TMI Blog2011 (2) TMI 99X X X X Extracts X X X X X X X X Extracts X X X X ..... of the aforesaid international transactions. The approach of the ld. CIT(A) in the AY 2002-03 and the TPO in the AY 2003-04 in comparing a controlled transaction with another controlled transaction is nowhere prescribed the Act or in Rule 10B(a) of the IT Rules,1962 and is against the spirit of CUP method. - Matter remanded back. - ITA NO. 1304/AHD./2006 - - - Dated:- 22-2-2011 - ORDER A.N Pahuja, ‑ These cross appeals against an order dated 23-3-2006 of the ld. CIT(Appeals)-VI, Ahmedabad, for the Assessment Year 2002-03 and an appeal by the Revenue against an order dated 24-4-2007 of the ld. CIT(Appeals)-VI, Ahmedabad for the Assessment Year 2003-04, raise the following grounds:- "I. On the facts, circumstances of the appellant's case, the order determining arm's length rate of commission payable to Arvind Worldwide Inc., (USA) an Associated Enterprise at 4.2% in place of 6.2% and thereby computing arm's length price at Rs. 13,13,532 as against Rs. 20,60,842 by the Commissioner of Income-tax (Appeals) is bad in law on following counts: (a) In the facts and circumstances of the case, the Commissioner of Income-tax (Appeals) ought to have appreciated that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et etc. (d) The Commissioner of Income-tax (Appeals) ought to have appreciated that besides same functions, Arvind Worldwide Inc. (Mauritius) operated on larger scale with branches in many parts including in the important European market whereas the scale of operation was lower in case of Arvind Worldwide Inc. which mostly operated in the US market and therefore determining arm's length price for comparison between both Associated Enterprises without making any adjustment to eliminate said material difference will never give correct picture. (e) The Commissioner of Income-tax (Appeals) determined the arm's length price by following internal CUP method but while doing so failed to appreciate that even under internal CUP, the controlled transaction need to be compared with uncontrolled transaction. III. (a) In the facts and circumstances of the case, the Commissioner of Income-tax (Appeals) erred in rejecting the claim of write off of Rs. 102.25 crores made by the appellant company during the course of assessment proceedings. (b) The Commissioner of Income-tax (Appeals) ought to have appreciated that in view of Circular No 14(XL-35) dated 11-4-1955, the Assessing Officer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cer [TPO]. Inter alia, the assessee paid commission of Rs. 8,38,02,080 @ 4.2% to its Associated Enterprise, Arvind Worldwide Inc., Mauritius and Rs. 20,60,842 @.6.2% to Arvind Worldwide Inc., USA while the TPO noticed that the assessee paid commission @ 2.8% to non-related parties. To a query by the TPO, the assessee, vide letter dated 3-01-2005 explained the nature of services rendered by the Associated Enterprises and other non-related parties and contended that they paid commission to the AE @ 2.8% only for procuring orders while additional amount of commission @ 1% was paid to AEs for identifying product market segment requirements of major customers and information besides 0.5% for collecting market related data and informing key buying factors, market strategy to be followed,1% for canvassing of textile products manufactured by parent company and del-credere commission @ 1%. It was also pointed out that the commission to AE was paid at the higher rates (which is lower than the arms length rate) Arvind Worldwide Inc., USA in view of small amount of business and to incur fixed overheads to maintain the office. In nut-shell, the assessee contended that : (i) comprehensive ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... terms:- "6. I have gone through the contention of the assessee and the main contentions of the assessee are as follows: (a) The services rendered by the non-related party are limited to the procurement of orders and forwarding it to the assessee for execution. (b) The AE has done comprehensive services which include exploring the new materials, make efforts to enhance market share, procure orders, negotiating terms of orders, collection of payments, inform best practices followed by competitors, inform about market sharing, carry out market research/survey and canvassing the textile products through various techniques. (c) AE do not receive commission if the sales amount of the order procured by it are not realized. Non related party paid commission irrespective of the fact that the sales amount is realized or not. (d) Commission payments are governed by the FEMA and also monitored by RBI, so if the rate of commission is excess, the RBI could not have allowed the assessee to remit the same. (e) Major communication with the AE were through E-mail or telephonic conversation and no corporate keeps the hard copy of E-mails. However, the assessee has produced som ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ules, 1962 prescribes the information documents to be maintained by every person who enters into international transaction. The relevant sub-rules is reproduced below: 10D(1)(e) - a description of the functions performed, risks assumed and assets employed or to be employed by the assessee and by the associated enterprises involved in the international transaction; 10D(1)(f) - a record of economic and market analyses, forecasts, budgets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately, which may have a bearing on the international transactions entered into by the assessee. 