TMI Blog2018 (11) TMI 1545X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of Blue Star as a comparable - Held that:- It is seen that the said comparable undertakes research and developmental activities which position is not disputed by the tax authorities. It is also seen that Blue Star has various other segments wherein assembly of air conditioners is also one of the segments. On a consideration of facts we deem it appropriate to remand the issue and direct the TPO to work out the profit margin of the relevant segment of this comparable the inclusion of the said comparable is upheld on the said condition. However in case the TPO is unable to obtain the relevant details then the comparable is directed to be excluded. Capacity utilisation benefit - Held that:- We have seen that the assessee has shown that after reaching a threshold of certain manufacturing activity level the assessee has finally broken even and has also returned profits. The chart and figures made available in the course of the hearing based on documents in public domain admittedly demonstrate the fact. It is well accepted that in the peculiar case like that of the assessee, the manufacturing costs would necessarily have certain fixed overheads and these costs would be met only w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anufacturing segment based on erroneous reasons and instead, applying Net Profit based approach by selecting Transactional Net Margin Method ('TNMM') as the most appropriate method. 3. The Ld. TPO, Ld. AO and Hon'ble DRP erred on facts and in law in indentifying Blue Star Limited as comparable to the Appellant disregarding the fact that the same was inappropriate comparable owing to differences in FAR profile ('Function performed, Assets utilized and Risk assumed') 4. The Ld. TPO, Ld. AO and Hon'ble DRP erred on facts and in law in cherry picking Frick India Limited and Rexnord Electronics Controls Limited as comparables to the Appellant in the Transfer Pricing ('TP') order dated 27 October 2016, which were not mentioned in the show cause notice dated 23 September 2016, with a prejudiced intention of making an addition to the returned income of the Appellant, without appreciating the fact that the same were functionally incomparable to the functions performed by the Appellant. 5. The Ld. TPO, Ld. AO and Hon'ble DRP erred on facts and in law violating the provisions of Rule 10B(3) of the Rules by denying the benefit of various ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see failed on the touchstone of the benefit test and determined the ALP of the transaction at Rs. Nil and made the addition. It was submitted that similar expenses were incurred in 2014-15 Assessment Year. However the AE agreed to waive these expenses in 2015-16 Assessment Year. Accordingly, on account of this fact, the entire amount was written back i.e; from 2013-14 to 2014-15 Assessment Year and keeping the requirement of Section 41(1) of the Act the amount was offered for tax in 2015-16 Assessment Year. Accordingly an appropriate direction was sought. Further relying on the judicial precedent as available in order dated 9.8.2017 in ITA No.5165/Del/2014 in the case of M/s Caparo Maruti Ltd. it was submitted that considering a near identical issue, the ITAT in para 10 to 12 accepted a similar prayer of the assessee. Similar request was prayed for in the present proceedings also. The relevant extract from the aforesaid decision relied upon is reproduced hereunder : 10. The facts apropos this issue are that the assessee claimed deduction towards interest (Prior period item) in the computation of income for the above referred two sums. The Assessing Officer did not allow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tood by the TPO has not taken RPM as the most appropriate method. The assessee has applied the other method which has been prescribed and the TPO without giving valid reasons in an arbitrary manner has deemed it necessary to substitute the same with TNMM as the most appropriate method. Having so held it was argued the TPO was duty bound to make the adjustments permissible under the said method. These were warranted and brought to the notice of the TPO who should have been done. The allowability of the to adjustments sought qua the comparables, it was submitted, are on record in the synopsis filed and were agitated before the DRP also which Forum has whimsically brushed aside the submissions. Referring to the record it was submitted the TPO refused to address those stating that the data was not robust. Having so held, it was argued the selection of TNMM as the most appropriate method (hereinafter referred to as MAM) becomes questionable as there were sufficient reasons on record brought out by the TPO himself that TNMM as a method to be applied for the transactions of the assessee was inappropriate. Arguing for the relief of capacity utilization, it was his submission that the yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee on this ground also. 7. It was his vehement argument that the assessee was not a fly by night operator only booking losses and is a genuine player in the market a new entrant with full intention to stay the long haul. The relevant charts relied upon are reproduced hereunder: Period Total capacity units) installed p.a (in Actual production p.a (in units) Utilization % Supporting document FY 2012-13 700,000 58,677 8.38 Tax Audit Report for FY 12-13 attached as Annexure 3A FY 2013-14 700,000 196,506 28.07 Tax Audit Report for FY 12-13 (relevant pages) attached as Annexure 3b Cost Audit Report attached as Annexure C FY 2014-15 697,500 246,547 35.35 Tax Audit Report for FY 14-15 attached as Annexure 3D FY 2015-16 697,500 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e was no comparison with assessee's line of business. 