VAIBHAV GLOBAL LIMITED,JAIPUR vs. DEPUTY COMMISSIONER OF INCOME TAX, JAIPUR, JAIPUR

आदेश/ORDER

Per Vikram Singh Yadav, Accountant Member:

This is an appeal filed by the assessee against the order dated 30.06.2021 passed u/s 143(3) read with section 144C(13) of the Income Tax Act, 1961 (‘the Act’) by the Deputy Commissioner of Income Tax, Central Circle-4, Jaipur for the assessment year 2016-17, wherein the assessee has taken the following grounds of appeal:

“1. On facts and in law, the Ld. AO has erred in assessing the total income of the Appellant for the relevant AY at INR 57,36,47,429 as against the returned income of INR 28,11,30,040.

ITA No.97/JP/2021 2 A.Y.2016-17

ITA No.97/JP/2021 3 A.Y.2016-17

Profit /Operating Cost ('OP/OC') as the most appropriate PLI and instead incorrectly applied the Berry Ratio. 5. On facts and in law, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in violating the provisions of Rule 10B(2) of the Rules by rejecting certain functionally comparable companies identified by the Appellant in its TP documentation. 6. On facts and in law, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in arbitrarily applying new filters and introducing new companies in the comparable set without sharing the entire search process with the Appellant. 7 On facts and in law, without prejudice to the above grounds, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in disregarding the Appellant's submissions for considering the correct computation of OP/ VAE under the Berry Ratio for the Appellant as well as the alleged comparable companies. 8. On facts and in law, without prejudice to the above grounds, the Ld. TPO, Ld. AO and the Hon'ble DRP erred in not allowing the benefit of proportionate adjustment to the Appellant, i.e. restricting the adjustment to the value of international transactions. 9 On facts and in law, the Ld. TPO grossly erred in not providing any opportunity of hearing/ responding to the show-cause notice proposing the impugned transfer pricing adjustment, and the Hon'ble DRP further erred in rejecting the Appellant's objections on this ground without appreciating the facts of the case thereby denying the Appellant the principle of natural justice. 10. On the facts and in the circumstances of the case, the Ld. AO erred in levying interest under section 234A/234B/234C of the Act. 11. That in view of the facts arid circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under Section 274 read with Section 271(l)(c) of the Act for concealment / furnishing inaccurate particulars of income.”

ITA No.97/JP/2021 4 A.Y.2016-17

carrying on the business of manufacturing and export of gold

jewellery studded with precious and semi-precious stones. It

filed its return of income declaring total income of

Rs.28,11,20,040/- which was selected for scrutiny and notices

u/s 143(2) and 142(1) were issued and served on the

assessee. During the course of assessment proceedings, a

reference was made by the Assessing officer to the Transfer

Pricing Officer u/s 92CA(1) of the Act on 31.10.2018 for

determination of arms’ length price of international

transactions undertaken by the assessee during financial year

relevant to the impugned assessment year. On going through

the transfer pricing documentation so furnished by the

assessee, the Transfer Pricing Officer issued a show cause

notice dated 15.10.2019 wherein it was stated that the

assessee has used Cost Plus Method (CPM) and selected gross

profit margin/cost of production (GPM/COP) as the

appropriate profit level indicator (PLI) for benchmarking its

international transactions and GPM/CPO margin has been

stated as 13.51% as determined by the assessee. The TPO

further observed that on going through the fact that the

assessee is purchasing from related parties and selling to

related parties, so both the cost and revenue sides are tainted

and in this scenario, OP/Cost of Production will not be an

ITA No.97/JP/2021 5 A.Y.2016-17

appropriate PLI and as against the same, OP/VAE has been

stated to be the appropriate PLI by the TPO. Further, referring

to the comparables for benchmarking the international

transactions, rejecting most of the comparables except few as

selected by the assessee and selecting fresh set of

comparables, the TPO stated that the median OP/VAE of the

comparables is proposed to be taken at 55.27% and using the

same, arms’ length revenues of the assessee were determined

at Rs.389,85,63,762/- as against reported operating revenues

of Rs. 360,60,46,377/- resulting in a difference of

Rs.29,25,17,385/- which was proposed as an adjustment u/s

92CA of the Act. Thereafter, the Transfer Pricing Officer

passed an order u/s 92CA(3) of the Act dated 25.10.2019

proposing an adjustment of Rs.29,25,17,385/- and taking into

consideration the adjustment so proposed by the Transfer

Pricing Officer, the draft assessment order u/s 143(3) read

with section 144C(13) of the Act was passed by the Assessing

officer on 13.11.2019 wherein adjustment on account of

transfer pricing as proposed by the Transfer Pricing Officer

was made and the assessed income was determined at

Rs.57,36,47,429/-.

objections before the Dispute Resolution Panel and after

considering the submissions of the assessee but not accepting

ITA No.97/JP/2021 6 A.Y.2016-17

the same, the Dispute Resolution Panel vide its order dated

20.1.2021 has confirmed the adjustment so proposed by the

Transfer Pricing Officer and thereafter the final assessment

order u/s 143(3) r/w 144C(13) was passed by the Assessing

officer on 30.6.2021 considering the adjustment so confirmed

by the Dispute Resolution Panel and making an addition of

Rs.29,25,17,385/- to the returned income so filed by the

assessee.

passed by the Assessing officer on 30.6.2021 considering the

adjustment confirmed by the Dispute Resolution Panel and

making of an addition of Rs.29,25,17,385/- to the returned

income by the Assessing officer, the assessee is now in appeal

before us.

the transfer pricing adjustment of Rs.29,25,17,385/- has been

upheld by the Dispute Resolution Panel in respect of the

assessee international transactions of sale and purchase of

goods to/from its Associated Enterprises. In doing so, it has

disregarded the economic analysis carried out by the assessee

in its transfer pricing documentation and has rejected the

Cost Plus Method, with gross profit margin/Cost of Production

(GP/COP) as the profit level indicator, which is the most

ITA No.97/JP/2021 7 A.Y.2016-17

appropriate method for the impugned transactions without

giving any cogent reasons. It was further submitted that the

Transfer Pricing Officer has applied and the Dispute

Resolution Panel has upheld the application of Berry ratio

with Operating Profit/Value Added Expenses (OP/VAE) as the

PLI under Transactional Net Margin Method (TNMM) without

appreciating that the assessee is engaged in manufacturing

activities and, therefore, purchases and cost of production

ought to be included in the cost base, thereby completely

disregarding the facts of the case, functional profile of the

assessee, established legal principles and internationally

accepted transfer pricing guidelines.

not the most appropriate PLI for assessee engaged in

manufacturing activities. It was submitted that based on the

detailed functional profile of the assessee as given in its

Transfer Pricing Report, the assessee was characterized as

a routine manufacturer performing all the entrepreneurial

functions and accordingly, the assessee applied the GP/COP

as the PLI and choose CPM as the most appropriate method

for the purpose of benchmarking analysis in the TP

documentation. It was stated that the TPO failed to

appreciate that the assessee is engaged in manufacturing

activities in complete disregard to the facts of the case,

ITA No.97/JP/2021 8 A.Y.2016-17

functional profile of the assessee, established legal

principles and internationally accepted transfer pricing

guidelines. Thereafter, the TPO rejected assessee’s

benchmarking approach and applied Berry

Ratio by observing the following in the TP order as under:

