Under RPM, Focus on Functional Similarity, Not Product Similarity: ITAT Mumbai

Troy Chemicals India Pvt. Ltd Vs CIT(A) (ITAT Mumbai)

ITAT Mumbai under Resale Price Method [RPM] focus is more on same or similar nature of products rather than similarity of products. Thus, TPO directed to include 5 companies as comparable for benchmarking international transaction.

Facts- The assessee is a subsidiary of Troy Corporation, USA and is primarily engaged in the trading of specialty chemicals, additives, etc., in India. During the year under consideration, the assessee has entered into an international transaction with Troy Siam Company Ltd., which is incorporated under the laws of Thailand, and is an indirect subsidiary of Troy Corporation, USA. Troy Siam Company Ltd. is engaged in the manufacturing of speciality chemicals used in paint, wood preservation, coatings and other allied industries.

For benchmarking the international transaction of purchase of finished goods and purchase return, the assessee adopted the Resale Price Method (“RPM”) as the most appropriate method. TPO by applying the arm’s length margin made an adjustment of Rs.2,39,98,806/- to benchmark the international transaction of the assessee on account of purchase of finished goods and purchase return of goods.

Thereafter, DRP rejected the objections filed by the assessee and upheld the exclusion of 13 companies selected as comparable by the assessee, inter alia, on the basis that these companies are engaged in trading of bulk chemicals, while the assessee is a distributor of specialty chemicals. In conformity with the directions issued by the DRP, the AO passed the impugned final assessment order. Being aggrieved, the assessee is in appeal before us.

Conclusion- Co-ordinate Benches of the Tribunal that under the RPM, the focus is more on same or similar nature of properties or services rather than the similarity of products, and therefore, the functional attribute is a primary factor while undertaking the comparability analysis under the RPM.

Held that the main income of these companies arises from the trading of chemicals, which, inter alia, are used in textiles, paper, leather, and paint industries. Therefore, in the light of the decisions of the Co-ordinate Benches of the Tribunal, as noted above, wherein it has been held that in RPM product similarity is not a vital aspect for carrying out comparability analysis, but operational comparability is to be seen, and therefore, product differentiation does not materially affect the gross profit margin, we are of the considered view that the afore-noted 5 companies, which are also engaged in trading of chemicals, are valid comparable with the assessee, being the distributor of the chemicals, for benchmarking the international transactions by adopting RPM as the most appropriate method. Accordingly, we do not find any merit in the findings of the TPO/DRP in rejecting these companies as comparable. Accordingly, we direct the TPO / AO to include the afore-noted 5 companies for benchmarking the international transactions entered into by the assessee with Troy Siam Company Ltd. As regards the other 8 companies excluded by the TPO, we are not expressing any views in the light of the submissions of the learned AR as noted above, and objections, if any, against the same are kept open for adjudication if it arises in assessee’s case in future. As the relief has been granted to the assessee on the grounds pressed before us, the other issues raised in the present appeal are kept open.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The assessee has filed the present appeal against the impugned final assessment order dated 19.09.2024, passed under section 143(3) r.w. section 144C(13) and section 144B of the Income Tax Act, 1961 (“the Act”), pursuant to the directions dated 21.08.2024 issued by the learned Dispute Resolution Panel – 2, Mumbai, (“learned DRP”) under section 144C(5) of the Act, for the assessment year 2021-22.

2. In this appeal, the assessee has raised the following grounds: –

“A. The ld. AO/DRP erred in law and on facts in confirming the addition of income for Rs. 2,39,98,806/- on account of addition on the basis of transfer pricing order despite the contrary rulings of Hon’ble special bench of the tribunal in the case of Aztec software & technology services ltd. Vs. ACIT, which was also confirmed by the Karnataka High Court vide their judgement in the case of Aztec software vs ACIT (2012) 209 taxman 187 (Kar).

B. The ld. AO/DRP erred in law and on facts in confirming the addition of income for Rs. 2,39,98,806/- on the pretext of google website or any such graph, which merely offers suggestive figures, is improper and misleading, as has also been held by the Karnataka high court in the case of Sri om Pratap Singh vs the station house officer, where the high court gave the finding that google reviews have no evidentiary value.

C. The ld. AO/DRP erred in law and on facts in confirming the addition of Rs. 2,39,98,806/-simply on the basis of whims, surmises and conjectures, that it can be argued that there is ‘no reason to believe’ that the assessess in present case manufacture speciality chemicals which would give them higher margins, rather it has been repeatedly submitted along with proof that the assesse is a mere trader (an intermediary) who makes miniscule margin upon selling such chemical which it imports from it’s associated enterprise in Thailand.

