TMI Blog2014 (10) TMI 460X X X X Extracts X X X X X X X X Extracts X X X X ..... interlinked or inter-related to each other and cannot be evaluated separately - To this extent the conclusions of the TPO regarding determination of ALP by taking segmental results without looking into as to whether the two segments are interlinked or inter-related cannot be sustained. The TPO has arrived at the bifurcation of the manufacturing and trading segmental operating results - the trading and manufacturing segments are interlinked and therefore a combined transaction approach has to be adopted, the results arrived at by the TPO is combined - If the segmental results are combined, the operating revenue of the assessee would be 3767.91 crores and the operating profit would be ₹ 94.34 crores - Thus, the operating profit margin on sales would be 2.517 - If the arithmetic mean of the five comparables as above is tested as against the operating profit margin on sales of the assessee at 2.517%, then the same would be within the (+)/(-) 5% range of the arithmetic mean and therefore no addition by way of adjustment to the ALP can be made – Decided in favour of assessee. Computation of ALP - Whether the TPO can come to a conclusion that the ALP of an international transa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taken up for consideration. If the contention of the assessee on ground No.12, 22 to 24 is accepted, then the other issues raised in the grounds of appeal need not be gone into and those grounds would be left open for adjudication in the appropriate proceedings in the appropriate assessment year. 3. Gr.No.12, 22 to 24 raised by the Assessee in its grounds of appeal reads thus: The learned Assessing Officer, learned Transfer Pricing Officer and Honourable Dispute Resolution Panel have erred in Gr.No.12: not appreciating that the trading and manufacturing segments are intertwined and inter-related warranting a combined Transaction Approach in arriving at the arm s length price. Gr.No.22: doing separate evaluation of royalty payment, technical fees and other payments by adopting CUP method without justifying how the same was most appropriate method. Gr.No.23: Concluding that arm s length price of royalty payment, technical fees and other payments as NIL without brining on record any comparable; Gr.No.24: Concluding that the taxpayer has not been able to show that it derived any economic benefit from the alleged know-how received from the associated enterprises i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... analysis was done at the entity level combining all the transactions including those as a distributor. The Assessee in his transfer pricing analysis took as comparable companies 7 companies who had business similar to that of the Assessee i.e., they were also engaged in manufacturing of motor vehicles as well as trading in parts and accessories. The profit level indicator (PLI) adopted was cash profit to sales. The Assessee arrived at the cash and operating profit margin of the 7 comparable and arrived at an arithmetic mean of 5.28% and 2.87% respectively of cash profit margin and operating profit margin of the 7 comparable. The Assessee s cash profit margin and operating profit margin were arrived at 11.36% and 8.84% respectively. It was submitted by the Assessee that on a comparison at the entity level, the profit margins of the Assessee was much higher than the arithmetic mean of the comparable and therefore the international transaction with the AE should be considered as at Arm s Length. 8. The TPO was of the view that segmental financials demarcating Manufacturing segment and Trading segment are important for transfer pricing analysis at the segmental level. The segmental ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hus: Most appropriate method. 10C(1) For the purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arms length price in relation to the international transaction. (2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely: (a) the nature and class of the international transaction; According to the TPO, the most appropriate method is to be applied keeping in view the nature and class of transaction. Thus each class of international transaction is to be analysed separately by applying the most appropriate method. 12. The TPO also held that the law provides for comparative analysis of the international transactions in TNMM on the basis of the net margin realized by the taxpayer during the year from the international transactions and not based on enterprise level earnings and in this regard referred to Sub clause (i) of clause (e) of Rule 10B(1) of the Income Tax Rules, 1962 (the Rules) is extracted below:- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd trading (x) Reimbursement of expenses received Manufacturing and trading The TPO then proceeded to categorize the aforesaid transactions into two distinct segments:- Manufacture and sale of passenger cars Trading in auto components 14. Thereafter, the TPO arrived at the results of the trading segment as well as manufacturing segment of the assessee. The PLI adopted was operating profit on sales. As far as trading segment is concerned, the AO arrived at the following segmental results:- The TPO was satisfied that the international transactions in the trading segments were at Arm s Length as the Assessee s profit margin was better compared to the profit margin of the comparable companies (in its trading segment) selected by the Assessee in it s TP study. No adjustment whatsoever was therefore suggested by the TPO in so far as it relates to the trading segment is concerned. 