MAGNETI MARELLI POWERTRAIN INDIA PVT. LTD. vs. DEPUTY COMMISSIONER OF INCOME-TAX

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data of Magneti Marelli Powertrain India Pvt. Ltd. The assessee, on the basis of its analysis claimed that its international transactions under the broad head (which included `Payment of technical assistance fee') were the Arm‟s Length Price (ALP). This was rejected by the TPO who held that the Transactional Net Margin Method (“TNMM”) had to be applied separately for each international transaction and not collectively as done by the assessee. He, therefore, held all international transactions could not be ALP merely because the overall operating profit was more than the comparables. The TPO consequently rejected the assessee‟s `entity level approach' applied by it to benchmark its international transactions which included `Technical assistance fees' of ` 38.58 crores. According to the TPO, the Comparable Uncontrolled Price (CUP) method was more apt and had to be applied. The assessee's TNMM was consequently rejected and the CUP method was adopted. Accordingly, ALP of this transaction was determined. The assessee was unsuccessful before the Dispute Resolution Panel (DRP). In the final order passed under Section 144C(13), the A.O added the amounts towards income. The assessee was aggrieved against such addition and appealed to ITAT. 4. The ITAT firstly held that merely because the assessee capitalized the amount (` 38.58 crores) in the year and claimed depreciation on it, did not take the transaction outside the ambit of `international transaction'. That the assessee incurred liability for the said amount and did acquire technical assistance in the financial year relevant to the assessment year under consideration in respect of ECUs to be manufactured distinctly for the four different car makes and their application was not disputed. Therefore, the character of international transaction was- according to ITAT, left intact. The

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assessee did not dispute this aspect. The ITAT, therefore, held that: “6. It is seen that the assessee clubbed transactions of import of raw material, sub-assembles and components, payment of technical assistance fees, payment of royalty, payment of software and purchase of fixed assets under one segment of 'Manufacturing of the automotive components' and analyzed all such transactions on a combined basis. This type of combined benchmarking of all the international transactions is not in accordance with law. The mere fact that the overall profit earned by the assessee is more, would not ipso facto lead to the interference then all the international transactions are at ALP. The Special Bench of the Tribunal in the case of LG Electronics India Pvt. Ltd. Vs ACIT 2013 140 ITD 41 (Delhi) (SB) has held to this extent. Thus, the approach so adopted by the assessee in combining so many international transaction for determining ALP on a consolidated basis, is incorrect.

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not result into the determination of correct prices. Nothing of the sort has been shown as to why the data of the comparables for the current year was not appropriate. We, therefore, reject this point of view canvassed by the assessee in making comparability.

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any advantage at all by making payment to its AE.

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methodology that TPOs are to adopt while determining ALP. The said judgment held, inter alia, that: “The use of the expression "class of transaction", "functions performed by the parties" in section 92C(1) illustrates to the contrary, that the word "transaction" can never include and would exclude bundle or group of connected transactions. More important would be reference to the meaning of the term "transaction" in section 92F, clause (v), which as per the said definition includes an arrangement or understanding or action in concert whether or not the same is formal or in writing, whether or not it is intended to be enforceable by legal proceedings. Rule 10A in clause (d) states that "for the purpose of this rule and rules 10AB and 10E", the term "transaction" would "include a number of closely linked transactions". This rule in positive terms declares that the legislative intent is not to deviate from the generic rule that singular includes plural. The meaning or definition of the expression "transaction" in clause (d) of rule 10A read with sub-section (1) of section 92C, therefore, does not bar or prohibit clubbing of closely connected or intertwined or continuous transactions. This is discernible also from sub-rule (2) of rule 10B quoted above. The sub-rule refers to "services provided", "functions performed", "contractual terms (whether or not such terms are formal or in writing) of the transactions" which lay down explicitly or impliedly the responsibilities, risks and benefits to be divided between the respective parties to the transactions. The use of plurality by way of necessity and legislative mandate is evident in the said rule.

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business, there is no bar or prohibition from applying the TNM method on entity level basis. The focus of this method is on the net profit amount in proportion to the appropriate base or the PLI. In fact, when transactions are interconnected, combined consideration may be the most reliable means of determining the arm's length price. There are often situations where closely linked and connected transactions cannot be evaluated adequately on separate basis. Segmentation may be mandated when controlled bundled transactions cannot be adequately compared on an aggregate basis. Thus, the taxpayer can aggregate the controlled transactions if the transactions meet the specified common portfolio or package parameters. For complex entities or where one of the entities is not "plain vanilla distributor", it should be applied when necessary and applicable comparables on functional analysis, with or without adjustments are available. Otherwise, the TNM method should not be adopted or applied on account of being an inappropriate method.

