The ACIT,A'bad Circle-1, Ahmedabad V. AIA Engineering Ltd., Ahmedabad

ITA 3036/AHD/2010

• Counselvise Citation: [2015] 120 COUNSELVISE.COM (IT) 9634 (ITAT-AHMEDABAD)
• Duration Of Justice: 4 year(s) 5 month(s) 13 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 17-04-2015
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: C
• Next Hearing Date: 07-04-2015
• Assessment Year: 2005-2006
• Appeal Filed On: 04-11-2010
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: MK SINGH
• Keywords: Transfer pricing; Opportunity of being heard; International transaction; Bad and doubtful debts
• Section: 92C; 143(3); 14A

Judgement Text

, IN THE INCOME TAX APPELLATE TRIBUNAL C BENCH, AHMEDABAD 00 , ! ' #$, % & BEFORE SHRI N.S. SAINI, ACCOUNTANT MEMBER AND SHRI KUL BHARAT, JUDICIAL MEMBER !./ ITA NO.3036/AHD/2010 % ) *)/ ASSESSMENT YEAR: 2005-06 ACIT, CIRCLE-1, AHMEDABAD. VS M/S AIA ENGINEERING LTD ., 115, G.V.M.M. ESTATE, ODHAV ROAD, ODHAV, AHMEDABAD. PAN : AABCA 2777 J +, / (APPELLANT) -. +, / (RESPONDENT) REVENUE BY : SHRI M.K. SINGH, SR. D.R. ASSESSEE(S) BY: SHRI TUSHAR HEMANI, A.R. / DATE OF HEARING : 07/04/2015 / DATE OF PRONOUNCEMENT: 17/04/2015 // O R D E R PER SHRI N.S. SAINI, ACCOUNTANT MEMBER: THIS IS AN APPEAL FILED BY THE REVENUE AGAINST THE ORDER OF THE COMMISSIONER OF INCOME-TAX (APPEALS)-VIII, AHMEDABA D DATED 16.08.2010. 2. THE SOLE GROUND OF APPEAL RAISED BY THE REVENUE IN THIS APPEAL READS AS UNDER :- 1. THE CIT(A) ERRED IN LAW AND ON FACTS IN DELETIN G THE ENTIRE ADJUSTMENTS MADE IN THE ARMS LENGTH PRICE AGGREGATI NG TO RS.2,87,76,983/- ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE AND IN LAW, THE CIT(A) OUGHT TO HAVE UPHELD THE ORDER OF T HE ASSESSING OFFICER SINCE THE ASSESSEE HAS FAILED TO DISCLOSE H IS TRUE INCOME. ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 2 3. THE DEPARTMENTAL REPRESENTATIVE HAS FILED A WRIT TEN SUBMISSION DURING THE COURSE OF HEARING WHICH READS AS UNDER : - GROUND NO.1: THE CIT(A) ERRED IN LAW AND ON FACTS IN DELETING TH E ENTIRE ADJUSTMENTS MADE IN THE ARMS LENGTH PRICE AGGREGATI NG TO RS.2,87,76,983/-. ON THE FACTS AND IN THE CIRCUMST ANCES OF THE CASE AD IN LAW, THE CIT(A) OUGHT TO HAVE UPHELD THE ORDER OF ASSESSING OFFICER SINCE THE ASSESSEE HAS FAILED TO DISCLOSE HIS RUE INCOME. TPOS COMMENTS: 1. THIS IS DEPARTMENTAL APPEAL FILED AGAINST THE DE CISION OF CIT(A). THE FACTS OF THE CASE IN BRIEF ARE AS UNDE R :- (I) THE ASSESSEE IS PRIMARILY ENGAGED IN THE MANUFA CTURING OF GRINDING MEDIA, LINERS FOR MILLS, DIAPHRAGMS, HAMME RS AND CRUSHERS, HEAT RESISTANT CAST STEEL, VERTICAL SPIND LE MILL SPARES, MIL CONTROL SYSTEMS, ETC. IT DISTRIBUTES ITS PRODUCTS IN THE INTERNATIONAL MARKETS THROUGH ITS SUBSIDIARIES. TH E SUBSIDIARIES ARE SITUATED IN MIDDLE EAST, UK AND USA. THE SUBSI DIARY SITUATED IN MIDDLE EAST IS RESPONSIBLE FOR SALES IN FAR EAST , MIDDLE EAST AND ASIAN COUNTRIES; THE SUBSIDIARY SITUATED IN UK IS R ESPONSIBLE FOR SALES IN EUROPE, RUSSIA, AFRICA, TURKEY AND OTHER E RSTWHILE CIS COUNTRIES; AND THE SUBSIDIARY SITUATED IN USA IS RE SPONSIBLE FOR SALES IN NORTH AMERICA. (II) THE INTERNATIONAL TRANSACTION ENTERED BETWEEN THE ASSESSEE AND ITS SUBSIDIARIES DURING THE FINANCIAL YEAR 2004 -05 ARE :- SR. NO. NATURE OF TRANSACTION NAME OF ASSOCIATED ENTERPRISE VALUE OF TRANSACTION METHOD RECEIPT(RS.) PAID (RS.) 1. EXPORT OF FINISHED GOODS VEGA INDUSTRIES (MIDDLE EAST) F.Z,E., UAE 264,472,942 TNMM VEGA INDUSTRIES LTD. (USA) 149,431,053 TNMM VEGA INDUSTRIES LTD. (UK) 320,753,086 TNMM ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 3 2. PAYMENT OF SALES COMMISSION VEGA INDUSTRIES LTD. (UK) 8,397,693 TNMM 3. RECOVERY OF EXPENSES VEGA INDUSTRIES LTD. (MIDDLE EAST) F.Z.E., UAE 37,7350 AT COST VEGA INDUSTRIES LTD. (USA) 7,965 AT COST VEGA INDUSTRIES LTD. (UK) 139,959 AT COST (III) THE MAIN INTERNATIONAL TRANSACTION WAS OF SAL E OF GOODS TO ITS AES OF RS.73.46 CRORES AND THE ASSESSEE HAD SEL ECTED TNM METHOD FOR BENCHMARKING THE ALP. ASSESSEE AGGREGAT ED THE INTERNATIONAL TRANSACTION OF PAYMENT OF COMMISSION WITH SALE OF GOODS TRANSACTION AND OPERATING PROFIT ON SALES WAS SELECTED AS PROFIT LEVEL INDICATOR. ASSESSEE HAD SELECTED 8 EX TERNAL COMPARABLES AND USED DATA OF FINANCIAL YEAR 2004-05 TO THE EXTENT AVAILABLE AND DATA OF TWO EARLIER YEARS FOR DETERMINING THE AVERAGE PLI MARGIN OF THE COMPARABLES. ACCORDINGLY , ARITHMETIC MEAN OF PLI OF THE COMPARABLES WAS WORKED OUT TO 6. 51% (OP/SALES). THE ASSESSEE HAD WORKED OUT ITS PLI MA RGIN AT 13.38% (OP/SALES) AND CLAIMED THAT THE PLI MARGIN OF THE ASSESSEE WAS BETTER THAN THE PLI MARGIN OF THE COMP ARABLES AND THEREFORE, IT CLAIMED THAT THE INTERNATIONAL TRANSA CTION OF SALE OF GOODS AND PAYMENT OF COMMISSION WAS AT ALP. IN RES PECT OF RECOVERY OF EXPENSES TRANSACTION, IT WAS CLAIMED TH AT THE TRANSACTIONS ARE AT ACTUAL COST AND HENCE SAME ARE AT ALP. (IV) DURING THE COURSE OF TP PROCEEDINGS TPO EXAMIN ED THE FINANCIAL STATEMENTS OF SUBSIDIARIES OBTAINED FROM THE ASSESSEE AND FOUND THAT THERE WERE WIDE VARIATIONS BETWEEN T HE OPERATING PROFITS TO SALES EARNED BY THEM. SIMILARLY, IT WAS NOTICED BY THE TPO THAT THERE WAS WIDE VARIATION BETWEEN THE RATIO OF DIRECT EXPENSES O THE SALES, DESPITE THE FACT THAT ALL THE SUBSIDIARIES WERE CARRYING OUT SIMILAR ACTIVITIES OF DISTRIBUTIO N OF ASSESSEES PRODUCT. THE TPO OBSERVED THAT THE RATIO OF OPERAT ING PROFIT TO SALES IN RESPECT OF AE IN UAE WAS 6.31% ; IN RESPECT OF AE IN UK, IT WAS (-)2.16% AND IN RESPECT OF AE IN USA THE SAME W AS FOUND AT (-)2.26% . SIMILARLY THE DIRECT EXPENDITURE INCURRED BY AE IN UAE WAS FOUND 10.9%; IN RESPECT OF AE IN UK, IT WAS 14. 