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Income Tax Appellate Tribunal, DELHI BENCH ‘F’, NEW DELHI
Before: SHRI PRAMOD KUMAR & SMT. BEENA A. PILLAI
Date of hearing: 26.04.2016 Date of Pronouncement: 27.06.2016 ORDER
PER BEENA A. PILLAI, JM:
1. The present appeal has been preferred by the assessee against the final assessment order passed by Ld. DCIT circle-15 (1), New Delhi, for assessment year 2007- 08.
The assessee filed its return of income on 13/10/2007 declaring a total income of Rs.3,07,46,170/-. The case was selected for scrutiny and notices under section 142(1) and 143(2) were issued to the assessee. In response to the notices the assessee filed details in support of the returns filed and submissions along with 2 I.T.A.N.5638./Del/2011 the necessary documents as per the questionnaire. During the course of the scrutiny proceedings the ld.AO noticed that the assessee has entered into international transaction with its AE. A reference was made to the Transfer Pricing Officer (TPO). Accordingly the Ld.AO referred the assessee’s case to the ld. TPO, for determination of the Arms Length Price (ALP) in respect of international transactions entered into by assessee with its AE for the year under consideration. On reference being made to the ld.TPO, notice under section 92CA was issued to the assessee. In response to the same the assessee filed documentations prescribed under Rule 10 D of Income Tax Rules.
2.1 During the proceedings, the Ld. TPO observed that assessee is 99% subsidiary of Rolls-Royce overseas Holdings Ltd., which in turn is a subsidiary of Rolls-Royce Plc. Assessee was incorporated on August 1999 to increase the Rolls-Royce groups focus on the expanding power generation and oil and gas markets in India, with a range of reciprocating engines covering gas engines, HFO engines and crude oil engines, it is distinctly placed as an integrated solution provider.
2.2 During the year under consideration the assessee has entered into international transaction with its associated enterprises (AE) as under:
3 I.T.A.N.5638./Del/2011 S. International Transaction Method Value (in Rs.) No . 1 Purchase of finished goods CUP 12,25,69353/- 2 Technical services provided to Aes CUP 1,41,34,365/- 3 Project Management Services TM,, 1,16,99,170/- 4 Marketing Support Services TNMM 1,31,98,459/- 5 Interest on Loan from AE CUP 51,11,158/- 6 Commission received CUP 97,25,602/- Total 17,64,38,107/- 2.3 It was observed by the ld.TPO that the assessee had applied comparable uncontrolled price (CUP) as the most appropriate method (MAM), for benchmarking the arms length price for the transaction of purchase of finished goods, technical service provided to its AE’s, interest on loan taken from AE’s and commissioned received from AE’s. For project management services and market support services provided to its AE’s, assessee had applied transactional net margin method (TNMM) as the MAM, taking operating profit by operating revenue (OP/OR) ( ld.AR mentioned that, it has been wrongly mentioned as OP/TC in the order of ld.TPO) profit level indicator (PLI). Segmental operating results has been prepared for project management services and market support services. The assessee arrived at set of 7 comparables with PLI of 2.63% using current year margins vis-à-vis PLI of 5.12% with assessee as the tested party.
4 I.T.A.N.5638./Del/2011 2.4 The ld. TPO has not objected to the MAM for benchmarking the arms length price (ALP) for transactions entered into by assessee with its AE’s. The comparables selected by assessee are as under:
S.No. Name of company OP/TC 1 Raunaq 12.42 2 D B Corp Ltd., 10.93 3 Khaitan (India) Ltd. 8.58 4 Tak Machinery & Leasing Ltd 6.11 5 Times Innovative Media Ltd. 1.14 6 UBL Sales Ltd. 31.32 7 Water & Power Co. India Ltd. 8.71 Average 2.36 2.5 The ld.TPO rejected the first six comparables selected by the assessee by applying quantitative and qualitative filter. The ld.TPO in turn selected additional three comparables selected as she was of the view that the marketing support services wore intrinsically linked with the project management services, which has led to deficiency in functional comparability of the companies selected by the assessee. The ld.TPO arrived at a new set of comparables which included one comparable selected by the assessee. The comparables shortlisted by the ld.TPO are as under:
S.No. Name of company Functions OP/TC
5 I.T.A.N.5638./Del/2011 1 ICRA Mgmt Consultancy Management 17.36% Services Consultancy Services 2 IDC (India) Ltd Business Services 16.23% 3 NTPC Electric Supply Co. Technical 22.02% Ltd. Consultancy & Engineering Services 4 Water & Power Co. India Technical 12.39% Ltd. Consultancy & Engineering Services Arithmetic Mean 17% 2.6 This led to the proposal for a transfer pricing adjustment in respect of project management services and marketing support services amounting to Rs. 20,65,638/-.
