Brief of the Case
Delhi High Court held In the case of Denso India Limited vs. CIT that there can be no dispute that the AO would normally accept the figures given in TP report, if they do not call for his interference. However, his job also extends to critically evaluating materials and in cases which do require scrutiny, go ahead and do so. The factual discussion in this case clearly reveals that the assessee chose to import components not from the manufacturer (which was an AE) but an intermediary. Normally, this would have been a commercial decision, which revenue authorities would not question. However, interestingly, the vendor of the components was also connected with both the assessee and the manufacturer. If these realities emerged during the TP exercise, compelling the TPO to closely scrutinize the value of such imports and seek further details from the assessee, to justify its decision, the onus was clearly on the assessee to afford a convincing and reasonable explanation. Such of the explanations that were forthcoming, were apparently unconvincing. Hence, the unusual features which remained unexplained by the assessee influenced the TPO and the AO to resort to transfer pricing adjustment and determine ALP by adopting the CUP method for the procurements from Sumitomo Japan.
Facts of the Case
The facts which are common for the specific questions of law framed by the Court are that for both the assessment years 2002-03 and 2003-04, the assessee had procured component level inputs for the manufacture of its products. The total raw material imported was to the extent of Rs. 57,77,00,221 of which the value of imports from Sumitomo Corporation was Rs. 49,86,69,729/- or 86.3% of the total import. It also constituted 37.5% of the total raw material consumed. This figure related to AY 2002-03. Likewise, for AY 2003-04, the facts were much the same and the transfer pricing adjustment leading to addition of Rs. 5.86 crores was recommended by the TPO. The AO, in his order dated 28.03.2006 noticed that there was no difference of facts between the previous year AY 2002-03 and the current year in question, AY 2003-04 in respect of supplies by Sumitomo Corporation and consequently directed addition of Rs. 97,44,630/-. The TPO had determined the ALP at an average margin of 6.92% after eliminating 7 out of the 11 comparable companies since their turnover was less than Rs.100 crores. The assessee’s turnover was over Rs.250 crores. The Profit Level Indicator (PLI) of the assessee, in terms of the documents furnished by it worked out to 4.36%. The adjustment was, therefore, arrived at Rs. 5.86 crores.
Like for AY 2002-03,the CIT (A) held by his order dated 30.12.2009 that the adjustments were not justified. The CIT(A) followed his previous order and held that the CUP method was not the most appropriate one and that the import prices were not comparable to the prices paid to domestic vendors after indigenisation. The adjustment of Rs. 97,44,630/- was, therefore, deleted. The common order of the ITAT set aside the order of the Appellate Commissioner and restored the adjustments directed by the AO.
Contention of the Assessee
The ld counsel of the assessee submitted that the ITAT fell into error in accepting the AO’s decision as opposed to the well reasoned orders of the appellate Commissioner. The assessee urges that to determine if the transaction value of the various raw materials, including payment of royalty, technical knowhow fees etc., is at arms’ length, the net profit margin contemplated under Section 92C of the Income Tax Act is determinative. The value of each transaction in respect of every component is to be judged within the net margin derived by the entity. In this regard, reliance is placed upon OECD guidelines, particularly Para 3.9.
Learned counsel contends that for the purpose of benchmarking transaction of a broad entity, it is to be considered as a whole or as a class rather than analyzed on a transaction by transaction basis. It is emphasized that all transactions which are integral and ancillary to the main operation of the entity – in the present case, one which engages in manufacturing, have to be taken together. The assessee had appropriately applied the transactional net margin method (TNMM) and in doing so aggregated all the transactions in its transfer pricing report for the purpose of benchmarking international transactions with the operating profit table cast as the relevant profit level indicator (PLI). Since the TPO accepted the value of royalty, technical knowhow and testing fee on the basis of TNMM, he could not have, in the same order rejected it for the purpose of component purchase and proceeded to apply an entirely different method, i.e. Comparable Uncontrolled Price (CUP) method for arriving at the net value of transactions.
Contention of the Revenue
The ld counsel of the revenue relied upon the ITAT’s orders and held that they were justified under the circumstances of the present case. It was pointed out that the TPO’s initial order for AY 2002-03 clearly revealed that Sumitomo Corporation, Japan had exported 83% of the total goods, of the value of 86.3% of the total imports by the assessee and accounted for 37.5% of the total raw material consumed. The precise reason why the TPO and the AO directed the additions which are in dispute were that Sumitomo Corporation does not manufacture but merely traded in the goods. The assessee was unable to shed any light why it chose to source the materials from Sumitomo Japan, which it could have purchased directly from the manufacturer, i.e. Denso, Japan. Given the close connection between Sumitomo Corporation, Denso and the assessee, the lack of the explanation coupled with other objective factors justified the addition.
It was submitted that the facts for AY 2002-03 and 2003-04 are identical. The Revenue was justified in treating Sumitomo Corporation, Japan as the assessee’s AE since the TPO correctly deduced that purchases routed through their entity were with the sole objective of camouflaging obvious fact that the assessee made purchases from an AE, i.e. Denso Corporation, Japan which was the manufacturer. The TPO justly concluded that the assessee failed to discharge its responsibility as to the application of the most appropriate method. Consequently, it failed to give reasonable data, i.e. cost of purchase in the hands of Sumitomo Corporation, Japan, for determination of aggregate ALP by retail price method and that no other method except CUP could be applied for ALP determination of the component value from Sumitomo Corporation.
Held by High Court
High Court held that the cumulative effect of various provisions of the Income Tax Act, notably Sections 92, 92C, 92D and 92E read together with Rule 10B and 10D is the obligation to discern, if in a given set of circumstances, the assessee has disclosed international transactions, as well as an ALP. The ultimate purpose of this exercise- the primary onus of which is upon the assessee, is to ensure that no amount which is otherwise to be designated or treated as income, under law, escapes assessment. The assessee’s TP report is to be accurate and based on materials; its explanations for the queries raised by the TPO, convincing and reasonable. The underlying emphasis of the law (Section 92-C) is that the method appropriate to the transaction, amongst the four specified ones, is to be applied.
The factual discussion in this case clearly reveals that the assessee chose to import components not from the manufacturer (which was an AE) but an intermediary. Normally, this would have been a commercial decision, which revenue authorities would not question. However, interestingly, the vendor of the components (which constituted over 85% of the raw materials imported and about 38% of the total raw materials sourced) was also connected with both the assessee and the manufacturer. If these realities emerged during the TP exercise, compelling the TPO to closely scrutinize the value of such imports and seek further details from the assessee, to justify its decision, the onus was clearly on the latter to afford a convincing and reasonable explanation. Such of the explanations that were forthcoming, were apparently unconvincing. What the assessee banks upon in its appeal to this Court is the unbending and inflexible acceptance of its TP exercise; according to its logic, a “bundled” or aggregated series or chain of transactions used in the TP report should remain undisturbed.
There can be no dispute that the AO would normally accept the figures given, if they do not show features that call for his interference. However, his job also extends to critically evaluating materials and in cases which do require scrutiny, go ahead and do so. In the process, at least in this case, the unusual features which remained unexplained by the assessee, influenced the TPO and the AO to resort to transfer pricing adjustment and determine ALP by adopting the CUP method for the procurements from Sumitomo Japan. The “second test” spoken of in Sony Ericcson (2015) 374 ITR 118 (Del) i.e “the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their totality, differ from those which would have been adopted by an independent enterprise behaving in a commercially rational manner..” was in effect adopted. This Court finds no infirmity in this approach.
Accordingly, appeal of the assessee dismissed.