12. The products of Frick India, it was submitted, include compressors and package condenser used in food/chemical industry and thus, this comparable was also functionally dissimilar. Attention was invited to page 515 onwards of the Paper Book for referring to supporting documents. It was further argued that this company in the year under consideration had undertaken several research and development activities in areas of its operations evident from page 9 of the Annual Report. Addressing his arguments for exclusion of Rexnord Electronics Controls Ltd. it was submitted that this company was also functionally dissimilar as it was engaged in manufacturing of fans, motors, blades and their accessories. The requirement of these products, it was submitted, is almost for the entire year unlike the assessee's product which has a limited seasonal requirement. Thus, it was argued, there was no comparison. Referring to the record, it was submitted, the Assessee manufactures copper heat exchanger coils which are assembled along with compressors, electric motors, blowers etc. which are assembled for air-conditioners. 13. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding precedent for the parties to be followed in subsequent years; ( d) Whether in view of the waiver by the AE(GP Midea) for payment of management and business support services be remanded back directing TPO to verify the facts following the precedent namely whether the amount stands offered to tax in subsequent year and whether similar position on facts has been accepted by the TPO in assessee's own case. The request made in the circumstances is without conceding the fact that services were made available. 17. Having so formulated the issues which fall for our consideration, we deem it appropriate to refer to some relevant facts. It is seen from the record that the assessee is engaged in the manufacturing and trading of light commercial air conditioning systems. The TPO picks up the above two international transactions entered by the assessee with its AEs. The TPO noted that for bench marking international transactions relating to manufacturing operations, the assessee has rejected RPM and applied other method . The TPO observed that for availing of management charges the said exercise has been done without demonstrating how independent third party would have p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for rejection of the assessee s method, heavily relied upon by the Revenue is extracted hereunder: The tax payer has selected other method by considering the PLI of GP/Sales, which is nothing e4lse but resale Price Method ( RPM ). Further the assessee in its report itself has rejected the RM by mentioning following paragraphs: The RPM is ordinarily used in cases involving the purchase and resale of tangible property and services in which the reseller has not added substantial value to the products or services. The RPM depends on comparability of functions performed or risks assumed by the controlled parties and the comparable uncontrolled parties. It requires a set of closer comparables as it uses 'gross cost margins' concept for its analysis, which is more susceptible to differences in functions and risks assumed between the lasted party and the comparables. The RPM is generally used in case of a distributor. In oilier words, RPM could be applied in cases where one enterprise obtains goods and services and sells the same to unrelated party without any value addition. Since. CMI is not engaged in purchase and resale of tangible property without ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of comparability required for the analysis is different for different methods. Thus, as a methodology, under the TNMM the standard of comparability is relaxed relative to the other methods and requires similarity of functions. This finds support even in the OECD guidelines which provides that where exact comparables (in terms of product or price) are not available, TNMM is the most 'preferred' methodology in analyzing transactions (at the net level) as it is more tolerant to differences between the tested party and comparable uncontrolled transactions. It is evident from the above that OECD guidelines advocate use of TNMM method as it allows comparability of the functions rather than strictly focusing on product/ service comparability as in the case of CPLM, Resale Price Method and CUP. Further, even developed nations like the US under its Transfer Pricing Regulations ( 1. 482-5) advocate use of TNMM as it compares functions rather than on products/ services and hence TNMM is more tolerant to differences that may arise from product differentiations: Because operating profit usually is less sensitive than gross profit to product differences, reliability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... seen that the contentions raised by the taxpayer in this regard cannot be accepted on following grounds: There is no evidence that the services have actually been provided. The taxpayer has failed miserably to demonstrate the need for these services as also the receipt of the same. Moreover, no cost allocation basis has been provided by the assessee for payment of such services to its AEs The taxpayer has failed to establish any direct nexus, whatsoever, of any kind, which may help its case of having received the business from its AE as a result of services provided by the AE. The taxpayer has failed to establish that its associated enterprises have specifically dedicated service centers for the taxpayer The AE was not prohibited from rendering services to third parties as well. It is apparent, as has been mentioned above, that services of such nature are being performed by the taxpayer itself during its normal course of business. Under arm's length circumstances no independent enterprise would be willing to pay for services which are a part of its routine business performed by it and would not engage it to receive such incidental services ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch related party transactions: The taxpayer s agreement with the associated enterprises related to intra group services is to be examined to see as to what kind of services were to be provided by the AE to the taxpayer. As normally such agreements refer to a large number of services which could be rendered by the AE, the taxpayer has to specify the service(s) which is actually received by it for which the payment is made. b. Whether the taxpayer really needed such services or not. If so, what direct or tangible benefit it has derived c. Contemporaneous information on the basis of which rate or payment for the service is determined This includes the cost benefit analysis done by the taxpayer at the time of entering into agreement. Whether any benchmarking analysis was done by the taxpayer so as to compare the