M/S. GAP INTERNATIONAL SOURCING (INDIA) PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

PER DIVA SINGH, JUDICIAL MEMBER The present appeal has been filed by the assessee assailing the correctness of the

order dated 12.11. 2013 of CIT(A)-XX, New Delhi pertaining to 2006-07 assessment year

on various grounds. For the purposes of the present proceedings, we propose to treat

Ground Nos.2 & 3 as Grounds to be decided by the ITAT and the remaining Grounds are

treated as arguments in support of the grounds raised. For ready-reference, these are

reproduced hereunder:-

That on the facts and circumstances of the case; l. “The CIT(A) erred in confirming the penalty under section 271(1) (c) of the Income -tax Act, 1961 (‘the Act’) amounting to Rs 1.65 crores, which was levied by the assessing officer (AO) for alleged concealment of income and also furnishing inaccurate particulars of income with respect to the transfer pricing (TP) adjustment of Rs 4.92 crores, which was ultimately confirmed by the Hon’ble Tribunal out of the original TP adjustment of Rs 236.23 crores initially made by the

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AO, after granting relief for the balance part of the TP adjustment amounting to Rs 231.31 crores. 2. The CIT(A) erred in invoking the provisions of Explanation 7 of section 271(1) (c) of the Act in confirming the aforesaid levy of penalty by holding that the Appellant had failed to prove before the AO and CIT(A) that the TP adjustment with reference to which the penalty had been levied, as referred to in Ground N0.1 above, did not arise due to any absence of good faith and due diligence on the part of the Appellant in computing the price of its international transactions with the foreign associated enterprises (AEs) in accordance with the provisions of section 92C of the Act. 3. The CIT(A) erred in holding that the TP adjustment, which was confirmed by the Hon’ble Tribunal amounting to Rs 4.92 crores out of the initial TP adjustment of Rs 236.23 originally made by the AO, having been computed with reference to a mark up of 32% on operational cost of the Appellant, was in fact the result of a concession or admission made by the Appellant before the Hon’ble Tribunal that the said figure of 32% actually represented the arm’s length mark up with respect to the international transactions of providing sourcing support services by the Appellant in favour of foreign AEs. 4. The CIT(A) erred in not appreciating that the Appellant had never conceded before the Hon’ble Tribunal that the said figure of 32% was the arm’s length mark up of the international transactions entered into with the foreign AEs, as referred to in Ground No. 3 above. 5. The said figure of 32% was a derived mark up on the operating cost earned by a private company, namely M/s Li & Fung (India) Private Limited, with respect to its global profits; and not limited to the profits made by it in India, where the Hon’ble Dispute Resolution Panel (‘DRP’) and accordingly the AO had relied upon the said company in the context of a judgement of the Hon’ble Delhi Tribunal rendered in the case of the said company for the proposition that the remuneration policy of the Appellant was to be computed with reference to commission of the value of the goods procured by the overseas AEs of the Appellant from India, an assertion which was outright rejected by the Hon’ble Tribunal in the Appellant’s own case for the relevant assessment year by holding that the remuneration policy of the Appellant was to be determined as a mark up on only its operational cost and not a commission on the value of goods procured by the overseas AEs from third party vendors in India. 6. The said figure of 32%, in the form of a mark up on the operational cost of the Appellant, was never ever applied or even proposed to be applied by the Transfer Pricing Officer (TPO), the DRP or the AO during the course of original assessment proceedings, since the line of action on the part of the said authorities was only to compute the arm’s length price of the international transactions of the Appellant entered into with foreign AEs with reference to a commission of 5% on the value of goods procured by the foreign AEs directly from third party vendors in India - an assertion which was outright rejected by the Hon’ble Tribunal while disposing the quantum appeal of the Appellant for the relevant assessment year. 7. On the premises of Ground Nos. 5 and 6 above, the CIT(A) erred in not appreciating the fact that there was no occasion or scope on the part of the Appellant to have not computed its arm’s length price in accordance with the provisions of section 92C of the Act with reference to such derived figure of 32% as a mark up on its operating cost, since the said figure of 32%, being a mark up

