DDIT, New Delhi V. M/s Corning S.A, Gurgaon

ITA 2564/DEL/2011

• Counselvise Citation: [2015] 140 COUNSELVISE.COM (IT) 97090 (ITAT-DELHI)
• Duration Of Justice: 4 year(s) 3 month(s) 12 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 28-08-2015
• Appeal Filed By: Department
• Order Result: Partly Allowed
• Bench Allotted: I
• Next Hearing Date: 01-06-2015
• Assessment Year: 2003-2004
• Appeal Filed On: 16-05-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: SANJAY PRASAD
• Keywords: Depreciation; Transfer pricing; Business expenditure; International transaction

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL (DELHI BENCH I-1 : NEW DELHI) BEFORE SHRI S. V. MEHROTRA, ACCOUNTANT MEMBER AND SHRI A.T. VARKEY, JUDICIAL MEMBER ITA NO.2564/DEL./2011 (ASSESSMENT YEARS : 2003-04) DDIT, VS. M/S. CORNING S.A, CIRCLE-3 (2), INDIA BRANCH OFFICE, INTERNATIONAL TAXATION, GATEWAY TOWERS, DLF PHASE -III, NEW DELHI. GURGAON 122 002. (PAN : AAACC3889Q) (APPELLANT) (RESPONDENT) REVENUE BY : SHRI SANJAY PRASAD, CIT DR ASSESSEE BY: SHRI AJAY VOHRA, SENIOR ADVOCATE, SHRI NEERAJ JAIN, ADVOCATE AND MS. DEEPIKA AGARWAL CA DATE OF HEARING : 02.06.2015 DATE OF PRONOUNCEMENT : 28.08.2015 O R D E R PER A.T.VARKEY JUDICIAL MEMBER : THIS APPEAL, AT THE INSTANCE OF THE REVENUE, IS FIL ED AGAINST THE ORDER OF THE CIT (A)-XX, NEW DELHI DATED 28.2.2 011 FOR THE ASSESSMENT YEAR 2003-04 ON THE FOLLOWING GROUNDS: 1 ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CAS E, THE LD. CIT(A) HAS ERRED IN DELETING THE ADDITION OF RS . 20.87 LAKHS BY EXCLUDING CERTAIN ITEMS OUT OF COST OF EXP ENDITURE INCURRED FOR EARNING THE SAME FOR BENCHMARKING THE ARMS LENGTH PRICE IN RESPECT OF AGENCY ACTIVITIES. ITA NO.2564/DEL./2011 2 2 ON THE FACTS AND IN THE CIRCUMSTANCES SO THE CASE THE LD. CIT(A) HAS ERRED IN DELETING THE ADDITION OF RS . 1.11 CRORES BY EXCLUDING THE INCREASE CUSTOM DUTIES OUT OF THE COST OF IMPORT OF ROUGH OPHTHALMIC BLANKET (ROB), F OR BENCHMARKING THE ARMS LENGTH PRICE, ON THE GROUND THAT AN ABNORMAL ITEM WAS NOT APPEARING IN THE FINANCIAL OF THE COMPARABLE CONCERNS. 3 ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE , THE LD CIT(A) HAS ERRED IN EXCLUDING THE CUSTOM DUTIES ON THE IMPORT OF ROB FOR BENCHMARKING THE ARMS PRICE IGNO RING THE FACT THAT THE CUSTOM DUTY PAID ON THE IMPORT OF GOODS IS A NORMAL BUSINESS EXPENDITURE. 2. BRIEFLY STATED THE FACTS OF THE CASE ARE THAT TH E RESPONDENT- ASSESSEE COMPANY IS A BRANCH OFFICE OF A FRENCH COM PANY, NAMELY, CORNING S.A. FRANCE WHICH IS A LEADING MAN UFACTURER OF VERY HIGH-GRADE OPHTHALMIC AND NON-OPHTHALMIC GLASS PRODUCTS IN THE WORLD E.G., OPHTHALMIC BLANKS FOR EYEGLASSES AN D OPTICAL FIBRE ETC. FOR THE INSTANT YEAR, ASSESSEE FILED RETURN O F INCOME ON 28.11.2003 DECLARING AN INCOME OF RS. 53,99,390/-. THE ASSESSEE HAD ENTERED INTO FOLLOWING INTERNATIONAL TRANSACTI ONS WITH THE HEAD OFFICE IN FRANCE AND OTHER CORNING GROUP COMPA NIES DURING THE RELEVANT PREVIOUS YEAR: (I) IMPORT OF ROBS OF RS. 20,89,44,767/- FROM CORN ING S.A, FRANCE AS PART OF DISTRIBUTION FUNCTION OF IMPORT O F ROUGH OPHTHALMIC BLANKS (ROBS) AND SALE TO CUSTOMERS I N INDIA; ITA NO.2564/DEL./2011 3 (II) RECEIPT OF AGENCY SERVICE COMMISSION OF RS. 55 ,94,311/- FROM THE CORNING S.A. FRANCE FOR PROVIDING SALES REPRESENTATION SERVICES WHERE ROBS WERE DIRECTLY IMPORTED BY CUSTOMERS IN INDIA, FROM M/S CORNING S.A. FRANCE ; (III) RECEIPT OF MARKETING SUPPORT SERVICES FEE OF RS. 3,41,76,307/- FROM CORNING INC., USA; AND, (IV) REIMBURSEMENT OF ACTUAL EXPENSES OF RS. 12,35, 029/- AND RS. 1,09,265/- RECEIVED FROM CORNING SHANGHAI AND CORNI NG COMMUNICATION EQUIPMENT LTD. RESPECTIVELY. 3. THE ASSESSEE COMPUTED THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS WITH THE AE M/S CORNIN G SA FRANCE, RELATING TO DISTRIBUTION AND AGENCY SERVICE ACTIVIT IES, WITH REFERENCE TO THE COMBINED OPERATING PROFITS FROM TH E AFORESAID ACTIVITIES, TREATING THE SAME TO BE PART OF DISTRIB UTION ACTIVITY/SEGMENT. THE APPELLANT CONSIDERING THE FU NCTIONAL AND RISK PROFILE OF THIS FUNCTION AND LOOKING AT THE AV AILABLE COMPARABLE DATA, SELECTED TRANSACTIONAL NET MARGIN METHOD USING NET PROFIT MARGIN BASED ON SALES AS THE PROFI T LEVEL INDICATOR TO BE THE MOST APPROPRIATE METHOD FOR DET ERMINING THE APPROPRIATE ARMS LENGTH PRICE. ITS SEARCH YIELDED A SET OF 13 INDEPENDENT COMPANIES THAT WERE BROADLY COMPARABLE TO APPELLANTS FUNCTIONAL AND RISK PROFILE FOR THE DIS TRIBUTION FUNCTION ITA NO.2564/DEL./2011 4 AND, BASED ON THREE YEARS DATE (I.E. FINANCIAL YEAR 2000-2001, 2001-2002 AND 2002-2003) OF THE 13 COMPARABLES, TH E NET PROFIT MARGIN EARNED BY THEM RANGED FROM (-3.10% TO 7.39% WITH AN ARITHMETIC MEAD OF 3.15%. ACCORDINGLY BASED ON +/- 5% VARIATION IN ARMS LENGTH PRICE, THE ARITHMETIC MEA N OF THE AVERAGE NET PROFIT MARGIN MARGINS OF THE COMPARABLE COMPANIES WAS STATED TO RANGE FROM (-) 1.15% TO 7.45% AND, SI NCE FOR THE YEAR ENDED 31.3.2003 APPELLANT HAD EARNED A NPM OF (-) 0.81% (AFTER FOREIGN EXCHANGE LOSS) FROM ITS