M/S ARROW ELECTRONICS INDIA LTD.,,BANGALORE vs. ADDL.DIT, BANGALORE

O R D E R PER BENCH : Two appeals are filed by the assessee for the a ys. 2000-01, 2001- 02 , three appeals are filed by the Revenue for the a y s. 2002-03 to 2004- IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 2 05 and three cross objections are filed by the assessee against those three appeals filed by the Revenue for the a ys. 2002-03 to 2004-05, respectively, against the respective orders of the CIT(A) –IV, Bangalore which are under consideration in this proceedings .

Complying with them, the assessee filed the returns declaring income on the basis of cost + 6% . The A O has recorded the findings of the survey. According to the A O, the LO was not supposed to do business in India as per the approval from the RBI but, in fact, the LO was carrying on some income earning activities in India which fact has been recorded by obtaining statements of former employees of the Indian subsidiary and the employees of the erstwhile LO. The AO noticed that out of the total profits earned, a portion of the profit was attributable to the Indian operations since they had liaison offices in lndia. After concluding so, he took into consideration the total sales and deducted the cost of sales to arrive at the gross. profit.

The Singapore expense was taken as claimed by the assessee and after deducting expenses of Singapore and of Indian liaison offices, net profit was determined and 40% of it was taken as profit attributable to the Indian LO. Before deciding the 40:60 ratio, the AO determined the functional analysis after fixing the relative weightage of 50:25:25 to Functions, Assets and Risks and finally determined the weighted average after taking into intra sectional IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 4 ratio between the LO and the HO and finally arrived at the profit attributable to Indian operations at 40%. Thus, the AO determined the profit attributable to the Indian LO at Rs. l,35,85,005/-, Rs.74,90,544/-, Rs. l,83,37,555/-, Rs. l,42,54,775/-& Rs.92,04,320/-, for a ys 2000-01,2001-‘02,2002-’03,2003-’04& 2004-05,respectively. Simultaneously, the AO referred the matter to the TPO for ays 2002-03 to 2004-05. The TPO determined adjustments u/s 92CA at Rs.5,65,55,609/-, Rs.4,96,10,165/- & Rs.1,70,10,258/-, respectively, for ays 2002-03 to 2004-05 and the AO substituted these figures as against his working of income for these ays as stated above and concluded the assessments , inter alia, charging of interest u/s. 234B , initiated penalty proceedings u/s 271(1)(c) and u/s 271B and accordingly issued demand notices.

Aggrieved by the finding that the Singapore branch had business connection in India and against the finding that the Singapore Company had a PE in India and determination of 40% of the total profits as attributable to the Indian operations etc, the assessee filed appeals before the CIT (A). The CIT (A) dismissed them for ays 2000-01& 2001-02. However, in the appeals related to ays 2002-03 to 2004-05, the CIT(A) gave part relief on the adjustments made by the TPO. Aggrieved, the assessee filed two appeals in I.T (TP). A Nos. 209 & 210/Bang/2011 for ays 2000-01& 2001-02 with similar grounds of appeal. One of the appeal grounds is extracted as under:

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IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 6

Additional grounds of appeal no 2:

The CIT (A) ought to have appreciated that on the facts and in the circumstances of the case, no interest was chargeable u/s.234B of the Act and consequently he ought to have directed the AO to delete the interest charged u/s.234B of the Act.

Additional grounds no 3 :

1. The learned CIT (A) erred in confirming the assessment order u/s.143(3) r.w.s.147 of the Act dt.28.12.2007, which was based entirely on statements recorded u/s.133A of the Act, which is bad in law.

IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 7 Additional grounds of appeal no 4 :

IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 8

5. The AR submitted the same plea which was taken before the CIT (A) and on the lines of the above additional grounds. Let us examine, how the CIT (A) dealt those issues by extracting the relevant portion of the order as under :

“4………………………………………………………………………………………….The following were the findings of A O: i. The LO could not make any supplies on its own but the Indian subsidiary could do so. This is evident from the statement of Mr. Singh, Sales Manager wherein he has stated that the customers had to import th eir requirements from th eir overseas office located at Singapore. ii. Salaries were earlier paid by the LO and later by the Indian company. iii. Earlier to incorporation of the subsidiary they were permitted to canvass imported sales from Singapore, but after the incorporation of the company they were permitted to do Rupee sales. iv. Revenue recognition was always there before incorporation in the hands of the LO and after the company came into existence. V. Profits arose to the Indian company after the incorporation and it was attributable to the LO before incorporation. vi. The nature of the business remain the same before and after the incorporation since the LO was dealing with the same functions like marketing, sales, service, accounts, administration etc. The LO was also assigned the task of identifying potential customers for which technically competent personnel were appointed. vii. The Indian LO was involved in procurement of orders and step by step execution including collection of payments. viii. Price negotiation was also one of the functions assigned to LO.

IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 9 X.The LO was taking the final decision on the pricing without even referring the issue to Singapore or Hong Kong. xi.LO was responsible for concluding the contracts. xii. Targets were given to the Indian LO.

negotiations and finalization, securing orders, processing Of orders, dispatching of materials, payment for materials, the AO held that LO could be assigned 565 points and the HO 235 points on a scale of 800 and concluded that 70.30 ratio is fair and reasonable. As regards assets analysis. The AO held that LO has virtually no assets and in view of the same tuck the ratio of 10:90 for LO : HO. As regards risk analysis, it was held that mostly it is borne by the HO and the LO was in charge of only the manpower and not for the stock he assigned the ratio of 90:10 for HO : LO. Finally he worked out the basis of 40:60 between LO and HO as under:

…………………………………………………………………………………………………………… …………………………………………………………………………………………………………… …………………….

distribution network maintenance, warehousing, shipping, selling to end users, sub-distributors, middlemen, determining its marketing and remuneration of sales personnel, undertaking warranties and other functions. In support of their arguments they have quoted judgment of the Hon'ble Supreme Court in the case of DIT vs. Morgan Stanley and Company Inc. It is held that this judgment was applicable only to the facts of the relevant case and it has no application to the facts of the appellant's case and hence is not relevant. Incidentally this judgment was based on clarification issued by the CBDT in circular no.23 of 1969. Since the circular itself is now withdrawn, the facts of the case are no longer relevant to the appellant's case. The appellant has also argued that preparatory to the auxiliary activities, the Indian LO carried on certain activities and their case is covered under Article 5(7) of the tax treaty between India and Singapore. It is held that that the Indian LO was carrying on activities right from the year 1996 and it w a s n o t a p r e p a r a t o r y a c t i vi t y a n d a c c o r d i n gl y t h e a p p e l l an t ' s argument does not survive. The restriction of the activities by the RBI is cited as one of the reasons to claim that they have-not conducted any business operations nor they had a PE. Incidentally the conduct of the appellant as found out after conducting survey u/s 133A and the appellant's own admission of existence of partial income attributable to the Indian operations do not support the appellant's arguments that their case is not covered under Section 9(1) (i) as also their argument about existence of PE in India. It is also further held that the AO has taken enormous pains in quantifying the percentage of profit attributable to Indian operations at 40% as depicted in page 16 and 17 of the assessment order. it is held that the AO was reasonable in considering sectoral weightage at 50:25:25 for functions performed, assets employed and risks involved. Further it is held that AU was correct in taking only 10% towards assets and risks in the intra sectoral ratio pertaining to LO and the balance 90% to the HO.

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Even in the functions performed, the 8 broad parameters as discussed in page 16 of the assessment order practically cover every aspect of functions performed and relative weightage allocation is also held to be proper and the final quantification of 565 to LO and 235 to HO on a scale of 800 is held to be perfectly justified and accordingly quantification of 70 : 30 between LO and HO is upheld. The final quantification of profits attributable to LO and HO as per the table 1 above as per para 5 at 40 : 60 is also upheld.”

5.1 With regard to the issues as to whether the assessee had any business connection in India as per provisions of Section 9(i) and whether the appellant had a PE in India, the assessee has relied on the following cases before the CIT(A):

- CIT vs RD Aggarwal & Co (SC) [56 ITR 201 - CIT vs. Hindustan Shipyard Ltd (AP) [109 ITR 158] - CIT vs Atlas Steel Company Ltd (Cal) [164 .ITR 4011 - CIT vs Gulf Oil (Great Britain) Ltd (Bom) [108 ITR 874] -Imperial Chemical Industries Limited vs inspecting Assistant Commissioner [19 ITD 275] - VDO Tachometer Warke, West Germany vs CIT (Kar) [117 ITR 804] and the circular no 23 of the CBDT. After considering them, the CIT (A) held as under:

