Income Tax Appellate Tribunal - Delhi
Oriflame India Pvt. Ltd.,, New Delhi vs Dcit, New Delhi on 24 March, 2017
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH: 'I' NEW DELHI
BEFORE SMT DIVA SINGH, JUDICIAL MEMBER
AND
SH.ANADEE NATH MISSHRA, ACCOUNTANT MEMBER
I.T.A .No.-960/Del/2014, 184/Del/2016 & 271/Del/2016
(ASSESSMENT YEAR-2009-10, 2010-11 & 2011-12)
Oriflame India Pvt.Ltd., Vs ACIT,
Ground Floor, Corporate One, Circle-13(1),
Plot No.5, NHCC, Jasola, New Delhi.
New Delhi-110076.
PAN-AAACO0256B
(APPELLANT) (RESPONDENT)
Assessee by Sh.Himanshu S.Sinha, Adv. &
Sh. Yeshu Arora, CA
Revenue by Sh. Amrendra kumar, CIT DR &
Sh. Neeraj Kumar, Sr.DR
Date of Hearing 03.01.2017
Date of Pronouncement 24.03.2017
ORDER
PER DIVA SINGH, JM
The present appeals have been filed by the assessee in 2009-10, 2010-11 and 2011- 12 assessment years. All these appeals are being decided by a common order for the sake of convenience. Whereas in the appeals pertaining to 2009-10 and 11-12 AYs, the correctness of the order dated 03/12/2013 and 18/12/2015 passed by the Assessing Officer under section 143(3) r.w.s 144C(13) and 143(3) r.w.s 144C(1) and 144C(5) respectively, is assailed. In 2010-11 assessment year, the assessee instead of approaching the Dispute Resolution Panel (hereinafter referred to as "DRP") Forum has availed of the appellate forum provided under the Statute by filing an appeal before the CIT(A). Accordingly it is the correctness of the order dated 01.09.2015 of CIT(A)-44, New Delhi which is assailed in the said year. It was a common stand of the parties before the Bench that the facts, circumstances and the issues in all the years are identical. Accordingly, Grounds from ITA No.960/Del/2014 are reproduced hereunder:-
1. "That on the facts and in the circumstances of the case and in law, the order passed by the Ld. Assessing Officer ("AO") is bad in law and void ab-initio.
2. The Ld. AO/Ld. Transfer Pricing Officer ("TPO") erred on facts and circumstances of the case in determining the arm's length adjustment to the I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 2 of 31 Appellant's international transaction from Associated Enterprises ("AEs"), thereby resulting in the enhancement of returned income of the Appellant by Rs. 14,29,24,000.
3. That the reference made by the Ld. AO suffers from jurisdictional error as the Ld. AO has not recorded any reasons in the draft assessment order based on which he reached the conclusion that it was "expedient and necessary" to refer the matter to the Ld. TPO for computation of the arm's length price, as is required under section 92CA(1) of the Income Tax Act, 1961 ("Act").
4. The Ld. AO/ TPO erred on facts and in law in the determination of the arm's length price of the Appellant's international transactions with its associated enterprises by-
4.1. using only one comparable company for the purpose of benchmarking under Resale Price Method ("RPM") and not considering product similarity of comparables adopted by the Appellant in its TP Documentation/ fresh search.
4.2. rejecting the arm's length price determined by the Appellant in the TP documentation maintained by the Appellant under section 92D of the Act read with Rule 10D of the Income Tax Rules, 1962 and its submissions and substituting the same with his own methodology without providing any cogent evidence or back up documentation in support of his statements used to reject the TP methodology adopted by the Appellant by 4.2.1 rejecting companies whose revenues are less than Rs. 5 crores without taking cognizance of the Appellant's submissions. 4.2.2 rejecting companies whose data is not available for FY 2008-
09. 4.2.3 holding that the quantitative filter of ratio of R&D expenses to sales more than 3% is an inappropriate filter.
4.2.4 applying the threshold limit of 25% for the related party transactions based on subjective grounds and without any rational justification and by disregarding various judicial pronouncements. 4.3. not following a detailed search methodology for the arm's length analysis, demonstrating cherry picking of companies, thus also reflecting a single minded intention of making an addition to the returned income of the Appellant.
5. The Ld. AO/ TPO/ DRP erred in facts and in law by considering direct selling companies to be the only appropriate comparables by ignoring the fact that the mode of selling impacts the expenses below the gross margin and would not affect the application of RPM.
6. The Ld. AO/ TPO/ DRP erred in facts and in law in selecting Modicare Ltd as a single comparable company for an arm's length analysis even though this company was not comparable on a standalone basis to the appellant in terms of functions, assets and risks assumed.
7. The Ld. AO/ TPO/ DRP erred in arbitrarily rejecting the comparables' search process and the comparables chosen by the Appellant.
8. That on the facts and circumstances of the case and in law, the Ld. AO / TPO / DRP erred on facts and in law in disregarding multiple year/ prior years' data as used by the Appellant in the TP documentation and holding that current year (i.e. FY 2008-09) data for the comparable companies should have been used despite the fact that the same was not available to the Appellant at the time of preparation of its TP documentation.
9. That the Ld. AO/ TPO /DRP erred in facts and in law in being inconsistent by rejecting the transfer pricing methodology for this financial year when the same was accepted in the prior years despite there being no change in facts and circumstances over the two years (i.e. financial year 2007-08 and 2006-07).
10. That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 274 read with section 271 of the Act mechanically for furnishing inaccurate particulars without recording any adequate satisfaction for such initiation I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 3 of 31
11. That the Ld. AO erred in facts and in law in charging and computing interest under section 234B of the Act.
The above grounds of appeal are mutually exclusive and without prejudice to each other.
The Appellant craves leave to add, alter, amend or vary any of the above grounds either before or at the time of hearing as we may be advised. The arguments taken hereinabove are without prejudice to each other."
2. Ld.AR inviting attention to the grounds submitted that Ground Nos.1 and 2 may be treated as general grounds wherein the entire issue agitated before the ITAT is highlighted and thus no specific finding qua the same may be required to be given. Ground Nos. 3 and 8 it was submitted are not being pressed in the present proceedings. Addressing Ground Nos. 4 and 5, it was submitted the issues agitated therein may be considered to be agitated before the ITAT. However, the specific grievance which the assessee wants to highlight is addressed by Ground No. 6 which is also addressed in Ground No. 4.1. Ground No. 7, it was submitted is also an argument in support of the prayer and vide Ground No. 9, reliance is being placed on the Rule of Consistency Ground Nos. 10 and 11 it was submitted may not require any specific adjudication.
2.1. In the light of the above submissions, it was submitted that the specific grievance of the assessee is primarily retention of Modi Care Ltd. as a standalone comparable rejecting the comparables selected by the assessee. The retention is also assailed as it has been done without making appropriate adjustments keeping in mind the peculiar business model of the assessee. The assessee, it was stated, is engaged in a direct sales business model the TPO wrongly rejected the comparables selected by the assessee ignoring the objection to retaining Modi Care Ltd. as a single comparable company, which has wrongly been selected and retained. The DRP in the two years and the CIT(A) in 2010-11 A.Y., it was submitted, have upheld the TPO's action in the respective years. The specific grievances of the assessee demonstrated on the basis of facts and evidences on record. It was submitted have been ignored without addressing the facts.