amount which he would have paid to an independent person under similar circumstances. d. Whether an independent person would have paid such amount in comparable circumstances e. Whether the expected benefit commensurate with the payment f. Whether the taxpayer has separately incurred any expenditure on similar services and if so the necessity of ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... benefit is necessary. He was of the view that there not only has to be an evidence in support of the receipt of the service but also that the payment should commensurate with the benefit. He was of the view that the benefit to the taxpayer should be direct and tangible and not indirect or incidental. Reliance was placed upon the following decisions available in various developed countries. Specific mention was made to the following decisions: In Saviano VS Commissioner 765F. 2d 643,654 (7th Cir 1985) it was observed, the freedom to arrange one's affairs to minimize taxes does not include the right to engage in financial fantasies with the expectation that the Internal Revenue service and the Courts will play along. In Frank Lyon Co Vs US 435,US 561,573(1978) the Hon ble US Supreme Court observed, In applying the doctrine of substance over form, the court has looked to the objective economic realities of a transaction rather than to the, particular form the parties employs. In the field of taxation administrators of law and the courts are concerned with substance, relations and formal written documents are not rigidly binding. (Helvery Vs Lazanus Go. 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... parties and if so the rate / amount charged from such persons. i. The cost incurred by the AE for providing such services and the basis of allocation key j. If the AE has charged any mark-up on such payments the arm's length margin is also In the present case for any of the transactions the taxpayer could not show that the above mentioned criteria were fulfilled. The taxpayer has not been able to show as to when and how the various services were requisitioned from the AEs, whether the services were actually needed by it, whether the same were actually received by it by producing contemporaneous documentary evidence, at the time of entering into agreement or at the time of avail ing the service (if actually availed) what benchmarking analysis was done, what cost benefit analysis was done particularly when a huge payment has been made by it to the AEs. In an arm s length situation, before availing any service, an independent person would consider the nature of services required by it and would make the payment which commensurate with the nature of the service and the expected benefit derived there from. As can be seen from the reply of the taxpayer as st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng it; and - What property is being used or transferred in connection therewith. - A written, binding service contract between the payer and payee companies, i.e. the c barter of the company which illustrates what policies have been adopted, what services are to be provided, what costs are to be included and what is to be excluded, etc. The taxpayer was unable to provide any contract agreement detailing at the minimum: full details of the nature and extent of services provided by AE, v the basis for determining the fees to be charged; The taxpayer unable to provide any of the following details - Proof beyond a reasonable doubt of the provision of the intra-group service, - A comprehensive and complete description of the benefits detailing the following: Description of the benefits provided by each business unit the costs of which are being allocated: - Examples to illustrate those benefits. - any documentation in support of justification of the fee for the services rendered, e.g. copies of time sheets or cost centre reports, any letters, manuals, instructions, proof of -visits, written advice, periodic activity r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f taxation administrators of law and the courts are concerned with substance, relations and formal written documents are not rigidly binding {Ftelvery Vs Lazanus Co. 308 US (252)}. The OECD also recognizes this reality in its guidelines of 2010. The relevant portions are reproduced below: 1.67 Associated enterprises are able to make a much greater variety of contracts and arrangements than can independent enterprises because the normal conflict of interns 1 which would exist between independent parties is often absent. Associated enterprises may and frequently do conclude arrangements of a specific nature that are not or are very rarely encountered between independent parties. This may be done for various economic, legal, or fiscal reasons dependent on the circumstances in a particular case. Moreover, contracts within an MNE could be quite easily altered, suspended, extended, or terminated according to the overall strategies of the MNE as a whole, and such alterations may even be made retroactively. In such instances tax administrations would have to determine what the underlying reality is behind a contractual arrangement in applying the arm s length principle ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to Intra Group Services and cannot be regarded as giving rise to arrangement subject to arm s length pricing as stipulated in OECD TP guidelines paragraph 7 13 under Chapter VII. These findings lead to an irresistible conclusion that payments for liaison services allegedly provided by the AEs are not at arm's length price. Moreover, it is seen from the details contained in the transfer pricing report of the taxpayer submitted under Rule 10D that the taxpayer had not conducted FAR analysis in regards to these alleged services and had failed to justify the functions performed by the AE for these payments. This is probably a reason that the receipt of alleged services have not been benchmarked under any of the five method prescribed under the Act in the .Transfer Pricing report. Furthermore, the taxpayer has at the time of requisitioning the so-called services, not carried out any cost- benefit analysis at its end. No independent party would agree to incur expenditure without independently ascertaining the value of the goods/services intended to be availed, in the market and that too at the best negotiated prices. No such effort has been demonstrated to be made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... service charges to the Singapore affiliate Therefore, the TPO is justified in making the adjustment of ALP under sec. 920A of the Income- tax Act 1961. 