DCIT, NEW DELHI vs. M/S PHILIP MORRIS SERVICES INDIA (S.A) INDIA BRANCH OFFICE, NEW DELHI

Briefly stated facts of this case are : during the processing of return of income filed by the assessee for assessment year 2004-05, the case was selected for scrutiny and consequent to the notice issued u/s 143(2) Shri Arun Sawara, C.A. attend the precedence from time to time, filed submissions and replies to the clarifications / questions raised.

Assessee company is a wholly owned subsidiary of FTR Holding S.A. (Swiss Holding Company) and is one of the group companies of Phillip Morris U.S.A. and is into the business of manufacturing and trading of cigarettes and other tobacco products main operation of the assessee company is Philip Morris Services India (S.A.) • “Import and distribution of the Marlboro brand of cigarettes in India as well as export of tobacco leaves ; and • Provides services to its Associated Enterprises i.e. marketing support services.”

During the assessment year under consideration the assessee has shown loss of Rs. 1,28,45,971/- as operating loss from total turnover of Rs. 7,10,50,023/- and entertain to following international transactions with its associated enterprises (A.E.)

On the basis o f TP study adopted by the assessee company for the purposes of transfer pricing analysis the assessee considered the aforesaid international transactions to be at an arm’s length. In the earlier years assessee has shown profit for rendering services to the group companies at cost plus method but during the year under consideration, it has shown loss amounting to Rs. 1,28,45,971/- marked as operating loss out of total trading turnover of Rs. 7,10,50,023/-. Assessee in its transfer pricing study chosen two comparables and taken the basis for comparison of profit on the basis of so-called “alternative practical approach” based on Resale Price Method. AO rejected the comparables taken by the assessee as not correct one as none of the comparable has actually incurred net loss in its trading transactions. Assessee explained the reason for net loss as huge expenditure incurred without comparable receipts. TPO noticed that the assessee has sold his entire purchases during the year leaving closing stock at nil.

Assessee carried the matter before the Ld. CIT(A) who has allowed the appeal. Feeling aggrieved the revenue has come up before the Tribunal by way of filing the present appeal.

Assessee company is one of the group companies of Phillip Morris U.S.A. engaged in the business of manufacturing and trading of cigarettes and other tobacco products and operates through its Indian Branch authorised to carry out activities inter alia that : • Import and distribution of the Marlboro brand of cigarettes in India as well as export of tobacco leaves; and • Provides services to its Associated Enterprises i.e. marketing support services.

Undisputedly assessee company is a part of group namely Altria group and Indian branch office is PE of the Assessee Company. AO after rejecting the TP study adopted by the assessee company on the basis of which it has Philip Morris Services India (S.A.)

But this contention of the ld. DR is not tenable on the grounds inter alia that no cogent reasons have been recorded for rejecting the TP study adopted by the assessee company nor disclosed the methodology adopted by him by affording an opportunity of being heard to the assessee to consider the international transaction at an arm’s length ; that the DR has failed to explain as to which method has been adopted by the AO to determine the international transaction at arm’s length ; that when the AO has himself not justified the segregation made by the assessee company he was not empowered to reject the TP study adopted by the assessee company summarily.

Bare perusal of aforesaid findings returned by the Assessing Officer goes to prove that he has proceeded on the basis of assumptions and guesswork that brand loyalty plays a vital role with regard to sales of a particulars brand which cannot be compared with any other entity trading in other brands by losing sight of the fact and reasons that the assessment year under consideration is the first Philip Morris Services India (S.A.) year of operation, in which assessee company incurred huge expenses without comparable receipt. Thus, assessee company cannot be compared with the assessee’s group company only without analysing the functional and risk disparities between the two company. Assessing Officer merely decided on the basis of profit margin of the group for bench marking without analysing the economic and marketing conditions of both the companies.

Assessing Officer again proceeded to recompute the income of the assessee on the basis guesswork by taking operating margin accounts for both manufacturing and selling at 50% of the profit attributable to the activities of the assessee in India, that too without providing opportunity of being heard to the assessee. AO also proceeded on the basis of reasonableness by attributing 30% of the profit outside India and remaining 70% to India where sales have taken place by ignoring law applicable to the facts and circumstances of this case.

