IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I : NEW DELHI
BEFORE SHRI R.S. SYAL, AM AND SHRI GEORGE GEORGE K., JM
ITA No.242/Del/2010
Assessment Year : 2002-03
CO No.77/Del/2010
(ITA No.178/Del/2010)
Assessment Year : 2002-03
Nokia India (P) Ltd., Vs. DCIT,
1st & 2nd Floor, Tower-A, Circle-13(1),
SP Infocity, Plot No.243, CR Building,
Udyog Vihar, Phase-I, New Delhi.
Dudahera,
Gurgaon.
PAN : AAACN2170R
ITA No.178/Del/2010
Assessment Year : 2002-03
DCIT, Vs. Nokia India (P) Ltd.,
Circle-13(1), 1st & 2nd Floor, Tower-A,
CR Building, SP Infocity, Plot No.243,
New Delhi. Udyog Vihar, Phase-I,
Dudahera,
Gurgaon.
PAN : AAACN2170R
(Appellant) (Respondent)
Assessee By : S/Shri Atul Ninawat, AR, Vikas
Srivastava, Atul Mittal &
Ms Varsha Bhattacharya, Advocate
Department By : Shri Peeyush Jain, CIT, DR
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
ORDER
PER R.S. SYAL, AM:
These two cross appeals one by the assessee and the other
by the Revenue along with a cross objection filed by the assessee
arise out of the order passed by the CIT(A) on 16.11.09 in relation
to the assessment year 2002-03.
2. Ground Nos. 2 and 3 of the assessee's appeal and Ground Nos.
3, 4, 5 and 6 of the Revenue's appeal are against the partial
sustenance/reduction in the addition on account of transfer pricing
adjustment under the Nokia Mobile Phone Sales Division (NMP
Sales) [hereinafter also called the `Trading segment'].
3. Briefly stated, the facts of the case are that the assessee is a
wholly owned subsidiary of Nokia Corporation, Finland. Nokia
Group is engaged in providing network solutions for phone
operators and internet service providers; manufacturing and
distributing mobile phones; providing strategic inputs for business
developments; and providing R&D support to the group entities for
maintaining its technological leadership and competitiveness. The
assessee has four distinct business segments. The major segment
is Nokia Mobile Phones Sales Division or the Trading segment.
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Under this segment, the assessee acts as a distributor of mobile
phones imported from Nokia affiliates throughout India, mainly
through HCL Infosystems (third party distributor). To be more
specific, the assessee acts as a trader of Nokia phones which are
sold mainly to single customer, HCL Infosystems, after importing
from its Associated enterprises (AEs). HCL Infosystems further
distributes the phones through its own network of dealers. The
assessee declared sales of `59 crore and operating loss of `13.9
crore under this segment. In benchmarking this international
transaction, the assessee selected Resale Price Method (RPM) as
the most appropriate method. Gross profit margin under this
segment at 11% was stated to be more than the arithmetic mean
of such margin, on a multiple year data basis, of 9% in respect of
23 comparable companies chosen by the assessee. The
assessee's list of 23 comparables with the business description and
the ratio of GP/sales has been tabulated on pages 3 and 4 of the
Transfer Pricing Officer's (TPO) order. That is how, it was claimed
that the international transactions under this segment were at
arm's length price (ALP). The TPO observed that the companies
chosen by the assessee were engaged in altogether different
nature of business. Some were distributing food products, while
others were trading in electronic goods or textiles etc. On being
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called upon to explain as to why RPM adopted by the assessee be
not rejected on account of high degree of functional and economic
divergence among the comparables and the assessee, it was
stated that all the comparables performed the basic function of
trading and distribution. Unconvinced with the assessee's
submissions, the TPO held that such a method was not capable of
application because apart from dissimilarity of the products dealt
with by the assessee vis-a-vis the so-called comparables, even the
data of the comparables chosen by the assessee was not
appropriately available. He, therefore, rejected the application of
RPM and proceeded to determine the ALP under the Transactional
Net Margin Method (TNMM). He adopted profit level indicator (PLI)
of the international transactions under this segment at Operating
profit margin/Sales. By applying certain filters, the TPO shortlisted
six comparables as listed on page 11 of his order, giving arithmetic
mean of 3.5%. Considering the fact that the assessee spent 23%
of its sales on marketing, whereas this expenditure was much less
in the comparables so chosen by him, the TPO suitably amended
the rate of operating profit. However, vide para 11.2 of his order,
the TPO noticed that accounts of one of the close competitors of
the assessee (whose name was not disclosed for reasons of
confidentiality) gave OP/Sales at 2.64%, whereas this ratio in the
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case of the assessee was at (-) 23%. After considering certain
factors and allowing the effect of higher marketing expenses, the
adjusted profit margin of the assessee was worked out at (-)
8.99%. That is how, the transfer pricing adjustment amounting to
`7,37,39,213/- in this segment was made at 12.49% [3.5%- (-)
8.99%].
4. In the first appeal, the ld. CIT(A) came to hold that RPM was
not capable of application as it was difficult to compute gross
margin by analyzing costs and then establish the functional
comparability of the comparables chosen by the assessee. He
upheld the TPO's action in employing TNMM as the most
appropriate method. He further noticed that both the assessee as
well as the TPO were not justified in not using the current year
data. Relying on certain decisions, it was held that only the
current year's data was required to be employed. Then, he
proceeded to examine the comparable companies as offered by
the assessee and also those chosen by the TPO. Out of 23
comparables chosen by the assessee, the ld. CIT(A) shortlisted four
companies as functionally comparable under the TNMM. From the
companies chosen by the TPO as comparable, the ld. CIT(A)
accepted four companies as comparable, one of which is common
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to both the assessee as well as the TPO. That is how the ld. CIT(A)
initially shortlisted the following seven companies:-
(i) Compuage Infocom Ltd.