"In this case the Appellant is purchasing from related parties and selling to related parties. So, both cost and revenue sides are tainted. In this scenario, OP/Cost of Production will not be an appropriate PLI. OP/VAE has been chosen as PLI"

mentioned in either the Indian TP regulations, OECD

Guidelines or the UN TP Manual that Berry Ratio is an

appropriate method when both sales and cost sides are

tainted. In fact, as per the aforementioned rules, regulations

and guidelines, the most appropriate method and PLI

which is to be chosen should be based on the

characterization of the taxpayer and hence, the very logic

applied by Ld. TPO for rejection of assessee’s PLI, and

application of Berry ratio is without any basis. Further, it

was submitted that the very reason given by TPO for

rejecting GP/COP as PLI and adopting Berry Ratio holds no

water since it is the sales transactions of VGL which is

primarily undertaken with the AEs and so called tainted in

the words so used by the TPO and only a small proportion of

ITA No.97/JP/2021 9 A.Y.2016-17

the purchases are attributable to the AEs. In this regard,

our reference was drawn to sales and purchases with the

AE’s/Non-AEs as under:

Sales to Amount (in INR) % of total sales Aes 3,18,54,77,750 88.34% Other 42,05,68,627 11.66% Parties/Non- Aes

Purchases Amount (in INR) % of total from purchases AEs 59,47,42,920 21.09% Other 2,22,53,31,523 78.91% Parties/Non- Aes

assessee from its AEs are undertaken on a Cost-to-Cost

basis since the AEs only facilitate in sourcing materials

from these jurisdictions occasionally on need basis. Our

reference was drawn to the detailed submissions made

before the DRP along with relevant evidences in form of

invoices and confirmations, placed at page No. 179 of the

Paper Book regarding the cost-to-cost nature of the

purchases made by the assessee from its AEs.

cannot be considered as an appropriate PLI for the assessee

since Berry Ratio only reflects value adding activities

performed by the entity and excludes any purchases and

ITA No.97/JP/2021 10 A.Y.2016-17

manufacturing related expenses in the cost base. It was

further submitted that the assessee is engaged in full-

fledged Manufacturing activities, hence, the purchases and

cost of production ought to be included in the cost base and

since Berry Ratio includes only the service element, it

cannot be applied in the case of the manufacturing assessee

as it is not reflective of assessee’s functional profile. The

manufacturing entities are not good candidates for Berry

Ratio because of their capital intensity. The Berry Ratio is

usually applied when the value of the goods is not directly

linked to the quantum of profits, and the profits are mainly

dependent on expenses incurred on value adding activities

(and not manufacturing costs). It was submitted that the

Berry Ratio is mostly used with low-risk procurement and

distribution service providers, which have no funds blocked

in inventories and employ no intangible assets. The Ld. AR

drawn our attention to the financial statements of the

assessee at Page 47-72 of the Paper Book for a detailed

break up of inventories and other assets of the assessee and

stated that the aforesaid analogy is considered under UN TP

manual (2017) as well, extract of which is enclosed on Page

379 of the Paper Book. It was stated that a similar view has

been adopted in the OECD guidelines (2017) and relevant

extract of the same is submitted at Page 376-378 of the

ITA No.97/JP/2021 11 A.Y.2016-17

Paper Book. The Ld. AR also relied upon the following

judicial precedents which clearly states that Berry ratio can

be effectively applied in cases of stripped-down distributors,

which have no financial exposure and risk in respect of

goods distributed by them:

• Delhi ITAT's decision in case of Mitsubishi Corporation India Pvt. Ltd (ITA number5042/Del/l 1 dated 21 s t October 2014) • Delhi High Court's decision in the case of Sumitomo Corporation India Private Limited (ITA number 381/2013 dated 22 n d July 2016) • Ahmedabad ITAT Bench decision in the case of Bagadiya Brothers (P) Ltd (ITA number 203/BLPR/2012 dated 1 s t March 2017)

selected as most appropriate method by the assessee, it was

further submitted by the ld AR that the assessee is engaged

in the business of manufacturing and selling of coloured

gemstones and studded jewellery. The assessee procures raw

material from both AEs and Non-AEs and subsequently

manufactures and sells the finished goods and accordingly,

based on the detailed FAR analysis, VGL was characterized

as a routine manufacturer performing all the

entrepreneurial functions and for ascertaining the arm's

length price of the international transactions of Sale/

Export of goods to AEs and Purchase of material from AEs, a

ITA No.97/JP/2021 12 A.Y.2016-17

methodical benchmarking search was undertaken, applying

CPM as the most appropriate method (with OP/COP as the

PLI) to identify independent third party comparable

companies in India that are engaged in manufacturing of

studded jewellery, i.e. gemstones/colored stones, diamonds,

and Silver/ Gold studded jewellery.

analysis of the assessee, the TPO and the DRP did not

appreciate that CPM has consistently been accepted by the

Revenue authorities in the prior years as the most

appropriate method and there being no change in the facts

and circumstances of current year vis-à-vis prior years, the

'Rule of consistency' cannot be summarily disregarded.

applied on the comparable companies selected by the TPO,

the international transaction of the assessee will meet the

arm's length requirement as explained in our detailed

submission made before the DRP and are contained at Page

141 of the paperbook. Further, the assessee has also

demonstrated that even if TNMM is considered as the Most

Appropriate Method and applied to the comparables selected

by the TPO, the transactions of the assessee are at arm's

length.

ITA No.97/JP/2021 13 A.Y.2016-17

India, assessee’s company endeavor is to enhance its net

worth and other economic indicators of its performance such

as the book value per share, the earnings per share, the

price earnings ratios etc., by dealing with its AEs on a

principal-to-principal basis and on an arm's length basis.

Further, as a matter of fact, the assessee’s AEs have made

very nominal or no profit during the year under

consideration as per details below:

Sr.No. Name of AE OP/OR(%) 1. STS Gems Limited, Hong -3.88% Kong 2. Jewel Gem USA Inc., USA 2.30% 3. STS Gems Thai Limited, 4.70% Thailand 4. The Jewellery Channel 3.67% Limited, UK 5. The Jewellery Channel Inc., -1.34% USA 6. STS Gems Limited, Japan - 7. STS Jewels Inc., USA 4.20%

margin (9.72%) is significantly higher than that of the AEs

and there is no motive for the assessee to shift profits

outside India and therefore, no adjustment is warranted.

Further, any transfer pricing adjustment to the aforesaid

transaction of VGL with its AEs would lead to double

taxation.

ITA No.97/JP/2021 14 A.Y.2016-17

the findings of the TPO as well as the DRP. The findings of

the TPO are already noted above. As far as the findings of

the DRP are considered, the contents thereof read as under:

“4.1.1 Ground number 1 is related to the overall proposed TP adjustment of Rs.29,25,17,385/- on account of application of Berry ratio as PLI by the TPO. As all the sub grounds 1.1 to 1.10 are concerned with this same issue, they are being taken together for adjudication. 4.1.1.1 As far as Ground number 1.1 is concerned it is observed that the AO/TPO gave show cause notice to the assessee dated 15.10.2019 wherein he gave detailed reason for rejecting the TP analysis of the assessee as the assessee was purchasing and selling to related parties and the reason why OP/Cost of production would not be an appropriate PLI, The TPO has clearly noted in his order that the assessee did not give the reply to the show cause letter. Thereafter the TPO had no option but to proceed with the determination of ALP in accordance with the facts of the case as submitted by the assessee in its TP analysis as well as the analysis as per Berry ratio. In view of this fact the Ground number 1.1 is rejected, 4.1.2 In Ground number 1.2, 1.7, 1.8 and 1.9 the assessee has contended the action of the AO/TPO in applying Berry ratio i.e. OP/VAE as the appropriate PLI and rejection of CUP as MAM 4.1.2.1 The Panel has noted the submission of the assessee given on 01.12.2020 and 13.12.2020 as well as the reasoning giving by the AO/TPO in the draft order dated 13.11.2019. In several judicial decisions it has been held that in cases where operating expenses are considered as a relevant base, then application of Berry ratio as PLI is most appropriate. The Panel also notes that in several judicial pronouncements, noteworthy being the case of Sumitomo Corporation India Pvt Ltd 2016-T1I-38-HC-DEL-TP, the Hon'ble Delhi High Court upheld the use of berry ratio in certain situations even though the Income Tax Act does not specifically provide for either the berry ratio, or the bright line test In the relevant case the TPO applied OP/VAE as PLI to calculate the margins of assessee. He rejected the CUP

