DENSO INDIA LIMITED vs.COMMISSIONER OF INCOME TAX
HIGH COURT OF DELHI
S. RAVINDRA BHAT & R.K. GAUBA, JJ.
ITA 443/2013, 451/2013
Feb 29, 2016
(2016) 95 CCH 0057 DelHC
Legislation Referred to
Section 92C(2), 143(1)
Case pertains to
Asst. Year 2002-03
Issue
Transfer Pricing Adjustments
Decision in favour of:
Revenue
Transfer Pricing—Computation of arm’s length
price—Transfer Pricing adjustment—Most Appropriate method—Adoption of
Transactional Net Margin Method—Assessee was engaged in manufacturing and sale
of auto electrical products such as Starters, Alternators, Wiper Motors, CDI,
Magnetos etc., for four wheel and two wheel vehicles—Promoters of assessee
included two Japanese Companies—Those promoters share holding was to extent of
47.93% and 10.27% respectively—Assessee had filed its return for AY 2002-03,
declaring total income of Rs.19,44,45,442/-—Transfer pricing adjustment made
pursuant to ALP determination recommended by TPO and accepted by AO to extent
of Rs.1,36,31,665—TPO had determined ALP at average margin of 6.92% after
eliminating 7 out of 11 comparable companies since their turnover was less than
Rs.100 crores—Assessee’s turnover was over Rs.250 crores—Profit Level Indicator
(PLI) of assessee, in terms of documents furnished by it worked out to
4.36%—Adjustment was, therefore, arrived at Rs.5.86 crore—CIT(A) held that the
adjustments were not justified. The CIT(A) followed his previous order and held
that CUP method was not most appropriate one and that import prices were not
comparable to prices paid to domestic vendors after indigenization—Adjustment of
Rs.97,44,630/- was, therefore, deleted—ITAT held that transactional net margin
method adopted by assessee was most appropriate method envisaged u/s 92C(2)
read with Rule 10C of the Income Tax Rules, 1962—Held, assessee chose to import
components not from manufacturer (which was an AE) but an
intermediary—Normally, this would have been commercial decision, which revenue
authorities would not question—However, interestingly, vendor of components
(which constituted over 85% of raw materials imported and about 38% of total
raw materials sourced) was also connected with both assessee and
manufacturer—If realities emerged during TP exercise, compelling TPO to closely
scrutinize value of such imports and seek further details from assessee, to
justify its decision—Onus was clearly on latter to afford convincing and
reasonable explanation—Such of explanations that were forthcoming, were
apparently unconvincing—Now, there could be no dispute that AO would normally
accept figures given, if they did not show features that call for his
interference—Unusual features which remained unexplained by assessee,
influenced TPO and AO to resort to transfer pricing adjustment and determine
ALP by adopting CUP method for procurements from ‘’X’’—Assessee’s appeal
dismissed
Held
The factual discussion in this case clearly reveals that
the assessee chose to import components not from the manufacturer (which was an
AE) but an intermediary. Normally, this would have been a commercial decision,
which revenue authorities would not question. However, interestingly, the
vendor of the components (which constituted over 85% of the raw materials
imported and about 38% of the total raw materials sourced) was also connected
with both the assessee and the manufacturer. If these realities emerged during
the TP exercise, compelling the TPO to closely scrutinize the value of such
imports and seek further details from the assessee, to justify its decision,
the onus was clearly on the latter to afford a convincing and reasonable
explanation. Such of the explanations that were forthcoming, were apparently
unconvincing. What the assessee banks upon in its appeal to this Court is the
unbending and inflexible acceptance of its TP exercise; according to its logic,
a "bundled" or aggregated series or chain of transactions used in the
TP report should remain undisturbed. Now, there can be no dispute that the AO
would normally accept the figures given, if they do not show features that call
for his interference. However, his job also extends to critically evaluating
materials and in cases which do require scrutiny, go ahead and do so. In the
process, at least in this case, the unusual features which remained unexplained
by the assessee, influenced the TPO and the AO to resort to transfer pricing
adjustment and determine ALP by adopting the CUP method for the procurements
from Sumitomo Japan. High Court finds no infirmity in this approach. As a
result, the first question framed is answered against the assessee and in
favour of the revenue.
(Para16)
Conclusion
When the features adopted for determining transfer
pricing adjustment remained unexplained by the assessee than the TPO and the AO
justified to resort to transfer pricing adjustment and determine ALP by
adopting the CUP method and not by TNMM method.
In favour of
Revenue
Transfer Pricing—Computation of arm’s length
price—Transfer Pricing adjustment— Most Appropriate method—Adoption of CUP
method—ITAT directed TPO to apply Comparable Uncontrolled Price Method—Held,
with regard to adoption of CUP method there was no argument on behalf of
Assessee—At time of framing question Court recorded that it was framed at
insistence of assessee's counsel—In view of findings on first question this
issue was answered in favour of revenue and against assessee.
