Income Tax Appellate Tribunal - Delhi
Horiba India Pvt. Ltd.,, New Delhi vs Dcit, New Delhi on 18 April, 2017
1 ITA No. 6638/Del/2015
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH: 'I-2' NEW DELHI
BEFORE SHRI J.S. REDDY, ACCOUNTANT MEMBER
&
SHRI AMIT SHUKLA, JUDICIAL MEMBER
ITA No.-6638/Del/2015
(ASSESSMENT YEAR-2011-12)
Horiba India Pvt. Ltd. Vs. Dy.Commissioner of
Plot No. 246, OkhlaIndl. Estate, Income Tax
Phase-III, New Delhi. Circle 11(1),
AABCH7371R New Delhi.
Assessee by Shri Kapil Hirani & Darpan
Kirpalani
Revenue by Shri T.M. Shiva Kumar, CIT DR
Date of Hearing 22.03.2017
Date of Pronouncement 18.04.2017
ORDER
PER AMIT SHUKLA, JUDICIAL MEMBER:
The aforesaid appeal has been filed by the assessee against impugned final assessment order dated 21/10/2015, passed by Deputy Commissioner of Income Tax, Circle 11(1), New Delhi u/s 143(3) read with section 144C(13), in pursuance of directions given by the Dispute Resolution Panel-1, New Delhi (DRP), vide order dated 15/09/2015.
2. In the grounds of appeal, the assessee has raised the following grounds:
2 ITA No. 6638/Del/20151. "The Learned Deputy Commissioner of Income Tax - Circle 11(1) ('Ld. AO') along with Learned Additional Commissioner of Income Tax, Transfer Pricing Officer - I (3) ('Ld. TPO') erred in making an adjustment of INR 3,63,66,656/- to the income of the Appellant on account of alleged difference in the arm's length price of the international transactions of purchase of goods for resale entered into by the Appellant with its Associated Enterprise ('AE') during the relevant previous year.
2. On facts and in law, the Ld. AO/ Ld. TPO and Hon'ble Dispute Resolution Panel ('DRP') erred in disregarding Resale Price Method ("RPM") as the most appropriate method for benchmarking the Appellant's international transactions based on erroneous reasons and instead, applying, Transactional Net Margin Method ("TNMM") as the most appropriate method.
3. On facts and in law, the Ld.AO/Ld.TPO and Hon'ble DRP erred in aggregating the medical and automotive trading segments while determining the arm's length price of international transaction.
4. On facts and in law, the Ld.AO/Ld.TPO and Hon'ble DRP erred in determination of arm's length price for the trading transactions based on an ad-hoc allocation methodology and segmental profitability.
5. On facts and in law, the Ld.AO/Ld.TPO and Hon'ble DRP erred in disregarding cash profits as an appropriate profit level indicator while applying TNMM as the most appropriate method.
6. On facts and in law, the Ld. AO /Ld. TPO and Hon'ble DRP erred, in disregards the adjustment on account of extra ordinary expenses incurred by the Appellant during the subject assessment year thereby contravening the provision of Rule 10B
7. The Ld AO erred on facts and in law in initiating penalty proceedings under sect271
(l)(c) of the Act.
8. The Ld. AO, based on directions of Hon'ble DRP, erred on facts and in a charging interest under section 234B and 234C of the Act."3 ITA No. 6638/Del/2015
3. The brief facts qua the issue raised are that the assessee company is a subsidiary of 'Horiba Limited, Japan' which is mainly engaged in manufacturing and sale of measuring instruments. The assessee in India undertakes the distribution of various finished goods manufactured by its holding company (AE) in India. The distribution of finished goods includes 'automotive test equipment' and 'medical diagnostic equipment'. For the segment of trading of medical equipment and auto components, the assessee had disclosed following transactions with its AE:
Nature of Value Method PLI No. of Com Arm's Result of Transaction Rs. Applied -parables Length Assessee Price Purchase of 11,84,32,963 RPM GP 12 16.24% 36.47% Goods for resale As regards the other segments like purchase of fixed assets, provision of support services, the assessee had separately shown the transaction and also separately benchmarked the same, which is not the issue before us. In the transfer pricing study report, the assessee has benchmarked the purchase of goods for resale by adopting Resale Price Method (RPM) as the most appropriate method. To benchmark the overall gross profit margin of 36.47%, the assessee had chosen 12 comparable companies which were mostly dealing in medical equipment or auto components. The average arithmetic mean of these comparables was arrived at 16.24%. Accordingly, it was reported that assessee's gross profit margin were at arm's length.
