Income Tax Appellate Tribunal - Delhi
Knorr Bremse India Pvt. Ltd., Faridabad vs Assessee on 3 October, 2011
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH "I" NEW DELHI
BEFORE SHRI B.R. JAIN : ACCOUNTANT MEMBER
&
SHRI I.C. SUDHIR: JUDICIAL MEMBER
ITA no. 5097/Del/2011)
Asstt. Yr: 2007-08
M/s Knorr-Bremse India Pvt. Ltd. Vs. ACIT, Circle-1,
Faridabad. Faridabad.
( Appellant ) ( Respondent )
Applicants by : Shri G.C. Srivastav Adv. &
Shri Manoneet Dalal
Respondent by: Shri Peeyush Jain (CIT- DR )
ORDER
PER B.R. JAIN:
This appeal by the assessee, against order dated 3-10-2011 by the ACIT, Circle-1, Faridabad, raises following grounds in appeal:
"On the facts and in the circumstances of the case and in law, the learned AO based on directions of DRP:
Not providing sufficient opportunity
1. Erred in not providing sufficient opportunity and order passed in violation of principles of natural justice and is otherwise arbitrary and is thus bad in law and is void ab- initio;
General
2. Erred in assessing the total income at Rs. 62,565,161/- as against total income of Rs. 17,161,832/- computed by the appellant;2
Segregation of closely linked transaction and
3. Erred in rejecting the Transactional Net Margin Method ('TNMM'), wherein closely linked transactions were benchmarked together and instead segregating the closely linked transactions for the purpose of benchmarking such transactions thereby making an adjustment of Rs. 56,157,877 by determining the arm's length price ("ALP") of the following international transactions of the appellant as NIL;
i. Payment of management fee;
ii. Payment of professional fee; and iii. Payment of SAP implementation fee.
Selection of method
4. Erred in rejecting the transfer pricing documentation maintained by the appellant and upholding the non- acceptance of Transactional Net Margin Method ('TNMM') adopted by the appellant for determination of its arm's length price in connection with its international transaction;
5. Erred in upholding the adoption of comparable uncontrolled price ('CUP') determining the arm's length price in respect of appellant's international transaction without providing any comparable uncontrolled transaction(s) for the computation of the ALP;
Scope of transfer pricing adjustment
6. Erred in not following one of the prescribed methods for computing the arm's length price in relation to international transaction, without appreciating that the scope of transfer pricing adjustment is restricted to computing the arm's length price for the international transaction with associated enterprises;
7. Erred in misinterpreting and ignoring the information provided by the appellant during the course of proceedings to substantiate the receipt of services and benefits and thus reaching at an inappropriate conclusion 3 that the arm's length value of the impugned transactions should be Nil;
SAP Implementation charges
8. The Learned TPO erred in determining the ALP of the SAP implementation transactions as Nil by ignoring the factual details wherein the benefits from receiving services from AE at lower rates was clearly evidenced by the appellant. Further, the AO/TPO erred in the facts and circumstances of the case, by not complying with the directions provided by the Hon'ble DRP with regard to recomputation of the ALP of the SAP implementation charges as the same were found to have met the benefit test by the DRP.
Benefit of +-5%
9. Without prejudice to above grounds, erred in not providing the benefit of +-5% under proviso to Section 92C of the Act for purposes of computing the arm's length price in respect of international transaction;
The above grounds are independent and without prejudice to each other unless mentioned specifically."
3. Briefly, the facts are that the assessee company is a wholly owned subsidiary of Knorr-Bremse Far East Ltd. It is engaged in the business of manufacturing air brake sets of passenger cars and wagon coaches, shock absorbers for passenger cars and locomotives, distributor valves, computer control break system, tread break unit and brake accessories. The business of the company is segregated in manufacturing and distribution segment. During the year under consideration, the assessee entered into international transactions with associated enterprise ("AE" in short). The details of such transactions were found mentioned in form no. 3CEB filed by the assessee along with the return of income. The AO thereafter referred the case to the TPO in terms of provisions of Sec. 92CA(1) of the Act after taking statutory 4 approval from the Commissioner of Income-tax at Faridabad for computation of Arm's length price ("ALP" in short) in relation to the international transactions. The TPO worked out adjustment of Rs. 5,61,57,877/-, the amount which was attributable to difference in ALP of the international transaction entered into by the assessee with its AE by passing an order dated 27-10-2010, which contained detailed reasoning for making the adjustment by application of CUP method and by determining ALP in respect of following transactions at Nil:
Professional consultancy 15,207,206 Debited to Profit & Loss Account Management fee for support 14,056,800 -do-
services SAP consultancy charges and 26,893,871 Capitalized in fixed asset other schedule. Expenses Total 56,157,877
3.1. The AO thereafter made a draft assessment order u/s 144C(5) of the Act on 20-12-2010 proposing to assess the returned income of Rs.
1,71,64,832/- to Rs. 6,25,65,161/-. In this income, the adjustment suggested by TPO was incorporated without any alteration or adjustment.
