TMI Blog2016 (3) TMI 718X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee had incurred abnormal expenses for specific activities conducted by the assessee for the predominant benefit of the assessee’s AEs, the decisions cited by the Ld. A.R. are rejected because in those cases only routine expenses were incurred unlike the case of the assessee. - Decided against assessee Non providing adjustments on account of differences in working capital - Held that:- DRP agreed with the view that adjustments has to be granted for eliminating material effects, if any, arising out difference in working capital between the tested party and comparables. It was the contention of the assessee that it was having negative working capital as against substantial positive working capital enjoyed by the comparables. Ld. DRP observed that the assessee has not demonstrated as to how the negative working capital of the assessee has affected its margin. Since the assessee was not able to justify the adjustments that were required to be made on account of negative working capital the Ld. DRP did not give effect to working capital adjustments. Before us also the Ld. A.R was not able to justify its stand on working capital adjustments in the case of the assessee with any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pellant and therefore cannot be considered as a part of value added expenses forming part of trading activity. vii) The Ld. A.O/TPO/DRP has failed to appreciate that the appellant its AE are two independent parties in joint venture and therefore would not allow inflation of purchase price. viii) The Ld. Assessing Officer/TPO/DRP had erred in not providing adjustments on account of differences in working capital. ix) The Ld. Assessing Officer/TPO/DRP had erred in not granting adjustments towards foreign exchange fluctuations. 3. The brief facts of the case are vividly brought out by the Ld. DRP in their order which is extracted herein below for reference:- M/s.Kubota Agricultural Machinery India Private Limited ( the assessee / Kubota India) was incorporated in the year December 2008 under the Companies Act, 1956 in Chennai and is jointly held by Kubota Corporation, Japan (60%) and Sumitomo Corporation, Japan (40%). It was set up with the objective of distribution of agricultural machinery in India. During financial year (Financial year) 2009-10, the assessee has entered into the following international transactions: Purchase of finished goods; Payme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of ₹ 12.83 crores to purchase price of goods from A.E.s. 4. Aggrieved by the order of the Ld. DRP and the DCIT dated 19.11.2014 28/01/2015 respectively, the assessee is now in appeal before us. 5.1 Ground Nos.(i) to (vii) - Rejection of the Resale Price Method as the Most Appropriate Method (MAM) and acceptance of Berry ratio as a the MAM:- The assessee has applied RP Method because it is applicable in situations where selling and distribution operations carried out by the reseller/distributor does not add substantial value to the product through use of tangible or intangible property. However, the Ld. TPO rejected the RP Method followed by the assessee because of the following reasons:- i) The assessee company is not only a trader but provider of value added services to its AEs. ii) The cost incurred for such value added services is huge and also closely interlinked with the distribution functions of the assessee company. iii) The functions assumed by the assessee is manifold and not proportionate with the kind of remuneration received. iv) The assessee and its AEs had not set the contractual terms appropriately to bench mark the transactions with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee company renders many functions to its AEs other than routine trading activity and therefore, reasonable markup on cost has to be accounted. The assessee company had widely advertised the trade mark and the brand legally owned by the assessee s AEs and had incurred substantial cost. The assessee company had also widely established the distribution net work and rendered marketing support services. Therefore it is essential for the assessee company and its AEs to set up contractual terms to ensure reasonable acceptable level of profit to the assessee. v) All the functions performed by the assessee company to its AEs are interlinked with the distribution services rendered by the assessee company. The value of the products that are distributed by the assessee company can only be considered as pass through cost . Such pass through costs are irrelevant for the low risk distributor as in the case of the assessee. Under this situation it is essential to verify whether the gross profit or operating profit achieved by the assessee company is commensurate with the total value added cost incurred by the assessee. Therefore in the case of the assessee the most appropriate method to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and resale the same to the third party in India without any value addition to the products, thus undertaking a limited risk. Therefore, RPM will be more suitable. iii) During the relevant financial year, it was a beginning phase of the business; therefore the assessee had to incur huge expenditure which would not be a regular feature. iv) The assessee neither bears any significant risk nor deploys significant assets other than the routine tangible assets for the purpose of carrying out its distribution activities. Thus, the function of the assessee company is very limited to buying and selling of the AE s products. v) The marketing research activities undertaken by the assessee is a separate activity and is not related to the distribution activity of the assessee 5.4. On appeal, the ld. DRP agreed with the view of the TPO that RP Method is not the most appropriate method for arriving at the ALP by observing as under:- For adopting the RPM as most appropriate method the OECD guidelines described as The resale price method begins with the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. This pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... panel finds that the contention of the assessee in respect to value added cost i.e, that only advertisement, marketing and promotion expenses are to be considered as value added expenses and other expenses such as employee cost, general administration, selling distribution and depreciation should not be considered as value added expenses, has no force as the definition of Berry Ratio clearly defines that all the operating cost / value added cost should be considered. The assessee has not brought out any cogent reasons as to why only advertisement, marketing and promotion expenses should be considered as operating expenses. This panel also decline to accept the contention that abnormal adjustment was made by the TPO as the quantum of adjustment was the result of FAR analysis. Coming to the next point, as to whether Berry Ratio is to be adopted or not, the following important factors have to be considered: - Whether the assessee company is engaged in distribution activity with a limited risk. The main issue in this case is adjudication on the question whether ...