DISTRIBUTION OPERATIONS THIS WAS CLAIMED TO BE WITHIN THE ABOVE MENTIONED +/-5% RANGE PRESCRIBED UNDER THE ACT. FURTHER, SO FAR MARKETIN G SUPPORT SERVICES TO CORNING USA, APPELLANT SELECTED TRANSAC TIONAL NET MARGIN METHOD USING NET PROFIT MARGIN BASED ON COST (NCP) AS THE PROFIT LEVEL INDICATOR TO BE THE MOST APPROPRIA TE METHOD FOR DETERMINING THE APPROPRIATE ARMS LENGTH PRICE. ITS SEARCH YIELDED A SET OF 7 INDEPENDENT COMPANIES AND, BASED ON THRE E YEARS DATA (I.E. FINANCIAL YEARS 2000-2001, 2001-2002, AND 200 2-2003) OF THE 7 COMPARABLE COMPANIES, THE NCP MARGINS EARNED BY THEM WAS FOUND TO RANGE FROM 3.03% TO 11.76% WITH AN ARI THMETIC ITA NO.2564/DEL./2011 5 MEAN OF 7.68%. ACCORDINGLY BASED ON +/-5% VARIATIO N IN ARMS LENGTH PRICE THE ARITHMETIC MEAN OF THE AVERAGE NCP MARGINS OF THE COMPARABLE COMPANIES WAS STATED TO BE IN RANGE FROM 2.30% TO 13.06%. THUS, AS FOR FINANCIAL YEAR ENDING 31 .3.2003 APPELLANT HAD EARNED A NCP MARGIN OF 6.45% FROM ITS MARKETING SUPPORT SERVICES FUNCTION IT WAS CLAIMED TO BE WITH IN THE ABOVE MENTIONED +/-5% RANGE PRESCRIBED UNDER THE ACT. 4. HOWEVER, THE TPO IN AN ORDER DATED 10.1.2006 REJ ECTED THE COMBINED EVALUATION OF AGENCY SERVICE ACTIVITY AND DISTRIBUTION ACTIVITY WITH M/S CORNING SA FRANCE, AS PART OF DIS TRIBUTION ACTIVITY/SEGMENT, FOLLOWED BY THE ASSESSEE. THE TP O SEGREGATED THE AFORESAID ACTIVITIES FOR THE COMPUTATION OF ARM S LENGTH PRICE AND CONSEQUENTLY MADE AN UPWARD ADJUSTMENT, RE-COMP UTING THE ARMS LENGTH PRICE IN RESPECT OF THE AGENCY ACTIVIT IES. THE TPO HELD IN THIS REGARD AS UNDER: (I) THE FUNCTIONS PERFORMED AND RISKS ASSUMED IN TH E DISTRIBUTION FUNCTION AND THE AGENCY SERVICES FUNCT ION ARE QUITE DIFFERENT AND THEREFORE ALP FOR EACH OF T HEM NEEDS TO BE DETERMINED SEPARATELY; AND, ITA NO.2564/DEL./2011 6 (II) AGENCY SERVICES RENDERED BY THE ASSESSEE WERE IN THE NATURE OF MARKETING SERVICES AND WERE OF SIMILAR NATURE AS MARKETING SUPPORT SERVICES PROVIDED BY TH E ASSESSEE TO CORNING INC. USA. 5. THE TPO IN VIEW OF THE AFORESAID BENCHMARKED THE OPERATING RESULTS OF EACH OF THE ACTIVITY, APPLYING TNMM. FOR CARRYING OUT THE AFORESAID ANALYSIS, THE TPO FIRSTL Y DETERMINED THE NET INCOME FROM THE AGENCY SERVICES FUNCTION BY ALLOCATING EXPENSES AGGREGATING TO RS. 32,73,93,696/- RELATING TO THE DISTRIBUTION SEGMENT (COMPRISING OF DISTRIBUTION AN D AGENCY SERVICE FUNCTIONS) IN PROPORTION OF DISTRIBUTION SA LES AND AGENCY COMMISSION (RS. 32,02,59,496/-AND RS. 71,34,200/- R ESPECTIVELY) AS UNDER: A) EXPENSES ATTRIBUTED TO AGENCY SALES TOTAL INDIRECT EXPENSES (1,93,29,321/ - X COMMISSION SALES (18,64,77,03 3/ ______________________________________ (COMMISSION SALES (18,64,77,033) + DISTRIBUTION SALES (31,87,61,777) = RS.71,34,200 B) EXPENSES ATTRIBUTED TO DISTRIBUTION = RS. 32,73,93,696/- - RS. 71,34,200/- = RS.32,02,59,496/- ITA NO.2564/DEL./2011 7 6. THE TPO ON THE BASIS OF THE AFORESAID WORKING CO NCLUDED THAT IN THE AGENCY SERVICE FUNCTION THE ASSESSEE HA S INCURRED LOSS OF RS. 15,39,883/- AS FOLLOWS: PROFIT/(LOSS) FROM AGENCY SERVICES FUNCTION = COMMISSION INCOME EXPENSES ATTRIBUTABLE TO COMM ISSION SALES = RS. 55,94,311/- - RS. 71,34,200/- = (-) RS. 15,3 9,883/- 7. FURTHER, THE TPO FOR BENCHMARKING THE AFORESAID NET INCOME FROM AGENCY SERVICE FUNCTION APPLIED THE DAT A OF COMPARABLE ENTITIES CONSIDERED IN THE TRANSFER PRIC ING DOCUMENTATION FOR BENCHMARKING THE MARKETING SUPPOR T FUNCTION, WHEREBY ARITHMETIC MEAN WAS DETERMINED AS 7.68%. TH E TPO ACCORDINGLY, COMPUTED THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTIONS OF AGENCY SERVICES AT RS. 76,82,106/- AS FOLLOWS: NET COST INCURRED IN RESPECT OF COMMISSION INCOME 71,34,200 ADD: NET PROFIT OVER THE COST @ 7.68% 5,47,907 ARMS LENGTH COMMISSION INCOME 76,82,106 8. ON THE BASIS OF ABOVE TPO ACCORDINGLY DETERMINED ARMS LENGTH PRICE IN RESPECT OF COMMISSION INCOME AT RS. 76,82,106/- AS COMPARED TO RS. 55,94,311/- THE COMMISSION INCOM E RECEIVED BY THE ASSESSEE AND COMPUTED ADJUSTMENT OF RS.20,8 7,795/- ITA NO.2564/DEL./2011 8 BEING THE DIFFERENCE BETWEEN THE ARMS LENGTH PRICE DETERMINED IN RESPECT OF COMMISSION INCOME AND THE ACTUAL AMOUNT RECEIVED BY THE ASSESSEE. 9. THE TPO THEREAFTER ALSO REVISED THE OPERATING RE SULTS OF THE DISTRIBUTION SEGMENT AS FOLLOWS: CALCULATION OF OP/SALES FOR DISTRIBUTION DIVISION: RUPEES REVENUE SALES 31,87,61,777 ADD: DUTY DRAW BACK 4,08,751 TOTAL (A) 31,91,70,528 COST TOTAL COST (FOR DISTRIBUTION & COMMISSION) (AS PER LETTER DATED 16.11.2005) LESS: COST ATTRIBUTABLE TO COMMISSION AS PER PARA 6 .3 OF THIS ORDER 32,73,93,696 71,34,200 COST OF DISTRIBUTION SEGMENT . (B) 32,02,59,496 LOSS: (A-B) (10,88,968) OP/SALES ( - )0.34% 10. THE TPO THEREFORE HELD THAT ASSESSEE HAS INCURR ED A LOSS OF RS. 10,88,968/- WHICH CORRESPONDS TO A LOSS OF 0.34 % ON SALES AS COMPARED TO AVERAGE NET PROFIT MARGIN OF COMPARABLE COMPANIES ENGAGED IN DISTRIBUTION FUNCTION AT 3.15% DETERMINE D BY ASSESSEE ON A SET OF 13 COMPARABLES IN TP DOCUMENTATION. 