Iljin Automotive Private Limited, Kancheepuram V. ACIT, CHENNAI

ITA 2182/CHNY/2010

• Counselvise Citation: [2011] 140 COUNSELVISE.COM (IT) 52111 (ITAT-CHENNAI)
• Duration Of Justice: 11 month(s) 6 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 30-11-2011
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: C
• Next Hearing Date: 05-10-2011
• Assessment Year: 2006-2007
• Appeal Filed On: 24-12-2010
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: M N MURTHY NAIK JT
• Assessee Lawyers: KUNJ VAIDYA
• Keywords: Business income; Transfer pricing; Opportunity of being heard; International transaction; Permanent establishment; Wholly owned subsidiary; Difference of opinion; Avoidance of tax; Tax effect; Onus to prove; Sham transactions
• Section: 92C; 234B; 32; 27; 37; 6; 12; 28; 2; 15

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL C BENCH, CHENNAI [BEFORE DR. O.K. NARAYANAN, VICE-PRESIDENT AND SHRI HARI OM MARATHA, JUDICIAL MEMBER] S.P.NO.67/MDS/2011 & I.T.A NO.2182/MDS/2010 (ASSESSMENT YEAR : 2006-07 ) ILJIN AUTOMOTIVE PRIVATE LTD B1 & B2 SIPCOT INDL. PARK IRUNGATTUKOTTAI SRIPERUMPUDUR KANCHIPURAM 602 105 VS THE ASST. COMMISSIONER OF INCOME-TAX CIRCLE II(3) CHENNAI [PAN AAACI2691E] (APPELLANT) (RESPONDENT) APPELLANT BY : SHRI KUNJ VAIDYA, CA RESPONDENT BY : SHRI M.N.MURTHY NAIK, JT. CIT/DR DATE OF HEARING : 05.10.2011 DATE OF PRONOUNCEMENT : 30.11.2011 O R D E R PER HARI OM MARATHA, JUDICIAL MEMBER: THE ABOVE CAPTIONED APPEAL AND STAY PETITION WE RE HEARD TOGETHER. APPEAL OF THE ASSESSEE, PERTAINING TO ASS ESSMENT YEAR 2006- 07, IS DIRECTED AGAINST THE ORDER OF THE ASST. C OMMISSIONER OF INCOME-TAX, COMPANY CIRCLE II(3), CHENNAI, DATED 22 .12.2010, PASSED U/S 143 R.W.S 92CA(3) OF THE ACT. STAY PETITION WAS FILED FOR THE ITA 2182/10 SP 67/11 :- 2 -: STAYAL OF THE OUTSTANDING DEMAND. BOTH THE MATTERS ARE BEING DISPOSED OF BY A COMMON ORDER. 2. BRIEFLY STATED, THE FACTS OF THE CASE ARE THAT THE ASSESSEE, A RESIDENT COMPANY, FOLLOWING MERCANTILE SYSTEM OF AC COUNTING, DOING BUSINESS IN AUTOMATIC COMPONENTS, FILED ITS RETURN OF INCOME THROUGH E-FILING ON 29.11.2006 DECLARING AN INCOME OF ` 7,58,05,067/-. THIS RETURN WAS PROCESSED U/S 143(1). SUBSEQUENTLY, A R EFERENCE U/S 92C OF THE ACT WAS MADE TO THE TPO BY THE ASSESSING OFF ICER FOR THE COMPUTATION OF THE ARMS LENGTH PRICE (ALP) IN RELA TION TO CERTAIN INTERNATIONAL TRANSACTIONS ENTERED INTO BY THE ASSE SSEE-COMPANY DURING THE YEAR UNDER CONSIDERATION. THE JT. CIT/T PO-II, CHENNAI, VIDE HIS ORDER DATED 30.10.2009, PROPOSED THE ADJUS TMENT OF ` 6,82,45,059/- ON ACCOUNT OF PURCHASES MADE BY THE A SSESSEE- COMPANY. A COPY OF THE DRAFT ASSESSMENT ORDER WAS FORWARDED TO THE ASSESSEE ON 30.12.2009 AGAINST WHICH THE ASSESSEE-C OMPANY FILED OBJECTIONS BEFORE THE DRP IN TERMS OF SECTION 144C( 2) OF THE ACT. THE DRP PASSED DIRECTIONS U/S 144C(5) R.W.S 144C(8) OF THE ACT ON 28.9.2010, DIRECTING THE ASSESSING OFFICER TO COMPL ETE THE ASSESSMENT AS PROPOSED BY T.P.O. DETERMINING THE ALP IN WRITI NG. ACCORDINGLY, THE ASSESSING OFFICER HAS PASSED THE IMPUGNED ORDER IN CONFORMITY ITA 2182/10 SP 67/11 :- 3 -: WITH THE ABOVE-MENTIONED DIRECTIONS AND IN TERMS OF SECTION 144C(13) R.W.S 144C(10) OF THE ACT. 3. TO FURTHER ELABORATE THE FACTS RELEVANT TO THE CONT ROVERSIAL ISSUE, IT IS NARRATED THAT THE ASSESSEE-COMPANY, BE ING ENGAGED IN THE BUSINESS OF MANUFACTURE OF AUTOMOTIVE COMPONENTS, H AS SHOWN AN INCOME OF ` 5,92,30,160/- DURING THE PERIOD UNDER REFERENCE QU A TOTAL RECEIPT OF ` 197,07,55,492/- AND OTHER INCOME OF ` 16,45,055/-. THE TRANSFER PRICING OFFICER (TPO), AFTER EVALUATING TH E CASE, HAS DETERMINED THE ALP VIDE ORDER IN F.NO.I-201/TPO-II/ A.Y 2006-07 DATED 30.10.2009. AS PER THIS ORDER, DOWNWARD ADJU STMENT OF ` 6,82,45,059/- IS REQUIRED TO BE MADE ON PURCHASES F OR THE ASSESSMENT YEAR 2006-07. THE ASSESSEE WAS ASKED TO EXPLAIN WH Y SUCH ADJUSTMENT OF PURCHASES SHOULD NOT BE MADE IN ACCO RDANCE WITH SECTION 92C(4) OF THE ACT. THE ASSESSEE FILED ITS W RITTEN SUBMISSION ON 18.12.2009 VIRTUALLY REFRAINING FROM MAKING ANY REL EVANT SUBMISSION ON THE PROPOSED ADJUSTMENT. ACCORDINGLY, THE DOWNWARD ADJUSTMENT OF ` 6,82,45,059/- ON PURCHASES, HAS BEEN SUGGESTED BY T HE TPO. THE ASSESSING OFFICER HAS MADE ADDITION OF SIMILAR AMOU NT TO THE TOTAL DECLARED INCOME FOR THE YEAR. FOLLOWING TABLE WILL GIVE THE COMPUTATION OF THE TOTAL INCOME ALONGWITH TAX PAYAB LE: ITA 2182/10 SP 67/11 :- 4 -: IN C OME AS PER COMPUTAT I ON 75 , 805, 0 67 ADD : ADJ U STMENT ON ACCOUNT DETERMINATION OF ARM' S 68,24 5 ,059 ARMS L E NG T H P R ICE TOTAL ASSESSED INCOME 14 4,050,126 TA X 4 3,215,038 SU RCH ARQE 4,321, 5 04 ED U CATION CESS 95 0, 7 31 48,487,273 LE S S : TDS 271,964 48,215 , 309 LE SS: ADVANCE TA X 2 0 ,500 , 000 27,715 , 309 ADD : INTE R EST U/S 234B 1 5 ,2 4 3,420 INTEREST U/S 234C 3 4 9 , 822 43,3 0 8 , 551 LES S: SELF ASSESSMENT TA X PAID ON 26.10 . 2006 5 , 528, 4 85 TA X PAYABLE 37,7 80 , 0 66 4. BEING AGGRIEVED, THE ASSESSEE HAS FILED THIS APPEAL . ORIGINALLY, INASMUCH AS 13 GROUNDS WERE RAISED, BUT SUBSEQUENTLY, THE COMPANY HAS FILED REVISED/MODIFIED GROUNDS THROUGH LETTER DATED 13.6.2011. THE MODIFIED GROUNDS OF APPEAL READ AS UNDER: 2. THE AO/DRP HAVE ERRED IN ACCEPTING THE PROPOSA L OF TRANSFER PRICING OFFICER (TPO) AND MAKING AN ADJUST MENT OF ` 6,82,45,059 TO THE INCOME OF THE ASSESSEE ON ACCOUN T OF DETERMINATION OF THE ARMS LENGTH PRICE BY: A) CONDUCTING A BENCHMARKING ANALYSIS WHICH WAS NOT SCIENTIFIC AND HENCE ARRIVING AT COMPARABLE COMPANIES WHICH DO NOT SATISFY THE TEST OF COMPARABILITY AS PROVIDED IN RULE /10C(2)(D); B) NOT APPLYING THE WORKING CAPITAL ADJUSTMENT ON T HE COMPARABLE COMPANIES AS SELECTED BY THE LD.TPO; C) DENYING THE BENEFIT OF +/-5% TO THE ASSESSEE AS PROVIDED IN THE SECOND PROVISO TO SEE. 92 C (2); AND SO, HE OUGHT TO HAVE FOUND THAT THE INTERNATION AL ITA 2182/10 SP 67/11 :- 5 -: TRANSACTIONS OF THE ASSESSEE WERE DONE AT ARMS LENG TH PRICE ONLY REQUIRING NO ADJUSTMENTS AND THEREFORE OUGHT T O HAVE REJECTED THE ADJUSTMENTS PROPOSED BY THE TPO. 5. AT THE TIME OF HEARING, THIS MODIFIED GROUND HAVING THREE LIMBS, WAS ONLY PRESSED AND OTHER GROUNDS WERE NOT PRESSED BY THE LD.AR SHRI KUNJ VAIDYA, C.A. APPEARING FOR THE APPE LLANT AS ITS AUTHORIZED REPRESENTATIVE. NOW, WE HAVE TO DECIDE ONLY GROUND NO.2(A,B,C), WHICH IS IN MODIFIED FORM AS EXTRACTED HEREIN ABOVE. 6. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND HAVE CAREFULLY TREADED THROUGH THE ENTIRE RECORD. WHILE ARGUING ON THE MODIFIED GROUNDS OF APPEAL, THE LD.AR SHRI KUNJ VAI DYA SUBMITTED THAT THE ASSESSING OFFICER AND DRP HAVE ERRED IN ACCEPTI NG THE PROPOSAL OF THE TPO AND MAKING AN ADJUSTMENT OF ` 6,82,45,059/- TO THE INCOME OF THE ASSESSEE ON ACCOUNT OF DETERMINATION OF THE ALP BY RELYING ON COMPANIES WHICH WERE NOT REALLY COMPARABLE ONES AS PER RULE 10C(2)(B) OF THE ACT, AND BY NOT APPLYING THE WORKI NG CAPITAL ADJUSTMENT ON THE COMPARABLE CASES AS SELECTED BY T HE TPO AND BY DENYING THE BENEFIT OF +/- 5% AS PROVIDED IN SECON D PROVISO TO SECTION 92C(2) OF THE ACT . ACCORDING TO THE LD.AR , THE INTERNATIONAL TRANSACTIONS WERE ACTUALLY DONE BY THE ASSESSEE-CO MPANY AT ALP ONLY ITA 2182/10 SP 67/11 :- 6 -: AND THERE IS NO NEED FOR MAKING ANY SUCH ADJUSTMEN T IN THE GIVEN FACTS AND THE CIRCUMSTANCES OF THE CASE. IT WAS ARG UED THAT THE ASSESSING OFFICER SHOULD HAVE IGNORED THE ADJUSTMEN TS PROPOSED BY THE TPO. 7. PER CONTRA, THE LD.DR HAS HEAVILY RELIED ON THE ORD ER(S) APPEALED AGAINST. BEFORE WE MOVE FURTHER TO ADJUDI CATE THE CONTROVERSIAL POINTS OF THIS APPEAL, WE MAY DISCUSS WITH CERTITUDE THE LAW RELATING TO TRANSFER PRICING WITH A VIEW TO ASC ERTAIN WHETHER THE INTERNATIONAL TRANSACTIONS IN THIS CASE, HAVE BEEN EXECUTED AT ALP OR NOT. OVER THE YEARS VARIOUS METHODS FOR DETERMINING ALP HAVE COME UP AND RECOGNIZED BY THE COURTS, BUT IT IS ALSO A F ACT THAT NO STRAIGHT JACKET FORMULAE HAS BEEN DEVELOPED OR EVOLVED BY N OW WHICH CAN BE APPLIED TO A GIVEN SET OF FACTS. IT DEPENDS UPON T HE FACTS OF EACH AND EVERY CASE/TRANSACTION AND THE SAME HAS TO BE DECID ED WITH REFERENCE TO THE TREATIES BETWEEN THE COUNTRIES AS WELL AS TH E CLANDESTINE/CLEAR TECHNICALITIES INVOLVED IN THE PROCESS OF A GIVEN C ASE. FOR THE DISPOSAL OF THE GIVEN CASE, HOWEVER, WE DO NOT NEED TO MENTI ON ALL THE MODES AND METHODS WHICH HAVE COME TO FORE BY NOW. THE AS SESSEE- COMPANY HAS FOLLOWED COMPARABLE UNCONTROLLED PRICE (CUP) METHOD FOR DETERMINING THE ALP. IN THIS CASE, THE TPO HIG HLIGHTED THE ITA 2182/10 SP 67/11 :- 7 -: SHAREHOLDING PATTERN OF THE HOLDING COMPANY (OF THE ASSESSEE- COMPANY) AND HAS COME TO THE CONCLUSION THAT TRANSA CTIONS ENTERED INTO BY ILGIN GLOBAL MAY NOT FIT INTO THE DESCRIPTI ON OF UNRELATED PARTIES AND HENCE, THE TRANSACTIONS MADE BY IT MAY NOT BE T AKEN AS UNCONTROLLED TRANSACTIONS AT ALP. THEREFORE, SHE H AS CONCLUDED THAT THE METHOD OF PICKING UP COMPARABLES IS IN CONTRAD ICTION WITH THE MANNER IN WHICH CUP IS TO BE APPLIED AS PRESCRIBED UNDER RULE 10B(1)(A) OF THE ACT. SHE HAS CONCLUDED THAT CUP METHOD CANNOT BE APPLIED TO THE FACTS OF THE GIVEN CASE AND THEREFOR E, SHE HAS APPLIED TO TNM METHOD FOR WORKING OUT ALP. SHE HAS SELECTED 1 3 COMPANIES ON THE BASIS OF WHICH ALP HAS BEEN COMPUTED WHICH HAS BEEN OBJECTED TO BY SUBMITTING THAT FOR COMPUTING ALP UNDER TNM METH OD, ALL THE FOUR COMPANIES CONSIDERED LAST YEAR, VIZ., AMFORGE IN DUSTRY, BHARAT GEARS LTD., JAIBARAT MARUTI LTD., RAJA FORGING, HAV E TO BE TAKEN INTO CONSIDERATION. SHE HAS REJECTED WITH REASONS AS T O WHY PROFIT RATIO OF THESE FOUR COMPANIES CANNOT BE APPLIED AND WHY ONLY 13 COMPANIES SELECTED BY HER, ARE RELEVANT FOR THE PURPOSE. THE OBJECTIONS RAISED BY THE ASSESSEE AND THE REASONING OF DRP ARE CONTAINED IN PARAGRAPH 6 OF THE ORDER WHICH ARE BEING REPRODUCED, FOR READY REFERENCE , VERBATIM, HEREIN AS BELOW: 6. THE ASSESSEE IN ITS LETTER DATED 30.1.2009 REBUT TED THE ARGUMENTS MADE BY THE TPO. THE ARGUMENTS CANVASSED BY THE ASSESSEE VIDE LETTER CITED REASONS AS UNDER: ITA 2182/10 SP 67/11 :- 8 -: (A)THE ASSESSEE VIDE PARA NO.1 UNDER THE HEADING 'APPLICABILITY OF TP RULE' HAS CONTESTED THE ACTION OF TPO ON THE PLEA THAT TPO / AO WAS NOT CORRECT IN RECORDING A FINDING THAT ASSESSE IS AN ASSOCIATE ENTERPRISE OF ILGIN GLOBAL. THE PERUSAL OF TPO'S OR DER SHOWED THAT SHE HAS STATED THAT BY VIRTUE OF ITS SH ARE HOLDING, M/S.ILGIN GLOBAL IS RELATED AS AE U/S.92A( 2)(B). THE CONCLUSION IS BASED ON THE FACT THAT THE SAME PERSON VIZ., LEE SANG II (HOLDING 55% SHARE) AND LE E DONG SEOB (HOLDING 25%) ARE ALSO THE SHARE HOLDER O F ILGIN GLOBAL LTD. WHERE LEE SANG II HOLDS 90% OF SH ARES AND LEE DONG SEOB HOLDS 10% OF THE SHARES. IN ASSESSEE COMPANY ,THUS, LEE SANG II INDIRECTLY HAD MORE THAN 26% OF SHARES DURING PERIOD UNDER CONSIDERATION. THUS THE FINDING OF TPO WITHIN THE MEANING OF SEC. 92A(2)(B) IS VALID. THEREFORE, THE TRANSACTIONS MADE BETWEEN ASSESEE AND ILGIN GLOBAL CO. LTD. MAY NOT BE EQUATED WITH UNCONTROLLED TRANSACTIONS IN NORMAL MARKET. (B) THE ASSESSEE HAD OBJECTED TO REJECTION OF CUP METHOD ADOPTED IN ITS ACCOUNT. THE TPO IN PARA 10 OF HER ORDER HAS STATED THE REASONS FOR COMING TO CONCLUSION THAT THE CUP METHOD IN RULE 10B(1)(A) CANNOT BE APPLIED . SHE HAS CLEARLY POINTED OUT THE STATISTICS RELIED ON BY THE ASSESSEE CONSTITUTE LIS T PRICE AND NOT THE PRICE FOR UNCONTROLLED TRANSACTIONS. SH E HAS CLEARLY STATED THAT FOR THE PURPOSE OF CUP METHOD T HE CONTROLLED TRANSACTIONS HAVE TO BE COMPARED WITH UNCONTROLLED TRANSACTIONS. IN THE ABSENCE OF UNCONTROLLED TRANSACTIONS, THE CUP METHOD AS STIPULATED IN 10B(1)(A) MAY NOT BE WORKED OUT. THUS THE ASSESSEE IN ITS WRITTEN SUBMISSIONS AS WELL AS IN O RAL ARGUMENTS COULD NOT REBUT THE FACTS FORMING THE BAS IS FOR CONCLUSION OF TPO AND HENCE NO INFIRMITY SAID T O HAVE BEEN CREPT IN THE DECISION OF THE TPO AND CONSEQUENTLY UPHELD. (C)THE ASSESSEE IN PARA 3 OF ANNEXURE 10 FILED WITH LETTER DATED 30.1.2010 HAD OBJECTED TO TPO TAKING A DIFFERENT STAND AS COMPARED TO THAT OF COMMISSIONER OF CUSTOMS CHENNAI. IN ASSESSEE'S LETTER DATED 278.201 0 IT WAS STATED THAT CUSTOMS ARE ALSO LOOKING AT ADJU STED ALP AS COMPARED TO ALP BY TPO. HOWEVER, THE FACT REMAINS THAT THE CONCEPT OF SALE TO UNRELATED PARTI ES ADOPTED BY CUSTOM IS DIFFERENT FROM CONCEPT OF UNCONTROLLED TRANSACTIONS AS MENTIONED IN SECTION 9 2A ITA 2182/10 SP 67/11 :- 9 -: OF IT.ACT. FURTHER THE PURPOSE OF WORKING BY IT DEP T IS TO FIND WHETHER THE INTERNATIONAL PRICE FALLS WITHI N THE TOLERANCE LIMIT OF ALP OR NOT, WHEREAS THE PURPOSE OF VALUATION BY CUSTOMS IS TO COLLECT CUSTOM DUTY BY PREVENTING UNDER-INVOICING OR UNDER-DECLARATION WHI CH IS ONE OF THE METHOD FOR EVASION. SO THERE IS NO INFIR MITY IN COMING TO INDEPENDENT DECISION, UNRELATED TO CONCLUSION OF CUSTOM, BY THE TPO. (D)THE ASSESEE HAS ALSO OBJECTED TO ACTION OF TPO I N NOT CONSIDERING THE INSTANCES FOUR COMPARABLES PROVIDED BY THE ASSESSEE COMPANY. IN HER ORDER THE TPO HAD MENTIONED THAT THE MERE FACT THAT THREE FOU R COMPANIES WAS TAKEN AS COMPARABLES IN EARLIER YEARS , DOES NOT NECESSARILY MEAN THAT THE SAME SHOULD BE TAKEN AS COMPARABLES FOR THE YEAR UNDER CONSIDERATI ON ALSO. IN THIS REGARD THE DRP OBSERVED THAT THE THR EE COMPANIES UNDER REFERENCE AMCO IND. LTD, BHARAT GEARS LTD. AND RAJA FORGING LTD. DO NOT CONSTITUTE THE CAPTIVE SUPPLIER AS THE CASE OF ASSESSEE COMPANY. T HE ASSESSEE HAS ALSO NOT MADE OUT A CASE THAT THE SHAR E HOLDING PATTERN AND ACTIVITY OF PURCHASE IN ALL THO SE COMPANIES ARE SIMILAR TO THAT OF ASSESSEE COMPANY. WITHOUT ANY OBJECTIVE FACT TO SUPPORT THE ASSESSEE CLAIM THERE IS NO INFIRMITY IN THE ORDER OF TPO BECAUSE O F NON INCLUSION OF RESULTS OF ABOVE COMPANIES FOR COMPUTI NG ALP. (E)THE ASSESSEE HAS ALSO CONTESTED THE FINDING OF T PO AND AO ON THE BASIS THAT ADJUSTMENT OF 2% WAS NOT MADE FOR ASSESSEE BEING CAPTIVE SUPPLIER TO HUYNDAI . FURTHER THE TPO IN HER ORDER HAD CLEARLY MENTIONED THAT THE ASSESSEE HAD NOT FURNISHED ANY BASIS FOR ARRIVI NG AT THE FIGURE OF 2% FOR ADJUSTMENT. THE DRP ALSO COULD NOT VERIFY THE BASIS FOR COMPUTATION OF CLAIM OF ADJUST MENT OF 2% FOR ASSESSEE BEING CAPTIVE SUPPLIER TO HUYNDAI. MOREOVER IT WAS OBSERVED THAT COMPANY LIKE SANA STEERING SYSTEMS, IS ALSO A CAPTIVE SUPPLIER. THE P ROFIT MARGIN OF THE COMPANY IS HIGH IN SPITE OF BEING CAP TIVE SUPPLIER AND THERE IS NO INFIRMITY IN ABOVE REFERRE D ORDER FOR IGNORING THE CLAIM OF THE ASSESSEE. SIMILARLY