TaxTMI 
TaxTMI 
2016 (5) TMI 145
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....sessee against the draft assessment order of the Assistant Commissioner of Income Tax-the AO which in turn was in accordance with the order of the TPO-Additional Commissioner of Income Tax. 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 Rs. 1,52,07,206/- (ii) Management fee for support services of Rs. 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....
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....uestions of law. 4. The assessee is a wholly owned subsidiary of Knorr- Bremse Asia Pacific (Holding) Limited (KBAP). KBAP was formally known as 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 com....
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.... Materials/Products imported free of costs as replacement/samples during the warranty period NIL 18. Use of technical know-how - NIL 19. Supply of materials at free of costs as samples/warranty NIL" The main grievance of the assessee is that item Nos.3,8,11 and 13 were valued separately by the authorities by the Comparable Uncontrolled Price Method (CUP Method). The assessee's contention is that the entire matter ought to have been determined by the TNMM. 6. While benchmarking the international transactions in its manufacturing segment, the assessee selected five independent comparable companies, the mean profit level indicator (PLI) of which was 8.47% against the assessee's margin of 9.01% from its manufacturing operations. With reference to its distribution activities, the assessee selected the comparables whose mean PLI was 3.53% against the assessee's margin of 5.20%. The assessee accordingly contended that its transactions with its AEs were more competitive than the ALP. 7. As regards item No.3 of the table - "Professional consultancy", the assessee's case is that during the financial year it received these services fr....
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....rt services, accounting, financial support and controlling services and IT support services. Service fee was paid by the assessee to KBAP computed on the basis of the expenses incurred by the KBAP. The assessee's case is that the expenses were based on the time spent and expenses actually incurred. Documentary evidence in this regard was also produced before the authorities and in these appeals. 9. The assessee's case is that these transactions were inextricably linked to the manufacturing and distribution functions performed by it and they were, therefore, aggregated and analyzed with the assessee's manufacturing and distribution functions. According to the assessee, there is no direct comparable as per the CUP Method for transactions of this nature. Further, the transactions being closely and intrinsically linked with the core business activities, the FAR analysis stipulated under Rule 10B(2) read with Rule 10A(d) calls for an aggregation. Further, still, according to the assessee, the various international transactions jointly contribute to the profitability of the manufacturing and distribution activities and the PLI. Lastly, it was contended that the PLI margin of manufacturi....
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....espect of all these transaction amounting to Rs. 7,29,00,346 shall be reduced to 'nil'." The assessee furnished the details and filed a reply dated 18.10.2010. 11. Before dealing further with the order of the TPO, it would be convenient to set out the following provisions of the Act and the Income Tax Rules. The relevant provisions of the Act are as follows:- "92-B. Meaning of International Transaction.-(1) For the purposes of this section and Sections 92, 92-C, 92-D and 92-E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. 92-C. Computation ....
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....length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XVII-B, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm's length price in the case of the first mentioned enterprise." 12. The relevant Rules are as follows:- "10A. For the purposes of this rule and rules 10B to 10E,- (a) "uncontrolled transaction" means a transaction between enterprises other than associated enterprises, whether resident or non-resident; (b) "property" includes goods, articles or things, and intangible property; (c) "services" include financial services; (d) "transaction" includes a number of closely linked transactions. 10B.(1) For the purposes of sub-section (2) of section 92C, the arms length price in relation to an international 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 transacti....
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....ultancy charges and other expenses 26,893,871 SAP License Fees 14,064,063 Software 2,678,406 Total 72,900,346" The TPO noted that under the above provisions of the Act and the Rules each class of transaction has to be examined having regard to the ALP by applying the most appropriate method. He held that the said services are a class of transactions of their own and, therefore, require separate analysis. He, therefore, analysed the said segregated services/transactions separately under the CUP Method observing that the Act does not preclude the TPO from applying the appropriate method for each class of transaction like payment for these services and also to apply the TNMM at the enterprise level. He held that when a taxpayer is involved in distinct activities they have to be analysed separately by applying the most appropriate method in each case. As we mentioned earlier, the TPO had issued a notice dated 29.09.2010 calling upon the assessee to furnish certain information and that the assessee furnished the same inter alia by its reply dated 18.10.2010. The order of the TPO refers to the same which includes some of the facts we set out earlier. The assessee also in....
