GAP International Sourcing (India) Pvt. Ltd., New Delhi V. ACIT, New Delhi

ITA 228/DEL/2012

• Counselvise Citation: 22820114 RSA 2012
• Duration Of Justice: 8 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 18-09-2012
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: C
• Next Hearing Date: 24-04-2012
• Assessment Year: 2006-2007
• Appeal Filed On: 13-01-2012
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Assessee Lawyers: RAHUL KRISHNA MITR A
• Keywords: Depreciation; Transfer pricing; Principle of natural justice; International transaction; Working capital adjustments; Wholly owned subsidiary

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH C NEW DELHI BEFORE SHRI R.P. TOLANI AND SHRI T.S. KAPOOR ITA NOS. 5147/DEL2011 & 228/DEL/2012 A.YRS. 2006-07 & 2007-08 GAP INTERNATIONAL SOURCING VS. ASSTT. COMMISSION ER OF (INDIA) PVT. LTD., INCOME-TAX, CIRCLE 12(1), B-1/1-2, MOHAN COOPERATIVE NEW DELHI. INDUSTRIAL ESTATE, MATHURA ROAD, NEW DELHI-110044. PAN: AACCG3437E ( APPELLANT ) ( RESPONDENT ) APPELLANT BY : SHRI RAHUL KRISHNA MITRA ADV. RESPONDENT BY : SHRI PIYUSH JAIN CIT ( DR) O R D E R PER R.P. TOLANI, J.M: : THESE ARE TWO APPEALS FILED BY THE ASSESSEE AGAIN ST ASSESSMENT ORDERS PASSED CONSEQUENT TO DIRECTIONS OF THE DISPU TE RESOLUTION PANEL-II, NEW DELHI U/S 144C(5) OF THE INCOME-TAX ACT, 1961, RELATING TO A.Y. 2006- 07 & 2007-08. RESPECTIVE GROUNDS ARE AS UNDER: ITA NO. 228/DEL/12 (A.Y. 2006-07) : 1. THE LEARNED DISPUTE RESOLUTION PANEL (LD. DRP ) AND THE LD. ASSISTANT COMMISSIONER OF INCOME-TAX (LD. A.O) (FOLLOWING THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW, IN ENHANCING THE INCOME OF THE APPELLANT BY RS . 236,22,31,473/- ON ACCOUNT OF THE TRANSFER PRICING (TP) ADJUSTMENT U/S 92CA(3) OF THE INCOME TAX ACT, 1961 (ACT) ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 2 2 MADE BY THE LD. ADDITIONAL COMMISSIONER OF INCOME-T AX, TRANSFER PRICING OFFICER 1(1) (LD. TPO). 2. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN UPHOLDING THE LD. TPOS STANCE OF NOT APPRECIATING THAT THE APPELLANT IS A LOW RISK SOURCING SUPPORT SERVICE PR OVIDER AND DISREGARDING THE FUNCTIONAL ASSET AND RISK (FAR) PROFIT OF THE APPELLANT, ON THE BASIS OF PRE-CONCEIVED NOTIONS, S URMISES AND CONJECTURES , AND WITHOUT ANY COGENT EVIDENCE, FACT S OR BASIS WHATSOEVER. 3. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN UPHOLDING THE LD. TPOS STANCE OF DISREGARDING THE CONSERVATIVE BENCHMARKING APPROACH ADOPTED BY THE A PPELLANT IN ITS TP DOCUMENTATION REPORT FOR THE YEAR (FULL F LEDGED DISTRIBUTORS CONVERTED INTO SERVICE PROVIDERS AFTER MAKING SUITABLE WORKING CAPITAL ADJUSTMENTS) TO SUBSTANTIA TE THE ARMS LENGTH NATURE OF ITS INTERNATIONAL TRANSACTIONS. 4. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN UPHOLDING THE LD. TPOS STANCE OF INCLUDING THE VA LUE OF THE GOODS SOURCED DIRECTLY BY THE AES OF THE APPELLANT FROM THIRD PARTY VENDORS IN THE COST BASE OF THE APPELLANT, FO R THE PURPOSE OF COMPUTING THE ARMS LENGTH PROFIT MARGIN OF THE APPELLANT ON THE ALLEGED GROUND THAT IT CREATED SUPPLY CHAIN AND HUMAN ASSET INTANGIBLES IN INDIA AND GENERATED LOCATION SAVINGS IN INDIA WHICH HAVE NOT BEEN FACTORED INTO IN ITS REMUNERATI ON MODEL. 5. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN UPHOLDING THE LD. TPOS STANCE OF REJECTING THE APP ELLANTS RELIANCE ON RELEVANT INTERNATIONAL JUDICIAL PRECEDE NTS ON ABSOLUTELY IRRELEVANT, INCONSISTENT AND EXTRANEOUS REASONS. 6. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN DISREGARDING THE DETAILED SUBMISSIONS AND EXTENSIVE ANALYSIS TO ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 3 3 DEMONSTRATE THAT THE SAID ADJUSTMENT(MADE BY THE LD . TPO) RESULTS INTO AN OPERATING PROFIT/ VALUE ADDED EXPEN SES (OP/VAE) RATIO OF 830.95% FOR THE APPELLANT, WHICH IS UNREALISTIC, IMPRACTICAL AND ABSURD. 7. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN APPLYING THE DECISION OF THE HONBLE DELHI TRIBUNAL RENDERED IN THE CASE OF LI & FUNG (INDIA) PVT. LTD. VS. DCIT IN THE CASE OF THE APPELLANT WITHOUT APPRECIATING THAT THE FAR PRO FILE OF THE APPELLANT WAS ENTIRELY DIFFERENT THAN THE ASSESSEE INVOLVED IN THE SAID CASE; AND ACCORDINGLY, THE SAID DECISION C OULD HAVE NO APPLICATION IN THE INSTANT CASE OF THE APPELLANT. 8. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW IN HOLDING THAT THE PROFIT LEVEL INDICATOR (PLI) ADOPT ED BY THE APPELLANT FOR SETTING THE PRICE AND ALSO TESTING TH E ARMS LENGTH ASPECT OF THE INTERNATIONAL TRANSACTIONS ENTERED IN TO BY THE APPELLANT WITH ITS ASSOCIATED ENTERPRISE, BEING OP/ VAE WAS NOT A VALID PLI FOR THE PURPOSES OF THE INDIAN TRANSFER PRICING REGULATIONS. 9. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED IN MISINTERP RETING DOCUMENTS AND EVIDENCES FILED BY THE APPELLANT TO H OLD THAT THE APPELLANT CREATED AND OWNED VALUABLE INTANGIBLES FO R DOING BUSINESS IN INDIA. 10. THAT THE LD. AO HAS ERRED ON FACTS AND IN LAW, IN ENHANCING THE INCOME OF THE APPELLANT BY RS. 2,702, 896 BY ALLOWING DEPRECIATION ON COMPUTER PERIPHERALS, PRIN TERS AND UPS @ 15% INSTEAD OF THE CORRECT RATE OF 60% AS ALL OWABLE UNDER THE INCOME TAX RULES, 1962. 11. WHILE ALLOWING DEPRECIATION @ 15%, THE LD. AO GROSSLY ERRED IN: - ERRONEOUSLY CONCLUDING THAT THE PRINTERS, SCANNER S, UPS ETC. CANNOT BE SAID TO BE PART AND PARCEL OF COMPUTER SY STEM AND HENCE HIGHER RATE OF DEPRECIATION IS NOT ADMISSIBLE ; ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 4 4 - DISREGARDING JUDICIAL PRONOUNCEMENTS (IN FAVOUR O F THE ASSESSEE ) WHILE MAKING THE PROPOSED ADJUSTMENT. 12. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CA SE AND IN LAW, THE LD. AO ERRED IN INITIATING PENALTY PROCEED INGS UNDER SECTION 271(1)(C) READ WITH SECTION 274 OF THE ACT. ITA NO. 5147/DEL/11 (A.Y. 2007-08) : 1. THE LEARNED DISPUTE RESOLUTION PANEL (LD. DRP ) AND THE LD. ASSISTANT COMMISSIONER OF INCOME-TAX (LD. A.O) (FOLLOWING THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW, IN ENHANCING THE INCOME OF THE APPELLANT BY RS . 2,628,618,693/- ON ACCOUNT OF THE TRANSFER PRICING (TP) ADJUSTMENT U/S 92CA(3) OF THE INCOME TAX ACT, 1961 (ACT) MADE BY THE LD. ADDITIONAL COMMISSIONER OF INCOME-T AX, TRANSFER PRICING OFFICER 1(2) (LD. TPO). 2. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON FACTS AND IN LAW: 2.1. IN UPHOLDING THE LD. TPOS STANCE OF NOT APPRE CIATING THAT THE APPELLANT IS A LOW RISK SOURCING SUPPORT S ERVICE PROVIDER AND DISREGARDING THE FUNCTIONAL ASSET AND RISK (FA R) PROFILE OF THE APPELLANT, ON THE BASIS OF PRE-CONCEIVED NOTION S, SURMISES AND CONJECTURES , AND WITHOUT ANY COGENT EVIDENCE, FACTS OR BASIS WHATSOEVER. 2.2. IN UPHOLDING THE LD. TPOS STANCE OF DISREGARD ING THE CONSERVATIVE BENCHMARKING APPROACH ADOPTED BY THE A PPELLANT IN ITS TP DOCUMENTATION REPORT FOR THE YEAR (FULL F LEDGED DISTRIBUTORS CONVERTED INTO SERVICE PROVIDERS AFTER MAKING SUITABLE WORKING CAPITAL ADJUSTMENTS) TO SUBSTANTIA TE THE ARMS LENGTH NATURE OF ITS INTERNATIONAL TRANSACTIONS. 2.3. IN UPHOLDING THE LD. TPOS STANCE OF INCLUDIN G THE VALUE OF THE GOODS SOURCED DIRECTLY BY THE AES OF THE APP ELLANT FROM THIRD PARTY VENDORS IN THE COST BASE OF THE APPELLA NT, FOR THE PURPOSE OF COMPUTING THE ARMS LENGTH PROFIT MARGIN OF THE APPELLANT ON THE ALLEGED GROUND THAT IT CREATED SUP PLY CHAIN AND ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 5 5 HUMAN ASSET INTANGIBLES IN INDIA AND GENERATED LOCA TION SAVINGS IN INDIA WHICH HAVE NOT BEEN FACTORED INTO IN ITS R EMUNERATION MODEL. 2.4. IN UPHOLDING THE LD. TPOS STANCE OF REJECTING THE APPELLANTS RELIANCE ON RELEVANT INTERNATIONAL JUDI CIAL PRECEDENTS ON ABSOLUTELY IRRELEVANT, INCONSISTENT AND EXTRANEO US REASONS. 2.5. IN DISREGARDING THE DETAILED SUBMISSIONS AND E XTENSIVE ANALYSIS TO DEMONSTRATE THAT THE SAID ADJUSTMENT(MA DE BY THE LD. TPO) RESULTS INTO AN OPERATING PROFIT/ VALUE AD DED EXPENSES (OP/VAE) RATIO OF 830.95% FOR THE APPELLANT, WHICH IS UNREALISTIC, IMPRACTICAL AND ABSURD. 3. THE LD. DRP AND CONSEQUENTLY THE LD. AO (FOLLOWI NG THE DIRECTIONS OF THE LD. DRP), ERRED ON THE PRINCI PLES OF NATURAL JUSTICE TO PASS A PROPER AND SPEAKING DIRECTION UND ER SECTION 144C OF THE ACT: 3.1. IN DISREGARDING THE VARIOUS SUBMISSIONS AND EX TENSIVE/ VOLUMINOUS DOCUMENTARY EVIDENCE FILED BY THE APPELL ANT DURING THE COURSE OF THE DRP/ ASSESSMENT PROCEEDINGS SUBS TANTIATING ITS ACTUAL FAR PROFILE. 3.2. IN FAILING TO PROVIDE THE APPELLANT A REASONAB LE OPPORTUNITY TO EXPLAIN THE CONTENTS OF EXTENSIVE/ V OLUMINOUS DOCUMENTARY EVIDENCE FILED BY THE APPELLANT DURING THE COURSE OF THE DRP/ ASSESSMENT PROCEEDINGS DESPITE VERBALL Y ACKNOWLEDGING DURING THE DRP PROCEEDINGS THAT THE LD. TPO HAD FAILED TO EXAMINE SUCH NECESSARY DOCUMENTARY AN D EVIDENCES AND THAT THE TPO WOULD BE DIRECTED TO EXA MINE THE SAME AND PROVIDE HIS COMMENTS TO THE LD. DRP, A FAC T WHICH THE APPELLANT ALSO FILED ON RECORD WITH THE DRP VID E A LETTER DATED JULY 27,2011 BEFORE PASSING OF THE FINAL DIRE CTIONS BY THE DRP. 1.1. THIS IS THE SECOND ROUND OF PROCEEDINGS BEFORE ITAT IN RESPECT OF A.Y. 2006-07 AND FIRST ROUND FOR A.Y. 2007-08. IN ORIGINAL PROCEEDINGS FOR ASSESSMENT YEAR 2006-07 SIMILAR ADJUSTMENT WERE PRO POSED BY TRANSFER ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 6 6 PRICING OFFICER (TPO) FOR THE ASSESSMENT YEAR (AY) 2006-07, WHICH WERE FOLLOWED BY AO AND A DRAFT ASSESSMENT ORDER WAS PRO POSED ACCORDINGLY. ASSESSEE APPROACHED THE DISPUTE RESOLUTION PANEL ( DRP), WHICH CONFIRMED THE ORDER OF AO BY A NON-SPEAKING ORDER. THE ASSESS EE FILED AN APPEAL BEFORE THE INCOME TAX APPELLATE TRIBUNAL (ITAT) IN THIS REGARD. THE ITAT, RESTORED THE CASE BACK TO THE DRP FOR FRESH ADJUDI CATION WITH DIRECTIONS TO PASS A SPEAKING AND REASONED ORDER AFTER CONSIDERIN G THE EVIDENCE AND SUBMISSIONS/ DOCUMENTS PRESENTED BY THE ASSESSEE. D URING THE PENDENCY OF SET ASIDE PROCEEDINGS FOR A.Y. 2006-07, DRP UPHELD SIMILAR ADJUSTMENTS FOR A.Y. 2007-08. THEREAFTER DRP RE-HEARD THE MATTER F OR A.Y. 2006-07 AND UPHELD THE ENTIRE TP ADJUSTMENTS AND AOS ORDER THER EON. AGGRIEVED ASSESSEE IS BEFORE US IN BOTH THE YEARS. 2. BRIEF FACTS ARE ASSESSEE (REFERRED TO AS GIS INDIA) IS A WHOLLY OWNED SUBSIDIARY OF GAP INTERNATIONAL SOURCING INC. , USA, REFERRED TO AS (GIS INC.). DURING THE AY 2006-07, THE APPELLANTS BUSINESS ACTIVITY IS CLAIMED TO FACILITATE SOURCING OF APPAREL MERCHAND ISE FROM INDIA FOR THE GAP GROUP. PRIOR TO THIS YEAR SIMILAR SERVICES WERE PROVIDED BY A LIAISONING OFFICE, AFTER INCORPORATION AS WHOLLY OWNED SUBSIDI ARY SIMILAR SERVICES ARE RENDERED BY THIS ASSESSEE. IT SHALL BE PERTINENT T O MENTION THAT LO WAS REMUNERATED AT COST+15% FOR THESE SERVICES. 