TMI Blog2015 (7) TMI 915X X X X Extracts X X X X X X X X Extracts X X X X ..... s appropriate to the facts and circumstances of this case, the objections taken by the authorities below to the use of berry ratio are unsustainable in law, and the adjustments for use of intangibles and locational savings are unwarranted. With these observations, the computation of ALP so far as buy sell segment of assessee’s activities are concerned stands restored to the assessment stage. The matter will be examined afresh in the light of the above observations which we respectfully concur with that laid by the co-ordinate bench in Mitsubhishi Corporation India Pvt. Ltd. (supra) and the matter is remanded back to be examined afresh at the assessment stage. Service fee segment which the TPO treated as trading segment - Held that:- The same issue cropped in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein held that 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 – following the decision in LI And Fung India Pvt. Ltd. Versus Commissioner of Income Tax [2014 (1) TMI 501 - DELHI HIGH COURT] - It is no longer open to the revenue authorities to reconstruct the financial statements of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trol of Marubeni Singapore which, inturn holds 99% share capital Marubeni Japan holds remaining 1% of Marubeni India. 4. The appellant/assessee, Marubeni-Itochu Steel India Private Limited ( MIIP ) / the Appellant ) brought to the notice of the TPO that assessee is a service and trading company and provides liaisoning support services to its parent and affiliates for purchase and sale of goods from India. It acts as a communication channel between its parent/affiliates companies and third parties in India. 5. The assessee states that it is engaged in undertaking two types of transactions with its Group Companies : a) Provision of support services to its Group Companies - Service Segment - where sales and purchases in relation to the import and export is recorded in the books of AE. The services include the following : Furnishing information regarding steel products and Indian steel market; Providing information concerning transportation, customs clearance and any other information as required by the AEs; Receiving and delivering of relative documents required in the contracts and shipping documents as required by the AEs; Acting as a channel of commu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9. That, in order to arrive at arm's length price, the appellant company carried out a benchmarking analysis; and to benchmark its indenting segment, appellant identified comparable companies (service providers) by applying appropriate search filters and average OP/VAE of these comparable companies was computed at 7.52% (using multiple-year data i.e. data for financial years 2007-08, 2008- 09 and 2009-10)( page 102 of P.B.). The appellant computed its own OP/VAE at 7.91 % for the financial year 2009-10 ( page 118 of the Paper Book).Since the OP/VAE (7.91%) of the appellant is better than the OP/VAE (7.52%)of the comparables, as such, indenting transaction entered with the AE was claimed to be at Arm's length. Further, similarly to benchmark the international transaction in the trading segment, appellant selected 17 comparables by applying appropriate search filters and average OP/Sales of these comparable companies was computed at 0.61 % (using multiple-year data i.e. data for financial years 2007-08, 2008-09 and 2009-10) (page 93 of P.B.). The appellant computed its own OP/Sales at 0.80% for the financial year 2009-10 (page 118 of P.B.) and since the margin of profit of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isregarded the functional and risk differences between the two segments; (emphasis added) (c) Added ₹ 948 Crores (which are purchases/sales in the books of the AE and upon which MIIP earns service fee/commission) to the cost base of the assessee; (d) Proceeded to compute the arm's length price of the said transaction by applying the percentage of operating profit earned by externally identified comparable companies to the aforesaid cost base and accordingly, made upward adjustment to the total income of the assessee; (e) The assessee is reimbursed based on cost plus model; (f) The commission business of the assessee is equivalent to the trading business and accordingly compared the assessee with trading companies and also the companies involved in manufacturing activities; (g) The assessee as part of this network and the synergy created by the same should be deriving income commensurate to the intangibles involved. The network of which assessee is a part consists of wholesaler, manufacturer, chemical dealers, paper traders etc. It is doing procurement and as well as sourcing for manufacturers and also of wholesaler. On this basis, the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... derstatement of arm's length price in respect of commission income earned by the appellant from its AEs. 18. The Ld counsel for the assessee submitted that the TPO/AO has added ₹ 648 crore (recorded as sale/purchase in the books of the AEs) in the AE segment which according him tantamount to treating the service/commission business of the assessee as that of a trader without stating any reason whatsoever. According to him, no basis for arriving at this conclusion has been stated in the said order. No evidence or material has been brought on record by the TPO/ AO to reach the aforesaid conclusion. As per the Ld counsel, the TPO has acted outside his jurisdiction by challenging the compensation model of the assessee. In this regard, the Ld counsel submits that it is a settled principle in tax jurisprudence that the business model method/ transaction chosen by a taxpayer has to be respected and it not open to the revenue to dictate the business model. According to him, the TPO has only contended that trading transactions and service/ commission transactions are equivalent without assigning any reason to arrive at this conclusion. However, the Ld counsel pointed out that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... development of a trademark/trade name. Yes Very limited After-sales Service: After-sales service is a mean by which a firm differentiates its products from those of others. After-sales service includes developing technical support and training for distributors and dealers; providing distributors with advice and training to improve operations and profitability; and ensuring component availability. Yes No Warranty and replacement services: The warranty support function is generally performed by the entity from which the customer receives a level of service prescribed by the legal obligation under the warranty Yes No Warehousing activities : Warehousing activities is performed for stocking the goods in which the trader deals in. It involves decision regarding level of inventory to be stocked, insurance and other incidental activities. Yes No Inventory Risk : Inventory risk relate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... osts 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. 