M/s Panasonic India Pvt. Ltd. Vs. Income Tax Officer (ITAT Delhi)

The advertisement reimbursement would definitely form a part of the operating profits of the assessee and would have to be taken into account for purposes of transfer pricing analysis.

in view of the correct analysis and working as given above on the comparison between the assessee and the com parables and by correcting the two errors committed by the TPO and CIT(A) and confining the financials to one year only and not to multiple years for the trading functioning of assessee, the PLI of the assessee comes to 8.43% and that of the com parables 3.58%. As the PLI of the assessee is higher of the two, the international trading transactions entered into by the assessee are held to be at arm’s length price as per transfer pricing regulations in India. Accordingly the addition made by the TPO and upheld by CIT(A) amounting to Rs. 1,23,48,509/- is ordered to be deleted.

Simply because there is loss in one year and addition to the assessee’s income cannot be made in accordance with transfer pricing regulations, especially when this loss has not been incurred due to any transaction with the AE. In this ISD Division, there is neither any sale nor any purchases from the AEs. It is purely a local service allocated to servicing goods sold by AEs to its customers in India plus commission on the goods sold by the AEs directly in India. It is, therefore, clear that no adjustment on the ISD Division is called for as the PLI for the three years average of assessee is higher than that of the comparable.(Para 31)

IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH ‘F’ : NEW DELHI

BEFORE SHRI I.P. BANSAL, JM AND SHRI R.C.SHARMA, AM

ITA No. 1417/Del/2008
Assessment Year : 2002- 03

 AND
ITA No. 1373/Del/2008
Assessment Year : 2002-03

Assessee by : Shri Pradeep Dinodia, Ms.Pallavi Dinodia & Shri R.K. Kapoor, CAs.
Department by : Shri Sanjay Sharma, CIT-DR

Date of Judgment: 24th September, 2010.

O R D E R

PER R.C.SHARMA, AM :

These are the cross appeals filed by the assessee and the revenue against the order of CIT(A) dated 31.01.2008 for the assessment year 2002-03, in the matter of order passed u/s 143(3) of the Income Tax Act, 1961.

2. Facts in brief are that the assessee National Panasonic India Pvt.Ltd. (NPIPL) is part of the Matsushita group of companies. The group is one of the world’s leading manufacturers of consumer electronics products. These products are sold under the brand names ‘National’, ‘Panasonic’, ‘Technics’ and ‘Quasar’. National Panasonic India Private Limited (NPIPL) is a wholly owned subsidiary of Matsushita Electric Industrial Company Limited, Japan (MEI). 99.99% of the shares of the assessee company are held by MEI, Japan and the remaining .01% are held by Matsushita Asia Private Limited, Singapore. The business of the assessee company is organized under three distinct segments. As per the TP report, the following are the three classes of international transactions (Table-3) described in Para 2.5 of the Report :-

Table- 3

Trading Function	Commission & Marketing agency services	Advertising Expenses Reimbursement
Import of CPD & SPD products by NPIPL from MEI ground entities	Rendering sales agency services by NPIPL to MEI group entities in respect of industrial sales division products against receipt of commission payments.	Reimbursement received by NPIPL from MEI group entities for certain advertising expenses.
Reimbursement of traveling expenses by MEI group entities to NPIPL.	Reimbursement of market development expenses incurred for the industrial products by MEI group entities to NPIPL.
Payment of Pananet support by NPIPL to MEI.	Additional income received by NPIPL for providing warranty services to ‘Panasert’ machines sold to customers in India from MEI group entities.
Service fee received by NPIPL for supervising authorized service centers, and reimbursement of cost of repair and replacement by MEI group entities to NPIPL.

3. During the course of scrutiny assessment, detailed information, clarification alongwith justification of allow ability of various expenses was called by the AO and the same were duly filed by the assessee. The AO framed assessment u/s 143(3) at an income of Rs.68.29 lakhs, as against returned loss of Rs. 4.73 crores, after making various additions and dis allowances. The AO also made a reference to the transfer pricing official to determine the net effect of all the transactions of the assessee with its associated enterprises. The AO found that assessee is a subsidiary company of M/s Matsushita Electric Industrial Company Limited (MEI). The main object of the company was selling and distributing domestic as well as export market the products having the Matsushita brand name of “National Panasonic” manufactured by Matsushita group and its various collaboration companies. From the record, we found that the business of the assessee was organized under three segments– (i) Consumer Product Division (CPD), (ii) System Product Division (SPD) and (iii) Industrial Sales Division (ISD). CPD and SPD divisions were performing trading functions and the ISD division was performing commission agency functions. The assessee company had also undertaken transfer pricing analysis for these functions. For this purpose, the results of CPD and SPD were aggregated and the results of ISD were considered separately. However, the TPO while scrutinizing the assessee’s accounts on segmental basis, re-written the accounts of three segments CPD, SPD and ISD. On the basis of re- written accounts, the TPO recommended transfer pricing adjustment of Rs. 1.12 crores in respect of imported finished goods for the CPD segment. An adjustment to the tune of Rs. 1.15 crores was also recommended in respect of remuneration earned from parent company pertaining to ISD division. In the economic analysis carried out by the assessee, the activities of the supervision of authorized service centers were aggregated with the main activity of trading function for the purpose of bench marking analysis. The TNMM method was found to be most appropriate method for testing profitability of trading functions. The net operating profit margin on sales was chosen as a profit level indicator for bench marking analysis for the trading function. Then TNMM was also found to be most appropriate method to test the profitability of commission and marketing agency services of ISD division. In respect of margin shown on SPD, the AO found that same was more than arm’s length margin of 2.48%, therefore international transaction pertaining to SPD was held to be at arm’s length. In respect of imported goods under CPD, the AO observed that the loss margin shown was below the arm’s length margin. The AO therefore observed that the transfer price of the imported finished goods under the CPD has to be adjusted downwards. Accordingly, arm’s length price was determined at the price declared in form 3CEB minus the adjustment amount i.e. Rs.74704584 – Rs.11237019 = RS.63467565. The arm’s length price in respect of remuneration received under ISD division was also enhanced by the AO by an amount equivalent to the difference of operating loss margin and the mean margin of the comparable companies chosen. This difference works out to be 6.11% – (-) 28.8% = 34.91% of the total costs. The total costs have been worked out to be Rs. 33131321.34.91% of this amount comes to Rs. 11566144/-. Thus, the total income of the assessee was enhanced by the AO by following amounts:-

For CPD imports –         Rs. 11237019

For ISD –                          Rs. 11566144

Total –                               Rs. 22803163

These additions have been dealt by CIT(A) as under:

“4.1 During the assessment proceedings, the AO noticed the following international transactions (Table-1) entered into by the appellant during the financial year 2001-02, as reported in Form 3CEB, filed along with the return of income:

Table- 1

Nature of Transaction	Method	Value (in Rs.)
Purchase of finished goods	TNMM	44,92,32,055
Purchase of spares	TNMM	56,39,260
Commission & Service income	TNMM	2,04,93,071
Payment for Pananet Services	TNMM	1,56,936
Reimbursements received	TNMM	15,97,82,249

4.2 A reference was made by the AO u/s 92CA(1) of the Act to the TPO for computation of ALP in respect of these international transactions. The TPO observed that the business of the company was organized under three distinct segments (i) Consumer Product Division [CPD] (ii) System Products Division [SPD] & (iii) Industrial Sales Division [ISD]. The first two divisions performed trading functions whereas the third one performed commission agency functions. The appellant had conducted transfer pricing analysis for these two functions separately. For this purpose, the results of CPD 7 SPD were aggregated and the results of ISD were considered separately. The TPO, however, analyzed the accounts of the appellant on segmental basis and redrew the accounts of the three segments CPD, SPD & ISD separately. Further, CPD was bifurcated into CPD (Local) & CPD (Imported Goods). On the basis of the redrawn segmental accounts, the TPO recommended transfer pricing adjustment of Rs.1,12,37,019/- in respect of imported finished goods in the CPD (imported goods) segment. A quantum of TP adjustment to the tune of Rs.1,15,66,144/- was also recommended in respect of remuneration received by the appellant from its parent company pertaining to ISD Division.

Transfer Pricing Report

4.3 The starting point of TPO’s endeavor to determine the ALP, is the Transfer Pricing Report (“TP Report”) prepared by the appellant. This report provides an analysis of functions performed, assets used and risk assumed by the appellant and examines whether return is commensurate with the functions performed, assets used and risk assumed. As per the provisions of the Act, a bench-marking analysis is done by first selecting the comparable uncontrolled cases, then my computing the ALP with data pertaining to these com parables, using the most appropriate method and finally, by ascertaining whether the intra- group transactions conform to the arm’s length standards prescribed by the Act or not.

A. Business Profile:

4.4 Before adjudicating on the TP issues, it would be appropriate to sketch the business profile of the appellant as described in the TP report:

(i) National Panasonic India Pvt. Ltd. (NPIPL or assessee or Taxpayer Company) is part of the Matsushita group of companies. The group is one of the world’s leading manufacturers of consumer electronics products. These products are sold under the brand names ‘National’ ‘Panasonic’, ‘Technics’ and ‘Quasar’.

(ii) National Panasonic India Private Limited (NPIPL) is wholly owned subsidiary of Matsushita Electric Industrial Company Limited, Japan (MEI). 99.99% of the shares of the assessee company are held by MEI, Japan and the remaining .01% are held by Matsushita Asia Private Limited, Singapore.

