The two appeals filed against the order passed by the Deputy CIT were identical in facts and the issues rose. The core issue involved was the addition made by the AO on account of Arm’s length price determined by Transfer Pricing Officer and confirmed by Dispute Resolution Panel. Facts of A.Y. 2007-08 were being considered.
Brief Background of case
The assessee company was a wholly owned subsidiary of Mitsui & Co.Ltd, Japan, one of the leading sogo shosha (General Trading Companies operating in wide range of products) establishment in Japan. The assessee company provides support services as the main activity whereby it acts as a facilitator for the transactions related to purchase and sale entered into by Mitsui & Co. Ltd., Japan and other group entities of the Mitsui & Co. Ltd., Japan. The Assessee used TNMM (Transactional Net Margin Method) as the most appropriate method and PLI (Profit Level Indicator) selected was ‘Berry Ratio’ against operating expense. The Ld. TPO was of the view that the cost of sale is to be included in the denominator of the PLI used. The TPO in support thereof invoked the provisions of Rule 10B(1)(e)(i) to hold that net profit margin realized by an assessee from an international transaction entered into with associated enterprises is to be computed in relation to costs incurred, sales effected or assets employed by the assessee. The TPO further held that as regards the support services provided by the assessee is concerned, the right course will be to treat such services as equivalent to trading and the income received by the assessee from such support services is to be considered as income from trading and comparison need to be made accordingly. Accordingly the ld. TPO identified the seven new comparables and issued a show cause notice and proposed adjustment to the value of international transactions. Aggrieved with the draft assessment order passed by the AO, based on the recommendations of the TPO, the assessee filed objection before the learned DRP. The ld. DRP upheld the action of the ld. TPO in re-characterizing the transaction as that of a trader as against service provider. Aggrieved by the order passed by the DRP and the consequential final assessment order passed by the AO, the assessee filed appeal before ITAT.
Contention of Assessee
It was contended by the ld. AR that the action of the TPO and the DRP in making the adjustment on account of arm’s length price is against the Transfer Pricing Regulations as well as decided case laws under similar set of facts. The activities of purchase and sale i.e. trading involves risk and finance whereas in the activity of support services i.e. intending transactions the assessee company has neither to incur any financial obligation nor carries any significant risk. The nature of two activities is absolutely different. The activities of trading i.e. purchase and sale are highly insignificant as compared to activity of support service which constitutes the core business activities of the assessee company. The learned TPO and the learned DRP has gone wrong in applying the trading margins ignoring the facts of the case that the assessee being a service provider the trading margins cannot be applied. Further the learned TPO and learned DRP has gone wrong in including the cost of sales in OP/TC ignoring the fact the value of the sale under no circumstances effects the activities of the assessee company, a service provider. For support services the correct method is the TNMM and the assessee has computed the same on the basis of OP/TC. The TPO was not justified in ignoring the same. The OECD guidelines also support this contention that in TP study business transactions cannot be re-characterized. The support service or intending provided by the assessee company is nothing but a trading facilitation both in form and substance. The Mitsui Japan has been operating since long and doing business on its own since long. The assessee company was established only to provide support services to the existing business of the Mitsui Japan. Mitsui India does not take title or possession of the merchandise at any moment and bears no price risk, inventory risk, warranty risk or credit risk. The Rule 10B(e)(i) specifically provides that net profit margin in relation to transaction entered into with an AE is computed in relation to costs incurred, or sales effected or assets employed or to be employed by the enterprise. The cost incurred here will mean the cost incurred by the enterprise which will in the case of the assessee mean the cost incurred in providing services. Since no sales have been effected by the assessee company it is not appropriate to take cost of sales for computing margin. It was argued by the ld. AR that in the preceding assessment year i.e.2006-07, the assessee’s method of benchmarking its international transaction relating to provision of business support services using TNMM at the most appropriate method with OP/TC as PLI has been accepted and the addition was made only with regard to the margin computed with reference to the comparables used. That there is no change in the nature of services being provided by the assessee company to its associate enterprise since 2003when the appellant company was incorporated and it has been consistently benchmarking its international transaction relating to business support services using TNMM at the most appropriate method with OP/TC as PLI. It was further submitted by the learned AR that the issue is squarely covered by the judgment of Delhi Tribunal in the case of Sojitz India (P)Ltd. vs. DCIT 24 ITR (Trib) 474 (Del) and judgment of Hon’ble jurisdictional Delhi High Court in the case of Li and Fund India Pvt. Ltd. vs. CIT 361 ITR 85 (Delhi) which has also been considered by Delhi Bench of ITAT in the case of Mitsubhishi Corporation India (P) Ltd. vs. DCIT, ITA No.5042/Del/11 dated 21.10.2014 where facts are identical and similar issue has come up and the coordinate bench has held that TPO was not justified in re-characterizing the transaction as trading transaction. It was further submitted by the ld AR that even as per TPO’s computation no adjustment can be made to the arm’s length price in view of the proviso to Section 92C as applicable for the assessment years under consideration the margin is within 5% of the price at which international transaction has been undertaken by the assessee company.
