TMI Blog2020 (11) TMI 476X X X X Extracts X X X X X X X X Extracts X X X X ..... mparability such as geographical location and volume of purchase. TPO, in similar circumstances for the AY 2003-04 and AY 2004-05 and AY 2006-07, has accepted that the international transaction involving purchase of raw materials by the assessee from associated enterprises is at arm s length under the TNMM and he has not directed ALP adjustment in respect of this international transaction by applying the CUP Method on transaction-by-transaction basis. Hence, we uphold the order of the ld. CIT(A) on this issue and dismiss Ground No. II of the revenue. Computing the figure for value addition for royalty computation - CIT-A considering only the cost of standard materials without appreciating the fact that cost of non-standard materials should also be considered for the purpose of analysis as raw material means both standard and non-standard materials - HELD THAT:- In the order issued under section 92CA (3) TPO has not disputed the computation of operating revenue and operating cost made by the assessee of its transfer pricing study report as aforesaid. As the operating cost includes royalty expenses in the instant case, we, in the light of the aforesaid decision of M/S. KAYPEE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 06. 2. At the outset we find that there is a delay of 5 (five) days in filing of this appeal by the assessee. After perusing the petition for condonation, we are convinced that the assessee was prevented by sufficient cause from filing the appeal on time. Hence the delay is condoned and the appeal is admitted. 3. The assessee is an Indian company which is engaged in the business of manufacture and sale of electronic components in India and abroad. These electronic components are primarily used in electronics industry. The assessee entered into the following international transactions with its associated enterprises during the previous year relevant to the assessment year 2005-06. Table No. 1 International Transactions Sl. No. Nature of International Transactions Amount Rs. 1. Purchase of Raw Materials Components 96,05,434 2. Sale of Finished Goods 65,60,50,486 3. Payment of Royalty 93,70,670 4. Receipt of Indenting Commission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Hon ble Tribunal Sl. No. Nature of International Transactions Value (INR) ALP Adjustments (INR) 1. Purchase of Raw Materials Components 96,05,434 5,98,693 2. Payment of Royalty 93,70,670 51,17,098 3. Receipt of Indenting Commission 2,95,50,194 2,78,73,247 Total 4,85,26,298 3,35,89,038 Grounds of appeal taken by the Revenue 4.1. Ground no. 1 is directed against the action of the CIT(A) in determining the arm s length price of the international transactions based on aggregate benchmarking approach under TNMM instead of transaction-by-transaction approach. Findings of the ld. TPO 4.2. In paragraph no. 5.1.2 contained in page no. 10-11 of the TPO s order, the TPO has held that the international transactions undertaken by the assessee are different in their nature and scope and their separate evaluation is possible. The TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . In support of this order, the ld. CIT(A), the assessee has filed an affidavit on 5th November, 2018, the relevant part of which is as under: It is stated in paragraph no. 7 that the assessee cannot adopt transaction-by transaction approach in respect of the international transactions involving (i) purchase of raw materials/components/goods-in-transit (GIT) from associated enterprises, (ii) payment of royalty to associated enterprise and (iii) receipt of indenting fees from associated enterprise, due to the unavailability of data of comparable uncontrolled transaction separately for each of the international transactions as aforesaid. It is stated in paragraph no. 8 that the assessee applies the Transactional Net Margin Method on aggregate basis at the entity level in respect of the international transactions referred to in paragraph no. (7) and documents the same in the Transfer Pricing Study Report maintained under section 92D of the Income-tax Act, 1961, read with rule 10D of the Income-tax Rules, 1962 which is filed with the Ld. TPO during the course of proceedings under section 92CA(3) of the Income-tax Act, 1961. It is stated in paragraph no. 9 that the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en into account is the availability, coverage and reliability of data necessary for application of the method. As mentioned in the affidavit referred to hereinabove, the assessee could not apply transfer pricing method on transaction-by-transaction basis in relation to the international transactions under dispute before the Hon ble Tribunal [i.e. (i) purchase of raw materials components from associated enterprises (INR 96,05,434), (ii) payment of royalty to associated enterprise (INR 93,70,670) and (iii) receipt of indenting fees from associated enterprise (INR 2,95,50,194)] due to the unavailability of comparable uncontrolled transaction separately for each of the international transactions as aforesaid. 