23. Similarly, the ld. Counsel took our attention to the view of the decision of co-ordinate bench in the case of Mitsubishi India Pvt. Ltd. [LT.A. No. 50421De1l1l] wherein it was held by the ITAT that: 80. Coming to the service feel commission segment, we have noted that as regards the service feel 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the nature of indenting transaction is different from the trading transactions. The trading transaction involves risk and finances, whereas in the indenting transaction the assessee has not to incur any such financial obligation or carry any significant risk. 25 The Ld Counsel thereafter submitted that it also needs to be noted that the question of adding the FOB value on which the assessee has earned service fee/commission as cost of goods sold (COGS) in the cost base does not arise because the assessee does not trade in any goods while performing the service of facilitation of trade and such transaction has never been routed through the books of the assessee. It does not take any title of the goods in form or in substance while performing coordination and sales support functions for its AEs. It does not assume title of the goods and the risks associated with such assumption of title are not borne by it in the service fee/commission business. The assets that are employed in assumption of the title to the goods are different from service transactions carried out without assumption of title. The assessee earns commission from its AEs on export to India or, in few cases, import ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ow : Allegation of TPO Remark of the Assessee Qualifying the contract manufacturer The assessee is not involved in Qualifying the contract manufacturer. Further, this function is also not mentioned in the TP Report Identifying appropriate source of goods The assessee is not involved in Identifying appropriate source of goods. Further, this function is also not mentioned in the TP Report. Warehousing of goods The assessee is not involved in Warehousing of goods with respect to its commission transactions. Further, this function is also not mentioned in the TP Report. Control over contracted manufacturer and quality control over manufacturing process The assessee is not involved in Control over contracted manufacturer and quality control over manufacturing process. Further, this function is also not mentioned in the TP Report. Scheduling of the products and order tracing The assessee is involved in scheduling of the products and order tracing. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wned by assessee as alleged by TPO Remark of the assessee Knowledge of subcontractor Knowledge of subcontractors is general information which is publicly available. Knowledge of products design There are no designs with respect to steel and chemical industry in which the assessee is primarily dealing with respect to commission business. Knowledge of acquisitions The assessee does not have any knowledge relating to acquisitions. It is merely providing support services and acquisitions have no relevance to its business. Knowledge of distribution and supply The assessee is engaged in providing support services and therefore knowledge of distribution and supply is irrelevant. Knowledge of quality control Quality control function is undertaken by a manufacturer and not by a service provider, particularly support services as rendered by the assessee. Knowledge of storage The assessee is engaged in providing support services and therefore knowledg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. Further, the CIT(A) has also upheld the comparison of the assessee with that of service providers, so there being no change in facts, there was no necessity for the TPO to depart from the said view. In light of the aforesaid submission, it was pleaded that addition made be held as unsustainable. 36. On the other hand the ld. DR submitted that the assessee is aggrieved that his Transfer pricing approach has been rejected and that his Commission/service business has been characterized as that of a trading business and also that FOB value has been included in the cost base, amongst various other grounds. According to Ld DR M/s Marubeni India is a service and trading company and provides liasioning support services to its parent and affiliates for purchase and sale of goods in India. It acts as a communication channel between its parent/affiliates companies and third parties in India. The assessee has used OP/VAE as the PLI for application of the TNMM method on support services. According to Ld DR in order to approach the main contentious issues as stated above, it is important to understand the relevant provisions of the TP rules as prescribed by the Statute under Rule 10B and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ive parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 40. According to Ld DR, the mandate is clear, that every TP report should contain information pertaining to the above for the purpose of the applying the PLI, and applying the method and computing the ALP for the transaction. The Ld DR contented that the findings of the TPO cannot be ignored on page 158 paras (a) to {g} which categorically records that a substantial portion of the profits which the assessee would have earned had the arrangement between the taxpayer and its associated enterprises been at arm's length. At Page 167 of the appeal paper book where the TPO records that the TP report does not demonstrate whether AE has either technical capacity or manpower to assist the assessee. In the absence of any credible evidence, such general remarks to somehow prove the involvement of the AE cannot be accepted. 