IN THE INCOME TAX APPELLATE TRIBUNAL
(DELHI BENCH "I" NEW DELHI)
BEFORE SHRI I.C. SUDHIR AND SHRI T.S. KAPOOR
ITA No. 6463 & 5082/Del/2011
Assessment Year: 2007-08
Mitsui & Co. India Pvt. Ltd., vs. Deputy CIT,
th
Plot No.1, 4 Floor, Circle 6(1),
Salcon Ras Vilas, District Centre Saket, New Delhi.
New Delhi.
(PAN: AADCM4488J)
(Appellant) (Respondent)
Appellant by: Shri Ved Jain & Ms. Rano Jain, CAs
Respondent by: Shri Sanjay Prasad, CIT( DR)
Date of hearing : 26.05.2015
Date of pronouncement: 20:08.2015
ORDER
PER I.C. SUDHIR: JUDICIAL MEMBER
These are two appeals for the assessment year 2007-08 and 2008-09
directed against the order dated 21-10-2011 and 26-11-2012 passed by the
Deputy Commissioner of Income Tax, Circle 6(1), New Delhi under Section
143(3) read with Section 144C of the Income Tax Act.
2. Since the facts and the issue raised in both these appeals are common,
the same are being disposed of by a common order and for the purpose of
adjudication the facts of assessment year 2007-08 are being taken up.
2
3. The assessee has raised as many as seven grounds of appeal.
However, the core issue involved in these appeals is addition made by the
AO on account of the arm's length price determined by the Transfer Pricing
Officer and confirmed by the Dispute Resolution Panel.
4. The assessee company is a wholly owned subsidiary of Mitsui & Co.
Ltd., Japan. Mitsui & Co. Ltd., Japan is one of the leading sogo shosha
establishment in Japan. Sogo shosha means general trading and these
companies are general trading companies. These companies play an
important role in linking buyers and sellers for wide range of products. The
range is very wide that it includes grain and oil, machinery, equipment, etc.
5. The assessee company being a subsidiary of the Mitsui & Co. Ltd.,
Japan provide support services to the various group entities of Mitsui & Co.
Ltd., Japan. This support services is the main activity whereby it acts as a
facilitator for the transactions entered into by Mitsui & Co. Ltd., Japan and
other group entities of the Mitsui & Co. Ltd., Japan.
6. During the assessment year 2007-08 the assessee company has
entered into following transactions:-
3
Transaction
(Rs.)
1. Provision of services 528,379,089
2. Purchase and sale of goods 118,385,397
3. Purchase of capital goods 1,987,760
4. Interest received 2,227,448
5. Reimbursement of expenses received/ receivable 52,587,644
6. Reimbursement of expenses paid/payable 100,737,320
7. The learned TPO noted that the assessee has used TNMM
(Transactional Net Margin Method) as the most appropriate method and the
Profit Level Indicator (PLI) selected is `Berry Ratio' against operating
expenses. The contention of the assessee was that the average berry ratio
come out to 1.34 as against 1.09 computed on the basis of the 20
comparables set out in the transfer pricing study and hence the transactions
entered into by the assessee company was at arm's length price.
8. The learned TPO, however, did not agree with the assessee's
contention. The TPO was of the view that under Rule 10B(4, the data to be
used has to be only of the related financial year. The leaned TPO was also
of the view that the way the assessee has computed arm's length price by
using berry ratio as PLI, the entire international transactions relating to sales
and services of the commodities have remained out of the PLI. The learned
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TPO was of the view that the cost of sale is to be included in the
denominator of the PLI used. It was the contention of the learned TPO that
as per the Income Tax Rules operating expenses cannot be the basis as these
expenses do not include cost of sales. The TPO in support thereof invoked
the provisions of Rule 10B(1)(e)(i) to hold that net profit margin realized by
an assessee from an international transaction entered into with associated
enterprises is to be computed in relation to costs incurred, sales effected or
assets employed by the assessee. The TPO further held that as regards the
support services provided by the assessee is concerned, the right course will
be to treat such services as equivalent to trading and the income received by
the assessee from such support services is to be considered as income from
trading and comparison need to be made accordingly.
9. On the above principle the learned TPO identified seven new
comparables and accordingly issued a show cause notice as under:-
"7. It is proposed to treat the service and commission income
segment as equivalent to trading segment and therefore,
propose to add the result of commission and service segment
related to AEs and include Rs.4512 crores as cost of goods sold
in this combined AE segment. You are hereby required to
show cause as to why the service/commission income is not
treated as trading business in substance.
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You are also required to show cause as to why Rs.4512
crores should not be included in the cost base of
service/commission segment. I propose to apply OP/TC
percentage of comparable companies, searched from Prowess
on the combined cost base, including the value of goods on
which commission is earned by Mitsui India, related to AE
segment to arrive at the arm's length profit fro the trading and
service/commission segment. A set of following comparable
companies were search from database available in the public
domain after applying a turnover filter of Rs.100 Crore in the
trading companies. Final set of the comparable companies are
hereunder:
Company Name OP/OE (percentage)*
Frost International Ltd. 1.99
P K S Ltd. 4.34
General Commodities Pvt. Ltd. 3.04
Sakuma Edports Ltd. 2.08
Kotak Ginning & Pressing Inds. Ltd. 2.94
Cottage Industries Exposition Ltd. 3.04
Euro Vistaa (India) Ltd. 5.78
Average (Mean) (percentage) 3.32
*Note: Financial Data of FY 2006-07
9. Computation of arm's length profit from service/commission
segment is given below:
Approx. Cost base of AE-segment (AE 45,589,044,859
service segment + AE- trading segment)
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(A)
Mean of OP/TC of comparables (Arm's 3.32%
length OP/TC): (B)
Operating profit reported before 59,774,453
including value of goods on which
commission is earned: (C)
Arm's length profit(D)=(A)X(B) 1,513,556,289
Deficit = D-C 1,453,781,837
The above difference of Rs.1,453,781,837 is proposed as an
adjustment to the value of international transactions for FY
2006-07"
10. In response to the show cause notice issued by the learned TPO the
assessee submitted a detailed reply contending as under:-
"i. The assessee essentially in the business of providing
sales support and coordination activities in relation to its
international transactions: The assessee argued by
comparing the FAR of trader vis-à-vis a service provider
and concluded that the FAR of the assessee is akin to the
FAR of a service provider.
ii. Berry Ratio has been rightly selected as the PLI:
iii. Value of Rs. 4512 Crores should not be added to the cost
base of the assessee's international transactions: The
assessee claimed that adding Rs.4512 Crores in the cost
base of the AE segment tantamount to recharactersing the
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service segment as a trader. The assessee once again
reiterated that the FAR of the service and commission
business is different from FAR of the trading business. It
claimed that FAR of the AE segment of the assessee is
akin to FAR of a service provider and therefore Rs.4512
Crores should not be included in the cost base.
iv. Comparables selected by the TPO are incorrect and the
margins computed by the assessee be accepted as the
same is derived from annual report which more reliable
source than Prowess."
