INDIAN EXPLOSIVES LTD.,KOLKATA vs. DCIT, CIR-11(1), KOLKATA, KOLKATA

We have given our thoughtful consideration to the rival submissions. The short question that arises for our apt adjudication is as to whether action of the lower authorities right from the TPO, DRP to Assessing Officer holding the assessee not to have derived any tangible and commensurative benefit of paying any of the interest sales thereby culminating in the impugned adjustment of the entire payment of Rs.16,24,110/- is sustainable or not. Learned CIT D/R vehemently supports the above extracted findings under challenge that the payee’s products in question had long been established in India. He points out the fact that this is the first year of the impugned royalty outgo forming the point of dispute as international transaction under the Act. whereas the assessee had been using the very brand name/trademark in the past without incurring any such expenditure. He terms the lower authorities action under challenge to be strictly as per law. We see no reason to accept the same. Hon’ble Delhi High Court’s judgement in Commissioner of Income-tax v. EKL Appliances Ltd. [2012] 24 taxmann.com 199 (Delhi), as well as this Tribunal’s decision in Deputy Commissioner of Income-tax, Circle- 1(1), Kolkata v. Landis+ Gyr Ltd. [2017] 86 taxmann.com 109 (Kolkata - Trib.), Deputy Commissioner of Income-tax, Circle -1(1), Hyderabad v. Air Liquide Engineering India (P.) Ltd. [2014] 43 taxmann.com 299 (Hyderabad - Trib.), Dresser-Rand India (P.) Ltd. v. Additional Commissioner of Income-tax, Range - 6(2), Mumbai [2011] 13 taxmann.com 82 (Mumbai) interalia conclude that Chapter-X, provisions in the Act do not require the tax payer to prove any expenditure to have been incurred out of necessity or for the purpose of business or that it should actually result in profits, an ALP cannot be NIL amount where the TPO’s order nowhere records that the relevant conditions incorporated in section 92C(3) of the Act, are satisfied, the TPO would not sit in judgement on a taxpayers business expediency so ITA No.418/Kol/2015 & Indian Explosives Pvt. Ltd. A.Y.2010-11 & 2011-12 5 as to conclude its ALP of international transactions as unreasonable thereby adopting nil ALP and that it is wholly irrelevant that these are no corresponding benefit since the real question in transfer pricing regime is as to what would be the price to be paid by an independent enterprise vis-à-vis the one shown by the concerned tax payer; respectively. The very legal position is reiterated in tribunal’s other decisions in Merck Ltd. vs. DCIT 2016 139 DTR 1 (Mum.), as well as in L.K. India Pvt. Ltd. vs Dy.Cit, Circle-1(2)in ITA No. 209/Ahd/2015, decided on 31st May, 2017. The co- ordinate bench(es), hold therein that it is an assessee’s call as to whether or not the services availed in question are commercially expedient rendering same benefits being derived from its business. 4.1 We keep in mind the said case-law to revert back to the relevant facts before us. It is clear first of all that the lower authorities have been very fair in not holding the assessee’s royalty transactions to be a sham ones. They have applied benefit and commercial expediency test in the instant case whilst computing nil ALP. We see no reason to approve the same these two tests of benefits and commercial expediency are not to be invoked as per the above legal position. The impugned action of the lower authorities under challenge is therefore held to be not sustainable.

Next comes the quantification aspect of the impugned ALP. The TPO admittedly applied ‘CUP' method in his order (supra). He appears to have treated the tax payer itself as a valid comparable as it had not paid any royalty to the very payee in earlier assessment years. This made him to adopt nil price of the impugned royalty so as to make the adjustment in question. We see no reason to concur with such a course of action since the assessee itself having paid Nil amount in the past to the AE, cannot be taken as a valid comparable. This tribunal in the case of Technimont ICB India (P) Ltd. v. Addl. CIT (2012) 138 ITD 23(Mumbai TM) has concluded long back that a transaction between payee and its AE is not an uncontrolled one so as to be taken as a comparable. We accept the assessee’s instant first substantive ground both on legality as well as on quantification therefore. The impugned ALP adjustment stands deleted accordingly.

Both the learned representatives state qua the assessee’s next substantive grievance with regard to the leave encashment provision of Rs. 15,97,944/- made u/s 43B(f) of the Act deserves to be remitted back to the Assessing Officer for taking a fresh call after the hon’ble apex court’s decision in the Revenue’s special leave petition converted to appeal staying operation of hon’ble jurisdictional high court’s judgment in Exide Industries Ltd. vs. UOI, 292 ITR 470, deleting identical disallowance as well as holding the statutory provision itself to be unconstitutional.

