TMI Blog2009 (5) TMI 600X X X X Extracts X X X X X X X X Extracts X X X X ..... is hereby vacated. Regarding method of computation of ALP - It is an undisputed position that the imports of raw material, which mainly consist of copper and lead, are charged by the AE on the basis of rates prevailing at London Metal Exchange. and certain mark up thereon - once it is not in dispute that the billing by the AE for raw materials supplied to the assessee is done on the basis of the London Metal Exchange prices plus certain mark up, there is no further need of the internal comparables since London Metal Exchange, being an independent organization entering into transparent and arm's length transactions with a number of other organizations, provides the most reliable prices at which uncontrolled comparable transactions are entered into - assessee had offered the comparison of gross profit mark up margin of the assessee company on transactions with AEs with gross profit mark up margin of the assessee company on transactions with unrelated parties. which in our considered view. was a sufficient basis for determination of ALP under r. 10(1)(c) - Held that: TNMM was indeed not the appropriate method of determining ALP on the facts of this case, these comparables are no lon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctors. Its entire shareholding is held by Bryden Properties Ltd., UK, which in turn is closely connected with MSS Investments Ltd., UK, inasmuch as the shareholdings in these two companies have common ownership. The transactions entered into with these companies admittedly classify as transactions with associated enterprises (AEs). During the relevant accounting period, the assessee entered into following transactions with its AEs: ------------------------------------------------------------- Particulars of transaction Amount ALP computation method applied ------------------------------------------------------------- Purchases of raw material 1,76,64,181 Cost plus method components Export of finished goods 4,03,67,972 Cost plus method Borrowing of foreign 1,04,65,500 Comparable currency loans uncontrolled price (CUP) method ------------------------------------------------------------- 4. In the course of assessment proceedings, a reference was under s. 92CA(1) made to the TPO for ascertaining the ALP in respect of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable cases which comes to 23.25 per cent. ------------------------------------------- Sl.No. Name of the company PBT/sales (%) ------------------------------------------- 1. G.K.W. Ltd. -36.42% 2. Shardlow India -7.78% 3. Sunderam Industries Ltd. -7.92% ------------------------------------------- 5. As the assessee was not able to give details on the basis of which the above companies were selected, all these comparables were rejected. The contention of the assessee that cost plus margin method was also rejected. The reasoning given by the TPO was as follows: It (the assessee) has applied cost plus margin method to suggest that margins earned by the assessee is comparable to those earned in export to non-AEs. The basis of calculation of the gross margin is not clear. While distributing various costs, it is always difficult to exactly find out the correct ratio in which all these costs should be allocated and if the distribution of all these costs is not done correctly, it may give undesirable results. 6. It was in this backdrop and having rejected the contentions of the assessee about the transaction prices being AL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ------------------- FCI Oen Connectors Ltd. 35.07% 22.39% 18.71% Connectors Salzer Electronics Ltd. 12.77% 5.94% 4.67% Connectors Salzer Exports Ltd. 5.05% 0 -1.68% Connectors and its accessories -------------------------------------------------------------- 7. The stand of the assessee that the product dealt with by these companies are not the same as being dealt with by the assessee company was brushed aside by the TPO, on the ground that "under TNMM, comparable need be only broadly similar and significant product diversity and some functional diversity between the controlled and the uncontrolled parties is acceptable" and that "in this case, comparables chosen are having the product connectors which is similar to the product made by the assessee". The TPO thus adopted average of PBT/cost ratio of these three companies, which worked out to 7.23 per cent, and computed the arms length operating profit at Rs. 42,68,141. Accordingly, the arms length operating revenue was computed by the TPO at Rs. 6,33,01,901. On this basis, an adjustment of Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and this is the major reason for the assessee making loss only in this financial year". In the remand report thus, all the contentions of the assessee were once again rejected. Be that as it may, learned CIT(A) did not quite agree with the TPO on these issues and he upheld the grievance of the assessee. Learned CIT(A) deleted the impugned ALP adjustment, and, in his brief operative portion of the order, observed as follows: The TPO has disregarded the com parables submitted by the assessee and has selected some other comparables and followed TNMM and made the adjustments. The assessee also objected to the comparables adopted by the TPO for the purpose of carrying out adjustments under s. 92CA(3) of the Act. The assessee was able to explain the losses during the financial year 2002-03 stating that there was substantial increase in material consumption (70 to 75 per cent) due to low end-products. The assessee also explained that the losses were due to lower capacity utilization. I also agree with the assessee's argument that there is no necessity for manipulating the export prices in view of the fact that theirs is a 100 per cent EOU. Thus, the assessee was able to explain the low ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e CIT(A) has clearly erred in deleting the impugned additions, inter alia, on the ground that "there is no necessity for manipulating the export prices in view of the fact that the assessee is a 100 per cent EOU (eligible for income-tax exemption)". 