TMI Blog2020 (1) TMI 606X X X X Extracts X X X X X X X X Extracts X X X X ..... dopting the gross margin rate of 26.98% (trading segment-AE) - adjustment towards shortfall of the amount recoverable by the assessee on account of supply of samples to its AE - HELD THAT:- No feasible comparison could have been made between the mark-up of 7.5% on cost of samples (after recovering salvage value) and the segmental profitability of trading segment of 26.98% i.e gross profit on cost, for determining the ALP of the aforesaid transaction. Apart from that, we find that the TPO had erroneously compared the margins of the controlled transaction i.e mark-up of 7.5% on cost of samples (fabrics) charged to A.E with the segmental profitability of the trading segment of 26.98% (average) of the AE segment. Aforesaid comparability analysis carried out by the TPO, wherein he has compared the margins of controlled transactions is fundamentally incorrect and defeats the very purpose of determining the arm s length price. In fact, the TPO was obligated to have made a comparison between controlled transactions and uncontrolled transactions i.e margins from transactions with AE and margins from transactions with third parties i.e non-AE s, which we find he had failed to do. Adjustm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owing effective grounds of appeal before us:- The appellant objects to the order of the learned Assessing Officer ('AO') dated 30 December 2015 (received on 1 January 2016) passed under Section 144C (13) of the Income tax Act, 1961 ( the Act ) read Section 143(3) of the Act, for the aforesaid assessment year on the following among other grounds: 1. Adjustment /Addition to Total Income INR 7,880,245 On the facts and in the circumstances of the case and in law, the learned Transfer Pricing Officer ('TPO') and the learned AO erred in proposing and the Hon'ble Dispute Resolution Panel ('DRP') further erred in confirming the proposed addition of INR 7,880,245 to the Appellant's total income of INR 198,044,775. 2. Transfer pricing adjustment of INR 68,63,889 on account of royalty shortfall in connection with the international transaction of provision of technical assistance and advisory services 2.1 On the facts and in the circumstances of the case and in law, the learned TPO /AO erred in proposing and the Hon'ble DRP further erred in confirming the proposed a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the Appellant being an Indian multinational ploughs back the money into India. 3.4 The learned TPO / AO has erred in comparing and the Hon'ble DRP erred in confirming the approach of the learned TPO / AO of comparing margins of controlled transactions i.e., mark-up on cost of samples (fabrics) charged to AE with the gross profit on cost earned by Appellant from its AE trading segment. 3.5 The learned TPO /AO and the Hon'ble DRP failed to appreciate that even if the recovery of samples were to be considered as routine trading activity, the same should be merged with normal trading activity of AE segment for the purpose of benchmarking. 4. Initiation of penalty proceedings under section 271(1)(c) of the Act The learned AO has erred in both in laws and on facts, in initiating penalty proceedings under section 271(1)(c) of the act against the appellant. 5. Each one of the above grounds of appeal is without prejudice to the other. 6. The appellant reserves the right to amend, alter or add to the grounds of appeal. 2. Briefly stated, the assessee company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ls of the AE, it was noticed by the TPO that technical know-how fees was charged by the assessee only on the manufacturing sales of the AE. Further, it was gathered by the TPO that the assessee had not charged any technical know-how fees on the manufacturing sales (as per the buyers specifications) and trading sales. On a perusal of the agreement of the assessee with its AE for provision of technical know-how services, it was observed by the TPO that it nowhere provided that the fees was only to be charged on the manufacturing sales of the assessee. On being called upon to explain as to why such fees was not charged in respect of the other items of income of the AE, the assessee filed with the TPO a letter dated 02.01.2003 of the AE. As per the letter, it was stated by the AE that it would not require technical assistance/services/advice as regards its supply to the local market in the middle east. As such, it was stated that the royalty was to be paid only for manufacturing sales to other markets only. However, the TPO was not inclined to accept the aforesaid explanation of the assessee. Observing, that while for the letter relied upon by the assessee was dated 02.01.2003, the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) ₹ 10,16,356/-], the A.O assessed the income of the assessee company at ₹ 22,38,66,940/-. 