(ii) Media Video Ltd.
(iii) Business Link Automation
(iv) Procal Electronics India Ltd.
(v) Redington (India) Ltd.
(vi) Amzel Automotive Ltd.
(vii) Gold Rock Investments Ltd.
Out of these seven companies, the ld. CIT(A) excluded Procal
Electronics India Ltd. which had a high negative margin of (-)
39.58% during the financial year relevant to the assessment year
under consideration, primarily due to excess depreciation cost
along with significant drop in the sales as compared to the
previous year. He further excluded Redington (India) Ltd. on the
premise that it had very high turnover in comparison with the
assessee. That is how, the ld. CIT(A) was finally chose five
companies as comparable with their respective OP/Sales margin as
hereunder:-
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(i) Compuage Infocom Ltd. 2.25%
(ii) Media Video Ltd. 6.77%
(iii) Amzel Automotive Ltd. 3.88%
(iv) Business Link Automation (India) Ltd. 2.81%
(v) Gold rock Investments Ltd. 0.35%
Average 3.21%
He held that only the current year's data should have been
considered. He further held that the TPO was not justified in
benchmarking the assessee's international transactions under this
segment with a competitor whose name was not disclosed. In his
opinion, a detailed review of Annual report and Director's report,
etc., must be made available to the assessee before considering
any case as comparable. He, therefore, excluded the secretly
selected case chosen by the TPO. Then, he went on to consider
advertisement and marketing expenses incurred by the assessee
as well as the final five comparables. After allowing a suitable
adjustment on this score, the TPO reduced the addition on account
of transfer pricing adjustment to ` 3,41,62,617/-. Both the sides
are in appeal against their respective stands.
5. We have heard the rival submissions and perused the
relevant material on record. The first major controversy raised by
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the assessee is on the selection of the most appropriate method
for determining ALP of the international transactions under this
segment. Whereas, the stand of the assessee is that RPM was
correctly employed by it for benchmarking its international
transactions under this segment, the stand of the Revenue is that
TNMM has been rightly held to be the most appropriate method
for the purposes of determination of the ALP.
6. Section 92C(1) of the Income-tax Act, 1961 (hereinafter also
called `the Act`) provides that "the arm's length price in relation to
an international transaction shall be determined by any of the
following methods, being, the most appropriate method, having
regard to the nature of transaction or class of transactions or class
of associated persons or functions performed by such persons or
such other relevant factors as the Board may prescribe." Five
specific methods have been given, which include, RPM and TNMM.
The sixth method is general as may be prescribed by the Board.
There is no quarrel on the point that the sixth method, now
prescribed under rule 10AB, is not applicable to the assessment
year under consideration as the same is operative from the A.Y.
2012-13. Sub-section (2) of section 92C provides that the most
appropriate method referred to in sub-section (1) shall be applied
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for determination of ALP in the manner as may be prescribed. Rule
10B sets out the procedure under the above referred five methods.
Sub-rule (1) of Rule 10B reiterates that the ALP in relation to an
international transaction shall be determined by any of the
prescribed methods being the most appropriate method. When
we read section 92C in juxtaposition to Rule 10B, two things
become vivid. First is that the ALP of an international transaction
is required to be determined by a most appropriate method which
has to be either of the five given in section 92C(1) at the material
time. Second is that such computation can be done only in the
manner as is prescribed under the rule. The instant controversy
narrows down to examining and deciding as to whether RPM or
TNMM is the most appropriate method in the present
circumstances.
7. Before ascertaining the most appropriate method as may be
applicable in the factual scenario obtaining instantly, it is crucial to
have a look at the functions performed and the nature of activity
undertaken by the assessee under this segment. At the cost of
repetition, we are mentioning that the assessee purchased mobile
phones and accessories from Nokia group companies situated
outside India and sold the same to local independent customers,
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mainly, HCL Infosystems. The TPO has also admitted this fact that
the international transactions under this segment involve import of
mobile phones and accessories from foreign AEs which are resold
in India to HCL Infosystems, which is an unrelated party. Thus, it is
palpable that the nature of work done by the assessee under this
segment is that of pure a trader inasmuch as the mobile phones
and accessories imported from foreign AEs have been resold as
such to the local customers without doing any value addition or
any other sort of processing whatsoever.
8. We take up the first issue that the ALP of an international
transaction should be determined by a most appropriate method
which has to be either of the five given in section 92C(1) at the
material time. It will be apposite to first set out the modus
operandi of the RPM, being the method chosen by the assessee as
the most appropriate method, given under Rule 10B(1)(b) for
determination of ALP as under:-
(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 ;
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(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 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 ;
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9. Sub-clause (i) of clause (b) of Rule 10B(1) deals with
identifying the price at which the goods purchased from an AE is
resold. Sub-clause (ii) of clause (b) of Rule 10B(1) talks of reducing
the amount of normal gross profit margin of comparable
uncontrolled transactions from such resale price of the assessee.
