Income Tax Appellate Tribunal - Delhi
Agilent Technologies India Private ... vs Assessee on 9 February, 2016
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I-1 : NEW DELHI
BEFORE SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM
ITA No.1487/D/12
Assessment Year :2006-07
Agilent Technologies India Pvt. Ltd., Vs. DCIT,
Unit No.105-116, First Floor, Circle 1(1),
Splendor Forum, Plot No.3, New Delhi.
District Centre, Jasola,
New Delhi.
PAN: AABCA9874A
(Appellant) (Respondent)
Assessee By : Shri Kanchan Kaushal, CA &
Shri Ravi Sharma, Advocate
Department By : Shri Amrendra Kumar, CIT, DR &
Shri Sudhanshu Dhar Mishra, Sr. DR
Date of Hearing : 04.02.2016
Date of Pronouncement : 09.02.2016
ORDER
PER R.S. SYAL, AM:
This appeal the assessee is directed against the final assessment order passed by the Assessing Officer (AO) on 21.01.2012 under ITA No.1487/Del/2012 sections 143(3)/144C(5)/254 of the Income-tax Act, 1961 (hereinafter also called `the Act') in relation to the assessment year 2005-06.
2. The only issue raised is this appeal through various grounds is against the addition on account of transfer pricing adjustment amounting to Rs.10,11,16,273.
3. Succinctly, the facts of the case are that the assessee is a 100% subsidiary of Agilent Technologies, Europe B.V. Its business operations comprise of facilitation of sales of Agilent products in the Indian market. Agilent Technologies is the world's leading designer, developer, manufacturer and provider of electronic and optical testing and monitoring instruments, systems and solutions. The assessee reported six international transactions in Form No. 3CEB. On a reference made by the Assessing Officer (AO), the Transfer Pricing Officer (TPO) took up for consideration the international transaction of 'Facilitation of sales of Agilent products in India' with transacted value of Rs.37,16,57,393/-. The assessee used the Transactional Net Margin Method (TNMM) as the most appropriate method with Profit level indicator (PLI) of Operating 2 ITA No.1487/Del/2012 profit/Value Added Expenses (OP/VAE) at 15.23%. Five comparables were chosen with their weighted average margin of profit of three years at 5.34% to demonstrate that this international transaction was at arm's length price (ALP). The assessee was called upon to file updated margins of the comparables for current year alone, which were filed declaring mean operating profit margin at 10.28%. The TPO rejected the comparables selected by the assessee. He finally selected two companies as comparable, namely, Educational Consultants India Ltd. (Technical Assistance and HRD segment: 12.56%) and Priya International Ltd. (Indenting segment: 26.09%) with their mean Operating Profit/Operating Cost (OP/OC) rate at 19.32%. He computed the assessee's profit from the international transaction by adopting PLI of OP/OC at 7.25% on page 8 of his order. By applying (OP/OC) rate of the comparables at 19.32% as benchmark, the TPO worked out transfer pricing adjustment at Rs.10,62,21,565. The Dispute Resolution Panel (DRP) vide its direction dated 21.12.2011 given u/s 144C(5) read with section 254 affirmed the view of the TPO on adoption of PLI as OP/OC of the assessee as well as comparables. The DRP also approved 3 ITA No.1487/Del/2012 the selection of comparables made by the TPO. It however, corrected the figure of OP/OC of these comparables, namely, Educational Consultants India Ltd. (Segmental: 14.85%) and Priya International Ltd. (Segmental:
22.63%), with their mean Operating Profit/Operating Cost (OP/OC) rate at 18.74%. By applying this average OP/OC of comparables at 18.74%, the DRP reduced the amount of transfer pricing adjustment to Rs.10,11,16,273. It is this amount which has been added by the AO in the final assessment order, against which the assessee has come up in appeal before us.
4. We have heard the rival submissions and perused the relevant material on record. It is noticed that the assessee applied the TNMM as the most appropriate method which was accepted by the TPO. The only controversy revolves around the adoption of PLI. The assessee in its TP study report applied PLI of OP/OC of comparables and OP/VAE of its own for determining the ALP of the international transaction. The TPO considered OP/OC of the assessee as well as that of comparables for benchmarking the assessee's international transaction, which led to the 4 ITA No.1487/Del/2012 making of addition on account of instant transfer pricing adjustment. The assessee is aggrieved against the change made by the TPO in applying its PLI of OP/OC instead of OP/VAE as considered by the assessee for the purposes of making comparison with OP/OC of the comparables. No other point was argued by the ld. AR, such as selection of comparables or the adoption of the current year data of comparables against the weighted average of three years. Thus it is manifest that the entire case of the assessee rests on the adoption of its PLI by the TPO as OP/OC as against OP/VAE used by it.