11. THE TPO ACCORDINGLY COMPUTED THE ADJUSTMENT ON ACCOUNT OF THE DIFFERENCE IN THE ARMS LENGTH COST OF IMPOR T GOODS FROM CORNING SA FRANCE AT RS. 1,11,42,839/- AS FOLLOWS: ITA NO.2564/DEL./2011 9 SALES OF CORNING SA INDIA (DISTRIBUTION) 31,91,70,528 NET PROFIT MARGIN @ 3.15% 1,00,53,871 LOSS INCURRED BY THE APPELLANT 10,88,868 ADJUSTMENT 1,11,42,839 12. ON THE BASIS OF ABOVE, THE ASSESSING OFFICER IN AN ORDER DATED 7.3.2006 MADE THE ADDITION OF RS. 1,32,30,634 /- BY EXTRACTING THE FOLLOWING OBSERVATIONS IN TPO ORDER: TO CONCLUDE THE ARMS LENGTH PRICES IN RESPECT OF COMMISSION INCOME AND IMPORT OF GOODS IS CALCULATED AS UNDER; NO. TRANSACTION AMOUNT IN RS. ALP 95% / 105% OF THE ALP ALP HELD DIFFERENCE IMPORT OF GOODS FROM COMING SA FRANCE 20,80,44,767 19,69,01,928 20,67,47,024 19,69,01,928 1,11,42,839 COMMISSION INCOME 55,94,311 76,82,106 72,98,000 76,82,106 20,87,795 13. ON APPEAL BOTH THE ADJUSTMENTS MADE WERE DELETE D BY CIT(A) IN AN ORDER DATED 28.2.2011 AND, HENCE THIS APPEAL BY REVENUE. 14. GROUND 1 OF APPEAL RELATES TO DELETION OF ADJUS TMENT OF RS. 20,87,795/- PERTAINING TO AGENCY SERVICES FUNCTION CARRIED ON BY THE APPELLANT. 15. APROPOS THE ADJUSTMENT OF RS. 20,87,795/- IT W AS CONTENDED BEFORE THE CIT(A) BY THE APPELLANT THAT T HE DISTRIBUTION ITA NO.2564/DEL./2011 10 ACTIVITY AND AGENCY SERVICE ACTIVITY ARE TO BE CONS IDERED TOGETHER AND ARE NOT TO BE EVALUATED SEPARATELY TO DETERMINE THE ARMS LENGTH PRICE IN RELATION TO THE AFORESAID INTERNAT IONAL TRANSACTIONS AS THE AFORESAID TWO ACTIVITIES TRANS ACTIONS FORM PART OF NATURAL BUSINESS SEGMENT OF DISTRIBUTION OF ROBS AND ARE INTER LINKED AND CLOSELY CONNECTED IN AS MUCH AS, (I) THE TWO ACTIVITIES RELATE TO THE SAME PRODUCTS AND INVOLVE PERFORMING SOME OF THE COMMON FUNCTIONS BY THE SAME EMPLOYEES AND IT IS NO T FEASIBLE TO SEGREGATE THE COST RELATING TO THE SAME; (II) THE A GENCY SERVICES RENDERED BY THE ASSESSEE IN RELATION TO SALE OF ROB S TO THE CUSTOMERS OF CORNING FRANCE IN INDIA, IS AKIN TO TH E DISTRIBUTION OF ROBS, IN AS MUCH AS BOTH ARE AIMED AT SALES AND REVENUES ARISE TO THE ASSESSEE IN BOTH THE CASES ON SALE OF PRODUCTS TO THE BUYER; ON THE OTHER HAND MARKETING SUPPORT SERVICE FEE IS NOT RELATED TO SALES; (III) CORNING SA AND THE ASSESSEE BRANCH ENSURE THAT ARMS LENGTH PROFIT IS EARNED CONSIDERING THE AGENCY SERVICE ACTIVITIES AS PART OF THE DISTRIBUTION BUSINESS. ITA NO.2564/DEL./2011 11 16. THE CIT(A) HOWEVER HELD THAT DISTRIBUTION FUNC TION INVOLVES IMPORT OF FINISHED GOODS, ITS WAREHOUSING, ADVERTISEMENT, MARKETING AND DISTRIBUTION/SALE OF P RODUCTIONS AND ASSESSEE ALSO UNDERTAKES CONTRACT RISK, MARKETING R ISK, CREDIT RISK, INVENTORY RISK, ETC. ON THE OTHER HAND, AGENCY SER VICE ACTIVITY MERELY INVOLVES COORDINATION BETWEEN CUSTOMERS AND THE HEAD OFFICE AND UNDERTAKING CERTAIN MARKETING AND LOGIST IC SERVICES AND THEREFORE THE SAME DOES NOT INVOLVE PURCHASE AND S ALE OF THE FINISHED GOODS, WAREHOUSING OF INVENTORY OF FINISHE D GOODS AND THE ASSESSEE DOES NOT UNDERTAKE CONTRACT RISK, INVE NTORY RISK, CREDIT RISK, ETC., AS OPPOSED TO THE DISTRIBUTION F UNCTION. ON THE BASIS OF THE AFORESAID FAR (FUNCTIONS PERFORMED, AS SETS UTILIZED AND RISKS ASSUMED) ANALYSIS, CIT(A) CONCLUDED THAT DISTRIBUTION FUNCTION AND AGENCY SERVICE ACTIVITY ARE FUNCTIONAL LY DIFFERENT AND COMPARABLE BENCHMARKS FOR DISTRIBUTION FUNCTION CAN NOT BE SAME AS AGENCY SERVICE ACTIVITY AND THE ASSESSEE WAS THU S NOT CORRECT IN UNDERTAKING THE COMBINED EVALUATION OF TWO ACTIVITI ES. ITA NO.2564/DEL./2011 12 17. BEFORE CIT(A) THE ASSESSEE FURTHER DISPUTED THE ALLOCATION OF EXPENSES RELATING TO AGENCY SERVICE ACTIVITY IN PROPORTION TO THE TURNOVER BY THE TPO AS IT IS INCONSISTENT WITH THE ACCEPTED ACCOUNTING PRINCIPLES OF MATCHING. THE ASSESSEE CON TENDED THAT CONTRACT SALES ARE MADE BY THE AE, I.E. CORNING-FRA NCE TO CERTAIN EXISTING CUSTOMERS IN INDIA, ON WHICH COMMISSION IS RECEIVED BY THE ASSESSEE WITHOUT SIGNIFICANT DEPLOYMENT OF EFFO RTS AND RESOURCES. THE CIT(A) ON THE BASIS OF THE AFORESAI D CONCLUSION IN THE FAR ANALYSIS HELD THAT A MUCH LOWER ALLOCATION OF COMMON EXPENSES WOULD BE REQUIRED TOWARDS AGENCY SERVICE A CTIVITY, IN AS MUCH AS IT INVOLVES LESSER EFFORTS AND DEPLOYMENT O F RESOURCES. OUT OF THE INDIRECT EXPENSES DETERMINED BY THE TPO OF RS. 1,93,29,321/-, CIT(A) HELD THAT ADVERTISEMENT EXPEN SES OF RS. 30,78,570/- AND INSURANCE OF RS. 3,77,758/- ARE ONL Y RELATABLE TO DISTRIBUTION FUNCTION AND, THEREFORE, CANNOT BE ALL OCATED TO AGENCY SERVICE ACTIVITY. THE CIT(A) FURTHER ALLOCATED THE REMAINING COMMON EXPENSES AS DETERMINED BY THE TPO/AO AGGREGA TING TO RS. 1,58,72,993/- (RS. 1,93,29,321/- -(RS. 30,78,57 0/- + RS. ITA NO.2564/DEL./2011 13 3,77,758/-) IN PROPORTION TO GROSS MARGIN OF DISTRI BUTION FUNCTION AND COMMISSION INCOME RECEIVED, AS FOLLOWS: GROSS PROFIT MARGIN FROM DISTRIBUTION ACTIVITIES AM OUNT (RS.) SALES 31,87,61,777 LESS: COST OF TRADED GOODS ( - ) 29,21,35,667 TOTAL (A) 2,66,26,1 10 COMMISSION INCOME (GROSS PROFIT FROM COMMISSION SAL ES) (B) 55,94,311 TOTAL (C) 3,22,20,421 