Sub-clause (iii) states that the result of sub-clause (ii) is further
reduced by the expenses incurred in connection with the purchase
of goods and sub-clause (iv) provides that the amount so deduced
under sub-clause (iii) is adjusted on account of differences in the
international transaction and comparable uncontrolled transactions
which materially affect the amount of gross profit margin in the
open market. Finally, sub-clause (v) provides that the adjusted
price found under sub-clause (iv) is taken as arm's length price in
respect of purchase of goods from the AE. When we consider the
methodology given under RPM, more specifically sub-clauses (i)
and (v), it becomes patent that sub-clause (i) refers to `property
purchased by the enterprise ... is resold ` and sub-clause (v) refers
to `arm's length price in respect of the purchase of the property ...
by the enterprise '. A close scrutiny of the above two sub-clauses
along with the remaining sub-clauses of rule 10B(1)(b) makes it
clear beyond doubt that RPM is best suited for determining ALP of
an international transaction in the nature of purchase of goods
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from an AE which are resold as such to unrelated parties.
Ordinarily, this method pre-supposes no or insignificant value
addition to the goods purchased from foreign AE. In a case the
goods so purchased are used either as raw material for
manufacturing finished products or are further subjected to
processing before resale, then RPM cannot be characterized as a
proper method for benchmarking the international transaction of
purchase of goods by the Indian enterprise from the foreign AE.
10. Adverting to the facts of the instant case, we find that the
assessee simply purchased mobile phones and accessories from
Nokia group companies situated outside India and resold the same
as such without any further value addition, mainly, to HCL
Infosystems in India. Since the goods imported from the foreign
AEs representing the international transaction under this segment
were neither processed further nor used as raw material for
manufacturing any other product, in our considered opinion, RPM is
the first choice as the most appropriate method for determination
of ALP of the international transaction under this segment.
11. The ld. DR vehemently argued against the application of RPM
in the given circumstances as the most appropriate method by
contending that the assessee incurred huge advertisement and
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marketing expenses. In view of such incurring of expenses, the ld.
DR stated that the better course would be to apply TNMM which
would consider operating profit. We are unable to accept the
contention advanced on behalf of the Revenue. The obvious reason
for this is that the incurring of high advertisement and marketing
expenses by the assessee vis-a-vis the other comparable
companies does not in any manner affect the determination of ALP
under the RPM. When we consider gross profit in numerator and
net sales in denominator, all the expenses debited to the Profit &
loss account automatically stand excluded. It is but natural that
only those expenses can have bearing on the gross profit that are
debited to the Trading account. As the amount of advertisement
and marketing expenses falls `below the line' and finds its place in
the Profit and loss account, the higher or lower spend on it cannot
affect the amount of gross profit and the resultant ALP under the
RPM. If the assessee has incurred more expenses on advertisement
and promotion, which, in the opinion of the ld. DR went on to brand
building for an AE, then, the transfer pricing adjustment on account
of such AMP expenses was separately called for. Since the TPO
has not made any separate adjustment on account of AMP
expenses and has given effect to the same under TNMM, we hold
that the incurring of such higher advertisement and marketing
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spend would not affect the calculation of ALP under the RPM. Ex
consequenti, we hold that RPM prima facie appears to be the most
appropriate method in the facts and circumstances of the instant
case.
12. At this juncture, we note the mandate of Rule 10C which
defines the `Most appropriate method'. Sub-rule (1) of Rule 10C
states that: "For the purposes of sub-section (1) of section 92C, the
most appropriate method shall be the method which is best suited
to the facts and circumstances of each particular international
transaction, and which provides the most reliable measure of an
arm's length in relation to the international transaction." Sub-rule
(2) of Rule 10C lists certain factors which should be taken into
account in selecting the most appropriate method as specified in
sub-rule (1). These factors, inter alia, include - `(c), the
availability, coverage and reliability of data necessary for
application of the method'; and `(d) the degree of comparability
existing between the international transaction and the uncontrolled
transaction ...'. An overview of the factors prescribed for choosing
the most appropriate method indicates that firstly, the data
necessary for application of the given method should be available
and secondly, the uncontrolled transactions should be functionally
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similar, if not identical. A company, in order to be ranked as
comparable under the RPM, should preferably be engaged in doing
similar activity as that of the assessee or at least of the same
genus of the activity albeit with a different species. The above
discussion boils down that if a particular method though on the
face of it appears to be the most appropriate method by
considering the nature of transaction and other relevant factors,
but, is incapable of application either because of the non-
availability/unreliability of the data of the comparables as required
under the given method or for want of functional similarity of the
available cases or for any other reason as given in clause (2) of
rule 10C, then, such a method initially chosen as comparable, is
required to be discarded for replacement with the second best
method that satisfies the requirements of rule 10C(2).
13. We have noticed above that in the given circumstances, RPM
is the first choice for consideration as the most appropriate
method. While discussing the modus operandi given under RPM,
we have noticed that sub-clause (ii) provides for calculation of
gross profit margin as a percentage of sales in respect of
comparable uncontrolled transactions. This primarily contains two
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things, viz., first, the selection of comparables and second, the
availability of their data enabling computation as prescribed.
14. Espousing the first issue of selection of comparables, it is
seen that the assessee chose the RPM as the most appropriate
method by selecting 23 companies as comparable in its TP study
report. A cursory look at the functional profiles of these companies
transpires that some of them are in entirely different line of
business. Obviously, such companies cannot be considered as
comparable. The ld. AR was fair enough to concede this position
by admitting that the companies which are not comparable should
be excluded from the list of comparables. To cut short the
controversy, it was stated by the ld. AR that he was agreeable with
the four companies chosen by the ld. CIT(A) as comparable with
the exception of Media Video Ltd. whose exclusion was assailed.
Apart from that, the ld. AR further requested for the inclusion of
Procal Electronics India Ltd., which was included by the ld. CIT(A)
in the initial list of seven comparables, but, was later on excluded
by stating that it had high negative margin of 39.58%.
15. Now, we will examine as to whether M/s Media Video Ltd.,
was rightly included by the ld. CIT(A) in the list of comparables.
