UPM KYMMENE INDIA P.LTD,MUMBAI vs. DCIT 1(3)(2), MUMBAI

The assessee-herein is a wholly owned Indian subsidiary of UPM- Kymmene Corporation, Finland. The assessee is engaged in the business of distribution of its parent’s company’s (herein referred to as ‘Associated Enterprise’or ‘AE’) filmic and paper products (self adhesive products). It mainly import papers and plastic films from its associated enterprise in jumbo rolls and slits these jumbo rolls into different sizes and distributes them to its customers. As per the agreement entered between the assessee and its associated enterprise, it is entitled to a protective margin of 4% in case of its distribution activity and 1% in case of its indenting agent activity. During the year under consideration, assessee had carried on distribution activity i.e. it

The Transfer pricing officer (TPO) did not accept the claim of the assessee that it is a limited risk distributor, as he noticed that the assessee is exposed to all types of business risks. Further the TPO held that the activity of slitting jumbo rolls results in value addition. TPO also noticed that the assessee has obtained factory license, paid excise duty and carried on operations of value addition through plant and machinery. Accordingly, TPO held that the assessee is carrying on “manufacturing activity”. Even though, the assessee contended that its activity was not considered to be a manufacturing activity under Excise Law, TPO did not accept the same. The TPO further noticed that the assessee was getting a margin of 1% in case of indenting activity, wherein the assessee does not take any risk, the goods do not reach its factory and it also does not carry on any value addition. However, in the case of distribution activity (which was considered by the TPO as manufacturing activity), the assessee was getting 4% i.e. the assessee was getting excess margin of 3% for the value addition. The TPO noticed that 4 comparables selected by the assessee are carrying on trading activities, which the TPO considered to be akin to indenting activity. Out of four comparables, TPO rejected two

The operating expenses reported by the assessee included expenses of ` 104.15 lakhs relating to “paper segment”. Though the assessee furnished segmental figures, i.e., operations pertaining to “self adhesive label segment” and “Paper segment”, yet the TPO did not recognize the segmental reports on the reasoning that they were not audited. Accordingly he considered the above said expenses of ` 104.15 lakhs as part of self adhesive label segment and accordingly proceeded to examine the issue at entity level.

Since the assessee was given protective margin of 4%, the TPO took the view that the AE is determining the selling price of products sold to the assessee by fixing the profit first and then determining the cost of materials, under reverse mechanism. Accordingly the TPO took the view that the profit of the assessee actually determines the cost of import to the assessee and not the reverse. Accordingly the TPO took the view that the extra profit, if any, that accrues to the assessee is being passed on to the AE under the above said reverse mechanism method. The assessee had shown the operating cost of Rs.6738.83 lakhs (including that of paper division) and operating income of Rs.6851.12 lakhs. Since the TPO has determined the margin at 6.6%, he took the operating cost at 93.40% of the revenue and accordingly arrived at a operating cost at Rs.6398.95 lakhs. The difference between the cost shown by the assessee and that determined by the assessing officer worked out to ` 339.88 lakhs. The ratio of transaction value of imports on the operating cost worked out to 77.91% and accordingly he proposed adjustment of ` 264.81 lakhs, which was calculated at 77.91% of difference cost of ` 339.88 lakhs.

The Ld D.R.P confirmed the order of TPO in holding that the activity carried on by the assessee is a manufacturing activity. The Ld DRP directed inclusion of M/s Arms paper Ltd as a comparable. However, it confirmed the rejection of M/s JMG Corporation Ltd. Though, the Ld DRP did not discuss anything about the addition of 3% to the margin, yet it appears that the Ld DRP has upheld the same also. Similarly it did not express its view on consideration of expenses at entity level without excluding expenses pertaining to paper segment.

