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Swarovski India Pvt. Ltd. Versus DCIT, Circle 7 (1) , New Delhi.

2016 (5) TMI 714 - ITAT DELHI

Transfer pricing adjustment - MAM - comparability - Held that:- As the assessee has been admitted by the TPO himself as a `contract manufacturer’, we fail to see as to how the CPM can not be considered as the most appropriate method in the given circumstances. No contrary view has been brought on record by the ld. DR holding CPM as not the most appropriate method in the case of receipt of job charges by a contract manufacturer. Even otherwise, we find that the CPM, like the CUP method, is a tran .....

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the considered opinion that it will be just and fair if the impugned order is set aside and the matter is restored to the file of AO/TPO for re-deciding the ALP of the international transaction of job charges of the Pune unit under Cost plus method. It is made clear that we have not examined the comparability or otherwise of the companies chosen by the assessee as comparable. This aspect also needs to be decided at the TPO/AO’s end. Care should be taken to select comparables which are rendering .....

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xed assets is in capital field, the same cannot be allowed as deduction. We, therefore, approve the impugned order on this score by dismissing the assessee’s ground. We are in agreement with the alternate prayer made by the assessee through the additional ground that such amount of ₹ 22.17 lac should be added to the purchase price of fixed assets. It is so for the reason that once the amount written off is not deductible, it will naturally add to the cost of assets purchased so that the ac .....

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f closing stock - Held that:- In support of determining the market price and the resultant loss from obsolescence, the assessee furnished Manual of Swarovski Group laying down mechanism for the write off of crystal products. It is not the case of the Revenue that the valuation done by the assessee does not accord with the method of valuation given in such Manual or such a global policy is defective. It is observed that the assessee purchased en bloc stock from SPA Agencies Ltd., which consisted .....

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ered by the assessee on the valuation of closing stock has to be and is hereby allowed as deduction

Disallowance of `Provision of doubtful debts’ and `Provision for doubtful advances’ and `Advance written off’ - Disallowance u/s 36(1)(vii) - Held that:- In so far as the first amount is concerned, this represents the amount of debtors acquired by the assessee from SPA Agencies Pvt. Ltd. and written off during the year itself. This amount has never been taken into account in computing t .....

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the ld. AR that it is the amount of advances and not the debts written off. Firstly, it is not a case of provision for bad debts as these are advances and not any debtors. Once it is so, there can be no question of compliance with the condition set out in section 36(2). The ld. AR’s contention for treating this amount as a `Business loss’, is again sans merit. Unlike bad debt, no amount can be allowed as a business loss on a mere write off. The assessee is required to expressly prove the occurr .....

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ent and publicity expenses - Held that:- The disallowance sustained by the ld. CIT(A) is in two parts. The first is 10% of total expenditure on advertisement and publicity treated as a capital expenditure to that extent. In this regard, we find that there is no dearth of decisions from various High Courts holding that the expenditure incurred on advertisement should be allowed as deduction in entirety as revenue expenditure in the year of incurring and no part of the same can be considered as ca .....

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ld that:- There is a reference in the assessment order to the fact that Swarovski AG would make direct sales to customers in the territory of India and the assessee would be paid commission @ 15% of the net value of the direct sales to the listed customers. Such income from commission in the hands of the assessee during the year under consideration stands at ₹ 15,06,754/-. We do not find much discussion in the assessment order about the reasons leading to such conclusion of brand building .....

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AM: This appeal by the assessee is directed against the order passed by the CIT(A) on 30.4.2010 in relation to the assessment year 2002-03. 2. The assessee, vide ground no. 8 of the appeal, is aggrieved against the confirmation of addition of ₹ 84,06,916/- towards transfer pricing adjustment. 3. Briefly stated, the facts of the case are that the assessee, an Indian company, is a part of Swarovski Group which is globally famous for crystal and crystal related products. It is a global leade .....

