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Income Tax Appellate Tribunal, DELHI BENCH ‘I’, NEW DELHI
IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH ‘I’, NEW DELHI Before Sh. N. K. Saini, AM and Smt. Beena Pillai, JM Asstt. Year : 2006-07 Deputy Director of Income Tax, Vs M/s Mori Seiki Co. Ltd., Circle-3(2), International taxation 404A, World Trade Centre, New Delhi Barakhamba Road, Connaught Place, New Delhi-110001 (APPELLANT) (RESPONDENT) PAN No. AAECM1522E Assessee by : Sh. Harpreet Singh & Rohan Khare, Advs. Revenue by : Sh. Amrendra Kumar, CIT DR Date of Hearing : 24.06.2016 Date of Pronouncement : 12.09.2016 ORDER Per N. K. Saini, AM:
This is an appeal by the assessee against the order dated 29.12.2008 passed by the AO u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the Act).
2. The only effective ground raised in this appeal reads as under:
“On the facts and in the circumstances of the case, the Ld. CIT(A) has erred in restricting the addition of Rs.1,42,10,927/- made by the AO to Rs.54,37,717/- thereby rejecting the AO’s method of dividing the profit earned by Mori Seiki-Japan on sales made through Mori Seiki – Branch Office 2 Mori Seiki Co. Ltd. at 50-50 ratio and further fixing of margins of the comparables at 20% following the Transaction Net Margin Method.” 3. The only grievance of the department in this appeal relates to the relief allowed to the assessee out of addition of Rs.1,42,10,927/- made by the AO.
Facts of the case in brief are that the assessee filed its return of income declaring a loss of Rs.44,88,297/- on 12.12.2006 which was processed u/s 143(1) of the Act on 18.03.2008. Later on, the case was selected for scrutiny. During the course of assessment proceedings, the AO noticed that the assessee had presence in India through a branch office, which commenced its operations in India on July 27, 2004 in accordance with the approval obtained from RBI and was selling machine tools manufactured by it in India and the neighboring countries and was primarily involved in providing marketing and sales services to the Head Office. It was also providing post sales, technical and consumer support services to dealer network of the Head Office and received an amount of Rs.60,72,269/- from the Head Office as commission and also received service fee income of Rs.1,03,508/- from its Indian customers with whom it was dealing directly and after incurring expenses amounting to 3 Mori Seiki Co. Ltd. Rs.1,07,54,690/-, the assessee had shown a loss of Rs.45,78,913/-. The AO asked the assessee to furnish the copies of agreements entered with the Head Office. The assessee furnished copies of such agreements vide its submissions dated 03.12.2008 which has been discussed by the AO at page nos. 2 & 3 of the assessment order dated 29.12.2008 for the cost of repetition, the same are not reproduced herein. On the basis of various clauses of the agreements, the AO was of the view that the assessee was involved in the selling of machines manufactured by the Head Office to various customers in India and also to the neighboring countries. He, therefore, asked the assessee to explain as to why the profit arising from the sales made by Mori Seiki, Japan in India (H.O) should not be attributed to the PE in India i.e. the assessee and taxed accordingly. In response, the assessee submitted the reply dated 18.12.2008 which read as under:
� The India-Japan treaty provides that profits attributable only to the activities carried out by MS-BO in India can be taxed in India. � Profits to be attributed are that the PE might have earned in same of similar activities under same or similar conditions and dealing wholly independently (Arm’s Length Profits). The assessee has placed reliance on the commentary of OECD and also the decision of Hon’ble 4 Mori Seiki Co. Ltd. Supreme Court in the case of Morgan Stanley – 292 ITR 416 (SC). � In view of the judgment of Hon’ble Supreme Court no further profits can be attributed to the PE if the transactions between MS-BO and HO are at arm’s length.”
