TMI Blog2016 (5) TMI 145X X X X Extracts X X X X X X X X Extracts X X X X ..... M method ought to be applied to the various transactions merely because each of them aided and resulted in the manufacture of the assessee’s final product. It is not possible to assess the weightage given to each of these questions by the authorities while determining the arm’s length price. There is nothing on record that indicates the same. It is not necessary that each aspect would have been given the same weightage. Further, this would be so not merely in computing the quantum but also the very question as to whether the services were rendered by the AEs and availed of by the assessee. These are issues of fact which must, in the first instance at least, be determined by the authorities under the Act. As we are remanding the matter, it is not necessary to deal with the voluminous evidence produced and relied upon by the assessee. The authorities have come to the conclusion that the same did not reflect that any valuable services were in fact rendered. As we are remanding the matter, we do not wish to make any observation in this regard, least it prejudices either of the parties while considering the matter upon remand. Suffice it to state that the assessee has relied upon vol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax. The Assessing Officer (AO) had made a reference to the TPO for determining the arm s length price (ALP) of certain international transactions entered into by the assessee with its associated enterprises (AEs). 2. The assessee s appeal was admitted by an order dated 11.09.2014 on the following substantial questions of law raised in paragraph-15 of the appeal:- A. Whether on a true and correct interpretation of section 92C(1) r/w 92CA(3) of the Income Tax Act the Tribunal was right in law in upholding an adjustment to the declared value of following International Transactions: (i) Professional consultancy of ₹ 1,52,07,206/- (ii) Management fee for support services of ₹ 1,40,56,800/-. B. Whether, the order of the Tribunal is perverse for nonconsideration of relevant material, the evidence placed on record and submissions made by the Appellant and reaching a conclusion that the services availed were in the nature of shareholder activities and that the benefit received by appellant was only incidental and passive association benefit. At the hearing before us on 04.08.2015, we permitted the following questions of law to be raised:- 1. Whether in fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Knorr-Bremse Far East Limited. It carries on business inter alia of manufacturing air brake sets for passenger cars and wagon coaches, shock absorbers for passenger cars and locomotives, distributor or valves, computer control break system, tread break units and brake accessories. The assessee s business is segregated into two parts, namely, manufacture and distribution. During the assessment year, it entered into various international transactions with its AEs. We will refer to these transactions shortly. The assessee had prepared a transfer pricing report which adopted the Transactional Net Margin Method (TNMM) considering it to be the most appropriate method for the purpose of benchmarking its activities under the manufacturing and distribution segments separately. The assessee has described its manufacturing and distribution functions as follows:- Manufacturing functions: The manufacture of the products, referred to earlier, is through its manufacturing facility in Faridabad, Haryana. For this purpose, it imports raw material and components mainly from its group companies. About 40 to 45 per cent of the assessee s purchases were of imported goods of which about 90 per cent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8. SAP development support charges 0.06 9. Design support charges 0.15 - 10. Technical assistance 0.05 - 11. Management fees for support services 1.41 12. SAP consultancy charges 2.69 Aggregated with Manufacturing Trading Function 13. SAP License Fees - 1.41 14. Software license fees - 0.27 15. Advance license fees - 0.48 No Benchmarking required 16. Recovery of expenses 0.86 - 17. Materials/Products imported free of costs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd Mrs. Suri, the learned senior counsel for the assessee, co-related these functions with the voluminous documentary evidence in support thereof including correspondence, bills and worksheets. Mrs. Suri also relied upon the fact that said Ms. Rita Ricken s salary from the AE was Euros 75,298.00 but that the assessee had paid/reimbursed her only to the extent of Euros 63,000.00. This, she contended, established beyond doubt that the amount paid was not only reasonable but was, in fact, lower than what Ms. Rita Ricken is paid by the AE. There is no question, therefore, according to her, of the amount paid being more than the ALP. The bills also indicate the days spent by these professionals and the hours worked by them. 8. Item-11 of the table refers to the management fee for support services which was also separately assessed by the authorities by applying the CUP Method. The assessee s case, in this regard, is that during the assessment year, it availed management support services from its said AE KBAP which acted as a regional service centre for providing management and operational support services to its group companies in the Asia Pacific Region. These services are provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thereof should be furnished. The cost benefit analysis should be (a) with reference to the cost of the services and benefit received there from and (b) services received from AEs vis a via (sic) independent parties. 6. Whether any such services have been availed from independent parties? If yes the details of such expenditure may be furnished. 7. Furnish the copy of agreement with AEs for receiving such services. 