TOTAL COMMON EXPENSES (D) 1,58,72,993 ALLOCATION OF TOTAL COMMON EXPENSES OF RS. 1,58,72, 993 EXPENSES ALLOCATED TO AGENCY SERVICES (B/CXD) 27,55 ,968 EXPENS ES ALLOCATED TO DISTRIBUTION ACTIVITIES (A/CXD) 1,31,17,025/ - 18. THE CIT(A) THUS CONCLUDED THAT ADJUSTMENT AFTER COMBINING THE AGENCY SERVICE ACTIVITY WITH MARKETING SERVICE FUNCTION WOULD BE AS FOLLOWS: PARTICULARS RUPEES INCOME FROM MARKET SUPPORT SERVICES 3,41,76,307 ADD: COMMISSION INCOME 55,94,311 TOTAL INCOME FROM MARKET SUPPORT AND AGENCY SERVICE ACTIVITY 3,97,70,618 COST FOR MARKET SUPPORT (FROM LETTER DATED 16.11.20 0) 3,21,05,659 COST FOR COMMISSION INCOME (AS DETERMINED IN PARA 2 1.3 ABOVE) 27,55,968 TOTAL AGGREGATED COST 3,48,61,627 ARMS LENGTH MARKETING SUPPORT SERVICE AND AGENCY S ERVICE INCOME (A) 3,75,38,999 MARKETING SUPPORT AND AGENCY SERVICE INCOME EARNED BY THE APPELLANT (B) 3,97,70,618 DIFFERENCE (A-B) (-) 22,31,619 19. AS TOTAL INCOME FROM MARKET SUPPORT AND AGENCY SERVICE ACTIVITIES WAS AT RS. 3,97,70,618/- WHICH WAS HIGHE R THAN THE ARMS LENGTH PRICE OF SUCH SERVICES, COMPUTED AS PE R BASIS ADOPTED BY THE TPO AT RS. 3,75,38,999/- SHE HELD NO ADJUSTMENT ITA NO.2564/DEL./2011 14 ON THIS ACCOUNT IS WARRANTED. ACCORDINGLY, ADJUSTM ENT OF RS. 20,87,795/- IN RESPECT OF INTERNATIONAL TRANSACTION S OF AGENCY SERVICE ACTIVITY WAS THEREFORE HELD NOT SUSTAINABLE AND WAS DIRECTED TO BE DELETED. 20. BEFORE US, THE LD DR RELIED UPON THE FINDINGS O F TPO TO CONTEND THAT ALLOCATION OF EXPENSES WAS PROPER AND, CIT(A) WAS NOT JUSTIFIED IN RE-COMPUTING THE ALLOCATION THE BA SIS OF NET MARGINS. ON THE OTHER HAND THE LEARNED SR. COUNSEL FOR THE ASSESSEE INVOKED RULE 27 AND CONTENDED THAT TPO HAS ERRED IN NOT CLUBBING THE TRADING/DISTRIBUTION AND COMMISSIO N FROM AGENCY TRANSACTION BECAUSE ASSESSEE EARNED INCOME F ROM DISTRIBUTION OF SELLING OF THE OPHTHALMIC PRODUCTS AND AGENCY COMMISSION FROM THE SAME PRODUCTS WHICH ARE DIRECTL Y SOLD BY THE AE AT FRANCE. IT WAS SUBMITTED THAT TPO ERRED IN CLUBBING AGENCY COMMISSION AND MARKET SUPPORTING SEGMENT TOG ETHER BECAUSE MARKETING SUPPORTING SEGMENT DEALS WITH PRO DUCTS WHICH ARE NOT OPHTHALMIC AND IT DEALS WITH TELECOMMUNICAT ION AND THE PRODUCTS ARE NOT FROM FRANCE. ACCORDING TO THE LD. SR. COUNSEL ITA NO.2564/DEL./2011 15 THE REASON FOR NOT CLUBBING THE AGENCY AND MARKETIN G SUPPORTING ARE THAT FOR AGENCY THE ASSESSEE GETS 3% COMMISSION GROSS SALES; WHEREAS ON THE OTHER HAND IN MARKET SUPPORTING THE ASSESSEE GETS COST OF +/5%. ACCORDING TO LEARNED COUNSEL, THERE IS NO COST INCURRED ADDITIONALLY FOR EARNING AGENCY COMMISSION BECAUSE IT IS INCIDENTAL TO THE WORK AT DISTRIBUTION OF SAME PROD UCTS; WHEREAS THERE WAS INFRASTRUCTURE LIAISON OFFICE SEPARATELY FOR MARKET SUPPORT AND THE ASSESSEE HAS INCURRED RS. 1.18 CROR ES FOR ENGAGING THE SERVICES OF SKILLED MANPOWER. IT WAS SUBMITTED THAT ASSESSEE HAS FOLLOWING TWO SEPARATE DISTINCT BUSIN ESSES: I DISTRIBUTION BUSINESS- INVOLVING IMPORT OF RGBS F ROM ITS ASSOCIATED ENTERPRISES (AES), VIZ, HEAD OFFICE OF CORNING S.A.S., FRANCE (CORNING FRANCE: AND WAREHOUSING THE SAME. THESE PRODUCTS ARE IN TURN, SOLD TO THE CUSTOMERS IN INDIA AND ITS NEIGHBOURING COUNTRIES. THE ASSESSEE ALSO PROVIDES AGENCY SERVI CES IN RESPECT OF THE OPHTHALMIC GLASS PRODUCTS SOLD BY CORNING FRANCE DIRECTLY TO BUYERS IN INDIA. TO AVA IL OF DUTY CONCESSIONS CERTAIN CUSTOMERS WHO ARE PRIMARILY 100 PERCENT EXPORT ORIENTED UNITS (EUOS) IN INDIA PREFER TO IMPORT RGSS DIRECTLY FROM CORNIN G FRANCE. IN TERMS OF THE SALES COMMISSION AGREEMENT ITA NO.2564/DEL./2011 16 DATED 1 ST JANUARY, 2001, IN RESPECT OF EXPORTS BY THE HEAD OFFICE, THE ASSESSEE GETS COMMISSION @ 3% OF SALES VALUE. II MARKETING SUPPORT SERVICES-THE ASSESSEE BRANCH, IN TERMS OF AGREEMENT WITH CORNING INC. USA AND CORNING SA RENDERS MARKETING SUPPORT SERVICES FOR SALE OF NON OPHTHALMIC PRODUCTS, E.G., OPTICAL FIBE R CABLE, OTHER TELECOMMUNICATION EQUIPMENTS AND AUTOMOTIVE SUBSTRATES ETC., IN INDIA. THE MARKETIN G SUPPORT SERVICES INVOLVE (A) COLLECTING OF MARKETIN G INFORMATION (B) EXPLORING SALES AND DISTRIBUTION OPPORTUNITIES (C) MARKET RESEARCH AND (D) PROMOTING AWARENESS ABOUT CORNING PRODUCTS IN INDIAN MARKET. THE ASSESSEE IS REMUNERATED FOR SUCH SERVICES AT CO ST PLUS A MARK UP OF 5%. 21. IT WAS CONTENDED THAT AGENCY SERVICE ACTIVITY U NDERTAKEN AS PART OF DISTRIBUTION BUSINESS IS DIFFERENT AND DIST INCT FROM THE MARKETING SUPPORT SERVICES ON ACCOUNT OF THE FOLLOW ING: I) THE PRODUCTS DEALT IN BY THE TWO BUSINESS SEGMEN TS (I.E. ROBS AND NON OPHTHALMIC PRODUCTS, E.G. OPTICA L FIBRE CABLES AND OTHER TELECOMMUNICATION EQUIPMENT RESPECTIVELY) ARE ENTIRELY DIFFERENT AND REQUIRE DIFFERENT MARKETING STRATEGIES EFFORTS AND ITA NO.2564/DEL./2011 17 UNDERSTANDING OF THE PRODUCT, ETC. FOR PROMOTING TH E SALE OF THE SAME IN INDIA. WHILE AGENCY REQUIRES PROMOTION OF SAME PRODUCTS, I.E., ROBS AS IN THE DISTRIBUTION BUSINESS. II) THE TARGET CUSTOMERS FOR THE TWO BUSINESS SEGME NTS ARE DIFFERENT. WHILE THE DISTRIBUTION AND AGENCY FUNCTION ARE PERFORMED BY THE SAME TEAM OF PEOPLE. III) THERE IS A SEPARATE TEAM OF PEOPLE FOR THE TWO BUSINESS SEGMENTS IV) FOR RENDERING MARKETING SUPPORT SERVICE, THE AS SESSEE IS REQUIRED TO PERFORM DIFFERENT FUNCTIONS, SUCH AS (A) COLLECTING MARKETING INFORMATION (B) EXPLORING SALE S AND DISTRIBUTION OPPORTUNITIES (C) UNDERTAKING MARK ET RESEARCH AND (D) PROMOTING AWARENESS ABOUT COMPANYS PRODUCT IN INDIA. ON THE OTHER HAND, IN RESPECT OF AGENCY SERVICE ACTIVITY, THE ASSESSEE ME RELY ACTS AS COMMUNICATION CHANNEL BETWEEN THE EXISTING CUSTOMERS OF CORNING FRANCE AND THE HEAD OFFICE. 