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Deputy Director of Income Tax, Circle-3 (2) International taxation New Delhi, Versus M/s Mori Seiki Co. Ltd.

2016 (11) TMI 202 - ITAT DELHI

Transfer pricing adjustment - MAM - TNMM - comparability - Held that:- It is an admitted fact that the assessee entered into international transaction with Moriseiki, Japan and to determine the armís length price, the assessee adopted TNMM method as most appropriate method in accordance with OECD Guidelines, and the operating profit/operating cost was considered as profit level indicator. The AO was of the view that the assessee ought to have earned gross profit rate of 38.09% on the direct sale .....

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quent year as there was no change in the functions, utilization of assets and risk profile of the assessee. Therefore, the ld. CIT(A) rightly held that the action of the AO was not sustainable because he on the one hand had accepted TNMM and also used profit split method for attribution of profit on the international transaction at 50:50 ratio. In our opinion either of the two methods could have been used and not both, therefore, the ld. CIT(A) was fully justified in holding that the action of t .....

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ned order passed by the ld. CIT(A). - Decided against revenue - ITA No. 879/Del/2012 - Dated:- 12-9-2016 - Sh. N. K. Saini, AM and Smt. Beena Pillai, JM Assessee by : Sh. Harpreet Singh & Rohan Khare, Advs. Revenue by : Sh. Amrendra Kumar, CIT DR ORDER Per N. K. Saini, AM: This is an appeal by the assessee against the order dated 29.12.2008 passed by the AO u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the Act). 2. The only effective ground raised in this appeal reads as .....

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wed to the assessee out of addition of ₹ 1,42,10,927/- made by the AO. 4. Facts of the case in brief are that the assessee filed its return of income declaring a loss of ₹ 44,88,297/- on 12.12.2006 which was processed u/s 143(1) of the Act on 18.03.2008. Later on, the case was selected for scrutiny. During the course of assessment proceedings, the AO noticed that the assessee had presence in India through a branch office, which commenced its operations in India on July 27, 2004 in ac .....

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ith whom it was dealing directly and after incurring expenses amounting to ₹ 1,07,54,690/-, the assessee had shown a loss of ₹ 45,78,913/-. The AO asked the assessee to furnish the copies of agreements entered with the Head Office. The assessee furnished copies of such agreements vide its submissions dated 03.12.2008 which has been discussed by the AO at page nos. 2 & 3 of the assessment order dated 29.12.2008 for the cost of repetition, the same are not reproduced herein. On the .....

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2008 which read as under: The India-Japan treaty provides that profits attributable only to the activities carried out by MS-BO in India can be taxed in India. Profits to be attributed are that the PE might have earned in same of similar activities under same or similar conditions and dealing wholly independently (Arm s Length Profits). The assessee has placed reliance on the commentary of OECD and also the decision of Hon ble Supreme Court in the case of Morgan Stanley - 292 ITR 416 (SC). In vi .....

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s of sales of machine tools made by Mori Seiki, Japan (HO) in India. For this purpose, one needs to analyze the agreements entered between the HO and the MS-BO. The assessee has furnished copies of three agreements which have been entered into between HO and MS-BO. The relevant clauses of such agreements have been extracted at para 3 above. On analyzing the same, the following crucial points emerge: i) The HO will sale machines In India and the neighboring countries through MS-BO; ii) MS-BO take .....

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nts of fees will depend on the number of installments of the machine in India; vii) MS-BO will maintain a stock of machines in India; viii) Any delay on MS-BO's part to sell the entrusted machines will add to the expenses to be borne by the HO. For this, the commission to be received by MS-BO will be reduced in accordance to the months left of the guarantee for machines for which the sales was delayed, The above points very clearly show that MS-BO is fully involved in the sales of the machin .....

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ome-tax Act, 1961, the profits arising on such sales needs to be reasonably attributed to MS-BO and taxed accordingly in India. b) The findings in the aforesaid paragraphs also find support in the decision of Hon'ble Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd. "The Protocol to the DTAA, in paragraph 6, discusses the involvement of the permanent establishment in transactions, in order to determine the extent of income that can be taxed. It is stated that the ter .....

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any, dependent agency permanent establishment (DAPE) in terms of Article 5(7) of the DTAA between India and Japan. For this purpose, it would be relevant to reproduce the relevant article - "Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 8 applies - is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in .....

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stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise ; or (c) he habitually secures orders in the firstmentioned Contracting State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control as that enterprise." Thus we can observe from above that the assessee is fulfilling the conditions laid down under Article 5(7)(b) as it is main .....

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course of assessment proceedings, the assessee furnished its transfer pricing updation study of the assessee (TP study) wherein it was mentioned that:- given the fact that the margins of the branch, under normal business circumstances are likely to meet the arm s length standard, the transactions involving provisions of business support services during F.Y. 2005-06 can be considered to be at arm s length from Indian transfer pricing perspective. 7. The AO however did not accept the contention of .....

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HO in India. iv) MS-BO will maintain such machines. v) MS-BO will maintain the stock of machines. Assets Used by MS-BO i) Land, building etc. owned/leased by MS-BO. ii) Equipments used for installation, maintenance etc. iii) Human capital (Quality man-power). And the risks borne by the assessee were following: i) Quality Risk - If the quality of the product is not good, the MS-BO will have to bear the risk of improving the quality at its own cost. ii) Delivery Risk - Any risk arising on account .....