The ld. AR contended that the related party transactions (RPTs) of
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this company were more than 40% and, hence, the same should be
excluded from the list of comparables. To bolster this submission,
the ld. AR invited our attention towards the Annual report of this
company. He referred to a chart prepared by him on page 520 of
the paper book deducing figures from the Annual report of Media
Video Ltd. The percentage of RPTs at more than 40 of this
company was demonstrated by taking in the numerator all the
international transactions of (i) purchase of goods and material; (ii)
sale of goods and raw materials; (iii) rend paid; and (iv) service
income. A sum total of the value of these four international
transactions was taken as numerator with the figure of sales as the
denominator. It was further argued that the RPT filter of 15% was
reasonable. The sum and substance of his submission was that if
all the RPTs of a company are more than 15% of its sales, then
such company should not be considered as comparable.
16. We find that this submission has two components, viz., the
composition of numerator and denominator and the percentage of
such numerator to the denominator. We agree in principle that if
any company though functionally comparable, but, has more than
a specific percentage of the RPTs, then, the same should be
ignored by treating it as a controlled transaction. However, the
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percentage of RPTs to make a company as ineligible for
comparison, in our considered opinion, should be taken as more
than 25% and not 15% as suggested on behalf of the assessee.
The view adopting more than 25% RPTs making a company
incomparable has been taken by various benches of tribunal
including Aglient Technologies International P. Ltd. VS. ACIT (2013)
36 CCH 187 Del Trib ; Stream International Services Pvt. Ltd. VS.
ADIT (IT) (2013) 152 TTJ (Mumbai) 553 ; and Actis Advisers Pvt.
Ltd. VS. DCIT (2012) 20 ITR (Trib) 138 (Delhi). We, therefore, hold
that a company can be considered as incomparable if its RPTs
exceed 25%.
17. Now, we take up the second argument of the composition of
numerator and denominator. Ratio of the RPTs represents the
proportion of transactions with the associated enterprises
(numerator) vis-a-vis the total of transactions (denominator). In
order to decide that what should constitute the contents of
numerator and denominator for the purposes of finding out the
percentage of RPTs, it is relevant to note the logic behind applying
this filter. It is manifest that the aim of the transfer pricing regime
is to ensure that the international transactions are recorded at
arm's length price. This is done under the TNMM by comparing the
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profit earned from the international transaction with that earned by
the comparable independent parties in an uncontrolled situation.
Thus, while choosing comparables, it must be ensured that the
profit earned by them correctly reflects true profit as is earned by
an enterprise from an independent third party. If such a chosen
company, though functionally comparable, has also entered into
international transactions beyond a particular percentage with the
related parties, it is quite possible that its overall profit may have
been distorted due to such transactions rendering it as
incomparable. That is why, this filter is applied to make certain that
a company sought to be considered as comparable should have its
profit uninfluenced by the impact of the related party transactions.
18. In view of the foregoing discussion, it is manifest that the
transactions which do not impact the profitability, such as loan
given or taken or other items finding place in the balance sheet,
can have no place either in the numerator or the denominator of
this formula. However, any income or expenditure
resulting/relating from/to or likely to result/relate from/to such
items of assets or liabilities, should not be confused with the per se
international transactions finding place in the balance sheet of the
company calling for exclusion.
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19. The numerator of this formula consists of all the related party
transactions of a company sought to be chosen as comparable
which affect the profit earned directly from operations. If, however
a related party transaction is of such a nature which does not
directly affect or insignificantly affects the profit earned from the
bare profit producing activity, then it should not be taken into
consideration. The reason for the exclusion of such related party
transactions from the numerator is that they have not at all or very
insignificantly affected the operating profit of such a company,
which is the driving force for the purposes of making a comparison
under the TNMM. To cite an example, the RPT of rent paid by a
company which is engaged in the business of trading or
manufacturing cannot constitute a part of the numerator, because
transaction of rent payment has no direct bearing on the trading or
manufacturing activity.
20. Now, we take up the contents of the denominator of this
formula. The percentage of numerator to denominator can be
calculated only when the contents of a part representing the RPT of
a particular nature is seen with reference to the contents of whole
of that nature. Both the numerator and denominator have to have
the same nature of contents. This can be done by segregating
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transactions of one nature, like, comparing RPT of purchase with
the total purchases or RPT of sales with the total amount of sales of
the company. It is also possible to club small transactions of a
distinct but related income producing activity with a large
transactions of major income producing activity as one unit, both
in the numerator as well as in the denominator. For example, RPT
of major sale transaction and minor job income can be combined to
find out the percentage of RPTs with the total of sales and job
income taken together. In a given case, similar to what is
prevailing before us, where the RPTs comprise of purchase, sales,
small non-operating expenses and service income, we can
preferably find out two percentages of RPTs by ignoring the RPT of
payment of non-operating expense of rent, which does not directly
affect the profit earned from trading activity. First percentage of
RPT purchases with total purchases and second of RPT sales and
service income as one unit with the total of sales and service
income again as one unit. The decision as to whether such a
company be included in the list of comparables by applying the
filter of more than 25% RPT, would depend on the outcome of two
such percentages of RPTs. If either of the two breaches the 25%
threshold, then the company will cease to be comparable. If
however, both the percentages are less than 25%, then the
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company would be liable for inclusion in the list of comparables.
We want to make it clear that the above discussion about the
components of RPT formula is relevant only in the case of an
assessee who is a Trader/Distributor and not a Service
provider/receiver or a Manufacturer. Since we are concerned in
the extant case with the application of RPT filter in the case of a
Trader, we have restricted ourselves only to a trader and have thus
desisted from examining the contents and other relevant
considerations in the application of this filter to a Service
provider/receiver or a Manufacturer.