28. The ld. AR though praying for remand as noted has stated that the assessee claims that services were necessary and were received the supporting arguments extracted from the synopsis filed is reproduced hereunder for the sake of completeness: Management and business support services During FY 2 12-13, the Appellant availed a number of management and business support services from GD Midea Air-conditioning Equipment Co., Ltd. ( GD Midea/ AE) as mentioned below: ( i) Support on engineering and manufacturing process ( ii) Assistance in new product designs and specifications ( iii) Information pertaining to technological advancements and product innovation ( iv) Training to employees etc. The appellant required these services for smooth and efficient running of its day to day operations. The AE had the detailed understanding and expertise on various plant operations globally and had better understanding on process improvements and its benefits. In order to improve die manufacturing effic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to tax in subsequent year (AY 2015-16). 2.7.Where disallowance proposed by the Ld. TPO (i.e. in AY 2013-14), has already been given effect in the computation of taxable income (i.e. in AY 2015-16), the same would result in double taxation. Accordingly, the Appellant would be gravely affected if such disallowance is imposed. 2.8.-Similar contention was also raised by the Appellant during the transfer pricing assessment proceedings for AY 2014-15. The same was accepted by the Ld. TPO; consequently, no TP adjustment was made on this transaction in AY 2014-15. 2.9.Without prejudice, the Appellant wishes to submit that in case no relief is provided in the subject AY on account of the disallowance made by the Ld. TPO then necessary direction may be given to the Ld. AO to delete such suo-moto addition and accordingly a corresponding relief should be provided in the assessment of the subject year, i.e. AY 2015-16. 29. Having thus, addressed the factual background, we revert to addressing the issues which we have formulated. We note that the assessee having argued that on same set of facts, the TPO in the manufacturing segment has in 2014-15 assessment year accepted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y test as the product manufactured is an all year round product as it is as it is manufacturing fans, motors, blades and accessories unlike the taxpayer who is manufacturing products which are assembled in the manufacturing of air conditioners . The rejection of the objections to the assessee to the inclusion of these comparables by the DRP in a mechanical manner without addressing the facts cannot be upheld. 31. Considering the comparables selected, we note that the assessee has also assailed the inclusion of Blue Star as a comparable. The said comparable has been included by the TPO and the objection of the assessee before the TPO was dismissed and further challenge before the DRP has also been dismissed we find sans reasoning. It is seen that the said comparable undertakes research and developmental activities which position is not disputed by the tax authorities. It is also seen that Blue Star has various other segments wherein assembly of air conditioners is also one of the segments. On a consideration of facts we deem it appropriate to remand the issue and direct the TPO to work out the profit margin of the relevant segment of this comparable the inclusion of the said comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... principles and was a decision under section 14A of the Act and thus would have no relevance. However, we find on going through the material available on record that the assessee though has relied on submissions, arguments and supporting facts and evidences referred to in the synopsis filed so as to claim that the rendering of services were necessary and had also been availed of, however remand is sought relying on precedent. The assessee claims that in view of the waiver of these payments by the AE, the amounts paid to the AE in 2013 14 and 2014 15 assessment years have been offered in 2015 16 assessment year in terms of provisions of section 41 (1) of the Act. The assessee has canvassed that since the TPO himself did not make any such adjustment/addition in 2014 15 Assessment Year on identical set of facts and circumstances even though the issue was referred to the TPO under section 92 C in the said year and has accepted the reply of the assessee as a result of which no addition was made hence the prayer. The submissions were not rebutted by the Revenue. The assessee claims that the position on facts remains identical. We find that though the legal position is well settled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o comparables not included in the Show Cause Notice even otherwise be excluded having failed the functionality test. 35.4 The third comparable i.e. Blue Star whose exclusion is sought by the assessee consistently before the TPO as well as the DRP, we have directed the TPO to obtain segmental details qua the air conditioning segment of Blue Star and only then include it as a comparable. 36. Addressing the issue framed under (c), we note that the issue framed under (a) has not been adjudicated upon and has been left open. We have held that the decision rendered in the face of the conditional concession of the assessee in the peculiar facts and circumstances shall not operate as a binding precedent for the assessee. The parties are at liberty to address the issue of selection of most appropriate method in any other year. For the sake of clarity, it is emphasized the tax authorities shall not be permitted to argue that the issue has been adjudicated upon in their favour as the decision is given on the basis of the concessions of the assessee and the decision, these shall not operate as a binding precedent. 37. The issue framed under (d) is remanded back for verification in ..... X X X X Extracts X X X X X X X X Extracts X X X X
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