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....e professional consultancy services, the TPO observed that formal training sessions were not held for the assessee's employees; that the cost accruing to the AE in this regard would be very small; that this kind of training would be picked up by the employees on the job and that it is not as if the employees were being given training in respect of all the maritime laws and other regulations that are prevalent all over the world; that the documents do not evidence "formal training"; that the invoices do not contain a description of the services and that the assessee had only relied upon some minutes of the meeting and monthly detailed reports of said Ms. Rita Ricken and that the assessee had supplied two pages of task-sheets which neither proved the delivery of services nor any benefit derived from the claimed services. It is also important to note that once again the TPO observed that the assessee had not been able to provide any evidence that its employees had actually been benefited from the same. The TPO held that no independent enterprise would have made the payment. The TPO then dealt with the management support services by dealing with each of the ingredients thereof, namely....
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.... services. (E) With respect to SAP consultancy services, the TPO observed that the assessee has mentioned that the expenses had been capitalised during the year but that during the discussion with the assessee's authorized representative, it had been observed that depreciation was being claimed and charged to the profit and loss account during the year. The TPO held that since depreciation was being claimed, this item had a bearing on the profitability of the assessee and, accordingly, the claim with respect to the capitalised nature of assessee fees did not have any force and that the transaction had to be benchmarked. The TPO held that the circulation of the Project Report Handbook did not justify the consultancy fee received. He further held that the few e-mails between the assessee and its AE and the service agreement did not quantify the services received nor any tangible benefit received out of it. It is important to note that the TPO observed that no independent enterprise would be able to pay out a portion of its profit before it knows what is the cost incurred by the service provider and that the assessee had failed to follow this basic tenet of independent behaviour. I....
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....see filed its objections on 01.09.2011 to the draft assessment order before the DRP. The DRP by its order dated 03.09.2011 issued directions under Section 144C(5) of the Act. With respect to the TPO having rejected the assessee's approach of aggregating the closely linked transactions, the DRP merely held that it found the reasoning of the TPO to be logical and agreed with him. Nothing further was stated. With regard to the assessee's objection to the TPO having used the CUP Method for benchmarking certain services only, the DRP observed that the SAP licence and MS Office had been purchased at lower rates benefiting the assessee and to that extent the benefit test for the assessee was clear and that the assessee must be given the benefit. The TPO was directed to verify and re-compute the ALP, if necessary. With regard to the appointment of Ms. Rita Ricken, the DRP observed that the e-mails did not show that any sales logistics work and that she merely coordinated training sessions which were restricted to a few people and not all end-user employees. It was further observed that the TPO had analysed these services and benefits and that no cost allocation fee has been furnished to ....
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.... After hearing the parties with reference to material on record, we find that the authorities below have not conclusively held that the assessee could not enter into such a transaction nor had they disallowed the same by holding that such an expenditure is not assessee's business expenditure. The DRP as well as the authorities below have merely elucidated that the payments are reimbursement in respect of Ms. Rita Ricken and other personnel's case to serve the interest of share holders. By saying so they have only described the circumstance under which the international transaction has been entered by the appellant, so as to test the benefit that can be said to have reached the assessee. It, therefore, cannot be said to have questioned the commercial expediency of such transactions entered by the appellant. The I.T. rules contain exhaustive detail regarding nature of information and documents which are required to be maintained by the assessee. Rule 10D(1) of the I.T. Rules, 1962 also mandates the maintainability of record of uncontrolled transactions to be taken into account in analysing the comparability of the international functions entered into by the assessee. It, therefore, i....
