assessee’s gross profit margin were at arm’s length. The TPO rejected one of the comparable, Avon Body Products Ltd., on the ground that RPT transactions were more than 25%. For the balance comparable companies, he held that none of these companies were into direct marketing as compared to the assessee, therefore, same cannot be taken for comparability analysis under RPM. He was of the opinion that only direct sellers should be taken as comparable and in his search analysis, he shortlisted Modicare Ltd. which was a direct selling company and has taken to be a sole comparable for bench marking the same under RPM. The gross profit margin of Modicare Ltd.

I.T.A. No.4750/DEL/2015 4 was 76.74% and accordingly following the same analysis by taking this comparable for all the years under dispute, TP adjustment has been made in all the years amounting to Rs.14,29,23,995/- for the Assessment Year 2009-10; Rs.45,44,16,384/- for the Assessment Year 2010-11; Rs.41,77,85,066/- for the Assessment Year 2011-12; and Rs.48,90,27,914/- for the Assessment Year 2012-13. The assessee remained unsuccessful before the Dispute Resolution Panel (DRP) for Assessment Year 2009-10 and in the Assessment Year 2011-12; and before Commissioner of Income Tax (Appeals) in the Assessment Year 2010-11 for Assessment Year 2012-13.

5. Aggrieved by these orders, the assessee preferred an appeal before the Tribunal. The Tribunal vide order dated 24th March, 2017 for the Assessment Years 2009-10 to 2011-12 and vide order dated 13th June, 2017 for the Assessment Year 2012-13, though held that Modicare Ltd. is not an appropriate comparable to the assessee due to several reasons, however, remanded the matter back to the file of ld. TPO to retain the sole comparable and examine the comparability adjustment on Modi Care Ltd. to enhance its comparability with the assessee. Aggrieved by the order of the Tribunal, assessee has preferred an appeal before the Hon'ble High Court, with the sole issue, as to whether under the facts and circumstances of the case the direction of the Tribunal to include Modicare Ltd. and the exclusion of other comparables chosen by the assessee were correct. The Hon'ble High Court

I.T.A. No.4750/DEL/2015 5 vide its judgment and order dated 10the April, 2018, in very detail judgment observed that the findings of the Tribunal were inconsistent in so far as selection of Modicare Ltd. is concern, because, despite noting various significant differences between the assessee and Modicare Ltd., still the Tribunal chose not to address how such difference can be adjusted while carrying out the comparability analysis. After considering the entire gamut of facts and contentions raised, the Hon'ble Hight Court remanded the issue back to the Tribunal to reconsider the appeal in view of the selection of Modicare Ltd. While remitting back the matter to the Tribunal, Their Lordships held that the Tribunal should examine the availability of data for various product segments of Modicare Ltd. and to examine the functional differences with respect to its marketing strategy. The Hon'ble High Court further observed that the comparables adopted by the Assessee should be to be considered with appropriate working capital adjustment. The applicability of TNMM should also be examined by the Tribunal and under in such circumstances, no enlarging of the existing comparables should be carried out, that is, no further comparables should be searched. The relevant observations and the findings of the Hon'ble High Court in this regard were as under:- “The appellant's grievance is that the ITAT noted the significant difference between the entities which were involved in marketing the products through direct marketing between the loan direct marketing comparables i.e. Modicare Ltd. and the assessee. The grievance nevertheless, the ITAT

I.T.A. No.4750/DEL/2015 6 directed a remand categorically ruling out the case of Modicare Limited (supra). It is highlighted on behalf of the assessee in this regard that the significant differences between the two, i.e., Modicare and the assessee are incapable of adjustment. Learned counsel highlighted upon this functional dissimilarity with respect to the differential products range in which both the entities were involved; the low proportion of total product turnover attributable to cosmetic and related line (personal care) and the most segmental data. It is submitted that having regard to these circumstances, the ITAT's findings are both inconsistent and contrary to law on functional differences. It was also submitted that having regard to these functional differences, the assessee had offered other comparables that did not involve direct marketing but were trading entities with appropriate adjustments having regard to the dissimilarities that could be eliminated and appropriately adjusted. These issues were, however, not considered and no findings were returned. . 4 The ITAT's findings pertinently with respect to the appropriateness or otherwise of Modicare Ltd. as a comparable are contained in paras 5.9, 5.11 and 5.12 of the impugned order. The Tribunal noted that Modicare Ltd. as a standalone comparable (since all other comparables were eliminated by the revenue authorities at the early stage of the proceedings) was "ideally not an appropriate comparable" and has also canvassed that the comparables selected by the taxpayer have wrongly been rejected by the tax authorities. In paras 5.8 and 5.9 it is stated as follows: ”5.8 Thus when considered in the light of the aforesaid statutory Rules, we find that the tax authorities while considering the grievance of the tax payer admittedly have taken a position contrary to what has been envisaged under the Rules.