4. The Ld. TPO, though accepted that assessee is engaged in the distribution of various finished products manufactured by its AE, 4 ITA No. 6638/Del/2015 however, rejected the assessee's adoption of RPM as most appropriate method. The main reasons for rejection of RPM by the Ld. TPO, were;
Firstly, in the cases where RMP is applied it is assumed that only the same kinds of goods are distributed and it is a case of pure distributor. The different kinds of goods give rise to different gross margins.
Secondly, the assessee is distributing medical equipment and automotive equipment and both these products have been clubbed together for the application of RPM which will not give correct gross profit margins for each segment. He also required the assessee to give the segmental gross profit margin for the automotive components and for the medical equipment. As per the working submitted by the assessee, he noted that the gross margin from automotive component was at 44% and from sale of medical equipment, gross margin was at 25%.Thus, he came to the conclusion that the pricing structures of both these classes of products are different.
Lastly, he re-characterized the assessee as full risk distributor and observed that a full-fledged distributor performs a whole range of marketing and selling functions; employs and develops valuable marketing intangible assets; and assumes a range of risk associated with its activity such as inventory risk, bad debt risk and market risks etc. From the transfer pricing report he also highlighted the functional analysis and noted the following functions performed by the assessee:-
i. Market research
ii. Purchase order
iii. Provision of goods
5 ITA No. 6638/Del/2015
iv. Custom clearance and transportation
v. Warehousing and Inventory control
vi. Quality control
vii. Sales and marketing
viii. Market risk
ix. Inventory risk
x. Product liability risk
xi. Credit risk
xii. Foreign exchange risk
He also took note of various assets utilized which were mostly in the form of tangible assets.
5. In the light of aforesaid reasons, TPO came to the conclusion that RPM would not be the appropriate method; instead TNMM should be adopted as MAM for bench marking the net profit margin of the assessee. He took the same set of comparables and benchmarked the assessee's net profit margin which was determined by him at 1.31% and the arithmetic mean of the 7 comparable was arrived at 5.38%. The lists of comparables with their margins under TNMM were as under:
S.No. Name OP/TC (%)
1. Frontline Electro Medical Ltd. 2.58
2. India Motor Parts & Accessories Ltd. 9.05
3. Jullundur Motor Agency (Delhi) Ltd. 6.62
4. Satyatej Commercial Company Ltd. 1.59
5. ADS Diagnostic Ltd. (Seg.) 11.21
6. Hicks Thermometers (India) Ltd. 1.93
7. Stanes Motor Parts ltd. 4.72
Average 5.38
Accordingly, upward adjustment of Rs. 3,63,80,656/- was made.
6 ITA No. 6638/Del/20156. The Ld. DRP too confirmed the action of the TPO that RPM cannot be held to be the Most Appropriate Method on the facts of the present case for bench marking the arm's length price albeit can be done by adopting TNMM as the MAM. The DRP further observed that in the case of the assessee it is an undisputed fact that the assessee is not only dealing in totally two independent products, i.e., automotive and medical equipment, but also involved in leasing of equipment. In such a situation, where assessee is having two different business models for earning revenue, RPM cannot be used as MAM. Further, once the assessee is full-fledged distributor carrying various functions as illustrated by the TPO, then in such a situation also, RPM cannot be adopted. Accordingly, the DRP confirmed the application of TNMM as the correct method.
