top high court judgements (india) on transfer pricing (2015 16)

High Court Judgments on Transfer Pricing

15 High Court Judgments on Transfer Pricing delivered in 2015-16

May 2016

High Court Judgments on Transfer Pricing (2015-16)

Sr. No.

Judgement Issue Slide Nos.

1 Rampgreen Solutions (P) Ltd vs CIT [2015] (Delhi HC)

Whether for benchmarking ITeS services under TNMM, KPO companies can be said to be comparable to BPO companies?

5 – 10

2 Chryscapital Investment Advisors (India) (P) Ltd vs DCIT [2015] (Delhi HC)

Whether Super-Profit companies can be considered as comparables under TNMM?

11 - 15

3 CIT vs Pentair Water India (P) Limited [2016] (Bombay HC)

Is Turnover a valid Criteria or Filter for selecting comparables under TNMM?

16 – 19

4 Advance Power Display Systems Ltd vs CIT [2016] (Bombay HC)

Whether comparables selected in subsequent AY have to be taken as comparables for preceding AY?

20 – 23

5 Knorr-Bremse India (P) Ltd vs ACIT [2015] (Punjab & Haryana HC)

Whether various transactions can be aggregated under TNMM? Whether increase in profit can be a determining factor for Arm’s Length Price?

24 – 31

2

Table of Contents

High Court Judgments – Transfer Pricing

Sr. No.


6 T. Rajkumar vs Union of India [2016] (Madras HC)

Whether Notification issued under Sec. 94A, notifying Cyprus as a Notified Jurisdictional Area, is constitutional?

32 – 38

7 Maruti Suzuki India Ltd vs CIT [2015] (Delhi HC)

Whether incurring of AMP expenses by an Indian Licensed Manufacturer gives rise to an International Transaction?

39 - 48

8 CIT vs ITC Infotech India Ltd [2016] (Calcutta HC)

What arm’s length remuneration should an Indian Taxpayer pay to its AE, for marketing and administrative services?

49 – 53

9 CIT vs Toll Global Forwarding India (P) Ltd [2016] (Delhi HC)

Whether 50:50 split of profits can be accepted as arm’s length price under CUP?

54 – 59

10 CIT vs Marubeni India (P) Ltd [2015] (Delhi HC

For logistics services which is the Most Appropriate Method - PSM or TNMM?

60 – 65

3

Table of Contents

High Court Judgments – Transfer Pricing

Sr. No.


11 CIT vs Everest Kento Cylinders Ltd [2015] (Bombay HC)

What should be the arm’s length fee for guarantee provided by an Indian Parent Company?

66 – 69

12 CIT vs Cotton Naturals (I) (P) Ltd [2015] (Delhi HC)

What should be the arm’s length interest for loan provided by an Indian Company to its AE?

70 – 74

13 CIT vs Ameriprise India Pvt Ltd [2016] (Delhi HC)

Can Forex Gain/Loss be treated as Operating Revenue/Cost?

75 - 78

14 CIT vs Johnson Matthey India(P) Ltd [2015] [Delhi HC]

Selection of PLI - What should be the right PLI (ROCE or OP/TC) with TNMM?

79 - 85

15 CIT vs Goldstar Jewellery Design (P) Ltd [2016] [Bombay HC]

Selection of PLI - What should be the right PLI (ROCE or OP/TC) with TNMM?

86 - 89

4

Table of Contents

1. Rampgreen Solutions (P) Ltd vs CIT [2015] 60 taxmann.com 355 [Delhi HC]

5

Rampgreen Solutions (P) Ltd vs CIT

6

RampgreenAE

India

Clients

ContractCall Center Services

Voice-based

Customer Care

Outside India

Does marketing, and Bears all the risk

Whether, for benchmarking ITeS services, KPO companies can be said to be comparable to BPO companies?

Facts: Rampgreen Solutions (the Assessee) provides Voice-based customer care services to the clients of the AE. The AE

undertakes marketing, enters into contracts with the clients, and bears risks

The AE pays remuneration to Rampgreen Solutions at cost plus 15%

TPO included two high margin companies (KPO Cos) in the set of comparables, to apply TNMM

The ITAT upheld the action of TPO on the reasoning that the Assessee was providing ITeS Services to the AE, and so both BPOs and KPOs (which can be broadly categorised as ITeS services) would be comparable entities. [The decision of ITAT was based on the ruling of Special Bench of ITAT in Maersk Global Service Centres (India) Pvt Ltd [2014] 43 taxmann.com 100/[2014] 147 ITD 83/[2014] 161 TTJ 137 (ITAT Mumbai - SB)]

Issue before the High Court: Whether, for benchmarking ITeS services, KPO companies can be said to be comparable to BPO companies?

7


Judgement of the Delhi High Court (1/3)• It is not disputed that voice call services are considered to be the lower-end of ITeS. KPO on the other hand are ITeS

where the service providers have to employ advanced level of skills and knowledge. A knowledge process is understood as a high value added process chain wherein the processes are dependent on advanced skills, domain knowledge and the experience of the persons carrying on such processes.

• The expression 'KPO' indicates the involvement of domain knowledge in providing ITeS. Typically, KPO includes involvement of advanced skills - the services provided may include analytical services, market research, legal research, engineering and design services, intellectual management etc. On the other hand, Voice Call Centers are normally involved in customer support and processing of routine data.

• While entities rendering Voice Call Centre services for customer support and a KPO service provider may be employing IT-based delivery systems, the characteristics of services, the functional aspects, business environment, risks and the quality of human resource employed would be materially different. It plainly follows that benchmarking international transactions on the basis of comparing the PLI of high-end KPO service providers with the PLI of Voice Call Centers would be unreliable and possibly flawed.

8


Judgement of the Delhi High Court (2/3)• According to the Tribunal, no differentiation could be made between the entities rendering ITeS. This view cannot

be accepted as it is contrary to the fundamental rationale of determining ALP by comparing controlled transactions/entities with similar uncontrolled transactions/entities.

• ITeS encompasses a wide spectrum of services that use Information Technology based delivery which could include rendering highly technical services by qualified technical personnel, involving advanced skills and knowledge, such as engineering, design and support. While, on the other end of the spectrum ITeS would also include voice-based call centers that render routine customer support for their clients.

• Clearly, characteristics of the service rendered would be dissimilar. Further, both service providers cannot be considered to be functionally similar. Their business environment would be entirely different, the demand and supply for the services would be different, the assets and capital employed would differ, the competence required to operate the two services would be different.

• Each of the aforesaid factors would have a material bearing on the profitability of the two entities. Treating the said entities to be comparables, only for the reason that they use Information Technology for the delivery of their services, would be erroneous.

9


Judgement of the Delhi High Court (3/3)• The expression 'BPO' and 'KPO' are, plainly, understood in the sense that whereas, BPO does not necessarily involve

advanced skills and knowledge; KPO would involve employment of advanced skills and knowledge for providing services.

