Income Tax Appellate Tribunal - Delhi
Adidas India Marketing Pvt. Ltd., New ... vs Department Of Income Tax on 26 February, 2016
1 ITA No. 3922.DEL.2011
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH: 'I-2' NEW DELHI
BEFORE SHRI N. K. SAINI, ACCOUNTANT MEMBER
AND
SMT SUCHITRA KAMBLE, JUDICIAL MEMBER
I.T.A .No.-3922/DEL/2011
(ASSESSMENT YEAR-2005-06)
ITO vs Adidas India Marketing Pvt.
Coy. Ward-1(2), Room No. 398-B, Ltd.
C. R. Building C-2, Ansal Villa, Satbari
New Delhi New Delhi
(APPELLANT) AAACA5313P
(RESPONDENT)
Appellant by Sh.Hemant Gupta, Sr. DR
Respondent by Sh. Ajay Vohra, Sr. Adv &
Sh. Neeraj Jain, Adv.
Date of Hearing 20.01.2016
Date of Pronouncement 26.02.2016
ORDER
PER SUCHITRA KAMBLE, JM
This appeal is filed by the Revenue against the order dated 08/08/2011 passed by CIT (A)-XX, New Delhi.
2. The grounds of appeal are as follows:-
"1. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs.2,87,51,769/- made on account of adjustment proposed by TPO in order u/s 92CA(3) of the I.T. Act, as:2 ITA No. 3922.DEL.2011
a) The Ld. CIT(A) has not been able to substantiate that the goods so exported were part of the slow moving old stock, whereas the TPO has clearly held that the assessee company could not produce anything on record which could substantiate that the goods so exported were part of the slow moving old goods.
b) Having held that the rejection of Quotes of the other companies by the TPO to be reasonable, the Ld. CIT(A) failed to appreciate that the exports of goods was required to be determined at the Arm's Length Price.
c) The Ld. CIT(A) has not provided any cogent explanation to adopt the rate of 8.25% while rejecting the GP of 22.64% adopted by the TPO to determine Arm's Length Price.
3. The assessee company was set up to engage in sourcing distribution and marketing of sportswear, sports footwear and sports equipment appearing the brand name 'Adidas'. M/s Adidas A G Germany has set up on the subsidiary company in the name and style of M/s Adidas India Pvt. Ltd after obtaining due approval. M/s Adidas India Pvt. Ltd. provided license technology to the assessee company i.e. M/s Adidas India Trading Pvt. Ltd. As per the agreement M/s Adidas India Pvt. Ltd. was to provide exclusive non-transferable rights to manufacture distribute and sale the license products in India, Nepal and Bhutan on payment of royalty at 5% of the sales effected. As per the agreement M/s Adidas India Pvt. Ltd was not to manufacture or distribute or sale the license products within the license territory so as to complete with the assessee company. The assessee company had also agreed to make 3 ITA No. 3922.DEL.2011 fulfill figures effect to increase sales and inherence good will of the license products in the territory. The Assessing Officer while determining the arm's length price of sale of goods to aSIS Rs, 5,73,67,313 in place of Rs. 2,86,15,544/- which is the book value of the international transactions. The adjustment on this account therefore calculates to Rs.2,87,51,769/-.
4. The Ld. DR submitted that the Transfer Pricing Officer has clearly mentioned that there was nothing on record to show that the said articles sold to the overseas associate was old and slow moving inventory and a specific query was made to the assessee on 22.09.2008 mentioning the same. In reply to the same the assessee produced two invoices vide its submission dated 29.09.2008. These two invoices shows that the goods was exported to the overseas entity (buyer) in two lots the first lot being invoiced on 14.07.2004 and the second lot being invoiced on 7.02.2005. In this manner both the lots were exported by taking into account only the two quotation principle and the overseas entity has no where tendered any quote for the same. The assessee placed on record the stock details of these goods which mentioned that they have been purchased in 2004 and earlier years. This would result in an obvious argument as to what would constitute the old stock. In this regard, the representative of the assessee has submitted that the fashion trend of the assessee company changes every six months. As such there is a fresh stock arrival after every six months and the 4 ITA No. 3922.DEL.2011 ones that are replaced are termed old. These stocks are then tried and sold at the factory outlets at discounted price and the ones that still remain unsold are consigned to the warehouse and dumped. It is this inventory that is termed as old and slow moving. One thing that clearly emerges from the limitations contained in the policy note is that under no conditions the assessee could have sold in the open market since it was barred by the policy to do so. In light of the same, the two quotations that have been submitted on record can in no way show the intention of selling to any party other than the associated enterprise. In view of this, the submission of the assessee that the quotes were invited for the purported sale on the "highest quote principle basis" defies logic. Moreover, there is no submission on record to prove that the two quotes were even used to end up in a negotiation process. However, it is seen that the inventory exported to the overseas AE is not the same that has been further sold to SIMO. This is established from the contents of the articles recorded in the invoice of sale to the AE and the invoice of sale to SIMO. This proves that the same articles have not been sold to any third party as claimed by assessee by filing invoice of sale to SIMO. If the assessee is to be believed then as per claim it has exported a part of its old goods to its AE in Singapore in the month of June, 2004 and these goods were sold to third party i.e. SIMO only in the month of February, 2005 i.e. after a gap of eight months. Taking into account the fact that goods were kept in warehouse in Singapore for a long period of eight months and huge warehousing cost at Singapore it would further increase the cost of these alleged 5 ITA No. 3922.DEL.2011 rejected goods and this will not make any business sense. The claim of sale of rejected goods Ex-Singapore which has a high cost of inventory holding, cannot be believed for the following reasons
