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Income Tax Appellate Tribunal, DELHI BENCH “I-2” NEW DELHI
Before: SHRI AMIT SHUKLA
PER AMIT SHUKLA, J.M.: In all the aforesaid appeals, the common issue involved relates to determination of arms length price of the “indenting transaction” of the assessee with its AE for various Assessment Years impugned before us, arising out of remand order passed by the Hon’ble High Court. Since common issue is involved arising out of identical set of facts permeating in all these years, therefore, same were heard together and are being disposed of by way of this consolidated order.
Background and Facts of the case
Before deciding the appeals on merit, it would be relevant to discuss the brief facts and background of the case, because appeals for the Assessment Years 2007-08 to 2010-11 have been 2 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 remanded back by the Hon'ble Delhi High Court vide its consolidated order and judgment dated 22.07.2016 passed in & 382/2012, 702/2014 and 738/2015, with certain directions. Appeal for the Assessment Year 2011-12 is arising out of final assessment order dated 31st December, 2015 passed u/s.143(3) r.w.s. 144C(13) of the Act in pursuance of DRPs direction vide order dated 23.11.2015. The assessee company, i.e., Sumitomo Corporation India Pvt. Ltd. is a wholly owned subsidiary of Sumitomo Corporation Asia Pte Limited. Sumitomo Corporation Japan is an ultimate holding company of the group. The assessee company in India is engaged in the business of providing trade facilitation and support services and such support services are provided across the products and service lines both to associated enterprises and unrelated parties. The business transaction of the assessee falls broadly into two categories; • firstly, indent/commission transactions wherein the assessee earned commissioner/fixed service fee; • secondly, the trading transactions wherein the assessee purchases and sells goods and earns trading profit thereon.
2.1. The ‘indent transaction’ comprises of the predominant part of the assessee business in all the years as compared to the ‘trading segments’ which is quite small wherein imports and exports of goods into/from India are affected on principal to principal basis. In the transfer pricing report, the functional profile regarding indent transaction have been stated that assessee acts as a mere facilitator and service provider for which it earn commission and therefore, such transaction involved relatively very low functional activity with minimal risk. Only risk is on these
3 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 transaction is volume risk or customer risk, i.e., the turnover of this business may not be sufficient to cover the costs. The functions of indent transactions are mainly maintaining close contacts with suppliers to ensure timely delivery of merchandise to the customers, in the quantity and grade desired for exports. Maintaining close contacts with AE’s customers in India to understand their needs for imports; communicating with AE or its affiliates; gathering information on demand and supply conditions of these commodities in India; and liaising with government or industry groups. The income arising from indent transaction is in the nature of service/commission income. The functions highlighted in the transfer pricing study report were as under:
“Sumitomo India is organized under commodity wise departments, while providing marketing support services to Sumitomo Group. Sumitomo India provides marketing support transactions, pertaining to the trading of goods by Sumitomo Group. The commissions earned by Sumitomo India will be from: • Imports into India Exports from India Sumitomo India with offices in Delhi, Mumbai and Chennai, provides marketing support services to its AEs. Sumitomo India handled different products and commodities during the year 2006-07 through its seven operating divisions with eleven departments. Sumitomo India merely provides marketing support services under indent sales. These transactions involve low-level activity and relatively limited risks for Sumitomo India in comparison to typical Indian export/ import companies. Sumitomo India provides services in respect of both exporting and importing of goods from and to India. Regardless of the type of transaction Sumitomo India acts as an intermediary in pursuing business opportunities for its customers, including local purchases, suppliers and related Group companies.