7. Aggrieved, the assessee objected to the aforesaid proposed TP adjustments before the Dispute Resolution Panel-2, Mumbai (for short, DRP ). The DRP not finding favour with the contentions advanced by the assessee, therein inter alia vide its order passed u/s 144(5), dated 29.10.2015 upheld the TP adjustments that were proposed by the A.O/TPO. 8. The A.O after receiving the order passed by the DRP under Sec. 144(5), dated 29.10.2015, therein passed the final assessment order under Sec. 144C(13) r.w.s 143(3), dated 30.12.2015, and assessed the income of the assessee company at ₹ 22,38,66,940/-. 9. Aggrieved, the assessee has assailed the final assessment order passed by the A.O under Sec. 144C(13) r.w.s 143(3), dated 30.12.2015 in appeal before us. We have heard the authorised representatives for both the parties, perused the orders of the lower authorities and the material available on record. Our indulgence in the present appeal has been sought by the assessee to adjudicate the sustainability of the orders of the lower au ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... east. As the royalty agreement that was submitted during the course of the proceedings was signed on 04.04.2008, therefore, the TPO declined to take cognizance of the aforesaid letter dated 02.01.2003 of the AE. Observing, that there was no mention in the aforesaid agreement about the exclusion of any area or services as was claimed by the assessee before him, the TPO worked out the royalty @3% on the entire sales of ₹ 700,362,813/- of the AE and made a consequential adjustment of ₹ 68,63,889/- in the hands of the assessee. 11. It is the claim of the ld. A.R, that the assessee had initially entered into an agreement , dated 09.11.2002 with its AE ,viz. M/s Zodiac Clothing Company, UAE LLC, as per which the assessee was to provide technical know-how services for efficient carrying on and running of the activities of manufacturing of readymade garments by its AE. Accordingly, royalty was to be charged only on the manufacturing sales and not on trading sales. For the sake of clarification, the assessee also had a letter of understanding dated 02.01.2003 with its AE ,viz. M/s Zodiac Clothing Company, UAE LLC, wherein it was clarified that the AE did ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yalty /fees for technical know-how was to be received by the assessee only on the manufacturing sales (export) of ₹ 46,71,99,283/-[i.e AED 3,79,66,396/-]. Accordingly, we direct the A.O/TPO to delete the TP adjustment of ₹ 68,63,889/- that was made in the hands of the assessee on account of royalty shortfall in respect of its international transaction of provision of technical assistance and advisory services to its AE, viz. M/s Zodiac Clothing Company, UAE LLC. 13. We shall now advert to the claim of the Ld. A.R, that the A.O/TPO had erred in adopting the gross margin rate of 26.98% (trading segment-AE) of the assessee and making an adjustment of ₹ 10,16,356/- towards shortfall of the amount recoverable on account of supply of samples to its AE. As observed by us hereinabove, the assessee company on a regular basis was buying fabrics for samples on behalf of its AE. It was noticed by the TPO, that the assessee had charged 7.5% mark-up on the cost of samples (after recovering the salvage value). .Being of the view, that gathering of samples which was a pre-requisite for a successful textile business, was the main/core activity of the assessee c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O had erroneously compared the margins of the controlled transaction i.e mark-up of 7.5% on cost of samples (fabrics) charged to A.E with the segmental profitability of the trading segment of 26.98% (average) of the AE segment. Aforesaid comparability analysis carried out by the TPO, wherein he has compared the margins of controlled transactions is fundamentally incorrect and defeats the very purpose of determining the arm s length price. In fact, the TPO was obligated to have made a comparison between controlled transactions and uncontrolled transactions i.e margins from transactions with AE and margins from transactions with third parties i.e non-AE s, which we find he had failed to do. Accordingly, in our considered view for both of the aforesaid reasons the adjustment of ₹ 10,16,356/- made by the A.O/TPO towards shortfall of the amount recoverable by the assessee on account of supply of samples to its AE cannot be sustained and is liable to be vacated. We thus in terms of our aforesaid observations direct the A.O/TPO to delete the addition of ₹ 10,16,356/-. The Ground of appeal No. 3 is allowed. 