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s, out of which only three related to the Pune unit. One of such international transactions is Coating of raw beads with transacted value of ₹ 316,84,850/-, which is under dispute. The assessee used Cost plus method (CPM) as the most appropriate method to demonstrate that this international transaction was at arm s length price (ALP). The Assessing Officer (AO) made reference to the Transfer Pricing Officer (TPO) for determining the ALP of the reported international transactions. The TPO t .....

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e sent back to the AE. For this, conversion charges to the tune of ₹ 3.16 crore were received by the assessee, which constitute the international transaction under consideration. The TPO noticed functional profile of the assessee by observing that the Pune unit was set up to colour beads for only Swarovski entities and was 100% captive unit taking minimal risks and all the raw materials were furnished by its AE free of cost for which the finished goods were sent back to the AE. He noted in .....

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of the assessee, on which the mark up could be applied, as under:- Total Expenditure as per audited financials Rs.39,963,455 Less: Salary to MD Rs.1,099,288 Rent of MD Rs.73,400 Conveyance of MD Rs.34,584 Entertainment of MD Rs.101,852 Bank charges, interest, loss on sale Of fixed assets, advances written off Rs.2,52,253 Rs.1,561,377 Cost Base Rs.38,402,078 4. Then, he proceeded to determine the ALP of the international transaction of receipt of revenue for coating raw beads. In this regard, he .....

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ALP in Rs. And in % terms Rs.8,406,916 (21%) 5. That is how, he recommended a transfer pricing adjustment amounting to ₹ 84,06,916/-. The AO while finalizing the order u/s 143(3) made this addition. The assessee challenged two aspects of this addition before the ld. CIT(A), namely, application of TNMM by the TPO as the most appropriate method and determination of ALP of this international transaction. The ld. CIT(A) agreed with the TPO in applying TNMM as the most appropriate method. On se .....

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d. We will espouse these issues, one by one. I. Selection of most appropriate method 7.1. First issue before us is selection of the most appropriate method. The ld. AR submitted that the assessee correctly applied CPM as the most appropriate method to benchmark this international transaction but the TPO fell in error in resorting to the TNMM. In the opposition, the ld. DR submitted that the TPO, in fact, applied Cost plus method only as was evident from the fact that nowhere in the order did he .....

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he assessee at ₹ 3.84 crore on which profit margin of 4.4% has been applied to determine the ALP at ₹ 4.00 crore. This 4.4% has been adopted on the basis of calculations given by the assessee during the course of proceedings before the TPO, a copy of which is available on pages 272- 275 of the paper book. Para 3 of the accompanying letter dated 17.01.2005 addressed to the TPO states that the assessee has : now computed mark-up on cost considering overhead expenses in respect of the a .....

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profit. Due to non-availability of any Annual report of the 19 comparable companies for any of the years, the manner of computation of profit rate so given in the Table on page 274 of the paper book is not capable of verification. Below this Table, the assessee computed its own profit margin in the similar way by considering Total income at ₹ 3.25 crore, Total cost at ₹ 3.92 crore and Net loss at ₹ 0.67 crore and in percentage terms at (-) 17.09%. Figure of Total income of the .....

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d by certain non-operating costs. When we consider these two figures, namely, Total income (Operating revenue) and Total cost (Operating costs) as calculated for the assessee, and, then, view it in the setting of the Table depicting calculation of similar figures of the comparables, there remains no doubt that 4.4% is the average operating profit margin of the comparables. In other words, profit margin of 4.4% of comparables is OP/TC. The TPO applied this profit margin on costs incurred in provi .....

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urred or sales effected or assets employed or to be employed. Under sub-clause (ii), the net profit margin realized by the enterprise from a comparable uncontrolled transaction is computed with regard to the same base, which is, then, adjusted under sub-clause (iii) on account of differences, if any, between the international transaction and comparable uncontrolled transaction to find out the arm s length margin under subclause (iv). On the other hand, the manner prescribed for calculation of AL .....