5. In order to appreciate this objection, it will be worthwhile to have a look at the prescription of the relevant parts of rule 10B(1)(e) of the IT Rules, 1962, which is a machinery provision for the determination of the ALP under the TNMM, as under : -
"(e) transactional net margin method, by which,--
(i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;5 ITA No.1487/Del/2012
(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ;
.................."
6. A bare perusal of sub-clause (i) of Rule 10B(1)(e) transpires that the net operating profit margin realized by the enterprise from an international transaction is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. Sub-clause (ii) of Rule 10B(1)(e) stipulates that the net operating profit margin realized by the enterprise or by an unrelated enterprise from the comparable uncontrolled transaction 'is computed having regard to the same base.' On a conjoint reading of sub-clauses (i) and (ii) of Rule 10B(1)(e), it becomes explicit that the net operating profit margin realized by the assessee from an international transaction has to be necessarily computed and compared with the net profit margin realized by comparable companies from the same base. In other words, if the operating profit margin of the assessee from international transaction has been computed with the base of `costs incurred', then, the operating 6 ITA No.1487/Del/2012 profit margin of the comparables has also to be computed with the same base of `costs incurred'. Similarly, if the base adopted by the assessee for its international transaction under the formula in TNMM is 'sales effected', then, similar base of `sales effected' must be adopted while computing profit margin of comparables. In the like manner, if 'any other relevant base' is adopted for computing the operating profit margin of the assessee, then, similar base should be considered while computing operating profit margin of comparables. To put it simply, the numerator and denominator in the computation of operating profit margin of the assessee must be similar to those of the comparables. In the formula given under the TNMM, numerator is always `Operating profit', but the choice has been given for selecting a suitable `denominator'. However, the condition precedent is that whichever denominator is selected by the assessee for working out its PLI in terms of sub-clause (i) of rule 10B(1)(e), similar denominator should be adopted in computing the profit margin of comparables as per sub-clause (ii) of the rule. It is impermissible to compare the assessee's operating profit margin computed with the base of, say, `costs incurred' with the operating profit 7 ITA No.1487/Del/2012 margin of comparables computed with the base of, say, `sales effected' or `any other relevant base'. Even when `any other relevant base' is adopted, such a base should remain consistent both in the computation of PLI of the assessee as well as comparables. The essence of the provision is that squares should be compared with squares and rounds with rounds, so that a rational and logical comparison could be made of the operating profit rate of the assessee and comparables. In other words, base or denominator of the international transaction and the comparable uncontrolled transactions must be identical.
7. Espousing the main controversy once again, we find that the assessee used OP/VAE as its profit level indicator, by impliedly treating base of `Value added expenses' as akin to `any other relevant base'. The TPO changed it to OP/OC and compared it with the similar PLI of OP/OC of the comparables finally selected. Thus, it is apparent that the TPO adopted OP/OC, both of the assessee and of comparables, for determining the ALP of the international transaction. 8 ITA No.1487/Del/2012
8. The ld. AR vehemently argued that the assessee is not a trader, but, simply a commission agent. He stated that the assessee was facilitating sales of Agilent products in India under two transaction models, namely, Indent model and Buy-Sell model. Taking us through the Transfer pricing study report, he contended that whereas under Indent model, the assessee was providing only marketing and sales support services in relation to the direct sales of Agilent products from overseas entities to customers in India without taking any physical possession or title of the goods, under Buy-Sell model, the assessee was importing products from Agilent for sale to domestic customers, specifically, against the confirmed orders by taking title of goods and, then, selling these to the distributors and customers in India. He argued that though the title of goods under Buy-Sell model was formally passing to the assessee, but, in fact, it was nothing more than Indenting model in the sense that the sale was made only on the basis of confirmed orders and the assessee was not taking delivery of goods and further no working capital of the assessee was involved in any manner. Sum and substance of his submissions was that under both the transaction models, namely, Indent 9 ITA No.1487/Del/2012 and Buy-Sell, the assessee was earning only commission and, there was no point in treating the assessee as a trader so as to consider `Operating costs' as the base in the PLI instead of `Value added expenses', which is really relevant for service providers.