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5.9. Having so addressed, we find that over the years primarily the taxpayer has raised the issue that Modi Care Ltd. as a stand-alone comparable was ideally not an appropriate comparable and has also canvassed that the comparables selected by the taxpayer have wrongly been rejected by the tax authorities. One of the many lines of arguments taken by the taxpayer is that firstly Modi Care Ltd. has a very limited cosmetic and personal care product category thus it lacks product similarity; secondly it also has income from franchisees, hence it is not a similar service, thirdly its discounts are below the line expense and Revenue recognition policies are also significantly incomparable; fourthly it has high AMP spend; fifthly it has fluctuating sales; its incentives schemes are different it has wide variation between its gross margins and net margins thereby giving weight to the allegation that heavy functions are being performed at the operating level". 5 Its final conclusions with respect to Modicare Ltd. include the observations that the comparable company differed from the assessee in reporting its cost. The highlighted differences were in regard to the discount; transportation costs, insurance and performing the warranty function as operating expenses or its costs of goods sold or the difference in the inventory valuation method. These variations will affect the gross margin. The Tribunal then concluded in para 5.12 as follows: ''Accordingly, in view of the above, we are of the considered view that ideally the tax authorities should not have selected Modi Care Pvt. Ltd. as a standalone comparable. The tax authorities should have carried out a search or directed the assessee to carry out a fresh search ensuring that the comparables selected were primarily engaged in directs sales with no meaningful value addition activities. To the extent possible product similarities

I.T.A. No.4750/DEL/2015 8 should have been aspired for and if it was found in a particular year that it was not available then carrying out the necessary adjustments on the comparables selected attempted to approach near comparable FAR. Thus complying with the requirements of sub-Rule (2) and (3) of Rule 10B and sub-clause (iv) of clause (b) of sub-Rule (1) of Rule 10B ideally more comparables should have been selected. We note that there is sufficient guidance and clarity in the aforesaid statutory provisions to ensure that the grievance of the assessee can be addressed as it has amply been provided that wherever the gross margins are demonstrated to be impacted with either incomparable activities; functions, accounting practices; product dissimilarities; etc. then necessary adjustments should be made. Herein noting that the tax payer's first grievance is that with necessary adjustments, even if Modi Care Limited is taken as a standalone comparable as has been done by the tax authorities even then adjustments proposed by the tax payer on valid grounds namely incomparable activities, functions accounting and Revenue recognition policies etc. is necessitated. We are given to understand that service income has been excluded by the TPO himself in the subsequent years and in fact in one of the years in the present proceedings. It has been argued that if the adjustments are thus made then no adjustments to be arm's length price of the assessee would be necessitated. We note that the tax authorities have not considered the calculations as principally they have been of the opinion that no relief was warranted. Holding the said approach of the tax authorities contrary to the statutory position we direct the TPO to look into the claim of adjustments required to be made to Modi Care Limited. While so directing it is made clear that the responsibility for providing the supporting data to the satisfaction of the TPO rests with the assessee. The TPO cannot be burdened to look for I.T.A. No.4750/DEL/2015 9 possible adjustments. In case the tax payer does not succeed on this ground then the TPO may consider directing the assessee to carry out a search of comparable companies from the list of direct sellers in the market, as has been referred to in the TPO in the respective years and the CIT(A) has also specifically mentioned the direct sellers at pages 8 and 9 of his Order. The comparable companies with suitable adjustments adhering to the requirements as set out in sub-Rule (1), (2) and (3) of Rule 10B of the IT Rules may be selected." 6 It is notable at the outset from the above quotation that the Tribunal was conscious of the significant differences yet it did not address how these differences could be adjusted so to speak. The assessee is involved solely in the marketing of cosmetics. However, Modicare Ltd. is also engaged in the marketing of other products, "laundry and home care, personal care, tea, agriculture, jewellery, cosmetics and health care" and "others". Each one of these have a separate proportion to the total product turnover. A tabular chart in this regard appears to have been noticed by the Tribunal in its impugned order, the same is reproduced herein as below.., 7 The assessee argued that the dissimilarity with respect to the products sold and the. proportion borne by each of the turnover cannot but impact the profitability of the entity as a whole and further emphasized that segmental laid for each of these product lines is missing for the relevant year (with respect to the data available vis-a-vis Modicare Ltd.). In the opinion of this Court, it is of vital importance and was not addressed by the ITAT which even while noticing the significant differences and seemingly accepting the assessee's arguments nevertheless did not exclude Modicare Ltd. altogether. In the opinion of this Court, this is a very vital infirmity which needs to be corrected.