15% AND IN RESPECT OF AE IN USA THE SAME WAS FOUND AT 18.88%. THUS IT WAS FOUND THAT DISTRIBUTION EFFORTS WERE MORE AT UK AND USA ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 4 SUBSIDIARIES, HOWEVER PROFIT RETAINED AT UAE WAS VE RY HIGH. THEREFORE A SHOW CAUSE NOTICE WAS ISSUED PROPOSING TO MAKE ADJUSTMENT TO UAE SUBSIDIARY. (V) IN RESPONSE TO THE SHOW CAUSE NOTICE, THE ASSES SEE CONTENDED THAT IT IS SELLING SAME ITEMS OF FINISHED PRODUCTS AT THE SAME RATE TO ALL THE AES AND THE HIGHER GROSS MARGI N AND NET OPERATING PROFIT IS DUE TO ACTIVATES OF THESE SUBSI DIARIES RESULTING IN HIGHER PROFITS TO THEM AND ASSESSEE HAD SUBMITTE D SEVERAL BILLS IN SUPPORT OF ITS CLAIM. ON EXAMINATION OF THE SAI D ILLS TPO FOUND THAT WHENEVER THERE WERE HIGH MARGINS, TRANSACTIONS WERE ROUTED THROUGH VEGA (UAE) TO RETAIN MORE PROFITS IN THE VE GA (UAE) ENTITY AS INCOME TAX RATES ARE EFFECTIVELY NIL IN U AE. IT WAS FURTHER NOTED BY THE TPO THAT VEGA (UAE) WAS SELLIN G PRODUCTS IN WHOLE ASIA REGION, AUSTRALIA, NEW ZEALAND, EUROPE, SOUTH AFRICA AND PACIFIC ISLAND IN PACIFIC SEA, WHEREAS IT SHOUL D BE SELLING IN UAE REGION OR NEAR AREAS. SALES TO BANGLADESH AND SOUTH EAST ASIA CAN BE BETTER HANDLED FROM INDIA RATHER THAN F ROM UAE. IN VEGA (UAE) THERE WERE ONLY THREE EMPLOYEES IN YEAR 2004S AND HERE WERE ONLY 6 EMPLOYEES IN 2005. THUS IT WAS NO T CLEAR TO THE TPO AS TO HOW THEY WERE ABLE TO HANDLE SUCH LARGE G EOGRAPHIC AREA AND HOW THEY WERE ABLE TO DISTRIBUTE HE PRODUC TS. IT WAS FURTHER OBSERVED BY THE TPO THAT IN RESPECT OF SALE S MADE TO VEGA (UAE), THE ASSESSEE COMPANY WAS DIRECTLY DISPATCHIN G PRODUCTS TO THE CLIENTS OF THE VEGA (UAE), EXCEPT IF THEY ARE T O BE DELIVERED IN UAE, WHICH CLEARLY SHOWS THAT, THESE TRANSACTIONS W ERE MERELY ROUTED THROUGH VEGA (UAE) AND THIS ENTITY WAS NOT C ARRYING OUT ANY DISTRIBUTION ACTIVITIES IN THIS REGARD. THE TP O FURTHER NOTICED THAT THE RATIO OF OPERATING PROFITS TO THE TOTAL CO ST OF THE ABOVE SUBSIDIARIES WAS 57.70% (VEGA UAE), 31.70% (VEGA UK) AND 18.56% (VEGA USA). THUS IT WAS FOUND THAT VEGA UAE RETAINED HIGHER MARGIN AS COMPARED TO VEGA UK AND VEGA USA. FURTHER IT WAS NOTED THAT VEGA UK WAS SHOWING HIGHER PROFIT DU E TO COMMISSION PAYMENT OF RS.83,97,693/- RECEIVED FROM THE ASSESSEE IN RESPECT OF ITS DIRECT SALES TO ONE ITAL IAN ENTITY. SINCE THE VEGA UK HAD NOT UNDERTAKEN ANY COMMISSION RELAT ED ACTIVITY AND HAD NOT TAKEN ANY RISK, THE PAYMENT OF COMMISSI ON TO VEGA UK WAS NOT APPROPRIATE AS THE VEGA UK WAS NO AGREEM ENT TO SHOW THAT VEGA UK WAS HAVING JURISDICTION OVER EURO PE AREA. THEREFORE TPO TREATED ALP OF COMMISSION EXPENSES AT NIL IN THE HANDS OF ASSESSEE AND EXCLUDED THE COMMISSION FROM INCOME OF VEGA UK. THUS HE WORKED OUT THE OPERATING MARGIN/O PERATING COST AT 19.89% WHICH WAS FOUND IN LINE WITH VEGA USA AND OTHER MARKET ENTITIES WHO ARE CARRYING OUT SIMILAR DISTRI BUTION FUNCTIONS. ACCORDINGLY THE ALP OF SALES TO SUBSIDIARIES WAS BE NCHMARKED TO 19.89% . BASED ON THE ABOVE EXERCISE, PRICE CHARGED TO VE GA ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 5 USA AND VEGA UK (EXCEPT ADJUSTMENT OF COMMISSION) W AS NOT DISTURBED. HOWEVER, THE SALE PRICE TO VEGA UAE WAS ADJUSTED TO ARRIVE AT OP/OPERATING COST OF 19.89%. THUS ADJUST MENT OF RS.2,03,79,290/- WAS PROPOSED. IN VIEW OF THE ABOV E FACTS, TOTAL ADJUSTMENT OF RS.2,87,76,983/- WAS PROPOSED VIDE OR DER U/S 92CA(3) DATED 22/10/2008. THE AO PASSED ORDER U/S 143(3) BY MAKING ADDITION OF RS.2,87,76,983/- AS PER ORDER PA SSED BY THE TPO. 2. THE ASSESSEE CONTESTED THE ASSESSMENT ORDER BEFO RE THE LD. CIT(A). THE LD. CIT(A) VIDE ORDER DATED 16/08/2010 , DELETED THE ENTIRE ADDITION MADE BY THE TPO/AO. THE FINDINGS O F LD. CIT(A) AND COMMENTS OF THE TPO THEREON AS UNDER :- 2.1 IN PARA 7.1, THE CIT(A) HAS GIVEN A FINDING THA T TPO WRONGLY COMPARED THE FOB SALE PRICE CHARGED BY VEGA UK TO C EMEX VENEZUELA WITH THE CIF PRICE OF SALES MADE BY VEGA UAE. FURTHER IT IS MENTIONED THAT EFFECTIVE FROM FEBRUARY 2005 V ENEZUELA TERRITORY HAS BEEN SHIFTED FROM VEGA UK TO VEGA UAE . FURTHER IT IS MENTIONED THAT APPELLANT HAS PROVIDED DETAILS OF ALL THE EMPLOYEES AT EACH OF THE TERRITORY AND THE ACTUAL E XPENSES INCURRED FOR MARKETING AND SALES PROMOTION AS WELL AS DISTRIBUTION BY THE SAID TERRITORY, HENCE I FIND NO REASON TO DO UBT MARKETING FUNCTIONS PERFORMED BY THE SUBSIDIARY COMPANIES. I T IS FURTHER MENTIONED THAT DIRECT DISPATCHES MADE BY THE APPELL ANT TO THE CUSTOMERS OF THE RESPECTIVE SUBSIDIARY COMPANIES IS ONLY A MODE OF DISPATCH AND DOES NOT NECESSARILY LEAD TO THE AD VERSE INFERENCE ABOUT MERE ROUTING OF THE TRANSACTIONS THROUGH VEGA UAE CARRYING OUT THE DISTRIBUTION ACTIVITY. TPOS COMMENTS:- IT IS SEEN FROM PAGE NO.6 OF THE APPEAL ORDER, ON W HICH ASSESSEES SUBMISSION ABOUT DIFFERENCE FOB AND CIF PRICE AS POINTED OUT, THAT EVEN IF THE ASSESSEES CONTENTION IS ACCEPTED, STILL THERE IS DIFFERENCE IN PRICE CHARGED BY VEGA UK (USD 1000.09 & 1340.56) AND PRICE CHARGED BY VEGA UAE (USD 1257. 