TMI Blog2019 (4) TMI 1866X X X X Extracts X X X X X X X X Extracts X X X X ..... le data for the various product and marketing strategy is not available, then accurate comparability adjustments would be very difficult to carry out. Because of the difference in accounting treatment, there is a gap between gross profit margin and net profit margin disclosed by the Modicare Ltd., which can be seen from the annual account that the gross profit margin of Modicare Ltd has been shown at 76.47%, whereas the net profit margin is at only 2.25%. Thus, there is substantial variance in the gross and net profit margin levels, which indicates that Modicare Ltd. is incurring heavy operating expenses and also substantiates heavy functions at the operating level. Further, Modicare Ltd. has significant AMP expenses of 7.32% which in the case of the assessee is only 0.94%. If a distributor is incurring substantial AMP expenses then it cannot be compared with routine distributor under RPM as it tantamount to value addition. This also goes to show Modicare Ltd. has different functions as compared to the assessee. There is also difference in the case of goods sold ratio and value-added expenses which is apparent from the fact that in case of Modi Care Ltd. the cost of goods sold r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4-2019 - Shri Amit Shukla, Judicial Member And Shri Prashant Maharishi, Accountant Member Appellant by: Shri Himanshu Sinha, Adv. Respondent by: Shri H.K. Chaudhary, CIT-.D.R. ORDER Amit Shukla, All the aforesaid appeals have been filed by the assessee against the separate impugned orders for the Assessment Years 2009-10, 2010-11, 2011-12 and 2012-13. In all the appeals, the assessee has challenged following transfer pricing adjustment in the distribution and sales of the cosmetics product, i.e., direct sale:- Assessment Year 2009-10 ₹ 14,29,24,000/- Assessment Year 2010-11 ₹ 45,44,16,384/- Assessment Year 2011-12 ₹ 41,77,85,066/- Assessment Year 2012-13 ₹ 48,90,27,914/- 2. Since the facts and issue involved are exactly same, therefore, all the aforesaid appeals were heard together and are being disposed of by way of this consolidated order. The key contention raised in all the appeals is with regard to the inclusion or exclusion of one comparable company, namely, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable and in his search analysis, he shortlisted Modicare Ltd. which was a direct selling company and has taken to be a sole comparable for bench marking the same under RPM. The gross profit margin of Modicare Ltd. was 76.74% and accordingly following the same analysis by taking this comparable for all the years under dispute, TP adjustment has been made in all the years amounting to ₹ 14,29,23,995/- for the Assessment Year 2009-10; ₹ 45,44,16,384/- for the Assessment Year 2010-11; ₹ 41,77,85,066/- for the Assessment Year 2011-12; and ₹ 48,90,27,914/- for the Assessment Year 2012-13. The assessee remained unsuccessful before the Dispute Resolution Panel (DRP) for Assessment Year 2009-10 and in the Assessment Year 2011-12; and before Commissioner of Income Tax (Appeals) in the Assessment Year 2010-11 for Assessment Year 2012-13. 5. Aggrieved by these orders, the assessee preferred an appeal before the Tribunal. The Tribunal vide order dated 24th March, 2017 for the Assessment Years 2009-10 to 2011-12 and vide order dated 13th June, 2017 for the Assessment Year 2012-13, though held that Modicare Ltd. is not an appropriate comparable to the assessee due t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Modicare and the assessee are incapable of adjustment. Learned counsel highlighted upon this functional dissimilarity with respect to the differential products range in which both the entities were involved; the low proportion of total product turnover attributable to cosmetic and related line (personal care) and the most segmental data. It is submitted that having regard to these circumstances, the ITAT's findings are both inconsistent and contrary to law on functional differences. It was also submitted that having regard to these functional differences, the assessee had offered other comparables that did not involve direct marketing but were trading entities with appropriate adjustments having regard to the dissimilarities that could be eliminated and appropriately adjusted. These issues were, however, not considered and no findings were returned. . 4 The ITAT's findings pertinently with respect to the appropriateness or otherwise of Modicare Ltd. as a comparable are contained in paras 5.9, 5.11 and 5.12 of the impugned order. The Tribunal noted that Modicare Ltd. as a standalone comparable (since all other comparables were eliminated by the revenue authorities at the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ities should have been aspired for and if it was found in a particular year that it was not available then carrying out the necessary adjustments on the comparables selected attempted to approach near comparable FAR. Thus complying with the requirements of sub-Rule (2) and (3) of Rule 10B and sub-clause (iv) of clause (b) of sub-Rule (1) of Rule 10B ideally more comparables should have been selected. We note that there is sufficient