8. As far as the reasoning of the Revenue Authorities, which has I.T.A. No.4750/DEL/2015 10

not been commented upon by the ITAT for excluding the other comparables offered by the assessee goes, for one, it was stated that mere acceptance in the past of such comparable did not bind the Revenue. The other was with respect to the differential marketing strategy adopted for the two sets of entities i.e. the trading entity/comparable on the one hand as opposed to the direct marketing entity i.e. assessee on the other hand. The assessee had stressed that if appropriate marketing was made from the data available, the differential marketing strategy per se would not pose a difficulty with respect to the transfer pricing adjustment. The Court finds some merits in the arguments, especially since what the Revenue Authorities would be left with if the ITAT's order was not to be disturbed, would be what a comparable in the form of Modicare Ltd (supra). 9 In view of the above reasons, this Court is of the opinion that the appeal should be re-examined by the ITAT; it should be addressed on these two aspects i.e. firstly, the appropriateness of including Modicare Ltd. having regard to the availability of data with respect to the different product segments, and secondly, involving the comparable, the functional difference with respect to its marketing strategy (i.e. discount, transportation costs, insurance and performing the warranty function). Having regard to the factors mentioned in clause 5.10 of the impugned order, the ITAT is also directed to re-examine whether and to what extent adjustment can be reasonably made, having regard to the available data in respect to the trading comparables offered for ALP determination, for all the relevant years by the assessee. It is also directed to consider the feasibility again having regard to the available data for all the concerned assessment years- marking appropriate

I.T.A. No.4750/DEL/2015 11 adjustments (including with respect to the working capital adjustments as is sought to be urged. 10 This Court is of the opinion that the ITAT may task by the assessee) in regard to the trading comparables offered by the assessee for these given years. the Transfer Pricing Officer (TPO) with specific remand report on these issues and seek a report in a time bound manner and thereafter proceed to return its findings having regard to the parties' submissions. All the rights and contentions of the parties are kept open. Having regard to the above directions, it is open to the assessee to urge that TNMM is the most appropriate method instead of RPM In these circumstances, it is also clarified that in the event the submission is accepted there would be no enlarging of a comparable offered.” [Emphasis in bold is ours]

I.T.A. No.4750/DEL/2015 12 Particulars Oriflame India Modicare Ltd. Whether adjustment can be made- Yes/No Product Cosmetic Diversified - Laundry and Portfolio Products Homecare, Personal care, Agriculture, Tea, Jewellery, No Healthcare, others apart from cosmetics. Functional Diversified - Has business profile apart from trading since it Trading i.e. recognizes service income Buying and re- in its P/L account, incurs selling without franchisee expenses, COGS No any value is not a dominant addition component of its total activities operating expenses Different Substantial variance in the business model Does not gross and net level margins - evidencing that it is undertake any No incurring heavy functions value addition at operating level functions Differential Incentives/ discounts are accounting shown as a part of Shows the treatment for operating expenses sales net of No incentives/ incentives discounts Marketing and More than 10% of sales- Business evidencing that it is Promotion engaged in value addition Yes. However, under expenses / activity transfer pricing norms a Sales ratio trader performing value Less than 1% addition cannot be of sales compared with a low risk distributor not performing any value addition.

I.T.A. No.4750/DEL/2015 13 Cost of Goods In the range of 20% to 30% sold / Total - evidencing that's its operating Cost functional profile is Yes. Though an ratio different from a normal adjustment can be trader made for COGS, In the range of under transfer 50% to 60% pricing norms such a comparable is not appropriate.

