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Income Tax Appellate Tribunal, DELHI BENCH ‘I-1’ : NEW DELHI
Before: SHRI S. V. MEHROTRA & SHRI A.T. VARKEY
O R D E R
PER A.T.VARKEY JUDICIAL MEMBER :
This appeal, at the instance of the assessee, is filed against the order of the AO, New Delhi dated 22.01.2014 for the assessment year 2009-10 on the following grounds. “That the assessing officer erred on facts and in law in 1. completing assessment under section 144C/143(3) of the Income Tax Act,1961 (‘the Act’) at an income of Rs. 48241533/- as against the income of Rs. 34719813 returned by the appellant.
2. That the assessing officer erred on facts and in law in making addition of Rs. 13521720/- on account of the alleged difference in the arm’s length price of the international transactions on the basis of the order passed under section 92CA(3) of the Act by the TPO. 2.1 That the DRP/TPO erred on facts and in law in inappropriately aggregating the international transaction of provision of agency services with market support services, without appreciating that such services ought to have been aggregated with the distribution segment, being closely linked with such segment. 2.2 That the DRP/TPO erred on facts and in law in not5 appreciating that the distribution and agency segment relates to the same products, viz., ROBs and involves performing some of the common functions by the same employees and it is not feasible to segregate the cost relating to the same. 2.3 That the DRP/TPO erred on facts and in law in not appreciating that the appellant does not employ any separate. Specific personnel/asset for provision of agency services and same employees engaged in the distribution segment perform the necessary functions for provision of agency services. 2.4 That the DRP/TPO erred on facts and in law in allocating common expenses to the agency segment in the ratio of sales, resulting in disproportionate allocation of expenses not commensurate with the functions per not appreciating that such expenses ought to have been allocated in the gross profit ratio. 2.5 That the DRP/TPO erred on facts and in law in using inappropriate quantitative filters which are not based on any rational or reasonable basis. 2.6 That the DRP/TPO erred on facts and in law in selecting the following companies which are functionally dissimilar to the appellant as comparable for the purpose of benchmarking analysis:
a) Choksi Laboratories Ltd. b) WAPCOS
2.7 That the DRP/TPO erred on facts and in law in allegedly rejecting the following comparable companies identified by the appellant: Name of the company Reasons for rejection 1 Educational Consultants India Functionally different Ltd 2 Indian Tourism Development Functionally different Corporation Ltd 3 In house productions Ltd Functionally different 4 ICC International Agencies Service income less Ltd than 75% of tatal sales 5 Access India Advisors Ltd Turnover less than Rs.5 crore 6 Indus Technicl and financial Turnover less than Rs consultants 5crore 7 Mafoi global services Turnover less than Rs.5 crore 8 Overseas manpower Turnover less than corporation Rs.5 crore 9 Priya International Ltd Turnover less than Rs.5 crore 2.8 That DRP/TPO erred on facts and in law in not appreciating that the aforesaid companies are functionally comparable to the appellant. 2.9 That the DRP/TPO erred on facts and in law in adopting inappropriate filter of selecting companies having sales more than five crore without objectively applying this filter for eliminating both low and high turnover companies. 2.10 That the DRP/TPO erred on facts and in law in considering WAPCOS having significantly higher turnover as compared to the appellant and is also not functionally comparable to the appellant. 2.11 That the DRP/TPO erred on facts and in law in not considering multiple year data so as to iron out the fluctuations caused by business/economic/product life cycle.
2.12 That the DRP/TPO erred on facts and in law in not appreciating that use of single year data of the comparable companies may not adequately capture the market and business cycle reflected in the industry. 2.13 That the DRP/TPO erred on facts and in law in not allowing appropriate risk adjustment to establish comparability on account of the appellant being a low-risk-bearing captive service provider as opposed to the comparable companies who were independent entrepreneurs. 2.14 That the DRP/TPO erred on facts and in law in not dealing with the objection of the appellant of comparability adjustment on account of working capital employed by the appellant vis-à- vis comparable companies.”