guidance and clarity in the aforesaid statutory provisions to ensure that the grievance of the assessee can be addressed as it has amply been provided that wherever the gross margins are demonstrated to be impacted with either incomparable activities; functions, accounting practices; product dissimilarities; etc. then necessary adjustments should be made. Herein noting that the tax payer's first grievance is that with necessary adjustments, even if Modi Care Limited is taken as a standalone comparable as has been done by the tax authorities even then adjustments proposed by the tax payer on valid grounds namely incomparable activities, functions accounting and Revenue recognition policies etc. is necessitated. We are given to understand that service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mportance and was not addressed by the ITAT which even while noticing the significant differences and seemingly accepting the assessee's arguments nevertheless did not exclude Modicare Ltd. altogether. In the opinion of this Court, this is a very vital infirmity which needs to be corrected. 8. As far as the reasoning of the Revenue Authorities, which has not been commented upon by the ITAT for excluding the other comparables offered by the assessee goes, for one, it was stated that mere acceptance in the past of such comparable did not bind the Revenue. The other was with respect to the differential marketing strategy adopted for the two sets of entities i.e. the trading entity/comparable on the one hand as opposed to the direct marketing entity i.e. assessee on the other hand. The assessee had stressed that if appropriate marketing was made from the data available, the differential marketing strategy per se would not pose a difficulty with respect to the transfer pricing adjustment. The Court finds some merits in the arguments, especially since what the Revenue Authorities would be left with if the ITAT's order was not to be disturbed, would be what a comparable in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ilability of data, adjustments cannot be made. This Bench on the earlier date of hearing had noted these differences in FAR between the assessee and Modicare Ltd. in the following manner:- Particulars Oriflame India Modicare Ltd. Whether adjustment can be made-Yes/No Product Portfolio Cosmetic Products Diversified - Laundry and Homecare, Personal care, Agriculture, Tea, Jewellery, Healthcare, others apart from cosmetics. No Functional profile Trading i.e. Buying and reselling without any value addition activities Diversified - Has business apart from trading since it recognizes service income in its P/L account, incurs franchisee expenses, COGS is not a dominant component of its total operating expenses No Different business model Does not undertake any value addition functions Substantial variance in the gross and net level margins - evidencing that it is incurring heavy functions at operating level No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considering the aforesaid submissions and in light of the directions given by the Hon ble High Court, we perceive that the scope of the remand is to carry out comparability analysis; firstly, whether the Modicare Ltd. can at all be included as comparable subject to availability of the data in respect of various different products segments dealt by the Modicare Ltd.; secondly, to what extent adjustment can easily be made with respect to the Modicare Ltd. having regard to the adjustability factors under RPM and not only in the case of Modicare Ltd. but also in the case of other comparables what kind of adjustments are permissible while determining the gross margins of the comparables for all the relevant years impugned before us; and lastly, if TNMM is be considered most appropriate method, then same needs to be examined within the scope of the comparables already there on record, i.e., chosen by the assessee/TPO and there should not be any enlargement of comparables. In light of this background, first of all we have to examine whether the relevant data with regard to various different segment of the Modicare Ltd. is available or not and to what extent adjustment can be made. In this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ral overall functions and products of the company is to be considered, i.e., supplier of d cosmetic products. 1.5 .. Accordingly, in the absence of any appropriate allocation of total costs into separate segments/products and services, Modicare Ltd. is considered comparable on the entity level. 1.7 Moreover, Modicare Ltd. itself, in a response to a notice issued to it u/s 133(6) has confirmed that its sales and marketing plan is based on directs selling model, which involves moving products from manufacturers to consumers directly....... 1.8. The other arguments of the assessee with respect to variance in gross and net level margins and COGS not being a dominant component of total operating expenses are found to be baseless. For any company, it can be argued that its gross and net margins are not matching with another company and therefore it has a different business model. However, this in itself should not be the factor to differentiate. The assessee must establish that business model of the two companies is different by giving cogent reasons and not by pointing out to differences in profit margins and expenses margins. 