2025 (5) TMI 2130 - AT - Income Tax

TP Adjustment pertaining to international transaction of sale of goods /felt packing material - Comparable selection - HELD THAT - Tangerine Design Private Limited is not an appropriate comparable as is not appearing in the detailed accept reject matrix for the benchmarking conducted by the Appellant for the transaction of sale of felt packing material. Apart from the same the above Company is engaged in the business of manufacturing of leather goods whereas the Appellant is engaged in the business of trading of felt packing material. Raymond Apparel Limited is engaged in the business of manufacturing of fabric. The primary source of the Revenue of operation of the Company is sale of manufactured goods. Raymond is one of the largest branded Apparel Company it operates a highly brand-drive industry. The Appellant is selling felt packaging material which serve as protective outer layer for its bags hence the fundamental nature of business and product differs significantly. Therefore Raymond Apparel Limited is not appropriate comparable. Shiva Suitings Limited Company is mainly engaged in the business of trading and manufacturing of textile which is evident from the Annual Report for financial year 2019-20. Since Shiv Suiting Limited is engaged in the manufacturing of textile which is not similar to the trading of goods made by the Appellant further the segment details for its trading activity is not available in the financial statements the said Company is not appropriate comparable. V-Mart Retail Limited operates as well-known value/fashion retail chains catering directly to price-sensitive consumers and their business model relies on brand recognition customer s footfall store experience and seasonal fashion trends. Whereas appellant is selling felt packaging material which serve as protective outer layer for its bags apparel and accessories are finished consumer products sold in the retail market. The pricing value drivers and market dynamics for branded consumer goods differ significantly from those of packaging material. Since the fundamental nature of business and products differs significantly the above said Company is not appropriate comparable. V2 Retail Limited operates as well-known value-fashion retail chains catering directly to price-sensitive consumers. Their business model relies on brand recognition customer footfall store experience and seasonal fashion trends. In contrast the Appellant is selling felt packaging material which serve as protective outer layer for its bags apparel and accessories are finished consumer products sold in the retail market. Thus V2 Retail Limited cannot be an appropriate comparable. 7NR Retail Limited company is engaged in business of readymade garments suiting shirting fabrics whereas the Appellant is engaged in sales of felt packing material therefore the transaction of sales of felt packaging material cannot be compared to a retailer as a retailer invests heavily store operations inventory management and has altogether has a different asset base risk profile and functional focus. Therefore 7NR Retail Limited cannot be an appropriate comparable. New India Retailing Investments Limited s majority of Revenue is from sale of traded products i.e. readymade garments. Whereas Appellant sells felt packaging materials used as protective outer layers garments are finished consumer products sold in the retail market. The pricing value drivers and market dynamics for branded consumer goods differ significantly from those of packaging material. Therefore it cannot be an appropriate comparable. Arnav Fashions Ltd. is engaged in business of products that are entirely different from the goods provided by the Appellant the same cannot be an appropriate comparable. Nivaka Fashions Ltd.is not appearing in the detailed accept reject matrix for the benchmarking conduct by the Appellant for the transaction of sale of felt packing material. Further the Ld. TPO has not rejected the search process undertaken by the Appellant. The business of the above Company is entirely different from the business of the Appellant. Therefore Nivaka Fashions Ltd. cannot be an appropriate comparable. Euro Vistaa India Ltd is engaged in wholesale of textiles fabrics and yarns and whereas the Appellant is not into wholesale business thus it cannot be an appropriate comparable. Adjustment on protective basis on the ground of excess advertisement marketing and promotion expenditure - If a situation of determining the ALP arises then no transfer pricing adjustment should be made by applying the Bright Line Test.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal relate to:

(a) Whether the Assessing Officer (AO) and Transfer Pricing Officer (TPO) erred in enhancing the income of the Assessee by INR 4,34,45,060/- pertaining to international transactions involving sale of felt packing material, contrary to the arm's length principle under the Income Tax Act, 1961 ("the Act");