21. Turning to the facts of the instant case, it is seen that the
assessee has computed the percentage of related party
transactions of Media Video Ltd. by clubbing all the four types of
international transactions in the numerator, viz., Purchase of goods
and materials; Sale of goods and materials; Rent paid; and Service
Income, all totaling Rs.22,43,46,000 and the amount of net sales
as denominator at Rs.55,25,22,266. We fail to appreciate the
rationale of the manner in which this exercise has been carried out
by the assessee for computing the percentage of RPTs of this
company at 40.60%. All the debit and credit items of trading and
profit and loss account representing related party transactions
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have been taken as numerator, but when the question of choosing
denominator came, the assessee preferred to pick only the figure
of net sales of this company. This approach is absolutely illogical
and lacks credibility. The ld. AR argued that even if the approach
adopted by him was not acceptable, still, the RPTs of Media Video
Ltd., were more than 25%. However, he admitted not to readily
have such figures to substantiate his contention. We find that the
international transactions of rent paid by this company at
`1,46,000 is quite insignificant and this transaction has no relation
with its main source of the income producing activity, viz., Sales
and Service charges. The same is, therefore, directed to be
excluded from consideration in the numerator. In so far as the
other international transactions of this company are concerned,
their percentage of RPTs is required to be considered as discussed
above by comparing the RPTs of purchases with total purchase and
the RPTs of sales and service income with the total of sales and
service income. Since thorough examination of the Annual
accounts of this company is necessary to deduce these figures, we
are of the considered opinion that this exercise should be left to be
done by the TPO at his end. We, therefore, direct the TPO to redo
this exercise for M/s Media Video Ltd., in accordance with our
above discussion for ascertaining whether this company should
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continue in or be excluded from the final list of comparables drawn
by the ld. CIT(A). If the percentage of RPTs as discussed above
finally comes to more than 25%, then, this company should be
excluded from the list of comparables. In the otherwise situation,
the inclusion of this company in the list of comparables is justified.
22. Now, we turn to M/s Procal Electronics India Ltd., which the ld.
AR insists for inclusion in the list of comparables. The ld. DR, on
the perusal of the Annual accounts of this company, submitted that
this company was engaged in manufacturing as well as trading
and, hence, the same cannot be included in the list of
comparables. There is no dispute on the fact that the assessee is
simply engaged in the trading activity under this segment. In such
a situation, a company can be included in the list of comparables
only if either it is not engaged in manufacturing or the segmental
results, if any of its trading segment are available. The ld. AR was
fair enough to concede that if the segmental results of this
company from the trading segment are not available, then, it
should not be included in the list of comparables.
23. We, therefore, set aside the impugned order on this issue and
remit the matter to the file of the TPO/AO for examining as to
whether the financial results of M/s Procal Electronics India Ltd. are
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available for the trading segment. If these are found to be
available, then, such segmental results should be included. In the
otherwise situation, the order excluding this company from the list
of comparables is justified.
24. As far as the Revenue's ground against the exclusion of some
of the companies chosen by the TPO is concerned, the ld. DR,
except for relying on the order passed by the TPO, could not point
out any cogent reason for including such disclosed companies in
the final list of comparables which were chosen by the TPO, but,
rejected by the ld. CIT(A). It can be seen that the ld. CIT(A) has
given valid reasons for rejecting the declared companies chosen by
the TPO, such as, M/s Batliboi Ltd. which is dealing in industrial
machinery and M/s Controlled Printing India Ltd., which is engaged
in the business of trading in coding and marketing machines. Ergo,
we uphold the impugned order to the extent of exclusion of some
of the disclosed companies which were chosen by the TPO. The ld.
DR contended that the undisclosed company (secret comparable)
was strictly in the assessee's line of business and presented a good
comparable. It was, therefore, requested that the same be directed
to be included in the list of comparables. We partly agree with the
contention advanced by the ld. DR on this score. There can be no
26
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CO No.77/Del/2010
question of a secret comparable. It goes without saying that if
there is a company which is comparable, then the same should be
included in the list of comparables, so as to make an effective
comparison. At the same time, no company can be considered by
the TPO as comparable, unless the assessee is given a chance to
show that it is not comparable. This can be possibly done only
when all the relevant particulars of such company including its
functional profile and annual accounts are made available to the
assessee giving it an effective and substantive opportunity. As
such, we direct the TPO to disclose all the necessary particulars of
such a secret company including its name etc., if the same is
proposed to be included in the list of comparables. If the assessee
succeeds in showing that this so far secret company is not
comparable, then the same be excluded and vice versa. This
disposes of the aspect of selection of companies as comparable.
25. Having dealt with the first component of sub-clause (ii) of rule
10B(1)(b) about the selection of comparables companies, now we
move on to the second component about the availability of their
data enabling computation as prescribed. On being called upon to
explain the working given by the assessee under the RPM in
respect of companies chosen by it as comparable, the ld. AR took
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us through such calculation, which brought out that the calculation
of gross profit has been wrongly made by reducing purchases from
the figure of sales with the adjustment on account of difference of
inventory, wherever applicable. It goes without saying that the
calculation of gross profit encompasses the consideration of not
only the figure of purchase as well as inventories, but also of the
direct expenses which are debited to the trading account. The ld.