Briefly stated the facts of the case are that the appellant company is a branch office of a French company, namely, Corning S.A. France which is a leading manufacturer of very high-grade ophthalmic and non-ophthalmic glass products in the world e.g., ophthalmic blanks for eyeglasses and optical fibre etc. For the instant year, appellant filed return of income on 20.09.2009 declaring an income of Rs.3,47,19,813/-. The appellant had entered into following “international transactions” with the head office in France and other Corning group companies during the relevant previous year: (i) Import of ROB’s of Rs. 24,88,09,859/- from Corning Inc. as part of distribution function of import of rough ophthalmic blanks (“ROB’s ) and sale to customers in India; (ii) Import of ROB’s of Rs. 18,843,023/- from Corning Inc. as part of distribution function of import of rough ophthalmic blanks (ROB’s”) and sale to customers in India; (iii) Receipt of agency service commission of Rs. 55,83,829/- from the Corning S.A. France for providing sales representation
services where ROB’s were directly imported by customers in India, from M/s Corning S.A. France; (iv) Receipt of marketing support services fee of Rs. 6,55,50,132/- from Corning Inc., USA; and, (v) Reimbursement of actual expenses of Rs. 81,39,038/- received from Corning China (Shanghai) and Corning SAS, France. (vi) Reimbursement of expenses of Rs. 22,12,448/- paid to Corning Inc.
The assessee computed the arm’s length price of the “international transactions” with the AE, M/s Corning SA France, relating to distribution and agency service activities, with reference to the combined operating profits from the aforesaid activities, treating the same to be part of distribution activity/segment. The appellant considering the functional and risk profile of this function and looking at the available comparable data, selected Transactional Net Margin method using Net profit Margin based on Sales as the profit level indicator to be the most appropriate method for determining the appropriate arm’s length price. It’s search yielded a set of 4 independent companies that were broadly comparable to appellant’s functional and risk profile for the distribution function and, based on three years date (i.e. financial year 2006-2007,2007-2008 and 2008-2009) of the 4 comparables, the net profit margin earned with an arithmetic mean of 2.17%. Accordingly for the year ended on 31.03.2009 appellant had earned a NPM of 7.37% (considering foreign exchange loss) from its distribution operations which was higher than the average OP/OC of comparable companies. Further, so far marketing support services to Corning USA, appellant selected Transactional Net Margin Method using Net Profit Margin based on cost (NCP) as the profit level indicator to be the most appropriate method for determining the appropriate arms length price. It’s search yielded a set of 13 independent companies and, based on three years data (i.e. financial years 2006-2007,2007-2008, and 2008- 2009) of the 13 comparable companies, the NCP margins earned by them was found to range from 3.44% to 14.32% with an arithmetic mean of 9.74%. Accordingly based on +/5% variation in arm’s length price the arithmetic mean of the average NCP margins of the comparable companies was stated to be in range from 3.44 to 14.32%. Thus, as for financial year ending 31.03.2009 appellant had earned a NCP margin of 8.88% from its marketing support services function it was claimed to be within the above mentioned +/-5% range prescribed under the Act.
However, the TPO in an order dated 14.12.2012 rejected the combined evaluation of agency service activity and distribution activity with M/s Corning SA France, as part of distribution activity/segment, followed by the appellant. The TPO segregated the aforesaid activities for the computation of arm’s length price and consequently made an upward adjustment, re-computing the arm’s length price in respect of the agency activities. The TPO held in this regard as under: (i) the functions performed and risks assumed in the distribution function and the agency services function are quite different and therefore ALP for each of them needs to be determined separately; and, (ii) agency services rendered by the appellant were in the nature of marketing services and were of similar nature as marketing support services provided by the appellant to Corning Inc. USA.