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in subclause (i) are increased by the adjusted profit mark up arrived at under subclause (iii) to find out the ALP of the international transaction. On a comparative study of TNMM and CPM, we find that whereas the base in case of TNMM may be Total operating costs (if not sales effected or assets employed etc.) with the Net profit always as numerator, the base in the case of CPM is Direct and indirect costs of services rendered with the Gross profit always as numerator. Not only there is a differ .....

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ained from the Trading account alone, some of the indirect costs, like depreciation etc. are found from the Profit and loss account. On the other hand, Operating costs include not only direct and indirect manufacturing costs as referred to in the CPM, but also certain other costs, such as, Selling and Administrative expenses, which can be found from the Profit and loss account. In other words, Operating costs are equal to Direct and indirect costs plus some other costs. Insofar as the numerator .....

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view the calculation made by the TPO in determining the ALP of this international transaction, it clearly emerges that he has taken costs incurred at ₹ 3.84 crore, which are Operating costs as per his calculation and profit margin of 4.4% of comparables, which is ratio of operating profit to total operating costs. Thus, it is evident that the TPO has applied TNMM for determining ALP of this international transaction. This disapproves the contention of the ld. DR that the TPO applied CPM as .....

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crore. The ld. AR contended that the assessee applied CPM in respect of similar international transaction of receipt of job charges in the subsequent years as well. A chart has been placed on record which divulges that right from the assessment year 2002-03 (i.e. the year under consideration) up to the A.Y. 2005-06, the assessee had been applying CPM as the most appropriate method for the international transaction of receipt of job charges, which stood accepted by the TPO. Copies of orders accep .....

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. As the assessee has been admitted by the TPO himself as a contract manufacturer , we fail to see as to how the CPM can not be considered as the most appropriate method in the given circumstances. No contrary view has been brought on record by the ld. DR holding CPM as not the most appropriate method in the case of receipt of job charges by a contract manufacturer. Even otherwise, we find that the CPM, like the CUP method, is a transaction specific method striving to determine ALP on a micro le .....

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that the TPO applied TNMM for calculating the ALP of the international transaction and, as such, did not have any occasion to examine the calculation given under the CPM. The assessee has made calculation of ALP under CPM in its Transfer pricing study report as per Annexure-B. When we peruse such Annexure in juxtaposition to the Profit & Loss Account of the Pune unit, it comes to the fore that in the Profit & Loss Account, there is a mention of first item of revenue as Sales (Including t .....

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taken in Annexure-B vis-àvis the amounts appearing in the Profit & Loss Account. Though some of the figures, namely, Chemical and clearing charges of chemicals consumed, Packing material and sewing thread consumed and Purchase of consumables, etc. given in the Annexure are matching with the respective amounts given in the Profit & Loss Account, but, there are certain other expenses whose figures are not matching. For example, in Annexure-B, there is mention of Wages at ₹ 18, .....

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₹ 86 lac in Annexure-B with the narration (approx.). As against that, the amount of depreciation in Profit & Loss Account is ₹ 1.07 crore. The ld. AR stated that the remaining amount of depreciation is in relation to Administrative wing of Pune unit, but, failed to point out the manner of such apportionment. Then, there is an item of ₹ 50 lac considered in Annexure-B with the narration Management cost (approx) and other expenses (approx.). Here again, the answer to the que .....

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al direct and indirect processing costs. When confronted with the above variations, the ld. AR submitted that during the course of proceedings before the TPO, the assessee revised its calculation and also furnished a supporting certificate from a Chartered Accountant, a copy of which is placed on pages 465 to 483 of the paper book. He stated that that this certificate represents exact calculations. When we peruse page 466 of the paper book, which is a part of the certificate along with the subse .....