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on operating cost, did not exist in the AOs order passed under section 143(3) of the Act read with section 144C of the Act or in any public database available either with the AO or the Appellant, namely Prowess and Capitaline Plus, with reference to which comparable benchmarking analysis was carried out whether during the course of preparing the return of income or even during the assessment proceedings; and therefore the CIT(A) further erred in confirming the levy of penalty as aforesaid, by invoking the provisions of Explanation 7 of 271 (1) (c) of the Act. 8. During the course of the proceedings of the quantum/ merit appeal before the Hon’ble Tribunal relating to the relevant assessment year, the authorised representative of the Appellant, while disputing the reliance placed by the DRP, the AO and the departmental representative on the judgement of the Hon’ble Tribunal rendered in the case of Li & Fung India (supra) for the proposition that, by following the said judgement of the Hon’ble Tribunal, a commission based form of remuneration model was to be applied even in the case of the Appellant, which as aforesaid, was outright rejected by the Hon’ble Tribunal in the Appellant’s own case , made a mention that even while adopting the correct model of mark up on operating cost, the said mark up could, under no circumstances, exceed the derived mark up on operating cost in the case of Li & Fung, representing its global profits; and not just the profits derived by such company in India, as opposed to the exorbitant mark up on operating cost amounting to 830.95%, which was imputed by the DRP and the AO, by wrongly applying a commission based model in the case of Appellant; and thus the authorised representative of the Appellant had never conceded before the Hon’ble Tribunal that the said figure of 32% was the arm’s length mark up of the relevant international transaction entered into by the Appellant with overseas AEs. 9. The CIT(A) erred in appreciating the fact that the Appellant placed the said figure of 32% as being one of the several data points which could have been taken for computing the arm’s length mark up on the operational cost of the Appellant, the other data points being 15.13%, 19% and 26%, as evident from the order of the Hon’ble Tribunal passed in the Appellant’s case for the relevant assessment year; and as also reproduced by the CIT(A) in its own order while confirming the penalty, with a further submission that arithmetic mean of all such data points was 22%, without prejudice to the primary contention that the Appellant’s original margin of 15% on operating cost remained uncontroverted by the DRP and the AO; and it is a different matter altogether that Hon’ble Tribunal adopted such extreme figure of 32% as the arm’s length price, in the process giving relief to the Appellant for an amount of Rs 231.31 crores out of the original TP adjustment of INR 236.22 made by the AO.

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during the course of discussions before the Hon’ble Tribunal and that too in the context of a private company, whose financials were not available in the public database and whose reference was made by the AO, the DRP and the Departmental Representative to augment their arguments for the adoption of a commission based remuneration model. 11. Without prejudice to any other contentions of the Appellant preferred in grounds as above, even assuming but not admitting that the adoption of the said figure of 32% as the arm’s length mark up on operating cost of the Appellant, arose due to a difference of opinion between the Hon’ble Tribunal and the Appellant, such difference of opinion did not automatically infer any lack of bonafide, good faith or due diligence adopted by the Appellant while determining the price for its international transactions entered into with its foreign AEs, more so when such derived figure was never available before the Appellant at the time of filing of Return of Income or by the Revenue authorities at the time of assessment proceedings for the relevant assessment year and ; in such premises the CIT(A) erred in confirming the levy of penalty amounting to Rs 1.65 crores in the case of the Appellant. 12. Without further prejudice to any of the grounds as mentioned above, the AO and the CIT(A) erred in levying and confirming the penalty respectively by ignoring the fact that the Appellant had invoked Mutual Agreement Procedure (MAP) under Article 27 of the India - US tax treaty inter-alia with respect to the TP adjustment of Rs 236.22 originally made by the TPO, which includes the sum of Rs 4.92 crores which was ultimately confirmed by the Hon’ble Tribunal under the circumstances as above, which as per Clause 5 of MOU entered between India and United States with reference to such MAP, any assessment and collection in relation, to penalty need to be kept in abeyance till the resolution of said MAP proceedings and therefore the order passed by the said AO in imposing the said penalty need to be cancelled and held void ab-initio. The Appellant craves leave to alter, amend or withdraw all or any of the grounds herein or add any further grounds as may be considered necessary either before or during the hearing.” 2. The Ld. AR carrying us through the penalty order, the impugned order and referring

to the order of the ITAT passed in the quantum proceedings submitted that the concession

of mark-up of 32% was made in the quantum proceedings in the background where there

was an order of the ITAT in the case of M/s Li and Fung India P. Limited vs DCIT

[2011] 16 taxmann.com 192 (Del.). A perusal of the TP study of the assessee

available on record, it was submitted would show that at no point of time mark up of 32%

was ever being considered by the assessee. Nor was any such proposal made by the TPO.

Amongst the several data points available for computing the arm’s-length price at no point

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of time 32% mark-up either by the assessee or by the authorities had ever been

considered. The said figure surfaced for the first time during the hearing of the quantum

proceedings in assessee’s case. It was submitted that since the order of the ITAT in Li and

Fung India P. Ltd. (cited supra) was available before the ITAT as a result of the view

expressed therein considering the fact that the ultimate impact on the assessee in the

quantum proceedings was not so detrimental to the assessee thus for the sake of peace of

mind, the concession was made before the ITAT. In the circumstances, it was his prayer

that penalty may be quashed as it is not a case of concealment. It was also submitted that

in the face of the decision of the Hon’ble High Court in the very case of Li and Fung India

P. Ltd. (cited supra) penalty in the peculiar facts and circumstances of the case was not

maintainable.

