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2016 (3) TMI 55 - DELHI HIGH COURT

2016 (3) TMI 55 - DELHI HIGH COURT - [2016] 388 ITR 324 - Transfer pricing adjustment - determination ALP by adopting the CUP method for the procurements from Sumitomo Japan - Held that:- What the assessee banks upon in its appeal to this Court is the unbending and inflexible acceptance of its TP exercise; according to its logic, a "bundled" or aggregated series or chain of transactions used in the TP report should remain undisturbed. Now, there can be no dispute that the AO would normally accep .....

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Sony Ericcson (2015 (3) TMI 580 - DELHI HIGH COURT) i.e "the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their totality, differ from those which would have been adopted by an independent enterprise behaving in a commercially rational manner.." was in effect adopted. This Court finds no infirmity in this approach. As a result, the first question framed is answered against the assessee and in favour of the revenue. - .....

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Dated:- 29-2-2016 - S. Ravindra Bhat And R. K. Gauba, JJ. For the Appellant : Sh. C.S. Aggarwal, Sr. Advocate with Sh. Prakash Kumar, Advocate For the Respondent : Sh. P. Roy Chaudhuri, Sr. Standing Counsel ORDER Mr. Justice S. Ravindra Bhat 1. These two appeals by the assessee require resolution of common questions of law and arise from identical or closely similar circumstances. The questions of law framed in these appeals, on 17.10.2014, are as follows: 1. Whether the Transactional Net Margi .....

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2. The appellant assessee is engaged in manufacturing and sale of auto electrical products such as Starters, Alternators, Wiper Motors, CDI, Magnetos etc., for four wheel and two wheel vehicles. Its promoters include two Japanese Companies, which are M/s Denso Corporation, Japan and M/s Sumitomo Corporation, Japan. These promoters share holding is to the extent of 47.93% and 10.27% respectively. M/s Sumitomo Corporation, Japan is an associate company of M/s Denso Corporation, Japan. The two comp .....

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recommended by the TPO and accepted by the AO to the extent of ₹ 1,36,31,665/-. The AO finalized the assessment on 30.03.2005. The assessee s appeal was allowed by the CIT, who on 30.04.2009 directed the cancellation of the above. The Revenue appealed and was successful before the ITAT which restored the addition of the said transfer pricing adjustment amount of ₹ 1.36 crores. 4. In ITA 451/2013 for AY 2003-04, the facts are similar except that the adjustment order was to the extent .....

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by the Court are that for both the assessment years 2002-03 and 2003-04, the assessee had procured component level inputs for the manufacture of its products. The total raw material imported was to the extent of ₹ 57,77,00,221 of which the value of imports from Sumitomo Corporation was ₹ 49,86,69,729/- or 86.3% of the total import. It also constituted 37.5% of the total raw material consumed. This figure related to AY 2002-03. Likewise, for AY 2003-04, the facts were much the same a .....

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their turnover was less than ₹ 100 crores. The assessee s turnover was over ₹ 250 crores. The Profit Level Indicator (PLI) of the assessee, in terms of the documents furnished by it worked out to 4.36%. The adjustment was, therefore, arrived at ₹ 5.86 crores. Like for AY 2002-03, the CIT(A) held by his order dated 30.12.2009 that the adjustments were not justified. The CIT(A) followed his previous order and held that the CUP method was not the most appropriate one and that the .....

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ction value of the various raw materials, including payment of royalty, technical knowhow fees etc., is at arms' length, the net profit margin contemplated under Section 92C of the Income Tax Act is determinative. The value of each transaction in respect of every component is to be judged within the net margin derived by the entity. In this regard, reliance is placed upon OECD guidelines, particularly Para 3.9. Learned counsel contends that for the purpose of benchmarking transaction of a br .....

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arking international transactions with the operating profit table cast as the relevant profit level indicator (PLI). Since the TPO accepted the value of royalty, technical knowhow and testing fee on the basis of TNMM, he could not have, in the same order rejected it for the purpose of component purchase and proceeded to apply an entirely different method, i.e. Comparable Uncontrolled Price (CUP) method for arriving at the net value of transactions. 7. Mr. C.S. Aggarwal, learned senior counsel po .....

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ntention that under TNMM, entity level margins have to be compared and that both imports and domestic purchases could be aggregated together is erroneous. Reliance is also placed upon para 3.10 of the OECD guidelines which, it is submitted, grants autonomy to the entity to adopt a "portfolio approach" as a business strategy where the tax payer bundles transactions for the purpose of earning appropriate return across portfolios rather than on a single product within it. These being inte .....

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37.5% of the total raw material consumed. The precise reason why the TPO and the AO directed the additions which are in dispute were that Sumitomo Corporation does not manufacture but merely traded in the goods. The assessee was unable to shed any light why it chose to source the materials from Sumitomo Japan, which it could have purchased directly from the manufacturer, i.e. Denso, Japan. Given the close connection between Sumitomo Corporation, Denso and the assessee, the lack of the explanati .....