1.9. In view of the above discussion, it can b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed when the other methods do not provide reliability of data, making it difficult to apply the Cost Plus Method or Resale Price Method. As has been already discussed in the preceding paragraphs, the comparables chosen by the assessee are neither direct seller of products, making them functionally dissimilar, nor are they dealing in cosmetics, making their products also dissimilar. Accordingly, TNMM cannot be chosen as the most appropriate method with respect to the comparables chosen by the assessee. Having regard to Modicare Ltd., both Medicare Ltd. and Oriflame India are direct resellers of cosmetic product, making it an appropriate situation for the application of RPM. The detailed discussion for selection of Modicare Ltd. under RPM has already been done in the preceding paragraphs. And since RPM is more suited in this situation, it eliminates the need for application of TNMM. 3.5. Thus, it can be concluded that TNMM cannot be considered as the most appropriate method and it is more appropriate to apply Resale Price Method after making comparability adjustment on account of working capital differences. Further, on request of the Ld. Departmental Representative (DR), Ld. TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny to another and the corresponding accounting entries also differ accordingly. In this case, Oriflame India records the sales net of discounts/incentives paid to its agents/consultants and hence shows a lower gross margin as per its accounting treatment. On the other hand, the discount given to the consultants/agents is categorized as Incentives by Modicare Limited. This is being shown as below the line in profit loss account as a part of operating expenses. This does not form part of the computation of gross profit margin of Modicare. 3. Modicare Ltd. has substantial variation between gross margin and net margin The Appellant would like to state that Modicare Ltd has a gross margin of 76.47% (as per TPO) whereas, its net margins are 2.25% for FY 2008-09 and similar percentages for subsequent years under consideration. The substantial variance in the gross and net level margins establishes the fact that the company is incurring heavy operating expenses, which substantiates heavy functions at the operating level that are not comparable to Oriflame India. This gives support to the argument that Modicare Ltd. is not just a direct marketer and reseller. Oriflame India on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om trading since it recognizes service Income in its P/L account, incurs franchisee expenses, COGS is not a dominant component of its total operating expenses No Different business model Does not undertake any value addition functions Substantial variance in the gross and net level , margins - evidencing that it is incurring heavy functions at operating1 level No Differential accounting treatment for incentives/ discounts Shows the sales net of incentives Incentives/ discounts are shown as a part of operating expenses Yes Marketing and Business Promotion expenses / Sales ratio Less than 1% of sales More than 10% of sales evidencing that it is engaged in value addition activity Yes. However, under transfer pricing norms a trader performing value addition cannot be compared with a low risk distributor not performing any value addition Cost of Goods Sold / Total operating Cost ratio In the range of 50% to 60% In the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... engaged in the business of distribution of the Appellant's products and is thus directly related to the distribution activities carried out by the Appellant. On the other hand, the service fee earned by Modicare Ltd. amounting to INR 300.84 lacs for FY 2011-12 and similar amount for other years under consideration, is on account of Annual Maintenance Contracts (AMC). Therefore, no valid comparison can be made between the two companies for transfer pricing purposes. The Ld. TPO in her remand report in para 1.6 has emphasized about Modicare Ltd. and the Appellant being direct selling Companies. It has been pointed out by the Ld. TPO in this paragraph that both Modicare Ltd. as well as Appellant sell their goods through individual consultants and are members of Indian Direct Selling Association (IDSA). In para 1.7 of the remand report, the Ld. TPO has stated that she had issued a notice under section 133(6) of the Income Tax Act to Modicare Ltd. to confirm whether it is operating on a direct selling model. An abstract of the reply received from M/s. Modicare Ltd. has been reproduced in para 1.7 of remand report where M/s. Modicare Ltd. has confirmed that it is a direct selling com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Modicare Ltd. Appellant 2008-09 TPO) 76.47% 45.58% 1.14% -0.63% 2009-10 70.33% 46.79% 4.99% 6.53% 2010-11 67% 48.72% -0.26% 5.60% 2011-12 69.35% 45.31% -6.50% 5.89% It is submitted that under the transfer pricing guidelines (both under OECD as well as United Nations manual), the distributor which is engaged in significant advertisement and marketing cannot be compared with a routine distributor under resale price method because of the value addition function carried out by the former. Please refer to para no 2.35, 2.37 and 2.38 of OECD TP Guidelines, 2017 and para no B,3.2.7.1 and B.3.2.7.2, B.3.2.9.6 of UN guidelines. Same view has been taken by the Hon'ble Bangalore Tribunal in M/s. Abott Medical Optics Private Ltd. Vs. DCIT for AY 2007-08 (I.T.