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SI Group-India Limited Versus Dy. Commissioner of Income Tax - LTU, Mumbai.

2016 (4) TMI 521 - ITAT MUMBAI

Transfer pricing adjustment - Addition in respect of payment of royalty to the associated enterprise - rejection of assessee’s benchmarking under CUP method - Held that:- There cannot be an adhoc adjustment in the course of ascertaining the arm’s length price. If the Transfer Pricing Officer was to reject the assessee’s benchmarking on the basis of Reserve Bank of India’s approval under CUP method, the Transfer Pricing Officer was required to decide the correct mechanism of deciding the arm’s le .....

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ing arm’s length price - Decided in favour of assessee

Addition in respect of import of product PTOP from the associated enterprise - Held that:- The quantities and sale instances in the case of the tested party are fewer but that does not lead to the inference that a comparison cannot be made at all. It is only when comparable instances are of relative smaller quantity and based on fewer sale instances that the bonafides of comparable are in the dock. When the quantity and the instan .....

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on the market conditions. It is also important to bear in mind the fact that the imports are of very small quantities which does not even account for one percent of total transactions. In the light of all these factors, and particularly bearing in mind smallness of the amount involved, in our considered view, it was not a fit case for rejection of CUP method, as employed by the assessee. We, therefore, deem it fit and proper to uphold the grievance of the assessee and direct the Assessing Offic .....

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f CUP method cannot be rejected because of the commercial outcome of the transaction being in the nature of loss. - Decided in favour of assessee - I.T.A. No.9197/Mum/2010 - Dated:- 31-3-2016 - Pramod Kumar AM and Pawan Singh JM For The Appellant : Karishma R. Phatarphekar, Divyesh I. Shah, Harsh Shah, Pratik Poddar For The Respondent : N.K. Chand ORDER Per Pramod Kumar, AM: This appeal, filed by the assessee appellant, is directed against the directions issued by the Disputes Resolution Panel i .....

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ed enterprise: Schenectady International Inc. amounting to ₹ 2,71,11,495 3.1 On the facts and in the circumstances of the case and in law, the TPO and the AO erred, and the DRP further erred in confirming the addition relating to payment of royalty under Section 92CA(3) of the Act by disregarding the documentation maintained under Section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 ('the Rules') and not appreciating the factual details, submissions and various d .....

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ion to be NIL is improper. (ii) Measuring payment of royalty based on the company's profitability would be inappropriate and has to be instead based on the technical expertise afforded to the Appellant from the AE and the benefit derived under such technical support. (iii) The aforesaid payment was essential since it was for the supply of know-how, provision of technical assistance, etc. which were necessary for the production of goods by the Appellant, sustain the market competition and hav .....

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dia, and is computed @ 2% of net sales price of goods manufactured in India. The submission of the assessee was that since the remittance of royalty is made on the basis of approval by the Reserve Bank of India, it should be treated as an arm s length transaction. The Transfer Pricing Officer, however, rejected the claim of the assessee, and proceeded to recommend an arm s length price adjustment of ₹ 2,71,11,495/- by observing as follows :- During A.Y. 2006-07, the Company has paid an amo .....

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s dropped by the Assessing Officer. Aggrieved, assessee carried the matter before the DRP but without any success. Learned DRP upheld the action of the Transfer Pricing Officer by observing as follows :- 2.4 We have considered the issue and our comments are as under- 2.4.1 It is seen that for benchmarking its transaction pertaining to the royalty payment, the assessee has used the CUP method and justified its transaction on the basis of the approval of RBI. However, it is seen that the applicati .....

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aid 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 and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length .....

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w, in the instant case, the assessee has not identified any such comparable uncontrolled transaction which could be used for benchmarking its international transaction pertaining to royalty payment. 2.4.2 The assessee has also contended that the royalty rates are approved by Reserve Bank of India, therefore, the rates are at Arm's Length. The contention of the company is not acceptable as the approval was sought by the company and granted by the Reserve Bank of India, under the Exchange Cont .....

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nk of India is clarifying the purpose of giving the approval. Such approvals by Reserve Bank of India indicate that such payments are not prevented or blocked by the Government, considering the present Exchange Control Policy but such transaction satisfies the principles of Arm's Length or not is not verified by the Reserve Bank of India. The payment should satisfy the provisions of the Act, separately and independently, irrespective of the allowability of payment as per the provisions of FE .....

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D Publications).. 2.4.3 Moreover, it was also observed by the TPO during the proceedings that the net profit margin of the assessee was lower than a set of the comparable companies. This would also show that the payment of royally has been one of the reasons for adversely affecting the margins of the assessee company. In fact, had all the transactions were combined together and TNMM would have been applied on aggregated basis at entity level, there would have still been adjustments due to margin .....

