Kubota Agricultural Machinery India Private Limited, CHENNAI V. DCIT, CHENNAI

ITA 441/CHNY/2015

• Counselvise Citation: 44121714 RSA 2015
• Duration Of Justice: 9 month(s) 8 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 11-12-2015
• Appeal Filed By: Assessee
• Bench Allotted: D
• Next Hearing Date: 13-10-2015
• Assessment Year: 2010-2011
• Appeal Filed On: 03-03-2015
• Court: TRIBUNAL
• Department Lawyers: M M BHUSARI CIT D R
• Assessee Lawyers: PERCY J PARDIVALA
• Keywords: Depreciation; Transfer pricing; International transaction; Working capital adjustments; Cost of acquisition; Tangible material
• Section: 10B

Judgement Text

, , IN THE INCOME TAX APPELLATE TRIBUNAL D BENCH, CHENNAI ... , . , , BEFORE SHRI N.R.S.GANESAN, JUDICIAL MEMBER AND SHRI A.MOHAN ALANKAMONY, ACCOUNTANT MEMBER ./ I.T.A.NO.441 /MDS./2015 ( !' #' / ASSESSMENT YEAR :2010-11) M/S. KUBOTA AGRICULTURAL MACHINERY INDIA PRIVATE LIMITED , NO.15,MEDAVAKKAM ROAD, SHOLINGANALLUR,CHENNAI 600 119. VS. THE DEPUTY COMMISSIONER OF INCOME TAX, COMPANY CIRCLE IV(4), NUNGAMBAKKAM, CHENNAI -34. PAN AADCK 5472 E ( / APPELLANT ) ( / RESPONDENT ) $% & ' / APPELLANT BY : MR.PERCY J. PARDIVALA ()$% & ' / RESPONDENT BY : MR.M.M.BHUSARI, CIT, D.R * + & ,- / DATE OF HEARING : 13.10 .2015 .# & ,- /DATE OF PRONOUNCEMENT : 11.12.2015 / O R D E R PER A.MOHAN ALANKAMONY , ACCOUNTANT MEMBER: THIS APPEAL IS FILED BY THE ASSESSEE, AGGRIEVED BY THE ORDER OF THE DEPUTY COMMISSIONER OF INCOME TAX, CORPORATE CI RCLE 4(2) CHENNAI DATED 28.01.2015 PASSED U/S.143(3) R.W.S. 1 44C(13) OF THE ITA NO.441/MDS/2015 2 ACT PURSUANT TO THE ORDER OF THE T.P.O AND THE DIRE CTIONS ISSUED BY THE D.R.P. 2. THE ASSESSEE HAS RAISED SEVERAL GROUNDS IN ITS APPEAL, HOWEVER THE CRUXES OF THE ISSUE ARE CONCISED HEREIN BELOW FOR ADJUDICATION:- I) THE LD. ASSESSING OFFICER/TPO/DRP HAS REJECTED THE RESALE PRICE METHOD (RPM) AS THE MOST APPROPRIATE METHOD (MAP) W HILE MAKING DOWNWARD ADJUSTMENTS AMOUNTING TO ` 12,83,34,282/- IN REGARD TO THE INTERNATIONAL TRANSACTION OF PURCHASE S MADE FROM ASSOCIATED ENTERPRISES (AE). II) THE LD. ASSESSING OFFICER /TPO/DRP HAD ERRED IN NOT APPLYING ANY OF THE PRESCRIBED METHOD FOR DETERMINING THE AL P. III) THE LD. ASSESSING OFFICER /TPO/DRP HAD ERRED I N ADOPTING BERRY RATIO AS PROFIT LEVEL INDICATOR (PLI) WHILE COMPUTI NG THE ALP. IV) THE LD. ASSESSING OFFICER /TPO/DRP HAD ERRED IN CONSIDERING ROUTINE NORMAL EXPENSES SUCH AS EMPLOYEE COST, GENE RAL AND ADMINISTRATION COST, SELLING AND DISTRIBUTION COST, AND DEPRECIATION AS VALUE ADDED EXPENSES (VAE) WHILE COMPUTING THE P LI. ITA NO.441/MDS/2015 3 V) THE LD. ASSESSING OFFICER/TPO/DRP HAS FAILED TO APPRECIATE THAT THE LOSSES INCURRED BY THE APPELLANT WERE ON ACCOUN T OF START-UP PHASE OF THE COMPANY. VI) THE LD. A.O/TPO/DRP FAILED TO APPRECIATE THAT MARKET RESEARCH ACTIVITY WERE RENDERED UNDER A SEPARATE AGREEMENT W HICH IS DISTINCT FROM DISTRIBUTION ACTIVITY OF THE APPELLAN T AND THEREFORE CANNOT BE CONSIDERED AS A PART OF VALUE ADDED EXPEN SES FORMING PART OF TRADING ACTIVITY. VII) THE LD. A.O/TPO/DRP HAS FAILED TO APPRECIATE THAT THE APPELLANT & ITS AE ARE TWO INDEPENDENT PARTIES IN JOINT VENTU RE AND THEREFORE WOULD NOT ALLOW INFLATION OF PURCHASE PRICE. VIII) THE LD. ASSESSING OFFICER/TPO/DRP HAD ERRED IN NOT PROVIDING ADJUSTMENTS ON ACCOUNT OF DIFFERENCES IN WORKING CA PITAL. IX) THE LD. ASSESSING OFFICER/TPO/DRP HAD ERRED IN NOT GRANTING ADJUSTMENTS TOWARDS FOREIGN EXCHANGE FLUCTUATIONS. 