2.1. Referring to the facts it was submitted that the record would show that penalty u/s

271(1)(c) was initiated on account of the following additions/disallowances:-

i) Addition on account of Transfer Pricing - Rs.2,36,22,31,473/- ii) Excessive claim of depreciation - Rs.27,02,896/- 2.2. In the quantum proceedings it was submitted the addition on account of excessive

claim of depreciation was deleted by the ITAT in ITA No.228/Del/2012 dated 18.09.2012

and only the addition on account of Transfer Pricing adjustment partially survived as the

mark-up on cost incurred for services provided was enhanced from 15% to 32%. However,

the remuneration model of the assessee it was submitted was accepted and the re-

characterizing done by the TPO of the remuneration model of the assessee on a commission

on the value of goods was not approved by the ITAT. This addition which has been

accepted by the assessee it was submitted has formed the basis for levying penalty u/s

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271(1)(c) by invoking Explanation 7 of the Income tax Act, 1961. It was submitted that

despite offering detailed explanations in waiting before the AO in the penalty proceedings

vide two specific letters the receipt of which is accepted but the AO he has held that the

assessee has remained silent.

2.3. It was submitted that though the submissions advanced on behalf of the assessee

before the CIT(A) on facts and law are extracted in para 5 from pages 14 to 18. However,

these did not meet with any success. The Ld.AR carrying us through them submitted that

by and large the assessee relies on these arguments and prays that penalty in the facts on

record was not leviable.

2.4. Carrying us through the finding of the CIT(A) it was submitted that the penalty has

been confirmed mechanically on the reasoning that due to variation in the mark-up from

the TP study to the enhanced mark-up “ignoring the detailed arguments on facts and law it

was held that the assessee did not carry out its TP study with good faith and due

diligence.” Addressing this finding it was submitted by the Ld.AR that the detailed

submission were completely ignored.

2.5. Relying upon the copy of the synopsis containing the gist of the arguments on

facts and law relied upon by the assessee, it was submitted that the penalty on facts

deserves to be quashed. Carrying us through the synopsis filed it was submitted that the

assessee operates as a procurement support service company for its foreign associated

enterprise (‘AE’) i.e. GAP US. It was submitted that GAP US sources the goods directly

from third party vendors in India (in respect of which the assessee had rendered sourcing

support services). These it was submitted are not routed through the financial accounts

of the assessee into its Profit & Loss account. The assessee it was submitted is Page 6 of 23

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remunerated at total operating costs plus a 15% mark-up thereon and therefore the total

operating cost does not include the value of goods sourced by GAP US from third party

vendors. The cost plus model adopted by the assessee it was submitted was not

accepted by the TPO and he applied a commission at the rate of 6.07% in AY 2006-07

on the value of goods procured by GAP US directly from third party vendors from India,

leading to a TP adjustment of Rs.236.22 crores. The TPO while proposing the addition it

was submitted relied upon the order of the ITAT in the case of Li & Fung India Private

Limited (‘Li & Fung India’). It was submitted that by the time the quantum appeal came

up before the ITAT considering the argument of the assessee that the facts in the case of

Li & Fung in assessee’s case were distinguishable which argument was accepted by the

ITAT and the remuneration model of the assessee as disclosed in the TP study was

accepted. The ITAT it was submitted held that the assessee was entitled to a mark-up

on total operating costs of GIS India only (and not the value of goods sourced by GAP

US) and thus commission based remuneration was held to be not applicable to the

assessee. However, on the issue of mark-up the derived mark-up on operational costs,

as in the case of Li & Fung India of 32% was accepted and not mark-up of 15% as per

assessee’s TP study based on agreement with the foreign AE. By conceding to accept the

said mark-up the assessee it was submitted was a beneficiary of relief to the extent of

Rs.231.31 crores out of the total adjustment of Rs.236.22 crores made by the AO and the

adjustment was thus restricted to only Rs.4.92 crores. As a result of this decision it was

submitted the assessee received relief of more than 98%. The said decision it was

submitted was accepted by the assessee and no appeal against the same was filed. The

decision to give up and settle the issue it was submitted was guided by wanting to buy Page 7 of 23

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peace and avoid protracted litigation. Inviting attention to the high handedness of the

Revenue it was submitted that the AO in the penalty proceedings in para 3 duly

acknowledged that in response to show cause notice requiring the assessee to explain

why the penalty under section 271(1)(c) of the Act should not be levied the assessee

responded by two specific letters. However, in subsequent paras i.e. para 4 and 6 of the

order, the AO noted that the assessee has been silent in response to the show cause

notice for imposing penalty and has failed to rebut the allegations.

2.6. Apart from relying upon the submission before the AO and the CIT(A) at pages 2

to 20 of the Paper Book it was reiterated that that it is merely a change in the mark-up

being adopted by the ITAT while accepting the cost plus remuneration model followed by

the assessee and thus there existed no basis for either initiating or imposing or for this

matter confirming the penalty.

2.7. It was also submitted that the ITAT in assessee’s own case in 2009-10 and 2010-11

AYs accepting the mark-up of 15% on operational costs the entire addition was deleted.

2.8. On the basis of these facts, arguments and legal position it was submitted adoption

of a different mark-up in the facts of the present case cannot be treated as concealment or

furnishing of inaccurate particulars. Reliance was placed on M/s. Babcock & Brown India Pvt.