(iii) The business of the taxpayer company is organized under three distinct segments (Table-2) :

Table- 2

Division

Sub-Division

Products

Brand

Name Functions

performed Remarks(i) Consumer Product Division (CPD)(i) Households appliances Microwaves, washing machines, home showers‘ National’ Trading/ Distribution  (ii) Consumer’s Electronic Color television,Plasma T.V., Audio video systems and Movie Cameras ‘Panasonic’ Trading/Distribution (ii) System Products Division (SPD)Office Automation and Telecommunications Fax Machine, Telephone Instruments, etc.‘Panasonic’ Trading Distribution (iii) Industrial Sales Division (ISD) Electronics components batteries, welding equipment and measuring instruments Commission & Marketing Agency Also provides after sales service for product

sold by MEI, Japan and other affiliates to Indian customers

 B. Nature of International Transactions:

4.5 As per the TP report, the following are the three classes of international transactions (Table-3) described in Para 2.5 of the report:

Table- 3

Trading Function	Commission & Marketing Agency Services	Advertising Expenses Reimbursement
_ Import of CPD & SPD products by NPIPL from MEI ground entities	_ Rendering sales agency services by NPIPL to MEI group entities in respect of industrial sales division products against receipt of commission payments.	_ Reimbursement received by NPIPL from MEI group entities for certain advertising expenses.
_ Reimbursement of traveling expenses by MEI group entities to NPIPL.	_ Reimbursement of market development expenses incurred for the industrial products by MEI group entities to NPIPL.
_ Payment of Pananet support by NPIPL to MEI	_ Additional income received by NPIPL for providing warranty services to “Panasert” machines sold to customers in India from MEI group entities.
_ Service fee received by NPIPL for supervising authorized service centers, and reimbursement of cost of repair and replacement by MEI group entities to NPIPL.

 

C. T.P. Report & Function, Assets & Risk (FAR) Analysis:

 

4.6 As per the functional analysis carried out at Para 3 to 3.4 in the T.P. Report, the following are the details relating to the major functions performed in respect of various international transactions along with risk assumed (Para 3.1.2) and assets deployed by the appellant (Table-4) :

Table-4

Trading Functions	Import of products	Payment for Pananet Support	Reimbursement of administrative expenses	Supervision of authorized service centers (ASC)
Functions	“Import products from MEI Group Entities.-Obtaining custom clearance. -Maintenance of warehouse facilities for stocks. -Selling and distribution functions. -Price determination. -Undertaking publicity and advertisement campaigns with full description	-Payment for use of Pananet software on the basis of number of hours used.	-Receipt of reimbursement for administrative and traveling expenses incurred by NPIPL for its dealers in India	Appointment ofASCs.-Distribution of service manual to ASCs. -Providing technical support to ASCs. -Administering supply of spare parts and tools to ASCs. -To collect records of service claims from ASCs. -Reporting of service activities of ASCs. -Replying to complaints, questions & inquiries from customers.
Risk	-Contract risk with dealer and distributors.-Inventory risk. -Market risk. -Quality and warranty risk. -Foreign exchange fluctuation risk.	No details in the TP report	No details in the TP report	No details in the TP Report
Assets deployed	-Owns assets to perform importing, warehousing, administration and distribution functions. -No intangible assets.	No details in theTP report	No details in the TPreport	No details in the TPreport

 

COMMISSION & MARKETING AGENCY SERVICES
Functions	_ Product presentation and sales representation services to customers;_ Conduct market research and survey in India;_ Undertake market/product development in India; _ Explore sales and distribution channels for ISD products; _ Increase awareness and use of ISD products in India; and _ After sales services and maintenance under warranty.
Risk	_ Foreign exchange fluctuation risk
Assetsdeployed	_ Uses the existing assets for discharging this function

 D. T.P. Report, Economic & Bench marking Analysis:

4.7 The economic analysis carried out by the appellant contained in Para 4 to 4.6 of the T.P. Report had drawn the following conclusions:

(i) The activities of supervision of authorized service centers are aggregated with the main activity of the trading function of NPIPL for the purpose of bench marking analysis.

(ii) TNMM was found to be the Most Appropriate Method (MAM) to test the profitability of NPIPL’s trading functions.

(iii) NPIPL is taken as a tested party.

(iv) NPIPL’s functional and risk profile seems more akin to that of a typical distributor.

(v) Net operating profit margin on sales (NPM) which is a ratio of net profit to total sales in chosen as the profit level indicator for the bench marking analysis for the trading function.

(vi) TNMM was found to be the Most Appropriate Method (MAM) to test the profitability of NPIPL’s commission & marketing agency services.

(vii) NPIPL is taken as a tested party for bench marking the agency function.

(viii) NPIPL’s functional and risk profile seems more akin to that of a service provider.

(ix) Net cost plus margin (NCP) which is a ratio of net profit total cost is chosen as the profit level indicator for the bench marking analysis.

(x) NPIPL was not in the business of providing services to unrelated parties in respect of advertising campaign. Any benefit on account of the campaign accruing to the MEI group was purely incidental. Hence, the reimbursement cost on account of advertising expenses would not warrant any mark up. Accordingly, no separate benchmarking analysis is required to be done for this transaction.

E. Multi-Year Data:

4.8 For carrying out the comparability analysis, the appellant had focused on the operating results of comparables over the three financial years 1999-2000, 2000-01, & 2001-02. This was stated to have been done to minimize the impact of abnormal factors on the outcomes of the comparable data.

F. Selection of Comparables : Trading Function:

4.9 The appellant identified a set of nine uncontrolled comparable companies from Prowess Database by way of three different searches. In the first search, companies classified under the broad head of electronics were considered as per the selection process detailed in Table-5 of this order, by adopting a formula based search strategy by applying various quantitative and qualitative filters to the set of potential comparables within this segment:

Table 5 : SELECTION PROCESS

Criteria	No.of Companies passing the criterion	Explanation
Starting Point	116	Companies in the electronics segment having the requisite financial information.
Manufacturing sales to total sales ratio of < 25% to be retained	27	To exclude companies those are primarily into manufacturing.
Trading sales to total sales ratio of > 75% to be

retained12To exclude companies those are not primarily engaged in distribution/trading activities.Research & development expenses to sales ratio < 5% to be retained.12To eliminate companies undertaking significant research and development activities.Qualitative analysis1To eliminate companies Companies having related party sales. Companies not dealing in similar product or having similar business and functional profile Companies having more than 10% of average loss.

In the second search, the criterion of selection was extended to include companies engaged in the trade of electrical machinery. Table No.6 of this order summarizes the selection process.

Table-6

Criteria	No. of Companies passing the criterion	Explanation
Starting Point	894	Companies in the electronics and electrical goods segment having the requisite financial information.
Manufacturing sales to total sales ratio of <25% to be retained.	385	To exclude companies those are primarily into manufacturing.
Trading sales to total sales ratio of >75% to be retained	56	To exclude companies those are not primarily engaged in distribution/ trading activities.
Research & development expenses to sales ratio<5% to be retained.	56	To eliminate companies undertaking significant research and development activities.
Qualitative analysis	3	To eliminate companies*Companies having related party sales. *Companies not dealing in similar product or having similar business and functional profile. *Companies having more than 10 of average loss. *Abnormal factors affecting profitability. *Insufficient information such as absence of director’s report.

 

In the third search, the criterion of selection was extended to include companies engaged in the trade of electrical machinery. Table No.7 of this order summarizes the selection process.

Table- 7

Criteria	No. of Companies passing the criterion	Explanation
Starting Point	730	Companies in the electronics,electrical & non-electrical goods segment having the requisite financial information.
Manufacturing sales to total sales ratio of <25% to be retained.	294	To exclude companies those are primarily into manufacturing.
Trading sales to totalsales ratio of >75% to be retained	167	To exclude companies those are not primarily engaged in distribution/ trading activities.
Research & development expenses to sales ratio<5% to be retained.	166	To eliminate companies undertaking significant research and development activities.
Qualitative analysis	6	To eliminate companies*Companies having related party sales. *Companies not dealing in similar product or having similar business and functional profile. *Companies having more than 10% of average loss. *Insufficient information such as absence of director’s report.

 The final set of com parables obtained by way of the three different searches along with the weighted average of net profit margins is detailed in Table No.8 below:-

Table- 8

S No.	Company Name	IdentifiedIn thesearch number	BusinessProfile	2000	2001	2002	WeightedAverage
1	AmzelAutomativeLimited	Search 3	Tradingbusiness ofExide car batteries	5.37	1.13	NA	3.22
2	Gold RockInvestmentsLtd.	Search 3	Engaged intrading ofelectrical goods.	6.02	5.31	NA	5.59
3	KDhandapani& Co. Ltd.	Search 2& 3	Carries ondealership inelectrical components for Siemens India Ltd.GEC Alsthom & Finotex Cables Ltd. Supplies switchboards, switches & distribution boards for industrial application and electrical installation contracts.	2.23	0.30	NA	1.25
4	Khaitan(India)Ltd.	Search 3	Engaged intrading of fans.Also trades in monobloc pumps, FHP motors, power driven pumps & other home appliances.	1.13	1.94	4.49	2.49
5	Redington (India) Ltd.	Search 2 & 3	Trading of computers &peripherals.Concentrating in small office, home office segments of personal computers.	2.43	2.27	NA	2.33
6	Remi Sales& Engg.Ltd.	Search 1& 2	Trades infloppy diskdrives, hard disk drives & other computer equipments.	(0.97)	NA	NA	(0.97)
7	Total						17.36
	ArithmeticMean						2.48%

 

The net profit margin of the assessee on the basis of the weighted average for the three financial years 1999-2000, 2000-01 & 2001-02 worked out to 6.15% computed (table-9) in the following manner:

 

Table-9

 

Trading Function
(Rupees’000)
Particulars	31-March-02	31-Mar-01	31-Mar-00	Weighted Average
Income from operation	9,25,934	7,13,907	4,25,271
Other income	1,150	0	0
TotalOperatingIncome	9,27,084	7.13.907	4,25,271	20,66,262
Expenditure
Cost of sales	6,84,856	5,42,125	3,05,761
Direct sellingexpenses	1,04,984	76,006	59,604
General &administrativeexpenses	69,925	56,381	39,553
TotalOperatingCost	8,59,765	6,74,512	4,04,918	19,39,195
TotalOperatingProfits	67,319	39,395	20,353	1,27,067
NPM	7.26%	5.52%	4.79%	6.15%

 

It was concluded in the TP report that the assessee had earned net profit margin of 6.15% which exceeded the arm’s length profit margin of 2.48%, the outcome of NPIPL’s international transactions satisfied the arm’s length standard.

 

The order of TPO was as under.