3. THE BRIEF FACTS OF THE CASE ARE VIVIDLY BROUGHT OUT BY THE LD. DRP IN THEIR ORDER WHICH IS EXTRACTED HEREIN BELOW FOR REFERENCE:- ITA NO.441/MDS/2015 4 M/S.KUBOTA AGRICULTURAL MACHINERY INDIA PRIVATE LI MITED (THE ASSESSEE/KUBOTA INDIA) WAS INCORPORATED IN THE YE AR DECEMBER 2008 UNDER THE COMPANIES ACT, 1956 IN CHENNAI AND IS JOINTLY H ELD BY KUBOTA CORPORATION, JAPAN (60%) AND SUMITOMO CORPORATION, JAPAN (40%). IT WAS SET UP WITH THE OBJECTIVE OF DISTRIBUTION OF AGRICU LTURAL MACHINERY IN INDIA. DURING FINANCIAL YEAR (FINANCIAL YEAR) 2009-10, T HE ASSESSEE HAS ENTERED INTO THE FOLLOWING INTERNATIONAL TRANSACTIO NS: PURCHASE OF FINISHED GOODS; PAYMENT OF GUARANTEE FEES; REIMBURSEMENT OF EXPENSES ; AND PROVISION OF MARKET RESEARCH SERVICES ACTIVITIES PERFORMED BY THE ASSESSEE : A. DISTRIBUTION THE ASSESSEE IS PRIMARILY ENGAGED IN DISTRIBUTION OF AGRICULTURAL MACHINERIES AND RELATED PARTS. FOR THE PURPOSE OF ITS BUY-SELL ACTIVITIES, THE ASS ESSEE BUYS MACHINERY AND SPARE PARTS FROM THE AE AND UNDERTAKES RESALE OF THE SAME IN THE INDIAN MARKET TO THIRD PARTY CUSTOMERS, THEREFORE ACTING AS A LIMITED RISK DISTRIBUTOR . B. MARKET RESEARCH THE ASSESSEE PROVIDES MARKET RESEARCH SERVICES TO K UBOTA CORPORATION, JAPAN FOR WHICH THE ASSESSEE RECEIVED SEPARATE COMP ENSATION. FOR SUCH ACTIVITIES UNDERTAKEN THE ASSESSEE IS CHARACTERIZED AS A LIMITED RISK SERVICE PROVIDER . THE ASSESSEE OPERATED IN TWO DISTINCT SEGMENTS OF DISTRIBUTION AND MARKET RESEARCH ACTIVITIES. METHOD ADOPTED IN THE TP DCOUMENT : THE SUMMARY OF MAM SELECTED, PLI ADOPTED AND THE MA RGIN EARNED BY THE ASSESSEE AND COMPARABLE COMPANIES ARE REPRESENTED B ELOW : ITA NO.441/MDS/2015 5 INTERNATIONAL TRANSACTION SEGMENT MAM PLI MARGIN OF KUBOTA INDIA MARGIN OF COMPARABLE PURCHASE OF FINISHED GOODS DISTRIBUTION RPM GROSS PROFIT MARGIN 20.04% 11.81% PAYMENT OF GUARANTEE FEES NOT APPLICABLE(NA) COMPARABLE UNCONTROLLED PRICE METHOD (CUP) NA REIMBURSEMENT OF EXPENSES NA ACTUAL NA PROVISION OF MARKET RESEARCH SERVICES MARKET RESEARCH TRANSACTIONAL NET MARGIN METHOD (TNMM) NET COST PLUS MARGIN 16.05% 6.36% ACCORDINGLY, THE ASSESSEE CONCLUDED THAT THE INTERN ATIONAL TRANSACTIONS ENTERED INTO WITH THE AE, WERE AT ARMS LENGTH. HOWEVER, THE TPO HAS NOT ACCEPTED THE METHOD ADOP TED BY THE TAXPAYER AND ADOPTED TNMM AS MAM ALONG WITH BERRY RATIO AS P LI FOR THE PURCHASE OF FINISHED GOODS. THE TPO DETERMINED THE ALP OF PURCH ASE OF GOODS FROM AES AS RS.23.65 CRORES AS AGAINST RS.36.48 CRORES RECORDED IN THE BOOKS OF ACCOUNTS AND THEREBY HAS MADE A DOWNWARD ADJUSTMENT OF RS.12 .83 CRORES TO PURCHASE PRICE OF GOODS FROM A.E.S . 4. AGGRIEVED BY THE ORDER OF THE LD. DRP AND THE D CIT DATED 19.11.2014 & 28/01/2015 RESPECTIVELY, THE ASSESSEE IS NOW IN APPEAL BEFORE US. ITA NO.441/MDS/2015 6 5.1 GROUND NOS.(I) TO (VII) - REJECTION OF THE RESALE PRICE METHOD AS THE MOST APPROPRIATE METHOD (MAM) AND ACCEPTANCE OF BER RY RATIO AS A THE MAM:- THE ASSESSEE HAS APPLIED RP METHOD BECAUSE IT IS APPLICABLE IN SITUATIONS WHERE SELLING AND DISTRIBUTION OPERAT IONS CARRIED OUT BY THE RESELLER/DISTRIBUTOR DOES NOT ADD SUBSTANTIAL V ALUE TO THE PRODUCT THROUGH USE OF TANGIBLE OR INTANGIBLE PROPERTY. H OWEVER, THE LD. TPO REJECTED THE RP METHOD FOLLOWED BY THE ASSESSEE BEC AUSE OF THE FOLLOWING REASONS:- I) THE ASSESSEE COMPANY IS NOT ONLY A TRADER BUT PROVIDER OF VALUE ADDED SERVICES TO ITS AES. II) THE COST INCURRED FOR SUCH VALUE ADDED SERVICE S IS HUGE AND ALSO CLOSELY INTERLINKED WITH THE DISTRIBUTION FUNCTIONS OF THE ASSESSEE COMPANY. III) THE FUNCTIONS ASSUMED BY THE ASSESSEE IS MANI FOLD AND NOT PROPORTIONATE WITH THE KIND OF REMUNERATION RECEIVE D. IV) THE ASSESSEE AND ITS AES HAD NOT SET THE CONTR ACTUAL TERMS APPROPRIATELY TO BENCH MARK THE TRANSACTIONS WITH T HE HELP OF RPM. ITA NO.441/MDS/2015 7 V) IN THE COMPARABILITY STUDY, THE COMPARABLE SELE CTED BY THE ASSESSEE CANNOT BE COMPARED WITH THE GROSS PROFIT M ARGINS BECAUSE WITHOUT ANALYZING THE VALUE ADDED COST OF EACH COMP ARABLE, TRUE COMPARABILITY CANNOT BE MADE. VI) SINCE THE ASSESSEE IS INCURRING HUGE COST SUCH AS EXPENDITURE RELATING TO ADVERTISEMENT, WARRANTY, SUPPLY CHAIN I NTANGIBLE ETC., AND IF UNDERTAKING HIGHER RISKS, THEN ITS MARGINS ALSO SHOULD BE HIGHER, HOWEVER IN THE CASE OF THE ASSESSEE, THE MARGINS AR E VERY LESS IN FACT THE ASSESSEE IS INCURRING LOSS. THEREFORE, THE RP M ETHOD CANNOT BE ADOPTED IN THE CASE OF THE ASSESSEE. VII) EVEN WHILE ANALYZING THE OTHER COMPARABLES, I T IS EVIDENT THAT THE ASSESSEE COMPANIES VALUE ADDED EXPENSES ARE HIGHER THAN ANY OF THE COMPARABLES. VIII) THE CONTENTION OF THE ASSESSEE THAT THE MARKE T RESEARCH ACTIVITIES