AR admitted that the figure of gross profit was computed by the
assessee in the manner as demonstrated, i.e., without the effect
on direct expenses incurred by the comparable companies. Such
an approach is totally misplaced inasmuch as it is not possible to
tinker with the modus operandi given in the formula for calculation
of the ALP. The numerator in the formula under the RPM is gross
profit. Obviously, such a numerator cannot be substituted with
anything less or more than the gross profit. The Special bench of
the tribunal in the case of L.G. Electronics India (P) Ltd. VS. ACIT
(2013) 152 TTJ 273 (Del) (SB) has held that `Rule 10B has specified
a set procedure to be followed for determining the ALP distinctly
under the five methods. It is ... not permissible to invent a new
procedure and try to fit such procedure within any of the existing
procedures prescribed as per these methods. No one is authorized
to add one or more new steps in the prescribed procedure or to
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ITA Nos.242 & 178/Del/2010
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substitute any other mechanism with the one prescribed under the
rule. It is neither possible to invent a new method nor to substitute
a new methodology in place of the one prescribed in the rule.'
Further sub-section (2) of section 92C makes it abundantly clear
that the most appropriate method referred to in sub-section (1)
shall be applied for determination of ALP in the manner as may be
prescribed. In the light of the above discussion, it is explicit that
the numerator in the formula given under the RPM cannot be
substituted with anything else. To be more precise, if the figure of
gross profit of the comparables is not readily available from their
annual accounts, then application of the RPM as the most
appropriate method would be jeopardized.
26. When this position was confronted to the ld. AR, he submitted
that the assessee can try to find out the figure of gross profit of the
final list of comparables for working out the ratio of GP to sales in
order to benchmark the international transactions of the assessee
under this segment. Under such circumstances, we are of the
considered opinion that it would be in the fitness of things if the
impugned order is set aside and the matter is restored to the
TPO/AO. It is directed to first try to determine the ALP under RPM
method strictly going by the mandate of Rule 10B(1)(b). If the
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ITA Nos.242 & 178/Del/2010
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assessee succeeds in placing before the TPO the figures of gross
profit of the comparables, then, the ALP should be determined by
considering GP/sales of the comparable companies as discussed
above and, thereafter, the prescription of other sub-clauses of Rule
10B(1)(b) be applied. If the figures of gross profit of the
comparable companies are not available, then, the RPM cannot be
considered as the most appropriate method. In such an
eventuality, TNMM should be applied with the suitable PLI.
27. With the above directions for a fresh computation of ALP of
the international transactions under the trading segment, the
grounds raised by the assessee are allowed for statistical purposes.
Ground No. 3 of the Revenue's appeal is dismissed inasmuch as we
hold that only the current year's data should be applied for
computation of PLI of the tested party as well as comparables.
Ground No.5 of the Revenue's appeal in allowing relief on account
of advertisement and marketing expenses cannot be decided at
this stage because of our direction for firstly applying RPM. Only if
RPM is found to be inapplicable, because of lack of data, etc., the
TNMM will be applied. If such an eventuality arises, then, the TPO
will consider the effect of advertisement and marketing expenses
afresh as per law, after allowing a reasonable opportunity of being
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ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
heard to the assessee. Ground No.6 of the Revenue's appeal in
allowing adjustment of (+)/(-) 5% of ALP is consequential which has
to be considered in the fresh determination of profit rate of
comparables as well as that of the assessee either under RPM or,
alternatively, under TNMM.
28. Ground nos. 4 and 5 of the assessee's appeal are against the
confirmation of disallowance of `26,19,816/- (after allowing
depreciation @ 20% on total expenses of `34,93,088/-) towards
marketing expenses incurred by the assessee on account of
providing handsets to AMSC's, dealers and employees.
29. After considering the rival submissions and perusing the
relevant material on record, we find that this issue is no more res
integra inasmuch as the Tribunal has restored such issue to the file
of AO by its order in the appeals for assessment years 2000-01 and
2001-02. Respectfully following the precedent, we set aside the
impugned order and remit the matter to the AO for deciding it in
conformity with the direction given by the Tribunal in its order for
the immediately preceding years.
30. Ground No. 1 of the Revenue's appeal is against the deletion
of disallowance of ` 58,72,028/- out of foreign travelling expenses.
The ld.CIT (A) deleted this disallowance made by the AO by
31
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
following the order passed by the Tribunal in assessee's own case
for assessment years 2000-01 and 2001-02. Respectfully following
the precedent, we uphold the impugned order. This ground fails.
31. Ground No. 2 of the Revenue's appeal is against the deletion
of disallowance of ` 77,95,857/- out of warranty provision. Here
again, we find that the Tribunal has decided this issue in
assessee's favour in the aforenoted order. This ground also fails.
32. Now we move on to the Revenue's ground no. 7, by which it is
aggrieved against the deletion of addition on account of transfer
pricing adjustment in NET R&D segment and NIC R&D segment.
The factual scenario of this ground is that the assessee rendered
contract services to Nokia Internet Communication (NIC) Research
Centre, Hyderabad, carrying out research on network security
appliances and network management solutions, for which it was
remunerated at cost plus 5%. Gross revenue under this segment
amounted to `5.9 crore. Apart from this, the assessee also
rendered contract R & D services to Nokia Network Technology, R
& D Division on cost plus 7%. Gross revenue under this segment
amounted to `3.9 crore. The assessee applied TNMM as the most
appropriate method for benchmarking these international
transactions with PLI of OP/TC. The assessee selected 51
32
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
comparable cases to demonstrate that the international
transactions under this segment, on a consolidated basis, were at
ALP. The mean margin of these companies, by taking the weighted
average for the years 1999-2000 and 2000-01, was taken at 20%.