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legal position. We find that the Transfer Pricing Officer did note, and was apparently swayed by the fact of, assessee s making losses. It was for this reason that the payment of royalty was held to be not at an arm s length price, as is implicit in the Transfer Pricing Officer s observation to the effect that having considered the submission made by the assessee in respect of payment of royalty, the position of the assessee cannot be accepted due to the fact that the assessee has incurred an op .....

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e s benchmarking on the basis of Reserve Bank of India s approval under CUP method, the Transfer Pricing Officer was required to decide the correct mechanism of deciding the arm s length price and compute the arm s length price on that basis. It was not open to him to simply brush aside the benchmarking done by the assessee and adopt the NIL value. That is not a scientific method of determining the arm s length price and it cannot meet any judicial approval. In this view of the matter, and also .....

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y. 8. Ground no.3 is thus allowed. 9. In ground no.4, the assessee has raised the following grievance :- Ground No. 4 - Addition under Section 92CA(3) of the Act in respect of import of product PTOP from the associated enterprise, amounting to ₹ 8,28,196 4.1 On the facts and in the circumstances of the case and in law, the TPO and the AO erred, and the DRP further erred in confirming the addition relating to import of the product PTOP to the extent of ₹ 8,28,196 under Section 92CA(3) .....

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in rejecting the without prejudice contention of the Appellant to consider the correct margin of alleged comparable companies computed based on the annual report available in the public domain. 4.4 The Appellant prays that the Transfer Pricing adjustment made under Section 92CA(3) of the Act in relation to import of product PTOP is erroneous, unwarranted and be deleted. 10. So far as this ground of appeal is concerned, the relevant material facts are like this. During the relevant previous year, .....

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justification for this determination was as follows :- (c) In respect of PTOP imported by the assessee during the year from its AE, the assessee has not provided any details or documentation regarding the benchmarking of the said transaction. The assessee was provided a further opportunity in the personal hearing held on 26 October 2009 to justify the arm s length nature of the import of PTOP. In this regard, the assessee submitted some customs related documents in its submission dated 27 Octob .....

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Aggrieved by the addition so proposed by the Assessing Officer, assessee raised the objection before the DRP but without complete success. The main justification of confirming the adjustment, in principle, was as follows :- 4.9 We have considered the issue and our comments are as under :- 4.9.1 It is evident from the facts of the case that the assessee in its reply dated 26th Oct, 2009 before the TPO has submitted that no independent third party CUP data is available lo benchmark the internatio .....

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nd by comparing the prices paid by an independent third party in China with that the price paid by the assessee. 4.9.2 However, submission of the assessee cannot be accepted in view of the fact that the assessee has failed to demonstrate and even admitted to that extent that no comparable uncontrolled transaction has been carried out by its AE in India. The assessee wants to compare the prices paid by it to its AE with the prices paid by an independent third party in China to its AE. However, su .....

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during one year for the assessee, whereas, five instances of sale over the year for the Chinese party) Moreover, the terms and conditions of the sale are also not available for both these transactions. 12. The DRP, however, restricted the ALP adjustment to ₹ 8,28,196/- by adopting TNMM, and observed, inter alia, as follows :- 4.9.5 However, we accept the submission of the assessee that the adjustment made by the TPO on the entire amount paid by the assessee to its AE seems to be adhoc, ar .....

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al transaction undertaken by the assessee for the import of PTOP and by adopting the entity level margin of the assessee at (-) 4.90 and that of the comparables at 10.65% . Accordingly, the adjustment is worked out as follows: • Import cost for PTOP: ₹ 53,26,020 • Difference in the mean of the operating margin of the comparables and that of the assessee: 15.55% • Adjustment over the import cost: ₹ 8,28,196/- 13. The assessee is not satisfied and is in further appeal be .....

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arison is wholly unwarranted. We have noted that the prices which have been taken for comparison are FOB prices in Korea and as such impact of geographical differences is minimised. The quantities and sale instances in the case of the tested party are fewer but that does not lead to the inference that a comparison cannot be made at all. It is only when comparable instances are of relative smaller quantity and based on fewer sale instances that the bonafides of comparable are in the dock. When th .....

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if any, of these factors on the market conditions. It is also important to bear in mind the fact that the imports are of very small quantities which does not even account for one percent of total transactions. In the light of all these factors, and particularly bearing in mind smallness of the amount involved, in our considered view, it was not a fit case for rejection of CUP method, as employed by the assessee. We, therefore, deem it fit and proper to uphold the grievance of the assessee and d .....