16. The assessee has assailed befor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tanding. 2.3. The learned TPO / AO erred in making recomputation and the Hon'ble DRP erred in confirming the action of the learned TPO / AO of recomputing the royalty without appreciating that the methodology followed by the Appellant had been accepted in the previous assessment years by the tax authorities. 2.4. The learned TPO / AO and the Hon'ble DRP failed to appreciate that commercial expediency / requirement of the AE business needs to be considered. 2.5. The learned TPO/AO and the Hon ble DRP failed to appreciate that the margin earned by the appellant from provision of said services is better than the margin earned by the comparable companies as per the Transfer Pricing ( TP ) documentation. Accordingly, the transaction is at arm s length and no further adjustment is warranted. 2.6. Without prejudice to the above, the learned TPO/AO erred in computing the royalty in respect of sale of garments not manufactured by the AE. 2.7. The learned TPO / AO and the Hon'ble DRP failed to appreciate that the Appellant being an Indian multinational ploughs back the money into India. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sr. No. Nature of Transaction Amount (in Rs.) 1. Export of finished goods 32,35,15,126/- 2. Export of traded goods 9,77,65,316/- 3. Technical Know-How received (royalty) 1,41,49,621/- 4. Payment of Marketing Services (Commission) 1,36,85,494/- 5. Recovery of expenses 1,14,67,404/- 6. Reimbursement of expenses 13,79,669/- 22. The TPO vide his order passed under Sec. 92CA(3), dated 18.01.2016, made an adjustment of ₹ 92,97,422/- to the ALP of the fees for technical know-how received by the assessee from its AE, viz. M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erms. 28. We shall now advert to the claim of the assessee that the A.O had erred in working out the disallowance under Sec.14A at ₹ 8,54,221/-. On a perusal of the orders of the lower authorities, we find, that the assessee company had received an exempt dividend income of ₹ 2,13,32,278/- during the year under consideration. In its return of income for the year under consideration, the assessee had on a suo-motto basis offered a disallowance of an amount of ₹ 3,56,230/- under Sec. 14A of the Act. As claimed by the assessee, the aforesaid disallowance u/s 14A of ₹ 3,56,230/- comprised of viz. (i). salary of one employee : ₹ 3,09,765/-; and (ii). administrative expenses: ₹ 46,465/-. However, the A.O in the course of the assessment proceedings was not inclined to accept the aforesaid claim of disallowance of the assessee. Observing, that the disallowance u/s 14A was to be worked out as per the methodology prescribed in Rule 8D of the Income-tax Rules, 1963, the A.O worked out the same at ₹ 8,54,221/-. The disallowance of ₹ 8,54,221/- worked out by the A.O under Sec. 14A r.w Rule 8D comprised of viz. (i). disallowance of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the absence of the facts and figures in support of the said claim, we refrain from adjudicating the same. Accordingly, we restore the issue to the file of the A.O, who shall after verifying the veracity of the aforesaid claim of the assessee, therein readjudicate the same. In case, the assesse's capital, profit reserves, surplus and current account deposits are found to be higher than its investment in tax-free securities, then the disallowance of the interest expenditure made by the A.O under Sec. 14A r.w Rule 8D(2)(ii) shall stand vacated. Needless to say, the A.O shall in the course of the set aside proceedings afford a reasonable opportunity of being heard to the assessee. The Ground of appeal No. 3 is allowed for statistical purpose. 32. The assessee has assailed before us the initiation of the penalty proceedings under Sec. 271(1)(c) of the Act. As the Ground of appeal No. 4 assailing the initiation of penalty u/s 271(1)(c) is premature, therefore, the same is dismissed. 33. The Grounds of appeal Nos. 5 6 being general in nature are dismissed as not pressed. 34. Resultantly, the appeal of the assessee for A. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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