2.2. Inviting attention to the material available on record, it was submitted that it was an accepted position that the assessee is a routine distributor and does not own any valuable I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 4 of 31 non-routine intangibles as it is engaged primarily in distribution and sale of cosmetic products and does not undertake any value addition activities. Accordingly, the assets deployed are routine tangible assets like computers, office equipment, furniture and fittings etc. for its operations and it assumes all normal business risks of a routine distributor like market risk, price risk, customer credit risk, product liability risk, foreign exchange risks etc. The major international transaction undertaken by the assessee which is a subject matter for consideration in the present proceedings, it was submitted, is purchase of finished goods. The assessee it was submitted has selected Resale Price Method (hereinafter referred to as "RPM") as the most appropriate method. It was submitted that the gross margins of the assessee have remained healthy consistently over the years when compared with the prior years. It was also submitted that it is a matter of record that for the two previous years i.e. 2007- 08 and 2008- 09 assessment years identical international transactions of the assessee after detailed TP scrutiny analysis the transaction on an identical set of facts has been accepted to be at arm's length. It was submitted that there was no change in either the FAR profile of the assessee or of the comparables it had selected. The method adopted for benchmarking methodology followed in the year under consideration, it was submitted, also remains the same.
2.3. Referring to the facts on record, it was submitted that the PLI of the assessee for 2009-10 assessment year to 2011-12 assessment years was 45.58%; 46.79% and 48.72% respectively and since the assessee in its documentation had taken into consideration multiple years data and claimed that compared to the PLI of the comparables the transaction was at arm's length. The assessee was required to carry out a fresh search and even then the PLI of the comparable companies selected by the assessee was 32.62%; 29.70% and 32.62% respectively in the 3 years. The transaction accordingly was still very much at arm's- length. However, the TPO rejected all the comparable companies selected by the assessee on the grounds that none of these companies were engaged in direct selling and thus selecting a single comparable i.e. Modi Care Ltd. on the basis of its TP/sales of 76.47% and I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 5 of 31 without making any adjustments in order to make it comparable as provided under Rule 10 B(2) proceeded to make adjustments. The issue, it was submitted had been agitated before the DRP on this ground however it did not meet with success resulting in filing of the present appeal before the ITAT. Reiterating the submissions made before the DRP and relying upon the synopsis filed it was the prayer of the assessee that Modi Care Ltd. as the sole comparable selected by the TPO and retained by the DRP was an incorrect comparable. In support of the said submission, it was stated that Modi Care Ltd. had a diverse product portfolio which included diverse products like auto care, agricultural products, tea, jewellery, healthcare etc. and even if the personal care products of Modi Care Ltd. are aggregated with cosmetics even then the total share of these two categories would be 42.56%. In support of the said submission, attention was invited to page 26 of the Annual Report for F.Y. 2008 -09 assessment year placed at paper book page 80 of volume I. It was his submission that Oriflame India Ltd. does not deal in any of these products or categories and the different product items as are dealt with by Modi Care Ltd. makes the said comparables an incomparable. Each of these products dealt with by Modi Care Ltd., it was submitted necessarily would involve different levels of assets, risks and markets and accordingly the selection of the said company as a stand-alone comparable on gross basis under RP method was heavily assailed.
2.4. Reliance was placed upon the decision of the ITAT in ITA No.7367/MUM/2012 in the case of M/s Carlyle India Advisors Pvt. Ltd. vs DCIT. Specific attention was invited to page 9 para 12 of the same wherein Motilal Oswal Investments Advisors Pvt. Ltd. had been rejected as a comparable with an extreme OP margin of 72.33% from the final set of comparable selected by the TPO on the grounds that it was engaged in diversified activities and the segmentals were not available.
2.5. Apart from the said fact, it was also his submission that Modi Care Ltd. should not be considered as a comparable especially on a standalone basis since on a perusal of its financials, it would be evident that apart from the direct selling Model Modi Care Ltd. also I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 6 of 31 includes service income in the nature of AMC and once its service income is excluded its TP/sales would be 69.66%. The fact that Modi Care Ltd. recognises service income, it was submitted is evident from the fact that the TPO in 2010-11; 2011-12; and 2012-13 assessment years has admitted that Modi Care Ltd. recognises service income in its Profit & Loss A/c and has accordingly removed service income from the competition of margins. It was his submission that the assessee is not praying that the service income be removed from the computation of the margins as the primary objection of the assessee remains that the segmental information for each product category or the care is not available. Even otherwise, it was his submission that the details of the service income are not available in the Annual Report. Referring to the record, it was submitted that the notes to the accounts on revenue recognition stated their revenues from annual maintenance contracts and other service contracts. It was his submission that it is quite possible that Modi Care Ltd. may be deriving franchise service fee from its franchisees. These factors, it was submitted admittedly demonstrate that the said company was functionally different from that of the assessee. 2.6. Apart from the above, it was also his submission that Modi Care Ltd. has fluctuating margins, the intensive fluctuation in the sales for Modi Care Ltd. it was submitted shows that it is assuming significant business and market risks whereas in the case of the assessee there is a consistent increasing trend and there is no such risk exposure of the assessee.
Table 3: Sales trend of Oriflame India vis-à-vis Modicare Limited (INR) Sales Oriflame India Year on Year Modicare Limited Year on Year change change FY 2006-07 656,303,028 - 344,886,627 -
FY 2007-08 968,658,047 47.59% 363,303,749 5.34%
FY 2008-09 1,355,759,156 39.96% 298,286,306 -17.90%
FY 2009-10 1,930,328,718 42.38% 439,442,705 47.32%
2.7. Inviting attention to paper book page No. 151 volume-1, it was his submission that Modi Care Ltd has persistent operating losses.
2.8. Apart from these differences, it was submitted that there is differential treatment of expenses incurred on incentives/discounts between the assessee and Modi Care Ltd. In support of the said submission, attention was invited to page 19 of the Annual Report for I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 7 of 31 F.Y.2008-09 page 73 of Volume1 filed before the ITAT. It was submitted that in any direct selling business the agents/consultants who act as retailers are paid incentives discounts to remunerate them for the contribution. The arrangement it was submitted varies from one company to another and the corresponding accounting entries also differ, accordingly thus before making any comparison of gross profit margin these differences have to be accounted for otherwise the results would become unreliable. Oriflame India Ltd., it was submitted recorded sales net of discounts/incentive paid to its agents/consultants and hence shows a lower gross margin as per its accounting treatment.
2.9. The Revenue recognition policy of the two companies it was submitted, was also divergently different. Referring to paper book page 433 of volume 2, the assessee it was submitted has a policy of allowing 20% of discount on MRP to its consultants which is equal to margin of 25% of sales for the consultants. When this position is compared with the discount given to the consultants/agents which is categorised as incentives by Modi Care Ltd, it was submitted that it is a below the line in Profit & Loss A/c as a part of operating expenses. Accordingly, it does not form part of the computation of gross profit margin of Modi Care Ltd. The incentive pay to the agents and consultants works out to be around 30% of the sales over and above the said discount the assessee also pays incentives to the tune of Rs.3,032,04/- as would be evident from paper book page 44 31 of volume11 of the paper book filed before the ITAT. Accordingly, it was his submission that it is improper to compare the gross margins of Modi Care Ltd.with the assessee.
2.10. Addressing the comparables selected by the assessee, it was submitted that for J.K. Helene Curtis Ltd., Wipro and Yardley the sales is net of incentives. Thus for an apple to apple comparison it was submitted economic comparable adjustments had to be undertaken to compute the PLI for this company to account for the significant dissimilarities in the functions and revenue streams of Modi Care Ltd. and the assessee. Accordingly it was submitted the sales of Modi Care Ltd. should be reduced by the amount of incentives paid as appearing in operating expenses in its financials since for an apple to apple comparison with I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 8 of 31 the assessee, the factors imparting comparability have to be given similar treatment. The accounting treatment similar between the comparables it was submitted needs to be kept acceptable on facts. Thus the revised GP/sales of Modi Care Ltd after accounting for this adjustment and after excluding the service income it was submitted would be 40% and the GP sales of the assessee, it was submitted is 45.6% therefore even on without prejudice basis if Modi Care Ltd. is to be taken as a comparable under RPM then no transfer pricing adjustment is warranted on facts. The impact of adjustment for incentives is 30% of the GP and the exclusion of service income is 6% of the GP.