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g to the export of the product PTOP amounting to ₹ 41,19,424 to its AE, under Section 92CA(3) of the Act by not appreciating/disregarding the benchmarking analysis, comparable transactions selected and the detailed submissions and the documentary evidence supplied by the Appellant. 5.2 The Appellant prays that the Transfer Pricing adjustment made under Section 92CA(3) of the Act in relation to export of the product IBB is erroneous, unwarranted and be deleted. 17. During the relevant previ .....

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ade by the TPO. Aggrieved, assessee raised an objection before the DRP but of no avail. Learned DRP confirmed the action of the DRP by observing as follows :- 5. Grounds of objection no. 1.4: Transfer pricing adjustment to the value of the international transaction of the assessee in respect of export of the product IBB 5.1 From the grounds of objection filed by the assessee we understand that during the year under consideration, the assessee had exported product named IBB to its AE, amounting t .....

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f substantiating the arm's length nature of the international transaction of export of IBB, the assessee extracted the customs data pertaining to all the exports of IBB made out of India during AY 2006-07 and submitted the same to the AO. The details of exports were provided by International Business Information Services (a third party service provider). As per the assessee, based on the above extracted details, the average FOB value of export of IBB works out to USD 1446.44 per metric tonne .....

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al submission made by the assessee before him in respect of export of IBB. According to the assessee, it had submitted details pertaining to all the exports of IBB made out of India during AY 2006-07 by way of its submissions dated 22 December 2009 to AO. Based on the CUP data, it is evident that the international transaction pertaining to import of IBB by the assessee from its AC is at arm s length from an Indian transfer pricing perspective. . 5.6 The A.R. also submitted that the AO was wrong .....

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in respect of IBB submitted by the assessee vide submission dated 22 December 2009. Therefore, having regard to the additional details submitted by the assessee, its international transaction in respect of export of IBB is at arm's length from an Indian transfer pricing perspective and hence, the addition made by the TPO should be deleted. 5.7 We have considered the issue and our comments are as under :- 5.7.1 It is evident from the facts of the case that the assessee in its reply dated 26th .....

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the export transaction of IBB Product by producing the export data as provided by International Business Information Services (IBIS). The assessee has contended that the benchmarking of international transaction needs to be done by using the CUP as the most appropriate method and by comparing the average price as determined from the data provided by IBIS with the rate earned by it from its transaction with the AE. 5.7.2 However, submission of the assessee cannot be accepted in view of the fact t .....

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e of the transaction, final market of the transaction, discount and bonus in the transaction, product quality, terms of payment etc. We have already discussed in detail in Para 4.10, 4.11 and 4.12 of this order that the CUP method is lo be judiciously used for the benchmarking transaction and the same envisages a strict comparability. No such evidence has been brought on record by the assessee in this case. Moreover, it is also observed that the assessee has incurred a substantial loss in this t .....

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eneric chemical product and so far as prices of generic products are concerned, CUP, on the basis of database built on inputs like customs data, is reasonably acceptable. While on this aspect of the matter, we may refer to the following observations made by a co-ordinate bench in the case of Tilda Riceland Pvt. Ltd. vs. ACIT [(2014) 64 SOT 61 (Delhi)] :- 11. We have noted that the information inputs given by the Tips Software, on the facts of this case, are inputs with regard to the information .....

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d to be maintained by the assessee under section 92 D, shall be supported by authentic documents, which may include the following (i.e. documents specified therein)". The logic employed by the Transfer Pricing Officer is that since databases compiled by private entities is not included in rule 10 D(3), such databases cannot be relied upon by the assessee. This logic is clearly fallacious inasmuch as an item not being included in illustrative list of required documents does not take outside .....

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upplier and examine authenticity of the data so furnished. Yet, instead of doing so, he summarily rejected the data as unreliable on a technical ground - which, as we have seen above, is not tenable in law. 12. We have also seen that the information so furnished by the database used by the assessee is fairly comprehensive information, including description and prices as per invoices presented to customs - a fact noted by the TPO himself, which can be cross checked and verified, in case of doubts .....

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g Officer was clearly in error in rejecting the information inputs received from the Tips Software and the database made available by the said entity. The DRP laid so much of emphasis on the observation that the assessee has not been able to rebut the argument of the TPO that Rule 10D(3) does not allow the use of private databases but did not note of the glaringly illustrative, rather than exhaustive, character of the documents listed in the said rule. As a quasi-judicial authority, and while pu .....