11. The TPO, however, did not agree with the contention of the assessee
and proposed an adjustment of Rs.107,53,92,764 as under:-
"It is concluded that the assessee has not been able to
substantiate its arguments with valid documentary evidences.
Following the discussion the preceding paras, the FOB value of
goods sourced from India, being Rs. 4512 Crores shall be taken
as part of the cost base to calculate the remuneration of the
assessee. Computation of arm's length profit for the combined
AE segment (computation of profit of AE segment is attached as
Annexure 1) is given below:
Cost base of AE segment
(AE-service segment + AE-Commission 45,589,044,859
segment) (A)
Mean of OP/TC of comparables
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(Arm's length OP/TC): 2.49%
(B)
Operating profit reported: 59,774,453
(C)
Arm's length profit 1,135,167,217
(D)=(A)X(B)
Difference to be adjusted 1,075,392,764
= D-C(Rs)
12. Aggrieved by the draft assessment order passed by the AO as per the
recommendations of the TPO, the assessed filed objection before the learned
DRP.
13. The learned DRP upheld the action of the learned TPO in re-
characterizing the transaction as that of a trader as against service provider.
It, however, directed the TPO to exclude one comparable viz., Cottage
Industries consequent to which the margin got increased from 2.49% to
2.56%. The adjustment thus was increased from Rs.107,53,92,764/- to
Rs.110,73,05,095/- in assessment year 2007-08.
In the A.Y. 2008-09
14. During the assessment year 2008-09, the assessee company entered
into following transactions:-
9
Transaction
(Rs.)
1. Provision of services 687,916,048
2. Purchase of goods 127,624,787
3. Sale of goods 23,900,120
4. Purchase of assets 1,289,604
5. Reimbursement of expenses received/ receivable 53,342,485
6. Reimbursement of expenses paid/payable 127,537,685
15. The learned TPO following order of assessment year 2007-08, re-
characterized the transaction as trading transaction and by including Rs.4005
Crores as cost of goods sold in the combined AE segment and by applying a
margin of 2.91% proposed an addition of Rs.116,60,28,331/-.
16. In this A.Y. 2008-09, the learned DRP again upheld the action of the
learned TPO. However, it directed the TPO to exclude three comparables
consequent to which the margin got reduced to 2.82% and accordingly
adjustment also got reduced to Rs.112,93,80,700/-.
17. Aggrieved by the order passed by the DRP and the consequential final
assessment order passed by the AO, the assessee is in appeal before us. It
was contended by the learned AR that the action of the TPO and the DRP in
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making the above adjustment on account of arm's length price is against the
Transfer Pricing Regulations as well as decided case laws under similar set
of facts. The activities of purchase and sale i.e. trading involves risk and
finance whereas in the activity of support services i.e. intending transactions
the assessee company has neither to incur any financial obligation nor
carries any significant risk. The nature of two activities is absolutely
different. The activities of trading i.e. purchase and sale are highly
insignificant as compared to activity of support service which constitutes the
core business activities of the assessee company. The learned TPO and the
learned DRP has gone wrong in applying the trading margins ignoring the
facts of the case that the assessee being a service provider the trading
margins cannot be applied. Further the learned TPO and learned DRP has
gone wrong in including the cost of sales in OP/TC ignoring the fact the
value of the sale under no circumstances effects the activities of the assessee
company, a service provider. For support services the correct method is the
TNMM and the assessee has computed the same on the basis of OP/TC. The
TPO was not justified in ignoring the same. The OECD guidelines also
supports this contention that in TP study business transactions cannot be re-
characterized. The support service or intending provided by the assessee
company is nothing but a trading facilitation both in form and substance.
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There is no allegation nor any material brought on record to suggest that
support services/intending transactions are trading transactions submitted by
the Learned AR. He submitted further that the TPO has not been able to
identify any intangible being created as is being alleged regarding human
intangible/supply chain. The Mitsui Japan has been operating since long and
doing business on its own since long. The assessee company was
established only to provide support services to the existing business of the
Mitsui Japan and as such to cut price such transaction and compare the same
with the trading transactions is not correct.TPO has not been able to point
out any error in the comparables submitted by the appellant company and
the same being at arm's length, the adjustment proposed by the TPO and as
confirmed by the DRP needs to be deleted. The TPO has gone wrong in
benchmarking the business support services provided by the assessee
company to AE with that of independent trading transactions for
determining the arm's length price in respect of business support services.
18. It was further argued by the ld. AR that the company is engaged in
providing business support services to various group companies of Mitsui
Japan. For this it has entered into arrangements whereby it provides
business support services which include:-
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(i) Support in business promotion
(ii) Collection of market information
(iii) Coordination with customers
(iv) Collection of account receivables from client on behalf of AE
(v) Administrative services
(vi) Networking
(vii) Other support services
The Learned AR submitted that the trading activities are undertaken
by Mitsui Japan not by Mitsui India. If it is import of goods for
buyers in India, the Mitsui Japan has a contract with the Japanese
suppliers and Mitsui Japan also enters into contract with the buyers in
India. Similarly for exports from India, Mitsui Japan enters into a
contract with Indian supplier directly for the purchase and sales
transactions. Thus the role of Mitsui India, the assessee company is a
mere facilitator, a mere service provider. Mitsui India does not take
title or possession of the merchandise at any moment and bears no
price risk. Mitsui India does not take inventory risk, it does not take
warranty risk, it does not take credit risk. It does not employ its
capital. In purchase and sale, inventory, advances, debtors, Mitsui
India's main function is to maintain contact with the suppliers to
ensure timely delivery of merchandise to the customers in the quality
and grade desired, communicating with Mitsui India or its affiliates,
gathering information on demand and supply conditions of the
commodities. The above functions are entirely different than the
trading business. In trading activities, one ventures himself. Buys
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and sells goods in it's account. It takes price risk, inventory risk, it
deploys capital in inventory, debtors. It takes risk in warranty, credit,
etc. Thus the functions performed, assets deployed and risk assumed
in trading are entirely different than that of business support services.