The assessee’s next substantive grievance challenges correctness of the lower authorities action in disallowing a sum of Rs.12,12,157/-, claimed as commission charges on the ground that the same is raised on accrual basis without any details being submitted.

The learned Counsel for the assessee vehemently contends that the payees in question have issue their respective bills in later assessment years. He relies on assessee’s mercantile system of accounting to stress the point that the impugned commission expenses is very much allowable on accrual basis. It thus transpires that the dispute herein is that of year of allowability than genuineness. Learned Departmental Representative, fails to dispute that the assessee’s stand throughout is of having filed all the relevant details before the Assessing Officer. We therefore conclude that in absence of any material doubting accrual of the impugned expenditure in the relevant previous year, the same has to be held allowable in the assessment year in question only as per the hon’ble apex court’s land mark decision in the case of Bharat Earth Movers v.Commissioner of Income-tax [2000] 245 ITR 428 (SC). The assessee succeeds in its instant substantive ground.

The assessee’s last grievance pleaded in this appeal challenges the disallowance of Rs.1,03,896/- while computing book profit u/s 115JB of the Act, when Section 14A r.w.r 8D disallowance pertaining to its exempt income.

We now advert to Assessment Year 2011-12 involving tax payer’s appeal ITA No. 85/Kol/2016.

Its first four substantive grounds seeks to delete trade-mark royalty fee’s upward ALP adjustment of Rs.1,66,27,119/- incurred in case of M/s. Orica International PTE Ltd. Singapore. Both the learned representatives, agree very fairly that our discussion qua identical adjustment at nil ALP in the preceding Assessment Year on both legality as well as on quantification would apply mutatis mutandis in the impugned assessment year as well. We accept assessee’s instant substantive grievance therefore as per our foregoing detailed discussion the ALP upward adjustment under challenge forming the subject matter of the instant issue to the tune of Rs.1,66,27,119/- is deleted.

The tax payers next substantive ground is that the lower authorities have erred in law on facts in making transfer pricing ‘TP’ Adjustment of Rs.18,84,152/-, in respect of goods exported to Associate Enterprises outside India forming subject matter of international transactions.

The question that we must decide at the threshold is as to which is the most appropriate method of determining arm's length price on the facts of this case. On this aspect of the matter, the dispute is confined to even narrower a question, i.e. whether or not CPM is the most appropriate method on the facts of this case, because neither revenue authorities have justified any other method of determining the ALP, nor is it in dispute that, if the CPM fails, the TNMM, as canvassed by the assessee, is the only method which can be applied.

Rule 10B(1)(c) defines the cost plus method, i.e. CPM, as follows: Cost plus method, by which,- ITA No.418/Kol/2015 & Indian Explosives Pvt. Ltd. A.Y.2010-11 & 2011-12 10 (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit markup in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise 16. The fundamental input for application of CPM method, next only to ascertainment of historical costs, is ascertainment of the normal mark-up of profit over aggregate of such direct costs and indirect costs in respect of same or similar property or services in a "comparable uncontrolled transaction" or, of course, a number of such "comparable uncontrolled transactions". When compared with CUP method, as against the "price" of a comparable uncontrolled transaction, one has to find out "normal mark up of profit" in a comparable uncontrolled transaction. Whether it is "price" or "normal mark up of profit", the starting point of both these exercises in the CUP and the CPM is finding a "comparable uncontrolled transaction". In order for such comparisons to be useful, the economically relevant characteristics of the situations being compared must be sufficiently comparable. It is only elementary, as is also noted in the OECD Transfer Pricing Guidelines, that "t o be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or that reasonably accurate adjustments can be made to eliminate the effect of any such differences".

Let us, in the light of the above discussions, take a look at the situation before us. What the assessee is doing for its AEs is manufacturing the products, and, as noted elsewhere in this order, it is an uncontroverted position that the assessee's AEs, collectively constituting Wrigley group, deal" in FMCG sector which is characterized by impulsive buying by the consumers, heavy expenditure is required to be made on planning and execution of sales promotion" and that "these expenditure were incurred by the Wrigley Group to penetrate new market as well as to retain share in the existing market". It is also an uncontroverted position that "in respect of sales promotion, both Wrigley India and the AEs carry out this function in their respective market". What in effect, thus, assessee does is that the assessee manufactures the products and sells those products to the AEs but sales promotion is required to be done by the respective AE in its respective market. To this extent, there is no dispute whatsoever on factual aspects by the parties before us.