10D(1)(m) - any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of arm's length price. The Rule 10D(3) states that the information in sub-rule (1) shall be supported by authentic documents which include (f) letters other correspondence documenting any terms negotiated between the assessee and the associated enterprise and (g) documents normally issued in connection with various transaction under the accounting practices follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een considered. The copy of agreements with each category of such agents were called for to verify what functions they were required to perform as per the agreement and whether transactions with them are comparable with the transactions undertaken with associated enterprises. The authorized representative of the Arvind Mills Limited submitted sample copies of agreements with both associated enterprises and non-related parties considered for comparison, and the copy of e-mails exchanged with associated enterprises. In respect of the e-mails the assessee stated: "... in respect of documentary evidence in support of services performed by the AEs, we wish to inform you that the major communications with the Associated Enterprises were through E-mail or telephonic conversation . We are fortunate that we were able to retrieve some E-mail's from the archive database and therefore able to produce some sample E-mails out of the mails retrieved for your kind perusal. Your honour will please note that these sample mails produced covers majority activity defined in the agreement viz. order/new order booking, market trend, fashion trend, technical support, payment follow-up, new custo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... part, so as to warrant a higher rate of commission. No other uncontrolled transaction exists in this category, as the assessee has not entered into similar agreements (the kind it has entered into with its AE) with any uncontrolled parties. All the other transactions that the assessee has compared with are those where the Parties to whom commission is being paid are performing lesser functions than those performed by its AEs. So the transaction of the AEs, as far as the intra AE rates are concerned, cannot be compared with transactions of any other parties, as there is no similarity in functions of the AE and the functions of other parties. Thus it is not explained why the assessee has compensated both the AEs differently for performing the same functions. As there is no uncontrolled transaction to compare with, for this transaction, the comparable transaction exists, in the form payment of lower rates of commission to a controlled entity of the group On the issue of use of controlled transaction, paragraph 1.70 of the 1995 OECD Report indicates that evidence from enterprises engaged in controlled transactions with associated enterprises may be useful in understanding the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt disallowed 1. Arvind Worldwide INC, Mauritius 507615508 2,93,32,703 2,50,25,444 43,07,259 Hence, the arms length price for the commission payments to the Associated Enterprises M/s. Arvind Worldwide Inc. Mauritius is determined at Rs. 2,50,25,444 as against Rs. 2,93,32,703 claimed by the assessee, resulting in an adjustment of Rs. 43,07,259. This will result in increasing the income of the assessee by Rs. 43,07,259. The AO will be required to make an addition of Rs. 43,07,259 to the income of the assessee on the basis of discussion in the preceding paras. In respect of remaining transactions no adjustment is made to the value of international transactions entered into by the assessee. This order is in response to specific reference under section 92CA(1) received and will apply to the case of the assessee for AY 2003-04 only." 2.4. In terms of the aforesaid order of the TPO, the AO added an amount of Rs. 43,07,259 in the AY 2003-04. 3. On appeal, the learned CIT(A) reduced the addition to Rs. 7,47,310 in the AY 2002-03 in the following terms:- "2.3 I have considered the submission for the appellant, facts of the ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew markets for textile products manufactured by the company as well as to make efforts to enhance market share of those products in international markets across the globe. The services are limited to the sale of the products i.e . just procuring the orders and forward it to the AML for execution. To procure orders for textile products manufactured by the AML from international markets In case of orders directly procured by AML then AE would have to help the AML in negotiating and concluding terms of such order. After execution by AML of order procured by AE, it is the sole responsibility of AE to collect payments of said orders and failing which it would not be entitled to any commission. AE would also have to help the company to realize the proceed of the order which the company has procured itself or through other agents. AE would identity product market segment, quality requirements of the major customers in the international market. It would inform the AML about the best practices followed by similar textile manufacturers in the in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are supported by various emails which have been exchanged between AE and the appellant. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm s length conditions, it is necessary to compare attributes of the transactions of enterprises that would affect conditions in arm length dealings. Attributes that may be important include the characteristic of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the economic circumstances of the parties and the business strategies pursued by the parties. Besides this, from the reply of the appellant it is also clear that the appellant as well as both the AEs are incurring huge losses and therefore there was no; intention of the appellant to transfer part of profit to the AEs. 2.3.2. From the above facts and considering the reply of the appellant I find that the services rendered by the AEs are definitely much wider and comprehensive than what have been provided by the non-related parties and even non-related parties have been paid commission @ 5% and more in many cases. Considering ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso noticed that sales by Mauritius Associate Enterprise was of Rs. 50.76 crores as against Rs. 36.24 crores by the US Enterprise and Mauritius Enterprise had done market survey for the assessee and as it was looking after sales in other countries like UK etc. its travelling expenses were also more which entitled it to a higher rate of commission. As discussed earlier, even higher rate of commission has been:*paid to unrelated parties and in these circumstances, comparison with US Enterprise itself was not proper for the simple reason that the extent of services provided by the US Enterprise and the territory covered by it was much smaller as compared to Associate Enterprise at Mauritius which was looking after sales in UK, Hong Kong as well. In view of this, I do not find any justification in the adjustment made by the Transfer Pricing Officer and the same is deleted." 5. The Revenue is now in appeal before us against the aforesaid findings of the learned CIT(A) in reducing the addition to Rs. 7,47,310 in the AY 2002-03 and deleting the addition in AY 2003-04 while the assessee is in appeal against upholding of the addition to the extent of Rs. 7,47,310 in the AY 2002-03.The lea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessing Officer and he can proceed to determine arm's length price where he either finds the existence of the circumstances mentioned in clauses (a) to (d) of sub-section (3) or where he considers it necessary and expedient to refer the determination of ALP to the TPO. There is no other requirement for invoking these provisions by the Assessing Officer. Besides, as per mandate of section 92(1) of the Act, income from international transactions between associated enterprises has to be computed having regard to arm's length price. Computation of arm's length price is essentially a factual exercise. Each case depends on its own peculiar facts and circumstances. In certain cases where identical or almost similar uncontrolled transaction is available for comparison; determination of Arm's Length Price is an easy task. However, it is not so in most of transactions and rarely one is able to locate an identical transaction. In such cases, Arm's Length Price is determined by taking results of a comparable transaction in comparable circumstances and make suitable adjustments for the differences. The Legislature in India, in order to determine true income of the assessee, have prescribed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffect the amount charged in an uncontrolled transaction. Comparability under this method depends on close similarities with respect to various factors. The CUP can be internal or external. The internal CUP is the price that the assessee has paid/charged in a comparable uncontrolled transaction with an independent party when compared to the price paid/charged in a controlled transaction. External CUP is a price charged in comparable uncontrolled transactions between third parties when compared to the price of a controlled transaction. However, where CUP method is to be applied on the basis of public data, it has to be ensured that the data is widely and routinely used in ordinary course of business in the industry to negotiate prices for uncontrolled sales/services and is used to set prices in the controlled transaction in the same way that it is used by uncontrolled taxpayers in the industry; and the amount charged in the controlled transaction is adjusted to reflect product and service variations. 6.2. It is well settled that the burden is on the assessee to select the most appropriate method and has to be substantiated by the assessee by an appropriate documentation as also as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f uncontrolled transactions taken into account for analyzing their comparability with the international transactions entered into, including a record of the nature, terms and conditions relating to any uncontrolled transaction with third parties which may be of relevance to the pricing of the international transactions; (h) a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transaction; (i) a description of the methods considered for determining the arm's length price in relation to each international transaction or class of transaction, the method selected as the most appropriate method along with explanations as to why such method was so selected, and how such method was applied in each case; (j) a record of the actual working carried out for determining the arm's length price, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any, which were made to account for differences between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... blish that international transaction is entered in to at ALP, is on the assessee who is to disclose all the relevant information and documents relating to prices charged and profit earned with related and unrelated customer. This view of ours is supported by following portions of circular no. 14 of 2001 issued by the CBDT: "Under the new provisions