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Income Tax Appellate Tribunal, “K” Bench, Mumbai
Before: Shri Shamim Yahya (AM) & Shri Amarjit Singh (JM)
Per Shamim Yahya (AM) :- is an appeal by the Revenue directed against the order of learned CIT(A) dated 22.12.2010 and pertains to A.Y. 2005-06. ITA no. 8148/Mum/2010 and DRP pertaining to assessment years 2006-07 and 2007-08.
Since the issues are common and connected and the appeals were heard together, these are being consolidated and disposed of by this common order.
2 M/s. Lubrizol India Pvt. Ltd.
One common issue raised relates to the transfer pricing adjustment by the Transfer Pricing Officer by rejecting the TNMM method adopted by the assessee and replacing the same with CUP method. The transfer pricing adjustment made in this regard are as under :- Assessment Year Amount
2005-06 2,75,93,140 2006-07 6,42,78,560 2007-08 6,37,42,069
Since facts are identical we are referring to facts and figures from A.Y. 2005-06.
Brief facts of the case and transfer pricing officer’s observation are as follows :- The assessee is engaged in the business of developing, manufacturing and marketing additive systems for Automotive and Industrial Lubricants and for treatment of fuels.
A summary of international transactions is as under:
A.Y.2004-05 A.Y.2005-06 Sr. Transaction Amount Method Amount Destination Method No 1 Exports of chemical 8,83,03,672 TNMM 22,55,18,766 Various TNMM additives countries 2 Commission for customer 25,97,102 TNMM 44,76,749 USA TNMM service support activities Total Receipts 9,09,00,774 2,99,95,515 3 Imports of intermediate 42,10,25,864 TNMM 48,32,87,438 USA, France TNMM and raw materials and Singapore 4 Royalty 10,88,88,386 TNMM 11,57,86,095 USA TNMM
Import of finished goods 1,52,01,954 TNMM 1,33,32,339 France TNMM
Total Payments 54,51,16,204 61,24,05,872 Export of chemical additives Rs. 22,55,18,766 :-
3 M/s. Lubrizol India Pvt. Ltd.
During the year under consideration the assessee company has exported chemical additives aggregating to Rs. 22,55,18,766. To determine the arms length price of this transaction, the TNMM has been used. During course of TP proceedings the assessee company was asked to furnish the details regarding purchase and sale of products as under: a. Name of the material/chemical sold/purchased b. Rate charged to the third party c. Quantity d. Total value
In reply to the above query by TPO, it has been submitted that during the year the assessee company has sold two products in export as well as domestic markets. The details are given as under: Product Qty. MT Rate, Rs./Mt Total value, Rs. Lacs EXPORT MARKET LZ 9222 362.57 78179.62 1578.52 LZ 6499 1757.19 73700.89 DOMESTIC MARKET LZ 9222 100.97 84405.53 167.42 LZ 6499 93.28 88119.26
From the above table TPO observed that it is clear that there is difference between the rates charged to the AEs and to the domestic parties (Non AEs). The difference is worked out as under: Products Qty.MT Difference / Mt (Rs.) Value of difference (Rs.) LZ 9222 362.57 6225,91 22,57,328.19 LZ 6499 1757.19 14418.37 2,53,35,815.58 TOTAL 2,75,93,143.58
To explain the above difference in the rates, the assessee has explained that the following factors have been kept in mind at the time of negotiating with the foreign buyers while fixing the prices. a. Spare capacity available with us after meeting the domestic demand. b. Export incentives available to the company in the shape of Advance License and Tax benefits, etc. c. Quantum of sales as compared to Domestic Sales of similar products.
4 M/s. Lubrizol India Pvt. Ltd.
The TPO was not convinced. He found that the explanation offered is very vague. Upon noticing difference in the prices, a show-cause notice dt.17.10.2008 was issued to explain as to why the arm's length price be not adjusted taking into account the prices charged to the unrelated parties. In reply the assessee objected to the modification in the arm's length price determined by it. The gist of objections is as under:-
“Merely the rate for metric ton charged for the products viz. LZ-9222 and LZ- 6499 cannot be compared without considering the factors that affect the comparability:- a. Geographical market:- The controlled transactions have taken place with enterprises located in France, Japan, Singapore, Brazil etc while the uncontrolled transactions have been entered into in the domestic market of India. b. Volume of sale of products:-
Product Qty sold to AE Qty sold to non-AE
LZ 9222 362.57 MT 100.97 MT LZ 6499 1757.19 MT 93.28 MT The volume of the products sold to the related parties is substantially higher than that sold to the domestic customers. The impact of such volumes on determination of prices needs an adjustment. c. Export benefits:-
The assessee has received export benefits by way of advance licenses on account of sales to related party which are not available in case of sales to domestic customers. d. Risk adjustment:-
There is no bad debt risk of the exports made to related parties as opposed to sales to unrelated customers.
