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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’ : NEW DELHI
Before: SHRI R.S. SYAL & SHRI KULDIP SINGH
PER KULDIP SINGH, JUDICIAL MEMBER :
(hereinafter referred to as ‘the assessee’), by filing the present appeal sought to set aside the impugned order passed by the TPO/DRP/AO qua the assessment year 2011-12 on the grounds inter alia that :-
“1. The Learned Dispute Resolution Panel ('Ld. DRP') and the Learned Deputy Commissioner of Income-tax ('Ld. AO') (following the directions of the Ld. DRP), erred on facts and in law by holding that the international transaction of provision of sourcing support services to associated enterprises ('AEs'), undertaken by the Appellant does not satisfy the arm's length principle envisaged under the Income-tax Act 1961 ('the Act'). In doing so, the Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP) have grossly erred in enhancing the income of the Appellant by INR 3,265,301,3351- on account of the Transfer Pricing ('TP') adjustment u/s 92CA(3) of the Act made by the Ld. TPO by ;
1.1 ignoring the decision of Hon'ble Income Tax Appellate Tribunal ('ITAT') in the Appellant's own case (GAP Ruling 20 ITR (Trib) 779) for earlier years i.e. assessment years ('AY') 2006-07, AY 2007-08 ), AY 2008-09 (ITA 55/Del/2013), AY 2009-10 (ITA 692/De1/2014) and AY 2010-11 (ITA 577/Del/2015) by rejecting the cost plus compensation model of the Appellant;
1.2 disregarding the fact that Hon'ble ITA T has accepted the Functional, Asset and Risk profile ('FAR') of the Appellant to be that of a low risk procurement support service provider and thereby ignoring that the Appellant neither creates supply chain or human intangibles nor bear any significant risks with respect to its business operations;
1.3 ignoring the fact that Hon 'ble ITA T has blessed the business model of the Appellant by accepting the application of 'Cost Plus' remuneration model followed by it; and 1.4 ignoring the fact that Hon'ble IT A T in A Y 2009-10 and A Y 2010-11 has upheld the mark-up of 15% applied by the Appellant to be at arm's length.
The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in upholding the Ld. TPO's approach of disregarding the benchmarking approach adopted by the Appellant of selecting companies engaged in providing marketing support low end technical support services in its TP Documentation report for the year to substantiate the arm's length nature of its international transactions.
3. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in upholding the Ld. TPO's approach of including the value of the goods sourced directly by the AEs of the Appellant from third party vendors in the cost base of the Appellant, for the purpose of computing the arm's length profit margin of the Appellant on the alleged ground that it created supply chain and human asset intangibles in India and generated location savings in India which have not been factored in its prevailing/ current remuneration model.
4. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in disregarding the detailed submissions and extensive analysis to demonstrate that Appellant is operating on a guaranteed profit margin of 15% on its operating cost and the Appellant does not procure contracts from the third party vendors or perform any significant functions whatsoever with reference to the goods supplied by the vendors directly to the AEs of the Appellant, and thus the Appellant was entitled to a remuneration only with a reference to the value of goods sourced by the AEs from the third party vendors.
5. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in disregarding the extensive/ voluminous documents evidencing that all key decisions in the value chain such as selection of vendors, designing of products, establishing parameters of sourcing, establishing quality standards, deciding vendor pricing etc. were taken by the overseas Associated Enterprises ('AEs ') of the Appellant and that the Appellant merely carried out low risk bearing liaisoning and coordination functions at the instance, behest and diktat of its AEs.
6. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in misinterpreting the extensive documents filed by the Appellant and drawing vague inferences from the same.
7. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP), erred on facts and in law in drawing an adverse inference in terms of Section 114 of the Indian Evidence Act and upholding that Appellant has failed to produce the best available evidence available with it.
8. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP) has completely disregarded the relevant judicial pronouncements which upholds cost plus remuneration for procurement support service providers.
9. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP) has grossly erred in stating that for the year under consideration, the facts of the Appellant have undergone a change whereas the facts are exactly the same as prior years. In doing so, the Ld. DRP and Ld. AO have not provided any documentary evidence to substantiate their claim.
10. The Ld. DRP and consequently the Ld. AO (following the directions of the Ld. DRP) has grossly erred in proposing an alternate economic analysis using profit split method without
appreciating the fact that the current business model and the functionality of the Appellant company (which has been duly approved by the Hon'ble TTAT in Appellant's own case in 2006-07 and A Y 2007-08) does not involve unique intangibles or transactions that are interlinked which would warrant such an analysis .