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would have been adopted by an independent enterprise behaving in a commercially rational manner. No reason or ground for holding or the ratio, is indicated or stated. There is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willing to incur heavy and substantial AMP expenses, if he presumes this is beneficial, and he is adequately compensated. The compensation or the rate of return would depend upon whether it is a case of long-term or short-term association and market conditions, turnover and ironically international or worldwide brand value of the intangibles by the third party."

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inconsistent. Having upheld the deployment of the TNMM, it was not open to use the CUP method for only one part of the transaction, i.e the one payment for technology. 9. Ms. Vibhuti Malhotra, counsel for the revenue, refuted the assessee‟s submissions. She urged firstly that Sony Ericsson (supra) does not stipulate any invariable rule with respect to aggregation or desegregation of transactions. Rather, it merely endorsed the view that aggregation is desirable. It was argued that while the commercial decision- making and choices of an entity are to be largely left intact, this court recognized that in ALP determination, it is essential that there are two exceptions to the principle: (i) where the economic substance of a transaction differs from its form; and (ii) where the form and substance of the transaction are' the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. 10. Learned counsel argued that the TPO in this case had noticed that the payment for „technical assistance fees was not benchmarked; the assessee‟s explanation that this was necessary, was rejected and it was concluded that the cost- benefit analysis provided did not explain why such a large amount was paid to the AE, when royalty was separately paid. Counsel argued that more importantly, the TPO noticed that large sums of money were paid towards travel expenditure of the AE‟s personnel, which was not explained. The inadequacy of the assessee‟s explanation led to the addition. Counsel contended that though the TPO‟s rejection of the TNMM was erroneous, that

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aspect was corrected. Still, the benchmarking needed for the technical fee had to be undertaken. Counsel relied on Denso India Limited v. Additional Commissioner Income Tax (ITA No. 443/2013 and ITA No. 451/2013) to say that whether to permit aggregation or desegregate bundled transactions is entirely dependent on facts of each case. On the second question, it was submitted that the ITAT left it to the AO to determine the most appropriate method to benchmark the transaction, i.e. the payment and that this finding does not call for interference. Analysis and Conclusions 11. Sections 92-A to 92-E were introduced into the Income Tax Act, to address a gap, i.e the evaluation of true income, which transnational entities strive to locate within a more friendly tax regime, as opposed to where they are in reality to be subjected to assessment. The Income Tax Rules were also appropriately amended to give effect to this Parliamentary intent. Broadly, the Act and rules posit the disclosure of various international transactions by domestic tax-payers to their “Associated Enterprises” (AE) with which they have disclosed nexus. The methodology indicated by law for identification of amounts, which otherwise would be income, but are shown as some form of payment, to the AEs, is the “Arm‟s Length Price” (or ALP) determination, where the particular business of the enterprise taxed is taken into consideration. Rule 10-B which is relevant, reads as follows: “10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :—

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(a) comparable uncontrolled price method, by which,— (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified; (ii) such price is adjusted to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or services provided in the international transaction or the specified domestic transaction;

(b) resale price method, by which,— (i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services; (iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the

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property or obtaining of the services by the enterprise from the associated enterprise;

(c) cost plus method, by which,— (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii) the normal gross profit mark-up referred to in subclause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under subclause (iii); (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise;

(d) profit split method, which may be applicable mainly in international transactions or specified domestic transactions involving transfer of unique intangibles or in multiple international transactions or specified domestic transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining the arm's length price of any one transaction, by which— (i) the combined net profit of the associated enterprises arising from the international transaction or the specified domestic transaction in which they are engaged, is determined; (ii) the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then

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evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances; (iii) the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub-clause (ii); (iv) the profit thus apportioned to the assessee is taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction: Provided that the combined net profit referred to in sub-clause (i) may, in the first instance, be partially allocated to each enterprise so as to provide it with a basic return appropriate for the type of international transaction or specified domestic transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprises, and thereafter, the residual net profit remaining after such allocation may be split amongst the enterprises in proportion to their relative contribution in the manner specified under sub-clauses (ii) and (iii), and in such a case the aggregate of the net profit allocated to the enterprise in the first instance together with the residual net profit apportioned to that enterprise on the basis of its relative contribution shall be taken to be the net profit arising to that enterprise from the international transaction or the specified domestic transaction ;

(e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction or a specified domestic transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction

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or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in subclause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction; (f) any other method as provided in rule 10AB."