Additionally, it is submitted that if the findings of DRP are allowed to sustain, then it would set a wrong precedent with respect to interpretation of “income attributable to business in India” under section 9 of the Income tax act, 1961.

D. The ld. AO/DRP erred in law and on facts in confirming the addition of Rs. 2,39,98,806/-, in the facts and circumstances of the case without giving proper personal hearing thereby denying the proper opportunity of being heard and without following the principles of natural justice. The personal hearing in the present case is in abeyance of the CBDT circular F.NO. PR. CCIT/NeAC/SOP/2020- 21, Dated 23-11-2020 which lays down the following mandatory conditions for personal hearing:-

1. The Assessee has submitted written submission in response to the DAO.

2. The Video Conference will ordinarily be of 30 minutes duration. It may be extended on the request of the Assessee or authorised representative.

3. The Assessee may furnish documents/ evidence, to substantiate points raised in the Video Conference during the hearing.”

3. The only issue that arises for the year under consideration in the present case pertains to the Transfer Pricing Adjustment in respect of the international transaction entered into by the assessee.

4. The brief facts of the case are that the assessee is a subsidiary of Troy Corporation, USA and is primarily engaged in the trading of speciality chemicals, additives, etc., in India. For the year under consideration, the assessee filed its return of income on 14.02.2022 declaring a total income of Rs.2,33,200/- During the year under consideration, the assessee has entered into an international transaction with Troy Siam Company Ltd., which is incorporated under the laws of Thailand, and is an indirect subsidiary of Troy Corporation, USA. Troy Siam Company Ltd. is engaged in the manufacturing of speciality chemicals used in paint, wood preservation, coatings and other allied industries. As per Form 3CEB, the assessee declared the following details of international transactions entered into with the Associated Enterprise (“AE”): –

5. As per the Transfer Pricing Study Report, for the purpose of distribution in India, the assessee purchases chemical products from its AE. The assessee also undertakes the storage, promotion and sale of such products in India. During the year under consideration, certain goods which were purchased by the assessee from its AE were returned to the said AE as the goods did not meet the quality standards. Since both the transactions entered into with the AE were inextricably linked to each other, the assessee aggregated these transactions for the purpose of transfer pricing benchmarking analysis. Various functions performed by the assessee in respect of international transactions with the AE, as detailed in the Transfer Pricing Study Report, are as follows: –

“(i) Strategic Planning, production scheduling and day to day activities

The activities of Troy India are such that they involve much strategic planning only at the operational level. Maintaining, searching and building relationships with distributors and customers – present and potential, entail significant functions of planning. Troy India undertakes day-to-day planning activities. These functions are performed by Troy India in accordance with strategic level guidance provided by the Group Companies.

AEs are engaged in manufacturing of chemicals, additives etc. to be distributed to Troy India. For the same, a production schedule is drawn up by AEs based on the forecast report received from Troy India. The production schedule is updated based on the confirmation of purchase orders issued by Troy India.

(ii) Procurement

The procurement function involves consideration of certain factors such as desired economic order quantity, capacity of warehousing / storage of products etc. All such factors are analyzed and managed by Troy India. Depending on its assessment, Troy India raises purchase orders on AEs indicating the quantity and other details/ specifications of the products required.

Troy India is involved in forecasting demand for its products. The Company shares the annual as well as monthly forecasts, prepared on the basis of market research, prior sales experience and interaction with distributors/toll manufacturer/customers, with AEs to enable it to accordingly procure, manufacture and export the raw material and chemicals to Troy India.

Based on the production schedule prepared, AEs carry out the material requirement planning and places the necessary orders for raw material and packaging material with the vendors.

(iii) Warehousing

The products are imported by Troy India in large size containers, which are transported from the port to the warehouse maintained by Troy India. The products are unloaded from the containers at the warehouse where they are stored until the final sales are made to the customers. The costs pertaining to the warehousing function is borne by Troy India.

(iv) Quality Control

AEs ensure that the products manufactured and distributed to customers/ group entities including Troy India are as per the standard quality and specifications.

No quality checks are undertaken prior to or post warehousing of the products since there are minimal chances of any contamination of the products in the container. The products which do not adhere to the specifications/ quality standards are replaced by AEs and hence AEs bear the incremental costs relating to such products.

Accordingly, quality assurance standards are determined by AEs and it is ensured that the products manufactured meet the minimum quality requirements.