The question that arises is whether these transactions can be compared with the sales of similar product to distributors or other entities in the domestic market and particularly in a situation in which not only the market is geographically different but also entire business model is different vis -à-vis transactions with the AEs, inasmuch as the sales in domestic market necessitates substantial expenditure by the assessee for marketing support and sales promotion strategy. In other words, whether "export price of product simplictor, without any marketing support in the related market" can have a "comparable uncontrolled transaction" in "domestic sale price of a product in a situation in which entire marketing function and sales promotion is seller's responsibility".

In our humble understanding, the answer has to be an emphatic 'No'. The two situations, i.e. sale simplictor of a FMCG product for an overseas AE without any costs being incurred on the marketing and sales promotion amongst the end users, and sale of a FMCG product to a domestic independent enterprises with full responsibilities for marketing and sales promotion amongst the end users, are not 'comparable transactions' in the sense that profitability in the latter cannot be a proper benchmark for profitability in the former. It i s not only in the marketing and sales promotion that the difference lies, but it extends to the fundamental business model itself particularly as the sale is not to an end user, such as in the cases of plant and equipment etc, but to an intermediary who, i n turn, has to sell it to, through yet another tier or tiers of intermediaries, the end user. The sale of products to the non-resident AEs is more akin to contract manufacturing arrangement, while the sale of products to independent enterprises domestically is a regular business entrepreneurial venture. As a matter of fact, it has been one of the arguments of the assessee before us, and the assessee has also filed some documents and copies of contracts in support of that contention, that the assessee had done the contract manufacturing for its overseas AEs as it had idle and underutilized capacity, but, as there are no findings by the authorities below on this aspect of the matter and as we can anyway dispose of the matter without giving any categorical find ings on that aspect of the matter, we see no need to deal with that contention at this stage. Suffice to say that whether contract manufacturing or not, as long as the business models of sales to AEs and sales to non AEs are different, the transactions under these business models cannot be "comparable transactions" for the purposes of transfer pricing. In the first business model, creation of market in the end users is not the responsibility of the vendor, but in the second business model, it is job of the vendor to create and maintain the market of end users as well. The product may be the same but the FAR profile is materially different and it is this FAR profile which governs the profitability. The basic notions of transfer pricing recognize the impact of FAR profiling on the profitability. When profitability levels in two business situations, due to significant differences in FAR profiles of two situations, are expected to be different, such transactions cease to be comparable transactions for the purposes of transfer pricing analysis. 20. In OECD Transfer Pricing Guidelines, this aspect of the matter, so far as comparability analysis is concerned, has been explained thus: 1.47 The functions carried out (taking into account the assets used and the risks assumed) will determine to some extent the allocation of risks between the parties, and therefore the conditions each party would expect in arm's length transactions. For example, when a distributor takes on responsibility for marketing and advertising by risking its own resources in these activities, its expected return from the activity would usually be commensurately higher and the conditions of the ITA No.418/Kol/2015 & Indian Explosives Pvt. Ltd. A.Y.2010-11 & 2011-12 12

In view of the above discussions, in our considered view, the authorities below were not justified in holding that the cost plus method was the most appropriate method on the facts of this case. One of the necessary ingredient for application of CPM, i.e. normal mark up of profit in the comparable uncontrolled transactions- whether internal or external, was not available as no comparable uncontrolled transactions were brought on record by the authorities below. What was brought on record as an internal comparable uncontrolled transaction, i.e. manufacturing for the domestic independent enterprises, was uncomparable as the FAR profile was significantly different. Undoubtedly, direct methods of determining ALP, including cost plus method, have an inherent edge over the indirect methods, such as TNMM, but such a preference can come into play only when appropriate comparable uncontrolled transactions can be identified and analysed accordingly. That has not been done in the present case. There is, therefore, no good reason to disturb the TNMM method adopted by the assessee. We have also noted that the TPO himself has accepted the TNMM for the assessment years 2007-08, 2008-09 and 2009-10. Learned Departmental Representative does not dispute that the facts for all these assessment years are similar in material respects. For this reason also, there was no good reason to disturb the ALP determination on the basis of TNMM in respect of the assessment years before us, i.e. 2003-04, 2004-05, 2005-06 and 2006-07.”