5. After considering the submissions of the assessee, the AO noted as under:- "a) The main argument of the assessee that the profits which are directly or indirectly attributable to the permanent establishment can only be taxed in India. In view of this it becomes essential to find out whether MS-BO is involved/plays any role in the business of sales of machine tools made by Mori Seiki, Japan (HO) in India. For this purpose, one needs to analyze the agreements entered between the HO and the MS-BO. The assessee has furnished copies of three agreements which have been entered into between HO and MS-BO. The relevant clauses of such agreements have been extracted at para 3 above. On analyzing the same, the following crucial points emerge: i) The HO will sale machines In India and the neighboring countries through MS-BO; ii) MS-BO takes order of machines from customers in India; iii) The sale price of the machine tools which are to be sold in India is to be determined by the HO and MS-BO with consideration to the market trends in India; 5 Mori Seiki Co. Ltd. iv) MS-BO will expand sales in India by holding exhibition and similar activities relating to the machines; v) MS-BO will get a sales commission @ 5% of shipment price of the machines; vi) MS-BO will be responsible for installation and maintenance of the machines sold by HO in India. The payments of fees will depend on the number of installments of the machine in India; vii) MS-BO will maintain a stock of machines in India; viii) Any delay on MS-BO's part to sell the entrusted machines will add to the expenses to be borne by the HO. For this, the commission to be received by MS-BO will be reduced in accordance to the months left of the guarantee for machines for which the sales was delayed, The above points very clearly show that MS-BO is fully involved in the sales of the machines made by the HO in India; to the extent that it is deciding the price of such machines (in consultation with the HO) and also bearing the risk of not selling/delaying the sales of the entrusted machines in India. In my opinion, these findings are more than sufficient to hold that MS-BO was fully involved in the sales transactions taken up by the HO in India. Therefore, as per the terms of article 7 read with paragraph 6 of the protocol of the Indo-Japan Treaty and the various provisions of Income-tax Act, 1961, the profits arising on such sales needs to be reasonably attributed to MS-BO and taxed accordingly in India.
6 Mori Seiki Co. Ltd. b) The findings in the aforesaid paragraphs also find support in the decision of Hon'ble Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd. "The Protocol to the DTAA, in paragraph 6, discusses the involvement of the permanent establishment in transactions, in order to determine the extent of income that can be taxed. It is stated that the term 'directly or indirectly attributable' indicates the income that shall be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions." c) Article 2 of "Memorandum Concerning the Reduction "of Duty Commission" entered between HO and MS-BO (extracted above in para 3) it is mentioned that MS-BO shall be maintaining stock of machines. In view of this fact, let us find out whether such activity of MS-BO creates any, dependent agency permanent establishment (DAPE) in terms of Article 5(7) of the DTAA between India and Japan. For this purpose, it would be relevant to reproduce the relevant article – "Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 8 applies - is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State, if 7 Mori Seiki Co. Ltd. (a) he has and habitually exercises in that Contracting State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 6 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; (b) he has no such authority, but habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise ; or (c) he habitually secures orders in the first- mentioned Contracting State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control as that enterprise." Thus we can observe from above that the assessee is fulfilling the conditions laid down under Article 5(7)(b) as it is maintaining stock of machines on behalf of the Head Office which is regularly delivered to the customers in India and neighboring countries. Thus there comes into existence a DAPE of the HO in India. It need not be further elaborated that the sales which are made by the HO in India are attributable to such DAPE. d) After having established that the MS-BO/DAPE (PE) is involved in the sales made by HO in India, 8 Mori Seiki Co. Ltd. it becomes essential to attribute profits on such sales to such PE in India.” 6. During the course of assessment proceedings, the assessee furnished its transfer pricing updation study of the assessee (TP study) wherein it was mentioned that:- given the fact that the margins of the branch, under normal business circumstances are likely to meet the arm’s length standard, the transactions involving provisions of business support services during F.Y. 2005-06 can be considered to be at arm’s length from Indian transfer pricing perspective.
7. The AO however did not accept the contention of the assessee by observing that the transaction were not a part of the TP study done by the assessee. The AO pointed out that the agreements entered between the HO and the assessee revealed that following functions were performed by the assessee in respect of sales made by HO in India: “i) MS-BO plays a crucial role in deciding the price of machines. ii) MS-BO will expand the market for the HO in India by holding exhibitions in similar activities. iii) MS-BO will install the machines sold by the HO in India. iv) MS-BO will maintain such machines. v) MS-BO will maintain the stock of machines.
9 Mori Seiki Co. Ltd. Assets Used by MS-BO i) Land, building etc. owned/leased by MS-BO. ii) Equipments used for installation, maintenance etc. iii) Human capital (Quality man-power).”