2.11. If these arguments advanced, it was submitted are considered to be not sufficient to direct necessary relief by holding that no adjustments are warranted then it may be noted that the Modi Care Ltd. has substantial variation between gross margin and net margin. Referring to the record, it was submitted that for the year under consideration, the gross margin of Modi Care Ltd. was 76.47% and its net margin was 33.78%. The substantial variance in the gross in the mid-level margins it was submitted establishes the fact that the company incurs heavy operating expenses. This factor substantiates that since heavy functions at the operating level are performed by Modi Care Ltd. accordingly the said company can not be considered to be a comparable to Oriflame India Ltd. i.e. the assessee. The said fact it was submitted further supports the argument that Modi Care Ltd. is not just a direct marketer and seller whereas Oriflame India Ltd. does not undertake any value addition functions.
2.12. Referring to the information available on the said company's website itself, it was submitted it has been stated that Modi Care Ltd manufactures its own products thus the value added expenses are high because of these manifestly high expenses and it cannot be considered as comparable to the assessee. It was submitted that even if the evidence of the website description for a moment is not considered, the incidence of such high operating expenses demonstrated that the said company having substantial value adding expenses unlike the assessee cannot be deemed to be comparable to the assessee.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 9 of 31 2.13. It was also submitted that significant advertising, marketing and promotion expenses spend when compared to its sales of 7.32% when compared to 0.49% of the assessee, would also show that functionally the companies cannot be said to be comparable and thus for an apple to apple comparison and economic adjustments for the said facts, should also be factored into and once a revised GP/sales post the said investments are carried out it would be seen that the GP is 65.95%.
2.14. Inviting attention to paper book page 19 of the Annual Report for financial year 2008 - 09 paper book page 73 volume1, it was submitted would show that Modi Care Ltd in its annual report for the aforementioned financial year has recorded franchisee expenses of Rs.20,308,572/- which is 5.09% of total operating expenses. Thus, Modi Care Ltd. admittedly is not wholly a direct seller as it has franchise business also. 2.15. Attention was again invited to paper book page 131 volume1 of the paper book filed. It was also submitted that the cost of goods sold i.e. COGS as per the financial statements for Modi Care Ltd. is only 22.56% of its total operating costs, its value, added expenses i.e.( VAE) are 77.44% of total costs. It was submitted its position admittedly is unlike the trading Co where COGS should be the dominant component of total costs as can be seen from the financials of Oriflame India Ltd. as a percentage of its total operating cost is 50.71% and the said position is in alignment with the description of a distributor hence the cost profile of Modi Care Ltd., it was submitted is also not similar to the assessee.
2.16. Without prejudice to these arguments, it was submitted that in case selection of Modi Care Ltd. as a comparable is retained as a stand-alone comparable then for an arm's-length analysis in such a situation it should be considered at net level under the TNMM as direct selling would effect net margins of the company and not the gross margins. Accordingly an analysis at the net level using TNMM which more tolerant of functional differences then the gross margin analysis it was submitted would show operating margins of Modi Care Ltd. taking OP/OI as PLI would be (-) 33.78% as compared to (-) 0.63% of the assessee.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 10 of 31 2.17. Relying upon the synopsis filed, it was submitted that the companies dealing in the business of cosmetics operate in an independent economic environment whether they engage in direct selling or retail selling. It was also submitted admittedly they are all competing against each other for capturing the attention of the same customers in the same market. Thus the mode of selling, it was submitted, does not take away the functional comparability of buying and reselling the cosmetics. Accordingly, it was argued that the comparables chosen by the assessee in its search process have been arbitrarily rejected. This argument, it was submitted in support of Ground No.4.1, 4.3.5 and 7. Attention was invited to paper book page number 123 to 127 filed. Thus, it was submitted that it is true that the assessee is a direct seller and hence may be considered to perform extra functions of carrying inventory for a longer duration at high-risk vis-a-vis an ordinary trader who may sell its inventory to another wholesaler, retailer but the said difference it was submitted can easily be accounted for by making an adjustment for higher working capital levels. A direct reseller would have a higher working capital requirement on account of higher inventory levels such an approach it was submitted is widely accepted by the OECD and the UN and has been endorsed by the ITAT also in a catena of cases.
2.18. The TPO and the DRP/CIT(A) in the respective years, in the circumstances, it was submitted has failed to appreciate that for applying RPM product comparability is necessary and since the comparables chosen by the assessee deals in cosmetics thus during the benchmarking analysis, the assessee has necessarily focused on the companies which are:-
a) primarily traders i.e. engaged in buying and selling activities; and/or
b) deal in the category of cosmetics 2.19. The business description of the comparable companies, it was submitted has been provided in the TP documentation. Attention was invited to paper book page 550 of volume II. Reliance was placed upon M/s Tupperware India Pvt.Ltd. vs DCIT (C.O.No.191/Del/2011 & 168/Del/2012): Tupperware India Pvt.Ltd., it was submitted, is a part of IDSA's list of direct selling companies. However as can be read from the said decision, the ITAT, it was I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 11 of 31 submitted, has not rejected non-direct resellers from the comparable set of companies to determine the arm's length gross margin for M/s Tupperware India Pvt.Ltd. Attention was also invited to Mattel Toys (I) Pvt. Ltd. vs DCIT (ITA No.2476/Mum/2008), ITA No.2801/mum/2008) (Para 39, page 22): It was submitted that RPM is the most appropriate method in case of distribution activities without any value addition. Hence functional and operational comparability has been defined as a necessary component and admittedly.
According all comparables selected by the Appellant should also be considered for an arm's length analysis.
3. The ld. CIT DR heavily relying on the orders of the DRP and the CIT(A) submitted that all the arguments of the assessee have already been considered in detail and have been rejected by a speaking order in the respective years. Since in 2010-11 assessment year, the CIT(A) had the benefit of the DRP's order, accordingly heavy reliance was placed on the reasoning addressed therein. Attention was invited to page Nos. 22 to 26 of the said order, it was submitted that Modi Care Ltd. has correctly been retained as a comparable. Similarly, it was submitted that the CIT(A) has also considered and rejected the supplementary TNMM analysis provided by the assessee at page 27 and 28 of the said order relying on the same it was submitted that RPM as a method is the MAM. Accordingly, it was his submission that on facts, the impugned orders may be upheld. For ready reference, the relevant extracts from the aforesaid order of the CIT(A) are extracted hereunder:-
"7.2 Decision:
I have considered the Transfer Pricing Order u/s 92CA(3), Assessment Order, Writing Submission and Oral Arguments of the Ld. AR.
First issue which is to decided as to whether the TPO action for computing ALP on the basis of singular comparable that is Modi Care Ltd. on the criteria of direct selling model is correct or not. Ld. TPO in his order has reproduced great emphasis in the functionality of the appellant on direct selling operation. The basic of TP report of the appellant laying emphasis on the profile of Oriflame Group is reproduced as under:-
2.1 Profile of Oriflame Group The Oriflamme Group was founded in Sweden in 1967. Oriflame is a global cosmetic group with direct selling operations. This means that independent sales personnel sell products directly to the end consumers, without any involvement of various retail chains.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 12 of 31 4.2.1. Functions performed by Oriflame Group.
The Oriflame group provides some 900 products in the field of skin care, make up, fragrances and toiletries through direct sales.
5. As per page-24 of TP report:-
5.2.1 Functions performed by Oriflame India Oriflame India is a routine distributor which carries out routine functions and assumes normal risks associated with carrying out such business.
The main business activity for Oriflame India is the distribution and sales of the cosmetic products through direct sales channel.
As per Page -34 of TP report:[ The company: Oriflame India faces the risk of adverse sales conditions due to increase competition in the market place. The company faces dual competition from both the cosmetics companies and direct sales companies. The company's business is also subject to adverse demand conditions.