On account of economic downturn experienced in this year owing
to 11th September disaster, a downward adjustment of 5% was
made in such margin of the comparables. Another 5% downward
adjustment was made to the mean margin on account of working
capital adjustment. The TPO found that the mean margin by use of
the current year data was 19.17%. He rounded it to 20%. No
deduction on account of downturn, as claimed by the assessee at
5%, was allowed. He took arm's length margin at 15% after
allowing adjustment of 5% on account of working capital
difference. As against the assessee's list of 51 comparable cases,
the TPO selected 60 companies as comparable, which have been
tabulated on pages 17 and 18 of his order. This exercise done by
the TPO resulted into transfer pricing adjustment of `85,20,942/-,
which was added by the AO. The ld. CIT(A) accepted the TPO's
action in not granting deduction of 5% on account of downturn.
He, however, excluded three sets of companies from the list of
comparables drawn by the TPO. After such exclusion and allowing
(+)/(-) 5% adjustment, the ld. CIT(A) found that the price charged
33
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
by the assessee from its associated enterprises was at ALP.
Consequently, the addition so made by the AO came to be knocked
down. The Revenue assails the deletion of this addition.
33. We have heard the rival submissions and perused the
relevant material on record. It is observed that there is no dispute
on any aspect other than the exclusion of three sets of companies
by the ld. CIT(A), which were chosen by the TPO. We will take up
these three sets of companies one by one for consideration and
decision.
34. The first set contains thirteen companies tabulated on page
65 of the impugned order, which were excluded by the ld. CIT(A)
on the touchstone of the filter of rejecting companies whose ratio
of depreciation to the total cost was less than 5% and more than
50%. It can be seen from the TPO's order that this filter was
applied by the TPO himself. However, while giving effect to this
filter, the TPO inadvertently failed to exclude these thirteen
companies from the list of comparables, albeit these admittedly
did not qualify for the inclusion on the basis of such filter. This
contention raised by the assessee before the ld. CIT(A) was
remitted to the TPO for examination. Vide remand report dated
24.08.09, the TPO simply stated that: "the proportion of
34
ITA Nos.242 & 178/Del/2010
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depreciation as a percentage of cost is a matter of fact and the
same needs to be decided accordingly." Thus, it is amply borne out
that the TPO himself applied this filter for rejecting some of the
companies from the list of comparables and by application of such
filter, these thirteen companies were also liable to be excluded
which were inadvertently included by the TPO in the list of
comparables. The application of this filter and these companies
consequently not qualifying for inclusion has not been denied by
the TPO in the remand report, the relevant part of which has been
reproduced above.
35. Ordinarily, we would not have approved the application of
the filter of excluding some companies on the basis of lower or
higher depreciation as a percentage of total costs (not the
simplicitor quantum of depreciation allowance) . It is axiomatic
that higher amount of depreciation follows in the initial years of the
installation of machinery or other assets because of the higher
base. With the increase in the age of the asset, the written down
value goes on decreasing, which results into downward sojourn of
the annual amount of deprecation over the years. At the same
time, it is equally true that when asset is new, there are low costs
of repairs and other incidental expenses connected with the
35
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
operation of the assets. Thus it is evident that the effect of higher
amount of depreciation in the initial years is set off by the lower
amount of the cost of repairs etc. But with the increase in the age
of the asset, no doubt, the amount of annual depreciation
allowance declines, but at the same time, repair costs etc. boost
up. Operating cost includes not only the cost of repairs etc. but
also the amount of depreciation allowance. Consequently,
operating profit also carries the effect of both the depreciation
allowance and repairs cost etc. Under the TNMM, the numerator is
always the amount of operating profit. When the amount of
operating profit embraces the effect of depreciation allowance and
also repairs cost etc., both of which ordinarily run in the opposite
directions, there is no reason to discard an otherwise comparable
case simply on the ground of higher or lower percentage of amount
of depreciation allowance. As the higher amount of depreciation is
usually coupled with the lower repair cost etc., and vice versa,
there can be no justification in applying the filter of rejecting the
companies with depreciation higher or lower than a particular
percentage of total costs.
36. Be that as it may, it is noticed that the TPO ventured to
apply this filter and by applying the same, excluded some of the
36
ITA Nos.242 & 178/Del/2010
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companies which were not suitable to him. However, he forgot to
exclude these thirteen companies, which were probably favoring
the assessee's case. As this filter has been applied and acted upon
by the TPO partially, we are unable to order at this stage that this
filter be not applied because the companies favoring the assessee
on this filter must have already been excluded by the TPO, which
now cannot be brought back. Since these thirteen companies are
liable to be excluded on the basis of the filter applied by the TPO,
we have no option but to countenance the view taken by the ld.
CIT(A) in excluding these thirteen companies from the list of
comparables on the strength of the same filter.
37. The second set of the companies excluded by the ld. CIT(A)
comprises of HCL Technologies Ltd., and Mastek Ltd. These
companies were excluded on the basis of the filter of rejection of
companies having related party transaction over 25%. Since RPTs
of these two companies stood at 36.89% and 47.45%, respectively,
the ld. CIT(A) directed their exclusion. The ld. DR failed to point
out with any cogent material that the related party transactions of
these two companies were less than 25%. In earlier part of this
order, we have held that the companies having related party
transactions of more than 25% cannot be considered as
37
ITA Nos.242 & 178/Del/2010
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comparable as these fail the test of uncontrolled transactions.
Following the same decision, we hold that the ld. CIT(A) was
justified in excluding these two companies, whose percentage of
RPTs stood at 36.89% and 47.45%. As such, we uphold the view
taken by the ld. CIT(A) on the exclusion of these two companies.