7. It was also submitted by the learned counsel that;  Firstly, if RPM method is to be applied, then it should be applied on all the comparables chosen by the assessee and after working capital adjustment, most of the differential factors would be removed and;  Secondly, in case adjustment cannot be made under RPM, then TNMM should be adopted as most appropriate method as observed by the Hon'ble High Court, then all the comparables selected by the assessee should be tested under TNMM and that is the mandate of the direction of the Hon'ble High Court.

I.T.A. No.4750/DEL/2015 14 comparability of TNMM, he submitted that again same needs to be verified and examined by the TPO, because this plea was only taken at the stage of DRP.

I.T.A. No.4750/DEL/2015 15 comparables chosen by the assessee in RPM, it would be very difficult to carry out various adjustments due to limitation under the RPM method. Therefore, we are of the opinion that these comparables can be examined under the TNMM and all the relevant data would be provided by the assessee which shall be verified by the TPO. Let the remand report from the TPO be placed before this bench on or before 18th July, 2018. The assessee is directed to provide all the relevant data within two days, i.e., by 11th July, 2018; and thereafter TPO should give this comment by 18th July, 2018. List this matter on 18th of July, 2018. A copy of this order sheet shall be served to the TPO by today or tomorrow.”

“1.2 Modicare Ltd. has not disclosed any separate business segments (as required by Accounting Standard 17) in its audited financial statements for the year ended March 2009. This makes it clear that the company does not differentiate its products into separate reportable segments. In the absence of availability of different segments, the general overall functions and products of the company is to be considered, i.e., supplier of d cosmetic products.

1.5 …….. Accordingly, in the absence of any appropriate allocation of total costs into separate segments/products and services, Modicare Ltd. is considered comparable on the entity level.

1.7 Moreover, Modicare Ltd. itself, in a response to a notice issued to it u/s 133(6) has confirmed that its sales and marketing plan is based on directs selling model, which involves moving products from manufacturers to consumers directly.......

1.8. The other arguments of the assessee with respect to variance in gross and net level margins and COGS not being a dominant component of total operating expenses are found to be baseless. For any company, it can be argued that its gross and net margins are not matching with another company and therefore it has a different business model. However, this in itself should not be the factor to differentiate. The assessee must establish that business model of the two companies is different by giving cogent reasons and not by pointing out to differences in profit margins and expenses margins.

1.9. In view of the above discussion, it can be concluded that Modicare Ltd. is an appropriate comparable as it is a direct marketer like assessee and earns majority of the revenues from sale of I.T.A. No.4750/DEL/2015 17 products similar to assessee. Further. In case of direct marketers, business model comparability is more important than products comparability.......

2.4. Hence, in view of the significant differences in the functional profile and product profile between assessee's comparables and Oriflame India, it is not possible to make reasonable accurate adjustments under RPM as can be seen from the table and explanations above, and accordingly none of them can be considered comparable to the assessee.

2.5. With respect to Modicare Ltd., functional and product similarity has already been established in the above.

S. No. Factors Whether adjustment can be made - Yes/No 1 Advertising, Marketing, Promotion No. (AMP) Modicare Ltd. has incurred expenses under the} head 'Marketing and Sales Promotion Expenses' I of Rs. 29,552,604. Out of these, as confirmed by Modicare Ltd. in a response to a notice issued to it u/s 133(6), [Refer Annexure A] there is no Advertisement expense. Hence, Modicare Ltd.; has not incurred any actual AMP expenses, thereby eliminating the need for comparability adjustment.

2. VAE No. As discussed in the preceding paragraphs, assessee has not submitted anything substantial that proves why COGS should be a dominants expense and why Modicare Ltd's high VAE cannot be accepted.