Ltd. (ITA No. 2214/MUM/2015); ADP Pvt. Ltd. [TS-310-ITAT-2013(HYD)-TP]; and United Online

Software Development (India) Pvt. Ltd [TS-493-ITAT-2015(HYD)-TP]. It was also submitted

that Non filing of appeal at higher forums does not necessarily attract penalty. In support

of the said proposition, reliance was placed on Boston Scientific India Pvt. Ltd [TS-73-ITAT-

20I6(DEL)-TP]; and Mitsui Prime Advanced Composites India . Ltd [TS-193-ITAT-

2016(DEL)-TP]. It was further submitted that for levying penalty there must be absence of

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good faith and due diligence as held by the ITAT in RBS Equities India Ltd (formerly known

as ABN Amro Asia Equities India Ltd.) [ITA No. 2570/Mum/2010, 201 l-TII-91-ITAT-MUM-

TP, TS-492-ITAT-201 l(Mum)]; M/s Verizon Communication India Pvt. Ltd. vs. DC1T [ITA

No: 5566/Del/2011]; Serdia Pharmaceuticals (India) Pvt. Ltd. (ITA No. 7215/Mum/2007);

M/s Firmenich Aromatics (India) Pvt. Ltd [ITA No 4654/Mum/2009].

2.9. Accordingly it was summed up that the assessee has conducted its transfer pricing

study in a bona fide manner and the ITAT has upheld the selection of most appropriate

method followed in the TP Documentation maintained by the Company has also accepted

the PLI and the remuneration model/stands accepted and has merely adopted a different

mark-up. Thus a mere difference in the mark-up adopted by the assessee it was submitted

does not justify the levy of penalty for concealment or of furnishing inaccurate particulars

of income.

penalty was leviable in terms of Explanation 7 of Section 271(1)(c) and considering these

very facts and submissions the penalty levied by the AO has been confirmed by the CIT(A).

Carrying us through the findings of the respective authorities, it was his argument that

there is no doubt that the TP Study of the assessee has not been accepted by the TPO and

even if the remuneration model of the assessee has ultimately been accepted in the

quantum proceedings by the ITAT the fact remains that the mark-up of 15% has not been

accepted and enhanced mark-up has been conceded by the assessee and the issue not

having been agitated further demonstrates that there was concealment. The decision in

subsequent years and the decision overturning the decision of the ITAT by the Hon’ble

High Court in Li and Fung it was submitted are subsequent facts and not relevant. Page 9 of 23

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Before we address the facts, we first extract the relevant provision which has been invoked

by the Revenue in the facts the present case:-

13.1. “The relevant provisions of section 271(1)(c) are set out hereunder for ready-reference:- 271(1). “If the [Assessing] Officer or the [Commissioner (Appeals) [or the [Principal Commissioner or] Commissioner] in the course of any proceedings under this Act, is satisfied that any person- (a) ************** (b) ************** (c) Has concealed the particulars of his income or furnished inaccurate particulars of [such income, or] (d) ************* Explanation 7:- Where in the case of an assessee who has entered into an international transaction [or specified domestic transaction] defined in section 92B, any amount is added or disallowed in computing the total income under sub-section (4) of section 92C, then, the amount so added or disallowed shall, for the purposes of clause (c) of this sub-section, be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished, unless the assessee proved to the satisfaction of the Assessing Officer or the Commissioner (Appeals) [or the [Principal Commissioner or] Commissioner] that the price charged or paid in such transaction was computed in accordance with the provisions contained in section 92C and in the manner prescribed under that section, in good faith and with due diligence].” 4.1. A perusal of the above makes it clear that Explanation 7 of section 271(1)(c) is a

deeming provision whereby it is deemed that in case of any addition or disallowance in the

case of an assessee who has entered into an “international transaction” defined in Section

92B of the Act then for the purposes of sub-section (c) of section 271(1) the said amount

added or disallowed would be deemed to represent such income in respect of which

particulars have been concealed or inaccurate particulars have been furnished. Exception

is carved out only in the case where the assessee proves that the price charged or paid in

such transaction was computed in accordance with the provisions contained in section 92C;

and in the manner prescribed under that section “in good faith” and “with due diligence”.

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Thus in order to consider whether the said requirements of Explanation 7 have been met or

not, it is necessary to consider the facts and circumstances leading to the addition having

been made. The discussion on these facts is relevant and material in order to decide the

issue. The facts related to the issue have been thrashed out in the quantum proceedings

and are a matter of record. Before we address the same, we are of the view that it would

not be out of place to refer to the settled legal position that levy of penalty is not

automatic. The explanation offered in the penalty proceedings is required to be considered

afresh in the light of the requirements of the relevant provision and simply because the

addition has been sustained in a contested issue or accepted without a contest cannot be

the criteria to mechanically levy or uphold the penalty levied.