11. The Hon'ble DRP and consequently the Ld. AO erred on facts and in law, in enhancing the income of the Appellant by INR 17,516,800 by disallowing rent expense being conversion charges paid to the Municipal Corporation of Delhi ('MCD'), pursuant to an arrangement between the Appellant and the lessors in connection with the premises occupied by the Appellant. While disallowing the claim of MCD conversion charges, the Hon'ble DRP and Ld. AO (following the directions of the Hon'ble DRP) grossly erred by:
10.1 erroneously relying on the decision of Arun Kumar Gupta (HUF) v. ACIT (2012) 54 SOT 509 (Delhi) on distinguishing facts to hold that one time conversion charges paid by the Appellant to the MCD were capital in nature as it resulted in enduring advantage to the Appellant;
10.2 concluding that the conversion charges paid were for violation of municipal laws, without obtaining! verifying necessary facts / information from the Appellant;
10.3 completely disregarding the fact that such payment was made on account of commercial expediency by the appellant and did not consider favourable decisions of the Jurisdictional ITAT in the case of DCTT v. Haldiram Products Pvt. Ltd. (I.T.A. No. 5158/DeV2012) and ACIT v. Kalinga International (I.T.A. 0.4500/DeIl2o.12), on identical facts, submitted by the Appellant during the course of proceedings before the Ld. DRP.
12. Without prejudice to the above, in the facts and circumstances of case and in law, the Ld. AO has erred in levying interest under section 2348 of the Act.
13. On the facts and in the circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under section 271 (1)( c) read with section 274 of the Act.
That the above grounds of appeal are without prejudice to each other.
That the Appellant reserves its right to add, alter, amend or withdraw any ground of appeal either before or at the time of hearing of this appeal.”
Briefly stated the facts of this case are : GAP International Sourcing (India) Pvt. Ltd. is a wholly owned subsidiary of GIS Inc. and its business activities are to facilitate sourcing of apparel merchandise from India and as such, GAP India acts as a sourcing support services provider of GAP Group. Functions performed by GAP India include support to GAP Group in identification and evaluation of vendors, provision of assistance to vendors in procurement of raw material, provision of assistance to vendors in designing, inspection and quality control and coordination with vendors to ensure delivery of goods to GAP Group as per schedule.
During the year under assessment, assessee company entered into international transaction as under :-
Nature of transaction Method Total value of Selected transaction (Rs.) Provision of sourcing support TNMM 59,24,41,155 services
Assessee company in its transfer pricing study to benchmark international transaction used Transactional Net Margin Method (TNMM) as the most appropriate method with Operating Profit / Total Cost (OP/TC) as Profit Level Indicator (PLI) and worked out its OP/TC at 15.52%. Assessee company chosen six comparables having average OP/TC at 13.28% against the margin of the assessee at 15.52% and treated its international transaction at arm’s length.
However, TPO, while rejecting the transfer pricing study undertaken by the assessee company, observed that the compensation model adopted by the assessee company with Associated Enterprises (AEs) is not at arms length and proposed to use the value of goods sourced by the assessee company as “FOB value of the goods sourced through you” to arrive at the ALP.
TPO further held that in view of the functional profile of the assessee company, which is that of a sourcing agent, it should be compensated in terms of higher commission as assessee company is controlling critical functions, such as, merchandising, fabric sourcing, product integrity, quality assurance, compliance and logistics and major risk arising from the aforesaid functions, such as, poor quality management lies with the assessee company.
Assessee’s compensation model is based on the cost on service rendered by the provider plus 5%. The ld. TPO observed that since the assessee is owner of supply chain management and intangibles, human assets intangibles, the compensation model in this case is very nominal and routine markup of 15% of the cost without allocating any profit component for development and use of unique intangibles by the assessee resulted into huge commercial and strategic advantage to the AE in the form of low cost goods. So, the TPO rejected economic analysis of the assessee company and computed ALP of international transaction at Rs.3,26,53,01,335/-.
In pursuance to the order passed by the ld. TPO/DRP, the AO made addition on account of transfer pricing adjustment at Rs.3,26,53,01,335/- and disallowed the rent expenses to the tune of Rs.1,75,16,800/-.
Assessee carried the matter before the DRP which has dismissed the objections raised by the assessee company. Feeling aggrieved, the assessee company has come up before the Tribunal by way of filing the present appeal.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
The assessee company claiming itself to be a sourcing support service provider for GAP Group, selected six companies as comparables for TP adjustment of its international transaction and the set of comparables selected in TP study is as under :-
S.No. Name of the company OP/TC 2 IDC (India) Limited 12.57 3 Quadrant Communication Ltd. 9.14 4 Empire Industries Ltd. (Trading & Indenting) 15.81 5 Entertainment Network (India) Ltd. (Consolidated) -0.3 6 Priya International Limited (Indenting) 29.2 13.28
Assessee, by using multiple year data, computed the mean margins of the comparable companies at 13.28% as against its own margin at 15.52% and treated its international transactions at arm’s length. However, ld. TPO raised the objection against the use of multiple year data and allowed the assessee to update the margin by using latest data available.