The TPO has gone wrong in holding that margins earned in trading
are in identical circumstances as while providing support services.
19. The learned AR further contended that the finding given by the TPO
that appellant company has over a period of time developed a supply chain
intangibles, which is all about having the right product in the right place, at
the right price, at the right time and in the right condition, is wrong and
against the facts. In this regard reference made by the TPO in its order about
the assessee company having developed knowledge of products and design,
knowledge of acquisition, knowledge of quality control, knowledge of
storage is wrong and against the facts. These are none of the activities of the
assessee company as is evident from the description of business support
service provided by it. Assessee company simply provides facilitation
services to entities in supply chain without being a part of the supply chain.
The assessee company has created human intangibles. In this regard the AR
submitted that TPO has just made a literary reference in his order about
human intangibles and held that assessee has created human capital
intangible ignoring the facts and the detailed reply submitted by the
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assessee. The facts are that the activities performed by the assessee are
routine, preparatory and auxiliary in nature which does not create any
intangibles. Organizations providing support services employ human
resources for the same and that does not lead to creation of any intangibles.
Assessee's role is limited to that of a routine coordination and support
service provider. It is Mitsui Japan which has the expertise, a strong relation
with a vast network of manufacturers, distributors and buyers.
20. On the issue of inclusion of cost of sales in the denominator it was
submitted by the Learned AR that reasoning given by the TPO in the order
that compensation model in the case of the assessee should be expressed as a
percentage of FOB price of goods serviced through the assessee is also
wrong. In this regard the observation of the TPO that the assessee has
played a major role in identifying supplier raw material are factually
incorrect. The Mitsui Japan has been in the business since long. It has been
doing international trading and making sale and purchase from India. It is
not that the business has been developed by the assessee company for Mitsui
Japan. The assessee company has been incorporated in March, 2005 to
provide facilitation services. Its role is to provide business support services
only. The comparison model as a percentage of the value of the goods can
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be good where the service provider has knowledge of the product,
knowledge of the quality, its usage and has developed competency. In this
regard this model can't be applied to an entity which is just providing
support services to an entity who in turn has core competency of that
business, its product, design, etc. There is a difference in carrying on the
business oneself and providing support service to the one who is doing the
business.That reasoning given by the TPO for adding cost of goods sold
while computing margin is not correct. The Rule 10B(e)(i) specifically
provides that net profit margin in relation to transaction entered into with an
AE is computed in relation to costs incurred, or sales effected or assets
employed or to be employed by the enterprise. The cost incurred here will
mean the cost incurred by the enterprise which will in the case of the
assessee mean the cost incurred in providing services. Since no sales have
been effected by the assessee company it is not appropriate to take cost of
sales for computing margin.That even otherwise the compensation model to
determine the arm's length price based on a single rate of commission on
total FOB value of all types of goods to be sold will not be appropriate. The
percentage of brokerage or commission for procuring business in respect of
luxury goods or commodities is higher as compared to the percentage of
commission or brokerage for high value products like gold, bullion.
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Similarly the percentage of commission or brokerage for consumer products
is always higher as compared to the industrial products. Thus even where
commission rate based on value of goods sold to be applied the nature and
type of product n respect of which such services have been rendered have to
be taken into consideration and then a comparison needs to be made with the
commission rate prevalent in respect of such product goods. In the present
case the nature of products and items varies a lot. The TPO without even
looking at any of these items details has in a most arbitrary manner
considered trading as one and the same to support services and applied
trading margin in different nature of the product and items to the support
services taking turnover of the AE as the basis. That the TPO was not
justified in re-characterizing the transaction of business support services as
that into trading and applying the profit margin in the trading as the PLI.
21. It was argued by the ld. AR that in the preceding assessment year i.e.
2006-07, the assessee's method of benchmarking its international transaction
relating to provision of business support services using TNMM at the most
appropriate method with OP/TC as PLI has been accepted and the addition
was made only with regard to the margin computed with reference to the
comparables used. The basis for computation i.e. OP/TC as PLI was not
17
tinkered with. That there is no change in the nature of services being
provided by the assessee company to its associate enterprise since 2003
when the appellant company was incorporated and it has been consistently
benchmarking its international transaction relating to business support
services using TNMM at the most appropriate method with OP/TC as PLI.
This is the correct method. The method adopted by the TPO is not a method
at all prescribed. As per the balance sheet of the company the total capital of
this company is just Rs.24.30 Crores (PB Pg. 140 Vol. II) and its main
activity is just to provide support services. It is just unimaginable that a
company with a capital of Rs.24.30 crores can do a trading of more than
Rs.4500 crores and earn a profit of Rs.114 crores as has been determined by
the TPO.
22. It was further submitted by the learned AR that the issue is squarely
covered by the judgment of Delhi Tribunal in the case of Sojitz India (P)
Ltd. vs. DCIT 24 ITR (Trib) 474 (Del), where facts being identical, exactly
the same issue has come up. Sojitz India (P) Ltd. was also a subsidiary of
Sojitz Corporation, Japan. Sojitz Corporation, Japan was also a sogo shasha
company i.e. general trading company. Sojitz India (P) Ltd. was also
engaged in providing support services to the Sojitz Corporation, Japan and
18
its group companies. The major activities of the Sojitz India (P) Ltd. were to
provide support services. A very small part of the activity was trading in
India as is the case here. The TPO was of the view that the activities of
service provider is similar to the activities of the trader and hence by
applying margin in trading activities he made an adjustment to the arm's
length price in respect of the support services.
