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Mitsui & Co. India Pvt. Ltd. Versus Deputy CIT, New Delhi

2015 (8) TMI 922 - ITAT DELHI

Transfer pricing adjustment - inclusion of cost of sales incurred by the AEs - Held that:- It was not correct on the part of the TPO to include the cost of sales incurred by the AEs in respect of which the assessee company has rendered services and then to work out the profit for determination of the armís length prices. Our view is also supported by the judgment of the Delhi Tribunal in the case of Sojitz India (P) Ltd. vs DCIT (2013 (6) TMI 550 - ITAT DELHI ) where a similar issue has come up. .....

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himself. The cost base as determined by the TPO in the assessment year 2008-09 is ₹ 4071,95,89,546. The adjustment proposed after order from the DRP is ₹ 114,82,92,425. This amount is also within 5% of the cost base determined by the TPO himself. Accordingly, no adjustment could have been made in view of the proviso to section 92C of the Act. The TPO is not right in including the cost of sales while determining armís length price and not considering the same while applying proviso t .....

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Jain & Ms. Rano Jain, CAs For the Respondent: Shri Sanjay Prasad, CIT( DR) ORDER PER I.C. SUDHIR: JUDICIAL MEMBER These are two appeals for the assessment year 2007-08 and 2008-09 directed against the order dated 21-10-2011 and 26-11-2012 passed by the Deputy Commissioner of Income Tax, Circle 6(1), New Delhi under Section 143(3) read with Section 144C of the Income Tax Act. 2. Since the facts and the issue raised in both these appeals are common, the same are being disposed of by a common o .....

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g sogo shosha establishment in Japan. Sogo shosha means general trading and these companies are general trading companies. These companies play an important role in linking buyers and sellers for wide range of products. The range is very wide that it includes grain and oil, machinery, equipment, etc. 5. The assessee company being a subsidiary of the Mitsui & Co. Ltd., Japan provide support services to the various group entities of Mitsui & Co. Ltd., Japan. This support services is the ma .....

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4 6. Reimbursement of expenses paid/payable 100,737,320 7. The learned TPO noted that the assessee has used TNMM (Transactional Net Margin Method) as the most appropriate method and the Profit Level Indicator (PLI) selected is Berry Ratio against operating expenses. The contention of the assessee was that the average berry ratio come out to 1.34 as against 1.09 computed on the basis of the 20 comparables set out in the transfer pricing study and hence the transactions entered into by the assesse .....

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at the cost of sale is to be included in the denominator of the PLI used. It was the contention of the learned TPO that as per the Income Tax Rules operating expenses cannot be the basis as these expenses do not include cost of sales. The TPO in support thereof invoked the provisions of Rule 10B(1)(e)(i) to hold that net profit margin realized by an assessee from an international transaction entered into with associated enterprises is to be computed in relation to costs incurred, sales effected .....

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oposed to treat the service and commission income segment as equivalent to trading segment and therefore, propose to add the result of commission and service segment related to AEs and include ₹ 4512 crores as cost of goods sold in this combined AE segment. You are hereby required to show cause as to why the service/commission income is not treated as trading business in substance. You are also required to show cause as to why ₹ 4512 crores should not be included in the cost base of .....

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nal set of the comparable companies are hereunder: Company Name OP/OE (percentage)* Frost International Ltd. 1.99 P K S Ltd. 4.34 General Commodities Pvt. Ltd. 3.04 Sakuma Edports Ltd. 2.08 Kotak Ginning & Pressing Inds. Ltd. 2.94 Cottage Industries Exposition Ltd. 3.04 Euro Vistaa (India) Ltd. 5.78 Average (Mean) (percentage) 3.32 * Note: Financial Data of FY 2006-07 9. Computation of arm s length profit from service/commission segment is given below: Approx. Cost base of AE-segment (AE ser .....

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essee submitted a detailed reply contending as under:- i. The assessee essentially in the business of providing sales support and coordination activities in relation to its international transactions: The assessee argued by comparing the FAR of trader vis-à-vis a service provider and concluded that the FAR of the assessee is akin to the FAR of a service provider. ii. Berry Ratio has been rightly selected as the PLI: iii. Value of ₹ 4512 Crores should not be added to the cost base of .....

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omparables selected by the TPO are incorrect and the margins computed by the assessee be accepted as the same is derived from annual report which more reliable source than Prowess. 11. The TPO, however, did not agree with the contention of the assessee and proposed an adjustment of ₹ 107,53,92,764 as under:- It is concluded that the assessee has not been able to substantiate its arguments with valid documentary evidences. Following the discussion the preceding paras, the FOB value of goods .....

