TMI Blog2015 (9) TMI 609X X X X Extracts X X X X X X X X Extracts X X X X ..... factual matrix we are thus inclined to uphold the conclusion of the CIT(A) to benchmark the two independent functions separately. We do not find any merit in the contention raised by the learned counsel that these are closely linked transactions undertaken by the appellant. On the contrary the nature of transactions are functionally different and even the risk assumed are different. We thus negate the stand of the assessee and uphold the findings of CIT(A) in benchmarking the distribution/agency function separately. Allocation of expenses - No infirmity in the approach adopted by the CIT(A). The CIT(A) has correctly held that allocation of expenses in proportion to sales would amount to give equal weightage in terms of functions performed, assets utilized and risks assumed to both distribution function as well as agency service activity, which otherwise involves much lesser functions and utilization of assets and risk. - Decided against revenue. Excluding the custom duties on the import of ROB for benchmarking the arm’s price - CIT(A) deleted the addition excluding the increased custom duties out of the cost of import of ROBs for benchmarking the arm’s length price of distrib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rough Ophthalmic Blanket (ROB), for benchmarking the arm s length price, on the ground that an abnormal item was not appearing in the financial of the comparable concerns. 3 On the facts and in the circumstances of the case, the ld CIT(A) has erred in excluding the custom duties on the import of ROB for benchmarking the arm s price ignoring the fact that the custom duty paid on the import of goods is a normal business expenditure. 2. Briefly stated the facts of the case are that the respondentassessee company is a branch office of a French company, namely, Corning S. A. France which is a leading manufacturer of very high-grade ophthalmic and non-ophthalmic glass products in the world e.g., ophthalmic blanks for eyeglasses and optical fibre etc. For the instant year, assessee filed return of income on 28.11.2003 declaring an income of ₹ 53,99,390/-. The assessee had entered into following international transactions with the head office in France and other Corning group companies during the relevant previous year: (i) Import of ROB s of ₹ 20,89,44,767/- from Corning S. A, France as part of distribution function of import of rough ophthalmic blanks ( ROB s ) an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpanies, the NCP margins earned by them was found to range from 3.03% to 11.76% with an arithmetic mean of 7.68%. Accordingly based on +/-5% variation in arm s length price the arithmetic mean of the average NCP margins of the comparable companies was stated to be in range from 2.30% to 13.06%. Thus, as for financial year ending 31.3.2003 appellant had earned a NCP margin of 6.45% from its marketing support services function it was claimed to be within the above mentioned +/-5% range prescribed under the Act. 4. However, the TPO in an order dated 10.1.2006 rejected the combined evaluation of agency service activity and distribution activity with M/s Corning SA France, as part of distribution activity/segment, followed by the assessee. The TPO segregated the aforesaid activities for the computation of arm s length price and consequently made an upward adjustment, re-computing the arm s length price in respect of the agency activities. The TPO held in this regard as under: (i) the functions performed and risks assumed in the distribution function and the agency services function are quite different and therefore ALP for each of them needs to be determined separately; and, (i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ived by the assessee and computed adjustment of ₹ 20,87,795/-being the difference between the arm s length price determined in respect of commission income and the actual amount received by the assessee. 9. The TPO thereafter also revised the operating results of the distribution segment as follows: Calculation of OP/Sales for distribution division: Rupees Revenue Sales 31,87,61,777 Add: Duty Draw Back 4,08,751 Total (A) 31,91,70,528 Cost Total cost (for distribution commission) (as per letter dated 16.11.2005) Less: Cost attributable to commission as per para 6.3 of this order 32,73,93,696 71,34,200 Cost of distribution segment . (B) 32,02,59,496 Loss: (A-B) (10,88,968) OP/Sales (-)0.34% 10. The TPO therefore held that assessee has incurred a loss of ͅ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of natural business segment of distribution of ROBs and are inter linked and closely connected in as much as, (i) the two activities relate to the same products and involve performing some of the common functions by the same employees and it is not feasible to segregate the cost relating to the same; (ii) the agency services rendered by the assessee in relation to sale of ROBs to the customers of Corning France in India, is akin to the distribution of ROBs, in as much as both are aimed at sales and revenues arise to the assessee in both the cases on sale of products to the buyer; on the other hand marketing support service fee is not related to sales; (iii) Corning SA and the assessee branch ensure that arm s length profit is earned considering the agency service activities as part of the distribution business. 16. The CIT(A) however held that distribution function involves import of finished goods, its warehousing, advertisement, marketing and distribution/sale of productions and assessee also undertakes contract risk, marketing risk, credit risk, inventory risk, etc. On the other hand, agency service activity merely involves coordination between customers and the head office ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... C) 3,22,20,421 Total common expenses (D) 1,58,72,993 Allocation of total common expenses of ₹ 1,58,72,993 Expenses allocated to agency services (B/CXD) 27,55,968 Expenses allocated to distribution activities (A/CXD) 1,31,17,025/- 18. The CIT(A) thus concluded that adjustment after combining the agency service activity with marketing service function would be as follows: Particulars Rupees Income from market support services 3,41,76,307 Add: Commission income 55,94,311 Total income from market support and agency service activity 3,97,70,618 Cost for market support (from letter dated 16.11.200) 3,21,05,659 Cost for commission income (as determined in para 21.3 above) 27,55,968 Total aggregated cost 3,48,61,627 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rance (Corning France: and warehousing the same. These products are in turn, sold to the customers in India and its neighbouring countries. The assessee also provides agency services in respect of the ophthalmic glass products sold by Corning France directly to buyers in India. To avail of duty concessions certain customers who are primarily 100 percent Export Oriented Units (EUOs) in India prefer to import RGSs directly from Corning France. In terms of the sales commission agreement dated 1st January, 2001, in respect of exports by the head office, the assessee gets commission @ 3% of sales value. II Marketing Support Services-the assessee branch, in terms of agreement with Corning Inc. USA and Corning SA renders marketing support services for sale of non ophthalmic products, e.g., optical fiber cable, other telecommunication equipments and automotive substrates etc., in India. The marketing support services involve (a) collecting of marketing information (b) exploring sales and distribution opportunities market research and (d) promoting awareness about Corning products in Indian market. The assessee is remunerated for such services at cost plus a mark up of 5%. 