Vaibhav Global Limited Vs DCIT (ITAT Jaipur)
Summary: The Income Tax Appellate Tribunal (ITAT), Jaipur Bench, in Vaibhav Global Limited Vs DCIT, allowed the assessee’s appeal for Assessment Year 2016-17 and directed deletion of a transfer pricing adjustment of ₹29,25,17,385, holding that the Berry ratio was inappropriate for benchmarking international transactions of a company engaged in substantial manufacturing activities. The assessee, a manufacturer and exporter of gemstones and studded jewellery, had adopted the Cost Plus Method (CPM), using gross profit relative to cost of production as the profit level indicator. However, the Transfer Pricing Officer rejected CPM and applied the Berry ratio under the Transactional Net Margin Method, resulting in the disputed adjustment. The Tribunal observed that the Berry ratio may be suitable for limited-risk distributors or intermediaries but not for manufacturers undertaking significant production, processing and inventory-related functions. It noted that the assessee operated manufacturing facilities in Jaipur and Mumbai, employed substantial assets and personnel, and assumed inventory, credit, foreign exchange and other business risks. The Tribunal also rejected the Revenue’s reliance on consolidated financial statements reflecting overseas subsidiaries’ retail operations, emphasising the need to examine the Indian assessee’s standalone functional profile. Applying a cost-based profitability analysis to the TPO’s comparable companies, the Tribunal recorded a median margin of 12.90%, against the assessee’s margin of 13.51%. Since the assessee’s profitability exceeded the comparable benchmark, its international transactions were held to satisfy the arm’s length requirement. Accordingly, the Tribunal deleted the entire adjustment of ₹29.25 crore and allowed the appeal.
The Income Tax Appellate Tribunal, Jaipur Bench “B”, allowed the appeal of Vaibhav Global Limited for Assessment Year 2016-17 and directed deletion of a transfer pricing adjustment of Rs. 29,25,17,385. The appeal arose from the final assessment order dated 30 June 2021 passed under Section 143(3) read with Section 144C(13) of the Income-tax Act, 1961. The assessee, engaged in manufacturing and exporting gold jewellery studded with precious and semi-precious stones, challenged the rejection of its transfer pricing benchmarking method and the application of the Berry ratio by the Transfer Pricing Officer. The central question was whether operating profit relative to value-added expenses could appropriately measure the arm’s length profitability of a company undertaking substantial manufacturing activities.
The assessee had filed its return declaring income of approximately Rs. 28.11 crore. During scrutiny proceedings, the Assessing Officer referred its international transactions to the Transfer Pricing Officer under Section 92CA(1). In its transfer pricing documentation, the assessee had adopted the Cost Plus Method (CPM) and used gross profit relative to cost of production as the profit level indicator. The TPO rejected this approach, reasoning that the assessee both purchased goods from and sold goods to associated enterprises, thereby affecting the cost and revenue sides of the transactions. The TPO instead selected operating profit divided by value-added expenses under the Transactional Net Margin Method, resulting in the disputed adjustment of Rs. 29.25 crore.
The TPO calculated a median operating profit-to-value-added-expenses ratio of 55.27% for the selected comparable companies. Applying that indicator, the arm’s length operating revenue was determined at Rs. 389,85,63,762 against reported operating revenue of Rs. 360,60,46,377. The difference of Rs. 29,25,17,385 was proposed as an adjustment under Section 92CA(3). The Dispute Resolution Panel, by its directions dated 20 January 2021, upheld the adjustment. Consequently, the Assessing Officer passed the final assessment order determining total income at Rs. 57,36,47,429. The assessee approached the Tribunal, arguing that the authorities had adopted an inappropriate indicator and had failed to undertake a proper functional comparability analysis.
The assessee submitted that the Berry ratio was ordinarily suitable for limited-risk distributors or procurement intermediaries whose profitability was principally linked to operating expenses rather than the value of goods handled. It argued that the indicator was inappropriate for a manufacturer because it excluded substantial raw material, production and inventory-related costs from the relevant cost base. Vaibhav Global manufactured coloured gemstones and studded jewellery using its own production facilities, equipment, infrastructure and personnel. Its operations involved procurement, designing, processing, manufacturing, finishing and export. The assessee maintained that these functions required consideration of the complete manufacturing cost structure and that its selection of CPM was consistent with the applicable transfer pricing principles.