23. The ITAT Delhi Bench after elaborate discussion has held as under:-
"12.19. On a consideration of the business profile of the
assessee as available on record and the nature of services
rendered and the risk profile of the assessee, we are of the
view, that the TPO erred in considering that the activity of a
service provider is similar to the activity of a trader."
24. The learned AR further submitted that the issue is also covered by the
judgment of Hon'ble jurisdictional Delhi High Court in the case of Li and
Fund India Pvt. Ltd. vs. CIT 361 ITR 85 (Delhi). Further the above
judgment has also been considered again recently by Delhi Bench of ITAT
in the case of Mitsubhishi Corporation India (P) Ltd. vs. DCIT, ITA No.
5042/Del/11 dated 21.10.2014 where facts are identical and similar issue has
come up and the coordinate bench has held that TPO was not justified in re-
19
characterizing the transaction as trading transaction and it has been further
held that cost of sales can't be included.
25. It was further submitted by the learned AR that even as per TPO's
computation no adjustment can be made to the arm's length price in view of
the proviso to Section 92C as applicable for the assessment years under
consideration the margin is within 5% of the price at which international
transaction has been undertaken by the assessee company. In this regard the
learned AR submitted that the TPO after holding that cost of goods sold is a
relevant criteria has not taken the issue to its logical conclusion. Per
contrary he has proposed an adjustment of Rs.107,53,92,762/- whereas
considering the provisions of proviso to section 92C(2) no adjustment was
called for. It was submitted that the proviso to Section 92C actually talks
about comparing the price of international transaction with the Arm's length
Price so determined. Thus even if it is assumed, without accepting it, that
TPO has correctly calculated the mean PLI of 2.49%, then also TPO has
erred in making addition to the income of the assessee as the transaction of
the assessee are within + / - 5% range, as provided in the proviso to section
92C as can be seen from the following table:-
20
Particulars Amount Rs.
A.Y. 2007-08 A.Y. 2008-09
Cost of Base of AE Segment (Z) ... refer TPO 45,589,044,859 4071,95,89,546
order Pg. 21
Operating Profit Reported by the assessee (Y) ... 59,774,453 1,89,11,725
refer TPO order pg 21
Total Sales / Commission Income (A) = (Z) + 45,648,819,312 4073,85,01,271
(Y)
Mean OP/TC (B) 2.56% 2.28%
Arm's Length Profit as per mean OP/TC (C) = B 116,70,79,548 114,82,92,425
*Z
Arm's Length Cost (D) = A C 4448,17,39,764 3959,02,08,846
Total Cost Base as per TPO (Z) 45,589,044,859 4071,95,89,546
Difference 110,73,05,095 112,93,80,700
5% of the ALP (As per proviso to Sec 92C) i.e. 222,40,86,988 197,95,10,442
5% of (D)
In the present case undisputedly even if cost of goods sold is included
as has been done by TPO in the total cost the gap is less than 5% and
hence no adjustment otherwise can be made.
26. The learned CIT(DR) supported the order of the learned TPO as
confirmed by the Dispute Resolution Panel (DRP). It was contended that the
TPO has given detailed reasoning in his order for making adjustment to the
arm's length price. It was further contended that the comparables selected by
the assessee and used in its TP report are not correct comparables and
accordingly the TPO was justified in rejecting the same. As regards the
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contention of the learned AR that the facts of the case are similarto the case
of Sojitz India (P) Ltd. (Supra) and Mitsubishi Corporation India (P) Ltd.
(Supra) it was submitted that though facts of the present case are almost
similar to the facts of these two judgments relied upon by the AR as all these
companies are providing support services to the parent company in Japan
engaged in Sogo Shosha i.e. general trading companies, but still each of the
case has to be considered on its own merit.
27. On the issue of consistency as argued by the learned AR it was
submitted by the Learned CIT(DR) that in the year under consideration the
TPO has carried out an in-depth analysis and hence the acceptance of the
assessee's arm's length price in the preceding year cannot be a ground to not
to make adjustment in the year under consideration. On the issue of the
alternative submission of the learned AR it was submitted that this benefit is
not available to the assessee company as the method applied is only one
method i.e. Transactional Net Margin Method. It was contended that the
benefit of this proviso will be available only when arm's length price is
determined by applying two methods and the difference in the two methods
is within 5 per cent.
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28. We have considered the arguments advanced by the parties and gone
through the orders of the authorities below as well as the judgments relied
upon. On going through the order of TPO in the case of the assessee and the
order passed by the ITAT in the case of Mitsubishi Corporation India (P)
Ltd., we note that the facts of the two cases are almost similar. In this regard
we note that the ITAT in Para 7 of its order has recorded the FAR analysis
carried out by the TPO. It may be relevant to quote para 7 of the order
passed by the ITAT in the case of Mitsubishi Corporation India (P) Ltd.
(supra) as under:-
"7. As the Transfer Pricing Officer rightly noted, the main
issue in this case is adjudication on the question "whether
...(the assessee).. is being adequately compensated" for the
functions performed by the assessee. The TPO then proceeded
to analyze functions of the assets, risks assumed by the
assessee and assets employed by the assessee. He noted that,
as set out in paragraph 3.4 of the transfer pricing study, the
assessee has provided the services for (a) facilitating
communication between buyer and seller; (b) arranging
freight, insurance and custom clearance through third parties;
(c) collecting market information; (d) identifying potential
customers (in import transactions only) or suppliers (in export
transactions only); and (e) advising an associated enterprise
or third party in regulatory or financial matters. It was also
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noted that, as stated in the transfer pricing study, "the
presence of assessee in India provides AEs a medium of
communication through which they can compete with their
competitors eyeing similar business in India". The TPO was of
the view that "the assessee has performed all the critical
functions, assumed significant risks and used both tangible
and unique intangibles developed by it over a period of time".
He then summarized the FAR analysis as follows:
Functions performed by the assessee:
-Purchasing activities: Mitsubishi India places orders with
related party vendors after receiving orders or projections
from its customers
-Distribution activities: In some of the principal transactions,
Mitsubishi India warehouses Inventory at public bonded
warehouses and maintains sufficient Inventory as per
agreement with customers. It performs Inventory control and
ships goods to customers. Mitsubishi India's customers
sometimes arrange for their own shipping and handling.