T HE ASSESSEE HAS FILED NOT FURNISHED OBJECTIVE METHOD O F COMPUTATION OF ADJUSTMENT OF 3% ON ACCOUNT OF SALE OF OEM . FURTHER IN PARA 8 OF HER ORDER THE TPO HAS CL EARLY MENTIONED THAT THE PROVISION FOR ADJUSTMENT OF 3% W HICH AMOUNT TO DOUBLE ADJUSTMENT AS SIMILAR ADJUSTMENT H AD BEEN CLAIMED FOR THE CAPITAL PROVIDED. THE FINDING OF TPO COULD NOT BE REBUTTED BY THE ASSESSEE'S AR BEFO RE ITA 2182/10 SP 67/11 :- 10 - : THE DRP. SO NO INFIRMITY IS FOUND IN THE ORDER OF T HE TPO ON ACCOUNT OF DENIAL OF SUCH UNSUBSTANTIATED ADJUST MENT. (F)THE ASSESSEE HAD FURTHER CONTESTED IGNORING THE ASSESSEE'S CLAIM OF ADJUSTMENT FOR FREIGHT INSURANC E AND OTHER EXPENSES. THE TPO IN PARA 9 OF HER ORDER HAS RECORDED A CLEAR FINDING FOR DENIAL OF ASSESSEE'S CLAIM. IT HA S BEEN CLEARLY MENTIONED THAT NO WORKING OF THE SAME WAS PROVIDED BY THE ASSESSEE AND MORE OVER THESE EXPENSES ARE COMMON BOTH ASSESSEE AS WELL AS FOR OTHER INSTANCES OF COMPARABLES WHO HAVE ALSO IMPORT ED ITEMS LIKE ASSESSEE. THE LEARNED A.R COULD NOT FUR NISH THE BASIS OF COMPUTATION OF SUCH ADJUSTMENTS BEFOR E DRP ALSO AND THE FINDING OF TPO THAT IT IS A COMMON FACTOR SHARED BY ASSESSEE WITH ITS COMPARABLES COUL D NOT BE REBUTTED. THUS THE CLAIM OF ADDITIONAL GROUN DS IS IN THE NATURE OF REPETITION OF CLAIM. THE ASSESSEE COULD NOT FURNISH ANY DOCUMENTS OR EVIDENCE TO DEPART FRO M THE FINDING MADE BY THE TPO AND HENCE NO INFIRMITY IS FOUND IN THE ORDER OF TPO ON THIS ACCOUNT. (G)THE ASSESSEE AND CLAIMED ADJUSTMENT ON THE PLEA THAT IT IS PERIOD OF CREDIT OF 75 DAYS AS AGAINST O THER COMPANIES WHO HAD THE BENEFIT OF CREDIT OF ONLY 60 DAYS. THIS PLEA WAS CANVASSED BEFORE TPO ALSO, WHO AS PER PARA 10 HAS CLEARLY STATED THAT NO FACTS OR EVIDENC E WAS BROUGHT ON RECORD TO SUBSTANTIATE THE ASSESSEE'S CL AIM THAT OTHER COMPANIES HAD BENEFIT OF ONLY 30 TO 60 D AYS. NO ADDITIONAL FACT OR EVIDENCE COULD BE PROVIDED BY THE ASSESSEE THAT OTHER COMPANY HAD THE BENEFIT OF CRED IT FOR THE PERIOD OF 60 DAYS ONLY AND HENCE THERE IS N O INFIRMITY IN THE ORDER OF TPO. (H)THE ASSESEE HAD ALSO ASKED FOR ADJUSTMENT OF CUS TOM DUTY WHILE COMPUTING THE ALP. THIS ISSUE HAD ALSO B EEN DEALT WITH BY THE TPO IN PARA 11 OF HER ORDER. IT IS AN ACCEPTED FACT THAT CUSTOMS DUTY CONSTITUTE AN INDIR ECT TAX WHICH IS PASSED ON TO THE CUSTOMER. THE COMPANY HAS TAKEN AS COMPARABLE ALSO PAY THE CUSTOM DUTY ON IMP ORT AND INCLUDE IN THE PROCESS OF PRODUCT IN THE SAME MANNER AS THAT OF ASSESSEE. HENCE THIS IS ALSO A COMMON FACTOR THE TPO HAD RIGHTLY DECLINED TO MAKE ANY ADJUSTMENT TO THE THE CLAIM. (I)THE CLAIM MADE BY THE ASSESSEE IN THE LETTER DT. 27.8.2010 HAD ALSO BEEN INCLUDED IN ADDITIONAL CLAI M ITA 2182/10 SP 67/11 :- 11 - : MADE BY THE ASSESSEE VIDE ITS LETTER DATED 30.01.10 AND ACCORDINGLY THE SAME HAS BEEN DISCUSSED ABOVE. 8. TO DECIDE THE CASE IN HAND, WE WOULD LIKE TO FURTHE R DISCUSS AS TO WHAT EXACTLY CUP AND TNM METHOD IMPLY IN RESP ECT OF INTERNATIONAL TAXATION. BEFORE THAT WE NEED TO DIS CUSS RELEVANT PROVISIONS OF THE ACT. SECTION 92C OF THE ACT PROVI DES FOR COMPUTATION OF ALP, WHICH HAS TO BE DONE BY ADOPTING EITHER OF THE FOLLOWING METHODS: - A) COMPARABLE UNCONTROLLED PRICE METHOD; OR B) RESALE PRICE METHOD; OR C) COST PLUS METHOD; OR D) PROFIT SPLIT METHOD; OR E) TRANSACTIONAL NET MARGIN METHOD; OR F) SUCH OTHER METHOD AS MAY BE PRESCRIBED BY THE BOARD 9. WHERE MORE THAN ONE PRICE IS DETERMINED BY THE MOST APPROPRIATE METHOD, THE ALP SHALL BE TAKEN TO BE TH E ARITHMETICAL MEAN OF SUCH PRICES. THE ASSESSING OFFICER MAY FO RM HIS OPINION ON THE BASIS OF MATERIAL OR INFORMATION OR DOCUMENTS I N HIS POSSESSION THAT THE PRICE CHARGED OR PAID IN AN INTERNATIONAL TRANSACTION HAS NOT BEEN DETERMINED IN THE AFORESAID MANNER; OR THE INF ORMATION AND DOCUMENT RELATING TO INTERNATIONAL TRANSACTION HAV E NOT BEEN KEPT AND MAINTAINED BY THE ASSESSEE AS REQUIRED UNDER SECTIO N 92D(1) AND (2) OF THE ACT OR FURNISH ANY INFORMATION OR DOCUMENT WITHIN THE SPECIFIED ITA 2182/10 SP 67/11 :- 12 - : TIME AS REQUIRED U/S 92E(3); OR COMPUTATION OF A LP IS UNRELIABLE OR INCORRECT, IN THAT CASE, HE MAY PROCEED TO DETERMIN E THE ALP IN RELATION TO THAT TRANSACTION ON THE BASIS OF MATERI AL OR INFORMATION OR DOCUMENTS AVAILABLE WITH HIM AND COMPUTE THE INCOM E ACCORDINGLY AFTER GIVING OPPORTUNITY TO THE ASSESSEE OF BEING H EARD. HERE, THE LEGISLATION SHIFTS THE BURDEN OF PROOF FROM TAX AUT HORITIES TO THE ASSESSEES IN SHOWING THAT THE TRANSACTION WITH ASSO CIATED ENTERPRISES (AES) WAS AT ALP ON THE BASIS OF DOCUMENTS MAINTAIN ED AND FILED BY IT (ASSESSEE). THE REQUIREMENT OF MAINTENANCE OF VARI OUS DOCUMENTS IS TO ENABLE THE ASSESSEE TO JUSTIFY AND DOCUMENT TRA NSFER PRICING ARRANGEMENT. 10. THE PRINCIPLE OF TRANSFER PRICING IS STATED IN ARTI CLE 9 OF THE OECD OR THE UN MODEL DOUBLE TAXATION CONVENTION. I T, HOWEVER, DOES NOT SPECIFY THE METHODOLOGY, WHICH IS DONE UNDER TH E DOMESTIC LAWS. THE INDIAN LAW ON THE SUBJECT IS CONTAINED IN SECTI ONS 92 TO 92F. THE CONCEPT OF TRANSFER PRICING IS APPLIED IN THE COMPU TATION OF INCOME FROM INTERNATIONAL TRANSACTION BETWEEN THE AES HAV ING REGARD TO ALP. THUS, THE IMPORTANT ASPECTS OF THE SUBJECT ARE I) ARMS LENGTH PRICE (ALP) II) INTERNATIONAL TRANSACTIONS (I.TS) III) ASSOCIATED ENTERPRISES (AES) ITA 2182/10 SP 67/11 :- 13 - : 11. AN INTERNATIONAL TRANSACTION IS A TRANSACTION BE TWEEN TWO OR MORE AES, EITHER OR BOTH OF WHOM ARE NON-RESIDEN TS, IN THE NATURE OF PURCHASE, SALE OR LEASE OF TANGIBLE OR INTANGIBL E PROPERTY; OR PROVISION OF SERVICES; OR LENDING OR BORROWING MONE Y; AND ANY OTHER TRANSACTION HAVING A BEARING ON THE PROFITS, INCOME , LOSSES OR ASSETS OF SUCH ENTERPRISES. A TRANSACTION IS THE TRANSFER OF GOODS OR SERVICES, INVOLVING A PHYSICAL PRODUCT OR KNOWLEDGE OR A RIGH T TO USE OR EXPLOIT AN INTANGIBLE ASSET. THE DEFINITION OF THE WORD T RANSACTION IS AN INCLUSIVE ONE. IT INCLUDES AN ARRANGEMENT, UNDERST ANDING OR ACTION IN CONCERT, IRRESPECTIVE WHETHER IT IS FORMAL OR IN WR ITING; OR WHETHER OR NOT IT IS INTENDED TO BE ENFORCEABLE BY LEGAL PROCE EDINGS. 12. TRANSFER PRICE MAY MEAN MANIPULATION OF PRICES IN RELATION TO INTERNATIONAL TRANSACTIONS BETWEEN THE PARTIES W HICH ARE CONTROLLED BY THE SAME INTEREST, INVOLVING TWO OR MORE COUNTRI ES WITH DIFFERING TAX RATES AND LEGISLATION A REALIZING PROFITS IN THE C OUNTRY WITH THE MOST FAVOURABLE TAX REGIME SO THAT TOTAL TAX LIABILITY I S REDUCED. 