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....on results in an increase in the assessee's profit. This would be contrary to the established manner in which business is conducted by people and by enterprises. Business decisions are at times good and profitable and at times bad and unprofitable. Business decisions may and, in fact, often do result in a loss. The question whether the decision was commercially sound or not is not relevant. The only question is whether the transaction was entered into bona fide or not or whether it was sham and only for the purpose of diverting the profits. 22. The TPO observed that regular increase in profits is a normal incidence in business. This is entirely incorrect. All businesses are not profitable. All decisions do not enhance profitability. Losses are also an incidence of business. Many are the failed business ventures of people and enterprises. 23. Enterprises, businessmen and professionals constantly experiment with different business models, theories and ventures. The aim indeed is to further the business, to enhance their profits. So long as that is the aim, it is sufficient for the purpose of the Income Tax Act. In a given case, profit may not even be the motive. Even so it would no....
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....n assessee does not profit from the use of the goods or services it does not follow that they were not sold at an arm's length price. 26. A view to the contrary would cause considerable confusion and lead to arbitrary, if not illogical, results. A view to the contrary would then raise a question as to the extent of profitability necessary for an assessee to establish that the transaction was at an arm's length price. A further question that may arise is whether the arm's length price is to be determined in proportion to the extent of profit. Thus, while profit may reflect upon the genuineness of an assessee's claim, it is not determinative of the same. 27. Mrs. Suri's reliance upon a judgment of the Delhi High Court in CIT vs EKL Appliances Ltd., [2012] 345 ITR 241 (Delhi) is well founded. In that case, the TPO noticed that the assessee had been incurring huge losses year after year and concluded, therefore, that the payment of royalty to the AE was not justified as the technical know-how/brand fee agreement with the AE had not benefited the assessee in achieving profits from its operations. The TPO also noticed that the assessee had itself thereafter stopped the payment and conc....
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.... no difference. 30. Mrs. Suri relied upon a judgment of the Delhi High Court in Commissioner of Income-Tax vs. Cushman and Wakefield (India) Pvt. Ltd., [2014] 367 ITR 730 (Delhi). The Division Bench held:- "35. The Transfer Pricing Officer's report is, subsequent to the Finance Act, 2007, binding on the Assessing Officer. Thus, it becomes all the more important to clarify the extent of the Transfer Pricing Officer's authority in this case, which is to determining the arm's length price for international transactions referred to him or her by the Assessing Officer, rather than determining whether [such services exist or benefits have accrued. That exercise - of factual verification is retained by the Assessing Officer under Section 37 in this case.] Indeed, this is not to say that the Transfer Pricing Officer cannot - after a consideration of the facts - state that the arm's length price is 'nil' given that an independent entity in a comparable transaction would not pay any amount. However, this is different from the Transfer Pricing Officer stating that the assessee did not benefit from these services, which amounts to disallowing expenditure. That decision is outside the authori....
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....s obvious, therefore, that this aspect weighed considerably with the authorities in rejecting the assessee's case even on merits. Considering these observations, we would presume that had the assessee established that the transactions had resulted in increased profitability, the assessee's contention on merits also would have been accepted. In any event, they would have enhanced the assessee's ability to establish the case on merits. The DRP and the Tribunal had rejected the assessee's contention regarding the true value of the services rendered by the assessee's AEs and its officers. It will be necessary, therefore, for the authorities to reassess even the evidence on record in the light of our decision that the mere failure to establish that the transactions resulted in a profit does not indicate that they were not at an arm's length price. We hasten to reiterate that even if profit is established, it does not necessarily follow that the transaction was at an arm's length price. 34. Whether the transaction was at an arm's length price or not must be determined on relevant factors. As we mentioned earlier, the assessee selected TNMM as the most appropriate method for benchmarking....