(v) Custom clearance and other compliances

Once the products are imported, Troy India is responsible for ensuring customs clearance and other related compliances. No functions are performed in this regard by AES.

(vi) Research and development (“R&D”)

R&D centre operated by Troy Siam in Thailand is involved in limited R&D activities only. All complex R&D activities focused towards continuous product and technology improvement of existing products and development of new products are carried out by Troy Corp.

(vii) Marketing

The entire routine marketing function is carried out by Troy India to ensure continuous demand for the products distributed by it in India.

Marketing budgets are prepared by Troy India after obtaining necessary approval from the parent company, which is in line with the overall group policy.

(viii) Inventory management

Troy India maintains a certain requisite level of inventory of finished goods, based on sales forecast, empirical sales data, information collated from customers and expected sales orders. Generally, Troy India maintains inventory based on demand estimated for 90 days. The decision to maintain a certain level of inventory, taking into account the shelf life of inventory and timely fulfilment of orders, is the prerogative of the Company. Further, the storage and maintenance of finished goods is the sole responsibility of Troy India. Hence, any loss arising from damage to the products and from unsalable inventory is borne by Troy India.

(ix) Sales and distribution

Sales: Sales, billing and collection from customers would be done directly by Troy India. The receipt of sales orders, achievement of sales targets and collection of the sales proceeds are the responsibilities of Troy India.

Distribution: Troy India sells the imported products, without any processing/ value addition, to distributors as well as final customers. Sales orders from such distributors/ customers are received and processed by Troy India.

Pricing: Troy India sets prices based on its desired target market, customer perception, market research, economic conditions and product substitutes available in market. The prices are decided and finalized by Troy India, however, the prices charged by AEs for import of products by Troy India may influence the prices charged by Troy India from distributors/ customers. The price at which the products are imported by Troy India are finalized by AEs. Troy India does not exercise any control over the price at which AEs sell to the Company.”

6. For benchmarking the international transaction of purchase of finished goods and purchase return, the assessee adopted the Resale Price Method (“RPM”) as the most appropriate method. By considering itself as a tested party, the assessee identified 22 comparable companies with 35^thto 65^thpercentile range of gross margin, i.e., GP/sales between 4.18% to 8.21% with a median of 6.80%. As the assessee has earned a gross profit margin of 4.58% on sales during the year, accordingly, it claimed that the international transaction undertaken by it with the AE are in accordance with the arm’s length standard required under the Indian Regulation. Pursuant to the reference made by the Assessing Officer (“AO”) under section 92CA(1) of the Act to the Transfer Pricing Officer (“TPO”) for determination of the Arm’s Length Price (“ALP”) of the international transactions undertaken by the assessee, the TPO issued notice to the assessee asking it to show cause as to why the companies which are involved in trading in bulk chemicals and are considered as comparable by the assessee be not excluded for the purpose of transfer pricing benchmarking analysis of the international transactions undertaken by the assessee. After considering the response of the assessee, the TPO vide order dated 19.10.2023 passed under section 92CA(3) of the Act excluded 13 companies considering as comparable by the assessee in its Transfer Pricing Study Report and arrived at a set of the following 9 comparable companies for benchmarking the international transactions entered into by the assessee with its AE: –

7. Since the 35^thand 65^th percentile range of 9 companies considered as comparable by the TPO ranged between 6.91% to 7.82%, with a median of 6.91%, the TPO by applying the arm’s length margin made an adjustment of Rs.2,39,98,806/- to benchmark the international transaction of the assessee on account of purchase of finished goods and purchase return of goods.

8. In conformity with the Arm’s Length Price so determined by the TPO, the AO passed the draft assessment order under section 144C(1) of the Act on 08.11.2023 computing the total income of the assessee at Rs.2,42,32,006/-. The assessee filed detailed objections before the learned DRP against the transfer pricing adjustment made by the TPO. Vide its directions dated 21.08.2024 issued under section 144C(5) of the Act, the learned DRP rejected the objections filed by the assessee and upheld the exclusion of 13 companies selected as comparable by the assessee, inter alia, on the basis that these companies are engaged in trading of bulk chemicals, while the assessee is a distributor of specialty chemicals.

9. In conformity with the directions issued by the DRP, the AO passed the impugned final assessment order. Being aggrieved, the assessee is in appeal before us.