2.7 Thereafter the assessee carried the matter before the dispute resolution panel (DRP)-II, New Delhi. The DRP under section 144C (5) of the IT act, 1961 gave following to Ld.TPO for arriving at arm’s length price. 2.8 The DRP upheld the rejection of the comparables by the ld.TPO, however directed ld.TPO to consider Tak Machinery and leasing Ltd, if its mental information/results are available. 2.9 The DRP also confirmed the addition made by the Ld.TPO in respect of foreign exchange fluctuation while computing the operating margins of the comparable companies as well as the assessee. On receipt of the directions passed by the DRP, the Ld. AO passed the 6 I.T.A.N.5638./Del/2011 assessment order on 28/10/2011, making the impugned additions. 3. Aggrieved by the order of the Ld. AO the assessee is in appeal before us in respect of the adjustments made to ALP on the following grounds:
“1) That the learned Assessing Officer has erred in law and on facts in making an addition of Rs.20,65,G38/- on wholly illegal, erroneous and untenable grounds. 2) The order of assessment is bad in law. 3) That the learned AO has erred in law, on facts and in the circumstances of the case in making addition on account of arms' length price under section 92CA(3) of the Income-tax. Act amounting to Rs. 20,65,638/- on wholly illegal, erroneous and untenable grounds. 4) The learned AO's order based on the findings of the learned Transfer Pricing Officer and the directions of the learned Dispute Resolution Panel u/s.144C(5) of the Income-tax, is erroneous, untenable in law and on the facts and circumstances of the assessee's case for various reasons and not limited to the following: - a) The TPO as well as the DRP and consequently the A.O. have erred in law and on facts and in the circumstances of the case in erroneously adjusting the ALP of the international transactions of the assessee related to project management services and marketing support services. b) The TPO as well as the DRP and consequently the A.O. has erred in law and on facts and in the circumstances of the case in erroneous selection of comparables for the computation of ALP. c) The TPO as well as the DRP and consequently the AO has erred in law and on facts and in the 7 I.T.A.N.5638./Del/2011 circumstances of the case in erroneously rejecting the comparable companies selected under a search driven process followed by a detailed FAR Analysis (functions performed, assets utilized and risk assumed) undertaken by the assessee. d) The TPO as well as the DRP and consequently the AO has erred in law and on facts and in the circumstances of the case in erroneously applying a defective FAR analysis and selecting and retaining non-comparable companies which render different services as compared to the assessee and thereby arriving at an incorrect arms' length price. e) The TPO as well as the DRP and consequently the AO has erred in law and on facts and in the circumstances of the case in erroneously not giving benefit of proviso to section 92C(2) of +/- 5% adjustment to the assessee. f) The TPO as well as the DRP and consequently the AO has erred in law and on facts and in the circumstances of the case in erroneously not giving benefit of risk adjustment to the assessee on account of material differences in risks with regard to the services rendered by the comparable companies chosen by the TPO and the services rendered by the assessee as mandated by Rule 10B(3) of the Income Tax Rules, 1962. g) The TPO as well as the DRP and consequently the AO has erred in law and in the facts and circumstances of the case in erroneously making a TP adjustments of Rs.20,65,638/- on account of project management service and marketing support service on wholly illegal, erroneous and untenable grounds.”