4 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
Under the Imports to India Sumitomo Group procures goods from the Japanese and/or other countries [collectively "Overseas Supplier") supplier and exports the same to the end customer in India. The contract is between Sumitomo Group and the overseas suppliers for the supplies and with the Indian customer for the sale. Since the customers are located in India, Sumitomo India maintains the relationships with the customers and based on the requirements of the local market informs to Group Companies. In most of cases the customers being traditional, the marketing efforts in identifying the customers are also minimal. The customers and Sumitomo India gets in touch with each other for the requirements and accordingly Sumitomo India informs its Group Companies. The negotiations with the suppliers and customers are undertaken by Sumitomo Group. Sumitomo India acts as conduit for passing the information between Sumitomo Group and the customers. Under the Exports from India the customers are located overseas and the suppliers are located in India. Sumitomo India maintains the relationships with the supplier on regular basis. Sumitomo Group helps in identifying the various customers and accordingly informs Sumitomo India for the requirements. Sumitomo India helps in connecting the supplier with Sumitomo Group. In general for the current year, Sumitomo India's trading transactions can be classified into two groups - indent sales and proper sales. Indent sales can also be classified into import from other country into India, export from India into other country. On its indent trading transactions, Sumitomo India's role is that of a mere service provider. Therefore, Sumitomo India never takes title or possession of the merchandise at any moment and bears no inventory risk. Accordingly, Sumitomo India provides marketing support services for facilitating both exports and imports in India through Sumitomo Group and other Group Companies. The support services include gathering information about customer requirements, products, local prices, market trend, etc. Sumitomo India has entered into various arrangements with different subsidiaries of Sumitomo Group and the main services among others include the following: • Networking with buyers and suppliers of steel
5 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
• Support in after sales services, business promotion • Collection of market information • Provide knowledge & experience • Coordination with customers • Collection of Account Receivables from client on behalf of AE • Administrative Services • Other support services Sumitomo India provides marketing support services to Sumitomo Group. Sumitomo India handles different products and commodities through its different commodity departments. Sumitomo India's main function in indent sales business is to maintain close contacts with the suppliers to ensure timely delivery of merchandise to the customers, in the quantity and grade desired (for exports); maintaining close contacts with Sumitomo Group's customers in India to understand their needs (for imports); communicating with Sumitomo Group or its affiliates; gathering information on demand and supply conditions of these commodities in India; and liaising with government or industry groups.”
2.2. Regarding assets deployed, it was stated that the business of the assessee does not require much assets and does not have significant tangible asset and only intangible asset is in the form of software use for its operation. Even under the risk profile also it was stated that it bears very minimum and is a low risk provider engaged in trade facilitation.
In the transfer pricing approach followed by the assessee to determine the ALP of the functional transaction, the assessee after characterizing itself as a low risk service provider has adopted TNMM as the most appropriate method with ‘berry ratio’ as PLI to compute the ALP. The ‘berry ratio’
6 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 was taken as gross profit/operating expenditure. Choice of TNMM over the other methods including CUP was also analyzed in detail in the transfer pricing report for all the years. For the Assessment Years 2010-11 and 2011-12, though the PLI was taken as ‘berry ratio’ however, it was adopted by taking profit/value added expenditure which in fact was a measure the return on operating expenditure. Accordingly, set of independent and uncontrolled entities were selected from data base and the average profit margin of these companies were compared with that of the assessee and since the assessee profit margin was found to be better as compared to the comparables, hence it was reported that the international transaction undertaken by the assessee with its AE were arm’s length.
The transfer pricing officer rejected the approach adopted by the assessee and without specifically rejecting the TNMM, mainly disapproved the PLI on the ground that it does not take into account of the FOB value goods transacted to the assessee and did not take into account the intangible created by the assessee. He held that assessee is creating valuable and human supply chain tangible which is benefitting the AEs and the independent transaction were akin to trading transaction, and therefore, gross profit margin rate earned with unrelated parties, i.e., non AE segment should be taken as ALP of the commissioned transaction. He was of the opinion that assessee-company had been allowed to earn a meager commission income despite having
7 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 undertaken significant risk and having created intangibles. He further observed that huge location savings have been generated to the advantage of the AEs for which the assessee has not been compensated. The TPO, in his conclusion, has re-characterized the indent transactions as trading transactions and held that for the gross profit margin earned by the assessee from the unrelated parties should be the bench mark arm’s length commission rate which assessee earned at the FOB value of goods transacted through it. For the Assessment Year 2011-12, the TPO instead of using the GP margin of the non AE trading segment of the assessee has identified trading companies as comparables and adopted their mean GP margin as the basis of arm’s length price. The reason being in this year, the GP margin in non-AE segment was lower than the profit margin earned by the AE indent segment. This led to the adjustments of the transfer pricing of the commission and service fee received by the assessee from its AEs leading to huge additions of varying amount in all the five years. In so far as trading segment is concern, the same was accepted by the TPO to its arm’s length.
