TMI Blog2021 (9) TMI 341X X X X Extracts X X X X X X X X Extracts X X X X ..... y so and further we have held hereinabove that the RPM is not the correct method to be applied, then there can be no hitch in accepting the assessee's contention of applying the TNMM as the most appropriate method in the facts and circumstances of the case. In fact, the DRP also directed to apply the TNMM for the next two years, which are part of this batch of appeals, in which the international transactions are sale of manufactured goods to the AEs. Assessee has came out with a contention that if the TNMM is to be applied, then its original ALP determination in the Transfer pricing study report should be accepted without remitting the matter to the AO. We cannot concur with this contention because the working done by the assessee in this regard has not been vetted either by the TPO or the DRP. The TPO rejected such a method and went ahead with the PSM and the DRP suggested the RPM. Hence veracity of the calculations made by the assessee under TNMM has yet to pass through the eyes of the authorities below. Under these circumstances, we set aside the impugned order and remit the matter to the file of the AO for a fresh determination of the ALP of international transaction of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ficiencies on the cost side - economies in terms of relatively cost-effective purchases of quality raw material and efficiencies in terms of having good and satisfied work force preferring to stick with an established and reputed brand thereby adding the value. Thus we do not countenance the contention that brand building exercise has no impact on the profitability from sales made to related parties. The position which finally emerges is that neither the Employee Cost and Operating and administration expenses have any relation with the 'brand building' nor even genuine brand building expenses can be excluded from the operating cost base on the facts and in the circumstances of the case. Thus the contention of the Ld. AR for reducing the operating cost base with the expenses of ₹ 10.94 for the A.Y. 2012-13 and ₹ 23.89 crores for the A.Y. 2013-14 is repelled. To sum up, we hold that the DRP rightly ordered the inclusion of such costs in the operating cost base for computing the assessee's PLI for both the years under consideration. Assessee's Additional ground contending that the reference made by the AO to the TPO for the second international trans ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct observed that: The detailed order explaining the business model of the assessee, the facts of the case and resultant adjustment under transfer pricing having been discussed in the case of Anagha Pharma Ltd for the Assessment Year 2007-08. As the facts of the case of this assessee for this assessment year are same these are not reproduced here . In the next para, the TPO concluded by noting that: In view of the discussion made in the order of Anagha Pharma Ltd for the A.Y. 2007-08, the adjustment of ₹ 94,92,109/- is made to the international transaction and as a consequence of the adjustments, income of the assessee shall be increased by ₹ 94,92,109/-. The draft order incorporating the transfer pricing adjustment of equal amount was notified by the TPO on 29.02.2016. The assessee assailed various facets of the transfer pricing addition before the Dispute Resolution Panel (DRP), which gave certain directions on 30.11.2016. The AO passed the impugned order, giving effect to the directions of the DRP, by making the transfer pricing addition at ₹ 37,78,910. Aggrieved thereby, the assessee has come up in appeal before the Tribunal. 3. We have heard both the side ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mine the ALP under the Profit Split method (PSM). He allocated 3% of the aggregate group profits to the AEs abroad for the services rendered by them and the balance 97% was divided between the two Indian entities. To be more precise, he aggregated the year-wise profits shown by the five group entities from the A.Ys. 2007-08 to 2013-14 and found out the total combined profit of ₹ 1,57,23,23,733 as per Table 28.1 of his order. Then he proceeded to split the combined profit through Table 28.2 as under:- A.Y. Combined Profit of Anagha and AE's % of Profit earned by the Comparables. As per assessee s T.P. Report Profit Attributable to the Anagha which is equal to the comparable s profit % AE's Share 3% Residual Profit allocated to Anagha Pharma Ltd Anagha s Total Profit A B C D (B*C%) E (B*3%) F (B-D-E) G (D+F) 2007-08 2,28,44,905 2.77 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the activities done by the foreign AEs at 3% of total profit, thereby maintaining separate independent status of them as distinct from the two Indian entities. It goes without saying that the order needs to be read as a whole. If some observations are made in the body of the order, which are eventually not acted upon, one cannot claim any decision based on such observations. 