(the assessee ).. is being adequately compensated for the functions performed. Unlike in Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... form any significant operations such as manufacturing or processing. Typically, a low risk high volume trading business involving back to back trading without any value addition to the goods traded, which is what AE is engaged in and the assessee is contributing to, satisfies all these tests. We are in agreement with the approach adopted by the OECD document in this regard. Going by this approach, and, applying the tests laid down above, it does indeed seem that Berry Ratio could be appropriate in the present case. Berry Ratio is increasingly finding specific acceptance in many jurisdictions. While it is use in US for long, in Japan, even as Berry Ratio was used in APAs earlier as well, the 2013 amendment to the transfer pricing regulations, with effect from 1st April 2013, now specifically list Berry Ratio as acceptable in appropriate cases. In India, there have been several recent judicial precedents, upholding the use of Berry Ratio as a PLI. The answer to the fundamental question of whether a taxpayer should be entitled to a return on the value of goods handled by it, would actually depend on the functions performed and the related risks borne by it, with respect to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the assessee was routine in nature such as trade fair/exhibitions/road-shows/promotion of products, dealers meeting and travels cost and therefore these expenses cannot be treated as value added activities. xiii) Pricing decisions were taken by the assessee and not by the AEs. xiv) Since the AEs and the assessee company were independent parties and they have acted in the capacity of joint venture partners, the transaction between them are not made with collusion but as per ALP. 5.6 Ld. D.R on the other hand relied on the orders of the Revenue and argued in support of the same. 5.7 We have heard both the parties and carefully perused the materials available on record. Considering the facts of the case we are in total agreement with the view of the Revenue on the issue of accepting Berry ratio as the most appropriate method for determining the ALP in the case of the assessee because of the following reasons:- i) It is undisputed fact that the assessee has incurred huge expenses on account of advertisement, supply chain intangibles, marketing and business promotion which is out of proportion considering the profit earned by the assessee. ii) It can also not be d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enses. The Berry ratio has been recognized in the U.S transfer pricing regulations since the early 1990s. Generally, the berry ratio should only be used to test the profits of limited risk distributors or service providers that do not own or use any intangible assets. This is because the reliability of the Berry ratio depends upon the existence of a relationship between gross profits and operating expenses. Chapter 2 of the OECD Guidelines gives the example of intermediary activities where a taxpayer purchases goods from an AE and on-sells those goods to other AEs an example of where the Berry ratio may be usefully applied. In such cases, both sales and costs of goods may be controlled transactions leaving operating expenses as the only reasonably independent accounting line item from which to base a transfer pricing methods (subject of course to the presence of other controlled transactions within operating expenses such as management service charges or royalties). The Berry ratio can also be useful when applied to limited risk distribution of high volume/low margin products as in the case of the assessee. vii) Berry ratio is accepted as a permissible tool for determining AL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee s AEs, considering the other functions performed by the assessee company the Berry ratio would be the most appropriate method in determining the ALP in the case of the assessee company. xv) The abnormal expenses incurred by the assessee company during the relevant assessment year cannot be considered as the routine expenses of the assessee for its role as distributor. xvi) The other argument of the Ld. A.R. that the pricing decision was made by the assessee and not by the AEs since both the parties are independent is also not acceptable because the structure of the assessee firm is such that the AEs has a tremendous influence in the functioning of the assessee company as the entire shares of the assessee company are held by the AEs. xvii) Further, to avoid further repetition we hereby affirm that we are in agreement with the reasoning discussed by the Revenue in the respective orders which we have concised herein above. We also make it clear that since the assessee had incurred abnormal expenses for specific activities conducted by the assessee for the predominant benefit of the assessee s AEs, the decisions cited by the Ld. A.R. are rejected because in those ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... minal exchange rate is not predictable and hence non-contractible. Hence it was upheld by the Ld.DRP that the assessee will not be eligible for adjustments on account of foreign exchange fluctuations. Before us, the Ld. A.R argued by stating that adjustments on account of foreign exchange fluctuations has to be made in the case of Transfer Pricing matters which is also recognized by Accounting Standards-11. He submitted that the foreign exchange variations affect the purchase price of the assessee though not explicitly shown in the P L A/c but is reflected in the purchase cost of the assessee and that affects the profit margin of the assessee substantially. The Ld. A.R. also relied in the decision in the case of Honda Trading Corp. India Pvt. Ltd Vs. ACIT Delhi reported in 46 ITD 591 wherein the Tribunal has held that necessary adjustments pertaining to the huge and abnormal fluctuation in the foreign exchange may be allowed to the assessee in determining the ALP of the international transaction. After hearing both the parties we are of the considered view that since the Tribunal on the earlier occasion has already recognized adjustments towards foreign exchange fluctuations, the s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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