IS A SEPARATE SEGMENT IS NOT TENABLE BEC AUSE, THE ASSESSEE HAS NOT MAINTAINED SEGMENTED ACCOUNTS BY APPORTIONI NG THE OVERHEADS SUCH AS ADMINISTRATIVE AND MANAGERIAL COS TS, HR COSTS AND OTHER COSTS. ITA NO.441/MDS/2015 8 5.2 THUS HAVING REJECTED THE RP METHOD, THE LD. TP O OPINED THAT BERRY RATIO WOULD BE THE MOST APPROPRIATE METHOD BE CAUSE OF THE FOLLOWING REASONS:- I) IT IS JUST AN ALTERNATIVE OF COST PLUS MARKUP MO DEL. THIS RATIO EVALUATES THE SUITABLE MARKUP THAT THE PRINCIPLE HAS TO REIMBURSE TO ITS AGENT. IT IS BEST SUITED FOR ROUTINE DISTRIBUTORS AND FOR SERVICE PROVIDERS AND MORE SO FOR CAPTIVE ENTITIES . II) THE VERY PURPOSE OF DETERMINING BERRY RATIO IS TO ENSURE THAT THE DISTRIBUTOR SHOULD EARN A RETURN COMMENSURATE TO TH E DISTRIBUTION SERVICE PERFORMED. THE DISTRIBUTORS MUST ACHIEVE A PARTICULAR GROSS PROFIT TO COMMENSURATE FOR THE VALUE ADDED SERVICES THE COST OF WHICH ARE ACCOUNTED AND INCLUDED IN THE OPERATING EXPENSE S. III) IN THE INDIAN CONTEXT THE DELHI BENCH OF THE TRIBUNAL IN THE CASE OF GAP INTERNATIONAL SOURCING (INDIA) PVT. LTD., VS . ACIT IN ITA NO.5147/DEL/2011 HAD HELD THAT FOR NON-RISK BEARING REQUIREMENT FACILITATING FUNCTIONS WHICH ARE PREORDAINED CONTRA CT OR HAND BOOK THE APPROPRIATE PLI WOULD BE THE NET PROFIT /TOTAL COST . FURTHER, IN THE CASE DCIT VS. CHEIL COMMUNICATIONS INDIA PVT LTD IN 137 TTJ 539, THE DELHI BENCH OF THE TRIBUNAL HELD THAT OPERATING PROFIT /VALUE ITA NO.441/MDS/2015 9 ADDED EXPENSES IS TO BE APPLIED WHERE THE APPELLANT PERFORMS AGENCY FUNCTIONS TO ITS AE. IV) IN THE CASE OF THE ASSESSEE, THE ASSESSEE COMPA NY RENDERS MANY FUNCTIONS TO ITS AES OTHER THAN ROUTINE TRADING ACT IVITY AND THEREFORE, REASONABLE MARKUP ON COST HAS TO BE ACCOUNTED. THE ASSESSEE COMPANY HAD WIDELY ADVERTISED THE TRADE MARK AND TH E BRAND LEGALLY OWNED BY THE ASSESSEES AES AND HAD INCURRED SUBSTA NTIAL COST. THE ASSESSEE COMPANY HAD ALSO WIDELY ESTABLISHED THE DI STRIBUTION NET WORK AND RENDERED MARKETING SUPPORT SERVICES. THERE FORE IT IS ESSENTIAL FOR THE ASSESSEE COMPANY AND ITS AES TO S ET UP CONTRACTUAL TERMS TO ENSURE REASONABLE ACCEPTABLE LEVEL OF PROF IT TO THE ASSESSEE. V) ALL THE FUNCTIONS PERFORMED BY THE ASSESSEE CO MPANY TO ITS AES ARE INTERLINKED WITH THE DISTRIBUTION SERVICES REND ERED BY THE ASSESSEE COMPANY. THE VALUE OF THE PRODUCTS THAT ARE DISTRIB UTED BY THE ASSESSEE COMPANY CAN ONLY BE CONSIDERED AS PASS THROUGH COST . SUCH PASS THROUGH COSTS ARE IRRELEVANT FOR THE LOW RISK DISTRIBUTOR AS IN THE CASE OF THE ASSESSEE. UNDER THIS SITUATIO N IT IS ESSENTIAL TO VERIFY WHETHER THE GROSS PROFIT OR OPERATING PROFIT ACHIEVED BY THE ASSESSEE COMPANY IS COMMENSURATE WITH THE TOTAL VAL UE ADDED COST ITA NO.441/MDS/2015 10 INCURRED BY THE ASSESSEE. THEREFORE IN THE CASE OF THE ASSESSEE THE MOST APPROPRIATE METHOD TO DETERMINE THE ALP WOULD BE TO APPLY THE BERRY RATIO. VI) THE ASSESSEE ASSUMES LIMITED RISK AS DISTRIBUTO R IS NOT DISPUTED. HOWEVER, THE ASSESSEE COMPANY HAS INCURRED HUGE VAL UE ADDED EXPENSES WHICH CANNOT BE DENIED PRECISELY WHICH IS NECESSARY WOULD DETERMINE THE ALP BY APPLYING THE BERRY RATIO. VII) THE CONCEPT THAT THE AES WILL NOT ABSORB THE LOSSES BUT ONLY ENJOY THE GAINS IS NOT ACCEPTABLE AND THEREFORE, TH E PRINCIPLE OF DETERMINING THE ALP COMES INTO FORCE. IX) THE BERRY RATIO IS AN ACCEPTABLE METHOD WHILE CONSIDERING THE PROVISIONS OF THE ACT BECAUSE IT IS A PLI UNDER TNM METHOD. UNDER TNM METHOD DIFFERENT PLI IS ADOPTED I.E. OP/OC, OP/ OI, OP/ASSETS, OP/VAE ETC. THEREFORE, THE ASSESSEES OBJECTION THA T THE BERRY RATIO IS NOT A RECOGNIZED METHOD UNDER THE PROVISIONS OF THE ACT, IS NOT ACCEPTABLE. X) THE ARGUMENT OF THE ASSESSEE COMPANY WAS THAT T HE ASSESSEE HOLDS THE TITLE OF THE GOODS PURCHASED AND THEREFOR E BERRY RATIO CANNOT BE APPLIED BECAUSE FOR APPLYING BERRY RATIO THE ASSESSEE ITA NO.441/MDS/2015 11 SHOULD HOLD ONLY FLASH TITLE AS HELD IN THE CASE OF DUPONT. THIS ARGUMENT IS NOT ACCEPTABLE BECAUSE THE TRANSACTING PARTIES ARE RELATED PARTIES AND THEREFORE THE TITLE OF PROPERTY IS IMMATERIAL AND