2.1. ASSESSEE FILED ITS TP REPORT CLAIMING TRANSACT IONAL NET MARGIN METHOD (TNMM) WITH COST PLUS 15% REMUNERATION TO BE MOST APPROPRIATE METHOD FOR DETERMINATION OF ARMS LENGTH PRICE ALP . TPO, HOWEVER LOOKING AT THE FAR AND OTHER FACTORS WHICH ARE MENT IONED HEREIN BELOW, REJECTED ASSESSEES COST PLUS 15% ALP AND HELD THAT COMMISSION @ 5% ON ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 7 7 THE FOB VALUE OF GOODS SOURCED BY THE FOREIGN ENTER PRISE THROUGH INDIAN VENDORS WAS THE MOST APPROPRIATE PLI FOR DETERMININ G ALP. TPOS REPORT HAS BEEN ACCEPTED BY DRP. THUS APART FROM OTHER ISS UES MAIN ISSUE FOR OUR ADJUDICATION IS, WHETHER PLI BASED ON COST PLUS MAR K-UP OR 5% OF COMMISSION ON FOB VALUE OF GOODS FACILITATED BY THE ASSESSEE FOR OUTSOURCING IS THE MOST APPROPRIATE IN GIVEN CIRCUM STANCE. 3. LD. COUNSEL FOR THE ASSESSEE SHRI RAHUL MITRA F CA, VEHEMENTLY ARGUES THAT AS A FACILITATOR FOR SOURCING OF APPARE L MERCHANDISE FROM INDIA BY THE ASSOCIATED ENTERPRISES (AES), THE APPELLANT O PERATES AS A LIMITED RISK BEARING SOURCING SUPPORT SERVICE PROVIDER. IN RESPECT OF THIS ACTIVITY, THE APPELLANT IS REMUNERATED ON A COST PLUS 15% MARK-UP BASIS FOR ACTING AS A CO-ORDINATION ARM FACILITATOR/ INTERFACE BETWEEN THE THIRD PARTY VENDORS IN INDIA AND ITS OVERSEAS AES. THERE IS A MARKED DIFFE RENCE BETWEEN A RISK BEARING AGENT AND LOW RISK FACILITATOR, THE LATER A MOUNTS TO A SERVICE PROVIDER ONLY. 3.1. DURING THE TP PROCEEDINGS FOR THE YEAR, THE LD . TPO DISREGARDED ASSESSEES FUNCTIONAL-ASSET-RISK (FAR) CHARACTERIZA TION. IT HAS BEEN ASSUMED THAT THE FUNCTIONS PERFORMED, ASSETS OWNED AND RISKS ASSUMED BY THE APPELLANT WERE SUBSTANTIALLY MORE THAN LIMITED RISK AND LOW VALUE ADDING SOURCING SUPPORT SERVICES. IT HAS BEEN SURMISED THA T IT CREATED SUBSTANTIAL INTANGIBLE ASSETS THROUGH ITS OPERATIONS, IGNORING THAT A.Y. 2006-07 WAS ONLY THE FIRST YEAR OF ASSESSEE SUBSIDIARY. THE LD. TPO ALSO ALLEGED THAT ON ACCOUNT OF OPERATING IN A LOW COST ECONOMY, THE ASS ESSEE HAD GENERATED LOCATION SAVINGS IN INDIA WHICH HAVE NOT BEEN FACTO RED INTO IN ITS REMUNERATION MODEL. TPO THUS REJECTED THE ASSESSEES COST PLUS BASED ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 8 8 REMUNERATION MODEL ON THE BASIS OF THEORETICAL ASSU MPTIONS, WHICH ARE UNSUSTAINABLE AND NOT BASED ON ANY EVIDENCE. ACCORD INGLY, THE LD. TPO HELD THE REMUNERATION MODEL OF COST-PLUS 15% TO BE NOT IN LINE WITH THE ARMS LENGTH STANDARDS 3.2. TPO RECONSTRUCTED THE PROFIT & LOSS ACCOUNT OF THE APPELLANT BY NOTIONALLY BRINGING THE VALUE OF GOODS SOURCED BY O VERSEAS AES FROM INDIA, WHICH WERE NEITHER FULLY SOURCED THROUGH IT NOR ROU TED THROUGH ITS FINANCIAL ACCOUNTS AND ITS PROFIT & LOSS ACCOUNT. THIS RESULT ED IN PHENOMENALLY EXORBITANT TP ADJUSTMENT OF RS. 2,362,231,473 IN A. Y. 2006-07 AND RS. 2,628,618,693 IN A.Y. 2007-08. 3.3. ASSESSEE APPROACHED DRP WHERE COPIOUS WRITTEN SUBMISSIONS AND ARGUMENTS IN SUPPORT OF ITS FAR PROFILE AS A LIMITED RISK BEARING SOURCING SUPPORT SERVICE PROVIDER WERE SUBMITTED. IT WAS CLA IMED THAT ASSESSES PRIMARY BUSINESS ACTIVITY COMPRISED IDENTIFICATION OF VENDORS, PROVISION OF ASSISTANCE TO VENDORS IN PROCUREMENT OF RAW MATERIA L, INSPECTION AND QUALITY CONTROL, AND CO-ORDINATION WITH VENDORS TO ENSURE D ELIVERY OF GOODS TO GAP GROUP AS PER SCHEDULE SUPPLIED BY GAP INC. 3.5. DRP HOWEVER RECONFIRMED THE ADDITIONS, HENCE T HESE APPEALS. 4. LD COUNSEL FOR THE ASSESSEE FURTHER CONTENDS THA T: (I) THE LIST OF ACTIVITIES CARRIED OUT BY THE APPEL LANT AS A SOURCING SUPPORT SERVICE PROVIDER AS PER SERVICE AND SUPPOR T AGREEMENT PLACED ON THE PAPER BOOK , ARE AS UNDER: - PRODUCT PURCHASE SUPPORT SERVICES RELATING TO QUA LITY CONTROL AND QUALITY ASSURANCE AND CONDUCTING PRODUCT MONITORING AND ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 9 9 MERCHANDISE MONITORING OF GOODS MANUFACTURED BY IND EPENDENT FACTORIES TO ASSURE TIMELY DELIVERY OF PRODUCT; - SUPPORT SERVICES FOR THE EXPORTATION OF PURCHASED PRODUCTS; - PURCHASING SUPPORT SERVICES RELATING TO IDENTIFYI NG AND EVALUATING NEW VENDORS; AND - ACT AS A LIAISON BETWEEN GIS INC. AND LOCAL VENDO RS. (II) THE SERVICES ARE SAME AS UNDERTAKEN BY EA RLIER LIAISON OFFICE, WHERE ALP WORKING AT COST + 15% BASIS HAS BEEN ACCE PTED. IN PERFORMANCE OF THE ABOVE MENTIONED SERVICES, THE NE CESSARY INPUTS I.E. SPECIFICATIONS AND DESIGNS OF THE PRODUCTS TO BE SO URCED, NAMES AND ADDRESSES OF VENDORS/ MANUFACTURERS, DETAILED INFOR MATION ON POTENTIAL OR NEW VENDORS, OPERATING SOFTWARES, TRAINING MATERIAL , OPERATING AND PROCESS KNOW-HOW ETC., WERE ALL PROVIDED BY THE AES . THE ASSESSEE HAS INHERITED THE SET UP ENJOYED BY L/A. (III) BESIDES, AS PER THE INTANGIBLE PROPERTY CLA USE OF THE SERVICE AND SUPPORT AGREEMENT, GAP GROUP PROVIDES THE FOLLO WING INFORMATION TO THE ASSESSEE : - VENDOR LIST CONTAINING BUSINESS INFORMATION RELAT ING TO THE ON-GOING SOURCING OF MERCHANDISE, YARN, FABRICS, TRIM AND PA CKAGING, WHICH INCLUDES NAME OF MANUFACTURERS OR VENDORS, ITEMS, P RODUCTION CAPACITY, PRICE, PRODUCTION LEAD TIME, AND QUALITY; INFORMATION ON BRANDED LABELS, ZIPPERS, BUTTONS, PLASTIC NOTIONS, SNAP FASTENERS, HASP AND SLIDERS, INTERLINING, METAL BUTTONS/BURRS AND R IVETS; AND INFORMATION ON PRINTED PAPER AND PLASTIC; ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 10 10 - BUSINESS INFORMATION RELATING TO EXISTING OR POTE NTIAL NEW MANUFACTURING VENDORS AND THEIR FACILITIES INCLUDES NAME OF VENDOR COMPANIES OR MANUFACTURING PLANTS, NAME OF REPRESEN TATIVES, ADDRESSES, TELEPHONE NUMBERS, FAX NUMBERS, EMAIL AD DRESSES, PRODUCTION OR SUPPLY ITEMS, SIZE OF OPERATIONS, PRO DUCTION FACILITIES, PRODUCTION CAPACITY, AND NUMBER OF EMPLOYEES; - INFORMATION PERTAINING TO SAMPLE DEVELOPMENT AND CONFIRMED SAMPLE ORDERS, WHICH INCLUDES RECORDS ON SAMPLE DEVELOPERS , SAMPLE MATERIALS, SEASONAL SAMPLES, AND SAMPLES OF PRODUCT S THAT HAS BEEN PRODUCED AND SHIPPED IN ACCORDANCE WITH GAP GROUPS INSTRUCTIONS; - SOFTWARE OR OTHER BUSINESS PROCESSES USED TO ORDE R AND TRACK MERCHANDISE OR USED IN ANY OTHER WAY WITH SOURCING ACTIVITIES; - TRAINING MATERIALS DEVELOPED EITHER BY GIS INDIA OR BY GAP GROUP; - ALL KNOW-HOW, PROCESSES AND TRADE SECRETS RELATIN G TO SOURCING ACTIVITIES; - ALL CONFIDENTIAL AND PROPRIETARY INFORMATION RELA TING TO SOURCING ACTIVITIES; - SIMILAR ITEMS AS NOW EXIST OR THAT MAY EXIST IN T HE FUTURE THAT ARE DEVELOPED EITHER BY GIS INDIA, GAP GROUP OR AN AFFI LIATE OF GAP GROUP IN CONNECTION WITH SOURCING ACTIVITIES. (IV) THUS THE RELEVANT, ASSETS REQUIRED FOR THE BUS INESS (INCLUDING INTANGIBLE ASSETS) LIKE VENDOR LISTS, BUSINESS INFO RMATION, SOFTWARE, BUSINESS PROCESSES, ETC. ARE DEVELOPED AND OWNED BY GAP INC. AND ARE PROVIDED TO THE APPELLANT FOR THE CONDUCT OF ITS BU SINESS. THUS ASSESSEE HAS TO RENDER SERVICE ON A FULLY GUIDED MODAL AND D OES NOT INVOLVE OWING ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 11 11 OR DEPLOYMENT OF INTANGIBLES. IT HAS TO FOLLOW THE INSTRUCTIONS WITH NO RISK VIS-A-VIS THIRD PARTY VENDORS OR GAP ENTITIES. (V) GIS INDIA AND GIS INC. HAD ENTERED INTO A LEGA LLY BINDING AGREEMENT WHICH STIPULATES THE ROLE AND RESPONSIBI LITIES OF BOTH THE PARTIES TO THE AGREEMENT. THEY HAVE NOT BEEN CONSID ERED AT ALL BY THE LD. TPO AS WELL AS LD. DRP. LD. TPO, REJECTED ALL THESE PERTINENT LEGAL AGREEMENTS AND VOLUMINOUS DOCUMENTS FURNISHED BY TH E ASSESSEE IN SUPPORT OF ITS CLAIMS. TPO/AO DID NOT ADDUCE ANY SU PPORTING INFORMATION/ DOCUMENTS TO COUNTER THE ASSESSEES C ONTENTIONS AND SUPPORT THEIR OWN PROPOSITIONS. APPELLANT BROUGHT O N RECORD, BEFORE THE LD. TPO AS WELL AS THE LD. DRP, A NUMBER OF EVIDENT IARY INFORMATION/ VOLUMINOUS DOCUMENTS TO SUBSTANTIATE ITS ARGUMENTS WHICH HAVE BEEN SUMMARILY OVERLOOKED. (VI) GOODS SOURCED BY THE AES FROM INDIA ARE DIRECT LY SOLD BY THE THIRD PARTY VENDORS TO THE OVERSEAS AES. THE APPELL ANTS ROLE IN THE ENTIRE PROCESS IS LIMITED TO PROVISION OF LIAISONIN G SUPPORT SERVICES . (VII) THE AUTHORITIES BELOW HAVE FAILED TO APPRECIA TE THE CRUCIAL POINTS THAT GIS INC. AND NOT THE ASSESSEE HAS NO RO LE TO PLAY IN SEVERAL KEY AND CRITICAL ACTIVITIES IN THE GROUPS VALUE CHAIN SUCH AS: - DEVELOP GLOBAL SOURCING STRATEGIES; - DELIVER GLOBAL COST OF GOODS TARGETS AND SAVINGS; - DEVELOP GLOBAL SOURCING POLICIES, PROCEDURES AND STANDARDS; - DEVELOP GLOBAL SOURCING ORGANIZATION AND OPERATIN G STRUCTURE; - MANAGE GLOBAL SOURCING ORGANIZATION; ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 12 12 - OWN AND MAINTAIN VENDOR RELATIONSHIPS; - AUTHORIZE AND NEGOTIATE CONTRACTS WITH FREIGHT FO RWARDERS, CARRIERS, DELIVERY AND OTHER LOGISTICS COMPANIES; - FACTORY AND MILL RELATIONSHIP MANAGEMENT, INCLUDI NG BUILDING AND DEVELOPING STRATEGIC RELATIONSHIPS; - LONG-RANGE PLANNING WITH VENDORS AND MILLS FOR CA PACITY PLANNING; - VENDOR LEVEL PLACEMENT DECISIONS FOR SAMPLES AND BULK PRODUCTION AND DIRECT NEGOTIATIONS WITH VENDORS ON COST, DELIV ERY, AND QUALITY; AND - EXCEPTION MANAGEMENT TO RESOLVE PRODUCTION ISSUES . (VIII) GIS INC. ALSO BEARS ALL THE RELEVANT RISKS I N CONNECTION WITH UNDERTAKING THE ABOVE ACTIVITIES AND NO RISK IS ATT RIBUTABLE TO ASSESSEE WHICH IS A KEY FACTOR IN DETERMINING THE FAR. IN TH E SOURCING VALUE CHAIN, THE APPELLANTS ROLE IS LIMITED TO OPERATING WITHIN THE CONFINES OF THE REQUIREMENTS/ STANDARDS PRESCRIBED BY OVERSEAS AES. IT PERFORMS STRICTLY ROUTINE/ LOW VALUE-ADDING ACTIVITIES AND D OES NOT BEAR ANY OF THE KEY BUSINESS RISKS SUCH AS MARKET RISK, PRODUCT LIA BILITY RISK, PRODUCT DESIGN AND DEVELOPMENT RISK, CREDIT RISK, PRICE RIS K, FOREIGN EXCHANGE RISK ETC. (IX) THERE IS NEITHER ANY BASIS NOR SUPPORTING FAC TUAL DATA FOR TPO TO REACH THE CONCLUSION THAT THE APPELLANT HAD CREA TED ANY VALUABLE / NON- ROUTINE INTANGIBLES, FOR WHICH A RETURN ON VALUE OF GOODS SOURCED BY OVERSEAS AES WAS REQUIRED AS CONSIDERATION. LD. TPO MERELY MADE A BALD ASSUMPTION THAT THE APPELLANT HAD CREATED VAL UABLE SUPPLY CHAIN AND HUMAN ASSET INTANGIBLES WITHOUT GIVING PROPER REASONINGS EVIDENTIAL DATA / PROOF WHATSOEVER TO SUGGEST THAT ANY INTANGI BLES HAVE BEEN CREATED. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 13 13 (X) IT IS ERRONEOUSLY PRESUMED THAT THE 210 PEOPLE EMPLOYED WITH GIS INDIA DURING THE YEAR WERE KEY DECISION MAKING EMPL OYEES OF THE COMPANY. IT IS EMPHASIZED THAT GIS INDIAS ROLE IS TO OPERATE STRICTLY WITHIN THE CONFINES OF THE STANDARDS PRESCRIBED BY THE OVERSEAS GAP GROUP COMPANIES, WHERE ALL THE KEY DECISIONS WITH R EGARD TO PRODUCT DESIGN AND QUALITY, VENDOR ACCEPTABILITY/ REJECTION , VENDOR PRICING, ETC. ARE TAKEN SOLELY BY THE GROUP COMPANIES AND THE RIS KS ARISING THERE FROM ARE ALSO BORNE ENTIRELY BY THE GROUP COMPANIES. AS SESSEES EMPLOYEES HAVE NOT GONE BEYOND THESE CONFINES. (XI) THE FACT REMAINS THAT THE 210 EMPLOYEES OF GIS INDIA WERE ENGAGED IN ACTIVITIES OF A SUPPORT NATURE, WITH NO DECISION MAKING OR ENTREPRENEURIAL ROLE EMBEDDED IN THEIR WORK PROFILE S. TPO EXCEPT QUOTING THE NUMBERS HAS OFFERED NO REASONS AS TO HOW THEIR ACTIVITIES LED TO CREATION/ DEVELOPMENT OF ANY VALUABLE SUPPLY CHAIN OR HUMAN ASSET. MOST OF THESE EMPLOYEES ARE ADMINISTRATIVE STAFF, GRADUA TES AND SOME OF THEM DIPLOMA HOLDERS IN DESIGNS AND PROCUREMENT AND ARE ABUNDANTLY AVAILABLE IN THE MARKET. (XII) ALL THE SUPPLY CHAIN RELATED INTANGIBLES SUCH AS VENDOR/ FABRIC SUPPLIER LISTS, SAMPLING PROCEDURES/ TECHNIQUES/ PR OCESSES, QUALITY CONTROL STANDARDS, ETC., ARE OWNED BY THE OVERSEAS GAP GROU P COMPANIES AND NOT GIS INDIA. THE ASSESSEE HAS TO CARRY OUT ITS FUNCT IONS STRICTLY AS PER THE SERVICE AGREEMENT BETWEEN GIS INDIA AND GIS INC. TH US, GIS INDIA PERFORMS A LIMITED ROLE AND BEARS LIMITED / MINIMAL RISKS AS A RESULT OF ITS STANDALONE LIAISONING AND CO-ORDINATION ACTIVITIES, UNDERTAKEN ON THE DETAILED GUIDELINES, STANDARDS, MANUALS, POLICES AN D PROCEDURES DEVELOPED / CREATED BY THE OVERSEAS GROUP COMPANIES . ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 14 14 5. THE RELEVANT DOCUMENTS SUBMITTED BY THE APPELLAN T TO SUPPORT ITS CONTENTIONS INCLUDE: - VENDOR HANDBOOK/ MANUAL WHICH DEMONSTRATE THE POL ICIES/ PROCESSES DEVELOPED/ SET BY THE GAP GROUP, WHICH IS A PART OF THE CORE INTANGIBLE PROPERTY DEVELOPED BY THE GAP GROUP OVER THE YEARS. - VENDOR COMPLIANCE AGREEMENT ENTERED INTO BETWEEN THE GAP RETAIL COMPANIES AND THE INDIAN VENDOR DESCRIBING IN THE C LAUSE IV (VENDORS REPRESENTATION AND WARRANTY OF ORIGINALI TY OF PRODUCT DESIGN SUPPLIED BY VENDOR) AND CLAUSE V ('PRODUCT PERFORMANCE STANDARDS AND PROCEDURES') THAT THE VENDOR BEARS TH E WARRANTY AND LIABILITY OF THE PRODUCT IN THE EVENT OF NOT MEETIN G THE SPECIFICATIONS AND REQUIREMENTS SET AND PRESCRIBED BY GAP US. - EXTRACT OF VENDOR COMPLIANCE HANDBOOK/ MANUAL WHICH CONTAINS A FORMAT OF THE VENDOR COMPLIANCE AGREEMENT AS WELL A S CONDITIONS THAT IN THE EVENT OF FAILURE TO COMPLY WITH ANY TERM OR REQUIREMENT OF A PURCHASE ORDER, RETAIL COMPANIES SHALL BE ENTITLED TO CANCEL, REJECT SHIPMENTS, INSIST ON RE-PERFORMANCE, WITHHOLD PAYME NTS, RECOVER COST, OFFSET ANY AMOUNTS DUE, ETC. THIS DEMONSTRATES THA T THE PRODUCT LIABILITY IN CASE OF DEFECT RESTS WITH THE VENDORS AND GIS INDIA DOES NOT HAVE ANY ROLE TO PLAY IN THIS REGARD. THUS THER E IS NO RISK INVOLVED ON THIS ACCOUNT. - SAMPLE DOCUMENTS TO SUBSTANTIATE THAT ALL PRODUCT LIABILITY CLAIMS ARE SETTLED BETWEEN GAP GROUP AND THE VENDOR AND GIS IN DIA ONLY ACTS AS A COORDINATOR WITH NO FINANCIAL IMPACT WHATSOEVER. - SAMPLE DOCUMENTS TO SUBSTANTIATE THAT GAP GROUP D IRECTLY MAINTAINS ALL VENDOR RELATIONSHIPS. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 15 15 - SAMPLE DOCUMENTS TO SUBSTANTIATE THAT GAP GROUP D RIVES ALL QUALITY CONTROL STRATEGY, STANDARD AND MANAGEMENT REQUIREME NT, WHEREAS GIS INDIA SIMPLY FOLLOWS THE INSTRUCTIONS GIVEN THEREIN WHICH BELIES THE ALLEGATION THAT ASSESSES EMPLOYEES AMOUNTED TO A HU MAN ASSET AND THERE WAS CREATION OF ANY INTELLECTUAL PROPERTY. - SAMPLE DOCUMENTS TO SUBSTANTIATE THAT GAP GROUP D RIVES ALL MARKET INTELLIGENCE AND PRODUCT COSTING STRATEGIES WHICH A RE FOLLOWED BY GIS INDIA FOR PERFORMING ITS FUNCTIONS. - SAMPLE DOCUMENTS INCLUDING STRATEGY MEETINGS COND UCTED BY GAP GROUPS LEADERSHIP TEAM AND GUIDANCE PROVIDED TO LO CAL TEAMS INCLUDING GISS INDIA ON VARIOUS VENDOR NEGOTIATING POINTS. - SAMPLE DOCUMENTS CONTAINING AGENDA CIRCULATED FOR THE 2 DAY U.S. GLOBAL SOURCING TEAM MEETING WHICH SUBSTANTIATE THA T GAP GROUP DRIVES ALL CRITICAL EFFORTS RELATED TO GLOBAL SOURC ING STRATEGY. - COPIES OF EMAIL CORRESPONDENCES BETWEEN THE APPEL LANT AND ITS OVERSEAS COUNTERPARTS, TO SUPPORT THE FACT THAT ALL THE KEY ACTIVITIES IN THE VALUE CHAIN ARE PERFORMED BY THE OVERSEAS GROUP ENTITIES, WHILE THE APPELLANTS ROLE IS LIMITED TO OPERATING AS A ROUTI NE/ LIMITED RISK- BEARING CO-ORDINATION AND FACILITATION SERVICE PROV IDER. - ANNUAL REPORT OF GAP INC . (THE ULTIMATE PARENT OF THE GAP GROUP) FOR FINANCIAL YEAR ENDED DECEMBER 2005 (RELEVANT TO INDIA AY 2006- 07) WHICH DEPICTS THAT GAP INC. CLASSIFIES THE TOTA L COST OF SOURCING OPERATIONS (INCLUDES THE ENTIRE COST OF INDIAN SOUR CING OPERATIONS) UNDER THE HEAD COST OF GOODS SOLD AND OCCUPANCY EX PENSES WHICH IS DIFFERENT FROM THE COST OF DESIGN AND DEVELOPMEN T WHICH IS CLASSIFIED AS VALUE ADDED EXPENSE, DEMONSTRATE THE FACT THAT THE DESIGN/ DEVELOPMENT FUNCTION IS CARRIED OUT ENTIREL Y IN USA . ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 16 16 - SAMPLE COPIES OF MEMOS/ DOCUMENTS/ DESIGNS CREATED BY GAP US AND SENT TO THE APPELLANT (OVER E-MAILS) EVIDENCING THE FACT THAT THE KEY ACTIVITIES IN THE VALUE CHAIN, NAMELY PRODUCT DESIG NING, TAKING ALL VENDOR AND SOURCING RELATED DECISIONS, SETTING QUAL ITY CONTROL NORMS ETC., ARE PERFORMED BY THE OVERSEAS GROUP ENTITIES. - DOCUMENT PRESENTING/ DEPICTING THE ENTIRE PRODUCT PROCESS (FROM CONCEPT TO LINE-FREEZE), AGAIN EVIDENCING THAT ALL KEY DECISIONS ARE PERFORMED/ UNDERTAKEN IN THE US BY THE RELEVANT GAP US EMPLOYEES/ PERSONNEL. - DOCUMENTS SETTING OUT THE IN-SEASON/ PRE-SEASON M EETING SCHEDULES CLEARLY EVIDENCING THAT ALL KEY DECISIONS ARE PERFO RMED/ UNDERTAKEN IN THE US BY THE RELEVANT GAP US EMPLOYEES/ PERSONNEL. - LIST OF EMPLOYEES WORKING IN US FOR GAP GROUPS D ESIGN, PRODUCTION AND TECHNICAL SERVICE TEAMS. THESE LISTS AMPLY DEMO NSTRATE THE FACT THAT THE DESIGN/ DEVELOPMENT FUNCTION IS CARRIED OU T ENTIRELY OUTSIDE INDIA. - MEMO FROM GAP US STATING THAT THE VENDOR HANDBOOK IS CREATED ONLY BY GAP US AND ONLY GAP US IS AUTHORIZED TO MAKE ANY CHANGES TO IT. - SAMPLE COPIES OF PURCHASE ORDERS WHICH CLEARLY ES TABLISH THE FACT THAT THE GOODS ARE DIRECTLY SOLD BY GAP INC. FROM THE TH IRD PARTY VENDORS. - RELEVANT EXTRACTS OF THE COMPANYS WEBSITE CLEARLY EVIDENCING/ CORROBORATING THE FACT THAT THE DESIGN/ DEVELOPMENT FUNCTION IS UNDERTAKEN ESSENTIALLY IN US, BUT CERTAINLY NOT IN INDIA. - PROCESS MAPS WHICH DOCUMENT THAT DESIGN, SPECIFIC ATION DEVELOPMENT AND FABRIC DEVELOPMENT ALL OCCUR IN THE US WHILE GI S INDIA PLAYS A LIMITED LIAISON ROLE. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 17 17 - SPREADSHEETS THAT CONTAIN THE US DESIGN, MERCHAND ISING AND SOURCING COSTS FOR YEARS 2005 AND 2006 AS WELL AS GIS INDIA OPERATING COSTS FOR THE SAME PERIOD. THE DISPARITY IN THE COSTS INCURR ED BY US GROUP ENTITIES VIS--VIS GIS INDIA INDICATES THE RELATIVE VALUE ADDITION DONE IN THE US VIS--VIS INDIA. 5.1. THERE IS NO SUBSTANCE IN TPOS HOLDING THAT GI S INDIA HAS ALSO BORNE MAJOR BUSINESS RISKS ARISING FROM ITS ACTIVITIES. T HE LD. TPO HAS NOT GIVEN ANY EXAMPLES TO DEMONSTRATE AS TO WHICH MAJOR BUSIN ESS RISKS IS BORNE BY GIS INDIA AND HOW. IT HAS BEEN MERELY STATED THAT S INCE FUNCTIONS FOLLOW RISKS, AND GIS INDIA UNDERTAKES KEY FUNCTIONS, THER EFORE IT MUST HAVE ALSO BORN THE CONSEQUENT RISKS. THIS AMOUNTS TO A MERE G UESS WORK AND SURMISE. 5.2. IT HAS BEEN MAINLY ALLEGED THAT THE APPELLANT IS OPERATING IN A LOW COST ECONOMY AND HAS GENERATED LOCATION SAVINGS IN INDIA WHICH HAVE NOT BEEN FACTORED INTO IN ITS REMUNERATION MODEL OF CHARGING VALUE ADDING (OPERATING) EXPENSES PLUS A MARK-UP OF 15%. IT IS WORTHWHILE TO MENTION THAT THE INTENT OF SOURCING FROM LOW COST COUNTRIES FOR A MANUFACTU RER / RETAILER IS TO PROVIDE A LOWER COST TO ITS END-CUSTOMERS. LOOKING AT THE T OUGH COMPETITION IN GARMENT MARKETING GENERALLY, THE ADVANTAGE OF LOCAT ION SAVINGS IS PASSED ONTO THE END-CUSTOMER IN THE FORM OF LOWER SALE PRI CES. THUS, THERE IS NO QUESTION OF ANY ALLOCATION ATTRIBUTABLE FOR LOCATIO N SAVINGS TO GIS INDIA, WHICH HAS NO ROLE IN SALE PRICES. 5.3. IT IS IMPORTANT TO NOTE THAT ANY PROFITS GENER ATED OUT OF THE MANUFACTURING ACTIVITY ON ACCOUNT OF LOCATION SAVIN GS IS EARNED BY THE DIFFERENT ENTITIES OF THE GAP GROUP. BESIDES ANY L OCATION SAVINGS GENERATED BY GAP GROUP FROM LOW RAW MATERIAL COSTS ARE PASSED ON TO END CUSTOMERS. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 18 18 IN NO CIRCUMSTANCES, GIS INDIA GETS A RETURN FOR TH E MANUFACTURING ACTIVITY OR IS ENTITLED TO A RETURN ON ACCOUNT OF LOCATION S AVINGS AS IT ONLY FUNCTIONS AS A MERE SUPPORT SERVICE PROVIDER AND A WATCH DOG ENS URING THAT THE RIGHT QUALITY OF GOODS REACHES AT RIGHT PLACE AT THE RIG HT TIME, AND OPERATES STRICTLY WITHIN THE CONFINES OF THE STANDARDS PRESCRIBED BY THE OVERSEAS GAP GROUP. 5.4. GIS INDIA AND GIS INC. HAVE ENTERED INTO A LEG ALLY BINDING AGREEMENT WHICH DEFINES THE ROLE, RESPONSIBILITIES AND REMUNE RATION OF BOTH THE PARTIES TO THE AGREEMENT. IT SHOULD HAVE BEEN DULY CONSIDER ED AND APPRECIATED BY THE LD. TPO AS WELL AS LD. DRP AND IN THE ABSENCE OF AN Y ADVERSE MATERIAL IS TO BE ACCEPTED ON COMMERCIAL PRINCIPLES. 5.5. WITHOUT PREJUDICE TO THE ABOVE, IT IS PLEADED THAT, EVEN IF IT IS ASSUMED THAT LOCATION SAVINGS HAVE INDEED ARISEN IN THE INS TANT CASE, THEN IN THAT SITUATION, THE QUESTION OF ALLOCATION TRULY NEEDS T O BE ADDRESSED IN LIGHT OF THE RELATIVE BARGAINING POWERS/ OWNERSHIP OF INTANGIBLE S OF THE PARTIES CONCERNED AND THE COMPETITIVE MARKET POSITION OF TH E COMPANY BASED IN THE LOW COST JURISDICTION, I.E. GIS INDIA . IN THE INSTANT CASE, ALL THE VALUABLE INTANGIBLES ARE OWNED BY OVERSEAS GROUP COMPANIES. AS A RESULT, THE RELATIVE BARGAINING POWER OF THE OVERSEAS GROUP COMPANIES IS SIGNIFICANT AND NOT OF THE ASSESSEE. ON THE CONTRARY, GIS INDIA IS A ROUTI NE SUPPORT SERVICE PROVIDER THAT UNDERTAKES ROUTINE LIAISONING AND CO-ORDINATIO N ACTIVITIES. ITS BARGAINING POWER IS NEGLIGIBLE AS COMPARED TO ITS OVERSEAS GRO UP COMPANIES. 5.6. GIVEN THE FACT THAT GIS INDIA DOES NOT HAVE AN Y UNIQUE INTANGIBLES OR ANY DISTINCTIVE COMPETITIVE ADVANTAGE VIS--VIS OTH ER SIMILAR SOURCING COMPANIES IN THE MARKET, WHICH COULD HAVE LED TO GI S INDIA WIELDING ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 19 19 SIGNIFICANT BARGAINING POWER VIS--VIS ITS OVERSEAS GROUP COMPANIES, IT CANNOT BE ENTITLED TO ANY LOCATION SAVINGS. 5.7. THE DRP, DURING THE REMANDED PROCEEDINGS, OUT OF VOLUMINOUS DOCUMENTS SUBMITTED BY GIS INDIA REFERRED TO ONLY O NE OF THE EMAIL EXCHANGED BETWEEN THE APPELLANT AND ITS GROUP COMPA NY REGARDING FABRIC HEDGING AND LONG TERM BOOKING. WITHOUT APPRECIATING THE ESSENCE OF THE SAME, THE LD. DRP SIMPLY HELD THAT THE FUNCTIONS CA RRIED OUT BY GIS INDIA IS SIMILAR TO THAT OF A MANUFACTURER. AN OUT OF CONTEX T REFERENCE FROM THIS EMAIL IS UNCALLED FOR, MORE SO WHEN THE LD. TPO HAD NOT D RAWN ANY SUCH CONCLUSION ABOUT ASSESSEES FUNCTIONAL PROFILE IN HI S OWN ORDER. THIS SUGGESTS THAT THE DRP ATTEMPTED TO RAISE NEW ISSUES IN REMAN DED PROCEEDINGS MERELY FOR THE SAKE OF SUPPORTING THE TPOS ORDER. 