22. IN LIGHT OF THE ABOVE, IT WAS SUBMITTED, TPO/AO OUGHT TO HAVE CONSIDERED THE INTERNATIONAL TRANSACTIONS RE LATING TO DISTRIBUTION ACTIVITY AND AFORESAID AGENCY SERVICE ACTIVITY IN A COMBINED MANNER CONSIDERING THE FACT THAT THE AFORE SAID TWO ACTIVITIES TRANSACTIONS FORM PART OF NATURAL BUSINE SS SEQUENT OF ITA NO.2564/DEL./2011 18 DISTRIBUTION OF ROBS AND ARE INTER LINKED AND CLOSE LY CONNECTED IN AS MUCH AS (I) THE TWO ACTIVITIES RELATE TO THE SAME PRODUCTS, VIZ., ROBS AND INVOLVES PERFORMING SOME OF THE COMM ON FUNCTIONS BY THE SAME EMPLOYEES AND IT IS NOT FEASI BLE TO SEGREGATE THE COST RELATING TO THE SAME; (II) THE A GENCY SERVICES RENDERED BY THE ASSESSEE IN RELATION TO SALE OF ROB S TO THE CUSTOMERS OF CORNING FRANCE IN INDIA, IS AKIN TO TH E DISTRIBUTION OF ROBS, IN AS MUCH AS BOTH ARE AIMED AT SALES AND REVENUES ARISE TO THE ASSESSEE IN BOTH THE CASES ON SALE OF PRODUCT TO THE BUYER; ON THE OTHER HAD MARKETING SUPPORT SERVICE F EE IS NOT RELATED TO SALES; (III) CORNING SA AND THE ASSESSEE BRANCH ENSURE THAT ARMS LENGTH PROFIT IS EARNED CONSIDERING THE AGENCY SERVICE ACTIVITIES AS PART OF THE DISTRIBUTION BUSINESS. 23. HOWEVER, ON ALLOCATION OF EXPENSES AND, WITHOUT PREJUDICE TO THE ABOVE CONTENTION HE SUPPORTED THE ORDER OF C IT(A) IN AS MUCH AS ALLOCATION OF EXPENSES ON MARGIN BASIS WAS PROPER, REASONABLE AND, IN ACCORDANCE WITH PRINCIPLE OF ACC OUNTANCY. 24. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSED THE MATERIAL ON RECORD. THE FIRST ISSUE WHICH INVOLVES CONSIDERATION ITA NO.2564/DEL./2011 19 AS CONTENDED BY THE LEARNED COUNSEL FOR THE ASSESSE E IS THAT, THE TPO/CIT(A) WERE INCORRECT IN NOT BENCH-MARKING THE FUNCTIONING OF IMPORT OF PRODUCTS FROM M/S CORNING SA FRANCE AN D RECEIPT OF AGENCY COMMISSION FROM M/S CORNING SA FRANCE. ACCO RDING TO THE ASSESSEE SINCE BOTH THE FUNCTIONS DEALT WITH TH E SAME PRODUCTS/SAME AE AND WERE IN RESPECT OF SALES MADE TO CUSTOMER IN INDIA, THEREFORE OUGHT TO HAVE BEEN BENCH- MARKE D TOGETHER, AS WAS DONE BY THE APPELLANT IN ITS TP DOCUMENTATION. THE CONCLUSION HOWEVER OF THE AUTHORITIES BELOW IS THAT THE DISTRIBUTION FUNCTION AND AGENCY SERVICE FUNCTION A RE NOT COMPARABLE. IT HAS BEEN FOUND THAT DISTRIBUTION FU NCTION INVOLVES IMPORT OF FURNISHED GOODS, ITS WAREHOUSING, ADVERTI SEMENT MARKETING AND DISTRIBUTION/SALE OF PRODUCTIONS; WHE REAS AGENCY FUNCTION INVOLVES COORDINATION BETWEEN CUSTOMERS AN D THE HEAD OFFICE AND UNDERTAKING CERTAIN MARKETING AND LOGIST IC SERVICES. FURTHERMORE THE RISKS ASSUMED IN DISTRIBUTION FUNCT ION ARE CONTRACT RISK, MARKETING RISK, CREDIT RISK, INVENTO RY RISK ETC.; WHEREAS AN AGENCY FUNCTIONS ASSESSEE DOES NOT UNDER TAKE CONTRACT ITA NO.2564/DEL./2011 20 RISK, INVENTORY RISK, CREDIT RISK, ETC. THERE IS N O DISPUTE TO THE ABOVE FINDINGS ARRIVED AT BY THE AUTHORITIES BELOW. 25. HAVING REGARD TO THE ABOVE FACTUAL MATRIX WE AR E THUS INCLINED TO UPHOLD THE CONCLUSION OF THE CIT(A) TO BENCHMARK THE TWO INDEPENDENT FUNCTIONS SEPARATELY. WE DO NOT FI ND ANY MERIT IN THE CONTENTION RAISED BY THE LEARNED COUNSEL THA T THESE ARE CLOSELY LINKED TRANSACTIONS UNDERTAKEN BY THE APPEL LANT. ON THE CONTRARY THE NATURE OF TRANSACTIONS ARE FUNCTIONAL LY DIFFERENT AND EVEN THE RISK ASSUMED ARE DIFFERENT. WE THUS NEGAT E THE STAND OF THE ASSESSEE AND UPHOLD THE FINDINGS OF CIT(A) IN B ENCHMARKING THE DISTRIBUTION/AGENCY FUNCTION SEPARATELY. 26. SO FAR AS THE ALLOCATION OF EXPENSES IS CONCERN ED IT IS NOTED THAT TPO HAD IDENTIFIED INDIRECT EXPENSES COMMON TO BOTH THE FUNCTIONS AT RS. 1,93,29,321/- DETAILS OF WHICH ARE AS UNDER: PARTICULARS AMOUNT (IN RS.) SALARIES 42,72,231/- ADVERTISEMENT 30,78,570/- INSURANCE 3,77,758/ - REPAIRS AND MAINTENANCE 8,24,105/ - PROFESSIONAL FEE 28,31,227/- RENT 12,57,636/- COMMUNICATION 5,93,240/- TRAVELLING & CONVEYANCE 33,79,299/- MISC. 12,32,610/ - DEPRECIATION 14,82,645/ - TOTAL (A) 1,93,29,321/ - ITA NO.2564/DEL./2011 21 27. THE CIT(A) HAS HELD THAT OUT OF THE AFORESAID S UM OF RS. 30,78,570/- AND RS. 3,77,758/- PERTAINING TO ADVE RTISEMENT AND INSURANCE HAVE NO NEXUS WITH THE AGENCY FUNCTION. 