4.2. The onus upon the taxpayer is only to show whether the arm’s length price has

been computed in accordance with the provisions of section 92C of the Act in good faith

and due diligence and nothing more. The fact that that the addition is contested or given

up per se would not be determinative of the issue. It is the evaluation of the facts and

circumstances as borne out from record which would throw light whether the decision not

to contest was bona fide or mala fide arising out of a failure of the assessee. It is

necessary to establish what were the guiding factors which contributed to the decision. It

is a settled legal position that the mere fact that an addition is accepted per se does not

mandate that penalty is leviable it is the explanation offered by the assessee in the penalty

proceedings addressing the facts why surrender is made which is required to be

considered. Applying the various tests and propositions laid down by the courts to the

levy of penalty and on consideration of the legal position on the facts the AO is required to

decide the issue. Consideration of the explanation offered is mandatory only then the Page 11 of 23

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decision can be said to be arrived at whether to levy or drop the proceedings. At the cost

of repetition, penalty cannot be imposed simply because the addition is accepted. It can

only be imposed if the explanation offered is shown to be lacking in good faith and the

transaction can be shown to be computed without due diligence with a willful attempt to

defraud the Revenue.

4.3. When the facts of the present case are considered, we find that the TP study qua

the issue was accepted by the TPO to the extent that the most appropriate method

selected as TNMM was not tinkered with. The comparables offered were also not

interfered with. Considering the Agreement of the assessee with the Foreign AE which has

been reproduced in the TPO’s order itself verbatim shows that full facts have been

disclosed all along including the fee schedule which has also been reproduced by the TPO.

On analyzing the same, the TPO held that the correct compensation model at arms length

price would be commission on FOB cost of goods sourced from India and the addition was

proposed. By the time, the issue in the quantum proceedings came up before the DRP the

decision of the ITAT in the case of Li & Fung holding the same view was available and the

assessee consequently failed to get any relief. It is a fact that the Co-ordinate Bench in the

quantum proceedings did not approve the interference with the remuneration model of the

assessee made by the TPO and upheld by the DRP. It would be appropriate to refer at this

stage to the findings arrived at in the quantum proceedings. The relevant extracts from

the order in the quantum proceedings are extracted hereunder:-

9.2. “Characterization of Assessee and its Associated Enterprises through Function, Assets and Risk (FAR) analysis of international transactions.

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The FAR analysis gives the basis of broad characterization for e.g. Manufacturer, Service Provider, Distributor, etc with a further sub-characterization including low-risk service provider, high risk service provider; Full-Fledged manufacturer, contract manufacturer, etc. These characterizations are vitally important to determine the arm’s length price of international transactions. i. Authorities below have proceeded on premise that assessee is a risk bearing AE and its functions are not in the nature of a service provider only. The FAR attributable to assessee are far greater than what are claimed. Assessee has developed substantial intangibles in the form of human resources and supply chain. Besides location advantages available to assessee have not been factored in the ALP.

ii. On these observations, and by putting reliance on the case of Li & Fung India, it has been held that assessee performs the functions of a risk bearing agent and therefore, cost plus PLI adopted by the assessee for ALP determination is not the most appropriate. Thereby the cost plus PLI has been substituted by 5% on FOB value of goods outsourced by the entities of foreign enterprises which has been considered to be the TP value.

iii. In our considered view, no supporting material has been brought on record that assessee; GIS India has borne any business risks arising from its activities with GAP USA. There are no adverse facts, material or evidence on the basis whereof Ld. TPO has made arrived at such a conclusion. The Ld. TPO has not given any examples or comparables whatsoever to demonstrate which major business risks much less any risk are borne by GIS India and how. In a sweeping manner it has been held that as functions follow risks, and since, in his wisdom GIS India undertakes key functions, therefore it must also be bearing the consequent risks. The observation is flawed as from the handbook and guidelines it clearly emerges that assessee had no wisdom or discretion in these terms.”

iv. ………………………….. v. ………………………….. vi. …………………………..

viii. In view of all these facts we are unable to agree with the propositions of TPO that assessee works as a risk bearing agent of the AE and it possesses human resources intangibles along with supply chain resources. The facts and circumstances lead us to a conclusion that assessee is a low risk procurement support service provider only.” (emphasis provided) 4.4. The following extracts from the order of the Co-ordinate Bench would further be

relevant to refer to in order to consider the conduct of the assessee vis-a-vis its claim of

good faith and due diligence which is under scrutiny:-

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9.4. Li & Fung Case and TPO / DRP Stand i. ……………………….. ii. ……………………….

iii. The department has heavily relied on the Li & Fung India’s case (supra). In this case, the Delhi Tribunal held that on the facts of the said case, the procurement company in India was entitled to a revenue linked remuneration. The decision in the case of Li & Fung proceeded on the specific findings of the TPO that the assessee was not able to establish that the foreign principal in Hong Kong had any substance, which the assessee was also not able to substantiate before the Tribunal. In these peculiar facts Tribunal accepted the factual position that the Indian assessee had actually carried out all the significant functions relating to procurement in India; and that very little or virtually nil functions were carried out at the level of Hong Kong.

iv. However, the facts in the appellant’s case are different in as much as all the significant directions relating to procurement of goods from third party vendors in India, namely – (a) designs & trends of apparel; (b) quality parameters of materials: (c) terms & conditions for dealing with vendors, etc, are all provided by GAP US to the appellant through the voluminous vendor handbook & other correspondences which are placed on record and have not been controverted by the department. It emerges that assessee follows and executes them as a service provider. For such preordained support services, the assessee cannot be held to be entitled to remuneration in terms of Li & Fung case on FOB value of goods procured by GAP US from third party vendors in India. In the case of Li & Fung India, assessee actually carried out significantly value added functions in India, which is not the case before us.