“ 7.1 ……………………………………………………………………………………….- i. The CBDT has withdrawn circular no 3 dated 23.07.1969 along with circular no. 163 dated 29.05.1975 and circular no. 786 dated 07.02.2000 vide Circular No.712009 [F.No. 500/ 135/2007- FTD-l], dated 22.10.2009. Accordingly relying on the above circular has no significance as it is no longer operative. It is IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 13 worthwhile to mention that the appellant themselves have filed returns in response to the notices u/s 148 by declaring income on the cost +6% basis. By filing the returns in response to the notices u/s 148 the appellant has categorically admitted that a portion of income was earned in India and was taxable in India. The only issue which remained to be decided was whether the quantification of profits of LO to HO was 40:60 or otherwise. Considering the appellant's submissions the AO was asked to submit the remand report and in turn the AO has submitted the remand report where-in he has reiterated whatever is stated in the assessment order. However, the AO has reiterated the fact that the appellant's themselves admitted to the activities of the .LO are taxable in India by showing income at cost + 6% basis. In view of the appellant's own admission by showing income attributable to the Indian operations, the appellant has indirectly accepted the Fact that they had business connection in India and also the Indian LO as the PE o f A r r o w S i n g a p o r e . T h e a p p e l l a n t ' s a r g u m e n t s d e s e r v e n o consideration in view of the detailed reasons given by the AO in the assessment order as also in view of the appellant's own admission of income having arisen in India and the indirect existence of the PE. Accordingly, the case laws cited by the appellant are held to be not relevant to the facts of the case and it is held that the appellant’s arguments deserve no consideration.”

It is seen that the AO gave due opportunity to the assessee in his letter dated 24.12.2007 drawing assessee’s attention towards using the statements recorded at the time of survey, its due analysis etc and thereafter passed the impugned assessment orders. The CIT (A) has also given an opportunity by way of a remand proceedings. The AO has reiterated the fact that the appellant's themselves admitted to the activities of the LO are taxable in India by showing income at cost + 6% basis. In view of the assessee's own admission by showing income attributable to the Indian operations, it has indirectly accepted the fact that they had business connection in India and also the Indian LO as the PE of Arrow S ingapo re. Th us, as he ld by the CIT(A) that the assessee's argu men ts deserve no consideration in view of the detailed reasons given by the AO in the assessment order as also in view of the appellant's own admission of income having arisen in India and the indirect existence of the PE. Accordingly, the case laws cited by the assessee and the circular are held to be not relevant to the facts of the case and it is held that the appellant’s arguments deserve no consideration. The CIT (A), inter alia, held that incidentally the conduct of the appellant as found out after the survey u/s 133A and the appellant's own admission of existence of partial income attributable to the Indian operations do IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 15 not support the appellant's arguments that their case is not covered under Section 9(1) (i) as also their argument about existence of PE in India. It is also further held that the AO has taken enormous pains in quantifying the percentage of profit attributable to Indian operations at 40% as depicted in page 16 and 17 of the assessment order. It is held that the AO was reasonable in considering sectoral weightage at 50:25:25 for functions performed, assets employed and risks involved. Further, it is held that AO was correct in taking only 10% towards assets and risks in the intra sectoral ratio pertaining to LO and the balance 90% to the HO. Even in the functions performed, the 8 broad parameters as discussed in page 16 of the assessment order practically cover every aspect of functions performed and relative weightage allocation is also held to be proper and the final quantification of 565 to LO and 235 to HO on a scale of 800 is held to be perfectly justified and accordingly quantification of 70 :

30 between the LO and the HO is upheld. The final quantification of profits attributable to the LO and the HO as per the table 1 , above , as per para 5 at 40 : 60 is also upheld. Before us, the assessee could not lay any material to dislodge the above findings and hence we uphold the orders of the CIT(A) for ays 2000-01 & 2001-02. The assessee by way of additional ground pleaded that the CIT (A) erred in confirming the assessment orders u/s.143(3) r.w.s.147 dt.28.12.2007, which was based entirely on statements recorded u/s.133A , which is bad in law. We have IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 16 considered this plea. It is clear from the survey findings extracted , supra, in sub-para 4 under para 5 etc, that the AO has relied on various relevant materials and hence this plea of the assessee is held as untenable. The CIT (A), applying the ratio laid by the Supreme Court in the case of CIT v Anjum M H Ghaswala 252 ITR 1, has held that the levy of interest u/s.234B is mandatory with which we are in agreement. In the result , all the above grounds of the assessee are dismissed for ays 2000-01 & 2001-02. to 619/Bang/2011 – By the Revenue CO Nos.31 to 33/Bang/2011 – By the Assessee : 07. Now, let us examine the Revenue’s three appeals I.T (TP).A Nos.617 to 619/Bang/2011for assessment years 2002-03, 2003-04 & 2004-05 & Assessee’s cross -objections Nos.31 to 33/Bang/2011 on I.T (TP). A Nos.617 to 619/Bang/2011 on Revenue’s above three appeals as under:

8. For a ys 2002-03, 2003-04 & 2004-05, the AO determined the profit attributable to the Indian L O at Rs. l,83,37,555/-, Rs. l,42,54,775/-& Rs.92,04,320/-, respectively. The AO noticed that the assessee's international transactions with its A E being more than 15 crores in each year referred the matter to the TPO. The TPO after making a detailed analysis, determined arm's length margin at 4.78%, 5.18% and 5.58% as mean PLI for the three years, and determined a r m ' s le n g t h p r o f i t a t R s . 5 , 6 5 , 6 6 , 6 0 9 / - , R s . 4 . 9 6 , 1 0 , 1 6 5 / - a n d Rs.1,70,10,258/-, respectively, for the three IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 17 assessment years. The TPO took the TNMM as the most appropriate method. The A O substituted these figures as against his working of income for these ays as stated above and concluded the assessments , inter alia, charging of interest u/s. 234B , initiated penalty proceedings u/s 271(1)(c) and u/s 271B and accordingly issued demand notices. Aggrieved by the finding that the Singapore branch had business connection in India and against the finding that the Singapore Company had a PE in India and determination of 40% of the total profits as attributable to the Indian operations and against the determination of adjustment u/s 92CA for these years etc, the assessee filed appeals before the CIT(A). The CIT (A) gave a part relief on the adjustments made by the TPO .

Aggrieved, the Revenue filed three appeals I.T (TP).A Nos.617 to 619/Bang/2011for assessment years 2002-03, 2003-04 & 2004-05 with similar grounds of appeal. One of the appeal grounds is extracted as under:

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9. The assessee filed three cross -objections Nos.31 to33/Bang/2011 on I.T (TP). A Nos.617 to 619/Bang/2011 for assessment years 2002-03, 2003-04 & 2004-05 with similar grounds of appeal. One of the cross -objection’s grounds is extracted as under:

percentage attributed to LO which was held by the department itself at 40% of global sales.

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Additional grounds of appeal no 2:

The CIT (A) ought to have appreciated that on the facts and in the circumstances of the case, no interest was chargeable u/s.234B of the Act and consequently he ought to have directed the AO to delete the interest charged u/s.234B of the Act. Additional ground no 3 :

IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 20 Additional grounds of appeal :

IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 21

10. The DR submitted his plea on the lines of the Revenue’s grounds of appeal. The AR submitted on the lines of cross objections and the additional grounds of appeal. Let us examine, how the CIT (A) dealt them by extracting the relevant portion of the order as under :

“8……………………………………………………………………………………………………………………… …………………………………………………………………………………………………………………………… …………………………………………………………………….The final quantification of profits attributable to LO and HO as per para 42 of the assessment orders and table I above as per Para 5 at 40:60 is also upheld. However, for AY 04-05 there is an arithmetical mistake committed by the AO in not allowing Singapore expenses and accordingly for AY 04-05 the IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 22 figures as determined under the head TP adjustments, (worked out below) of Rs.52,82,613/- is confirmed.

9.2 The appellant has raised objections on the determination of the ALP on its entire sales rather than applying the above percentage on the profit attributable to LO. Besides that, it is also stated that the working capital adjustment has not been given by the TPO. It was also pointed out that the AO has determined certain profit for the same year on protective basis but the TPO has determined income at much higher ratio which was 3.09 times, 3.48 times and 1.85 times higher as compared to the AO. This is because of the fact, that the TPO has not considered applying the determined percentages attributable to the LO which was held by the department itself at 40%. of the global sales. Besides that, it was stated that by not giving working capital adjustment of 2.75%, 2.81% and 1.92%, the TPO has arrived at a much higher figure as compared to what the AO under identical circumstances has computed. The appellant has also relied on the following judgments in support of the working capital adjustment:

(a) Philips Software Centre Pvt. Ltd Vs. ACT (119 TTJ 721)

(b) Sony India Pvt. Ltd Vs. CIT (315 ITR 150) (C)Egain Communications Pvt. Ltd (Delhi Tribunal in ITA No.1885/PM/2007). (d) Mentor Graphics P. Ltd., [109 ITD 101] [2007] [Delhi] IT(TP)A.209,210,617 to 619,COs.31 to 33/B/2011 Page - 23

After considering the appellant's arguments on these issues only two issues have to be determined.