• Thus, the expression 'KPO' in common parlance is used to indicate an ITeS provider providing a completely different nature of service than any other BPO service provider. A KPO service provider would also be functionally different from other BPO service providers, inasmuch as the responsibilities undertaken, the activities performed and the quality of resources employed would be materially different.

• In the circumstances, broadly ITeS sector cannot be used for selecting comparables without making a conscious selection as to the quality and nature of the content of services.

• Rule 10B(2)(a) mandates that the comparability of controlled and uncontrolled transactions be judged with reference to service/product characteristics. This factor cannot be undermined by using a broad classification of ITeS which takes within its fold various types of services with completely different content and value.

• Thus, where the tested party is not a KPO service provider, an entity rendering KPO services cannot be considered as a comparable for the purposes of Transfer Pricing analysis.

10


2. Chryscapital Investment Advisors (India) (P) Ltd vs DCIT [2015] 56 taxmann.com 417 [Delhi HC]

11

Chryscapital Investment Advisors India (P) Ltd vs DCIT

12

Chryscapital IndiaAEs

IndiaOutside India

Investment Advisory Services

Is there a concept of super-profit comparables in the process of determination of Arm’s Length Price (ALP) under the Indian TP Regulations? Mere fact that an entity makes extremely high profit cannot lead to its exclusion

from the set of comparables


Facts: Chryscapital India provides Investment Advisory Services to its AEs

To determine the ALP of such services, TNMM was used

The TPO included 3 additional companies in the set of comparables

Those 3 companies were highly profitable, as compared to the other companies included in the set of comparables

Chryscapital argued that companies earning abnormally high profits must not be considered as comparables

Issue before the High Court: Can super-profit making companies be considered as comparables under TNMM?

13


Judgement of the Delhi High Court (1/2)• The mere fact that an entity makes high/extremely high profits/losses does not, ipso facto, lead to its exclusion from the list

of comparables for the purposes of determination of ALP. In such circumstances, an enquiry under Rule 10B(3) ought to be carried out, to determine as to whether the material differences between the assessee and the said entity can be eliminated. Unless such differences cannot be eliminated, the entity should be included as a comparable.

• The matter was remitted to the DRP to carry out the analysis under Rule 10B(3) and determine, whether the material differences, arising out of the exceptionally high profits of the 3 companies, could be eliminated. If not, the said companies cannot be included as comparables.

• If the super-profit companies are functionally similar to the assessee, they would be included as comparables, notwithstanding their high profit margins, provided that the material difference on account of such high profit margins can be eliminated under the Rule 10B(3) analysis.

14

Chryscapital Investment Advisors India (P) Ltd vs DCITJudgement of the Delhi High Court (2/2)[Rule 10B(3) reads as under:

An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if—

(i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or

(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.]

15

Note:

Another point that was decided by the high court was about use of multiple year data for benchmarking. On that point the High Court ruled that as a general rule it is not open to the Tax Payer to rely upon previous years data. Multiple-Year data can only be considered in the manner provided in Rule 10B(4) i.e. the Taxpayer has to establish that such data has an influence on the determination of price. In the present case, the High Court held that Chryscapital failed to establish the relevance of previous years data, and so multiple year data cannot be used. (From FY 2014-15 the law has changed and Taxpayers may now use multiple year data along with the arm’s length range)

3. CIT vs Pentair Water India Private Limited [2016] TS-566-HC-2015-TP [Bombay HC]

16

Pentair WaterAE

USA

CIT vs Pentair Water India Pvt Ltd

17

Facts: Pentair Water India (the Assessee) rendered IT Enabled Services to its Parent Company, Pentair Inc USA

For applying TNMM, the TPO included ‘Wipro Ltd’, ‘Infosys BPO Ltd’ and ‘HCL Comnet Systems and Services’ in the set of comparables

Pentair Water provided IT Enabled Services

Can Turnover be a valid criteria or filter for selecting comparables under TNMM?

India

Facts (contd): The ITAT held that these 3 companies had Turnover far in excess of the Turnover of the Assessee. The Turnover of

those 3 companies as multiple of the Turnover of the Assessee (11 crores) was as under:

i. Wipro Ltd – 85 times

ii. Infosys BPO Ltd – 65 times

iii. HCl Comnet systems and Services – 23 times

Issue before the High Court: Is Turnover a valid criteria or filter for selecting comparables under TNMM?

18


Judgement of Bombay High Court:• The findings of the Tribunal in respect of the said three Companies are on the basis of appreciation of evidence on

record. There is no infirmity in the said findings of the Tribunal on that count.

The Bombay High Court accepted the Taxpayer’s argument that Turnover is obviously a relevant factor to consider the comparability.

19


4. Advance Power Display Systems Ltd vs CIT [2016] 65 taxmann.com 92 [Bombay HC]

20

AssesseeAE

IndiaOutside India

Advance Power Display Systems Ltd vs CIT

21

Supply of Switch Mode Power Supplies

Whether certain comparable relied upon by the Assessee could be accepted, merely because they were accepted in the subsequent Assessment Year?

Facts: The Assessee (APDSL) manufactures/assembles Switch Mode Power Supplies (SMPS) on demand and specification of its AE and

supplies the entire production to the AE. Thereafter, the AE further sells the SMPS to its customers.

Before CIT (Appeals), the Assessee presented three additional comparables (which were not presented before TPO), to determine the arm's length price (ALP) of the SMPS sold to the AE.

The basis of the Asseesee seeking to have the three additional comparables examined in appeal was that the same had been considered as comparables for the subsequent Assessment Years. The CIT (Appeals) considered the three additional comparables being relied upon by the Assessee, to determine ALP of the Assessee’s product, for the reason that those three comparables had been used as comparables to determine ALP in the subsequent Assessment Years.

On Revenue’s appeal, the ITAT accepted the Revenue's contention that merely because the comparables had been accepted for the subsequent assessment year would not ipso facto lead to same comparables being applied to the subject assessment year.

On merits, the Tribunal rejected all the three comparables.

Issue before the High Court: Whether certain comparable relied upon by the Assessee could be accepted, merely because they were accepted in the subsequent

Assessment Year?22


Judgement of the Bombay High Court

• No fault can be found with the order of the Tribunal to the extent it holds that merely because a comparable has been used in the subsequent assessment year for determining the ALP, it would not ispo facto apply to determine the ALP in the subsequent Assessment Year.

• However, after having held so, it would have been appropriate for the Tribunal to restore the issue to TPO to consider applicability of three comparables to determine the ALP in respect of the subject Assessment Year.