 

T.P.O’s ORDER

 

“5. During the TP proceedings, the TPO observed that the combined results of the two segments namely CPD and SPD were benchmarked against the margins of the comparables. It was also noticed that CPD division had made an operating loss of Rs. 2.72 crores as against an operating profit of Rs. 5.79 crores made3 by the SPD division. The TPO also noticed that the segmental accounts of CPD & SPD INCLUDED THE SUM OF Rs 15.3 crores as reimbursements received from associated enterprises for certain advertising expenses incurred by the appellant. Removing the reimbursement as operating income, the CPD would make an operating loss of Rs 16.59 crores and the SPD an operating profit of Rs. 4.35 crores. An opportunity was given by the TPO to the appellant to explain as to why the operating margins of the two divisions CPD & SPD should not be recomputed by excluding the advertisement reimbursement. In response to the query, the appellant submitted that the reimbursed amount was exclusively spent on meeting advertising and marketing expenses and therefore, that should be treated as operating income. Further, while examining the segmental accounts, the TPO observed that most of the goods in SPD were imported from the A.Es as against only 5% in the CPD. The conclusions drawn by the TPO in these regards are discussed in the subsequent sub-paras.

A. Aggregation of CPD & SPD Divisions

5.1 According to the TPO, the aggregation of the results of the two divisions was not appropriate. Facts do not support the contention that the CPD and SPD are so closely interlinked that no separate evaluation is possible. This fact is evident from the segmental accounts prepared by the appellant itself. As transactions between the appellant and the related parties constitute only 5% of the total transactions of CPD division, it would be fair to analyze the transaction of the appellant with the AE as ‘CPD Imported” separately. The TPO cited the following reasons for coming to the conclusion that CPD (Local), CPD (Imported) & SPD divisions have to be evaluated separately:

i. Though Rule 10A of the Rules clarifies that “transaction” includes a number of closely linked transactions, the transactions n the two divisions CPD & SPD are not closely linked.

ii. Trading of consumer goods like TV sets, washing machines and cameras cannot be said to be closely interlinked or integrated with the trading of office automation and telecom products.

iii. The marketing strategy and the target consumer group differ widely for the two segments. The dynamics of the two segments are vastly dissimilar.

iv. The difference in gross margins between the SPD (26%) and CPD (19%) segments reflects the distinctions.

v. The ratio of selling expenses to net sales for CPD is 18.63% as against 14% for SPD.

vi. It is inappropriate to say that import of consumer goods is closely interlinked with import of office products.

vii. The very purpose of transfer pricing analysis is to segregate controlled transactions from uncontrolled transactions and then to evaluate the controlled transactions separately. Thus, aggregation of unrelated and related party transactions would distort the evaluation process. CPD with very insignificant proportion of related party transactions cannot be aggregated with SPD.

viii. If aggregation of results is done for the two divisions CPD & SPD, then the net losses from the controlled transactions could be justified through profits from another set of controlled transactions, thereby making the analysis meaningless.

C. Redrawing of Segmental Accounts

5.3 The TPO had redrawn the segmental accounts pertaining to CPD (imported goods) and SPD in the light of his findings discussed in the preceding paras and following the methodology detailed below:

a) the gross profits of CPD (imported), CPD (local) and SPD have been taken straight from the accounts without any allocation as furnished by the appellant;

b) the marketing assistance received by the assessee from its AEs has been excluded from other operating income;

c) the expenses pertaining to marketing of imported goods (Rs. 70.5 lacs) has been identified by the assessee from its books and records; this has been booked under CPD (imports);

d) The remaining operating expenses (without interest and finance expenses) have been allocated in proportion of sales of CPD (imported) to total sales of CPD; this works out to 4.76%;

e) The allocation of admn. Expenses have been made in proportion to sales between CPD and SPD; within CPD 4.76% has been attributed to imported goods segment;

f) The operating profit/loss margins have been worked out after deducting the operating expenditure from operating revenues. The correct operating profit in respect of each division (Table-13) as per the TPO’s order is reproduced below:

Table-13

 

	CPD (only imported from AEs) (Rs.)	SPD (Rs.)
Net Sales	132,982,473	777,133,469
Other Operating income	179,443	1,301,080
Total Operating Revenues	133,161,916	778,434,549
Cost of Goods Sold	104,476,649	575393430
Advt. expenses	7,054,248	21,975,346
Selling expenses (otherthan advt.)	20,395,201	93,538,482
Other operating expenses	7,005,786	30,731,073
Administration expenses	2,172,687	12,874,141
Total operating expenses	141,102,571	734,512,472
Operating Profit (OP)	(-)7940655	43,922,077
Operating Profit Marginon Sales (OP/Sales)	(-)5.97%	5.65%

 

D. Computing of Arm’s Length Price

5.4 On the basis of redrawn segmental accounts, the TPO had drawn the following conclusions relating to transfer price adjustments to be made in the respect of each of the divisions:

i. No TP adjustment was proposed in the respect of SPD as the operating profit margin of SPD (5.65%) was more than the arm’s length margin of 2.48%, the three-year weighted average net profit margin of the comparables.

ii. In respect of CPD (Imported goods) segment, the loss margin of (-)5.97% was found to be below the arm’s length margin of 2.48%. Accordingly, it was held that the appellant and overpaid for the imported goods to its associated enterprises to the extent of Rs. 1,12,37,019/-. This amount was calculated by multiplying the net sales value of the division of Rs. 132,982,473/- with 8.45% being the difference between the arm’s length margin of 2.48% and loss margin of 5.97% realized in this segment by the appellant.

iii. The arm’s length price of the international transaction relating to the import of finished products from the A.E. was computed at Rs. 6,34,67,565/- as the difference between the book value of the transaction of Rs. 7,47,04,584/- and the TP adjustment of Rs. 1,12,37,019/-. The benefit of +-5% under the proviso to section 92C(2) of the Act was not allowed to the appellant as the TP adjustment of Rs. 1,12,37,019/- was more than +5% variations from the ALP allowed under the law for a purchase transaction.

4. Assessee’s submissions before the CIT(A) were summarized by the CIT(A) in his order as under:

“7. During the appellate proceedings, the following submissions were made in support of the Grounds of Appeal No. 9 to 9.2:

i. The appellant had raised objections and pointed out serious lapses and shortcomings in the order passed by the TPO u/s 92CA(3) of the I.T. Act. It was inter alia highlighted that the comparisons of profits made by the TPO by splitting the activities of the appellant were unrealistic and non-comparable. However, he had completely ignored all such submissions and made additions as per order of TPO u/s 92CA(3) of the I.T. Act.

ii. In the TP report filed by the appellant, comparables were chosen after an extensive exercise and many attempts were made to find the comparables. After all these efforts, a net profit of 2.48% was adopted as the arm’s length margin for benchmarking the trading activity of the appellant.

iii. The TPO on the contrary had bifurcating the trading activity of the assessee into two separate divisions of CPD & SPD as against the consolidated trading activity reported and compared by the appellant in its TPO Analysis report.

iv. The TPO had given many reasons for bifurcating the activity of the assessee into two different divisions but safely assumed the consolidated profit margin of 2.48% of the comparables as the common net margin indicator as was reported by the assessee in its TP analysis report. Alternatively, he should have found out comparables and adopted a lower margin for the CPD division of the assessee.

v. The TPO had simply reworked the financials of the assessee with regard to certain items without making any corresponding adjustments in the PLI of the comparable cases or without finding any further comparable data. The approach adopted by the TPO is arbitrary and not as per the prescribed Rule 10B of The Rules and needs to be rejected. The order of TPO, thus, on this score is defective and needs to be modified and the addition of Rs. 1,12,37,019/- be deleted.

vi. In fact, if transactions of both the divisions having international transactions as found out by the TPO in his order are consolidated as one trading activity (apart from and without prejudice to some adjustments which he has made on which our objections are contained in the paragraphs herein below), the net margin & ALP will be determined as under;

CONSOLIDATED SUMMARISED POSITION

Net Sales	910,115,942
Other operating IncomeTotal Operating Reserves	1,480,523   911,596,465
Cost of Goods Sold	679,868,079
Adv. ExpSelling Exp. (other than adv.)	29,029,594 113,933,683
Other operatingExpense	37,736,859
Administration Exp.	15,046,828
Total Operating Exp.	875,615,043
Operating Profit	35,981,422
Operating Profit Margin on sales	3.95%

 

(vii) The consolidated net profit margin of 3.95% computed above exceeds the arm’s length margin of 2.48% and therefore, assessee’s international transactions should have been concluded to be at arm’s length.

(viii) The TPO has substantially reduced the other operating income by excluding the advertisement assistance received by the assessee from its AE’s on the grounds that such financial assistance do not form part of operations of the assessee. Such an approach of the TPO is arbitrary and based on wrong assumptions.

(ix) The financial assistance received is either to be added to operating income or the expenses of the assessee on advertisement selling expenses have got to be reduced for the similar amount. Either way such receipt being of revenue nature, as has been held by the tax authorities in earlier years, has to be accounted for. This receipt cannot be left out of computation.

(x) The TPO has concluded and recommended an addition of Rs.1,12,37,019/- in the trading activity of the assessee as according to him the assessee has overpaid on the imported goods in the CPD division @ 8.45% of the sales. In absence of any evidence, such an allegation that assessee has overpaid is highly unreasonable based on surmises which do not hold well on the facts of the assessee’s case.

(xi) The TPO had called for exhaustive information, including the price paid by the assessee towards the local purchases. A complete list of purchases of the same/identical items which were imported was furnished along with the purchase cost. It was also explained that the price paid for the imported goods were very competitive and in no case higher than that paid to the local sellers including the unrelated parties.

(xii) The assessee had submitted before the TPO that custom duty was paid on all the imports. In fact, the customs department had charged the assessee with under invoicing the goods but later on SVB (Special Valuation Bench) cleared the assessee of such charges and ordered refund of the duty charged. Hence, any allegation by the tax authorities that assessee had overpaid for its imported goods is uncalled for and contrary to the findings of Customs Department of the Government of India.

(xiii) It was explained to the TPO that the ISD division of the assessee was a self-contained independent division exploring the possibility of earning higher commission from agency services. In fact, in the initial years, assessee had made profits but in the year under consideration did not get through enough commission income which resulted in lower income.

(xiv) The TPO has totally misdirected himself in not appreciating that fixed expenses/establishment expenses cannot be varied on day to day basis. The assessee had to incur fixed expenses as in the earlier years, but the decline in the variable revenue resulted in lower net margin during the year under consideration.

(xv) Without prejudice, the further allocation of unallocated expenses are wholly unjustified as all the expenses such as, rent salaries, traveling etc. were already fully allocated to the ISD division. The unallocated expenses were explained to be pertaining to the trading activity of the assessee and the same were required to be allocated to trading activity only. Accordingly, the TPO has misdirected himself in allocating the expenses, none of which pertained to ISD division.