6. LD. COUNSEL THEN DREW OUR ATTENTION TO THE JUDGM ENT PASSED BY THE SUPREME COURT OF NETHERLANDS IN THE CASE OF BELGIAN COORDINATION CENTRE. THE RULING ADJUDICATED ON THE ARM'S LENGTH REMUNERA TION MODEL TO BE FOLLOWED IN RESPECT OF PROCUREMENT/ PURCHASING COOR DINATION ACTIVITIES PERFORMED BY BELGIAN COORDINATION CENTRE (BCC). TH IS IS THE ONLY INTERNATIONAL JUDGMENT AVAILABLE, PROVIDING GUIDANC E ON THE PRICING MODEL TO BE FOLLOWED IN CASE OF PROCUREMENT SUPPORT SERVICE PROVIDERS. RELEVANT FACTS ARE AS UNDER: (A) THIS DISPUTE REVOLVED AROUND A DUTCH MULTINATIO NAL GROUP (TAXPAYER) ENGAGED IN MANUFACTURING OF METAL PACKAG ING, BEVERAGE PACKS, ETC., FOR WHICH IT SOURCED RAW MATERIALS FRO M VARIOUS SUPPLIERS IN EUROPE. THE TAXPAYER SET UP BCC WHICH PERFORMED CENTRALIZED PURCHASING ACTIVITIES ON ITS / OTHER OPERATING COMP ANIES WITHIN THE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 20 20 GROUPS BEHALF. AS PART OF ITS PURCHASE COORDINATIO N ACTIVITIES, BCC ALSO CONDUCTED PRICE NEGOTIATIONS (INCLUDING TALKS ON PAYMENT TERMS) WITH THE SUPPLIERS. HOWEVER, THE OPERATING COMPANIE S WERE RESPONSIBLE FOR CONCLUDING AND SIGNING INDIVIDUAL C ONTRACTS AND ALL OTHER PURCHASE RELATED ACTIVITIES SUCH AS PLACING O RDERS AND MAKING PAYMENTS FOR THE RAW MATERIALS. THE SUPPLIERS DELIV ERED THE RAW MATERIALS DIRECTLY TO THE OPERATING COMPANIES . BASED ON THE ABOVE FACTS, THE SUPREME COURT OF NETHERLANDS HELD THAT I N RESPECT OF THE PROCUREMENT/ PURCHASING COORDINATION/ SUPPORT SERVI CES PROVIDED, BCC IS ENTITLED TO A RETURN ON ITS COSTS WHICH WAS QUANTIFIED TO A 5% MARGIN ON COSTS. (B) THE ACTIVITIES CARRIED OUT BY BCC ARE IN FACT S UBSTANTIALLY MORE THAN THE LIMITED RISK ROUTINE SERVICES CARRIED OUT BY THE ASSESSEE. BCC CARRIED OUT PRICE NEGOTIATIONS WITH THE SUPPLIERS A LSO WHEREAS THE ASSESSEE ONLY PERFORMS ROUTINE ACTIVITIES WITHIN TH E CONFINES OF THE INSTRUCTIONS PROVIDED BY THE AES. (C) APPLYING THE RATIO OF THIS RULING, THE REMUNERA TION MODEL OF CHARGING A MARK-UP ON THE VALUE ADDING COSTS INCURR ED BY THE APPELLANT IN ITS PROCUREMENT/ PURCHASING COORDINATI ON/ SUPPORT SERVICES ACTIVITY, SHOULD BE ACCEPTED AS THE ARMS LENGTH BUSINESS MODEL. FURTHER, IT MAY ALSO BE NOTED THAT THE APPEL LANT HAS CHARGED A MARK-UP OF 15% ON THE COSTS INCURRED BY IT IN CONNECTION WITH ITS SERVICE PROVISION ACTIVITY (VALUE ADDED COSTS), WHI CH IS THREE TIMES THE COST PLUS MARGIN SPECIFIED IN THE AFOREMENTIONE D DUTCH RULING FOR PURCHASING COORDINATION/ SUPPORT SERVICES, THE SCOP E OF WHICH IS ANYWAY BROADER THAN THOSE PROVIDED BY THE APPELLANT . ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 21 21 6.1. LD. TPO WHILE WORKING OUT ADJUSTMENTS, DREW A TOTALLY IRRELEVANT REFERENCE FROM THE CASE OF AN OUT OF COURT SETTLEM ENT BETWEEN USA TAX AUTHORITIES & TOMMY HILFIGER. TOMMY HILFIGER REMU NERATED ITS BUYING AGENCY AFFILIATE ON THE BASIS OF A COMMISSION (10% AND SUBSEQUENTLY 7.5%) ON THE VALUE OF GOODS SOURCED BY IT. THE LD. TPO TH EREBY CLAIMED THAT GIS INDIA SHOULD ALSO HAVE BEEN REMUNERATED BY A COMMIS SION ON VALUE OF GOODS SOURCED IGNORING THAT THE INFORMATION WAS NOT IN RE LATION TO A JUDICIAL PRONOUNCEMENT. THE RELIANCE ON AN OUT OF COURT SETT LEMENT BETWEEN THE US REVENUE AUTHORITIES AND TOMMY HILFIGER HAS NO PERSU ASIVE VALUE AS IT IS NOT ANY JUDICIAL PRONOUNCEMENT ON THE MATTER. IT IS PE RTINENT TO NOTE THAT THIS INSTANCE DOES NOT CONTAIN ANY INFORMATION ABOUT THE ACTUAL FACTS AND GROUND REALITIES OF THE CASE OR THE SETTLEMENT REACHED, NO R DOES IT THROW ANY LIGHT ON THE NATURE OF ISSUES UNDER CONTENTION BETWEEN THE U S REVENUE AUTHORITIES AND TOMMY HILFIGER. SIMILARLY NOTHING ABOUT NATURE OF F AR, SERVICES AND OTHER SERVICES, HAS BEEN MENTIONED. IN THE ABSENCE OF TH IS CRITICAL SET OF INFORMATION AND AN OBJECTIVE ANALYSIS, IT IS NOT PO SSIBLE TO USE IT WHILE COMPARING THE CASE FOR GIS INDIA, WHICH STANDS FAR APART ON FACTS. 6.2. TRANSACTIONAL NET MARGIN METHOD (TNMM) AS ONE OF THE METHODS TO BE USED FOR DETERMINATION OF THE ARMS LENGTH PRICE (ALP) UNDER INDIAN TP LEGISLATION. ACCORDINGLY THE APPELLANT HAS USED OP/ VAE AS A PROFIT LEVEL INDICATOR (PLI) WHICH IS A VALID PLI. RULE 10(E)(I) OF THE INCOME TAX RULES, 1962 (RULES) WHICH STATES AS FOLLOWS: (E) TRANSACTIONAL NET MARGIN METHOD, BY WHICH,- (I) THE NET PROFIT REALISED BY THE ENTERPRISE FROM AN I NTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSOCIATED ENTERPR ISE IS COMPUTED ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 22 22 IN RELATION TO THE COSTS INCURRED OR SALES EFFECTED OR ASSETS EMPLOYED OR ANY OTHER RELEVANT BASE 6.3. APPELLANTS ONLY COSTS WERE OPERATING COSTS/ V ALUE ADDED COSTS (EXPENSES) AS IT DID NOT PAY FOR THE PRICE OF GOODS SOURCED BY GAP GROUP AND THEREFORE, NEVER CARRIED THE COST IN RELATION T O PRICE OF GOODS. THEREFORE, THE PLI USED BY THE APPELLANT IN ITS OWN CASE IS AC TUALLY OP/TC SINCE THE APPELLANTS VAE IS EQUAL TO TC. THE RELEVANT RULE C LEARLY SUGGESTS THAT BASED ON THE INTENSITY OF FUNCTIONS PERFORMED (WHIC H IS MEASURED BY VALUE ADDED EXPENSES), UNDER TNMM, A RELEVANT COST BASE I .E. VAE IN THE INSTANT CASE, CAN BE USED. THIS CONCEPT IS VERY WELL SUPPOR TED BY THE RULING BY THE HONBLE DELHI TRIBUNAL IN THE CASE OF DCIT VS. CHEI L COMMUNICATIONS INDIA PVT. LTD. (ITA NO. 712/DEL/2010) (137 TTJ 539), WHI CH HOLDS AS FOLLOWS: THE RIVAL CONTENTIONS OF BOTH THE PARTIES HAVE BEE N CONSIDERED AND ORDERS OF THE AUTHORITIES BELOW HAVE CAREFULLY BEEN PERUSED. THE ONLY QUESTION THAT FALLS FOR OUR CONSIDERATION IS WITH REGARD TO THE METHOD OF COMPUTING PROFIT/TC MARGIN WHETHER ON GROSS BASIS AS DONE BY THE TPO OR NET BASIS AS WORKED OUT BY THE ASSESSEE. IN THIS CASE THE ASSESSEE HAS APPLIED TNM M METHOD TO DETERMINE ALP, WHICH HAS ALSO BEEN ACCEPTED BY T HE REVENUE AUTHORITIES.. THE PAYMENT MADE BY THE ASSESSEE TO THIRD PARTY VEN DOR/MEDIA AGENCIES FOR AND ON BEHALF OF THE PRINCIPAL HAS NOT BEEN INCLUDED IN THE TOTAL COST FOR DETERMINING THE PROF IT MARGIN, THOUGH, ON THE OTHER HAND, THE TPO HAS INCLUDED THE PAYMENT REIMBURSED BY THE ASSESSEE'S ASSOCIATE ENTERPRISE T O THE ASSESSEE ON ACCOUNT OF PAYMENT MADE TO THIRD PARTY VENDOR/ME DIA AGENCIES... WE HAVE GONE THROUGH THE INVOICES AND PURCHASE ORDE RS FROM THIRD PARTY VENDORS AND FIND THAT THEY CONTAIN CUST OMERS' NAME, AND ALL THE TERMS OF ADVERTISEMENT ARE FINALIZED AF TER TAKING THE APPROVAL FROM THE CUSTOMERS. THE ASSESSEE SIMPLY AC TS AS AN ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 23 23 INTERMEDIARY BETWEEN THE ULTIMATE CUSTOMER AND THE THIRD PARTY VENDOR IN ORDER TO FACILITATE PLACEMENT OF THE ADVE RTISEMENT. THE PAYMENT MADE BY THE ASSESSEE TO VENDORS IS RECO VERED FROM THE RESPECTIVE CUSTOMERS OR AES. IN THE EVENT CUSTO MER FAILS TO PAY ANY SUCH AMOUNT TO THE ADVERTISEMENT AGENCY, TH E BAD DEBT RISK IS BORNE BY THE THIRD PARTY VENDOR AND NOT BY THE ADVERTISING AGENCY I.E. THE ASSESSEE. IT IS, THUS, CLEAR THAT THE ASSESSEE HAS NOT ASSUMED ANY RISK ON ACCOUNT OF NON -PAYMENT BY ITS CUSTOMERS OR AES. AT THIS STAGE A USEFUL REF ERENCE MAY BE MADE TO ITS 2009 TRANSFER PRICING GUIDELINES ACCEPT ED BY THE OECD WHERE IT IS LAID DOWN THAT WHEN AN AE IS ACTIN G ONLY AS AN AGENT OR INTERMEDIARY IN THE PROVISION OF SERVIC E, IT IS IMPORTANT IN APPLYING THE COST PLUS METHOD THAT THE RETURN OR MARK-UP IS APPROPRIATE FOR THE PERFORMANCE OF AN AG ENCY FUNCTION RATHER THAN FOR THE PERFORMANCE OF THE SER VICES THEMSELVES, AND, IN SUCH A CASE, IT MAY NOT BE APPR OPRIATE TO DETERMINE ALP AS A MARK-UP ON THE COST OF SERVICES BUT RATHER ON THE COST OF AGENCY FUNCTION ITSELF, OR ALTERNATI VELY, DEPENDING ON THE TYPE OF COMPARABLE DATA BEING USED, THE MARK -UP ON THE COST OF SERVICES SHOULD BE LOWER THAN WOULD BE APPR OPRIATE FOR THE PERFORMANCE OF THE SERVICES THEMSELVES. IN THIS TYPE OF CASE, IT WILL BE APPROPRIATE TO PASS ON THE COST OF RENDE RING ADVERTISING SPACE, TO THE CREDIT RECIPIENT WITHOUT A MARK-UP AND TO APPLY A MARK-UP ONLY TO THE COSTS INCURRED BY TH E INTERMEDIARY IN PERFORMING IT'S AGENCY FUNCTION IN THE LIGHT OF THESE GUIDELINES, IT WOULD BE, THER EFORE, CLEAR THAT A MARK-UP IS TO BE APPLIED TO THE COST INCURRED BY THE ASSESSEE COMPANY IN PERFORMING ITS AGENCY FUNCTION AND NOT T O THE COST OF RENDERING ADVERTISING SPACE ON BEHALF OF ITS AES . 6.4. LD. COUNSEL THEN REFERRED TO THE WELL RECOGNIZ ED BERRY RATIO IN DETERMINATION OF ALP. BERRY RATIO ALSO PROPOUNDS T HAT ROUTINE DISTRIBUTORS SHOULD EARN A RETURN COMMENSURATE TO THE DISTRIBUTI ON SERVICES PERFORMED, MEASURED AS A PERCENTAGE OF THE VALUE-ADDING (OPERA TING) EXPENSES INCURRED BY THEM. THE VALUE OF THE PRODUCTS BEING DISTRIBUTE D, IN OTHER WORDS, IS IRRELEVANT. DISTRIBUTORS MUST ACHIEVE A PARTICULAR GROSS PROFIT IN ORDER TO ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 24 24 COMPENSATE THEM FOR THEIR VALUE-ADDING SERVICES, TH E COSTS OF WHICH ARE ACCOUNTED FOR IN THEIR VALUE-ADDING (OPERATING) EXP ENSES. AN EXCERPT FROM THE ARTICLE BY DR. BERRY ON THIS ASPECT READS AS UN DER:- SIMILARLY, THE COST OF GOODS SOLD IS EXCLUDED FROM THE COST BASE BECAUSE THE MEASURE INDICATES THE VALUE OF THE MERCHANDISE DISTRIBUTED, NOT THE SERVICE RENDERED B Y THE FIRM THAT DISTRIBUTES THE MERCHANDISE. IT WAS FOR EXACTL Y THE SAME REASON THAT I EXCLUDED IN THE CASE OF ADVERTISING A GENCIES, THE COST OF ADVERTISEMENT PLACEMENT. THE PLACEMENT COST IS A MEASURE OF THE ACTIVITIES OF THE MEDIA CARRYING THE ADVERTISING AGENCY IN PLANNING AND DESIGNING THAT ADVERTISING. IF WE USE A COST PLUS METHOD, AND THE BERRY RATIO IS A COST PLU S METHOD, WE WANT A MEASURE OF THE COSTS OF THE FIRM INVOLVED, I .E. THE DISTRIBUTOR OR ADVERTISING AGENCY IN THESE EXAMPLES , NOT SOMETHING THAT MEASURES ONLY THE VALUE OF THE PRODU CT DISTRIBUTED, OR THE VALUE OF THE EXPOSURE PROVIDED BY RADIO, TELEVISION OR PRINT MEDIA. 6.5. IT IS CONTENDED THAT THE BERRY RATIO IS MERELY A VARIANT OF THE COST PLUS METHOD. IF ONE WERE TO THINK OF THE GROSS MARGINS E ARNED BY A DISTRIBUTOR AS ANALOGOUS TO A FIRMS TOTAL REVENUES AVAILABLE TO A DISTRIBUTOR, AND THE OPERATING EXPENSES INCURRED TO DISTRIBUTE PRODUCTS AS ANALOGOUS TO THE FIRMS TOTAL COSTS, THEN THE RATIO OF GROSS MARGIN TO OPER ATING EXPENSES WOULD CAPTURE THE MARK-UP ON OPERATING EXPENSES THAT IS A FFORDED TO THE DISTRIBUTOR. 6.6. THE BERRY RATIO CAN ALSO BE APPLIED TO SERVICE PROVIDERS, AS IT CAN BE CONCEPTUALIZED AS THE MARK-UP EARNED ON THE COSTS O F PROVISION OF SERVICES, BY SUBTRACTING ONE FROM THE BERRY RATIO EXPRESSED I N UNIT TERMS AS FOLLOWS:- BERRY RATIO - 1 = GP/VAE - 1 = (GP-VAE)/VAE = OP/VAE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 25 25 WHEREIN GP = GROSS PROFIT; OP = OPERATING PROFIT; A ND VAE = VALUE ADDING (OPERATING) EXPENSES. THE ABOVE CONCEPT AND APPROACH FOR ROUTINE DISTRIBU TORS AND SERVICE PROVIDERS HAS ALSO BEEN WELL ACCEPTED BY THE ORGANI ZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) IN PAR AS 2.100 TO 2.102. 6.7. THE SEARCH RESULTS FROM EACH OF THE REGIONS AL SO CORROBORATE THE FINDINGS OF DR. BERRY WITH REGARD TO THE HIGH DEGRE E OF CORRELATION BETWEEN THE LEVEL OF OPERATING EXPENSES INCURRED AS A PERCE NTAGE OF TURNOVER AND THE LEVEL OF GROSS PROFITS EARNED BY DISTRIBUTORS, AS C AN BE SEEN FROM THE CORRELATION COEFFICIENTS BETWEEN THEM . THE SEARCH RESULTS CLEARLY SHOW THAT THERE IS A HIGH POSITIVE CORRELATION BETWEEN NET MA RGINS AND THE BERRY RATIO FOR DISTRIBUTORS. THIS IMPLIES THAT FOR A SET OF DISTRIBUTOR COMPANIES, ONE CANNOT SIMPLY ADOPT A PROFIT LEVEL INDICATOR OF RET URN ON SALES (OR TOTAL COSTS) WITHOUT TAKING INTO CONSIDERATION, THE CORRESPONDIN G OP/VAE AND BERRY RATIO OF THESE COMPARABLES. 