13. SUCH MANIPULATIONS ARE DIFFICULT TO BE ESTABLISHED BECAUSE OF THE PROBLEMS OF OFF-SHORE INVESTIGATIONS. FOR T HAT MATTER, STATES HAVE, THROUGH LEGISLATION, RESORTED TO A HYPOTHESIS OF ALP I.E WHAT WOULD HAVE BEEN THE PRICE IF THE TRANSACTIONS WERE BETWEEN TWO ITA 2182/10 SP 67/11 :- 14 - : UNRELATED PARTIES SIMILARLY PLACED AS THE RELATED P ARTIES. AS REGARDS NATURE OF PRODUCT AND CONDITIONS AND TERMS OF THE T RANSACTIONS. METHODOLOGY FOR THE PURPOSE OF COMPARABILITY HAS BE EN FORMULATED, UNDER THE RESPECTIVE DOMESTIC LAWS OF THE COUNTRIES . THE HYPOTHESIS PRESUMES THAT THE TAX PAYERS INCOME IS INCORRECTLY REPORTED ON THE ALP STANDARD AND PERMITS THE REVENUE AUTHORITIES TO MAKE A DETERMINATION OF TRUE TAXABLE INCOME. THIS IS APAR T FROM INCORRECT REPORTING BECAUSE OF FRAUDULENT, COLOURABLE OR SHAM TRANSACTIONS. THE GENERAL THEORY OF TRANSFER PRICING IS THAT THE LEGI SLATION IS TO TREAT EACH OF THE INDIVIDUAL PRICE OF COMMONLY CONTROLLED GROU P AS A SEPARATE ENTITY, TRANSACTIONS BETWEEN WHICH ARE TAXABLE EVEN TS TO BE FORMED TO THE ECONOMIC REALITIES THAT WOULD OBTAIN BETWEEN IN DEPENDENT ENTITIES CONDUCTING IDENTICAL TRANSACTIONS AT ARMS LENGTH. TO TRANSFER A TANGIBLE PROPERTY, CUP METHOD, OR RESALE PRICE METH OD OR COST PLUS METHOD ARE APPLIED. IF NONE OF THEM IS APPLICABLE, THE FOURTH METHOD KNOWN AS APPROPRIATE METHOD I.E., COMPARABLE PRO FIT METHOD OR PROFIT SPLIT METHOD OR UNSPECIFIED METHOD IS APPLIE D. IT IS TO BE SEEN IF THE AMOUNT CHARGED IS ARMS LENGTH BY REFERENCE TO GROSS PROFIT MARGIN IN COMPARABLE TRANSACTION. THE COMPARABILITY DEPEN DS ON SIMILARITY OF THE PRODUCT UNDER CUP METHOD. ITA 2182/10 SP 67/11 :- 15 - : 14. BEFORE DECIDING THE IMPUGNED ISSUE LET US TRY T O UNDERSTAND THE NEED, THE NECESSITY AND METHODOLOGY UTILIZED IN INT ERNATIONAL TAXATION. IN THE YEAR 1991, THE INDIAN ECONOMY STARTED OPENIN G UP. FOREIGN INVESTMENT POURING IN AS A RESULT OF ECONOMIC REFOR M MEASURES WAS TAKEN BY THE GOVERNMENT. INDUSTRIAL LICENSING POLI CY WAS CONSIDERABLY LIBERALIZED; TAX STRUCTURE SIMPLIFIED AND MADE INTE RNATIONALLY COMPATIBLE. IN ORDER TO HAVE SMOOTH FLOW OF INVEST MENT AND TRADE, INDIA HAS MADE ITS ECONOMIC CLIMATE CONDUCIVE TO IN VESTMENT AND FOR THAT PURPOSE, IT HAS ENTERED INTO AGREEMENTS WITH A LMOST ALL THE CAPITAL AND TECHNOLOGY EXPORTING COUNTRIES WITH A VIEW TO A VOID DOUBLE TAXATION OF INCOME ARISING IN INDIA BY VIRTUE OF TH E BUSINESS CONNECTION. DOUBLE TAXATION AGREEMENTS ARE ESTABL ISHED THE WAY FOR THE STATES TO AGREE AT INTERNATIONAL LEVEL FOR RESO LUTION OF THE PROBLEMS ARISING FROM THE CROSS-BORDER TRADING AND INVESTMENTS. THE TAX TREATY FACILITATES INVESTMENTS AND TRADE FLOW B Y PREVENTING DISCRIMINATION BETWEEN TAXPAYERS, ADDS FISCAL CERT AINTY TO CROSS-BORDER OPERATION, PREVENTS EVASION AND AVOIDANCE OF TAX A T INTERNATIONAL LEVEL. APART FROM FACILITATING COLLECTION OF TAXES AND ATTAINMENT OF NATIONAL DEVELOPMENT GOAL, THE TREATY WARRANTS THE STABILITY OF TAX BURDEN, SO THAT ITS PROVISIONS MAY NOT BE ABUSED BY MULTI-NATIONAL ENTERPRISES (MNES) BY FIXING PRICES, TERMS AND COND ITIONS OF ITA 2182/10 SP 67/11 :- 16 - : TRANSACTIONS BETWEEN THEIR CONTROLLED ENTERPRISES L OCATED IN DIFFERENT JURISDICTIONS. THE TREATY REQUIRES THAT SUCH TRANS ACTIONS BE DEALT WITH AS IF THEY ARE BETWEEN UNRELATED PARTIES AND EVEN A CCOUNT BE RE- WRITTEN IF REQUIRED, SO THAT REAL PROFIT WOULD BE T AXED, WHICH IS SOUGHT TO BE MANIPULATED. THE RELEVANT PROVISIONS OF THE ACT ARE PATTERNED ON THE OECD GUIDELINES1995. THESE PROVISIONS ARE E ROSION OF INDIAN TAX BASE BY MULTI-NATIONALS THROUGH A MECHANISM OF WHAT IS KNOWN AS TRANSFER PRICING . IN A MODERN DEMOCRATIC SET UP , THE GOVERNMENTS LOCAL, STATE OR CENTRAL ARE MODIFIED VERSION OF SERVICE CORPORATIONS OF WHICH ALL THE PEOPLE IN THE COMMUNITY ARE THE M EMBERS AND THE PRINCIPLE OBJECT OF THE GOVERNMENT IS TO SERVE THE PEOPLE, SO THAT WE CAN ACHIEVE THE GOAL OF ESTABLISHING EGALITARIAN SO CIETY AS ENVISAGED IN THE CONSTITUTION OF INDIA. IN INDIA, THERE IS NO C ROWN AND THERE IS NO SUBJECT. WE, THE PEOPLE OF INDIA, ARE THE REAL S OVEREIGN AND IT IS THE PEOPLE, WHO DECIDE TO TAX THE COMMUNITY FOR THE BEN EFIT AND WELFARE OF THE SOCIETY. THE GOVERNMENT COLLECTS MOST OF TH E MONEY IT NEEDS FROM ITS CITIZENS AND THE COMPANIES BY TAXING THEIR INCOME ACCORDING TO THEIR CAPACITY TO PAY, TO SPEND ON BEHALF OF THE CI TIZEN IN MAINTAINING LAW AND ORDER, DEFENDING FROM OUTSIDE ATTACK AND PR OVIDING EDUCATION, HEALTH CARE, SOCIAL SECURITY ETC. SO TAXATION IS A MEANS OF APPORTIONING THE COST OF GOVERNMENT AMONGST THOSE, WHO BENEFITS FROM IT. NON- ITA 2182/10 SP 67/11 :- 17 - : PAYMENT OF TAX BY ANY PERSON WHEN IT IS DUE INCREAS ES THE BURDEN OF THOSE WHO PAY. THAT IS WHY GOVERNMENT TAKES MEASUR ES TO CURB EVASION OF TAX RESORTING TO PENALTY AND PROSECUTION . NO GOVERNMENT CAN AFFORD MULTINATIONAL COMPANIES TO DICTATE TRANS ACTIONS AMONGST THEIR AFFILIATES AND AVOID PAYMENTS OF TAX IN THE STATE WHERE IT IS DUE, CAUSING SUBSTANTIAL LOSS OF MUCH NEEDED PUBLIC REVE NUE IN A WELFARE STATE. THERE ARE TWO WAYS OF PREVENTING THIS: (1) - GLOBAL FORMULARY APPORTIONMENT AND (2) -ARMS LENGTH PRINCIPLE FOR T RANSFER PRICING ADJUSTMENT. WHERE TAX RATES ARE DIFFERENT BETWEEN C OUNTRIES, THERE IS A STRONG INCENTIVE TO SHIFT INCOME TO A LOWER TAX A ND DEDUCTIONS TO A HIGHER TAX COUNTRY, SO THAT THE OVERALL TAX EFFECT IS MINIMIZED. THERE ARE TWO DIFFERENT APPROACHES TO DEAL WITH SHIFTING OF THE PROFITS FROM ONE JURISDICTION TO ANOTHER; EITHER TO IGNORE THE I NDEPENDENT STATUS OF THE CORPORATIONS WITHIN THE GROUP AND CONSEQUENTLY ALSO THE TRANSACTIONS BETWEEN THEM OR TO TREAT THEM INDEPEND ENT AND MAKE ADJUSTMENTS TO THEIR INCOME. THE FORMER IS KNOW AS THE GLOBAL FORMULARY APPORTIONMENT METHOD AND THE LATTER IS KN OW AS TRANSFER PRICING ADJUSTMENT APPROACH. IN FIRST, CORPORATE GR OUP IS TAXED AS A WHOLE AND THE GLOBAL PROFITS ALLOCATED AMONGST THE ASSOCIATED ENTERPRISES IN DIFFERENT COUNTRIES ON THE BASIS OF PRE-DETERMINED FORMULA. IN THE OTHER, ASSOCIATED ENTERPRISES ARE TAXED AS SEPARATE ITA 2182/10 SP 67/11 :- 18 - : ENTITIES. THE LATTER IS MOSTLY ADOPTED, BECAUSE COR PORATE LAWS RECOGNIZE INDEPENDENT STATUS. TO ILLUSTRATE THIS, S UPPOSE AN AMERICAN MANUFACTURING COMPANY A SELLS GOODS TO ITS ASSOCI ATED ENTERPRISES IN A LOW TAX RATE COUNTRY B FOR SAY $ 100 THAT ENTE RPRISE SELLS IT TO AN UNRELATED ENTITY IN INDIA FOR $400. GLOBAL FORMULA RY METHOD APPROACH IS THE TRANSACTION BETWEEN A & B IS IGNORED AND THE SALE BETWEEN B AND THE INDIAN COMPANY IS TREATED AS IF A MADE IT D IRECT AND THE ENTIRE SALE PROCEEDS OF $400 BELONGS TO A AND NOT JUST $10 0. IN OTHER WORDS, THE INCOME OF ASSOCIATED ENTERPRISE B ( $ 300) IS A TTRIBUTED TO THE AMERICAN COMPANY. THE ARMS LENGTH TRANSACTION ADJ USTMENT REQUIRES THAT SALES PRICE UP AND CONSEQUENTLY, THE PROFIT OF B INCREASED BY $300. IN BOTH THE CASE, THE CONCLUSION IS THE SAME , HOWEVER, THE ROUTE IS DIFFERENT. UNDER THE TRANSFE R PRICING APPROACH RELATIONSHIP BETWEEN THE CORPORATIONS AND TRANSACTI ONS BETWEEN THEM ARE RECOGNIZED WHILE UNDER CONSOLIDATION APPROACH T HEY ARE IGNORED. THE CONSOLIDATION APPROACH HAS MANY ADVANTAGES. IT PREVENTS TRANSFER PRICING BY THE RESIDENTS; DOES AWAY WITH TREATY SHO PPING, WHICH INVOLVES RE-CHARACTERIZATION AS WELL AS DIVERSION O F INCOME; ELIMINATES THE VICE OF THIN CAPITALIZATION. 