(b) Whether the inclusion of additional comparable companies by the TPO beyond those selected by the Assessee for benchmarking the transfer pricing adjustment was justified;

(c) Whether the AO/TPO erred in proposing a protective adjustment of INR 1,84,35,150/- on account of alleged excess Advertisement, Marketing and Promotion (AMP) expenditure, including the validity of applying the Bright Line Test (BLT) for benchmarking such AMP expenses;

(d) Whether the disallowance of INR 25,92,830/- on account of late deposit of employees' provident fund contributions under section 36(1)(va) of the Act was justified (this ground was not pressed by the Assessee);

(e) Whether the initiation of penalty proceedings under sections 270A and 271AA of the Act was erroneous (also not pressed by the Assessee).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 & 2: Transfer Pricing Adjustment and Selection of Comparable Companies

Relevant Legal Framework and Precedents: The transfer pricing provisions under Chapter X of the Act, particularly sections 92, 92B, 92C, 92CA and 92D, govern the determination of arm's length price (ALP) for international transactions between associated enterprises (AEs). Rule 10B and Rule 10D of the Income-tax Rules, 1962, prescribe the methodology for comparability analysis and maintenance of transfer pricing documentation. The principle of arm's length price requires benchmarking of international transactions against comparable uncontrolled transactions, using appropriate comparables selected based on functional, risk, and economic comparability.

Court's Interpretation and Reasoning: The Tribunal noted that the Assessee had selected five comparable companies in its transfer pricing documentation, all of which were accepted by the TPO. The TPO, however, added ten additional comparable companies, resulting in a final set of fifteen comparables. The TPO's arm's length range for operating profit to cost (OP/OC) ratio was 10.49% to 17.03%, with a median of 11.43%.

The Assessee challenged the inclusion of the additional ten comparables, arguing that these companies were functionally dissimilar and engaged in manufacturing or retail businesses, unlike the Assessee, which was engaged in trading of felt packing materials. The Assessee contended that the pricing, value drivers, market dynamics, and functional profiles of these companies differed significantly from those of the Assessee, making them inappropriate for benchmarking.

The Department defended the inclusion of these companies on the basis that they were engaged in market support services similar to the Assessee, and that the Transactional Net Margin Method (TNMM) allows for wider flexibility in selecting comparables based on functional, asset, and risk (FAR) analysis.

Key Evidence and Findings: The Tribunal examined the nature of business activities, principal revenue sources, and segmental information of each of the ten challenged comparables, relying on their annual reports and other documentary evidence. It found that:

• Tangerine Design Pvt. Ltd. was primarily a manufacturer of leather goods, not a trader of packing materials;
• Raymond Apparel Ltd. was a manufacturer and retailer of branded apparel, with a fundamentally different product and market;
• Shiva Suitings Ltd. engaged in manufacturing textiles, not trading;
• V-Mart Retail Ltd., V2 Retail Ltd., 7NR Retail Ltd., New India Retailing & Investments Ltd. were retail chains dealing in readymade garments and accessories, with different asset bases, risk profiles, and business models;
• Aarnav Fashions Ltd. was an integrated financial services company, unrelated to the Assessee's business;
• Nivaka Fashions Ltd. engaged in trading of textiles and apparel retailing, but was not included in the Assessee's benchmarking matrix and differed in business profile;
• Euro Vistaa India Ltd. was engaged in wholesale trading of textiles and yarns, differing from the Assessee's trading activity.

Application of Law to Facts: The Tribunal applied the principle that comparables must be functionally and economically similar to the Assessee's international transactions. It held that the ten additional comparables selected by the TPO were not appropriate due to their dissimilar business activities, product nature, and market dynamics compared to the Assessee's trading of felt packing materials.