27) BECAUSE NEITHER THE ASSESSEE NOR THE LD. CIT(A) HAS POINTED THE EXACT CIF PRICE CHARGED BY VEGA UK WHICH IS COMPARA BLE WITH THE TRANSACTION OF VEGA UAE OF USD 1257.27. AS FAR AS THE EVIDENCE FOR SHIFTING OF TERRITORY IS CONCERNED, THE SAME WA S NEVER FURNISHED BEFORE THE TPO. THUS THE LD. CIT(A) HAS RELIED ON THE EVIDENCE WHICH WAS NOT FURNISHED BEFORE THE TPO. R EGARDING THE ABILITY TO CARRY OUT THE MARKETING FUNCTIONS, THE T PO HAD RAISED DOUBTS REGARDING VEGA UAE CONSIDERING ONLY 4 TO 6 E MPLOYEES WHICH WERE FOUND INADEQUATE CONSIDERING VIDE AREA O F JURISDICTION ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 6 OF VEGA UAE. HOWEVER, LD. CIT(A)S FINDING ALL THE SUBSIDIARIES WERE CAPABLE OF CARRYING MARKETING FUNCTION IS BASE D ONLY EXPENSES INCURRED IGNORING THE MEAGER NUMBER OF EMP LOYEES WORKING WITH VEGA UAE. THE FINDING OF LD. CIT(A) A BOUT THE DIRECT DISPATCHES IS ALSO INCORRECT AS THE TPO HAD CLEARLY POINTED THAT ALL THE DISTRIBUTION ACTIVITIES FOR THE TERRITORY OTHER THAN UAE WERE CARRIED OUT THE ASSESSEE ITSELF BUT THE SALES WERE ROUTED THROUGH VEGA UAE (NOW VEGA ME). THEREFORE THE DECISION OF THE LD. CIT(A) IS NOT ACCEPTABLE. 2.2 IN PARA 7.2, THE LD. CIT(A) HAS GIVEN FINDING T HAT THE TPO HAS NOT BEEN ABLE TO ESTABLISH AS TO HOW THIS SALES COMMISSION IS NOT JUSTIFIABLE AND HAS MERELY INFERRED WITHOUT ANY BASE THAT VEGA UK HAS NOT CARRIED OUT ANY MARKETING ACTIVITY RELAT ED TO THESE SALES AND HAS NOT TAKEN ANY RISK IN THIS REGARD. I ALSO FIND THAT CONTRARY TO THE PROVISIONS OF SECTION 92CA(3) AND T HE SETTLED LEGAL POSITION IN THIS REGARD, THE TPO/AO DO NOT SEEM TO HAVE ACCORDED AN OPPORTUNITY OF BEING HEARD ON THIS PARTICULAR IS SUE AFTER ISSUING A SPECIFIC SHOW CAUSE NOTICE TO APPELLANT. FURTHER BASED ON THE PREMISES THAT IN THE CASE OF CEMEX VENEZUELA (REFER RED TO ABOVE), VEGA UAE HAS ALSO CARRIED OUT SALES IN EURO PE AND NO COMMISSION HAS BEEN PAID TO VEGA UK ON THIS PARTICU LAR TRANSACTION, HE HAS WRONGLY CONCLUDED THAT NO SUCH COMMISSION SHOULD HAVE BEEN PAID TO VEGA UK. FROM THE SUBMISS IONS MADE BY THE APPELLANT THE FACT OF SHIFTING OF THE TERRIT ORY OF VENEZUELA FROM VEGA UK TO VEGA UAE IS QUITE CLEAR. AS SUCH T HEREFORE I DO NOT FIND MERIT IN TPOS ADJUSTMENT OF THE TRANSFER PRICE OF THE APPELLANT IN RESPECT OF THE COMMISSION PAID TO VEGA UK TO ZERO. TPOS COMMENTS :- AS DISCUSSED IN PARA 1 ABOVE, ON THE BASIS OF CERTA IN DISCREPANCIES IN MARGINS EARNED BY THE ASSESSEE PAR TICULARLY HIGH MARGINS EARNED BY THE SUBSIDIARY IN NO TAX JURISDIC TION, A SHOW CAUSE NOTICE U/S 92CA(3) WAS ISSUED PROPOSING AN AD JUSTMENT IN THE CASE OF VEGA UAE AND AFTER CONSIDERING THE REPL Y OF THE SHOW CAUSE NOTICE, FINAL ORDER WAS PASSED POINTING OUT T HE FLAWS IN THE REPLY OF THE ASSESSEE. THUS THE TPO HAD PROVIDED R EASONABLE OPPORTUNITY OF BEING HEARD BEFORE MAKING THE ADJUST MENT. AS FAR THE ASSESSEES CLAIM OF SHIFTING IS CONCERNED, THE SAME WAS NEVER PRODUCED BEFORE THE ASSESSEE AND LD. CIT(A) DID NOT PROVIDE OPPORTUNITY TO THE TPO/AO FOR EXAMINING THE SAID EV IDENCE. THEREFORE THE DECISION OF LD. CIT(A) IS NOT ACCEPTA BLE. 2.3 IN PARA 7.3 OF THE APPEAL ORDER, THE LD. CIT(A) HAS GIVEN THE FINDING ON THE BASIS OF INFERENCE DRAWN IN PARA 7.1 & 7.2 THAT TREATING THE ALP OF COMMISSION PAYMENT AS ZERO (NIL ) AND ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 7 BENCHMARKING THE OP/TC RATIO OF VEGA UAE TO 19.89% IS INCORRECT. TPOS COMMENTS :- AS EXPLAINED IN THE COMMENTS IN PARA 2.1 & 2.2 ABOV E, THE FINDINGS OF THE LD. CIT(A) ARE FOUND TO BE INCORREC T. THEREFORE, FINDING GIVEN IN PARA 7.3 OF APPEAL ORDER ARE NOT A CCEPTABLE. 2.4 IN PAR 7.4 OF THE APPEAL ORDER THE LD. CIT(A) G IVEN A FINDING THAT I ALSO FIND A CONSIDERABLE MERIT IN THE APPEL LANTS OBJECTION TO THIS PARTICULAR METHODOLOGY OF ADOPTING THE RATI O OF OP/TC AS PROFIT LEVEL INDICATOR BY THE TPO. FURTHER EVEN WH ILE COMPUTING THE TOTAL COST THE TPO HAS IGNORED THE COST OF PURC HASES WITHOUT GIVING ANY LOGICAL REASONING FOR SUCH EXCLUSION. I T ALSO BECOMES APPARENT THAT NEITHER TPO NOR AO HAS EVALUATED THE FOUR PRE- CONDITIONS GIVEN IN SECTION 92C(3) NOR THEY HAVE GI VEN A FINDING TO THE EFFECT THAT AT LEAST ONE OF THOSE FOUR PRE-C ONDITIONS HAS BEEN SATISFIED AFTER RECORDING THE REASONS IN SUPPO RT OF THE FINDINGS. AGAIN IT BECOMES APPARENT THAT WHILE TPO HAS ACCEPTED THE TRANSACTIONAL NET MARGIN METHOD (TNMM), HE HAS WRONGLY USED THE CONTROLLED PARTY I.E. VEGA UK FOR THE PURP OSE OF BENCHMARKING THE PROFITS EARNED BY VEGA UAE WHICH I S AGAINST THE PROVISIONS OF SECTION 92(1) READ WITH RULE 10B( 1)(E) R.W. RULE 10A OF THE INCOME TAX RULES. TPOS COMMENTS :- THE OBSERVATION OF LD. CIT(A) THAT THE TPO DID NOT CONSIDER THE COST OF PURCHASES FOR COMPUTATION OF OP/TC IS I NCORRECT. THE TPO INK PARQ-5 ON PAGE 5 HAS GIVEN A TABLE EXPLAINI NG THE VARIOUS RATIOS OF PROFITS AND EXPENSES IN RESPECT OF ALL TH E THREE SUBSIDIARIES. AT SERIAL NO.5 THE TPO HAS MENTIONED THE OPERATING COST I.E. SELLING/DISTRIBUTION AND ADMINISTRATIVE E XPENSES. AT SERIAL NO.5, TPO HAS MENTIONED NET OPERATING PROFIT EARNED BY ALL THE SUBSIDIARIES AND AT SERIAL NO.7 THE RATIO OF OP ERATING PROFIT (NET OPERATING PROFIT MENTIONED AT SERIAL NO.6) TO OPERATING COST (SELLING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES MENTIONED AT SERIAL NO.5). THE TPO HAS USED THE TERM TC FOR OPE RATING COST AS CAN BE SEEN FROM THE ABOVE REFERRED TABLE. ACCORDI NGLY, THE TPO HAD WORKED OUT THE RATIO OF OP/TC AT 57.77% (UAE AE ), 31.90% (UK AE) AND 18.56% (USA AE). FROM THE ABOVE, IT IS CLEAR THAT PURCHASE EXPENSES ARE NOT PART OF SELLING, DISTRIBU TION AND ADMINISTRATIVE EXPENSES AND THEREFORE, THERE WAS NO ERROR IN THE COMPUTATION OF TPO AS INFERRED BY LD. CIT(A). ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 8 REGARDING THE OBSERVATION OF LD. CIT(A) ABOUT THE APPLICABILITY OF PROVISIONS OF SECTION 92C(3), IT I S STATED THAT THE PROVISIONS OF SECTION 92C(3)(A) IS APPLICABLE IN TH IS CASE. AS PER THE PROVISIONS OF SECTION 92C(3)(A), IN CASE THE PR ICE CHARGED OR PAID IN AN INTERNATIONAL TRANSACTION IS NOT DETERMI NED IN ACCORDANCE WITH SUB-SECTIONS 1 AND 2 OF SECTION 92C THEN THIS PROVISION CAN BE INVOKED. FROM THE PERUSAL OF SUB- SECTION 1 AND 2 OF SECTION 92C READ WITH RULE 10C, IT CAN BE SEEN THAT THE PRICE CHARGED OR PAID IN THE INTERNATIONAL TRANSACTION IS REQUIRED TO BE BENCH MARKED USING THE MOST APPROPRIATE METHOD WHIC H IS DEFINED TO BE THE METHOD WHICH IS DEFINED TO BE THE METHOD WHICH IS BEST SUITED TO THE FACT AND CIRCUMSTANCES OF EAC H PARTICULAR INTERNATIONAL TRANSACTIONS AND WHICH PROVIDED THE A LMOST RELIABLE MEASURE OF ARMS LENGTH PRICE. IN THIS REGARD, IT CAN BE SEEN THAT THOUGH THE TPO HAS NOT CHARGED THE MOST APPROPRIATE METHOD SELECTED BY THE ASSESSEE I.E. TNMM BUT THE TPO PROP OSED TO CHANGE THE TESTED PARTY AS CAN BE SEEN FROM PARA 5 (PAGE 4 & 5) OF THE TRANSFER PRICING ORDER THAT THE TPO HAD GIVE N THE BASIS FOR PROPOSING THE ADJUSTMENT IN THE CASE OF AES. THE I NTENTION OF THE TPO OF CHANGING TESTED PARTY IS CLEAR FROM THE SHOW CAUSE NOTICE. IT MAY BE MENTIONED THAT ASSESSEE HAD SELECTED ITSE LF AS A TESTED PARTY; HOWEVER, IT IS SEEN FROM THE FAR ANALYSIS OF THE ASSESSEE THAT AIA ENGINEERING, IN LIGHT OF ITS LONG HISTORY, DEVELOPMENT OF COMPANY BRAND, RESEARCH AND DEVELOPMENT ACTIVITIES, MANUFACTURING, MARKETING AND BRAND INTANGIBLES, IS MUCH MORE COMPLEX ENTITY AS COMPARED TO VEGA UAE (VEGA ME). AIA ENGINEERING TAKES THE ENTREPRENEURIAL RISK AND IS S UBJECT TO A NUMBER OF OTHER RISKS NORMALLY INCIDENTAL TO MANUFA CTURING OF TECHNOLOGICALLY UNIQUE PRODUCTS IN WHICH GLOBAL COM PETITION IS AVAILABLE. CONVERSELY, VEGA UAE (VEGA ME) IS A SIM PLE ENTITY HAVING NO MANUFACTURING ACTIVITY, NO INVENTORY HOLD ING, NO RESEARCH & DEVELOPMENT ACTIVITY AND IS WITHOUT ANY INTANGIBLES. VEGA UAE (VEGA ME), BEING A MUCH SIMPLER ENTITY, SH OULD HAVE BEEN AN AUTOMATIC CHOICE FOR BEING SELECTED AS A CO MPARABLE. HENCE, THE TPOS PROPOSAL TO MAKE ADJUSTMENT IN THE HANDS OF VEGA UAE AS MENTIONED IN THE SHOW CAUSE NOTICE WAS CORRECT STEP. AS FAR AS THE COMPARABILITY AS PER RULE 10B(1)(E) I S CONCERNED, THE TPO HAD GIVEN CONCLUSION IN PARA-6 ( PAGE-7) OF THE TP ORDER THAT THE OP/TC MARGIN OF 19.89% IS IN LINE WITH THE OTHER MARKET ENTITIES WHO ARE CARRYING OUT SIMILAR DISTRIBUTION FUNCTIONS. THEREFORE, THE OBSERVATION OF LD. CIT(A ) IS INCORRECT. 3. WITHOUT PREJUDICE TO THE ABOVE SUBMISSION, IT MA Y BE POINTED OUT THAT FOR AY 2006-07, HONBLE ITAT AHMED ABAD HAS ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 9 DELETED THE ADJUSTMENT MADE ON THE SIMILAR ISSUE. HOWEVER, HONBLE GUJARAT HIGH COURT VIDE ORDER DATED 16/08/2 012 IN TAX APPEAL NO.475 OF 2012 HAS ADMITTED THE FOLLOWING SU BSTANTIAL QUESTIONS OF LAW. 1. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW AND ON FACTS IN HOLDING THAT VEGA UAE IS A COMP ANY WHEN AT LEAST TWO SHARE HOLDERS ARE REQUIRED AS PER UAECCL AND AS PER ARTICLE 151 OF THE CONSTITUTION OF UAE, THE CONSTIT UTION SHALL HAVE PRECEDENCE OVER CONSTITUTION OF EMIRATES ? 2. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW AND ON FACTS IN HOLDING THAT THE VEGA UAE HAS T O BE ACCEPTED AS A COMPANY WITHIN THE DEFINITION OF SECTION 2(17) OF THE INCOME TAX ACT, 1961 WHEN 100% OF ITS SHARE ARE HELD BY AI A ENGINEERING LTD. ? 3. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW AND ON FACTS IN HOLDING THAT NO TP ADJUSTMENT I S CALLED FOR IN RESPECT OF VEGA UAE WHEN VEGA UAE WAS NOT A DISTRIB UTOR BECAUSE IT DID NOT HAVE INVENTORY RISK, DID NOT HAV E WAREHOUSING FACILITY AND PRODUCTS WERE DISPATCHED DIRECTLY BY T HE ASSESSEE COMPANY TO THE CUSTOMERS, AND IT WAS ONLY A SERVICE PROVIDER ? 4. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW AND ON FACTS IN HOLDING THAT NO TP ADJUSTMENT I S REQUIRED IN RESPECT OF COMMISSION PAYMENT TO VEGA UK ? 5. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW AND ON FACTS IN HOLDING THAT RULE 8D IS NOT APP LICABLE IN WORKING OUT THE DISALLOWANCE UNDER SECTION 14A AND CONFIRMING ONLY RS.11,48,609/- AGAINST RS.1,23,58,175/- WORKED OUT IN THE ASSESSMENT ORDER ? 6. WHETHER THE APPELLATE TRIBUNAL HAS SUBSTANTIALLY ERRED IN LAW ON FACTS IN HOLDING THAT TAX WAS NOT DEDUCTIBLE FROM THE PAYMENT MADE BY THE COMPANY TO THE NON-RESIDENT MR. EUR IVAN MONJE CASTRO BOLIVIA ? 4. ON THE OTHER HAND, THE AUTHORISED REPRESENTATIVE OF THE ASSESSEE SUPPORTED THE ORDER OF CIT(A) AND SUBMITTED THAT TH E FACTS OF THE CASE ARE THAT ARITHMETIC MEAN OF NET OPERATING PROFIT MA RGIN OF THE COMPARABLE COMPANIES ON THE BASIS OF THE CURRENT YE AR WAS 6.51% AS ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 10 AGAINST NET OPERATING PROFIT MARGIN OF 13.38% OF TH E ASSESSEE FOR THE PRESENT YEAR AS WILL BE OBSERVED FROM PAGE NO.19 OF CIT(A)S ORDER. UPON COMPARISON OF NET OPERATING PROFIT MARGIN OF V EGA UAE, VEGA U.K. AND VEGA US WITH ARITHMETIC MEAN OF THE COMPARABLE COMPANIES, IT WAS FOUND THAT THE ARITHMETIC MEAN OF COMPARABLE COMPAN IES IS HIGHER IN RESPECT OF ALL THE THREE VEGA ENTITIES AS WILL BE O BSERVED FROM PAGE 11 PARA 6.5 READ WITH PAGE 20 TOP PARA OF CIT(A)S ORD ER. HE SUBMITTED THAT PERCENTAGE OF EMPLOYEE COST TO TOTAL TURNOVER OF VEGA US IS HIGHEST I.E. 5.91% AND IT IS LOWEST FOR THE VEGA UA E I.E. 2.55%. SIMILARLY, PERCENTAGE OF ADMINISTRATIVE EXPENSES TO TURNOVER IS HIGHEST FOR VEGA, US AND VEGA UK @ 9.44% AND 5.39% RESPECTI VELY AND IT IS ONLY 3.89% FOR VEGA UAE. IF THE OPERATING COST IS H IGHER IN VEGA US, IT CANNOT BE SAID THAT THE PROFIT MARGIN OF OTHER VEGA