23


5. Knorr-Bremse India (P) Ltd vs ACIT [2015] 63 taxmann.com 186 [Punjab & Haryana HC]

24

Knorr-Bremse India (P) Ltd vs ACIT

25

Increase in profit cannot be a factor in determining whether an International Transaction is at ALP or not Several transactions can form one single transaction if they are closely linked

KBILAEs

IndiaOutside India

Manufacturing Trading

• Purchase of Raw materials

• Purchase of Finished Goods

• Sale of Raw Materials

• Payment of Management Service Fees

This is a Landmark Judgement on ALP of Management

Service Fees

Facts: Knorr-Bremse India (P) Ltd (KBIL) has two segments: Manufacturing and Trading

In both the segments KBIL entered into various International Transactions with its AEs, including payment of Management Service Fees

For benchmarking, KBIL segregated the two segments (Manufacturing & Trading Segments)

However, several transactions including payment of management service fees, under each segment, were combined together (under the relevant segment), for benchmarking under TNMM

The TPO segregated the payment of Management Service Fees, from other transactions, and applied CUP Method to benchmark such payment

26


Under CUP Method, the TPO determined ALP of the payment of Management Service Fees at ‘NIL’ on the following grounds:

i. KBIL was not able to show any increase in its profits due to receipt of Management Service

ii. KBIL did not prove that it had benefited from the Management Service

iii. The Service obtained from AEs could have been obtained by KBIL locally in India

iv. KBIL need not have made any payment from Management Service

Issues before the High Court: Whether the International Transaction of payment of Management Service Fees should be segregated and

Benchmarked separately?

Whether the TPO can determine ALP of payment of Management Service Fees at ‘NIL’ under the CUP Method?

27


Judgement of the Punjab & Haryana High Court (1/4)I. On ALP of Payment of Management Service Fee at Nil

• The answer to the issue whether a transaction is at an arm's length price or not is not dependent on whether the transaction results in an increase in the assessee's profit. This would be contrary to the established manner in which business is conducted by people and by enterprises. Business decisions are at times good and profitable and at times bad and unprofitable. Business decisions may and, in fact, often do result in a loss. The question whether the decision was commercially sound or not is not relevant. The only question is whether the transaction entered into was bona fide or not or whether it was sham and only for the purpose of diverting the profits.

• The TPO observed that regular increase in profits is a normal incidence in business. This is entirely incorrect. All businesses are not profitable. All decisions do not enhance profitability. Losses are also an incidence of business. Many are the failed business ventures of people and enterprises. Every business venture is not necessarily profitable or successful. All business ventures do not succeed equally or uniformly. Indeed, if an assessee is able to establish financial or other commercial benefits arising from a transaction, it would further strengthen its case. But if it cannot do so, it does not weaken it.

• Enterprises, businessmen and professionals constantly experiment with different business models, theories and ventures. The aim indeed is to further the business, to enhance their profits. So long as that is the aim, it is sufficient for the purpose of the Income-tax Act.

28


Judgement of the Punjab & Haryana High Court (2/4)• The profit earned by an assessee could be for reasons other than those relating to the international transactions or by virtue

of international transactions as well as by virtue of other factors. In that event, the assessee having profited from the venture involving the international transactions, obviously, would not establish that the arm's length price was correct or justified. Mere profitability does not indicate that the transaction which was responsible for the enhancement of the profits was at an arm's length price.

• Merely because an assessee profits by the use of the goods supplied or the services rendered, it does not follow that the same were sold or supplied at an arm's length price. Conversely, merely because an assessee does not profit from the use of the goods or services, it does not follow that they were not sold at an arm's length price.

• The assessee’s claim of payment of service fee to AEs cannot be disallowed, even if the assessee fails to establish that it has benefited from the services provided by the AEs.

• The TPO's conclusion that assessee cannot escape its responsibilities of having to show the actual benefit it has received; and that the assessee will also have to demonstrate that independent parties would be inclined to make such a payment in similar circumstances does not follow from the OECD Guidelines quoted by him. The OECD Guidelines merely state that the result must be consistent with what comparable independent enterprises would have been prepared to accept.

29


Judgement of the Punjab & Haryana High Court (3/4)• The TPO held that the assessee had sufficient local help to allow it to overcome the legal challenges at the local level. The

TPO held that there was no reason to believe that the AEs provided assistance that the assessee could not obtain at the local level in India.

• That, however, cannot be a ground for rejecting a claim for deduction. Nor can that be a ground for assuming that the consideration paid for the same is not the genuine arm's length price. I

• In absence of any law, an assessee cannot be compelled to avail the services available in India. It is for the assessee to determine whose services it desires availing of and whose goods it intends purchasing. It is certainly understandable if the assessee prefers to deal with its Group Entities/AEs. This is for a variety of reasons which are far too obvious to state.

• So long as there is no bar in law to the assessee availing the services of a particular party, the authorities under the Act must determine whether the consideration paid for the same is at an arm's length price or not.

30


Judgement of the Punjab & Haryana High Court (4/4)II. On combining several transactions for benchmarking under TNMM

• Several transactions can be combined and aggregated TNMM can be applied if it is established that each transaction was so inextricably linked to the other that the one could not survive without the other, and if the receipt of services formed a part of a composite transaction.

• The assessee would, however, have to prove that although each sale and each provision of service is priced separately, they were all provided under one composite agreement which constitutes an international transaction.

31


6. T. Rajkumar vs Union of India [2016] 68 taxmann.com 182 [Madras HC]

32

Assessee

A Transaction

One of the parties is located in a NJA

All parties to the transaction shall be deemed to be Associated Enterprises

Transaction between those parties will be deemed to be an Intl. Transaction

TPR will apply to that transaction

Enters into

And

Under Sec. 94A(1), if a Country or Territory does not effectively exchange tax related information with India, then Indian Government can notify that Country or Territory as a Notified Jurisdictional Area (NJA)

33

T. Rajkumar vs Union of India Whether Sec. 94A, which lays down that any Transaction with a Person located in a Country or Territory that does

not exchange information with India will be deemed to be an International Transaction (subject to Transfer Pricing Regulation), is constitutional? Whether Sec. 94A has to yield to a Bilateral Tax Treaty?

Background - Relevant Legal Provisions: Under Sec. 94A, if an Indian Taxpayer enters into a transaction with any person located in a Notified Jurisdictional Area (NJA), then the

Indian Taxpayer and the person located in the NJA are deemed to be Associated Enterprises; and any transaction between them is deemed to be an International Transaction.

NJA means a Country or Territory that does not effectively exchange tax related information with India.

The Indian Government issued a Notification No. 86/2013 dated 1/11/2013 specifying Cyprus as a NJA for the purposes of Sec. 94A.

Facts: Three persons filed writ petitions before the Madras High Court challenging the constitutional validity of Sec. 94A (1) and the

Notification specifying Cyprus as a NJA

India had entered into a Bilateral Tax Treaty with Cyprus in 1994

Issue before the High Court: Are the provisions of Sec. 94A and the Notification specifying Cyprus as a NJA, constitutionally valid? Whether Sec. 94A has to yield to

the bilateral Tax Treaty?34

T. Rajkumar vs Union of India

Judgement of the Madras High Court (1/4)• The principles of international law contain two theories namely (i) monism and (ii) dualism.

• Monism is the idea that assumes that international law and national law are nothing but two components of a single legal system or body of knowledge. Both are different parts of a single legal structure. Persons, who follow this school of thought propagate superiority of international law over the national law in cases of conflicts.

• In contrast, dualistic theory assumes that international law and internal law of States are two separate and distinct legal systems. Persons, who follow the dualistic theory argue that the rule of international law apply within a State only as a result of their adoption by the local law of the State. In other words, the principles of international law apply not as such, but as part of the municipal law.