The assessee also furnished details of transactions with associated and unrelated enterprises. Sales to associated enterprises amounted to Rs. 318,54,77,750, representing 88.34% of total sales, while sales to unrelated parties constituted 11.66%. However, purchases from associated enterprises amounted to Rs. 59,47,42,920, representing only 21.09% of total purchases. The remaining 78.91% of purchases were from unrelated parties. The assessee explained that purchases from associated enterprises were generally undertaken on a cost-to-cost basis to facilitate sourcing of materials from overseas jurisdictions. It therefore disputed the TPO’s assumption that the company operated merely as a trading intermediary whose cost and revenue sides were substantially controlled.
The Revenue defended the adjustment, contending that the assessee’s dealings with associated enterprises justified adopting the Berry ratio. The Department relied upon the DRP’s findings and judicial authorities recognising that the Berry ratio could be used in appropriate circumstances. It also referred to the company’s consolidated financial statements and overseas retail operations to support its characterisation of the business. The assessee responded that the consolidated financial statements included overseas subsidiaries engaged in retailing, whereas the Indian assessee’s standalone activities were those of a manufacturer and exporter. The Tribunal examined this distinction and found that the manufacturing functions performed by the Indian company could not be disregarded merely because its overseas associated enterprises undertook downstream distribution and retail activities.
The Tribunal considered the OECD Transfer Pricing Guidelines, the United Nations Practical Manual on Transfer Pricing and the judicial decisions cited by the parties. It particularly examined the principles discussed in Sumitomo Corporation India Pvt. Ltd. and Mitsubishi Corporation India Pvt. Ltd. The Tribunal observed that the Berry ratio may be appropriate where an enterprise performs limited-risk distribution functions and where the value of goods does not materially contribute to its profits. However, where a taxpayer undertakes manufacturing, processing, inventory management and other functions requiring substantial assets and expenditure, operating expenses alone may not adequately reflect the economic activities and risks involved. The Tribunal concluded that the assessee’s functional profile did not justify the application of the Berry ratio.
On the facts, the Tribunal found that Vaibhav Global undertook significant manufacturing functions at its facilities in Jaipur and Mumbai and assumed inventory, credit, collection, product, manpower, technology, foreign exchange and general business risks. The Tribunal rejected the TPO’s characterisation of the assessee as a mere intermediary purchasing from one associated enterprise and reselling to another. It held that the substantial processing and manufacturing operations, together with the employment of tangible and intangible assets, made the Berry ratio unsuitable. The Tribunal further observed that the approach adopted by the TPO was inconsistent with the functional analysis contemplated by the relevant international transfer pricing guidance and the judicial precedents considered in the order.
The Tribunal then examined the arm’s length position using the comparable companies selected by the TPO and the cost-based profitability indicator. The comparable companies’ median margin was recorded at 12.90%, while the Tribunal referred to the assessee’s margin of 13.51%. The assessee’s financial analysis also separately reported gross profit relative to cost of production of 15.62%. Since the assessee’s profitability exceeded the relevant comparable benchmark, the Tribunal concluded that its international transactions satisfied the arm’s length requirement. It accordingly directed deletion of the entire transfer pricing adjustment of Rs. 29,25,17,385. By its order pronounced on 7 February 2022, the Tribunal allowed the assessee’s appeal.
Cases Discussed
- Sumitomo Corporation India Pvt. Ltd. v. CIT, ITA No. 381/2013, Delhi High Court, judgment dated 22 July 2016 — Considered regarding the circumstances in which the Berry ratio may be adopted and the importance of functions, assets and risks in selecting an appropriate profit level indicator.
- Mitsubishi Corporation India Pvt. Ltd., ITA No. 5042/Del/2011, ITAT Delhi, order dated 21 October 2014 — Discussed concerning the application of the Berry ratio to low-risk, high-volume trading operations involving limited value addition.
- ACIT v. Bagadiya Brothers Private Limited, ITA No. 203/BLPR/2012, ITAT, order dated 1 March 2017 — Considered for the principle that the Berry ratio cannot automatically be applied where an enterprise undertakes substantive functions, employs assets and assumes business risks.
- Radhasoami Satsang v. CIT, , Supreme Court, decision dated 15 January 1991 — Cited in the Revenue’s submissions concerning consistency of tax treatment across assessment years and circumstances permitting a different approach.
- Anjala Exhibition Pvt. Ltd. v. ACIT, ITA No. 162/Del/2012, ITAT Delhi, order dated 31 May 2013 — Cited by the Revenue regarding the principle of consistency and the possibility of departing from earlier treatment for justifiable reasons.
