DCIT, NEW DELHI vs. M/S. AGILENT TECHNOLOGIES INDIA PVT. LTD., NEW DELHI

This appeal filed by the Revenue is directed against the order passed by the CIT(A) on 29.7.2011 in relation to the assessment year 2005-06.

The solitary effective ground raised by the Revenue is as under:-

Briefly stated, the facts of the case are that the assessee is a 100% subsidiary of Agilent Technologies, Europe B.V. Its business operations comprise of facilitation of sales of Agilent products in the Indian market.

We have heard the rival submissions and perused the relevant material on record. It is noticed that the assessee applied the TNMM as the most appropriate method which was accepted by the TPO. The only controversy revolves around the adoption of PLI under the TNMM.

At the outset, the ld. AR contended that the ld. DR was not entitled to challenge the finding of the ld. CIT(A) equating the assessee’s OP/VAE with OP/OC of comparables as this issue does not arise out of the ground taken in appeal. We are afraid that this objection of the ld. AR is bereft of any force. The only effective ground raised by the Revenue has been reproduced above, from which it is apparent that the assail is to the decision of the ld. first appellate authority in holding `that the international transaction undertaken by the assessee was at Arm’s Length’. Treating international transaction at ALP covers all the aspects of the determination of its ALP, which obviously include not only the selection of comparables and their profit margin but also the selection of the most appropriate method and determination of the correct PLI of the assessee and that of comparables. In fact, the ld. DR has argued only this aspect of determination of the PLI and nothing else. If this aspect is held to be not emanating from the ground of appeal, then it would mean that the Department has accepted the decision of the ld. CIT(A) and as such there was no need to file second appeal before the tribunal, which is not the correct position. Since the Revenue has filed appeal with the 6 ground covering all the aspects of the transfer pricing adjustment, we hold that the ld. DR was within his right in arguing this aspect of the matter. We, therefore, jettison this preliminary objection raised by the ld. AR.

A cursory glance at sub-clause (i) of Rule 10B(1)(e) transpires that the net operating profit margin realized by the enterprise from an international transaction is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. Sub-clause (ii) of Rule 10B(1)(e), which is equally significant for our purpose, stipulates that the net operating profit margin realized by the enterprise or by an unrelated enterprise from the comparable uncontrolled transaction ‘is computed having regard to the same base.’ On a conjoint reading of sub- clauses (i) and (ii) of Rule 10B(1)(e), it is vivid that the net operating profit margin realized by the assessee from an international transaction has to be necessarily computed and compared with the net profit margin realized by comparable companies with the same base. In other words, if the operating profit margin of the assessee from international transaction has been computed with the base of `costs incurred’, then, the operating profit margin of the comparables has also to be computed with the same base of `costs incurred’. Similarly, if the base adopted by the assessee for its international transaction under the formula in 8 TNMM is ‘sales effected’, then, similar base of `sales effected’ must be necessarily adopted while computing profit margin of comparables. In the like manner, if ‘any other relevant base’ is adopted for computing the operating profit margin of the assessee, then, similar base should be considered while computing operating profit margin of comparables. To put it simply, the numerator and denominator in the computation of operating profit margin of the assessee must be similar to those of the comparables. In the formula given under the TNMM, numerator is always `operating profit’, but the choice has been given for selecting a suitable `denominator’. However, the condition precedent is that whichever denominator is selected by the assessee for working out its PLI in terms of sub-clause (i) of rule 10B(1)(e), similar denominator should be adopted in computing the profit margin of comparables as per sub-clause (ii) of the rule. It is impermissible to compare the assessee’s operating profit margin computed with the base of, say, `cost incurred’ with the operating profit margin of comparables computed with the base of, say, `sales effected’ or `any other relevant base’. Even when `any other relevant base’ is adopted, such a base should remain consistent 9 both in the computation of PLI of the assessee as well as comparables.