No marketing function carried out on sales to related party.
Inventory carrying cost:-
If the above-mentioned export was not made to the related party, the assessee would have to incur inventory carrying cost till the time such huge quantities are disposed off in domestic market.
5 M/s. Lubrizol India Pvt. Ltd.
Spare capacity utilization and economy circumstances:- Till 1991, the assessee was enjoying almost monopolistic position. Thereafter, the assessee started facing stiff competition in the domestic as well as international market. The assessee has further tried to demonstrate that its sales have gone down and the demand for the additives is less than the installed capacity. Therefore, the assessee has utilized the idle capacity by exporting to reduce the operational cost. The costs may take various forms like normal wear and tear, depreciation, wages etc. The exports also enable the assessee to have a broader market base by reducing the dependence on the domestic market.”
The assessee has further submitted that it is not possible to carry out an effective quantification of the differences. However, it has attempted to adjust the benefits on account of advance licenses.”
On the strength of its details and arguments, the assessee has pleaded that TNMM is the most appropriate method to be applied and no other method can be applied for benchmarking the transaction relating to export of goods. This has also been accepted by the Revenue in the earlier years.
However, transfer pricing officer was not convinced. He noted that the assessee had already been selling the products the unrelated parties. Hence, he held that those prices will be benchmark for negotiation with a related party too. He summarily rejected the assessee’s contention that certain other factors as indicated above like geographical market, volume of sales, export benefits, risk adjustment, inventory and spare capacity are to be taken into account by observing that these have to be quantified by the assessee. Further he held that transactional net margin method is not foolproof. Hence, he held that the application of TNMM is not justified.
Upon assessee’s appeal in A.Y. 205-06, learned CIT(A) accepted the contention of the assessee and rejected the Assessing Officer’s rejection of assessee’s TNMM method by an elaborate order as under :- “9. I have considered the submissions furnished by the Appellant, grounds of appeal and statement of facts along with various documentary evidences furnished by the Appellant. The observations made by the TPO in his order have also been considered.
6 M/s. Lubrizol India Pvt. Ltd.
10. TPO erred in not appreciating that, the assessee during the relevant period had performed a scientific analysis for selection of the Most Appropriate method having regard to the provisions of the rule 10B of the Income Tax Rules, 1962 (Rules). The TPO has further erred in considering CUP as the Most Appropriate method to benchmark the export of Chemical Additives disregarding the rules laid down in Rule 10B (2) and Rule 10B (3) of the Rules, which are a prerequisite, were not considered for application of CUP method. The TPO failed to take into account the huge difference in volume between sales to AE and Nor AE. In respect of one product, it is more than 300% times while in another it is more than 1700%. Such huge difference in volume pre-empts any application of CUP.
Besides the TPO also failed to take into account the geographical difference in sales to AE and Non AE. A market price depends on identical product and same geographical region. In the present case, the regions too are different. While the A.E's are in France, Japan, Singapore, Brazil, the independent third parties are based in India. Thus the two essential pre- requisites (similar volume and region) for adoption of CUP is not satisfied. The Mumbai ITAT decisions in Dufon Laboratories (Volume) and Intervet India P.Ltd. (Region) also support the appellant's position and makes the CUP untenable.
11 Coming to the TNMM adopted by the appellant, the entity level cost plus margins of the appellant are favourable higher vis-a-vis its comparables. Further the appellant was directed u/s 250(4) of the Income Tax Act, 1961 to submit the financials of Indian Additives Limited ("IAL") which was found as a closest comparable company. Therefore the assessee had submitted the financial analysis of IAL for the year ended March 2005. IAL is engaged in the business of manufacturing and sale of lubricating oil additives which is identical to the appellant's business activities. However in the Transfer Pricing report, IAL was rejected on subjective quantitative criteria of sales less than 150 crores. The operating margin comes to 5.05% as opposed to 13.27% of the appellant.
12 On the directions u/s 250(4), the appellant also submitted afresh search by taking 'Lubricants' as the economic activity. This search demonstrated that the appellant (13.27%) is earning more than the industry average (6.77%).