8. Please state as to what tangible and direct benefit has been derived by you. 9. Documentary evidence of cost incurred by the AE for rendering each type of services purportedly received by you and the mark up applied, if any by the AE. 10. Whether AE is rendering such services to any other AEs/independent parties. If yes the details thereof whether such payments are paid by any independent concern or entity in any other country through which Knorr Bremse/AE Group carries on similar business as that of you. If yes, copies of the agreements for such services and also the basis on which such payments are paid. 11. If the AE has rendered services to more than one entities including you, then the basis of allocation amongst various entities. Also furnish the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of Section 92-D. the Assessing Officer may proceed to determine the arm s length price in relation to the said international transaction or specified domestic transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm s length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer. (4) Where an arm s length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm s length price so determined: Provided that no deduction under Section 10-A or Section 10-AA or Section 10-B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 subclause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the 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 amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arms length price in relation to the international transaction. 13. The TPO by his order dated 27.10.2010 noted that for the manufacturing segment, the assessee had selected the TNMM as the most appropriate method with Net Profit Margin (NPM) as the PLI. From the major international transactions tabulated above, the TPO segregated the ones at serial nos.3, 8, 11, 12 and 13 and tabulated the same separately. For the purp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d are as follows:- The assessee has stated that the these services payments have contributed to the improved client services and profitability of the assessee. The assessee has however not been able to substantiate that the payment for these services has actually increased the profits of the assessee. The assessee should have been able to show that the level of increase in profit post the these services agreement in April 2006 has increased. It has been unable to do that. The assessee has only mentioned that the gross profit has increased. Regular increases in profits are a normal incidence in business. Besides that, it has been pointed out earlier that the payment of these services is actually a payment for services. Therefore, there is actually no basis for the assessee to make a claim that its clientele have actually increased pursuant to the payment of Business Service . The OECD guidelines lay down the principle that the basis of indirect charge will have to answer the benefit test. Para 7.24 of the OECD guidelines further states, To satisfy the arm s length principle, the allocation method chosen must lead to a result that is consistent with what comparable independe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... providing all the necessary support that it was in need of for its operations in India and that the assessee had not provided any evidence that the services were actually provided. (c) With respect to accounting, financial support and controlling services, the TPO held that the assessee had not been able to bring out anywhere that the AE had some special local knowledge that the assessee lacked; that without the AEs support it would have been at a loss to manage its affairs and that the level of support indicated in the correspondence is expected from the AE without any charge since the assessee is a subsidiary and the SAP system was implemented because of alignment with the global network. The TPO further held that the assessee had sufficient local help to allow it to overcome the legal challenges at the local level, if any. It was further held that the kind of services referred to were at best duplicate services for which the assessee need not make any separate payment. (D) With reference to IT services, the TPO held that the assessee had not been able to provide any proof as to the complex problems that the AE had solved which the assessee would have been unable to; that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the countries like UK, USA, Germany etc it is an established position that a subsidiary does not to have to pay for the auditing, accounting and such other functions performed by the parent company as owner of the subsidiary company. If the subsidiary were an independent company it would neither require such services nor would it pay for the same. CONCLUSION: Following the discussion in the preceding paras of this order, it is concluded that the assessee has not been able to demonstrate that an independent party would have made the following payments as the assessee has done. Professional Consultancy 15,207,206 Debited to Profit Loss Account Management fee for support services 14,056,800 SAP consultancy charges and other expenses 26,893,871 Capitalized in Fixed asset schedule Total 56,157,877 Therefore, by the application of CUP, the arm s length price in respect of the transactions mentioned above and amounting to ₹ 5,61,57,877/- is determined at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... documents and the evidence submitted. The references indeed are many. One of the questions would be whether the evidence was properly and adequately considered and analysed. The Tribunal agreed with the TPO that the assessee s approach did not conform to the Transfer Pricing Regulations. The important findings of the Tribunal are as follows:- The impugned transactions relating to payment of ₹ 1,52,07,206/-, ₹ 1,40,56,800 and ₹ 2,68,93,871/- under the heads Professional Consultancy, Management Fee