Loading judgment…
No AI summary yet for this case.
Income Tax Appellate Tribunal, DELHI BENCH ‘I-1’, NEW DELHI
Before: SHRI N. K. SAINI & SMT. BEENA A. PILLAI
Date of hearing: 04.08.2016 Date of Pronouncement: 26.08.2016 ORDER
PER BEENA A. PILLAI, JM:
The present appeal arises out of the order dated 20.10.2009 passed by ADIT, Circle 2(1), New Delhi for the Assessment Year 2006-07 on the following grounds of appeal: “That on the facts and circumstances of the case, and in law;
1. That the Assessment Order passed in pursuance to the directions issued by the Learned Dispute solution Panel ('Ld. DRP') is a vitiated order as the Ld. DRP erred both on facts and in law in confirming the addition made by the Ld. Assessing Officer ('AO') to 2 I.T.A.No.5380./Del/2010 the appellant's income by issuing the order without appropriate application of mind;
2. The Ld. DRP erred both on facts and in law in upholding the upward adjustment to the operating margin of the Service segment of the appellant, made by the Ld. TPO, and confirming the addition of Rs. 19,98,418 to the income of the appellant by holding that its international transaction under the service segment of the appellant does not satisfy the arm's length principle envisaged under the Act. In doing so the Ld. DRP has grossly erred in agreeing with the Ld. TPO's action of: 2.1. disregarding the ALP, as determined by the appellant in the Transfer Pricing ('TP') documentation maintained by it in terms of section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 ('Rules'); 2.2. using current year data for comparable companies, i.e., data for FY 2005-06, despite the fact that the same was not available with the appellant at the time of preparing its TP Documentation report;
2.3. Disturbing the new set of com parables arrived at by the appellant under the fresh search and aggregating the comparable set of companies used in the TP audit of the appellant in earlier year i.e. 2004-05, without giving any regard/ considering the reasons/ explanations provided by the appellant for not including such - functionally uncomparable - companies for benchmarking the appellant's services segment
2.4. arbitrarily rejecting the loss making companies to arrive at the final set of comparable companies to determine the arm's length margin;
3 I.T.A.No.5380./Del/2010
2.5. not allowing any appropriate adjustments to the appellant to account for the differences in intensity of functions performed, assets employed and risk assumed between the appellant and comparables; and 2.6. disregarding judicial pronouncements in India in undertaking the TP adjustment;
That on the facts and in the circumstances of the case & in law, the Ld. DRP erred in:
3.1. not giving the complete benefit of set-off of brought forward losses/unabsorbed depreciation of earlier years as claimed in the return of income while computing the assessed income.
3.2 agreeing with the Ld. AO in charging interest under section 2348 of the Act.
3.3 agreeing with the Ld. AO's act of initiation of penalty proceedings under section 271(1)(c) of the Act for concealment of income without recording any adequate satisfaction for such initiation.
The above grounds are without prejudice to each other.”