ENTITIES I.E. VEGA UK AND VEGA UAE SHOULD BE AT PAR WITH THE PROFIT MARGI N OF VEGA US AND HENCE, TRANSFER PRICING ADJUSTMENT PROPOSED BY TPO AND CONFIRMED BY DRP ON THE BASIS OF OPERATING COST/OPERATING PROFIT OF VEGA US IS NOT SUSTAINABLE. IT WAS FURTHER SUBMITTED THAT WITH RE SPECT TO COMMISSION PAYMENT TO VEGA UK, IT IS SUBMITTED THAT THE SOLE P URPOSE OF MAKING THE ADJUSTMENT WAS TO MAKE OPERATING PROFIT/OPERATI NG COST RATIO OF VEGA UK COMPARABLE TO OPERATING PROFIT/OPERATING CO ST RATIO OF VEGA US. WHILE DECIDING THE TRANSFER PRICING ADJUSTMENT ISSU E IN RESPECT OF VEGA UAE, IT WAS HELD THAT ON THE BASIS OF OPERATING PRO FIT/OPERATING COST RATIO OF VEGA US, IT CANNOT BE HELD THAT SOME TRANS FER PRICING ADJUSTMENT CAN BE MADE AS STATED IN PAGE 18 OF CIT( A)S ORDER. IN VIEW OF THE ABOVE, IT WAS SUBMITTED THAT THE PRESEN T APPEAL OF THE REVENUE MAY BE DISMISSED. 5. THE AUTHORISED REPRESENTATIVE FURTHER SUBMITTED THAT THE ISSUE AT HAND IS DECIDED IN THE CASE OF THE ASSESSEE ITSELF BY THIS BENCH OF THE TRIBUNAL IN FAVOUR OF THE ASSESSEE IN A.Y. 2006-07 IN ITA ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 11 NO.580/AHD/2011, ORDER DATED 19.01.2012, IN GROUND NO.2 AND 3 OF THE APPEAL RAISED THEREIN. 6. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSED THE ORDERS OF THE LOWER AUTHORITIES AND MATERIALS AVAILABLE ON RE CORD. BOTH THE PARTIES HAVE AGREED BEFORE US THAT THE ISSUE IS COV ERED IN FAVOUR OF THE ASSESSEE BY THE ORDER OF THE TRIBUNAL IN ASSESSEES OWN CASE IN THE A.Y. 2006-07 VIDE ORDER DATED 19.01.2012 IN ITA NO.580/A HD/2011. WE FIND THAT THE TRIBUNAL IN A.Y. 2006-07 HELD AS UNDE R :- 15. GROUNDS NO.2 & 3 ARE REGARDING TP ADJUSTMENT MADE BY THE A.O. OF RS.4,32,70,240/- IN RESPECT OF SALES MADE T O VEGA UAE AND OF RS.95,56,360/- IN RESPECT OF COMMISSION PAYM ENT TO VEGA UK. THERE IS ONE MORE CONTENTION RAISED BY THE ASSE SSEE IN RESPECT OF BOTH THESE ISSUES THAT BENEFIT OF 5% RAN GE SHOULD HAVE BEEN ALLOWED AS PROVIDED IN PROVISO TO SECTION 92C( 2) OF THE INCOME TAX ACT, 1961. 16. IT IS NOTED BY THE DRP ON PAGE 19 OF ITS ORDER THAT TPO DURING THE COURSE OF PROCEEDINGS REQUIRED THE ASSES SEE TO FURNISH THE GROSS AND NET MARGIN OF VEGA ENTITY. THE SAME W AS SUBMITTED BY THE ASSESSEE BEFORE THE TPO AND IT HAS BEEN REPR ODUCED BY THE DRP AS PER WHICH GROSS PROFIT PERCENTAGE OF VEGA UA E IS @ 14.5%, VEGA UK @ 14.2% AND VEGA US @ 9.1%. SIMILARL Y, NET OPERATING PROFIT PERCENTAGE HAS BEEN SHOWN AS VEGA UAE @ 7.4%, VEGA UK @ 4.9% AND VEGA US @ 2.9%. THIS CONTE NTION WAS RAISED BY THE ASSESSEE BEFORE THE TPO THAT THE DIFFERENCE IN THE GROSS AND NET MARGINS OF VARIOUS VEGA ENTITIES IS BECAUSE OF DIFFERENCE IN ULTIMATE SALE PRICE AND THE LEVEL OF OPERATING EXPENSES AND NOT FOR THIS REASON THAT DIFFERENT PUR CHASE PRICE HAD BEEN PAID TO THE ASSESSEE. A WORKING HAS BEEN SUBMI TTED REGARDING TOTAL OPERATING EXPENSES OF THESE THREE V EGA ENTITIES AND ITS PERCENTAGE TO TURNOVER. AS PER THIS, THE PE RCENTAGE OF TOTAL OPERATING EXPENSES TO TURNOVER OF VEGA UAE WA S WORKED OUT @ 7.7%, OF VEGA UK @ 14.5% AND VEGA US @ 11.8%. THE ASSESSEE HAD ALSO FURNISHED SEPARATE WORKING OF THE PERCENTAGE OF TOTAL EMPLOYEES COST TO TURNOVER WHICH IS WORKED OUT @ 1.3% FOR VEGA UAE, 3.6% FOR VEGA UK AND @ 6.5% FOR VEGA US. THIS SUBMISSION WAS ALSO MADE THAT TRUE PLI FOR DISTRIBU TOR CAN ONLY BE THE NET OPERATING PROFIT MARGIN I.E. NOPM AND THE S AME WAS GIVEN ALONG WITH ARITHMETIC MEAN OF COMPARABLE COMP ANIES. AS ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 12 PER THE CHART REPRODUCED BY THE DRP ON PAGE 23 OF I TS ORDER, NET OPERATING PROFIT MARGIN OF VEGA UAE IS WORKED OUT @ 7.4% WHEREAS ARITHMETIC MEAN OF THE COMPARABLE COMPANIES HAS BEEN WORKED OUT @ 8.5%. SIMILARLY NOPM MARGIN OF VEGA UK HAS BEEN WORKED OUT @ 4.9% AND THAT OF THE COMPARABLE COMPAN IES @ 6.5% AND SIMILARLY FOR VEGA US, NOPM MARGIN WAS WOR KED OUT @ 2.9% AND THAT OF COMPARABLE COMPANIES WAS WORKED OU T @ 5.9%. IT WAS SUBMITTED BY THE ASSESSEE BEFORE THE DRP THA T THE TPOS CONCLUSION BASED ON COMPARISON OF OPERATING PROFIT TO TOTAL COST IS IMPROPER AND HENCE, CANNOT BE RELIED UPON. THE TPO HAD CHARACTERIZED THE VEGA UAE AS ONLY MARKETING ENTITY BUT AS PER THE ASSESSEE, THIS IS NOT CORRECT. VEGA UAE IS A FU LL FLEDGED DISTRIBUTOR. THE RELEVANT PARAS OF THE ORDER OF DRP ARE PARAS 22- 25 OF DRP ORDER AND THE SAME ARE REPRODUCED BELOW: 22. THE ASSESSEE HAS FURTHER OBJECTED TO THE ACTI ON OF THE TPO IN PROPOSING THE ADJUSTMENT TO THE INCOME OF TH E ASSESSEE IN RESPECT OF GOODS SOLD TO VEGA UAE BY CONSIDERING THE CONTROLLED TRANSACTIONS OF THE ASSE SSEE AS COMPARABLE FOR BENCHMARKING THE INTERNATIONAL TRANS ACTION. THE ASSESSEE HAS CONTENDED THAT THIS ACTION OF THE TPO IS NOT IN CONSONANCE WITH RULE 10B(1)(E)(II) OF THE RU LES. IN THIS REGARD, IT IS SEEN THAT VARIOUS DEFECTS WERE N OTICED BY THE TPO IN THE TRANSFER PRICING ANALYSIS CONDUCTED BY THE ASSESSEE AND THEREFORE THE TPO HAD RIGHTLY REJECTED THE SAID TRANSFER PRICING ANALYSIS CONDUCTED BY THE ASSESSEE . FURTHER, IN THE TRANSFER PRICING ANALYSIS CONDUCTED BY THE ASSESSEE KEEPING THE ASSOCIATED ENTERPRISES AS TEST ED O> PARTIES WHICH WAS SUBMITTED LATER BY THE ASSESSEE V IDE LETTER DATED 13.03.2009, THE ASSESSEE HAD TAKEN COMPARABLES WHOSE FUNCTIONS AND RISK PROFILES WERE NOT SIMILAR TO THAT OF VEGA UAE AND THE SAID TRANSFER P RICING ANALYSIS WAS ALSO RIGHTLY NOT CONSIDERED BY THE TPO . IN SUCH EVENTUALITY, WHEN THE TRANSFER PRICING ANALYSIS CON DUCTED BY THE ASSESSEE WAS DEFECTIVE AND THE COMPARABLES