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1,135,167,217 Difference to be adjusted = D-C(Rs) 1,075,392,764 12. Aggrieved by the draft assessment order passed by the AO as per the recommendations of the TPO, the assessed filed objection before the learned DRP. 13. The learned DRP upheld the action of the learned TPO in recharacterizing the transaction as that of a trader as against service provider. It, however, directed the TPO to exclude one comparable viz., Cottage Industries consequent to which the margin got increased from 2.49% to 2 .....

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7,685 15. The learned TPO following order of assessment year 2007-08, recharacterized the transaction as trading transaction and by including ₹ 4005 Crores as cost of goods sold in the combined AE segment and by applying a margin of 2.91% proposed an addition of ₹ 116,60,28,331/-. 16. In this A.Y. 2008-09, the learned DRP again upheld the action of the learned TPO. However, it directed the TPO to exclude three comparables consequent to which the margin got reduced to 2.82% and accord .....

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ves risk and finance whereas in the activity of support services i.e. intending transactions the assessee company has neither to incur any financial obligation nor carries any significant risk. The nature of two activities is absolutely different. The activities of trading i.e. purchase and sale are highly insignificant as compared to activity of support service which constitutes the core business activities of the assessee company. The learned TPO and the learned DRP has gone wrong in applying .....

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n ignoring the same. The OECD guidelines also supports this contention that in TP study business transactions cannot be recharacterized. The support service or intending provided by the assessee company is nothing but a trading facilitation both in form and substance. There is no allegation nor any material brought on record to suggest that support services/intending transactions are trading transactions submitted by the Learned AR. He submitted further that the TPO has not been able to identify .....

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y and the same being at arm s length, the adjustment proposed by the TPO and as confirmed by the DRP needs to be deleted. The TPO has gone wrong in benchmarking the business support services provided by the assessee company to AE with that of independent trading transactions for determining the arm s length price in respect of business support services. 18. It was further argued by the ld. AR that the company is engaged in providing business support services to various group companies of Mitsui .....

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India, the Mitsui Japan has a contract with the Japanese suppliers and Mitsui Japan also enters into contract with the buyers in India. Similarly for exports from India, Mitsui Japan enters into a contract with Indian supplier directly for the purchase and sales transactions. Thus the role of Mitsui India, the assessee company is a mere facilitator, a mere service provider. Mitsui India does not take title or possession of the merchandise at any moment and bears no price risk. Mitsui India does .....

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nt than the trading business. In trading activities, one ventures himself. Buys and sells goods in it s account. It takes price risk, inventory risk, it deploys capital in inventory, debtors. It takes risk in warranty, credit, etc. Thus the functions performed, assets deployed and risk assumed in trading are entirely different than that of business support services. The TPO has gone wrong in holding that margins earned in trading are in identical circumstances as while providing support services .....

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control, knowledge of storage is wrong and against the facts. These are none of the activities of the assessee company as is evident from the description of business support service provided by it. Assessee company simply provides facilitation services to entities in supply chain without being a part of the supply chain. The assessee company has created human intangibles. In this regard the AR submitted that TPO has just made a literary reference in his order about human intangibles and held th .....

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i Japan which has the expertise, a strong relation with a vast network of manufacturers, distributors and buyers. 20. On the issue of inclusion of cost of sales in the denominator it was submitted by the Learned AR that reasoning given by the TPO in the order that compensation model in the case of the assessee should be expressed as a percentage of FOB price of goods serviced through the assessee is also wrong. In this regard the observation of the TPO that the assessee has played a major role i .....

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e good where the service provider has knowledge of the product, knowledge of the quality, its usage and has developed competency. In this regard this model can t be applied to an entity which is just providing support services to an entity who in turn has core competency of that business, its product, design, etc. There is a difference in carrying on the business oneself and providing support service to the one who is doing the business.That reasoning given by the TPO for adding cost of goods so .....

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opriate to take cost of sales for computing margin.That even otherwise the compensation model to determine the arm s length price based on a single rate of commission on total FOB value of all types of goods to be sold will not be appropriate. The percentage of brokerage or commission for procuring business in respect of luxury goods or commodities is higher as compared to the percentage of commission or brokerage for high value products like gold, bullion. Similarly the percentage of commission .....

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these items details has in a most arbitrary manner considered trading as one and the same to support services and applied trading margin in different nature of the product and items to the support services taking turnover of the AE as the basis. That the TPO was not justified in re-characterizing the transaction of business support services as that into trading and applying the profit margin in the trading as the PLI. 21. It was argued by the ld. AR that in the preceding assessment year i.e. 20 .....