And the risks borne by the assessee were following: i) Quality Risk – If the quality of the product is not good, the MS-BO will have to bear the risk of improving the quality at its own cost. ii) Delivery Risk – Any risk arising on account of non-delivery of the product is to be borne by MS- BO. iii) Man power Risk – The risk associated with the quality of manpower is to be borne by MS-BO. iv) Inventory Risk – The piling of stock results into “inventory obsolescence , ageing of the product, the price risk associated with the fluctuating market – all such risks are borne by MS-BO.”
The AO concluded that the assessee played almost equal role when compared with the HO in respect of the sales made by the HO in India. He, therefore, held that the 50% of the gross profit arising from the sales was attributable to the PE in India, however, the assessee had not maintained any books of accounts in respect of transaction pertaining to the sales made by HO in India. The AO invoked the provisions of Rule 10(ii) of the Income Tax Rules, 1962 to determine the income of the HO. He also pointed out that the gross profit 10 Mori Seiki Co. Ltd. of the HO in Japanese Yen was 55355 millions and the net sales was Japanese Yen 145340 millions which gave a gross profit in percentage terms at 38.09%. The AO also mentioned that the direct sales made by HO in India during the relevant period was Japanese Yen 31,22,69,000 and by applying the conversion rate of 0.378618 as on 31.03.2006, the sales in Indian Rupees came at Rs.11,82,30,664/- and by applying the GP rate of 38.09%, the gross profit was worked out at Rs.4,50,34,060/- out of which 50% was held to be attributable to the PE in India i.e. the assessee, which worked out to Rs.2,25,17,030/- and as HO has made a payment of Rs.60,72,269/- to the assessee for rendering various services, the AO considered those expenses were exclusively incurred for the purposes of sales made by the HO in India and accordingly the same were deducted from the gross profit and the net profit attributable to the assessee was worked out at Rs.1,64,44,761/- (Rs.2,25,17,030 – Rs.60,72,269). The AO further observed that the assessee received commission income of Rs.60,72,269/- from HO in respect of various services rendered under the agreement but it had not made any effort to carry out a proper risk analysis because of lack of information. The AO determined the arm’s length price entered between the HO and the assessee by taking net operating margin @ 20% on the operating cost and 11 Mori Seiki Co. Ltd. the net operating profit was worked out at Rs.21,50,938/- which was also added to the income of the assessee.
Being aggrieved the assessee carried the matter to the ld. CIT(A) and submitted that the AO fixed the margin without making any reference to any comparables and on the other hand, the assessee had filed the transfer pricing documentation using TNMM as the most appropriate method and operating profit/operating cost as the profit level indicator. It was further submitted that the assessee had used 13 comparable companies in order to benchmark the provision of support services by the assessee to the H.O. and that the assessee had taken 3 year average data to do the analysis. It was further submitted that the AO had not disputed the functions performed by the assessee nor he had questioned the assets employed by the assessee but made some general observations regarding the risk profile of the assessee.
The assessee also furnished copy of the assessment order dated 28.12.2010 for the assessment year 2007-08 passed by the AO on the directions issued by the DRP. The said order has been reproduced by the ld. CIT(A) at page nos. 7 to 9 which read as under:
12 Mori Seiki Co. Ltd. “1. MS, a company incorporated in Japan, has a branch, office in India (MS-BO) which assists MS to better co-ordinate and communicate with its existing and potential customers and be better placed to obtain the local market information in India. Such service to be provided through provision of marketing assistance party support services and other business support services. MS-BO had entered into agreements with MS Japan for providing sales support and installation support services to MS.
It is further submitted that MS-BO does not have authority to conclude the contracts since all orders procured by MS-BO are subject to acceptance by MS. Such goods are sold at the prices and conditions offered by MS-BO's services are limited to providing liaisoning/ support services. In addition to that, it also provides market research reports and other relevant information on the conditions prevailing in the South Asian markets and industries to MS. Hence, MS-BO could be characterized as a limited risk marketing support service provider having no inventory risk, no credit risk, no contract risk, etc. and thus only profits attributable to the said liaisoning and marketing support service can be taxed in India.