ITA No.97/JP/2021 15 A.Y.2016-17

method and used TNMM as MAM for computation of ALP. The TPO thereafter analysed the nature and the number of transactions undertaken by the assessee with related parties. The Panel therefore observes that as long as one can come to the conclusion, under any method of determining the arm's length price, that price paid for the controlled transactions is the same as it would have been, under similar circumstances and considering all the relevant factors, for an. uncontrolled transaction, the price so paid can be said to be arm's length price. In view of the above discussion the Panel does not find any reason to interfere with the order of the AO/TPO on this issue.”

Transfer Pricing Officer dated 16.11.2011 and contents

thereof read as under:

“2. In the above context, point wise reply to the contentions raised by Ld. AR was sought from this office. The point wise replies to the contentions are given below:- i) Comments on show cause notice was not considered. In the last paragraph of show cause notice dated 15.10.2019, it was dearly stated that if the Taxpayer does not attend hearing on the said date i.e. 18.10.2019 or any other date communicated by the TPO, it is presumed that the tax payer does not want to avail the opportunity of hearings and in that case, the proceedings would be continued or decided based on the written submission made and/or material available on record. Again, the noticed 16,10,2019 was issued providing the last opportunity to submit the reply of above-mentioned show cause notice by 18.10.2019. However, the reply of the assessee or any other intimation had not been received in this office till 24,10.2019 and the TP proceedings had been concluded with the materials on record and order u/s 92 CA(3) of the income Tax Act 1961 was passed on 25.10,2019. Further, the assessee had enough opportunity to file its submission through email dated 29,10.2019 before the Hon'ble DRP.

ITA No.97/JP/2021 16 A.Y.2016-17

ii) Comments on Consistency is to be followed. The then TPO at Para No, 03 (Page No, 3} of TP order had rejected the method adopted by the assessee and stated that the assessee is purchasing from related parties and selling to related parties. So both cost and revenue sides are tainted. In this scenario, OP/Cost of Production will not be an appropriate PLI, OPA/AE has been chosen as PL!. The TPO had provided the justifiable ground for change in his approach and following mentioned judgments also cited that change in approach should be based on the justifiable ground. In this regards, the decision of Hon'ble Apex Court in the case of Radhasoami Satsang Vs. Commissioner of Income Tax decided on dated 15.01.1991 is imperative to mention here. In the above mentioned case, Apex Court held that each assessment year being a unit, what is decided in one year may not apply in the following year. The same question had been dealt in length by ITAT in the case of Anjala Exhibition Pvt. Ltd. Vs. ACIT in ITA No.162/DEL/2012 dated 31.05.2013. In that case, after referring various pronouncement of Hon'ble Supreme Court and other High Courts, it is held that the principle of consistency is a rule in general but for cogent reasons or on justifiable ground, the Revenue has got right to depart from its earlier practice and take a different view which shall be determined upon the facts and circumstances of each case. iii) Comments on Berry’s ratio is not applicable in the case. In this regards, it is stated at Para No.03 (Page NO.3) of TP order that the assessee is purchasing from related parties and selling to related parties. So, both Revenue and Cost side are tainted. Their degrees might differ but since assessee has engaged substantially with its AEs in both sale and purchase, neither revenue nor cost would serve as a good denominator to compare the profit margins with the comparables. Thus, the PLI of the assessee is rejected and OP/VAE has been taken as the correct PLI. iv) Comments on rejection or acceptance of TP Study. The then TPO was of the view that the MAM applied by the assessee was not in accordance with the provisions and also mentioned the reason for such rejection at Para No.03 (Page No.3) of TP Order.”

ITA No.97/JP/2021 17 A.Y.2016-17

Statements of the assessee company, it was submitted that

the assessee is an international electronic retailer of fashion

jewellery and in year 2015-16 through its e-stores

represented by US and UK TC channels and supported by e-

commerce platform, it had sold 8.1 million products and

generated Rupees 1276 crores in revenues. It was

accordingly submitted that the assessee is basically a

retailer where it buys goods from its related entities and has

substantially sold to its related entities and, therefore, the

TPO has rightly applied Operating Profit/Value Added

Expenses as an appropriate PLI and rejecting the Gross

Profit/Cost of Production as adopted by the assessee. It was

accordingly, submitted that there is no infirmity in the order

of the DRP which has rightly confirmed the adoption of

Operating Profit/Value Added Expenses as an appropriate

PLI and, therefore, the transfer pricing adjustment has been

rightly confirmed by the DRP which may kindly be affirmed

and no interference is called for in the impugned so passed

by the Assessing officer.

has referred to the consolidated financial statements of the

assessee company which includes its subsidiaries. On a

standalone basis, the assessee company has reported

ITA No.97/JP/2021 18 A.Y.2016-17

revenues of Rs 367.99 crores as disclosed in its financial

statements submitted at pages 47-72 of the paperbook

which the ld PCIT DR has failed to take into consideration.

It was further reiterated that the assessee is a manufacturer

and exporter of colored gemstones and studded fashion

jewellery and sells its products through the retail stores

network of its associated enterprises and non-associated

enterprises across various countries. It was submitted that

e-stores represented by US and UK TV channels are that of

its associated enterprises and the detail profile of its

associated enterprises were also submitted as part of the

transfer pricing report. It was accordingly submitted that

the ld PCIT DR was not correct to state that the assessee is

a retailer of fashion jewellery and functional profile of the

assessee company is that of manufacturer and exporter of

coloured gemstones and studded jewellery having all the

characteristics of a routine manufacturer performing all the

entrepreneurial functions which is duly corroborated by its

transfer pricing report and financial statements and in this

regard, our reference was drawn to the following facts and

figures as contained in its financial statements:

ITA No.97/JP/2021 19 A.Y.2016-17

“10. Fixed Assets Name of Assets As at 31.03.2016 A. Tangible Assets Freehold land 48,94,908 Leasehold Land 3,51,56,343 Building 21,50,47,894 Plant & Machinery 18,79,50,445 Electric Installation 7,55,,77,605 Furniture & Fixtures 2,19,30,577 Office Equipment 1,52,02,246 Computer 5,55,71,870 Vehicles 85,46,685 B Intangibles Computer Software 1,97,27,351 Total 63,96,05,924 C Capital Work in progress 2,82,05,679 Total 66,78,11,603

18.1 Particulars of Sale of Products Particulars Year ended 31st March, 2016 (Rs.) Gem Stones 56,25,10,29 Jewellery 2,86,46,93,753 Life Style Products 14,98,67,046 Diamonds 2,52,63,600

ITA No.97/JP/2021 20 A.Y.2016-17

3,60,23,34,698

20 a. Cost of Materials Consumed Particulars Year ended 31st March, 2016 (Rs.) Materials Consumed Opening Material-in- 72,68,15,922 process Add: Purchases 2,69,18,74,749 3,41,86,90,671 Less: Closing Material-in- 1,14,71,78,872 2,27,15,11,799 process 2,27,15,11,799