IRRELEVANT. XI) AN INDEPENDENT LIMITED RISK DISTRIBUTOR WILL N OT INCUR SUCH HUGE EXPENSES KNOWING VERY WELL THAT IT WOULD RESULT INT O LOSS. THEREFORE, THE PRICE CHARGED BY THE AE IS NOT AN ARMS LENGTH. XII) THE FINAL DECISION REGARDING PRICING LIES WIT H THE PARENT COMPANY; THEREFORE KNOWINGLY THE ASSESSEE COMPANY IS MADE TO INCUR LOSSES WHILE AS THE AE COMPANIES ABSORBED THE PROFITS. XIII) THE ASSESSEE COMPANY WAS INCORPORATED ONLY T O CATER TO THE NEEDS OF THE AE TO DISTRIBUTE THE PRODUCTS MANUFACT URED BY THE AE. THEREFORE, THE AGGREGATE PROFIT HAS TO BE SHARED BY BOTH THE ASSESSEE COMPANY AND THE AES CONSIDERING THE ALP. XIV) DURING THE RELEVANT ASSESSMENT YEAR, THE ASSE SSEE COMPANY HAD CLAIMED WARRANTY EXPENSES TO THE TUNE OF RS.28, 60,589/- IN ITS P&L A/C WHICH SHOWS THAT THE ASSESSEE COMPANY HAD A SSUMED THE RISK OF PROVIDING WARRANTY. ITA NO.441/MDS/2015 12 5.3 THE LD. A.R. HAD OBJECTED TO THE BERRY RATIO A S PLI BEFORE THE REVENUE BECAUSE OF THE FOLLOWING REASONS:- I) ON PLAIN READING OF THE SECTION-92C OF THE ACT, THE BERRY RATIO IS NOT A METHOD PRESCRIBED UNDER THE ACT FOR DETERMINI NG PLI. II) THE ACTIVITY OF THE ASSESSEE IS TO BUY FINISHED GOODS FROM ITS AES AND RESALE THE SAME TO THE THIRD PARTY IN INDIA WIT HOUT ANY VALUE ADDITION TO THE PRODUCTS, THUS UNDERTAKING A LIMITE D RISK. THEREFORE, RPM WILL BE MORE SUITABLE. III) DURING THE RELEVANT FINANCIAL YEAR, IT WAS A BEGINNING PHASE OF THE BUSINESS; THEREFORE THE ASSESSEE HAD TO INCUR HUGE EXPENDITURE WHICH WOULD NOT BE A REGULAR FEATURE. IV) THE ASSESSEE NEITHER BEARS ANY SIGNIFICANT RISK NOR DEPLOYS SIGNIFICANT ASSETS OTHER THAN THE ROUTINE TANGIBLE ASSETS FOR THE PURPOSE OF CARRYING OUT ITS DISTRIBUTION ACTIVITIES . THUS, THE FUNCTION OF THE ASSESSEE COMPANY IS VERY LIMITED TO BUYING AND SELLING OF THE AES PRODUCTS. V) THE MARKETING RESEARCH ACTIVITIES UNDERTAKEN BY THE ASSESSEE IS A SEPARATE ACTIVITY AND IS NOT RELATED TO THE DISTRIB UTION ACTIVITY OF THE ASSESSEE ITA NO.441/MDS/2015 13 5.4. ON APPEAL, THE LD. DRP AGREED WITH THE VIEW O F THE TPO THAT RP METHOD IS NOT THE MOST APPROPRIATE METHOD FOR AR RIVING AT THE ALP BY OBSERVING AS UNDER:- FOR ADOPTING THE RPM AS MOST APPROPRIATE METHOD TH E OECD GUIDELINES DESCRIBED AS THE RESALE PRICE METHOD BEGINS WITH T HE PRICE AT WHICH A PRODUCT THAT HAS BEEN PURCHASED FROM AN ASSOCIATED ENTERPRISE IS RESOLD TO AN INDEPENDENT ENTERPRISE. THIS PRICE (THE RESALE PRICE) IS THEN REDUCED BY AN APPROPRIATE GROSS MARGIN ON THIS PRICE (THE RES ALE PRICE MARGIN) REPRESENTING THE AMOUNT OUT OF WHICH THE RESELLER W OULD SEEK TO COVER ITS SELLING AND OTHER OPERATING EXPENSES AND, IN THE LI GHT OF THE FUNCTIONS PERFORMED (TAKING INTO ACCOUNT ASSETS USED AND RISK S ASSUMED), MAKE AN APPROPRIATE PROFIT. WHAT IS LEFT AFTER SUBTRACTING THE GROSS MARGIN CAN BE REGARDED, AFTER ADJUSTMENT FOR OTHER COSTS ASSOCIAT ED WITH THE PURCHASE OF THE PRODUCT (E.G. CUSTOM DUTIES), AS AN ARMS LENGT H PRICE FOR THE ORIGINAL TRANSFER OF PROPERTY BETWEEN THE ASSOCIATED ENTERPR ISES. THIS METHOD IS PROBABLY MOST USEFUL WHERE IT IS APPLIED TO MARKETI NG OPERATIONS. CONSIDERING THE FACTS AND CIRCUMSTANCES OF THE CA SES THE PANEL FINDS THAT THE TPO HAS RIGHTLY REJECTED THE RPM AS MAM AD OPTED BY THE ASSESSEE. THE RPM IS MOSTLY ADOPTED TO SELLING AND DISTRIBUTION OPERATIONS WHEREIN THE RESELLER/DISTRIBUTOR DOES NOT ADD ANY S UBSTANTIAL VALUE TOT EH PRODUCT THROUGH USE OF TANGIBLE AND INTANGIBLE PROP ERTY. THE COMPANY ACCEPTED THE FACT THAT IT IS LIMITED RISK DISTRIBUT OR WHICH IS ENTITLED TO THE MARGINS BASED ON THE CASE INCURRED BY THEM WHICH HO WEVER HAS NOT ACTUALLY BEEN REFLECTED IN THIS CASE. HENCE, WE REJ ECT THE OBJECTIONS OF THE ASSESSEE AND UPHOLD THE ACTION OF THE TPO. ITA NO.441/MDS/2015 14 AFTER FURTHER ANALYZING THE ISSUE, THE LD. DRP ONCE AGAIN AGREED WITH THE VIEW OF THE LD. TPO THAT THE BERRY RATIO WOULD BE THE MOST APPROPRIATE METHOD IN THE CASE OF THE ASSESSEE TO D ETERMINE THE ALP. THE RELEVANT PORTION OF THE ORDER IS REPRODUCE D HEREIN BELOW FOR REFERENCE:- BEFORE GOING INTO THE ARGUMENTS, IT