DDIT, NEW DELHI vs. M/S. NIPRO ASIA PTE. LTD., SATARA

This appeal by the Revenue arises out of the order passed by the CIT(A) on 29.04.2013 in relation to the assessment year 2003-04.

The only issue raised in this appeal is against the attribution of income by the ld. CIT(A) at a mark-up of 15% on costs incurred as against the Assessing Officer's profit attribution to sales activity in India at 40% of the profit from sales made in India.

Succinctly, the factual matrix of the case is that the assessee is a company incorporated under the laws of Singapore. Its main business activity is trading of medical equipments to and from India. The assessee is operating in India through a branch office which, apart from doing all the activities relating to marketing, sales, warehousing, after sales service and technical services to the customers on behalf of its head office in India, is also marketing Nipro brands in India. The head office of the assessee company is also directly undertaking sales activity in India. The assessee company made sales in India of Nephrology products and cardiology products, injection related products and bulk products through distributors or through the sales from overseas to the end users. The Indian branch office showed only the transactions in its account which were routed through the branch and the value of products sold directly or through distributors was not incorporated. It is undisputed that the Indian branch undertakes all the activities for marketing, selling and after sales services of the products sold by the assessee in India, either directly or through the distributors, apart from making sales to customers in India from the branch office. In the given facts, the AO held that the branch office constituted permanent establishment in India under Article 5 of the Double Taxation Avoidance Agreement with Singapore as well as the business connection in India in terms of section 9(1) of the Income-tax Act, 1961 (hereinafter also called ‘the Act’). Thereafter, he computed the amount of profit attributable to the business connection/PE. In this regard, it was noticed that the assessee filed audit report under section 92E in Form No.3CEB divulging international transactions between the head office and branch office. As the Indian branch was not receiving any income in lieu of services rendered in selling the products directly by the Head office, the AO held that the transfer pricing study report was not reliable. It was further found that no comparable cases were cited in the transfer pricing study report. In view of these facts, the AO held that 3 there was no justification for the applicability of `Cost plus method’ as allegedly applied by the assessee for arriving at arm’s length compensation. The AO found the case to be unique in nature having no exact comparables. He observed that the ultimate holding company of the assessee, namely, Nipro Corporation, Japan, was having three overseas branch offices including one in India and others in Africa and UAE. He invoked the provisions of Rule 10 for determining the income of the assessee. For doing this, he visited the website of the Nipro Corporation providing details of comparative profit and margin of the parent company as tabulated on page 16 of his order. Considering Net sales of Nipro Corporation and its consolidated subsidiaries for the calendar year ending 31.12.2003 at 180370 millions of yen and Cost of sales at 128776 millions of yen, he computed gross profit @ 28.60%.

Aggrieved thereby, the assessee moved the first appellate authority against the addition of Rs.80.95 lac. The ld. CIT(A) came to hold that the transfer pricing study report was rightly rejected by the AO inasmuch as it did not give any indication key for allocation of cost and how the segments were created. He, therefore, refused to take cognizance of the segmental results shown by the assessee for the purposes of comparison. He further did not agree with the AO in taking 40% contribution of selling and marketing functions. Taking note of the TP study report of the assessee for the A.Y. 2006-07 in which the assessee had used cost plus of 15% as a mark-up on the total cost incurred by the branch office in India as against the compensation to the branch office at cost plus 5%, the ld. CIT(A) held that Cost Plus Method should be the most appropriate method in the given facts and circumstances of the case. As the business model of the assessee for all the years remained the same, the ld. CIT(A) held that 15% should be added to the assessee’s costs for the purposes of mark-up, which resulted in reducing the total income to Rs.16,75,217/-. The Revenue is aggrieved against the reduction in addition. There is no cross appeal from the side of the assessee, meaning thereby, that all the adverse findings of the AO as upheld by the CIT(A), have been impliedly accepted. 6

We have heard the rival submissions and perused the relevant material on record. There is no dispute on the fact that the branch office constitutes a permanent establishment of the assessee in India which has been fairly accepted by the ld. AR as well. Entire controversy before us revolves only around the attribution of income to such PE. The assessee filed report in Form No. 3CEB and tried to justify the ALP of the international transaction under the `Cost Plus Method’ on the services rendered, `Comparable Uncontrolled Price’ Method on trading of nephrology products and `Resale Price Method’ on other products sold in India. The TP study report, as held by the ld. CIT(A), did not give any indication as to the allocation of costs and how these segments were created, which was rejected by the authorities below. On a specific query, the ld. AR candidly accepted that the TP study report was not available and the same be treated as rightly rejected in view of the deficiencies pointed by the authorities. We, ergo, approve this finding.