(xvi) Thus, a cumulative reading of all the aforesaid facts and legal submissions made herein above, it would be appreciated that the TP adjustment of Rs.1,15,66,144/- made by the AO/TPO in respect of the ISD has no legal basis to stand upon and the same is required to be deleted. ”

5. The CIT(A) then considered the remand report received from the TPO and the assessee’s objection to bifurcation of its international transactions into CPD and SPD Divisions. The assessee then gave a rejoinder to the TPO’s remand report’ Apart from other issues, the assessee raised the issue that even if the bifurcation is accepted as stated by the TPO, then further adjustment is required to be made in the comparables to test the PLI of the tested party i.e. the assessee. This is given at page 25 (xiii), (xiv), (xv) and (xvi) of the CIT(A)’s order as under:-

“(xiii) The following additional risk factors identified by the TPO to justify the bifurcation of assessee’s trading activity into CPD & SPD in para 7 of his order but had chosen not to made any adjustment to the profit level indicators of the comparables.

a) The marketing strategy and target consumer group differ widely for the two segments.

b) The dynamics of the two segments are vastly dissimilar.

c) The difference in gross margins between SPD (26%) and CPD (19%) segment shows the differentiation in this respect.

d) The ratio of selling expenses to net sales for CPD is 18.63% as against 14% for SPD.

(xiv) If the adjustments are made to the profit level indicator of 2.48% of the comparables only for (c) & (d) above, the profit of CPD will work out to be as under:

– Profit level indicator                                      – 2.48% – unrelated comparable.

– Adjustment for G.P.                           (-) 7.00%

– Adjustment for selling expenses        (-) 4.63%

————– ———–

Comparable Profit level                                    (-) 9.15%

Indicator of CPD                                              =======

(xv) The profit determined by the TPO of (-) 5.97% is well above the adjusted PLI of CPD for the comparables at (-) 9.15% and therefore, the transactions of the assessee could only be concluded to be at arm’s length.

6. CIT(A) finally adjudicated on the said issue at pages 32, 33 and 34 in paras 9.3, 9.3.1, 9.3.2, 9.3.3, and 9.3.4 wherein he held.

“9.3 There is no dispute between the appellant and the TPO/AO regarding using TNMM as the Most Appropriate Method (MAM), the use of net profit margin on sales as the PLI for the trading function and the use of the appellant as the tested party. Therefore, these issues are not discussed in this order.

9.3.1 The first bone of contention between the appellant and the TPO/AO relates to the use of aggregate versus segmental data across the two divisions CPD & SPD.

9.3.2 Para 1.42 of the OECD Guidelines deals with the issue of evaluation of separate and combined transactions. The relevant extract underlying the basic principle is reproduced below:

‘’1.42 Ideally, in order to arrive at the most precise approximation of fair market value, the arm’s length principle should be applied on a transaction – by – transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis.”

Following this principle, whether aggregation of the transactions is to be done or not would depend on the very nature of the transactions.

9.3.3 In the present case, the appellant has combined all the transactions relating to the trading functions across the two divisions CPD & SPD. The reason for aggregating these transactions has been cited as the integrated business model under which similar trading function is discharged through both the divisions. The TPO, however, recorded a finding that aggregation of the results of the two divisions would render the transfer pricing analysis meaningless as the losses from one set of international transaction were sought to be justified through profits from another set of international transactions. For coming to this conclusion, the TPO had cited a number of reasons are summarized in Para 5.1 and 7.1 of this order. I am in agreement with the finding of the TPO regarding the necessity for separately analyzing the results of the CPD and SPD for the reasons cited by him in the TP order. The following are the additional reasons for concurring with the finding of the TPO in respect of segregation of division-wise data:

(i) The auditor of the appellant categorically made segmental reporting in Note 15 to the Notes to the Accounts. The bifurcation of the two divisions CPD & SPD within the trading function was made on the basis of customers and product lines by following the ICAI Guidelines.

(ii) The CPD section had both local and imported sub-segments. Since related party transactions of CPD division constituted only 5% of total transaction of the CPD division, further bifurcation of CPD into CPD (local) & CPD (Imported) lent more credibility to the benchmarking analysis

(iii) The dynamics of the two divisions CPD & SPD are vastly dissimilar as the drivers of consumer products and office automation products are very different. The consumer durables like the products handled by the SPD have different target customers, growth potential and follow different strategies.

(iv) Two or more operating segments can be aggregated only if the segments have the same characteristics in each of the following areas:

• The nature of the products and services provided

• The nature of the production process

• The type or class of customer

• The methods of product or service distribution

• If applicable, the nature of the regulatory environment

CPD and SPD do not share the same basic characteristics in each of these areas, even if they share some characteristics in some of these areas.

(v) The appellant itself has admitted the distinguishing features of the two divisions [Refer Para 7.2(v) of this order]. The SPD product line is characterized by high technology and supported by proprietary intellectual property and therefore, that segment is unique and high quality feature driven. On the other hand, CPD product line is yet to create its market presence.

(vi) The spirit of transfer pricing analysis under the TNMM method by choosing a set of narrowly defined transactions is satisfied in terms of Rule 10B(1)(e)(i) only when the aggregation is done of very similar transactions. CPD (local), CPS (Imported) & SPD are well defined divisions in the spirit of TNMM for the purpose of aggregation but the transactions across segments cannot be aggregated due to their diverse characteristics. The trading function of the two divisions of CPD & SPD broadly may be the same but the value drivers are different.

9.3.4. In view of the foregoing analysis, I am of the considered view that the three classes of transactions undertaken by the appellant with its AEs cannot be aggregated for the purpose of benchmarking analysis. Due to the distinct differences between the dynamics of the two divisions, the main rule and not the exception enunciated in para 1.42 of the OECD Guidelines is applicable to the facts of this case. The transactions of the two divisions cannot be said to be closely interlinked.”

7. Before the Tribunal following grounds have been taken by the assessee.

I.T.A. No.1417/D/08- Appeal of the assessee:

 

1. That the learned CIT(A) has grossly erred in law and on the facts and in the circumstances of the appellant’s case in holding that the segregation of trading functions pertaining to the CPD and SPD divisions of the assessee were properly done by TPO although:

i) Function performed, risk assumed and assets employed by both the divisions were identical.

ii) Method employed for determining the arm’s length i.e. TNMM was proper.

iii) The PLI of the comparables was right.

2. That the order passed by the CIT(A) is bad in law and on the facts and in the circumstances of the appellant’s case on the aspect of transfer pricing in which addition of Rs.1,98,40,745/- has been confirmed by CIT(A) u/s 92CA(3) of the Income-tax Act.

3. That the CIT(A) has grossly erred in holding that segregation of CPD and SPD division of the assessee, which are two trading divisions was proper, merely on the ground that /the target customers of these two divisions were different.

4. The CIT(A) ought to have held that under the TNMM method it is the broad functions which are required to be compared and if most of the functions performed by the assessee and the comparable cases are identical, the same cannot be rejected on an isolated reason that the target customers and product lines of CPD and SPD are different.

5. The CIT(A) has grossly erred in law in mis-interpreting the OECD guidelines pertaining to aggregation Vs. Segregation of the functions.

6. The CIT(A) has grossly erred on the facts of the appellant’s case in holding that there exist a distinct difference between the dynamics of the two divisions of the assessee i.e. CPD and SPD.

7. The CIT(A) ought to have held that once having accepted the TNMM method, having accepted the comparables and the PLI of the comparable, the CIT(A) should not have rejected assessee’s trading functions on merely conjectures, surmises, and erroneous considerations.

8. The order of the CIT(A) is full of contradictions inasmuch as that on the one hand he has accepted the comparables found by the assessee in its transfer pricing study and on the other hand he has partially rejected the same when it comes to aggregation and segregation of the two trading divisions of the assessee.

9. The CIT(A) has grossly erred in holding that appellant’s reliance on the Special Valuation Cell of the custom’s department was not proper and he has further erred in rejecting the same.

10. The CIT(A) has erred on law and on the facts of the circumstances in the appellant’s case in confirming the view of the Assessing Officer/TPO for treating the reimbursement of advertisement expenses by assessee’s AE as a nonoperating revenue receipt.

11. the CIT(A) has grossly erred in holding that the reimbursement of expenses cannot be considered either as a revenue receipt or in holding that the same are not to be “netted” off against the expenditure incurred on the advertisement by the assessee.

12. That the CIT(A) has failed to take a holistic view of the matter pertaining to the reimbursement of advertisement expenses inasmuch as that the pure reimbursement could not fall within the purview of transfer pricing.

13. The CIT(A) has grossly erred in law and on the facts of the appellant’s case in not entertaining the pleas of the assessee for allowing an adjustment on account of huge advertisement cost incurred by the assessee whereas the comparable cases had not incurred the similar amount of advertisement costs for determining the NPM.

14. The CIT(A) has grossly erred in holding that allocation of the unallocated expenses and income to the ISD division of the assessee was proper by the TPO.