Held
As far as the second question, i.e the adoption of CUP
method being contradictory with the ITAT's decision is concerned, there was no
argument on behalf of the appellant. That apart, noticeably at the time of
framing the question HIGH Court recorded that it was framed at the insistence
of the assessee's counsel. In view of the findings on the first question and in
view of these facts, this question too is answered in favour of the revenue and
against the assessee.
(Para17)
In favour of
Revenue
Cases Referred to
Commissioner of Income Tax vs. EKL Appliances Ltd. (2012)
345 ITR 241 (Del)
Sony Ericsson Mobile Communications India (P) Ltd vs.
Commissioner of Income Tax (2015) 374 ITR 118 (Del)
Counsel appeared:
C.S. Aggarwal, Sr. Advocate with Prakash Kumar, Advocate
for the Petitioner.: P. Roy Chaudhuri, Sr. Standing Counsel for the Respondent
S. RAVINDRA BHAT, J.
1. These two appeals by the assessee require resolution
of common questions of law and arise from identical or closely similar
circumstances. The questions of law framed in these appeals, on 17.10.2014, are
as follows:
1. Whether the Transactional Net Margin Method adopted by
the assessee is the most appropriate method envisaged under Section 92C(2) of
the Income Tax Act, 1961 read with Rule 10C of the Income Tax Rules, 1962 and
whether the Income Tax Appellate Tribunal had erred in directing the Assessing
Officer to apply Comparable Uncontrolled Price Method?
2. Whether there is a contradiction in the order of the
Income Tax Appellate Tribunal as it has directed that the Transfer Pricing
Officer should apply Comparable Uncontrolled Price Method?
2. The appellant assessee is engaged in manufacturing and
sale of auto electrical products such as Starters, Alternators, Wiper Motors,
CDI, Magnetos etc., for four wheel and two wheel vehicles. Its promoters
include two Japanese Companies, which are M/s Denso Corporation, Japan and M/s
Sumitomo Corporation, Japan. These promoters’ share holding is to the extent of
47.93% and 10.27% respectively. M/s Sumitomo Corporation, Japan is an associate
company of M/s Denso Corporation, Japan. The two companies exercise an overall
share holding control of 58.20%, sufficient to exercise overall management and
control of the assessee.
3. In ITA 443/2013, the facts are that the assessee had
filed its return for AY 2002-03, declaring a total income of Rs.19,44,45,442/-
which was originally processed under Section 143(1). It was later taken up for
scrutiny during the course of which the AO referred the case to the TPO. In
issue is the transfer pricing adjustment pursuant to the ALP determination
recommended by the TPO and accepted by the AO to the extent of
Rs.1,36,31,665/-. The AO finalized the assessment on 30.03.2005. The assessee’s
appeal was allowed by the CIT, who on 30.04.2009 directed the cancellation of
the above. The Revenue appealed and was successful before the ITAT which
restored the addition of the said transfer pricing adjustment amount of `1.36
crores.
4. In ITA 451/2013 for AY 2003-04, the facts are similar
except that the adjustment order was to the extent of Rs.6.83 crores. Of that
amount, the TPO had determined the ALP (to be added to the income) at `5.86
crores. The AO added a further sum of Rs.97 lakhs (Rs.97,44,630/-). The
assessee’s appeal, like for AY 2002-03, was allowed by the CIT(A) on
30.12.2009. The impugned common order of the Tribunal accepted the Revenue’s
contentions and restored the additions made by the AO pursuant to the TPO’s
determination.
5. The facts which are common for the specific questions
of law framed by the Court are that for both the assessment years 2002-03 and
2003-04, the assessee had procured component level inputs for the manufacture
of its products. The total raw material imported was to the extent of
Rs.57,77,00,221 of which the value of imports from Sumitomo Corporation was
Rs.49,86,69,729/- or 86.3% of the total import. It also constituted 37.5% of
the total raw material consumed. This figure related to AY 2002-03. Likewise,
for AY 2003-04, the facts were much the same and the transfer pricing
adjustment leading to addition of Rs.5.86 crores was recommended by the TPO.
The AO, in his order dated 28.03.2006 noticed that there was no difference of
facts between the previous year AY 2002-03 and the current year in question, AY
2003-04 in respect of supplies by Sumitomo Corporation and consequently
directed addition of Rs.97,44,630/-. The TPO had determined the ALP at an
average margin of 6.92% after eliminating 7 out of the 11 comparable companies
since their turnover was less than Rs.100 crores. The assessee’s turnover was
over Rs.250 crores. The Profit Level Indicator (PLI) of the assessee, in terms
of the documents furnished by it worked out to 4.36%. The adjustment was,
therefore, arrived at Rs.5.86 crores. Like for AY 2002-03, the CIT(A) held by
his order dated 30.12.2009 that the adjustments were not justified. The CIT(A)
followed his previous order and held that the CUP method was not the most
appropriate one and that the import prices were not comparable to the prices
paid to domestic vendors after indigenisation. The adjustment of Rs.97,44,630/-
was, therefore, deleted. The common order of the ITAT set aside the order of
the Appellate Commissioner and restored the adjustments directed by the AO.