Being a branch office, MS-BO constitutes a fixed place Permanent Establishment ("PE") of MS under Article 5(2) of Double Taxation Avoidance Agreement entered between India and Japan ("India-Japan tax treaty"). Further, as per Article 7() of the Treaty only the profits attributable to the PE in India are taxable in India. It states as under: "The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the 13 Mori Seiki Co. Ltd. other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprises may be taxed in that other Contracting State but only so much of them as is directly or indirectly attributable to that permanent establishment". Accordingly, the India-Japan tax treaty provides that only those profits attributable to the activities carries out by MS-BO in India can be taxed in India. Further, as per Article 7(2) of the Treaty the profits attributable to the PE in India ' shall be determined based on arm's length principle. It states that: "Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profit which it might be expected to make if it were a district and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment."
Hence, profits to be attributed are that the PE might have earned in same or similar activity under same or similar conditions and dealing wholly independently. Accordingly, an internationally accepted approach for attribution of profits to a PE is to first carry out a detailed functional analysis of the PE and the organization of which such PE is a part of and determine the economically significant activity of the 14 Mori Seiki Co. Ltd. PE based on such analysis. Thereafter, an arm's length profit based on arm's length principle is attributed to the PE as if it was separate and legally distinct entity.
In the present case, the remuneration received by MS-BO for the said support activities has already been demonstrated to be at arm's length in the Transfer Pricing documentation maintained and furnished by the assessee before your goodself. Further, it may be noted that the case of the assessee was also referred to the Transfer Pricing Officer ("TPO") to determine the arm's length price under Section 92CA(3) of the Act in respect of the international transactions entered into by the assessee. After taking into consideration the services rendered by MS-BO to MS, the TPO has determined the arm's length remuneration what MS-BO should get from MS and proposed an addition of Rs. 79,53,726.
It has been a settled position now that once a PE is being remunerated at arm’s length then there is no need for further attribution. In view of the judgment of Hob'ble Supreme Court no further profit can be attributed to the PE if the transactions between MS- BO and HO are at arm's length. The assessee was asked to justify that the transactions and the agreement which were under consideration by the TPO for the TP analysis is the same transaction and agreement which is subject to profit attribution. The assessee also mentioned that the branch office has not render any services to its head office other than the services mentioned in the agreement. The assessee has submitted the TP analysis alongwith other details. The submissions made by the assessee are considered."
15 Mori Seiki Co. Ltd. 11. The ld. CIT(A) after considering the submissions of the assessee observed that for the succeeding assessment year, the DRP directed the AO to take following 5 comparables in consideration:
S. Company Name Operating No. Profit/Operating Costs FY 2005-06 1. Agrima Consultants International -10.29% Ltd.
2. Hincon Technoconsult Ltd. 5.47% 3. ICRA Management Consulting 15.50% Services Ltd.
4. IDC (India) Ltd. 14.05% 5. NTPC Electric Supply Ltd. 3.29% Arithmetic Mean 5.60% 12. The ld. CIT(A) was of the view that the aforesaid set of comparable can be considered for the year under consideration because there was no significant change in the functions, assets and risk profile of the assessee. The ld. CIT(A) further observed that the assessee had filed set of 13 comparables in its transfer pricing study before the AO as per following details:
S. Company Name Operating No. Profit/Operating Costs FY 2005-06 1. Agricultural Finance Corporation -8.22% Ltd. 2. Besant Raj International Ltd. -14.45% 3. Capital Trust Ltd. -9.18% 4. Crisil Ltd. 11.49% 16 Mori Seiki Co. Ltd.