4.3. The ld. Counsel for the assessee further refers to the provision of rule 10A (d) of the Income-tax Rules, 1962, wherein it has been provided that: (d) transaction includes a number of closely linked transactions. It is the contention of the assessee that the three international transactions under consideration emanate from the same source i.e. the business of the assessee involving manufacture and sale of electronic components and hence, the aforesaid transactions ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (name of the company changed to EPCOS India Pvt Ltd after subsequent merger), wherein the Hon ble Tribunal accepted the application of the TNMM at the entity level in relation to the following international transactions: import of raw materials, import of tools and capital equipment, payment, for service charge for it services, sales support, marketing and advertisement and sorting services, export of tools, export of finished goods and payment of royalty for technical know-how. (ii) Decision of the Hon ble Pune Tribunal in the matter of Demag Cranes Components (India) (P.) Ltd vs. Deputy Commissioner of Income-tax reported in [2013] 30 taxmann.com 364 (Pune - Trib.) wherein the Hon ble Tribunal has explained the term closely linked transactions and held that in appropriate circumstances where closely linked transactions exist, the same should be treated as one composite transaction and a common transfer pricing analysis be performed for such transactions by adopting the most appropriate method. (iii) Decision of the Hon ble Pune Tribunal in the matter of Cummins India Ltd vs. Addl. CIT reported in [2015] 53 taxmann.com 53 (Pune - Trib.), wherein the Hon ble Tribunal acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AY 2004-05 Method appliedby the assessee: TNMM No adjustment was directed by the TPO. Method applied by the assessee: TNMM No adjustment was directed by the TPO. It was the contention of the assessee that the aforesaid transaction was at arm s length because the same was approved by the Reserve Bank / SIA. Further, the assessee performed entity level TNMM analysis which covered this transaction. An ALP Adjustment was directed by the TPO. However, the said adjustment was deleted by the CIT(A). No appeal lies before the Hon ble Tribunal due to low tax effect. AY 2006-07 Method applied by the assessee: TNMM No adjustment was directed by the TPO. Method applied by the assessee: TNMM No adjustment was directed by the TPO. It was the contention of the assessee that the aforesaid transaction was at arm s length because the same was approved by the Reserve Bank / SIA. Further, the assessee performed entity level TNMM analysis which covered this transaction. No adjustment was directed by the TPO. AY 2007-08 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14 restored the impugned arm s length price adjustments back to the TPO for simultaneous adjudication with the cases for AY 2011-12 and AY 2012-13, since the transfer pricing issues involved in appeal for AY 2013-14 were mostly the same as those involved in appeal for AY 2011-12 and AY 2012-13. Transfer pricing issues involved in appeal for AY 2013-14: (a) Payment for intra-group services (IT support and other services) (b) Sales Margin (c) Sale of ferrite (d) Management services (e) Mechanical services 4.10. That the transfer pricing issues involved in appeal for AY 2005-06 (bearing ITA No. 1783/Kol/2017) were completely different from the transfer pricing issues involved in appeals for AY 2011-12, AY 2012-13 and AY 2013-14. Transfer pricing issues involved in appeal for AY 2005-06: (a) Payment made for purchase of raw materials / components (b) Receipt of indenting commission (c) Payment of royalty 4.11. As mentioned in the affidavit filed by the assessee referred to hereinabove, the assessee could not adopt transaction-by-transaction approach for the AY 2005-06 due to unavailability of comparable uncontrolled transaction separately for each of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the data made available to him by the assessee, computed the negative variance (=price paid to unrelated supplier price paid to associated enterprise) amounting to INR 598693.20 (=74804.18+523889.02). Thus, the TPO directed an ALP adjustment of INR 5,98,693/-. Findings of the CIT(A) 6.3. The CIT(A) has noted that in respect of purchase of raw materials and components, the