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these heads. When we peruse the Profit & Loss Account of the assessee, it discerns that there is an item of revenue characterized as Sales (including trading) with the value of ₹ 3,16,84,843/-. We find that this is the exact amount of the revenue received by the assessee from its AE as job work charges. This is also fortified from the TPO s order in which the international transactions have been reproduced and the transaction at Sl. No.3 is Coating of raw beads with value of ₹ 3 .....

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ity carried out by the assessee in Pune unit except Coating of raw beads. Once it is established that the assessee did not carry out any income-generating activity in its Pune unit except Job work , we fail to comprehend any logic in allocating costs to non-existent Trading and Transfers heads also, which have been artificially created so that the costs qua Job work could be reduced to show higher artificial profit with a view to demonstrate this international transaction at ALP. Even otherwise, .....

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ionment of costs amongst the sole existing head of Coating of Raw Beads and other non-existing heads, the ld. AR stated that it was done as per the subjective satisfaction of the management. Firstly, we find that there is no Trading or any other activity and allocation of costs to such heads has been made with the ulterior motive of reducing the cost base of Job work and, secondly, such allocation is absolutely on ad hoc basis without there being any parameter to justify the rationality of such .....

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plus method. It is made clear that we have not examined the comparability or otherwise of the companies chosen by the assessee as comparable. This aspect also needs to be decided at the TPO/AO s end. Care should be taken to select comparables which are rendering job charges in the capacity of a contract manufacturer alone assuming minimal risks and not the fullfledged manufacturers purchasing raw materials and then selling similar finished goods at their own assuming all the manufacturing risks .....

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preciation on total cost of the fixed assets acquired during the year and added to the WDV of the respective block of assets, including the amount of ₹ 22,17,399 written off under the head fixed assets written off , under section 32 of the Income Tax Act, 1961. 9.2. No serious objection was taken by the ld. DR against the admission of the above additional ground. The same, being a legal ground, is hereby admitted for consideration. 9.3. Briefly stated, the facts of these grounds are that t .....

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er at the value appearing in their books of account, namely, ₹ 96,52,099/-. The same were revalued after acquisition at ₹ 74,34,700/- and the differential amount of ₹ 22,17,399/- was written off. The AO treated this amount as capital loss and did not grant deduction for the same. The ld. CIT(A) approved the action of the AO in this regard. 9.4. We have heard the rival submissions and perused the relevant material on record. Detail of the assets purchased from SPA Agencies Pvt. .....

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amounting to ₹ 22.17 lac was written off, which is under dispute. The ld. AR submitted that the assessee was set up in November, 2000 and prior to that SPA Agencies was acting as Distributor of Swarovski Products. On being asked to produce a copy of agreement, if any, between the assessee and SPA Agencies Pvt. Ltd., for acquiring their business of distributorship, the ld. AR contended that no such agreement was entered into because the assessee did not acquire business of distributorship .....

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e fail to see as to how such differential amount on account of fixed assets written off can be considered as revenue loss deductible in the computation of income. It is a clear cut case of capital loss resulting from the valuation of fixed assets. In support of the contention that it was business expediency of the assessee in purchasing these fixed assets from SPA Agencies and hence the loss written off be allowed as deduction, the ld. AR relied on the judgment of the Hon ble Supreme Court in th .....

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ts. This shows that the purchase of Government bonds was obviously a pre-condition for securing orders from the Government. It was under those circumstances that the Hon ble Supreme Court held the loss to be deductible. The facts of the extant case are entirely different. It is not the case that the assessee had to purchase the fixed assets for acquiring the distributorship from SPA Agencies (P) Ltd. The assessee s stand ab initio has been that there was no acquisition of any business as such by .....

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. On the additional ground, the ld. AR contended that if loss of ₹ 22.17 lac was not to be allowed as deduction, then, such loss written off in the accounts by reducing the value of block of fixed assets, be added to the value of assets so as to restore the full value of purchase price of such assets and the resultant depreciation may be claimed on the full purchase price of such assets. We are in agreement with the alternate prayer made by the assessee through the additional ground that s .....

