CA Rohit Gupta
Aggregation of transactions or ‘Combined Transaction Approach’ is a well-accepted practice for benchmarking and determination of Arms’ Length Price of international transaction/ specified domestic transactions in Transfer Pricing Certification and assessments and is widely upheld in many judgements.
The aggregation and clubbing of closely linked transactions is permitted under Indian transfer pricing legislation. Section 92C (1) of the Income-tax Act, 1961 speaks about “nature of transaction or class of transaction”. Further the term “transaction” itself is defined in Rule 10A(d) of the Income-tax Rules, 1962 to include a number of “closely linked transactions”.
If a number of transactions are closely linked or continuous in nature and arising from a continuous transactions of supply of amenity or services, the transactions can be permitted as closely linked transactions for the purpose of transfer pricing and in terms of rule 10A(d) of Transfer Pricing Rules.
The OECD transfer pricing guidelines Para 3.9 and 3.11 also highlights that in certain situations it is difficult to evaluate transactions separately and need to be evaluated by bundling them. The OECD guidelines have referred a portfolio approach as business strategy consisting of tax payers bundling certain transaction for the purpose of earning an appropriate return across portfolio rather than single product. For instance, some products may be marketed by the tax payer with a low profit or even at loss because they create a demand for other products or related services of the same tax payer that are then sold or provide high profit. Some of the examples given in the OECD guidelines for transfer pricing are the equipment and captive after-market consumables such as vending coffee machines and coffee capsules, or printers and cartridges. Therefore, if two or more transactions between the same parties i.e., the Assessee and its associate enterprise can be said to be closely linked if the transactions are interlinked and terms and condition as well as prices between the parties are determined based on the totality of the transactions and not on individual and separate transactions.
Also, as per an example noted by the Institute of Chartered Accountants of India (in short the ‘ICAI’) in its Guidance Notes on transfer pricing, it is stated that two or more transactions can be said to be ‘closely linked’, if they emanate from a common source, being an order or contract or an agreement or an arrangement, and the nature, characteristic and terms of such transactions substantially flow from the said common source.
The Indian Courts and Tribunals have analysed and discussed the concept of bundled approach or aggregation approach in many cases.
In a recent case of Avery Dennison (India) Pvt. Ltd. [TS-527-HC-2016(Del)], the assessee had entered into international transactions with its AEs under a composite agreement for purchase of raw material, sale of finished goods, payment of service fee, etc, however TPO split the transactions and proceeded to apply the CUP method for service charges and made adjustments. The honorable Delhi High Court (HC) upheld the order of Income Tax Appellate Tribunal(ITAT) which rejected the approach of TPO and accepted the ALP determined by the assessee by aggregating transactions under Transaction Net margin Method (TNMM), observing that the assessee was predominantly a manufacturer, and that services received by it from its AEs were intrinsically linked to core business operations.
Let us see some other cases where aggregation of transactions for the purpose of benchmarking and determination of Arms’ Length Price (ALP) of same have been discussed:
- Transactions emanating from common source can be aggregated: Tribunal held that where number of transactions are closely linked, then the same the same should be treated as composite transaction and can be aggregated and construed as a single transaction for the purpose of determining the arm’s length price. Where two or more transactions emanate from common source being an order or contract or an agreement or an arrangement, then such transactions could be said to be closely linked as the nature, characteristic and terms of such transactions substantially flow from the said common source and construed as a single transaction for purpose of determining arm’s length price. (Cummins India Ltd.  53 taxmann.com 53 (Pune – Trib.))
- Transactions should be part of total package deal: The Punjab & Haryana High Court had held that in order to combine two or more transactions, it is essential that they should be either inextricably linked to each other either by way of a package deal or that a number of transactions are priced differently but on the understanding that the assessee will accept all of them together (i.e. either take all or leave all). It further held that merely because purchase of goods and acceptance of services lead to manufacture of final product, it does not follow that they are dependent transactions. (Knorr-Bremse India P. Ltd. v. Asstt. CIT  380 ITR 307/ 236 Taxman 318/63 taxmann.com 186))
- Services/Goods used for Manufacture not decisive for aggregation: The relevant criteria to determine whether certain transactions be considered as one international transaction or not is to see if such transactions were entered into a package deal or were intended to be simultaneously accepted or these are so closely linked that one cannot at all stand without the other. The mere fact that both the intra-group services and goods are utilized by the assessee for the manufacture of the final product cannot be treated decisive to consider such separate transactions as a single transaction. (Gruner India (P.) Ltd.  70 taxmann.com 240 (Delhi – Trib.))