7. Before us, the Ld. Counsel Shri Kapil Hirani after narrating the entire facts and background of the case submitted that, it is an undisputed fact here in this case that assessee is engaged in distribution of various furnished products without any value addition. It is purely involved in buying and selling function. Once the assessee is performing pure distribution functions and the business model is based on distribution of various finished products of its AE, then RPM is to be considered as MAM. In support, he relied upon the following judicial pronouncements:
"Judicial Pronouncements:
i. Mattel Toys India Pvt. Ltd. (Mumbai ITAT)- (2013)158 TTJ 461, wherein it has been held that where the assessee is a distributor and gets the finished goods from its AE and resells the same to independent parties without any value addition, in such 7 ITA No. 6638/Del/2015 a situation, RPM can be the best method to evaluate the transactions whether they are at ALP. Thus in case of distribution activities i.e., import of products and services from the AE and resale to the independent parties without any value addition, the RPM would be the most appropriate method on for determining the ALP.
ii. Danisco (India) Pvt. Ltd. (Delhi ITAT) - (2014) 151 ITD 460- wherein it has been held that first examine whether there as any value addition on imported goods and if the answer is in the negative then apply RPM as a most appropriate method for trading transaction of imported goods.
iii. Star Diamond Group (Mumbai ITAT) - (2011) 141 TTJ 21 (UO)/ITA No. 3923/Mum/2008- RPM is the most appropriate method for determining the ALP with respect to imports by a trader assessee.
iv. Kodak Polychrome Graphics (I) (P) Ltd - (Mumbai ITAT) (2015) 171 TTJ 224 (Mum) - The assessee is, in fact, engaged in distribution activities. In such an activity RPM can be considered to be most appropriate method because bench marking is done at a gross level.
v. ITO Vs. L'oreal India Pvt. Ltd. (Mumbai ITAT) - ITA No. 5423/Mum/2009- Held - RPM is one of the standard method and OECD guidelines also states that in case of distribution and marketing activities when the goods are purchased from AE's which are sold to unrelated parties, RPM is the most appropriate method. In the case before us, there is no dispute to the fact that the assessee buys products from its AEs and sells to unrelated parties without any further processing.
8 ITA No. 6638/Del/2015vi. Nokia India (P) Ltd. (Delhi ITAT) - (2015) 167 TTJ 243 (Del)- A close scrutiny of the above two sub-clauses along with the remaining sub clauses of rule 10B(l)(b) makes it clear beyond doubt that RPM is best suited for determining ALP of an international transaction in the nature of purchase of goods from an AE which are resold as such to unrelated parties. Further concluded that RPM is best suited for determining ALP of an international transaction in nature of purchase of goods from an AE which are resold as such to unrelated parties.
vii. L'oreal India Pvt. Ltd. (Bombay High Court) - IT Appeal No. 1046 of 2012- RPM is one of the standard method and the OECD (Organization of Economic Commercial Development) guidelines also state in case of distribution or marketing activities when the goods are purchased from associated entities and there are sales effected to unrelated parties without any further processing, then, this method can be adopted viii. Swarovski India Private Limited (Delhi ITAT) - ITA No. 5621/Del/2014- Adverting to the facts of the instant case, we find that the assessee purchased Crystal goods and Crystal components from its AE. No value addition was made to such imports. The goods were sold as such. In the given circumstances, the RPM is the most appropriate method for determining the ALP of the international transaction of' Import of Crystal goods and Crystal components."