• In Jolly George Varghese vs The Bank of Cochin [AIR 1980 SC 470], the Supreme Court held that the executive power of the Government of India to enter into international Treaties does not mean that international law, ipso facto, is enforceable upon ratification. The Supreme Court observed that the Indian Constitution followed the 'dualistic' doctrine with respect to international law. Consequently, the Court held that international Treaties do not automatically form part of international law, unless incorporated into the legal system by a legislation made by the Parliament. And so an international Treaty can be enforced only so long as it is not in conflict with the municipal laws of the State.

35


Judgement of the Madras High Court (2/4)• It must be kept in mind that Sec. 90(1), which empowers the Central Government to enter into an Agreement with

the Government of a foreign country and Sec. 94A (which is the subject matter of controversy herein), which empowers the Central Government to specify any country as a notified jurisdictional area, deal with delegation of powers. While Sec. 90(1) deals with the delegation of power to enter into an agreement, Sec. 94A(1) deals with the delegation of power to specify a country as a notified jurisdictional area.

• Therefore, even if a conflict is imagined to be in existence, it is not between a Treaty on the one hand and a Municipal Law on the other hand as sought to be projected on behalf of the petitioners. It could, at the most, be a conflict between the manner in which, the delegated power conferred under one provision is exercised and a similar power under another provision is exercised.

• Once it is stated that India has followed the dualistic model and once it is found that the Courts have drawn inspiration from Treaties, whenever the Municipal Law was silent, it is impossible to think that the supremacy of the Parliament could be compromised by the Executive entering into a Treaty. The very fact that Article 253 confers power upon the Parliament to make any law for implementing any Treaty, coupled with the fact that Section 90(1) of the Income Tax Act enables the Central Government to enter into an agreement, would show that the Parliament is supreme. The collective will and the collective conscience of the people, which the Parliament is supposed to reflect, cannot be subordinated to the power of the Executive. 36


Judgement of the Madras High Court (3/4)• Section 90(2) does not deal with the question of conflict between a Treaty and the provisions of a statute. It merely

deals with the option given to an assessee, to whom an agreement referred to in Section 90(1) applies, to choose either the provisions of the Treaty or the provisions of the Act, whichever is more beneficial to him.

• It is impossible to think that once a Treaty is entered into, the Parliament loses the power conferred by the Constitution, to make a law even in respect of a matter assigned to it under the Constitution.

• One of the four purposes, for which an agreement could be entered into by the Central Government under Sec. 90 (1), is for the exchange of information. If one of the parties to the Treaty fails to provide necessary information, then such a party is in breach of the obligation under Article 26 of the Vienna Convention. The beneficiary of such a breach of obligation by one of the contracting parties (like the assessee herein) cannot invoke the Vienna Convention to prevent the other contracting party (India in this case) from taking recourse to internal law, to address the issue.

37


Judgement of the Madras High Court (4/4)• Therefore, we are of the considered view that the challenge to the Constitutional validity of Sec. 94A(1) is without

any merit. The argument that Sec. 90(1)(c) cannot be diluted by Sec. 94A(1) overlooks the fundamental fact that if the purpose of the Central Government entering into an agreement under Sec. 90(1) is defeated by the lack of effective exchange of information, then Sec. 90(1)(c) is actually diluted by one of the contracting parties and not by Sec. 94A(1).

• A clause relating to Mutual Agreement Procedure, for resolution of disputes, contained in a Tax Treaty, cannot oust the jurisdiction of the Parliament to enact a law and the Executive to issue a Notification in exercise of the power conferred by such a law.

38


7. Maruti Suzuki India Ltd vs CIT [2015] 64 taxmann.com 150 [Delhi HC]

39

IndiaOutside India

Maruti Suzuki India Ltd vs CIT

40

Licence Agreement between MSIL and SMC by which MSIL was permitted to use the co-branded trademark 'Maruti-Suzuki' on cars manufactured by MSIL

Whether incurring of AMP expenses by an Indian Licensed Manufacturer gives rise to an International Transaction?

Maruti Suzuki India Ltd (MSIL)

Advertisement, Marketing &

Promotion (AMP)

Suzuki Motor Corp. (SMC)Japan Customers

Expenses

Licensed Manufacturer

This is a landmark Judgement on Marketing Intangibles after Sony Ericsson Judgement

Facts: Maruti Suzuki India Ltd (MSIL - the Assessee) is a manufacturer of passenger cars in India

Suzuki Motor Corporation, Japan (SMC) is the holding company of MSIL

MSIL incurred Advertisement, Marketing and Promotion (AMP) expenditure, for selling the cars. AMP expenditure of MSIL was only 1.87% of its Sales, whereas the worldwide AMP expenditure of SMC was 7.5% of Total Sales.

TPO worked out the excess AMP expenditure incurred by MSIL vis-à-vis comparable car manufacturers, and held that such excess AMP expenditure was incurred by MSIL for promoting the “Suzuki” brand which was legally owned by SMC

To identify the excess AMP expenditure, the TPO applied the Bright Line Test i.e. the TPO compared the ratios of AMP/Sales of MSIL and comparable enterprises

Issue before the High Court: Is incurring of AMP expenditure by MSIL an International Transaction ?

41


Judgement of the Delhi High Court (1/7)

• The decision in Sony Ericsson Mobile Communications India (P) Ltd [2015] 374 ITR 118 (Delhi) expressly negatived the use of the BLT, both as forming the base and determining if there is an international transaction and secondly for the purpose of determining the ALP. Once BLT is negatived, there is no basis on which it can be said in the present case that there is an international transaction as a result of the AMP expenses incurred by MSIL.

• As far as the benefit to the AE, i.e. SMC, is concerned, the revenue has been unable to counter the submission on behalf of the MSIL that by the time SMC acquired a controlling interest in MSIL in 2002, the Maruti brand had already built a huge reputation. A significant amount of AMP expenses had already been incurred by MSIL on its products. These products carried the co-branded mark 'Maruti-Suzuki' which had a high degree of name recognition. The revenue has been unable to dispute that MSIL has the highest market share of automobiles manufactured in India (about 45 per cent) and year on year growth of turnover of about 21 per cent. In other words, the AMP expenses incurred by it have substantially benefited MSIL.

42



• The revenue has failed to demonstrate the existence of an international transaction only on account of the quantum of AMP expenditure by MSIL. Secondly, the decision in Sony Ericsson Mobile Communications India (P) Ltd (supra) holding that there is an international transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present assessee MSIL is concerned since finding in Sony Ericsson Mobile Communications India (P) Ltd (supra) to the above effect is in the context of those assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses.

• Even if the word 'transaction' is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the revenue, and even if resort is had to Sec. 92F(v) which defines 'transaction' to include 'arrangement', 'understanding' or 'action in concert', 'whether formal or in writing', it is still incumbent on the revenue to show the existence of an 'understanding' or an 'arrangement' or 'action in concert' between MSIL and SMC as regards AMP spend for brand promotion. What has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC.