9. Before delving into the point further, we want to highlight difference between Operating cost (OC) and VAE (Value Added Expenses) and their respective impact on the overall operating profit margin. In common parlance, operating costs are the expenses which are related to the operation of a business. If an enterprise is in the business of manufacturing or trading, then its operating costs will also include cost of goods sold apart from other operating administrative and selling expenses. If some services are required to be rendered by the assessee in respect of goods already manufactured by a third party, then the costs incurred in rendering such services are called valued added expenses in the hands of such person rendering services. Cost of goods sold is an immaterial factor in the case of an assessee engaged in commission business, having no relevance whatsoever with his 10 ITA No.1487/Del/2012 operating costs. Operating costs to him will mean only administrative and selling expenses connected with his business operations, which comprise of effort in facilitating sale of other's goods. Thus it is vivid that whereas cost of goods sold is an important ingredient of total operating costs of a manufacturer or trader, it has no relevance in the case of a service provider or a commission agent. Operating costs of a commission agent are the costs incurred in facilitating sale of goods, which patently exclude cost of goods. Substance of the matter is that whereas operating costs in the case of a trader include cost of goods sold, the same are absent in the case of a commission agent. It is obvious for the reason that while the only element of profit of a commission agent is compensation for the efforts put in by him in effecting sales, the profit of a trader, in addition to that, also includes compensation for the amount invested by him in inventory and debtors etc. This divulges that operating costs of a trader always include cost of goods sold and operating costs of a commission agent can never have such costs. If there is some Cost of goods sold and Sale appearing in the books of an assessee, then it would mean that the title in goods passed on to him, 11 ITA No.1487/Del/2012 which he sold as an owner. In that case, he ceases to be characterized as a mere commission agent qua such goods. If a trader computes his operating profit margin by excluding cost of goods sold from the cost base and considering only administrative and selling expenses etc., it means that his total operating profit, which is a compensation not only for the sale of goods but also towards investment in goods, is being wrongly matched with the base of expenses incurred to the exclusion of cost of goods. Here we want to accentuate that the issue is not that a trader cannot work out his profit margin as a percentage of value added expenses to the exclusion of cost of goods sold, but the real thing is that such a profit margin can not be compared, for the transfer pricing purposes, with the profit margin of comparables, computed as a percentage of total operating expenses, which apart from value added expenses also include cost of goods sold. It is, thus, axiomatic that there is always bound to be some difference between operating profit as a percentage of operating costs including cost of goods sold on one hand and exclusive value added expenses on the other.
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10. Now we will examine and evaluate the ld. AR's contention that the transactions of the assessee under the Buy-Sell model are identical to the Indent model and there is no difference between the sales made under both the models. We have perused the assessee's Annual accounts for the year, a copy of which has placed at pages 190 onwards of the paper book. Profit & Loss Account of the assessee records 'Sales' of Rs.44,52,28,224/- apart from `Commission' income amounting to Rs.37.16 crore. Debit side of the assessee's Profit & Loss Account discloses an item of expenditure of 'Cost of trade sales' at Rs.36.62 crore and also `Spare parts consumed' amounting to Rs.9.48 crore. This shows that the assessee purchased goods to the above extent by acquiring their title and thereafter sold the same as principal and not as an agent. The assessee's TP Study report also discloses that the title of goods passed on to the assessee in respect of goods sold under Buy-Sell model. When we peruse the assessee's balance sheet, it turns out that `Inventories' have been reflected at Rs.22.70 crore along with `Sundry debtors' at Rs.30.33 crore. It shows that the amount of Sundry debtors and Inventories stands at a staggering figure of Rs.53.03 crore, which is 13 ITA No.1487/Del/2012 even more than the amount of sales of Rs.44.45 crore made during the year. These figures leave nothing to doubt that there is a huge investment of the assessee in Stock and Debtors, which belies its claim of having no investment in working capital in the transactions under Buy-Sell model in the same way as is under Indent model.
11. The ld. AR further contended that the assessee was not holding any stock-in-trade and purchases were being made on the basis of confirmed orders with supply directly going to the end customers. This position is again, contrary to material on record. Schedule-D of the Balance sheet contains break-up of Inventories. Its perusal shows that as against total Inventories of Rs.22.70 crore, stock of `Finished goods' is to the tune of Rs.11.49 crore and that of `Spare parts' at Rs.11.21crore. There is further bifurcation available in respect of Finished goods and Spare parts
- both 'At warehouse' and 'In transit.' Thus, it is manifest that the argument put forth by the ld. AR about the assessee holding no physical stock at any point of time, is fallacious and contrary to the actual figures reflected in the balance sheet. It is plentifully lucid from the details of 14 ITA No.1487/Del/2012 `Inventories' given in the balance sheet that the assessee is not only having Finished goods and Spare parts `In transit', but also `At warehouse'.