In view of the appellant profile it would not be appropriate to treat the appellant as a routine distributor though marketing channels i.e. whole seller, retailer, show room etc. The appellant is the undisputedly member of Indian Direct Selling Association (IDSA). This Association is an autonomous body which acts as an interface between the industries and policy making body of the Government. Oriflame and Modi Care are the members of Indian Direct Selling Association. The TPO has taken the members profile from IDSA site and reproduced in the order. In view of the functionality being direct sales in my view if the comparable exists in the same segment i.e. direct selling model, then other distributors there the chains of whole selling, distributing and show rooms should not be considered. The reasons behind this conclusion is that the FAR of direct sellers or through the chain of distributing network or through show rooms are bound to be different. Risk in the case of direct selling is different as sales are affected through its own employee and the product reaches directly to the customers whereas, in the case of other distributor channels goods do not reach to the customers directly but sold through the whole seller & distributor etc. Similarly as the function is different the asset employed are also bound to be different in these two models of selling. Considering these facts, 1 am of the considered opinion that the direct selling model a strong factor in deciding comparable in the case of appellant. Though the product remains the same the profitability is bound to be different in these two business models i.e. direct sale model or sales through whole seller and distributor. Considering these entire facts and circumstances in my view the TPO is correct in his approach is not considering M/s. JK Helene Curtis Ltd and M/s. Rama Vision Ltd and other distributors as comparables while computing ALP of the International Transactions of the appellant. Under direct selling model undisputedly financial data of others companies were not available in public domain therefore, TPO was justified in considering M/s. Modi Care Ltd as single comparable to compute Profit Level Indicator as it gross margin for benchmarking the transaction through RPM. Now I would examine the various adjustment sought by the Ld. AR.
(i) Adjustment on account of cost of goods sold (COGS): Ld. AR has sought adjustment in COGS on the basis of average cost of goods sold and other expense by the appellant as well as other comparable such as J K Helene Curtis Ltd and M/s. Rama I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 13 of 31 Vision Ltd. etc. If the adjustment on account of COGS is allowed which is the main cost to compute gross margin of M/s. ModiCare.the entire purpose of computing Gross Profit Margin for the purpose of RPM analysis is lost. Tinkering of Gross Profit Margin of the comparable on the basis of other comparables which are not considered as comparable is not proper. Further, at gross margin level major cost is COGS is adjusted on the basis of appellant's result then gross margin is itself adjusted then there is no meaning of taking gross margin as profit level indicator. Accordingly, this adjustment is rejected.
(ii) Adjustment on the basis of Service Income: Ld. AR has sought exclusion of service income for the computation of Gross Margin for its trading segment. As the service income is not related to attain the direct selling activities. I have perused the financials of M/s. ModiCare Ltd. It has declared service income of Rs. 5,47,26,523/- in its Profit & Loss A/s for the Financial Year ending 31.03.2010. I have also perused the working of Gross Profit Margin computed by the TPO in its show cause. The TPO has computed Gross Profit Margin at the rate of 73.68% and while computing this Gross Profit Margin the TPO has included service income. Further, after considering the reply of the appellant Gross Profit Margin has been reduced to 70.33%.
I agree with the argument of the Ld. AR that the service income is not a part of direct sales and purchase of the goods, therefore, it should not be included while computing Gross Profit Margin. Accordingly, AO/TPO is directed to exclude the service income while computing PLI on the basis of Gross Profit 8s and reduce further if such adjustment exceeds the lowering of gross profit margin from 73.68% to 70.33%.
(iii) Adjustment sought on account of AMP:- The Ld. AR in her argument has argued that AMP expenditure in the case of Modi Care Ltd compared to sales is 10.06% and average of such expense for appellant is very low. Ld. AR has not given break up of such AMP expenses. I have perused the financials of M/s. Modi Care Ltd for Financial Year ending on 31.03.2010 the details of expenses other than cost of good sold are contain in schedule 15, 16 of the audit report which comprises of personal expense and operating and other expenses. Schedule 17 is the financial expenses which cannot be said to relate to AMP expenses. It would be proper to reproduced Schedule 15 and 16 to understand the claim of the Ld. AR for AMP expense. Schedule 15 and Schedule 16 are reproduced as under:-
Schedule 15 Personnel Expenses For the year ended For the year ended March March 31, 2009 31, 2010 (Amount in Rs.) (Amount in Rs.) Salaries, wages, bonus etc. 63,508,585 64,371,816 Contribution to provident 7,762,369 7,595,193 and other funds Staff welfare expenses 7,043,139 4,749,473 Total 78,314,093 76,716,482 Schedule 16 Personnel Expenses For the year ended For the year ended March March 31, 2009 31, 2010 (Amount in Rs.) (Amount in Rs.) Packing & other material 6,632,667 4,616,088 consumed Rent 13,447,476 13,274,323 Postage & 8,677,857 8,246,290 Communication Expenses I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 14 of 31 Insurance 2,377,921 2,522,786 Insurance employees 407,063 389,605 Travelling & Conveyance 16,536,549 21,820,807 expenses Legal, Professional & 8,287,372 7,755,203 Consultancy Charges Repair & Maintenance Others 4,428,456 5,016,559 Auditor's remuneration
-audit fee 425,000 425,000 Tax audit fee 75,000 75,000 Rates & taxes 790,292 800,462 Electricity & water 2,326,068 2,208,565 charges Provision for doubtful - 952,220 advances Advances written off 3000 855,533 Fixed assets written off 1,198,152 -
Loss on disposal of fixed 293,194 - assets -net of gain Rs. 75,430(previous year NIL) Franchise expenses 22,499,788 20,308,572 Marketing & sales 44,213,293 29,552,604 promotion expenses Freight & cartage 16,711,545 11,637,296 Incentive to consultants 99,338,781 91,171,340 Freight exchange - 123,971 difference (net) MISC Expenses 6,744,486 5,618,955 Total 255,913,960 227,071,179
A perusal of this schedule reveals that there are no item apparently of advertisement expenses as such. In any case, expenses related to marketing and sales promotion expenses effects net profitability of the business and in my view they did not affect gross margin. Accordingly, no adjustment of these alleged AMP expenses is allowed while arriving at Gross Profit Margin.
(iv) Claim of adjustment on account of incentives/discount between the appellant and M/s Modi Care Ltd.: A perusal to Schedule. 15 & 16 reproduced as above does not show any discount on the product sold. M/s. Modi Care Ltd has debited Rs. 9.93 Crores under the head incentives to consultants. This expense item is in the nature of affecting the net profitability and below the line item for computing Gross Profit Margin. Accordingly, no adjustment is allowed for computing Gross Profit Margin.
Other arguments of the Ld.AR are that M/s. Modi Care Ltd is debited franchisee expenses of Rs. 2.22 Crores. Therefore, M/s. Modi Care Ltd is not acting on direct selling model. I do not agree that the argument of the Ld. AR. M/s. Modi Care Ltd is a member of Direct Selling Association of India (IDSA). Further, from the website nowhere it has emphasized that they are working on franchise model. Therefore, apparently these franchise expense may be in the nature of some compensation to its employee and agent engaged in direct selling. Therefore, just because in the account I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 15 of 31 same expense is termed as franchises expense the business model of M/s. Modi Care Ltd. cannot be said to be non-direct selling model.
Another argument of the Ld. AR is that the cosmetics sale of M/s. Modi Care Ltd. is only 12.6% and personal care is included which percentage of sales comes to 35.87% only. Therefore M/s. Modi Care Ltd. is trading in diversified product port folios including agricultural data, jewellery etc. The TPO has dealt this issue and he has included Home Care Product of M/s. Modi Care and came to the conclusion that these three segments construte more than 60% of total sales. The Home care product can also be classified similar to personal care products.