7. LD. COUNSEL CONTENDS THAT DRP RELIED ON ITAT JUD GMENT IN CASE OF LI & FUNG INDIA (P) LTD. VS. DCIT 12 ITR (TRIB.) 748. RELEVANT FACTS ARE - 7.1. LI & FUNG INDIA PROVIDED SOURCING SUPPORT SERV ICES TO ITS RELATED PARTY BASED IN HONG KONG (LI & FUNG HK) UNDER AN ARRANGEM ENT OF COST PLUS 5% MARK-UP, AND RECEIVED A TOTAL REMUNERATION OF RS 47 .69 CRORE FROM LI & FUNG (TRADING) LIMITED (LI & FUNG HK). THE OPERATIN G COSTS OF LI & FUNG INDIA WERE RS 45.42 CRORE AND THE MARK-UP @ 5% THER EON WAS RS. 2.27 CRORE. LI & FUNG HK ENTERED INTO SOURCING AGREEMEN TS WITH ITS GLOBAL CUSTOMERS FOR PRODUCTS SOURCED DIRECTLY BY SUCH GLO BAL CUSTOMERS FROM THIRD ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 26 26 PARTY VENDORS IN INDIA. FOR SUCH SOURCING SERVICES, LI & FUNG HK RECEIVED A COMMISSION OF 5% FROM ITS GLOBAL CUSTOMERS, ON THE VALUE OF GOODS PROCURED BY SUCH CUSTOMERS DIRECTLY FROM THIRD PARTY VENDORS IN INDIA. 7.2. THE GLOBAL CUSTOMERS OF LI & FUNG HK PROCURED PRODUCTS WORTH RS 1202.96 CRORE DIRECTLY FROM THIRD PARTY VENDORS OF INDIA AND ACCORDINGLY PAID A COMMISSION OF RS 60.15 CRORE TO LI & FUNG HK , COMPUTED @ 5%. LI & FUNG HK IN TURN PAID A REMUNERATION OF RS 47.69 C RORE TO LI & FUNG INDIA UNDER A COST PLUS 5% MODEL. THE TPO CHALLENGE D THE COST PLUS 5% MODEL OF LI & FUNG INDIA AND HELD THAT LI & FUNG IN DIA SHOULD ALSO RECEIVE A 5% PROFIT ON THE VALUE OF PRODUCTS SOURCED FROM I NDIA. THE DRP ALLOWED PARTIAL RELIEF BY REDUCING IT TO 3%. ON ASSESSEES APPEAL, ITAT IN SHORT HELD AS UNDER: (A) THE ASSESSEE COULD NOT REFUTE THAT IT HAD ACTUA LLY PERFORMED ALL CRITICAL FUNCTIONS, ASSUMED SIGNIFICANT RISKS AND A LSO DEVELOPED SIGNIFICANT SUPPLY CHAIN INTANGIBLES IN INDIA AND L I & FUNG HK DID NOT HAVE EITHER ANY TECHNICAL EXPERTISE OR MANPOWER TO CARRY OUT THE SOURCING ACTIVITIES IN HK. (B) IN VIEW OF THE ABOVE, THE TRIBUNAL AGREED THAT LI & FUNG INDIA SHOULD ALSO RECEIVE A REMUNERATION BASED ON A PERCE NTAGE OF VALUE OF GOODS SOURCED BY THE GLOBAL CUSTOMERS OF LI & FUNG HK DIRECTLY FROM THIRD PARTY VENDORS IN INDIA. (C) HOWEVER, THE TOTAL AMOUNT OF COMMISSION ACCRUIN G FOR THE LI & FUNG GROUP AS A WHOLE, COULD NOT EXCEED 5% OF THE V ALUE OF SUCH GOODS, I.E. RS 1202.96 CRORE. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 27 27 (D) LI & FUNG HK HAD ALREADY PAID REMUNERATION TO L I & FUNG INDIA UNDER THE COST PLUS 5% MODEL, THUS RETAINING, AT ITS LEVEL, ABOUT 20% OF THE TOTAL RECEIPTS FROM THE CUSTOMER, I.E. R S 60.15 CRORE. (E) THE ITAT HELD THAT IN VIEW OF THE ABOVE FACTUAL MATRIX, LI & FUNG INDIA SHOULD RECEIVE 80% OF THE TOTAL COMMISSI ON GIVEN BY THE END-CUSTOMER IN FAVOUR OF LI & FUNG HK AND THE BALA NCE 20% WOULD BE RETAINED BY LI & FUNG HK AND ACCORDINGLY ASKED T HE TPO TO RECOMPUTE THE TP ADJUSTMENT. 7.3. ANALYSING LI & FUNG CASE FURTHER LD. COUNSEL P LEADS THAT: (A) INSTEAD OF 3%, EVEN IF ENTIRE 5% COMMISSION OF RS. 60.15 CRORE IS RETAINED WITH LI & FUNG INDIA, THE SAME WOULD HAVE RESULTED IN AN OPERATING PROFIT OF RS. 14.73 CRORE, AFTER DEDUCTIN G ITS ACTUAL COSTS OF RS. 45.42 CRORE OR ON OTHER WORDS, AN OP/VAE OF 32. 43%, WHICH IS SHOWN THROUGH THE COMPUTATION, AS BELOW: LI & FUNG INDIA (AMOUNT IN RS. CRORES) SERVICE FEES 60.15 LESS: OPERATING EXPENSES (VAE) 45.42 OPERATING PROFIT (OP) 14.73 RETURN ON TOTAL COST = OP/VAE 32.43% (B) IF THE ABOVE OP/TC ANALYSIS OR THE ONES DISCUSS ED BY TPO FOR FY 2007-08 TP ORDER COMPARABLES ARE CONSIDERED, THE OP /TC RESULTS FOR A SERVICE PROVIDER LIKE THE APPELLANT ESSENTIALLY R ANGE BETWEEN 15%- 30%, WHICH CLEARLY SHOWS THE INADEQUACY OF THE TP A DJUSTMENT MADE IN ASSESSEES CASE WHERE IT IS RESULTING INTO AN OP /TC OF 830.95%. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 28 28 (C) THUS EVEN IF THE ENTIRE COMMISSION OF 5% WAS RE TAINED WITH LI & FUNG INDIA, THE MAXIMUM RETURN ON OPERATING COSTS E ARNED BY IT WORKS OUT AROUND 32% WHICH IS STILL POSSIBLE FOR A COMMISSION AGENT/ SERVICE PROVIDER. WHEREAS, IN CASE OF GIS INDIA, TH E 5% ADOPTED RESULTED INTO A RETURN ON OPERATING COSTS OF 830.95 %. THIS VERY DISTINCTION BRINGS OUT THE CIRCUMSTANTIAL DIFFERENC ES IN THE TWO CASES AND THE FACT THAT LI & FUNG CASE IS NOWHERE COMPARA BLE TO THAT OF THE GIS INDIA. (D) IT IS STATED THAT THE LI & FUNG'S CASE RESTS O N THE PECULIAR FACTS OF ITS CASE AND DOES NOT HAVE A GENERAL APPLICATION FOR AL L SOURCING COMPANIES/ ACTIVITIES. THE FOLLOWING COMPARATIVE TA BLE WILL SHOW HOW FACTS ARE DIFFERENT FROM GIS INDIAS CASE. S. NO. LI & FUNG INDIA GIS INDIA 1. LI & FUNG GROUP IS ONE OF THE WORLDS LARGEST LEADERS IN EXPORT TRADING. THE LI & FUNG INDIA (ALONG WITH ITS OVERSEAS AE - LI & FUNG HK) IS ITSELF A SOURCING COMPANY AND IS ENGAGED IN THE BUSINESS OF PROVIDING SOURCING SERVICES TO THIRD PARTY BUYERS/ RETAILERS. THE OVERSEAS AE OF THE TAX PAYER IS NOT THE ULTIMATE BUYER OF THE PRODUCTS SOURCED FROM INDIAN VENDORS. (PARAS 2, 6 & 8 OF THE RULING AND REFER TO PAGES 1401, 1408 GAP GROUP IS AN INTERNATIONAL SPECIALTY RETAILER OFFERING APPAREL, ACCESSORIES, AND PERSONAL CARE PRODUCTS. GIS INDIA IS CAPTIVE UNIT OF GAP GROUP WHEREIN, IT IS TO BE NOTED THAT THE GROUP ITSELF IS NOT IN THE BUSINESS OF PROVIDING SOURCING SERVICES BUT THE SAME BEING PERFORMED BY JUST AN IN-HOUSE ARM, OPERATING IN INDIA. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 29 29 S. NO. LI & FUNG INDIA GIS INDIA AND 1432 OF THE PAPER BOOK) 2. THE LI & FUNG INDIA PERFORMED ALL THE CRITICAL FUNCTIONS, ASSUMED SIGNIFICANT RISKS AND USED BOTH TANGIBLES AND UNIQUE INTANGIBLES DEVELOPED BY IT OVER A PERIOD OF TIME (INTANGIBLES INCLUDED SUPPLY CHAIN MANAGEMENT WHICH IS IMPORTANT TO ACHIEVE THE STRATEGIC AND PRICING ADVANTAGE, AS WELL AS HUMAN INTANGIBLES IN THE FORM OF TECHNICAL CAPACITY AND OWNED MANPOWER TO PERFORM THE CRITICAL FUNCTIONS). ALL INTANGIBLES INCLUDING TRADEMARKS, PROCESSES, KNOW- HOW, TECHNICAL DATA, OPERATING/ QUALITY STANDARDS ETC. ARE DEVELOPED AND OWNED BY THE OVERSEAS GAP GROUP COMPANIES. GIS INDIA DOES NOT CREATE ANY VALUABLE/ NON-ROUTINE INTANGIBLE AND DOES NOT UNDERTAKE ANY ACTIVITY ON ITS ACCOUNT THAT LEADS TO THE DEVELOPMENT OF NON- ROUTINE INTANGIBLES. 3. THERE HAVE BEEN AMPLE DOCUMENTS FILED AT VARIOUS LEVELS (TPO, DRP) TO EVIDENCE THE FUNCTIONAL PROFILE OF THE OVERSEAS GAP GROUP COMPANIES AND THE FACT THAT THEY OWN PERFORM CRITICAL FUNCTIONS IN THE SUPPLY CHAIN AND OWN SIGNIFICANT INTANGIBLES AND THAT GIS INDIA PRIMARY BUSINESS ACTIVITY IS TO SERVE AS A COMMUNICATION LIAISON BETWEEN GIS INC. AND THE THIRD-PARTY INDIAN VENDORS THAT MANUFACTURE GAP INC.S MERCHANDISE BY LEVERAGING COMMON SPOKEN LANGUAGE AND GEOGRAPHIC PROXIMITY TO THESE VENDORS. 4. AN APPLICATION OF 5% GOING BY THE TP ORDER, IF A ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 30 30 S. NO. LI & FUNG INDIA GIS INDIA COMMISSION ON THE VALUE OF GOOD SOURCED LEADS TO A COST PLUS OF AROUND 32% WHICH IS STILL NOT ABSURD IN CASE OF A SERVICE PROVIDER. 6.07% (APPROX.) COMMISSION IS APPLIED IN GIS INDIAS CASE, IT LEADS TO A COST PLUS OF 830.95%, WHICH IS COMPLETELY ABSURD . 5. BASED ON THE ABOVE FUNCTIONAL PROFILE AND FACTS, IT WAS DECIDED THAT THE INDIAN SOURCING SUPPORT COMPANY SHOULD NOT RECEIVE A COST PLUS FORM OF REMUNERATION, AND SHOULD INSTEAD RECEIVE A PERCENTAGE OF COMMISSION ON THE VALUE OF GOODS . IN GIS INDIAS CASE, THERE ARE AMPLE SUBSTANTIVE EVIDENCES TO DEMONSTRATE THAT THE COMPENSATION BASED ON COST PLUS REMUNERATION IS JUSTIFIED. (E) IN THE LI & FUNG RULING, THE DELHI TRIBUNAL HEL D THAT ON THE FACTS OF THE SAID CASE, THE PROCUREMENT COMPANY IN INDIA WAS ENTITLED TO A REVENUE LINKED REMUNERATION. (F) THE DECISION IN THE CASE OF LI & FUNG PROCEEDED ON THE SPECIFIC FINDINGS OF THE TPO THAT THE ASSESSEE WAS NOT ABLE TO ESTABLISH THAT THE FOREIGN PRINCIPAL IN HONG KONG HAD ANY IMPORTAN T ROLE. THUS, THE TRIBUNAL ACCEPTED THE FACTUAL POSITION THAT THE LI FUNG INDIA ACTUALLY CARRIED OUT ALL THE SIGNIFICANT FUNCTIONS RELATING TO PROCUREMENT IN INDIA; AND THAT VERY LITTLE OR VIRTUALLY NIL FUNCTI ONS WERE CARRIED OUT AT THE LEVEL OF HONG KONG. 7.4. HOWEVER, THE FACTS IN THE APPELLANTS CASE ARE COMPLETELY DIFFERENT IN THE SENSE THAT ALL THE SIGNIFICANT DIRECTIONS RELAT ING TO PROCUREMENT OF GOODS FROM THIRD PARTY VENDORS IN INDIA, NAMELY (A) DES IGNS & TRENDS OF APPAREL; (B) QUALITY PARAMETERS OF MATERIALS: (C) TERMS & CO NDITIONS FOR DEALING WITH ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 31 31 VENDORS, ETC, ARE ALL PROVIDED BY GAP US TO THE APP ELLANT THROUGH THE VOLUMINOUS VENDOR HANDBOOK & OTHER CORRESPONDENCES FROM TIME TO TIME; AND THE APPELLANT MERELY EXECUTES THE SAME WITH DIL IGENCE. 7.5. THE TNMM WITH COST PLUS MARK-UP AS PLI IS RECO GNIZED BY OECD GUIDELINES, BERRY RATIO, CHEIL COMMUNICATIONS PROPO SITIONS, AS MENTIONED ABOVE. FOR MERE NON RISK BEARING FACILITATING FUNCT IONS, THE APPELLANT IS NOT ENTITLED TO A SHARE OF FOB VALUE OF GOODS PROCURED BY GAP US FROM THIRD PARTY VENDORS IN INDIA. IN THE CASE OF LI & FUNG IN DIA, THE ASSESSEE HAD ACTUALLY CARRIED OUT SIGNIFICANTLY VALUE ADDED FUNC TIONS IN INDIA. IN THE LIGHT OF THE FACTS THAT LI & FUNG INDIA CARRIED OUT SIGNI FICANTLY HIGH-END AND VALUE ADDED FUNCTIONS IN INDIA, IF THE INTENSITY OF FUNCT IONS OF LI & FUNG INDIA, ARE MEASURED AS A PERCENTAGE OF OPERATING EXPENSES OR V AE OF LI & FUNG INDIA TO THE VALUE OF GOODS PROCURED, COMES TO 3.78%. IN REAL TERMS, LI & FUNG INDIA HAD CARRIED OUT VIRTUALLY FIVE TIMES GREATER FUNCTIONS AS COMPARED TO THE APPELLANT. THE ASSESSEES PERCENTAGES VAE COMES TO 0.73% AND 0.79% IN THE CASE OF THE APPELLANT FOR AYS 2006-07 AND 20 07-08 RESPECTIVELY. EVEN IF THE ENTIRE COMMISSION OF LI & FUNG GROUP IS ASSI GNED TO LI & FUNG INDIA, THEN THE OP/ VAE OF LI & FUNG INDIA WORKS OUT TO 32 .43%, AS COMPARED TO 15% ADOPTED BY THE APPELLANT, WHICH AGAIN, IS WITHI N ACCEPTABLE LIMITS. LOOKING AT THE INSIGNIFICANT FAR OF THE ASSESSEE. 7.6. ALTERNATIVELY IT IS PLEADED THAT, LOOKING AT T HE 5 TIMES FUNCTIONAL INTENSITY OF THE LI & FUNG GROUP OF THE SAME CAN B E ESTIMATED TO A MAXIMUM OF 1% OF FOB VALUE. THE ASSESSEES INTENSIT Y OF FUNCTIONS BEING LESS THAN ONE-FIFTH OF LI & FUNG, APPLYING A 1% COM MISSION IN THE CASE OF THE APPELLANT WOULD YIELD IN OP/ VAE MARGINS OF 36. 90% AND 26.56% FOR AYS 2006-07 AND 2007-08 RESPECTIVELY. THIS ACCORDIN G TO LD. COUNSEL IT IS ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 32 32 MAXIMUM TO ESTIMATE TO WHICH T.P. ADJUSTMENT CAN BE STRETCHED, AS OPPOSED TO THE EXORBITANTLY ADJUSTMENTS S OF 830% AND 660% AS APPLIED BY THE TPO FOR AYS 2006-07 AND 2007-08 RESPECTIVELY. 