IS NECESSARY T O ANALYSE THE DEFINITION OF BERRY RATIO. AS THE SAME HAD NOT BEEN DEFINED IN TH E DOMESTIC LAW, IT IS NECESSARY TO SEE THE OTHER GUIDELINES. PARA 2.100 O F OECD GUIDELINES DEFINES THE BERRY RATIO AS: BERRY RATIOS ARE DEFINED AS R ATIO OF GROSS PROFIT TO OPERATING EXPENDITURES. INTEREST AND EXTRANEOUS INCOME ARE GE NERALLY EXCLUDED FROM THE GROSS PROFIT DETERMINATION; DEPRECIATION AND AMORTI ZATION MAY OR MAY NOT BE INCLUDED IN THE OPERATING EXPENSES, DEPENDING IN PA RTICULAR ON THE POSSIBLE UNCERTAIN THEY CAN CREATE IN RELATION TO VALUATION AND COMPARABILITY. THIS PANEL UPHOLDS THE ACTION OF THE TPO AS HE HA S TAKEN UNIFORM STAND WHILE COMPUTING THE OPERATING/VALUE ADDED EXPENSES IN THE CASE OF ASSESSEE AND COMPARABLE COMPANIES. THIS PANEL FINDS THAT THE CONTENTION OF THE ASSESSEE IN RESPECT TO VALUE ADDED COST I.E, THAT ONLY ADVER TISEMENT, MARKETING AND PROMOTION EXPENSES ARE TO BE CONSIDERED AS VALUE AD DED EXPENSES AND OTHER EXPENSES SUCH AS EMPLOYEE COST, GENERAL & ADMINISTR ATION, SELLING & DISTRIBUTION AND DEPRECIATION SHOULD NOT BE CONSIDERED AS VALUE ADDED EXPENSES, HAS NO FORCE AS THE DEFINITION OF BERRY RATIO CLEARLY DEFI NES THAT ALL THE OPERATING COST / VALUE ADDED COST SHOULD BE CONSIDERED. THE ASSESSEE HAS NOT BROUGHT OUT ANY COGENT REASONS AS TO WHY ONLY ADVERTISEMENT, MARKET ING AND PROMOTION EXPENSES SHOULD BE CONSIDERED AS OPERATING EXPENSES . THIS PANEL ALSO DECLINE TO ACCEPT THE CONTENTION THAT ABNORMAL ADJUSTMENT W AS MADE BY THE TPO AS THE QUANTUM OF ADJUSTMENT WAS THE RESULT OF FAR ANALYSI S. ITA NO.441/MDS/2015 15 COMING TO THE NEXT POINT, AS TO WHETHER BERRY RATIO IS TO BE ADOPTED OR NOT, THE FOLLOWING IMPORTANT FACTORS HAVE TO BE CONSIDERED: - WHETHER THE ASSESSEE COMPANY IS ENGAGED IN DISTRI BUTION ACTIVITY WITH A LIMITED RISK. THE MAIN ISSUE IN THIS CASE IS ADJUDICATION ON THE QUESTION WHETHER ...(THE ASSESSEE ).. IS BEING ADEQUATELY COMPENSATED FOR T HE FUNCTIONS PERFORMED. UNLIKE IN INDIAN TP REGULATION, WHEREIN NO SPECIFIC RATIOS ARE PRESCRIBED, US REGULATION 482-5(B)(II)(4)(B) ACCEPTS THIS PLI A S ONE OF THE FINANCIAL RATIOS THAT MAY BE APPROPRIATE TO MEASURE THE ARMS LENGT H PRICE. SO FAR AS INDIAN TP PROVISIONS ARE CONCERNED, THE PLIS SET OUT IN RULE 10B(1)(E)(I) ARE ONLY ILLUSTRATIVE IN AS MUCH AS IT ENDS WITH THE EXPRESSION OR HAVING REGARD TO ANY OTHER RELEVANT BASE BUT THERE IS NO PROHIBITION AS SUCH ON THE USE OF THIS RATIO. HOWEVER, HAVING REGARD TO THE USE OF THIS RATIO WOR LDWIDE, AND FOR THE REASONS WE WILL SET OUT IN DETAIL IN A SHORT WHILE, THE USE OF THIS RATIO CANNOT BE ELIMINATED FROM THE INDIAN TRANSFER PRICING PRACTICES ALTOGETH ER. IN THE JULY 2010 VERSION OF OECD TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX ADMINISTRATIONS, BERRY RATIO IS SPECIFICALLY RECOGNIZED AS FOLLOWS: BERRY RATIOS ARE DEFINED AS RATIOS OF GROSS PROFI T TO OPERATING EXPENSES. INTEREST AND EXTRANEOUS INCOME ARE GENERALLY EXCLUD ED FROM THE GROSS PROFIT DETERMINATION; DEPRECIATION AND AMORTIZATION MAY OR MAY NOT BE INCLUDED IN THE OPERATING EXPENSES, DEPENDING IN PA RTICULAR ON THE POSSIBLE UNCERTAINTIES THEY CAN CREATE IN RELATION TO VALUAT ION AND COMPARABILITY. IN ORDER FOR A BERRY RATIO TO BE APPROPRIATE TO TES T THE REMUNERATION OF A CONTROLLED TRANSACTION (E.G. CONSISTING IN THE DIST RIBUTION OF PRODUCTS), IT IS NECESSARY THAT: THE VALUE OF THE FUNCTIONS PERFORMED IN THE CONTR OLLED TRANSACTION (TAKING ACCOUNT OF ASSETS USED AND RISKS ASSUMED) IS PROPOR TIONAL TO THE OPERATING EXPENSES. ITA NO.441/MDS/2015 16 THE VALUE OF THE FUNCTIONS PERFORMED IN THE CONTR OLLED TRANSACTION (TAKING ACCOUNT OF ASSETS USED AND RISKS ASSUMED) IS NOT MA TERIALLY AFFECTED BY THE VALUE OF THE PRODUCTS DISTRIBUTED, I.E. IT IS NOT P ROPORTIONAL TO SALES, AND THE TAXPAYER DOES NOT PERFORM, IN THE CONTROLLED TRANSACTIONS, ANY OTHER SIGNIFICANT FUNCTION (E.G. MANUFACTURING FUNCTION) THAT SHOULD BE REMUNERATED USING ANOTHER METHOD OR FINANCIAL INDIC ATOR. AS EVIDENT FROM THE OECD APPROACH, BERRY RATIO CAN BE PARTICULARLY USEFUL IN THE