41. The Ld DR submitted that the TPO after carefully examining the facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsumer goods (LI and FUNG). Therefore risk being intrinsically connected to the function performed and the assets deployed, the level of risk demonstrated by the taxpayer in the instant case is inadequate and hence it can only be presumed that the assessee was involved in the key functions of the business, unless categorically rebutted with sufficient evidence. The decision in the case of LI and FUNG proceeded on a different footing and cannot be of any help to the assessee. So the Ld DR does not want us to interfere in the order impugned before us. 45. We have heard both the parties and have gone through the records. We find that the assessee company is a part of one of the leading Sogo Shosha establishment in Japan. Sogo Shosha , a Japanese expression, means general trading . So they are generally described as general trading companies . The assessee is a wholly owned subsidiary of MO. These Sogo Shosha companies are unique in the world of commerce and play an important role in linking buyers and sellers for products ranging from bulk commodities, such as, grain and oil to more specialised products like industrial equipments, ranging from noodles to missiles. The peculi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re the activities were initially performed. It follows that the savings have to be with respect to the activities and operations performed, which MNE was earlier performing at another location, and not with respect to the costs of purchases. Therefore, if an assessee is able to buy a product or service at a lower price vis- -vis price in another jurisdiction, including the domicile I.T.A. No.: 5042/Del/11 Assessment years 2007-08 Page 39 of 95 jurisdiction, such purchases of goods or services per se donot give rise to a locational saving for the purpose of ALP determination. In the present case, the price advantage to the assessee, on account of sourcing his purchases from India, thus may not amount to any locational savings at all, but then, as we could make out from a perusal of material on record, that precisely is the case of the TPO. No doubt United Nations Practical Manual on Transfer Pricing for Developing Countries does include locational savings in its comparability analysis and defines it as net cost savings that an MNE realizes as a result of relocation of operations from a high cost jurisdiction to a low cost jurisdiction but then it is not even TPO s case that an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e were any such locational savings but given the facts of the present case that aspect of the matter is wholly academic in effect. 47. The facts circumstance being similar, we concur with the aforesaid view of the co-ordinate bench and so the adjustment for use of locational savings was unwarranted. 48. Thereafter, the Coordinate Bench considered the other issue that has been raised before us that is in respect to the TPO s contention that the assessee is the owner of the supply chain intangibles and human asset intangibles has also cropped in Mitsubishi Corporation India Pvt. Ltd. (supra) wherein the Coordinate Bench held as follows:- Human asset intangibles and supply chain intangibles correctness of TPO s stand 71. Coming to TPO s observations that the compensation model adopted in this case does not provide for meeting the costs of developing supply chain intangibles and human assets intangibles, but the intangible so developed by the assessee are routine intangibles developed only during the course of work carried out by the assessee and any other intangibles, other than the ones developed in the course of this business, are owned by the AEs and not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and not when it merely consists of the passive association benefits. There is no such suggestion of deliberate concerted action benefits in the present case. 73. In any event, as observed by Hon ble Delhi High Court, in Li Fung s case (supra), the assesse may have developed experience and expertise which the Tribunal has held to be human capital and supply chain intangibles but such description does not in any way reveal how the appellant bears any risk - either enterprise or economic . Summing up the decision, Their Lordships have further observed that, Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as significant risk , functional risk , enterprise risk etc. without any material on record to establish such findings. If such findings are warranted, they should be supported by demonstrable reason, based on objective facts and the relative evaluation of their weight and significance . These observations equally apply to the fact situation before us as well. As learned counsel for the assessee very aptly puts it, all these intangibles, as perceived by the TPO, are more of his figment of his imagination rather than ba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tle of goods is held only momentarily, it could 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. Use of berry ratio when tested party has high level of current assets 66. As for the objection regarding use of this ratio only in the situations in which current assets are not significant, there cannot indeed be much dispute with this proposition on principle but there is nothing on the record to evidence that there are high current assets in the present case either. Such vague generalities, as resorted to the TPO, cannot be sustained in law. There is no mention about any specific element of assets which can be related to high current assets. The TPO has mentioned about use of intangibles but on the question of intangibles as well, for the reasons we will set out in a short while, the stand of the TPO was devoid of any legally sustainable foundation. It is not the case of the TPO that the assessee owns any significant unique intangibles, which are acquired by the assessee at a specific cost , which have significant replacement cost or whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ible to visualize and deal with the difficulties with regard to variations in, and impact of, accounting policies in such cases. Having said that, we must may also reiterate that when we are only dealing with trading activities of the tested party and the comparables, without any processing or other costs, the occasion for any impact of significant variations in the accounting policies does not arise. There can be little scope of differences in approach so far as trading costs are involved. 50. In the light of the above decision, respectfully following the same, we repel the contention of the TPO and uphold the contention of the assessee that Berry Ratio adopted by the assessee does not offend Rule 10B. 51. In view of these discussions, in our considered view, the use of berry ratio as PLI is appropriate to the facts and circumstances of this case, the objections taken by the authorities below to the use of berry ratio are unsustainable in law, and the adjustments for use of intangibles and locational savings are unwarranted. With these observations, the computation of ALP so far as buy sell segment of assessee s activities are concerned stands restored to the assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordships have, interalia, 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 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 c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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