28. WE FIND MERIT IN THE SAID CONCLUSION AS NO MATE RIAL HAS BEEN LEAD TO DISCREDIT THE ABOVE CONCLUSION. THUS WE HO LD THAT AGGREGATE INDIRECT EXPENSES COMMON TO BOTH THE FUNC TIONS ARE OF RS. 1,58,72,993/- (RS. 1,93,29,321/- - RS. 30,78,5 70/- - RS. 3,77,758/-). THE CIT(A) FURTHER MORE HELD THAT ALLOCATION OF SUCH EXPENSES SHOULD BE DONE ON THE BASIS OF GROSS MARGIN OF DISTRIBUTION FUNCTION AND COMMISSION INCOME RECEIPT S AND NOT ON THE BASIS OF SALES, AS ADOPTED BY THE TPO. HERE TO O, WE DO NOT FIND ANY INFIRMITY IN THE APPROACH ADOPTED BY THE C IT(A). THE CIT(A) HAS CORRECTLY HELD THAT ALLOCATION OF EXPENS ES IN PROPORTION TO SALES WOULD AMOUNT TO GIVE EQUAL WEIG HTAGE IN TERMS OF FUNCTIONS PERFORMED, ASSETS UTILIZED AND R ISKS ASSUMED TO BOTH DISTRIBUTION FUNCTION AS WELL AS AGENCY SERVIC E ACTIVITY, WHICH OTHERWISE INVOLVES MUCH LESSER FUNCTIONS AND UTILIZATION OF ASSETS AND RISK. THE CIT(A) HAS HELD AS UNDER: ITA NO.2564/DEL./2011 22 IT WOULD NOT BE CORRECT TO ALLOCATE EXPENSES ATTRI BUTED TO PURCHASE/SALE OF FINISHED GOODS, WAREHOUSING AND HANDLING OF INVENTO RY ETC., TO THE AGENCY SERVICE ACTIVITY, WHEREIN SUCH ACTIVITIES ARE NOT I NVOLVED. ALLOCATION OF COMMON EXPENSES IN PROPORTION TO GROSS MARGIN/INCOME FROM DISTRIBUTION FUNCTION AND THE COMMISSION INCOME, IRONS OUT OR ELIMINATE THE I MPACT OF PURCHASE OF FINISHED GOODS, HANDLING OF INVENTORY AND UNDERTAKI NG DISTRIBUTION FUNCTION, ETC. ALLOCATION OF COMMON EXPENSES IN PROPORTION TO GROS S MARGIN FROM DISTRIBUTION FUNCTION AND COMMISSION INCOME IS A REASONABLE AND RATIONALE BASIS OF ALLOCATING OF SUCH COMMON EXPENSES BETWEEN THE TWO ACTIVITIES. I ACCORDINGLY UPHOLD ALLOCATION OF COMMON COST BY THE ASSESSEE AN D ACCORDINGLY COMPUTED THE ADJUSTMENT AFTER COMBINING THE AGENCY SERVICE A CTIVITY WITH MARKETING SERVICE FUNCTION, AS FOLLOWS: PARTICULARS RUPEES INCOME FROM MARKET SUPPORT SERVICES 3,41,76,307 ADD: COMMISSION INCOME 55,94,311 TOTAL INCOME FROM MARKET SUPPORT AND AGENCY SERVICE ACTIVI TY 3,97,70,618 COST FOR MARKET SUPPORT (FROM LETTER DATED 16.11.20 0) 3,21,05,659 COST FOR COMMISSION INCOME (AS DETERMINED IN PARA 2 1.3 ABOVE) 27,55,968 TOTAL AGGREGATED COST 3,48,61,627 ARMS LENGTH MARKETING SUPPORT SERVICE AND AGENCY S ERVICE INCOME (A) 3,75,38,999 MARKETING SUPPORT AND AGENCY SERVICE INCOME EARNED BY THE APPELLANT (B) 3,97,70,618 DIFFERENCE (A-B) (-) 22,31,619 20 SINCE TOTAL INCOME FROM MARKET SUPPORT AND AGENC Y SERVICE ACTIVITIES AT RS. 3,97,70,618/- IS HIGHER THAN THE ARMS LENGTH P RICE OF SUCH SERVICES, COMPUTED AS PER BASIS ADOPTED BY THE TPO AT RS. 3,7 5,38,999/-, NO ADJUSTMENT ON THIS ACCOUNT IS WARRANTED. ACCORDINGLY, ADJUSTM ENT OF RS. 20,87,795/- IN RESPECT OF INTERNATIONAL TRANSACTIONS OF AGENCY SER VICE ACTIVITY IS, THEREFORE NOT SUSTAINABLE AND IS DIRECTED TO BE DELETED. 29. HAVING REGARD TO THE ABOVE FACTUAL CONCLUSION W E UPHOLD THE ACTION AND REJECT THE GROUNDS RAISED BY THE REV ENUE. GROUND 1 THUS STANDS DISMISSED. 30. GROUND NO. 2 AND 3 OF THE APPEAL FILED BY THE R EVENUE ARE AGAINST THE DELETION OF ADDITION OF RS. 1.11 CRORES BY EXCLUDING ITA NO.2564/DEL./2011 23 THE INCREASED CUSTOM DUTIES OUT OF THE COST OF IMPO RT OF ROBS FOR BENCHMARKING THE ARMS LENGTH PRICE OF DISTRIBUTION SEGMENT. 31. THE FACTS ARE THAT ASSESSEE IN THE COURSE OF TR ANSFER PRICING ASSESSMENT VIDE LETTER DATED 16.11.2005 SUBMITTED T HE FOLLOWING SEGMENTATION OF THE NET PROFIT MARGIN FOR THE VARIO US SEGMENT: HEADS DISTRIBUTION AND COMMISSION MARKET SUPPORT SERVICES OTHERS TOTAL REVENUE: SALES 31,87,61,777 - - 31,87,61,777 INCOME FROM MARKETING SERVICES 3,41,76,307 3,41,76,307 COMMISSION 55,94,311 - - 55,94,311 PROFIT ON SALE OF ASSETS - - 91,201 91,201 DUTY DRAWBACK 4,08,751 - - 4,08,751 INTEREST INCOME - - 23,53,366 23,53,366 TOTAL (A) 32,47,64,839 3,41,76, 307 24,44,567 36,13,85,713 COST: COST OF TRADED GOODS 29,21,35,667 - - 29,21,35,667 SALARIES ETC. 42,72,231 1,18,25,085 - 1,60,97,316 ADVERTISEMENT 30,78,570 6,61,657 - 37,40,227 INSURANCE 3,77,758 2,03,215 - 5,80,973 REPAIRS & MAINTENANCE 8,24,1 05 12,25,418 - 20,49,523 PROFESSIONAL CHARGES 28,31,227 13,73,098 - 42,04,325 RENT 12,57,636 33,42,044 - 45,99,680 TELEPHONE & TELEX 5,93,240 16,46,587 - 22,39,827 TRAVELLING & CONVEYANCE 33,79,299 56,99,879 - 90,79,178 FREIGHT OUTWARD 6,24,242 - - 6,24,242 WAREHOUSE FIXED CHARGES 15,63,032 - - 15,63,032 FOREIGN EXCHANGE LOSS 1,37,41,434 - - 1,37,41,434 MISCELLANEOUS 12,32,610 16,30,296 - 28,62,906 DEPRECIATION 14,82,645 44,98,380 - 59,81,025 TOTAL (B) 32,73,93,696 3,21,05,659 - 35,94,99,355 PROF IT (A) (B) (26,28,857) 20,70,648 24,44,567 18,86,358 NPM (A) (B)/(A)*100 -0.81% NCP (A)-(B)/ (B)*100 6.45% LESS: EXTRAORDINARY ITA NO.2564/DEL./2011 24 ITEMS: - FOREIGN EXCHANGE LOSS - CUSTOMS DUTY 1,37,41,434 3,73,85,897 PROFIT AFTER ADJUSTMENTS 4,84,98,473 NPM 14.93% 32. IT CAN BE PERUSED FROM THE AFORESAID TABLE THAT WHILE COMPUTING THE OPERATING PROFIT MARGIN OF THE DISTRI BUTION SEGMENT, THE ASSESSEE EXCLUDED FOREIGN EXCHANGE LOS S OF RS. 1,37,41,434/- AND ABNORMAL CUSTOM DUTY OF RS. 3,73, 85,895/- FROM THE OPERATING EXPENSES. THE ASSESSEE SUBMITTED IN HIS BROAD SUBMISSION BEFORE CIT(A) AS UNDER: (I) FOREIGN EXCHANGE LOSS OF RS. 1,37,41,434/- IT IS SUBMITTED THAT DURING THE RELEVANT PREVIOUS YEAR, THE SIGNIFICANT MOVEMEN T IN EURO, VIA-A-VIS INDIAN RUPEE AND INDIAN RUPEE DEPRECIATED