In view of the above facts, I agree with the finding of the TPO that contribution of similar product which is sold by Oriflame excess 65% of turnover, therefore the Modi Care Ltd is good comparable as its working on direct selling model and is having mostly similar profile of products. As a result all these grounds of appeal are dismissed except adjustment allowed on account of services charges.
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9.2 Decision;
I have considered the Transfer Pricing Order, Assessment Order, Written submission and argument of the Ld. AR. Ld. AR has opted for TNMM as alternative method for benchmarking the International Transaction and has consider average net PLI (OP/OI) 12.7% being average of PLI of JK Helene Curtis Ltd and M/s. Rama Vision Ltd and Modi Care Ltd. I do not agree with the arguments of Ld. AR. The appellant is a trader, therefore, the most appropriate method is RPM for benchmarking International Transaction and therefore the Profit Level Indicator has to be considered at Gross Profit Level only. Accordingly, I confirm the approach of the TPO for benchmarking the international transaction of the appellant on the basis of RPM. Hence, this ground of appeal is dismissed."
3.1 The arguments, it was submitted, would remain the same for each of the years despite the differences in amounts and the minor variations of the names of the companies proposed by the tax payer as principally the most appropriate method; methodology; selection of comparables and the reasons for rejecting the objections of the assessee continue to remain the same.
4. Countering the submission of the ld. CIT DR, the ld AR relying upon the synopsis filed, submitted that the objections have not been considered on facts. Inviting attention to the synopsis filed for 2010-11 assessment year, following paragraphs were specifically highlighted in order to show that the grievance of the assessee still persists.
Grounds of appeal and reasoning thereon
8. Arm 's Length Price of Assessee's international transactions of purchase of finished goods had been accepted by the customs department as per the Special Valuation Board Order. (Page no.133 of ITAT paperbook) - Ground no. 5.4 I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 16 of 31 The Special Valuation Board Order of the Customs Authorities (dated 8.2.2013 and valid till 8.2.2016) has accepted the arm's length price of the international transactions of import of goods by Oriflame India.
9. Selecting Modicare Ltd as a single comparable company for the arm's length analysis even though this company was not comparable on a standalone basis to the appellant in terms of functions, assets and risks assumed and its product profile and by disregarding that this company was a persistent loss making company (Page no. 114-125 of ITAT paperbook} - Ground no. 5.2 As per Rule 10B(3) of the Income Tax Rules 1962, reasonably accurate adjustments need to be made to enhance the comparability. Also, as per 3.51 of OECD guidelines 2010, if reasonably accurate adjustments cannot be made then the comparable needs to be rejected. Hence, in view of the significant differences in the product profile, functional profile and accounting differences between Modicare Ltd. and Oriflame India it is not possible to make reasonable accurate adjustments specially as Modicare Ltd. has a diversified product profile and product segmental are not available, Modicare Ltd. should be rejected. 9.1 Diversified product portfolio (Please refer to Page 54 - 55 of the Annual Report for FY 2010-11 ) Cosmetics comprised only 15.68% of the total product portfolio of Modicare Ltd. Even if personal care is aggregated with cosmetics, then also the total share of these two categories is only 37.57%. Therefore 62.43% share comprises as diverse products like auto care, agricultural products, tea, jewellery, healthcare, etc. (Please refer to Page 54-55 of the Annual Report for FY 2010-1 1) (Page no. 114- 115 of ITAT paperbook) It may be noted that Oriflame India does not deal in any of these product categories. (Page no. 115 of ITAT paperbook) Different product items would involve different level of assets, risks and markets and accordingly this company cannot be selected as a standalone comparable on a gross basis under RPM. Table no. 2: Diversified product portfolio as per annual report of Modicare Ltd.
S.No. Products Sales (INR) % of the total
product turnover
1. Laundry & Home Care 78,765,810 14.34%
2. Personal Care 120,292,729 21.89%
3. Agriculture 79,718,481 14.51%
4. Tea 8,045,875 1.46%
5. Jewellery 53,766,590 9.79%
6. Cosmetics 86,129,350 15.68%
7. Healthcare 88,886,747 16.18%
8. Others 33,819,599 6.16%
Total 549,425,182
Case laws relied upon: M/s Carlyle India Advisors Pvt. Ltd. vs. DCIT (ITA no. 7367/ Mum/2012) (Page 9. para 12): Hon'ble Mumbai CIT rejected a comparable Motilal Oswal Investment Advisors Pvt Ltd with an extreme OP margin of 72.33% from the final set of comparables selected by the Ld. TPO since it was engaged in diversified activities and segmental was not available. 9.2. Diverse functional profile (Please refer to Page 35 of the Annual Report for FY 2010-11) Modicare Ltd. recognizes service income in its profit and loss account to the extent of 9.66% of its total revenue (including service income). This as per its annual report is in the nature of AMC income and other service income on the basis of the agreement. This service income clearly shows that the revenues are not only from reselling activity. Hence, as it has businesses apart from direct selling Modicare Ltd. should not be considered as a comparable, especially on a standalone basis. Further, the Ld. TPO in the FY 2009-10, FY 2010-11 and FY 2011-12 has admitted that Modicare Ltd recognizes service income in its Profit & Loss account and has accordingly removed service income from the computation of margins. Hence, the Ld. TPO has accepted that Modicare Ltd is not comparable to the Appellant. However this adjustment is not appropriate as segmental information for Modicare Ltd is not available.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 17 of 31 9.3 Fluctuating Sales Modicare Ltd. has highly fluctuating sales while the Appellant has a consistent increasing trend. The intensive fluctuation in sales for Modicare Ltd shows that it is assuming significant business and marker risks while the same is not the case for the Appellant. (Page no. 115-116 of ITAT paperbook) Table 3: Sales Trend of Oriflame India vis-a-vis Modicare Limited (INR) Sales Oriflame India Year on Year Change Modicare Limited Year on Year change FY 2006-07 656,303,028 - 344,886,627 -
FY 2007-08 968,658,047 47.59% 363,303,749 5.34% FY 2008-09 1,355,759,156 39.96% 298,286,306 -17.90% FY 2009-10 1,930,328,718 42.38% 439,442,705 47.32%
9.5 Differential treatment of expenses incurred on incentives/ discounts between the Appellant and Modicare Limited (Please refer to Page 86 of the Annual Report for FY 2010-11, Page 122-124 of ITAT paperbook) Oriflame India shows the sales net of incentives and hence shows a lower gross margin as per its accounting treatment. The revenue recognition policy of the Appellant is shown at Page No 339 of the ITAT paperbook). The amount shown as discount is categorized as Incentives by Modicare Limited. Accordingly, it is shown as below the line in profit & loss account as a part of operating expenses. The Appellant over and above the discount pays incentive to the tune of INR 3,974,543 (Page 337 of ITAT paperbook). Therefore it is improper to compare the gross margins of Medicare Limited with the Appellant.
Table 5: Discounts/ Incentives shown in operating expense Particulars Oriflame India Modicare Rama Vision Ltd. J K Helene (INR) Limited (INR) (INR) Curtis Ltd.
(INR Lakhs)
Incentives/Discount 3,974,543 110,428,823 2,126,923 91.40
Incentives/Discount/Total 0.18% 18.21% 1.26% 0.58%
operating Cost %
Without prejudice, for an apple to apple comparison economic comparability adjustments have to be undertaken to compute the PLI for this company to account for the significant dissimilarities in the function and revenue streams, between Modicare Ltd. and the Appellant. Hence sales of Modicare Ltd should be reduced by the amount of incentives paid as appearing in operating expenses in its financials since for an "apple to apple" comparison with the Appellant and other comparables acceptable to the Appellant, so as to keep the accounting treatment similar (Page no. 123 of ITAT paperbook). The revised GP/ Sales of Modicare Limited would be 48%.