The DRP for the Assessment Years 2007-08 to 2010-11 has upheld the approach of the TPO without any variation. However, in the Assessment Year 2011-12, the DRP has disagreed with TPO’s approach of determining the ALP of the indent transactions by re-characterizing them as trading transactions. It was held that the method mandated by the Tribunal in the Assessment Years 2007-08 to 2010-11 was 8 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 the most suitable method and directed the TPO to apply the same and benchmark the ALP of the indent transaction.
In the Assessment Years 2007-08 to 2010-11, the matter had reached up to the Tribunal, wherein the Tribunal has rejected the approach adopted by the TPO and held that indent and trading transactions cannot be treated as comparable on account of dissimilar functions, assets and risk involved in the two types of transactions and therefore, such a re-characterization was not permissible under law. However, the Tribunal has adopted altogether a different approach to determine the ALP of the Indian transaction with the AEs. It was held that average commission rate of non AE segment should be taken as the ALP for the commissioned transaction of the AEs segment. In other words the AE and non AE transaction were directed to be benchmarked to determine the ALP of indent transaction. Though explicitly it was not stated that it is a CUP method, however in fact CUP method was followed to determine the said transactions. One important fact to be noted here is that, in the Assessment Year 2010-11, after giving effect to the ITAT order, the transaction entered by the assessee with its AE was found to be at arm’s length and no addition/adjustment to the ALP has been made, for the reason that the average commission rate earned by the assessee in respect of Indian transaction with AE was higher than the commission rate earned from the non AEs and consequently the adjustment to the ALP was found to NIL.
9 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
The assessee aggrieved by the order of the Tribunal right from the Assessment Years 2007-08 to 2010-11 went in appeal u/s.260A before the Hon'ble High Court. The Hon’ble High Court vide its consolidated order and judgment dated 22.07.2016 had threadbare analyzed and discuss this issue. The substantial question of law formulated by the Hon'ble High Court for its adjudication read as under: “(1) Whether the Income tax Appellate Tribunal was right in applying and computing arms length price with associated enterprise on indenting transactions by applying average rate of commission with non-associated enterprise in spite of difference in the turnover and the purported segments and no such correction/computation on this account was made by the Transfer Pricing Officer? (2) Whether the Income Tax Appellate Tribunal has disregarded the assessee’s claim that they had followed Transactional Net Margin Method? (This question will include the submission of the appellant that the Transfer Pricing Officer’s order does not adopt any specified method).”
7.1 After discussing the entire facts, arguments placed by the parties and considering the relevant provisions of the law, Their Lordships opined and held as under:
“31. The Assessee had, for reasons indicated in its transfer pricing report, adopted TNMM as the most appropriate method with Berry ratio as the PLI. Although, the TPO found fault in the use of Berry ratio - according to him, the same was not permissible under Rule 10B(1)(e) of the Rules - he did not proceed to select the most appropriate method for computation of ALP. This, in our view, would be essential as the reliability of the determination of the ALP is in turn dependent on the effectiveness of the method in relation to the controlled transaction being tested. In the present case, the dispute essentially relates to the 10 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 commission earned by the Assessee in respect of transaction with its AEs.
We are inclined to accept Mr Agarwal's contention that although the TPO had discarded the method adopted by the Assessee, it had not followed any particular method in making the ALP adjustment. It appears that the TPO has adopted a hybrid method. He imputed the character of trading transactions to the indenting transactions entered into by the Assessee with its AEs. Having done so, he compared the profit margin realized by the AE from such transactions with profit margin realized by the AE from a comparable uncontrolled transaction. The said approach was rejected by the Tribunal - and, in our view, rightly so - as it was not permissible for TPO to re- characterize the tested transaction.
We find no infirmity with the Tribunal's finding that indenting transactions reported by the Assessee were plainly in the nature of facilitating trade where the Assessee was required to do nothing more than to follow up the customers for facilitation of the transaction. The Assessee was not required to raise any invoice for sale and purchase and its financial commitment and risk were inconsiderable.