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re the purchase price of such fixed assets in the block of fixed assets and allow depreciation accordingly. 10.1. The next issue raised in this appeal is against the sustenance of disallowance of amount claimed under the head Provisions for obsolete goods amounting to ₹ 99,95,581/-. Facts of this ground are that during the course of assessment proceedings, the assessee was required to file detail of valuation of closing stock as on 31.3.2002. From the detail so filed, it was observed that .....

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of which several items go out of present trend, which are required to be written off. Amount of ₹ 99.95 lac was claimed as loss from such obsolescence. The assessee further stated that in some cases, the stocks written off were as old as 4-5 years while in other cases, the obsolescence was not full for which valuation was proportionately reduced. The AO observed that the assessee started its CCD and CGD business in November, 2000 only and there was no possibility of having any goods 4-5 y .....

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submit basis of valuation of closing stock and also the mechanism for deciding on the write off. The assessee stated that Swarovski Group was following a global policy of write off of obsolete items of stock and the amount written off by it was determined following such policy only. Relevant extract of the Manual dealing with inventory valuation was also placed on record. Unconvinced, the ld. CIT(A) upheld the addition. The assessee is before us against the sustenance of this addition. 10.2. Aft .....

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ssessee furnished Manual of Swarovski Group laying down mechanism for the write off of crystal products. It is not the case of the Revenue that the valuation done by the assessee does not accord with the method of valuation given in such Manual or such a global policy is defective. It is observed that the assessee purchased en bloc stock from SPA Agencies Ltd., which consisted of both good and obsolete stocks. It was a package deal for purchase of stock. The Revenue has not doubted such purchase .....

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allowed. 11.1. The next ground is against the confirmation of disallowance of Provision of doubtful debts amounting to ₹ 2,89,475/- and Provision for doubtful advances amounting to ₹ 5,10,254/- and Advance written off at ₹ 4,218/-. The facts of this ground are that the assessee claimed deduction of these three amounts. On inquiry by the AO, it transpired that the provision for doubtful debts amounting to ₹ 2,89,475/- pertained to old debts recoverable by SPA Agencies, wh .....

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75+4,218). The ld. CIT(A) echoed the action of the AO in this regard. 11.2. Having heard the rival submissions and perused the relevant material on record, we find that the assessee claimed deduction for these three amounts u/s 36(1)(vii) as a provision for doubtful debts/doubtful advances. The claim of the assessee that the amounts be allowed as deduction in terms of section 36(1)(vii), in our considered opinion, is not acceptable in view of the fact that firstly, deduction under this provision .....

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t of ₹ 2,89,475/- is concerned, this represents the amount of debtors acquired by the assessee from SPA Agencies Pvt. Ltd. and written off during the year itself. This amount has never been taken into account in computing the income of the assessee in the current year or any earlier year. Such debts might have been considered in the computation of income of SPA Agencies Ltd. in earlier years, but that does not satisfy the condition in the hands of the assessee. Thus, there is failure on th .....

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in section 36(2). The ld. AR s contention for treating this amount as a Business loss , is again sans merit. Unlike bad debt, no amount can be allowed as a business loss on a mere write off. The assessee is required to expressly prove the occurrence of loss. Here is a case in which the amount due from Customs Department has been written off. No amount recoverable from the Government can under any circumstance be considered as loss. This amount in our considered opinion has been rightly disallowe .....

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d that 10% of such expenditure was of capital nature because of the benefit from such advertisement also spilled over in the later years and a further 10% was disallowed by treating it as brand building of Swarovski owned by its AE abroad. In reaching the latter conclusion, the AO observed that as per Agreement dated 15.1.2002, Swarovski AG was competent to make direct sales to the customers in the territory of India on which the assessee was to be paid commission @ 15% of the net invoice value. .....

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