3. Working Capital Yes. As per Annexure B.

I.T.A. No.4750/DEL/2015 18 3.3. On the basis of the above, it can be established that though while applying TNMM the standard of comparability is less stringent, however, some extent of comparability must be established. Application of TNMM cannot justify comparison between two entities which are neither functionally similar, nor dealing in broadly similar products. TNMM is less dependent on product and functional comparability because net margins are less influenced by differences in products and functions. However, even the net margins of two separate entities which are not even broadly similar will tend to have variations. Moreover, TNMM is normally used when the other methods do not provide reliability of data, making it difficult to apply the Cost Plus Method or Resale Price Method. As has been already discussed in the preceding paragraphs, the comparables chosen by the assessee are neither direct seller of products, making them functionally dissimilar, nor are they dealing in cosmetics, making their products also dissimilar. Accordingly, TNMM cannot be chosen as the most appropriate method with respect to the comparables chosen by the assessee. Having regard to Modicare Ltd., both Medicare Ltd. and Oriflame India are direct resellers of cosmetic product, making it an appropriate situation for the application of RPM. The detailed discussion for selection of Modicare Ltd. under RPM has already been done in the preceding paragraphs. And since RPM is more suited in this situation, it eliminates the need for application of TNMM.

3.5. Thus, it can be concluded that TNMM cannot be considered as the most appropriate method and it is more appropriate to apply Resale Price Method after making comparability adjustment on account of working capital differences.

I.T.A. No.4750/DEL/2015 19 Further, on request of the Ld. Departmental Representative (DR), Ld. TPO also issued notice u/s 131 of the Income Tax Act 1961 to Modicare Ltd. to sought clarification with respect to certain issues. In response to the notice, wherein the Finance Director of Modicare was examined on oath, Modicare Ltd. has clarified that it is not possible to draw product segmental in its case. The relevant extract from the response from Modicare Ltd. u/s 131 is given below:

In order to recast the segments of laundry and home care, personal care, cosmetics and health care, the company was issued notice u/s 131 wherein he was required to furnish "segmental information {clearly indicating all income & expense} under the following heads: i. Laundry, ii. home care, iii. personal care, iv. cosmetics and v. health care In the submission dated 18.09.2018 ref. nil, the comparable assessee has clearly denied the possibility of such bifurcation stating that "bifurcation of other major expenses in separate product categories is not feasible due to nature of these expenses, which are incurred for total business of the company." The major heads of expenses have also been discussed in the submission which is enclosed for ready reference.”

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“1. Diverse Product Profile Modicare Ltd. had a diversified product portfolio ranging from Laundry and Homecare, Personal care, Agriculture, Tea, Jewellery, Healthcare, cosmetics, others apart from cosmetics. The share of cosmetics ranges from 12% to 18% for the years under consideration, Even if personal care is aggregated then also more than 50% comprise diverse products. The Appellant does not deal in any of these product categories. Different product items would involve different level of assets, risks and markets and accordingly this company cannot be selected as a standalone comparable on a gross basis under RPM.

2. Differential treatment of expenses incurred on incentives/ discounts between the Appellant and Modicare Limited.

In any direct selling business, the agents/consultants who act as retailers are paid incentives or discounts to remunerate them for their contribution. This arrangement varies from one company to another and the corresponding accounting entries also differ accordingly. In this case, Oriflame India records the sales net of discounts/incentives paid to its agents/consultants and hence shows a lower gross margin as per its accounting treatment. On the other hand, the discount given to the consultants/agents is categorized as "Incentives" by Modicare Limited. This is being shown as below the line in profit & loss account as a part of operating expenses. This does not form part of the computation of gross profit margin of Modicare.

3. Modicare Ltd. has substantial variation between gross margin and net margin The Appellant would like to state that Modicare Ltd has a gross margin of 76.47% (as per TPO) whereas, its net margins are 2.25% for FY 2008-09 and similar percentages for subsequent years under I.T.A. No.4750/DEL/2015 21 consideration. The substantial variance in the gross and net level margins establishes the fact that the company is incurring heavy operating expenses, which substantiates heavy functions at the operating level that are not comparable to Oriflame India. This gives support to the argument that Modicare Ltd. is not just a direct marketer and reseller. Oriflame India on the other hand does not undertake value addition functions.

6. Franchise business model Modicare Ltd. has recorded franchisee expenses in its financial statements. Thus, Modicare Ltd. is operating as a franchise business and is not wholly a direct seller. The segmental accounts given in the Annual report is only in respect of products and there is no segmental

I.T.A. No.4750/DEL/2015 22 account available for franchise business. The revenues from franchise business are presumably being included in the sales figures as there is no separate line item showing any income from franchise business.