the primary onus is on the taxpayer to determine an Arms length price in accordance with the rules, and to substantiate the same with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the Arms length price is reliable and correct there can be no intervention by the Assessing Officer. This made clear by sub-section (3) of section 92C of the Income-tax Act which provides that the Assessing Officer may intervene only if he is, on the basis of material or information or document in his possession, of the opinion that the price charged in international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to ascertain as to whether or not such documentation prescribed in Rule 10D was maintained or submitted by the assessee before the Revenue authorities . In the absence of relevant documentation, justifying higher rate of commission to AEs, the TPO determined the rate of 2.8% paid to non-related party as the ALP by applying the CUP method in the AY2002-03. According to the ld. CIT(A),the TPO took total average commission of large number of non-related enterprises and has made adjustment by restricting this commission to 2.8%. In these circumstances, the ld. CIT(A) concluded that the comparison made by the TPO of the average commission of all non-related parties taken together was neither fully justified nor in accordance with the principle of CUP method; because under the CUP method, the comparison will have to be made with each transaction of similarly placed non-related party. According to the ld. CIT(A),the non-related enterprises were given commission ranging from 1% to 10% depending upon the volume of business, services rendered, location of party, country and various economic consideration and under the CUP method, the AO was required to examine the transaction with each of n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsidered CUP method as the most appropriate method for determining ALP of the aforesaid international transactions. The approach of the ld. CIT(A) in the AY 2002-03 and the TPO in the AY 2003-04 in comparing a controlled transaction with another controlled transaction is nowhere prescribed the Act or in Rule 10B(a) of the IT Rules,1962 and is against the spirit of CUP method. In the instant case, as already mentioned there is nothing to suggest that the assessee discharged their burden of establishing ALP before the AO or the ld. CIT(A) nor even placed any economic analysis or FAR analysis before the Revenue authorities or even before us, which would enable us to conclude that the price paid by the assessee to the AEs for services rendered is at ALP. It was for the assessee to show that results of these international transactions were not inconsistent with results of similar uncontrolled transactions carried in similar circumstances. In the absence of relevant FAR analysis and economic analysis in the light of relevant data of comparable controlled or uncontrolled transactions carried in same or similar circumstances, we are of the opinion that the ALP furnished by the assessee d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by it to AEs is at ALP nor referred to any economic and FAR analysis. Even when the ld. CIT(A) determined the ALP in the light of transaction with another AE, no such economic and FAR analysis has been referred to nor the ld. CIT(A) considered factors like economic conditions, geographical areas, risks assumed, functions assumed etc. in relation to transactions with the two AEs vis-a-vis uncontrolled transactions. At the cost of repetition, even before us, the ld. AR did not place us any economic and FAR analysis, suggesting that price paid by the assessee to its AE for services rendered was at ALP. Having regard to the statutory provisions, particularly the mandate of sections 92(1) and 92D read with relevant rules, we are of the opinion that the adjustments made on account of ALP by tax authorities can be deleted in appeal only if the appellate authorities are satisfied and record a finding that ALP submitted by the assessee is fair and reasonable. Merely by finding faults with the transfer price determined by the revenue authorities, addition on account of "adjustments" cannot be deleted. This is because the mandate of section 92(1) is that in every case of international trans ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fair and appropriate to set aside the impugned orders of the Commissioner of Income-tax (Appeals) in these two years and restore the matter to his file for fresh adjudication in accordance with law in the light of our aforesaid observations and of course after allowing sufficient opportunity to the assessee, bringing out clearly as to how the assessee through their economic and FAR analysis established ALP of the international transactions entered in to with the aforesaid AEs .In the event, the assessee fails to submit the relevant economic and FAR analysis or other relevant prescribed documents, ALP should be determined after having a robust transfer pricing analysis as also after examining the documents which the assessee is obliged to maintain under Rule 10D of the Income-tax Rules,1962. We may clarify that the assessee is free to submit fresh information and documentation and is free to chose any of the prescribed methods as most appropriate method. In nutshell, the ld. CIT(A) should by way of a speaking order bring out clearly as to how the price determined by him is ALP in respect of the transactions entered into by the assessee with its AE. Be that as it may, a fair and reas ..... X X X X Extracts X X X X X X X X Extracts X X X X
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