for support services and SAP Consultancy Charges were distinguishable and separate international transactions carried out by the assessee with its AE. Each transaction was, therefore, required to be benchmarked separately. The transactions were shown to be closely linked with each other. The assessee had not demonstrated as to how the transaction-by-transaction approach was not possible. It had also not been shown as to whether there has been any real or tangible benefit by carrying out such international transactions with the AEs. The appellant did not compute the net profit margin realised from each such transaction and had not produced any material to establish t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd to have considered these services as nonbeneficial for the recipient and did not take it as chargeable services. The perusal of e-mails and other contemporaneous record only goes to reveal that incidental and passive association benefit has been provided by the associate enterprise. In this view of the matter there could neither be any cost contribution or cost reimbursement nor payment for such services to the AE. The TPO, therefore, has rightly adopted Nil value for benchmarking the arm s length price in respect of both these services. We, therefore, do not find any reason to interfere with the well reasoned conclusion reached by the AO on this count. The grounds raised in appeal in this respect, therefore, stand rejected. 19. The appeal was partly allowed by the Tribunal against which the Revenue is in appeal in ITA No.172 of 2013. The Tribunal found that the SAP licence and MS Office had been purchased at a lower rate and had benefited the assessee. The Tribunal further noted that this was, in fact, the finding of the DRP and, accordingly, the DRP was not justified in upholding the conclusion of the TPO for making addition to the assessee s income on that account. The Tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... do not succeed equally or uniformally. Indeed, if an assessee is able to establish financial or other commercial benefits arising from a transaction, it would further strengthen its case. But if it cannot do so, it does not weaken it. 24. The profit earned by an assessee could be for reasons other than those relating to the international transactions or by virtue of international transactions as well as by virtue of other factors. In that event, the assessee having profited from the venture involving the international transactions, obviously, would not establish that the arm s length price was correct or justified. 25. It would make no difference even if the profit is entirely on account of the international transaction. In fact, even if it is established that on account of an international transaction an assessee s venture has profited, it does not necessarily establish that the transaction was entered into at an arm s length price. Mere profitability does not indicate that the transaction which was responsible for the enhancement of the profits was at an arm s length price. That an international transaction has enabled an assessee to earn profit is one thing and the price p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t interaction with IBM on behalf of the assessee-activities for which, according to the assessee s claim-interaction with IBM s regional offices in Singapore and the United States was necessary. These services cannot - as the Income-tax Appellate Tribunal correctly surmised-be duplicated in India insofar as they require interaction abroad. Whether it is commercially prudent or not to employ outsiders to conduct this activity is a matter that lies within the assessee s exclusive domain, and cannot be secondguessed by the Revenue. [brackets provided by us] We respectfully agree with the observations. We, however, do not express any view regarding the observations bracketed by us. 31. The TPO, in the case before us, had observed as under:- The OECD guidelines lay down the principle that the basis of indirect charge will have to answer the benefit test. Para 7.24 of the OECD guidelines further states, To satisfy the arm s length principle, the allocation method chosen must lead to a result that is consistent with what comparable independent enterprises would have been prepared to accept. Therefore, the assessee cannot escape its responsibilities of having to show the actua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... international transactions were at an arm s length price. 35. The TPO observed that as per the Act each class of transaction has to be examined having regard to the arm s length principal by applying the most appropriate method. In a given case, however, two or more classes of transactions may be telescoped into a separate transaction altogether and thereby fall within yet another class of transaction. The TPO also observed that the payments towards the said five transactions, namely, those at serial Nos.3, 8, 11, 12 and 13 of the table were a class of transactions of their own and the payment for the same required separate analysis. He held that for the transfer pricing study these service transactions ought to be analyzed separately under CUP Method. He further held that the Act does not preclude the TPO from applying the appropriate method for each class of transaction like payment for services and also apply TNM Method at the enterprise level. 