15. THE LEAGUE OF NATIONS TO INTERNATIONAL ASSOCIAT IONS OF COUNTRIES CREATED TO MAINTAIN PEACE AMONG THE NATIONS OF THE WORLD IN THE YEAR ITA 2182/10 SP 67/11 :- 19 - : 1920 AND HAD ITS HEADQUARTERS IN GENEVA, SWITZERLAN D. BUT THIS ASSOCIATION CEASED TO FUNCTION AFTER THE SECOND WOR LD WAR AND WAS FINALLY DISSOLVED IN APRIL, 1946, AND ITS PLACE WAS TAKEN BY THE UNITED NATIONS. THE LEAGUE PLAYED A PIONEERING ROLE IN DE VELOPING MODEL TAX TREATIES DURING THE PERIOD BETWEEN 1930S AND 1940S, ITS WORK BEING TAKEN OVER IN 1960S BY THE ORGANIZATION FOR EUROPEA N ECONOMIC CO- OPERATION (IN SHORT OEEC). THIS OEEC SUBSEQUENTLY WAS SUBSTITUTED BY THE ORGANIZATIONS FOR ECONOMIC CO-OPERATION AND DEV ELOPMENT (OECD). THE OECD IS A MULTILATERAL ORGANIZATION CO MPRISED OF MOSTLY WESTERN EUROPEAN COUNTRIES, THE UNITED STATES, CANA DA, JAPAN, AUSTRALIA AND NEW ZEALAND. ITS HEADQUARTERS ARE IN PARIS (FRANCE) AND IT WAS FOUNDED IN THE YEAR 1961 BY REPLACING OEEC. IT WAS ESTABLISHED IN THE YEAR 1948 IN CONNECTION WITH THE MARSHALL PL AN, AND IT PROVIDES A FORUM FOR REPRESENTATIVES OF INDUSTRIALIZED COUNTRI ES TO DISCUSS AND ATTEMPT TO CO-ORDINATE ECONOMIC AND SOCIAL POLICIES . ITS PRIMARY OBJECTIVES ARE: (I) TO MAINTAIN AND STIMULATE ECONO MIC GROWTH AND (II) TO INCREASE CO-OPERATION AND PROMOTE ECONOMIC DEVEL OPMENT WITHIN AND OUTSIDE OF THE TERRITORIES OF THE MEMBER COUNTR IES AND ASSIST DEVELOPMENT AND GROWTH OF WORLD TRADE. THE OECC AN D OECD PLAYED AN IMPORTANT AND PIONEERING ROLE IN THE DEVELOPMENT OF MODEL TAX ITA 2182/10 SP 67/11 :- 20 - : TREATIES DURING 1960S TO THE PRESENT DAY. THE OECD S WORK ON TAXATION IS MANAGED BY TAX CENTER FOR TAX POLICY AND ADMINIS TRATION. 16. SEPERATE TAXATION AND NOT THE CONSOLIDATION AP PROACH IS GENERALLY FAVOURED BECAUSE UNDER THE ARMS LENGTH S TANDARD, EACH NATIONS TAX SYSTEM OPERATES UNDER ITS OWN DOMESTIC TAX RULES SUBJECT TO RELATIVELY MINOR QUALIFICATIONS OF ARMS LENGTH PRICES IN CERTAIN INTERNATIONAL TRANSACTIONS. IT FACILITATES SHARING OF REVENUE BETWEEN TWO STATES, UNLIKE UNDER THE CONSOLIDATION APPROACH . THE CONSOLIDATION APPROACH IS BASED ON A FORMULATORY A PPORTIONMENT SYSTEM, WHICH HAS ITS OWN DIFFICULTY OF OPERATIONS . THE REASONS FOR THE ABOVE ARE THAT ONE - IT RELATES TO DEFINING RELATI ONSHIP AMONG CORPORATIONS AS TO BRING THEIR PROFITS WITHIN THE FORMULAE, TWO - TO THE FORMULAE TO BE USED IN THE ALLOCATION OF PROFITS AM ONG THE JURISDICTIONS AND THREE - TO DEFINING WORLD WIDE TAX BASE USED IN IDENTIFYING GROUP OF PROFITS. THESE DIFFICULTIES ARE NOT ADDRESSED T O IN TAX TREATIES. MOST OF THEM FAVOURED SEPARATE TAXATION OF ASSOCIATED EN TERPRISES AND THE TRANSFER PRICING APPROACH. THE OECD TRANSFER PRICIN G GUIDELINES ARE AS FOLLOWS: 1) THERE ARE SEVERAL REASONS OECD MEMBER COUNTRIES AND OTHER COUNTRIES HAVE OPTED ARMS LENGTH PRINCIPLE. THE M AJOR REASON FOR THE SAME IS THAT THE ARMS LENGTH PRINCIPLE PRO VIDES BROAD ITA 2182/10 SP 67/11 :- 21 - : PARITY OF TAX TREATMENT FOR MNES AND INDEPENDENT EN TERPRISES. BECAUSE THE ARMS LENGTH PRINCIPLE PUTS ASSOCIATED AND INDEPENDENT ENTERPRISES ON A VERY EQUAL FOOTING FOR TAX PURPOSES AND AVOIDS THE CREATION OF TAX ADVANTAGEOU S OR DIS- ADVANTAGEOUS THAT WOULD OTHERWISE DISTORT THE RELAT IVE COMPETITION PURPOSES. 2) THE ARMS LENGTH PRINCIPLE HAS ALSO BEEN FOUND TO W ORK EFFECTIVELY IN THE VAST MAJORITY OF THE CASES LIKE THERE ARE MANY CASES WHICH INVOLVE THE PURCHASE AND SALE OF COMMOD ITIES AND THE LENDING OF MONEY, WHERE ARMS LENGTH PRICE MAY READILY BE FOUND IN THE COMPARABLE TRANSACTION UNDERTAKEN BY T HE COMPARABLE ENTERPRISES UNDER COMPARABLE CIRCUMSTANC ES. ONE OF THE MAJOR FLAWS IN THE SYSTEM IS THAT THE ARMS LENGTH PRINCIPLE DIS-REGARD INTEGRAL AND FUNCTIONAL UNITY OF A MNE, WHICH IS RESPONSIBLE FOR GREATER EFFICIENCIES AND A DVANTAGEOUS COMPETITION EDGE. THE FUNCTION OF ALL ITS SUBSIDIA RIES LOCATED IN VARIOUS TAX JURISDICTIONS CANNOT BE ANALYZED IN ISO LATION OF EACH OTHER; AND DEALINGS AND TRANSACTIONS WITHIN MNES AR E TREATED AT PAR WITH THE DEALINGS AND TRANSACTIONS BETWEEN UNRE LATED PARTIES AT ARMS LENGTH PRINCIPLE. TRANSFER PRICIN G GUIDELINES AS CONTAINED IN THE OECD GUIDELINES ARE LARGELY FOLLOW ED BY VARIOUS ITA 2182/10 SP 67/11 :- 22 - : COUNTRIES, BUT THEIR IMPLEMENTATION BY THE TAX AUTH ORITIES DIFFER. THE FOCUS OF TAX AUTHORITIES IS ON INCREASING NATIO NAL TAX BASE. IN AN ATTEMPT TO ACHIEVE THAT OBJECTIVE THEY LOSE T HE INTERNATIONAL PERSPECTIVE. THE SAME ISSUES ARE TREA TED IN DIFFERENT WAYS IN DIFFERENT JURISDICTIONS, FOR EXAM PLE, SUCH AS ALLOCATION OF CAPITAL RISK, ENTREPRENEUR FUNCTION, LOCAL MARKET PENETRATION RISKS AND REWARDS. THERE ARE PRACTICAL DIFFICULTIES IN APPLYING ARMS LENGTH PRINCIPLE. THE CONCEPT OF SE PARATE TAXATION IS NOT ONLY CONFINED TO THE RECOGNITION OF A CORPORATION AS AN ENTITY INDEPENDENT OF THE PARENT, BUT ALSO EX TENDED TO TREATING A BRANCH OF THE PARENT AS SEPARATE AND IND EPENDENT. THE ARMS LENGTH PRINCIPLE IS APPLIED BOTH IN THE C ONTEXT OF TRANSFER PRICING AND ATTRIBUTION OF PROFITS TO THE PERMANENT ESTABLISHMENT (PE). COMMERCIAL TRANSACTIONS BETWEE N DIFFERENT PARTS OF THE MULTINATIONAL GROUPS MAY NOT BE SUBJEC T TO THE SAME MARKET FORCES SHAPING RELATIONS BETWEEN TWO IN DEPENDENT FIRMS. OPEN MARKET CONSIDERATIONS NEED NOT NECESSA RILY GOVERN TRANSACTIONS BETWEEN TWO ENTERPRISES UNDER THE SAME OR COMMON CONTROL. THE PRICES PAID FOR TRANSACTION BE TWEEN MEMBERS OF A MULTINATIONAL ENTERPRISE MAY BE FIXED IN ORDER TO MEET THE CONVENIENCE OF THE MULTINATIONAL ENTERPRIS E OR A GROUP ITA 2182/10 SP 67/11 :- 23 - : AS A WHOLE AND DONE IN A VARIETY OF WAYS. SUCH FIX ING WOULD NOT HAVE BEEN POSSIBLE. IF THE PARTIES TO THE TRANSACTI ON WERE INDEPENDENT ACTING AT ARMS LENGTH. A TRANSFER PRI CE IS DEFINED AS A PRICE PAID FOR GOODS TRANSFERRED FROM ONE ECON OMIC UNIT TO ANOTHER, ASSUMING THAT TWO UNITS INVOLVED ARE SITUA TED IN DIFFERENT COUNTRIES, BUT BELONG TO THE SAME MULTINA TIONAL FIRM. TRANSFER PRICE IS THE PRICE CHARGED IN A TRANSACTIO N, WHICH MEANS AN ACTUAL PRICE CHARGED BETWEEN THE ASSOCIATE D ENTERPRISES IN AN INTERNATIONAL TRANSACTION. TRANS FER PRICING IS WIDELY USED IN MULTINATIONAL ORGANIZATION, WHICH TY PICALLY INVOLVE A PARENT COMPANY DOMICILED IN ONE COUNTRY AND A NU MBER OF SUBSIDIARY COMPANIES OPERATING IN OTHER COUNTRIES. WHEN MULTINATIONAL FIRMS CONDUCT BUSINESS WITHIN THEIR G ROUP, THE CONCEPT OF MARKET PRICING OR ARMS LENGTH PRICING H AS NO RELEVANCE. INCOME OR DEDUCTION IS ARBITRARILY SHIFT ED. SUPPOSING A PURCHASES GOODS WORTH RS.100 AND SELLS THEM TO IT S ASSOCIATED COMPANY B IN ANOTHER COUNTRY FOR RS.200/ -, WHO IN TURN SELLS IN THE OPEN MARKET FOR RS.400/-. IF A WO ULD HAVE SOLD IT DIRECTLY, ITWOULD HAVE MADE A PROFIT OF RS.300/- WHICH HAS BEEN RESTRICTED TO RS.100/- BY SOMETHING IT THROUGH B. THE TRANSACTION BETWEEN A & B IS ARRANGED AND IS NOT SU BJECT TO ITA 2182/10 SP 67/11 :- 24 - : MARKET FORCES. THE PROFIT OF RS.200/- HAS BEEN, THU S, SHIFTED TO COUNTRY OF B. THE GOODS HAVE BEEN TRANSFERRED ON A PRICE (TRANSFER-PRICE) WHICH IS ARBITRARY OR DICTATED BEI NG RS.200/- AND NOT BEING RS.400/- WHICH IS ITS MARKET PRICE. TRANS FER BETWEEN ENTERPRISES UNDER THE SAME CONTROL AND MANAGEMENT, OF GOODS, COMMODITIES, MERCHANDISE, RAW-MATERIAL, STOCK OR SE RVICES IS MADE ON A PRICE, WHICH IS NOT DICTATED BY THE MARKE T BUT CONTROLLED BY SUCH CONSIDERATIONS. TRANSFER OF GOO DS OR SERVICES AS AFORESAID IS AS DICTATED BY THE MARKET BUT IT IS CONTROLLED BY THE CONSIDERATION OF SHIFTING TAXABLE PROFITS OR DU TIES OR OF ARRANGING THE DIRECTION OF CASH FLOW. THE DEVELOPI NG COUNTRIES LAY HEAVY RESTRICTIONS IN REGARD TO REMITTANCE OF P ROFITS, BUT IN THEIR ENGINEERS TO SECURE ACCESS TO FOREIGN TECHNOL OGY, EXPERTISE TECHNICAL KNOW-HOW, CAPITAL GOODS AND COMPONENTS FO R THEIR INDUSTRIAL DEVELOPMENT. THE MNCS HAVE CHANGED THEIR INVESTMENT AND TECHNICAL