3.2. Thereafter the assessee carried the dispute before the Dispute Resolution Panel-I, New Delhi ("DRP" in short), by way of filing his objections in prescribed form no. 35A on 25-1-2011. The DRP after affording effective opportunity of being heard to the assessee and after considering entire facts as brought before it by the assessee found ( as noted in para 3.1 of their order) that the determination of ALP which is different from that determined by the assessee indicates that there were flaws in TP study by the assessee and hence sec. 92C of the Act was rightly invoked in 5 this case. The ld. DRP also took note of the fact that a show cause notice was issued to the assessee on 29-9-2012 and the draft assessment order was passed by the AO after considering the assessee's reply dated 18-10-2010 and 19-10-2010. It, however, found no reason to interfere with the adjustment of Rs. 5,61,57,877/- by observing as under:
"DRP has perused facts on record and finds that SAP license and M.S. Office have been purchased at a lower rate benefiting the assessee and to that extent benefit test for the recipient is clear and assessee must be given benefit. Accordingly, TPO to verify and recompute ALP if needed. The assessee has furnished letter of appointment of Ms. Rita Ricken as team leader sales logistics. The emails enclosed in submissions dated 24-01-2011 before DRP do not however on perusal show any sales logistics work. She seems to be merely coordinating training sessions which are restricted to a few people and not all the user employees. It appears that the emails are an effort to justify her presence which appears to be for safeguarding group interest/ shareholder interest. TPO has analysed each service and benefit received by assessee in detail. No cost allocation key has been furnished to DRP either. The arguments/ evidences have been considered including these submitted before DRP. Payment of taxes in India by expat employees is as per domestic laws and are not related to ALP determination. So this argument of the assessee before DRP is illogical."
3.3. The AO made the assessment on 3-10-2011 by making addition of Rs. 2,92,64,006/- comprising of Rs. 1,52,07,206/- on account of professional consultancy and Rs. 1,40,56,800/- on account of management fee for support services. The AO also made another addition of Rs. 1,61,36,923/- on account of disallowance of depreciation on SAP consultancy charges of Rs. 2,68,93,871/-, that had been capitalized in fixed asset schedule. Depreciation had been claimed at Rs. 1,61,36,923/- being 60% of Rs. 2,68,93,871/-.
64. In appeal before us, the ld. counsel for the assessee in his written and oral submissions states as under:
(i) The TPO erred in rejecting the TNMM approach used by the assessee Knorr Bremse India Private Limited ("KB India" or "The assessee") had entered into multiple international transactions with its Associated Enterprises ("AEs") during the year, including the following -
purchase of raw material and consumables; receipt of testing services; purchase of finished goods; sale of raw material and consumables; purchase of capital items; payment of SAP license and software licenses fees; reimbursement and recovery of transactions;
and three other transactions, the arm's length value of which was determined to be 'NIL' by the TPO ("impugned transactions") -
receipt of professional services; receipt of management services; and receipt of SAP consultancy services.
(ii) The assessee in the transfer pricing report maintained by it, adopted transactional Net Margin Method ("TNMM") as the most appropriate method for various international transactions aggregated together under the two business segments - "manufacturing" and "trading". The approach used by the assessee was in accordance with Rule 10A (d) of the Income Tax Rules, 1962, which defines the term transaction to include a "number of closely linked transactions".
(iii) The various transactions were considered closely linked by the assessee because -
7The transactions benchmarked together are closely linked to the primary business activities of KB India - manufacturing and trading.
Various international transactions jointly contribute to the profitability of the assessee in its manufacturing and trading businesses, but none of them have capability to contribute to profits solely on its own.
Application of the TNMM on the two business segments considers the entire cost base of the assessee, including the impact of the impugned transactions on the cost base.
The transactions including the impugned transactions are of such nature that separate transaction-by-transaction approach is not possible.
(iv) While the TPO accepted the above mentioned approach for various international transactions of the assessee, he rejected the same on unfounded reasons for the impugned transactions TPO erred in adopting the CUP method without using any comparable uncontrolled transaction to benchmark the price as 'Nil' The TPO determined the arm's length price of the impugned transaction to be 'Nil' by applying the CUP method. However, he failed to provide comparable uncontrolled transactions data wherein independent parties are receiving similar services at 'Nil' value.
In this relation, Rule 1 OB(1) (a) of the Rules require that for the application of the CUP method the first step is identification of the price charged or paid for services provided in a comparable uncontrolled transaction. The TPO erred in applying the CUP method without identifying any such comparable transactions where 'Nil' price was paid for receipt of similar professional, management and SAP implementation services.
4.1. In this relation the assessee contended the following issues -
- The TPO failed to apply the CUP method in the manner required by law. Rather he derived his conclusion of a 'Nil' ALP 8 based on his unfounded assumption that no independent party would be willing to make any payment for receipt of such services. Effectively, the TPO has exceeded his powers by following a method which is not authorised under the law.
- The TPO exceeded his role, which is to determine the arm's length price of international transactions entered into by the assessee, by disallowing the transactions itself. In other words, the TPO drew presumption that there were no international transactions themselves. There was no information or material on record that may lead to such conclusion.
- Even as the TPO used the CUP method, he failed to apply the available CUP information for the SAP implementation services transaction provided by the assessee. For the SAP implementation services, the assessee had provided the fee quoted by third party services provider in India. Even the DRP failed to correct this anomaly.
4.2. The TPO erred in determining 'Nil' value as the arm's length price for the receipt of management support services KB India has entered into a service agreement with its AE for the receipt of Marketing, HR, IT and other business related support services to KB India.
Details of information submitted to the TPO Nature of services Provided vide submission dated 18 October 2010 Evidence for HR services - Copies of emails wherein the details and receipt of services schedule for regional HR manager summit have been discussed. Further, the letter of invitations issued to the specified employees were also submitted (pg 148-151 of paper book, Page 68 - 70) Accounting and financial support - KB India submitted emails wherein it requested the AE for an alternate arrangement of funds due to delay in receiving funds from their regular channel (Page 80-81) and the advice given by the AE on the interest rate of 9 loan proposed to be rolled over (Page 125-127).