8. As regards the TPO's and DRP's observation that assessee has two different segments for distribution of finished goods with different gross 9 ITA No. 6638/Del/2015 profit margins, he first of all submitted that, there is no restriction imposed by law that RPM cannot be applied where there are distribution of two different products. Under the RPM method the focus is more on functions rather than similarity of products because product differentiation does not materially affect the gross profit margins, as it represents gross composition after the cost of sales for specific functions performed. Though product similarity is most desired but for applying RPM it is not mandatory that product should be similar as in the case of CUP method. The main focus is on the functions performed. In support of, he strongly relied upon the decision of ITAT Mumbai Bench in the case of Mattel Toys India P. Ltd. (supra). Without prejudice, he submitted that during the course of transfer pricing proceedings when assessee was required to give the separate working of the gross profit margins for the sale of automotive components and medical equipment, the same was duly provided and it was reported that under the automotive products the gross margin was44% and from medical equipment the gross profit margin was 25% and in that case also, vis-a-vis the comparables, the assessee's gross profit margin are far more and hence these separate gross margin can also be accepted as arm's length price.
9. Regarding DRP's observation that the assessee was also engaged in leasing of equipment, the Ld. Counsel clarified that the same pertain to a different segment all together, i.e., the purchase of fixed assets, which has been separately benchmarked by applying CUP method and it has no correlation with the functions of purchase and resale of goods. Regarding various functions as highlighted by the TPO as well as the DRP in holding that assessee is a full-fledged distributor, he submitted that the costs related to functions such as market research, purchase 10 ITA No. 6638/Del/2015 order, ware housing, inventory control, quality control, sales and marketing etc. is the normal cost even for the normal distributors performing functions of distribution. Under the comparable uncontrolled transactions who are engaged in distribution function, they also undertake similar kinds of functions and, therefore, on this ground alone RPM cannot be rejected. If the version of the TPO is to be accepted then in no cases RPM method can be applied. In support he strongly relied upon the following OECD guidelines:
"2.21 The resale price method begins with the price at which a product has been purchased from an associated enterprise is resold to an independent enterprise. The price (the resale price) is then reduced by an appropriate gross margin on this price (the "resale price margin") representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risk assumed), make an appropriate profit. What is left after subtracting the gross margin can be regarded, after adjustment for other costs associated with the purchase of the product (eg. Custom duties), as an arm's length price for the original transfer of property between the associated enterprises. This method is probably useful where it is applied to marketing operations."
10. Lastly the Ld. Counsel submitted that in the succeeding years, i.e., AY 2012-13 and AY 2013-14 the Ld. TPO has himself accepted RPM as the most appropriate method even though the assessee in those years 11 ITA No. 6638/Del/2015 also assessee was carrying distribution of similar products as a full risk distributor. Thus, on the 'principle of consistency' also RPM should be applied in this year also to benchmark the transaction of sale and purchase of goods from the AE for resale in India.
11. On the other hand, Ld. CIT DR, Shri TM Shiv Kumar, submitted that, whence the assessee is purchasing two different products which has different gross profit margins then these two different products cannot be clubbed together to arrive at appropriate gross profit margin for the purpose of bench marking. The huge variation in the gross profit margin (i.e. 44% for the automotive products and 25% for the medical equipment) together cannot give proper benchmarking analysis. On this factor alone RPM cannot be said to be the correct method to apply in the present case. The reason being the manner of pricing for both the products is different and so also the income. Further the cost related to all the various functions as highlighted by the TPO would again is vital factor, because under the distribution function, only the gross compensation after the cost of sales is taken and, therefore, it is different to apply RPM in the case of full risk distributor. He also pointed out to the observations of the DRP that assessee had two models one outright sale of equipment and other leasing of equipments and, therefore, in this situation also RPM cannot be considered. In the nutshell, we strongly relied upon the observation and the finding of the DRP as well as the TPO.