However, we find that the Tribunal erred in proceeding to determine the ALP on the basis of the rate of commission reported by the Assessee in respect of indenting transactions with Non-AEs, without further examination as to the similarity between the two transactions. The Tribunal effectively used the CUP Method for imputing the ALP of Assessee's indenting transaction with AEs. This may well be the most appropriate method to be used for determining the ALP. However, if the Tribunal thought that this was the case, it was necessary for the Tribunal to conduct a further in-depth inquiry as to the relevant uncontrolled transactions. It is well settled that in applying the CUP Method, a very high degree of similarity between the 11 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
controlled and uncontrolled transactions is required. It is the Assessee's case that volume of such transactions in the Non-AEs segment was insignificant as compared to the transactions in the AE segment against such transactions were only in a few product categories. If the average rate of commission on such transactions was to be applied to the FOB value of the goods involved in the indenting transactions with AEs, the Tribunal would have to satisfy itself that there is no significant variation in the rate of commission between different products. This would confirm that the dissimilarity between the product categories did not have a vital bearing on the rate of commission. The Tribunal did not conduct any such enquiry and it is material to note that the TPO also did not conduct any such exercise. In our view, this methodology was used by the Tribunal at a stage at which - given the extent of the examination required - it may not be feasible.”
7.2. In so far as the use of ‘Berry ratio’ of PLI is concerned, Their Lordships held that the same is permissible under the Rules and where operating expenses is considered as a relevant base then there would be no difficulty in using ‘berry ratio’ as PLI in terms of Rule 10B(1)(e) of the Rules. From the aforesaid observations of the Hon'ble High Court, the infirmities highlighted in the Tribunal’s order can be summarized as under: a) The Tribunal erred in proceeding to determine the ALP on the basis of the average percentage of commission reported by the assessee in respect of indenting transactions with non-AEs, without further examination as to the similarity between the two transactions. (b) The Tribunal effectively used the CUP method for 12 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 computing the ALP of Assessee’s indenting transaction with AEs. (c) This may well be the most appropriate method to be used for determining the ALP. However, if the Tribunal thought that this was the case, then it was necessary for the Tribunal to conduct a further in-depth inquiry as to the relevant uncontrolled transactions. (d) It is the assessee’s case that volume of such transactions in the Non-AEs segment was insignificant as compared to the transactions in the AE segment, because such transactions were only in a few product categories. (e) If the average rate of commission on such transactions was to be applied to the FOB value of the goods involved in the indenting transactions with AEs, the Tribunal would have to satisfy itself that there is no significant variation in the rate of commission between different products. This would confirm that the dissimilarity between the product categories did not have a vital bearing on the rate of commission. (f) The Tribunal did not conduct any such enquiry and it is material to note that the TPO also did not conduct any such exercise.
Thus, in the wake of aforesaid direction of the Hon'ble High Court, this Tribunal is required to examine the similarity of the indent AE transactions for each of the Assessment Year and to see whether the higher standard of comparability required under the CUP method are met or not.
13 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
Arguments by the parties and our Decision
We have heard both the parties and also perused the relevant findings given in the judgment of the Hon'ble High Court and the orders of the authorities below. Now our endeavor would be to examine the facts and material on record based on the guidelines and the directions given by the Hon'ble High Court, as to; firstly, under the facts and circumstances whether the CUP can be applied by taking the average commission rate of non AE segment to adopt at arm’s length bench mark for AE indent segment; secondly, if after considering the high standard of comparability analysis required under the CUP method, gets failed, then whether TNMM can be considered to be the most appropriate method; thirdly, if TNMM is considered as MAM, then whether ‘berry ratio’ can be taken as PLI as the Hon'ble High Court has otherwise held that ‘berry ratio’ is a valid PLI which is permissible under the provisions of the rules contained in Section 10B(1)(e).