Particulars LIPL As per TP study report 13.27% 8.81% As per TP study report (updated margins) 13.27% 7.27% Comparison with IAL 13.27% 4.76% Comparison with Lubricants industry 13.27% 6.77% 13 It is obvious from the exercise undertaken at this level that appellant's margin are far better than its only identical comparable Indian Additives Ltd. Even if one takes the Generic Lubricant Industry, the margins of the appellant is double that of arithmetic mean of the comparables. As such,
7 M/s. Lubrizol India Pvt. Ltd. based on this comprehensive comparable analysis under TIM MM, it is held that the appellant's transactions are at Arms Length. The consequent adjustment of Rs. 2,75,93,140/-, is therefore deleted.”
For A.Y. 2006-07 and 2007-08 learned CIT(A) had upheld the action of TPO. As regards assessee’s objection to change of the method from consistently applied TNMM method to the cup method, learned DRP without any elaboration simply upheld the TPO order. However, it provided some directions accepting the assessee’s plea for adjustment for packing cost.
Against the above order assessee and Revenue have filed appeal before the ITAT. We have heard both the counsel and perused the records. We find that assessee has been consistently applying TNMM method for transfer pricing benchmarking as in the past earlier years. The same has been duly accepted by the Department. In the present assessment year the Assessing Officer has rejected the same without brining on record any cogent material as to why the facts are different from earlier assessment years. The main reason for the Assessing Officer in rejecting the TNMM method is his finding that the assessee has also transactions with unrelated parties. However he has summarily rejected the assessee’s contention that there are various factors which have to be taken into account and adjustment thereof will have to be required for a comparable analysis with those parties. The Assessing Officer has not given reasons for rejecting the contention. However he has held that the onus was upon the assessee to quantify the adjustment. He has also held that TNMM method is not foolproof.
For A.Y. 2005-06, learned CIT(A) has rightly rejected the Assessing Officer’s change of method. We find that consistently applied method should not be rejected without bringing on record cogent reasons. We also note that the facts in the present year are not different. It is also not the case that there is change in any fact or law. As a matter of fact assessee’s objection to the change of method by submission that there are various factors which make the comparison to the parties incomparable has not been rejected by the TPO.
8 M/s. Lubrizol India Pvt. Ltd.
Rather he has held that onus was upon the assessee to quantify the difference. By no stretch of imagination this observation by the TPO can help in rejection of TNMM method applied consistently in earlier year and accepted by the Revenue. The TPO’s bland observation that TNMM method is not foolproof by no stretch of imagination permits the TPO to change the method. In this regard the Tribunal in the case of Omni Active Health Technologies Ltd. (92 taxmann.com 88) and Glenmark Pharmaceuticals Ltd. (102 taxmann.com 438) has elaborately considered such change in method without cogent reasons. In the case of Omni Active Health Technologies Ltd.(supra) Tribunal had held as under :-
“27. We have carefully considered the submissions and all the relevant records have been perused. We find that the first objection of the ld. Counsel of the assessee is that in the preceding years, for three years transactional net margin method was used to bench mark the international transaction. In the present assessment year, the Transfer Pricing Officer noted that the assessee has adopted transactional net margin method for determining the arms length price for export of finalised goods to the Associate Enterprises. During the course of assessment proceedings, the Transfer Pricing Officer proceeded with the same and also asked the assessee to provide an updated margin of the comparable selected. The updated margin was given to the Transfer Pricing Officer. From the computation of updated margin also, the PLI of the assessee come to 15.21% which was higher than the PLI of the two comparable companies. Hence, from this analysis of updated comparables also, the transaction was found to be at arm's length. At this juncture, the Transfer Pricing Officer changed his tracks. He observed that no verifiable data has been provided to substantiate the method used. He further held that CUP would be a more appropriate method to bench mark the sale transaction. The assessee objected to the same. In the objections, the assessee also relied upon the OECD guidelines and the ITAT decision in the case of Welspun Zucchi Textiles Ltd. Vs ACIT. However, the Transfer Pricing Officer summarily rejected and held that the application of TNMM is the method of last resort when the comparable price method cannot be applied. However, he noted that in the assessee's case since the comparable price for the same or similar products to the third parties has been provided by the assessee, the same has to be considered for bench-marking this transaction. Accordingly, Transfer Pricing Officer proceeded to apply the CUP method for bench marking. The assessee's objection in this regard was also by the DRP when it held that it was of the opinion that when internal CUP is easily available, the TNMM is to be treated as method of last resort.