-Sales marketing and after sales activities: In principal
transactions, the Group Companies coordinates in negotiating
prices with Mitsubishi India's customers. Mitsubishi India's
sales personnel requirements are Identified by Mitsubishi
India and also remuneration of sales personnel is determined
by Mitsubishi India. Mitsubishi India is responsible for billing
and collection. Mitsubishi India provides market research
relating to local market and develops marketing strategy.
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-Identifying potential customers and suppliers.
-Information gathering.
-Facilitating communication
-Arrangement of logistics.
-Accounting and administration.
-Developing long term strategic policies.
-Dealing with finance, accounting, IT and legal issues.
-Human Resource Management:
(b) risks assumed by the assessee:
-bears volume risk
-bears foreign exchange risk
-bears manpower risk
(c) assets used by the assessee:
-Fixed asset"
29. In the order passed by the learned TPO in the case of the assessee
before us, the FAR analysis stated by the TPO in para 5.2.1 is exactly the
same as stated hereinabove in the case of Mitsubishi Corporation India (P)
Ltd.. The conclusion drawn by the TPO and quoted in the judgment of the
Mitsubishi Corporation India (P) Ltd. in para 9 of the order are also exactly
the same as in para 5.3 of the TPO's order in the case of the assessee
25
company. Thus we are of the view that the facts of the present case are
similar to the facts of the Mitsubishi Corporation India (P) Ltd. In the
Mitsubishi Corporation India (P) Ltd.(supra), the ITAT has held that it is
impermissible to make notional addition in the cost base and then take into
account the cost which are not borne by the assessee. The ITAT while
giving the above finding has relied upon the judgment of the Hon'ble
jurisdictional Delhi High Court in the case of Li & Fung (Supra) whereby
the Hon'ble Court has held as under:-
"...........This Court is of opinion that to apply the TNMM, the
assessee's net profit margin realized from international
transactions had to be calculated only with reference to cost
incurred by it, and not by any other entity, either third party
vendors or the AE. Textually, and within the bounds of the text
must the AO/TPO operate, Rule 10B(1)(e) does not enable
consideration or imputation of cost incurred by third parties
or unrelated enterprises to compute the assessee's net profit
margin for application of the TNMM. Rule 10B(1)(e)
recognizes that "the net profit margin realized by the
enterprise from an international 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 ..." (emphasis supplied). It thus
contemplates a determination of ALP with reference to the
relevant factors (cost, assets, sales etc.) of the enterprise in
26
question, i.e. the assessee, as opposed to the AE or any third
party. The textual mandate, thus, is unambiguously clear.
40. The TPO's reasoning to enhance the assessee's cost base by
considering the cost of manufacture and export of finished
goods, i.e., ready-made garments by the third party venders
(which cost is certainly not the cost incurred by the assessee), is
nowhere supported by the TNMM under Rule 10B(1)(e) of the
Rules. Having determined that (TNMM) to be the most
appropriate method, the only rules and norms prescribed in
that regard could have been applied to determine whether the
exercise indicated by the assessee yielded an ALP."
30. In view of the above judgment of Hon'ble jurisdictional High
Court, we hold that it was not correct on the part of the TPO to include
the cost of sales incurred by the AEs in respect of which the assessee
company has rendered services and then to work out the profit for
determination of the arm's length prices. Our view is also supported by
the judgment of the Delhi Tribunal in the case of Sojitz India (P) Ltd. vs
DCIT (Supra) where a similar issue has come up. In that case also the
learned TPO has included the cost of sale of all the AEs while
determining the arm's length price and has also considered the
transactions entered into by the assessee company as transaction that of
27
trading activity. The ITAT has examined this issue and has held as
under:-
"12.18 In the aforementioned background we are of the
view that in order to adjudicate upon the issues it would be
appropriate for us to formulate the questions as under:-
(a) Whether the TPO on facts was justified to treat the
indenting activity at par with the trading activity ;
(b) If the answer to the query posed in (a) is "yes" then were
the margins earned in the trading activity by the assessee with
non AEs correctly applied to the indenting activity with AEs ;
(c) If the answer to the query posed in (b) is "yes" then would
the 'costs' referred to in Rule 10B (1) (e) (i) be the FOB value
of goods on the facts of the present case or would it be the
operating cost of the assessee;
(d) If the answer posed to the query in (a) is "no" then is there
any justification on facts in applying the margins earned in the
trading activity to the profits of indenting activity for working
out the Arms Length Price.
12.19. On a consideration of the business profile of the
assessee as available on record and the nature of services
rendered and the risk profile of the assessee, we are of the
view, that the TPO erred in considering that the activity of a
service provider is similar to the activity of a trader. The
decisive factors as to why the question framed in (a) has been
28
answered in the negative, are being elaborated in the
following paras based on the Business Profile, FAR analysis
etc. which we have deliberated on in the earlier paras.
12.20. The unrebutted facts available on record is that the
assessee is a service provider to the extent of 88.67% of its
total earnings. As per the contracted terms and the unrebutted
stand of the assessee it is merely providing indenting services.
At no point of time the title in goods or possession of the
merchandise is in assessee's hands. The contract is entered
into by SCJ and Indian customers directly whether for export
or import. The negotiations are directly done by SCJ and the
Indian customers and the assessee merely functions as a
facilitator. Looking at the nature of services rendered and the
arguments advanced which also remain unrebutted and as
such are taken to be correct the assessee does not need to
incur cost either for maintaining or storing the inventory or
for the transportation as the title in goods is never held by the
assessee for its indenting activity as a service provider.
Consequently the assessee is not exposed to any credit risk in
maintaining the inventory nor is the assessee exposed to price
risk or the risk linked with offering credit sales. From the
nature of the risk profile of the assessee and on considering
the functions performed and the assets deployed it can be
safely concluded to be that of a low risk business, which has
also been the claim of the assessee. It is a matter of record
that in these years the assessee has also shown profits on its
29
own trading with non AEs. In the facts available on record,
nothing has been brought on record by the TPO to either
justify that the assessee has made a wrong claim on facts
while claiming to be engaged in indenting activities or was
infact performing all or some of the functions of a trader, in
which eventuality the TPO would have been well within his
rights to re-characterize the assessee's indenting activities as
a trading activity. It is an accepted economic principle that
the trader acting as an entrepreneur is exposed to price risk,
cost risk, credit risk, warranty risk etc, which would
necessitate the contract being entered into and negotiated by
assessee. In its indenting activity these facts are not evident.