SITUATIONS IN WHICH THE ENTITY IS ENGAGED IN THE BU SINESS AS A TRADE, THE VALUE OF SERVICES PERFORMED BY THE ENTITY IS ADEQUATELY REFL ECTED BY OPERATING EXPENSES, THE VALUE OF FUNCTIONS PERFORMED AND ASSETS EMPLOYE D IN THE CONTROLLED TRANSACTIONS IS NOT PROPORTIONATE TO SALES AND WHEN THE ENTITY DOES NOT PERFORM ANY SIGNIFICANT OPERATIONS SUCH AS MANUFACTURING OR PROCESSING. TYPICALLY, A LOW RISK HIGH VOLUME TRADING BUSINESS INVOLVING BACK TO BACK TRADING WITHOUT ANY VALUE ADDITION TO THE GOODS TRADED, WHICH IS WHAT A E IS ENGAGED IN AND THE ASSESSEE IS CONTRIBUTING TO, SATISFIES ALL THESE TE STS. WE ARE IN AGREEMENT WITH THE APPROACH ADOPTED BY THE OECD DOCUMENT IN THIS REGAR D. GOING BY THIS APPROACH, AND, APPLYING THE TESTS LAID DOWN ABOVE, IT DOES INDEED SEEM THAT BERRY RATIO COULD BE APPROPRIATE IN THE PRESENT CAS E. BERRY RATIO IS INCREASINGLY FINDING SPECIFIC ACCE PTANCE IN MANY JURISDICTIONS. WHILE IT IS USE IN US FOR LONG, IN J APAN, EVEN AS BERRY RATIO WAS USED IN APAS EARLIER AS WELL, THE 2013 AMENDMENT TO THE TRANSFER PRICING REGULATIONS, WITH EFFECT FROM 1ST APRIL 2013, NOW S PECIFICALLY LIST BERRY RATIO AS ACCEPTABLE IN APPROPRIATE CASES. IN INDIA, THERE HA VE BEEN SEVERAL RECENT JUDICIAL PRECEDENTS, UPHOLDING THE USE OF BERRY RATIO AS A P LI. THE ANSWER TO THE FUNDAMENTAL QUESTION OF WHETHER A TAXPAYER SHOULD BE ENTITLED TO A RETURN ON THE VALUE OF GOODS HANDLED BY IT, WOULD ACTUALLY DEPEND ON THE FUNCTIONS PERFORMED AND THE RELATED RISKS BORNE BY IT, WITH RESPECT TO THE GOODS. WHAT BERRY RATIO THUS SEEKS TO EXAMINE IS TH E RELATIONSHIP OF THE OPERATING COSTS WITH THE OPERATING PROFITS. IT THUS PROCEEDS ON THE BASIS THAT THERE ITA NO.441/MDS/2015 17 IS A CAUSE AND EFFECT RELATIONSHIP BETWEEN OPERATIN G COSTS AND THE OPERATING PROFITS. IN THIS SCENARIO IT IS NECESSARY TO CONSIDER THAT IF AN INDEPENDENT DISTRIBUTOR WOULD DO ALL SUCH MARKETING SUPPORT/BRA ND PROMOTION! DISTRIBUTION FUNCTIONS ON BEHALF OF PRINCIPLE, HE WOULD HAVE DEF INITELY CLAIMED HIS TOTAL COST ALONG WITH SUITABLE MARK-UP ON IT. CONSIDERING THIS FACT, THE ADDITIONAL SUBMISSIONS SUBMITTED BY THE ASSESSEE AND THE REPLY OF THE TPO ON THE SUBMISSIONS MADE BY THE ASSESSEE, THIS PANEL UPHOLD TNMM AND THE USE OF BERRY RATIO (RETURN ON VALUE ADDED EXPENSES) AS AN APPROPRIATE PLI IN THE PRESENT CASE. 5.5 BEFORE US, THE LD. A.R. MADE THE FOLLOWING SUB MISSIONS:- I) BERRY RATIO IS NOT A PRESCRIBED METHOD U/S.92C OF THE ACT FOR THE DETERMINATION OF THE ALP. MOREOVER, BERRY RATIO CA NNOT BE APPLIED AS PLI UNDER CPM AS PER RULE 10B (1)(C) OF THE RULE S WHICH PRESCRIBES GROSS PROFIT TO DIRECT AND INDIRECT COST OF PRODUCTION AS PLI UNDER CPM. II) RESALE PRICE METHOD IS THE MOST APPROPRIATE ME THOD CONSIDERING THE FACT THAT THE ASSESSEE BUYS FROM THE RELATED PA RTIES AND SALE TO UNRELATED PARTIES. III) NO VALUE ADDED ACTIVITIES UNDERTAKEN BY THE AS SESSEE BUT ONLY ROUTINE OPERATIONS OF THE COST OF THE INCOME. ITA NO.441/MDS/2015 18 IV) THE ASSESSEE HAD INCURRED LOSS ON ACCOUNT START -UP PHASE AND NOT DUE TO PRICING OF THE PURCHASES FROM THE AES. V) MARKET RESEARCH ACTIVITIES HAVE BEEN SEPARATELY COMPENSATED FOR BY THE AES. VI) FILTERS ADOPTED BY THE TPO IS INCORRECT AND NO T COMPARABLE TO THE CASE OF THE ASSESSEE. VII) PROPER SEGMENTAL ACCOUNTING WAS MADE BY THE AS SESSEE WITH RESPECT TO MARKET RESEARCH AND DISTRIBUTION ACTIVIT IES. VIII) THE ASSESSEE HAD ONLY ESTABLISHED A DEALER N ETWORK FOR SELLING THE PRODUCTS PROCURED FROM THE AES DIRECTLY TO THE END CUSTOMERS AND THEREFORE THERE WAS NO VALUE ADDITION MADE TO THE P RODUCTS OF THE AES. IX) THE MARKET RESEARCH ACTIVITIES CONDUCTED BY TH E ASSESSEE WERE RESTRICTED TO DATA COLLECTION FROM THE POTENTIAL CU STOMERS OF THE ASSESSEE AND THE SAME WAS DEALT AS SEPARATE BUSINES S SEGMENT FROM WHICH THE ASSESSEE WAS REMUNERATED SEPARATELY. X) THE WARRANTY EXPENSE WAS BORNE BY THE AES AND N OT BY THE ASSESSEE. ITA NO.441/MDS/2015 19 XI) BUSINESS PROMOTION EXPENSES INCURRED BY THE AS SESSEE WAS ROUTINE IN NATURE SUCH AS TRADE FAIR/EXHIBITIONS/RO AD-SHOWS/PROMOTION OF