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TMI Blog2015 (11) TMI 26X X X X Extracts X X X X X X X X Extracts X X X X ..... Limited ('MUL') is a major customer of JMIPL accounting for most of its sales. 3. JMIPL and MUL agreed on an arrangement where JMIPL would sell finished catalysts to the vendors of MUL under the instructions of MUL. JMIPL used two basic raw materials for the manufacture of the catalyst i.e. precious metals and wash coated substrates. JMIPL procured the precious metals (such as Platinum, Palladium and Rhodium) from one of its associate enterprises ('AE') JMUK and the wash coated substrates from another AE, Johnson Matthey Malaysia ('JMM'). On its part, the AE (JMM) purchased raw substrates from international suppliers for further processing, performed wash coating operations on them and then supplied the wash coated substrates to JMIPL. The agreement between JMIPL and MUL 4. JIMPL states that since the prices of precious metals in the market fluctuate heavily, it entered into a Platinum Group Metals ('PGM') Forward Cover Agreement with MUL on 6th September 2002. Schedule I to the PGM Forward Cover Agreement comprised supplementary terms and conditions of sale. Under Clause 1.1, JMIPL agreed to give a quote to Maruti for the price of a quantity of PGM to be purchased on a specifie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rplus PGM which JMIPL was unable to use in the manufacture of autocatalyst products for MUL within 3 months of the maturity date of each order, such surplus PGM would become payable by MUL together with interest at the prevailing Bank of India Base Lending Rate. 7. The supplementary terms and conditions of sale were incorporated into the agreement itself. Clause 7 of the Supplementary Terms and Conditions, i.e. Schedule-1 to the agreement, set out the mechanism concerning PGM purchasing and pricing. It read as under: 'Maruti will provide their requirement for three months. Base on their requirement for a particular month say month (n), JM will purchase metal two months prior to dispatch on daily basis i.e. in the months (n-2). The weighted average price of the purchased metal shall be incorporated in the Quotation. Maruti will ensure that the canners will raise the Purchase order for the deliveries to be made in the month (n) prior to the commencement of the supplies. Similarly if the number of pieces supplied in the month (n) is more than the Quoted quantity, the PGM price for the extra dispatch would be agreed on the last day of that month. The price for the extra number of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ended that the international transaction of sales to the AEs was also at ALP. 12. On 28th January 2005, the TPO passed an order setting out the various international transactions entered into by the Assessee during the AY 2002-03 by relying on the TNMM with ROCE as the PLI. The TPO stated that after discussing the matter with the authorised representatives ('ARs') of the Assessee 'no adverse inference is drawn' in respect of the ALP declared in respect of the international transactions entered into by the Assessee. 13. In the order dated 22nd March 2006 for AY 2003-04, the TPO discussed the various types of PLIs and how the reliability of each could be enhanced through a number of adjustments for differences in capital employed and functions performed. One method was the 'Return on Operating Assets' ('ROA') which refers to the return on capital employed. The next method was the Berry Ratio, or Gross Profit measured against Operating Expenses. Analysing Rule 10B(1)(e) of the Income Tax Rules, 1962 ('Rules'), the TPO noted that it did not permit ratios which use gross profit margin, and therefore, under the transfer pricing regulations, Berry ratio could not be used as a PL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rnational transaction at Rs. 62,49,06,744 instead of the reported value of Rs. 70,82,93,603. He recommended an addition of Rs. 8,33,86,859 to the income of JMIPL. Proceedings before the AO, the CIT (A) and ITAT 16. The AO passed the assessment order on 29th March 2006 accepting the order of the TPO and concluding that the difference between the average OP/TC of the comparable companies (16.85%) and that of JMIPL (6.79%) was 10.06% which was double the normal acceptable range of +/-5%. Accordingly, JMIPL's income was enhanced by Rs. 8,33,86,859. 17. JMIPL's appeal against the aforementioned order was dismissed by the CIT (A) by an order dated 26th November 2009. It was observed that 'since the appellant is not engaged in a seasonal business and the appellant is engaged in the manufacturing of automobile exhaust catalysts and making import of raw-material from its AE, in these circumstances, I am of the view that Return on Capital Employed is not an appropriate PLI in the case of appellant and thus the TPO was right in rejecting such PLI.' 18. The above order of the CIT (A) was affirmed by the ITAT by its order dated 27th March 2012. It was, inter alia, observed that 'the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elines'), the United States Regulation on Transfer Pricing and the Taxation Ruling TR 97/20 issued by the Australian Tax Office as well as the ICAI Guidance note on Transfer Pricing, and submitted that given that JMIPL was a contract manufacturer in a highly capital intensive industry, an asset based PLI would be appropriate. Therefore, ROCE was an appropriate PLI. ROCE would be the best indicator of profitability as long as the risks are properly accounted for. In the case of JMIPL for AYs 2002-03 to 2011-12, the Revenue had accepted that it was a contract manufacturer. Therefore any