At the very outset, it is fairly conceded by Ld. D.R. that there is no dispute regarding the extended marketing supports services rendered by the assessee company and the only dispute is regarding the aspect of distribution. Ld. A.R. for the assessee by relying upon the impugned order passed by Ld. CIT(A) contended inter alia that the Assessing Officer has applied the operating profit rate of the group arbitrarily without any basis and without considering the assessee’s duly audited accounts; that profits and loses offered for taxation by the assessee are in line with the principles of attribution of profits as per Article 7 of India-Switzerland Tax Treaty and as per the Arm’s Length Principles; that assessee carried out a detailed FAR analysis (Functions performed, assets employed and risk assumed) and its operation in India and then determined the Arm’s Length Margin, which is required to be attributed to a Permanent Establishment (PE) using the third party industry benchmark; that Assessing Philip Morris Services India (S.A.) Officer has also erroneously presumed that assessee is the main performing arm of the company through which all the activities of the company are carried out by ignoring the fact of Altria Group (of which assessee company is a wholly owned subsidiary) is engaged in a vide area of functions, own significant tangible and intangible assets and operates vast geographical spread; that if the gross margin is determined based on margin computed by Assessing Officer, it results into gross margin of approximately 49%, which is much higher than the average gross margin earned by the independent distributor; that assessee also adopted fresh search comparables during appellate proceedings by taking three comparable company apart from the two comparables already adopted in the TP study and has shown the more gross margin of the comparable company @ 15.70% or 18.31% as against the gross margin earned by the assessee @ 14.43% and by applying + 5% ranged the assessee’s international transaction at arm’s length. Ld. CIT(A) has reproduced the fresh search of comparables undertaken by the assessee during appellate proceedings in para 5.3.2 and 5.3.3 of the impugned order.

Keeping in view the facts and circumstances of the case; findings returned by the Assessing Officer and the fact that Ld. CIT(A) is not bound by the TP study undertaken by the Assessing Officer for T P adjustment, we are of the considered view that the contentions raised by the Ld. D.R. are not sustainable and no ground is made out to interfere into the findings returned by Ld. CIT(A) for the following reasons: i) that when the Assessing Officer has lost sight of the fact that trading activities have been carried out by the assessee company for a period of five months only during the year under consideration and in such a short period it is not feasible for expenses of Indian Branch Offices to be set off by income generated out of trading activities because Philip Morris Services India (S.A.) during the initial years of operation, expense of a company ought to be at higher side; ii) that the Assessing Officer has merely taken GP rate @ 16.57% of assessee’s group companies by rejecting TP study adopted by the assessee company as against GP rate claimed by the assessee @ 14.44% by comparing it with the group as a whole without discussing the total number of functions being carried out by the Altria group; iii) that the Assessing Officer has also lost sight of the fact that assessee company having branch offices in India, is a distributor having responsibility for its business operation in India including market risk, price risk etc. So, keeping in view the facts, Ld. CIT(A) has rightly applied the resale price method (RPM) for benchmarking, which is the most appropriate method in this case;; iv) that gross margin of the assessee company cannot be compared with the group company as the assessee company is an importer and distributor of cigarettes in India without any value addition; v) that when the assessee company is not maintaining any warehouse nor it has any R&D activities and trade mark is also owned by the group company, manufacturing is also done by the group company and as such FAR of the assessee is not comparable with the FAR of its group company; vi) that Ld. CIT(A) after considering all these facts, TP study undertaken by the assessee company initially on the basis of two comparables showing GP @ 6.81% as against GP rate of assessee company @ 14.44% and during the appellate proceedings, the appellant filed fresh search on the basis of three comparables showing average GP @ 18.31% has rightly held the international transaction at arms length; Philip Morris Services India (S.A.) vii) that Ld. CIT(A) has also rightly considered the detailed comparison of assessee’s distribution agreement with another company namely God fray Phillips India showing GP rate of 4.42% and this comparison is showing distribution segment of the appellant at Arm’s Length Principle; viii) that Arm’s Length nature of distribution segment of assessee company has otherwise not been disputed by TPO during Assessment Year 2005-06; ix) that a bare perusal of the distribution agreement dated 01.09.2013 entered into between the assessee company with Fillet Morris Products SA shows that assessee company was appointed as non exclusive distributor of the product manufactured by the assessee in the territory of India making it ineligible to compare with its group company; x) that it is further agreed in the agreement (supra) that the assessee company shall sell the products of its parent company at prices agreed by the parties from time to time and in these circumstances, it was not feasible to acquire the operating profit rates of the group arbitrarily for benchmarking without considering the assessee’s duly audited account; xi) that Ld. CIT has rightly came to the conclusion on the basis of TP study adopted by the assessee company during appellate proceedings vide which three comparable companies have been taken showing GP rate of three new comparables @ 18.31% as against GP rate of assessee company shown @ 14.44% and by applying the safe harbour rule having benefit of + 5%, the TP study adopted by the assessee company is at arm’s length; xii) that fresh search brought out on record by the assessee company for TP study goes to prove that the assessee company has brought out on Philip Morris Services India (S.A.) record detailed comparison of its distribution agreement with the comparable company namely God fray Phillips India showing GP rate of 4.42% which is much lower than the assessee company; xiii) that the contention of Ld. D.R. that fresh TP study adopted by the assessee during appellate proceedings, cannot be relied upon without providing opportunity of being heard to the A.O. /TPO, is not tenable because the fresh TP study adopted by the assessee apparently goes in favour of the Revenue showings distribution segment of the assessee at arm’s length principle; xv) that the A.O. has also arbitrarily disallowed various expenses claimed by the assessee without specifying how and which of the expenses are not allowable.

In view of what has been discussed above we find no ground to interfere into the impugned order passed by Ld. CIT(A), consequently present appeal of the Revenue is hereby dismissed.