36. Mrs. Suri, on the other hand, contended that the various components of a transaction cannot be subjected to different methods of transfer pricing. Thus, in the present case, she submitted that a few of the international transact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ternational transaction must be between only two parties. There can be a single composite transaction between two or more associated enterprises . This is clear from the opening words of Section 92B that for the purposes of Sections 92, 92B, 92C, 92D and 92E, international transaction means a transaction between two or more associated enterprises. The subsequent part of Section 92B makes this clearer by providing that the international transaction means a transaction between two or more associated enterprises in the nature of purchase, sale, etc. and shall include a mutual agreement or arrangement between two or more associated enterprises . Thus, a mutual agreement or arrangement meaning thereby a single agreement or arrangement is contemplated between two or more associated enterprises. It would follow then that several transactions between two or more AEs can form a single composite transaction. The doubt, if any, in this regard is set at rest by Rule 10A(d) which provides that for the purposes of Rule 10A and Rules 10B to 10E, transaction includes a number of closely linked transactions . Thus, the closely linked transactions can in a given situation be components of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arm s length price of each of them must be determined separately. The question, therefore, in each case must first be whether the sale of goods or the provision of services was a separate independent agreement or whether they formed part of an international transaction i.e. a composite transaction. 42. Mrs. Suri relied upon the following observations of the Division Bench of the Delhi High Court in Sony Ericsson Mobile Communications India Pvt. Ltd. v. Commissioner of Income Tax, (2015) 374 ITR 118 (Delhi):- 101. However, once the Assessing Officer/Transfer Pricing Officer accepts and adopts TNM Method, but then chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/ segregation, it would as noticed above, lead to unusual and incongruous results as AMP expenses is the cost or expense and is not diverse. It is factored in the net profit of the inter-linked transaction. This would be also in consonance with Rule 10B(1)(e), which mandates only arriving at the net profit margin by comparing the profits and loss account of the tested party with the comparable. The TNM Method proceeds on the assumption that functions, assets ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the determination of the authorities under the Act. 45. In the present case, during the assessment year the assessee received professional consultancy services from KBSFS for improvement of its production process including planning of new machines, provision of internal machinery support, coordination of maintenance activities and provision of technical support. However, the assessee availed management support services from another AE i.e. KBAP which acted as a regional service centre for providing management and operational support services pursuant to an agreement. The transactions were not entered into with merely one AE. They were entered into with various entities within the group. This is clear from the transfer pricing study relied upon by the assessee itself. Throughout the report, the reference is to the group entities in the plural. Our attention has not been invited to anything that suggests that these various transactions formed a composite agreement, to wit that the various agreements with the various group entities were, in fact, part of one single indivisible transaction. Nor was our attention invited to anything that suggests that the pricing in respect of eac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. 49. A purchaser of goods or of services is not concerned with the price at which its vendor of goods or supplier of services in turn acquired the same. This, at the highest, would be a factor while negotiating the purchase of goods or the acquisition of services. Even if the vendor or supplier acquired the assets or the know-how as a gift, it would be irrelevant as far as the onward sale thereof is concerned. The purchaser determines the price it is willing to pay for the goods or services independent of what the same cost its vendor/service provider. The TPO, therefore, proceeded on an entirely erroneous basis while computing the arm s length price. 50. We have with respect disagreed partly with the approach adopted and the legal principles applied by the authorities while computing the arm s length price. We have also disagreed with Mrs. Suri s contention that the TNM method ought to be applied to the various transactions merely because each of them aided and resulted in the manufacture of the assessee s final product. It is not possible to assess the weightage given to each of these questions by the authorities while determining the arm s length price. There is nothing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to determine the ALP of the transactions if they are otherwise genuine. 53. There is another aspect which requires further clarification and elucidation. The Tribunal upheld the contention on behalf of the assessee that the TPO is no authority to judge the allowability of the business expenditure. This finding is based on the judgment of the Delhi High Court in CIT vs EKL Appliances Ltd. (supra). The relevant findings of the Tribunal, in this regard, have already been reproduced above. On the one hand, in paragraph 9.2, the Tribunal interpreted the order of the DRP to mean that the DRP has only described the circumstances under which the international transactions had been entered into so as to test the benefits that can be said to have reached the assessee and that it cannot be said to have questioned the commercial expediency of such transactions entered into by the assessee. On the other hand, in paragraph, 9.3, the Tribunal held that a perusal of the e-mails and the other contemporaneous record reveals that only the incidental and passive association benefit had been provided by the associate enterprise. In fact, the TPO and the DRP did question the commercial expediency ..... X X X X Extracts X X X X X X X X Extracts X X X X
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