15. That the aforesaid grounds of appeal are without prejudice to one another.

8. Rival contentions have been considered in the light of judicial pronouncements cited at bar by LD AR and DR. Ground no. 1 to 8 deals with the controversial issue of segregation vs. aggregation with regard to the Consumer Product Division (CPD) and the Systems Product Division (SPD) of the assessee. From the record, we found that the business of the assessee was organized under three segments – (i) Consumer Product Division (CPD), (ii) System Product Division (SPD) and (iii) Industrial Sales Division (ISD). CPD and SPD divisions were performing trading functions and the ISD division was performing commission agency functions. The assessee company had also undertaken transfer pricing analysis for these functions. For this purpose, the results of CPD and SPD were aggregated and the results of ISD were considered separately. However, the TPO while scrutinizing the assessee’s accounts on segmental basis, re-written the accounts of three segments CPD, SPD and ISD. On the basis of rewritten accounts, the TPO recommended transfer pricing adjustment of Rs.1.12 crores in respect of imported finished goods for the CPD segment. An adjustment to the tune of Rs.1.15 crores was also recommended in respect of remuneration earned from parent company pertaining to ISD division. In the economic analysis carried out by the assessee, the activities of the supervision of authorized service centers were aggregated with the main activity of trading function for the purpose of benchmarking analysis. TNMM as adopted by assessee was found to be most appropriate method by the TPO and CIT(A) to test the profitability of commission and marketing agency services of ISD division. In respect of margin shown on SPD, the AO found that same was more than arm’s length margin of 2.48%, therefore international transaction pertaining to SPD was held to be at arm’s length. In respect of imported goods under CPD, the AO observed that the loss margin shown was below the arm’s length margin. The AO therefore observed that the transfer price of the imported finished goods under the CPD has to be adjusted downwards. Accordingly, arm’s length price was determined at the price declared in form 3CEB minus the adjustment amount i.e. Rs.74704584 – Rs.11237019 = RS.63467565. The arm’s length price in respect of remuneration received under ISD division was also enhanced by the AO by an amount equivalent to the difference of operating loss margin and the mean margin of the comparable companies chosen. This difference works out to be 6.11% – (-) 28.8% = 34.91% of the total costs. The total costs have been worked out to be Rs.33131321.34.91% of this amount comes to Rs.11566144. Thus, we found that an addition of Rs.2.28 crores was made by the TPO and the CIT(A) has confirmed the same. From the record, we found that while doing so, the AO has totally ignored the reimbursement of advertising expenses from its associated enterprises (AE) which amounted to Rs.15.30 crores. The plea of the TPO was that such reimbursement of advertising expenses was not operating income to be considered for the purpose of transfer pricing. However, for the purpose of regular income tax proceedings, the AO has duly included as taxable income such reimbursement and held the same as revenue income since inception of the company i.e. AY 1994-95 onwards. The legislative intent for introducing new provisions pertaining to determination of arm’s length price between the two associated enterprises, is to prevent the transfer between the associated enterprises of a high tax jurisdiction to a lower tax jurisdiction. Since the revenue income received by the assessee company was much more than the addition made in the arm’s length price in the international transactions, there is no justification for making any addition. During the assessment proceedings, the AO noticed the following international transactions entered into by the assessee during the financial year 2001-02, as reported in Form 3CEB, filed alongwith the return of income:-

Nature of Transaction	Method	Value (In Rs.)
Purchase of finished goods	TNMM	44,92,32,055/-
Purchase of spares	TNMM	56,39,260/-
Commission & Service income	TNMM	2,04,93,071/-
Payment for Pananet Services	TNMM	1,56,936/-
Reimbursements received	TNMM	15,97,82,249/-

9. A reference was made by the AO u/s 92CA(1) of the Act to the TPO for computation of ALP in respect of these international transactions. The TPO observed that the business of the company was organized under three distinct segments (i) Consumer Product Division (CPD) (ii) System Products Division (SPD) and (iii) Industrial Sales Division (ISD). The first two divisions performed trading functions whereas the third one performed commission agency functions. The assessee had conducted transfer pricing analysis for these two functions separately. For this purpose, the results of CPD & SPD were aggregated and the results of ISD were considered separately. The TPO, however, analyzed the accounts of the assessee on segmental basis and redrew the accounts of the three segments CPD, SPD & ISD separately. Further, CPD was bifurcated into CPD (Local) & CPD (Imported Goods). On the basis of the redrawn segmental accounts, the TPO recommended transfer pricing adjustment of Rs.1,12,37,019/- in respect of imported finished goods in the CPD (imported goods) segment. A quantum of TP adjustment to the tune of Rs.1,15,66,144/- was also recommended in respect of remuneration received by the assessee from its parent company pertaining to ISD Division. In the instant case, in the TP report filed by the assessee before the AO, the comparables were chosen after extensive exercise and a net profit of 2.8% was adopted as the arm’s length margin for benchmarking the trading activity of the assessee. However, the TPO has bifurcated the trading activity into two separate divisions of CPD and SPD as against consolidated trading activity. However, the TPO himself has assumed the consolidated profit margin of 2.48% of the comparables as the common net margin indicator. The TPO had also reworked the financial of the assessee without making any corresponding adjustment in the PLI of the comparable cases. This approach of the TPO was not as per the prescribed Rule 10B. If the transactions of both the divisions having international transactions as found by the TPO in his report are consolidated as one trading activity, the operating profit margin of sales was worked out at 3.95% which exceeds the arm’s length margin of 2.48%. Thus, assessee’s international transaction works out to be at arm’s length. The reimbursement of advertising expenses by the parent company was required to be either added in the operating income or the expenses of the assessee on advertising, selling expenses have got to be reduced by the similar amount. Since the expenditure on advertising actually incurred by the assessee was of revenue nature, the reimbursement of such expenses was also of the revenue nature. Even in the earlier years, the department has treated such receipts as of revenue nature, the same cannot be left out of computation while determining the arm’s length price paid by the assessee or the income earned by it from its associated enterprises. We found that during the course of hearing the TPO has called for exhaustive information, including the price paid by the assessee on account of local purchases, the assessee had furnished the detailed information with regard to comparable list of purchases of identical items which were imported alongwith their purchase cost. It was also explained that the price paid for imported goods was very competitive and in no case higher than the price paid to the local sellers. However, with regard to allocation of unallocated expenses, the CIT(A) has already allowed allocation of Rs.87,48,348/- in the proportion of net sales of various segments viz. CPD(Local), CPD (Imported), SPD and ISD, the CIT(A) has directed the AO to take the same into account while finalizing the segmental accounts of these divisions. Against the adjustment proposed in the cost of CPD imports and ISD division, the assessee is in appeal before us. From the record, we found that advertisement reimbursement was part of the package deal wherein assessee company was being compensated for marketing of all products as well as establishing as well as new, the gain of which will accrue to the Indian counterpart in the form of additional sales. There is no dispute to the well-settled legal proposition that marketing and advertising expenses play a vital role in facing the competition from foreign brands and driving the sales. The sales of CPD and SPD divisions both are dependent on the advertising expenses incurred by the assessee, we therefore do not find any justification in not allowing setting off such reimbursement of advertising expenses insofar as it was a part of package deal. Ignoring such reimbursement would lead to erroneous conclusion. As per records, the reimbursement was an intentional set off received by the assessee for creating market for its products. The assessee has historically been getting reimbursement of about 2/3rd of its total advertisement and produce promotion expenses from its associated enterprises whose products the assessee markets in India. Therefore, the reimbursement of these expenses should be taken into account in the light of provisions of Rules 10B(2)(c) of the Rules. As per clause (c) of Rule 10B(2), the assessee was duly entitled to set off against the historical amount received as reimbursement of advertising expenses on its imported products. We found that the risk of bearing advertisement cost to sell goods imported from its associated enterprises was almost met by its AEs and therefore, to that extent, the adjustment made by the TPO in excluding the reimbursement from income was unwarranted. With regard to earning of ISD division, the TPO has ignored the fact that after having created an infrastructure in the earlier years wherein ISD division has made profits, it was not possible to close down such unit overnight. The earning of commission income was lower because of lower business done by the principal in Indian territory on which assessee was getting commission income. We found that here is no increase in the expenses of ISD division, earning of income was less only due to the less sales, which resulted into loss.

10. The advertisement expenses incurred by the assessee was in the normal course of its business operation and this formed part of operating expenses of the assessee. When the assessee was in receipt of reimbursement of such expenses from the associated enterprises which reimbursement as per the accounting policy of the assessee had been shown under the separate head of operating revenue instead of netting of the operating expenses, there was no justification for treating the same as non-operating receipt. Even the reimbursement of advertisement expenses as revenue receipt was certified by its auditors as per the guidelines of the Institute of Chartered Accountants of India. Thus, the reimbursement was operating revenue and the TPO was not justified in ignoring the same while arriving at the arm’s length price and while recognizing the income of ISD division. Even in double entry system of book keeping, the income and expenses have to be balanced out either through netting of from operating expenses or through including in the operating income of the profit & loss account, the treatment given by the assessee which was duly approved by the auditors was correct and has to be considered while making adjustment on account of transfer pricing. Only because the comparable selected by the TPO was not in receipt of such reimbursement, the assessee’s case cannot be said to be at par with those, when fact was on record that assessee has got huge reimbursement of such expenses. We found that comparables were not incurring the same levels of advertisement expenses, therefore they were not in receipt of such reimbursement, the same cannot be made basis for ignoring the actual reimbursement received by the assessee. Thus, we found that all the variation of the PLI with the tested party with the PLI of comparables have occurred on this sole account which needed adjustment while arriving at price paid by the assessee to its associated enterprises or the income earned by the assessee from the associated enterprises. Mere book entry of such reimbursement, as income instead of netting of expenses will not alter the character of receipt which is revenue in nature, and the department itself has considered such reimbursement as revenue income of the assessee in earlier years. During the course of arguments before us, both the sides agreed and this is also reiterated by the CIT(A) that there is no dispute between the assessee and the Revenue regarding. (i) use of TNMM as the most appropriate method (MAM) and (ii) the use of net profit margin on sale as the profit level indicator i.e. PLI for the trading functions as the assessee is only doing trading functions and is not engaged in the manufacturing business whatsoever and (iii) the use of the assessee as the tested party. The assessee has no difficulty in accepting the first observation of the CIT(A) that ideally each international transaction should be tested with a comparable transaction of uncontrolled parties to arrive at arm’s length price, but it was submitted that this ideal situation rarely exists. Normally, the transactions of a tax-payer have to be aggregated to test them for arm’s length price where these transactions are closely linked and/or are continuous transactions and the same cannot be adequately valued on a separate basis. In fact, the assessee also agreed with the OECD guidelines reiterated by CIT(A) in para 9.3.2 of his order. The basic difference between the assessee and the Revenue, before us relates to the reasons for segregation vis-à-vis aggregation. The reasons for the same have been reproduced above and are mentioned at page 33 of CIT(A)’s order. The basic objection that the assessee has is that the reasons given are extraneous to Chapter X contained in the ACT read with rules thereunder. Once a particular law has been enacted by Parliament, then the same cannot be given go-bye by resorting to analysis de-horse Chapter X and the rules made thereunder. Aggregation and segregation both depend upon the analysis to be made under the Act and the rules thereunder and not by bringing extraneous factors. Contention of learned AR was that the provisions of Chapter X and the rules made thereunder would over-ride any guidelines – whether of OECD, Accounting Standards or other statutory provisions under other Act.