v. Even if we overlook the factual dissimilarities between the Li & Fung India and assessee’s case, the transactional profitability earned by Li & Fung India supports the case of assessee. The department has heavily relied on the fact that Li & Fung Hong’ remuneration of 5% of value of goods procured should be used as benchmark rate by the assessee. The department overlooked the other extremely important fact of the profitability earned by Li & Fung through 5% procurement service model. The total remuneration earned by Li & Fung Hong Kong was Rs. 60.15 crores against cost incurred by Indian company of Rs. 45.42 crores and some minor costs incurred in Hong Kong. The ITAT bench held that considering the facts of the case, 80% of commission (Rs. 48.12 crores) earned by Li & Fung Hong Kong should be attributed to Indian company. This attribution resulted in profitability of Rs. 2.72 crores (Rs. 48.12 crores – Rs. 45.42 crores) for the Indian Company resulting in the net profit / total cost of 6%. Department overlooked these important facts which must be taken into consideration using this example as benchmark for determining arm’s length price of international transactions for taxpayers.” (emphasis provided)

4.5. In the face of these clear critical and speaking observations of the Co-ordinate

Bench, we find that there is not even a whisper of a slur on the conduct of the assessee

and infact it is the Revenue which is severely castigated for the “flawed” approach and Page 14 of 23

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“sweeping” manner of decision making. The TP study relied upon by the assessee as far

as the selection of most appropriate method and selection of comparables is concerned,

has been upheld by the TPO himself. The remuneration model has been upheld by the

ITAT. Thus, to this extent as per record there is no doubt that the TP study has been

prepared with due diligence and in good faith.

4.6. The next issue which then arises for our consideration is can the acceptance of

enhanced mark-up of 32% as against the mark-up of 15% in the TP study be so fatal as to

attract the rigorous of the Act. The fact that the mark-up of 32% was an estimated mark-

up is an accepted fact and has not been disputed by the Revenue. Admittedly the said

mark-up has neither been considered by the assessee in its TP study nor has it been

proposed by the TPO or for that matter by the DRP. The said issue admittedly surfaced for

the first time before the ITAT where faced with the position where the assessee realizing

and accepting its inability to persuade the Bench to take a view on the facts and not on

precedent available in the case of LI & Fung, the facts of which case had been held to be

distinguishable that the assessee finding itself unable to convince to the contrary finally

chose to accept part addition as a lesser evil by proposing and suggesting the estimated

mark-up of 32% as opposed to continue litigation on the issue till the last possible stage.

The record shows that the mark-up of 32% was one of the many data points for

consideration before the Bench.

4.7. The correctness of the TP study with due diligence and good faith is evident from

the fact that in two consecutive subsequent years for the same activity the Co-ordinate

Benches of the ITAT have accepted the mark-up of 15%. The fact that the Co-ordinate

Benches took the view not only relying on the documentation in the TP study and the Page 15 of 23

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Agreements which were made available to the TPO even in the present proceedings. The

decision of the Jurisdictional High Court dated 16.12.2013 in the case of Li & Fung wherein

the Hon’ble Court had been taken into consideration by the Co-ordinate Benches noting

that the Court had approved the remuneration model of mark-up of 5% on the operation

cost of Li & Fung India, without considering the value of goods procured by the foreign AE

of Li & Fung directly from third party vendors in India. It is not relevant here to address in

detail the severe castigation of the approach of the Revenue noted and pointed out by the

Hon’ble Court which has observed that “tax authorities should base their conclusions on

specific facts and not on vague generalities such as ‘significant risk’ ‘functional risk’ ‘enterprise risk’

etc. without any material on record to establish such findings.” The Hon’ble Court has further

held “if such findings are warranted, they should be supported by demonstrable reason, based on

objective facts and the relative evaluation of their weight and significance.” Following the said

principle and applying them to the facts of the present case, we are of the view that simply

because an estimate laid down as a standard by the ITAT in a case where admittedly it had

been held that the facts qua the assessee were materially, significantly and substantially at

variance and different where the Co-ordinate Bench in the quantum proceedings has

elaborately discussed and concluded that the facts and circumstances in the case of Li &

Fung were entirely distinguishable the acceptance of an enhanced mark-up does not erode

the claim of the assessee in the peculiar facts of the case. Considering the facts of the Li &

Fung, the Co-ordinate Bench had held that the foreign AE admittedly lacked the peculiar

domain knowledge necessary for carrying out the activities which knowledge and expertise

exclusively vested with the Indian AE. The Co-ordinate Bench had also observed that the

higher returns of this foreign AE who had no core competence vis-a-vis the Indian AE

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entity which had the core strength and did the entire legwork having demonstrative

knowledge, expertise and capability for the tasks undertaken by it deserved a higher share

in the profits. As opposed to this in the facts of the present case the entire decision-making

on apparel specifications, fashions quality, colour design was well within the capability of

the foreign AE who as per its handbook directly placed orders meeting requirements with

the third-party Vendors and the assessee’s role was only limited to providing services to

facilitate these. Thus in the face of these clear-cut distinctions the Co-ordinate Bench in

the quantum proceedings concluded that the assessee was a low-risk service provider.