13. Dr. Pathak, on the other hand, relies upon a recent decision of a Co-ordinate Bench in the case of Philips Software Centre (P) Ltd. vs. Asstt. CIT (2008) 119 TTJ (Bang) 721 : (2008) 15 DTR (Bang)(Trib) 505 : (2008) TIOL 471 ITAT Bang wherein it is, inter alia, held that since the basic intention behind introducing the transfer pricing provisions in the Act is to prevent shifting of profits outside India, and the assessee is claiming benefit under s. 10A of the Act, the transfer pricing provisions ought not to be applied to the assessee. He submits that the Bangalore Bench has duly considered the impact of decision in Aztec Software Technology Services Ltd. by the Five Member Bench of the Tribunal, and yet the Division Bench was of the considered view that the transfer pricing provision cannot be applied in a case where profits of the assessee are fully exempt from tax under s. 10A. It is contended that, once a Co-ordinate Bench ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learned CIT-Departmental Representative, disregards the basic principles of judicial precedents. Such a decision cannot have any binding character on another Division Bench. It is also submitted that the issue is squarely covered in favour of the Revenue by a Larger Bench of this Tribunal which is binding on us. We are thus urged to vacate the findings of the CIT(A) in this regard. 15. We see substance in Shri Kaushal's submissions. No doubt, as pointed out by Dr. Pathak, Bangalore Division Bench of the Tribunal, in Philips Software Centre (P) Ltd.'s case, has held that, "Since the basic intention behind introducing the transfer pricing provisions in the Act is to prevent shifting of profits outside India, and the assessee is claiming benefit under s. 10A of the Act, the transfer pricing provisions ought not to be applied to the assessee", but then this view of the Division Bench is diametrically opposite to the views of an earlier Five Member Special Bench of this Tribunal in the case of Aztec Software Technology Services Ltd. wherein this Larger Bench, inter alia, observed as follows: "21. It is abundantly clear that legislature while introducing the enactment did comprehen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a conscious decision not to follow the Larger Bench does not make things better. When the law mandates that a Division Bench cannot disregard another Division Bench, and here is a Division Bench decision which is directly contrary to a Larger Bench decision, the order so disregarding the Larger Bench cannot be said to have any binding force. A decision does not have binding precedence value because the reasoning of the decision is indisputable or because the matter is not capable for another view being taken, even if that be so, but the decision is binding because it is delivered by a higher judicial forum and the elementary principles of judicial discipline warrant that superior wisdom of the tier below has to give way to the higher wisdom of the tier above. It is in this backdrop, we are unable to follow the decision of the Bangalore Division Bench in Philips Software Centre (P) Ltd.'s case, so far as the question of applicability of transfer pricing provisions in a case in which assessee is eligible for tax exemption under s. 10A is concerned, and we respectfully follow the Five Member Special Bench decision in the case of Aztec Software Technology Services Ltd., and adopt th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the method; (d) the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; and (f) the nature, extent and reliability of assumptions required to be made for application of the method. 22. In a situation in which the Revenue authorities seek to disturb the method of determining the ALP, as adopted by the assessee, it is necessary for them to demonstrate that, on the given facts of the case, a particular method will be more appropriate vis-a-vis the method adopted by the assessee, and such an appropriateness of method must be shown on the touchstone of the factors set out in r. 10C(2) above. The ALP adjustments are counter measures to ensure that the prices at which international transactions are entered into by the AEs are not so contrived as to adversely affect the domestic tax base, and, therefore, most appropriate meth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ying the traditional methods are not always available and that is the reason that despite better results produced by these methods, these methods are not as much put to use. However, whenever necessary inputs for applying one of these methods are available and there is no dispute about comparability of those inputs, there is no good reason to resort to transactional profit methods. It would thus follow that in a situation in which the assessee has followed one of the standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods unless the Revenue authorities are able to demonstrate the fallacies in application of standard methods. In any event, any preference of one method over the other method must be justified by the TPO on the basis of cogent material and sound reasoning. Let us, in the light of this factual position, revert to the facts of this case. 23. It is an undisputed position that the imports of raw material, which mainly consist of copper and lead, are charged by the AE on the basis of rates prevailing at London Metal Exchange. and certain mark up thereon. This mark up ranging between 2 per cent to 6 per cent, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ficult to exactly find out the correct ratio in which all these costs should be allocated and if the distribution of these costs are not done correct, it may give undesirable results". He has further observed that "cost plus method is not applicable here because the gross margins of the comparable companies are difficult to find in prowess database or capital line database". That again proceeds on the fallacy that for application of cost plus method, internal CUP is not sufficient. The TPO, having noted that the cost of material consumption in the relevant previous year was 76.24 per cent as against 46.75 per cent in the immediately preceding year, has also observed that "in view of the increase in the cost of raw material, it is expected that the assessee should have charged correspondingly higher figure for its sale to the AE, which has not been done and this is one of the major reasons for the assessee making the loss in the this financial year". He then added that "in other words, the assessee has absorbed the increase in cost of raw material instead of passing it on to the AE" and, therefore, "an adjustment is required and the same is done as per TNMM". The TPO has also observ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "adjusted on account of differences, if any, between the international transactions and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market". What it translates into, on the facts of the present case, is that the adjustments on account of services rendered by the AE . and the insurance and freight costs are required to be made to the LME prices. An adjustment of 2 per cent to 6 per cent, for such factors, cannot be said to be unjustified. The TPO has made no efforts to demonstrate unreasonableness of this mark up. In any event, in view of a series of judgments of this Tribunal, the benefit of the +/- 5 per cent range is available to the taxpayers in all the cases and the TP adjustment should be restricted only on the net amount remaining after allowing the benefit of 5 per cent range provisions. Therefore, even if we were to assume that, what the TPO himself terms as 'significant services provided in procuring the raw material' were worth nothing-an unrealistic assumption anyway, at best an adjustment could be made in the cases of uncontrolled transaction price, i.e., LME pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng out several peculiar factors which applied to this year alone such as lower capacity utilization and efforts in developing new product lines which resulted in higher consumption ratio of the raw materials. The TPO has not even gone into merits of these explanations and simply brushed aside the same by observing that the assessee should have passed on these additional costs to the AE. We are unable to understand the rationale of this approach at all. The TP Regulations do require that the transactions should be entered into at an ALP. as close to the independent transactions between unrelated transactions as possible, but there is certainly no such requirement that the AE must enter into transactions in such a manner as to ensure that the AEs are allowed to make a reasonable profit margin. As long as the prices at which international transactions are entered into are ALPs, it is hardly relevant whether or not the AE has ensured that the assessee makes reasonable profits. As much as hypothetical independence of the transactions it does not permit artificially low profits by manipulating prices at which transactions are entered into by the AEs, it does not also require that the tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al costs are to be passed on to the AEs is a business decision, which may or may not be relevant in an ALP determination on the basis of transactional profit methods, but when traditional methods of ALP determination are being pressed into service, such considerations are wholly irrelevant. We are, therefore, not inclined to approve the line of reasoning adopted by the TPO in adopting this approach. We have also noted that the TPO has observed that cost plus method cannot be applied as the relevant data is not available in the databases available to him, but this reasoning proceeds on the fallacy that for application of cost plus method, internal comparable uncontrolled transaction is not sufficient. Rule 10B(1)(c)(ii), inter alia, provides for determination of the amount of normal gross profit mark up to direct and indirect costs, computed according to the same accounting norms as followed in the transaction with AE, by the enterprise in a comparable uncontrolled transaction. In the present case the assessee has entered into export transactions with the unrelated parties and the assessee's mark up on such transactions is admittedly comparable with the exports to related parties. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f r. 10B(1)(c)(ii) which refers to the gross profit mark upto such costs arising from the transfer of similar property by the assessee in a comparable controlled transaction. The assessee had offered the comparison of gross profit mark up margin of the assessee company on transactions with AEs with gross profit mark up margin of the assessee company on transactions with unrelated parties. which in our considered view. was a sufficient basis for determination of ALP under r. 10(1)(c). The TPO therefore did not have any good reason to reject the method adopted by the assessee. As regards the lack of clarity about the gross profit margin and difficulties in allocation of costs, it is only elementary that the same parameters were to be applied to the gross profit margin on uncontrolled comparable transactions and therefore the difficulties perceived by the TPO were not of much consequence. Having regard to these discussions, and bearing in mind entirety of the case, we are of the considered view that the TPO did indeed err in applying the TNMM on the facts of this case and thereby disturbing the ALP determined by the assessee. We agree with the assessee that, on the facts of the presen ..... X X X X Extracts X X X X X X X X Extracts X X X X
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