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DDIT, Circle-3 (2) , New Delhi Versus M/s. Corning S.A, Gurgaon

2015 (9) TMI 609 - ITAT DELHI

Transfer pricing adjustment - deletion of adjustment pertaining to agency services function carried on by the appellant by CIT(A) - whether 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 - Held that:- 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 .....

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spute to the above findings arrived at by the authorities below.

Having regard to the above 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 neg .....

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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 distribution segment - Held that:- . It may be taken note that in TNMM, basically a single line item of an expenditure of customs duty should not be excluded from the total cost for comput .....

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r pricing policy was at gross margin or net margin level in order to examine the reason for the loss. It is only after doing the said exercise the functional profile of the assessee as a normal risk taking distributor, which is capable of suffering a loss or limited risk distributor which generally operates with a steady but routine operating margin, can be ascertained. Thereafter, based upon such exercise, the applicability of the proper transfer pricing methodology namely re-sale price or TNMM .....

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A.T.VARKEY JUDICIAL MEMBER : This appeal, at the instance of the revenue, is filed against the order of the CIT (A)-XX, New Delhi dated 28.2.2011 for the assessment year 2003-04 on the following grounds: 1 On the facts and in the circumstances of the case, the ld. CIT(A) has erred in deleting the addition of ₹ 20.87 lakhs by excluding certain items out of cost of expenditure incurred for earning the same for benchmarking the Arm s length price in respect of agency activities. 2 On the fact .....

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he 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 28.11.2 .....

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viding sales representation services where ROB s were directly imported by customers in India, from M/s Corning S. A. France; (iii) Receipt of marketing support services fee of ₹ 3,41,76,307/-from Corning Inc., USA; and, (iv) Reimbursement of actual expenses of ₹ 12,35,029/- and ₹ 1,09,265/- received from Corning Shanghai and Corning Communication Equipment Ltd. respectively. 3. The assessee computed the arm s length price of the international transactions with the AE M/s Corni .....

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propriate arm s length price. It s search yielded a set of 13 independent companies that were broadly comparable to appellant s functional and risk profile for the distribution function and, based on three years date (i.e. financial year 2000-2001, 2001-2002 and 2002-2003) of the 13 comparables, the net profit margin earned by them ranged from (-3.10% to 7.39% with an arithmetic mead of 3.15%. Accordingly based on +/-5% variation in arm s length price, the arithmetic mean of the average net prof .....

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ator to be the most appropriate method for determining the appropriate arms length price. It s search yielded a set of 7 independent companies and, based on three years data (i.e. financial years 2000-2001, 2001-2002, and 2002-2003) of the 7 comparable companies, 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 compani .....

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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, (ii) agency services rendered by the assessee were in th .....

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rvice functions) in proportion of distribution sales and agency commission (Rs. 32,02,59,496/-and ₹ 71,34,200/- respectively) as under: a) Expenses attributed to agency sales Total Indirect Expenses (1,93,29,321/- X Commission sales (18,64,77,033 (Commission sales (18,64,77,033) + Distribution sales (31,87,61,777) = Rs.71,34,200 b) Expenses attributed to Distribution = ₹ 32,73,93,696/- ₹ 71,34,200/- = Rs.32,02,59,496/- 6. The TPO on the basis of the aforesaid working concluded .....

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ction, whereby arithmetic mean was determined as 7.68%. The TPO accordingly, computed the arm s length price of the international transactions of agency services at ₹ 76,82,106/-as follows: Net cost incurred in respect of commission income 71,34,200 Add: Net profit over the cost @ 7.68% 5,47,907 Arm s Length Commission income 76,82,106 8. On the basis of above TPO accordingly determined arm s length price in respect of commission income at ₹ 76,82,106/-as compared to ₹ 55,94,31 .....

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llip;……………… (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 ₹ 10,88,968/- which corresponds to a loss of 0.34% on sales a .....

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,11,42,839 12. On the basis of above, the Assessing Officer in an order dated 7.3.2006 made the addition of ₹ 1,32,30,634/- by extracting the following observations in TPO order: To conclude the arm s length prices in respect of commission income and import of goods is calculated as under; No. Transaction Amount in Rs. ALP 95% / 105% of the ALP ALP held Difference Import of goods from Coming SA France 20,80,44,767 19,69,01,928 20,67,47,024 19,69,01,928 1,11,42,839 Commission Income 55,94,3 .....

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nsidered together and are not to be evaluated separately to determine the arm s length price in relation to the aforesaid international transactions as the aforesaid two activities transactions form part 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 .....

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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 and undertaking certain marketing and logistic services and therefore the same does not involve purc .....

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and the assessee was thus not correct in undertaking the combined evaluation of two activities. 17. Before CIT(A) the assessee further disputed the allocation of expenses relating to agency service activity in proportion to the turnover by the TPO as it is inconsistent with the accepted accounting principles of matching. The assessee contended that contract sales are made by the AE, i.e. Corning-France to certain existing customers in India, on which commission is received by the assessee witho .....

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ribution function and, therefore, cannot be allocated to agency service activity. The CIT(A) further allocated the remaining common expenses as determined by the TPO/AO aggregating to ₹ 1,58,72,993/- (Rs. 1,93,29,321/-(Rs. 30,78,570/- + ₹ 3,77,758/-) in proportion to gross margin of distribution function and commission income received, as follows: Gross profit margin from distribution activities Amount (Rs.) Sales 31,87,61,777 Less: Cost of traded goods (-) 29,21,35,667 Total (A) 2,6 .....