The remuneration model of cost plus method was held to be most appropriate. Hence the

decision to accept an estimate by the assessee of the standard laid down in a

distinguishable case was made in peculiar facts and circumstances of the present case. It

cannot be said to be an acceptance by the assessee on account of any malafide or

carelessness detected where after offering an explanation relying upon the agreements

and the correctness of the same based on the TP study, the assessee faces a wall of

obstruction, the assessee either had a choice to accept a modicum of addition by way of an

estimate or go the full circle of legal battle right up to the top. The exercise of choice to

close an issue with the addition in order to achieve peace of mind cannot be said to be so

fatal, in the absence of malafide, that the assessee must necessarily be visited by a penalty

of concealment or of filing inaccurate particulars. The claim of TP study having been

prepared and claim of transaction being at arms length mode in good faith and due

diligence cannot be said to have been eroded by accepting an enhanced mark-up in these

peculiar facts.

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4.8. No doubt Explanation 7 to Section 271(1)(c) is a deeming provision and postulates

that any addition on account of transfer pricing adjustment shall be deemed to represent

income in respect of which particulars have been concealed or inaccurate particulars have

been furnished in terms of section 271(1)(c). However, the Legislature has not intended

the penalty to be automatically invoked and has carved out an exception by setting out in

clear unambiguous language that no penalty will be imposed as a result of the addition on

account of transfer pricing adjustment if the assessee is able to prove that the price

charged or paid in such transaction was in accordance with the provisions of section 92C

and such price was computed as per the manner prescribed under that suction in good

faith and with due diligence. Thus only if on record, considering the Explanation of the

assessee it can be concluded that the addition on account of transfer pricing adjustment is

a result of computation of price charged or paid without adhering to or meeting the

requirements of computing the price charged or paid as required by section 92C either in

good faith nor with due diligence, the penalty can be imposed.

4.9. In the facts of the present case it is seen that the requirements of section 92C have

been met as the selection of TNMM is one of the methods provided and addressing the

ingredients of section 271(1)(c) the selection of method by the TPO has not been upset.

4.10. Considering the overall factual matrix wherein the facts have been re-visited by us in

great detail, we find ourselves unable to agree with the view taken by the tax authorities.

No doubt the onus is placed by the Statute upon the assessee to demonstrate that its

computation of price paid or charged was within the four corners of the manner prescribed

u/s 92C and notwithstanding the addition made the exercise was undertaken in good faith

and with due diligence. Having so demonstrated by the consistent explanation on record in Page 18 of 23

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the facts of the present case the onus shifts to the Revenue to demonstrate that by a

specific act, fact or conduct the affairs of the assessee in regard to computation of price

charged or paid was lacking in good faith and was done without due diligence. No such

argument has been raised nor any fact has been brought to our notice to suggest

otherwise. The view taken appears to be that simply because the addition is accepted the

penalty is to be levied.

4.11. We find considering the judicial precedent and the peculiar facts of the present case

the said argument does not lend any help to the Revenue. Though the terms ‘good faith’

and ‘due diligence’ have not been defined under the Act accordingly the definition of the

term ‘in good faith’ as defined under the General Clauses Act may be taken into

consideration. The term “in good faith” has been defined in The Black’s Law

Dictionary; Sixth Edition which defines the term as Good faith is an intangible and

abstract quality with no technical meaning or statutory definition, and it encompasses,

among other things, an honest belief, the absence of malice and the absence of design to

defraud or to seek an unconscionable advantage, and an individual’s personal good faith is

concept of his own mind and inner spirit and, therefore, may not conclusively be

determined by his protestations alone. (Doyle vs. Gordon, 158 N.Y. S.2d 248, 259,

260]. In common usage this term is ordinarily used to describe that state of mind denoting

honesty of purpose, freedom from intention to defraud, and, generally speaking, means

being faithful to one’s duty or obligation. [Efrone vs. Kahnanovitz, 249 Cal. App. 187s 57

Cal. Rptr. 248, 251]. It may not be out of place to quote from the order dated 01.03.2016

of the ITAT in ITA No.1062 & 1063/Del/2013 in the case of ACIT vs Boston Scientific

India Pvt. Ltd. Wherein it has been observed:- Page 19 of 23

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13.8.2. “Good faith presupposes honesty and fairness at its core. However, good faith does not cover the sins of omission or negligence. Due diligence on the other hand does not tolerate negligence and may be defined as prudent, responsible care and attention required to be exercised by a reasonable and prudent person in a given situation. Thus, as observed in acts of “good faith” it may not be possible to question negligence where due diligence standards are required to be met negligence cannot be tolerated. Similarly due diligence standards may not necessarily be embedded with good faith.