From the above discussion, we find that the Transfer Pricing Officer has rejected the consistently applied TNMM method without bringing on record any cogent reason. It is the settled law that the consistent method followed
9 M/s. Lubrizol India Pvt. Ltd. can be changed only if there is a change of facts or law. There are various decisions of Hon'ble Apex Court in this regard including that from Radhasoami Satsang (supra). In the present case, there is no case that there is a change of law or there is a change in fact. It is also not the case that TNMM method which has been consistently applied in past was totally wrong method. In this regard, we may gainfully refer to the relevant provisions contended by the Transfer Pricing Officer as under: i. 92C Computation of arm's length price 2) The arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe namely :-
(a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board.
3) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed; Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices. ii. Rule 10C of the Income-tax Rules, 1962 ("Rules") states that:
(1) For the purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction provides the most reliable measure of an arm's length price in relation to the international transaction.
(2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely:-- (a) the nature and class of the international transaction; (b) the class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises;
10 M/s. Lubrizol India Pvt. Ltd.
(c) the availability, coverage and reliability of data necessary for application of the method; (d) the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method. iii. Rule 10B of the Income-Tax Rules, 1962 ("Rules") states that:
(1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :-- (e) transactional net margin method, by which,--
(i) the net profit margin realised 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 or having regard to any other relevant base;
(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;
(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);
(v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction
Thus from the above, it is evident that the arm's length price in relation to an international transaction is to be determined by one of the prescribed methods which is most appropriate method having regard to the nature of transaction, class of transaction, class of associated persons, functions to 11 M/s. Lubrizol India Pvt. Ltd.
form by such person, or such other relevant factors. Section 92C(2) provides that it is only the appropriate method as referred to in section 92C(1) which can be applied for determining arm's length price in the prescribed manner. The choice of method on the basis of which arm's length price is determined has to be exercised on the touch stone of principles governing selection of most appropriate method set out in section 92C(1). The legislature does not provide for an order of preference of method of determining of arm's length price. Now once an appropriate method for determining the arms length price has been chosen and accepted by the Revenue consistently over a number of years, there has to be some cogent reason to make it departure from the consistent method. We do not find that any case has been made out by the Transfer Pricing Officer or the DRP that there was an error committed earlier when the TNMM method was chosen and approved. The Transfer Pricing Officer while justifying the change stated that in T.P. report assessee has bench marked the transaction under TNMM, verifiable data has been provided to substantiate the method used. Hence, from the above discussion, we find that no cogent reason has been pointed out by the authorities below that the TNMM method applied earlier was not in accordance with the mandate of law as above.
It is settled law that resjudicata does not apply to taxation proceedings but it has fairly often been held by the higher courts including by the Hon'ble Apex Court that the consistency should be maintained in the assessment proceedings. A consistently applied method can be changed only if there is a change in facts and law. In the present case, we find that there is no such case has been made out. Rather the Transfer Pricing Officer has proceeded to examine the issue on the basis of TNMM method. He has ordered for updated data of comparable. Thereafter, when even on the basis of updated data, the international transaction was found to be at arm's length, he laconically held that CUP method would be preferred. The DRP had summarily upheld the change from TNMM to CUP method without assigning any cogent reason whatsoever. By no means it is justified to keep on finding a method for addition by trial and error method. Accordingly, on the anvil of aforesaid Hon'ble Apex Court's decision as discussed hereinabove, we hold that there was no justification in rejecting the TNMM method applied by the assessee as in the preceding year. Since as per the same computation the assessee's margin was found to be at arm's length, we set aside the order of authorities below and decide the issue in favour of the assessee. Since we have already allowed the assessee's appeal on this issue, for lack of justification in changing the method of bench marking we are not dealing with the arguments on other aspects of merits of application of CUP method computation of arms length price by the Transfer Pricing Officer in this case. The case law referred by the ld. Departmental Representative are distinguishable on the facts of this case.”
In our considered opinion the aforesaid reasoning fully applies to the facts of the present case. Without any change in facts and law the Transfer Pricing officer has changed the consistently applied TNMM method to the cup method. While doing so he has blandly held that TNMM method is not full
12 M/s. Lubrizol India Pvt. Ltd. proof. Furthermore the assessee's objection that the comparison of other transactions have to be considered by adjustment of various factors is also not fully dislodged.
In the background of the aforesaid discussion and precedent we hold that the change in method from TNMM to CUP method is not justified. Hence, we set aside the order of the Assessing Officer. Accordingly, the order of learned CIT(A) for A.Y. 2005-06 is upheld and the order of Assessing Officer pursuant to DRP direction for A.Y. 2006-07 and 2007-08 is set aside.
Other issues raised in assessee’s appeal relates to adjustment for tax deducted at sources. These are consequential and Assessing Officer shall consider the same.
In the result, Revenue appeal is dismissed and assessee appeals are allowed. Order has been pronounced in the Court on 20.11.2019.