21. It wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... istribution business. 23. However, on allocation of expenses and, without prejudice to the above contention he supported the order of CIT(A) in as much as allocation of expenses on margin basis was proper, reasonable and, in accordance with principle of accountancy. 24. We have heard the rival submissions and perused the material on record. The first issue which involves consideration as contended by the learned counsel for the assessee is that, the TPO/CIT(A) were incorrect in not bench-marking the functioning of import of products from M/s Corning SA France and receipt of agency commission from M/s Corning SA France. According to the assessee since both the functions dealt with the same products/same AE and were in respect of sales made to customer in India, therefore ought to have been bench- marked together, as was done by the appellant in its TP documentation. The conclusion however of the authorities below is that the distribution function and agency service function are not comparable. It has been found that distribution function involves import of furnished goods, its warehousing, advertisement marketing and distribution/sale of productions; whereas agency function in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3,77,758/-). The CIT(A) further more held that allocation of such expenses should be done on the basis of gross margin of distribution function and commission income receipts and not on the basis of sales, as adopted by the TPO. Here too, we do not find any infirmity in the approach adopted by the CIT(A). The CIT(A) has correctly held that allocation of expenses in proportion to sales would amount to give equal weightage in terms of functions performed, assets utilized and risks assumed to both distribution function as well as agency service activity, which otherwise involves much lesser functions and utilization of assets and risk. The CIT(A) has held as under: It would not be correct to allocate expenses attributed to purchase/sale of finished goods, warehousing and handling of inventory etc., to the agency service activity, wherein such activities are not involved. Allocation of common expenses in proportion to gross margin/income from distribution function and the commission income, irons out or eliminate the impact of purchase of finished goods, handling of inventory and undertaking distribution function, etc. Allocation of common expenses in proportion to gross margin fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le computing the operating profit margin of the distribution segment, the assessee excluded foreign exchange loss of ₹ 1,37,41,434/- and abnormal custom duty of ₹ 3,73,85,895/-from the operating expenses. The assessee submitted in his broad submission before CIT(A) as under: (i) Foreign Exchange Loss of ₹ 1,37,41,434/- It is submitted that during the relevant previous year, the significant movement in Euro, via-a-vis Indian rupee and Indian rupee depreciated o the extent of 24% leading abnormal foreign exchange loss of ₹ 1,37,41,434/-,. It would further be appreciated that apart from the abnormal foreign exchange fluctuation loss, the said loss is in the nature of finance cos. as opposed to operating expenses in as much as the foreign exchange loss could be avoided by incurring finance cost on account of hedging of the receivables. Further, the comparable companies which have been considered for benchmarking of distribution segment did not incur foreign exchange loss and in any case for the purpose of comparison, the foreign exchange loss has not been taken as part of operating cost while computing the profit margin of the appellant as well as that of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tort the comparison, when the comparable companies do not incur similar expenses on account of custom duty. 34. Having considered the rival submissions and perused the material on record we find the CIT(A) in this regard has held as under: I have examined the document on record and it is noted that in the financial of the comparable companies, custom duty does not appear as expenditure. The Delhi bench of the Tribunal in the case of Schefenacker Moherson vs. ITO 123 TTJ 509, held that the assessee was justified in determining the ALP under TNMM method by taking profit level indicator of the comparable cases excluding depreciation to eliminate difference on account of different depreciation polices, etc. The jurisdictional Tribunal in that case observed as under: 22. The learned CIT(A) has observed fresh investment was being made in automobile ancillary industry which was in expansion phase and, therefore, there is no requirement to exclude depreciation in computing PLI . What expansion, when made, the date and year of expansion, its comparability with taxpayer s case ? Nothing relevant is stated in the impugned orders. We do not know how differences on account of dep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cash profit to sales if uniformly applied. As the deduction of depreciation is leading to wide differences, the same should be excluded. The only reason given for rejecting taxpayer s analysis and for making adjustment in the two years is that use of ratio of cash profit without depreciation is not permitted under the law. This view in the light of above discussion cannot be accepted as correct and is disapproved. 50 Therefore it would be appropriate to exclude the amount of custom duty of ₹ 3,73,85,895/- from the operating cost for computing the operating profit margin of the distribution segment. 51 Profit margin of the distribution segment is accordingly computed at 10% as follows: Calculation of OP/Sales for Distribution division Rupees Revenue Sales Add: Duty Draw Back 31,87,61,777 4,08,751 Total .(A) 31,91,70,528 Cost Total cost (for distribution commission) (as per letter dated 16.11.2005) Less: Cost attributable to agency service Less: Custom Duty ..... X X X X Extracts X X X X X X X X Extracts X X X X
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