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.... the case may be, is required to determine the arm's length price in relation to "an international transaction". The acquisition of various items/components in the assessee's venture could indeed be telescoped into and form a single transaction. For instance, in the case of a package deal where each item of the package is not separately valued but all the components thereof are given a composite price, the transactions form but one composite transaction. An assessee may enter into one composite transaction with its AE involving the provision of various services or the sale of various goods. A party may opt for a single window facility where all the services and/or goods are provided under a composite agreement. Each of the components may even be priced differently. If it is established that each transaction was so inextricably linked to the other that the one could not survive without the other, it could be said that it formed a part of a transaction and that it was an international transaction. Take, for instance, a case where an AE offers to provide a bouquet of services and goods to the assessee each priced differently but on the understanding that the pricing was dependent upon....
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....endent transactions for the sale of goods or provision of services. The end product requires several inputs. The inputs may be acquired as part of a single composite transaction or by way of several independent transactions. In the latter case, the sale of certain goods and/or the provision of certain services from out of the total goods purchased or services availed of by an assessee together can form part of a separate independent international transaction. In such an event, the AO/TPO must value this group of sale or purchase of goods and/or provision of services as separate transactions. 41. The TNM Method may establish the aggregate price paid for the goods and services received under independent transactions to be an arm's length price. This, however, would give a skewed picture. One of these independent transactions may be at a bargain and the pricing, therefore, is not objected to by the department. This bargain may be for a variety of reasons and in a variety of circumstances unconnected however to the other transactions. The value of the other transactions, on the other hand, may be overestimated and would not be at the arm's length price. In that event, for the purpose ....
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....ot assist the assessee. 43. It follows, therefore, that if the TPO had correctly come to the conclusion that the said five items were not connected to the rest, he was justified in determining the arm's length price thereof separately from and independent of the others. It would be neither logical nor rational in that event to club several independent and unconnected transactions for the purpose of determining the arm's length price. If, on the other hand, it is established that the sale of various goods and/or the provision of services formed one composite indivisible transaction, TNM Method cannot be applied selectively to some of the components and the CUP or any other method to the remaining components. 44. In the present case, all the items tabulated above were not provided by the same entity. They were provided by different entities. That these entities were all part of the same group is not determinative of the issue whether they were part of a single international transaction. Each party to the group is a separate legal entity. We do not rule out the possibility of there being a single international transaction where goods are sold and/or services are supplied by various ....
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....ort and controlling services and IT services. With regard to the same, the TPO held that the assessee had sufficient local help to allow it to overcome the legal challenges at the local level. The TPO held that there was no reason to believe that the AEs provided assistance that the assessee could not obtain at the local level in India. Mr. Joshi, the learned counsel appearing on behalf of the respondent, submitted that for these and other services, the appellant could always have availed of the services of personnel and enterprises in India. 47. That, however, in our view, cannot be a ground for rejecting a claim for deduction. Nor can that be a ground for assuming that the consideration paid for the same is not the genuine arm's length price. Absent any law, an assessee cannot be compelled to avail the services available in India. It is for the assessee to determine whose services it desires availing of and whose goods it intends purchasing. It is certainly understandable if the assessee prefers to deal with its group entities/AEs. This is for a variety of reasons which are far too obvious to state. So long as there is no bar in law to the assessee availing the services of a par....
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....ng the matter upon remand. Suffice it to state that the assessee has relied upon voluminous evidence which cannot be ignored. The same must be considered and analyzed. It cannot by any stretch of imagination be held that the evidence is irrelevant. For instance, the assessee has produced all the invoices and proof of payments including in respect of services rendered by the employees of the AE's. The assessee has also established that such employees of the AE had actually visited India. Mrs. Suri also relied upon the tax structure in Germany and in India in support of her contention that the transactions were genuine. It is also difficult to understand the basis on which it was held that some of the services rendered were only shareholder activities. The nature of the services prima facie at least does not indicate that the said four transactions, which have been separated and segregated and the ALP whereof was determined by the CUP Method, were shareholder activities. 52. We intend remanding the matter as the entire approach of the authorities in determining the ALP would be different in view of our above observations. Even the appreciation of the evidence produced and relied upo....