The assessee before us had filed various charts giving details of the products and transaction undertaken with the AE and non AE to demonstrate that the nature of transactions with AE and non AE in indent segments are completely dissimilar and incomparable. For example, in the Assessment Year 2007-08, Ld. Sr. Counsel, Shri C.S. Agrawal
14 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 pointed out from the details filed before us that the assessee has dealt in ten different product categories, comprising of Automotive, Chemicals, Electronics, Food and Fertilizer, Minerals, Power, Steel, Telecommunication, Textiles and Transport. In each of these product categories, there were numerous products that have been transacted. For instance, under the product category, ‘automotive’, the major products transacted were automobile, equipment, industrial machinery and spare parts, etc. All these products were transacted only in the AE indent segment and not in non-AE segment, i.e., there were no unrelated party transactions in these products. Similarly from the details pertaining to the ‘chemical’ product category, it was shown before us that the products dealt with the AE indent segment were completely different from the products transacted in the non AE segment. For instance, in AE segment, assessee has transacted the items like, potassium manufacturing products, polypropy, resin, acrylic resin, aromatic hydrocarbon, pesticides, thermoplastics, adhesive paints, dyestuff and pharmaceutical intermediates. In the non AE segment, the products transacted were inorganic, industry chemicals, dimethyl terephalate, adhesive and paints. While most of the products dealt were different barring two products, viz., the pharmaceutical intermediates and adhesive and paints. Despite this similarity of two products, it was pointed out by him that the unrelated parties who had transacted with the assessee in pharmaceutical intermediates and adhesive and paints were in India as 15 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 against the AEs who had dealt with the same product located overseas. Thus, it was submitted by him that volume, contractual terms and description of products differed within the same product distribution. Our attention was also drawn to various invoices on sample basis to show the difference in volume and products. The entire thrust of the ld. Senior Counsel was to show that there are huge product and geographic dissimilarities besides the difference in volume, value and exact product description. Mr. Agrawal submitted that the Hon'ble High Court had categorically observed that average commission rate of non AE segment can only be adopted as arm’s length bench mark for AE indent segment, only when it can be found that volume and product are same and if there are huge variation in commission rate across various products and product categories in the non AE segment, then same cannot be compared. The entire endeavor of Mr. Agrawal after referring to the various charts and details for all the years has been that, not only there is a wide variation of commission rates in the non AE segment but also the product category dealt with the assessee in the non AE segment were far less in number as compared to the indent segment in each of the Assessment Year and therefore, by any stretch it would be unfair to compare the commission rate of transaction of small value/volumes with the commissioned rates earned on transaction with value and volumes multiple times higher. The AE indent transactions were invariably much bigger and higher. The striking dissimilarities
16 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 highlighted by the learned counsel in his written submissions with reference to the material placed before us were as under: “a) Dissimilarity of the products, i.e., the products intended with non AEs are dissimilar in as much as in many of the product segment, there are no transactions with non-AEs, though there are indent transactions with AEs. Where there are transactions with Non-AEs such transactions are of much smaller value and very few in numbers as compared to the transactions with the AEs. b) The transactions which had been entered into with AEs and non-AEs are not identically entered as they are on different dates and of different volumes which effect the margin of commission depending upon the day to day transaction entered by the assessee with non-AEs. (c) The commission rates within Non-AE segment vary a lot from product to product and from date to date. In some cases even in the same product and on the same date the commission rate varies (e.g. Commission on sale of Dimethyl Terephalate on 1-7- 2007 to two different parties has resulted in commission rates of 0.39% and 0.43%). Some of the products like Atenolol has yielded commission rate of 7.14% and on the other hand several products have yielded commission rates of less than 1%. A similar variation can be seen in the AE segment. Accordingly, it is quite clear that averages cannot be taken for an appropriate comparison. d) Geographical locations of the AEs are different as compared with geographical locations of the non-AEs. From the perusal of the details regarding the controlled and 17 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 uncontrolled indent transactions, it can clearly be seen that there is a complete dissimilarity between them on account of different product lines, for different periods, different geographical locations and in many of the products there are no transactions at all.”
After drawing our attention to the factual aspects of the ‘indent transactions’ between the AEs and non AEs segments for all the Assessment Year impugned before us, Mr. Agrawal referred to the OCED and the UN commentaries/guidelines on Transfer Pricing to show how higher degree of comparability is required while applying CUP at transactional level and such higher degree of similarity between the transactions in terms of products, contractual terms, volume, value, markets and geographic locations are required to be seen.