PRODUCTS, DEALERS MEETING AND TRAVELS COST AND T HEREFORE THESE EXPENSES CANNOT BE TREATED AS VALUE ADDED ACTIVITIE S. XIII) PRICING DECISIONS WERE TAKEN BY THE ASSESSEE AND NOT BY THE AES. XIV) SINCE THE AES AND THE ASSESSEE COMPANY WERE I NDEPENDENT PARTIES AND THEY HAVE ACTED IN THE CAPACITY OF JOIN T VENTURE PARTNERS, THE TRANSACTION BETWEEN THEM ARE NOT MADE WITH COLL USION BUT AS PER ALP. 5.6 LD. D.R ON THE OTHER HAND RELIED ON THE ORDERS OF THE REVENUE AND ARGUED IN SUPPORT OF THE SAME. 5.7 WE HAVE HEARD BOTH THE PARTIES AND CAREFULLY P ERUSED THE MATERIALS AVAILABLE ON RECORD. CONSIDERING THE FAC TS OF THE CASE WE ARE IN TOTAL AGREEMENT WITH THE VIEW OF THE REVENUE ON THE ISSUE OF ACCEPTING BERRY RATIO AS THE MOST APPROPRIATE METHO D FOR DETERMINING THE ALP IN THE CASE OF THE ASSESSEE BECAUSE OF THE FOLLOWING REASONS:- ITA NO.441/MDS/2015 20 I) IT IS UNDISPUTED FACT THAT THE ASSESSEE HAS INC URRED HUGE EXPENSES ON ACCOUNT OF ADVERTISEMENT, SUPPLY CHAIN INTANGIBL ES, MARKETING AND BUSINESS PROMOTION WHICH IS OUT OF PROPORTION C ONSIDERING THE PROFIT EARNED BY THE ASSESSEE. II) IT CAN ALSO NOT BE DISPUTED THAT THE ASSESSEE COMPANY WAS BROUGHT INTO EXISTENCE BY ITS AES FOR THE ONLY PURP OSE OF MARKETING THE PRODUCT OF THE AES IN INDIA BECAUSE. IT SHOULD BE TAKEN NOTE OF THAT THE ENTIRE SHARE OF THE ASSESSEE COMPANY ARE HELD BY BOTH THE AES MS/.KUBOTA AGRICULTURAL MACHIN ERY INDIA PVT LTD., JAPAN AND M/S.SUMITOMO CORPORATION, JAPAN, 6 0% & 40% RESPECTIVELY. THEREFORE, BY LIFTING THE CORPORATE V EIL OF THE ASSESSEE COMPANY IT IS APPARENT THAT ALL THE PARTIE S ARE CLOSELY INTER-RELATED AND THEREBY HAS ENORMOUS INFLUENCE IN THEIR RESPECTIVE FUNCTIONING. III) IN SUCH CIRCUMSTANCES, IT IS OBVIOUS THAT THE AES WOULD BE MAINLY INTERESTED TO ABSORB MAXIMUM PROFIT LEAVING OVER EI THER NIL OR MINIMAL PROFIT TO THE ASSESSEE COMPANY. IV) FURTHER IT IS APPARENT THAT THE ASSESSEE COMPAN Y HAS BEEN AGGRESSIVELY ADVERTISING AND INDULGING MARKET PROMO TION ACTIVITIES ITA NO.441/MDS/2015 21 ETC., IN ORDER TO POPULARIZE THE PRODUCTS OF THE AE S. THE LD. A.R REFERS THIS PHENOMENAL TO BE EXPENSES RELATED TO SE TUP OF THE BUSINESS. AS OPINED BY THE REVENUE, THE FRUITS BEA RING OUT OF THESE EXPENSES WILL BE ENJOYED BY THE ASSESSEES AE S BECAUSE THEIR BRAND VALUE AND MARKETABILITY OF THEIR PRODUC TS WILL INCREASE. RESULTANTLY IN THE LONG RUN, THE ASSESSEE ALSO WILL BE ABLE TO ENJOY PROFIT AS A CONSEQUENCE TO THE GOODWILL EARNED BY T HE ASSESSEES AES. V) IN THESE CIRCUMSTANCES THE CONTENTION OF THE RE VENUE THAT THE ASSESSEE IS INDULGING IN VALUE ADDED SERVICE TO ITS AES ALONG WITH DISTRIBUTION ACTIVITIES IS UNQUESTIONABLE. VI) THE BERRY RATIO IS THE RATIO OF GROSS PROFIT T O OPERATING EXPENSES AND IS NAMED AFTER AMERICAN ECONOMIST PROFESSOR CHA RLES BERRY, WHO FIRST APPLIED IN THE TRANSFER PRICING COURT CAS E E.I DU PONT DE NEMOURS & CO. V. U.S.,608 F.2D 445(CT.CL.1979). THE DU PONT CASE INVOLVED A DISTRIBUTOR WHICH ALSO PERFORMED RE LATED MARKETING SERVICES. WHEN EVALUATING THE PERFORMANCE OF THE DISTRIBUTIONS, PROFESSOR BERRY COMPARED THE RATIO O F GROSS PROFIT TO OPERATING EXPENSES TO THIRD PARTY COMPARABLE COMPAN IES RATIOS OF ITA NO.441/MDS/2015 22 GROSS PROFITS (LESS UNRELATED OTHER INCOME) TO OPER ATING COSTS (EXCLUDING INTEREST AND DEPRECIATION). IN THIS WAY , PROFESSOR BERRY WAS ABLE TO EVALUATE THE RETURN THE DU POINT DISTRI BUTOR EARNED ON ITS PURELY VALUE ADDING DISTRIBUTION ACTIVITIES, TH OUGH WITH AN IMPORTANT UNDERLYING ASSUMPTION THAT THE COST OF TH ESE ACTIVITIES WERE FULLY CAPTURED IN THE DISTRIBUTORS OPERATING EXPENSES. THE BERRY RATIO HAS BEEN RECOGNIZED IN THE U.S TRANSFER PRICING REGULATIONS SINCE THE EARLY 1990S. GENERALLY, THE B ERRY RATIO SHOULD ONLY BE USED TO TEST THE PROFITS OF LIMITED RISK DISTRIBUTORS OR SERVICE PROVIDERS THAT DO NOT OWN OR USE ANY INTANG IBLE ASSETS. THIS IS BECAUSE THE RELIABILITY OF THE BERRY RATIO DEPENDS UPON THE EXISTENCE OF A RELATIONSHIP BETWEEN GROSS PROFITS A ND OPERATING EXPENSES. CHAPTER 2 OF THE OECD GUIDELINES GIVES THE EXAMP LE OF