departure from the PLI employed by JMIPL, keeping in line with the guidelines aforementioned, required cogent reasons to be given. Under the economic theory of capital, capital always flowed from low return to high return activities and in time risk-adjusted return on capital would be equalized. Therefore, ROCE would be the best indicator of profitability in spite of variations in comparable functionalities as long as risks are properly accounted for. He submitted that neither the TPO nor the CIT (A) have offered any cogent reasons for rejecting ROCE as the appropriate PLI. 23. Mr. Srivasatava submit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ms based on the risk profile of an enterprise. Thus, if an enterprise bears no risk in terms of inventory, raw materials etc. and these do not contribute to its returns, such items should be excluded from calculations. If, at all, the PLI of OP/TC had to be used then it had to be after deducting the cost of raw material from the total cost. The said PLI of OP/(TC-RMC) had been in use by JMIPL for AY 2004-05, 2005-06 and 2006-07 and this was accepted by the tax authorities without challenge. Invoking the rule of consistency, as expostulated in Radhasoami Satsang v. CIT (1992) 193 ITR 321 (SC); CIT v. Ashok Mittal (2014) 360 ITR 12 (Del); CIT v. Mohan Meakin Ltd. [2010] 189 Taxman 377 (Del) and DIT v. India Habitat Centre [2011] 203 Taxman 510 (Del)Mr. Srivasatava submitted that no departure ought to have been made for the AY in question i.e. 2003-04. Submissions of counsel for the Revenue 26. Countering the above submissions, Mr. Kamal Sawhney, learned Senior Standing counsel for the Revenue submitted that the attempt by JMIPL at adopting ROCE as the PLI was contrary to Rule 10 B (1) (e) (i) because assets (or capital employed) had no relationship to the international transactions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n would be a futile exercise. This was because during the year under consideration JMIPL had a total revenue of Rs. 88.49 crores against which raw material consumption was Rs. 75.85 crores. Out of total raw material consumption, purchase worth Rs. 69.28 crores was from JMUK. Thus if RMC from JMUK was excluded, very little would remain on which net margin could be computed. It was further submitted that JMIPL's argument was unsupported by the provisions of the Act and the Rules. They did not envisage removing any element from the appropriate base. Further, it would be self-contradictory to compute ALP of international transaction between JMUK and JMIL on the one hand and remove the figures pertaining to the international transaction from the computation on the other hand. 29. Mr. Sawhney next argued that the principle of res judicata may not apply and merely because in the earlier or subsequent AYs JMIPL's position had been accepted, it did not imply that the same must be adopted for the AY in question as well. Each year had to be considered separately. Further the principle of res judicata did not apply to decisions of the income tax authorities. Reliance was placed on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to have itself realised the limitations of adopting ROCE as the PLI for the subsequent AYs. It states that it " improved upon the PLI used in AY 2003-04 taking into account the economic realities in AY 2004-05." It explains how it arrived at the PLI of OP/TC-RMC "after excluding the cost on which no risk was undertaken by the Appellant which is also appropriate for contract manufacturers" in terms of the OECD Guidelines. In its written submissions JMIPL itself explains: "The exclusion of cost of raw material in respect of which the Appellant bears no costs or risks presents a very accurate picture of the profit margins of the Appellant. The exclusion of factors which do not affect returns is allowed under all the guidelines mentioned above. This PLI used in AYs 2004-05,2005-06 and 2006-07 was accepted without any objection by tax authorities." 34. Consequently, it appears to the Court that the rejection of ROCE as PLI by the Revenue for the AY in question is a fact that has been accepted and acted upon by JMIPL itself for the subsequent AYs when it changed its PLI to OP/TC-RCM, which appears to have been accepted by the Revenue. 35. Question (i) is accordingly answered in the n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding a pass though cost from the TC in the denominator. The expression "any other relevant base" occurring in Rule 10 (1) (e) (i) of the Rules is wide enough to encompass a denominator that excludes pass through costs as long it is demonstrated to be at arm's length. 38. It is further importantly pointed out that the very purpose of transfer pricing is to benchmark transactions between related parties in order to discover the true price if such entities were unrelated. If MUL had bought the PGM directly from JMUK there would have been no application of transfer pricing since MUL and JMUK are unrelated entities. MUL would have purchased the PGM just like JMIPL did on negotiated prices. There is merit in the contention that the prices at which JMIPL purchased PGM from JMUK were already at arm's length and that it was for administrative convenience that MUL had outsourced this function to JMIPL. The submission of the Revenue that the accounting entries of JMUK do not treat the cost of PGM as a pass through cost fails to acknowledge that JMUK is in the business of selling PGM. It does not require to charge JMIPL for processing the raw material i.e. PGM as that is passed on to MUL& ..... X X X X Extracts X X X X X X X X Extracts X X X X
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