15. As far as manufacturing segment is concerned, the TPO as we have already seen had arrived at the operating profit margin on sales at 1.94% in the chart given at para-9 of this order. The taxpayer had identified 7 comparables at the enterprise level by taking manufacturing seg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is able to control the indirect expenses like employee cost etc, its profitability improves. Thus, before comparing the taxpayer with the comparable companies, their efficiencies also have to be equalized. Otherwise, the comparability exercise would be distorted. Adjustments have to be made for the differences in operational efficiency levels between the taxpayer and the comparable company. Thereafter the TPO drew the following conclusion with regard to the operational efficiency of the Assessee and that of the comparable companies. The TPO concluded that the operative efficiency of the Assessee vis- -vis the comparable companies is higher by 3.57%. This difference according to the TPO was material as the margins of the comparable companies in this sector varied only from 3.52% on sales to 9.35% on sales for the FY 2006-07. The TPO therefore proposed to increase the margins of the comparable chosen i.e., he revised the profit margins of the comparables so that they would be on par with the Assessee. 19. The Assessee however vehemently opposed such a course of action being adopted by the TPO. According to the Assessee adjustment on account of operating efficiency is not c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fit level as required under TNMM. The Assessee also submitted that if operating efficiency is criteria for evaluation for selecting comparables, then companies with wide disparities in operating efficiencies cannot be compared at all. We are not going into the other elaborate submissions made by the Assessee in this regard as the issue raised in Gr.No.12 proceeds under the assumption that even if the adjustment on account of operating efficiency is given even then the margins of the Assessee if compared at entity level rather than at segmental level, will be well within the permitted (+) (-) 5% range of arithmetic mean PLI of the comparable companies chosen by the TPO. 20. The TPO did not agree with the submissions of the Assessee regarding upward adjustment of the margins of the comparable for the purpose of comparability and accordingly arrived at the margin of the comparables after making adjustments towards operational efficiency as follows:- 21. The TPO thereafter compared the net margin earned by the Assessee as computed by him in para-9 of this order on segmental basis for manufacturing segment to the Adjusted Net Margin earned by the comparable companies as follo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... view that the Assessee did not prove that benefit accrued as a result of payment for royalty. He therefore held that the royalty payments by the taxpayer for use of know how has to be taken at nil because: 1. The Assessee has not produced any evidence that it had actually received any technical know-how during the year from the AE. 2. There is no proof that the other group concerns or third parties are also charged identical royalty. 3. The Assessee has also not been able to show that it derived any economic benefit from the alleged know how received from the AE. 4. The profitability is much below the comparable companies. The Arm s Length Price of royalty was determined at Rs.Nil by the TPO and an adjustment u/s.92CA of the Act of ₹ 78,13,84,839/- was made by the AO. No separate addition was however made by the TPO because according to him this adjustment would merge with the overall adjustment of ₹ 152,88,21,900 made in the manufacturing segment by applying TNMM at the segment level. 23. Aggrieved by the order of the TPO which were incorporated by the AO in the draft order of assessment, the Assessee filed objections before the Disputes Resolution P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsactions between the Assessee and its AE include both service and sale transactions; 3. The various activities are intertwined and inter-related. Part of the trading activities were prompted by and are a result of the manufacturing activities, including the warrant commitments; 4. The data in the public domain is not detailed enough to permit a comparison of the results at the transaction level; 5. In the peculiar circumstances of the operations involving various types of transactions entered into, towards achievement of a common goal, it is not possible to split the financial data to arrive at the net result from particular and individual transaction. 6. The data regarding comparable transactions are available only at the entity level and not at individual transaction level; and 7. The net profit at the entity level would broadly justify the intrinsic value of all the underlying transactions particularly when the organization views them as independent and integrated whole. The assessee explained that it had accordingly bunched all the international transactions the segment level for determining the arm's length price. 