12. We have heard the rival submissions and perused the relevant finding given in the impugned order qua the issue, whether under the facts and circumstances of the case RPM should be considered as most appropriate method or not? It is an undisputed fact that the assessee 12 ITA No. 6638/Del/2015 under the segment of purchase of goods for resale from its AE is purely into distribution of finished goods in India. It purchases automotive test equipment and medical diagnostic equipments, manufactured by its AE and is sold to third party customer in India without any further value addition. Since it was purely performing the distribution function, therefore, to benchmark the arm's length transaction, assessee adopted RPM is the Most Appropriate Method (MAM). The RPM has been described in Rule 10B(1) and (b) in the following manner:
"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 shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely : --
(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 and the comparable 13 ITA No. 6638/Del/2015 uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;
(iv) 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;
Thus, the RPM method identifies the price at which the product purchased from the A.E. is resold to an unrelated party. Such price is reduced by normal gross profit margin, i.e., the gross profit margin accruing in a comparable controlled transaction on resale of same or similar property or services. The RPM is mostly applied in a situation in which the reseller purchases tangible property or obtain services from an A.E. and reseller does not physically alter the tangible goods and services or use any intangible assets to add substantial value to the property or services, i.e., resale is made without any value addition having been made.
13. In the case of Mattel Toys India P. Ltd. (supra), the Tribunal after analyzing the RPM method, observed and held as under:-
"-------------Since in RPM only margins are seen with reference to items purchased and sold or earned by an independent enterprise in comparable uncontrolled transactions vis-a- vis the one in the controlled transactions, therefore, in such a situation, the nature of products has not much relevance though their closer comparable may produce a better result. The focus is more on same or similar nature of properties or services rather than similarity of products. In RPM other attributes of comparability than the product itself can produce a reliable measure of arm's length conditions. The main reason is that the product differentiation does not materially affect the gross profit margin as it represents gross compensation 14 ITA No. 6638/Del/2015 23 after the cost of sales for specific function performed. The functional attribute is more important while undertaking the comparability analysis under this method. Thus, in our opinion, under the RPM, products similarity is not a vital aspect for carrying out comparability analysis but operational comparability is to be seen. Since the gross profit margin is the main criteria while evaluating the transactions in the RPM wherein price is identified at which property or services are resold and normal gross profit margin is derived at by the enterprise which is deducted from the resale price of such property or service in comparable uncontrolled transactions. The gross profit margin earned by the independent enterprise in comparable uncontrolled transactions is served as a guidance factor. This is also what happens in the case of a distributor wherein the property and service are purchased from the A.E. and are resold to other independent entities, without any value additions. The gross profit margin earned in such transactions becomes the determination factor to see the gross compensation after the cost of sales. In the instant case, the assessee is a distributor of Mattel toys and gets the finished goods from its A.E. and resells the same to independent parties without any value addition. In such a situation, RPM can be the best method to evaluate the transactions whether they are at ALP.
39. Some of the case laws relied upon by the learned Counsel also support our above conclusion that in case of distribution activities i.e., import of products and services from the A.E. and resale to the independent parties without any value addition, the RPM would be the most appropriate method for determining the ALP. This view has been upheld by the Tribunal, Mumbai Bench, in Textronix India P. Ltd. (supra), L'oreal India P. Ltd. (supra and Star Diamond Group v/s DDIT, 141 TTJ
21. The OECD guidelines and ICAI guidelines as have been referred to by the learned Counsel have also expressed on the similar line that RPM would be the best method when resale takes place without any value addition to a product for bench 15 ITA No. 6638/Del/2015 marking the ALP.
40. On the other hand, under the TNMM, the ALP is determined by comparing the operating profit related to an appropriate base i.e., cost or sale or assets of the "tested party" with the operating profit of an uncontrolled party engaged in comparable transactions. Under the TNMM, net margin or operating profit is compared against with the independent entities against those achieved in related party transactions. Under the TNMM, the major thrust is to derive at the operating profit at the transactional level and to identify the operating expenses of both the tested party as well as the independent parties. This requires a lot of adjustments to derive at the actual operating profit. If the ALP of any transaction can be determined by applying any of the direct methods like CUP, RPM, CPM then they should be given the preference and once these traditional methods have been rendered inapplicable then only TNMM should be resorted to. On the facts of the assessee's case, in our opinion, the assessee being a distributor who is purchasing the goods from its A.E. and reselling them to independent parties / unrelated parties, resale price method would be the most appropriate method for determining the ALP of the transactions between the assessee and the AE."