The assessee filed its return of income declaring total income of Rs.39,44,335/- on 24.11.2006. During the course of assessment proceedings, the Ld. Assessing Officer observed certain international transactions entered into by the assessee with its AE. Accordingly, reference was made to the TPO-II(2) for determination of Arm’s Length Price (ALP) u/s 92CA(3) of the Act in respect of 4 I.T.A.No.5380./Del/2010 international transaction. The assessee company is a company incorporated in Switzerland. It is one of the group companies of Altria Group USA which is engaged in the business of manufacturing and trading cigarettes and other tobacco product internationally. The assessee is into trading of Malbaro brand of cigarettes and tobaccos in India and is operating in India through a branch. The Indian branch is engaged in trading of cigarettes/tobacco leaves and is providing representation and logistics / marketing support services to / on behalf of the group entities. 2.1 The international transaction entered into by the assessee is as follows: S.N. Nature of transaction Method Used Value of by assess transaction ee Method PLI 1 Purchase of Cigarettes 45,382,050 2 Export of tobacco leaves 130,687,923 3 Services rendered TNMM OP/TC 31,889,661 2.2 The assessee treated itself as tested party in the TP report for the purpose of T P analysis. The assessee used Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for benchmarking the international transaction. In the TP report, the profit level indicator (PLI) used in the distribution segment is OP/Sales ratio and the margin was arrived @ 1.28%. In the T P report, the assessee had selected 5 comparables which are as under:
5 I.T.A.No.5380./Del/2010 S.No. Name of the company Weighted Updated margin average as with current year per TP study data 1 Alfred Herbert (India) -10.91% -29.74% Ltd. 2 Priya International Ltd. 17.51% 22.58% 3 Ujjwal Ltd. 3.78% Data not available 4 Shanti Sales Ltd. 1.61% Data not available 5 Fortune Communications 3.15% Data not available Ltd. Average 3.15% -3.58% Assessee’s Margin 5% 5% 2.3 The assessee had a mean margin of OP/Sales at 0.32%. Subsequently, during the TP proceedings, the assessee conducted fresh search including the following comparable companies:
S.No. Name of the company OP/TC(%) 1 Cyber Media Events Ltd. 9.42% 2 Educational Consultants (India) Ltd. 2.72% 3 Priya International Ltd. (Indenting Segment) 22.58% 4 Agrima Consultants International Ltd. -7.76% 5 Capital trust (Foreign Consultancy Segment) -11.11% 6 Tata Services Ltd. 6.35% 7 Hindustan Housing Co. Ltd. 9.68% 8 IDC (India) Ltd. 14/49% 9 Empire Industries Ltd. (Trading & Indenting 15.79% Segment) 10 Times Infotainment Media Ltd. -13.24% 11 Contract Advertising India Pvt. Ltd. 21.07% 12 Fortune Communications Pvt. Ltd. Data not avilable Mean 6.36% 2.4 Out of the above 12 comparable companies, Ld. TPO selected 7 comparables to benchmark marketing and representative services which are as under:
6 I.T.A.No.5380./Del/2010 S.No. Name of the company OP/TC(%) 1 Cyber Media Events Ltd. 9.42% 2 Educational Consultants (India) Ltd. 2.72% 3 Priya International Ltd. (Indenting Segment) 22.58% 4 Tata Services Ltd. 6.35% 5 Hindustan Housing Co. Ltd. 9.68% 6 IDC (India) Ltd. 14/49% 7 Empire Industries Ltd. (Trading & Indenting 15.79% Segment) 8 Mean 11.58% 2.5 The issue before us is regarding inappropriate rejection / inclusion of certain companies in the final list of comparables which are as under: i) The assessee has disputed rejection of following companies:
(a) Capital Trust Ltd. (b) Agrima Consultants International Ltd. The assessee has also disputed inclusion of following companies being ; (a) IDC India Ltd. (b) Empire Industries Ltd. (Trading & Indenting Segment)
2.6 Before dealing with the comparability of these companies, with that of the assessee, it is necessary sine qua non to analyse the functional profile of the assessee before us. From the TP study present at pages 11-69 of the Paper Book, it is observed as under: “Ulteria Group Inc. through its wholly owned subsidiaries, Philip Morris USA Inc. IPM USA) Philip Morris International Inc. (PMI) and its majority owned (88.1%) subsidiary, Kraft Foods Inc. (Kraft) is engaged
7 I.T.A.No.5380./Del/2010 in the manufacture and sale of various consumer products including cigarettes, packaged grocery products, snacks, beverages, cheese and convenient meals. Altria’s net revenues for 2005 and 2004 were $97854 and $89610 million respectively. Philip Morris Services India S.A. (Switzerland), a wholly owned subsidiary of FT Holding S.A. (Swiss Holing Company) had set-up its branch in August 30, 2001 in India. It was primarily engaged in providing services to its Group Cos. During the 2003-04 financial year. PM India started the import trading of cigarettes in India. From financial year 2004-05, PM India also started exporting tobacco leaves to Group Cos.