The summary of the functional and product differences between Modicare Ltd and Appellant have been provided in the following table:

Table: Differences in Functions. Assets and Risk and product profile of the Appellant vis-a- vis Modicare Limited and comparability adjustments (recognized by the IT AT in Paras 5.9 & 5.11) Whether adjustment can be made – Particulars Modicare Ltd. Yes/No Oriflame India

Diversified - Laundry and Homecare, Personal care, Product Cosmetic Products Agriculture, Tea, No Portfolio Jewellery, Healthcare, others apart from cosmetics.

Diversified - Has business1 apart from trading since it Trading i.e. recognizes service Buying and re- Income in its P/L Functional selling without account, incurs No profile any value franchisee expenses, addition activities COGS is not a dominant component of its total operating expenses

Substantial variance in the gross and net Does not Different level , margins - undertake any business evidencing that it is No value addition model incurring heavy functions functions at operating1 level

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Differential accounting Incentives/ discounts are treatment Shows the sales shown as a part of Yes for net of incentives operating expenses incentives/ discounts Yes. However, under transfer pricing norms a trader Marketing performing value More than 10% of and addition cannot be sales evidencing that Less than 1% of Business compared with a low risk it is engaged in value Promotion sales distributor not addition expenses / performing any value activity Sales ratio addition

Yes. Though an adjustment can be In the rage of 20% to Cost of made for COGS, 30%- evidencing that's Goods Sold / In the range of 50% under transfer Total its functional profile is to 60% operating pricing norms such different from a normal Cost ratio a comparable is not trader appropriate.

I.T.A. No.4750/DEL/2015 24 then same has to be rejected. He also gave point-wise rebuttal to the remand report of the TPO in the following manner:

“The Ld. TPO in her remand report has stated that segmental data for different products is riot available in the annual report of Modicare Ltd. However, she has stated that the data for the company at an entity level can be taken into account because personal care, cosmetics and healthcare products comprises 59.88% of the total sales for FY 2011-12 and similar percentages for other years under consideration. It is pertinent to note that Ld. TPO has not been able to rebut the claim of the Appellant regarding incomparable product profile of Appellant and Modicare Ltd. and has also not been able to show that comparability adjustments are possible on account of different product profiles.

Modicare Ltd. has a different business model as compared to the appellant as it is also incurring substantial franchise expenses and earning service fee by entering into annual maintenance contract. Ld. TPO in para no. 1.4 & 1.5 in her remand report has mentioned LI idL since the appellant Is also deriving service fee, similar to Modicare Ltd., there is no functional difference, in this respect.

Ld. TPO has failed to appreciate that the service tee earned by the appellant is on account of renewal fees (INR 38.09 lacs for FY 2011 12 and similar amount for other years under consideration) and handling fees (INR 67.32 lacs for FY 2011-12 and similar amount for other years under consideration) received from individual consultants who were engaged in the business of distribution of the Appellant's products and is thus directly related to the distribution activities carried out by the Appellant. On the other hand, the service fee earned by Modicare Ltd. amounting to INR 300.84 lacs for FY 2011-12 and I.T.A. No.4750/DEL/2015 25 similar amount for other years under consideration, is on account of Annual Maintenance Contracts (AMC). Therefore, no valid comparison can be made between the two companies for transfer pricing purposes. The Ld. TPO in her remand report in para 1.6 has emphasized about Modicare Ltd. and the Appellant being direct selling Companies. It has been pointed out by the Ld. TPO in this paragraph that both Modicare Ltd. as well as Appellant sell their goods through individual consultants and are members of Indian Direct Selling Association (IDSA). In para 1.7 of the remand report, the Ld. TPO has stated that she had issued a notice under section 133(6) of the Income Tax Act to Modicare Ltd. to confirm whether it is operating on a direct selling model. An abstract of the reply received from M/s. Modicare Ltd. has been reproduced in para 1.7 of remand report where M/s. Modicare Ltd. has confirmed that it is a direct selling company whereby the goods are moved from manufacturers to consumers directly without involving any intermediaries. It is submitted that at no stage has the appellant denied that Modicare Ltd. is not a direct selling company. Its contention all along has been that Modicare Ltd., despite being a direct selling company cannot be chosen as a solitary comparable because of numerous differences in product diversity, difference in functions and difference in business model as well as differences in accounting policies.

These differences cannot be adjusted by way of reasonably accurate adjustments. The Ld, TPO has failed to provide any justification in this regard, thereby confirming the appellant contention that if material difference cannot be adjusted, comparable has to be excluded.