11. As per our considered view that where specific rules of law exist in the Statute on a particular subject, then they would hold the field over all other treaties, commentaries, like the OECD, other Acts, Companies Act etc. Chapter X and Rules made thereunder are a self contained code and answers to all questions must be found in the written law contained in the Act and Statute. The Apex Court in the Azadi Bachao Andolan case reported as 263 ITR 706 (SC) has reiterated this well known and accepted concept of interpretation of tax laws in India. Ld. AR has rightly pointed out during the course of hearing that if the TPO and the CIT(A) were of the opinion that these two Divisions viz., CPD and SPD were separate Divisions and required a different criteria for determining the arm’s length price, then they could not have compared both the Division’s results as has been done by them with the same set of comparables; there is obviously a contradiction between the two. If the TPO and the CIT(A) were serious in segregating the two, then they should have applied different set of comparables for both. Therefore, the first point made on merits which deserve to be accepted is that if for the sake of argument it is accepted that the two Divisions have separate characteristics, then obviously different comparables should have been used. We further hold that if the two are to be treated separately but same set of comparables are used as done by the TPO & CIT(A), then the PLI of comparable for the CPD division would have to be adjusted as provided in Rule 10(B(1)(e)(iii) according to which following is the correct working.

PLI 2.48% of unrelated comparables.

PLI of unrelated comparables.                          2.48%

Adjustments

 

1. Difference in GP as given by the

TPO & CIT (A)

(SPD 26% – CPD 19%)                           (-)        7.00%

2. Selling expenses difference

(CPD 18.63% – 14% SPD)                       (-) 4.63%

———

Adjusted

Comparable PLI                                                (-) 9.15%

———

PLI of CPD division as worked out

by TPO                                                             (-) 5.97%

PLI of comparables                              (-) 9.15%

Therefore, in our opinion, the trading transactions are at Arms’ Length and no adjustment is required.

12. From the record we found that the CIT(A) has given five criteria for segregating the two Divisions. Out of these five criteria, three criteria are absolutely the same in both the Divisions i.e. nature of product is the same viz., electrical/electronic goods, secondly distribution channel is the same i.e. the same dealers were used for sale of these products; and thirdly regulatory environment is the same i.e. they both fall under the broad category of electrical/electronic goods. The fourth criteria is that of production process. This is absent. Admittedly, the appellant is only a trading company and does not undertake any production or manufacturing activity. Therefore, out of five, there is no difference as far as the four criteria are concerned. Therefore, CIT(A)’s analysis relating to segregation was incorrect. The only difference relates to the fifth criteria viz., different set of customers. This is again a non-starter as the customers for all the five comparables vis-à-vis the tested party i.e the assessee are different. This itself has not weighed upon neither the TPO nor the CIT(A) and nor has it been argued by the CIT-DR that this should be used to reject the comparables or the analysis done by the appellant and the TPO as given at page 8 of CIT(A)’s order, table 8, viz., (1) Amazel Automative Company Ltd., trading in exide batteries, (2) Gold Rock Investment Ltd., dealing in electrical goods, (3) K.Dhandapani & Company Ltd., dealing in electrical components for Siemens India Ltd., GEC, Aisthom & Finolex cables, supplying switchboards, switches and distribution boards for industrial application etc., (4) Khaitan India Ltd., trading in fans, monobloc pumps etc., (5) Rington India Ltd., trading in computers and peripherals, office and home segments, (6) Remi Salws & Engg., Ltd trading in fans, electric motors and scientific instruments; and (7) ACI Infocm Ltd., trading in floppy disk drives, hard disk drives and other computer equipments. All these comparables which have been held to be correct by all the authorities below, as well as, not objected to by CIT-DR would show that the customer is not relevant to compare the results of the assessee i.e. the tested party with that of the comparables. If this is not an important criteria for rejecting comparables, then it cannot be an important criteria for segregation of results of the assessee. We are the view that the reasons given by both TPO and CIT(A) with regard to the difference between the two Divisions for purposes of segregation are legally and factually incorrect and cannot be accepted. Rule 10B(2) very clearly lays down as under:-

“R.10B(2) For the purposes of sub-rule (1),the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:-

(b) the functions performed, taking into account assets employed or to be employed and the risks assumed by the respective parties to the transactions;”

13. It is statutorily laid down as to how an international transaction is to be compared with uncontrolled transaction. We found that the criteria used for segregation is incorrect and factually inaccurate, despite the fact that under the Transfer Pricing Regulations the only reason which can be used for segregation is the FAR analysis as provided in Rule 10B(2)(b). The FAR is the same for the trading functions for both the divisions is an admitted fact. Refer to page 4, Table 4 of the CIT(A)’s order.

“4.6 As per the functional analysis carried out at Para 3 to 3.4 in the T.P. Report, the following are the details relating to the major functions performed in respect of various international transactions along with risk assumed (Para 3.1.2) and assets deployed by the appellant (Table-4) :-

Table-4

 

Trading Functions
Functions	-Import products from MEI Group Entities.-Obtaining custom clearance.-Maintenance of warehouse facilities for stocks. -Selling and distribution functions. -Price determination. -Undertaking publicity and advertisement campaigns with full description
Risk	-Contract risk with dealer and distributors.-Inventory risk.-Market risk. -Quality and warranty risk. -Foreign exchange fluctuation risk.
Assets deployed	-Owns assets to perform importing, warehousing, administration and distribution functions.-No intangible assets.

 

14. These details are also given at pages 89-90 of the Paper Book of the Transfer Pricing Report submitted by the assessee on this issue submitting that the functions performed, risks assumed, and the assets deployed are absolutely the same in all its trading functions which clearly indicate the fact that segregation for any other reason is not permitted as per Statutory Rule 10B(2)(b) of the Rules which are part of the Transfer Pricing Regulations contained in Chapter X of the Income Tax Act and the Rules made thereunder. Therefore, the test for finding whether segregation is required is provided in the Rules themselves and as is borne out from the facts of the case, Rule 10B(2(b) clearly is in favour of the proposition that segregation should not be done. In addition, the comparables used are also the same for both the Divisions. It also lends weight to returning the finding that segregation was not called for. We have given our careful consideration to the issue and the order of the authorities below and the submissions of both the parties before us. The above expression is also found in the Rules itself. Therefore, there is no possibility of de-linking the closely linked transactions for transfer pricing analysis. As already stated above, the test for the proposition whether the transaction is closely linked or not is given in Rule 10B(2)(b). Therefore, the grounds raised on the issue of segregations vs. desegregation, as per the provisions of law, segregation was not called for. The Senior DR in his defence of the order of CIT(A) has reiterated the reasons given by TPO and the CIT(A). He also reiterated para 1.42 of OECD guidelines on transfer pricing as reproduced by CIT(A) in para 9.3.2 of his order. The Senior DR also raised doubt about the transfer pricing report given at page 110 of the Paper Book by the assessee. The assessee in his rejoinder to the DR’s submissions has stated that the audited accounts filed by the assessee including statutory documents in form 3CEB, Tax Audit Report under Rule 44AB, transfer pricing documentation under Rule 92D have all been accepted by TPO, AO and CIT(A). None of the authorities below have doubted the veracity of the accounts or the figures given in the TPO’s report. In fact, page 110 has been verified by TPO and bill-wise details have been given by the assessee to the TPO vide his letter dated 21.12.2004. Again, TPO wanted to have further details which were given to him as at pages 384-389 of the Paper Book. The reconciliation of the figures was asked for and the same was given at page 390 of the Paper Book in which income of Rs. 92.59 crores was reconciled and also the operating profit of Rs. 6.73 crores was reconciled. The TPO then went further and had also taken line by line reconciliation for all segments and the audited balance sheet was also made available to him at pages 428-435 of the Paper Book. The segment-wise details of sales and purchase at GP level were also made available to him at page 485. All these were also pointed out to us by the AR during the course of hearing and the Senior DR could not rebut any factual aspects thereof. On a careful consideration thereof, no discrepancy is found in the figures as reported by the assessee. In any case, TPO, as well as, the CIT(A) have re-drawn the accounts as has been categorically found by CIT(A) at pages 13 and 14, para 5.3. of his order as reproduced above. We, therefore hold that on the facts and circumstances of the case and as per the provisions laid down in the Transfer Pricing Regulations in India, the assessee succeeds on these grounds. The segregation was totally artificial and uncalled for and the authorities below were not justified in segregating them. The trading functions having the same FAR and having closely linked transactions were to be taken as a whole and not separately, thereby creating artificial loss in one segment and profit in the other. Both have to be taken as a whole and the additions made by TPO and confirmed by CIT(A) for doing this segregation are required to be deleted.

15. Grounds Nos. 10, 11, 12 and 13 raised by the appellant are in respect of treating the reimbursement of advertisement expenses by assessee’s A.E. as a nonoperating revenue receipt.

16. The issues with regard to these grounds deal with the concept of how operating profit should be calculated for working out the profit in a TNMM method. The Transfer Pricing Officer on page 5 para 7.1.1 states that reimbursement of advertisement expenditure is not operating income. He further goes on to say in para 7.1.3 that the comparable companies chosen have not received similar re-imbursement but all of them have spent on advertising and marketing. In para 7.1.4 the TPO further states that as advertisement income has been received from sources extraneous to the business of the appellant, therefore, this income cannot be treated as operating income. The CIT (A) in his order deals with these issues in para 5.2 page 12, para 7.3 on pages 26, 27 and 28. On page 28 para 8(v), the CIT(A) raised the question which needed to be answered in the appellate proceedings before him which is reproduced as under:-

(iv) Under the given circumstances, whether the TPO was right in excluding the reimbursement of advertisement and sales promotion expenses as non-operating revenue?

17. He then went on to give his findings in para 9.5 pages 34, 35 and 36. The CIT(A) largely concurred with view of the TPO and the reasons given by the TPO. He went on further to state that as there was no legal obligation for the AEs to reimburse the advertisement expenses and to that extent reimbursement was ad hoc in nature as they did not flow from any formal agreement between the appellant and the AE and therefore could not be made a part of the operating income. The CIT(A) further stated that no linkages were documented wherein the quantum of marketing support subsidy would have influenced the prices of exports or imports or royalty. He then concluded that marketing support subsidy partake the character of financing rather than operating in nature.