26. The Assessee pointed out that Org ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olled after-sales services or sales of spare parts provided by a distributor to unrelated end-user customers where they are closely linked to controlled purchase transactions by the distributor (or resale to the same unrelated end-user customers. 28. The Assessee submitted that based on the above guidelines sale services or sales are to be considered as closely linked to purchase transactions from AE even if the after sale services or sales are with unrelated parties. The Assessee pointed out that the proposal to evaluate after sales services (part of Intra Group services) separately was not feasible because those transactions with the AE are closely linked and should be evaluated together. The Assessee also pointed out that doing so would be in accordance with Rule 1O A( d) of the Income Tax Rules, 1962 (hereinafter referred as Rules for short) which defines transaction to include a number of closely linked transactions. Linked means something which is connected. It was submitted that the definition does not provide that the transactions should be identical or similar. Once the transactions are connected, they can be evaluated together. 29. Further the assessee also re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l) level, where multiple intertwined transactions exist, it is not possible to identify or pinpoint the contribution of each facet or transaction to the earning of net profit. The Assessee pointed out that in the process of adopting the TNMM, it adopted the Net Profit as the starting point. In arriving at this net profit, it had factored the royalty payments / management fee / intra group service fees. Once the net profit margin is demonstrated to be at arm s length, it pre-supposes that the various components of income and expenditure that have been considered in the process of arriving at the Net Profit are also at arm s length. The operating margins as computed by it are demonstrated to be at arm's length. Accordingly, the Assessee submitted that in its case the TNMM is to be applied at the entity level and not transaction level as proposed by your honour. The assessee drew attention of the TPO to the decision of the Hon ble Pune ITAT decision in the case of Skoda Auto (I) Pvt. Ltd. vs. ACIT [2009-TIOL-214-ITAT-Pune] wherein on identical facts the TPO accepted aggregation of international transactions observing that when TNMM is used to bench mark the assessee s margin the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we find that the Tribunal has examined the Chapter-X of the Income tax Act, relating special provisions relating to avoidance of tax in detail and the Tribunal has held that ideally in order to arrive at the most precise approximation of fair market value arms length principle should be applied on transaction to transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be adequately dealt with on a separate basis. The Tribunal has also held that the burden of proving and establishing Arms Length Price and to furnish the relevant information lies initially on the assessee. 34. The assessee submitted that the decision in the case of Aztec Software (supra) is binding and needs to be followed. 35. The assessee reiterated that it had already demonstrated that all its activities are closely linked and interdependent. The assessee submitted that the decisions in the case of Star and UCB India are applicable only when the activities clubbed are dissimilar or are not closely linked. It was submitted that even otherwise, the Tribunal in the above cases has nowhere held that after applying TNMM at entity lev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment as 'NIL' is his perception that the assessee did not need these services at all, as the assessee had sufficient experts of his own who were competent enough to do this work. For example, the Transfer Pricing Officer had pointed out that the assessee has qualified accounting staff which could have handled the audit work and in any case the assessee has paid audit fees to external firm. Similarly, the Transfer Pricing Officer was of the view that the assessee had management experts on its rolls, and, therefore, global business oversight services were not needed. It is difficult to understand, much less approve, this line of reasoning. It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not. An assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and management consultancy; it is not for the revenue officers to question assessee's wisdom in doing so. The Transfer Pricing Officer was not only going much beyond his powers in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fficer. As such, there is no fresh reason for reconsideration of the matter. No interference is called for on this account. 38. With regard to the action of the TPO in determining the royalty payment at NIL, the DRP upheld the order of the TPO. Reasons given by the DRP in this regard are identical to the reasons given for rejecting the claim of the assessee for a combined transaction approach set out in the earlier paragraph. The DRP also made an observation that similar issues were sub-judice before different higher appellate and judicial forums and taking any other view would prejudice the pending proceedings on the issue for the revenue. 39. Aggrieved by the aforesaid directions of the DRP, the assessee has raised ground No.12, 22 to 24 before the Tribunal. 