COLLABORATIONS, POLICIES A ND THE DEVELOPING COUNTRIES UNPREDICTABILITY ABOUT POLITIC AL AND ECONOMIC STABILITY OF A COUNTRY MAY NECESSITATE FLI GHT OF CAPITAL AND PROFIT THERE FROM. THIS FLIGHT IS ACHIEVED THR OUGH THE DEVICE OF TRANSFER PRICING. ITA 2182/10 SP 67/11 :- 25 - : 17. THE REASON FOR FIXING A PRICE, WHICH IS NOT AN ARMS LENGTH PRICE, WHATEVER BE THE MOTIVE, IS THE AVOIDANCE OF THE PRO FIT FROM A COUNTRY WHERE IT WOULD HAVE ACCRUED, HAD THE TRANSACTIONS B EEN AT ARMS LENGTH. THE AVOIDANCE OR EVASION OF TAX CANNOT BE THE PURPOSE OR THERE COULD BE HONEST DIFFERENCE OF OPINION ABOUT W HAT SHOULD BE THE ARMS LENGTH PRICE, THE TAX AUTHORITIES ARE AWARE T HAT TAX IS AVOIDED. THEREFORE, THE QUESTION OF THE TAX TREATMENT OF THE TRANSFER PRICING IS ALWAYS CONSIDERED IN ASSOCIATION WITH AVOIDANCE OR EVASION OF TAX. THE NET EFFECT OF TRANSFER PRICING ABUSED IS THAT PROFI TS PROPERLY ATTRIBUTABLE TO ONE JURISDICTION ARE SHIFTED TO ANOTHER JURISDIC TION. IN CONTROLLED TRANSACTION IF IT IS NOT FOUND AT ARMS LENGTH SHIFT ING OF PROFIT AND CONSEQUENTLY AVOIDANCE OF TAX IS HEAVILY PRESUMED E VEN IF IT IS DONE INADVERTENTLY OR WITH PURPOSE. THE ARMS LENGTH PRI NCIPLE CANNOT BE APPLIED, IF INCOME COULD NOT BE LEGALLY RECEIVED. MNE GROUP TO COMPANIES SEEK TO ACHIEVE THE BEST TAX RESULTS NOT ONLY BY MANIPULATING EXPORT AND IMPORT PRICES, BUT ALSO BY MANIPULATING CATEGORY OF INCOME. WORLD OVER, DIFFERENT CATEGORIE S OF INCOME ARE DEALT WITH DIFFERENTLY AND SO ALSO THE TREATIES ON TAX ARE STRUCTURED. INCOME IS SEPARATE INTO SEPARATE CATEGORIES AND EAC H CATEGORY HAS ITS OWN ROLE FOR COMPUTATION AS WELL AS TAX RATE. BUSI NESS INCOME IS TAXED AT THE NORMAL RATES IN A GIVEN COUNTRY ON A NET BAS IS WHEREAS ROYALTY, ITA 2182/10 SP 67/11 :- 26 - : INTEREST AND DIVIDEND ARE TAXED AT REDUCED RATES ON GROSS BASIS. THEREFORE, A NON-RESIDENT TAX PAYER BEING PERMANENT ORGANIZATION OF THE SUBSIDIARY COMPANY INCORPORATED IN THE SOURCE C OUNTRY WOULD BE ENCOURAGED TO CATEGORIZE BUSINESS INCOME AS ROYALTY OR TECHNICAL FEE. BECAUSE THE PARENT ORGANIZATION AND ITS SUBSIDIARY COMPANY ARE TREATED AS INDEPENDENT ENTITIES FOR TAX PURPOSES AN D TREATY PURPOSES, THE CHARACTERISATION OF INCOME CHANGES THE SAME RES ULT AS FOR UNRELATED TAX PAYERS, FOR EXAMPLE, THE NON-RESIDENT CONFERRING PATENT RIGHT ON A RESIDENT MAY TRANSFER A PATENT IN EXCHAN GE OF SHARES (PRODUCING DIVIDEND INCOME) OR CAN LEAVE PURCHASE P ARTICULARS OUTSTANDING AS A LOAN ( PRODUCING INTEREST INCOME) OR MAY LICENSE PATENT IN EXCHANGE FOR ROYALTIES. THUS, THE TAX MA NIPULATION AMONG THE RELATED CORPORATIONS NOT ONLY INVOLVES THE USE OF ARBITRARY PRICES, BUT ALSO CONVERSION OF RETURNS ON EQUITY, INVESTMEN T TO ROYALTY AND INTEREST. TRANSFER PRICING MAY MEAN MANIPULATION O F PRICES IN RELATION TO INTERNATIONAL TRANSACTION BETWEEN THE PARTIES, W HICH ARE CONTROLLED BY THE SAME INTEREST, INVOLVING TWO OR MORE COUNTRI ES WITH DIFFERENT COUNTRIES HAVING DIFFERENT TAX RATES AND REALISING PROFITS IN THE COUNTRY, WHICH HAS THE PAYABLE TAX REGIME RESULTING INTO RED UCTION OF PAYABLE TAX LIABILITY. SUCH MANIPULATIONS ARE DIFFICULT TO BE CAUGHT AND ESTABLISHED BECAUSE THE TAXMAN IS HANDICAPPED TO MA KE OFF-SHORE ITA 2182/10 SP 67/11 :- 27 - : INVESTIGATIONS. WITH A VIEW TO DEAL SUCH A SITUATI ON, SO THAT A LEGITIMATE TAX TO WHICH A STATE IS ENTITLED TO, A C OMBINED EFFORT HAS BEEN MADE THROUGH LEGISLATION. ACCORDING TO WHICH ON HYPOTHETICAL MANNER SUCH EVASION OF TAX CAN BE CONTROLLED, A TER M KNOWN AS AN ARMS LENGTH HAS BEEN COINED. WHAT WOULD HAVE BEE N THE PRICE IF THE TRANSACTIONS WERE BETWEEN TWO UNRELATED PARTIES , SIMILARLY PLACED AS THE RELATED PARTIES IN SO FAR AS NATURE OF PRODU CT, CONDITIONS AND TERMS AND CONDITIONS OF THE TRANSACTIONS ARE CONCER NED? FOR THAT PURPOSE METHODOLOGY AND MODALITIES TO COMPARE THE R ESULTS UNDER PERSPECTIVE DOMESTIC LAWS OF A GIVEN COUNTRY HAVE B EEN FORMULATED. ACCORDING TO THIS HYPOTHESIS, IT IS PRESUMED THAT T AX PAYERS INCOME HAS BEEN INCORRECTLY REPORTED ON THE ARMS LENGTH ST ANDARD WHICH PERMITS THE REVENUE AUTHORITIES TO DETERMINE A CORR ECT TAXABLE INCOME. THIS METHODOLOGY IS DIFFERENT FROM INCORRECT REPORT ING BY WAY OF FRAUDULENT, COLORFUL OR SHAM TRANSACTIONS. THE BAS IC THESIS IS THAT TRANSFER PRICING LEGISLATION IS TO TREAT EACH OF T HE INDIVIDUAL MEMBERS OF A COMMONLY CONTROLLED GROUP AS A SEPARATE ENTITY , THE TRANSACTIONS BETWEEN WHOM ARE TAXABLE EVENTS TO BE CONFORMED TO THE ECONOMIC REALITIES OBTAINING BETWEEN INDEPENDENT ENTITIES EN TERING INTO SIMILAR AND IDENTICAL TRANSACTIONS, AT ARMS LENGTH. THUS, A TRANSFER PRICING IS A DEVICE TO CONTROL AVOIDANCE OF TAX IN A JURISDICTIO N WHERE IT IS OTHERWISE ITA 2182/10 SP 67/11 :- 28 - : DUE. THE RIGHT TO DO BUSINESS IN A MOST BENEFICIAL MANNER GIVEN TO A BUSINESSMAN IS THUS ABUSED CAUSING LOSS TO EX-CHEQU ER OF A COUNTRY WHERE THE PROFIT IS DRAWN AND IT IS SHIFTED TO ANOT HER COUNTRY. THE LAW DOES NOT PERMIT OR SANCTION ABUSE OF SUCH A RIGHT. THIS ABUSE CAN BE CURBED IN THE FOLLOWING WAYS: (1) BY ESTABLISHING AN ARMS LENGTH TRANSFER PRICE WHICH REQUIRES ENQUIRY/INVESTIGATION AS TO WHAT UNRELATED PARTIES, WHICH ARE NOT UNDER COMMON CONTROL, WOULD DO IN SIMILAR CIRCUMSTANCES. SO IT IS AN ATTEMPT TO ESTABLISH THE PRICES THAT WOULD PREVAIL IN THE MARK ET PLACE; OR APPORTIONING OF OVER ALL PROFIT OF THE ENTERPRISES THOSE ESTABLISHING A FAIR OR PROPER DIV ISION OF GLOBAL PROFITS. (2) BY NON-DEDUCTING OF INTRA FIRM PAYMENT, UNLESS SUCH PAYMENTS ARE CONSISTENT WITH NORMAL COMMERCIAL PRACTICES. THEREFORE, WITH A VIEW TO PROVIDE A STAT UTORY FRAMEWORK WHICH CAN LEAD TO COMPUTATION REASONABLE, FAIR AND EQUITABLE PROFITS AND TAXING THE SAME IN I NDIA, IN RELATION TO INTERNATIONAL TRANSACTIONS BETWEEN T WO OR MORE ASSOCIATED ENTERPRISES, NEW PROVISIONS HAVE BE EN INTRODUCED IN THE INCOME TAX ACT EFFECTIVE FROM ITA 2182/10 SP 67/11 :- 29 - : 01.04.2002. THESE PROVISIONS ARE MORE OR LESS BASE D ON TRADITIONAL RULES OUTLINED IN THE WORK OF THE OE CD. FOR THAT MATTER STRICT CONDITIONS HAVE BEEN IMPOSED ON THE TAX PAYER TO MAINTAIN AND PROVIDE DOCUMENTATION OF TRANSFER PRICING, METHODOLOGY, NON-COMPLIANCE THEREOF ATTRACTS HEAVY PENALTIES. CONTROLLED TAX PAYER MEANS ONE OF THE TWO OR MORE T AX PAYERS OWNED OR CONTROLLED DIRECTLY OR INDIRECTLY BY THE SAME IN TERESTS, AND INCLUDES THE TAX PAYER WHO OWNS OR CONTROLS THE OTHER TAX PA YERS. UNCONTROLLED TAX PAYERS MEAN ANY ONE OF THE TWO OR MORE TAX PAYE RS NOT OWNED OR CONTROLLED DIRECTLY OR INDIRECTLY BY THE SAME INTER EST. LIKEWISE CONTROL MEANS ANY KIND OF CONTROL DIRECTLY OR INDIRECTLY W HETHER LEGALLY OR NOT AND HOWEVER, EXERCISEABLE OR EXERCISED, INCLUDING CONTROL RESULTING FROM THE ACTIONS OF TWO OR MORE TAX PAYERS ACTING I N CONCERT OR WITH A COMMON GOAL OR PURPOSE. THUS, IT IS THE EXERCISE OF REAL CONTROL, WHICH IS DECISIVE BUT IN ITS FORUM OR MORE OF ITS EXERCIS E. A PRESUMPTION OF CONTROL ARISES IF INCOME OR DEDUCTIONS HAVE BEEN AR BITRARILY SHIFTED. A TRANSACTION MEANS SAME ASSIGNMENT, LEASE, LOAN, ADVANCE, CONTRIBUTION OR ANY OTHER TRANSFER OF INTEREST IN O R RIGHT TO USE ANY PROPERTY WHETHER TANGIBLE OR INTANGIBLE OR MONEY. HOWEVER, SUCH ITA 2182/10 SP 67/11 :- 30 - : TRANSACTION IS