Further, emails were provided wherein KB India has enquired on any possible methods of a sub classification of assets class (Page 118-119, 74-81) IT services -several emails evidencing receipt of IT Services wherein KB India has received support as well as maintenance services in respect of the same were submitted (Pages 82-87, 132-138 and 649-721). IT training workshop was organized in Hong Kong and KB India personnel were also invited therein (Page 67, Business development! project management - Copies of email/ documents submitted wherein KB India has received support on various business development activities such as participation in Indian Railway Equipment Exhibition, wherein, KB India participated along with its AE. Similarly details of other project such as Delhi Metro Airport Link Tender, Localization project, EOI document for DMRC Airport link etc (Refer Page 1-39) Other documents Copies of invoices raised by the AE, Service Agreement submitted between KB India and its AE (page 64-66). Evidence for cost Payment for services to be determined on the basis of incurred by AE actual cost incurred by the AE (as per Agreement) and the basis of allocation Working of cost allocation sheet detailing the cost incurred/ basis of charge submitted (page 3).
Further, the assessee also submitted that the receipt of these services has helped KB India in many ways that include the following:
Smooth running of the day to day operations along with ensuring strategic planning; Helped in creating a unique intangible for KB India, i.e., a trained workforce;
Accounting and financial support makes the internal reporting robust and as per the best practices;10
Moreover, the IT services assist in trouble shooting on job problems and other IT glitches.
Further, KB India submitted a chart providing the details of increase in sales and profitability over the years.
4.3. The TPO brushed aside the documents and evidences submitted by KB India and held that:
The services provided by the AE are very generic in nature and such support is expected from AE even without payment of any such charge In relation to the business development services - "However, no tangible benefits have been demonstrated by the Assessee in this respect' In relation to the Human Resources Services - "This services that the AE has provided, if at all, is for the group. The assessee should not be expected to make a payment for the same."
In relation to the Accounting, financial support and controlling services -
"the assessee has sufficient local help to allow it to overcome the legal challenges at the local level, if any. The kinds of services that the assessee speaks of are at best duplicate services for which the assessee need not make any separate payment."
In relation to the IT services - "the assessee has not been able to provide any proof as to what are the complex problems that the AE has solved, which the assessee would have been unable to do. The problems solved by the AE have been created only because of the implementation of SAP. Further, the implementation of hotline services and ongoing support is expected from the AE without any charge"
4.4. From the above, it seems clear that the TPQ has not questioned the 11 actual receipt of services by KB India rather he has disregarded the transaction on the contention that KB India has not received any benefit from the services.
4.5. The TPO, according to M/s K.B. India has inferred that:
(i) For receipt of such "routine" services no payment needs to be made.
(ii) The services are "duplicate" services for which payment need not be made
(iii) The services are for the "group" for which assessee should not be expected to make payment.
In this regard, the following points need to be considered.
- Benefits cannot be quantified separately for such services The assessee has further submitted that these services have helped KB India in smooth running of the day to day business operations. However, it should be duly considered that these services by themselves do not generate any revenue for the assessee, rather they support the overall business in generating revenue.
4.6. TPQ exceeded his role by questioning commercial expediency:
The TPO has exceeded beyond his powers by questioning the commercial expediency of the expenditure incurred by KB India. In this regard, it is important to note that there are various judicial precedents wherein the courts have held that the TPO should not question the benefit derived or expected by the assessee from an expenditure and should restrict themselves to determination of correct arm's length price of a transaction. List of these cases is provided below:12
- CIT vs EKL Appliances (ITA No 1068/2011 &.1070/2011) (Delhi High Court)
- Dresser Rand India Private Limited vs ACIT (ITA No 8753/Mum/2010) (ITAT Mumbai)
- McCann Erickson India Pvt. Ltd., vs ACIT (ITA No. 5871/0e1/2011) (Delhi ITAT)
- Ericsson India Private Limited vs OCIT (ITA No 5141/0e1/2011) (Delhi ITAT)]
-
4.7. No basis for the conclusions reached by the TPQ As discussed above, the TPO concluded for several services that no payment need to be made for such services. In this regard, the TPO has not provided any material or comparable uncontrolled transactions wherein an independent party has not made any payment for receipt of such services. In this regard the following points should be noted.
- The TPO has not placed any material on record to show that independent parties do not make any payment for "routine services"
- The TPO has not placed any material on record to show that independent parties do not make any payment for "implementation of hotline services and ongoing support services"
- The TPO has not placed any material on record to substantiate that the Accounting, financial support and controlling services provided by the AE are "duplicate".
4.8. TPO erred in determining 'Nil' value as the arm's length price for the receipt of Professional Services 4.9. During the relevant assessment year KB India had made payment for the salary cost of three employees, one of which was seconded to KB India and was on payroll of KB India. The services rendered by these employees to KB India include assistance in planning, expansion of production 13 facilities, provision of technical support to the sourcing team, supplier identification and coordination of maintenance activities. The actual costs incurred by the AE in relation to provision of these services have been charged as professional consultancy services.