We have heard the rival contentions of both the sides, perused the orders passed by the authorities below, the paper books filed by the assessee and the case laws relied upon by both the sides. The only dispute that arises
8 I.T.A.N.5638./Del/2011 is with respect to selection of the comparables. To be precise the controversy rotates around the exclusion by the Ld. TPO/DRP of the following companies in the list of comparables:- 1. Khaitan India Ltd 2. Times innovative media Ltd 3. UBL sales Ltd 4.1 Apart from that the assessee is insisting on inclusion of the following comparables which were not included by the DRP as well as the TPO:- 1. ICRA Management 2. IDC India 3. NTPC Electric Supply 4.2 We shall take up these companies one by one to ascertain their compatibility or otherwise with the assessee. Before embarking upon this exercise it is sine qua non to precisely consider the functional profile of the assessee. Functional analysis of the assessee from the TP study: 4.3 From the TP study it is seen that assessee was providing optimum, efficient and environmentally sound products and services for the power generation and oil and gas markets. For power generation, Rolls-Royce gas engines are widely used for industrial cogeneration and try generation applications. In the oil and gas sector the Rolls-Royce equipment derives large palms to properly crude oil and refinery products through black pipelines
9 I.T.A.N.5638./Del/2011 and provides electricity for pumping stations. Rolls-Royce addresses to the needs of its energy customers in India through a wholly owned subsidiary being the assessee under consideration. Rolls-Royce is expanding its energy customer base in India with leading businesses such as Garden Silk Mills,, and Terry towels in Gujarat and Sally exports, Vaighai Chemicals, MMS Steel and Power and Kaveri gas powered in Tamil Nadu.
4.4 The assessee under consideration transacts with 3 related entities: a) it has taken a loan from its ultimate parent company, Rolls-Royce plc, based in United Kingdom and interest on the same has been provided for during the year, 2006 7 b) it buys finished goods from and provides technical services to Rolls-Royce Power engineering plc also based in United Kingdom c) it buys finished goods Frum, provides technical, project management and marketing support services to and receives commission from Rolls-Royce Marine AS based in Norway.
4.5 The assessee markets itself primarily in the power generation and oil and gas markets, with a range of reciprocating engines covering gas engines, HFO engines and crude oil engines, it is distinctly placed as an integrated solution provided for project management
10 I.T.A.N.5638./Del/2011 service (PMS) and marketing support service markets (MSA) within the territory of India and Bangladesh. Assessee has a little competition in the oil and gas markets due to its superior technical enterprise.
4.6 The ld.AR has placed reliance on pages 222 to 264 of the paper book wherein the agreements between Rolls- Royce Marine A-S and assessee for the provision of marketing support services and project management services are contained. He has referred to pages 229 and 233 for services rendered by the assessee in relation to market support services to Rolls-Royce Marine AS in India and Bangladesh are as under: • maintain close business and marketing relationships with the third-party adviser of Rolls-Royce Marine AS in Bangladesh and India to provide support as necessary; • to develop and maintain close relationship with prospective customers in Bangladesh and India supplementing local advisers activities and draw their attention suitable products of Rolls-Royce Marine AS and ascertain what Rolls-Royce Marine AS competitors are offering; • help the local advisor to create and nurture an interest in the products in the minds of end customers;
11 I.T.A.N.5638./Del/2011 • assistance in the identification of new business prospects or Rolls-Royce Marine AS in Bangladesh and India; • to ensure that Rolls-Royce Marine AS is made aware of any criticism of the products and has the opportunity of countering the technical and commercial proposals of the competition; • to make Rolls-Royce Marine AS avail of the most effective strategies to be used with all external parties inside the territory and assist with its preparation and implementation as requested; • to make Rolls-Royce Marine AS avail of all matters relating to competition, potential competition and other business hazards facing Rolls-Royce Marine AS within the territory of India and Bangladesh in a timely manner so as to permit Rolls-Royce Marine AS to develop and implement and is a strategy to overcome such matters; • attend meetings upon the instructions of Rolls-Royce Marine AS, to assist in providing appropriate follow- up services to the advisor; • maintain constant lies in with the third-party adviser of Rolls-Royce Marine AS in India and Bangladesh and with operators of the products in India and Bangladesh in order to obtain early warning of all technical and commercial problems;