40. We have heard the submissions of the learned counsel for the assessee and the learned Departmental Representative. The submissions of the learned counsel for the assessee were reiteration of the stand of the assessee before the Revenue authorities besides reliance on some decisions of ITAT and Hon ble High Court. The learned Departmental Representative relied on the order of the TPO, DRP and the AO. It was furth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y linked or continuous that they cannot be evaluated adequately on an individual basis. In such a situation, rather than assessing the ALP of the transactions individually, the transactions could be evaluated together using the most appropriate method. 43. The above being the legal position, it becomes necessary to examine the international transactions carried out by the assessee with its AE during the previous year which have been categorized into 2 segments by the TPO in his order and find out if they are interlinked or interconnected so that the transactions need to be evaluated together rather than individually. In this regard, we find that the submissions made by the Assessee before TPO as well as before DRP have not been considered at all. The TPO proceeded on the basis that ALP of each transaction has to be examined independently/individually by placing reliance on the decisions of Tribunal in the case of Star India Ltd. (supra) and UKB(I) (P) Ltd. (supra). We agree with the submissions of the learned counsel for the assessee that these decisions have in fact accepted in principle that aggregation of transactions have to be done where they are interlinked but have on fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es. Needless to add that this finding / decision by its very nature has to be case-specific and year-specific as the decision is based on the facts and circumstances of this particular case and of this particular year and is not to be construed as laying down the principle in this regard. We, therefore, direct the Assessing Officer / TPO to ompute the ALP at the entity / enterprise level by combining the trading and manufacturing segments. 45. It is no doubt true that the Tribunal has observed that the ruling given in that year is based on the facts that prevailed in that year. We find that the facts in the present assessment year are also identical and there has been no change whatsoever in the business model of the assessee. In these ircumstances, we are of the view that the decision rendered by the Tribunal would be applicable for this assessment year also. Respectfully following the decision of the Tribunal, we hold that the trading and manufacturing segment of the assessee are not distinct and are inter-related warranting combined transaction approach. 46. We have already seen in para 9 of this order that the TPO has arrived at the bifurcation of the manufacturing and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... astrol India Ltd. v. ACIT in ITA No.3938/MUM/2010 dated 14.09.2012 wherein it was held that it was incumbent upon the TPO to work out the ALP of the relevant transactions by following some authorized method and the entire cost borne by the assessee cannot be disallowed by taking the ALP at Nil. The Tribunal also referred to the decision of the Hon ble Delhi High Court in the case of CIT v. EKL Appliances Ltd., ITA No.1068/2011 dated 29.03.2012. In the aforesaid decision, the assessee entered into an agreement pursuant to which it paid brand fee/ royalty to an associated enterprise. The TPO disallowed the payment on the ground that as the assessee was regularly incurring huge losses, the know-how/ brand had not benefited the assessee and so the payment was not justified. This was reversed by the CIT (A) Tribunal on the ground that as the payment was genuine, the TPO could not question commercial expediency. On appeal by the department, the Hon ble Delhi High Court held that the transfer pricing guidelines laid down by the OECD make it clear that barring exceptional cases, the tax administration cannot disregard the actual transaction or substitute other transactions for them and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion before the DRP in the appeals for other years also. For AY 2006-07 I find that the DRP has confirmed the TPO s determination of ALP of royalty at nil through order dt. 30.09.2010. In this order, however, at page 10 while recording its directions, the DRP mentions the TPO s admission that in view of the time barring situation he was unable to examine the objections raised by the assessee. After independently studying these objections, the DRP cryptically approved the TPO s position of nil ALP. In AY 2009-10 however, the DRP has discussed in elaborate detail the assessee s objections on similar grounds and has arrived at the conclusion that the assessee not only received the technology support as well as the related intangibles in terms of production processes, but has also benefitted from these technological practices, standards and know-how which were not created locally by itself. The Toyota Production System, standardized on a world-wide basis, has also been studied for its operational efficiency by premier academic institutions. I am inclined to agree with this conclusion after examining the facts of the appellant s case and the evidences available. The TPO s argument t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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