Details of information submitted by the assessee Nature of Provided vide submission dated 19 October 2010 services providing details of visits of the employees of AE and description of various activities performed by these employees of the AE (page 165-166) Evidence for KB India has submitted the following sample evidences -
receipt of services a) Minutes of the meetings where the employees of
the AE (Mr. George Moll) participated to improve and develop product (page 43 to 49);
b) Copies of appointment letter, police verification records of Rita Ricken were submitted to substantiate the presence of these employees in India (page 234-236);
c) Copies of attendance sheets, task sheets in respect of vendor visits submitted to substantiate their presence (page 50-55);
d) Copies of emails in providing details of trainings imparted by Rita Ricken to the employees of KB India (page 237-243);
Other Copies of invoices submitted (page 63, 272-273 and 539-
documents 550), appointment letter issued by KB India to Rita submitted Ricken. Details of In this regard, it was submitted that the receipt of these tangible and services has helped KB India in many was that include direct benefit the following:
Improved alignment of strategies and operations;
Improved productivity and insight 14 Reduced costs through increased flexibility Increase in turnover.
Evidence for Copies of income tax return of Rita Ricken and George cost incurred by Moll were submitted to substantiate cost-to-cost recharge AE (Page 175-184, 43).
4.10. The TPO summarily brushed aside the documents and evidences submitted by KB India and held that:
- KB India has not been able to demonstrate the benefits received.
- No formal trainings have been provided by the AE. The TPO in his order mentioned that "It can be concluded that the cost accruing to the AE on this account will be very small. This kind of training will be picked up by the employees on the job."
- Copies of emails, minutes of the meetings/task sheets of the employees of the AE do not prove delivery of service
- Details of cost incurred by the AE have not been provided 4.11. From the above, it seems clear that the TPO has not questioned the actual receipt of services by KB India rather he has disregarded the transaction itself. Please note that Benefits cannot be quantified separately for such services 4.12. TPO exceeded his role by questioning commercial expediency - the TPO made comments that training can be picked up by the employees on the job. In this regard, it should be duly considered and given regard that it is assessee's discretion on how to run its business and whether to provide training to its employees on the job or vide some other manner.
4.13. Sufficient back-up documents evidencing the receipt of such services are already provided.15
4.14. The cost incurred by the AE is provided by the assessee. The professional services charges are mere reimbursement of expenses wherein the salary cost of the three personnel is reimbursed by the assessee.
4.15. TPO erred in determining 'Nil' value as the arm's length price for the receipt of SAP consultancy services 4.16. During the relevant assessment year SAP was implemented by KB India in place of the earlier used Fox-pro. KB India had made payment for the services received in connection with the implementation of SAP and with respect to data migration from the earlier used system to SAP.
Details of information submitted by the assessee Nature of Provided vide submission dated 19 October 2010 (page services 165-196) Evidence for KB India has submitted the following evidences in respect receipt of of these services:-
services a) E-mails evidencing provision of SAP support services and training workshops/programmes on SAP. Further, the letter of invitations to the specified employees for different trainings and the training completion certificates issued to the employees who have successfully completed their trainings were also provided.
b) Copy of email in relation to integration test for SAP implementation at KB India (page 90-92)
c) Copy of the User Handbook provided as a part of SAP implementation project (page 563-577);
d) Details of visits of SAP consultants (Page 88-89);
e) License agreement and details of the end users (Page 187-196);
Other details Copies of invoices, copy of service agreement with KB submitted Germany for SAP implementation and with KB Austria to provide support for data migration from legacy system to 16 SAP were submitted.
Cost-benefit KB India obtained quotation from a third party in India. analysis The services availed from the AE are at a much lower price a compared to price quoted by third party.
Details of In this regard, it was submitted that the receipt of these tangible and services has helped KB India in many ways that include direct benefit the following:
Improved alignment of strategies and operations; Supported changing industry requirements Improved financial management and corporate governance;
Immediate access to enterprise information;
Further KB India submitted a detailed article on the need and benefits of SAP implementation under the current business environment (Page 100-111) Evidence for Quotation from third party (page 90);
cost incurred by Documents showing invoices raised by AEs and AE and the corresponding third party invoices (Evidencing no mark basis of up) (page 155-164); allocation
4.17. The TPO summarily brushed aside the documents and evidences submitted by KB India and held that:
- The detail provided by KB India is of a "very general nature".
-. There is no reason to believe that the AEs are providing assistance that KB India cannot obtain at the local level, here in India.
4.18. From the above, it seems clear that the TPO has not questioned the actual receipt of services by KB India rather he has disregarded the transaction itself on the basis that no independent party would have made the payment. In this regard, the following points need to be considered
- TPO exceeded his role by questioning commercial expediency -17
the TPO has again questioned the commercial wisdom of KB India to select the service provider from which it wants to avail these services. In this regard, as submitted above, there are various judicial precedents wherein it has been held that such an act on the part of TPO is not permitted under the provision of the Act. Further, the TPO has failed to appreciate that had KB India availed such services from a third party service provider, it would have paid a higher sum to the third party service provider than what it actually paid to the AE.
4.19. TPO cannot disregard a transaction merely by stating that services are of a very general nature.
4.20. The DRP in its order merely confirmed the findings of the TPO without considering the merits of the case. In this relation, the DRP provided its finding in a few lines merely focusing on one transactions relating of receipt of professional services. In this relation, the DRP order mentions -
"The assessee has furnished letter of appointment of Ms Rita Ricken as team leader sales logistics. The email enclosed in submission dated 24.01.2011 before DRP do not however on perusal show any sales logistics work. She seems to be merely coordinating training sessions which are restricted to a few people and not al/ end user employees"
4.21. In this relation, the assessee submits that -
(i) DRP has not examined in details the documents and evidences furnished by the assessee. The panel has not given any finding in respect of several dozen other email and documents provided by the assessee for the management, professional and SAP consultancy charges 18
(ii) DRP has also not questioned receipt of services by the assessee, rather it has confirmed TPO's findings that no amount need to be paid for such services as benefits have not been received.