Accordingly the question posed in (a) is answered in the
negative.
12.21 Considering the next question posed, even if the answer
in (a) is in the negative, we see that there is no reasoning and
justification for applying the margins earned in trading
activity to indenting activity as the two are distinct and
separate. Merely because the assessee was also having a
small level of trading activity in its own name, there is no
reason available on record either justifying the action of re-
characterizing the nature of assessee's activity from a service
provider to that of a trader. As observed, neither the TPO has
lead any discussion nor has the DRP cared to throw any light
on the aspect for upholding the action of the TPO. Where all
the critical functions were being performed by the AE, the
30
services provided, as a facilitator, by the assessee cannot be
treated as a trading activity. The performance of the critical
functions, like decisions to enter into contract, to negotiate the
terms of the contract, to decide the level and extent of
exposure for price risk, credit risk, warranty risk etc are some
of the risks to which a trader is exposed. The record shows
that at no point of time the assessee was ever exposed to any
of those risks as such, the two activities could not be treated at
par and thus invited a similar treatment.
12.22. The Ld. CIT DR has relied upon various decisions in
support of the TPO's order and the order of the DRP which we
propose to discuss subsequently. However it can never be over
emphasized that each decision operates on its own peculiar
facts and circumstances. This holds equally good for orders
and judgments rendered in the context of transfer pricing as
each change or nuanced change in facts and circumstances
would call for a detailed appreciation of facts and
circumstances of both sets of cases. Transfer pricing litigation
as we have seen is very fact drive. Consequently for
appreciating the principles laid down in the judgements and
orders, a detailed factual study of the business model FAR
analysis and even economic conditions, if need be, have to be
closely examined. Only then the applicability or relevance of
the principle laid down be considered. The issues being purely
factual necessarily warrant a detailed discussion.
31
12.23. In the facts of the present case it is seen that the
assessee is using the network of SCJ for rendering its services.
Reference may also be made to page 248 of the paper book
which contains the TP study of the assessee the same is
reproduced for ready reference.
"Patents, License Rights, and other Intellectual Property
Rights
The various intangibles required to carry out the operations of
the Assessee namely trademark, patents, licence, are owned by
Sojitz Japan.
Sojitz Japan possesses entrepreneurial knowledge with respect
to the operation of the global trading network. Sojitz India has
not developed and does not use any intangible assets in its
business operations in India."
12.24. As such it is seen that no intangible assets are held by
the assessee in terms of supply chain intangibles etc. It is
further seen that the AE is trading in a diverse range of goods
right from aero space, chemicals, plastics, high technology
machinery, automobiles, tele-communications industry or
reality etc. and no effort has been made to show that the
limited trading activity belongs to which of those segments
were anyway the FAR analysis shows that there is no
comparison in the two activities
12.25. Accordingly on account of these facts, we are unable to
agree with the TPO who chose to re-characterize the activities
32
of the service provider and treated them at par with the
activities of a trader since the nature of the activities of a
trader and service provider are materially distinct and
different.
12.26. As we have held on facts that the two sets of activities
are distinct and different, consequently we are of the view that
there is no justification for applying the margins earned in
trading activity to those earned in the indenting services. As
such, we find ourselves unable to agree with the reasoning
and the decision of the TPO which has been upheld by the
DRP. At the cost of repetition the consistent and unrebutted
material available on record shows that in the trading activity,
the assessee has entered into contracts with the parties in
India in its own name. The title in goods has been held for
these contracts in assessee own name as such the assessee as
any other trader has exposed itself to the price risk, the credit
risk and other related risks of inventory risk etc. The
negotiations for the same has directly been done by the
assessee and not by the SCJ. As such not only the efforts
required but even the risk borne is completely different. The
risks being of a higher level the rewards if the venture
succeeds can also move upwards in regard to the trading
activity. This fact is demonstrated from assessee's own record
of the two years under consideration whereas in the first year
it is 1.81%, in the other it is 13.29%.
33
12.27. While holding that the margins of one activity cannot
be applied to other activity we consider it necessary to
address another aspect of the issue as Ld. CIT DR has
specifically relied upon orders of the ITAT for the proposition
that the TPO can re-characterize the transaction under the
Act. We hold that no doubt that the TPO under the Income Tax
Act and the rules there under has the powers to re-
characterize the transaction if so warranted on facts, in the
facts of the present case, this power has been erroneously
exercised. On a detailed consideration of the functions
performed by the assessee in the two separate class of
activities and, considering the assets utilized by the assessee
in the two ventures and on a consideration of the risks to
which the assessee is exposed to in the two activities as
discussed above we are of the considered that on facts re-
characterization was not called for and further the margin
earned in one cannot be blindly applied to the other activity in
the facts of the present case.
12.28. Thus in view of the above the answer posed in (b)
which was to be answered only if (a) was in the affirmative,
has still been decided as parties had addressed and the facts
were available on record, is also necessarily answered in the
negative.
12.29. The query posed in (c) calls upon us to decide whether
as per Rule 10B(1)(e)(i), the TPO, in the facts of the present
case, was justified in holding that net profits margins should
34
be computed in relation to FOB value of goods/ or the
operating cost to the assessee. The said query was also to be
addressed only if the answer posed to us in the said question
was in the affirmative. Herein also it is seen that although the
answer is in the negative but, since the parties have addressed
and the facts are available on record we propose to deal with
the said question also.
12.30. Rule 10 B (1) (c) (i) reads as under:-
Determination of arm's length price under section 92C.
