BESTSELLER UNITED INDIA PVT. LTD.,NEW DELHI vs. ADDL. CIT, NEW DELHI

PER KULDIP SINGH, JUDICIAL MEMBER :

“l. That on the facts and in the circumstances of the case and in law, the order passed by the Assistant Commissioner of Income Tax, Range 2, New Delhi ("Learned Assessing Officer" or "Ld. AO") is bad in law and void ab-initio.

2. That on facts and circumstances of the case and in law, the Ld. AO/ Assistant/Deputy Director of Income Tax, Transfer Pricing Officer - 1(4), New Delhi (Ld. TPO) and Learned Dispute Resolution Panel - I, New Delhi ("Ld. DRP") erred in re- computing the arm's length price ("ALP") of the Appellant's international transaction at Rs.27,76,86,636 as against Rs.13,88,43,318 adopted by the Appellant and recommending an addition of Rs.13,88,43,318 on that account to the Appellant's income.

3. That the Ld. AO/TPO/DRP has erred in law and facts by: a. not appreciating the fact that the appellant has complied with the Indian transfer pricing regulation by maintaining appropriate documentation a mandated by Section 92D of the Act and Rule 10D of the Income-tax Rules, 1962 ("Rules") and adopting appropriate benchmarking approach to substantiate the arm's length nature of its international transactions;

b. not appreciating that the appellant is a low risk sourcing support service provider and disregarding the functional asset and risk (‘FAR’) profile of the appellant, on the basis of pre-conceived notions, surmises and conjectures, and without any cogent evidence, facts or basis whatsoever; c. including the value of the goods sourced directly by the associated enterprises 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 into in its remuneration model. d. disregarding the fact that the arm's length price adopted by the TPO leads to the Appellant's operating profit / operating cost (OP/TC) ratio going up to an absurdly high figure of 1069%. e. applying the decision of the Hon'ble Delhi Tribunal in the ca e of Li & Fung (India) Pvt. Ltd. Vs. DCIT in the case of the appellant without appreciating that the FAR profile of the appellant was entirely different than the appellant involved in the said case; and accordingly, the said decision could have no application in the instant case of the appellant. f. determining arm's length margin at the rate of 5% of the FOB value of goods sourced by AEs from India on an ad-hoc basis without applying any appropriate transfer pricing method as prescribed in Sec. 92C(1) of the Act. g. holding that the appellant has developed unique intangibles like supply chain management intangibles and human asset intangibles which has resulted in huge commercial and strategic advantage to the associated enterprise without providing any basis or evidence whatsoever. a. holding that the value addition made by the appellant to the FOB value of goods remained uncompensated despite its compensation model based on the value of goods.

4. That the Ld. DRP erred in law and in facts in ignoring the principles laid down in the case of GAP International by the Hon'ble IT AT, Delhi Bench.

5. That on facts and in law, the Ld. AO/Ld. DRP erred in disallowing Rs.203,725 u/s 14A of the Act.

6. That on facts and circumstances of the case, the learned Assessing officer has erred in initiating penalty proceedings under section 271(1)(c) of the Act against the appellant, which is inappropriate.

Particulars Amount (in Rupees) Commission Income 138843318 Administrative & Other Expenses 25633901 Depreciation 241608 Total Operating Cost 25875509 Operating Profit (OP) 112967809 OP/OC 437%

“48. The TPO after taking into account all relevant facts and data available to him has to determine arm’s length price and pass a speaking order after obtaining the approval of the Department of Income Tax (Transfer Pricing). The order should contain details of data used, reasons for arriving at a certain price and applicability of methods, subject to judicial scrutiny. The order of the TPO, in the instant case, has not provided any substantive reasons for disregarding the TNM method as applied by LFIL. Further, the TPO‟s arbitrary exercise of adjusting the cost plus mark up of 5% on the FOB value of exports finds no mention in the IT Act nor the Rules. Such an exercise of discretion by the TPO, disregarding the LFIL’s lawful tax planning measures with its group companies, is not in compliance with the IT Act and Rules of Income Tax.