4.22. Neither the TPO not DRP has questioned the receipt of various services by the assessee. The TPO has rejected the transactions altogether based on his assumptions that such services were not needed by the assessee or payment for such services need not be made Various documents and information provided by the assessee in support of the services were summarily rejected by the TPO and the DRP without a thorough examination and review The TPO while applying the CUP method failed to put on record any material to demonstrate that Comparable uncontrolled transactions were of value "Nil". Such services are received by independent parties at "Nil" price
5. On the other hand, ld. CIT (DR) Shri Peeyush Jain supporting the impugned order contended that there is no merit in the arguments and pleas being advanced by the ld. Counsel for the assessee as the issues raised by him stand duly considered by the authorities below before passing the impugned order. The assessee was granted reasonable and effective opportunity of being heard by the DRP as well and a speaking order thereof has been passed. This order had a binding effect on the AO in terms of sec. 144C(10) of the Act.
5.1. The assessee, among other things had entered into international transactions relating to business service/ intra group charges with its AE as follows:
19Professional consultancy 15,207,206 Management fee for support services 14,056,800 SAP consultancy charges and other expenses 26,893,871 SAP license fees 14,064,063 Software 2,678,406 Total 72,900,346
5.2. The assessee had bench marked these transactions relying upon transactional net margin method ("TNMM" in short), wherein it had bench marked all its transactions after aggregating them. According to the assessee, these transactions relating to professional consultancy and management fee for support service and SAP consultancy charges and other expenses amounting in all to Rs. 5,61,57,877/- are so closely interlinked with other transactions that the same were aggregated under TNMM. The aggregation of separate, distinct and distinguishable transactions is not permitted as per Indian TP legislation. Under TNMM, each international transaction entered into with an AE, is to be bench marked separately.
5.3. Rule 10B(1)(e) of the Income-tax Rules, 1962 reads as follows:
"10B(1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner namely:-
....
.....
(e) Transactional net margin method, by which, __
(i) The net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;20
(ii) The net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;
(iii) The net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv) The net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);
(v) The net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction."
5.4. The logic for bench marking of each transaction independently can be understood by a simple example. Let us say an independent assessee is in the business of manufacturing and sale of gold jewellery in India. For the purpose of jewellery manufacturing in India the assessee imports gold as well as semi finished jewellery from its foreign AE. The assessee uses this imported gold and the semi finished jewellery for manufacturing and sale of gold ornaments in India. The assessee earns net profit margin of 40% against that of comparable entities at 12%. The assessee claims that its net profit margin at 40% is much better than that of comparables at 12% and therefore all its transactions are at Arm's length despite the fact that he has imported gold at Rs. 50,000/- per ten gms., against the prevailing market price of Rs. 30,000/- per ten gms., coming by the argument of the appellant's case, the transaction of import of gold at Rs. 50,000/- cannot be a subject matter of 21 adjustment a it is closely interlinked with the transactions of import & semi finished jewellery and with manufacture and sale of jewellery in India. If this plea is accepted, the scheme as contained under Income-tax Rules, shall stand frustrated and the AO shall be rendered powerless in making any adjustment or additions by accepting the price for services or goods paid by the assessee even though they were not at ALP in respect of each transaction so carried by him. The element of "cross subsidisation" is not permitted under Indian Income Tax Legislation. The assessee cannot take a plea of set off of the higher price paid (over and above ALP) in one international transaction with lower price paid (below the ALP) in another identical transaction, and vice versa.
5.5. In this connection reliance is placed upon order of the Appellate Tribunal in DCIT Vs. Ankit Diamonds (2011) 8 ITR (Trib) 487 (Mum.) dated 26-11-2010. The relevant portion in para 21 of the order is as under:
"In our view, these submissions of the assessee are the correct legal position. The Assessing Officer himself states that, he finds some merit and force in the submission of the assessee, but in view of the directions of the Transfer Pricing Officer and as the assessment is getting time barred, he made the addition in question. The submission of the assessee that the Transfer Pricing Officer is not authorized to determine the net operational profits at the enterprise level and thereby determine the total income of the assessee, but that he shall determine only the arm's length price of the international transaction, is correct."
5.6. Reliance is also placed upon the order of the Appellate Tribunal in the case of Star India Pvt. Ltd. Vs. ACIT (2008) TIOL-426-ITAT Mumbai and UCB India Pvt. Ltd. 317 ITR 292 (AT) Mumbai in the case of UCB India 22 Pvt. Ltd., para 75 thereof, which has also been reproduced by the TPO at internal page 8 of his order, reproduced as under:
"75. In our understanding, the international transaction or an aggregate of similar international transactions, have to be evaluated, on a standalone basis and then compared with similar analysis undertaken on independent transactions. Comparison of the operating profits of the assessee company as a whole, with the overall operating profits of certain other companies, without any adjustments. In our considered opinion, would not satisfy the requirements of evaluation on international transaction under TNMM, for the purpose of arriving at the arm's length price. In this case, the assessee has taken all the activities of the company as one unit and on an analysis of its profit & loss account, arrived at an overall operating profit margins of 27%. This is compared with the chart of overall operating profit margin of identified comparable companies, which is summarized in Table 5 of the report. No adjustments or segregations have been made between turnovers involving licensed manufacturing, patented drugs, trading and other revenues. No exercise has been done to iron out the variations by making suitable adjustments. In other words, what the assessee has tried to do is to compare the overall operating profit of one entity, with the overall operating margins of the assessee and as the operating margin of the assessee is higher, it asserts that all its international transactions done, with its AE are at arm's length price. This cannot be accepted. Thus, as already stated we argue with the revenue that provisions of section 92C(3) are attracted in the instant case on this ground. As we have decided this issue in favour of the revenue on this ground, we do not feel it necessary to go into other arguments of the revenue. Once the method adopted by the assessee is rejected, the revenue is duty bound to compute the ALP by adopting a most appropriate method and it has also to substantiate and justify the use of such a method."