(T.P) A, No.lll6/Bang/2011) (Para 8, Page7-8), which h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ✓ Trading in cosmetics ✓ Diversified product profile with cosmetics comprising only 12-18% over various years ✓ Sells through : intermediaries ✓ ✓ ✓ Incentives/Discounts accounted for below the gross profit X ✓ X Significant AMP expenses X ✓ ✓ From the above table, it was contended that, a direct selling trader like the assessee is in all respects similar to any other trader except for the higher working capital requirement which a direct seller may have. This material difference can be adjusted by way of a reasonably accurate adjustment in the manner provided in the OECD and UN guidelines. Since a direct seller must store inventory in such a manner that it is able to match the demand of the customers through individual consultants, the inventory cost of a direct seller would ordinarily be higher than that of a distributor. Once an in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be excluded. 15. On the other hand, ld. CIT-DR, submitted that the mandate of the Hon'ble High Court was; firstly, to consider the appropriateness of including Modicare Ltd. having regard to the availability of data with respect to different products segment and; secondly, the functional difference with respect to marketing strategy, etc. There cannot be any dispute that Modicare Ltd. is into direct selling and is also into similar kind of products with the assessee. Under RPM broader difference can be allowed as the property transaction in the control transaction must be compared to that being transferred in the uncontrolled transaction. Under RPM, the focus is not much on product comparability. Here other attributes of comparability like functions, performed, economic circumstances, etc which required to be seen when the profit margin relates familiar to those other attributes and only secondarily to the particular products being transferred. Even if Modi Care Ltd. was dealing in more products but it does not mean that same should be rejected simply on the ground that assessee is not dealing in such kind of product. Thus, Modi Care Ltd. cannot be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er, it was also directed that the comparables given by the assessee should also be examined under TNMM for which relevant data would be provided by the assessee and same should be verified by the TPO. Now as is evident from the content of the remand report, the Ld. TPO has admitted that, Modicare Ltd. has not disclosed any business segment for its various products and from this she has inferred that the company does not differentiate its products into separate reportable segments and accordingly, different segment cannot to be considered. As per the Ld. TPO, since Modi Care Ltd. is also into direct selling model as that of the assessee, therefore, it is a most appropriate comparable. She has also referred to marketing and selling function of the assessee-company and also that of Modicare Ltd. regarding their sale and marketing pattern and concluded that Modicare Ltd. is an appropriate comparable as it has direct selling like assessee and hence majority of revenue is from the sale of products similar to that of assessee. Apart from that, she has rejected all the comparables shown by the assessee on the ground that they were dealing in different kind of product segments. 18. First ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en shown at 76.47%, whereas the net profit margin is at only 2.25%. Thus, there is substantial variance in the gross and net profit margin levels, which indicates that Modicare Ltd. is incurring heavy operating expenses and also substantiates heavy functions at the operating level. Further, Modicare Ltd. has significant AMP expenses of 7.32% which in the case of the assessee is only 0.94%. If a distributor is incurring substantial AMP expenses then it cannot be compared with routine distributor under RPM as it tantamount to value addition. This also goes to show Modicare Ltd. has different functions as compared to the assessee. There is also difference in the case of goods sold ratio and value-added expenses which is apparent from the fact that in case of Modi Care Ltd. the cost of goods sold ranges from 22% to 28% of its total operating cost and value-added expenses/operating expenses are more than 70%. Modicare Ltd. has also recorded franchisee expenses and hence it cannot be inferred wholly as a direct seller. In view of such differences, it would be very difficult to carry out adjustment especially with regard to the product portfolio, functional portfolio, etc. Adjustment if a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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