10. During the hearing, the learned Authorised Representative (“learned AR”) by referring to the submissions filed before the learned DRP, forming part of the paper book from pages 600-648, submitted that if only 5 companies, namely, A-one Chem – Trade Pvt. Ltd., CHD Chemicals Ltd., Prakash Chemicals Agencies Pvt. Ltd., Siskaa Chemicals Ltd. and Yash Chemex Ltd., which operate in a similar line of business and closely resemble the type of chemical traded by the assessee, are directed to be included to the already accepted 9 comparable companies, then the assessee would fall within the arm’s length margin range. By referring to the relevant extracts of Annual Reports of these 5 companies, the learned AR submitted that these companies are traders of chemicals, and therefore, are comparable to the assessee for benchmarking the international transaction entered into by the assessee by adopting RPM as the most appropriate method. During the hearing, by referring to internal page 40 of the Transfer Pricing Study Report, the learned AR submitted that under the RPM, comparability is primarily depended upon the similarity of the functions performed and the risk assumed by the controlled and uncontrolled distributor and is less depended on the similarity of the goods bought and resold. Accordingly, the learned AR submitted that since these 5 companies are also engaged in the trading of chemicals, therefore, they should be considered as comparable to the assessee, as it is also involved in trading of wide range of chemical and chemical compounds.

11. On the other hand, the learned Departmental Representative (“learned DR”), vehemently relying upon the orders passed by the lower authorities, submitted that the assessee, as per its own admission in the Transfer Pricing Study Report, is a trader of specialty chemicals and since specialty chemicals and bulk chemicals serve different purpose and have distinct characteristics, therefore, the assessee cannot be compared with companies which are not involved in trading of specialty chemicals.

12. We have considered the submissions of both sides and perused the material available on record. In the present case, there is no dispute regarding the profile of the assessee, that it is a distributor of chemical products in India, which it has purchased from its AE in Thailand. Further, there is no dispute regarding the fact that the assessee has not assumed any significant risk and also did not make any value addition to the products sold by it in the Indian market. Thus, the transfer pricing benchmarking analysis of the international transactions undertaken by the assessee with its AE by adopting RPM as the most appropriate method has not been disputed by any of the lower authorities. As is evident from the record, the TPO only disputed the transfer pricing analysis conducted by the assessee only qua the selection of comparables, and out of 22 companies considered as comparable by the assessee, the TPO excluded 13 companies on the basis that these companies are involved in business of trading in bulk chemicals while the assessee is a trader of specialty chemicals. Accordingly, by agreeing with the 9 companies considered as comparable by the assessee, the TPO arrived at an arm’s length margin of 6.91% and computed the impugned adjustment of Rs.2,39,98,806/-. We find that the learned DRP was also not convinced with the detailed objections filed by the assessee and by noting the comparison between the specialty chemicals and bulk chemicals in respect of production volume and value, market dynamics, customer base and applications, profit margins, cost structures, concluded that the entities dealing with bulk chemicals are not comparable due to Function, Assets and Risk profile difference with the assessee engaged in trading of specialty chemicals, additives, etc., in India.

13. Therefore, in the present case, before proceeding further, it is pertinent to analyse the relevance of product similarity for benchmarking the international transactions by applying the RPM as the most appropriate method. The RPM has been prescribed as one of the methods under Rule 10B(1)(b) of the Income Tax Rules (“the Rules”) for the determination of arm’s length price under section 92C of the Act. Rule 10B(1)(b) of the Rules reads as follows: –

“Section 10B(1)(b) in Income Tax Rules, 1962

(b) resale price method, by which,-

(i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified;

(ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;

(iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;

(iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;

(v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm’s length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise;”

14. From a plain reading of the provisions of Rule 10B(1)(b) of the Rules, it is evident that in RPM the gross sale margin realised by an enterprise from a control transaction are compared with gross margins realised by the enterprise or an unrelated party from comparable uncontrolled transaction of purchase and resale of the “same or similar” property or from obtaining and providing the “same or similar” services. Thus, it is evident that Rule 10B(1)(b) of the Rules, which prescribes the RPM as one of the methods for the determination of arm’s length price, also does not require strict product similarity for benchmarking the international transaction. We find that while analysing this aspect of the matter, i.e., the relevance of product similarity for benchmarking the international transaction by adopting the RPM as most appropriate method, the Co-ordinate Bench of the Tribunal in the case of Mattel Toys (I) (P) Ltd. vs. DCIT, reported in (2014) 30 ITR(T) 283 (Mumbai), observed as follows: –