Espousing the main controversy once again, we find that the assessee used OP/VAE as its profit level indicator, by impliedly treating base of `Value added expenses’ as akin to `any other relevant base’ and the TPO also used similar base in the PLI of comparables. The assessee claimed before the ld. first appellate authority that `VAE’, being the base of the assessee is the same thing as `OC’ of the comparables. The ld. CIT(A) accepted this contention by recording in para 11.8 of his order that: ‘This position was not objected to by the TPO while passing the order.’ In our considered opinion, the position so recorded in the impugned order is contrary to the order of the TPO. It is obvious that the TPO, firstly, found on page 2 of his order that the assessee’s OP/VAE stood at 13.96% and OP/OC at 4.9%. and then in the ultimate analysis, he adopted OP/VAE of the assessee for the purposes of comparing it with OP/VAE of the comparables. The TPO has no where admitted that the assessee’s OP/VAE was similar to that of OP/OC of the comparables. To proceed on the premise that the TPO accepted the assessee’s OP/VAE as equivalent of OP/OC of the comparables, either expressly or impliedly, is imaginary and without any bedrock. The TPO categorically adopted OP/VAE, both of the assessee and of comparables, for determining the ALP of the international transaction. Thus, it is manifest that the impugned order is based on an incorrect assumption by the ld. CIT(A), which has changed the entire direction of his order, resulting in the ultimate deletion of addition. We are unable to countenance such a view.

The ld. AR vehemently argued that the assessee is not a trader, but, simply a commission agent. He stated that the assessee was facilitating sales of Agilent products in India under two transaction models, namely, Indent model and Buy-Sell model. Taking us through the Transfer pricing study report, he contended that whereas under Indent model, the assessee was providing only marketing and sales support services in relation to the direct sales of Agilent products from overseas entities to customers in India without taking any physical possession or title of the goods, under Buy-Sell model, the assessee was importing products from Agilent for sale to domestic customers, specifically, against the confirmed sale orders by taking title of goods and, then, selling these to the distributors and customers in India. He argued that though the title of goods under Buy-Sell model was formally passing to the assessee, but, in fact, it was nothing more than Indenting model in the sense that the sale was made only on the basis of confirmed orders and the assessee was not taking delivery of goods and further the assessee’s working capital was not involved in any manner. Sum and substance of his submissions was that under both the transaction models, namely, Indent and Buy-Sell, the assessee was earning only commission and, there was no point in treating the assessee as a trader so as to consider `Operating costs’ as the base in the PLI instead of `Value added expenses’, which is really relevant for service providers.

Before delving into the point further, we want to highlight difference between Operating cost (OC) and VAE (Value Added Expenses) and their respective impact on the overall operating profit margin. In common parlance, operating costs are the expenses which are related to the operation of a business. If an enterprise is in the business of manufacturing or trading, then its operating costs will also include cost of goods sold apart from other operating administrative and selling expenses. If some services are required to be rendered by the assessee in respect of goods already manufactured by a third person, then the costs incurred in rendering such services are called valued added expenses in the hands of person rendering such services. Cost of goods sold is immaterial factor in the case of an assessee engaged in commission business, having no relevance whatsoever with his operating costs. Operating costs to him will mean only administrative and selling expenses connected with his business operations, which comprise of effort in facilitating sale of other’s goods. Thus it is crystal clear that whereas cost of goods sold is an important ingredient of total operating costs of a manufacturer or trader, it has no relevance in the case of a service provider or a commission agent. Operating costs of a commission agent are the costs incurred in facilitating sale of goods, which patently exclude cost of goods. The epitome of the matter is that whereas operating costs in the case of a trader include cost of goods sold, the same are absent in the case of a commission agent. It is obvious for the reason that while the only element of profit of a commission agent is compensation for the efforts put in by him in effecting sales, the profit of a trader, in addition to that, also includes compensation for the amount invested by him in inventory and debtors etc. That is why, operating profit of a trader can be correctly deduced by considering his operating costs, which always include cost of goods sold; and that of a commission agent by never including cost of goods sold, which he never incurs. This divulges that operating costs of a trader always include cost of goods sold and operating costs of a commission agent can never have such costs. If there is some Cost of goods sold and Sale 14 appearing in the books of an assessee, then it would mean that the title in goods passed on to him, which he sold as an owner. In that case, he ceases to be characterized as a mere commission agent qua such goods.