38. The last set of companies excluded by the ld. CIT(A) on
turnover filter includes seventeen names. The TPO applied the
filter rejecting companies having sales less than `5 crore without
any upper cap. The assessee argued before the ld. CIT(A) that its
turnover under this segment amounted to `9.72 crore and, as
such, there was no justification in either excluding the companies
with sales less than `5 crore or including the companies with
turnover of more than `50 crore. After obtaining the remand
report from the TPO, the ld. CIT(A) held that these seventeen
companies with sales of more than `50 crore be excluded from the
list of comparables.
39. After considering the rival submissions and perusing the
relevant material on record, we find that the assessee's turnover
under this segment is to the tune of `9.72 crore. The TPO excluded
the companies with the turnover of less than `5 crore without
applying any upper limit of the turnover. The preliminary question
38
ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
which looms large before us is whether the application of this filter
is correct? In this regard, it is relevant to note that the
computation of arm's length price under the Indian transfer pricing
provisions is embodied in section 92C of the Act. Sub-section (1) of
this section provides that the arm's length price in relation to an
international transaction shall be determined by any of the given
methods, being the most appropriate method, having regard to
certain factors. Proviso to sub-section (2), which assumes
significance for the present purpose, states that : `where more
than one price is determined by the most appropriate method, the
arm's length price shall be taken to be the arithmetical mean of
such prices`. In contrast, some countries have adopted the
interquartile range, which is also called the midspread or middle
fifty, instead of arithmetic mean of all, as used in India. When
arithmetic mean is taken of the all the otherwise comparables
companies, it tends to iron out the differences due to higher or
lower size of a company or vacillating profitability rates. A
company otherwise found to be functionally comparable cannot be
excluded either on the ground of higher or lower profit rate or
higher or lower turnover. There is no mention in the language of
the provisions for the exclusion of potential comparable companies
simply on account of high or low turnover or profit rate. The Special
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ITA Nos.242 & 178/Del/2010
CO No.77/Del/2010
bench of the tribunal in Maersk Global Centres (India) (P.) Ltd. VS.
ACIT (2014) 147 ITD 83 (Mum)(SB) has also held that potential
comparables cannot be excluded merely on the ground that their
profit is abnormally higher. There can be no justifiable reason to
exclude such high or low profit companies unless it is shown that
such high or low profit was due to abnormal factors. Same logic
applies to the high or low turnover companies also. The mere fact
that a company has a high or low turnover can be no reason to
justify its exclusion if it is otherwise functionally comparable. The
exclusion of companies on such a rationale runs contrary to the
express provisions of the Act.
40. At this stage, we consider it our duty to go through the
judgment of the Hon'ble jurisdictional High Court in CIT VS. Agnity
India Technologies (P.) Ltd. (2013) 219 Taxman 26 (Del). In that
case, the assessee was a captive unit providing software services
to its associated enterprises. The Hon'ble High Court directed the
exclusion of Infosys Ltd. from the list of comparables, which list
otherwise included several companies with huge turnover. The
exclusion was ordered on account of the giantness of this
company, which was, in turn, determined by seeing the cumulative
effect of several factors, including risk profile, nature of services,
40
ITA Nos.242 & 178/Del/2010
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turnover, ownership of branded/proprietary products, onsite vs.
offshore services, expenditure on advertisement and R&D etc. The
higher turnover was only one of the criterion and not the sole
criteria for the exclusion of this company. In view of the above
discussion, we hold in principle that no potentially comparable
company can be expelled from the list of comparables simply for
the reason of high or low turnover.
41. Adverting to the facts of the instant case, it is seen that the
assessee's turnover under this segment amounted to less than `10
crore. The TPO has applied the turnover filter by setting a lower
limit of turnover at `5 crore without setting any upper ceiling of
turnover. We fail to comprehend any legally sustainable reason
for applying the filter setting a lower limit of turnover at around
half of the assessee's turnover and leaving the upper limit
uncapped. It is trite that law does not permit a person to both
approbate and reprobate. This proposition has sanction of the
Hon'ble Supreme Court in R. N. Gosain Vs. Yashpal Dhir (1992) 4
SCC 683. Under this rule, a person cannot be permitted to blow
hot and cold in the same breath. As the TPO has himself applied
the lower limit at half of the assessee's turnover, there is
justification in applying some upper limit as well. Taking a holistic
41
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view of the matter, we approve the view taken by the ld. CIT(A) in
the present peculiar facts and circumstances by fixing the upper
limit of turnover filter at `50 crore. The situation would have been
different if the TPO had either set no or a nominal lower limit of the
turnover filter, leaving the upper limit open. In that situation, there
would have been no reason to set any upper turnover filter as well.
Ergo, we countenance the conclusion drawn by the ld. CIT(A) in the
present unusual circumstances.
42. When the above three sets of companies are held to be
rightly excluded, the price charged by the assessee from its
associated enterprises in this segment of international transactions
comes within (+)/(-) 5% range as per proviso to section 92C(2) of
the Act, warranting no addition on account of transfer pricing
adjustment. We, therefore, uphold the deletion of the addition of
`85.20 lac.
43. The cross objection filed by the assessee is simply in support of
the impugned order granting relief to the assessee on the grounds
which are subject matter of the Revenue's appeal. In view of our
decision on the appeal filed by the Department, the Cross objection
of the assessee has become infructuous.
42
ITA Nos.242 & 178/Del/2010
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44. In the result, the appeals of the Revenue and the assessee
are partly allowed for statistical purposes and the Cross objection
of the assessee is dismissed.
The order pronounced in the open court on 31.10.2014.
Sd/- Sd/-
[GEORGE GEORGE K.] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 31st October, 2014.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.*
*
43
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