(a) The broad basing of the profit determining denominator as the entire FOB value of the contracts entered into by the AE to determine the LFIL‟s ALP, as an “adjustment”, is contrary to provisions of the Act and Rules; (b) The impugned order has not shown how, and to what extent, LIFIL bears “significant” risks, or that the AE enjoys such locational advantages as to warrant rejection of the Transfer pricing exercise undertaken by LFIL; (c) Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as “significant risk”, “functional risk”, “enterprise risk” etc. without any material on record to establish such findings. If such findings are warranted, they should be supported by demonstrable reason, based on objective facts and the relative evaluation of their weight and significance.

(d) Where all elements of a proper TNMM are detailed and disclosed in the assessee’s reports, care should be taken by the tax administrators and authorities to analyze them in detail and then proceed to record reasons why some or all of them are unacceptable. (e) The impugned order, upholding the determination of 3% margin over the FOB value of the AE‟s contract, is in error of law.

“2 - Tasks of Bestseller India: 2.1 Bestseller India shall collect collection samples and price estimates from producers in India and forward these to Bestseller DK. 2.2 Bestseller OK shall select amongst these collection samples or shall produce itself collections which shall then be forwarded to Bestseller India with a statement of which quantities, quality and colours are of interest. Furthermore, Bestseller DK shall state the requested time of delivery, the quantities and the price level it is willing to pay for the order. 2.3 Bestseller India shall enter into negotiations with the producers estimated to be able to deliver the order on the stated terms and at the lowest price possible. 2.4 Bestseller India shall act in its own name and shall not be empowered to bind Bestseller DK legally or financially when they enter into any agreements with suppliers in India 2.5 Bestseller India shall see to the most appropriate distribution of orders amongst the producers and shall collect for Bestseller DK written quotations for delivery from the producers. 2.6 All binding agreements between Bestseller India and producers shall be in writing and shall be approved by Bestseller DK. 2.7 As regards orders placed Bestseller India shall see to the follow-up of such orders towards producers in order to perform current quality controls and any other tasks to ensure that the product is delivered in the agreed quality and on the agreed terms.

2.8 Bestseller India shall be obliged to keep Bestseller DK currently informed of such developments of orders, complaints etc. in progress which may be important to Bestseller DK's dispositions made in anticipation of the planned implementation of the order. 2.9 Bestseller India shall be obliged to make complaints towards the individual producers once it is ascertained that an order does not proceed satisfactorily or that it is not performed according to contract. Bestseller India shall be obliged to make such complaint in accordance with Indian rules of law. 3 - Scope of The Agreement: 3.1. This agreement shall be operative for all purchases made by Bestseller DK in India. Bestseller DK is not allowed to make any purchases in India through other trading partners or to make any purchases directly. 4 - Quantities: 4.1 The Business Bestseller DK shall not be obliged to buy articles from India at a fixed amount of money. 5 - Remuneration: 5.1 It is agreed that Bestseller India shall receive a remuneration of 2.5% of the price which the producer bills Bestseller DK (net price exclusive of freight, VAT, duty and discounts, if any). 5.2 The commission shall be paid by the supplier. Bestseller DK draws the commission from the payment to the supplier and sends on behalf of the supplier the commission to Bestseller India once a month.”

Particulars Amount (in Rupees) Commission Income 138843318 Administrative & Other Expenses 25633901 Depreciation 241608 Total Operating Cost 25875509 Operating profit (OP) 112967809 OP/OC 437%

S.No. Name of the Company Weighted Average of 3 years margin 1. Educational Consultants 3% 2. Epic Energy Ltd. 55% 3. Geefcee Finance Ltd. 0% 4. NIS Sparta Ltd. -8% 5. IDC (India) Ltd. 14% 6. Priya International Ltd. 9% 7. Ratan Glitter India Ltd. -7% 8. Rites Ltd. 35% Mean 12.72%