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2003 when the appellant company was incorporated and it has been consistently benchmarking its international transaction relating to business support services using TNMM at the most appropriate method with OP/TC as PLI. This is the correct method. The method adopted by the TPO is not a method at all prescribed. As per the balance sheet of the company the total capital of this company is just ₹ 24.30 Crores (PB Pg. 140 - Vol. II) and its main activity is just to provide support services. It .....

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Sojitz Corporation, Japan. Sojitz Corporation, Japan was also a sogo shasha company i.e. general trading company. Sojitz India (P) Ltd. was also engaged in providing support services to the Sojitz Corporation, Japan and its group companies. The major activities of the Sojitz India (P) Ltd. were to provide support services. A very small part of the activity was trading in India as is the case here. The TPO was of the view that the activities of service provider is similar to the activities of the .....

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f a trader. 24. The learned AR further submitted that the issue is also covered by the judgment of Hon ble jurisdictional Delhi High Court in the case of Li and Fund India Pvt. Ltd. vs. CIT 361 ITR 85 (Delhi). Further the above judgment has also been considered again recently by Delhi Bench of ITAT in the case of Mitsubhishi Corporation India (P) Ltd. vs. DCIT, ITA No. 5042/Del/11 dated 21.10.2014 where facts are identical and similar issue has come up and the coordinate bench has held that TPO .....

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is regard the learned AR submitted that the TPO after holding that cost of goods sold is a relevant criteria has not taken the issue to its logical conclusion. Per contrary he has proposed an adjustment of ₹ 107,53,92,762/- whereas considering the provisions of proviso to section 92C(2) no adjustment was called for. It was submitted that the proviso to Section 92C actually talks about comparing the price of international transaction with the Arm s length Price so determined. Thus even if i .....

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) …refer TPO order pg 21 59,774,453 1,89,11,725 Total Sales / Commission Income (A) = (Z) +(Y) 45,648,819,312 4073,85,01,271 Mean OP/TC (B) 2.56% 2.28% Arm s Length Profit as per mean OP/TC (C) = B * Z 116,70,79,548 114,82,92,425 Arm s Length Cost (D) = A - C 4448,17,39,764 3959,02,08,846 Total Cost Base as per TPO (Z) 45,589,044,859 4071,95,89,546 Difference 110,73,05,095 112,93,80,700 5% of the ALP (As per proviso to Sec 92C) i.e. 5% of (D) 222,40,86,988 197,95,10,442 In the present cas .....

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are not correct comparables and accordingly the TPO was justified in rejecting the same. As regards the contention of the learned AR that the facts of the case are similarto the case of Sojitz India (P) Ltd. (Supra) and Mitsubishi Corporation India (P) Ltd. (Supra) it was submitted that though facts of the present case are almost similar to the facts of these two judgments relied upon by the AR as all these companies are providing support services to the parent company in Japan engaged in Sogo S .....

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arned AR it was submitted that this benefit is not available to the assessee company as the method applied is only one method i.e. Transactional Net Margin Method. It was contended that the benefit of this proviso will be available only when arm s length price is determined by applying two methods and the difference in the two methods is within 5 per cent. 28. We have considered the arguments advanced by the parties and gone through the orders of the authorities below as well as the judgments re .....

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Officer rightly noted, the main issue in this case is adjudication on the question "whether …(the assessee).. is being adequately compensated" for the functions performed by the assessee. The TPO then proceeded to analyze functions of the assets, risks assumed by the assessee and assets employed by the assessee. He noted that, as set out in paragraph 3.4 of the transfer pricing study, the assessee has provided the services for (a) facilitating communication between buyer and sel .....

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their competitors eyeing similar business in India". The TPO was of the view that "the assessee has performed all the critical functions, assumed significant risks and used both tangible and unique intangibles developed by it over a period of time". He then summarized the FAR analysis as follows: Functions performed by the assessee: -Purchasing activities: Mitsubishi India places orders with related party vendors after receiving orders or projections from its customers -Distributi .....

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Mitsubishi India's sales personnel requirements are Identified by Mitsubishi India and also remuneration of sales personnel is determined by Mitsubishi India. Mitsubishi India is responsible for billing and collection. Mitsubishi India provides market research relating to local market and develops marketing strategy. -Identifying potential customers and suppliers. -Information gathering. -Facilitating communication -Arrangement of logistics. -Accounting and administration. -Developing long .....

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drawn by the TPO and quoted in the judgment of the Mitsubishi Corporation India (P) Ltd. in para 9 of the order are also exactly the same as in para 5.3 of the TPO s order in the case of the assessee company. Thus we are of the view that the facts of the present case are similar to the facts of the Mitsubishi Corporation India (P) Ltd. In the Mitsubishi Corporation India (P) Ltd.(supra), the ITAT has held that it is impermissible to make notional addition in the cost base and then take into acc .....