As a part of its business operations, PM India, operates in the tobacco industry. Therefore, the performance of PM India is inter linked to the performance of tobacco industry. The following section contains an analysis designed to provide an overview of the industry under which PM India operates. An overview of the industry would assist in the understanding of the business risks faced by, operational characteristics of, and assets employed by PM India in relation to other players in industry.
The market for tobacco products is highly competitive, characterized by brand recognition and loyalty, with product quality, price, branding and packaging constituting the significant methods of competition. Promotional activities include, in certain instances and where permitted by law, allowances, the distribution of incentive items, price promotions and other discounts.
The product development, innovation / R&D and production and brand development are undertaken by the Group Cos. PM India, on the other hand is engaged in the business of import trading of cigarettes, imported from Group Cos. And export of 8 I.T.A.No.5380./Del/2010 tobacco leaves to Group Cos. Apart from this, it also provides representation services to / on behalf of the overseas Group Cos. Accordingly, the Indian entity performs routine functions in the value chain of the group. Functions performed by Group Cos Functions Performed 4.3.1 Trademark Owner: Group Cos own the rights to various 'trademarks, trade names and other commercial and product intangibles. Group Cos exploit these rights in a variety of ways, such as licensing them to related and unrelated parties for the production and sale of cigarettes, as well as having cigarettes produced under contract manufacturing arrangements. 4.3.2 Manufacturer: Group Cos manufacture, market, sell and distribute quality cigarettes in more than 160 countries around the world. 4.3.3 Research and Development: The primary role of the R&D function is to create and commercialize products that addresses adult consumers' and societal expectations. Whilst ensuring compliance with external regulations and internal standards, activities include research into, and development of, products which have the potential to reduce the harm caused by the harmful compounds in cigarette smoke. 4.3.4 Marketing and Sales: To promote its own sales and the sales of its licensees, as appropriate and in accordance with local market conditions, customs, and practices and as permitted by local laws and regulations, Group Cos spend significant amounts for direct and indirect advertising and promotion of brand names and trademarks.
9 I.T.A.No.5380./Del/2010 4.3.5 World wide supply of products to distributors/subsidiaries: Group Cos. are responsible for logistics management, supply of goods to distributors/ sales offices, providing post sales support, etc. 4.3.6 General management functions: Group Cos take care of group functions like subsidiary operations, logistics, IT, HR, Quality management, facility management, communications, etc. Further, Group Cos are responsible for developing the long term strategy of the group.
4.3.7 Accordingly, Group Cos virtually own all the valuable intellectual property rights (patents, know-how, etc.) and other commercial or marketing intangibles (brand names, trademarks, logos etc.) and are involved in product development and manufacturing. They are engaged in product innovation, manufacturing and brand development operations, which are key contributors to the overall value generated by the group. Functions performed by assessee:
4.3.8 PM India undertakes import trading of Marlboro cigarettes and assumes limited risks associated with carrying out such business. Further, PM India exports tobacco leaves to Group Cos and also provides representation services to Group Cos.
4.3.9 The above functions performed by PM Services India can be categorized into two class of transactions:
Class I: Trading of cigarettes and tobacco leaves are included under this class of transaction. Class II: Representation services are included under this class of transaction.
10 I.T.A.No.5380./Del/2010 4.3.10 Accordingly, the functions performed by PM India, under these three classes, are described in the following paragraphs: Class I: Trading of cigarettes and tobacco leaves 4.3.11 PM India has entered into a distribution agreement with Philip Morris Products S.A., a company registered in Switzerland. PM India undertakes the following functions pertaining to its distribution activities:
4.3.12 Import and Resale: PM India imports cigarettes from Philip Morris Products S.A. and resells to distributors who are its customers in India. This function includes taking orders from distributors and placing them with manufacturers, shipment tracking, clearance of goods through local customs, invoicing etc. PM India does not maintain any warehouses/depots for rendering these services. The imported cigarettes are directly sent to distributors' warehouses. PM India has appointed two distributors, one distributor is responsible for sales and distribution in the North and Central India and the other distributor is responsible for sales and distribution in the western and southern parts of India. These distributors undertake the storage and logistics function, maintain sales force and are responsible for appointing dealers and retailers in their territories and pushing sales through them.