Contention of Revenue
The learned CIT(DR) supported the order of the ld. TPO as confirmed by DRP. The comparables selected by the assessee and used in its TP report are not correct comparables and accordingly the TPO was justified in rejecting the same. It was submitted that though facts of the present case are almost similar to the facts of these two judgments relied upon by the assessee, as all these companies are providing support services to the parent company in Japan engaged in Sogo Shosha i.e. general trading companies, but still each of the case has to be considered on its own merit. On the issue of consistency as argued by the learned AR it was submitted by the Ld CIT(DR) that in the year under consideration the TPO has carried out an in-depth analysis and hence the acceptance of the assessee’s arm’s length price in the preceding year cannot be a ground to not to make adjustment in the year under consideration. On the issue of the alternative submission of the learned AR it was submitted that this benefit is not available to the assessee company as the method applied is only one method i.e. Transactional Net Margin Method. It was contended that the benefit of this proviso will be available only when arm’s length price is determined by applying two methods and the difference in the two methods is within 5 per cent.
Decision of ITAT
On going through the order of TPO in the case of the assessee and the order passed by the ITAT in the case of Mitsubishi Corporation India (P)Ltd., it was noted that the facts of the two cases were almost similar. In theMitsubishi Corporation India (P) Ltd., the ITAT has held that it is impermissible to make notional addition in the cost base and then take into account the costs which are not borne by the assessee. The ITAT while giving the above finding relied upon the judgment of the Hon’ble jurisdictional Delhi High Court in the case of Li & Fung whereby the Hon’ble Court has held that:
“to apply the TNMM, th eassessee’s net profit margin realized from international transactions had to be calculated only with reference to costincurred by it, and not by any other entity, either third party vendors or the AE…Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assessee’s net profit margin for application of the TNMM…The TPO’s reasoning to enhance the assessee’s cost base by considering the cost of manufacture and export of finished goods, by the third party venders(which cost is certainly not the cost incurred by the assessee ), is nowhere supported by the TNMM under Rule 10B(1)(e) of the Rules.”
In view of the above judgment of Hon’ble jurisdictional High Court, it was held that it is not correct on the part of the TPO to include the cost of sales incurred by the AEs in respect of which the assessee company has rendered services and then to work out the profit for determination of the arm’s length prices. This view was also supported by the judgment of the Delhi Tribunal in the case of Sojitz India (P) Ltd. Vs DCIT wherein it was held that-
“On a consideration of the business profile of the assessee as available on record and the nature of services rendered and the risk profile of the assessee, we are of theview, that the TPO erred in considering that the activity of aservice provider is similar to the activity of a trader.The unrebutted facts available on record is that the assessee is a service provider to the extent of 88.67% of itstotal earnings. As per the contracted terms and the un rebutted stand of the assessee it is merely providing indenting services. At no point of time the title in goods or possession of the merchandise is in assessee’s hands. The contract is entered into by SCJ and Indian customers directly whether for exporter import. The negotiations are directly done by SCJ and the Indian customers and the assessee merely functions as a facilitator. Looking at the nature of services rendered and the arguments advanced which also remain un rebutted and as such are taken to be correct the assessee does not need to incur cost either for maintaining or storing the inventory orfor the transportation as the title in goods is never held by the assessee for its indenting activity as a service provider .Consequently the assessee is not exposed to any credit risk inmaintaining the inventory nor is the assessee exposed to price risk or the risk linked with offering credit sales. From the nature of the risk profile of the assessee and on considering the functions performed and the assets deployed it can be safely concluded to be that of a low risk business, which has also been the claim of the assessee. It is an accepted economic principle that the trader acting as an entrepreneur is exposed to price risk, cost risk, credit risk, warranty risk etc, which would necessitate the contract being entered into and negotiated byassessee. Where all the critical functions were being performed by the AE the services provided, as a facilitator, by the assessee cannot betreated as a trading activity.”
The issue is also covered by the judgment of the MitsubishiCorporation India (P) Ltd. vs. DCIT (Supra) where the coordinate bench has held that
“In our considered view, to sum up, in a situation in which a business entity does not assume any significant inventory risk or perform any functions on the goods traded or add any value to the same, by use of unique intangibles or otherwise, the right profit level indicator should be operating profit to operating expenses i.e. berry ratio.”
Further the contention of the learned CIT(DR) that the proviso to section 92C is applicable only when two different methods are adopted is also not correct. The language of the proviso in this regard is quite clear. First the most appropriate method has to be determined. Based on that arm’s length price is to be found out by using various comparables. When more than one comparable is applied then arithmetical mean is to be worked out and no adjustment is to be made when arm’s length price is determined on the basis of such arithmetical mean is within 5% of the cost paid or charged by the assessee.
Following the above judgment of the coordinate benches Hon’ble ITAT was of the view that the adjustment made to arm’s length price as upheld by the DRP cannot be sustained and the same are directed to be deleted. In result, the appeals of assessee allowed.