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her 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 incu .....

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e., ready-made garments by the third party venders (which cost is certainly not the cost incurred by the assessee), is nowhere supported by the TNMM under Rule 10B(1)(e) of the Rules. Having determined that (TNMM) to be the most appropriate method, the only rules and norms prescribed in that regard could have been applied to determine whether the exercise indicated by the assessee yielded an ALP. 30. In view of the above judgment of Hon ble jurisdictional High Court, we hold that it was not corr .....

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so considered the transactions entered into by the assessee company as transaction that of trading activity. The ITAT has examined this issue and has held as under:- 12.18 In the aforementioned background we are of the view that in order to adjudicate upon the issues it would be appropriate for us to formulate the questions as under:- (a) Whether the TPO on facts was justified to treat the indenting activity at par with the trading activity ; (b) If the answer to the query posed in (a) is " .....

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g the margins earned in the trading activity to the profits of indenting activity for working out the Arms Length Price. 12.19. On a consideration of the business profile of the assessee as available on record and the nature of services rendered and the risk profile of the assessee, we are of the view, that the TPO erred in considering that the activity of a service provider is similar to the activity of a trader. The decisive factors as to why the question framed in (a) has been answered in the .....

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nds. The contract is entered into by SCJ and Indian customers directly whether for export or import. The negotiations are directly done by SCJ and the Indian customers and the assessee merely functions as a facilitator. Looking at the nature of services rendered and the arguments advanced which also remain unrebutted and as such are taken to be correct the assessee does not need to incur cost either for maintaining or storing the inventory or for the transportation as the title in goods is never .....

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rd that in these years the assessee has also shown profits on its own trading with non AEs. In the facts available on record, nothing has been brought on record by the TPO to either justify that the assessee has made a wrong claim on facts while claiming to be engaged in indenting activities or was infact performing all or some of the functions of a trader, in which eventuality the TPO would have been well within his rights to re-characterize the assessee's indenting activities as a trading .....

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tion for applying the margins earned in trading activity to indenting activity as the two are distinct and separate. Merely because the assessee was also having a small level of trading activity in its own name, there is no reason available on record either justifying the action of recharacterizing the nature of assessee's activity from a service provider to that of a trader. As observed, neither the TPO has lead any discussion nor has the DRP cared to throw any light on the aspect for uphol .....

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assessee was ever exposed to any of those risks as such, the two activities could not be treated at par and thus invited a similar treatment. 12.22. The Ld. CIT DR has relied upon various decisions in support of the TPO's order and the order of the DRP which we propose to discuss subsequently. However it can never be over emphasized that each decision operates on its own peculiar facts and circumstances. This holds equally good for orders and judgments rendered in the context of transfer pr .....

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wn be considered. The issues being purely factual necessarily warrant a detailed discussion. 12.23. In the facts of the present case it is seen that the assessee is using the network of SCJ for rendering its services. Reference may also be made to page 248 of the paper book which contains the TP study of the assessee the same is reproduced for ready reference. "Patents, License Rights, and other Intellectual Property Rights The various intangibles required to carry out the operations of the .....

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space, chemicals, plastics, high technology machinery, automobiles, tele-communications industry or reality etc. and no effort has been made to show that the limited trading activity belongs to which of those segments were anyway the FAR analysis shows that there is no comparison in the two activities 12.25. Accordingly on account of these facts, we are unable to agree with the TPO who chose to re-characterize the activities of the service provider and treated them at par with the activities of .....

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st of repetition the consistent and unrebutted material available on record shows that in the trading activity, the assessee has entered into contracts with the parties in India in its own name. The title in goods has been held for these contracts in assessee own name as such the assessee as any other trader has exposed itself to the price risk, the credit risk and other related risks of inventory risk etc. The negotiations for the same has directly been done by the assessee and not by the SCJ. .....

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another aspect of the issue as Ld. CIT DR has specifically relied upon orders of the ITAT for the proposition that the TPO can re-characterize the transaction under the Act. We hold that no doubt that the TPO under the Income Tax Act and the rules there under has the powers to recharacterize the transaction if so warranted on facts, in the facts of the present case, this power has been erroneously exercised. On a detailed consideration of the functions performed by the assessee in the two separa .....

