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2016 (3) TMI 815 - ITAT DELHI

2016 (3) TMI 815 - ITAT DELHI - TMI - Transfer pricing adjustment - whether the international transaction undertaken by the assessee were at Arm’s Length as against the adjustment made by the AO? - adoption of PLI under the TNMM challenged - correctness of the ALP of the international transactions undertaken by the assessee under both the business models of `Indenting’ as well as 'Trading' - Held that:- We have noticed that operating costs of a `Commission agent’ are always exclusive of cost of .....

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of a `Commission agent’ can be `Value added expenses’, which, in fact, represents his total operating costs alone, but in case of a `Trader’, it can be cost of goods sold plus other operating expenses, which represents his total operating costs and not `Value added expenses’ to the exclusion of cost of goods sold. We, therefore, set aside the impugned order in comparing OP/VAE of the assessee on combined transactions under both the models with OP/OC of the comparables.

Having disappro .....

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the TPO, though compared the assessee’s PLI of OP/VAE with OP/VAE of the comparables, but he also fell in error by jointly considering the international transactions of both the business models, namely, Indenting and Trading, under one umbrella. We thus hold that both the assessee as well as the TPO fell in error in considering the international transactions under both the models as of uniform character. It has been noticed supra that the ingredients of Operating costs under the Trading model ar .....

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rately under Chapter X of the Act in consonance with our above analysis. Needless to say, the assessee will be allowed an adequate opportunity of hearing in such a de novo determination. - Decided in favour of revenue for statistical purposes. - ITA No.4324/Del/2011 - Dated:- 8-2-2016 - SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM For The Assessee : Shri Kanchan Kaushal, CA and Shri Ravi Sharma, Advocate For The Department : Shri Amrendra Kumar, CIT, DR and Shri Sudhanshu Dhar Mishra, Sr. DR O .....

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t the assessee is a 100% subsidiary of Agilent Technologies, Europe B.V. Its business operations comprise of facilitation of sales of Agilent products in the Indian market. Agilent Technologies is the world s leading designer, developer, manufacturer and provider of electronic and optical testing and monitoring instruments, systems and solutions. The assessee reported two international transactions in Form No. 3CEB. On a reference made by the Assessing Officer (AO), the Transfer Pricing Officer .....

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ssessee also mentioned that its Operating profit/Value added expenses (OP/VAE) stood at 13.96%. Certain comparables were chosen with their weighted average margin of profit at 12.19% to demonstrate that this international transaction was at ALP. The assessee was called upon to file updated margins of the comparables for current year alone, which were filed declaring mean operating profit margin at 5.8% using their OP/OC as the PLI. The TPO observed that though the assessee stated that it used OP .....

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ate reply was given on the first query about the PLI of the assessee and that of comparables. The TPO excluded two comparables as originally objected to by him and took total of three companies as comparable, namely, Educational Consultants India Ltd., Geefcee Finance Ltd., and Priya International Ltd.. He computed profit from the international transaction by adopting the assessee s PLI of OP/VAE at 13.96% as also shown by the assessee in its TP study report. Applying such PLI of 13.96% to the V .....

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ring verification of the OP/OC margin of the three comparable companies chosen by the TPO with their mean profit margin computed by the assessee at 5.32%. He further came to hold that the TPO did not object to the PLI of OP/VAE used by the assessee. The ld. CIT(A) noted that the assessee characterized itself as a service provider and its OP/VAE was comparable to the OP/OC of the service provider comparables, which position, in his opinion, was not objected to by the TPO. By considering average O .....

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in its TP study report computed and applied OP/OC at 4.9% and also computed its OP/VAE at 13.96%. It compared its OP/OC with the mean of OP/VAE of comparables. The TPO applied OP/VAE of the assessee as well as that of comparables for benchmarking the assessee s international transaction. The ld. CIT(A) compared the assessee s OP/VAE with OP/OC of comparables. It is this point which has been argued by the ld. DR. There is no dispute on inclusion or exclusion of comparables by the lower authoritie .....

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the international transaction undertaken by the assessee was at Arm s Length . Treating international transaction at ALP covers all the aspects of the determination of its ALP, which obviously include not only the selection of comparables and their profit margin but also the selection of the most appropriate method and determination of the correct PLI of the assessee and that of comparables. In fact, the ld. DR has argued only this aspect of determination of the PLI and nothing else. If this asp .....

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ed by the ld. AR. 6. Now coming to the merits of the objection, we find that the Revenue s case is directed against the finding given by the ld. CIT(A) that the assessee s OP/VAE is comparable to the OP/OC of comparables under the TNMM. In order to appreciate this objection, it will be worthwhile to have a look at the prescription of the relevant parts of rule 10B(1)(e) of the IT Rules, 1962, which is a machinery provision for the determination of the ALP under the TNMM, as under : - (e) transac .....

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aving regard to the same base ; ……………… 7. A cursory glance at sub-clause (i) of Rule 10B(1)(e) transpires that the net operating profit margin realized by the enterprise from an international transaction 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. Sub-clause (ii) of Rule 10B(1)(e), which is equally significant for our purpose, stipulates th .....

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the operating profit margin of the assessee from international transaction has been computed with the base of costs incurred , then, the operating profit margin of the comparables has also to be computed with the same base of costs incurred . Similarly, if the base adopted by the assessee for its international transaction under the formula in TNMM is sales effected , then, similar base of sales effected must be necessarily adopted while computing profit margin of comparables. In the like manner, .....