(i) Whether the determined margin of ALP for three years are to be applied on the total turnover or on the turnover of the LO which is determined to be 40% of the total turnover. (ii) Whether the appellant can be given working capital adjustment as claimed by them.

To be in consistent with the departmental stand for AY 00-01 & 01- 02 which is also confirmed by the CIT (A) as also in view of the AO's protective assessment wherein he has taken 40 : 60 to LO HO it is to be held that the percentage of ALP as determined by the TPO should have been applied only on 40% of the total sales and the ALP should have been determined accordingly. Coming to the working capital adjustment the appellant has given a detailed working but ultimately arrived at the figure of working capital by taking the PLR as determined by the Centre for Monitoring Indian Economy (CMIE). The appellant had adopted percentage of 10.31, 10.21 & 9.81 for the three FY's respectively. Incidentally there is no uniform agreement on the adoption of PLR as adopted by the CMIE. Though approximately the RBI and the CMIE determined PLR are almost the same still SBI PLR and LIBOR rates vary. Accordingly, there is no uniformity in adoption of the PLR rate as determined by the CMIE. Accordingly, it is not possible to allow working capital adjustment as requested by the appellant though the appellant is right in asking for certain percentage of working capital adjustment. Considering the fact that the AO has independently determined the profit attributable to the LO, corresponding to this determination the working capital adjustment could be given. Accordingly working capital adjustment of 0.906% and 1.459% could be given in AY's 02-03 & 03-04 respectively. Accordingly, the ALP margin to be re-determined for AY 02-03 & 03-04 works out as under:

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AO is directed to adopt ALP adju stments of Rs.1,83137,996/- and Rs.1142,54,781/- for AY 02-03 & 03-04 respectively which are almost the same as Rs.1,83,37,555/- and Rs.1,42,54,775/- determined by the AO on protective basis.

However, for AY 04-05 AO has determined on protective basis income attributable to. LO at Rs.92,04,320/- but it is seen from his table in para 42 that he has not allowed Singapore expenses while arriving at this figure. For AY 04-05, the AO is directed to allow an adhoc figure of 1.25% towards Working capital adjustment. Hence the ALP margin shall be taken at 4.34% ( 5.59% - 1.25%) and on 40% of the global sales, being Indian LO sales, ALP is to be determined. This percentage is to be adopted on Rs.12,17,19,202/- (bein g 40% of Rs.30,42,98,005/-) an d th e ALP i s to be taken at Rs.52,82,613/- for AY 04-05. Though this figure is slightly lower than the income determined by the AO, in view of the AO's non allowance of Singapore expenses the profit was determined at Rs. 92,04,320/- though in the other two years AO has allowed the same.”

Considering the fact that the AO has independently determined the profit attributable to the LO, corresponding to this determination the working capital adjustment could be given.

Accordingly, the working capital adjustment of 0.906% and 1.459% could be given in ay's 02-03 & 03-04, respectively. Thus, the CIT (A) re-determined the ALP margin for a ys 02-03 & 03-04. For a y 04- 05, the CIT (A) found that the AO has determined on protective basis income attributable to the LO at Rs.92,04,320/- but it is seen from the AO’s table in para 42 that he has not allowed Singapore expenses while arriving at this figure. For ay 04-05, the CIT (A) directed the AO to allow an adhoc figure of 1.25% towards working capital adjustment. Hence, the ALP margin shall be taken at 4.34% ( 5.59% - 1.25%) and on 40% of the global sales, being Indian LO sales, and re-determine the ALP . Before us, the Revenue could not assail such findings with any material. The CIT (A) orders are consistent with the findings in ays 2000-01 & 01-02 and on the facts and circumstances appears reasonable . Hence, the orders of the CIT (A) do not require any interference and hence we dismiss the Revenue’s appeal for a ys 02-03, 03-04 & 04-05, respectively.

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