9.6 Medicare Ltd, has substantial variation between gross margin and net margin The Appellant would like to state that Modicare Ltd has a gross margin of 66.77% (as per Ld. TPO) whereas, its net margins are -9.94%. 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 other hand does not undertake value addition functions. (Page no. 117 of ITAT paperbook) 9.8 Significant Advertising Marketing and Promotion (AMP) spend (Please refer to Page 86 of the Annual Report for FY 2010-1 1) Modicare Ltd. has significant AMP/sales of 10.41% as compared to Oriflame India which is only 0.85%. This clearly shows that this company has significantly different functions as compared to the Appellant and is being remunerated on a premium pricing. (Page no. 121 -122 of 1TAT paperbook). An economic adjustment for the same should be carried out for an apple comparison. The revised GP/ Sales post the said adjustment would be 62.02%.
9.9 Franchise business model Modicare Ltd. in its Annual Report for FY 2010-11, has recorded franchisee expenses of INR 26,914,881 which is 4.44% of total operating expenses. In this regard, Modicare Lid. is operating as a franchise business and is not wholly a direct seller (Page no. 120 of ITAT paperbook) 9.10 Difference in COGS ratio and VAE ratio I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 18 of 31 The total COGS, as per the financial statements, for Modicare Ltd is only 28.61% of its total operating costs. Its Value added expenses ("VAE")/ operating expenses (other than COGS) are 71.39% of total costs. This is unlike a trading company where COGS should be the dominant component of total costs. As can also be seen from the financials of Oriflame India, its COGS as a percentage of its total operating cost is 50.06% as is the case that should be with a distributor. Hence, the cost profile of Modicare Limited is not similar to the Appellant. (Page no. 118 of ITAT paperbook) Table 6: Comparison of cost profile of Modicare Limited with other distributors FY 2010-11 Particulars COGS/Total cost% Other expenses (Excluding COGS/Total Cost%) Oriflame India 50.06% 49.94% Modicare limited 28.61% 71.39% J K.Helene Curtis Limited 54.01% 45.99% Rama Vision Ltd. 71.3% 28.65% From the above table, it can be inferred that either:
i. Modicare Ltd is not acting as a reseller as it undertakes substantial value added expenses or ii. It has recorded some of the COGS related expense items as part of operating expenses An economic adjustment for differences in the cost profile of Modicare Ltd, and the Appellant should be carried out. This adjustment has been computed by bringing the VAE of Modicare Limited to the level of VAE of the independent distributors of Cosmetics. As can be seen from the analysis below the ratio of COGS to VAE in case of a trader is 60:40 approximately. Modicare Limited is incurring heavy expenditure at the operating level for instance its freight outward expenses, incentives and franchisee expenses are very high in proportion to the purchase cost that it is incurring. If the VAE adjustment is carried out then the gross margin of Modicare Ltd. is25.02% (Page no. 119 of ITAT paperbook) 16 The companies chosen by the Appellant in the TP documentation/ fresh search are comparable to the Appellant in terms of their products, functions, assets and risks and should be considered while computing the arm's length margin.
17 If these companies are considered, then the results of the benchmarking analysis would be: (Page no. 113 of ITAT paperbook) Table no. 9: GP/Sales margins of comparables engaged in trading of cosmetic products S.No. Name of the Company GP/Sales FY 2010-11
1. J K Helene Curtis Ltd. 52.05%
2. Rama Vision Ltd. 30.61% Average 41.33% Oriflame India's Margin 48.72%
5. We have heard the rival submissions and perused the material available on record.
Before we proceed to adjudicate upon the issues arising in the present appeal, it is appropriate to first refer to certain relevant facts. Oriflame India Private Limited is a subsidiary of Oriflame Investments Ltd., Mauritius and the ultimate holding company is Oriflame Cosmetics S.A. Luxemburg. The assessee is stated to be primarily engaged in distribution and sale of cosmetic products and does not undertake any value addition activities. It also does not own any valuable non-routine intangibles and deploys only routine tangible assets like computers, office equipment, furniture and fittings etc. for its operations.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 19 of 31 Accordingly, the assessee described itself as a routine distributor, who is assuming all normal business risks like market risk, price risk, customer credit risk, product liability risk, foreign exchange risk etc. It undertook 6 international transactions in the year under consideration with its Associated Enterprise, the dispute in the present proceedings and in the other two years, revolves around only the international transaction pertaining to purchase of finished cosmetic goods . The international transactions undertaken by the taxpayer in 2009-10 assessment year are summarised hereunder:-
No. Nature of transaction Method Value of transaction
1. Purchase of finished cosmetics goods 41,84,39,934
2. Sale of finished cosmetic products 3,76,715
3. Use of catalogue services in the nature of 1,34,58,598
drawing and design for products RPM
4. Receipt of services 3,00,35,592
5. Cost reimbursements paid 1,57,57,891
6. Cost reimbursements received 1,24,744
5.1. It is a matter of record that the taxpayer in the year under consideration selected Resale Price Method (hereinafter referred to as "RPM") as the most appropriate method selecting Gross Profit / sales as the Profit Level Indicator (hereinafter referred to as "PLI"). Considering the adjusted average 3 years margin of Avon Beauty Products India Private Limited; Bodyline International Private Limited; JK Helene Curtis Ltd; Paramount cosmetics (India) Private Limited and Surya Vinayak Industries Ltd in 2009-10 assessment years, it was concluded that compared to the unadjusted average margin of 3 years as 29.95%, the tax payer's margin of 45.58% did not warrant any adjustment as the transaction was admittedly at arm's length. It has also been argued that the PLI of 2010-11 assessment year was 46.79% and in 2011-12 assessment year it was 48.72%, which was much higher than that of the comparables. On the basis of these facts, it was claimed that the transactions with its AE over the years were at arm's length. Since the unadjusted average margin of 3 years was not accepted by the TPO, the taxpayer was required to carry out a fresh search of the comparable companies for the respective years, even then the GP margins were 36.62%; 29.70% and 37.47% respectively and it was again claimed that no adjustment was I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 20 of 31 warranted. It has also been argued before the tax authorities and repeated before us that the gross margins of the assessee have remained healthy and consistent over the years. 5.2 It has also been argued by the ld AR that identical international transactions of the assessee in the immediately preceding two assessment years namely 2007 - 08 and 2008 - 09 assessment years similarly claimed and supported by identical documentation and methodology after detailed TP scrutiny and analysis and many rounds of discussion have been accepted to be at arm's length by the tax authorities. Thus in the absence of any change either in the FAR profile of the assessee or of the comparables selected or the method of TP report documentation adopted or the benchmarking methodology, the rejection of the tax payers comparables has been assailed on the grounds of being arbitrary and ignoring rule of consistency as the same is comparable to the immediately preceding assessment years.