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department at various ports, compiled by a private entity. 13. As regards learned DRP's additional observation that, Further, in a commodity like Basmati rice, it is very difficult to find the exact comparables which can meet the stringent standards required for application of CUP method , we are unable to see any merits in this approach either. Undoubtedly, product comparability should be closely examined in applying the CUP Method as a price may be materially influenced by differences betw .....

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orts the comparison altogether. In any event, even if there are minor variations in prices of generic goods, such factors are adequately taken care of by average in the case of large size of comparables, as is the situation before us. As noted in the UN Transfer Pricing Manual for Developing Countries, with which we are in considered agreement, the CUP Method is appropriate especially in cases where an independent enterprise buys or sells products that are identical or very similar to those sold .....

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s and six sub categories. Let us also not forget that the classification is done on the basis of geographical markets and normally the products sold in a geographical market, due to sheer competitive forces, are broadly similar. It is also useful to refer to certain observations made in UN Transfer Pricing Manual, with which we are in considered agreement, to the effect that External comparables may be difficult to find in practice unless the transactions involve a fairly common and homogeneous .....

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umption market being covered by the comparables, can be ignored. 14. As for rejection of CUP method on the ground that prices of uncontrolled transactions often fluctuate on weekly and even daily basis. The TPO himself has noted in his order, the assessee did not have any contractual arrangement and these were market driven prices on which the exports to AEs took place. It is also important to bear in mind the fact that the assessee has taken average of a quarter so as to ensure that day to day .....

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hoose a less imperfect alternative from the various alternatives available. 15. Coming to the inherent edge that direct methods have over indirect methods of determining the arm's length principle, which justifies selection of CUP method as the most appropriate method, we may refer to the following observations made by a coordinate bench in the case of Serdia Pharmaceuticals Pvt. Ltd. Vs. ACIT (136 TTJ 139): 60. The thrust of learned counsel's arguments is that since transfer pricing leg .....

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rder or priority of methods which the assessee must follow, and no method can invariably be considered to be more reliable than others, on a conceptual note, transactional profit methods(i.e., TNMM and profit split method) are treated as methods of last resort which are pressed into service only when the standard methods, which are also termed as 'traditional methods' (i.e., CUP method, resale price method and cost plus method) cannot be reasonably applied". It was noted by the Coor .....

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ferred over traditional profit methods. 62. We are alive to the fact that in the 2010 version of OECD Guidelines, OECD has done away with hierarchical approach in selecting the method for determination of ALP. The OECD has abandoned its earlier position that transactional profit methods may be used "to approximate arm's length conditions when traditional transactional methods cannot be reliably applied alone, or exceptionally cannot be applied at all". In sharp contrast to the said .....

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election of most appropriate method rather than the method being picked up in the order of priority. To this extent, the approach of OECD and Indian transfer pricing legislation is now quite in harmony with each other. 63. It will, however, be stretching the things too far to suggest that in the 2010 version of OECD Guidelines, all the methods of determining the ALP have been placed at par with each other. The change in the OECD Guidelines, as we see it, is in respect of the order in which suita .....

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0 2.3 Traditional transaction methods are regarded as the most direct means of establishing whether conditions in the commercial and financial relations between AEs are at arm's length. This is because any difference in the price of a controlled transaction from the price of a comparable uncontrolled transaction can normally be traced directly to the commercial and financial relations made or imposed between the AEs, and the arm's length conditions can be established by directly substitu .....

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be applied in an equally reliable manner, the CUP method is to be preferred" 64. In other words, therefore, even as there may not be any order of preference in which methods of determining the ALP must be considered, the traditional transaction methods, and particularly CUP, have an edge in the sense that all things being equal, CUP and traditional transaction methods are preferred over the transaction profit method. We are broadly in agreement with these views. Whether we proceed on the b .....

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to a transaction at such conditions in commercial and financial terms, which are different from commercial and financial terms imposed in comparable transaction between independent enterprises, the differences in these two sets of conditions in financial and commercial terms are attributed to interrelationship between the AEs, and it is this impact of inter-relationship between the AEs that is sought to be neutralized by the transfer pricing regulations. As long as CUP method can be reliably app .....

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P. 21. In this view of the matter, and particularly looking to the smallness of transaction, the inputs from International Business Information Services were reasonable and should have been accepted. 22. We have noted that the assessee has incurred a loss on this transaction but when arm s length price is determined on the basis of CUP, it is wholly immaterial as to whether the assessee has earned profit or incurred a loss. The Transfer Pricing Officer was thus swayed by a wholly irrelevant cons .....

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