O THE EXTENT OF 24% LEADING ABNORMAL FOREIGN EXCHANGE LOSS OF RS. 1,37,41,434/-,. IT WO ULD FURTHER BE APPRECIATED THAT APART FROM THE ABNORMAL FOREIGN EXCHANGE FLUCT UATION LOSS, THE SAID LOSS IS IN THE NATURE OF FINANCE COS. AS OPPOSED TO OPERATI NG EXPENSES IN AS MUCH AS THE FOREIGN EXCHANGE LOSS COULD BE AVOIDED BY INCURRING FINANCE COST ON ACCOUNT OF HEDGING OF THE RECEIVABLES. FURTHER, THE COMPARABL E COMPANIES WHICH HAVE BEEN CONSIDERED FOR BENCHMARKING OF DISTRIBUTION SE GMENT DID NOT INCUR FOREIGN EXCHANGE LOSS AND IN ANY CASE FOR THE PURPOSE OF CO MPARISON, THE FOREIGN EXCHANGE LOSS HAS NOT BEEN TAKEN AS PART OF OPERATI NG COST WHILE COMPUTING THE PROFIT MARGIN OF THE APPELLANT AS WELL AS THAT OF T HE COMPARABLE COMPANY. (II) ABNORMAL CUSTOM DUTY OF RS. 3,73,85,895/-: TH E APPELLANT IN THE RELEVANT PREVIOUS YEAR HAS PAID CUSTOM DUTY @ 50% O F THE VALUE OF IMPORT. THE RATE OF CUSTOM DUTY, IT WOULD BE NOTED, WAS INCREAS ED FROM 35% TO 50% IN THE RELEVANT YEAR. THE SIGNIFICANT INCREASE IN CUSTOM DUTY COULD NOT BE PASSED ON TO THE CUSTOMERS ON ACCOUNT OF COMPETITION. FURTHER, THE COMPARABLE COMPANIES WHICH HAVE BEEN CONSIDERED FOR BENCHMARKING ANALYSI S APPLYING TNMM DID NOT INCUR EXPENDITURE ON ACCOUNT OF CUSTOM DUTY. FOR TH E AFORESAID REASONS, THE CUSTOM DUTY EXPENDITURE IS SOUGHT TO BE EXCLUDED WH ILE COMPUTING OPERATING PROFIT MARGIN OF THE APPELLANT FROM THE DISTRIBUTIO N BUSINESS. 32 IT IS SUBMITTED BY THE AR THAT, HE CARDINAL PRIN CIPLE OF THE TRANSFER PRICING REGULATIONS IS TO COMPARE LIKE WITH LIKE AN D TO ELIMINATE DIFFERENCES, IF ANY, BY SUITABLE ADJUSTMENT. THE SAID REGULATIONS CLEARLY PROVIDE FOR ITA NO.2564/DEL./2011 25 ADJUSTMENTS IN MARGINS OF THE ENTERPRISE ENTERING I NTO INTERNATIONAL TRANSACTIONS FOR ANY DIFFERENCES BETWEEN SUCH INTERNATIONAL TRAN SACTIONS AND THE TRANSACTION OF THE COMPARABLES OR BETWEEN THE ENTERPRISE ENTERI NG INTO INTERNATIONAL TRANSACTIONS AND COMPARABLE COMPANIES. 33 RELIANCE IS ALSO PLACED ON THE FOLLOWING DECISIO NS OF THE BENCHES OF THE TRIBUNAL, WHEREIN UNDERTAKING ECONOMIC ADJUSTMENT F OR IMPROVED COMPARABILITY OF THE ENTITIES BEING COMPARED FOR BE NCHMARKING EXPERIENCE HAS BEEN EMPHASIZED: - MENTOR GRPAHICS (NOIDA) PVT. 109 ITD 101 (DEL) - SONY INDIA (P) LTD. 106 ITD 175 (DEL) - SKODA AUTO INDIA (P) LTD. VS. ACIT 122 TTJ699 (PU NE) - EGAIN COMMUNICATION PVT. LTD. VS. ITO 118 ITD 243 (PUNE) - SCHEFENACKER MOTHERSON LTD. VS.ITO (IN ITA NOS 44 59 & 4469/D/2007) - HONEYWELL AUTOMATION INDIA PVT. LTD. VS.DCIT (ITA NO. 4/PN/0) 33. ON PERUSAL OF THE ABOVE, CIT(A) HAS HELD THAT F OREIGN EXCHANGE LOSS OR GAIN IS REQUIRED TO BE TAKEN AS PA RT OF PROFIT OF THE BUSINESS. THE ABNORMAL EVALUATION IN INDIAN RUP EE IN THE RELEVANT PREVIOUS YEAR CANNOT BE THE REASON FOR EXC LUDING THE SAME FROM THE OPERATING COST OF THE DISTRIBUTION BU SINESS. HOWEVER, CIT(A) AGREED WITH THE CONTENTION OF THE A SSESSEE THAT CUSTOM DUTY WHICH IS PAID TO THE GOVERNMENT NEED NO T TO BE TAKEN INTO ACCOUNT FOR THE PURPOSE OF BENCHMARKING ANALYS IS, PARTICULARLY FOR THE REASON THAT ABNORMAL INCREASE IN CUSTOM DUTY DURING THE RELEVANT PREVIOUS YEAR WOULD DISTORT THE COMPARISON, WHEN THE COMPARABLE COMPANIES DO NOT INCUR SIMILAR EXPENSES ON ACCOUNT OF CUSTOM DUTY. ITA NO.2564/DEL./2011 26 34. HAVING CONSIDERED THE RIVAL SUBMISSIONS AND PER USED THE MATERIAL ON RECORD WE FIND THE CIT(A) IN THIS REGAR D HAS HELD AS UNDER: I HAVE EXAMINED THE DOCUMENT ON RECORD AND IT IS N OTED THAT IN THE FINANCIAL OF THE COMPARABLE COMPANIES, CUSTOM DUTY DOES NOT APPE AR AS EXPENDITURE. THE DELHI BENCH OF THE TRIBUNAL IN THE CASE OF SCHEFENA CKER MOHERSON VS. ITO 123 TTJ 509, HELD THAT THE ASSESSEE WAS JUSTIFIED IN DE TERMINING THE ALP UNDER TNMM METHOD BY TAKING PROFIT LEVEL INDICATOR OF THE COMPARABLE CASES EXCLUDING DEPRECIATION TO ELIMINATE DIFFERENCE ON A CCOUNT OF DIFFERENT DEPRECIATION POLICES, ETC. THE JURISDICTIONAL TRIB UNAL IN THAT CASE OBSERVED AS UNDER: 22. THE LEARNED CIT(A) HAS OBSERVED 'FRESH INVESTM ENT WAS BEING MADE IN AUTOMOBILE ANCILLARY INDUSTRY WHICH WAS IN EXPANSIO N PHASE AND, THEREFORE, THERE IS NO REQUIREMENT TO EXCLUDE DEPRECIATION IN COMPUTING PLI'. WHAT EXPANSION, WHEN MADE, THE DATE AND YEAR OF EXPANSIO N, ITS COMPARABILITY WITH TAXPAYERS CASE ? NOTHING RELEVANT IS STATED IN THE IMPUGNED ORDERS. WE DO NOT KNOW HOW DIFFERENCES ON ACCOUNT OF DEPRECIATION COU LD BE IGNORED ON THE FACTS STATED ABOVE MERELY ON GENERAL OBSERVATIONS THAT AU TOMOBILE ANCILLARY INDUSTRY IS IN THE EXPANSION PHASE. TAXPAYER IS SEEKING ADJUSTMENT OF DIFFERENCES ON AC COUNT OF DEPRECIATION AND NO PLAUSIBLE REASON HAS BEEN GIVEN FOR NOT ACCEPTIN G THIS CLAIM. THERE IS NO FINDING THAT THERE ARE NO DIFFERENCES IN CLAIM OF D EPRECIATION AND, THEREFORE, IT SHOULD HAVE BEEN EXCLUDED IN COMPUTING 'OPERATING P ROFIT' AS WARRANTED BY RULES. ON THE OTHER HAND, THE DIFFERENCES AS PER TH E CHART ARE ACCEPTED. THE FINDING THAT CASH PROFIT CANNOT BE CONSIDERED IS NO T LEGALLY CORRECT. THE TAXPAYER IN ORDER TO GET ADJUSTMENT