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as in the affirmative, has still been decided as parties had addressed and the facts were available on record, is also necessarily answered in the negative. 12.29. The query posed in (c) calls upon us to decide whether as per Rule 10B(1)(e)(i), the TPO, in the facts of the present case, was justified in holding that net profits margins should be computed in relation to FOB value of goods/ or the operating cost to the assessee. The said query was also to be addressed only if the answer posed to u .....

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y of the following methods, being the most appropriate method, in the following manner, namely : (a) ** ** ** (b) ** ** ** (c) ** ** ** (d) ** ** ** (e) Transactional net margin method, by which- (i) the net profit margin realised 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 or having regard to any other relevant base; ** ** ** 12.31 .....

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cilitator 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. As such (c) is also decided accordingly. 12.32. Arguments on the .....

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s favour. However in order to maintain coherence and lucidity in our findings which are fact driven, we propose to discuss the judgements subsequently. For the present purposes on consideration of the functions performed by the assessee, the assets deployed using the intangibles of SCJ networks, the risks to which the assessee is consequently exposed we are unable to concur with the conclusion of the TPO that the assessee has created human assets and supply chain intangibles. The unrebutted fact .....

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nnel from utilizing any skills which they may have acquired during employment as no specific skills for indenting are required for indenting and acting as a facilitator. It is not the case of the department that the assessee is performing critical functions which admittedly are performed by the AE or that the assessee is contributing by way of analysis, reports and opinions, being provided as such value added services are being performed wherein the analysis/opinions may turn out to the correct .....

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uestion (d), which we have posed to ourselves since the answer to question (a) is in the negative the question regarding justification on facts in applying margins earned in trading activity to the profits of indenting activity for working out the Arms Length Price requires to be considered. For the said purpose we are of the view that elaborate discussions are not necessary as it would necessitate re-iterating the distinctions in the two separate sets of activities and the conclusions on the de .....

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is the immediately subsequent assessment after the two years under consideration, same method has been followed by the assessee. According to the Ld. CIT DR the method has not been accepted though adjustments have not been made as the margins in the trading activity vis-à-vis the indenting activity, declined. The Ld. CIT D.R has been at pains to emphasize that no doubt no adjustment was made in the TP proceedings for 2009-10 assessment year but no deviation has been made from the stand ta .....

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find their way to the current assets, and in which no functions are performed in respect of these inventories, except to facilitate trading in respect of the same, the very raison d'être for the cost of inventories being included in the cost base ceases to exist. The FAR analysis set out in the TPO's order, which is summarized in paragraph 7 earlier in this order, does not support the inclusion of inventory costs in the cost base either. 57. In our considered view, to sum up, in a .....

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sing costs involved, and (iii) there is no unique intangible for which the business entity is to be compensated. 65. As for the objection that use of berry ratio is not permitted under rule 10B(1)(e)(i) as it does not deal with costs incurred, sales effected or assets employed or to be employed, it proceeds on the fallacy that the basis of computation, as set out in rule 10B(1)(e)(i), is exhaustive whereas it is only illustrative and it ends with the expression "or having regard to any othe .....

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In our considered in a situation in which trading is on back to back basis without anything actually going to the current assets and flash title 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. 80. Coming to the service fee/commission segment, we have noted that as regards the service fee/commission segment, the TPO has r .....

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now covered in favour of the assessee by Hon'ble jurisdictional High Court's decision in the case of Li & Fung wherein Their Lordships have, inter alia, 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 bou .....

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he 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 considering the cost of manufacture and export of finished goods, i.e., ready-made garments by the third party venders (which cost i .....

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is so opined by Hon'ble jurisdictional High Court on a careful analysis of rule 10B(1)(e)(i). It is, therefore, no longer open to the revenue authorities to reconstruct the financial statements of the assessee by including the cost of products incurred by the AEs, in respect of which services are rendered, in its reconstructed financial statements, and then putting the hypothetical trading profits, so arrived at in these reconstructed financial statements, to the tests for determining arms& .....

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e are of the further view that the adjustment as confirmed by the DRP is otherwise untenable in view of the proviso to section 92C of the Act. The TPO has included the cost of sales of the AEs while making adjustment to the arm s length price. The cost base as determined by the learned TPO in the assessment year 2007-08 is ₹ 4558,90,44,859. The adjustment proposed after order from the DRP is ₹ 116,70,79,548. This amount is within 5% of the cost base of ₹ 5589044859/- determined .....

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applying proviso to section 92C of the Act. The language of the proviso to Section 92C as it was applicable for the assessment year under consideration is very clear and unambiguous. According to provision of section 92C first arm s length price has to be determined. Thereafter the same has to be compared with the price charged by the assessee and if the difference between the price determined by TPO and the price charged by the assessee is within ±5% then no adjustment is required to be .....

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