The compensation model in this case is based on the cost on service rendered by the provider plus 15% which has not been accepted by the TPO, who has held that the correct compensation model at ALP in this case would be commission of FOB cost of the goods sourced from India by taking into consideration the factors inter alia that the assessee is owner of supply chain management intangibles; that the assessee owns human assets intangibles; that the compensation model of the assessee does not include the profit attributable to the assessee on account of location savings; and that the assessee’s remuneration should be expressed as a percentage of the FOB price of goods sourced through the assessee.
Consequently, the ld. TPO held that functional profile of the assessee company apparently proves that it is not a market support service provider and considering its functional profile and risk borne by it, the assessee was not reasonably compensated in comparison of its effort put in towards sourcing goods to its AE and computed the ALP of international transaction undertaken by the assessee during the period under assessment as under :-
“12. Following the discussions in the preceding paras the comparables that shall be used in the assessee’s case are :-
S.No. Name of the company OP/OC 1 Pantaloon Retail (India) 8.01 Limited 2 Shoppers Stop Limited 7.54 3 Trent Limited -0.12 4 Jaypee Spintex Limited 5.88 AVERAGE 5.33
13. Computation of Arm’s Length Price
Details Amount in INR Total FOB Value of exports 62,756,195,91 0 Arm’s Length margin @ 5.33% 3,344,905,24 2 Margin shown by the assessee 79,603,907 Difference 3,265,301,33 5
Since the difference between the arm’s length margin and the margin shown by the assessee varies by more than 5% of the arms length price has taken place, an adjustment of Rs.3,26,53,01,335/- is to be made to the income of the assessee i.e. the Assessing Officer shall enhance the income of the assessee by an amount of Rs.3,26,53,01,335/- while computing its total income.”
Undisputedly, identical issue was cropped up before the ITAT, Delhi in assessee’s own case qua the assessment years 2006- 07 and 2007-08 bearing and 228/del/2012 order dated 18.09.2012, wherein the Delhi Bench of the Tribunal distinguished the assessee’s case from Li & Fung India Pvt. Ltd. vs. DCIT reported in 12 ITR (Trib) 748 relied upon by the TPO to benchmark the international transactions and held that the assessee company was entitled to a cost plus form of remuneration, as claimed by the assessee and not a commission based remuneration.
So, in other terms, the assessee company has been declared as a service provider and not being into buy and sell company rather functions as a facilitator only. So, now the profit margin of the assessee is in dispute only in this case.
However, the ld. DR, by relying upon the order passed by the TPO/DRP, contended inter alia that the remuneration model adopted by the ld. TPO is appropriate in view of the TP provisions as the cost base was not making valid compensation; that the TP adjustment has been made by the TPO keeping in view the creation of intangibles by the assessee company and location savings to its AEs; that GAP international, AE of the assessee company, has outsourced all its functions and as such, FAR of the taxpayer is the first and foremost to determine the compensation model.
However, to repel the argument addressed by the ld. DR, the ld. AR for the assessee simply relied upon the findings returned by the Tribunal in assessee’s own case in and 228/Del/2012 (supra) and further contended that each and every point as to creation of intangibles, location savings, assessee having no human assets intangibles have been set at rest; that the assessee company has been performing normal and routine function and no intangibles are being created.
Ld. DRP while rejecting the objections raised by the assessee upheld the findings returned by the TPO by adopting the same reasoning that the assessee is owner of supply chain management intangibles; that the assessee owns human assets intangibles; that the compensation model of the assessee does not include the profit attributable to the assessee on account of locational savings etc. by adopting the findings returned by the DRP in the earlier years i.e. 2006-07, 2007-08, 2008-09, 2009-10 and 2010-11, which have admittedly been set aside by the Tribunal in AY 2006-07, 228/Del/2012 AY 2007- 08, 55/Del/2013 AY 2008-09, 692/Del/2014 AY 2009-10 and 577/Del/2015 AY 2010-11.
So, by respectfully following the decisions rendered by the coordinate Bench of the Tribunal in assessee’s own case in AYs 2006-07, 2007-08, 2008-09, 2009-10 and 2010-11 and judgment delivered by the Hon’ble jurisdictional High Court in case entitled Li & Fung India Pvt. Ltd. on 16.12.2013 wherein remuneration model of markup of 5% on the operation cost without considering the value of the cost procured by the AE directly from the third party vendors in India has been held as a valid remuneration model for benchmarking the TP adjustment. So, we are of the considered view that the assessee is not into buy and sell rather it is a facilitator/service provider and its compensation model at ALP would not be commission of FOB cost of goods sourced from India, rather assessee company is entitled to cost plus remuneration and not a commission based remuneration.