The TPO in view of the aforesaid benchmarked the operating results of each of the activity, applying TNMM. For carrying out the aforesaid analysis, the TPO firstly determined the net income from the agency services function by allocating expenses aggregating to Rs. 4,22,77,131/- relating to the distribution segment (comprising of distribution and agency a service functions) in proportion of distribution sales and agency commission (Rs. 2,76,36,560/- and Rs. 1,46,40,570/- respectively) as under:
Particulars Distribution Marketing Distribution Commission Market + + Commission Commission Sales 333,116,146 333,116,146 Other Income- 5,583,829 5,583,829 5,583,829 Commission Other Income – 17,718,834 65,550,132 17,718,834 65,550,132 Marketing Other Income 475,827 475,827 Profit on sale of fixed asset Interest Income Operating 356,894,636 65,550,132 351,310,807 5,583,829 71,133,961 Revenue
Imputed 186,127,633 sales@ 3% commission Sales Ratio 65.37% 34.63%
Expenses Cost of Sales 275,938,204 0 275,938,204 0 0 Salary 14,887,386 28,930,631 9,731,532 5,155,854 34,086,485 Contribution to 1,711,608 1,862,285 1,118,838 592,770 2,455,055 PF and others Staff Welfare 513,928 569,518 335,943 177,985 747,503 Advertisement 1,999,649 352,095 1,999,649 0 352,095 & Promotion Insurance (129,957) 347,523 (129,957) 0 347,523 Repairs & 1,861,291 2,122,772 1,216,682 644,609 2,767,381 Maintenance office Other 3,710,585 10,211,376 2,425,522 1,285,063 11,496,439 Professional service Rent 2,394,226 3,389,657 1,565,049 829,177 4,218,834 Werehouse 9,098,994 9,098,994 0 0 fixed charges Telephone & 1,143,648 1,508,309 747,576 396,072 1,904,381 Telex Travelling and 10,181,431 8,398,832 6,655,361 3,526,070 11,924,902 Conveyence Freight 1,489,326 1,489,326 0 0 Outward Donation 0 Membership & 33,590 564,192 21,957 11,633 575,825 Subscription charges Foreign 1,244,327 813,387 0 0 Exchange Fluctuation Miscellaneous 594,641 1,000,047 388,703 205,938 1,205,985 Depreciation 654,645 1,287,464 427,926 226,719 1,514,183 Recruitment 1,848,868 1,060,150 1,208,561 640,307 1,700,457 Redistributed 1,402,103 (1,402,103) 916,522 485,582 (916,522) charge out Operating 330,578,493 60,202,748 315,969,774 14,177,780 74,380,527 Expenses Reimburseme 347,869 nt of expenses Revised 7,47,28,396 operating cost Operating 26,316,143 5,347,384 35,341,033 -8,593,951 -3,246,566 Profit
Operating 8.88% -60.62% -4.34% Margin (on cost ) Operating 7.37% 10.06% Margin (on revenue)
The TPO on the basis of the aforesaid working concluded that in the agency service function the assessee has incurred loss of Rs. 85,93,951/-.
Further, the TPO for benchmarking the aforesaid net income from agency service function applied the data of comparable entities considered in the Transfer Pricing documentation for benchmarking the marketing support function, whereby arithmetic mean was determined as 9.74%. The TPO accordingly, computed the arm’s length price of the “international transactions” of agency services at Rs. 76,82,106/- as follows:
Operating cost 74728396 Arms length margin% 13.75 Arms length price (ALP) 85003550 Price received 71481830 Shortfall being adjustment u/s 92CA 13,521,720
On the basis of above, the TPO accordingly determined arm’s length price in respect of commission income at Rs. 8,50,03,550/- as compared to Rs. 7,14,81,830/- the commission income received by the assessee and computed adjustment of Rs. 1,35,21,720/- being the difference between the arm’s length price determined in respect of commission income and the actual amount received by the appellant. 3.7 The Dispute Resolution panel (DRP) upheld the order of the TPO and accordingly, the assessing officer on the basis the order of the DRP passed the final order.
Ground No. 1 is general.
Ground 2 to 2.14 of appeal relates to deletion of adjustment of Rs.1,35,21,720/- pertaining to agency services function carried on by the appellant.