The first grievance of the assessee is about non-exclusion of expenses relating to “Paper segment”. The Ld A.R submitted that the assessee has quantified the expenses from out of audited accounts and had disallowed the same while computing total income and accordingly arrived at total income of Rs.322.84 lakhs. He submitted that the AO has accepted the same and made addition to the total income returned by the assessee. Accordingly he submitted that the assessee did not claim the expenses relating to paper segment amounting to Rs.104.15 lakhs as deduction at all and hence the tax authorities are not justified in including the same while determining Arms length price of import transactions.

The Ld D.R submitted that the segmental reports were not audited and hence it was rightly rejected by TPO.

However, we find merit in the contentions of the assessee. We notice from the statement of total income placed in the paper book that the assessee has disallowed the above said expenses relating to paper segment, while arriving at the returned income, i.e., it has quantified the expenses from the audited figures and disallowed the same. The assessee disallowed the same on the reasoning that the paper factory did not commence production during the instant year. We notice that the AO has accepted the same, meaning thereby,

The next issue contested by the assessee is about the nature of activities carried on by it, i.e., whether it is a distributor/trading transaction or manufacturing activity. According to the assessee, the operations carried on by it by way of slitting the jumbo roll into smaller rolls and repacking it would not amount to manufacturing activity. Further, it claims to be a distributor with limited risk. The said claims of the assessee have been rejected by the tax authorities.

We notice that the assessee has purchased plant and machinery and installed the same in a factory duly determining the installed capacity and also reporting actual production. It is also disclosing wastage while producing smaller rolls, paid excise duty and also incurred expenses on power and fuel. It has obtained license under the Factory Act. The ld DRP has taken support of the decision rendered by Hon’ble Delhi High Court in the case of Northern Strip Ltd & Another Vs. ITO, wherein it was held that cutting and slitting of polyester films was a manufacturing activity. We notice that the Hon’ble Supreme Court has also taken an identical view in the case of M/s Indian Cine Agencies Vs. CIT (Civil Appeal No.3649 – 3650 of 2003 dated 12.11.2008). In view of the above discussions, we are of the view that the activity carried on by the assessee in slitting the jumbo rolls into small sizes should be considered as manufacturing activity and accordingly uphold the view taken by the tax authorities on this issue.

We notice that the assessee has considered itself to be a distributor and accordingly it has selected comparables, which are engaged in trading activity. However, we have agreed with the view taken by the TPO that the activities of the assessee results in manufacturing activity. Hence the comparables selected by the assessee would fail in functionality test. We further notice that the TPO, after having held that the assessee is engaged into manufacturing activity, has chosen to increase the margin by 3% to the average margin reported by the comparables engaged into trading. According to TPO, the same would give results of carrying on manufacturing activity. Further the TPO has taken the view that the trading activities are akin to indenting agency activities. In our view, the methodology adopted by the TPO was not realistic. In our view, the companies engaged in trading activities cannot be equated with an indenting agent because of risk profiles attached to each of the activity. Further the presumption drawn by the TPO that the increase of margin by 3% would bring out the result for manufacturing activity also does not appear to be correct, since it does not consider the risks attached to manufacturing activity. Further the assessee claims that the enhanced margin of 3% is a protective measure adopted by the AE to ensure profits to the assessee. Hence, it cannot be said that there will always be an additional margin of 3% in case of manufacturing activity vis-à-vis trading activity. Further the TPO has presumed that the cost of import is determined by reverse mechanism by determining the profits first. The TPO has not substantiated the same on the basis of record. Accordingly we are not able to agree with the theory of TPO in arriving at the cost of import by reverse mechanism and accordingly making adjustments.

Thus, we are not in agreement with the approach adopted by the assessee as well as the TPO in benchmarking the import transactions. The proper course, in our view, should be to select comparables which are engaged in similar activities of converting jumbo rolls into smaller sized rolls. Accordingly we are of the view that this matter requires fresh exercise and examination. Accordingly we set aside the order passed by the tax authorities

In the result, the appeal of the assessee is treated as partly allowed for statistical purposes.