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see failed to discharge its responsibility as to the application of the most appropriate method. Consequently, it failed to give reasonable data, i.e. cost of purchase in the hands of Sumitomo Corporation, Japan, for determination of aggregate ALP by retail price method and that no other method except CUP could be applied for ALP determination of the component value from Sumitomo Corporation. Analysis and conclusions: 9. It is evident from the above discussion that the narrow controversy which t .....

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support of its contentions. It also relies upon certain rulings of different Benches of the ITAT to urge that such sequential segregation and setting portion of the TP exercise - so to say, to break with the integrity is unjustified and unsupported by the text of the law, i.e. Section 92C of the Income Tax Act. The assessee also relies upon Rule 10E of the Income Tax Rules, which guide the proper approach of the TPO in such matters. In the present case, the reasons for addition of ₹ 1.36 c .....

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or provide particulars with respect to components sold to Sumitomo Corporation by Denso, Japan; expenses incurred by Sumitomo Corporation towards storage, clearing charges, Customs Duty etc; agreements, if any, between Sumitomo Corporation and Denso, Japan and broadly reveal what was the business expediency leading to purchase components through the intermediary Sumitomo Corporation instead of buying directly from Denso, Japan, the manufacturer. The assessee s explanations were that Denso s ser .....

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e TPO rejected the explanation and noticed that Sumitomo Corporation held a substantial holding in the assessee company. He also concluded that the relationship between the assessee, its holding company, Denso and Sumitomo Corporation was such that Denso, Japan could influence the transactions between the assessee and Sumitomo Corporation. This, according to him, fell within the mischief of Section 92B and amounted to an international transaction. The TPO concluded that there was no explanation .....

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the interest rate in Japan is in the range of 0 to 1% as against 12 to 15% in India in that year. The cost of capital is a major element of cost in any industry. Next, higher scale of economies because of production of large quantities of goods results into substantial cost savings. Further, the indirect taxes in Japan are very low (the Rate of VAT is 5%) as compared to India. The lower tax burden brings down the costs in any economy. It is true that wages are comparatively high in Japan but it .....

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of assessee is not very convincing and not corroborated by concrete facts and evidence. 7.2 It is true that in some cases the prices at which the assessee purchased components and spare parts from SCJ during the year under assessment have been compared with the rates at which purchases were made in the following year(s) from the local parties. Even so, the comparison is not unreasonable and the circumstances of the case. In fact assessee itself has used the data of previous two years while using .....

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domestic market in the immediately following year(s). 7.3 The facts that Customs authorities did not raise objections to the invoice value of spare parts and components imported from Sumitomo Corporation can in no way take away or abridge the power and the duty vested in the undersigned to satisfy regarding the correctness of the income returned. COMPUTATION OF ALP The responsibilities to establish the arm s length nature of the international transaction lies with the assessee. The assessee fail .....

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fference in the quality of components purchased from SCJ and from uncontrolled domestic suppliers, the ALP of imports from SCJ can be determined by comparing it with the prices of uncontrolled domestic suppliers. Though, for some components, the indigenization took place in the subsequent years it can still be used as a valid comparable because it gives fairly good idea about the cost of production of such components. Wherever, the indigenization has taken place in the subsequent years, the unco .....

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Arm s Length Price (ALP) w.r.t. International Transactions with M/s. Sumitomo Corporation Japan (SCJ) During the year the assessee has imported raw material of ₹ 51.54 crores from Sumitomo Corporation Japan (SCJ) out of total import of raw material of ₹ 58.29 Crores. Total consumption of raw material has been shown at ₹ 138.43 Crores. It means that import from Sumitomo Corporation Japan are 88.42% of total import and 37.23% of total raw material consumed. It was found that dur .....

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the associated enterprise of the assessee. After considering assessee s plea and iddc0after giving detailed reasoning, the TPO in AY 2002-03 has held that international transactions undertaken with SCJ are covered by scope of Section 92B(2) of Income Tax Act and most appropriate method to determine arm s length price in respect of international transactions undertaken by assessee with M/s. SCL is Comparable Uncontrolled Priced Method (CUP). There being no charge in facts and circumstances as co .....

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uppliers as their exist certain differentiating factors. The differentiating factors highlighted by the assessee, have elaborately been discussed by TPO during the course of proceedings of AY 2002-03, the facts remaining same therefore, I rely on TPO s order of last year on the issue of purchases made from Sumitomo Corporation, Japan. After allowing assessee opportunity of being heard and on the basis of details filed before me, arm s length price of imports of various components made from SCJ a .....