43


Judgement of the Delhi High Court (3/7)• The sine qua non for commencing the transfer pricing exercise is to show the existence of an international

transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the specified methods. The fourth step would be to compare the price of the transaction that is shown to exist with the ALP and make the transfer pricing adjustment by substituting the ALP for the contract price.

• A reading of the Transfer Pricing provisions of Chapter X makes it clear that the transfer pricing adjustment is to be made by substituting the ALP for the price of the transaction. To begin with there has to be an international transaction with a certain disclosed price. The transfer pricing adjustment envisages the substitution of the price of such international transaction with the ALP.

• Since on applying the BLT, the AMP spend of MSIL was found 'excessive' the revenue deduced the existence of an international transaction. It then added back the excess expenditure as the transfer pricing 'adjustment'. This runs counter to legal position explained in CIT v. EKL Appliances Ltd. [2012] 345 ITR 241/209 Taxman 200/24 taxmann.com 199 (Delhi), which required a TPO 'to examine the 'international transaction' as he actually finds the same.' In other words, the very existence of an international transaction cannot be a matter for inference or surmise.

44



• The existence of an international transaction will have to be established de hors the Bright Line Test (BLT). There is nothing in the Act which indicates how, in the absence of the BLT, one can discern the existence of an international transaction as far as AMP expenditure is concerned.

• What is clear is that it is the 'price' of an international transaction which is required to be adjusted. The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an ALP, an 'adjustment' has to be made. The burden is on the revenue to first show the existence of an international transaction.

• Since a quantitative adjustment is not permissible for the purposes of a TP adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. What the revenue has sought to do in the present case is to resort to a quantitative adjustment by first determining whether the AMP spend of the assessee on application of the BLT, is excessive, thereby evidencing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case.

45


Judgement of the Delhi High Court (5/7)• No provision in Chapter X of the Act contemplates such quantitative adjustment. An AMP TP adjustment, to which

none of the substantive or procedural provisions of Chapter X of the Act apply, cannot be held to be permitted by Chapter X.

• It is not for the revenue to dictate to an entity how much it should spend on AMP. That would be a business decision of such entity keeping in view its exigencies and its perception of what is best needed to promote its products. The argument of the revenue, however, is that while such AMP expense may be wholly and exclusively for the benefit of the Indian entity, it also inures to building the brand of the foreign AE for which the foreign AE is obliged to compensate the Indian entity. In such a scenario what will be required to be benchmarked is not the AMP expense itself but to what extent the Indian entity must be compensated. That is not within the realm of the provisions of Chapter X.

• Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for? There is no 'machinery' provision in Chapter X which enables an Assessing Officer to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found that there is an international transaction in that regard.

46


Judgement of the Delhi High Court (6/7)• In the instant case, in the absence of there being an international transaction involving AMP spend with an

ascertainable price, neither the substantive nor the machinery provision of Chapter X are applicable to the transfer pricing adjustment exercise.

• The revenue has been unable to contradict the submission of the Assessee that the co-brand mark 'Maruti-Suzuki' in fact does not belong to SMC and cannot be used by SMC either in India or anywhere else - this co-brand cannot be used by SMC and is not owned by it.

• The revenue is proceeding on a presumption regarding the comparative benefits to MSIL and SMC as a result of the AMP expenditure incurred by MSIL. The revenue is unable to deny that MSIL’s expenditure on AMP is only 1.87 per cent of its total sales whereas SMC's expenditure worldwide on AMP is 7.5 per cent of its sales. In the circumstances, in the absence of some data, it cannot be simply asserted that the benefit of MSIL's AMP spend to SMC is not merely incidental. The assertion of the revenue cannot be accepted that the mere fact of incurring AMP expenditure should lead to an inference of the existence of an international transaction.

47


Judgement of the Delhi High Court (7/7)• The issue is not about the expenditure incurred by MSIL in engaging Indian third parties for AMP but the extent to

which the AMP spend can be attributed to inure to the benefit of SMC's brand. This can be a complex exercise and in the absence of clear guidance under the statute and the rules, can result in arbitrariness as a result of proceeding on surmises or conjectures. The TPO will need to access data as regards the strength of the foreign AE's brand and what it commands in the international market and to what extent the presence of the brand in the advertisement actually adds to the benefit of the brand internationally.

• The operating profit margin of MSIL is 11.19 per cent which is higher than that of the comparable companies whose profit margin is 4.04 per cent. Therefore, under TNMM there is no question of TP adjustment on account of AMP expenditure.

[Note: This judgement in case of Maruti Suzuki was rendered in the context of a Licensed Manufacturer. However, subsequent to this judgement, Delhi HC examined the issue in detail and applied the same principle also to Distributors, in the cases of Bausch & Lomb [2016] 65 taxmann.com 141 (Delhi) and Whirlpool India [2015] 64 taxmann.com 324 (Delhi)].

48


8. CIT vs ITC Infotech India Ltd [2016] 66 Taxmann.com 106 [Calcutta HC]

49

AssesseeAE

India

Foreign

CIT vs ITC Infotech India Ltd

50Customers

Contract

IT Development Services

Foreign

ARRANGEMENT TYPE 1

What Arm’s Length remuneration should the Assessee pay to its AE, for marketing and administrative services provided by the AE?

Marketing and Administrative

Services

The contract is between the AE and the customers, for delivery of IT Development Services

AssesseeAE

India

Foreign


51Customers

Contract

IT Development Services

Foreign

ARRANGEMENT TYPE 2

Marketing and Administrative

Services

The contract is directly between the Assessee and the customers, for delivery of IT Development Services

What Arm’s Length remuneration should the Assessee pay to its AE, for marketing and administrative services provided by the AE?

Facts: ITC, Infotech India Ltd (the Assessee) rendered IT Development Services to its customers. The AE provided

marketing & Administrative Services to the Assessee.

There were 2 types of business arrangements for delivery of IT Development Services :

o The contract between the AE and the customers; or

o The contract directly between the Assessee and the customers

Under both arrangements, the Assessee shared 25% of revenue with the AE for marketing and administrative services rendered by the AE. The Assessee retained 75% of the revenue realised from the Customers.

The TPO accepted remuneration at 25% of revenue, for the first type of arrangement, where the AE had entered into contract with customers

However, the TPO did not accept such remuneration, for the second type of arrangement, where the Assessee had directly entered into contract with the customers. For that arrangement, the TPO allowed remuneration at only 15% of revenue, on the reasoning that the AE bore greater risk in the first type of arrangement.

52


Facts (Contd): The CIT (Appeals) and the ITAT held that the FAR profile of the Assessee and the AE was same under both the

arrangements. So, 25% of revenue-sharing was valid under both arrangements.

Issue before the High Court:

Whether 75:25 revenue-sharing, for marketing and administrative services provided by the AE, was at Arm’s Length?