1. The sale invoice did not contain sale or resale of rejected goods.
2. It is against prudent business practice due to huge ware housing charges.
The claim is not supported by any credible evidence. The purported sale to the third party does not corroborate economic prudence and this further establishes that the assessee's export of the inventory was not resold to SI MO as claimed. The assessee has not sold any old stock and the sale is simply out of the normal stock- and- sell, as no mention of the same is found in any of the invoices raised on the overseas AE. In view of the same, the market value of the inventory has to be seen in economic reality and also in light of the accounting standards adopted in India. As per AS-2 the net realizable value booked in the balance sheet is net of gross margins and covers incidental costs. As such the value of the closing stock which has been toned down by Rs.4.67 crores contains no element of profit which the assessee should have earned in terms of market outgo. The gross percentage earned by the assessee has been found at Annexure-XIII of the Tax Audit Report. The gross profit margin posted by the assessee in this year is 22.64% which the assessee should have earned over and above the cost of the inventory. Therefore, the market price of the inventory reportedly sold to the 6 ITA No. 3922.DEL.2011 overseas AE is determined at Rs. 5,73,67,313 (4,67,77,000 x 1,2264.)
5. The Ld. DR submitted that in the manner discussed above, the value of stock sold by the assessee to aSIS is determined at Rs. 5,73,67,313. The same is held to be the price which the stock would have fetched in realization by application of Comparable Uncontrolled Price method. Moreover, when the audited figures are available and the assessee has chosen an equivalent platform in its TP study, the alternate recourse to a different geographical terrain is neither correct nor would lead to any credible determination of Arm's Length Price. In light of the above observations of the TPO, the arm's length price of sale of goods to aSIS is determined at Rs. 5,73,67,313 in place of Rs. 2,86,15,544 which is the book value of the international transactions. The adjustment on this account therefore was correctly calculated to Rs. 2,87,51.769 .
6. The Ld. AR submitted that a Group Manual which summarizes that the inventory provisions has to be made in respect of goods which can no longer be sold for their full value or are slow moving to ensure they are valued at the lower of their cost or net realizable value. The provisions are to be calculated monthly based on standard cost; however for practical purposes, the calculation may be based on the actual cost of the inventory as it approximates to 7 ITA No. 3922.DEL.2011 the standard cost. The value of the inventory is to be depreciated at variable rates over a one year period. A closer look shows that there exists a close out date for an inventory and it starts getting depreciated even before the close out date and continues progressively at regular intervals of three months. The Ld. AR further stated that the inventory was valued at standard cost. In this light the provisions of AS-2 which defines the valuation of inventories was required to be visited. The Accounting Standard (AS-2) stipulated that when it was impractical to calculate at cost, the following methods may be followed to ascertain cost.
> Standard Cost > Retail Cost The accounting standard stipulates that these methods may be used for convenience if the results approximate actual cost.
> The standard cost takes into account normal level of consumption of material and supplies, labour, efficiency and capacity utilization. It may be regularly reviewed and revised taking into consideration the current situation > Retail method is generally used in retail business, when it is difficult to ascertain cost of individual item. It is applicable when items of inventories are rapidly changing items and have similar margins and for which it is impracticable to use other costing method. Under this method, the cost of inventory is determined by reducing from the sale value of inventories the approximate value of 8 ITA No. 3922.DEL.2011 gross margin. The percentage used takes into consideration the inventory that has been marked down to below its original selling price. In view of the above, it is seen that the standard costing applies mostly to manufacturing industries without any speck of doubt. The usually followed accounting principles across the world follow the LIFO method and it is widely used as per US GAAP (ARB-
3). However, the accounting principle that is followed in India would be based on the accounting principles in vogue and this is certainly not standard costing. The indication is therefore certainly inclined towards retail costing that has been discussed in the discussion above.
In view of the foregoing, there is absolutely no doubt that the toning down of inventory which was written down in valuation of stock has been based on the retail pricing method.