It was further submitted that comparability cannot be established merely on the grounds of membership of IDSA. It should be noted that IDSA has a very diverse group of members and includes companies

I.T.A. No.4750/DEL/2015 26 which are engaged in Financial Services (for eg Max Life Insurance) and very large FMCG companies (for eg Hindustan Lever Ltd). It also has companies like Tupperware (dealing in plastic products) and Herbal Life (Nutrition of weight management). It is quite evident that all these companies have not been taken as a comparable despite being members of IDSA.

Further, in the case of Tupperware India Pvt Ltd vs DCIT fITA no, 2140/Del/20Hand the Delhi ITAT has considered non- direct sellers/ normal trading companies as comparables even though Tupperware is a direct seller.

In para 1.8 of the remand report, the Ld. TPO has stated that no adverse conclusion can be drawn regarding Modicare on account of the fact that there is a very big divergence between gross margin and operating profit margin and this fact by itself doesn't show difference in business model. It is submitted that Modicare Ltd. has a high gross profit margin and negative operating profit margin because it is incurring substantial operating expenses mainly by way of advertisements and marketing. The table below gives a comparative figure of the four financial years. Operating Profit (%) Gross Profit (%) Financial Modicare Ltd. (as Appellant Modicare Ltd. Appellant year determined by 2008-09 TPO) 76.47% 45.58% 1.14% -0.63% 70.33% 46.79% 4.99% 6.53% 2009-10 2010-11 67% 48.72% -0.26% 5.60% 2011-12 69.35% 45.31% -6.50% 5.89% It is submitted that under the transfer pricing guidelines (both under OECD as well as United Nations manual), the distributor which is engaged in significant advertisement and marketing cannot be compared with a routine distributor under resale price method

I.T.A. No.4750/DEL/2015 27 because of the value addition function carried out by the former. Please refer to para no 2.35, 2.37 and 2.38 of OECD TP Guidelines, 2017 and para no B,3.2.7.1 and B.3.2.7.2, B.3.2.9.6 of UN guidelines.

Same view has been taken by the Hon'ble Bangalore Tribunal in M/s. Abott Medical Optics Private Ltd. Vs. DCIT for AY 2007-08 (I.T.(T.P) A, No.lll6/Bang/2011) (Para 8, Page7-8), which has been further upheld in the same Appellant's case in AY 2008-09 in 2018 (I.T.(T.P) A. No.08/Bang/2014).

In para 1.9, the Ld. TPO has concluded that Modicare is an appropriate comparable to the Appellant both in terms of product comparability as well as business model. It is submitted that on both these accounts, the Ld. TPO has failed to rebut the elaborate contentions and evidence submitted by the appellant to show there are no suitable methods to carry out the adjustments to account ail these material differences. As per the established principles of transfer pricing endorsed by the Delhi High Court in Chryscapital Investor Advisors (India) Private Ltd. vs. vs. DCIT (ITA 417/2014) [2015], if reasonable adjustments are not possible to account any material differences then the comparable cannot be taken and has to be necessarily excluded.

Hence, in view of the significant differences in the product profile, functional profile and accounting difference between Modicare Ltd and Oriflame India it is not possible to make reasonable accurate adjustments as can be seen from the table above, Modicare Ltd. should be rejected.”

Particulars Other comparable companies selected by Oriflame India Modicare Ltd. the Somewhat as also have Buy-sell trading ✓ ✓ Franchise business model operations and service Diversified product profile with cosmetics comprising ✓ Trading in cosmetics ✓ only 12-18% over various years Sells through : ✓ ✓ ✓ intermediaries Incentives/Discounts ✓ X X accounted for below the gross profit