TPO applies the CUP Method erroneously without having regard to the factor of comparability namely conditions prevailing in the market in which the respective parties to the transactions operate as prescribed under clause (d) of sub-rule (2) of rule 10B of the Income-tax Rules, 1962 ( Rules ). The TPO compares the prices paid by the assessee to EPCOS Brazil (South America) with the prices paid by the assessee to Beer Blumenauer (Germany) and Bharat Products (India) for identical products. The TPO compares the prices paid by the assessee to EPCOS Malaga (Spain) with the prices paid by the assessee to Steiner (Germany), Sung Moon (Korea), Sun Polymers (India), Vishay (India), Hafner Josef (Germany), Electro Crimp (India), Seolin (Korea), Ujjwish Udyog (India), Shiba Container (India), Modiplast (Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ferred over the External CUP method as it neutralizes several distinguishing factors, such as the local factors and the economies available or unavailable to the assessee in particular, having bearing over the comparison of price charged from unrelated parties and AE. The essence of determining ALP under CUP method is to ensure that the price charged by the Indian Enterprise from its AE should be consistent with that charged from unrelated parties under similar circumstances. The importance of the similar circumstances cannot be lost sight of in this context because a round cannot be compared with a square and a rectangle with a triangle. In other words, the uncontrolled transactions which are contemplated for comparison should be alike, if not identical. Similarity between the two sets of transactions can be judged by the quality, grade and quantity of the material. In addition, the factors like the location of the parties, availability of raw material; demand and supply equation also play pivotal role in finding out as to whether the two are really comparable or not. Thus in the Internal CUP method the local factors of AE in the other country and all the relevant factors which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... between the AEs transaction and third party transaction, the CUP method is not the MAM method. It, therefore, held that TNM method is the most appropriate. In these circumstances, the view of the Tribunal that the TNM method is the most appropriate method is a reasonable and possible view on application of appropriate test in the present facts. iv) The Hon ble Cochin Tribunal in the matter of ACIT vs. Akay Flavours Aromatics (P.) Ltd. reported in [2015] 64 taxmann.com 431 (Cochin - Trib.), wherein the Hon ble Tribunal interalia held that: 6.2 Thirdly, the TPO has compared the exports in different geographical locations. For instance, as rightly observed by the DRP, exports to Germany cannot be compared with exports to Italy. The TPO has not appreciated the price fluctuation/difference according to demand / supply position in different geographical locations. The adoption of non-AE export sale price as internal CUP is therefore incorrect and bad in law. 7. The ld. CIT(A) in his order stated that the, import of raw materials components from associated enterprises (INR 96,05,434/-) constitutes a small part of the total raw materials consumed (INR 63,26,73,000/-) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... umstances, the price charged from AEs and non-AEs cannot be compared under the CUP method. The Hon'ble jurisdictional High Court in Pr. CIT v. Amphenol inter connect India (P.) Ltd. [2018] 91 taxmann.com 441/[2019] 410 ITR 373 (Bom.) considered almost a similar situation in which there were differences in volumes and locations and the TPO had applied the CUP method for bench marking the assessee's international transaction. The Tribunal did not approve the application of the CUP method on account of such difference. When the Revenue preferred an appeal against the Tribunal order, the Hon'ble High Court held that the CUP method is not appropriate method in case of geographical difference, volume difference, timing difference, risk difference and functional difference. Reverting to facts of the extant case, we find that since there are significant differences in the sales made by the assessee to its AEs and non-AEs, the effect of which has neither been given by the TPO nor it has been shown that how it can be given, we hold that the action of the authorities below in applying the CUP as the most appropriate method cannot be countenanced. 7.1. In view of the above de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xxx During the relevant financial year, the assessee pays royalty to EPCOS AG for a sum of INR 93,70,670/-. 