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ice of international purchase transactions of raw material from SCJ. 13. Section 92 (3) of the Income Tax Act reads as follows: "(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or sub-section (2A) or the determination of the allowance for any expense or interest under sub-section (1) or sub-section (2A), or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-sectio .....

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transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) comparable uncontrolled price method, by which,- (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified; (ii) such price is adjusted to account for differences, if any, between the international transaction or the specified domestic transaction and .....

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terprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) the price so arrived at is further reduced by the .....

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margin in the open market; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise; (c) cost plus method, by which,- (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark .....

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ic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under subclause (iii); (v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise; (d) profit split method, which m .....

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tion in which they are engaged, is determined; (ii) the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances; (iii) the combi .....

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return appropriate for the type of international transaction or specified domestic transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprises, and thereafter, the residual net profit remaining after such allocation may be split amongst the enterprises in proportion to their relative contribution in the manner specified under sub-clauses (ii) and (iii), and in such a case the aggregate of the net profit allocated to .....

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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; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into acco .....

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stablished is then taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction; (f) any other method as provided in rule 10AB." 14. The cumulative effect of various provisions of the Income Tax Act, notably Sections 92, 92C, 92D and 92E read together with Rule 10B and 10D is the obligation to discern, if in a given set of circumstances, the assessee has disclosed international transactions, as well as an ALP. T .....

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ied. In the judgment of this Court, reported as Commissioner of Income Tax v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del), it was held as follows: "It is very imperative on the part of the assessee, to establish before the TPO, that the payments made were commensurate to the volume and quality of services and such costs are comparable. No such efforts was made. No ALP was computed by the assessee. As held by the Assessing Officer, as well as the Commissioner (Appeals), the assessee has not .....

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different skill, experience, knowledge level, complexity of software projects handled, risk bearing capacity, etc. The entire revenue of the assessee are from the Deloitte. The evidence filed in support of the fact that services are rendered in the form of e-mails show that they are not e-mails relating to marketing, but that they relate only to billing. As rightly pointed out by the learned Departmental Representative, the assessee has no role in interacting with the client to modify, cancel, .....

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el for the assessee that these three marketing personnel project the capabilities of the assessee company so that Deloitte gets work, is not supported by any evidence and, hence, without basis. In our view, under similar circumstances a uncontrolled comparable company would not incur such expenditure. Hence, the ALP is rightly determined at "nil". As no expenditure would have been incurred, there is no necessity to apply a particular method to arrive at such conclusion. In fact, by all .....

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ransactions when the TNM Method or even in other methods is sought to be applied, must have reference to the strength and weaknesses of the TNM Method or the applicable method. Aggregation of transactions is desirable and not merely permissible, if the nature of transaction(s) taken as a whole is so inter-related that it will be more reliable means of determining the arm's length consideration for the controlled transactions. There are often situations where separate transactions are intertw .....

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ssary. ********** ***************** ******* 140. Sub-section (3), we do not think incorporates a bar or prohibits set offs or adjustments. It states that Section 92, which refers to computation of income from international transaction with reference to arm's length price under sub-section (2) or (2A), would not have the effect of reducing income chargeable to tax or increase the loss, as the as may be, computed by the assessee on the basis of entries in the books of account. Income chargeabl .....

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ncome chargeable to tax or loss shall not be decreased or increased by reason of Transfer Pricing computation. Thus, transfer pricing adjustments do not enure to the benefit or advantage the assessed, thereby reducing the income declared or enhancing the declared loss. Pertinently, the Sub-Section makes reference to the income chargeable to tax or increase in the loss on the basis of the entries in the books of account. The concept of set off or adjustments was/is well recognized and accepted in .....

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tually undertaken and structured by the parties. Normally, tax authorities cannot disregard the actual transaction or substitute the same for another transaction as per their perception. Restructuring of legitimate business transaction would be an arbitrary exercise. This legal position stands affirmed in EKL Appliances Ltd. (supra). The decision accepts two exceptions to the said rule. The first being where the economic substance of the transaction differs from its form. In such cases, the tax .....

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cond exception also mandates that actual structure should practically impede the tax authorities from determining an appropriate transfer price. The majority judgment does not record the second condition and holds that in their considered opinion, the second exception governs the instant situation as per which, the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their totality, differ from those which would have been adop .....

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s are beyond the bright line, the transaction viewed in their totality would differ from one which would have been adopted by an independent enterprise behaving in a commercially rational manner. No reason or ground for holding or the ratio, is indicated or stated. There is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willi .....

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as an AE) but an intermediary. Normally, this would have been a commercial decision, which revenue authorities would not question. However, interestingly, the vendor of the components (which constituted over 85% of the raw materials imported and about 38% of the total raw materials sourced) was also connected with both the assessee and the manufacturer. If these realities emerged during the TP exercise, compelling the TPO to closely scrutinize the value of such imports and seek further details f .....

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