One very important fact brought to our notice by Mr. Agrawal was that, Advance Pricing Agreement (APA) has been signed by the assessee and the CBDT on 02.08.2016 in respect of assessee’s indent transaction with its AEs which is applicable for the Assessment Years 2014-15 to 2018-19 and Assessment Years 2011-12 to 2013-14. Under this APA, the CBDT has agreed to treat the assessee as a low risk service provider and has agreed to apply TNMM as the most appropriate method to determine the ALP of the international transactions of the indent and trading transactions. The APA contains a detailed FAR (functions, assets and risks) analysis and it was pointed out that the FAR of the assessee has 18 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 remained the same over the years and therefore, such an agreement also justifies the assessee’s contention that TNMM should be the MAM for bench marking this segment. One of the appeals before us pertaining to A.Y. 2011-12 is thus stated to be covered by the said APA. In this background, the assessee has also amended its grounds of appeal that the issues agreed to have been resolved in any APA should be followed and the appeal for the A.Y. 2011-12 is now restricted to the indent transactions with the AEs which are in countries other than Japan (because the APA is confined to international transactions with AEs in Japan). Mr. Agrawal submitted that it would be appropriate that the approach and method adopted in the APA should also be approved for the years in question, because as far as the FAR and international transactions continue to be the same in all the years. He thus concluded by submitting that TNMM should be the most appropriate method which should be taken to determine the ALP of the indenting transactions of the assessee with its AEs.
Mr. Agrawal further emphasized that Operating profit margin in relation to operating expenses is the right PLI which should be taken, because the same has been approved by the CBDT also as the assessee has been rightly characterized as a low risk service provider. He finally submitted that, since the APA does not reveal any specific independent comparable companies as having been taken while computing the arm’s length profit margin, it would be 19 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 appropriate to remand the file to the TPO with the directions to find suitable low risk service provider companies which can be chosen under TNMM for the computation of the ALP of the international transactions in question.
On the other hand, ld. CIT-DR submitted that here in this case AE and non AEs indent segments are similar and the approach adopted by the Tribunal in its earlier years was logical which needs to be followed. The commission earned from unrelated parties could serve as a valid CUP benchmark to determine the average commission rate of the AE indent transactions. Regarding value and volume itself, he submitted that same should be compared on transactional level, i.e., transaction to transaction rather than by comparing the transaction with each party together in one bundle. Regarding APA, he submitted that APA is a negotiated agreement and should not be used as a precedent for the other years. The assessee in its TP study report has treated trading and indent segment as a single segment and has applied TNMM, whereas the TPO had applied gross margin on the turnover and has benchmarked similar transaction taken by the AE with non AEs. Thus, in the case of the assessee such transaction with AE and non AE is a classical case of internal CUP and hence same should be applied.
We have heard the parties at length and also perused the material referred to before us as discussed herein above. The approach of determining the ALP on the basis of average
20 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 percent of commission reported by the assessee in respect of indenting transactions with the non AEs as held by the Tribunal has not found judicial favour with the Hon'ble High Court and matter has been remanded back for further examination of similarity between the two transactions and to conduct further in depth inquiry to examine the high degree of comparability of relevant control and uncontrolled transactions. Further, if the average rate of commission on such transactions was to be applied to the FOB value of goods involved in the indenting transactions with the AEs, then this Tribunal has to satisfy itself that there is no significant variation in the rate of commission between different products. From the perusal of the indenting transactions undertaken by the assessee with AE and non AE under various product segments, it is discerned that, for instance in the product segment ‘Automotive’, the assessee has undertaken 249 transactions with AE and only 4 with non AE and in the Assessment Year 2007-08 the volume of transaction, FOB value wise is ‘Nil’ in the case of non AE; and the commission earned with the AE is Rs. 7,50,43,686/- and with the non AE it is only Rs.9,672/-. Similarly the products dealt with AE in automotive segment are entirely different and the geographies involved are Switzerland, Singapore, Thailand and Japan whereas non AE transactions are with Suzuki Motorcycle India Pvt. Ltd. and Bajaj Auto Ltd in India. Likewise under the product ‘chemicals’ the assessee has undertaken 1044 transaction with AE and only 112