8.2. For the purpose of computation of royalty, the assessee has classified the raw materials / components used for the purpose of manufacturing the finished products to which the aforesaid agreement applies, into two categories such as standard items and non-standard items . The raw materials / components categorized as non-standard are the ones which the assessee specifically orders and gets them manufactured as per the specifications required by it. On the other hand, the raw materials / components categorized as standard are the ones which are readily available in the market. The details of standard and non-standard items hereunder: Table No. 4 Standard and non-standard items of raw materials/components (Disclosed in page no. 17 of TPO s order) Sl. No. Material Standard INR Non-Standard INR 1 Aluminium Foil 9,71,537 2 Metallised Film ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... one in-house by the assessee and as such, adds value to the produce. Masking tape This is used to facilitate spraying of Zinc/Tin/Copper solution on the end points of the would element on a fully automated spraying machine. The masking tape is tailor-made as per EPCOS AG s specification to suit automatic loading of the would elements. Tin Copper Wire Bi-metal wire made to Tin/Copper Alloy is used for spraying operation produced to EPCOS AG s specifications. Plastic cans Plastic cans are made out of injection moulds designed by EPCOS AG with appropriate polymer compound, dimensions to withstand filling of hot resin on a fully automated assembly line. Terminal wire Bi-metal wire made of copper and steel gets manufactured as per EPCOS AG s specification. 8.4. While computing the royalty, the assessee has deducted interalia the cost of standard items of raw materials / components from the net selling price as per the formula provided in the TALA. The cost of non-standard items which are manufactured by the suppliers as per the specifications received by the assessee from EPCOS AG and communicated to the suppliers, is not deducted from the net selling price. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... epted that aluminium foil, metallised films, masking tape, tin copper wire, plastic can and terminal wire are non-standard items which are specifically designed to satisfy the requirement of the assessee. Accordingly, he has computed the royalty that would be allowed as deduction under the provision of Income-tax Act, 1961, for the previous year relevant to the assessment year 2005-06: Table No. 6 Computation of royalty and ALP adjustment by the CIT(A) Particulars Amount (INR) FOB value of sales 318310190 Less: Cost of standard items 34846089 Net Sales 283464101 Royalty: 3% of INR 283464101/- 8503923 Less: Royalty paid by assessee to EPCOS AG 9370670 Arm s length price adjustment directed by CIT(A) 866747 8.7. We have considered rival submissions. 8.8. The assessee has classified the raw materials / components into two categories such as standard items and non-standard items . The raw materials ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of doubt that the royalty payment on technical knowhow is not at arm'slength. ii) the Hon ble Kolkata Tribunal in the matter of NLC Nalco India Ltd vs. DCIT reported in [2016] 71 taxmann.com 57 (Kolkata - Trib.), held that: In the instant case also, we find in page no. 53 of the assessee's paper book that assessee made application dated 14th March, 2001 to the General Manager, Exchange Control Department, Reserve Bank of India. In the aforesaid application, assessee explained the scope of services receivable from Nalco Pacific under the aforesaid agreement, the benefits to be received by it from entering into the aforesaid agreement with Nalco Pacific and the maximum amounts to be remitted as consultancy charge to Nalco Pacific under the aforesaid agreement. In reply, theRBI intimated their in-principle approval for remittance of consultancy charge toNalco Pacific @ 2% of net sales for the calendar year 2001. In view of this, we areof the view that the aforesaid payment (₹ 1,51,74,980/-) made to Nalco Pacific @2% of net sales, having been the rate of consultancy charge approved by the RBI,are at arm's length price. Accordingly, we delete the addition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... royalty rate was obtained the payment was considered to be held at arm's-length. It is also noted that various Tribunals such as Air Liquide Engg. India (P.) Ltd. (supra), Dy. CIT v. Sona Okegawa Precision Forgins Ltd. [2012] 17 taxmann.com 98/49 SOT 520 (Delhi), Hero Motocorp Ltd. v. Addl. CIT (IT Appeal No. 5130/Del/2010), ThyssenKrup Industries India Ltd v. Addl. CIT [2013] 33 taxmann.com 107 (Mum. - Trib.), Abhishek Auto Industries Ltd. v. Dy. CIT [2011] 9 taxmann.com 27 (Delhi) have taken a view that RBI approval of the Royalty rates itself implies that the payments are at Arm's Length and hence no further adjustment needs to be made viewed from this angle too. v) the Hon ble Pune Tribunal in the matter of Kinetic Honda Motor Limited vs. JCIT reported in 77 ITD 393 (Pune) held that when one wing of the Government approves a transaction, another wing of the Government should not treat the payment as excessive. 