12. When we consider Profit & Loss Account and Balance sheet of the assessee in unison, it unambiguously follows that the assessee purchased goods under Buy-Sell model as principal by acquiring title in them and, thereafter, sold the same as owner and not as an agent. The Hon'ble Delhi High Court in Mitsubishi Corporation India Pvt. Ltd. vs. Addl.CIT (2014) 366 ITR 495 (Del) has held that where transactions of purchase and sale between the assessee and a non-resident holding company were done on a principal to principal basis and recorded in books of account on principal to principal basis by the assessee, activity undertaken by the assessee was in the nature of trading. We, therefore, repel the assessee's contention that the transactions under Buy-Sell model were on commission basis rather than as a trader.
13. Having held that the assessee is a `Commission agent' as regards its transactions under the Indent model and a `Trader' as regards its 15 ITA No.1487/Del/2012 transactions under the Buy-Sell model, we again revert to the moot point of determination of ALP. It is noticed that the assessee clubbed transactions under both the models and determined their ALP by computing OP/VAE on consolidated basis and then compared the same with OP/OC of comparables. The TPO adopted denominator of 'Operating Costs' in the computation of operating profit margin of the assessee from combined international transactions under both the models with similar base of comparables. We have noticed above that operating costs of a `Commission agent' are always exclusive of cost of goods sold, whereas a `Trader' has to have them as an essential element. Albeit a `Trader' can ascertain his operating profit margin as a percentage of VAE to be designated as `any other base', but in our considered opinion that can not be described as a `relevant' base, so as to fall within the ambit of the expression `any other relevant base' as used in sub-clauses (i) and (ii) of rule 10B(1)(e). The corollary, which ergo follows, is that whereas `any other relevant base' under the TNMM in case of a `Commission agent' can be `Value added expenses', which, in fact, represents his total operating costs alone, but in case of a 16 ITA No.1487/Del/2012 `Trader', it can be cost of goods sold plus other operating expenses, which represents his total operating costs and not `Value added expenses' to the exclusion of cost of goods sold.
14. Now let us examine what has been done in the instant case with a view to judge the correctness of the ALP of the international transactions undertaken by the assessee under both the business models of `Indenting' as well as `Trading', which are obviously distinct from each other. It can be seen that the assessee tried to demonstrate that its combined international transactions under both the models were at ALP by comparing its PLI of OP/VAE on overall basis with OP/OC of comparables, which is an incorrect approach. In the like manner, the TPO, though compared the assessee's PLI of OP/OC with OP/OC of the comparables, but he also fell in error by jointly considering the international transactions of both the business models, namely, Indenting and Trading, under one umbrella. We thus hold that both the assessee as well as the TPO fell in error in considering the international transactions under both the models as of uniform character. It has been noticed supra 17 ITA No.1487/Del/2012 that the ingredients of Operating costs under the Trading model are different from those under Indenting model. Ex consequenti, transactions under both the models are required to be benchmarked separately.
15. At this stage, it is pertinent to mention that for the immediately preceding year also, that is, the A.Y. 2005-06, the assessee combined its international transactions under both the business models and tried to show that these were at ALP by comparing its PLI of OP/VAE with OP/OC of comparables, which was not accepted by the TPO, who held that OP/VAE of the assessee should be compared with the OP/VAE of comparables on a combined basis. The ld. CIT(A) accepted the assessee's contention and deleted the addition by comparing the assessee's overall OP/VAE with the OP/OC of the comparables. The appeal of the Revenue for the immediately preceding year has been heard simultaneously with the appeal of the assessee for the current year. In fact, it is the appeal for the earlier year which was extensively argued by both the sides and the rival parties have largely adopted such 18 ITA No.1487/Del/2012 arguments advanced in support of their respective stands for the instant appeal. We have disposed of the appeal for the A.Y. 2005-06 (ITA No. 4323/Del/2011) by a separate order dated 08.02.2016 disapproving the combined processing of the international transactions under the Indent model and Buy-Sell model and restored the matter to the file of the AO/TPO for separately determining the ALP of the international transactions under the `Indenting' and `Trading' models.
16. We find that there is insufficient information available on record facilitating the determination of ALP of the international transactions under these two business models separately at our end. Following the view taken for the preceding year, we set aside the impugned order and remit the matter to the file of AO/TPO for processing the international transactions of `Indenting' and `Trading' separately under Chapter X of the Act in consonance with our above analysis. Needless to say, the assessee will be allowed an adequate opportunity of hearing in such a de novo determination.
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17. In the result, the appeal is allowed for statistical purposes.
The order pronounced in the open court on 09.02.2016.
Sd/- Sd/-
[KULDIP SINGH] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 09th February, 2015.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.
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