4.3.13 Sales Co-ordination: PM Services India SA has a small team to conduct sales liaison activities for continuous interaction with the distributors setting targets and helping them with coordination of sales activities. The sales co-ordination team assists the distributors to achieve the desired sales volume through carefully planned strategies and field implementation.
11 I.T.A.No.5380./Del/2010 4.3.14 The marketing co-ordination team is responsible for gathering information about the market, consumer preferences, etc. for developing marketing strategy and plans for India, in consultation with Group Cos. It works closely with Group Cos to co- ordinate market surveys, packaging and brand related activities along with ensuring compliance with local regulatory requirements. 4.3.15 From financial year 04-05, PM India also started exporting tobacco leaves to Group Cos. PM India entered into an agreement with Group Cos for supply of tobacco leaves. The tobacco leaves vendors are however decided and approved by Group Cos. Even the purchase price is directly negotiated between the vendor and Group Cos. PM India basically facilitates the process of leaves exports by looking after the customs clearance, shipment and logistics, ensuring timely delivery of leaves etc. PM India releases payments to the vendors only after recovering the money from Group Cos.”
2.5 On analysing functions performed by the assessee, it has been categorized as a low risk company in India. It is also reported to be not owning any intangible and does not undertake any research and development that leads to the development of non routine intangible of brand ‘Malboro’. Accordingly, the assessee is importer and reseller of branded product, the funds being owned by AE. The sale of branded product to a distributor carries with the status of employee’s right to use of supplier trade mark and trade name owned for the purpose of selling the suppliers products. As per the TP study, the assessee before us does not have any additional right to use and 12 I.T.A.No.5380./Del/2010 explain the marketing intangible owned by the group company. Accordingly, the assessee has been categorized to be routine distributor under class I and the service provider under class II exposed to limited risk associated with carrying out such business. 2.6 On the basis of above facts, we now consider each of the companies as under: 3. Capital Trusts Ltd.:- This company has been selected by the assessee, which is rejected by Ld. TPO as it has incurred losses. The Ld. A.R. submitted that this company provides services to a foreign bank, which has developed correspondent relationship of foreign bank with Indian Banks, providing assistance to facilities operations between foreign banks, promoting the services offered by foreign banks and canvassing for documentary credit business, referring trade finance proposals, assisting foreign banks in country review, monitoring of business & investment opportunities in India. 3.1 The DRP has upheld the rejection of this company as comparable by holding that the foreign consultancy segment has miniscule proportion of total revenue. 3.2 On perusal of financial statement of the company placed at pages 1-32 of the Paper Book, it is observed that the functional profile of this company under foreign consultancy segment is similar to the market support segment of the assessee before us. Ld. A.R. placed reliance on the decision of this Tribunal in the case of 13 I.T.A.No.5380./Del/2010 Nortel Network India Pvt. Ltd. Vs ACIT in where the said comparable has been included in the set of comparbles. 3.3 In our view, foreign consultancy segment has been reported to be the primary business segment of this company in the audited financials. By applying the ratio laid down by Hon'ble High Court in the case of CrysCapital Investment Advisors (India) Pvt. Ltd. vs. DCIT, I.T.A.No. 417/2014 that because a comparable company has abnormally high profits or losses, the comparable cannot be rejected. 3.4 The assessee also placed reliance upon the decision of Mumbai Tribunal in the case of Goldman SACHS India Security Pvt. Ltd. Vs ACIT in I.T.A. No. 7724/Mum./2011 wherein this company has been considered as comparable in the nature of services rendered by the comparable were exactly on the similar lines as that of the assessee therein, during the year under consideration. 3.5 Similar is the situation before us and in our considered view, the company running losses cannot be disqualified as a legitimate comparable unless any functional dissimilarity is brought on record by the authorities below. Respectfully following the above decisions, we hold that this company is a valid comparable and should be included.