5.3 We find that in the face of the given facts where admittedly there is no dispute on the selection of most appropriate method, the without prejudice prayer of the ld. AR for a direction that TNMM may be directed to be selected as the MAM, has to be rejected. While so holding we make it clear that this conclusion is specific to the facts of the present three years and is not a conclusion that need necessarily bind the parties in the subsequent years as firstly the issue does not arise in the present appeals and thus is academic in nature. Secondly since the parties were not required to address the same and thus the issue is left open as without a proper representation on the same by both the parties it cannot be decided. Having so held, we record that although we have deliberated on the merits and demerits of the most appropriate method in passing and are conscious of the fact that TNMM as a method is more tolerant to minor functional and product variation and thus tolerates a higher level of deviation in the comparables selected and is also a more reliable method where data may not be very robust. However, since in the facts of the present case the tax payer has consistently proposed RPM as the most appropriate method and this method has been accepted by the TPO, the occasion to comment upon and proceed to decide the I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 21 of 31 method in the absence of a dispute even on an oral request of the ld. AR has to be rejected. We also note that RPM is one of the traditional methods and is ideally the best suited method to a case like the present case where admittedly no value added services are performed by the taxpayer. The function performed is that of a routine low-risk distributor. The product is directly purchased from the foreign AE and resold at a specific price as per the sale policy of the foreign AE. We, thus, do not deem it appropriate to address the issue as we find that the selection of the most appropriate method is an accepted fact as the method adopted by the assessee has been accepted by the TPO. It goes without saying that the product which is purchased by the assessee admittedly falls in the category of cosmetic and personal care. The product is stated to be competing in a highly competitive socio economic market segment in the country with many domestic and international players competing for attention in the limited segment. The assets stated to be employed by the taxpayer are routine assets like computers, office paraphernalia etc. Qua the risks also the taxpayer is stated to be reasonably cushioned as the market risk; capital risk etc. are risks borne by the foreign AE. The taxpayer is stated to be exposed to normal inventory risk and limited credit risk. We find that the tax authorities have noted in passing that the risk of unsold inventory is entirely borne by the taxpayer. We find that such an observation without addressing the sale policies of unsold inventory of the foreign AE cannot be of any relevance. Accordingly if inventory risk is to be inferred as a negative in favour of the assessee then the specific contractual agreements and the cost/pricing policies of unsold inventory, also will need to be necessarily addressed. We find that the taxpayer has consistently in all the three years namely two years before the DRP i.e. in 2009-10 and 2011-12 assessment year has taken objections to the selection of Modi Care Ltd. as a stand-alone comparable on multiple grounds. These arguments and objections have already been brought out in detail in the earlier part of this order. We also note that the taxpayer in 2010-11 assessment year has availed of the Appellate forum by filing an appeal before the CIT(A) wherein again similar objections as posed before the DRP have been raised by the taxpayer.
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 22 of 31 5.4 Before we address the aforesaid submissions, we deem it appropriate to first extract the specific Rule which is required to be considered as the tax payer has taken shelter under the rule to support its prayers. For the purposes of sub-section (2) of Section 92C, Rule 10 B (1) of the Income Tax Rules, 1962 sets out that the arm's length price shall be determined by any of the following methods being the most appropriate method. As noted in the facts of the present case there is no dispute on the selection of most appropriate method. Whereas clause (a) of sub clause (1) of Rule 10B talks of CUP method clause (b) of the said sub clause with which we are concerned in the present proceedings sets out the requirements of RPM.
5.5 For ready reference the relevant Rule is reproduced hereunder:-
Determination of arm's length price under section 92C . 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction 55a[or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :--
(a ) comparable uncontrolled price method, by which,--
(i) xxxxxxxxxxxxxxxxxx
(ii) xxxxxxxxxxxxxxxxxx
(iii) xxxxxxxxxxxxxxxxxxx
(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) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;
(iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;
(iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction 55a[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 gross profit margin in the open market;
(v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise."
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 23 of 31 5.6. On a perusal of the above, we note that the legislature envisages in its wisdom in sub-clause (ii) of clause (b) of sub-Rule (1) of Rule 10B that the comparison would be with the resale of the same or similar property and also envisages a comparison with a company providing the same or similar services. Sub clause (iv) of clause (b) of sub- Rule(1) of Rule 10B further necessitates that the price so arrived at is to be adjusted to take it into account the functional and other differences including differences in accounting practices...... Which could materially affect the amount of gross profit margin in the open market. Accordingly looking at the requirements of the Act as set out in the Rules, we find that the grievance of the taxpayer has admittedly neither been addressed by the DRP in the two years nor by the CIT(A) in the respective years. A further perusal of sub-Rule (2) of Rule 10B of the I.T. Rules, 1962 throws light on the aspect that comparability of international transaction with an uncontrolled transaction for the purposes of sub-Rule (1) shall be judged with reference to the specific characteristics of the property transferred or services provided; the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties; contractual terms (whether or not such terms are formal or in writing), which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties; conditions prevailing in the markets in which the respected parties to the transactions operate etc. Thus it is unambiguously made clear by sub-Rule (2) of Rule 10B that there should be a FAR comparability and the degree of comparability is insisted upon to the extent that it is likely to a materially effect the price or cost charged or paid in or the profit arising from such transactions or reasonable accurate adjustments can be made to eliminate the material facts of such differences.
5.7 For ready references we also reproduce sub-Rule (2) and (3) of Rule 10B of the IT Rules, 1962:-
10B(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following; namely:-
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 24 of 31
(a) the specific characteristics of the property transferred or services provided in either transaction;
(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;
(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retain.
10B(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if-
(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or
(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences."
5.8 Thus when considered in the light of the aforesaid statutory Rules, we find that the tax authorities while considering the grievance of the tax payer admittedly have taken a position contrary to what has been envisaged under the Rules.
5.9. Having so addressed, we find that over the years primarily the taxpayer has raised the issue that Modi Care Ltd. as a stand-alone comparable was ideally not an appropriate comparable and has also canvassed that the comparables selected by the taxpayer have wrongly been rejected by the tax authorities. One of the many lines of arguments taken by the taxpayer is that firstly Modi Care Ltd. has a very limited cosmetic and personal care product category thus it lacks product similarity; secondly it also has income from franchisees, hence it is not a similar service; thirdly its discounts are below the line expense and Revenue recognition policies are also significantly incomparable; fourthly it has high AMP spend; fifthly it has fluctuating sales; its incentives schemes are different it has wide variation between its gross margins and net margins thereby giving weight to the allegation that heavy functions are being performed at the operating level. 5.10 We note that as per text book definitions RPM, pre-supposes that there is no value added services being provided by the distributor and since marketing and promotion are I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 25 of 31 considered to be value adding services thus in order to make the selected companies comparable this activity also has to be factored in. The taxpayer has claimed that when the expense of advertising and marketing of Modi Care Ltd is compared to the taxpayer there are significant differences in the 3 years under consideration. This fact becomes more significant when considered in the peculiar facts that a distributor is remunerated for the functions performed by it. The higher the functions performed higher is the expectation of higher profits.