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d that the 50% of the gross profit arising from the sales was attributable to the PE in India, however, the assessee had not maintained any books of accounts in respect of transaction pertaining to the sales made by HO in India. The AO invoked the provisions of Rule 10(ii) of the Income Tax Rules, 1962 to determine the income of the HO. He also pointed out that the gross profit of the HO in Japanese Yen was 55355 millions and the net sales was Japanese Yen 145340 millions which gave a gross prof .....

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and as HO has made a payment of ₹ 60,72,269/- to the assessee for rendering various services, the AO considered those expenses were exclusively incurred for the purposes of sales made by the HO in India and accordingly the same were deducted from the gross profit and the net profit attributable to the assessee was worked out at ₹ 1,64,44,761/- (Rs.2,25,17,030 - ₹ 60,72,269). The AO further observed that the assessee received commission income of ₹ 60,72,269/- from HO in r .....

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t the AO fixed the margin without making any reference to any comparables and on the other hand, the assessee had filed the transfer pricing documentation using TNMM as the most appropriate method and operating profit/operating cost as the profit level indicator. It was further submitted that the assessee had used 13 comparable companies in order to benchmark the provision of support services by the assessee to the H.O. and that the assessee had taken 3 year average data to do the analysis. It w .....

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y incorporated in Japan, has a branch, office in India (MS-BO) which assists MS to better co-ordinate and communicate with its existing and potential customers and be better placed to obtain the local market information in India. Such service to be provided through provision of marketing assistance party support services and other business support services. MS-BO had entered into agreements with MS Japan for providing sales support and installation support services to MS. 2. It is further submit .....

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ing support service provider having no inventory risk, no credit risk, no contract risk, etc. and thus only profits attributable to the said liaisoning and marketing support service can be taxed in India. 3. Being a branch office, MS-BO constitutes a fixed place Permanent Establishment ("PE") of MS under Article 5(2) of Double Taxation Avoidance Agreement entered between India and Japan ("India-Japan tax treaty"). Further, as per Article 7() of the Treaty only the profits att .....

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that permanent establishment". Accordingly, the India-Japan tax treaty provides that only those profits attributable to the activities carries out by MS-BO in India can be taxed in India. Further, as per Article 7(2) of the Treaty the profits attributable to the PE in India ' shall be determined based on arm's length principle. It states that: "Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State .....

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ivity under same or similar conditions and dealing wholly independently. Accordingly, an internationally accepted approach for attribution of profits to a PE is to first carry out a detailed functional analysis of the PE and the organization of which such PE is a part of and determine the economically significant activity of the PE based on such analysis. Thereafter, an arm's length profit based on arm's length principle is attributed to the PE as if it was separate and legally distinct .....

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ered into by the assessee. After taking into consideration the services rendered by MS-BO to MS, the TPO has determined the arm's length remuneration what MS-BO should get from MS and proposed an addition of ₹ 79,53,726. 7. It has been a settled position now that once a PE is being remunerated at arm s length then there is no need for further attribution. In view of the judgment of Hob'ble Supreme Court no further profit can be attributed to the PE if the transactions between MSBO .....

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are considered." 11. The ld. CIT(A) after considering the submissions of the assessee observed that for the succeeding assessment year, the DRP directed the AO to take following 5 comparables in consideration: S. No. Company Name Operating Profit/Operating Costs FY 2005-06 1. Agrima Consultants International Ltd. -10.29% 2. Hincon Technoconsult Ltd. 5.47% 3. ICRA Management Consulting Services Ltd. 15.50% 4. IDC (India) Ltd. 14.05% 5. NTPC Electric Supply Ltd. 3.29% Arithmetic Mean 5.60% 1 .....

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nternational Ltd. -14.45% 3. Capital Trust Ltd. -9.18% 4. Crisil Ltd. 11.49% 5. Educational Consultants Ltd. 16.60% 6. Electronica Machine Tools Ltd. NC 7. Epic Energy Ltd. NC 8. ICC International Agencies Ltd. NC 9. IDC (India) Ltd. 14.05% 10. Priya International Ltd. 26.09% 11. Ratan Glitter Industries Ltd. NC 12. T S R Darashaw Ltd. 10.32% 13. Ujjwal Ltd. NC Arithmetic Mean 5.84% 13. The ld. CIT(A) also pointed out that the aforesaid comparables had been considered by the AO, therefore, the m .....

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because he had used TNMM method and also used profit split method for the attribution of profit for the same international transaction at 50:50 ratio which was not permitted in law. He further observed that the transaction between the head office and the branch office was one and the same transaction. Therefore, this transaction could be validated using either of the methods and not both. The ld. CIT(A) further observed that the AO had come to the conclusion that once the same transaction was b .....

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. The ld. DR strongly supported the order of the AO and reiterated the observations made in the assessment order dated 29.12.2008. It was further submitted that the assessee entered into in agreement with its head office Mori Seiki, Japan (H.O.) and maintained the stock of goods from which it regularly delivered the goods or merchandise on behalf of the head office. It was also submitted that the assessee had undertaken all the risks relating to the sales and played a crucial role in deciding th .....

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the impugned order passed by the ld. CIT(A). It was further submitted that in the subsequent year, TNMM was used to benchmark the similar transaction which was approved by the DRP and accepted by the department. Therefore, for the assessment year under consideration also TNMM was the most appropriate method and the assessee by selecting 13 comparables in its transfer pricing study worked out the margin at 5.84% which has not been doubted by the AO. Therefore, the ld. CIT(A) rightly applied 5.84 .....

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