10B. (1) For the purposes of sub-section (2) of section 92C,
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, in the following
manner, namely :
(a) ** ** **
(b) ** ** **
(c) ** ** **
(d) ** ** **
(e) Transactional net margin method, by which-
(i) the net profit margin realised by the enterprise from an
international 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;
35
** ** **
12.31. In the facts of the present case which have been
discussed at length while considering the action of the TPO in
re-characterizing the transactions, we are of the view that on
the basis of the detailed FAR analysis of the assesses, the
"costs" referred to in Rule 10 B (1)(e)(i) does not suggest that
in the facts of a case like the present case the 'costs' would
mean the FOB value of goods. The assessee demonstrably is a
low risk entity as a service provider functioning as a
facilitator who is not exposed to price risk, warranty risk,
inventory risk, etc., whose funds are not locked in the cost of
goods, title in goods never vests with the assessee contracts
are entered in the name of SCJ and its affiliates at one end
and the customers in India also in their own names. In these
unrebutted facts on record, the TPO was not correct in
holding that the 'costs' as per the Rule were FOB value of
goods. As such (c) is also decided accordingly.
12.32. Arguments on the creation of and contributing to the
human intangibles and supply chain intangibles have been
addressed as such we propose to addresses these also at this
stage. Since we are of the view that issues in transfer pricing
are very fact specific and conclusion necessarily are fact
driven as such it may be pertinent to add that while
deliberating on facts we have also taken into consideration the
orders relied upon by the parties, specifically the department,
while deciding the issue in assessee's favour. However in
36
order to maintain coherence and lucidity in our findings
which are fact driven, we propose to discuss the judgements
subsequently. For the present purposes on consideration of
the functions performed by the assessee, the assets deployed
using the intangibles of SCJ networks, the risks to which the
assessee is consequently exposed we are unable to concur
with the conclusion of the TPO that the assessee has created
human assets and supply chain intangibles. The unrebutted
fact on record is that the assessee has been able to render
services utilizing the network of the AE and all intangibles and
patents etc. utilized internally belong to the AE and the level
and degree of the qualification required of the personnel of
the assessee is low and skill requirement is so low that no
specific skills are required by the personnel who replace the
existing personnel who may choose to move on for better
options. The assessee does not need to and cannot restrain the
leaving personnel from utilizing any skills which they may
have acquired during employment as no specific skills for
indenting are required for indenting and acting as a
facilitator. It is not the case of the department that the
assessee is performing critical functions which admittedly are
performed by the AE or that the assessee is contributing by
way of analysis, reports and opinions, being provided as such
value added services are being performed wherein the
analysis/opinions may turn out to the correct or grossly wrong
as such due to the high risks of both eventualities occurring
the personnel are necessarily highly qualified sought after
37
experts, commanding high salaries. The simple performance
of a low risk activity of facilitator does not lead to the
conclusion that a human intangible is being created. It is seen
that there is no material on record as to how supply chain
intangibles are being created as the assessee is using the
network and intangibles of its AE.
12.33 Coming to the final question (d), which we have posed
to ourselves since the answer to question (a) is in the negative
the question regarding justification on facts in applying
margins earned in trading activity to the profits of indenting
activity for working out the Arms Length Price requires to be
considered. For the said purpose we are of the view that
elaborate discussions are not necessary as it would
necessitate re-iterating the distinctions in the two separate
sets of activities and the conclusions on the detailed FAR
analysis already done in the earlier paras especially while
considering queries (a) and (b). Accordingly relying on the
same we hold that there is no justification to apply the
margins of trading activity to indenting activity in the facts of
the present case.
12.34. We further support the view taken, by referring to
2006-07 assessment year wherein the Revenue has accepted
the method applied and only on comparables there have been
a dispute. Similarly in 2008-09 assessment year, that is the
immediately subsequent assessment after the two years under
consideration, same method has been followed by the
38
assessee. According to the Ld. CIT DR the method has not
been accepted though adjustments have not been made as the
margins in the trading activity vis-à-vis the indenting activity,
declined. The Ld. CIT D.R has been at pains to emphasize that
no doubt no adjustment was made in the TP proceedings for
2009-10 assessment year but no deviation has been made from
the stand taken by the department in the TP proceedings.
12.35. Accordingly on facts for the detailed reasoning given
hereinabove on the issues addressed before us we are of the
view that the TPO's action upheld by the DRP cannot be
upheld by us."
The issue is also covered by the judgment of the Mitsubishi
Corporation India (P) Ltd. vs. DCIT (Supra) where the coordinate
bench has held as under:-
"35. In the cases in which no economic risk for inventories is
assumed, in which these inventories do not even find their way
to the current assets, and in which no functions are performed
in respect of these inventories, except to facilitate trading in
respect of the same, the very raison d'être for the cost of
inventories being included in the cost base ceases to exist. The
FAR analysis set out in the TPO's order, which is summarized
in paragraph 7 earlier in this order, does not support the
inclusion of inventory costs in the cost base either.
57. In our considered view, to sum up, in a situation in which
a business entity does not assume any significant inventory
39
risk or perform any functions on the goods traded or add any
value to the same, by use of unique intangibles or otherwise,
the right profit level indicator should be operating profit to
operating expenses i.e. berry ratio. In such a situation, no
other costs are relevant since (a) the cost of goods sold, in
effect, is loses its practical significance, (ii) there is no value
addition, and, accordingly, there are processing costs
involved, and (iii) there is no unique intangible for which the
business entity is to be compensated.
65. As for the objection that use of berry ratio is not permitted
under rule 10B(1)(e)(i) as it does not deal with costs incurred,
sales effected or assets employed or to be employed, it proceeds
on the fallacy that the basis of computation, as set out in rule
10B(1)(e)(i), is exhaustive whereas it is only illustrative and it
ends with the expression "or having regard to any other
relevant base". Just because a cost base is not of costs
incurred, sales effected or assets employed, such a base does
not cease to permissible under rule 10B(1)(e)(i) unless such a
base can be held to be irrelevant. In view of the elaborate
discussions earlier, justifying exclusion of inventory costs, the
cost of base of the operating expenses is relevant. When cost of
inventory is excluded from the cost base, for all practical
purposes, cost bases consists only of the operational costs. In
our considered in a situation in which trading is on back to
back basis without anything actually going to the current assets
and flash title of goods is held only momentarily, it could
40
indeed actually be a relevant base as to what are the operating
costs or value added expenses - particularly when, as we have
noted above, no resources are used in the inventories.