Judgement of the Calcutta High Court:The Hon. Calcutta High Court upheld the decision of CIT (Appeals) and the ITAT, with the following observations:

• The First as well as the Second Appellate Authority had given a concurrent finding of fact that the TPO in principle accepted the remuneration model of 25% revenue sharing and the same has been substantiated and justified by the documents so submitted before the authorities below. Accordingly, no question of law arises out of the judgment rendered by the authorities below.

53


9. CIT vs Toll Global Forwarding India (P) Ltd [2016] 66 taxmann.com 53 [Delhi HC]

54

CIT vs Toll Global Forwarding India (P) Ltd

55

Toll Global IndiaAE

IndiaOutside India

Provision and receipt of Logistics Services

Which is the Most Appropriate Method ? CUP or TNMM?

Facts: Toll Global Group in engaged in freight Forwarding Business.

Toll Global India is a logistics service provider , offering a bouquet of international and domestic freight handling services, including air and ocean transport of goods.

Toll Global India (the Assessee) provided, as well as received, logistics services to/from its AE. While providing such services Toll Global India handled the freight in India on behalf of the AE for the AE’s customers. Similarly for outbound freight from India, the AE handled the freight outside India, on behalf of Toll Global India for Toll Global India’s customers.

For the Logistics Services provided and received to/from the AE, Toll Global India received/paid remuneration (from/to the AE) equal to 50% of the residual profits. So, in effect, the residual profits earned from freight forwarding services was split 50:50 between Toll Global India and its AE.

Toll Global India contended that the 50:50 split of residual profits met the Arm’s length Standard under CUP Method.

56


Facts: The TPO, however, rejected CUP Method and applied TNMM.

The ITAT did not approve of the TPO’s action. The ITAT upheld CUP at 50:50 split of residual profits between Toll Global India and its AE.

Issue before the High Court: Which is the most appropriate method ? CUP or TNMM?

57



The High Court observed that the ITAT had noted as under -

• In the field of logistics services, the 50:50 business model (i.e. the business model of sharing residual profits in equal ratio with the service provider at the other end of the transaction i.e. at the consignee's end in the case of export transaction and at consigner's end in the case of import transaction), is a standard practice.

• In other words, even with respect to the transaction with unrelated parties in this line of activity, it is admitted practice to share the residual profit in equal ratio and that is precisely what the assessee had adopted with the AE as well.

• There is no dispute that the price determination for all business associates, whether associated enterprises or independent enterprises, is on the same terms and as per the same business model, which is admittedly unique to the logistics line of business.

• The ITAT held that the price of services rendered to, or received from, the associated enterprises, which was computed on the basis of the same 50:50 model, as is the industry norm and as has been employed by the assessee for computing price of similar services to the independent enterprises, was at arm's length.

58



Finally the High Court held as under -

• The order of the Tribunal was well reasoned and well researched. The legal principles governing the determination of ALP in a TP adjustment exercise have been expounded lucidly by the Tribunal in the impugned orders.

Thus, the High Court upheld the CUP method at 50-50 split of residual profits.

59


10. CIT vs Marubeni India (P) Ltd [2015] 58 Taxmann.com 257 [Delhi HC]

60

Marubeni India

Customers/Vendors

AEs

IndiaOutside India

CIT vs Marubeni India (P) Ltd

61

Liaisoning

(Mediator)

Which method – PSM or TNMM – is the Most Appropriate Method for determining the Arm’s length Price of Agency and marketing services provided by the Assessee to its AEs?

Agency and marketing support

services

Facts: Marubeni India (the Assessee) rendered Agency & Marketing Support Services to its AEs. In course of rendering those services,

Marubeni India acted as a mediator between its AEs and the customers/vendors (in India) of the AEs

Marubeni India was responsible for (i) liaisoning with customers/vendors, (ii) co-ordinating, and (iii) supplying marketing information to the AEs

To benchmark these services, Marubeni India applied TNMM

The TPO, however, applied Profit Split Method (PSM), and split the profits in the ratio of 70 (the Assessee) : 30 (the AE)

Thus, the TPO held that 70% of profit earned by the AEs, out of goods traded from/to India, should be taxed in hands of Marubeni India as arm’s length remuneration for the services rendered to the AEs

The TPO applied PSM based on the following reasoning:

i. Marubeni India provided some crucial services to its AEs

ii. The functions of Marubeni India were not restricted to provision of marketing support services; those functions also included arranging for feasibility studies, industry analysis, and project evaluation for the AEs

iii. Marubeni India made significant investments in exploring and analysing the Indian market62


Facts (contd):iv. Marubeni India developed several unique intangibles which gave advantage to the AEs. - yet, Marubeni India was not

compensated for the cost incurred on the development of intangibles

v. Marubeni India performed critical functions in the process of rendering services to its AEs, by assuming significant risks

The ITAT rejected Profit Split Method (PSM) and accepted TNMM as the Most Appropriate Method, taking into account the following facts:

i. The assessee was acting as a mediator between the AEs and the vendors/customers.

ii. The assessee's risk was limited and minimal with least capital employed, as opposed to the TPO's findings that it (the assessee) performed all the crucial functions on behalf of the AEs.

iii. The TPO did not elaborate any critical function except saying that the assessee was also engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs.

iv. The ITAT's order in Li & Fung (India) (P) Ltd [2011] 16 taxmann.com 192 (ITAT Delhi) influenced the decision of the TPO that the assessee should get 70% share in the overall profits of the transactions, carried out by the AEs which have source or destination in India. This was not based on any material or evidence.

v. The use by the assessee of intangible assets vis-à-vis international transactions was not proved; likewise no document showed the risk assumed or that its task was anything "beyond mediating between the AEs and customers/vendors in India".

63


Facts (contd):vi. The assessee only supplied information to the AEs and mediated between them and Indian enterprises in the transactions

arranged independently between them. There was, as a result, no question of its assuming higher risk or using its highly valued intangibles.

vii. The TPO embarked upon the PSM throughout the length and breadth of his order without giving any serious consideration to the alternative approach of TNMM. There is no discussion even about the comparables chosen by the assessee and whether they were acceptable or not.

viii. The conclusion drawn by the authorities in applying the PSM, by basing their finding on the strength of the order of the Tribunal in the case of Li & Fung (India) (P) Ltd (supra), cannot be sustained because of the reversal of Tribunal’s order in that case by the Hon'ble Delhi High Court.

Issue before the High Court: Which method – PSM or TNMM – is the Most Appropriate Method for determining the Arm’s length Price of Agency and Marketing

services provided by the Assessee to its AEs?

64


Judgement of the Delhi High Court

• The Assessee merely mediated between the AEs and customers/vendors in India. Furthermore, it only supplied information to the AEs. There was, as a result, no question of its assuming higher risk or using its highly valued intangibles.

• The High Court concurred with the ITAT's finding that the assessee's risk was limited and minimal with least capital employed, and that the TPO's findings that it (the assessee) performed all the crucial functions on behalf of the AEs was not proved.

• The TPO never elaborated any critical function or decision of the assessee inuring to the AEs except saying that the assessee was engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs. It is quite evident that the TPO based his findings and conclusions on the decision of the ITAT in Li Fung (India) (P) Ltd (supra), which was subsequently reversed by this Court.