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t 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 Arm s length marketing support service and agency service income (A) 3,75,38,999 Marketing support and agency service income earned by the appellant (B) 3,97,70,618 Difference (A-B) (-) 22,31 .....

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upon the findings of TPO to contend that allocation of expenses was proper and, CIT(A) was not justified in re-computing the allocation the basis of net margins. On the other hand the learned Sr. counsel for the assessee invoked Rule 27 and contended that TPO has erred in not clubbing the trading/distribution and commission from agency transaction because assessee earned income from distribution of selling of the ophthalmic products and agency commission from the same products which are directly .....

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essee gets cost of +/5%. According to learned counsel, there is no cost incurred additionally for earning agency commission because it is incidental to the work at distribution of same products; whereas there was infrastructure liaison office separately for market support and the assessee has incurred ₹ 1.18 crores for engaging the services of skilled manpower. It was submitted that assessee has following two separate distinct businesses: I Distribution business- Involving import of RGBs f .....

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y 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 .....

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ments (i.e. ROBs and non ophthalmic products, e.g. Optical fibre cables and other telecommunication equipment respectively) are entirely different and require different marketing strategies efforts and understanding of the product, etc. for promoting the sale of the same in India. While agency requires promotion of same products, i.e., ROBs as in the distribution business. ii) The target customers for the two business segments are different. While the distribution and agency function are perform .....

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nel between the existing customers of Corning France and the head office. 22. In light of the above, it was submitted, TPO/AO ought to have considered the international transactions relating to distribution activity and aforesaid agency service activity in a combined manner considering the fact that the aforesaid two activities transactions form part of natural business sequent of distribution of ROBs and are inter linked and closely connected in as much as (i) the two activities relate to the s .....

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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. 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 r .....

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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 involves coordination between customers and the head office and undertaking certain marketing and logistic services. Furthermore the risks assum .....

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earned 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. 26. So far as the allocation of expenses is concerned it is noted that TPO had identified indirect expenses common to both the functions at ₹ 1,93,29,321/- deta .....

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agency function. 28. We find merit in the said conclusion as no material has been lead to discredit the above conclusion. Thus we hold that aggregate indirect expenses common to both the functions are of ₹ 1,58,72,993/- (Rs. 1,93,29,321/- ₹ 30,78,570/- ₹ 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 TP .....

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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 from distribution function and co .....

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upport (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 Arm s length marketing support service and agency service income (A) 3,75,38,999 Marketing support and agency service income earned by the appellant (B) 3,97,70,618 Difference (A-B) (-) 22,31,619 20 Since total income from market support and agency service activities at ₹ 3,97,70,618/- is higher than the arm s length price of such servic .....

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e against the deletion of addition of ₹ 1.11 crores by excluding the increased custom duties out of the cost of import of ROBs for benchmarking the arm s length price of distribution segment. 31. The facts are that assessee in the course of Transfer Pricing assessment vide letter dated 16.11.2005 submitted the following segmentation of the net profit margin for the various segment: 32. It can be perused from the aforesaid table that while computing the operating profit margin of the distri .....

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7,41,434/-,. 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, t .....

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competition. Further, the comparable companies which have been considered for benchmarking analysis applying TNMM did not incur expenditure on account of custom duty. For the aforesaid reasons, the custom duty expenditure is sought to be excluded while computing operating profit margin of the appellant from the distribution business. 32 It is submitted by the AR that, he cardinal principle of the transfer pricing regulations is to compare like with like and to eliminate differences, if any, by .....

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ties being compared for benchmarking experience has been emphasized: - Mentor Grpahics (Noida) Pvt. 109 ITD 101 (Del) - Sony India (P) Ltd. 106 ITD 175 (Del) - Skoda Auto India (P) Ltd. vs. ACIT 122 TTJ699 (Pune) - Egain Communication Pvt. Ltd. vs. ITO 118 ITD 243 (Pune) - Schefenacker Motherson Ltd. vs. ITO (in ITA Nos 4459 & 4469/D/2007) - Honeywell Automation India Pvt. Ltd. vs. DCIT (ITA No. 4/PN/0) 33. On perusal of the above, CIT(A) has held that foreign exchange loss or gain is requir .....

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r would distort 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 .....

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t 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 depreciation could be ignored on the facts stated above merely on general observations that automobile ancillary industry is in the expansion phase. Taxpayer is seeking adjustment of differences on account of depreciation and no plausible reason has been given for not accepting this claim. There is no find .....

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profit of the taxpayer was quite comparable to the mean margin of other comparables similarly computed. This demonstratively showed that deduction of depreciations was making huge difference and required suitable adjustment. This claim has not been challenged. It is clear that the best way to adjust difference on account of depreciation was to ignore depreciation both in case of the tested party and the comparables. After all TP adjustments are to be made of differences in price charged or paid .....

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differences. The case of the Revenue is not clear. If depreciation is not leading to any difference, its exclusion is immaterial. If it is leading to differences, then differences are required to be adjusted, as required by provisions of IT Regulations. There is no way to dislodge the claim of the taxpayer. The context and purpose of legislation and facts of case overwhelmingly approve adoption of cash profit only. 23. The taxpayer in both the assessment years showed before the Revenue authorit .....

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d. 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 distributi .....

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