12 I.T.A.N.5638./Del/2011 • to inform Rolls-Royce Marine AS as early as possible of all prospective sales and other business opportunities with or concerning the territory; • provide necessary inputs to enable the advisor and Rolls-Royce Marine AS to submit requisite tenders in the territory; • access Rolls-Royce Marine AS with its promotional activities in Bangladesh and India; • to assist Rolls-Royce Marine AS with its promotional activities in India and Bangladesh; • to make Rolls-Royce Marine AS aware of the development of the market for products and on the activities of Rolls-Royce Marine’s competitors within India and thereby assisting development of Rolls- Royce Marine ES marketing and business strategy • to undertake investigation enquiries and other duties and provide general advice and assistance as necessary and at the request of Rolls-Royce Marine AS; • to establish and maintain contact as required and by agreement with Rolls-Royce Marine AS with actual and prospective suppliers and partners and with relevant organisations, institutions and governmental agencies within India.
13 I.T.A.N.5638./Del/2011 4.7 Reference has been made on pages 240 and 252 for services rendered in respect of project management which are as under: • to review in accordance with the good practice framework; • to coordinate the purchase of balance of plant and expediting of suppliers; • to control and review expenditure on the project and identifying and claiming additional costs from clients; • coordinating with suppliers in relation to supply of drawings and specifications; • ensuring the correct resources available at the correct time for management of the projects undertaken; • coordinating way between Rolls-Royce and Marine AS/Rolls-Royce plc and customers for raising bank guarantees required by the project and retraining guarantees after expiry; • managing/coordinating the logistics of Rolls-Royce Marine AS scope of supply to be delivered to the correct place, with correct documentation;
14 I.T.A.N.5638./Del/2011 • arranging for attendance at factory witness test and accompanying the customer’s representatives were required; • coordination of approval of drawings by customer and providing quality documentation; • maintaining customer satisfaction to protect the company’s commercial interests; • maintaining the risk register on large projects identifying risks and managing them. 4.8 The agreements entered into by assessee with Rolls-Royce Marine A-S in respect of marketing support service and project management support service has clearly mentioned that the reimbursement will be on the basis of actual costs 6.52% markup, which represents the markup appropriate for a non-risk bearing service provider. (clause 5 at pages 223, 234, 246 and 257) with reference to these clause the learn ADR demonstrated that assessee is essentially a non- risk bearing service provider.
4.9 With this background we shall take up the compatibility of the company excluded by ld.TPO one by one.
Khaitan (India) Ltd. 4.9.1 The ld.TPO rejected this company as it is engaged in trading of fans, sugar etc and was not 15 I.T.A.N.5638./Del/2011 comparable to marketing and consultancy or project consultancy activities of the assessee. It has been submitted by the ld.AR that this company has a separate marketing division which is ancillary to its main trading activities in fans, sugar etc. The ld.AR submitted that the marketing segment is functionally comparable to assessee even though the product marketed by this company may be different. He further submitted that assessee has used only the marketing segment for the purposes of computation of ALP. The ld.AR placed reliance at page 172 of the paper book wherein the segmental information relating to marketing division, carried on by this company has been placed.
4.9.2 On the contrary the ld.DR places reliance on the findings of ld. TPO/DRP. He submitted that this company is functionally different with that of assessee and also has a very small portion of revenue earned from marketing services.