• Resultantly, the ITAT's conclusion that the TNMM was the most appropriate method is reasonable.

65


11. CIT vs Everest Kento Cylinders Ltd [2015] 58 Taxmann.com 254 [Bombay HC]

66

Everest Kento India

Bank

AEs

IndiaOutside India

CIT vs Everest Kento Cylinders Ltd

67

AE Borrowed Funds from Bank

Assessee provided Guarantee to Bank

What should be the quantum of guarantee-fee charged by the Assessee for providing guarantee to the Bank against borrowings made by the AE?

Facts: The AE borrowed funds from ICICI Bank (Dubai) for purchase of assets, purchase of inventory and working capital

Everest Kento India (the Assessee) provided guarantee to the bank, guaranteering the repayment of funds borrowed by the AE

The Assessee charged guarantee-fee of 0.5% from the AE

The TPO benchmarked the guarantee-fee at 3%, based on the guarantee commission charged by banks for providing guarantee to their customers

The ITAT, however, rejected the TPO’s benchmarking, and accepted 0.5% guarantee-fee charged by the Assessee

Issue before the High Court: What should be the quantum of guarantee-fee charged by the Assessee for providing guarantee to the Bank against

borrowings made by the AE?

68


Judgement of the Bombay High Court• The adjustment made by the TPO was based on instances restricted to the commercial banks providing guarantees

and did not contemplate the issue of corporate guarantee.

• When commercial banks issue bank guarantees, which are treated as the blood of commerce being easily encashable in the event of default, the higher commission could have been justified.

• In the present case, it is assessee-company that is issuing corporate guarantee to the effect that if the subsidiary AE does not repay loan availed of it from the Bank, then in such event, the assessee would make good the amount and repay the loan.

• The considerations which apply for issuance of a corporate guarantee are distinct and separate from those that apply to bank guarantee. So, the guarantee commission charged cannot be called in question, in the manner TPO has done.

• The comparison is not as between like transactions. Rather, the comparisons are between guarantees issued by the commercial banks as against a corporate Guarantee issued by holding company for the benefit of its AE, a subsidiary company.

• In view of the above discussion, appeal of Revenue does not raise any substantial question of law and it is dismissed.

69


12. CIT vs Cotton Naturals (I) (P) Ltd [2015] 55 Taxmann.com 523 [Delhi HC]

70

Cotton Naturals IndiaSubsidiary

IndiaUS

CIT vs Cotton Naturals (I) (P) Ltd

71

Facts: Cotton Naturals (the Assessee) gave loan in US Dollars to its US Subsidiary at 4% interest

The Assessee benchmarked Interest under the CUP method, with reference to the export packing credit rate obtained from independent banks in India

Cotton Naturals India gave Loan (in US $) to its Foreign Subsidiary at 4% interest

What should be the Arm’s Length interest on foreign currency loan given by an Indian Company to its foreign Subsidiary? Should it be based on Prime Lending Rate (or Base Rate) in India, or on LIBOR?

Facts (Contd): The TPO held that interest should be benchmarked with reference to prevalent rate of interest in India – the

interest that could have been earned on loan given to an unrelated party ( having the same credit rating as the subsidiary) in India was relevant, according to the TPO

Accordingly, the TPO charged interest at 14%

The ITAT rejected the TPO’s view and upheld the Assessee’s benchmarking

Issue before the High Court: What should be the Arm’s Length interest on foreign currency loan given by an Indian Company to its Foreign

Subsidiary? Should it be based on Prime Lending Rate (or Base Rate) in India, or on LIBOR?

72


Judgement of Delhi High Court (1/2)• Transfer pricing determination is not primarily undertaken to re-write the character and nature of the transaction, though this is

permissible under exceptional circumstances. Chapter X and Transfer Pricing rules do not permit the Revenue authorities to step into the shoes of the assessee and decide whether or not a transaction should have been entered. It is for the assessed to take commercial decisions and decide how to conduct and carry on its business. Actual business transactions that are legitimate cannot be restructured.

• The Assessee had incorporated a subsidiary in United States for undertaking distribution and marketing activities for the products manufactured by them. It is obvious that this was done with the intention to expand and promote exports in the said country and was a legitimate business decision. The transaction of lending of money by the Assessee to the subsidiary, should not be seen in isolation, but also for the purpose of maximising returns, propelling growth and expanding market presence.

• As per the prevalent practice, Subsidiary AEs are often incorporated to carry on distribution and marking function. This is not unusual but quite common.

• The transfer pricing determination would decide what an independent distributor and marketer, on the same contractual terms and having the same relationship, would have earned/paid as interest on the loan in question. What an independent party would have paid under the same or identical circumstances would be the arm's length price or rate of interest. What the assessee would have earned in case he would have entered into or gone ahead with a different transaction, say with a party in India, is not the criteria. What is permitted and made subject matter of the arm's length determination is the question of rate of interest and not re-classification or substitution of the transaction.

• The comparison, therefore, has to be with comparables and not with what options or choices which were available to the assessee for earning income or maximizing returns.

73


Judgement of Delhi High Court (2/2)• The finding recorded in the TPO's order that the comparable test to be applied is to ascertain what interest would have been earned by

the assessee by advancing a loan to an unrelated party in India with a similar financial health as the taxpayer's subsidiary, cannot be accepted. The aforesaid reasoning is unacceptable and illogical as the loan to the subsidiary AE in the instant case is not granted in India and is not to be repaid in Indian Rupee. It is not a comparable transaction.

• The interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest.

• The loan in question was given in foreign currency i.e. US $ and was also to be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency are different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency.

[Note: In CIT vs Tata Autocomp Systems Ltd [2015] 56 taxmann.com 206 (Bombay) the Bombay High Court held that ALP in the case of loans advanced to foreign Associate Enterprises would be determined on the basis of rate of interest being charged in the country where the loan is received/consumed.]

74


13. Ameriprise India Pvt Ltd [TS-174-HC-2016(DEL)-TP] [Delhi HC]

75

Ameriprise USA

IndiaOutside India

CIT vs Ameriprise India Pvt Ltd

76

Supply of Products and Services

Whether Foreign Exchange Gain/Loss can be treated as Operating Revenue/Cost?

Assessee

Facts: The assessee supplied products and services to its AE Ameriprise USA.

The agreement between assessee and its AE prescribed invoicing for specific products and services on a “Cost plus pricing methodology”.

The assessee derived foreign exchange gain in relation to the trading items emanating from the international transactions with the AE.

Issue before the High Court: Whether Foreign Exchange Gain or Loss arising out of trading or revenue transactions is an item of Operating Revenue/Cost?

77


Judgement of the Delhi High Court

• Foreign exchange gain or loss arising out of revenue transactions is an item of operating revenue or cost.

• ITAT had observed that foreign exchange gain earned by Assessee was in direct relation to trading items emanating from international transactions.

• Noting DRP’s finding that service agreement between assessee and its AE prescribed invoicing for specific products and services on a “Cost plus pricing methodology”, High Court confirmed ITAT order holding that AO was not justified in considering the foreign exchange loss as a non-operating cost.