The above was demonstrated by the Note 13 of the Schedule 19 of the notes to accounts. Note 13 of Schedule 19 of notes to accounts of the assessee company values the stock of the goods and in the footnote to the same it reads as under:-
"Closing stock is a derived figure, based on book records of the company and is net of Rs. 46,777 thousands (previous year Rs. 77,784 thousands) written down from the earning value of inventories, to bring them to net realizable value in accordance with laid down policy of the Company.'1 9 ITA No. 3922.DEL.2011
7. Further, the Ld. AR submitted that the Net Realizable Value was as per AS-2 of the Accounting Standards. The net realizable value means the estimated selling price in ordinary course of business, less estimated cost of completion and estimated cost necessary to make the sale. Net realizable value is estimated on the basis of most reliable evidence at the time of valuation. Such net realizable value is reduced by the Gross Margins' and is arrived at the figure that is reflected in the balance sheet. Estimation of net realizable value also takes into account the purpose for which the inventory is held. Estimation of net realizable value is made at each balance sheet date.
8. The Ld. AR further submitted that to bring the inventory to its net realizable value stock of valuation of Rs. 46,777,000/- has to be toned down. This is indication enough that the toned down value of stock is the least value that has to be netted off from the closing value of stock and that the same is congruent to the market value without the gross margin. During the course of discussion, the assessee has further confirmed that the stock pertains to this block. The assessee was also specifically asked as to what amount out of this stock pertained to its sale to its overseas Associated Enterprise. The assessee has not been able to submit any detail. However, the figurative details furnished on record shows that the assessee has sold the stock which totally pertains to the toned downed value. It was contended that the assessee submitted before the Assessing 10 ITA No. 3922.DEL.2011 Officer that the overseas subsidiary has further sold the stock to an independent third party SIMO. The margin of profit earned is less than 8.25% which has been reportedly paid by the assessee as commission for procurement. Therefore, a CUP method was intended to be established by the assessee.
9. The AR submitted that the assessment of the TPO that the assessee should have earned 22.64% gross profit on old stock and slow moving items is farfetched and not based on any sound reasoning. The gross profit earned by the assessee is in India. TPO had not disputed the classification of the goods as slow moving or as old stock. The very nature of slow moving and old stock is that the assessee is not able to sell them in the market at the market price. This is a kind of 'depress sale or clearance sale'. Therefore, to expect the assessee to earn the same margin on such goods is unreasonable and not based on appreciation of circumstances of the assessee. TPO, on the one hand, accepting these goods as slow moving, on the other, he expects the assessee to earn margin at the same rate at which the normal goods of the assessee are also earning. TPO is contradicting himself. Secondly, the TPO had not disputed that these goods are sold to foreign entity. Therefore, even on this ground to expect the assessee to earn the same margin as in Indian market is also an unacceptable logic. Thirdly, the calculation of GP at 22.64% includes the transaction with related party. It is 'tainted' transactions, because this GP of 22.64% is not the result of transactions with independent parties alone, but with related parties as well. It was the duty of the TPO to arrive at the 11 ITA No. 3922.DEL.2011 ALP of this international transaction. TPO cannot use this figure of 22.64% itself as at arm's length. In effect, the sale invoices of the assessee to its AE can be compared with the sale of invoices of the AE to the independent party. The goods sold are exactly the same, as the goods were dispatched from the warehouse of the assessee to the ultimate buyer who is an independent entity. The time gap between the sale of the assessee and the sale of the AE are negligible because it has happened within the same month. Therefore, this is a fit case to use CUP as a most appropriate method. Thus the CIT(A) has rightly allowed the appeal of the assessee.
10. We have perused all the records and heard both the parties. The contention of the DR that the assessee instead of selling old stock through AE has directly sold the same to the third party is not correct. The CIT(A) gave finding after considering all the aspects to that effect. It can be found that the said stock was of old stock and the sale was also through the AE as well. The goods sold are exactly the same, as the goods were dispatched from the warehouse of the assessee to the ultimate buyer who is an independent entity. The time gap between the sale of the assessee and the sale of the AE are negligible because it has happened within the same month. The gross profit earned by the assessee is in India. TPO had not disputed the classification of the goods as 12 ITA No. 3922.DEL.2011 slow moving or as old stock. Therefore, the CIT(A) has rightly held in favour of the assessee.
11. In result, the appeal is dismissed.
The order is pronounced in the open court on 26th of February 2016.
Sd/- Sd/-
( N. K. SAINI) (SUCHITRA KAMBLE)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated: 26/02/2016
*R. Naheed*
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(Appeals)
5. DR: ITAT ASSISTANT REGISTRAR
ITAT NEW DELHI
Date
1. Draft dictated on 18/01/2016 PS
2. Draft placed before author PS
19/01/2016
3. Draft proposed & placed before 02.2016 JM/AM
the second member
4. Draft discussed/approved by JM/AM
13 ITA No. 3922.DEL.2011
Second Member.
5. Approved Draft comes to the PS/PS
Sr.PS/PS 26.02.2016
6. Kept for pronouncement on PS
7. File sent to the Bench Clerk 29 .02.2016 PS
8. Date on which file goes to the AR
9. Date on which file goes to the
Head Clerk.
10. Date of dispatch of Order.
14 ITA No. 3922.DEL.2011