“4.2 Grounds 2 & 3 are considered together. a) It is seen that the assessee company has provided sourcing support services and it has bench marked its services against other support companies to demonstrate that the transactions are at arm's length. The compensation model of the assessee is 2.5% on the cost of goods sourced. Accordingly to assessee “all 4 sourcing services providers within the Bestsellar group are compensated based on 2.5 % of the total purchases in the country in question." b) We have seen and examined that the functions and scope of work of the assessee are defined in the Cooperation Agreement which the TPO has reproduced at page 8 of its order. We find that all the critical functions related to the services are performed by the assessee. Furthermore the scope and substance of the agreement reveals that normal risks akin to the business are also undertaken by the assessee. In such a situation, while performing the margin analysis, the assessee should have taken the cost of goods in its cost base which it did not. c) We have also examined the case of the assessee in light of the functions performed by it and are of the opinion that the assessee has indeed developed unique intangibles like supply chain management intangibles and Human asset intangibles which has resulted in huge commercial and strategic advantage to the AE. To take the argument further, the value addition made by the assessee to the FOB value of goods remained uncompensated despite its compensation model based on the value of goods. d) The DRP also examined the contention of the assessee alleging that the facts and circumstances of the case are distinguishable from the case of Li & Fung. We have critically gone through the submissions made by the assessee at para 3.4.26 in its paper book. We do not find any remarkable difference in the cases. The only point in contention is that the Li & Fung case was on a cost plus compensation and the case of the assessee has been on a commission basis. However, we have examined that in both cases, the point of examination boils down to examination of compensation as a percentage of cost of goods sourced so the difference is not really material as the assessee has pointed out. e) The next point of contention is choice of com parables and compensation percentage. The TPO has taken a set of textile manufacturing companies and has arrived at a margin of 8.07% which the assessee should have received on costs including the FOB value of goods. We are in agreement with 'the TPO that the characteristics of the instant case cannot partake the comparability with support service companies. However we are also not in complete agreement that the comparability should be made with manufacturing companies. During the course of discussions with the counsels of the assessee before us, they submitted that the Denmark Parent company namely Bestseller, A/S Denmark "Koetshuis Nimmerdor" earns 9% on cost. Looking into the fact that the most critical functions in the chain of business is performed by the Indian Entity, we are of the opinion that the assessee should have been compensated at 5% of costs including the FOB value of goods. Since now cost base includes FOB value, the margin must increase in view of the submission as quoted in the earlier para. The TPO is directed to recompute ALP accordingly.”

(iii) that the findings returned by the TPO that the assessee company is a contract manufacturer have already been upset by the DRP and as such, there is no need to go into the details of this issue; (iv) that the DRP in agreement with TPO also rejected the comparables selected by the assessee company on the ground that the assessee company cannot be compared with sport service companies; (v) that at the same time, the DRP also set aside the comparables selected by the TPO to determine the ALP of the international transaction with manufacturing company; (vi) that when the TP study adopted by the assessee company has been rejected by the TPO and at the same time, comparables chosen by the TPO have been rejected by the DRP, we are of the considered view that TP adjustment in this case cannot be made except by resorting to the fresh TP study chosen by the assessee company and examined by the TPO by providing opportunity of being heard to the party; (vii) that from the schedule showing role and responsibility of assessee company qua FY 2007-08, lying at page

245 of the paper book, it is apparently clear that the assessee company is having 11 employees only with total expenditure of Rs.29,78,340/- and as such, the cost of the assessee company is totally captured. In these circumstances, assessee company’s ALP is to be determined on its own cost and not on the FOB value of export plus value added expenses (VAE) as has been held by the TPO/DRP; (viii) that the TPO/DRP has broadly returned the findings that the assessee company is performing critical function having significant risk and AE is also enjoying locational advantages of the assessee company buy has not given any analysis by computing the entire gross profits as well as operative cost; (ix) that the contention of the ld. DR that the assessee companies has been operating on the basis of Darling Agreement to avoid the accurate ALP of the international transactions despite the fact that the assessee company is bearing all the risks, is not sustainable because assessee company has not entered to any agreement with the manufacturer, thus have no accountability, and as such, the question of bearing risk does not arise; (x) that the AEs entered into an agreement with the manufacturer on its own and the role of the assessee company is just to perform the liaison work to ensure that the quantities, qualities and colours are in accordance with the order placed by its AEs; (xi) that the assessee company is also to follow up the orders placed by its AEs towards manufacturer and to ensure the quality control and that the product is delivered as per the order placed; (xii) that when the assessee company is not having any machinery or technical work force, it has been rightly treated by the DRP not as a manufacturer; (xiii) that the DRP vide impugned order has sailed in two boats – (a) that the assessee company is not a manufacturer; and (b) that the assessee company cannot be compared with the sport services companies but has failed to pinpoint the actual functional profile of the assessee company to arrive at the logical conclusion to determine the ALP of the international transaction;