EFFECTED AND WHETHER OR NOT THE TERM S OF SUCH TRANSACTION ARE FORMALLY DOCUMENTED. SUCH A TRANSA CTION ALSO INCLUDES PERFORMANCE OF ANY SERVICES FOR THE BENEFIT OF OR T AXES, OTHER TAX PAYERS. IN DETERMINING THE TRUE TAXABLE INCOME OF A CONTROLLED TAXPAYER, THE STANDARD TO BE APPLIED IN SEVERAL CAS E IS THAT OF A TAXPAYER DEALING AT ARMS LENGTH WITH AN UNCONTROLL ED TAX PAYER. WHETHER A TRANSACTION RESULTS AN ARMS LENGTH RESUL T WILL TO BE DETERMINED WITH REFERENCE TO THE RESULTS OF A COMPA RABLE UNDER COMPARABLE CIRCUMSTANCES. TRANSACTIONS ARE NOT ORD INARILY CONSIDERED COMPARABLE IF THEY ARE NOT MADE IN THE ORDINARY COU RSE OF BUSINESS OR ONE OF THE PRINCIPAL PURPOSES OF THE UNCONTROLLED T RANSACTION WAS TO ESTABLISH AN ARMS LENGTH RESULT WITH RESPECT TO TH E CONTROLLED TRANSACTION. SPECIFIC METHODS FOR THAT PURPOSE HAV E BEEN PROVIDED FOR DETERMINING ARMS LENGTH RESULTS, IF THE TRANSACTIO NS DO NOT SATISFY THAT STANDARD. TRANSACTIONS MAY INVOLVE DIFFERENT KINDS OF TRANSFER SUCH AS TRANSFER OF PROPERTY, SERVICES, LOAN OR ADVANCES AN D THEREFORE, MAY REQUIRE SELECTION OF APPROPRIATE METHOD FOR THE CAL CULATION OF ARMS LENGTH RESULTS. NO SHIFT METHOD OF PRIORITY IS RE COMMENDED THE BEST SUITABLE METHOD FOR DETERMINING A MOST RELIABLE MEA SURE OF ARMS LENGTH RESULT HAS TO BE GIVEN PRIORITY. IN SELECTIN G THE BEST METHOD, TWO FACTORS TO BE TAKEN INTO ACCOUNT ARE:- (I) THE DEGREE OF ITA 2182/10 SP 67/11 :- 31 - : COMPARABILITY AND (II) COMPLETENESS AND ACCURACY OF THE DATA. DEGREE OF COMPARABILITY DEPENDS ON THE FOLLOWING FACTORS: (I) FUNCTIONS IDENTIFYING AND COMPARING THE ECONOMICAL SIGNIFICAN T ACTIVITIES; (II) COMPARING SIGNIFICANT CONTRACTUAL TERMS, (III) COMP ARING SIGNIFICANT REASONS (IV) COMPARING SIGNIFICANT ECONOMIC CONDITI ONS (V) COMPARING OF PROPERTY OR SERVICES AND (VI) MARKET STRATEGIES, LOCATION, SAVINGS, ETC. 18. THE METHODS TO DETERMINE ARMS LENGTH PRIC E OF TANGIBLE PROPERTY ARE (I) COMPARABLE CONTROLLED PRICE (CUP) METHOD (II) RESULT PRICE METHOD (3) CUP PLUS METHOD (4) ( IF NONE OF T HE ABOVE APPLIED) APPROPRIATE METHOD IS COMPARABLE PROFITS METHOD; P ROFITS SUPPLIED METHOD; UNSPECIFIED METHOD. THE CUP METHOD IS ONE COMPARABLE UNCONTROL LED PRICE METHOD, WHICH IS DEFINED AS TRANSFER PRICE METHOD THAT CO MPARES THE PRICE FOR PROPERTY OR SERVICES TRANSFERRED IN A CONTROLLED TR ANSACTION TO THE PRICES CHARGED FOR PROPERTY OR SERVICES TRANSFERRED IN A C OMPARABLE UNCONTROLLED TRANSACTION IN COMPARABLE CIRCUMSTANCE S. THUS, CUP METHOD IS THE MOST DIRECT AND RELIABLE METHOD. THE RESALE PRICE METHOD MEASURES THE VALUE OF FU NCTIONS PERFORMED AND IS ORDINARILY USED IN CASES OF PURCHA SE AND RESALE OF TANGIBLE PROPERTY IN WHICH THE RESELLER HAS NOT ADD ED SUBSTANTIAL VALUE ITA 2182/10 SP 67/11 :- 32 - : TO THE TANGIBLE GOODS BY PHYSICALLY ALTERING THE GO ODS BEFORE RESALE (PACKAGING, RE-PACKAGING, LABELING OR MINOR ASSEMBL E DO NOT CONSTITUTE PHYSICAL ALTERATION). THIS METHOD IS NOT AN ORDINA RILY USED WHERE THE CONTROLLED TAXPAYER USES IN ITS TANGIBLE PROPERTY T O ADD SUBSTANTIAL VALUE TO THE TANGIBLE GOODS. COST PLUS METHOD IS ORDINARILY USED IN CASES INVOLV ING THE MANUFACTURE, ASSEMBLY, OR OTHER PRODUCTION OF GOODS, THAT ARE SO LD TO RELATED PARTIES. COMPARABILITY UNDER THIS METHOD IS DEPENDE NT ON SIMILARITY OF FUNCTIONS PERFORMED, RISKS BORNE AND CONTRACTUAL TE RMS, AND ADJUSTMENTS TO ACCOUNT FOR THE EFFECTS OF ANY SUCH DIFFERENCES. WITH RESPECT TO INTANGIBLE PROPERTY, THE METHOD S WHICH APPLY ARE (I) COMPARABLE UNCONTROLLED TRANSACTION METHOD WHIC H EVALUATES WHETHER AMOUNT CHARGED FOR CONTROLLED TRANSFER OF A N INTANGIBLE PROPERTY WAS AT ARMS LENGTH BY REFERENCE TO THE AM OUNT CHARGED IN COMPARABLE UNCONTROLLED TRANSACTIONS. THIS METHOD REQUIRES THAT CONTROLLED OR THE UNCONTROLLED TRANSACTIONS INVOLVE EITHER THE SAME INTANGIBLE PROPERTY OR COMPARABLE INTANGIBLE PROP ERTY. THE BURDEN OF PROOF IS ALWAYS ON THE TAXPAYER . ITA 2182/10 SP 67/11 :- 33 - : TRANSACTIONAL NET MARGIN METHOD (TNMM) IS APPLIED IN A CASE WHERE THE SALE ITS PRODUCTS TO ITS SUBSIDIARY AND MAKES N O UNCONTROLLED SALES IN GEOGRAPHIC MARKET, BUT THERE ARE OTHER PLAYERS, WHO SELL SIMILAR PRODUCT TO OTHER DISTRIBUTORS IN THAT MARKET. THE UNCONTROLLED DISTRIBUTORS PURCHASE THE PRODUCT FROM UNRELATED PA RTIES, BUT THERE IS A DIFFERENCE IN THAT THEY DO NOT HAVE THE BRAND NAMES . BECAUSE RELIABLE ASSESSMENTS CAN NOT BE MADE FOR THE BRAND NAME, THE CUP METHOD CAN NOT BE USED. BUT WHEN THERE IS A CLOSE FUNCTIO NAL SIMILARITY BETWEEN CONTROLLED AND UNCONTROLLED FUNCTION IN TER MS OF MARKET IN WHICH THEY OCCUR THE VOLUME OF THE TRANSACTIONS, TH E MARKETING ACTIVITIES UNDERTAKEN BY THE DISTRIBUTOR, INVENTORY LEVELS, FLUCTUATION OF CURRENCY RISKS AND OTHER RELEVANT FUNCTIONS AND RIS KS AND RELIABLE ADJUSTMENTS CAN BE MADE FOR SIMILAR DIFFERENCE IN P AYMENT TERMS AND INVENTORY LEVELS FOR SAME DIFFERENCES IN PAYMENT TE RM AND INVENTORY LEVEL, RE-SALE PARTICULARS METHOD JUST A HIGHER D EGREE OF COMPARABILITY AND THUS PROVIDES A RELIABLE MEASURES ON ARMS LENGT H RESULT. IT IS PREFERRED OVER TNMM. TNMM IS PREFERRED TO COSTLY PR ICE METHOD BUT COSTLESS METHOD IS PREFERRED TO TNMM. TNMM IS ANOTHER METHOD WHICH PROVIDES A PRACTICA L SOLUTION TO OTHERWISE INSOLVABLE TRANSFER PRICING PROBLEM. THI S METHOD IS USED ITA 2182/10 SP 67/11 :- 34 - : WHERE NET MARGINS ARE DETERMINED FROM THE UNCONTROL LED TRANSACTION OF THE SAME TAXPAYER IN COMPARABLE CIRCUMSTANCES, O R COMPARABLE TRANSACTIONS OF TWO INDEPENDENT ENTERPRISES WITH TH E MATERIAL DIFFERENCES AFFECTING PRICE BETWEEN THE ASSOCIATED AND INDEPENDENT ENTERPRISES HAVING BEEN ADJUSTED. IF NOT ADJUSTED, THE METHOD IS NOT TO BE USED. THIS METHOD REQUIRES COMPARISON BETWEE N INCOME DERIVED FROM THE OPERATIONS OF THE UNCONTROLLED PARTIES AND INCOME DERIVED BY AN ASSOCIATED ENTERPRISE FROM SIMILAR OPERATIONS. T HE TNMM IS A MODIFIED, COST +/- RESALE PRICE METHOD. PRICE GUID ELINES DEFINED IT AS THE METHOD, WHICH EXAMINED THE NET PROFIT MARGIN RE LATING TO AN APPROPRIATE BASE ( FOR E.G. COSTS, SALES, ASSETS ) THAT TAXPAYER REALIZES FROM A CONTROLLED TRANSACTION. THIS METHOD IS USED WHERE CUP OR RESALE OR COST PLUS METHOD CANNOT BE APPLIED. IN T HIS METHOD FOCUS IS ON TRANSACTIONS RATHER THAN BUSINESS LINE OR THE OP ERATING INCOME OF THE COMPANY. AS REGARDS COMPARABILITY, THE FOCUS I S ON COMPARABILITY IN THE TRANSACTION AND ENTERPRISES RATHER THAN ON T HE SAME LEVEL OF COMPARABILITY IN PRODUCT AND FUNCTION HAS REQUIRED IN TRADITIONAL METHOD. THIS IS BASED ON NET PROFIT MARGIN RELATIV E TO ANAPPROPRIATE BASE COSTS, SALES, ASSETS- WHICH THE TAXPAYER MAK ES FROM A CONTROLLED TRANSACTION. THIS METHOD HAS BEEN APTLY DESCRIBED IN RULE- 10(B)(1)(E) OF THE INCOME TAX RULE AS UNDER:- ITA 2182/10 SP 67/11 :- 35 - : ( E )TRANSACTIONAL NET MARGIN METHOD, BY WHICH, ( I ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSO CIATED ENTERPRISE IS COMPUTED IN RELATION TO COSTS INCURRE D OR SALES EFFECTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY TH E ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT BASE; ( II )THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE O R BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTI ON OR A NUMBER