- Transactions must be influenced by/dependent on each other: In order to examine whether the number of transactions are closely linked or continuous so as to aggregate for the purpose of evaluation it is to be considered that one transaction is follow-on of the earlier transaction and then the subsequent transaction is carried out and dependent wholly or substantially on the earlier transaction. It can be vice-versa when the earlier transaction has been entered into between parties by keeping in mind that a continuous transaction of similar nature will be entered into between the parties thereafter. Therefore, when the transactions are influenced by each other and particularly in determining the price and profit involved in the transactions then those transactions can safely be regarded as closely linked transactions. (Boskalis International Dredging International CV  47 taxmann.com 150 (Mumbai – Trib.))
- Transactions should conform to same or similar activity or functions: High Court held tht the international transaction of AMP expenses should be bundled/aggregated with other international transaction carried out by the assessee as a distributor, who either simply acts an agent of manufacturer or purchases goods from the manufacturer for resale at his own account. Also, HC held that Inter-connected international transactions can be aggregated and section 92(3) does not prohibit the set-off. (Sony Ericsson Mobile Communications India (P) Ltd. v. CIT  374 ITR 118/231 Taxman 113/55 taxmann.com 240 (Delhi))
Comment: It is discernible from the order that the application of TNM Method is not appropriate and proper in case the assessee is engaged in manufacturing activities. In such circumstances, the import of raw material for manufacture would be an independent international transaction viz., marketing and distribution activities or functions. The essence of said order is that two or more unrelated transactions cannot be aggregated and in case of a ‘Manufacturer’, the international transactions concerned with the manufacturing activity cannot be aggregated with the AMP activities as both are separate and distinct.
- Aggregation by TPO not permissible if separate benchmarking by assessee: The aggregation approach of benchmarking the international transactions by the TPO is not sustainable as per the today’s legal position. It is a trait law that the transactions have to be independently benchmarked applying the appropriate method in benchmarking of the transactions. (SAS Institute (India) (P.) Ltd  67 taxmann.com 271 (Mumbai – Trib.))
Comment: In this case, tribunal upheld the assessee approach of separately benchmarking the transactions however the reasoning given by the tribunal was not in line with accepted legal practice and law. Even the TP rules expressly permit the aggregation or combined transaction approach and also OECD guidelines also advocate portfolio approach in detail. However, the decision reflects that TPO cannot insist on aggregation of transactions where assessee himself has benchmarked the transactions separately in accordance with rules in force.
- Aggregation of Unrelated transactions not permissible: Also, even though in transfer pricing proceedings, aggregation of related transactions is permissible, yet there is no rule that all related and unrelated transactions can be combined and shown at ALP under TNMM on entity level. (JCB India Ltd.  69 taxmann.com 383 (Delhi – Trib) )
- Clubbing dependent on availability of comparables: Held, International transaction of AMP expenses can be clubbed with other international transactions carried out by assessee as distributor only when AMP functions performed by tested party and comparables are same (Zimmer India (P.) Ltd.  60 taxmann.com 170 (Delhi – Trib.)
- Payment of royalty for use of machine is separate from manufacturing activity– Assessee-company was engaged in manufacture of construction equipments and paid royalty to its AE for usage of a particular machine and applied TNMM on entity level. Delhi tribunal held that since said transaction of payment of royalty was independent of other transactions, ALP of transaction in question was to be determined seperately under CUP method. (JCB India Ltd.  69 taxmann.com 383 (Delhi – Trib.))