5. Thereafter, the TPO computed the net transfer pricing adjustment in the hands of OIE, through para 28.3, as under:- A.Y. Anagha s Total Profit Less O.P. shown by the Assessee Total Adjustment Less Adjusted in the hands of Sava Medica Ltd. (As mentioned below) Net Adjt in the hands of OIE A B C D E F 2007-08 2,21,59,558 1,30,38,449 91,21,109 0 91,21,109 2008-09 17,16,80,562 1, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rm's length profit rate) has been applied. The figures of the AE's operating profit at ₹ 46.93 crore and operating revenue of ₹ 158.31 crore have been taken from the Table 5.1 on page 2 of the TPO's order in the hands of the assessee. 7. On an overview of the discussion made by the TPO in his order passed in the case of the assessee read in conjunction with the order in the case of OIE, it can be seen that he rejected the adoption of the TNMM and instead chose the PSM as the most appropriate method for determining the ALP. Insofar as the assessee is concerned, the TPO has simply taken the value of the international transaction of exports to the AEs and then applied the profit rate of the AE for determining the ALP. As the assessee reported only one international transaction of 'Sale of finished goods' with transacted valued of ₹ 3.20 crore, the TPO determined the ALP of such a transaction leading to the transfer pricing adjustment of ₹ 94,92,109. 8. The assessee assailed the draft order before the DRP on several issues. The DRP called for comments/reports from the TPO/AO on certain aspects and also the comments of the assessee. Afte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rwise, there are certain flaws in the application of the PSM by the TPO, which we will touch very briefly. 11. Rule 10B(1) of the Income-tax Rules, 1962 (hereinafter also called 'the rules') deals with the determination of the ALP as per section 92C under different methods. The modus operandi for determining the ALP under the 'Profit Split method' has been set out in rule 10B(1)(d) reading as under:- (d) profit split method, which may be applicable mainly in international transactions or specified domestic transactions involving transfer of unique intangibles or in multiple international transactions or specified domestic transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining the arm's length price of any one transaction, by which-- (i) the combined net profit of the associated enterprises arising from the international transaction or the specified domestic transaction in which they are engaged, is determined; (ii) the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of the functions performed, asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een them in proportion of their relative contributions for finding out the ALP. 13. On going through the prescription of the method, it becomes overt that it requires determination of the arm's length profit in two stages, which is then aggregated as per the latter part of the proviso providing for aggregating basic return with the residual net profit remaining after such allocation. The first stage is enshrined in the opening part of the proviso expressly providing for computation of the basic return corresponding to the efforts put in by a particular entity. The second stage is set out in various sub-clauses of rule 10B(1)(d). Sub-clause (i) provides for aggregating net profit earned by the concerned associated enterprises. The TPO on Table 28.1 of his order in OIA has aggregated operating profits of five entities from A.Ys. 2007-08 to 2013-14 and the combined net profit has been determined at ₹ 157.23 crores as under:- 28.1 Determination of Combined Profits of the Assessee and AE's Anagha Pharma - India Anam Trading Co. Mauritiu Sava Trading Co. (Sava Pharma Ltd) Mauritiu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... split amongst the enterprises in proportionate to their relative contribution. However, before undertaking this exercise, the basic return particular to the concerned entity is to be determined as per first part of the proviso, which is to be reduced from the aggregate profit. The TPO in the extant case determined the basic return for OIE (Column D) and the overseas entities (Column E) in Table 28.2 and then worked out the entire Residual profit (Column F). In finding out the figures under certain columns of Table 28.2, the TPO made some infirmities. Firstly, for calculating the basic return of OIE under column D, the TPO applied percentages of profit earned by the comparables as per the TP report of OIE on the combined operating profit of all the five entities taken together. Instead of that, he should have determined the basic return of OIE by applying the comparables' net profit rate to the amount of sales made by OIE for such years. Similar mistake was committed in computing the amount of basic return appropriate for overseas entities by applying 3% of the combined profit of all the five entities. He mentioned in para 28 that: 'The roles of the AEs have been narrated a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ged international transaction of Control Management of Sava Group to the learned TPO, without complying with the provisions of section 92CA(1) r.w.s. 92C(3) and 92B of ITA, 1961. 