78


14. CIT vs Johnson Matthey India(P) Ltd [2015] 63 taxmann.com 2 (Delhi HC)

79

JM India(Contract manufacturer

for Maruti)

Vendors of MarutiJM UK

IndiaUK

CIT vs Johnson Matthey India (P) Ltd

80

What should be the right Profit Level Indicator for application of TNMM?

Maruti

Import of Raw Materials

Supply of Manufactured Components

Johnson Matthey UKJohnson Matthey India

Facts: Johnson Matthey India (JM India) entered into Agreement with Maruti Udyog Ltd (MUL) to manufacture and supply finished catalysts

to vendors of MUL

Raw Materials were imported by JM India from JM UK at a price dictated by MUL. That price had been set in negotiations between MUL and JM UK

JM India was entitled to a per unit fixed manufacturing charge over and above the actual cost of raw material. Thus, the entire cost of raw material was passed on or recovered from the end-consumer without any mark-up

To establish the Arm’s Length Price (ALP) of raw material imported by JM India from JM UK, Transactional Net Margin Method (TNMM) was used.

JM India (the Assessee) considered Profit Level Indicator (PLI) of ‘Return on Capital Employed’ (ROCE = Operating Profit/ Capital Employed)

The Transfer Pricing Officer (TPO) however rejected ROCE as PLI and instead considered ‘Operating Profit/ Total Cost’ as the appropriate PLI

A question arose: What would be the appropriate PLI for application of TNMM?

81


Facts (contd): JM India (the Assessee) argued that it was a Contract Manufacturer in a capital intensive industry. So, ROCE would

be the appropriate PLI.

In the alternative, JM India argued that PLI of ‘Operating Profit/(Total Cost – Raw material Cost)’ should be used because raw material cost was passed on to the end-customers, without any mark-up

Decision of Lower Appellate Authorities: The CIT(A) and the ITAT dismissed the Assessee’s appeals and upheld the PLI of ‘Operating Profit/Total Cost’ used by the TPO

Issue before the High Court: What PLI should be used with TNMM?

82



I. On RoCE as PLI

• The reliability of ROCE as a PLI depends upon the extent to which ‘the composition of assets and their valuation or the capital deployed by the tested party’ is similar to that of the comparables.

• If operating assets reported in Balance Sheet do not reliably measure the capital employed, ROCE would be less reliable than other financial ratios.

• ROCE would also be less reliable if the Balance Sheet does not accurately reflect the average use of capital throughout year.

• For the subsequent Assessment Years (AYs) JMI stated that it “improved upon the PLI used in AY 2003-04 taking into account the economic realities in AY 2004-05." For the subsequent AYs JMI adopted PLI of ‘Operating Profit/Total Cost -Raw Material Cost (OP/TC-RMC)’ after excluding the ‘raw material cost’ on which no risk was undertaken by JMI. This PLI was used by JMI in AYs 2004-05, 2005-06 and 2006-07, and it was accepted without any objection by tax authorities. Therefore, RoCE cannot be taken as the appropriate PLI of AY 2003-4 (the year under consideration).

83



II. On PLI of ‘Operating Profit/Total Cost -Raw Material Cost’ (OP/TC-RMC)

• The Assessee explains that the exclusion of cost of raw material, in respect of which the Assessee bears no costs or risks, presents a very accurate picture of the profit margins of the Assessee. The exclusion of factors which do not affect returns is allowed under the OECD Guidelines.

• The Revenue has not been able to counter the submission of the Assessee that entire cost of raw materials comprising of precious metals and substrates is passed on to, or recovered from, the ultimate customer without any mark-up. In other words, the contention of the Assessee that its profit is not at all affected by the cost of raw materials remains uncontested.

• The exclusion of pass through costs from the denominator of total costs, where the financial ratio of OP to TC is used, is acknowledged in Para 2.93 and 2.94 of the OECD Guidelines.

• This Court has in CIT vs EKL Appliances Ltd. [2012] 345 ITR 241 (Delhi) noted that the OECD Guidelines have been recognised in our tax jurisprudence.

84


Judgement of the Delhi High Court (3/3)• In the absence of proper reasons, the Revenue cannot simply reject a financial ratio (PLI) adopted by the Assessee,

for computing the net profit margin, by excluding a pass through cost from the Total Cost in the denominator.

• The expression "any other relevant base" occurring in Rule 10(1)(e)(i) of the Rules is wide enough to encompass a denominator that excludes pass through costs as long it is demonstrated to be at arm's length.

• The fact that JM India is paid a fixed manufacturing charge per unit shows that costs associated with the possible fluctuations in the price of the raw material is passed on to the customers and does not affect the profits of JM India.

• Finally, the Revenue has been unable to deny that the above alternate computation of the net profit margin by JM India for the subsequent AYs 2004-05, 2005-06 and 2006-07 has been accepted by the Revenue. While as a general proposition each assessment year should merit independent consideration, the Court finds no reason why for the AY in question, i.e. 2003-04, with no distinguishing features being pointed out, the Revenue would want to reject the alternate PLI adopted by JMI.

85


15. CIT vs Goldstar Jewellery Design (P) Ltd [2016] 67 Taxmann.com 86 [Bombay HC]

86

GJDPLAE

IndiaOutside India

CIT vs Goldstar Jewellery Design (P) Ltd

87

What should be the right Profit Level Indicator for application of TNMM?

Manufacturing and Export of Jewellery

Facts: In this case the Assessee used the Profit Level Indicator (PLI) of Operating Profit/Total Cost (OP/TC) with TNMM to

benchmark the International Transaction of Manufacturing and export of jewellery.

The TPO Considered the PLI of Return on Capital Employed (ROCE) on the ground that the business of the Assessee is capital intensive.

The DRP upheld the action of TPO.

The ITAT, however, rejected ROCE as PLI and directed to use OP/TC as PLI

Issue before the High Court: What PLI should be used with TNMM?

88


Judgement of the Bombay High Court• In terms of Rule 10B(1)(e)(i) it is open for the authorities to determine the net profit margin by applying as its base

either cost or sales or any other relevant base. It is for the authorities to determine the appropriate base while applying the TNMM. And that would entirely depend on the facts and circumstances of the case.

• ROCE could be a basis to determine the profit margin to arrive at ALP having regard to capital employed as a base.

• But in the present facts, there is a common pool of capital used, both for International Transaction with AEs and for other transactions with third parties.

• Thus, in the absence of identification or segregation of capital employed with regard to transactions with AEs and those with others, ROCE would not indicate the appropriate margin for determining the ALP.

• Further, the revenue has not been able to show any determination of margin by ROCE method in the assessee's industry, to arrive at the ALP of International Transactions.

• In the present case, therefore, ITAT is justified in holding that the appropriate PLI is OP/TC, not ROCE.

89


Thank You

For any queries related to this Presentation you may Contact:

Nilesh Patel – CPA (USA), IRS (Former) Email ID: [email protected] Phone No: +919819060323

90

mailto:[email protected]