7.7. IT IS CONTENDED THAT EVEN IF THE FUNDAMENTAL D IFFERENCES IN THE FACTS OF THE ASSESSEES CASE & LI & FUNG ARE IGNORED. A JUDI CIOUS APPLICATION OF LI & FUNGS RULING ALSO WILL NOT ENHANCE THE OP/ VAE MAR GIN OF THE APPELLANT AT ANY LEVELS ABOVE 30 TO 32% FOR AYS 2006-07 AND 2007 -08, AS COMPARED TO THE 15% MARK UP ADOPTED BY THE ASSESSEE. 7.8. TO SUMMARIZE, THE FAR (FUNCTIONS, ASSETS AND R ISK) OF SOURCING SUPPORT ENTITIES AS WELL AS THEIR OVERSEAS GROUP CO MPANIES NEEDS TO BE EVALUATED IN DETAIL REGARDING THE SUITABILITY OF A REMUNERATION MODEL: - A COST PLUS REMUNERATION MODEL IS A WORLD RECOGNI ZED METHOD FOR A SOURCING ENTITY WHICH PERFORMS LIMITED FUNCTIONS AN D ASSUMES LIMITED RISKS, AND DOES NOT CONTRIBUTE TO THE DEVELOPMENT O F ANY INTANGIBLE; - A SOURCING AGENT WHICH UNDERTAKES GREATER FUNCTIO NS, AND ASSUMES FAR HIGHER RISKS WOULD IDEALLY MAY BE ENTITLED TO A COM MISSION-BASED REMUNERATION, THE ASSESSEES CASE DOES NOT FALL IN THAT CATEGORY. - A BUY-SELL SOURCING ENTITY, WHICH WOULD LIE AT TH E HIGHEST END OF THE VALUE CHAIN, WOULD IN FACT BE ENTITLED TO A BUY-SE LL MARGIN. 7.9. IT IS REITERATED THAT A PROPER ANALYSIS OF THE INTENSITY OF FAR IS CRUCIAL BEFORE DRAWING ANY INFERENCES REGARDING REM UNERATION MODEL, AS DIFFERENT BUSINESS MODELS MAY UNDOUBTEDLY WARRANT DIFFERENT REMUNERATION MODELS. GIS INDIA IS A LIMITED RISK SERVICE PROVIDE R, WHICH WOULD LOGICALLY ASCERTAIN ITS OPERATING PROFITABILITY BY MEASURING THE PROFITS EARNED AS A PERCENTAGE OF THE VALUE ADDED EXPENSES INCURRED (OR TOTAL COSTS IN CASE OF ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 33 33 GIS INDIA). ON THIS REASONING, THE ASSESSEE SEARCHE D FOR COMPARABLE SOURCING SUPPORT SERVICE PROVIDERS FROM THE DATABAS ES BUT COULD NOT FIND ANY AND THEREFORE, IT HAD TO RESORT TO AN ALTERNATE SEA RCH BY IDENTIFYING DISTRIBUTOR COMPANIES AND MAKE SUITABLE WORKING CAPITAL ADJUSTM ENT, CHOOSING OP/VAE AS THE PLI IN ORDER TO MAKE A CLOSER AND MORE LIKE- TO-LIKE COMPARISON OF THE OPERATING PROFITABILITY OF GIS INDIA WITH SUCH DIST RIBUTOR COMPANIES. ACCORDINGLY, FOR THE CHOSEN COMPARABLE COMPANIES AS WELL, IT WAS DEEMED APPROPRIATE TO COMPUTE THEIR OPERATING PROFITABILIT Y ON A SIMILAR BASIS, I.E. WITH REFERENCE TO THE RESPECTIVE VALUE ADDED EXPENS ES INCURRED AND NOT WITH REFERENCE TO THEIR TOTAL COSTS, WHICH WOULD ALSO HA VE INCLUDED COGS OR INPUT COSTS, THE COMPANIES BEING DISTRIBUTORS. 7.10. LD. COUNSEL AT THE END OF HIS ARGUMENTS SUMMA RIZED THE ARGUMENTS AS UNDER: - GIVEN THE FUNCTIONAL, ASSET AND RISK PROFILE OF T HE APPELLANT, IT IS ENTITLED TO A REMUNERATION MODEL OF A MARK UP OR PR OFIT ON ONLY ITS OPERATING EXPENSES OR VAE; AND NOT ON THE VALUE OF GOODS SOURCED BY GAP US FROM THIRD PARTY VENDORS IN INDIA. - INCIDENTALLY, ON IDENTICAL FACTS, THE DUTCH SUPRE ME COURT HAD ALSO APPROVED A COST PLUS REMUNERATION MODEL FOR A SIMIL AR PROCUREMENT COMPANY; AND NOT A COMMISSION LINKED TO VOLUME OF G OODS PROCURED, AS THE LATTER OPTION WOULD HAVE RESULTED IN EXORBIT ANT PROFIT MARGIN ACCRUING TO THE PROCUREMENT COMPANY, NAMELY IN EXCE SS OF 600%. - THE APPELLANTS MARK UP OF 15% ON OPERATING COSTS H AVE NOT BEEN CONTROVERTED BY THE TPO, WHO IN FACT, COMMITTED A G RAVE ERROR IN TAKING THE SAME COMPARABLES, AS CHOSEN BY THE APPEL LANT, BUT MERELY CHANGING THE PLI, WITHOUT EVEN APPRECIATING THAT TH E INTENSITY OF ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 34 34 FUNCTIONS OF SUCH COMPARABLES WERE MORE THAN 25 TIM ES THAN THAT OF THE APPELLANT FOR APPLYING A TURNOVER LINKED REMUNE RATION MODEL - IN THE EXTREME SITUATION, EVEN WITHOUT ADMITTING A FACTUAL SIMILARITY TO THE LI & FUNG RULING, THE MARK-UP ON OPERATING COST S CANNOT EXCEED ABOUT 32%, AFTER DULY ADJUSTING THE INTENSITY OF FU NCTIONS OF THE APPELLANT, VIS--VIS LI & FUNG. - IN RESPONSE TO A SEPARATE SHOW-CAUSE NOTICE ISSUE D BY THE TPO FOR AY 2006-07 ITSELF, THE APPELLANT HAD CARRIED OUT A SEA RCH FOR SERVICE PROVIDERS, WHICH YIELDED AN OPERATING MARGIN OR OP/ VAE OF 19%, WHICH REMAINS UNCONTROVERTED BY THE TPO AND DRP. - WHILE CONDUCTING THE TP ASSESSMENT IN THE CASE OF THE APPELLANT FOR AY 2008-09, THE TPO HAD HIMSELF PROPOSED IN HIS SHO W CAUSE NOTICE, AN ALTERNATIVE SEARCH FOR SELECTING COMMISSION AGE NTS, WHICH THE APPELLANT, WITH THE OBJECTIVE TO AVOID PROTRACTED L ITIGATION, HAD FORMALLY OFFERED TO ACCEPT. THE SAID SET OF COMPARA BLES WILL RESULT IN A PROFIT ON OPERATING COSTS OF 26% FOR AY 2006-07. - THUS, THERE ARE SEVERAL DATA POINTS AVAILABLE BY NOW FOR COMPARABLE MARGINS AROUND THE PLI OF OP/ VAE, NAMELY (A) 3 C OMPARABLES IN THE APPELLANTS INITIAL SEARCH FOR DISTRIBUTORS, YI ELDING 15.13% (B) 6 COMPARABLES IN THE APPELLANTS SUBSEQUENT SEARCH FO R SERVICE PROVIDERS, YIELDING 19%; (C) 7 COMPARABLES CHOSEN B Y THE TPO IN ITS SEARCH FOR COMMISSION AGENTS DURING THE TP ASSESSME NT FOR AY 2008- 09, AS UPDATED WITH THE RESULTS RELATING TO AY 2006 -07, YIELDING 26.01%. AND (D) LI & FUNGS RESULT OF 32.43%. - THE ARITHMETIC MEAN OF ALL THE ABOVE RESULTS YIEL D AN OP/ VAE OF [(3 X 15.13) + (6 X 19) + (7 X 26.01) + 32.43] / [3 + 6 + 7 + 1] = 21.99% OR 22%. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 35 35 - THUS, THE MAXIMUM MARGIN ON OPERATING COSTS WOULD STILL HOVER AROUND 32% IN THE CASE OF THE APPELLANT, WITH 22% A S THE CENTRE OF ALL THE DATA POINTS, WITHOUT PREJUDICE TO THE PRIMARY C ONTENTION THAT THE APPELLANTS ORIGINAL MARGIN OF 15% ON OPERATING COS TS REMAINS UNCONTROVERTED BY THE TPO & DRP. 8. LD CIT(DR) SHRI PIYUSH JAIN ON THE OTHER HAND, V EHEMENTLY SUPPORTS THE ORDER OF TPO, AO AND DRP. AT THE OUTSET IT IS P LEADED THAT ASSESSEE IS A WHOLLY OWNED SUBSIDIARY OF ITS FOREIGN AE. SUPPORTI NG AGREEMENTS AND SIMILAR DOCUMENTARY EVIDENCE ARE IRRELEVANT FOR THE PURPOSES OF DETERMINATION OF ALP AS PER THE TP REGULATIONS LAID DOWN IN IT ACT IN THIS BEHALF. TP AUTHORITIES HAVE STATUTORY DUTY TO EVALU ATE SUCH TRANSACTIONS ON THE BASIS OF COMPARABLES AND OTHER RELEVANT PARAMET ERS AND NOT ON THE BASIS OF CONVENIENT AGREEMENTS. 8.1. GIS INDIA USED MULTIPLE YEAR DATA INSTEAD OF C ONTEMPORANEOUS COMPARABLE DATA. THUS ASSESSEE ON ITS PART HAS FAIL ED TO GIVE PROPER COMPARABLES. IN THIS SITUATION RULE 10B(4) EMPOWERS THE TPO TO APPLY PROPER COMPARABLES FOR DETERMINATIONS OF ALP. GIS I NDIA HAS USED THE WEIGHTED AVERAGE OF THE FINANCIAL DATA FOR THE LAST COUPLE OF YEARS TO BENCHMARK THE INTERNATIONAL TRANSACTIONS. THE PROVI SIONS OF RULE 10B(4) OF THE INCOME-TAX ACT PRESCRIBE THAT FOR THE PURPOSES OF BENCHMARKING INTERNATIONAL TRANSACTIONS THE DATA OF COMPARABLES USED SHALL BE THE DATA FOR THE YEAR IN WHICH TRANSACTION TOOK PLACE. 8.2. TPO HAS REASONABLE INDICATORS THAT THE ASSESSE E PERFORMED ALL THE CRITICAL FUNCTIONS, ASSUMED SIGNIFICANT RISKS AND U SED BOTH TANGIBLES AND UNIQUE INTANGIBLE DEVELOPED BY IT OVER A PERIOD OF TIME. THE CRITICAL ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 36 36 FUNCTIONS INVOLVE GREAT CARE TO BE TAKEN WHILE SELE CTING THE QUALITY, QUANTITY AND ITS FEASIBILITY AT THE SOURCING STAGE. ANY DEFE CT OR INFIRMITY IN THESE SERVICES WILL RESULT IN HUGE ADVERSE IMPACT ON THE FUNCTIONS OF VARIOUS ENTITIES OF GAP, USA. THE RISK THOUGH ON PAPER IS T RANSFERRED TO AE, IT IS TO BE TESTED ON THE BASIS OF REALITIES LOOKING AT THE CONTROL OF THE AE OVER ASSESSEE SUBSIDIARY. THEREFORE, THE REAL MAGNITUDE OF RISK IS TO BE ASCERTAINED BY A DISPASSIONATE VIEW OF THE FACTS AND CIRCUMSTAN CES. 8.3. IT CAN BE SIMULATED BY A PROJECTION THAT ASSES SEE WAS NOT THERE IN INDIA AND GAP, INC. HAD TO PROCURE SIMILAR TYPE OF SERVI CES FROM A THIRD PARTY FACILITATOR I.E. AN UNCONTROLLED SITUATION. THE QUE STION WHICH ARISES IS WHETHER, THE SAME SERVICES CAN BE PROVIDED ON COST PLUS BASIS OR ON % OF FOB VALUE. SIMILARLY, IF THE ASSESSEE IS ALLOWED TO RENDER SIMILAR SERVICES FOR A THIRD PARTY, WHETHER GAP, INC. WILL ALLOW ASSESSE E TO CHARGE COST PLUS BASIS OR % OF FOB FOR SUCH SERVICES. THIS REPLY WILL BE C HARGING % OF FOB AND NOT COST PLUS MARKUP. MORE SO, WHEN THE ASSESSEE HA S NOT PROVIDED CONTEMPORANEOUS DATA IN SUPPORT OF ITS TP WORKING. THE COST PLUS 15% COMPENSATION MODEL OFFERED BY ASSESSEE IS BEREFT OF ANY JUSTIFIED BASIS, BASED MORE ON MUTUAL CONVENIENCES AND PLANNING RATH ER THAN ON TP REGULATIONS AND UNCONTROLLED DETERMINATION OF ALP T RANSACTIONS. 8.4. IT IS NOT CORRECT TO VIEW THAT RESOURCES AND E STABLISHMENT OF ASSESSEE IN INDIA HAVE NOT LEAD TO DEVELOPMENT OF ANY INTANGIBL ES. THE FACT THAT THE ASSESSEE HAS A WELL ORGANIZED WORK FORCE WITH VARIO US DEPARTMENTS WORKING IN COORDINATION INDICATE THAT IT HAS EARNED A SIGN IFICANT AMOUNT OF SUPPLY CHAIN INTANGIBLES, GOODWILL AND NAME IN INDIA. THUS , ASSESSEE HAS DEVELOPED SUBSTANTIAL INTANGIBLES IN TERMS OF SUPPLY CHAIN, H UMAN RESOURCES AND GOODWILL FOR WHICH IT IS TO BE SUITABLY REMUNERATED . IF GAP, USA ALLOWS THE ASSESSEE TO RENDER SIMILAR TYPE OF FUNCTIONS FOR A THIRD PARTY, THESE INTANGIBLE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 37 37 WILL GIVE PRIORITY TO ASSESSEE FOR SOLICITING SUCH SERVICES TO THIRD PARTIES, WHICH CONSTITUTES ADVANTAGE OF INTANGIBLES. 8.5. IN VIEW OF THE FACTS OF THE CASE, ASSESSEE ENJ OYS INTANGIBLES IN TERMS OF: - GIS INDIA OWNS HUMAN ASSET INTANGIBLES - GOODWILL AS A PROCUREMENT FACILITATOR IN GARMENT TRADE. 8.6. THE COMPENSATION MODEL OFFERED BY THE ASSESSEE LACKS IN PROPER VALUATION OF USE OF SUCH INTANGIBLES, WHICH ARE AVA ILED BY THE AES. TPO HAS CORRECTLY ANALYSED ASSESSEES FAR HOLDING THAT IT H AS DEVELOPED A SUPPLY CHAIN MANAGEMENT INTANGIBLE OVER A PERIOD OF TIME W HICH IS ALL ABOUT HAVING THE RIGHT PRODUCT IN THE RIGHT PLACE, RIGHT PRICE, RIGHT TIME AND RIGHT CONDITIONS. IN OTHER WORDS, THE SUPPLY CHAIN MANAGE MENT AS DEVELOPED BY THE ASSESSEE IS THE MANAGEMENT OF THE LINK BETWEEN AND ORGANIZATION AND ITS SUPPLIERS AND CUSTOMER TO ACHIEVE STRATEGIC AND PRI CING ADVANTAGE. THIS SUPPLY CHAIN MANAGEMENT (SCM) AS DEVELOPED BY THE ASSESSEE IN INDIA IS A PART OF THE GLOBAL SUPPLY CHAIN MANAGEMENT OF THE G AP GROUP OF THE COMPANIES. THE SCM AS DEVELOPED BY THE ASSESSEE CON SISTS OF FOLLOWING PROPRIETARY INFORMATIONS: - KNOWLEDGE OF VENDORS - KNOWLEDGE OF PRODUCTS AND DESIGN - KNOWLEDGE OF ACQUISITION AND SUPPLY - KNOWLEDGE OF QUALITY CONTROL - KNOWLEDGE OF STORAGE - KNOWLEDGE OF LOGISTIC INVOLVED IN EXPORTS OF THE GOODS. 