6. The appellant/assessee argues that the ITAT fell into
error in accepting the AO’s decision as opposed to the well reasoned orders of
the appellate Commissioner. The assessee urges that to determine if the
transaction value of the various raw materials, including payment of royalty, technical
knowhow fees etc., is at arms' length, the net profit margin contemplated under
Section 92C of the Income Tax Act is determinative. The value of each
transaction in respect of every component is to be judged within the net margin
derived by the entity. In this regard, reliance is placed upon OECD guidelines,
particularly Para 3.9. Learned counsel contends that for the purpose of
benchmarking transaction of a broad entity, it is to be considered as a whole
or as a class rather than analyzed on a transaction by transaction basis. It is
emphasized that all transactions which are integral and ancillary to the main
operation of the entity – in the present case, one which engages in
manufacturing, have to be taken together. The assessee had appropriately applied
the transactional net margin method (TNMM) and in doing so aggregated all the
transactions in its transfer pricing report for the purpose of benchmarking
international transactions with the operating profit table cast as the relevant
profit level indicator (PLI). Since the TPO accepted the value of royalty,
technical knowhow and testing fee on the basis of TNMM, he could not have, in
the same order rejected it for the purpose of component purchase and proceeded
to apply an entirely different method, i.e. Comparable Uncontrolled Price (CUP)
method for arriving at the net value of transactions.
7. Mr. C.S. Aggarwal, learned senior counsel points out
that by virtue of Section 92C(1) and (3), statutory guidance in such matters is
that the method most appropriate “having regard to the nature of transaction or
class of transactions or class of associated persons or functions” is to be
viewed. Thus, it is not open to the TPO/AO to segregate a set of transactions
from a series or class of transactions, in the overall benchmarking exercise to
arrive at the PLI. It is urged in this regard that the ITAT’s decision,
rejecting the assessee’s contention that under TNMM, entity level margins have
to be compared and that both imports and domestic purchases could be aggregated
together is erroneous. Reliance is also placed upon para 3.10 of the OECD
guidelines which, it is submitted, grants autonomy to the entity to adopt a
"portfolio approach" as a business strategy where the tax payer
bundles transactions for the purpose of earning appropriate return across
portfolios rather than on a single product within it. These being international
commercial transactions cannot be looked into by tax authorities placing
themselves in the armchair of the businessmen.
8. Learned counsel for the revenue relied upon the ITAT’s
orders and held that they were justified under the circumstances of the present
case. It was pointed out that the TPO’s initial order for AY 2002-03 clearly
revealed that Sumitomo Corporation, Japan had exported 83% of the total goods,
of the value of 86.3% of the total imports by the assessee and accounted for
37.5% of the total raw material consumed. The precise reason why the TPO and
the AO directed the additions which are in dispute were that Sumitomo Corporation
does not manufacture but merely traded in the goods. The assessee was unable to
shed any light why it chose to source the materials from Sumitomo Japan, which
it could have purchased directly from the manufacturer, i.e. Denso, Japan.
Given the close connection between Sumitomo Corporation, Denso and the
assessee, the lack of the explanation coupled with other objective factors
justified the addition. It was submitted that the facts for AY 2002-03 and
2003-04 are identical. The Revenue was justified in treating Sumitomo
Corporation, Japan as the assessee’s AE since the TPO correctly deduced that
purchases routed through their entity were with the sole objective of
camouflaging obvious fact that the assessee made purchases from an AE, i.e.
Denso Corporation, Japan which was the manufacturer. The TPO justly concluded
that the assessee failed to discharge its responsibility as to the application
of the most appropriate method. Consequently, it failed to give reasonable
data, i.e. cost of purchase in the hands of Sumitomo Corporation, Japan, for
determination of aggregate ALP by retail price method and that no other method
except CUP could be applied for ALP determination of the component value from
Sumitomo Corporation. Analysis and conclusions:
9. It is evident from the above discussion that the
narrow controversy which this Court is called upon to decide is as to whether
the adoption of the CUP method by the revenue authorities was justified. What
the assessee urges essentially is that whereas the TP report furnished by it
applied the TNMM method which was found acceptable as regards all other
transactions/business activities, it was not open to the revenue to segregate a
portion and subject it to an entirely different method, i.e. CUP. The assessee
relies upon paras 3.6, 3.9 and 3.10 of the OECD guidelines in support of its
contentions. It also relies upon certain rulings of different Benches of the
ITAT to urge that such sequential segregation and setting portion of the TP
exercise – so to say, to break with the integrity is unjustified and
unsupported by the text of the law, i.e. Section 92C of the Income Tax Act. The
assessee also relies upon Rule 10E of the Income Tax Rules, which guide the
proper approach of the TPO in such matters. In the present case, the reasons
for addition of `1.36 crores for AY 2002-03 and addition of Rs.97 lakhs for AY
2003-04 may be seen from the following extracts of the orders made by the TPO
and AO respectively.