5.7. Thus, the bench marking of the impugned transactions under TNMM is not correct as each transaction has not been benchmarked separately.
235.8. The assessee has challenged that CUP method was not the most appropriate method in this case. It is pointed out that the assessee, by not bench marking each transaction separately did not discharge its burden of proof. The TPO has noticed that CUP was the most suitable method for bench marking these transactions. It has been pointed out buy the TPO on page 19 of his order as follows:
(a) The assessee has not been able to provide any basis of this payment made to the AE.
(b) The assessee has not been able to provide any separate benchmarking for the payments of these services. The assessee should have been able to demonstrate that any independent party would also have made this payment in similar circumstances, it has not been able to do so.
(c) The assessee has not been able to give the details of cost incurred by AE on account of various services.
(d) The assessee has not been able to provide any documentary proof of tangible benefit received on account of these services. Some document had been provided in its submission of 18.10.2010 and 19-10-2010. They were evaluated it was found that they are simples copies of invoices raised without any justification or quantification of the services rendered and therefore, they do not constitute credible evidence.
As per the comments above it can be seen that none of the benefits are tangible or real. A mere façade has been raised to give an impression that some vital benefit has passed to the assessee which is actually not the case. Related parties are quite likely to give a form that will give an impression that a real service is being rendered by one to another. But the necessity to look beyond the vell is recognized across tax jurisdictions. In the above circumstances the payment of service fee is only an 24 arrangement to change tax base without any economic substance in the transaction.
5.9. With regard to assessee's objection that the CUP method has not been followed as specified in Rule 10B(1)(a) of the I.T. Rules. It is pointed out that ALP in a similar situation has to be NIL being a case where the assessee fails to demonstrate that an independent party would have made similar payments as the assessee has made. The assessee did not bring forth specific instances where similar payments in similar circumstances were paid by third parties.
5.10. In the case of Deloitte Consulting India Pvt. Ltd. Vs. DCIT in ITA no. 579, 1272 & 1273/Mum/2011 & others dated 30-3-2012 the Mumbai Bench of the Tribunal has expressed its opinion in following terms"
"39. On the issue as to whether the TPO is empowered to determine the ALP at "nil", we find that the Bangalore Bench of the Tribunal in Gemplus India Pvt. Ltd. (supra), held that the assessee has to establish before the TPO that the payments made were commensurate to the volume and quality service and that such costs are comparable. When commensurate benefit against the payment of services is not derived, then the TPO is justified in making an adjustment under ALOP.
40. In the case in hand, the TPO ha determined the ALP at "nil" keeping in view the factual position as to whether in a comparable case, similar payments would have been made or not in terms of the agreements. This is a case where the assessee has not determined the ALP. The burden is initially on the assessee to determine the ALP. Thus, the argument of the assessee that the TPO has exceeded his jurisdiction by disallowing certain expenditure, is against the facts. The TPO has not disallowed any expenditure. Only the ALP was determined. It was the Assessing Officer who computed the income by adopting the ALP decided by the TPO at "nil".25
5.11. The Appellate Tribunal further goes on to state in para 45 of its order and concluded as under:
"45. ......... In our view, under similar circumstances a uncontrolled comparable company would not incur such expenditure. Hence, the ALP is rightly determined at "nil". As no expenditure would have been incurred, there is no necessity to apply a particular method to arrive at such conclusion. In fact, by all the five methods or any one of them, when applied to the fact that there is no necessity of payment, the result of "nil" ALP will come."
5.12. Reference has also been made to the judgment by Bangalore Bench of the ITAT in the case of M/s Gemplus India Pvt. Ltd. Vs. ACIT 2010-TLL- 55-ITAT-Bang-TP dated 21-10-2010.
5.13. The ld. Counsel of the assessee has raised a plea that the separate payments for each service have been made by the appellant and these payments have gone to benefit the assessee in conducting his business and the same are not shown to have been paid for any exteneous reasons. The assessee may argue that the services have benefited in conducting of his business, but he was under duty to bring on record as to whether the payments made for such services is at Arm's length by benchmarking each transaction. This, however, has not been done. Moreover, the benefits received by the assessee are incidental.