As a matter of fact, both the sides have focused only on the manner of determination of the quantum of income of the assessee chargeable to tax in India. The AO has started with the figure of total turnover of the assessee in India from all sources at US Dollars 36,15,095, whose bifurcation is available on page 41 of the paper book viz., sales by Singapore head office through Indian branch office at USD 6,46,408; sales by Singapore head office to the distributors in India at USD 11,06,680; and sales by Singapore head office to direct customers in India at USD 18,62,007. The AO took up total sales made by the assessee in India either directly or through the branch office for the purpose of determination of income. It is not disputed that the branch office in India was not only effecting sales directly, but also undertaking marketing activities in respect of goods sold directly by the head office in India either through distributors or direct customers. Under these circumstances, it is incorrect to argue that the AO applied `force of attraction’ rule for determining the income of the assessee. Au contraire, We find that the AO has restricted himself to the `profit attribution’ principle, inasmuch as the branch office in India rendered marketing services to its head office for making direct sales and the AO has confined the computation of income only to the extent of the 8 contribution made by such marketing services rendered in India. An income which is a quid pro quo to the branch office for rendering marketing services directed towards effecting direct sales by the head office in India, falls within the sweep of `profit attribution’. `Force of attraction’ rule is said to be applied when income from activities directly undertaken by head office in India, de hors the involvement of Indian branch office, is also included in the total income. Where, however, the Indian branch office renders some services in respect of the direct sales made by the head office, the determination of income for such services, cannot be brought within the ambit of force of attraction rule. As the AO has restricted the computation of total income of the assessee only to the extent of contribution made by the marketing effort done by the Indian branch office in the overall profit from the sales made by the head office in India, we, will have to reject the contention of the ld. AR that the authorities below applied force of attraction rule.

Now we turn to the determination of the quantum of income chargeable to tax in India. It is reiterated at the cost of repetition that both the sides have limited their respective arguments only to the working done by the AO or CIT(A). It is not the case of either side that the income should have been determined in any other manner. As such, we will also limit ourselves to the arguments made without going into the larger question whether such mechanism of working of total income is right or not.

It has been noticed above that the direct sales made by the head office were not recorded in the books of the branch office. It is further not disputed that the assessee booked all the expenses incurred in marketing activity for such direct sales made by the head office without receiving any corresponding income. In such circumstances, coupled with the absence of any correct transfer pricing study report, the AO was left with no alternative but to determine income on some reasonable basis, for which he invoked the provisions of Rule 10 of Income-tax Rules, 1962. The ld. CIT(A) noted in para 5 of the impugned order that the assessee in subsequent assessment years, namely, 2005-06 and 2006- 07 has used cost plus 15% as a mark up on total cost incurred by the branch office in India, whereas the branch office was compensated at cost plus 5%. We find some infirmities in this finding. We have gone through the Transfer pricing study report for the A.Y. 2005-06 which has been placed at page 158 of the paper book. It can be seen that the assessee applied Transactional Net Margin Method (TNMM) and not the Cost Plus Method (CPM) as has been taken note of by the ld. CIT(A).

The working done by the AO is also equally not up to the mark. He computed `gross profit’ margin at 28.60% of Nipro Corporation and its consolidated subsidiaries. Such gross profit rate was applied to all the sales made by the assessee in India, whether directly or through its branch office. 40% of such determined profit was attributed to sales activity in India through PE. That is how, profit rate from the activities in India was determined at 11.44% (i.e. 40% of 28.60%). We are unable to countenance the view adopted by the AO because he took the figures of net sales and cost of sales and computed gross profit at 28.6% from the accounts of Nipro Corporation and its consolidated subsidiaries. The table from which such percentage of 28.6% was worked out, also shows the amount of Selling, general and administrative expenses to the tune of 36695 millions of yen, which is a little more than 20% of sales value.

At this juncture, it is relevant to note the prescription of Rule 10 of Income-tax Rules, 1962, dealing with the determination of income in the case of non-residents, as under :-

A bare perusal of the Rule transpires that where actual amount of income accruing to non-resident from any business connection, etc., in India cannot be definitely ascertained, the amount of such income may be calculated in one of the three ways as given under clauses (i) to (iii) of Rule 10 and the first, being `at such percentage of the turnover so accruing or arising as the Assessing Officer may consider to be reasonable’ and the third, being `in such other manner as the Assessing Officer may deem suitable’. In principle, the AO has rightly invoked this rule for determining the income of the assessee. As the annual accounts of Nipro Corporation and its consolidated subsidiaries were not made available and the AO got some of the important figures from the website of Nipro Corporation, such selective figures cannot be equalized with the full fledged annual accounts of the assessee company, facilitating the precise determination of income accordingly. We have noticed above that the working done by the AO in considering gross profit margin as a base point from such selective figures, is also not capable of acceptance.

Then comes the question of attributing income to the activities of marketing and sales carried out by the branch office in India. In this regard, it is seen that the Delhi Bench of the Tribunal in Rolls Royce PLC vs. DDIT 2007-TII-32-ITAT-DEL-INTL, has applied 35% of 10% of the total profit as pertaining to marketing activities, which stands affirmed by the Hon’ble Delhi High Court in Rolls Royce PLC vs. DIT(IT) (2011) 339 ITR 147 (Del). It is further noted that the Delhi Bench of the Tribunal in ZTE Corporation vs. Addl. DIT (2016) 159 ITD 696 (Del) has also attributed 35% of the profits attributable to marketing activities in India. It is still further noted that the Delhi Bench of the Tribunal in G.E. Energy Parts Inc. VS. ADIT in after considering the earlier decisions and the nature of activities carried out by the PE in India, has attributed 26% of the profits attributable to marketing activities in India. There can be no hard and fast rule of attribution of profit to marketing activities carried out in India at a particular level. In fact, attribution of profits to PE in India is fact based, depending upon the role played by the PE in the overall generation of income. Such activities carried out by a PE in India resulting in generation of income, may vary from case to case. Attribution of income has to be in line with the extent of activities of PE in India.

In the result, the appeal is partly allowed.