✓ ✓ Significant AMP expenses X

I.T.A. No.4750/DEL/2015 29 From the above table, it was contended that, a direct selling trader like the assessee is in all respects similar to any other trader except for the higher working capital requirement which a direct seller may have. This material difference can be adjusted by way of a reasonably accurate adjustment in the manner provided in the OECD and UN guidelines. Since a direct seller must store inventory in such a manner that it is able to match the demand of the customers through individual consultants, the inventory cost of a direct seller would ordinarily be higher than that of a distributor. Once an inventory adjustment using working capital adjustment is made to account for the working capital differences as per the standard adjustment methodology (accepted in India and globally) a direct seller stands at the same economic footing as any other trader/wholesaler/distributor. The OECD, UN manual and guidance note issued by the ICAI on Section 92, has approved this Working Capital adjustment approach. In para 2.1 to 2.5 of the remand report for FY 2008-09 (similar paras for other years under consideration), the Ld. TPO has stated that the companies adopted by the assessee as comparable should not be accepted as valid comparable under RPM because these companies are not dealing in cosmetics and are not operating under the direct selling model. She has further stated that reasonable adjustments cannot be carried out to account for all these differences. She has however accepted that working capital adjustment is I.T.A. No.4750/DEL/2015 30 possible and can be made to account for the working capital differences. It is submitted that the Ld. TPO in her remand report has arrived at the above conclusion despite accepting that the companies chosen by the assessee are not engaged in trading of similar products. It was further submitted that the Hon'ble High Court had endorsed arguments taken by the assessee with the difference between direct selling company and normal distributor is in respect of working capital. A direct selling company undertakes much higher inventory risk as compared to normal traders, who would be selling to another intermediary. Since this difference can be adjusted by way of a working capital adjustments using the method recommended by OECD and UN (and accepted by the Ld. TPO in here remand report), these comparable should be accepted after making working capital adjustments. The assessee humbly submits that it is an irony that on one hand, the selection of an non- comparable company for which adequate adjustments cannot be made has been upheld and on the other hand, companies on which comparability adjustments permissible in Rule 10B(3) can be made to bring them at par with the Appellant have been outrightly rejected.

I.T.A. No.4750/DEL/2015 31

I.T.A. No.4750/DEL/2015 32

I.T.A. No.4750/DEL/2015 35 Though it is not always necessary under resale price analysis that each product line distributed should be examined, but there should be broadly similar products so that gross compensation of the functions performed, that is, marketing and selling functions can be analysed. If reliable data for the various product and marketing strategy is not available, then accurate comparability adjustments would be very difficult to carry out. Another distinctive feature, which we have noted is that, Oriflamme India records the sale, net of discounts/ incentives paid to its agent/consultant and that is the reason why the gross profit margin is lower. On the other hand, in the case of Modicare Ltd. discount given to the consultants/agents has been categorized as ‘incentives’ which has been taken below the line in the Profit & Loss account treating to be a part of operating expenses. Because of the difference in accounting treatment, there is a gap between gross profit margin and net profit margin disclosed by the Modicare Ltd., which can be seen from the annual account that the gross profit margin of Modicare Ltd has been shown at 76.47%, whereas the net profit margin is at only 2.25%. Thus, there is substantial variance in the gross and net profit margin levels, which indicates that Modicare Ltd. is incurring heavy operating expenses and also substantiates heavy functions at the operating level. Further, Modicare Ltd. has significant AMP expenses of 7.32% which in the case of the assessee is only 0.94%. If a distributor is incurring substantial AMP expenses then it cannot be compared with I.T.A. No.4750/DEL/2015 36 routine distributor under RPM as it tantamount to value addition. This also goes to show Modicare Ltd. has different functions as compared to the assessee. There is also difference in the case of goods sold ratio and value-added expenses which is apparent from the fact that in case of Modi Care Ltd. the cost of goods sold ranges from 22% to 28% of its total operating cost and value-added expenses/operating expenses are more than 70%. Modicare Ltd. has also recorded franchisee expenses and hence it cannot be inferred wholly as a direct seller. In view of such differences, it would be very difficult to carry out adjustment especially with regard to the product portfolio, functional portfolio, etc. Adjustment if at all can be made would be to some extent of differential accounting treatment for incentive/ discount. Even the TPO in her remand report has unable to demonstrate incomparable product profile of Modi Care Ltd. and assessee and how the comparability adjustment is possible on account of such huge difference in product profile. Further, the service fee earned by the assessee is on account of renewal fees and handling fees received from the individual consultants, engaged in distribution of assessee’s product and directly related to assessee’s business. Whereas, the service fee earned by Modi Care Ltd. is on account of annual maintenance contract (AMC). This factor also vitiates the comparability analysis.

I.T.A. No.4750/DEL/2015 37 profile and other differences and lack of data for various factors, reasonably accurate adjustment cannot be made. as was directed by the Hon'ble High Court. Hence Modi Care Ltd. cannot be taken as a comparable company under RPM.

Order pronounced in the open Court on 15th April, 2019.