21 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 transaction with non AE and the commission with AE is 1.28%, whereas non AE it is 2.26%. Similarly, the products dealt with AE and non AE under this segment are quite different and geography involved with AE are Spain, Japan, Italy, Switzerland, Thailand, whereas with non AE it is India. Likewise in ‘electronics’ segment the transaction undertaken with the AE are 253, whereas with the non AE it is 5 and again not only the products are different but also geographical location are different with that of non-AE which are mostly with Indian parties and all AE transactions are with various foreign countries. Similar differences are noted in all across 10 to 11 products dealt by the assessee with AEs and non AEs. The total number of transactions with the AE during the year was 3,145 and with non AE it was only 371. Thus, apparently there is a huge difference in volume on FOB basis and the geographies dealt are also entirely different. The amount of average commission earned with the AE, is 1.58% whereas in the case of non AE it is 2.26. All these differences are permeating in all the Assessment Years as highlighted by the assessee in the chart submitted before us and on perusal of the same, it is quite glaring that under both the transactions, i.e., controlled transaction with the AE and uncontrolled transaction with the non AEs, there are huge dissimilarity between the products, difference in volume, difference in value, markets and geographical location.
It is quite settled proposition that while applying CUP method, a very high degree of similarity has to be seen
22 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 between the control and uncontrolled transactions not only in terms of products, contractual terms, volume, value but also market and geography locations. The reason being under CUP, price charged or paid for the property transferred has to be identified and the differences between the international transaction and the comparable uncontrolled transactions has to be seen which could materially affect the price in the open market. The price of different products cannot be the same as it depends upon the negotiation based on volumes, value and other contractual terms. Further different market and geographical location also affects the pricing factors and therefore, if there are differences on account of these factors CUP cannot be held to be the most appropriate method for bench marking the arm’s length price. Here in this case, under the indenting segment there are various dissimilarities in the transaction with the AE and non AE as discussed above and for this reason alone the average commission earned cannot be the benchmarking factor for determining the ALP, and therefore, we hold that neither the CUP method can be applied nor the transaction with the AE and non AE can be taken for the purpose of comparability analysis. Thus, we reject the CUP method by taking the average commission earned in the transaction with the AE and non AE.
Now, in these circumstances, we have to see whether TNMM can be considered as most appropriate method. First of all, it has been brought on record before us that right from the Assessment Years 2003-04 to 2006-07, TNMM has been 23 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 accepted as the most appropriate method by the TPO. However, instead of ‘berry ratio’ as PLI, TPO has taken OP/TC as PLI. Further, it has been brought to our notice that from the Assessment Years 2011-12 to 2018-19 under the MAP agreement it has been agreed that TNMM should be the most appropriate method to determine the ALP of the international transaction of the indent keeping into the fact that assessee is a low risk service provider and there is no change in FAR right from Assessment Years 2003-04 to 2018-19. Once TNMM has been accepted under the similar FAR, we do not find any reason to deviate by adopting some other method. Otherwise also we have held that CUP method cannot be applied and other methods admittedly are incapable of capturing the true arm’s length result and therefore, we hold that TNMM should be taken as a most appropriate method for benchmarking the said transaction.
Now having accepted that TNMM is the most appropriate method, the second issue which needs to be clarified is what should be the base for computing the PLI. As stated above, the Hon'ble High Court has approved the permissibility of using all ‘berry ratio’ as PLI in a situation where the functions performed did not entail huge creation of valuable intangibles. The nature of the assessee’s business is a routine business support services and there is no creation of any human capital or supply chain intangible. The Hon'ble High Court has held that ‘berry ratio’ can only be applied where the value of goods is not directly linked to the quantum
24 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016 of profits and the profits are mainly determined on expenses incurred. Here in this case, the assessee is acting as an indenting agent commission service provider, i.e., as a facilitator of a trade and has no financial risk, because assessee was not required to raise any invoice for sale and purchase in its financial commitment and risk are insignificant. As a service provider, the key business driver for the assessee is operating expenses incurred on establishment and operation of business, i.e., salary, rent and other such expenses and it does not employ any significant assets in the business except for routine assets like office, furniture and fixtures to run its business and also there is no intangible creation by the assessee company. Besides there is no trading capital employed as goods are neither bought nor sold by the assessee in the indenting segment. Under these facts and circumstances, the profit derived by the assessee is mainly depended on its operating expenditure as the value of goods does not enter in its financial. As a low risk service provider, it seeks to obtain adequate return on its operating expenses as the operating expenses incurred represents the value added carried on by the assessee. In other words, the operating expenses adequately and sufficiently represents the functions performed and the risk undertaken by the assessee. Thus, we hold that the ‘berry ratio’ should be accepted as the most appropriate PLI for taking as base under TNMM while determining the ALP of the Indian transaction for all the five years under appeal.