(xiv) that when the assessee company is not having any plant and machinery nor it has incurred any expenses under the head ‘machinery expenses’ nor purchased any raw material and all these functions have been independently done by manufacturer engaged by the AE, the assessee company cannot be kept in the category of manufacturer; (xv) that merely on the basis of FAR analysis and broad based findings that the assessee company used tangibles and intangibles developed over the years and the locational savings enjoyed by the assessee company and its AE, it cannot be held that the compensation that the assessee receives in a cost plus model is not adequate and does not meet the arm’s length principle, by relying upon the case of Li and Fung India Pvt. Ltd. which has been overruled by the Hon’ble jurisdictional High Court as discussed in the preceding paragraphs; (xvi) that a bare scrutiny of the functions of the assessee company as enumerated in the cooperation agreement shows that it is to perform as a coordinator, follow up, quality control, ensured delivery of goods, and to perform the liaison work between the AE and local vendor and has been running its business with 11 employees having expenditure of Rs.29,78,340/- per annum and in these circumstances, the ALP of its international transaction is required to be determined by selecting proper comparables by the TPO; (xvii) that the TPO has determined the arm’s length margin at 8.07% on the basis of comparables chosen by him, which are full-fledged manufacturer having 8.07% of OP/OC and this finding of the TPO has been quashed by the DRP but at the same time, DRP proceeded to determine the ALP on the basis of hypothetical figure of 5% which is also not sustainable in the eyes of law; (xviii) that assessee company in its TP study chosen 8 comparable companies who are support service provider and their weighted average of 3 years margin is 12.72% as against OP/TC of assessee company at 437%; (xix) that TPO rejected the TP study of the assessee primarily on the grounds inter alia that the assessee had used multiyear data vis-à-vis current year data; that assessee company is not a service provider;

(xx) that as discussed in the preceding para, assessee company is proved to be a support service provider and so far as 2nd objection as raised by TPO is concerned since the OP/TC of assessee company at 437% is much higher than 12.72% of comparable companies and in case it is computed on the basis of single year data, it is far behind the OP/TC of the assessee company; (xxi) that in the given circumstances, we are of the considered view that as the basis of TP study adopted by the assessee company, its international transactions are at arm’s length prices.

GROUND NO.5 22. The assessee company during the year under consideration has claimed exemption under section 10 (34) of the Act on the dividend income of Rs.10,65,515/-. The assessee company on its own has disallowed 10% of the exempted income earned during the year by stating that provisions contained under Rule 8D are not applicable.

So, the AO computed the disallowance under Rule 8D of the Income-tax Rules, 1963 and determined the amount to Rs.2,03,725/- on account of disallowance under section 14A of the Act.

“4.7 Accordingly, the disallowance is worked out as per the provisions of Rule 8D (2) as under :-

(i) Amount of expenditure Nil directly relating to income which does not form part of total income (ii) A Amount of interest by which Nil is not directing attributable to any particular income/ receipt i.e. other interest B Average value of investment related to exempt income (as submitted by assessee)

- Opening Balance of 25132247 Investments - Closing balance of 60619687

Investments - Average value of above 42875967 investment C Average of total assets –

- Opening Balance of 486717610 assets - Closing Balance of 572928624 assets - Average value of above 529823117 assets A x B / C = Nil x 42875967 Nil 529823117 (iii) Average value of Investment (as submitted by assessee) - Opening Balance of 25132247 Investments - Closing Balance of 60619687 Investments - Average value of above 42875967 investment - ½ % of average value of 214380 investment of Rs.42875967 Disallowance u/s 14A of the 214380 Act i.e. aggregate of (i), (ii) and (iii)

Order pronounced in open court on this 25th day of April, 2016.