OF DIFFERENCE I N DEPRECIATION FURNISHED ARMS LENGTH WORKING AFTER EXCLUDING DEPRECIATION A ND BY TAKING ALL OTHER EXPENSES INTO CONSIDERATION AND SHOWED THAT SUCH PR OFIT OF THE TAXPAYER WAS QUITE COMPARABLE TO THE MEAN MARGIN OF OTHER COMPAR ABLES SIMILARLY COMPUTED. THIS DEMONSTRATIVELY SHOWED THAT DEDUCTION OF DEPRE CIATIONS WAS MAKING HUGE DIFFERENCE AND REQUIRED SUITABLE ADJUSTMENT. THIS C LAIM HAS NOT BEEN CHALLENGED. IT IS CLEAR THAT THE BEST WAY TO ADJUST DIFFERENCE ON ACCOUNT OF DEPRECIATION WAS TO IGNORE DEPRECIATION BOTH IN CAS E OF THE TESTED PARTY AND THE COMPARABLES. AFTER ALL TP ADJUSTMENTS ARE TO BE MAD E OF DIFFERENCES IN PRICE CHARGED OR PAID FOR INTERNATIONAL TRANSACTION AND N OT OF DIFFERENCE IN THE CLAIM OF DEPRECIATION AS HAS BEEN DONE IN THIS CASE. SUCH ADJUSTMENTS ALSO MATCHED THE REQUIREMENT OF THE CONTEXT (TP PRINCIPLES). THE BASIC ISSUE INVOLVED WAS WHETHER THE COST PAID OR CHARGED FOR INTERNATIONAL TRANSACTIONS WAS AT ARMS LENGTH OR NOT. THE FACTORS WHICH GO TO INFLUENCE PR ICE, COST OR PROFIT ARE/WERE RELEVANT FOR COMPUTING PROFIT AND NOT DEPRECIATION HAVING NO DIRECT CONNECTION WITH PRICE OR PROFIT BUT RESPONSIBLE FOR WIDE DIFFE RENCES. THE CASE OF THE REVENUE IS NOT CLEAR. IF DEPRECIATION IS NOT LEADIN G TO ANY DIFFERENCE, ITS ITA NO.2564/DEL./2011 27 EXCLUSION IS IMMATERIAL. IF IT IS LEADING TO DIFFER ENCES, THEN DIFFERENCES ARE REQUIRED TO BE ADJUSTED, AS REQUIRED BY PROVISIONS OF IT REGULATIONS. THERE IS NO WAY TO DISLODGE THE CLAIM OF THE TAXPAYER. THE CONT EXT AND PURPOSE OF LEGISLATION AND FACTS OF CASE OVERWHELMINGLY APPROV E ADOPTION OF CASH PROFIT ONLY. 23. THE TAXPAYER IN BOTH THE ASSESSMENT YEARS SHOWE D BEFORE THE REVENUE AUTHORITIES THAT PROFIT SHOWN BY THE TAXPAYER SATIS FIES ARMS LENGTH REQUIREMENT ON RATIO OF CASH PROFIT TO SALES IF UNIFORMLY APPLI ED. AS THE DEDUCTION OF DEPRECIATION IS LEADING TO WIDE DIFFERENCES, THE SA ME SHOULD BE EXCLUDED. THE ONLY REASON GIVEN FOR REJECTING TAXPAYERS ANALYSIS AND FOR MAKING ADJUSTMENT IN THE TWO YEARS IS THAT USE OF RATIO OF CASH PROFI T WITHOUT DEPRECIATION IS NOT PERMITTED UNDER THE LAW. THIS VIEW IN THE LIGHT OF ABOVE DISCUSSION CANNOT BE ACCEPTED AS CORRECT AND IS DISAPPROVED. 50 THEREFORE IT WOULD BE APPROPRIATE TO EXCLUDE THE AMOUNT OF CUSTOM DUTY OF RS. 3,73,85,895/- FROM THE OPERATING COST FOR CO MPUTING THE OPERATING PROFIT MARGIN OF THE DISTRIBUTION SEGMENT. 51 PROFIT MARGIN OF THE DISTRIBUTION SEGMENT IS ACC ORDINGLY COMPUTED AT 10% AS FOLLOWS: CALCULATION OF OP/SALES FOR DISTRIBUTION DIVISION RUPEES REVENUE SALES ADD: DUTY DRAW BACK 31,87,61,777 4,08,751 TOTAL.(A) 31,91,70,528 COST TOTAL COST (FOR DISTRIBUTION & COMMISSION) (AS PER LETTER DATED 16.11.2005) LESS: COST ATTRIBUTABLE TO AGENCY SERVICE LESS: CUSTOM DUTY 32,73,93,696 27,55,968 3,73,85,895 COST OF DISTRIBUTION SEGMENT..(B) 28,72,51,833 LOSS: (A-B) 3,19,18,695 OP/SALES 10% SINCE THE ARMS LENGTH OPERATING PROFIT MARGIN FOR THE DISTRIBUTION BUSINESS HAS BEEN DETERMINED BY THE TPO AT 3.15% AS AGAINST 10% EARNED BY THE ASSESSEE, HENCE, THE ADJUSTMENT MADE BY THE TPO IN RESPECT OF DISTRIBUTION BUSINESS, THEREFORE, IS DIRECTED TO BE DELETED. 35. THE AFORESAID REASONING OF THE CIT (A) CANNOT BE COUNTENANCED. IT MAY BE TAKEN NOTE THAT IN TNMM, B ASICALLY A ITA NO.2564/DEL./2011 28 SINGLE LINE ITEM OF AN EXPENDITURE OF CUSTOMS DUTY SHOULD NOT BE EXCLUDED FROM THE TOTAL COST FOR COMPUTING THE OPER ATING PROFIT. IT IS SEEN THAT THE DISTRIBUTOR / RESPONDENT HAS MA DE A OPERATING LOSS FOR THE DISTRIBUTION BUSINESS. IT IS NOTED TH AT THE ASSESSEE, TPO IN SPITE OF THE LOSS SUFFERED BY THE DISTRIBUTO R, HAVE APPLIED TNMM TO BENCH MARK THE DISTRIBUTION RESULTS. IN OU R VIEW THE REVENUE AUTHORITIES AND ASSESSEE SHOULD HAVE LOOKED INTO THE CHARACTERIZATION AND ACCORDINGLY PRICING POLICY FOR THE DISTRIBUTION BUSINESS NEED TO HAVE BEEN MADE AFT ER ASCERTAINING AS TO WHETHER THE REMUNERATION OR PRICING POLICY WA S AT GROSS MARGIN OR NET MARGIN LEVEL IN ORDER TO EXAMINE THE REASON FOR THE LOSS. IT IS ONLY AFTER DOING THE SAID EXERCISE THE FUNCTIONAL PROFILE OF THE ASSESSEE AS A NORMAL RISK TAKING DISTRIBUTOR , WHICH IS CAPABLE OF SUFFERING A LOSS OR LIMITED RISK DISTRIB UTOR WHICH GENERALLY OPERATES WITH A STEADY BUT ROUTINE OPERAT ING MARGIN, CAN BE ASCERTAINED. THEREAFTER, BASED UPON SUCH EX ERCISE, THE APPLICABILITY OF THE PROPER TRANSFER PRICING METHOD OLOGY NAMELY RE-SALE PRICE OR TNMM MAY BE APPLIED WITH PROPER CO MPARABLES. IN THE LIGHT OF THE AFORESAID OPINION OF OURS, WE S ET ASIDE THIS ITA NO.2564/DEL./2011 29 ISSUE BACK TO THE FILE OF THE TPO/AO FOR FRESH ADJU DICATION AS STATED ABOVE. 36. IN THE RESULT, THE APPEAL FILED BY THE REVENUE IS PARTLY ALLOWED FOR STATISTICAL PURPOSE. ORDER PRONOUNCED IN OPEN COURT ON THIS 28 DAY OF AUGUST, 2015. SD/- SD/- (S.V. MEHROTRA) (A.T.VARKEY) ACCOUNTANT MEMBER JUDICIAL MEMBER DATED THE 28 DAY OF AUGUST, 2015 TS COPY FORWARDED TO: 1.APPELLANT 2.RESPONDENT 3.CIT 4.CIT(A)-XX, NEW DELHI. 5.CIT(ITAT), NEW DELHI. AR, ITAT NEW DELHI.