19. The Hon'ble Supreme Court in National Thermal Power Company Ltd. Vs. CIT (1998) 229 ITR 383 (SC) has observed that the purpose of the assessment proceedings before the taxing authorities is to assess correctly the tax liability of an assessee in accordance with law. If, for example, as a result of a judicial decision given while the appeal is pending before the Tribunal, it is found that a non-taxable item is taxed or a permissible deduction is denied, we do not see any reason why the assessee should be prevented from raising that question before the tribunal for the first time, so long as the relevant facts are on record in respect of that item . Answering the question posed before it in affirmative, their Lordships held that on the facts found by the authorities below, if a question of law arises (though not raised before the authorities) which has bearing on the tax liability of the assessee, the Tribunal has jurisdiction to examine the same. Having gone through the subject matter of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity cannot be made good by restoring back the same to the file of AO.......It is the case of violation of principles of natural justice and such an order passed in the hands of the assessee cannot stand and the same is invalid and bad in law . It can be seen from the order of the Tribunal in the case of OIE that the AO made a reference to the TPO in respect of two transactions viz., the first of sale to the AEs which was declared by the assessee in its Form No. 3CEB and the second of worldwide sale by the assessee group, which was not declared. We have reproduced Table 28.2 from the order of the TPO in the case of OIE in which Column No. D represents profit attributable to OIE for the reported international transactions and then Column No. F with the Residual profit allocated to OIE . These two transactions determined by the TPO under the Profit split method were clubbed and in table No. 28.3 he proposed the transfer pricing addition for them after excluding the arm's length profit in the hands of the assessee under consideration for the assessment years 2011-12, 2012-13 and 2013-14, which amount was, in turn, computed by applying the profit rate of AEs to the exports made by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts in the case of the assessee nor has been referred to the TPO, the ratio laid down by the Tribunal in the case of OIE has no application here. Had the factual position prevailing in the case of the assessee been similar, following the rule of stare decisis, we would have gone with the order passed in OIE. The fact that there is only one international transaction in the case of the assessee which was referred by the AO to the TPO and whose ALP has been determined, there can be no question of declaring the assessment order to be bad in law on this score. 22. The next contention of the Ld. AR, relying on the Tribunal order in OIE, is that the assessment order is bad in law because the TPO had no power to conclude that the control and management of affairs was situated wholly in India, which could have been done only by the AO. Again here, we find this argument as not applicable to the facts of the assessee before us. The contention put forth before the Tribunal in OIE, which got accepted, has to be seen in the background of the facts in which that case was placed. We have noted above that the TPO determined the ALP in the case of OIE of the international transactions of direct ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s length price of international transaction of ₹ 3.20 crores vide his letter dated 19.11.2014, a copy of which has been placed at page 1009 of the paper book. The Ld. AR contented that Circular No. 3/2003 dated 20.05.2003 expressly provides that reference to the TPO can be made by the AO only when the value of international transaction exceeds ₹ 5 crores. It was submitted that since the value of international transaction in the instant case was less than such a threshold, it was incumbent upon the AO himself to determine the ALP. As the AO made a reference to the TPO, and the latter determined the ALP, all the proceedings were vitiated. 24. There is no doubt that Circular No. 3/2003 provides for making reference to the TPO only where the value of international transaction exceeds ₹ 5 crores. In other words, if the aggregate value of international transaction in a case is less than that, then the AO is supposed to benchmark the international transaction at his own level without making a reference to the TPO. To this extent, the argument of Ld. AR is correct. However, the consequence of such a wrong doing, as claimed by the Ld. AR to be fatal and vitiating the fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s' to its AE. The DRP held in para 66 that: Since the assessee is into trading exports of pharma products, Resale Price Method will be the most appropriate method . In order to evaluate if the RPM was properly directed to be applied, we need to refer to the relevant part of rule 10B(1)(b), which reads as under: 10B(1)..... (b) resale price method, by which-- (i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) to (v) .... 