5.14. The assessee has also made a plea that the OECD Guidelines permit aggregation of all international transactions with the main activity. Such guidelines, however, are not binding but are merely elucidative. Moreover, 26 Indian is not a member of OECD. The assessee has relied upon the order of the Hon'ble Delhi High court in the case of CIT Vs. EKL Appliances [ITA no. 1068/2011 & 1070/2011). The Hon'ble High Court has rendered its judgment in a specific situation only, where the TPO made wholesale disallowance of the expenditure for the reason that the assessee had suffered continuous losses. This case, therefore, is not applicable as disallowance has not been made in this case on account of expense and having been incurred inspite of continuous losses. This order of the Hon'ble Delhi High Court has been interpreted by the Delhi Bench of t4he Tribunal in the case of M/s Ericsson India Pvt. Ltd. Vs. DCIT (ITA no. 5141/Del/2011 dated 11-5-2012, by observing that reasonableness of an expenditure has not been excluded from determination in the aforesaid order by the Hon'ble Delhi High Court. The observations are contained at para 30 of the said Tribunal's order, reproduced as under:
"30. Keeping in view the aforementioned decision of Hon'ble Delhi High Court, we are of the opinion that it will be wrong to hold that the expenditure should be disallowed only on the ground that these expenses were not required to be incurred by the assessee. At the same time it has also to be seen that whether the price paid by the assessee is at arm's length. The term 'arm's length price' has been defined in section 92F which means a price which is applied or proposed to be applied in the transactions between the persons other than Associate Enterprises in uncontrolled conditions. It is only because of that their Lordships in the aforementioned decision have observed that "the quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses". Earlier to this they have observed that Revenue cannot disallow any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred 27 the same or that in view of the Revenue the expenditure was unremunerative. Looking into observations of their Lordships, it has to be held that reasonableness of an expenditure has not been excluded from determination."
5.15. The principle stated in MC Ericsion Vs. ACIT (ITA no. 5871/Del/11 dated 8-6-2012) is on the issue of commercial expediency. Though it does not need any deliberation, the applicability of principle of arm's length test of international transactions has not been done away with. The expenditure incurred in an international transaction has necessarily to pass the test of ALP.
5.16. Further more, it has been contended that the expenditure which is the subject matter of adjustments by the TPO ought to have been allowed in the same manner as the expenditure is allowable u/s 37(1) of the Act. This plea of the assessee however cannot be allowed for the simple reason that the provisions of sec. 37(1) and proviso to sec. 92 operate in different field and thus the argument becomes devoid of any merit.
5.17. For this reference may be made at para 10 of the Tribunal's order in Dresser Rand India Pvt. Ltd. (ITA no. 8753/Mum/2010) dated 7-9-2011, the relevant portion is reproduced below:
"10. Once we come to the conclusion that the assessee has indeed received the services from the AI the next question which we have to decide is as to what is the arm's length price of these services received under cost contribution agreement. It hardly needs to be emphasized that even cost contribution arrangement should be consistent with arm's length principle, which, in plain words, requires that assessee's share of overall contribution to the costs is consistent with benefits expected to be received as an independent enterprise would have assigned to the contribution in hypothetically similar situation."28
5.18. In the case of Dresser Rand India Pvt. Ltd. (supra), the assessee had adopted TNMM as the most appropriate method.
5.19. The revenue in this case has already demonstrated that TNMM method is not the most appropriate method in the assessee's case. Since the CUP method adopted by the TPO is the most appropriate method and the assessee has not been able to demonstrate that an independent party would have made such payments in similar circumstances, no interference is called for in the well reasoned decision of the TPO followed by the AO and approved by the DRP.
6. Ground nos. 1 & 2 have not been pressed. The same are dismissed as not pressed.
7. We have heard parties on rejection of TNMM method with reference to material on record and case laws brought to our notice. The appellant is a wholly owned subsidiary of Knorr-Bremse Far East Ltd., and has entered into several international transactions with its Associate Enterprise. The TPO in respect of subject transactions did not find TNMM as most appropriate method for determining ALP, even though he had accepted Benchmarking of other transactions under TNMM. According to the appellant, the subject transactions are of such nature that transaction by transaction approach is not possible. The assessee has considered TNMM as most appropriate method because various international transactions jointly contribute to the profitability of the assessee in its "manufacturing" and "trading" segment of the business and none of them have capability to contribute to the profitability solely on its own. Upon perusal of entire material on record, we find ourselves in agreement with the TPO, as the approach of the appellant does not conform to the transfer pricing regulations. Chapter X of the Income-tax Act, 1961, makes special 29 provisions relating to avoidance of tax. The transfer pricing regulations under this Chapter is a code in itself. Section 92(1) of the Act and Explanation thereunder as reproduced herein below, are relevant for computation of income from international transactions:
"92(1) Any income arising from an international transaction shall be computed having regard to the arm's length price.
Explanation - For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm's length price."
7.1. The aforesaid Explanation provides that allowance for any expense or interest, arising from an international transaction, shall be determined having regard to the arm's length price. The CBDT in its Circular no. 9 of 27-8- 2002 have explained that the intention in laying the provision is to prevent avoidance of tax by subjecting taxable income to a jurisdiction outside India by Associate Enterprise, controlling the price charged in intra group transactions. The Explanation to Sec. 92(1) of the Act has been inserted with a view to further clarify the position and state clearly that expense and outgoing shall also be determined having regard to arm's length price. In the appellant's case the impugned transactions resulting into payment of Rs. 1,52,07,206/- under the head "Professional Consultancy", Rs. 1,40,56,800/- under the head "Management fee for support services" and Rs. 2,68,93,871/- on SAP consultancy charges and other expenses are found to be distinguishable and separate international transactions, carried by the assessee with its Associate Enterprise. Each and every transaction was required to be bench marked separately. The appellant did not compute net profit margin realized from each such transaction nor laid any material on 30 record to show that the available data of comparable transactions, if any, is unreliable or inadequate. These transactions are also not shown to be closely linked with each other. In fact in India no guidance is provided regarding criteria for choosing a particular method and the law also does not provide for priority of any particular method to be applied. However, as per the rational approach followed by OECD and also by some countries, the CUP method is considered to be most direct method for determining ALP wherein the tax payer can use the published data of stock exchange or any other media quotation as an indirect or secondary evidence or such data as specified in Rule 10D(3) of I.T. Rules, 1962, for comparing the transactions and making adjustments for differences, if any.