SELE CTED BY THE ASSESSEE HAVE NOT BEEN FOUND TO BE APPROPRIATE, BENCHMARKING HAS TO BE CARRIED OUT BY THE TPO BASED ON THE LIMITED INFORMATION THAT MAY BE PROVIDED BY THE ASSESSEE TO THE TPO. UNDER THE CIRCUMSTANCES, THE T PO HAD TO RESORT TO THE COMPARISON OF OPERATING PROFIT TO THE TOTAL COST OF THE SUBSIDIARIES/ENTITIES OF THE ASSESSEE C OMPANY AND THE SAID RATIO FOR THE US ENTITY COMPUTED AT 26 .49% WAS RIGHTLY APPLIED BY THE TPO TO VEGA UK AND VEGA UAE, IT MAY BE MENTIONED HERE THAT THE FOCUS OF TRANSFER PR ICE OF DETERMINATION IS ON THE REASONABLENESS OF THE RESUL T AND NOT THE DETAILS OF THE METHODOLOGY EMPLOYED, IF THE ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 13 COMPARABILITY AND RELIABILITY LEVEL IS OF HIGH DEGR EE, THERE COULD BE NO OBJECTION IN TAKING TRANSACTIONS WITH R ELATED PARTIES AS TRULY COMPARABLES. IN VIEW OF THE ABOVE, THE TPO WAS JUSTIFIED IN COMPARING THE OPERATING PROFIT TO THE TOTAL COST OF THE THREE SUBSIDIARIES/ENTITIES OF THE ASSE SSEE COMPANY. HENCE, THE UPWARD ADJUSTMENT OF RS.4,32,70,2407- MADE BY THE TPO IN THE SALE PRICE TO VEGA UAE IS HEREBY UPHELD. 23. THE ASSESSEE HAS FURTHER OBJECTED TO THE ADDITI ON OF RS,95,56,3607- PROPOSED BY THE TPO BY MAKING DOWNWA RD ADJUSTMENT IN RESPECT OF SALES COMMISSION PAID TO V EGA UK. THE ASSESSEE HAS SUBMITTED THAT THE SAID ADJUSTMENT HAS BEEN MADE BY THE TPO WITHOUT PROVIDING AN OPPORTUNI TY OF BEING HEARD AND WITHOUT EXAMINING THE RELEVANT FACT S. THE ASSESSEE HAS FURTHER OBJECTED TO THE ACTION OF THE TPO IN CONCLUDING THAT VEGA UK HAD NOT CARRIED OUT ITS FUN CTIONS IN RESPECT OF WHICH THE COMMISSION WAS PAID BY THE ASS ESSEE TO VEGA UK. 24. WE DO NOT AGREE WITH THE CLAIM OF THE ASSESSEE THAT WHILE MAKING THE SAID ADJUSTMENT, NO OPPORTUNITY OF HEARING WAS ALLOWED BY THE TPO. A QUESTIONNAIRE DATED 06.05 .2008 WAS ISSUED BY THE TPO AND THE HEARING WAS FIXED ON 04.06.2008. THE SECOND NOTICE WAS ISSUED ON 07.01.2 009 AND THE HEARING WAS FIXED ON 21.01.2009. THE THIRD NOTICE WAS ISSUED ON 21.07.2009 AND THE HEARING WAS FIXED ON 28.07.2009. WE ARE THEREFORE SATISFIED THAT ADEQUAT E OPPORTUNITY OF HEARING WAS ALLOWED BY THE TPO TO TH E ASSESSEE BEFORE PASSING THE ORDER. 25. THE TPO HAS MADE DOWNWARD ADJUSTMENT OF RS.95,56,3607- OUT OF THE TOTAL CLAIM OF COMMISSION OF RS.3,03,95,4057- SHOWN TO HAVE BEEN PAID BY THE ASS ESSEE TO M/S. VEGA UK, ON THE GROUND THAT THE SAID SUBSID IARY HAS NOT CARRIED OUT ALL THE FUNCTIONS RELATED TO COMMIS SION EARNING ACTIVITIES AND THE GEOGRAPHICAL TERRITORY H AS ALSO NOT BEEN ASSIGNED TO IT. AS ALREADY DISCUSSED EARLIER I N THIS ORDER, WE HAVE UPHELD THE FINDING OF THE TPO THAT T HERE WAS NO PROPER DISTRIBUTION OF TERRITORIES AMONGST THE A SSESSEE'S SUBSIDIARIES/ENTITIES. SINCE THERE IS NO CLEAR-CUT DEMARCATION OF THE GEOGRAPHICAL TERRITORIES AMONGST THE THREE SUBSIDIARIES OF THE ASSESSEE, THE TPO IS JUSTIFIED IN HOLDING THAT ALL THE FUNCTIONS RELATED TO COMMISSION EARNIN G ACTIVITIES HAVE NOT BEEN CARRIED OUT BY VEGA UK AND THEREFORE THE DOWNWARD ADJUSTMENT OF RS.95,56,360/- ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 14 MADE BY THE TPO IN THE COMMISSION INCOME EARNED BY M/S. VEGA UK IS UPHELD. 17. IT IS ALSO SUBMITTED BY THE LD. COUNSEL FOR THE ASSESSEE THAT THE ASSESSEE IS ENGAGED IN THE BUSINESS OF MANUFACT URING OF GRINDING MEDIA, LINERS FOR MILLS, DIAPHRAGMS, HAMME RS AND CRUSHERS, HEAT RESISTANT CAST STEEL, VERTICAL SPIND LE MILL SPARES, MILL CONTROL SYSTEMS ETC. IT WAS ALSO SUBMITTED THA T ASSESSEE HAS THREE OVERSEAS SUBSIDIARIES, NAMELY, VEGA INDUSTRIE S LIMITED UK (VEGA UK), VEGA INDUSTRIES LIMITED, USA (VEGA US) A ND VEGA INDUSTRIES (MIDDLE EAST) FZE, UAE (VEGA UAE). IT IS ALSO SUBMITTED THAT THE ASSESSEE PRIMARILY SELLS ITS PRODUCTS IN T HE DOMESTIC MARKET WHEREAS MARKETING AND DISTRIBUTION OF ITS PR ODUCTS IN THE INTERNATIONAL MARKETS IS UNDERTAKEN BY VEGA ENTITIE S IN THEIR SPECIFIED JURISDICTIONS. THIS IS ALSO SUBMITTED THA T VEGA UK WAS ADDITIONALLY RESPONSIBLE FOR SALES IN EUROPE, RUSSI A, AFRICA, TURKEY AND OTHER ERSTWHILE COMMONWEALTH OF INDEPENDENT STA TES, (CIS COUNTRIES), VEGA US WAS RESPONSIBLE FOR SALES IN NO RTH AMERICA AND VEGA UAE WAS RESPONSIBLE FOR SALES IN FAR EAST, MIDDLE EAST AND ASIAN COUNTRIES. IT IS FURTHER SUBMITTED THAT S PECIFICALLY, THE REVENUE PROCEEDED ON THE ASPECT ASSUMING THAT VEGA UAE WAS NEITHER BEARING ANY INVENTORY RISK NOR CONDUCT RISK AND HENCE IS ENTITLED ONLY TO A MARKUP ON VALUE ADDED EXPENSES I NCURRED BY IT. IT WAS SUBMITTED THAT THE ACTIVITIES CARRIED OUT BY VARIOUS VEGA ENTITIES IN THEIR RESPECTIVE JURISDICTION ARE AS UN DER: (A) ESTIMATION OF MARKET SIZE AND SALES FORECAST; (B) CUSTOMER VISITS; (C) QUOTATION / OFFER TO THE CUSTOMER; (D) INTERACTION WITH CUSTOMERS FOR PRICING AND PERF ORMANCE OF PRODUCTS; (E) CUSTOMER ORDER/ CONTRACT; (F) SUPPLY OF MATERIAL; (G) INSTALLATION OF PRODUCT AND (H) BILLING AND COLLECTION 18. IT IS ALSO SUBMITTED THAT VEGA UAE BEARS INVEN TORY RISK ALSO. IT IS FURTHER SUBMITTED THAT IN ARRIVING AT T HE CONCLUSION, THE TPO AND DRP HAVE MAINLY PROCEEDED ON THIS BASIS THA T IN CERTAIN CASES, THE GOODS WERE DIRECTLY DELIVERED BY THE ASS ESSEE TO THE PARTIES ON CUSTOMERS DESTINATION AND THE SAME WERE NOT STORED BY VEGA UAE IN ITS WAREHOUSE. IN THIS REGARD, IT WA S SUBMITTED BY THE LD. COUNSEL FOR THE ASSESSEE THAT THE SALES MAD E BY THE ASSESSEE TO VEGA UAE ARE ON FREE ON BOARD (FOB) BAS IS AND ONCE THE GOODS LEAVE THE INDIAN CUSTOM STATION, THE INVE NTORY RISK WITH REGARD TO THE SAID GOODS ARE CATEGORICALLY BORNE