OF SUCH TRANSACTIONS IS COMPUTED HAVING REGA RD TO THE SAME BASE; ( III ) THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE ( II ) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES, IF ANY, BETWEEN THE INTERN ATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSAC TIONS, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACT IONS, WHICH COULD MATERIALLY AFFECT THE AMOUNT OF NET PROFIT MA RGIN IN THE OPEN MARKET; ( IV ) THE NET PROFIT MARGIN REALISED BY THE ENTERPRISE AND REFERRED TO IN SUB-CLAUSE ( I ) IS ESTABLISHED TO BE THE SAME AS THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE ( III ); ( V ) THE NET PROFIT MARGIN THUS ESTABLISHED IS THEN TA KEN INTO ACCOUNT TO ARRIVE AT AN ARMS LENGTH PRICE IN RELATION TO T HE INTERNATIONAL TRANSACTION. HAVING DISCUSSED FROM RELEVANT PROVISIONS, TERMS US ED THEREIN AND RELEVANT METHODS TO BE EMPLOYED IT FOR DETERMINING ARMS LENGTH IN AN INTERNATIONAL TRANSACTION; WE NOW ADVERT TO THE FAC TS OF THE HANDS IN HAND. WE MAY MENTION THAT THE ASSESSEE HAS ADOPTED METHOD AGAINST WHICH ASSESSING OFFICER HAS ADOPTED TNMM METHOD. A CCORDING TO LD. AR, THE CUP METHOD ADOPTED BY THE ASSESSEE IS MOST APPROPRIATE METHOD WHICH CAN BE APPLIED IN THIS CASE. AS AGAIN ST WHICH THE CASE OF LD. DR IS THAT THE METHOD SUGGESTED BY DRP AND A DOPTED BY THE ASSESSING OFFICER I.E. TRANSACTIONAL NET MARGIN MET HOD (TNMM) IS THE ITA 2182/10 SP 67/11 :- 36 - : MOST APPROPRIATE METHOD, WHICH HAS TO BE GIVEN PRIO RITY BECAUSE THIS METHOD ANALYSES THE NET PROFIT OF TAXPAYER FROM A C ONTROLLED TRANSACTION RELATING TO A DEFINED BASE SUCH AS COST S OF ASSETS. 19. AFTER GOING THROUGH THE RECORDS, WE HAVE FOUND THAT THE ASSESSEE HAS SELECTED FEW COMPANIES FOR COMPARING ITS RESULTS AS AGAINST WHICH THE ASSESSING OFFICER HAS SELECTED D IFFERENT COMPANIES, WHICH ACCORDING TO AR ARE NOT AN ACTUAL COMPARABLE COMPANIES AS THEY DO NOT SATISFY THE TEST OF COMPARABILITY AS PR OVIDED IN RULE- 10C(2)(D) OF THE RULES. IN ADDITION TO THE ABOVE, IN THE ALTERNATIVE, IT HAS BEEN ARGUED BY THE LD. AR THAT IN ANY CASE THE DIFFERENCE OF +/- 5% HAS TO IGNORE IN VIEW OF SECOND PROVISO TO SEC.9 2C(2) OF THE ACT. IN NUTSHELL THE SUBMISSION OF THE LD. AR IS THAT TH E INTERNATIONAL TRANSACTION OF THE ASSESSEE COMPANY WERE DONE AT A RMS LENGTH PRICE ONLY REQUIRING NO ADJUSTMENTS AND THEREFORE, OUGHT TO HAVE REJECTED THE ADJUSTMENTS PROPOSED BY THE TPO. THE ASSESSEE IS A JOINT VENTURE OF ILGIN AUTOMOTIVE (P) LTD. -100% SUBSIDIARY OF DO NG A AUTOMOTIVE CO. LTD. AND (2) DONG A AUTOMOTIVE CO. LIMITED (I) LEE SANG II -55%, (II) LEE DONG SEOB -10% AND (3) ILGIN GLBAL CO. LTD ., - WHERE THE TWO SHAREHOLDERS OF DONG A AUTOMOTIVE LTD. HOLDS 100% S HARES. THE ASSESSEE COMPANY FOLLOWED CUP METHOD FOR DETERMIN ING ALP AFTER DISCUSSING SHAREHOLDING PATTERN OF THE HOLDING COMP ANY OF THE ITA 2182/10 SP 67/11 :- 37 - : ASSESSEE COMPANY. THE TPO HAS CONCLUDED THAT TRANSA CTIONS ENTERED BY ILGIN GLBAL COMPANY DOES NOT FIT INTO THE DESCRI PTION OF UNRELATED PARTIES AND HENCE THE TRANSACTIONS MADE BY IT MAY N OT BE TAKEN AS UNCONTROLLED TRANSACTIONS AT ARMS LENGTH. THE DRP HAS OPINED THAT THE METHOD OF PICKING UP COMPARABLES IS IN CONTRADI CTION WITH THE MANNER IN WHICH CUP IS TO BE APPLIED AS PRESCRIBE D UNDER RULE 10B(1)(A). THE DRP HAS FOUND THAT THE NARRATION OF TPO IN PARA-9 OF HER ORDER THAT THE ASSESSEE HAS NOT GIVEN THE WORKI NG AS PER ITS OBJECTIVE GIVEN VIDE LETTER DT.31.02.09 REBUTTING T HE ARGUMENT OF THE TPO. THE ASSESSEE HAS NOT PROVIDED WORKING IN RELA TION TO THE POINTS RAISED IN THE LETTERS AND TPO HAS GIVEN A CLEAR FIN DING THAT THE EXPENSES TO WHICH ASSESSEE HAS REFERRED TO ARE COMM ON TO BOTH THE ASSESSEE AS WELL AS OTHER COMPARABLES WHO HAVE ALSO IMPORTED ITEMS LIKE THE ASSESSEE. THE BASIS OF COMPUTATION OF SUC H ADJUSTMENTS BEFORE DRP ALSO COULD NOT BE PRODUCED. THEREFORE, WE ALSO FIND THAT IT IS COMMON FACTOR SHARED BY THE ASSESSEE WITH ITS CO MPARABLES AND THIS FACT HAS NOT BEEN REBUTTED ON RECORD. ASSESSEE COU LD NOT FURNISH ANY DOCUMENTS OR EVIDENCES TO DEPART FROM THE FINDING M ADE BY THE TPO. THE ASSESSEE HAS CLAIMED ADJUSTMENTS ON THE PLEA TH AT ITS PERIOD OF CREDIT IS 75 DAYS AGAINST OTHER COMPANIES WHO HAD T HE BENEFIT OF CREDIT OF ONLY 60 DAYS. BUT TO PROVE THIS FACTUM NO EVIDE NCE WAS BROUGHT ON ITA 2182/10 SP 67/11 :- 38 - : RECORD THAT OTHER COMPANIES HAD BENEFIT OF 30 TO 6 0 DAYS. REGARDING ADJUSTMENT OF CUSTOMS DUTY, IT IS FOUND THAT THE AS SESSEE AS WELL AS COMPARABLES HAD PAID THE CUSTOMS DUTY ON IMPORT AND THE PROCESS OF PRODUCT IS THE SAME AS THAT OF THE ASSESSEE. BUT S TILL WE ARE NOT CONVINCED THAT AS TO HOW THE TPO/ASSESSING OFFICER HAS PREFERRED TNMM METHOD OVER THE CUP METHOD. THE VARIOUS METHOD S AND THEIR APPLICABILITY HAS BEEN DISCUSSED BY US ELABORATELY IN THE FORMER PART OF THIS ORDER. BEFORE CHOOSING ANY OTHER APPROPRIATE METHOD, THE TPO IS BOUND TO EXPLAIN AS TO WHY THE CUP METHOD IS NOT APPLICABLE. HE HAS ALSO TO STATE AS TO WHY THE OTHER METHOD IS MOST AP PROPRIATE METHOD IN THE GIVEN FACTS AND CIRCUMSTANCES OF THE CASE. IN FACT, THE ASSESSING OFFICER HAS NOT PASSED A SPEAKING ORDER AND HAS SIMPLY MADE ADJUSTMENTS. THEREFORE, IN THE GIVEN FACTS AN D CIRCUMSTANCES OF THE CASE, WE ARE OF THE CONSIDERED OPINION THAT THI S MATTER NEEDS TO BE REMITTED BACK TO THE FILE OF THE ASSESSING OFFICER /TPO WITH A DIRECTION THAT HE WILL GIVE A CLEAR FINDING REGARDING (I) WHY THE CUP METHOD IS NOT APPROPRIATE METHOD IN THE GIVEN CASE? (II) HOW TNMM METHOD IS PREFERABLE TO THE CUP ME THOD ? (III) HE HAS TO ELABORATELY GIVE REASONS WITH DATA AS TO WHY HE IS ADOPTING TNMM METHOD AND AFTER ADOPTING THE SAME WH AT ARE THE EXACT ADJUSTMENTS TO BE CARRIED OUT, IF ANY IN THIS CASE ? ITA 2182/10 SP 67/11 :- 39 - : (IV) WHETHER THE ASSESSEE IS ENTITLED TO BENEFIT O F SEC.92C(2) OF THE ACT OR NOT ? THE ASSESSEE WILL BE AT LIBERTY TO PLEAD ITS CASE I N THE MANNER IT LIKES, IF SO ADVISED. THE ASSESSING OFFICER/TPO HAS TO GIVE OPPORTUNITY OF BEING HEARD TO THE ASSESSEE COMPANY. ACCORDINGLY, THIS APPEAL STANDS ALLOWED FOR STATISTICAL PURPOSES. 20. IN RESULT, THE APPEAL OF ASSESSEE STANDS ALLOW ED FOR STATISTICAL PURPOSES. THE STAY PETITION BECOMES INFRUCTUOUS. ORDER PRONOUNCED IN THE OPEN COURT O N 30.11.2011 /CONCURRING ORDER/ SD/- (DR. O.K. NARAYANAN) VICE-PRESIDENT (HARI OM MARATHA) JUDICIAL MEMBER DATED: 30 TH NOVEMBER, 2011 RD / KSS COPY TO: 1. APPELLANT 2. RESPONDENT 3. CIT(A) 4. CIT 5. DR ITA 2182/10 SP 67/11 :- 40 - : S.P.NO.67/MDS./2011 & I.T.A.NO.2182/MDS.2010 CONCURRING ORDER PER DR. O.K. NARAYANAN, VICE PRESIDENT WHILE DISTANCING FROM THE DISCUSSION MADE BY THE L EARNED JUDICIAL MEMBER IN PAGES 12 TO 35 IN PARAGRAPHS 10 TO 14 OF THE ORDER, ON THE LAW AND SUBJECT OF TRANSFER PRICING, I AGREE WITH HIS OPERATING ORDER REMITTING BACK THE CASE TO THE ASSE SSING OFFICER WITH A DIRECTION TO RE-DO THE TRANSFER PRICING ASSE SSMENT AFRESH, IN ACCORDANCE WITH LAW. THE CASE IS R EMITTED BACK TO THE ASSESSING OFFICER. 2. THE APPEAL IS TREATED AS ALLOWED FOR STATISTICAL PURPOSES. 3. THE STAY PETITION IS DISMISSED AS INFRUCTUOUS. SD/- (DR.O.K.NARAYANAN) VICE-PRESIDENT CHENNAI: DATED: 30 TH NOVEMBER, 2011 MPO* ITA 2182/10 SP 67/11 :- 41 - :