7.2. The appellant in the present case also did not demonstrate as to how the transaction by transaction approach in his case is not possible. It has also not been shown as to whether there has been any real or tangible benefit by carrying such international transactions with the AEs. The comparable uncontrolled price method ("CUP" method), for the subject transactions being most direct method for determining arm's length price and chosen as most appropriate method in this case by TPO, therefore, cannot be faulted with. We, therefore, do not find any error in rejecting the TNMM method applied by the assessee and determination of ALP by applying CUP method for Benchmarking international transactions in a case like this. The DRP also cannot be said to have erred in approving the CUP method adopted by the TPO for Benchmarking international transactions with the AE. The assessee's ground on this count being devoid of any merit stands rejected.
8. The assessee has assailed the impugned order with respect to TPO's action in determining Nil value as the ALP for the receipt of SAP 31 consultancy charges and thereby making addition of Rs. 2,68,93,871/- to the income of the assessee for entering into international transaction with its AE. 8.1. Having heard the parties and after perusal of the entire material on record as well as the impugned order, we find that the DRP has recorded a finding that SAP license and MS office have been purchased at a lower rate and to that extent benefit test for the recipient is clear and assessee must be given benefit. Accordingly, it was of the opinion that the TPO is to verify and recompute ALP, if any. In the same breath it, however, has found logic in the conclusion of TPO and decided not to interfere in the conclusion of TPO.
8.2. Having heard parties with reference to material on record and since the DRP, upon perusal of facts on record, reached a finding that SAP license and MS office have been purchased at a lower rate and has gone to benefit the assessee requiring assessee to be allowed benefit on that account, it was neither proper nor justified to uphold the conclusion of the TPO for making addition in his income on that account. Since the onus that lay upon the appellant that the international transaction has been Benchmarked at ALP in respect of payment for SAP stands discharged and that also is found to have passed the benefit test, the addition so made, therefore, is unjust and uncalled for. Accordingly, we direct the assessing authority to delete the addition on that account and allow the ground raised in appeal by the assessee accordingly.
9. The appellant has also assailed the addition made on account of international transactions ( Rs. 1,52,07,206/- towards professional consultancy and Rs. 1,40,56,800/- towards management fee for support services), by determining Nil value as the ALP. The TPO found that these services provided by the AE are very general in nature and such a support 32 is expected from AE even without payment of any such charge. The assessee argued that the authorities below are stated to have acted beyond their jurisdiction in touching upon the commercial expediency of the transactions. The DRP, however, has found that Emails brought on record merely justify presence of Ms. Rita Ricken as team leader of sales logistics, which is only an effort to justify her presence. She in fact is safeguarding group interest/ shareholder interest. The TPO has analysed each service and benefit received by assessee in detail. No cost allocation key has been furnished to the DRP either which confirmed the addition made for both such services claimed by the assessee.
9.1. The appellant's contention that TPO is no authority to judge the allowability of the business expenditure is a correct proposition of law in view of the decision rendered by the Hon'ble Delhi High Court in its order dated 29th March 2012 in the case of EKL Appliances Ltd. (ITA nos. 1068/2011 & 1070/2011). The Hon'ble High Court in para 22 of its judgment has ruled as under:
"Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee ahs suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO ha done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment ahs been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected 33 to examine the international transaction as he actually finds the same and then makes suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorized."
9.2. After hearing the parties with reference to material on record, we find that the authorities below have not conclusively held that the assessee could not enter into such a transaction nor had they disallowed the same by holding that such an expenditure is not assessee's business expenditure. The DRP as well as the authorities below have merely elucidated that the payments are reimbursement in respect of Ms. Rita Ricken and other personnel's case to serve the interest of share holders. By saying so they have only described the circumstance under which the international transaction has been entered by the appellant, so as to test the benefit that can be said to have reached the assessee. It, therefore, cannot be said to have questioned the commercial expediency of such transactions entered by the appellant. The I.T. rules contain exhaustive detail regarding nature of information and documents which are required to be maintained by the assessee. Rule 10D(1) of the I.T. Rules, 1962 also mandates the maintainability of record of uncontrolled transactions to be taken into account in analysing the comparability of the international functions entered into by the assessee. It, therefore, is obligatory on part of the appellant to maintain such record and produce the same before the TPO to show that it has benchmarked the international transaction at ALP. This obligation, however, has not been discharged by the assessee.
9.3. The appellant in the present case is also not shown to be willing to pay any amount for such services, if it were, so provided by an independent enterprise or if the same would have been performed in house. The DRP is 34 found to have considered these services as non-beneficial for the recipient and did not take it as chargeable services. The perusal of e-mails and other contemporaneous record only goes to reveal that incidental and passive association benefit has been provided by the associate enterprise. In this view of the matter there could neither be any cost contribution or cost reimbursement nor payment for such services to the AE. The TPO, therefore, has rightly adopted Nil value for benchmarking the arm's length price in respect of both these services. We, therefore, do not find any reason to interfere with the well reasoned conclusion reached by the AO on this count. The grounds raised in appeal in this respect, therefore, stand rejected.
10. In the result, appeal by assessee stands partly allowed.
Order pronounced in open court on 31-10-2012.
Sd/- Sd/- (I.C. SUDHIR) (B.R. JAIN) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 31-10-2012. MP Copy to : 1. Assessee 2. AO 3. CIT 4. CIT(A) 5. DR