Now, the next question arises for determination in this case is “as to whether ld. TPO/DRP have correctly benchmarked the international transaction by using appropriate comparables?”
The TPO selected three comparables with an average OP/OC of 5.33% which has applied on the FOB value of the export and thereby made an adjustment of Rs.3,26,53,01,335/-. Detailed findings returned by the TPO are as under :-
“ Whereas, in your TP Study for AY 2007-08 you have taken comparables who are in business of Garments. This has been accepted by the TPO consistently. Since, there has been no change in your functions compared to previous years as depicted by your TP documentations, on what basis you have changed your search criteria this time is not mentioned in the TP Study. Based on the last years comparables used by the assessee in its TP Study, updated margins of the comparables are as given below :- S.No. Name of the company OP/OC 1 Pantaloon Retail (India) 8.01 Limited 2 Shoppers Stop Limited 7.54 3 Trent Limited -0.12 4 Jaypee Spintex Limited 5.88 AVERAGE 5.33
Accordingly, the arm’s length price in your case is calculated as below :- Details Amount in INR Total FOB Value of exports 62,756,195,910 Arm’s Length margin @ 5.33% 3,344,905,242 Margin shown by the assessee 79,603,907 Difference 3,265,301,335 The above shortfall of Rs.326,53,01,335/- is being proposed as an adjustment to the profit shown by the taxpayer in its books of account.” 19. Assessee company filed comprehensive reply dated 08.05.2015 raising objection to the TP adjustment made by the TPO by relying upon the decision rendered by ITAT, Delhi in assessee’s own case for AYs 2006-07 and 2007-08. However, the ld. TPO without legally controverting the fact that the decisions rendered by ITAT in assessee’s own case has not been challenged by the revenue, indulged in recording findings that, “the Hon’ble ITAT erred in completely disregarding the critical functions carried out by the assessee and the consequent risks borne by the assessee and further recorded the finding that even the judgment rendered by the High Court in Li & Fung India Pvt. Ltd. case has not been accepted by the revenue as filing of SLP to the Supreme Court has been suggested” as if he was sitting in appeal on the assessee’s case of earlier year.
So, in the totality of the facts and circumstances narrated above, we are of the considered view that the ld. TPO has not made a fair analysis of the comparables, though chosen by the assessee in its TP study for the AY 2007-08, rather relied upon his own finding for the earlier years which have undisputedly been set aside by the Tribunal. So, we are of the further opinion that the ld. TPO to benchmark international transactions afresh by examining the suitable comparables by providing opportunity of being heard to the assessee. So, file is ordered to be restored to the TPO to benchmark the international transactions in the light of the observations made hereinbefore.
The next issue arises for determination is “as to whether DRP/AO have erred in enhancing the income of the assessee by Rs.1,75,16,800/- by disallowing the rent expenses being conversion charges paid to the Municipal Corporation of Delhi (MCD)? 22. Undisputedly, the assessee company has claimed rent expenses to the tune of Rs.4,96,35,663/- and from the details supplied by the assessee company, AO noticed that a sum of Rs.1,75,16,800/- has been claimed in the name of Dua Associates.
Assessee pleaded before the AO that the amount of Rs.1,75,16,800/- has been paid as conversion charges to MCD through Dua Associates, legal consultant of the assessee. AO has not disputed the payment of Rs.1,75,16,800/- as conversion charges to MCD but treated the same as capital expenditure in connection with the business activities.
However, coordinate Bench in the judgment in case of ACIT, Circle 33 (1), New Delhi vs. Kalinga International – order dated 08.09.2014 decided the identical issue in favour of the assessee by returning the following findings:-
“8. In view of the fact that the assessee was to use this property of some third person for business purpose and the same was not possible unless it was so converted, the conversion charges in such circumstances could not have been considered as a capital expenditure. The case is not even hit by Expl. 1 to sec. 32(1) inasmuch as payment of such conversion charges cannot be considered as any capital expenditure ‘on the construction of any structure or doing of any work in or in relation to, and by way of renovation or extension of, or improvement to, the building’. We, therefore, hold that such a payment cannot be considered as capital expenditure. The impugned order on this score is upheld.”
So, by following the decision rendered by the coordinate Bench, we hereby held that the ld. DRP/AO have erred in disallowing the expenses of conversion charges to the tune of Rs.1,75,16,800/- claimed by the assessee and then added the same to the total income of the assessee company which are not to be considered as capital expenditure as the same have been expended for business purpose and without conversion of the property, the business would not have been started even and as such, allowable for deduction. So, ground no.11 is determined in favour of the assessee.
In view of what has been discussed above, the present appeal filed by the assessee is partly allowed for statistical purposes. Order pronounced in open court on this 17th day of May, 2016.