10. The TPO, for the first year (AY 2002-03) noticed that
the assessee had sought to justify imports from Sumitomo Japan by relying upon
an agreement of September 2000. That was an umbrella contract merely enabling
supply to the assessee of certain components, materials and production testing
equipments. The assessee was asked to disclose or provide particulars with
respect to components sold to Sumitomo Corporation by Denso, Japan; expenses
incurred by Sumitomo Corporation towards storage, clearing charges, Customs
Duty etc; agreements, if any, between Sumitomo Corporation and Denso, Japan and
broadly reveal what was the business expediency leading to purchase components
through the intermediary Sumitomo Corporation instead of buying directly from
Denso, Japan, the manufacturer. The assessee’s explanations were that Denso’s services
were essential as a procurement platform through “innovative logistic
activities; preparation of shipping documents, liaison with shipping companies
and airlines agents, for the purpose of negotiation with banks; following-up
with Denso entities to stabilise production through one time delivery of
components and raw materials”. The assessee further stated that the customs
authorities had accepted the import value which could not be questioned by the
revenue in income tax proceedings.
11. The TPO rejected the explanation and noticed that
Sumitomo Corporation held a substantial holding in the assessee company. He
also concluded that the relationship between the assessee, its holding company,
Denso and Sumitomo Corporation was such that Denso, Japan could influence the
transactions between the assessee and Sumitomo Corporation. This, according to
him, fell within the mischief of Section 92B and amounted to an international
transaction. The TPO concluded that there was no explanation that could be reasonable
sound business practice to support the sourcing of components not manufactured
by Sumitomo Corporation. He thereafter concluded as follows:
“7.1 The assessee has not submitted any specific evidence
to substantiate its argument that cost of production is higher in Japan. It has
relied upon general arguments, e.g. high cost of living, difference in wage and
electricity charges, ranking in terms of cost etc. The assessee has chosen to
ignore certain vital facts. For example, the interest rate in Japan is in the
range of 0 to 1% as against 12 to 15% in India in that year. The cost of
capital is a major element of cost in any industry. Next, higher scale of
economies because of production of large quantities of goods results into
substantial cost savings. Further, the indirect taxes in Japan are very low
(the Rate of VAT is 5%) as compared to India. The lower tax burden brings down
the costs in any economy. It is true that wages are comparatively high in Japan
but it is more than effectively neutralized by large scale mechanization,
ingenious management techniques, training, infrastructure etc. resulting in
economies of scale High productivity, to a very large extent, compensates for
the higher wages. The incremental Capital output ratio in Japanese economy is
much better than that in India, i.e. 2.5 (appx) against 4.5 (appx) in India.
Japanese industry is known all over the world for their quality management and
high efficiency. Therefore, this contention of assessee is not very convincing
and not corroborated by concrete facts and evidence.
7.2 It is true that in some cases the prices at which the
assessee purchased components and spare parts from SCJ during the year under
assessment have been compared with the rates at which purchases were made in
the following year(s) from the local parties. Even so, the comparison is not
unreasonable and the circumstances of the case. In fact assessee itself has
used the data of previous two years while using TNMM for computation of ALP of
international transactions. In the absence of information about any other
comparables or costing of such components, it is reasonable to have a look at
the Uncontrolled Cost of such components during the immediately succeeding
year(s). Shorn of legal embellishments, the fact remains that the assessee
purchased components and spare parts manufactured by its holding company. Denso
Corporation, Japan at the rates which were exorbitant as compared to the rates
in the domestic market in the immediately following year(s).
7.3 The facts that Customs authorities did not raise
objections to the invoice value of spare parts and components imported from
Sumitomo Corporation can in no way take away or abridge the power and the duty
vested in the undersigned to satisfy regarding the correctness of the income
returned.