Now we will examine and evaluate the ld. AR’s contention that the transactions of the assessee under the Buy-Sell model are identical to the Indent model and there is no difference between the sales made under both the models. We have perused the assessee’s Annual accounts for the year, a copy of which has placed at pages 111 onwards of the paper book. Profit & Loss Account of the assessee records ‘Sales’ of Rs.71,13,35,944/- apart from `Commission’ income amounting to Rs.30.81 crore and income from `Support services’ at Rs.7.62 crore.

The ld. AR further contended that the assessee was not holding any stock-in-trade and purchases were being made on the basis of confirmed orders with supply directly going to the end customers. This position is again, contrary to material on record. Schedule-D of the Balance sheet contains break-up of Inventories. Its perusal shows that as against total Inventories of Rs.22.98 crore, stock of `Finished goods’ is to the tune of Rs.13.71 crore and that of `Spare parts’ at Rs.9.27 crore. There is further bifurcation available in respect of Finished goods and Spare parts - both ‘At warehouse’ and ‘In transit.’ Thus, it is manifest that the argument put forth by the ld. AR about the assessee holding no physical stock at any point of time, is fallacious and contrary to the actual figures reflected in the balance sheet. It is plentifully lucid from the details of `Inventories’ given in the balance sheet that the assessee is not only having Finished goods and Spare parts `In transit’, but also `At warehouse’.

When we consider Profit & Loss Account and Balance sheet of the assessee in unison, it unambiguously follows that the assessee purchased goods under Buy-Sell model as principal by acquiring title in them and, thereafter, sold the same as owner and not as an agent. The Hon’ble Delhi High Court in Mitsubishi Corporation India Pvt. Ltd. vs. Addl.CIT (2014) 366 ITR 495 (Del) has held that where transactions of purchase and sale between the assessee and a non-resident holding company were done on a principal to principal basis and recorded in books of account on principal to principal basis by the assessee, activity undertaken by the assessee was in the nature of trading. We, therefore, repel the assessee’s contention that the transactions under Buy-Sell model were on commission basis rather than as a trader.

Having held that the assessee is a `Commission agent’ as regards its transactions under the Indent model and a `Trader’ as regards its transactions under the Buy-Sell model, we again revert to the moot point of determination of ALP. It is noticed that the assessee clubbed transactions under both the models and determined their ALP by computing OP/VAE on consolidated basis and then compared the same with OP/OC of comparables. The TPO adopted the base of ‘Value Added Expenses’ as denominator in the computation of operating profit margin from combined international transactions under both the models with similar base of comparables. The ld. CIT(A) deleted the addition by comparing the base of OP/VAE of the assessee under both the models of transactions in a combined manner with OP/OC of the comparables.

Having disapproved the view taken by the ld. CIT(A), we need to judge the correctness of the ALP of the international transactions undertaken by the assessee under both the business models of `Indenting’ as well as `Trading’, which are obviously distinct from each other. It can be seen that the assessee tried to demonstrate that its combined international transactions under both the models were at ALP by comparing its PLI of OP/VAE with OP/OC of comparables, which is an incorrect approach. In the like manner, the TPO, though compared the assessee’s PLI of OP/VAE with OP/VAE of the comparables, but he also fell in error by jointly considering the international transactions of both the business models, namely, Indenting and Trading, under one umbrella. We thus hold that both the assessee as well as the TPO fell in error in considering the international transactions under both the models as of uniform character. It has been noticed supra that the ingredients of Operating costs under the Trading model are different from those under Indenting model. Ex consequenti, transactions under both the models are required to be benchmarked separately.

We find that there is insufficient information available on record facilitating the determination of ALP of the international transactions under these two business models separately. We, therefore, set aside the impugned order and remit the matter to the file of AO/TPO for processing the international transactions of `Indenting’ and `Trading’ separately under Chapter X of the Act in consonance with our above analysis. Needless to say, the assessee will be allowed an adequate opportunity of hearing in such a de novo determination.

In the result, the appeal is allowed for statistical purposes.