20 b. Particulars of Material Consumed Particulars Year ended 31st March, 2016 (Rs.) Gem Stones 1,46,47,89,128 Alloys 55,98,204 Diamond 12,57,03,250 Gold 14,06,08,480 Platinum 69,98,367 Silver 41,34,12,926 Parts & Findings 9,36,19,065 Others Metal 2,07,82,379 2,27,15,11,799

25 Other Expenses a. Manufacturing Expenses Particulars Year ended 31st March, 2016 (Rs.) Job Work Charge 29,71,74,362 Stores and Consumables 5,64,85,051 Power and Fuel 3,57,87,155 Repairs and Maintenance # 1,22,48,322 Other Manufacturing 1,32,81,415 Expenses 41,49,76,305

material available on record. As contended by the ld AR

during the course of hearing, the principle dispute which

ITA No.97/JP/2021 21 A.Y.2016-17

arises in the present case is adoption of appropriate PLI for

benchmarking and determining the arms’ length nature of

the international transactions undertaken by the assessee

company with its associated enterprises. The assessee has

adopted Gross Profit Margin/Cost of Production as the PLI

whereas the TPO has applied Operating Profit/Value Added

Expenses as an appropriate PLI for benchmarking the

international transactions with the associated enterprises.

in the instant case, it would be relevant to refer to the

OECD Transfer Pricing Guidelines (2017) wherein the

relevant discussions are found at para B.3.5 and the

relevant contents thereof read as under:

“B. 3.5 Berry ratios 2.106 "Berry ratios" are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability. 2.107 The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.98 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition,

ITA No.97/JP/2021 22 A.Y.2016-17

the issues raised at paragraphs 2.99-2.100 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: • The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is proportional to the operating expenses,

• The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is not materially affected by the value of the products distributed, i.e. it is not proportional to sales, and • The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator. 2.108 A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above.”

Manual on Transfer Pricing for developing countries

(2017) wherein the relevant discussion reads as under:

ITA No.97/JP/2021 23 A.Y.2016-17

“B.3.3.7.3. Although all of the above PLIs are possible, the three PLIs: (i) return on capital employed (ROCE) (ii) operating margin (OM) and (iii) return on total cost (ROTC) are most used in practice. The Berry Ratio may also be used, but subject to certain concerns about its inappropriate use.50 An OM is typically used for marketing, sales and distribution activities; a Berry ratio may sometimes be used for service of distribution activities; and full cost plus, ROCE or ROA are typically used for manufacturing activities. The ROA and ROCE divide operating profit by a balance sheet figure. These PLIs are based on assets actively employed in the business. Such tangible assets consist of all assets minus investments (e.g. in subsidiaries), minus cash and cash equivalents beyond the amount needed for working capital. In the case of the ROA a deduction is also made for intangible assets such as goodwill. These two PLIs may, for example, be used for leasing companies. This type of PLI maybe the most reliable if the tangible operating assets have a high correlation, to profitability. For example, a manufacturer's operating assets such as property, plant, and equipment could have more impact on profitability than a distributor's operating assets, since often the primary value added by a distributor is basedon services it provides and these are often less dependent on operating assets. The difference between the ROA and the ROCE is that the ROA focuses on the assets used while the ROCE focuses on the amount of debt and equity capital that is invested in the company. B.3.3.7.4. Other PLIs listed above are ratios between income statement items. PLIs based on income statement items are often used when fixed assets do not play a central role in generating operating profits. This is often the case for wholesale distributors and service providers. Operating margin has often been used when functions of the tested party are not close to those of the comparables, since differences in function have less effect on operating profit than on gross profit. B.3.3.7.5. The Berry Ratio represents a return on a company's value added functions on the assumption that these value added functions are captured in its operating expenses. It has been observed in practice that the Berry Ratio is used as a PLI for distributors and service providers. The Berry Ratio assumes that there is a relationship between the level of operating expenses and the level of gross profits earned by distributors and service providers in situations where their value-added functions can be considered to be reflected in the operating expenses. Consequently, it may be

ITA No.97/JP/2021 24 A.Y.2016-17

appropriate to use the Berry Ratio if the selling or marketing entity is a service provider entitled to a return on the costs of the provision of its services. However, some key limitations of the Berry Ratio are: > The Ratio is very sensitive to functions and classifying of cost as operating cost; > It misses values of cost needed to maintain the intangible property of an entity; and > Its reliability diminishes if asset intensities (the efficiency with which assets are used) of the entities differ.”

Sumitomo Corporation India Private Limited Vs. CIT

(Supra) had an occasion to examine the applicability of

Berry ratio and the relevant findings reads as under:

“45. Traditionally, the denominator of the ratio only comprised of selling, general and administration expenses. However, the Treasury Legislation of USA also included depreciation as a part of the Operating Expenses used as a denominator in the berry ratio. As is apparent, Berry ratio has limited applicability; it can be used effectively only in cases where the: value of goods have no role to play in the profits earned by an Assessee and the profits earned are directly linked with the operating expenditure incurred by the Assessee. In other words, the operating expenditure incurred by the Assessed effectively captures all functions; performed and risks undertaken by the Assessee. Thus, in cases where an Assessee uses intangibles as a part of its business, Berry ratio would not be an apposite PLI as the value of such tangibles would not be captured in the operating cost and, therefore, it would not be appropriate to compute the ALP based on net profit margin having regard to the operating cost as a relevant base. Similarly, Berry ratio would not be an appropriate PLI for determining ALP in cases of Assessees who have substantial fixed assets since the value added by such assets would not be captured in Berry ratio. 46. It can be seen from the above that the Berry ratio can be used only in very limited circumstances and the limitations

ITA No.97/JP/2021 25 A.Y.2016-17

that we have listed above are by no means exhaustive. There is also a view expressed that use of Berry ratio as a PLI results in indicating less than fair ALPs in tax jurisdiction where the Assessees have a lower bargaining power. In the aforesaid context, in our view, the TPO had correctly reasoned that Berry ratio could not be used as a PLI in cases of Assessees which were using intangibles. However, we find that there was no cogent material for the TPO to hold that the Assessee had developed supply chain and human resources intangibles. In any event, there was no material to conclude that costs of such intangibles were not captured in the operating expenses. 47. In our prima facie view, the third reason stated by the TPO, that is, the rate of commission, paid to the Assessee is based on the value of the goods, would be a valid reason to reject the use of Berry ratio because Berry ratio can only be applied where the value of the goods are not directly linked to the quantum of profits and the profits are mainly dependent on expenses incurred. The fundamental premise being that the operating expenses adequately represent all functions performed and risks undertaken. For this reason Berry ratio is effectively applied only in cases of stripped down distribution; that is, distributors that have no financial exposure and risk in respect of the goods distributed by them.” 23. Further, we refer to the Coordinate Delhi Benches

decision in the case of Mitsubishi Corporation India

Private Limited Vs. DCIT (Supra) and the relevant

discussion and findings are contained at paras 44 to 59 of

its order which read as under:

Berry ratio: connotations and its background 44. Simply put, berry ratio is ratio of gross profit to the operating expenses. 45. Unlike in Indian TP regulation, wherein no specific ratios are prescribed, US Regulation 482- 5(b)(ii)(4)(B) accepts this PLI as one of the “financial ratios that may be appropriate” to measure the arm’s length price, even though it puts