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r, the condition precedent is that whichever denominator is selected by the assessee for working out its PLI in terms of sub-clause (i) of rule 10B(1)(e), similar denominator should be adopted in computing the profit margin of comparables as per sub-clause (ii) of the rule. It is impermissible to compare the assessee s operating profit margin computed with the base of, say, cost incurred with the operating profit margin of comparables computed with the base of, say, sales effected or any other r .....

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s must be identical. 8. Espousing the main controversy once again, we find that the assessee used OP/VAE as its profit level indicator, by impliedly treating base of Value added expenses as akin to any other relevant base and the TPO also used similar base in the PLI of comparables. The assessee claimed before the ld. first appellate authority that VAE , being the base of the assessee is the same thing as OC of the comparables. The ld. CIT(A) accepted this contention by recording in para 11.8 of .....

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ssessee s OP/VAE was similar to that of OP/OC of the comparables. To proceed on the premise that the TPO accepted the assessee s OP/VAE as equivalent of OP/OC of the comparables, either expressly or impliedly, is imaginary and without any bedrock. The TPO categorically adopted OP/VAE, both of the assessee and of comparables, for determining the ALP of the international transaction. Thus, it is manifest that the impugned order is based on an incorrect assumption by the ld. CIT(A), which has chang .....

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ing only marketing and sales support services in relation to the direct sales of Agilent products from overseas entities to customers in India without taking any physical possession or title of the goods, under Buy-Sell model, the assessee was importing products from Agilent for sale to domestic customers, specifically, against the confirmed sale orders by taking title of goods and, then, selling these to the distributors and customers in India. He argued that though the title of goods under Buy .....

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see as a trader so as to consider Operating costs as the base in the PLI instead of Value added expenses , which is really relevant for service provideRs. 10. Before delving into the point further, we want to highlight difference between Operating cost (OC) and VAE (Value Added Expenses) and their respective impact on the overall operating profit margin. In common parlance, operating costs are the expenses which are related to the operation of a business. If an enterprise is in the business of m .....

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s, having no relevance whatsoever with his operating costs. Operating costs to him will mean only administrative and selling expenses connected with his business operations, which comprise of effort in facilitating sale of other s goods. Thus it is crystal clear that whereas cost of goods sold is an important ingredient of total operating costs of a manufacturer or trader, it has no relevance in the case of a service provider or a commission agent. Operating costs of a commission agent are the c .....

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y him in inventory and debtors etc. That is why, operating profit of a trader can be correctly deduced by considering his operating costs, which always include cost of goods sold; and that of a commission agent by never including cost of goods sold, which he never incuRs. This divulges that operating costs of a trader always include cost of goods sold and operating costs of a commission agent can never have such costs. If there is some Cost of goods sold and Sale appearing in the books of an ass .....

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ched with the base of expenses incurred to the exclusion of cost of goods. Here we want to accentuate that the issue is not that a trader cannot work out his profit margin as a percentage of value added expenses to the exclusion of cost of goods sold, but the real thing is that such a profit margin can not be compared, for the transfer pricing purposes, with the profit margin of comparables, computed as a percentage of total operating expenses, which apart from value added expenses also include .....

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e s Annual accounts for the year, a copy of which has placed at pages 111 onwards of the paper book. Profit & Loss Account of the assessee records Sales of ₹ 71,13,35,944/- apart from Commission income amounting to ₹ 30.81 crore and income from Support services at ₹ 7.62 crore. Debit side of the assessee s Profit & Loss Account discloses an item of expenditure of Cost of trade sales at ₹ 65.54 crore and also Spare parts consumed amounting to ₹ 3.17 crore. Th .....

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tors and Inventories stands at ₹ 52.63 crore as against sales of ₹ 71.13 crore, which is roughly 75% of Sales . These figures leave nothing to doubt that there is a huge investment of the assessee in Stock and Debtors, which belies its claim of having no investment in working capital in the transactions under Buy-Sell model in the same way as is under Indent model. 12. The ld. AR further contended that the assessee was not holding any stock-in-trade and purchases were being made on t .....

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sit. Thus, it is manifest that the argument put forth by the ld. AR about the assessee holding no physical stock at any point of time, is fallacious and contrary to the actual figures reflected in the balance sheet. It is plentifully lucid from the details of Inventories given in the balance sheet that the assessee is not only having Finished goods and Spare parts In transit , but also At warehouse . 13. When we consider Profit & Loss Account and Balance sheet of the assessee in unison, it u .....

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asis by the assessee, activity undertaken by the assessee was in the nature of trading. We, therefore, repel the assessee s contention that the transactions under Buy-Sell model were on commission basis rather than as a trader. 14. Having held that the assessee is a Commission agent as regards its transactions under the Indent model and a Trader as regards its transactions under the Buy-Sell model, we again revert to the moot point of determination of ALP. It is noticed that the assessee clubbed .....

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manner with OP/OC of the comparables. We have noticed above that operating costs of a Commission agent are always exclusive of cost of goods sold, whereas a Trader has to have it as an essential element. Albeit a Trader can ascertain his operating profit margin as a percentage of VAE to be designated as any other base , but in our considered opinion that can not be described as a relevant base, so as to fall within the ambit of the expression any other relevant base as used in sub-clauses (i) an .....

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