9. In the light of the above decisions, the royalty for a sum of INR 93,70,670/- paid by the assessee to EPCOS AG as per the TALA (including the method of computation of royalty contained in Article 3 Consideration of the aforesaid agreement) which h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 13. In view of the above, we uphold the findings of the ld. CIT(A) and dismiss Ground No. 3 of the revenue. Ground No. IV 14. Ground no. IV is directed against the action of the CIT(A) in stating that the financial indicator for the indenting activity segment of the assessee has nothing to do with the sales revenue generated by associated enterprise in the Indian market without appreciating that the indenting activity is performed for promoting sales of AE in the Indian market. Facts 14.1. EPCOS AG has entered into Marketing and Service Agreement with the assessee (kindly refer to page no. 292 of the paperbook) under which the assessee agrees to use its best effort to promote, solicit and mediate sale of specified products of EPCOS AG in India. The customers, however, import products directly from EPCOS AG. Thus, EPCOS AG has appointed the assessee as its indenting agent in India. In return for provision of indenting services, EPCOS AG paid indenting commission for a sum of INR 2,95,50,194/- to the respondent. Findings of the ld. TPO 14.2. The TPO noted that during the year under consideration, the assessee has received an amount of INR 2,95,50,1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sideration in the following manner: INR 50,64,18,000/- X (5.996-0.492)/100 = INR 2,78,73,247/- Findings of the CIT(A) 14.5. In respect of receipt of indenting commission, it is the observation of the CIT(A) that the TPO failed to appreciate that the profit earned by the assessee (INR 24,94,835/) represents return from the indenting activity performed by the assessee that enables the assessee to earn commission of INR 2,95,50,194/-. Thus, the financial indicator under this segment of activity would be 8.44% (i.e. ₹ 24,94,835 / ₹ 2,95,50,194). He held that the TPO failed to further appreciate that the aforesaid profit (₹ 24,94,835/-) earned by the assessee has nothing to do with the sales revenue (₹ 50,64,18,000/-) received by the associated enterprise from sale of its manufactured goods in India. Thus, the computation made by the TPO of the financial indicator for the indenting activity segment of the assessee with reference to the sales revenue generated by associated enterprise in Indian market at 0.492% has been erroneous. The CIT(A) has noted that the financial indicator of the indenting segment would be 8.44% (=24,94,835/2,95,50,194) which i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction]; 14.8. Now we consider the case-law on this issue:- i) The Hon ble Delhi Tribunal in the matter of DCIT vs. Agilent Technologies India (P.) Ltd reported in [2016] 67 taxmann.com 95 (Delhi - Trib.), held that: A cursory glance at sub-clause (i) of Rule 10B(1)(e) transpires that the net operating profit margin realized by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the foreign entity i.e. Associated Enterprises does not pass through the books of accounts of the assessee. As per the liability clause of the agreement, it is abundantly clear that the assessee is not responsible for the payment from the customers to the Associated Enterprises. The bills are not raised by the assessee on Indian customers for the sales made by Associated Enterprises. Therefore, the sales made by the Associated Enterprises cannot be treated as sales made by the assessee 15. As a result, the appeal filed by the Revenue is dismissed. 14.9. The TPO has erroneously considered the sales made by associated enterprise directly in India (INR 50,64,18,000/-) through the marketing service rendered by assessee to the associated enterprise, as sales of the assessee and based on this consideration, he has taken the aforesaid sales figure as the denominator of the financial indicator of the assessee under the indenting segment (0.492% i.e. INR 2494835 / INR 50,64,18,000). That the TPO has failed to appreciate that the aforesaid sales figure does not pass through the books of account of the assessee and it is solely the commission income (INR 2,95,50,194/- ..... X X X X Extracts X X X X X X X X Extracts X X X X
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