13.8.3. Thus the law requires that the standards to be met by a taxpayer pleading that penalty is not leviable in situations where Explanation 7 is attracted has been kept very high. The twin requirements of the Act may be capable of being summed up in the term “best efforts” which not only presuppose “due diligence” but also “good faith” as best efforts may incorporate not only “a diligent standard” but can also subsume “a good faith standard”.”

4.12. The Allahabad High Court in the case of Kedar Nath v. State [AIR 1965 ALL

233] (at p. 236) while opining on the meaning of the said term, held “Good faith imports

the exercise of due care and attention. A person can be excused for having committed an

error of judgment only if he exercised due care and attention and his conduct makes it

clear that there was no negligence according to reasonable standards. The standard of

care required is that of a reasonably prudent man who acts with the care and caution

required of a person in his position dealing with a matter of similar importance.”

4.13. At the cost of re-iteration in order to decide and adjudicate upon the said issue, it is

necessary to consider the conduct of the assessee and ascertain whether it can be said to

have been governed and guided by good faith and due diligence or not. In the facts of the

present case as per the TP study report made available by the assessee to the tax

authorities the assessee operates as a procurement support service company for its foreign

AE. The foreign AE directly sources the goods from third-party vendors in India and in

respect of these the assessee renders sourcing support services. For the said exercise the

assessee is remunerated at total operating costs +15% markup. It is a fact that the TPO

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did not accept the remuneration model of the assessee and changed the characterization

from limited risk bearing source single support service provider to a commission agent. The

said issue in the quantum proceedings reached the ITAT and it is a fact that the ITAT

upheld the remuneration model of the assessee that is a markup on total operating costs.

It is a fact that the markup of 15% as claimed by the assessee was not accepted by the

ITAT and as per the arguments of the assessee, a markup of 32% was accepted in order

to achieve a closure on the issue where the energy and costs devoted towards litigation

were considered to be not sufficient to agitate for the further relief of about 2% of the

relief which was withheld by virtue of the concession made by the assessee that the

markup of 32% is acceptable. We have no reason to disbelieve the claim that in the facts

the present case that the decision not to agitate the issue beyond the ITAT was guided by

prudence in order to buy peace and avoid protracted litigation where the amount at stake

for the assessee was not sufficient to consider the option of further litigation. It is a fact

that as a result of the additions made by the TPO wherein addition of Rs.236.22 crores was

proposed and pursuant to the order of the DRP had been made by the Assessing Officer,

which stood reduced to Rs.4.92 crore with the resultant relief of deletion of addition of

Rs.231,31 crore. The consequent addition sustained of Rs.4.92 crores was considered to

be not so big an amount that in the face of the prevalent view of the ITAT in Li & Fung

wherein the assessee understood that the ITAT was not willing to accept the argument

that 15% was correct and true. The decision so made in the peculiar facts and

circumstances does not make out a case that the decision not to litigate and accept was

malafide.

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4.14. Thus the decision to accept a partial addition in the facts of the present case no

where reflects negatively on either the claim of good faith nor the claim of due diligence

and instead only addressed the sheer helplessness of the assessee. It is necessary to

consider the claims realistically and an assessee after relying upon the correctness of its

TP study in the face of then prevalent view as per judicial precedent either has a choice to

accept a modicum of addition by way of an estimate or go the full circle of litigation right

upto the top. The exercise of choice to close an issue by accepting a paltry addition

wherein admittedly relief to the extent of 98% of the addition was granted and only 2% of

the addition stood sustained is a personal choice depending on a persons appetite to

litigate. The choice to maintain peace of mind and avoid protracted litigation does not in

any way lead to the conclusion that inaccurate particulars were filed or there was

concealment. Infact the prudent decision resulted in substantial relief being granted to the

assessee. It is seen that subsequent judicial precedent would show that had the assessee

not conceded the issue the assessee may have had a good arguable case before the next

forum as the decision of the Hon’ble High Court in Li and Fung’s case has shown. It is

further seen that the decision in the quantum proceedings has not been upset by the

Hon’ble high Court and infact the Revenue’s appeal in 2007-08 AY has been dismissed by

the Hon’ble High Court vide order dated 29.01.2016 as per copy placed at Paper Book page

118 to 119 on account of extraordinary delay of 815 days.

4.15. Accordingly considering the facts, arguments, legal precedent, relevant provision

and the material available on record, we hold that the penalty order deserves to be

quashed as no case has been made out by the Revenue to show that the assessee

conducted its affairs without good faith and due diligence. On the contrary we find that at Page 22 of 23

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every step the assessee has been able to demonstrate that the notwithstanding the

addition accepted by way of an estimate the claim that the arms length price has been

computed in accordance with the provisions of section 92C of the Act stands unrebutted on

record. The mere fact that addition has been partially sustained by itself in the facts and

circumstances of the present case does not warrant the penal action.

appeal of the assessee.

Sd/- Sd/-

(PRASHANT MAHARISHI) (DIVA SINGH) ACCOUNTANT MEMBER JUDICIAL MEMBER *Amit Kumar* Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(Appeals) 5. DR: ITAT ASSISTANT REGISTRAR ITAT NEW DELHI

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