4.9.3 We have perused the relevant material on record filed in the paper book as well as the orders passed by the authorities below. It is observed that the assessee has compared only the marketing segment of this company with that of assessee. This segment of the company is engaged in sales promotion and marketing of fans. The ld.AR demonstrated that this company has a marketing segment like assessee. In the present case
16 I.T.A.N.5638./Del/2011 the ld.TPO has rejected its inclusion on the ground that this company is trading in fans, sugar etc. However it is observed from the TP study that the assessee has considered the revenue from marketing division of this company. There has been no functional dissimilarity in the marketing segment performed by this company that has been brought out by the ld.TPO or DRP.
5.9.4 There is no quarrel that functional test plays a paramount role in the selection of comparables. It is a settled law that functionality tested to be applied having regard to the segmental details. If a particular segment is performing specific function, then for determining functional similarity, those comparables should be selected which have close similarity with the functional segment under consideration.
4.9.5 It has been submitted that this company pays the risks associated with carrying out the functions of marketing whereas assessee is a no risk, in relation to the functions performed in respect of marketing, since these are borne by the AE. We therefore direct the ld.TPO to provide adjustments in terms of risk.
4.9.6 We therefore direct the ld.TPO to include this company in the list of comparables.
17 I.T.A.N.5638./Del/2011 4.10 The ld.TPO has rejected this company as it is engaged in event management and this activity will be classified as entertainment and media related services. The ld.AR however submitted that this company is functionally comparable to assessee in terms of its marketing and project management activities.
4.10.1 On the contrary ld.DR places reliance upon the findings of ld. TPO and DRP. He submitted that the functions performed by this company relates to the event management and therefore is not similar with the functions performed by the assessee.
4.10.2 We have perused the relevant material on record filed in the paper book as well as the orders passed by the authorities below.
4.10.3 It is observed from the segmental information of this company placed at page 175 of the paper book that the main revenue is generated from events. The assessee does not have event management under the segment of marketing and project management services. We therefore reject this company as a comparable due to the functional dissimilarity with assessee.
4.11 The ld.TPO rejected this company as 100% revenue by this company is from commission on 18 I.T.A.N.5638./Del/2011 marketing of financial products from UTI bank. He therefore opined that the activities carried on by this company are not comparable to the marketing and consultancy or project consultancy activities carried on by the assessee. The Ld. AR submitted that even though the products traded by this company are different from that of the assessee, it has a separate marketing segment. Reliance has been placed at the segmental information of this company at page 176 of the paper book. Reliance has been placed on the decision of Mumbai tribunal in the case of ACIT versus M/s NGC network (India) private limited in ITA number 5307/M/2008, wherein the principle of close compatibility was upheld and the tax payer’s contention that company is engaged in similar activity can be compared was sustained.
4.11.1 On the contrary the Ld. DR places reliance on the findings of ld. TPO/DRP.
We have perused the relevant material on record filed in the paper book as well as the orders passed by the authorities below.
4.11.2 It is observed that the assessee has compared only the marketing segment of this company with that of assessee. This segment of the company is engaged in sales promotion and marketing functional products from UTI Bank. The Ld. AR demonstrated that this 19 I.T.A.N.5638./Del/2011 company has a marketing segment like that of assessee. In the present case the ld.TPO has rejected its inclusion on the ground that this company is earnings commission from marketing the financial products of UTI. It is observed from the TP study that the assessee has considered the revenue from marketing division of this company. There has been no functional dissimilarity in the marketing segment performed by this company that has been brought out by the Ld.TPO or DRP.
4.11.3 It has been submitted that this company pays the risks associated with carrying out the functions of marketing whereas assessee is a no risk, in relation to the functions performed in respect of marketing, since these are borne by the AE. We therefore direct the ld.TPO to provide adjustments in terms of risk.
4.11.4 We therefore direct the ld.TPO to include this company in the list of comparables.
4.12 As regards the exclusion of ICRA Management, IDC India and NTPC Electric Supply, the ld.AR has not raised any ground. Therefore we do not go into this aspect. 4.12.1 Accordingly grounds raised by the assessee stand allowed.
5. In the result the appeal filed by the assessee stands allowed.
20 I.T.A.N.5638./Del/2011 Order pronounced in open court on 27th June, 2016.