ITA No.97/JP/2021 26 A.Y.2016-17

a rider that, “reliability under this profit level indicator also depends on the extent to which the composition of tested party’s operating expenses is similar to that of the uncontrolled comparables”. So far as Indian TP provisions are concerned, the PLIs set out in rule 10B(1)(e)(i) are only illustrative inasmuch as it ends with the expression “or having regard to any other relevant base” but there is no prohibition as such on the use of this ratio. However, having regard to the use of this ratio worldwide, and for the reasons we will set out in detail in a short while, the use of this ratio cannot be eliminated from the India transfer pricing practices altogether. 46. In the July 2010 version of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, berry ratio is specifically recognized as follows: 2.100 “Berry ratios” are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability. 2.101 The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.76. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.92 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition, the issues raised at paragraphs 2.93-2.94 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry

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ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: • The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is proportional to the operating expenses, • The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is not materially affected by the value of the products distributed, i.e. it is not proportional to sales, and • The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator. 2.102 A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above. 47. As evident from the underlined portion of the OECD approach, highlighted above, berry ratio can be particularly useful in the situations in which the entity is engaged in the business as a trade intermediary, the value of services performed by

ITA No.97/JP/2021 28 A.Y.2016-17

the entity is adequately reflected by operating expenses, the value of functions performed and assets employed in the controlled transactions is not proportionate to sales and when the entity does not perform any significant operations such as manufacturing or processing. Typically, a low risk high volume trading business involving back to back trading without any value addition to the goods traded, which is what MCJ is engaged in and the MCI is contributing to, satisfies all these tests. We are in agreement with the approach adopted by the OECD document in this regard. Going by this approach, and, applying the tests laid down above, it does indeed seem that berry ratio could be appropriate in the present case. 48. Berry ratio is increasingly finding specific acceptance in many jurisdictions. While it is use in US for long, in Japan, even as berry ratio was used in APAs earlier as well, the 2013 amendment to the transfer pricing regulations, with effect from 1st April 2013, now specifically list berry ratio as acceptable in appropriate cases. In India, there have been several recent judicial precedents, which we will deal with a little later, upholding the use of berry ratio as a PLI. 49. Lets take a pause here and take a look at the circumstances in which berry ratio came into existence and its common usage in the TP analysis. 50. In the landmark case of E.I. DuPont de Nemours & Co. v. United States, 608 F.2d 445, Charles Berry, an economist, served as an expert witness on behalf of the U.S. government and the development of berry ratio is attributed to his testimony. What came up for consideration in the said case was the "proper," arm's length compensation that a Swiss subsidiary of DuPont- USA, engaged as a distributor of the DuPont-USA, should earn on the distribution services it performed in Switzerland on behalf of the AE. In his analysis, Charles Berry determined that the best method for determining an arm's length result was to compare the Swiss distributor's markup on operating expenses to the same markup earned by uncontrolled (i.e., third-party) distributors performing substantially similar functions. Berry's

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key insight in the case was that distributors should earn a return commensurate to the distribution services performed and that the value of the products being distributed, in other words, was irrelevant. The implicit emphasis was thus on the service element even in trading activity, and in the costs incurred on rendering this service rather than in the value of goods traded. That was a case in which the assessee was simply involved in distributorship function without much risks, though certainly much more risks than in a back to back trading, associated with inventories or with uncertainties of normal trading. The key contribution to the economic activity was recognized as performing the distributorship function rather than the value of goods sold. Accordingly, distributors must achieve a particular gross profit in order to compensate them for their services, the costs of which are accounted for, almost entirely, in their operating expenses. To reflect the reality of distributors' economic significance and to provide an arm's length return to DuPont's Swiss subsidiary, Berry utilized a ratio that has since been named in his honor and is computed as gross profit to operating expenses. There are some variants to this ration but that aspect of the matter is not really relevant for the present purposes. 51. The underlying assumption for applicability of berry ratio is that the return to the tested party should be commensurate with his operating expenses and the value of goods dealt in was irrelevant for this purpose. While this proposition so laid down was in the case of a limited risk distributor without any value addition to the goods or significant risks associated with inventories, we are of the considered view that it is equally useful in a case in which the business entity is engaged in trading, with zero or low inventory levels, and particularly as it does not involve any unique intangibles or value addition to the goods traded. 52. The answer to the fundamental question of whether a taxpayer should be entitled to a return on the value of goods handled by it, would actually depend on the functions performed and the related risks borne by it, with respect to the goods; and

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not on whether the taxpayer has taken title to the goods, shorn of the assessee’s FAR profile. 53. Clearly and undisputedly, on the facts of this case, neither the assessee has performed any functions on or with respect to the goods traded by it, beyond holding flash title for the goods in some of the cases, nor has the assessee borne any significant risks associated with the goods so traded. All the functions, assets and risk of the assessee are quite reasonably reflected by the operating costs incurred and the value of goods traded does not have much of an impact on its analysis of FAR. The cost of goods sold would be relevant if and only if the assessee would have assumed any significant risks associated with such goods sold and when monetary impact of such risks is not reflected in operating expenses of the assessee. The berry ratio should, therefore, be equally useful in the present case as well. In the case of the traders like assessee, who neither assume any major inventory risk nor commit any significant assets for the same and particularly as there is no value addition or involvement of unique intangibles, the berry ratio should also be equally relevant as in the case of a limited risk distributor. 54. In the case of GAP International Sourcing India Pvt Ltd Vs ACIT [20 ITR (Trib) 779], a coordinate bench has upheld the use of this ratio. While taking note of the contentions of the assessee in this case, the coordinate bench has, inter alia, observed as follows: 6.4 Ld. counsel then referred to the well recognized Berry ratio in determination of ALP. Berry ratio also propounds that routine distributors should earn a return commensurate to the distribution services performed, measured as a percentage of the value-adding (operating) expenses incurred by them. The value of the products being distributed, in other words, is irrelevant. Distributors must achieve a particular gross profit in order to compensate them for their value-adding services, the costs of which are accounted for in their value-adding (operating) expenses. An excerpt from the article by Dr.

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Berry on this aspect reads as under:- "Similarly, the cost of goods sold is excluded from the cost base because the measure indicates the value of the merchandise distributed, not the service rendered by the firm that distributes the merchandise. It was for exactly the same reason that I excluded in the case of advertising agencies, the cost of advertisement placement. The placement cost is a measure of the activities of the media carrying the advertising agency in planning and designing that advertising. If we use a cost plus method, and the Berry ratio is a cost plus method, we want a measure of the costs of the firm involved, i.e. the distributor or advertising agency in these examples, not something that measures only the value of the product distributed, or the value of the exposure provided by radio, television or print media". 6.5 It is contended that the Berry ratio is merely a variant of the cost plus method. If one were to think of the gross margins earned by a distributor as analogous to a firm's total revenues available to a distributor, and the operating expenses incurred to distribute products as analogous to the firm's total costs, then the ratio of gross margin to operating expenses would capture the mark-up on operating expenses that is afforded to the distributor. 6.6 The Berry ratio can also be applied to service providers, as it can be conceptualized as the mark-up earned on the costs of provision of services, by subtracting one from the Berry ratio expressed in unit terms as follows:- Berry ratio - 1 = GP/VAE - 1 = (GP-VAE)/VAE = OP/VAE wherein GP = gross profit; OP = operating profit; and VAE = value adding (operating) expenses. 55. In the case before the coordinate bench, it was