18. The learned Sr. D.R. ITAT stated that reimbursement of advertisement expenditure would not fall within the definition of operating income. The assessee’s case which is also summarized by the CIT(A) in para 7.3. pages 26, 27 and 28 is as follows:-

(i) All advertisements are carried out by various local branches of Panasonic India Ltd. for activity all over India in the local languages just to achieve sales of the products being sold by the assessee in the Indian market.

(ii) The assessee had to incur huge advertisement costs because the assessee operated in a highly competitive environment against the market leaders such as SONY, SAMSUNG, LG and many local brands of Indian origin such as Videocon etc.

(iii) In order to finance its operations, the parent company had been giving financial help by way of reimbursing about 2/3rd of its advertisement bill.

(iv) Although the assessee had advertised under the name `PANASONIC’ and has used brand name of `NATIONAL’ for trying to make sales in India, yet no royalty for brand name usage has been paid to any of it’s A.E’s or parent company MEI, Japan as is normal in such cases.

(v) It is a settled preposition of law that entry in the books of accounts does not come in the way of determining the true nature of a transaction and the true nature of the receipts of advertisement expenses is pure and simple reimbursements to part finance assessee’s routine operations and meeting part of assessee’s advertisement bill for its local operations, as it was unable to support its own expenses from its sales.

(vi) Expenses incurred by the assessee on advertisement and sales promotion for achieving sales targets in India are claimed from the parent company by raising simple debit notes with details of the advertisement e4xpenses incurred.

(vii) These international transactions are pure and simple financial help by a parent A.E. in Japan to its subsidiary A.E. ailing in India to cope up with the high costs of advertisement to survive in the local Indian highly competitive market and it has no other implications except that the larger part of the cost of advertisement has been shared by the parent company without any corresponding or reciprocal benefit to the parent company.

(viii) The advertisement expenses that have been incurred by the assessee are in the course of its business operations and thus form part of the operating expenses of the assessee. However, when the same expenses are reimbursed by way of financial support from the A.E. which reimbursements as per the accounting policy of the assessee have been shown under the separate head of operating revenue instead of netting off the operating expenses, the TPO has treated the same as nonoperating receipt.

(ix) The Accounting Standards as applicable to the assessee under the ICAI Guidelines, which have been certified by the financial auditors have treated such reimbursements as operating revenue and have found no mistake in the accounting treatment given to such revenues.

(x) Since in a double-entry book-keeping system, the income and or expense have to be balanced out either through netting off from operating expenses or through including in the operating income of the Profit and Loss Account, the treatment given by the assessee and approved by the Statutory Auditors is correct and does not require any modification as has been done by the TPO.

(xi) One reason given by the TPO for excluding the advertisement support from the financials as non-operating income is that comparables have not reported such receipts. However, the TPO while making this conclusion seems to have completely ignored the fact that the comparables are not incurring the same level of advertisement expenses. The comparables have almost nil advertisement expense as against above 10% in assessee’s case. Perhaps all the variations in the PLI of tested party with the PLI of comparables have occurred on this sole account, which needed adjustments in favour of assessee.

19. Learned AR during his submissions before the ITAT also brought to the attention of the Tribunal on pages 43 and 44 para 12 of the CIT(A)’s order wherein the advertisement expenditure of Rs.23,15,18,053/- was disallowed. However, assessee’s submissions after taking a remand report were accepted by the CIT(A) in paras 12.3, 12.4 and 12.5 which are reproduced as under:-

12.3 In the rejoinder to the remand report, it was submitted that the Delhi Bench of the Tribunal has in the appellant’s own case for A.Y: . 1998-99 in ITA No. 3238(Del)/2002 dated 20.01.2006 deleted all the disallowances made by the A.O. including disallowances on account of trade discount, cash discount, advertisement, and sales promotion expenses. A copy of the order was also enclosed. It was further submitted that the AO had based all the disallowances on the assessment order for the A.Y. 1998-99. Since the very basis has been knocked out in appeal, all the disallowances are to be allowed in this appeal. Reliance is also placed on another decision of the jurisdictional Tribunal in the case of M/s. Becon Dickinson India Pvt. Ltd. where ithas been held that if expenditures incurred by taxpayer wholly and exclusively for the purpose of its own business, even if any benefit accrues to a third party, it cannolt be held that the expenditure did not have any nexus with the taxpayer’s business. During the course of appellate proceedings, copies of the jurisdictional ITAT’s orders in the appellant’s own case for the A.Y.s 1999-2000, 2000-01 & 2001-02 were also furnished where relying on the order for the A.Y. 1998-99, all the disallowances were allowed.

12.4 I have carefully considered all the submissions made by the appellant and also perused the orders of the Delhi Tribunal in the appellant’s own case for the A.Y.s 1998-99, 1999-2000, 2000-01 & 2001-02. It was abundantly clear from the orders of the Tribunal that there was no basis for the AO to make the disallowances relating to trade discount, cash discount, sales promotion and advertisement. The relevant extract from the order for the A.Y 1999-2000 is reproduced below:

“6. We are in agreement with the above observations. We find that the transactions relating to advertisement, sales promotion, commission trade discount etc. are not between the resident and the non-resident. There is no arrangement with the non-resident to hold that the arrangement produces to the resident less profit than the ordinary profit. I is settled law that if due to certain expenditure incurred by an assessee a benefit flows to the third party, it cannot be a ground to disallow the expenses in the hands of the assessee who has legitimately incurred the expenses wholly and exclusively for the purpose of his business. Thus the Assessing Officer was not correct in invoking the provisions of section 92 of the Act. Similarly since we find that the expenses are incurred wholly and exclusively for the purpose of business, the same are allowable in full and a partial disallowance is to be deleted. Accordingly grounds No. 1 to 3 raised by assessee are allowed and grounds No. 1& 3 raised by the revenue are dismissed.”

12.5. In view of the categorical finding given by the Hon’ble Tribunal in the appellant’s own case exactly on the same issues, I delete the disallowances made by the AO respectfully following the Tribunal’s order. Accordingly, Grounds of Appeal No. 1.4 to 5.5 are allowed.

20. The additions were, therefore, deleted by the CIT(A) following the assessee’s own case decided by the Tribunal in AY 1998-99 onwards. The Revenue has accepted this part of the CIT(A)’s order and has not appealed before the Tribunal on any issue other than transfer pricing issue.

21. As regards the nature of expenditure, learned AR Shri Dinodia brought to our notice P.B. Vol. II page 436 which gives details of category of expenditure, voucher number, date, debit note, party from whom reimbursement has been claimed and received and the division to which it pertains. So the entire reimbursement expenditure details have been given voucher-wise. Learned AR further submitted that it is a finding of fact recorded by the Tribunal in previous years which have become final as there has been no challenge by the Revenue in further appeals before the High Court. Similarly even in the relevant order, it has been established by the order of CIT(A) that the advertisement expenditure incurred by the assessee is local in nature and does not have any direct or indirect benefit which is disallowable under the provisions of Income Tax Act flowing to the AE. The question before us is when reimbursement is made by anybody of any specific expenditure incurred for specific purposes, whether the expenditure deserves to be taken into account either for computation of income or for calculating operating profits for purposes of transfer pricing analysis. As found by the Tribunal in A.Y. 1998-99, what we have to see in cases like this is what is the substance of the transaction. A local expenditure incurred for benefit of local sale which does not enure any benefit to AE but is still reimbursed by the AE can have either of the two effects – one it may reduce the expenditure to the extent of reimbursement and this concept of reduction of expenditure to the extent of reimbursement is a well known concept under various provisions of Income Tax Act including for purposes of calculating WDV of a depreciable asset wherein a reimbursement is made or subsidy received it will go to reduce the cost of the asset or it may have the effect of increasing the income. Reimbursement of expenditure implicitly or explicitly linked to the incurring of revenue expenditure can have no other character than of revenue receipt and as the receipt is directly linked with the business of the assessee, it cannot be disregarded while calculating its income either for the purpose of Income Tax Act or for the purpose of calculating his operating income. It may be looked at from any angle whatsoever – either it will go to reduce the expenditure thereby increasing the income or it may become a part of operating income. Therefore, in our opinion the assessee has correctly taken the reimbursement of expenditure of Rs.15,30,40,478/- as a part of its operating income for transfer pricing analysis.

22. A question was posed by Ld. DR as to whether the assessee was in expectation of this reimbursement while doing its business in India. The TPO and CIT(A) have raised the issue in the absence of formal agreements. The assessee has filed sample copies of advertisement support agreements entered into by the appellant with the AE’s. Similarly, some debit notes with regard to claim of reimbursement of expenditure have been filed on pages 704 to 724 of PB Vol. III. The learned AR has further submitted that as per assessee’s past history, it has been receiving 2/3rd of its total advertisement expenditure by way of reimbursement from its AEs. Its detail has been given in PB Vol. II page 474. The assessee received 68% of his total expenditure by way of reimbursement in assessment year 2000-01, 67% in the assessment year 2001-02 and 66% in assessment year 2002- 03, i.e. the year under appeal. Looked at from this perspective that year after year almost 2/3rd of the total expenditure is being reimbursed as compensation by AEs. In our opinion it is a reasonable expectation to assume such reimbursement will continue in the future as well. Some sample formal agreements also produced before the authorities below as well as before us show that reimbursement of expenditure was a normal expectation of the assessee from its AEs in the normal course of its business.

23. Rule 10B(2)(c) states “the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions.” . The transfer pricing rule itself states that the contractual terms may be formal or may not be formal, may be in writing, may not be in writing and may be implicit or explicit. Now here the assessee has demonstrated by fact that it was in reasonable expectation of reimbursement of expenditure by the past conduct of its mother companies, i.e. AEs of receiving at least 2/3rd of its expenditure in reimbursement. Therefore as per the Rule itself, this has to be taken cognizance of and could not be ignored arbitrarily. Once Rule 10B(2)(c) is seen and invoked, then the objections both of the TPO and CIT(A) would not hold ground and the conduct of the assessee is based on facts and figures from the AY 1998-99 on record, the order of the Tribunal on record accepted by the Revenue, it can be concluded that the receipt of advertisement reimbursement would form a part of operating profit either by way of by adding to income or by way of reduction of advertising expenditure to the extent of reimbursement. Both have the same effect of increasing operating profits to this extent. We therefore hold that the TPO and the CIT(A) wrong in excluding reimbursement of advertisement expenses while calculating the PLI of the appellant.