BY VEGA UAE AND ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 15 EVEN THE INSURANCE COST FOR COVERING THE RISKS ASSO CIATED WITH THE TRANSIT OF GODS UP TO THE CUSTOMERS CHOSEN DESTINA TION ARE BORNE BY VEGA UAE. IT IS FURTHER SUBMITTED THAT AS PER TH E AUDITED FINANCIAL STATEMENTS OF VEGA UAE AS AVAILABLE ON PA GE 421 OF THE PAPER BOOK-II, INVENTORY OF FINISHED GOODS IS APPEA RING IN THE CURRENT ASSETS OF VEGA UAE. IT IS FURTHER SUBMITTED THAT AS PER PARA 11 OF THE AGREEMENT AVAILABLE ON PAGE 594 59 5 OF THE PAPER BOOK-III, IT IS STATED THAT THE ASSESSEE WOUL D BE RESPONSIBLE TO REPLACE/REPAIR DEFECTIVE PRODUCTS MANUFACTURED B Y IT ONLY IF THE ASSESSEE RECEIVES AN INTIMATION FROM THE DISTRIBUTO R VIZ. VEGA UAE THAT THE ASSESSEES PRODUCTS ARE DEFECTIVE WITHIN A PERIOD OF TWO WEEKS AFTER THE DATE OF DELIVERY TO THE DISTRIBUTOR AND/OR THE END CUSTOMER AND HENCE, IF THE DISTRIBUTOR VEGA UAE IS UNABLE TO INTIMATE THE DEFECTS IN SUCH PRODUCT WITHIN A PERIO D OF SALES WITHIN TWO WEEKS, VEGA UAE IS EXPOSED TO INVENTORY RISK. R EGARDING CREDIT RISK ALSO, IT WAS SUBMITTED THAT AS PER THE DISTRIBUTOR AGREEMENT BETWEEN THE ASSESSEE COMPANY AND VEGA UAE AS AVAILABLE ON PAGE 576 OF THE PAPER BOOK, IT IS CLEA RLY MENTIONED THAT THE DISTRIBUTOR SHALL BE RESPONSIBLE FOR ALL T HE PAYMENTS FROM ITS CUSTOMERS AND HENCE, BAD DEBTS IF ANY, SHALL BE TO THE COST OF THE DISTRIBUTOR. REGARDING THE OBSERVATION OF THE T PO THAT VEGA UAE DOES NOT PROVIDE FOR BAD DEBS WHEREAS THE ASSES SEE COMPANY HAS PROVIDED FOR BAD DEBTS IN FINANCIAL YEA R 2005-06, IT WAS SUBMITTED THAT PROVISION IN FINANCIAL YEAR 2005 -06 HAS BEEN MADE IN RESPECT OF INDIGENOUS SALE IN THE DOMESTIC MARKET BUT IN FINANCIAL YEAR 2007-08, VEGA UAE HAS MADE PROVISION FOR BAD DEBTS ON ACCOUNT OF UNRECOVERABLE AMOUNT FROM ITS E ND CUSTOMER IN OVERSEAS MARKET. IT IS SUBMITTED THAT UNDER THES E FACTS, VEGA UAE MUST BE CATEGORIZED AS A DISTRIBUTOR AND NOT AS A MARKET SERVICE PROVIDER. 19. AS AGAINST THIS, IT WAS SUBMITTED BY THE LD. D .R. THAT VEGA UAE IS NOT A DISTRIBUTOR AS IT DOES NOT HAVE INVENT ORY RISK AND THE PRODUCTS ARE BEING DISPATCHED DIRECTLY BY THE ASSES SEE COMPANY AND VEGA DOES NOT HAVE WAREHOUSING FACILITY. HE FUR THER SUBMITTED THAT VEGA DID NOT BEAR ANY CREDIT RISK AS AMOUNTS ARE BEING PAID TO ASSESSEE AFTER RECEIPT BY VEGA FROM C USTOMERS. HE FURTHER SUBMITTED THAT AS PER THE ANNUAL REPOT, ASS ESSEE HAS STATED THAT THE ASSESSEE COMPANY HAS SALES OFFICES IN UAE, UK, USA, AUSTRALIA, AND PHILIPPINES AND TWO WAREHOUSES IN USA AND ONE WAREHOUSE IN UK. HE FURTHER SUBMITTED THAT MANP OWER OF VEGA HAS BEEN CREATED BY THE PARENT COMPANY BY TRAN SFERRING THE PART OF ITS OWN EMPLOYEES AND IT DOES NOT HAVE ANY PERSON TO LOOK AFTER DISTRIBUTION AND LOGISTICS BUT CONSISTS ONLY OF TECHNICAL PERSONS. HE FURTHER SUBMITTED THAT VEGA UAE DOES NO T HAVE CAPACITY TO HANDLE TECHNICAL ISSUES AND FIXATION OF FINAL PRICING. ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 16 20. IN THE REJOINDER, IT WAS SUBMITTED BY THE LD. COUNSEL FOR THE ASSESSEE THAT THE ASSESSEE HAS AMPLY DEMONSTRATED T HAT PURSUANT TO ITS PROPER AND VALIDLY EXECUTED DISTRIB UTOR AGREEMENT, THE ROLE OF VEGA UAE WAS OF A DISTRIBUTOR FOR ITS P RODUCT AS CLEARLY DEFINED. IT IS ALSO SUBMITTED THAT THE ASSESSEE HAS ALSO DEMONSTRATED CONSISTENCY WITH THE DISTRIBUTOR AGREE MENT IN ITS CONDUCT WITH ALL ITS DISTRIBUTORS INCLUDING VEGA UA E. HE FURTHER SUBMITTED THAT THE ASSESSEE HAS DEMONSTRATED CLEARL Y THAT VEGA UAE ACTUALLY BEARS THE ENTIRE INVENTORY RISK AND TH E CREDIT RISK INCLUDING PROVIDING FOR BAD DEBTS OF UNRECOVERABLE AMOUNTS FROM ITS END CUSTOMERS. HE FURTHER SUBMITTED THAT SINCE THE TITLE TO THE GOODS ACTUALLY PASSES TO THE DISTRIBUTOR ON THEIR D ELIVERY AT INDIAN PORTS ON FOB BASIS, THE FACTS OF GOODS BEING DISPAT CHED DIRECTLY TO SOME CUSTOMERS IN KEEPING WITH COMMERCIAL AND INDUS TRY PRACTICES IS NOT DETERMINATIVE AND DOES NOT SUPPORT THE INCORRECT RE-CHARACTERIZATION OF VEGA UAE AS MARKETING SERVIC E PROVIDER. HE FURTHER SUBMITTED THAT VEGA UAE AS A DISTRIBUTOR HA S CONSISTENTLY SHOWN PURCHASES, SALES AND INVENTORIES IN ITS OWN A UDITED ANNUAL FINANCIAL STATEMENTS AND IN THE YEAR IN WHICH NEED AROSE TO PROVIDE FOR BAD DEBTS, VEGA UAE HAS DONE SO, DEMONS TRATING THAT IT BEARS CREDIT RISK AND BAD DEBS RISK. HE FURTHER SUBMITTED THAT ADMITTEDLY, THE ASSESSEE HAS SEVERAL OFFICES AND WA REHOUSES IN VARIOUS COUNTRIES BUT IT DOES NOT TAKE THE CASE OF THE REVENUE ANY FURTHER AS ON THE VERY SAME PAGE OF THE ANNUAL REPO RT. THE MANAGING DIRECTOR OF THE ASSESSEE COMPANY HAS CLEAR LY STATED THAT THE ASSESSEE COMPANY MARKET AND SELL ITS PRODU CTS INTERNATIONALLY THROUGH ITS SUBSIDIARIES LOCATED IN UK, USA AND MIDDLE EAST UNDER VEGA BRAND. REGARDING THIS ALLEGA TION THAT MOST OF THE IMPORT OF THE ASSESSEE COMPANY WERE TRANSFER FROM VEGA UAE, IT WAS SUBMITTED THAT IT CANNOT CHANGE THE CHA RACTER OF VEGA UAE FROM DISTRIBUTOR TO MARKETING SERVICE PROVIDER. 21. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS, PERU SED THE MATERIAL ON RECORD AND HAVE GONE THROUGH THE ORDERS OF AUTHORITIES BELOW. WE FIND THAT THIS IS ONE OF THE OBJECTIONS OF THE REVENUE THAT VEGA UAE IS NOT A DISTRIBUTOR BUT MARK ET SERVICE PROVIDER AND MERELY ON THIS BASIS, THE TP ANALYSIS CONDUCTED BY THE ASSESSEE HAD BEEN REJECTED BY THE TPO. HE HAS A DOPTED THE TRANSFER PRICING ADJUSTMENT ON THE BASIS OF OPERATI NG COST/OPERATING PROFIT PERCENTAGE OF VEGA UAE, VEGA UK AND VEGA US. REGARDING THIS ASPECT THAT AS TO WHETHER VEGA U IAE IS A DISTRIBUTOR OR SIMPLY MARKETING SERVICE PROVIDER, W E FIND THAT THE OBJECTION OF THE REVENUE ON THIS ASPECT IS NOT SUST AINABLE IN VIEW OF THE FACTS OF THE PRESENT CASE BECAUSE WE FIND TH AT THE ASSESSEE COMPANY HAS EXECUTED PROPER DISTRIBUTOR AGREEMENT W ITH VEGA ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 17 UAE AND IT HAS BEEN ADHERED TO ALSO AND SINCE THE O BJECTION OF THE REVENUE THAT VEGA UAE IS NOT BEARING ANY INVENT ORY AND CREDIT RISK, WE FIND THAT AS PER THE FACTS OF THE PRESENT CASE, BOTH THESE OBJECTIONS ARE NOT CORRECT AND VEGA UAE IS CARRYING BOTH THE INVENTORY RISK AS WELL AS CREDIT RISK AND THEREFORE , WE HOLD THAT VEGA UAE IS NOT A MARKETING SERVICE PROVIDER IN THE FACTS OF THE PRESENT CASE BUT IT IS A DISTRIBUTOR OF THE ASSESSE E COMPANY. ONCE IT IS ACCEPTED THAT VEGA UAE IS A DISTRIBUTOR, ALP HAS TO BE DETERMINED ON THE BASIS OF PROFIT ON SALE OF GOODS BY THE ASSESSEE COMPANY AS COMPARED TO THE COMPARABLE COMPANIES. TH E ASSESSEE HAS DEMONSTRATED THAT THE ARITHMETIC MEAN OF 3 YEARS WEIGHT AGE AVERAGE NOPM OF 12 COMPARABLE COMPANIES WAS 7.92% AS AGAINST NOPM OF 18.89% OF THE ASSESSEE FOR THE PRESENT YEAR. LATER ON THE ASSESSEE HAS ALSO FURNIS HED THE REVISED ARITHMETIC MEAN OF NOPM OF THE COMPARABLE COMPANIES ON THE BASIS OF CURRENT YEAR DATA ONLY AND IT WAS 7.04% WH EREAS MEAN OF 3 YEARS WEIGHT AGE AVERAGE NOPM OF 12 COMPARABLE COMPANIES WAS 7.92% AS AGAINST NOPM OF 18.89% OF THE ASSESSEE FOR THE PRESENT YEAR. LATER ON, THE ASSESSEE HAS ALSO FURNI SHED THE REVISED ARITHMETIC MEAN OF NOPM OF THE COMPARABLE C ASES ON THE BASIS OF CURRENT YEAR DATA ONLY AND IT WAS 7.04% AS AGAINST 7.92% ON THE BASIS OF 3 YEAR WEIGHT AGE AVERAGE. TH E ASSESSEE HAS ALSO FURNISHED ONE ALTERNATIVE WORKING ON THE B ASIS OF NET OPERATING PROFIT MARGIN OF VEGA UAE, VEGA UK AND VE GA US AND ARITHMETIC MEAN OF COMPARABLE COMPANIES. THE ARITHM ETIC MEAN OF COMPARABLE COMPANIES IS HIGHER IN RESPECT OF ALL THE THREE VEGA ENTITIES AND HENCE, ON BOTH THESE BASIS, NO TP ADJU STMENT IS CALLED FOR. TP ADJUSTMENT HAD BEEN PROPOSED BY THE TPO AND CONFIRMED BY DRP ON THE BASIS OF OPERATING COST/OPE RATING PROFIT MARGIN OF VEGA UAE, VEGA UK AND VEGA US. THE SAME F OR VEGA US WAS CONSIDERED AS BASE AND DIFFERENCE OF VEGA UA E WAS PROPOSED AS TP ADJUSTMENT BY THE TPO BUT WHILE DOIN G SO, IT HAS TO BE KEPT IN MIND THAT OPERATING COST/OPERATING PR OFIT MARGIN DEPENDS ON LEVEL OF OPERATING EXPENSES INCURRED BY THE RESPECTIVE VEGA ENTITIES AND ALSO THE MAKING OF BUSINESS EARNI NG BY THE RESPECTIVE VEGA ENTITIES. WE FIND THAT PERCENTAGE O F EMPLOYEE COST TO TOTAL TURNOVER OF VEGA US IS HIGHEST I.E. 6 .5% AND IT IS LOWEST FOR VEGA UAE I.E. 1.3%. SIMILARLY, PERCENTAG E OF ADMINISTRATIVE EXPENSES TO TURNOVER IS HIGHEST FOR VEGA US AND VEGA UK @ 4.9% AND IT IS ONLY 2% FOR VEGA UAE. IF T HE OPERATING COST IS HIGHER IN VEGA US, IT CANNOT BE SAID THAT T HE PROFIT MARGIN OF OTHER VEGA ENTITIES I.E. VEGA UK AND VEGA UAE SH OULD BE AT PAR WITH THE PROFIT MARGIN OF VEGA US AND HENCE, TP ADJ USTMENT PROPOSED BY TPO AND CONFIRMED BY DRP ON THE BASIS O F OPERATING COST/OPERATING PROFIT OF VEGA US IS NOT SUSTAINABLE . VARIOUS ALLEGATIONS RAISED BY THE TPO FOR NOT ACCEPTING THE TP ANALYSIS ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 18 CARRIED OUT BY THE ASSESSEE ARE NOT FOUND TO BE VAL ID AND HENCE, WE HOLD THAT NO TP ADJUSTMENT IS CALLED FOR IN RESP ECT OF VEGA UAE. THE SAME IS DELETED. HENCE, GROUND NO.2 OF THE ASSESSEE IS ALLOWED. 22. REGARDING GROUND NO.3 I.E. REGARDING TP ADJUST MENT PROPOSED BY THE TPO IN RESPECT OF COMMISSION PAYMEN T TO VEGA UK, WE FIND THAT THE SAME IS ALSO ON THE SAME BASIS THAT OPERATING PROFIT/OPERATING COST RATIO OF VEGA UK SH OULD BE COMPARABLE TO OPERATING PROFIT/OPERATING COST RATIO OF VEGA US. WHILE DECIDING THE TP ADJUSTMENT ISSUE IN RESPECT O F VEGA UAE, WE HAVE HELD THAT ON THE BASIS OF OPERATING PROFIT/ OPERATING COST RATIO OF VEGA US, IT CANNOT BE HELD THAT SOME TP AD JUSTMENT CAN BE MADE. HENCE, WITH REGARD TO THIS TP ADJUSTMENT A LSO, WE HOLD THAT THE SAME IS NOT SUSTAINABLE AND, THEREFORE, IT IS DELETED. GROUND NO.3 OF THE ASSESSEE IS ALSO ALLOWED. 7. THE DEPARTMENTAL REPRESENTATIVE SUBMITTED THAT T HE DEPARTMENT HAS PREFERRED AN APPEAL BEFORE THE HONBLE HIGH COU RT OF GUJARAT AGAINST THE ABOVE DECISION OF THE TRIBUNAL BUT THE DEPARTMENTAL REPRESENTATIVE COULD NOT PRODUCE ANY MATERIAL TO SH OW THAT THE ABOVE ORDER OF THE TRIBUNAL HAS BEEN REVERSED OR MODIFIED BY THE HONBLE HIGH COURT OR THE OPERATION OF THE ABOVE ORDER HAS BEEN SUSPENDED BY THE HONBLE HIGH COURT. IN ABSENCE OF THE SAME, IN OUR CONSIDERED VIEW, WE ARE DUTY BOUND TO FOLLOW THE ABOVE DECISION OF THE CO-ORDINATE BENCH OF THE TRIBUNAL PASSED IN THE CASE OF THE ASSESSEE ITS ELF AND WHICH SQUARELY COVERS THE CONTROVERSY IN QUESTION. WE, T HEREFORE, FOLLOWING THE ABOVE DECISION OF THE TRIBUNAL, CONFIRM THE ORD ER OF THE CIT(A) AND DISMISS THE GROUND OF APPEAL OF THE REVENUE. 8. IN THE RESULT, APPEAL OF THE REVENUE IS DISMISSE D. ORDER PRONOUNCED IN THE COURT ON FRIDAY, THE 17 TH OF APRIL, 2015 AT AHMEDABAD. SD/- SD/- (KUL BHARAT) JUDICIAL MEMBER ( N.S. SAINI) ACCOUNTANT MEMBER AHMEDABAD; DATED 17/04/2015 ITA NO.3036/AHD/2010 AIA ENGINEERING LTD FOR AY 2005-06 19 PBN/* / 0 -%$12 32*$ / COPY OF THE ORDER FORWARDED TO : 1. / THE APPELLANT 2. / THE RESPONDENT. 3. ! / CONCERNED CIT 4. ! () / THE CIT(A)-VIII, AHMEDABAD 5. $%& '', , )*++ / DR, ITAT, AHMEDABAD 6. &,- . / GUARD FILE. / ' / BY ORDER, 4/ !5 ( DY./ASSTT.REGISTRAR) , / ITAT, AHMEDABAD