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noticed that the berry ratio is used for distributorship functions, though, as a variant of the berry ratio, its application could also be related to the service providers. This decision, however, is important for the short reason that it recognizes and upholds application of berry ratio in the situations in which value of goods traded is not important enough a consideration. We would draw analogy from this case to the limited extent that when the assessee does not assume any significant risks associated with the goods traded nor performs any functions on the same, and all the risks assumed by the assessee are adequately reflected by the operating costs, the berry ratio could be equally relevant. 56. What berry ratio thus seeks to examine is the relationship of the operating costs with the operating profits. It thus proceeds on the basis that there is a cause and effect relationship between operating costs and the operating profits. The factors, however, which can also have substantial impact on the operating profits, and thus dilute this direct relationship, could be factors like (a) in terms of functions – processing and value addition to the goods; (b) in terms of assets – fixed assets such as machinery, inventory, debtors and otherwise high assets, including intangible assets; and (c) in terms of risks – risk associated with holding inventories. In a diagram form, this relationship could be as follows: WH ERE REL AT I O SHI P I N O PERATI N G CO STS AN D O PERAT IN G PRO FI T S I S DI REC T AN D UN DI LU AT ED; APPLI C ATI ON OF BERRY RAT I O I S J U ST IF I ED

WH ERE REL AT I O SHI P I N O PERATI N G CO STS AN D O PERAT IN G PRO FI T S I S NO T DI REC T AN D I S DI LU T ED BY U SE OF M O RE F UNC T ION S (SU CH AS PRO C ESSIN G), MO RE ASSET S (SU C H AS SI GN IF IC AN T CU RRENT ASSET S O R UN IQU E I NT AN GI BL ES) AND M O RE RI SK S (SUC H AS RI SK S ASSOC I AT ED WI T H I NV EN TO RI ES); APPL I C AT IO N OF BERRY RAT IO I S N OT JU STIF I ED

ITA No.97/JP/2021 33 A.Y.2016-17

operating profit to operating expenses i.e. berry ratio. In such a situation, no other costs are relevant since (a) the cost of goods sold, in effect, is loses its practical significance, (ii) there is no value addition, and, accordingly, there are processing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 58. In typical cases of pure international trading, there is neither any processing of goods involved nor is there use of any significant trade or marketing intangibles. The inventory levels are also extremely low, at least with respect to the goods traded, since the nature of activity does not require maintenance of inventories and there is sufficient lead time between order being received and the actual procurement activity. There are no other factors, in addition to the operating costs, which affect direct relationship between operating costs and operating profits. Therefore, except in a situation in which significant trade or marketing intangibles are involved or in a situation in which there is further processing of the goods procured before selling the same or in a situation which necessitates employment of assets in infrastructure for processing or maintenance of inventories, the use of berry ratio does seem to be quite appropriate. 59. As we make the above observations, we also make it clear that in case the assessee is not able to find other comparables with significantly low or zero inventory levels, it does not prejudice the interests of the revenue authorities in any manner. The reason is this. When a comparable has an additional risk associated with inventories, which is not present in the case of the assessee, the profits achieved by the comparables can only be higher than the profits achieved by the assessee. As is elementary, higher the functions performed, risks assumed and assets employed, higher the profits. A comparables, with economic justification for higher profits, cannot be rejected on the ground of being eligible for higher profits.”

ITA No.97/JP/2021 34 A.Y.2016-17

of ACIT Vs. Bagadiya Brothers Private Limited (Supra) had

an occasion to examine the applicability of the Berry ratio

and the relevant findings are contained at para 6.5 to 6.9 of

its order which read as under:

“6.5 Adverting to assessee's adoption of TNMM method as most appropriate method for computation of ALP under TP regulation and adopting AE as a tested party, we find the TP working provided by the assessee to be correct. Similarly Berry Ratio cannot be applied to the assessee's case as it is applicable in specific circumstances of a pure distributor where no value added services are rendered. The observation of the TPO that AE had utilized the tangible and intangible assets of the parent company in earning such huge profit in the first year of its activity and cannot be treated as independent shipping service provider is only a presumption without any support. We are of the view that various functions for ship chartering have been outsourced by the AE to one M/s R. M. Martine, since inception of the AE. The AE had its own funds, undertook business risk and many instances of such risk which actually borne by AE pertaining to various vessels have been proved with evidence. The payment of hire charges, bunker charges, port charges have been made by the AE from its own funds evidenced by cash flow statement could not be controverted by revenue. In our studied and considered view the AE has performed proper business functions, assumed business risks by employing its own funds independently without help of appellant and, therefore, in no way AE can be considered as pure distributor. In view of these facts and circumstances, the Berry ratio is not at all applicable in the present case. Our view is fortified by Hon'ble Delhi High Court judgment in the case of Sumitomo Corpn. (supra) 6.6 In Transfer Pricing study, it is imperative to employ proper understanding of business, business practice, functions performed by AE and the appellant, risks assumed by both the parties and the assets employed by both of them is very relevant. In our view Id. TPO/AO did not properly appreciated the functions performed, risk assumed and bassets employed by the AE and appellant.

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6.7 In this year, only 20 vessels were chartered by AE to the appellant, where large number of employees are not required. The number of employees quoted by TPO in the comparable company as 216 to 5056 is not relevant as these companies were having their own vessels and are also engaged in other allied business activities with wider assets base. The least number of employees is 48 in case of Sanyan Group Limited. Considering the size and the assets employed, the number of employees in such comparable cases may be higher as compared to the case of AE. 6.8 We are of the considered opinion that Berry ratio is not applicable in this case and therefore, appropriate profit indicator in this case is operating profit to total cost i.e. OP/TC. In case of pure distributor, only value added expenses are considered and Berry ratio can be applied. The AE made value addition, assumed various risks of business and also incurred damages and losses in the business, as discussed by me in detail earlier. As per TNMM study filed by the appellant, the margin on total cost earned by AE is 4.52% which is less when compared with 5.18% in case of other eleven comparable companies. This is within arm's length. Therefore, otherwise also no transfer pricing adjustment is called for by the safe harbor clause. 6.9 In view of the facts, circumstances, material available on record and after hearing the rival contentions we uphold the order of Id. CIT(A) on all counts which are upheld. Revenue grounds in this behalf are dismissed.

domestic jurisprudence, for the applicability of appropriate

PLI or for that matter, Berry ratio in the instant case, what

is therefore relevant to determine is the profile of the

assessee company in terms of functions performed, assets

employed and related risk undertaken by it. In this regard,

we refer to the Transfer Pricing Report submitted by the

assessee before the Transfer Pricing Officer wherein the

ITA No.97/JP/2021 36 A.Y.2016-17

profile of the assessee company has been described at para

4.1, which reads as under:

“4.1 Profile of VGL Vaibhav Global Ltd. ("VGL'') was incorporated in 1989 in Jaipur. VGL is engaged in the business of manufacturing and exports of colored gems stones and studded Jewellery. VGL has presence in USA, Gerrnany, Thailand, Hong Kong, Japan, etc. by way of its subsidiaries. VGL is one of the largest exporters of colored gemstones from India & also one of the largest exporters of studded Jewellery. VGL processes gems and raw materials into rings, bracelets, pendants, etc. and export it to its associated company in U.S.A and other overseas countries, in financial year 2005-06, VGL become an Indian MNC, perhaps the first in the Indian gems and Jewellery sector by extending its operations in more than 10 countries through the acquisition of Companies of STS Group and extending its Retail Stores network at major holiday destination of the world from 12 to 19. It has also launched operation through TV channels by its associates i.e., The Jewellery Channel Ltd, UK and Jewellery Channel, USA. VGL is professionally managed, end-to-end vertically integrated gems and jewellery business organization. It is one of the eight world-wide 'sight holder' in Tanzanite and is the leader in processing other popular gemstones such as Fire Opal, Apatite and Emerald. Procuring directly from the sources, it imports raw material like Stones, Rough Gems Stones, Chains, Findings, Diamond, Mounting and Preform, etc. The raw materials imported undergoes through various stages of processing (like cutting calibrating, polishing, etc.) and is used captively for the manufacturing of studded jewellery which is then exported. At VGL manufacturing infrastructure is most contemporary and significant by making full use of CAD, CAM system and equipment such as Laser soldering machines. Besides this, the company has a modern, extensive computer network, and implemented an ERP solution to integrate all its operations. 1. Adarsh Nagar, Jaipur - It has Gems Stones and diamond-processing unit for processing rough gems stone to finished gems stone, which are either directly exported to