- Import, export, IT Support and Warranty are inter-related: The Tribunal, concluded that import, export of spare parts, IT support services, access to customized parts catalogue and amount received for warranty consideration were inter-related transactions, which were sourcing activities of assessee-company and, therefore, same had to be aggregated in order to benchmark international transaction. (Cummins India Ltd.  53 taxmann.com 53 (Pune – Trib.))
- Royalty inextricably linked with Production and sales: The tribunal upheld the aggregation approach adopted by assessee where assessee aggregated royalty with ITES services and applied TNMM on overall basis and held that royalty is inextricably linked with production and sales and the assessee was correct in employing an overall TNMM for examining the royalty. In the absence of production and sale of products, there would be no question arising regarding payment of any royalty. That being so, royalty cannot be considered, and examined in isolation on a standalone basis. (Daksh Business Process Services (P.) Ltd.  72 taxmann.com 44 (Delhi – Trib.))
- Royalty for know-how cannot be aggregated with imports and exports: Tribunal held that Where assessee-company entered into international transactions of import of raw materials and export of finished goods alongwith royalty payment for use of technical know-how and brand name of AE, since said transactions had no link with each other, TPO was justified in segregating those transactions and determining ALP of royalty payments by applying CUP method. (Gruner India (P.) Ltd.  70 taxmann.com 240 (Delhi – Trib.))
- Transaction with each AE should be separately aggregated: Held, where for execution of project, assessee company had hired equipments and dredgers from more than one associated enterprise, in determining ALP, aggregation of transaction would be permitted only to extent of transactions or to extent of members of transactions with each associated enterprise separately and not by clubbingtransactions with all AEs (Boskalis International Dredging International CV  47 taxmann.com 150 (Mumbai – Trib.))
- Separate invoicing does not mean separate benchmarking: Held, separate invoicing of an activity, flowing from a singular contract /negotiation, would not ipso facto lead to an inference that they are individual/independent transactions. (Demag Cranes & Components (India) (P.) Ltd.  30 taxmann.com 364 (Pune – Trib.))
- Portfolio of products to be benchmarked together: Held that the individual item which is part of a basket of products cannot be benchmarked separately but all the products in the same basket should be clubbed together for the purpose of determining the arm’s length price. Further, ITAT held that where assessee sold various insecticide products such as coil, liquid repellants, etc., to its AEs in various countries, since all products fell in category of insecticides and were used as supplementary to each other, all insecticide products sold by assessee to its AE in each country would be clubbed and aggregated together country-wise for purpose of determining arm’s length price of said transaction. Godrej Sara Lee Ltd.  58 taxmann.com 109 (Mumbai – Trib.))
- Installation service can be aggregated with manufacturing activity: Held, activity of installation and commissioning/engineering services of products was ‘closely linked’ with manufacturing activity of such products, the same deserved to be aggregated and construed as a single transaction for purposes of determining ALP (Demag Cranes & Components (India) (P.) Ltd.  30 taxmann.com 364 (Pune – Trib.)
- Separate benchmarking of each unit/branch of assessee not justified: Held, that the assessee is correct in contending that software development services rendered by it are of the same or similar nature amongst all three of its STP units, inter se, and they should be combined and evaluated by adopting a combined transaction approach, rather than employing the unitwise approach, as adopted by the TPO. (Birla Soft India Ltd.  46 taxmann.com 29 (Delhi – Trib.)
As can be seen from detailed discussion above, though aggregation of transactions with AEs for the purpose of benchmarking and determination of ALP is a widely accepted practice but the same has to be done keeping in mind the judicial pronouncements as mentioned above. Also, there are other parameters which should be carefully considered while benchmarking the transactions in Transfer Pricing study and form 3CEB.
The controversy revolving around analysing the arm’s length price of international transactions on “transaction by transaction” basis or as a “bundled transaction” is more or less settled in the present context.
However, applying the aggregation or combined transaction approach for the sake of convenience or ease of preparation of TP study without due consideration can lead to significant TP adjustments and demand by the department resulting in significant time consuming litigation and accompanying costs.
I hope the article shall be of use to the readers at large in Transfer Pricing Studies/ 3CEB certification and assessments/litigations.
(Author can be reached at firstname.lastname@example.org/9873832979 for any queries/comments/suggestions)