5.11 RPM is a traditional method and is typically resorted to in order to determine ALP of purchases made by the distributor from related party. The method is applied where necessarily the distributor does not carry out any material value addition services and confines itself only to distribution activities. Ownership of intangibles by the distributor would ordinarily discard RPM as the appropriate method for determining ALP. Similarly marketing and promotion activities being value additional activities are not presumed to be carried out by a low-risk routine distributor. No doubt, product comparability is less decisive when using RPM as opposed to when using CUP method but the fact remains that at the micro-level differences in product would impact the FAR of the two companies being compared. Thus, many factors determine the comparability of companies under the RPM method also which also includes the similarity of functions assets and risks and a broad level similarity of product is expected. It is emphasised that near identical comparability in product is not necessary but to the extent, it is possible it should be ideally aspired for. At the same time wherever it is demonstrated that it impacts the gross profit of the comparable transactions appropriate adjustments are required to be made. In view of the fact that there are difficulties in identifying identical or near identical FAR profiles where Indian companies are not required to disclose gross margins earned in the financials, identification of gross margins based on limited disclosures in financials at times may make the method unsuitable in certain conditions. The insistence on accounting consistency cannot also be over emphasised as gross profit margins will not be comparable if accounting principles and/or practices differ I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 26 of 31 between the controlled transaction and the uncontrolled transaction. As has been argued by the taxpayer, the comparable company differs from the assessee company in reporting certain costs. Thus where a comparable company reports certain costs, for example discounts, transportation costs, insurance and performing the warranty function as operating expenses or its costs of goods sold or the differences in inventory valuation methods these variations will also affect the gross margins. It is thus important that the analysis does not compare apples with oranges but rather apples with apples. Therefore there can be no escaping the undeniable conclusion that appropriate adjustments should be performed to the data used in computing the gross margin to make sure that similar gross margins are compared. Thus in order to ensure that the selected company and the comparable company perform a similar and a near identical function and is also a low-risk distributor of the product purchased from the foreign AEs, there is again no escaping the statutory requirements and thus there can be no two opinions to hold that it is imperative to consider the contractual terms and the risks undertaken the economic conditions and the class of asset or services in which the two companies operate. The said exercise is necessary undeniably as it is important to keep in mind the fact that the distributor is remunerated for its functions as it does not carry out any value adding activities. Thus the gross margins earned by the distributor being a reflection of functions performed; risks assumed; and assets employed necessarily mandates that the comparable selected which performs more functions and assumes a higher risk or owns more valuable assets then the selected party then it should necessarily also earn a higher gross margin to cover additional costs and earn additional profit. It is for this purpose that comparability of similar functions needs to be identified. No doubt as opposed to CUP where a higher order of product comparability is necessary, in the case of RPM product comparability is not as strictly required to be adhered to as distribution activities may broadly remain the same. However, again there is no escaping the undeniable truth i.e. certain degree of similarity of class of goods is necessary as it cannot be presumed that the FAR of an agricultural-based automated component, company would be similar to I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 27 of 31 the FAR of a pharmaceutical company or a company distributing chemicals for industrial or agricultural activity. Thus we find that the objections of the taxpayer to the extent that the stand-alone comparable has higher advertise spend; has franchisee income has a different product mix has different accounting policies and Revenue recognition policies has higher discounts and rebates are not given as below the profit line, expenses which are not reflected in the Profit & Loss account of the said comparable etc. are arguments, which principally should have been accepted and the calculations of the tax payer be examined and required to satisfactorily demonstrate its claim.
5.12. Accordingly, in view of the above, we are of the considered view that ideally the tax authorities should not have selected Modi Care Pvt. Ltd. as a standalone comparable. The tax authorities should have carried out a search or directed the assessee to carry out a fresh search ensuring that the comparables selected were primarily engaged in direct sales with no meaningful value addition activities. To the extent possible product similarities 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 either with 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 income has been excluded by the TPO himself in the subsequent I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 28 of 31 years and in fact in one of the years in the present proceedings. It has been argued that if the adjustments are thus made then no adjustments to the arm's length price of the assessee would be necessitated. We note that the tax authorities have not considered the calculations as principally they have been of the opinion that no relief was warranted. Holding the said approach of the tax authorities contrary to the statutory position we direct the TPO to look into the claim of adjustments required to be made to Modi Care Limited. While so directing it is made clear that the responsibility for providing the supporting data to the satisfaction of the TPO rests with the assessee. The TPO cannot be burdened to look for possible adjustments. In case the tax payer does not succeed on this ground then the TPO may consider directing the assessee to carry out a search of comparable companies from the list of direct sellers in the market, as has been referred to in the TPO in the respective years and the CIT(A) has also specifically mentioned the direct sellers at pages 8 and 9 of his order. The comparable companies with suitable adjustments adhering to the requirements as set out in sub-Rule (1), (2) and (3) of Rule 10B of the IT Rules may be selected.
5.13 We also deem it appropriate to note that the arguments of the tax payer that similar comparables have been selected in the earlier years and thus the comparables who admittedly are retail sellers and not in direct sales should still be retained on the grounds of consistency we find on consideration is an argument which has to be rejected as the said comparables fail on the threshold level of functional aspect itself at the outset. The mistakes made if any in the earlier year with regard to the selection of comparables cannot be an acceptable basis either for retaining or rejecting a comparable. The selection and retention of a comparable should be justified on the basis of facts ex facie on record and not on the basis of omissions or mistakes of the parties. It would not be out of place to quote from the well celebrated judgment of the Hon'ble Apex Court the oft repeated dictum that there is no heroism in perpetuating an error. Thus, shelter behind the rule of consistently for retaining the comparables selected by the assessee on this ground has to be rejected out rightly as it reeks of "lazy repetition" as considered and referred to by their Lordships and extracted in I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 29 of 31 Chryscspital Investment Advisors (India) Pvt. Ltd. Vs DCIT 2015-TII-13-HC-DEL-TP dated 27/4/2015 wherein their Lordships quote Justice Felix Frankfurter's following extract from Tiller v. Atlantic Coast Line Railroad Co. 318 U.S. 54 (1943);
"A phrase begins life as a literary expression; its felicity leads to its lazy repetition; and repetition soon establishes it as a legal formula, indiscriminatingly used to express different and sometimes contradictory ideas".
(emphasis provided) 5.14 Though, in the facts of the present case as noted earlier also for the three years under consideration selection of most appropriate method is not in dispute, we deem it appropriate to refer to sub-Rule (2) of Rule 10C of the IT Rules, 1962 for the sake of clarity noting that since it is a recurring issue and that in the peculiar niche area of cosmetics there are multiple players in the limited market the persuasiveness of the arguments that the business model of direct sales or retail sales as far as the specific target customer base is concerned the business model of direct sales may not be a relevant criteria thus we make it clear that the issue has been left open to be decided as and when and if ever a challenged is posed to the application of RPM as the most appropriate method. In order to take guidance from the Rules we deem it appropriate to refer to Rule 10C of the IT Rules wherein sub-Rule (1) of Rule 10C throws light on the criteria to be adhered to and makes it clear that for the purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction or specified domestic transaction, and which provides the most reliable measure of an arm's length price in relation to the international transaction or the specified domestic transaction, as the case may be. Sub-Rule (2) of Rules 10C further succinctly and unambiguously elaborates that in selecting the most appropriate method various other factors set out in clause (a) to (f) need also to be taken into account. Thus we note that there is ample guidance and clarity which shines as a beacon light on the selection of most appropriate method and tacit mistakes or omissions if any committed in the past by the parties need not be repeated ad infinitum as has been well settled by the Hon'ble Apex I.T.A .No.-960/Del/2014, 184 & 271/Del/2016 Oriflame India Pvt.Ltd. vs ACIT Page 30 of 31 Court when it observed in the celebrated judgment that there is no heroism in perpetuating an error.
5.15 For ready reference and for the sake of convenience, sub-Rule (2) of Rule 10C referred to in the above deliberation is reproduced herein:-
"10C(2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely:-
(a) the nature and class of the international transaction [or the specified domestic transaction];
(b) the class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises;
(c) the availability, coverage and reliability of data necessary for application of the method;
(d) the degree of comparability existing between the international transactions [or the specified domestic transaction] and the uncontrolled transaction and between the enterprises entering into such transactions;
(e) the extent of which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transaction or between the enterprises entering into such transactions;
(f) the nature, extent and reliability of assumptions required to be made in application of a method."
5.16. Thus though the issue may be of academic interest in the present proceedings we deem it appropriate to clearly and ambiguously set out that on the selection of the most appropriate method there is no finding given as the issue is not under challenge in the present proceedings.
6. Accordingly, in view of the above detailed reasoning and the conclusion the issues are remitted back to the TPO in the respective years to comply with the aforesaid directions set out hereinabove.
7. Accordingly, the appeals of the assessee are partly allowed for statistical purposes.
The order is pronounced in the open court on 24th of March 2017.
Sd/- Sd/-
(ANADEE NATH MISSHRA) (DIVA SINGH)
ACCOUNTANT MEMBER JUDICIAL MEMBER
*Amit Kumar/Amit Ranjan*
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016
Oriflame India Pvt.Ltd. vs ACIT
Page 31 of 31
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(Appeals)
5. DR: ITAT
ASSISTANT REGISTRAR
ITAT NEW DELHI
I.T.A .No.-960/Del/2014, 184 & 271/Del/2016
Oriflame India Pvt.Ltd. vs ACIT