COMPUTATION OF ALP
The responsibilities to establish the arm’s length nature
of the international transaction lies with the assessee. The assessee failed to
discharge this responsibility as the method relied upon by it is not the most
appropriate method for the reasons discussed above. It has failed to give
reasonable data, i.e. cost of purchase in the hands of SCJ to determine the ALP
by RPM. Therefore, it clearly emerges from the discussion above that no method
other than the CUP, i.e. CPM, RPL, TNMM or PSM, can be applied in this case to
determine the ALP of the import of the component from SCJ. Since the assessee
has not brought out any difference in the quality of components purchased from
SCJ and from uncontrolled domestic suppliers, the ALP of imports from SCJ can
be determined by comparing it with the prices of uncontrolled domestic
suppliers. Though, for some components, the indigenization took place in the
subsequent years it can still be used as a valid comparable because it gives
fairly good idea about the cost of production of such components. Wherever, the
indigenization has taken place in the subsequent years, the uncontrolled
domestic price for subsequent years is required to be discounted by the underlying
rate of inflation in the Indian economy to adjust the effect of inflation to
arrive at the comparable uncontrolled price for the year under assessment. For
this purpose, the rate of inflation has been taken at 5% per annum. Further,
imports aggregating to less than Rs.2 lakhs in the years have also been
ignored.”
12. For the succeeding year, i.e. AY 2003-04, the AO held
as follows:
“2. Determination of Arm’s Length Price (ALP) w.r.t.
International Transactions with M/s. Sumitomo Corporation Japan (SCJ)
During the year the assessee has imported raw material of
Rs.51.54 crores from Sumitomo Corporation Japan (SCJ) out of total import of
raw material of Rs.58.29 Crores. Total consumption of raw material has been
shown at Rs.138.43 Crores. It means that import from Sumitomo Corporation Japan
are 88.42% of total import and 37.23% of total raw material consumed. It was
found that during the proceedings of last year, the TPO has found that the said
transactions with SCJ have not been reported as international transaction with
associated enterprise in Form No.3CEB. The situation remains same this year as
well, as international transactions with SCJ have not been incorporated in Form
No.3CEB on the ground that share holding of Sumitomo Corporation Japan (SCJ) of
10.27% in assessee company is less than the required limit of 26% of share
holding provided under IT Act to make SCJ the associated enterprise of the
assessee. After considering assessee’s plea and after giving detailed
reasoning, the TPO in AY 2002-03 has held that international transactions
undertaken with SCJ are covered by scope of Section 92B(2) of Income Tax Act
and most appropriate method to determine arm’s length price in respect of
international transactions undertaken by assessee with M/s. SCL is Comparable
Uncontrolled Priced Method (CUP).
There being no charge in facts and circumstances as
compared to last year therefore, during assessment proceedings assessee company
was asked to furnish details of components which were imported from associated
enterprise (AE) Sumitomo Corporation (SCJ) as well as purchased from domestic
suppliers in same year or in subsequent years. The assessee company furnished
its reply vide letter dated 24.3.2006 giving details of such components stating
that it may not be fair to undertake any comparison between prices charged by
Indian vendors and Japanese suppliers as their exist certain differentiating
factors. The differentiating factors highlighted by the assessee, have
elaborately been discussed by TPO during the course of proceedings of AY
2002-03, the facts remaining same therefore, I rely on TPO’s order of last year
on the issue of purchases made from Sumitomo Corporation, Japan. After allowing
assessee opportunity of being heard and on the basis of details filed before
me, arm’s length price of imports of various components made from SCJ and
adjustments arising out of arm’s length price and book entries have been
calculated in Annexure-A, taking rate of inflation at 5% per annum and ignoring
imports aggregating to less than Rs. 2 lacs during the year, as was the
criteria applied in assessment year 2002-03. As per working made in Annexure-A
to this order, total income of the assessee will be increased by an amount of
Rs.9744630/- which calculating its total income for AY 2003-04 on account of
adjustment in arm’s length price of international purchase transactions of raw
material from SCJ.”
13. Section 92 (3) of the Income Tax Act reads as
follows:
"(3) The provisions of this section shall not apply
in a case where the computation of income under sub-section (1) or sub-section
(2A) or the determination of the allowance for any expense or interest under
sub-section (1) or sub-section (2A), or the determination of any cost or
expense allocated or apportioned, or, as the case may be, contributed under
sub-section (2) or sub- section (2A), has the effect of reducing the income
chargeable to tax or increasing the loss, as the case may be, computed on the
basis of entries made in the books of account in respect of the previous year
in which the international transaction or specified domestic transaction was
entered into."