26. Sub-clause (i) of the rule emphatically provides that: 'the price at which property purchased ... by the enterprise from an associated enterprise is resold ... to an unrelated enterprise, is identified'. Thus, it is glaring that this method applies where an Indian entity purchases goods from its foreign/AE and then resells the same. The entire mechanism in the subsequent sub-clauses of rule 10B(1)(b) is a consequence of this foundational fact. If the international transaction is not that of purchase by an Indian entity, then the RPM cannot be applied. Here is a case in which the assessee sold ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amount of transfer pricing adjustment at ₹ 54,08,226. He did not separately discuss the merits of the transfer pricing addition but, as done for the preceding year, relied on the discussion made by him in his order passed in the case of OIE for the A.Y. 2007-08. Similarly, for the A.Y. 2013-14, the assessee filed return declaring loss of ₹ 20,82,40,706. The assessee reported international transaction of 'Sale of finished goods' at ₹ 13,25,91,855. The AO made a reference to the TPO for determining the ALP of international transaction. The latter vide his order dated 29.01.2016, passed in the same way as for the preceding two years, determined the amount of transfer pricing adjustment at ₹ 4,66,98,148 by mainly relying on his order in the case of OIE for the A.Y. 2007-08. For both the years, the assessee had applied Transactional Net Margin Method (TNMM). The TPO rejected this method and resorted to the PSM. The assessee assailed the drafts orders containing such transfer pricing adjustments before the DRP, which did not countenance the approach of the TPO in applying the PSM. It directed to apply the TNMM for both the years and required the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he A.Y. 2012-13, the assessee treated ₹ 10.94 crores as non-operating costs on the premise that such expenses were incurred for the purpose of brand building, which efforts were from a futuristic perspective and results of these efforts were not reaped in the current year. The assessee has demonstrated its PLI working on this basis on pages 761 and 762 of paper book. Whereas the above extracted note has been given on page 761, it has been mentioned on page 762 that: The cost with respect to employees hired for the purpose of brand creation, promotion and marketing in domestic market which has no relevance with the sales of manufactured products sold to AEs, hence the same is carved out to determine operating cost'. The Ld. AR attempted to justify the exclusion of sum of ₹ 10.94 crores by contending that the assessee incurred these expenses considering the futuristic impact of the market creation made in this year. He elaborated by stating that such costs resulted into the brand building of the assessee, whose benefit was to be reaped in future years. Thus, it can be seen that the assessee adduced two reasons for the carve-out, viz., first that such costs resulted i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onwards and out of total sales of ₹ 11.26 crores, domestic sales amounted to ₹ 1.71 crores. It, therefore, transpires that the assessee incurred Employee cost and Operating administrative expenses in relation to its manufactured products, which were sold in the year under consideration both in the domestic market to non-AEs and in the foreign market to the AEs. In such a situation, the assessee cannot justify the exclusion by correlating the same with its impact in the years to come. On a pertinent query, the Ld. AR admitted that these costs were not capitalized in the books of account but were taken as revenue expenses for the year under consideration. Once these costs are incurred for the year in question and claimed as deduction in entirety in this year alone, we fail to understand as to how these can be correlated with the sales to be made in future years without capitalizing them for accounting or tax purpose. 34. If the contention is that such expenses, which are otherwise operating in nature, relate to the future years, then naturally such expenses should have formed part of the operating costs base for the future years. On a clarification in this regard, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to Total cost. The transfer pricing addition will result only by applying the differential PLI rate (PLI of the assessee and PLI of the comparables) only on sales made to the AEs and not the entity level transactions. 37. The position which finally emerges is that neither the Employee Cost and Operating and administration expenses have any relation with the 'brand building' nor even genuine brand building expenses can be excluded from the operating cost base on the facts and in the circumstances of the case. Thus the contention of the Ld. AR for reducing the operating cost base with the expenses of ₹ 10.94 for the A.Y. 2012-13 and ₹ 23.89 crores for the A.Y. 2013-14 is repelled. To sum up, we hold that the DRP rightly ordered the inclusion of such costs in the operating cost base for computing the assessee's PLI for both the years under consideration. 38. But for the above, the Ld. AR did not assail any other aspect of its own ALP determination presented before the DRP. We, therefore, accord our imprimatur to the final assessment orders making the above additions. 39. For the two years under consideration also, the assessee has raised additional gr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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