Treatment of Competing Arguments: The Tribunal rejected the Department's argument that TNMM allows wide flexibility to include these comparables, emphasizing that functional dissimilarity and different value drivers cannot be ignored. It also noted that the TPO did not carry out an independent search or provide detailed methodology for selection, thereby violating principles of natural justice.

Conclusions: The Tribunal directed the AO/TPO to exclude the ten challenged companies from the final set of comparables for determining the ALP. The appeal on this ground was allowed.

Issue 3: Protective Adjustment on AMP Expenditure and Application of Bright Line Test

Relevant Legal Framework and Precedents: Chapter X of the Act requires that international transactions between AEs be benchmarked to determine ALP. Adjustments on AMP expenditure require existence of an international transaction as per section 92B. The Bright Line Test (BLT) is not a prescribed method under section 92C and has been rejected by various High Court rulings. Judicial precedents cited include decisions of the Delhi High Court in cases involving Sony Ericsson Mobile Communications India Pvt. Ltd., Bausch & Lomb Eye Care (India) Pvt. Ltd., Whirlpool of India Ltd., Rayban Sun Optics India Ltd., Toshiba India Pvt. Ltd., and Bose Corporation (India) Pvt. Ltd.

Court's Interpretation and Reasoning: The Tribunal noted the Assessee's submissions that the BLT lacks statutory backing and that the assumption of an international transaction for AMP expenses without valid agreement or arrangement is contrary to law. The Assessee argued that the AMP expenses were routine selling expenses incurred by the distributor (the Assessee) for its own benefit and not for the AE, and thus no adjustment was warranted.

The Tribunal examined the Assessee's earlier case for Assessment Year 2012-13, where a coordinate bench had held that BLT should not be applied for transfer pricing adjustments and that existence of an international transaction must be established before making any adjustment on AMP expenditure.

Key Evidence and Findings: The Tribunal reviewed relevant judicial pronouncements and the Assessee's functional and risk profile, which showed that the Assessee was a distributor responsible for key decisions and primary beneficiary of the AMP expenses incurred.

Application of Law to Facts: The Tribunal applied the legal principle that transfer pricing adjustments require an established international transaction. It held that the protective adjustment on AMP expenditure without such proof was not sustainable. It further held that the BLT is not a recognized method under the Act and has been rejected by the High Courts.

Treatment of Competing Arguments: The Tribunal rejected the Department's reliance on the BLT and protective adjustment, finding that the approach violated established judicial precedents and mischaracterized the Assessee's business profile.

Conclusions: The Tribunal allowed the appeal on this ground, disallowing the protective adjustment on AMP expenditure and rejecting the application of the BLT.

Issue 4 & 5: Disallowance of Provident Fund Contribution and Penalty Proceedings

The Assessee did not press these grounds. Accordingly, the Tribunal dismissed these grounds without detailed analysis.

3. SIGNIFICANT HOLDINGS

"The Tribunal directs the AO/TPO to exclude the ten companies included by the TPO from the final set of comparables for determining the Arm's Length Price in the international transaction."

"If a situation for determining the ALP of AMP expenses arises, then no transfer pricing adjustment should be made by applying the Bright Line Test because the Hon'ble Jurisdictional High Court has not approved the application of the bright line test in several decisions."

"The protective adjustment proposed on AMP expenditure without establishing the existence of an international transaction is bad in law."

Core principles established include:

• Comparables selected for transfer pricing must be functionally and economically comparable, with similar business activities, products, and risk profiles;
• Transfer pricing adjustments require the existence of an international transaction between associated enterprises;
• The Bright Line Test is not a prescribed method under the Income Tax Act and has been judicially rejected for transfer pricing purposes;
• Protective adjustments without statutory backing and proper basis are not sustainable;
• Natural justice requires transparency in the selection and application of comparables and methodology by tax authorities.

Final determinations were that the Assessee's appeal was partly allowed by excluding inappropriate comparables and disallowing the protective AMP adjustment, while other grounds were dismissed or not pressed.