Rule 10B reads as follows:
“10B. (1) For the purposes of sub-section (2) of section
92C, the arm's length price in relation to an international transaction or a
specified domestic transaction shall be determined by any of the following
methods, being the most appropriate method, in the following manner, namely :—
(a) comparable uncontrolled price method, by which,—
(i) the price charged or paid for property transferred or
services provided in a comparable uncontrolled transaction, or a number of such
transactions, is identified;
(ii) such price is adjusted to account for differences,
if any, between the international transaction or the specified domestic transaction
and the comparable uncontrolled transactions or between the enterprises
entering into such transactions, which could materially affect the price in the
open market;
(iii) the adjusted price arrived at under sub-clause (ii)
is taken to be an arm's length price in respect of the property transferred or
services provided in the international transaction or the specified domestic
transaction;
(b) resale price method, by which,—
(i) the price at which property purchased or services
obtained by the enterprise from an associated enterprise is resold or are
provided to an unrelated enterprise, is identified;
(ii) such resale price is reduced by the amount of a
normal gross profit margin accruing to the enterprise or to an unrelated
enterprise from the purchase and resale of the same or similar property or from
obtaining and providing the same or similar services, in a comparable
uncontrolled transaction, or a number of such transactions;
(iii) the price so arrived at is further reduced by the
expenses incurred by the enterprise in connection with the purchase of property
or obtaining of services;
(iv) the price so arrived at is adjusted to take into
account the functional and other differences, including differences in
accounting practices, if any, between the international transaction or the
specified domestic transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which could materially
affect the amount of gross profit margin in the open market;
(v) the adjusted price arrived at under sub-clause (iv)
is taken to be an arm's length price in respect of the purchase of the property
or obtaining of the services by the enterprise from the associated enterprise;
(c) cost plus method, by which,—
(i) the direct and indirect costs of production incurred
by the enterprise in respect of property transferred or services provided to an
associated enterprise, are determined;
(ii) the amount of a normal gross profit mark-up to such
costs (computed according to the same accounting norms) arising from the
transfer or provision of the same or similar property or services by the
enterprise, or by an unrelated enterprise, in a comparable uncontrolled
transaction, or a number of such transactions, is determined;
(iii) the normal gross profit mark-up referred to in
sub-clause (ii) is adjusted to take into account the functional and other
differences, if any, between the international transaction or the specified
domestic transaction and the comparable uncontrolled transactions, or between
the enterprises entering into such transactions, which could materially affect
such profit mark-up in the open market;
(iv) the costs referred to in sub-clause (i) are
increased by the adjusted profit mark-up arrived at under subclause (iii);
(v) the sum so arrived at is taken to be an arm's length
price in relation to the supply of the property or provision of services by the
enterprise;
(d) profit split method, which may be applicable mainly
in international transactions or specified domestic transactions involving
transfer of unique intangibles or in multiple international transactions or
specified domestic transactions which are so interrelated that they cannot be
evaluated separately for the purpose of determining the arm's length price of
any one transaction, by which—
(i) the combined net profit of the associated enterprises
arising from the international transaction or the specified domestic transaction
in which they are engaged, is determined;
(ii) the relative contribution made by each of the
associated enterprises to the earning of such combined net profit, is then
evaluated on the basis of the functions performed, assets employed or to be
employed and risks assumed by each enterprise and on the basis of reliable
external market data which indicates how such contribution would be evaluated
by unrelated enterprises performing comparable functions in similar
circumstances;
(iii) the combined net profit is then split amongst the
enterprises in proportion to their relative contributions, as evaluated under
sub-clause (ii);
(iv) the profit thus apportioned to the assessee is taken
into account to arrive at an arm's length price in relation to the
international transaction or the specified domestic transaction: Provided that
the combined net profit referred to in sub-clause (i) may, in the first
instance, be partially allocated to each enterprise so as to provide it with a
basic return appropriate for the type of international transaction or specified
domestic transaction in which it is engaged, with reference to market returns
achieved for similar types of transactions by independent enterprises, and
thereafter, the residual net profit remaining after such allocation may be
split amongst the enterprises in proportion to their relative contribution in
the manner specified under sub-clauses (ii) and (iii), and in such a case the
aggregate of the net profit allocated to the enterprise in the first instance
together with the residual net profit apportioned to that enterprise on the
basis of its relative contribution shall be taken to be the net profit arising
to that enterprise from the international transaction or the specified domestic
transaction ;
(e) transactional net margin method, by which,—
(i) the net profit margin realised by the enterprise from
an international transaction or a specified domestic transaction entered into
with an associated enterprise 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;
(ii) the net profit margin realised by the enterprise or
by an unrelated enterprise from a comparable uncontrolled transaction or a
number of such transactions is computed having regard to the same base;
(iii) the net profit margin referred to in sub-clause
(ii) arising in comparable uncontrolled transactions is adjusted to take into
account the differences, if any, between the international transaction or the
specified domestic transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which could materially
affect the amount of net profit margin in the open market;
(iv) the net profit margin realised by the enterprise and
referred to in sub-clause (i) is established to be the same as the net profit
margin referred to in subclause (iii);
(v) the net profit margin thus established is then taken
into account to arrive at an arm's length price in relation to the
international transaction or the specified domestic transaction; (f) any other
method as provided in rule 10AB."