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Associated Enterprises or Independent party or used as captive consumption in manufacturing studded jewellery. 2. Sitapura, Jaipur - Sitapura is 100% EOU. It has Chain Division and Jewellery Division, manufacturing chains and studded Jewellery. Company required to purchase gold from banks locally and gems stones from Adarsh Nagar, Jaipur. These are processed together or manufactured studded jewellery, which are majorly exported to its associated enterprises and to a limited extent exported to third parties. 3. SEZ, Jaipur - SEZ unit started commercial production during the financial year 2015-16. The VGL has set up state of the art jewellery manufacturing unit at Sitapura SEZ and is involved in manufacturing of high end Jewellery. These are mainly exported to associated enterprises. 4. Seepz, Mumbai - In Seepz Unit, company is involved in manufacturing of high end Jewellery. These are either exported to associated enterprises as well as to non associated enterprises. 3. Bharat Diamond Bourse, BKC, Mumbai - It purchases diamond locally as well as imported from its associated enterprises. These are either exported or used for captive consumption for manufacturing of studded jewellery which is sold to unrelated party locally or internationally.”

show cause notice as well as while proposing the adjustment

as well as the DRP has not disputed the fact rather there is

an categorical affirmation that the assessee is engaged in

the business of manufacture and export of colored stones

and studded jewellery and has manufacturing units in

Jaipur and Mumbai as noted from para 2 of the order so

passed by the TPO.

ITA No.97/JP/2021 38 A.Y.2016-17

and the risk undertaken by the assessee while carrying out

its manufacturing activities, it is noted from the transfer

pricing report and the financial statements placed on record

that the assessee performs the functions of purchases,

product conceptualization and designing,

manufacturing/processing of final product, sales and

marketing and after sales services. It has the necessary

manufacturing set up with requisite assets and

infrastructure in place which are employed. The associated

enterprises perform substantial part of marketing, sales and

distribution functions. The assessee takes all types of risk

such as inventory risk, credit & collection Risk, product

risk, manpower risk, market risk (to limited extent),

technology risk, general business risk and foreign exchange

risk. Therefore, we donot find any infirmity in assessee

being classified as a manufacturer performing all the

entrepreneurial functions. It is again noted that the TPO

while issuing the show cause notice as well as while

proposing the adjustment as well as the DRP has not

disputed the functions performed, the assets employed and

the risk undertaken (nature and extent thereof) by the

assessee while carrying out its business of manufacture and

export of colored stones and studded jewellery.

ITA No.97/JP/2021 39 A.Y.2016-17

transactions undertaken by the assessee which are subject

matter of examination before us, the same relates to import

of gems stones, rough diamonds and other raw material from

its associated enterprises as well as export of gems stones

and studded jewellery to its associated enterprises. For the

purposes, the assessee has considered the Cost Plus Method

as the most appropriate method for determining the arms’

length and has adopted Gross Profit/COP as the appropriate

Profit Level Indicator and accordingly has carried out the

benchmarking analysis with independent third party

comparables.

Method, from the transfer pricing report, it is noted as

under:

“In the case of VGL, the associated enterprises are only facilitating the procuring or purchasing activities for and on behalf of VGL. The associated enterprises purchase Roughs, Color stones, Diamonds, Mountings/findings, etc., from the local market of their respective countries and send/export such goods/materials to VGL. For such facilitations/support work, the associated enterprises incur logistics and administration costs in this regard. We have been explained that these logistics and administration costs are recovered from VGL on actual basis. In substance, associated enterprises purchase these goods/materials from the local market and export it to VGL after adding logistics and administration costs incurred by them in this regard.

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We have been further given to understand that, no mark-up has been charged by such associated enterprises. The costs incurred have been charged back to / recovered from VGL on actual basis. Therefore, the price paid by VGL for such imports from its associated enterprises would be obviously lower than the price prevalent in the industry for similar purchases. Therefore, based on the facts and circumstances of the case, Cost Plus Method (CPM) appears to be the most appropriate method to benchmark VGL's import transactions.” 30. Regarding export of gems stones and gems jewellery

and adoption of cost plus method, from the transfer pricing

report, it is noted as under:

“The CPM examines the gross profit mark-up to direct and indirect cost that a taxpayer realizes from a controlled transaction. First, the direct and indirect costs of production incurred by the enterprise in respect of the goods transferred to an associated enterprise are determined. To this, a normal gross profit mark up in the same or similar comparable uncontrolled transactions by the enterprise or an unrelated enterprise is added. The price so arrived at is then adjusted to take into account the functional and other differences between the international transactions and comparable uncontrolled transactions which could materially affect the amount of gross profit margin in the open market to arrive at the ALP. The CPM method is used to test transfer price of manufacturers, assemblers and others that add value. Determination of comparability under the CPM depends in particular on similarity between functions employed. In the instant case, as VGL during the year has mainly exported Gold / Silver Studded Jewellery, we have determined CPM as the most appropriate method due to following reasons: - a. Comparability between international transactions and comparable transactions:

ITA No.97/JP/2021 41 A.Y.2016-17

VGL's export to AE's mainly consists of Gold/Silver/Other Metal Studded Jewellery which forms more than 80% of the total turnover of the VGL. Since in current year 80% of the VGL transactions is of Gold/Silver/ Other Metal Studded Jewellery, the functional and product similarity between independent companies becomes quite reliable as the functions involved in manufacturing of Studded Jewellery is very much same across the industry which includes designing, mounting, setting, polishing, finishing etc. b. Extent to which reliable and accurate adjustments can be made: Once the functional and product similarity is established, under CP method not many adjustments are required except that of accounting and other differences. Since the comparables used in testing are from listed companies and are available publicly which are following ail Accounting Standards and are governed by the Companies Act. VGL also prepare its financial statements in compliance to applicable Accounting Standards and as per the Companies Act. Since, both the comparables and VGL are governed by Companies Act and follow accounting standards; no adjustment is warranted in respect of the accounting aspects. We, therefore, based on the above facts, have determined that CPM is the most appropriate method to evaluate the arm's-length nature of inter- company transactions based on Gross Profit mark- up as the profit level indicator.”

and adopting the Gross Profit/cost of production as the PLI

has worked out its Gross Profit Margin during the year

under consideration as under:

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Year ended 31st Particulars March, 2016 Sales (A) 360.60 Less: Direct and Indirect costs of production a. Material Costs (Refer schedule 21,22 & 23 234.59 to the P&L A/c) b. Manufacturing Expenses (Refer schedule 26 41.50 to P&L A/c) c. Employment Cost (Refer schedule 24 35.78 to P&L A/c) Cost of Production (B) = (a + b + c) 311.87

Gross Profit (C) = (A) - (B) 48.73 % of Gross Profit to Cost of Production = (C) / (B) 15.62% % of Gross Profit to Total Sales = (C)/(A) 13.51%

procedure for independent comparable companies and

selecting the comparables has determined yearly average

gross margin of 8.95% of cost of production (GP/COP) and

given its GP/COP of 15.62% has determined its sales

transactions to its associated enterprises which constitute

88.34% of total sales at arm’s length. The TPO however has

not agreed with the PLI so adopted by the assessee

company and has adopted OP/VAE as the appropriate PLI.

assessee is purchasing from related parties and selling to

related parties, both cost and revenue sides are tainted and

in such a scenario, OP/COP will not be an appropriate PLI

ITA No.97/JP/2021 43 A.Y.2016-17

and OP/VAE has then been adopted by him. The DRP has

upheld the reasoning so adopted by the TPO drawing

reference to the decision of Hon’ble Delhi High Court in

case of Sumitomo Corporation (Supra) where use of berry

ratio in certain situations has been upheld even though the

Income Tax Act doesn’t specifically provide for either the

Berry ratio or the bright line test.