14. From the aforesaid decision it is quite ostensible that in case of a distributor, wherein the goods are purchased from AE and resold to other independent entities without any value addition, then resale price method should be reckoned as MAM. One of the main reason given by the TPO as well as the DRP is that the assessee is a full-fledged/full risk distributor and performing host of functions, therefore, RPM should not be taken us the MAM, because all these functions required huge cost which may not represent correct gross profit margin. We are unable to appreciate such proposition, because in a comparable uncontrolled transactions scenario, a normal distributor will undertake all kind of 16 ITA No. 6638/Del/2015 functions which are related to sales of the product. The functions like market research, sales and marketing, ware-housing, inventory control, quality control etc. and also risk like market risk, inventory risk, credit risk etc all are undertaken by any distributor for sale of products. No comparable instances have been brought either by the TPO or by the Ld. DRP that the other distributors are not performing such functions. What is important is to see is, whether there is any value addition or not on the goods purchased for resale? If there is no value addition and if the finished goods which are purchased from AE are resold in the market as it is, then gross profit margin earned on such transaction becomes the determinative factor to analyse the gross compensation after the cost of sales. Thus, we hold that under the facts of the present case, RPM should be held as MAM.
15. The other main objection of the Department before us is that, there is a huge variation in the gross profit margin of the two products distributed by the assessee and, therefore, under the RPM same cannot be clubbed together, because it will not yield proper arm's length result. As already clarified by the assessee before the authorities below as well as before us that, assessee has separately worked out the gross profit margin for both the items distributed and even then the assessee's gross profit margin is higher than the comparables. However, in order to examine whether the gross profit margin for both the products are at arm's length margin or not vis-a-vis the comparables, we are of the opinion that for the limited purpose of benchmarking the gross margins of the comparables selected by the assessee for both the products, i.e., automotive components and medical equipment should be separately benchmarked; and if on comparison it is found that the gross profit margin of these comparables chosen by the assessee as well as accepted 17 ITA No. 6638/Del/2015 by the Department are within the arm's length range, then no adjustment should be made. With this limited direction the matter is remitted back to the TPO/AO only to verify the gross margins of the comparable companies.
16. In the result, grounds no. 1 & 2 are allowed.
17. In view of the finding given above that RPM is the MAM, then the issues raised in ground nos. 3 to 6 will become infructuous and purely academic, because these are the grounds relating to certain adjustments, if TNMM is applied and taken as MAM. Thus, ground nos. 3 to 6 are treated as academic and hence, are dismissed for statistical purposes.
18. Ground no. 7 is admitted to be pre-mature and ground no. 8 is consequential. Accordingly, both the grounds are dismissed.
19. In the result, the appeal of the assessee is partly allowed.
Order is pronounced in the open court on 18th April, 2017.
Sd/- Sd/-
(J.S. REDDY) (AMIT SHUKLA)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated: 18.04.2017
*Kavita Arora
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(Appeals)
5. DR: ITAT
ASSISTANT REGISTRAR
18 ITA No. 6638/Del/2015
ITAT NEW DELHI
Date
1. Draft dictated on 24.03.2017
2. Draft placed before author 10.04.2017
3. Draft proposed & placed
before the second member
4. Draft discussed/approved by
Second Member.
5. Approved Draft comes to the
Sr.PS/PS
6. Kept for pronouncement on 18.04.2017
7. File sent to the Bench Clerk 17.04.2017
8. Date on which file goes to the
AR
9. Date on which file goes to the
Head Clerk.
10. Date of dispatch of Order.
19 ITA No. 6638/Del/2015