14. The cumulative effect of various provisions of the
Income Tax Act, notably Sections 92, 92C, 92D and 92E read together with Rule
10B and 10D is the obligation to discern, if in a given set of circumstances,
the assessee has disclosed international transactions, as well as an ALP. The
ultimate purpose of this exercise- the primary onus of which is upon the
assessee, is to ensure that no amount which is otherwise to be designated or
treated as income, under law, escapes assessment. The assessee's TP report is
to be accurate and based on materials; its explanations for the queries raised
by the TPO, convincing and reasonable. The underlying emphasis of the law
(Section 92-C) is that the method appropriate to the transaction, amongst the
four specified ones, is to be applied. In the judgment of this Court, reported
as Commissioner of Income Tax v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del),
it was held as follows:
"It is very imperative on the part of the assessee,
to establish before the TPO, that the payments made were commensurate to the
volume and quality of services and such costs are comparable. No such efforts
was made. No ALP was computed by the assessee. As held by the Assessing
Officer, as well as the Commissioner (Appeals), the assessee has not furnished
personnel have rendered marketing services to the assessee company. In fact,
the assessee company has no revenue which has been derived as a result of these
marketing expenses. At the cost of repetition, we state that in the TP report, the
company's submission is recorded at Page-30, and it states that the software
services obtained by the Deloitte from the third party, are not similar to the
services obtained by the Deloitte from the assessee company on account of
requirements of different skill, experience, knowledge level, complexity of
software projects handled, risk bearing capacity, etc. The entire revenue of
the assessee are from the Deloitte. The evidence filed in support of the fact
that services are rendered in the form of e-mails show that they are not
e-mails relating to marketing, but that they relate only to billing. As rightly
pointed out by the learned Departmental Representative, the assessee has no
role in interacting with the client to modify, cancel, renew or extend the
contract. The assessee cannot, even after expiry of the agreement between the
Deloitte and its client, supply services without written consent of Deloitte.
Deloitte has to pay the assessee irrespective of it getting payment or not
within sixty days of raising invoices. Deloitte is responsible for generation
of sales management, delivery of projects, maintaining customer relationship
and billing and collection. The assessee has no market risk. The argument of
the learned Counsel for the assessee that these three marketing personnel
project the capabilities of the assessee company so that Deloitte gets work, is
not supported by any evidence and, hence, without basis. In our view, under
similar circumstances a uncontrolled comparable company would not incur such
expenditure. Hence, the ALP is rightly determined at "nil". As no
expenditure would have been incurred, there is no necessity to apply a
particular method to arrive at such conclusion. In fact, by all the five
methods or any one of them, when applied to the fact that there is no necessity
of payment, the result of "nil" ALP will come."
15. Sony Ericsson Mobile Communications India (P) Ltd v
Commissioner of Income Tax (2015) 374 ITR 118 (Del) was a subsequent decision
by another Bench of this Court, which reviewed the methodology that TPOs are to
adopt while determining ALP. The said judgment held, inter alia, that:
"137. The question of aggregation and disaggregation
of transactions when the TNM Method or even in other methods is sought to be
applied, must have reference to the strength and weaknesses of the TNM Method
or the applicable method. Aggregation of transactions is desirable and not
merely permissible, if the nature of transaction(s) taken as a whole is so
inter-related that it will be more reliable means of determining the arm's
length consideration for the controlled transactions. There are often
situations where separate transactions are intertwined and linked or are
continuous that they cannot be evaluated adequately on separate basis. Secondly,
the controlled transaction should ordinarily be based on the transaction
actually undertaken by the AEs as has been struck by them. We should not be
considered as advocating a broad-brush approach but, a detailed scrutinized
ascertainment and determination whether or not the aggregation or segregation
of transactions would be appropriate and proper while applying the particular
Method, is necessary.
*** ***
140. Sub-section (3), we do not think incorporates a bar
or prohibits set offs or adjustments. It states that Section 92, which refers
to computation of income from international transaction with reference to arm's
length price under sub-section (2) or (2A), would not have the effect of
reducing income chargeable to tax or increase the loss, as the as may be,
computed by the assessee on the basis of entries in the books of account.
Income chargeable to tax or loss as computed in the books is with reference to
the previous year. The effect of sub-section is that the profit or loss
declared, i.e. computed by the assessee on the basis of entries in the books of
account shall not be enhanced or reduced because of transfer pricing
adjustments under sub- section (2) or (2A) to Section 92. It states the obvious
and apparent. In case the assessed has declared better and more favourable
results as per the entries in the books of account, then the income chargeable
to tax or loss shall not be decreased or increased by reason of Transfer
Pricing computation. Thus, transfer pricing adjustments do not enure to the benefit
or advantage the assessed, thereby reducing the income declared or enhancing
the declared loss. Pertinently, the Sub-Section makes reference to the income
chargeable to tax or increase in the loss on the basis of the entries in the
books of account. The concept of set off or adjustments was/is well recognized
and accepted internationally and by the tax experts/ commentators. In case the
legislative intent behind sub-section (3) to Section 92 was to deny set off,
the same would have been spoken about and asserted in different and categorical
words. Legislative intent to the contrary should not be assumed."