14 I.T.A.No.5380./Del/2010
Agrima Consultant International Ltd.: This company was included by the assessee and excluded by Ld. TPO on the basis that this company is showing a negative economic trend. Ld. A.R. submitted that the turnover of this company is Rs.1.05 crores while the assessee has a turnover of Rs.3.18 crores. Ld. A.R. submitted that from the annual accounts placed at pages 51-55, the company was carrying on with the activities of preparation of feasibility report in respect of cement grinding plant. 4.1 Ld. A.R. submitted that this activity carried on by the comparable company is akin to the market support services provided by the assessee and merely because there is negative trend in the economy of the company, cannot be excluded from the lists of comparbles. The segment details in respect of the feasibility report must be taken into consideration. The authorities below have not brought on record any functional dissimilarity between this company and that of the assessee. Since the nature of services rendered by this company was similar to that of the assessee, we uphold the inclusion of this comparable to the final list.
IDC (India) Ltd.: This comparable has been selected by Ld. TPO which has been objected by the assessee. Ld. A.R. submitted that this company is functionally not similar with that of the assessee. He submitted that the activities performed by this company is more of the 15 I.T.A.No.5380./Del/2010 knowledge process and requires extremely skilled personnel for the same. The company is also into research and survey activities including a very high level management consultancy. The assessee has placed reliance upon the decision of Hon'ble Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd. Vs CIT in I.T.A.No. 102/2015 wherein the Hon'ble Court has held that where the tested party is not a KPO service provider, an entity rendering KPO services cannot be considered as a comparable for the purpose of TP analysis. He also placed reliance upon the decision of this Tribunal in the case of Microsoft Corporation India Pvt. Ltd. VS DCIT in wherein this company has been characterized as an information technology, research and advisory firm. Further, it has been held that his company earns its income in the form of research and survey. 5.1 We have perused the above details placed in the Paper Book and the judgements relied upon by the Ld. A.R. It is also observed from the functional profile that this company is in the knowledge process outsourcing unit and cannot be compared with the back office support services carried by the assessee. Respectfully following the ratio laid down by Hon'ble Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd. Vs CIT (supra), we accordingly reject this company from the list of comparables.
16 I.T.A.No.5380./Del/2010
Empire Industries Ltd: This company has been included by the TPO which has been objected by the assessee for the reason that it is engaged in the distribution and sale support of highly technical machines and pharmaceuticals. Ld. A.R. submitted that this company is engaged in the trading and indenting of industrial and medical equipments and machine tools, therefore, cannot be recorded as a comparable with that of the assessee. The assessee has placed reliance on the decision of Bangalore Tribunal in the case of Cisco Systems India Pvt. Ltd. Vs DCIT in I.T.A. No. 271/Bang./2014. 6.1 We have perused the annual report of this company place at pages 33-50 of the Paper Book. It is observed that this company earns its primary source of income from manufacturing, trading and indenting activities, therefore, it cannot be a comparable with the market supp[ort services carried out by the assessee. We are, therefore, of the considered opinion that this company has to be excluded from the list of comparables.
In view of above discussion, Ground No.2 of the assessee’s appeal stands allowed. 8. Ground No.3.1 of the assessee’s appeal stands set aside to the Assessing Officer for verification and following the directions as per DRP order. 9. Ground No.3.2 being consequential in nature, is not adjudicated upon and Ground No.3.3 is premature.
17 I.T.A.No.5380./Del/2010 Accordingly, grounds raised by the assessee stand allowed.
10. In the result, appeal filed by the assessee stands partly allowed for statistical purposes. Order pronounced in the open court on 26th Aug., 2016.