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comparable. No such efforts was made. No ALP was computed by the assessee. As held by the Assessing Officer, as well as the Commissioner (Appeals), the assessee has not furnished personnel have rendered marketing services to the assessee company. In fact, the assessee company has no revenue which has been derived as a result of these marketing expenses. At the cost of repetition, we state that in the TP report, the company's submission is recorded at Page-30, and it states that the software services obtained by the Deloitte from the third party, are not similar to the services obtained by the Deloitte from the assessee company on account of requirements of different skill, experience, knowledge level, complexity of software projects handled, risk bearing capacity, etc. The entire revenue of the assessee are from the Deloitte. The evidence filed in support of the fact that services are rendered in the form of e-mails show that they are not e-mails relating to marketing, but that they relate only to billing. As rightly pointed out by the learned Departmental Representative, the assessee has no role in interacting with the client to modify, cancel, renew or extend the contract. The assessee cannot, even after expiry of the agreement between the Deloitte and its client, supply services without written consent of Deloitte. Deloitte has to pay the assessee irrespective of it getting payment or not within sixty days of raising invoices. Deloitte is responsible for generation of sales management, delivery of projects, maintaining customer relationship and billing and collection. The assessee has no market risk. The argument of the learned Counsel for the assessee that these three marketing personnel project the capabilities of the assessee company so that Deloitte gets work, is not supported by any evidence and, hence, without basis. In our view, under similar circumstances a uncontrolled comparable company would not incur such expenditure. Hence, the ALP is rightly determined at "nil". As no expenditure would have been incurred, there is no necessity to apply a particular method to arrive at such conclusion. In fact, by all the five methods or any one of them, when applied to the fact that there is no necessity of payment, the result of "nil" ALP will come."

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assessee was unable to substantiate the need for payment of technical assistance fees to its foreign AE. The TPO has observed that the assessee tried to establish its case for the arm's length nature of the transaction by stating that it gained in the form of higher sales. The TPO observed that neither any cost benefit analysis nor any benchmarking exercise was undertaken at the time of entering into the agreement. The TPO‟s rejection of the TNMM method at entity level was undoubtedly not correct. That, however, would not conclude the issue. 15. The assessee‟s argument that the technology itself would not have been given to it, but for the substantial fee (paid over and above the royalty payable), in the opinion of this court, requires a closer scrutiny. The initial burden is always upon the assessee to prove that the international transaction was at Arm‟s Length. Its TP report necessarily had to draw a comparison with other entities (maybe competitors) to show the general degree of profitability of the venture in question. The lower authorities quite correctly turned down the method of explaining the justification of the technical fee- with “proof” of its necessity by relying on profits. Undoubtedly the assessee was obliged to make the payment and that obligation arose from the agreements, a pre-incorporation binding contract. However, that such contractual obligation existed cannot ipso facto be the end of the enquiry. ALP determination in respect of every payment that is part of an international transaction is to be conducted irrespective of such obligation undertaken by the parties. If the transactions are, in the opinion of the TPO, not at arm's length, the required adjustment has to be made, as provided in the Act, irrespective of the fact that the expenditure is allowable under other provisions of the Act. There can conceivably be various reasons not to

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subject such payments, such as for instance, if no similar data exists at all; or that sectional data for such payments is absent. Quite possibly, this may also be a general pattern of expenditure which AEs may insist to part with technology; further, similarly, other models of payment- deferred or lump sum, along with royalty or inclusive of it, may be discerned in comparable transactions. However, to say that such a substantial amount had to necessarily be paid and that it was a commercial decision, dictated by need for the technology, in the light of a specific query, it could not be said by the assessee that later profits justified it, or that has essentiality precluded the scrutiny. 16. In the light of the above discussion, this court holds that the explanation by the assessee that the payment of ` 38.58 crores in the circumstances was correctly not accepted. The first question is answered against the assessee. The remit directed by the impugned order is, therefore, upheld. 17. As far as the second question is concerned, the TPO accepted TNMM applied by the assessee, as the most appropriate method in respect of all the international transactions including payment of royalty. The TPO, however, disputed application of TNMM as the most appropriate method for the payment of technical assistance fee of ` 38,58,80,000 only for which Comparable Uncontrolled Price (“CUP”) method was sought to be applied. Here, this court concurs with the assessee that having accepted the TNMM as the most appropriate, it was not open to the TPO to subject only one element, i.e payment of technical assistance fee, to an entirely different (CUP) method. The adoption of a method as the most appropriate one assures the applicability of one standard or criteria to judge an international

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transaction by. Each method is a package in itself, as it were, containing the necessary elements that are to be used as filters to judge the soundness of the international transaction in an ALP fixing exercise. If this were to be disturbed, the end result would be distorted and within one ALP determination for a year, two or even five methods can be adopted. This would spell chaos and be detrimental to the interests of both the assessee and the revenue. The second question is, therefore, answered in favour of the assessee; the TNMM had to be applied by the TPO/AO in respect of the technical fee payment too. 18. In view of the above conclusions, the appeal has to fail; subject to the findings and observations regarding applicability of TNMM, it is dismissed.

S. RAVINDRA BHAT (JUDGE)

DEEPA SHARMA (JUDGE) OCTOBER 25, 2016