When this appeal was called out for hearing, learned counsel for the assessee submitted that this appeal can be decided on the short ground as to whether or not aggregate indirect expenses common to both distribution and agency functions should be done on the basis of gross margin and not on the basis o9f sales, as adopted by the TPO. It is contented that in the event of this issue being decided in favour of the assessee, all other issues raised in this appeal will be rendered academic. Learned counsel thus prays that this issue raised in ground no. 2.4 and 2.5 can be taken up at the threshold itself.
Apropos the adjustment of Rs.20,87,795/- it was contended before the DRP by the appellant that the distribution activity and agency service activity are to be considered together and are not to be evaluated separately to determine the arm’s length price in relation to the aforesaid “international transactions” as the aforesaid two activities transactions form part of natural business segment of distribution of ROBs and are inter linked and closely connected in as much as, (i) the two activities relate to the same products and involve performing some of the common functions by the same employees and it is not feasible to segregate the cost relating to the same; (ii) the agency services rendered by the assessee in relation to sale of ROBs to the customers of Corning France in India, is akin to the distribution of ROBs, in as much as both are aimed at sales and revenues arise to the assessee in both the cases on sale of products to the buyer; in the other hand marketing support service fee is not related to sales; (iii) Corning SA and the assessee branch ensure that arm’s length profit is earned considering the agency service activities as part of the distribution business. 13. With respect to the aforesaid ground of appeal, the Tribunal in the appellant’s own case for the assessment year 2003-2004, rejected the contention of the appellant holding as under: “Having regard to the above factual matrix we are thus inclined to uphold the conclusion of the CIT(A) to benchmark the two independent functions separately. We do not find any merit in the contention raised by the learned counsel that these are closely linked transactions undertaken by the appellant. On the contrary the nature of transactions are functionally different and even the risk assumed are different We thus negate the stand of the assessee and uphold the findings of CIT(A) in benchmarking the distribution/agency function separately.”
14. Accordingly, ground no 2.1 to 2.3 were not pressed by the appellant.
15. With respect to ground no. 2.4-2.5, the appellant further disputed the allocation of expenses relating to agency service activity in proportion to the turnover by the TPO as it is inconsistent with the accepted accounting principles of matching. The appellant contended that contract sales are made by the AE, i.e. Corning France to certain existing customers in India, on which commission is received by the appellant without significant deployment of efforts and resources. The DRP upheld the contention of the TPO. 16. Before us, the Ld. DR relied upon the findings of TPO/DRP to contend that allocation of expenses was proper.
So far as the allocation of expenses is concerned it is noted that TPO had identified indirect expenses common to both the functions at Rs. 4,22,77,131/- details of which are as under:
Particular Distribution and Commission Salary 148,87,386 Staff Welfare 5,13,928 Repairs & Maintenance- office 18,61,291 Other Professional service 37,10,585 Payroll outsourced 13,39,181 Rent 23,94,226 Telephone & Telex 11,43,648 Travelling & Conveyance 101,81,431 Contribution to PF and others 17,11,608 Membership & Subscription 33,590 charges Miscellaneous 5,94,641 Depreciation 6,54,645 Recruitment 18,48,868 Redistributed charge out 14,02,103 Total 422,77,131
With respect to the aforesaid ground of appeal
, the Tribunal in the appellant’s own case for the assessment year 2003-2004, upheld the action of the Ld. CIT(A) and directed the TPO to allocate common expenses in the ratio of gross profit.
19. Following the decision for the assessment year 2003-2004, thus we hold that aggregate indirect expenses common to both the functions should be done on the basis of gross margin of distribution function and commission income receipts and not on the basis of sales, as adopted by the TPO. Allocation of expenses in proportion to sales would amount to give equal weightage in terms of functions performed, assets utilized and risks assumed to both distribution function as well as agency service activity, which otherwise involves much lesser functions and utilization of assets and risk.
20. In the result, the appeal filed by the appellant is allowed for statistical purpose. Order pronounced in open court on this 6th day of November 2015.