25 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
Accordingly, we remand the matter back to the file of the TPO to examine and benchmark the international transaction by adopting TNMM as the most appropriate method by taking ‘berry ratio’ as PLI. The assessee has to substantiate its margin by bringing comparable uncontrolled transactions to demonstrate that its commission earned in this segment is at arm’s length; and the TPO shall examine the same and decide accordingly. Needless to say that TPO shall give due and effective opportunity to the assessee to substantiate its ALP as per direction given above.
In the result, the appeal for all the Assessment Years are treated as partly allowed for statistical purposes.
In Assessment Year 2007-08, another ground raised relates to disallowance of claim of expenditure incurred of Rs.3,72,560 under the head ‘legal and professional’ charges; and addition of Rs.2,56,257/- on account of bad debts and deposits written off.
As regards disallowance of claim of expenditure under the head ‘legal and professional charges, it has been stated before us that the details of such expenditure are as under: S. No. Name of the Remarks Date Amount Payee 1. Writer 21.06.2006 Rs. 1,33,000/- Charges of Relocations unaccompanied passenger baggage clearing new Delhi to 2. -Do- 21.06.2006 Rs. 34,000/- Charges of unaccompanied passenger baggage clearing new Delhi to 26 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
-Do- 30.03.2007 Rs. 70,000/- Charges of unaccompanied passenger baggage 3. clearing new Delhi to Japan Mrs. Rie Nagashima. 31.03.2007 Rs.47,5000/- Charges of unaccompanied -Do- passenger baggage 4. clearing new Delhi to Tokyo, Japan Mrs. Rie Nagashima 02.08.2006 23,200/- Charges of unaccompanied passenger baggage clearing Mumbai to New Delhi Mrs. Rie Nagashima 23.11.2006 61,360/- Charges of unaccompanied -Do- passenger baggage 5. clearing New Delhi to Chiba, Japan Mrs. Rie Nagashima
The Assessing Officer has held that these expenditures are personal in nature. It has been submitted before us that in the Assessment Year 2006-07 the ld. CIT (A) has deleted the said disallowance and in Assessment Year 2008-09, DRP has directed the Assessing Officer to delete the said disallowance.
After considering the entire facts and findings given in the impugned order, it is seen that these expenses have been incurred as per the details given above. It is quite apparent that these are routine expenditure incurred during the regular course of business and nowhere has it been alleged by the Assessing Officer that these are for non business purpose and are not related to the assessee’s business. Once similar addition has been deleted in the earlier and subsequent year which has attained finality then no addition could be made here, accordingly the same is deleted.
27 I.T.As. No.5095/Del/2011, 5850/Del/2012, 328 & 6646/Del/2014 & 1321/DEL/2016
As regards claim of deduction of deposit written off, it has been brought to our notice that assessee has not written off any such deposit in the instant year, albeit the same was debited in the Assessment Year 2006-07 and that was claimed in the same year only and the Assessing Officer has completely misunderstood and has taken the figure from the P&L account of Assessment Year 2006-07 and has been understood to have been claimed and Assessment Year 2007- 08. In fact DRP has directed the Assessing Officer to delete the same if the same has not been debited and yet the Assessing Officer has not carried out the direction of the DRP. Accordingly, we hold that the addition made by the Assessing Officer is unjustified on facts and same is directed to be deleted.
In the result all the appeals are partly allowed for statistical purposes.
Order pronounced in the open Court on 22nd October, 2018.