24. The last point raised by the CIT(A) and TPO is that comparables do not have reimbursement. As submitted by the learned AR, the comparables do not have advertisement expenses of this magnitude at all. Therefore, even on the first principles of FAR analysis as contained in Rule 10B(2), either the entire advertisement expenditure the comparables operating profits would have to be adjusted to bring it at par with the tested party to the extent of reimbursement, if not to the extent of entire advertisement expenditure of the appellant would have to be taken out because for the purpose of comparison between comparable companies’ PLI and the tested company’s PLI, elements have to be more or less similar or same. It is not possible to compare a company which incurs heavy advertisement expenditure with a company which incurs almost nil or very little expenditure. If comparables have to be retained, then this adjustment would have to be made.

25. In view of above discussion, we can safely conclude that looked at from any angle, the advertisement reimbursement would definitely form a part of the operating profits of the assessee and would have to be taken into account for purposes of transfer pricing analysis. Now we recast the Table-17 given by the CIT on page 411 of his order in terms of our finding recorded hereinabove, to find out if any addition is required on account of difference in PLIs of comparables:-

Table 17

 

Particulars	CPD(imported) (B)	SPD (C)	CPD(Imported)+SPD (B)+(C )	ISD (D)	Total(A)+(B)+(C )+(D)
Income:
Net Sales	132,982,473	777,133,469	910,115,942	1,228,831	3,569,519,600
Other Income
Other Operating Income as per TPO	179,443	1,301,080	1,480,523	–	27,836,673
Allocation ofunallocatedother income (Rs. 87,48,348) in proportion to sales	325,920	1,904,636	2,230,555	3,012	8,748,348
COGS				415,117
Gross Profit (A)				816,726
Advt. Subsidy(Rs.153,040,478) in proportion to sales	5,703,487	33,330,489	39,033,977	–	153,040,478
Other OperatingIncome as perTPO				22,765,791
Total Revenue	139,191,323	813,669,674	952,860,997	23,582,517	3,759,145,099
COGS	104,474,649	575,393,430	679,868,079	–	2,823,770,299
Operating Exp.	–	–	37,736,859	17,098,649	162,017,256
Adv. Exp.	7,054,248	21,975,346	29,029,594	–	504,886,414
Selling Exp.	20,395,201	93,538,482	113,933,683	406,022	114,339,705
Other operatingexpenses	7,005,786	30,731,073
Admn Exp.	2,172,687	12,874,141	15,046,828	–	15,046,828
Personnel Exp. Depreciation	–	–	–	12,499,107 1,067,873	99,592,440 16,294,218
Finance Charges	–	–	–	–	–
Allocation of unallocated exps. In proportion to sales	76,759	448,573	525,332	–	2,059,669
OperatingExpenditure	141,179,330	734,961,045	876,140,375	31,071,651	3,738,006,829
OperatingProfit/Loss	(1,988,007)	78,708,629	76,720,622	(7,489,134)	21,138,270
PLI as operatingprofit to salesratio	-1.49%	10.13%	8.43%
PLIs ofComparablecompanies as given in Table 16 on page 40 of CIT(A)’s order.			3.58%
Addition onaccount ofdifference in PLIs of comparables			NIL
PLI as operatingprofit to Costratio – Weighted average mean of last three previous year, as adopted by assessee to justify the lossreworking ofTable on Pg 111 of Paper Book. PLIs of Comparable companies as given in Table 15 on page 40 of CIT(A)’s order. 2.95% Addition on account of difference in PLIs of comparables				-23.79% 33.27% 2.95% Nil

 26. We, therefore, hold that in view of the correct analysis and working as given above on the comparison between the assessee and the comparables and by correcting the two errors committed by the TPO and CIT(A) and confining the financials to one year only and not to multiple years for the trading functioning of assessee, the PLI of the assessee comes to 8.43% and that of the comparables 3.58%. As the PLI of the assessee is higher of the two, the international trading transactions entered into by the assessee are held to be at arm’s length price as per transfer pricing regulations in India. Accordingly the addition made by the TPO and upheld by CIT(A) amounting to Rs.1,23,48,509/- is ordered to be deleted.

27. Next grievance of the assessee pertains to allocation of the unallocated expenses and income to the ISD division of the assessee. As done by TPO. We have considered rival contentions and gone through the relevant materials placed before us and towards which our attention was invited. From the record, we find that the Industrial Sales Division or ISD Division of the assessee is a commission and marketing agency which provides after sales service for products sold by MEI Japan and other affiliates to Indian customers and also gets commission on sales of MEI products in India. The assessee appoints various service centres, distributes service manuals to these, provides technical support to these and administers supply of spare parts and it reports all the service activities of these centres, it deals with all complaints, questions and answers from customers, i.e. ISD Division is the service part of the assessee. For the ISD Division, the CIT(A) has discussed this issue on page 15 of his order. As there was a loss in these operations, the question raised was why a loss in a service industry. In the previous year, there was expansion of business and therefore in expectation of other business it incurred extra costs, but due to lack of adequate sales made by the AEs in India, costs could not be recovered. The assessee’s submissions in this regard are contained in para 7.2 (xix) and (xx) on page 26 of CIT(A)’s order which is reproduced below:-

“(xix) The TPO misdirected himself in concluding that the risks of running the establishment for earnings in the ISD division was on assessee’s account. After having created an infrastructure in the earlier years, wherein the ISD division had made profits, it could not have closed it down overnight. The earnings from commission income were lower because of the lower business done by the Principals in the Indian Territory on which the assessee was entitled to commission. It is submitted that there was no increase in expenses of the division. The earning of income was less during the year which resulted into loss.”

28. The CIT(A) recorded his finding in para 9.8.2 page 39 of his order which is reproduced below:-

“9.8.2 I am inclined to agree with the arguments put forward by the TPO that no unrelated party would have incurred such a loss by maintaining a dedicated establishment and personnel to provide services exclusively mark-up. This is a clear cut example of related parties imposing special conditions on an entity, thereby adversely affecting its profitability as described in Article 9 of the OECD Model Tax Convention.”

29. The CIT(A) concluded in para 0.8.5 page 40 of his order which is reproduced below:-

“9.8.5 In view of the foregoing analysis, I am of the considered view that the TPO has correctly recorded a finding that the TP adjustment is to be made by applying the arm’s length margin worked out on the basis of the results of the comparables. However, the TPO committed an error by using the arm’s length margin at 6.11%, which is a weighted average over a period of three years. In view of the finding already given at Para 9.2 of this order that only contemporaneous data is to be used, the quantum of TP adjustment in respect of the commission agency function is to be computed by taking the arm’s length margin of the comparables at 2.95% furnished by the appellant (Table-15) during the appellate proceedings as per the details below:

Table- 15

S.No.	Company Name	31st March 2002
1	Purak Vinimay Limited	-7.38%
2	Marketing Consultants and agencies Limited	5.28%
3	N I S Sparta Limited	8.76%
4	Indiacom Directiories Limited	8.94%
5	Concept Marketing and Advertising Limited	-5.00%
6	Interads Limited	7.09%
	Average Operating Profit Margin (%)	2.95%

30. Contention of LD. AR was that the entrepreneurial risk of running a business is always of the person who conducts the business and can never be passed on to any other person including an AE. Therefore, to say that the business of the assessee in providing commission services is risk free is wholly incorrect statement of facts. There was no agreement with the AEs, neither there is anything to the contrary pointed out by the TPO or the CIT(A) or the Sr. DR that there was any arrangement between the assessee and the AEs to take over the risk of loss in this business by the AEs. Therefore, the basic premises on which this adjustment has been made is factually incorrect. On page 111 of PB-I, the transfer pricing stated in para 4.6 in which the weighted average profit of three years has been taken as at 14.03% of total operating income. The learned AR has submitted before the Tribunal that this was the only year in which it made a loss and in subsequent year also it has made profits. This year the loss was unique in the sense that the business of the ISD Division was low. The entire business of the ISD Division is to non-AEs, i.e. to Indian customers. Therefore, the AE had no control over the volume of business of the appellant’s ISD Division. It was further submitted that as per Proviso to Rule 10B(4) the data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. Thus the assessee was entitled to take into account data of a period of two years prior to the financial year under review. This is for the simple fact that in service industry once you hire people in expectation of larger volume of business, it is not possible to reduce the people immediately for lack of business. The loss has to be borne till such time the volume of business picks up. Therefore for the purposes of transfer pricing, the Proviso will come to play and the data of previous two years should also be taken into account to find out whether the transactions with the AE is at arm’s length or not. The same argument was also raised before the authorities below. Attention has been drawn to pages 470 and 471 of PB Vol.II. The ISD Division has also documentary evidence, evidence with regard to the agreements with the AEs which are given from pages 411 to 414 of PB Vol. I. The learned AR submitted that due to continue loss and low volume of business, this Division was closed down on 31st March 2003. This is also recorded on page 471 of PB Vol.II.

31. We have considered rival contentions and the facts on record and the submission of both parties. It is manifest that hiring and firing of people is a longterm affair and cannot be done overnight. The Proviso to Rule 10B(4) would come into play and would allow the assessee to take Average of previous two years along with the current year for working PLI of the tested party. Similarly, three years’ average would also be taken into account for its comparables so that like can be compared with the like. The Proviso to Rule 10B(4) clearly permits this. It is also seen from the facts of the case given on page 29 of the assessee’s written note filed by covering letter of 12th March 2010 on page 29, the assessee made a profit of Rs.0.15 lakhs in the next year and the activity was closed at the end of the next year. Simply because there is loss in one year and addition to the assessee’s income cannot be made in accordance with transfer pricing regulations, especially when this loss has not been incurred due to any transaction with the AE. In this ISD Division, there is neither any sale nor any purchases from the AEs. It is purely a local service allocated to servicing goods sold by AEs to its customers in India plus commission on the goods sold by the AEs directly in India. It is, therefore, clear that no adjustment on the ISD Division is called for as the PLI for the three years average of assessee is higher than that of the comparables. The chart at page 111 is reworked as under in line with our findings given here in above.

Table 18

Commission and marketing agency

services (ISD)

(Rupees in ‘000)

Particulars	31-Mar-02	31-Mar-01	31-Mar-00	Weighted Average
	[As per CIT(A) orderpage 41 -Table 17]
Income
Income fromoperations	1,229	231	–
Other Income	22,769	30,367	30,629