High Court in case of Sumitomo Corporation (Supra), in

that case, it was held that Berry ratio can be used

effectively where the value of goods have no role to play in

the profits earned by the assessee and the profits earned

are directly linked with the operating expenditure incurred

by the assessee. It has been held that where the assessee

uses intangibles or has substantial fixed assets, the value

of such intangibles or value addition by such assets would

not be captured in the operating cost and thus, Berry

ration would not be an appropriate PLI. It has been held

that the fundamental premise which needs to be examined

before applying Berry ratio is that the operating expenses

should adequately represent all functions performed and

risk undertaken and for this reason, Berry ratio is

effectively applied only in case of stripped down

distributors which have no financial exposure and risk in

ITA No.97/JP/2021 44 A.Y.2016-17

respect of goods so distributed by them. Therefore, we

agree that the Berry ratio can be applied in certain

circumstances but in the facts of the present case, where

the assessee is admittedly and undisputedly, a

manufacturer and exporter of coloured gemstones and

studded fashion jewellery and not a distributor, one wonder

how the value of goods so manufactured and exported have

no role to play in the profits earned by the assessee. The

assessee performs significant manufacturing functions

right from procurement of raw material in terms of rough

diamonds and gemstones, product conceptualization and

designing, processing of rough diamonds and gemstones at

its Adarsh Nagar, Sitapura and SEZ Jaipur, SEEPZ Mumbai

facilities thereby employing its assets both tangible and

intangibles and infrastructure facility and requisite

manpower, which are further used for manufacture of

studded jewellery and subsequent marketing and sales to

its associated enterprises and other independent entities

and providing after sales services. We find that it is the

associated enterprises which performs the distributorship

functions and sells the assessee’s products through its

retail stores and TV Channels and not the assessee. In the

process, the assessee takes all types of risk such as

inventory risk, credit & collection risk, product risk,

ITA No.97/JP/2021 45 A.Y.2016-17

manpower risk, market Risk (to a limited extent),

technology risk, general business risk and foreign exchange

risk. In terms of cost base for carrying out these functions

and related risk, there are material costs, manufacturing

expenses and employment/manpower costs which have

been incurred by the assessee and therefore, for

determining an appropriate return on such costs, these

costs have to be necessarily considered and which has been

rightly considered by the assessee as part of its “cost of

production” and based thereon, has adopted operating

profit/cost of production as an appropriate PLI. We failed

to understand how the TPO has worked out the value added

expenses and quantum thereof in the face of these

undisputed facts and circumstances of the case ignoring

the manufacturing functions and risk so undertaken and

the asset employed by the assessee. We therefore find that

the decision of the Hon’ble Delhi High Court doesn’t

support the case of the Revenue rather its supports the

contentions advanced by the ld AR on behalf of the

assessee.

where he says that since the assessee is purchasing from

related parties and selling to related parties, both cost and

revenue sides are tainted and in such a scenario, OP/COP

ITA No.97/JP/2021 46 A.Y.2016-17

will not be an appropriate PLI and OP/VAE has then been

adopted by him. It appears that the TPO seems to be

guided by some misconception that the assessee is in the

business of trade intermediary where it buys from its

associated enterprises and then, sells to its associated

enterprises. As we noted above, the undisputed facts are

that the assessee is a manufacturer and exporter and as

part of its activities, it procures certain goods from its

associated enterprises which constitute merely 21.09% of

its total purchases besides purchases from other entities,

process them in its manufacturing facilities and thereafter,

export them to its associated enterprises. Therefore, it

carries out significant manufacturing and processing

operations and it is not a case of simpliciter purchase and

sale activity which is being undertaken by the assessee.

Only in a latter scenario, where it purchases from its

associated enterprises and on-sells them to other

associated enterprises, berry ratio can be held to be useful

and appropriate PLI as stated in para 2.102 of the OECD

guidelines. Following the same, the Coordinate Bench in

case of Mitsubishi Corporation (supra) has also held that in

case of a low risk high volume trading business involving

back to back trading without any value addition to the

goods traded, berry ratio could be appropriate PLI.

ITA No.97/JP/2021 47 A.Y.2016-17

However, in a situation in which there is further processing

of the goods procured before selling the same or in a

situation which necessitates employment of assets in

infrastructure for processing or maintenance of inventories,

the use of berry ratio does not seem to be quite

appropriate. We therefore find that in the facts of the

present case, the approach adopted by the TPO is bereft of

the factual position of the assessee in terms of functions

performed, the assets employed and risk undertaken while

carrying out its manufacturing and export activities and

the approach so adopted is also not in consonance with the

approach so suggested by OCED and UN, and the decisions

of the Hon’ble Delhi High Court and the Coordinate

Benches and therefore, the adoption of berry ratio as an

appropriate PLI is not justified in the instant case.

application of the PLI (i.e. Gross Profit margin / Cost of

production), it has been submitted by the ld AR that where

the PLI of GP/COP is applied on the comparable companies

so selected by TPO, the transaction of assessee will meet

the arm's length test requirement and our reference was

drawn to the following figures which are available as part

of assessee’s paperbook and submitted before the lower

authorities:

ITA No.97/JP/2021 48 A.Y.2016-17

No. Name of comparable companies Weighted Average selected by TPO PLI GP/COP 1 A.B.Jewels Pvt.Ltd. 3.86% 2 Karp Impex Ltd. 9.39% 3 Shantivijay Jewels Ltd. 10.26% 4 Golkunda Diamonds & Jewellery 10.70% Ltd. 5 Asian Star Jewels 15.10% 6 D.Navinchandra 30.87% 7 Jashan Jewels Pvt. Ltd. 34.57% 8 Azure Jouel Pvt. Ltd. 47.49% Average 20.28% 35 th Percentile 10.26% Median 12.90% 65 th Percentile 30.87%

by the TPO where the median OP/COP comes to 12.90% and

given that the assessee has reported OP/COP of 13.51%, we

find that the assessee’s transactions with its associated

enterprises meets the arms length requirements and no

adjustment is warranted.

the case and in light of aforesaid discussions and following

the approach so suggested by OECD/UN transfer pricing

guidelines and the decisions of the Hon’ble High Court and

Coordinate Benches referred supra, the transfer pricing

adjustment of Rs 29,25,17,385/- is hereby directed to be

deleted.

ITA No.97/JP/2021 49 A.Y.2016-17

In the result, the appeal of the assessee is allowed and disposed off in light of aforesaid directions.

Order pronounced on 07.02.2022.

Sd/- Sd/- (VIKRAM SINGH YADAV) (SANDEEP GOSAIN) �याय�क सद�य/Judicial Member लेखा सद�य/Accountant Member Dated: 07.02.2022 *रती* आदेश क� ��त�ल�प अ�े�षत/ Copy of the order forwarded to : 1. अपीलाथ�/ The Appellant 2. ��यथ�/ The Respondent 3. आयकर आयु�त/ CIT 4. आयकर आयु�त (अपील)/ The CIT(A) 5. �वभागीय ��त�न�ध, आयकर अपील�य आ�धकरण, च�डीगढ़/ DR, ITAT, JAIPUR 6. गाड� फाईल/ Guard File आदेशानुसार/ By order, सहायक पंजीकार/ Assistant Registrar