Sony Ericcson (supra) thereafter discussed the context
and ruling in EKL Appliances Ltd. (supra) and held as follows:
"147. Tax authorities examine a related and
associated parties' transaction as actually undertaken and structured by the
parties. Normally, tax authorities cannot disregard the actual transaction or
substitute the same for another transaction as per their perception.
Restructuring of legitimate business transaction would be an arbitrary
exercise. This legal position stands affirmed in EKL Appliances Ltd. (supra).
The decision accepts two exceptions to the said rule. The first being where the
economic substance of the transaction differs from its form. In such cases, the
tax authorities may disregard the parties' characterisation of the transaction
and re-characterise the same in accordance with its substance. The Tribunal has
not invoked the said exception, but the second exception, i.e. when the form
and substance of the transaction are the same, but the arrangements made in
relation to the transaction, when viewed in their totality, differ from those
which would have been adopted by the independent enterprise behaving in a
commercially rational manner. The second exception also mandates that actual
structure should practically impede the tax authorities from determining an
appropriate transfer price. The majority judgment does not record the second
condition and holds that in their considered opinion, the second exception
governs the instant situation as per which, the form and substance of the
transaction were the same but the arrangements made in relation to a
transaction, when viewed in their totality, differ from those which would have
been adopted by an independent enterprise behaving in a commercially rational
manner. The aforesaid observations were recorded in the light of the fact in
the case of L.G. Electronics (supra). Commenting on the factual matrix of L.G.
Electronics case (supra) would be beyond our domain; however, we do not find
any factual finding to this effect by the TPO or the Tribunal in any of the
present cases. However, in L.G.Electronics decision (supra), it is observed
that if the AMP expenses and when such expenses are beyond the bright line, the
transaction viewed in their totality would differ from one which would have
been adopted by an independent enterprise behaving in a commercially rational
manner. No reason or ground for holding or the ratio, is indicated or stated.
There is no material or justification to hold that no independent party would
incur the AMP expenses beyond the bright line AMP expenses. Free market
conditions would indicate and suggest that an independent third party would be
willing to incur heavy and substantial AMP expenses, if he presumes this is
beneficial, and he is adequately compensated. The compensation or the rate of
return would depend upon whether it is a case of long-term or short-term
association and market conditions, turnover and ironically international or
worldwide brand value of the intangibles by the third party."
16. The factual discussion in this case clearly reveals
that the assessee chose to import components not from the manufacturer (which
was an AE) but an intermediary. Normally, this would have been a commercial
decision, which revenue authorities would not question. However, interestingly,
the vendor of the components (which constituted over 85% of the raw materials
imported and about 38% of the total raw materials sourced) was also connected
with both the assessee and the manufacturer. If these realities emerged during
the TP exercise, compelling the TPO to closely scrutinize the value of such
imports and seek further details from the assessee, to justify its decision,
the onus was clearly on the latter to afford a convincing and reasonable
explanation. Such of the explanations that were forthcoming, were apparently
unconvincing. What the assessee banks upon in its appeal to this Court is the
unbending and inflexible acceptance of its TP exercise; according to its logic,
a "bundled" or aggregated series or chain of transactions used in the
TP report should remain undisturbed. Now, there can be no dispute that the AO
would normally accept the figures given, if they do not show features that call
for his interference. However, his job also extends to critically evaluating
materials and in cases which do require scrutiny, go ahead and do so. In the
process, at least in this case, the unusual features which remained unexplained
by the assessee, influenced the TPO and the AO to resort to transfer pricing
adjustment and determine ALP by adopting the CUP method for the procurements
from Sumitomo Japan. The "second test" spoken of in Sony Ericcson
(supra) i.e "the form and substance of the transaction were the same but
the arrangements made in relation to a transaction, when viewed in their
totality, differ from those which would have been adopted by an independent
enterprise behaving in a commercially rational manner.." was in effect
adopted. This Court finds no infirmity in this approach. As a result, the first
question framed is answered against the assessee and in favour of the revenue.
17. As far as the second question, i.e the adoption of
CUP method being contradictory with the ITAT's decision is concerned, there was
no argument on behalf of the appellant. That apart, noticeably at the time of
framing the question the Court recorded that it was framed at the insistence of
the assessee's counsel. In view of the findings on the first question and in
view of these facts, this question too is answered in favour of the revenue and
against the assessee.
18. For the foregoing reasons, the appeals fail and are
dismissed. No costs.
*****
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