“38. Thus, the RPM method identifies the price at which the product purchased from the A.E. is resold to a unrelated party. Such price is reduced by normal gross profit margin i.e., the gross profit margin accruing in a comparable controlled transaction on resale of same or similar property or services. The RPM is mostly applied in a situation in which the reseller purchases tangible property or obtain services from an A.E. and reseller does not physically alter the tangible goods and services or use any intangible assets to add substantial value to the property or services i.e., resale is made without any value addition having been made. Since in RPM only margins are seen with reference to items purchased and sold or earned by an independent enterprise in comparable uncontrolled transactions vis-a-vis the one in the controlled transactions, therefore, in such a situation, the nature of products has not much relevance though their closer comparable may produce a better result. The focus is more on same or similar nature of properties or services rather than similarity of products. In RPM other attributes of comparabilities than the product itself can produce a reliable measure of arm’s length conditions. The main reason is that the product differentiation does not materially effect the gross profit margin as it represents gross compensation after the cost of sales for specific function performed. The functional attribute is more important while undertaking the comparability analysis under this method. Thus, in our opinion, under the RPM, products similarity is not a vital aspect for carrying out comparability analysis but operational comparability is to be seen. Since the gross profit margin is the main criteria while evaluating the transactions in the RPM wherein price is identified at which property or services are resold and normal gross profit margin is derived at by the enterprise which is deducted from the resale price of such property or service in comparable uncontrolled transactions. The gross profit margin earned by the independent enterprise in comparable uncontrolled transactions is served as a guidance factor. This is also what happens in the case of a distributor wherein the property and service are purchased from the A.E. and are resold to other independent entities, without any value additions. The gross profit margin earned in such transactions becomes the determination factor to see the gross compensation after the cost of sales. In the instant case, the assessee is a distributor of Mattel toys and gets the finished goods from its A.E. and resells the same to independent parties without any value addition. In such a situation, RPM can be the best method to evaluate the transactions whether they are at ALP.”

15. We find that similar findings have been rendered by the Co-ordinate Benches of the Tribunal in the following decisions: –

• ACIT vs. Kobelco Construction Equipment India Ltd., (2017) 81 com31 (Delhi – Trib.)
• Pepperl & Fuchs (India) (P.) Ltd. vs. DCIT, (2019) 105 com29 (Bangalore – Trib.)

16. Thus, we find that it has been consistently held by the Co-ordinate Benches of the Tribunal that under the RPM, the focus is more on same or similar nature of properties or services rather than the similarity of products, and therefore, the functional attribute is a primary factor while undertaking the comparability analysis under the RPM.

17. In the light of the aforesaid analysis, we shall now proceed to determine the comparability of the 5 companies, namely, A-One Chem-Trade Pvt. Ltd., CHD Chemicals Ltd., Prakash Chemicals Agencies Pvt. Ltd., Siskaa Chemicals Ltd. and Yash Chemex Ltd., with the assessee. We are confining our findings only with respect to the aforesaid 5 companies in view of the submissions of the learned AR that if these 5 companies are considered as comparable, then the assessee’s gross margin will fall within the arm’s length range. The brief functional profile of these 5 companies, as submitted by the assessee before the lower authorities, is as follows: –

18. Before us, learned AR also furnished the complete set of Annual Reports of the aforesaid 5 companies to substantiate the business description of these companies. From the perusal of the business description of these companies as noted above and as provided in the Annual Reports filed by the assessee, we find that the main income of these companies arises from the trading of chemicals, which, inter alia, are used in textiles, paper, leather, and paint industries. Therefore, in the light of the decisions of the Co-ordinate Benches of the Tribunal, as noted above, wherein it has been held that in RPM product similarity is not a vital aspect for carrying out comparability analysis, but operational comparability is to be seen, and therefore, product differentiation does not materially affect the gross profit margin, we are of the considered view that the afore-noted 5 companies, which are also engaged in trading of chemicals, are valid comparable with the assessee, being the distributor of the chemicals, for benchmarking the international transactions by adopting RPM as the most appropriate method. Accordingly, we do not find any merit in the findings of the TPO/DRP in rejecting these companies as comparable. Accordingly, we direct the TPO / AO to include the afore-noted 5 companies for benchmarking the international transactions entered into by the assessee with Troy Siam Company Ltd. As regards the other 8 companies excluded by the TPO, we are not expressing any views in the light of the submissions of the learned AR as noted above, and objections, if any, against the same are kept open for adjudication if it arises in assessee’s case in future. As the relief has been granted to the assessee on the grounds pressed before us, the other issues raised in the present appeal are kept open.

19. In the result, the appeal by the assessee is allowed.

Order pronounced in the open Court on 30/05/2025