5. Educational Consultants Ltd. 16.60% 6. Electronica Machine Tools Ltd. NC 7. Epic Energy Ltd. NC 8. ICC International Agencies Ltd. NC 9. IDC (India) Ltd. 14.05% 10. Priya International Ltd. 26.09% 11. Ratan Glitter Industries Ltd. NC 12. T S R Darashaw Ltd. 10.32% 13. Ujjwal Ltd. NC Arithmetic Mean 5.84% 13. The ld. CIT(A) also pointed out that the aforesaid comparables had been considered by the AO, therefore, the margin of 5.84% should have been taken as the arm’s length price. On the basis of the said margin, the ld. CIT(A) worked out the adjustment of Rs.54,37,717/- as under:
Particulars Amount (in Rs.) Operating cost of Assessee 10,972,689 Arm’s Length margin as computed above 5.84% Arm’s length price @ 105.84% of 11,613,494 operating cost Revenue as per P & L Account 6,175,777 Shortfall being adjustment 5,437,717 14. The ld. CIT(A) also observed that the approach of the AO was not sustainable because he had used TNMM method and also used profit split method for the attribution of profit for the same international transaction at 50:50 ratio which was not permitted in law. He further observed that the transaction between the head office and the branch office was one and the same transaction. Therefore, this transaction 17 Mori Seiki Co. Ltd. could be validated using either of the methods and not both. The ld. CIT(A) further observed that the AO had come to the conclusion that once the same transaction was benchmarked under the provision of Section 92 of the Act, there was no need to attribute the profit to the PE separately. He also observed that in the subsequent assessment year, in the assessee’s own case, the TNMM was used to benchmark the transaction which was approved by the DRP, therefore, in the year under consideration also TNMM was the most appropriate method. The ld. CIT(A) accordingly directed the AO to make the adjustment of Rs.54,37,717/- only.
Now the department is in appeal. The ld. DR strongly supported the order of the AO and reiterated the observations made in the assessment order dated 29.12.2008. It was further submitted that the assessee entered into in agreement with its head office Mori Seiki, Japan (H.O.) and maintained the stock of goods from which it regularly delivered the goods or merchandise on behalf of the head office. It was also submitted that the assessee had undertaken all the risks relating to the sales and played a crucial role in deciding the price of machines and was responsible to install the machine sold by head office in India and maintained stock of such machines. Therefore, the AO was justified in holding that 18 Mori Seiki Co. Ltd. 50% of the gross profit arising from such sales was attributable to the assessee in India. Therefore, the ld. CIT(A) was not justified in reducing the addition made by the AO.
In his rival submissions the ld. Counsel for the assessee reiterated the submissions made before the authorities below and strongly supported the impugned order passed by the ld. CIT(A). It was further submitted that in the subsequent year, TNMM was used to benchmark the similar transaction which was approved by the DRP and accepted by the department. Therefore, for the assessment year under consideration also TNMM was the most appropriate method and the assessee by selecting 13 comparables in its transfer pricing study worked out the margin at 5.84% which has not been doubted by the AO. Therefore, the ld. CIT(A) rightly applied 5.84% as average margin on the operating cost to work out the arm’s length price adjustment.
We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, it is an admitted fact that the assessee entered into international transaction with Moriseiki, Japan and to determine the arm’s length price, the 19 Mori Seiki Co. Ltd. assessee adopted TNMM method as most appropriate method in accordance with OECD Guidelines, and the operating profit/operating cost was considered as profit level indicator. The AO was of the view that the assessee ought to have earned gross profit rate of 38.09% on the direct sales made by the HO in India and 50% of that gross profit was attributable to the assessee. In the present case, it is an admitted fact that in the subsequent year, the DRP considered the TNMM as the most appropriate method and worked out the arithmetic mean margin at 5.60% on the basis of 5 comparables while the assessee had calculated the average margin on the basis of 13 comparables at 5.84% and since the facts in the year under consideration are similar to the facts involved in the subsequent year as there was no change in the functions, utilization of assets and risk profile of the assessee. Therefore, the ld. CIT(A) rightly held that the action of the AO was not sustainable because he on the one hand had accepted TNMM and also used profit split method for attribution of profit on the international transaction at 50:50 ratio. In our opinion either of the two methods could have been used and not both, therefore, the ld. CIT(A) was fully justified in holding that the action of the AO was not sustainable in the eyes of law. In the present case, when the AO himself accepted that the transaction was benchmarked 20 Mori Seiki Co. Ltd. under the provision of Section 92 of the Act, so there was no need to attribute the profit separately to the assessee PE. Since, there is no change in the facts for the year under consideration vis-à-vis subsequent year, the ld. CIT(A) rightly restricted the adjustment to the international transaction at Rs.54,37,717/-. We do not see any infirmity in the impugned order passed by the ld. CIT(A).
In the result, the appeal of the department is dismissed. (Order Pronounced in the Court on 12/09/2016)