8.7. ALL THESE ACTIVITIES PROVIDE SIGNIFICANT VALUE ADDED TRADE BENEFIT AND STRATEGIC ADVANTAGE TO THE AE. HOWEVER, THE COMPENS ATION MODEL DOES NOT ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 38 38 INCLUDE THE BENEFITS ATTRIBUTABLE TO THE GIS INDIA ON ACCOUNT OF LOCATION SAVINGS ALSO. GLOBALIZATION AND CONTINUOUS SEARCH F OR LOWER COST HAS RESULTED IN TRANSFER OF MANUFACTURING AND PROCUREMENT ACTIVI TIES FROM HIGH COST ECONOMY LIKE EUROPEAN UNION, JAPAN, UK AND UNITED S TATES, TO LOWER COST ECONOMICS LIKE INDIAN AND CHINA TO STAY COMPETITIVE AND TO INCREASE PROFITS. IN THIS CASE, GAP GROUP HAS RECOGNIZED THAT INDIA O FFERS BOTH COST AND OPERATIONAL ADVANTAGE SUCH AS LOWER SALARIES FOR TH E EMPLOYEES, LOW COST MATERIAL AND LOW COST MANUFACTURE. IT IS A RECOGNIZ ED FACT THAT FOR A TRADING COMPANY FOR PROCURING GOODS FROM INDIA, LOCATION S AVINGS GENERALLY EMERGE WHEN COMPANIES TRANSFER THEIR OPERATION SITE FROM H IGH COST ECONOMY TO ECONOMIES WITH LOW COST. IN THIS CASE, THE ASSESSEE IS ADMITTEDLY OPERATING IN LOW COST ECONOMY AND HAS GENERATED LOCATION SAVINGS FOR AES DUE TO HUGE DIFFERENCE IN COST OF PROCUREMENT BETWEEN HIGH COST ECONOMY AND LOW COST ECONOMY LIKE INDIA. FROM A TRANSFER PRICING PERSPEC TIVE THE ADDITIONAL PROFITS ATTRIBUTABLE TO LOCATION SAVINGS ARE TO BE FACTORED . ASSESSEE IS RESPONSIBLE FOR IDENTIFYING AND QUALIFYING THE CONTRACTED MANUFACTU RER, FOR WORKING WITH THEM AND OTHER DESIGNS TO MANUFACTURE GARMENTS IN T HE TECHNICAL SPECIFICATIONS, FOR SELECTION OF FABRICS, FOR CONTR OL OVER THE MANUFACTURE, FOR IDENTIFYING APPROPRIATE SOURCING OF FABRICS AND ACC ESSORIES, FOR QUALITY INSURANCE, TRANSPORTATION LOGISTICS, COORDINATING L OGISTICS ETC. THEREFORE, THE COST PLUS COMPENSATION @ 15% OF DIRECT COST IS NOT AT ARMS LENGTH BECAUSE IT DOES NOT INCLUDE PROFIT ATTRIBUTABLE TO THE ASSE SSEE ON ACCOUNT OF LOCATION SAVINGS. 8.8. A RESEARCH REPORT ON LOCATION SAVINGS IN GARME NT INDUSTRY IS DONE BY WERNER INTERNATIONAL MANAGEMENT CONSULTANTS (WIMC), AND PUBLISHED IN THE HINDUSTAN TIMES, DELHI EDITION ON 10-08-2010. T HIS SHOWS THAT THE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 39 39 AVERAGE COST PER OPERATOR IN 2008 FOR WORKERS IN TH E GARMENT INDUSTRY IS LIKE: (IN USD) JAPAN 30.81 FRANCE 30.39 GERMANY 25.42 SPAIN 18.39 UK 17.7 US 17.41 BRAZIL 3.41 CHINA 0.85 INDIA 0.85 PAKISTAN 0.56 8.9. LD. DR CONTENDS THAT ASSESSEE IS NOT ONLY AVAI LING LOWER PROCUREMENT COST IN INDIA BUT ALSO THE LOWER PRICES OF PURCHASE OF RAW MATERIAL FROM INDIA. THIS ARRANGEMENT AT THE FIRST BLUSH INDICATE S THAT THE COST PLUS FORMULA HAS BEEN DEVISED BY THE GAP, INC. TO ATTRIBUTE LOWE ST INCOME TO THE INDIAN SUBSIDIARY. THE WIMS DETAILS THOUGH IS PUBLISHED IN 2010, RELATE TO MARKET RESEARCH IN 2008 AND A SUITABLE ADJUSTMENT TO F.YS. 2005-06 & 2006-07 SHOULD BE CONSIDERED. IT IS EMPHASIZED THAT THE ONL Y APPROPRIATE REMUNERATION MODEL FOR COMPENSATION TO INDIAN ENTIT Y OUGHT TO BE IN TERMS OF % OF FOB AND NOT THE COST PLUS MARK-UP. ASSESSEE EXCEPT RELYING ON ITS CONSERVATIVE METHOD IN EARLIER YEARS WITH LIAISONIN G OFFICE HAS FAILED TO PROVIDE ANY JUSTIFICATION TO SUPPORT ITS TP WORKING BASED ON COST PLUS MARKUP. IN THESE CIRCUMSTANCES TPO WAS LEFT WITH NO CHOICE BUT TO HOLD ALP 5.22% ON FOB VALUE RELYING ON ARITHMETIC MEAN O F FOLLOWING COMPARABLES AND WORKING. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 40 40 S.NO. NAME OP/TC(%) 1. PANTALOON RETAIL (INDIA) LTD. 6.70 2. TRENT LTD. 6.19 3. JAYPEE SPINTEX LTD. 2.77 ARITHMETIC MEAN 5.22 ACCORDINGLY, THE ARMS LENGTH PRICE IS WORKED OUT BY TPO ON FOB VALUE OF EXPORTS OF RS. 3963,38,34,240/- FOR A.Y. 2006-07; AND RS. 51,535,602,475/- FOR A.Y. 2007-08, RESULTING INTO RESPECTIVE ADDITIO NS. 8.10. IT WILL BE THEREFORE JUST AND PROPER THAT GIS INDIAS COMMISSION IS WORKED OUT IN TERMS OF PERCENTAGE OF THE FOB PRICE OF GOODS SOURCED THROUGH THE GIS INDIA. THE INDIAN REVENUE SHOULD NO T BE DEPRIVED OF DUE TAXES IN THE PRETEXT OF IN HOUSE CONVENIENT ARRANGE MENTS. 8.11. LD. DR RELIED ON THE ORDERS OF DRP, TPO AND A SSESSING OFFICER AND OUT OF COURT SETTLEMENT BETWEEN US REVENUE AUTHORIT IES LI FUNG CASE AND TOMY HILFGER COMPARISON. 9 DECISION ON THE CASE 9.1 WE HAVE HEARD THE RIVAL CONTENTIONS AND PERUSED THE MATERIAL AVAILABLE ON RECORD INCLUDING THE WRITTEN SUBMISSIO NS AND SYNOPSIS FILED BY THE ASSESSEE WHICH IS PLACED ON THE PAPER BOOK. THE ACT PRESCRIBES A SCHEME FOR DETERMINING THE ARMS LENGTH PRICE OF EVERY INT ERNATIONAL TRANSACTION FOR ASCERTAINING THE ALP. TO DECIDE THE SAME IT IS IMPE RATIVE TO TAKE THE FOLLOWING FACTORS INTO CONSIDERATION: 9.2 CHARACTERIZATION OF ASSESSEE AND ITS ASSOCIATED ENTERPRISES THROUGH FUNCTION, ASSETS AND RISK (FAR) ANALYSIS OF INTERNATIONAL TRANSACTIONS. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 41 41 THE FAR ANALYSIS GIVES THE BASIS OF BROAD CHARACTE RIZATION FOR E.G. MANUFACTURER, SERVICE PROVIDER, DISTRIBUTOR, ETC WI TH A FURTHER SUB- CHARACTERIZATION INCLUDING LOW-RISK SERVICE PROVIDE R, HIGH RISK SERVICE PROVIDER; FULL-FLEDGED MANUFACTURER, CONTRACT MANUF ACTURER, ETC. THESE CHARACTERIZATIONS ARE VITALLY IMPORTANT TO DETERMIN E THE ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTIONS. I. AUTHORITIES BELOW HAVE PROCEEDED ON PREMISE THAT ASSESSEE IS A RISK BEARING AE AND ITS FUNCTIONS ARE NOT IN THE NATURE OF A SERVICE PROVIDER ONLY. THE FAR ATTRIBUTABLE TO ASSESSEE ARE FAR GREA TER THAN WHAT ARE CLAIMED. ASSESSEE HAS DEVELOPED SUBSTANTIAL INTANGI BLES IN THE FORM OF HUMAN RESOURCES AND SUPPLY CHAIN. BESIDES LOCATION ADVANTAGES AVAILABLE TO ASSESSEE HAVE NOT BEEN FACTORED IN THE ALP. II. ON THESE OBSERVATIONS, AND BY PUTTING RELIANCE ON THE CASE OF LI & FUNG INDIA, IT HAS BEEN HELD THAT ASSESSEE PERFORMS THE FUNCTIONS OF A RISK BEARING AGENT AND THEREFORE, COST PLUS PLI ADO PTED BY THE ASSESSEE FOR ALP DETERMINATION IS NOT THE MOST APPROPRIATE. THEREBY THE COST PLUS PLI HAS BEEN SUBSTITUTED BY 5% ON FOB VALUE OF GOODS OUTSOURCED BY THE ENTITIES OF FOREIGN ENTERPRISES W HICH HAS BEEN CONSIDERED TO BE THE TP VALUE. III. IN OUR CONSIDERED VIEW, NO SUPPORTING MATERIAL HAS BEEN BROUGHT ON RECORD THAT ASSESSEE; GIS INDIA HAS BORNE ANY BUSIN ESS RISKS ARISING FROM ITS ACTIVITIES WITH GAP USA. THERE ARE NO ADVE RSE FACTS, MATERIAL OR EVIDENCE ON THE BASIS WHEREOF LD. TPO H AS MADE ARRIVED AT SUCH A CONCLUSION. THE LD. TPO HAS NOT GIVEN ANY EXAMPLES OR COMPARABLES WHATSOEVER TO DEMONSTRATE WHICH MAJOR B USINESS RISKS MUCH LESS ANY RISK ARE BORNE BY GIS INDIA AND HOW. IN A SWEEPING ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 42 42 MANNER IT HAS BEEN HELD THAT AS FUNCTIONS FOLLOW RI SKS, AND SINCE, IN HIS WISDOM GIS INDIA UNDERTAKES KEY FUNCTIONS, THEREFOR E IT MUST ALSO BE BEARING THE CONSEQUENT RISKS. THE OBSERVATION IS FL AWED AS FROM THE HANDBOOK AND GUIDELINES IT CLEARLY EMERGES THAT ASS ESSEE HAD NO WISDOM OR DISCRETION IN THESE TERMS. IV. BESIDE IT IS COMMON TREND IN GARMENT THAT GOODS ARE GENERALLY SUPPLIED ON CREDIT BASED WHICH THE SUPPLIERS HAVE T O EXTEND TO GAP, USA ENTITIES AND ASSESSEE BEARS NO RISK. THE ASSESS EE ROLE, FUNCTIONS AND ACTIVITIES ARE LIMITED TO SCRUPULOUSLY FOLLOW T HE HANDBOOK AND OTHER INSTRUCTIONS PROVIDED BY THE PARENT GROUP. TH ESE FACTS AND CIRCUMSTANCES INDICATE LACK OF AUTHORITY OR DISCRET ION WITH ASSESSEE IN DEVIATING OR CHANGING FROM THE POLICIES AND PROCEDU RES PRESCRIBED BY THE PARENT COMPANY. THEREFORE, WE ARE UNABLE TO AGR EE WITH THE VIEW THAT ASSESSEE INCURRED ANY SIGNIFICANT RISK IN ITS FUNCTIONS. V. COMING TO THE ISSUE ABOUT ASSESSEE HAVING DEVELO PED SUBSTANTIAL HUMAN RESOURCES INTANGIBLES, THERE IS NO SUPPORTING MATERIAL AVAILABLE ON RECORD TO HOLD IT AGAINST ASSESSEE. EXCEPT GENER ALIZED ASSERTIONS NOTHING RELIABLE IS PLACED ON RECORD TO SUPPORT THE SE OBSERVATIONS. ASSESSEE HAD 230 EMPLOYEES ON ITS PAYROLL ENGAGED I N EXECUTION OF PREORDAINED SUPPORT NATURE ACTIVITIES AS PER THE GU IDELINES. THEIR QUALIFICATIONS ARE GENERAL AND ROUTINE IN NATURE AN D DEPARTMENT HAS FAILED TO DEMONSTRATE THAT ANY OR FEW OF EMPLOYEES WERE ANY ACCLAIMED PERSONALITIES OR INDISPENSABLE IN GARMENT PROCUREMENT TRADE SO AS TO CONSTITUTE ANY HUMAN INTANGIBLES AS ALLEGE D. WITH NO DECISION MAKING OR ENTREPRENEURIAL ROLE EMBEDDED IN THEIR WO RK PROFILES, IT IS NOT CLEAR HOW THE TPO OR DRP CAN ARRIVE AT SUCH A C ONCLUSION THAT ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 43 43 THESE ROUTINE ACTIVITIES LED TO CREATION/ DEVELOPME NT OF ANY VALUABLE SUPPLY CHAIN OR HUMAN ASSET. MAJORITY OF THESE EMPL OYEES ARE GRADUATES OR POST GRADUATE DIPLOMA HOLDERS. EMPLOYE ES WITH SUCH EDUCATIONAL QUALIFICATIONS ARE ABUNDANTLY AVAILABLE IN THE INDIAN RECRUITMENT CIRCLES. VI. COMING TO THE DEVELOPMENT OF SUPPLY CHAIN ISSUE ALSO, THE CONCLUSION IS BEREFT OF ANY DISCERNIBLE BASIS. ASSESSEES ROLE , ACTIVITIES AND SUPPLIERS ARE ALREADY IDENTIFIED MERELY FOLLOWING T HE GUIDING INSTRUCTIONS CANNOT BE ASSUMED TO CREATE A SUPPLY C HAIN. SUPPLY CHAIN OF GARMENT MANUFACTURERS IN INDIA WAS PROVIDED BY G AP, USA AND NOT ASSESSEE. UNDER THESE CIRCUMSTANCES WE ARE UNAB LE TO ACCEPT THIS PROPOSITION. VII. TPO HAS THEORETICALLY RELIED ON A HINDUSTAN TI MES NEWS PAPER REPORT PUBLISHED IN 2008 IN RESPECT OF COST OF PROCUREMENT SERVICES IN VARIOUS COUNTRIES. IN OUR VIEW THIS NEWS PAPER REPO RT BY ITSELF CANNOT PARTAKE THE CHARACTER OF A COMPARABLE DATA. IT IS A FACT THE LABOR COSTS INCLUDING PROCUREMENT SERVICES ARE VERY LOW IN INDI A, PAKISTAN, BANGLA DESH AND CHINA. BUT IT DOES NOT IMPINGE ON T HE ASSESSES PROFITABILITY BY DRAWING A ASSUMING PERCEIVED LOCAT ION ADVANTAGES. LOCATION SAVINGS TO DEVELOPING ECONOMY ARISE TO THE INDUSTRY AS A WHOLE, THERE IS NOTHING ON RECORD THAT ASSESSEE ON STANDALONE BASIS WAS SOLE BENEFICIARY. WE FIND MERIT IN THE ARGUMENT OF MR. MITRA THAT THE INTENT OF SOURCING FROM LOW COST COUNTRIES FOR A MANUFACTURER / RETAILER IS TO SURVIVE IN STIFF COMPETITION BY PROV IDING A LOWER COST TO ITS END-CUSTOMERS. GENERALLY, THE ADVANTAGE OF LOCA TION SAVINGS IS PASSED ONTO THE END-CUSTOMER VIA A COMPETITIVE SALE S STRATEGY. THE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 44 44 ARMS LENGTH PRINCIPLE REQUIRES BENCHMARKING TO BE DONE WITH COMPARABLES IN THE JURISDICTION OF TESTED PARTY AND THE LOCATION SAVINGS, IF ANY, WOULD BE REFLECTED IN THE PROFITAB ILITY EARNED BY COMPARABLES WHICH ARE USED FOR BENCHMARKING THE INT ERNATIONAL TRANSACTIONS. THUS IN OUR VIEW, NO SEPARATE / ADDI TIONAL ALLOCATION IS CALLED FOR ON ACCOUNT OF LOCATION SAVINGS. VIII. IN VIEW OF ALL THESE FACTS WE ARE UNABLE TO A GREE WITH THE PROPOSITIONS OF TPO THAT ASSESSEE WORKS AS A RISK BEARING AGENT OF THE AE AND IT POSSESSES HUMAN RESOURCES INTANGIBLES ALONG WITH SU PPLY CHAIN RESOURCES. THE FACTS AND CIRCUMSTANCES LEAD US TO A CONCLUSION THAT ASSESSEE IS A LOW RISK PROCUREMENT SUPPORT SERVICE PROVIDER ONLY. 9.3 MOST APPROPRIATE METHOD I. FROM RECORDS IT IS CLEAR THAT THE ASSESSEE PROPO SED THE USE OF TRANSACTIONAL NET MARGIN METHOD (TNMM) AS THE MOS T APPROPRIATE METHOD WITH NET PROFIT / TOTAL COST AS A PROFIT LEV EL INDICATOR (PLI). FURTHER, THE DEPARTMENT HAS ACCEPTED THE USE OF TNMM WITH A PERCENTAGE OF FOB VALUE OF GOODS PROCURED BY PARE NT AS PLI. ACCORDINGLY, WE PROCEED ON THE BASIS OF TNMM AS THE MOST APPROPRIATE METHOD WITHOUT GOING INTO ANALYSIS OR M ERITS OF OTHER METHODS. THE DISPUTE IS LIMITED TO THE SELECTION O F PLI, WHERE THE ASSESSEE HAS PROPOSED USE OF NET PROFIT / TOTAL COS T WHEREAS THE DEPARTMENT HAS USED A PERCENTAGE OF FOB VALUE OF GO ODS PROCURED BY PARENT AS PLI. CONSEQUENTLY WE PROCEED TO DEAL WIT H THE ISSUE OF PLI. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 45 45 II. THE SELECTION OF MOST APPROPRIATE METHOD AND PL I DEPENDS UPON THE FAR AND AVAILABLE DATA OF COMPARABLES. WE HAVE TO KEEP IN MIND THE GUIDING PRINCIPLES IN ALP DETERMINATION THAT THE ME THOD AND PLI USED SHOULD NOT LEAD TO MANIFESTLY ABSURD RESULTS, SO AS TO PUT ONE OF THE PARTIES TO TRANSACTIONS AT ABNORMALLY HIGHER PROFIT ABILITY AND THE OTHER PARTY AT SIGNIFICANT LOSS. IF A PARTICULAR PLI RES ULTS IN ABNORMAL RESULTS THEN ONE SHOULD MOVE ON TO CHOOSE A METHOD AND PLI WHICH PROVIDES RATIONAL RESULTS. THE ARMS LENGTH PRICING SHOULD BE THE ONE WHICH REFLECTS COMMERCIAL AND ECONOMIC REALITIES OF THE I NDUSTRY AND ALSO SHOULD BE THE ONE WHICH SUPPORTS THE FAR ANALYSIS O F THE SUBJECT INTERNATIONAL TRANSACTION. ABSURD AND DISTORTED LEA D TO CREATE ABERRATIONS IN DISPENSATION OF TAX ADMINISTRATIONS. THEY REFLECT AN ADVERSARIAL APPROACH ON THE PART OF ADMINISTRATORS WHICH BEST SHOULD BE AVOIDED. III. IT IS CLEAR THAT THE ASSESSEE IS A LOW RISK PR OCUREMENT SUPPORT SERVICE PROVIDER. A SERVICE PROVIDER MOSTLY WORKS TOWARDS R ECOVERING ITS COSTS AND EARNING A REASONABLE MARK-UP IN LINE WITH ITS FUNCTIONS PERFORMED. THE PROCUREMENT SERVICE PROVIDER WORK O N VARIOUS MODELS INCLUDING THE PERCENTAGE OF VALUE OF GOODS P ROCURED AND THE COST PLUS MARK-UP MODEL DEPENDING UPON THE SET OF F ACTS. IV. IN PERCENTAGE MODEL THE PROCUREMENT SERVICE PRO VIDER IS REMUNERATED ONLY IN THE EVENT OF GOODS PROCURED BY THE PROCURER ; IF THE GOODS ARE NOT PROCURED THEN THE SERVICE PROVIDER WILL INCUR L OSS TO THE TUNE OF COSTS INCURRED IN THE PROCESS AND NOTIONAL LOSS ON ACCOUNT OF TIME SPENT BY THE SERVICE PROVIDER WHICH IT WOULD HAVE S PENT ON OTHER PROFIT GENERATING ACTIVITY. ACCORDINGLY, PERCENTAG E MODEL PUTS THE ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 46 46 PROCURER AT SIGNIFICANT ADVANTAGE AND THE PROCUREME NT SERVICE PROVIDER AT SIGNIFICANT MARKET RISK. V. THE COST PLUS MARK-UP MODEL IS IN ABSOLUTE CONTR AST TO THE PERCENTAGE MODEL WHEREBY THE SERVICE PROVIDER IS ASSURED OF CO ST RECOVERY ALONG WITH A MARK-UP IRRESPECTIVE OF THE FACT WHETHER THE PROCURER PURCHASES ANY GOODS OR NOT. THIS MODEL PUTS THE PROCURER AT THE DISADVANTAGE WITH A SIGNIFICANT ADVANTAGE TO SERVICE PROVIDER. VI. IT IS IMPORTANT TO NOTE THAT THE IRRESPECTIVE O F THE MODEL FOLLOWED, BOTH PROCURER AND SERVICE PROVIDER WILL SET THE TERMS WH ICH WORK IN SERVING THE BEST INTEREST OF BOTH THE PARTIES, MEANING PUTT ING BOTH THE PARTIES AT A WIN-WIN SITUATION. IN PERCENTAGE MODEL IF THE PRO CURER FEELS THAT THE PERCENTAGE AGREED IS RESULTING IN VERY HIGH PROFITA BILITY FOR SERVICE PROVIDER, THEN THE PROCURER WOULD PROCEED TO RE-NEG OTIATE THE PERCENTAGE FOR BRINGING IT DOWN TO REASONABLE LEVEL . SIMILARLY, UNDER THE COST PLUS MODEL IF THE SERVICE PROVIDER FEELS T HAT REASONABLE MARK- UP WOULD BE MORE THAN THE AGREED MARK-UP THEN THE S ERVICE PROVIDER WILL TAKE APPROPRIATE STEPS TO GET IT CORRECTED. VII. THE ESSENCE OF ABOVE DISCUSSION IS TO THE EFFE CT THAT MARKET FORCES WILL INTERACT IN ANY BUSINESS MODEL AND LEAD TO REASONAB LY ACCEPTABLE PROFITABILITY. CONSIDERING THIS WE NOW PROCEED TO DECIDE THE PLI WHICH WOULD RESULT IN REASONABLE PROFITABILITY. 9.4 LI & FUNG CASE AND TPO / DRP STAND I. THE PLI OF PERCENTAGE OF FOB VALUE OF GOODS PROC URED BY PARENT RESULTS IN NET PROFIT / TOTAL COST OF ASSESSEE AT 8 30% AND 660% FOR AY ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 47 47 2006-07 AND AY 2007-08. WITHOUT GOING TO ANY ADDIT IONAL FACT ONE CAN CLEARLY MENTION THAT THE USE OF THIS PLI HAS RE SULTED IN ABSURD AND DISTORTED RESULTS. ANY BUSINESS MODEL FOLLOWED WOU LD REFLECT IN BOTTOM LINE PROFITABILITY OF THE ASSESSEE. THE PLI AND PERCENTAGE PROPOSED BY DEPARTMENT AS THE ARMS LENGTH PRICE MA Y HAVE DEMANDED CONSIDERATION PROVIDED IT PRODUCES PROCUREMENT SERV ICE PROVIDER COMPARABLES WHICH FOLLOW PERCENTAGE BASED MODEL AND AT THE SAME TIME END UP EARNING EXORBITANT MARK-UP OVER COSTS. IN OUR CONSIDERED VIEW THE DEPARTMENT HAS FAILED TO PRODUCE A SINGLE COMPARABLE SUPPORTING THEIR STAND. II. IT HAS BEEN PLACED ON RECORD THAT THE TPO PROVI DED THE ALTERNATE OF USING 7 COMMISSION AGENT COMPARABLES FOR AY 2008-09 . THE ASSESSEE OFFERED TO ACCEPT THOSE IN ORDER TO AVOID PROTRACTED LITIGATION. THESE COMPARABLES WITH UPDATED FINANCIAL RESULTS FO R AY 2006-07 RESULT IN NET PROFIT / TOTAL COST OF 26.01%. III. THE DEPARTMENT HAS HEAVILY RELIED ON THE LI & FUNG INDIAS CASE (SUPRA). IN THIS CASE, THE DELHI TRIBUNAL HELD THA T ON THE FACTS OF THE SAID CASE, THE PROCUREMENT COMPANY IN INDIA WAS ENT ITLED TO A REVENUE LINKED REMUNERATION. THE DECISION IN THE CASE OF LI & FUNG PROCEEDED ON THE SPECIFIC FINDINGS OF THE TPO THAT THE ASSESS EE WAS NOT ABLE TO ESTABLISH THAT THE FOREIGN PRINCIPAL IN HONG KONG H AD ANY SUBSTANCE, WHICH THE ASSESSEE WAS ALSO NOT ABLE TO SUBSTANTIAT E BEFORE THE TRIBUNAL. IN THESE PECULIAR FACTS TRIBUNAL ACCEPTED THE FACTUAL POSITION THAT THE INDIAN ASSESSEE HAD ACTUALLY CARRIED OUT A LL THE SIGNIFICANT FUNCTIONS RELATING TO PROCUREMENT IN INDIA; AND THA T VERY LITTLE OR VIRTUALLY NIL FUNCTIONS WERE CARRIED OUT AT THE LEV EL OF HONG KONG. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 48 48 IV. HOWEVER, THE FACTS IN THE APPELLANTS CASE ARE DIFFERENT IN AS MUCH AS ALL THE SIGNIFICANT DIRECTIONS RELATING TO PROCUREM ENT OF GOODS FROM THIRD PARTY VENDORS IN INDIA, NAMELY (A) DESIGNS & TRENDS OF APPAREL; (B) QUALITY PARAMETERS OF MATERIALS: (C) TERMS & CO NDITIONS FOR DEALING WITH VENDORS, ETC, ARE ALL PROVIDED BY GAP US TO TH E APPELLANT THROUGH THE VOLUMINOUS VENDOR HANDBOOK & OTHER CORR ESPONDENCES WHICH ARE PLACED ON RECORD AND HAVE NOT BEEN CONTRO VERTED BY THE DEPARTMENT. IT EMERGES THAT ASSESSEE FOLLOWS AND EX ECUTES THEM AS A SERVICE PROVIDER. FOR SUCH PREORDAINED SUPPORT SERV ICES, THE ASSESSEE CANNOT BE HELD TO BE ENTITLED TO REMUNERATION IN TE RMS OF LI & FUNG CASE ON FOB VALUE OF GOODS PROCURED BY GAP US FROM THIRD PARTY VENDORS IN INDIA. IN THE CASE OF LI & FUNG INDIA, A SSESSEE ACTUALLY CARRIED OUT SIGNIFICANTLY VALUE ADDED FUNCTIONS IN INDIA, WHICH IS NOT THE CASE BEFORE US. V. EVEN IF WE OVERLOOK THE FACTUAL DISSIMILARITIES BETWEEN THE LI & FUNG INDIA AND ASSESSEES CASE, THE TRANSACTIONAL PROFIT ABILITY EARNED BY LI & FUNG INDIA SUPPORTS THE CASE OF ASSESSEE. THE DE PARTMENT HAS HEAVILY RELIED ON THE FACT THAT LI & FUNG HONG REM UNERATION OF 5% OF VALUE OF GOODS PROCURED SHOULD BE USED AS BENCHM ARK RATE BY THE ASSESSEE. THE DEPARTMENT OVERLOOKED THE OTHER EXTR EMELY IMPORTANT FACT OF THE PROFITABILITY EARNED BY LI & FUNG THROU GH 5% PROCUREMENT SERVICE MODEL. THE TOTAL REMUNERATION EARNED BY LI & FUNG HONG KONG WAS RS. 60.15 CRORES AGAINST COST INCURRED BY INDIAN COMPANY OF RS. 45.42 CRORES AND SOME MINOR COSTS INCURRED I N HONG KONG. THE ITAT BENCH HELD THAT CONSIDERING THE FACTS OF THE C ASE, 80% OF COMMISSION (RS. 48.12 CRORES) EARNED BY LI & FUNG H ONG KONG ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 49 49 SHOULD BE ATTRIBUTED TO INDIAN COMPANY. THIS ATTRI BUTION RESULTED IN PROFITABILITY OF RS. 2.72 CRORES (RS. 48.12 CRORES RS. 45.42 CRORES) FOR THE INDIAN COMPANY RESULTING IN THE NET PROFIT / TOTAL COST OF 6%. DEPARTMENT OVERLOOKED THESE IMPORTANT FACTS WHICH M UST BE TAKEN INTO CONSIDERATION USING THIS EXAMPLE AS BENCHMARK FOR DETERMINING ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTIONS FO R TAXPAYERS. VI. CONSIDERING ABOVE WE CONCLUDE THAT NON RISK BEA RING PROCUREMENT FACILITATING FUNCTIONS WHICH ARE PREORDAINED BY CON TRACT AND HAND BOOK, THE APPROPRIATE PLI WILL BE NET PROFIT / TOTA L COST AND NOT THE % OF FOB VALUE OF GOODS SOURCED BY AE. ACCORDINGLY, W E UPHOLD THE NET PROFIT / TOTAL COST REMUNERATION MODEL ADOPTED BY THE ASSESSEE. HAVING HELD SO NOW WE PROCEED TO DECIDE THE PERCENT AGE OF MARKUP TO BE APPLIED TO ASSESSEES COST. 9.5 DETERMINATION OF COST PLUS REMUNERATION IN ASSE SSEES CASE I. LD COUNSEL SHRI MITRA HAS PLACED ON THE RECORD A WORKING SUGGESTING THAT EVEN IF ONE WERE TO ASSIGN THE ENTIRE COMMISSI ON OF LI & FUNG GROUP TO LI & FUNG INDIA, THEN THE OP/ TOTAL COST O F LI & FUNG INDIA WORKED OUT TO 32.43%, AS OPPOSED TO 15% ADOPTED BY THE APPELLANT, WHICH AGAIN, IS WITHIN ACCEPTABLE LIMITS. THUS AT THE END OF THE ARGUMENTS, SHRI MITRA THUS PLEADS THAT IN EXTREME SCENARIO ALSO, THE COST+ MARK UP IN ASSESSEE CASE CANNOT BE STRETCHED BEYOND 32% LOOKING FROM LI FUNG CASE OR ANY OTHER ANGLE. (II) IT IS TRITE LAW THAT INCOME TAX ASSESSMENTS AN D APPELLATE PROCEEDINGS ARE NON ADVERSARIAL IN NATURE, HELD TO BE AN EXERCI SE OF FAIR ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 50 50 DETERMINATION OF TAX LIABILITY PAYABLE BY THE ASSES SEE. LOOKING AT THE SWEEPING OBSERVATIONS OF THE TPO AND DRP WHICH ARE NEITHER BASED ON ANY COGENT REASONING NOR FACTUAL RELIABILI TY, THE ASSESSMENTS AS FRAMED GIVE AN IMPRESSION OF BEING W ORK OF ADVERSARIAL APPROACH IN TAX LIABILITY DETERMINATION . HONBLE FINANCE MINISTER GENERALLY AND RECENTLY IN PARTICUL AR GAVE A CLARION CALL THAT THE INCOME TAX PROCEEDINGS SHOULD BE FAIR AND NON ADVERSARIAL IN NATURE. THIS IS RIGHTLY SO AS IT IS A SINE QUA NONE OF A TAX ADMINISTRATION WHICH USHER INTO A RULE OF LAW W HICH IS PREDICTABLE AND BASED ON SOUND REASONING AND IS NOT FRAUGHT WITH THE PERILS OF UNCERTAINTIES AND ADVERSITIES FOR THE TAXPAYERS. (III) IN VIEW OF THE FOREGOING WE HAVE NO HESITATIO N TO ACCEPT A CANDID PROPOSAL GIVEN BY THE ASSESSEE AND HOLD THAT ASSESS EE TP ADJUSTMENTS BE MADE BY ADOPTING THE 32% COST PLUS M ARK UP OF THE ASSESSEE FOR AY 2006-07 AND 2007-08. THE MARK-UP PR OPOSAL OF ASSESSEE IS HIGHER THAN MARK-UP OVER TOTAL COST EAR NED BY ALL COMPARABLES PLACED ON RECORD. THE ASSESSMENTS SHOU LD BE FRAMED ACCORDINGLY. WE MAY HASTEN TO ADD THAT THIS MARK WE WILL BE SUBJECTED TO VARIATION IS SUBSEQUENT YEARS IF THE F ACTS AND CIRCUMSTANCES OF THE CASE SO WARRANT. 10. COMING TO THE ISSUE ABOUT RATE OF DEPRECIATION IT IS BY NOW SETTLED THAT THE COMPUTER PERIPHERALS ARE ELIGIBLE FOR 60% DEPRE CIATION WHICH SHOULD BE ALLOWED TO THE ASSESSEE. 11. IN VIEW OF THE ABOVE BOTH THE APPEALS FILED BY THE ASSESSEE ARE PARTLY ALLOWED. ITA 5147/DEL/11 & 228/DEL/12 GAP INTERNATIONAL SOURCING (I) P. LTD. 51 51 12. BEFORE PARTING WE WISH TO PLACE ON RECORD OUR S INCERE APPRECIATION OF THE CLARITY, ERUDITENESS AND TIMELY COMPLETION OF ARGUM ENTS BY THE LD. COUNSEL SHRI RAHUL MITRA FOR THE ASSESSEE AND LD. CIT (DR) SHRI PIYUSH JAIN FOR THE DEPARTMENT WHICH GREATLY HELPED US IN DECIDING THES E APPEALS. ORDER PRONOUNCED IN OPEN COURT ON 18-09-2012. SD/- SD/- ( T.S. KAPOOR ) ( R.P. TOLANI ) ACCOUNTANT MEMBER JUDICIAL MEMBER DATED: 18-09-2012. MP COPY TO : 1. ASSESSEE 2. AO 3. CIT 4. CIT(A) 5. DR