80. Coming to the service fee/commission segment, we have
noted that as regards the service fee/commission segment, the
TPO has re-characterized the same as trading activities as he
was of the view that the right course of action will be to treat
the same as equivalent to trading segment, because what the
assessee has disclosed as service/commission income is infact
trading income. Accordingly, the cost of goods sold by the
AEs, which was 2927,92,05,406, was also to be included in
cost base of the service/commission segment and then ALP
was recomputed. So far as this aspect of the matter is
concerned, the issue is now covered in favour of the assessee
by Hon'ble jurisdictional High Court's decision in the case of
Li & Fung wherein Their Lordships have, inter alia, observed
as follows:
...........This Court is of opinion that to apply the TNMM, the
assessee's net profit margin realized from international
transactions had to be calculated only with reference to cost
incurred by it, and not by any other entity, either third party
vendors or the AE. Textually, and within the bounds of the text
must the AO/TPO operate, Rule 10B(1)(e) does not enable
consideration or imputation of cost incurred by third parties
or unrelated enterprises to compute the assessee's net profit
41
margin for application of the TNMM. Rule 10B(1)(e)
recognizes that "the net profit margin realized by the
enterprise from an international 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 ..." (emphasis supplied). It thus
contemplates a determination of ALP with reference to the
relevant factors (cost, assets, sales etc.) of the enterprise in
question, i.e. the assessee, as opposed to the AE or any third
party. The textual mandate, thus, is unambiguously clear.
40. The TPO's reasoning to enhance the assessee's cost base
by considering the cost of manufacture and export of finished
goods, i.e., ready-made garments by the third party venders
(which cost is certainly not the cost incurred by the assessee),
is nowhere supported by the TNMM under Rule 10B(1)(e) of
the Rules. Having determined that (TNMM) to be the most
appropriate method, the only rules and norms prescribed in
that regard could have been applied to determine whether the
exercise indicated by the assessee yielded an ALP.
81. Clearly, therefore, it is impermissible to make notional
additions in the cost base and thus take into account the costs
which are not borne by the assessee. It is so opined by Hon'ble
jurisdictional High Court on a careful analysis of rule
10B(1)(e)(i). It is, therefore, no longer open to the revenue
authorities to reconstruct the financial statements of the
assessee by including the cost of products incurred by the
42
AEs, in respect of which services are rendered, in its
reconstructed financial statements, and then putting the
hypothetical trading profits, so arrived at in these
reconstructed financial statements, to the tests for determining
arms' length price. Respectfully following the esteemed views
of Their Lordships, we hold that the adjustments carried out in
the cost base of ALP computation, in respect of service
fee/commission segment, are indeed devoid of legally
sustainable merits. We direct the Assessing Officer to delete
these adjustments."
31. Respectfully following the above judgment of the coordinate
benches we are of the view that the adjustment made to arm's length price
as upheld by the DRP cannot be sustained.
32. We are of the further view that the adjustment as confirmed by the
DRP is otherwise untenable in view of the proviso to section 92C of the
Act. The TPO has included the cost of sales of the AEs while making
adjustment to the arm's length price. The cost base as determined by the
learned TPO in the assessment year 2007-08 is Rs.4558,90,44,859. The
adjustment proposed after order from the DRP is Rs.116,70,79,548. This
amount is within 5% of the cost base of Rs. 5589044859/- determined by
the learned TPO himself. The cost base as determined by the TPO in the
assessment year 2008-09 is Rs.4071,95,89,546. The adjustment proposed
43
after order from the DRP is Rs.114,82,92,425. This amount is also within
5% of the cost base determined by the TPO himself. Accordingly, no
adjustment could have been made in view of the proviso to section 92C of
the Act. The TPO is not right in including the cost of sales while
determining arm's length price and not considering the same while
applying proviso to section 92C of the Act. The language of the proviso
to Section 92C as it was applicable for the assessment year under
consideration is very clear and unambiguous. According to provision of
section 92C first arm's length price has to be determined. Thereafter the
same has to be compared with the price charged by the assessee and if the
difference between the price determined by TPO and the price charged by
the assessee is within ±5% then no adjustment is required to be made.
33. Further the contention of the learned CIT(DR) that the proviso to
section 92C is applicable only when two different methods are adopted is
also not correct. The language of the proviso in this regard is quite clear.
First the most appropriate method has to be determined. Based on that
arm's length price is to be found out by using various comparables.
When more than one comparable is applied then arithmetical mean is to
be worked out and no adjustment is to be made when arm's length price is
44
determined on the basis of such arithmetical mean is within 5% of the
cost paid or charged by the assessee.
34. In the present case the most appropriate method applied by the
learned TPO is TNMM. The arm's length price has been determined
using more than one comparable as is evident from the TPO's order for
both the assessment years. This arithmetical mean has been taken into
consideration for determination of the arm's length price by the TPO as is
evident from the TPO order and accordingly the proviso to section 92C
will be applicable to the present case. Since in the present case such
difference is less than 5% and hence no adjustment can be made.
35. Accordingly under the facts and the reason discussed hereinabove
and respectfully following the order of the co-ordinate bench on an
identical issue under almost similar facts, we are of the view that
adjustment made by the Assessing Officer in the assessment order cannot
be sustained and the same are directed to be deleted. Accordingly, Ground
no.1 to 4 of both the assessment years i.e. 2007-08 and 2008-09 are
allowed.
45
36. In view of our above finding on ground nos. 1 to 4, ground nos. 5 to
7 of both the assessment years need no adjudication and accordingly the
same are dismissed as having been infructuous.
36. In result, the appeals are allowed.
Decision pronounced in the open court on 20.08.2015
Sd/- Sd/-
( T.S. KAPOOR ) ( I.C. SUDHIR )
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated: 20/08/2015
Mohan Lal
Copy forwarded to:
1) Appellant
2) Respondent
3) CIT
4) CIT(Appeals)
5) DR:ITAT
ASSISTANT REGISTRAR
Date
Draft dictated on computer 31.07.2015
Draft placed before author 07.08.2015
Draft proposed & placed before the second
member
Draft discussed/approved by Second Member.
Approved Draft comes to the Sr.PS/PS 21.08.2015
Kept for pronouncement on 20.08.2015
File sent to the Bench Clerk 21.08.2015
Date on which file goes to the AR
Date on which file goes to the Head Clerk.
Date of dispatch of Order.
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