INTERMEDIARY ACTIVITIES WHERE A TAXPAYER PURCHASES GOODS FROM AN AE AND ON-SELLS THOSE GOODS TO OTHER AES AN EXAMPLE OF WHERE THE BERRY RATIO MAY BE USEFULLY APPLIED. IN SUCH CA SES, BOTH SALES AND COSTS OF GOODS MAY BE CONTROLLED TRANSACTIONS L EAVING OPERATING EXPENSES AS THE ONLY REASONABLY INDEPENDE NT ITA NO.441/MDS/2015 23 ACCOUNTING LINE ITEM FROM WHICH TO BASE A TRANSFER PRICING METHODS (SUBJECT OF COURSE TO THE PRESENCE OF OTHER CONTROLLED TRANSACTIONS WITHIN OPERATING EXPENSES SUCH AS MANA GEMENT SERVICE CHARGES OR ROYALTIES). THE BERRY RATIO CAN ALSO BE USEFUL WHEN APPLIED TO LIMITED RISK DISTRIBUTION OF HIGH V OLUME/LOW MARGIN PRODUCTS AS IN THE CASE OF THE ASSESSEE. VII) BERRY RATIO IS ACCEPTED AS A PERMISSIBLE TOOL FOR DETERMINING ALP BY THE TRIBUNAL IN THE CASE MITISUBISHI IN ITA NO.5 042/DEL./2011. IT WAS HELD IN THE CASE THAT IN A SITUATION WERE SI GNIFICANT FUNCTIONS AND RISKS PERTAINING TO INVENTORIES WERE NOT UNDERT AKEN, THE COST OF INVENTORY BECOME IRRELEVANT AND ONLY THE VALUE A DDED EXPENSES NEEDED TO BE CONSIDERED IN THE COST BASE D FOR COMPUTING THE PLI. IT WAS FURTHER HELD THAT BERRY R ATIO WILL BE SUITABLE IN A SITUATION WHERE CURRENT ASSETS ARE NO T SIGNIFICANT. BERRY RATIO IS ALSO SIGNIFICANT BECAUSE THE FUNDAME NTAL OF TRANSFER PRICING WITH RESPECT TO ALP IS THAT THE REMUNERATIO N SHOULD BE CONSISTED WITH THE FUNCTIONS PERFORMED, RISKS ASSUM ED AND ASSETS EMPLOYED. ITA NO.441/MDS/2015 24 VIII) SINCE THE TRIBUNAL ON SEVERAL OCCASIONS HAS A CCEPTED THE BERRY RATIO, THE CONTENTION OF THE LD. A.R. THAT THE SAME CANNOT BE APPLIED AS PER RULE 10B(1C) OF THE RULES, IS NOT AC CEPTABLE. IX) IN THE CASE OF THE ASSESSEE COMPANY IT WAS NOT A ROUTINE PURCHASE AND SALE TRANSACTIONS BUT IMMENSE ACTIVITI ES WERE PERFORMED IN ORDER TO BRING AWARENESS OF THE EXISTE NCE OF THE AES PRODUCTS AND THE AE. THEREFORE, THE CONTENTIO N OF THE LD. A.R. THAT RESALE PRICE METHOD IS MOST APPROPRIATE M ETHOD CANNOT BE ACCEPTED. X) THE ARGUMENT OF THE LD. A.R. THAT NO VALUE ADDE D ACTIVITIES IS UNDERTAKEN BY THE ASSESSEE IS NOT JUSTIFIED BECAUSE THE ASSESSEE HAS BEEN ADVERTISING THE PRODUCTS OF AES EXTENSIVEL Y AND INDULGING IN MARKET PROMOTIONAL ACTIVITIES AND ESTA BLISHING SUPPLY CHAIN INTANGIBLE ETC., THE BENEFIT OF WHICH IS DIRE CTLY ENJOYED BY THE AES WITHOUT PRODUCING ANY SIGNIFICANT PROFIT TO THE ASSESSEE FOR THE RELEVANT ASSESSMENT YEAR. XI) THE ARGUMENT OF THE LD. A.R. THAT THE ASSESS EE HAD INCURRED LOSS ON ACCOUNT OF START-UP PHASE IS ALSO NOT APPRE CIABLE BECAUSE ITA NO.441/MDS/2015 25 THE EXPENSES INCURRED BY THE ASSESSEE IS ABNORMAL C OMPARED WITH A NORMAL START-UP PHASE. XII) MARKET RESEARCH ACTIVITIES PERFORMED BY THE A SSESSEE COMPANY IS INTER LINKED WITH THE DISTRIBUTION ACTIVITIES OF TH E ASSESSEE COMPANY AND INSEPARABLE. FURTHER, WE ALSO FIND THAT PROPER SEGMENTAL ACCOUNTING IS ALSO NOT CARRIED OUT BY THE ASSESSEE. XIII) IT IS PERTINENT TO MENTION THAT THE ASSESSEE COMPANY NOT ONLY ESTABLISHED A DEALER NETWORK FOR SELLING THE PRODUC TS OF THE AES TO THE END CUSTOMERS BUT ALSO MADE TREMENDOUS AWARENES S OF THE EXISTENCE OF THE ASSESSEES AES AND THEIR PRODUCTS IN THE INDIAN MARKETS. XIV) EVEN IF THE WARRANTY EXPENSES WERE BORNE BY T HE ASSESSEES AES, CONSIDERING THE OTHER FUNCTIONS PERFORMED BY T HE ASSESSEE COMPANY THE BERRY RATIO WOULD BE THE MOST APPROPRIA TE METHOD IN DETERMINING THE ALP IN THE CASE OF THE ASSESSEE COM PANY. XV) THE ABNORMAL EXPENSES INCURRED BY THE ASSESSEE COMPANY DURING THE RELEVANT ASSESSMENT YEAR CANNOT BE CONSI DERED AS THE ROUTINE EXPENSES OF THE ASSESSEE FOR ITS ROLE AS DI STRIBUTOR. ITA NO.441/MDS/2015 26 XVI) THE OTHER ARGUMENT OF THE LD. A.R. THAT THE PR ICING DECISION WAS MADE BY THE ASSESSEE AND NOT BY THE AES SINCE BOTH THE PARTIES ARE INDEPENDENT IS ALSO NOT ACCEPTABLE BECAUSE THE STRUCTURE OF THE ASSESSEE FIRM IS SUCH THAT THE AES HAS A TREMEN DOUS INFLUENCE IN THE FUNCTIONING OF THE ASSESSEE COMPAN Y AS THE ENTIRE SHARES OF THE ASSESSEE COMPANY ARE HELD BY THE AES. XVII) FURTHER, TO AVOID FURTHER REPETITION WE HEREB Y AFFIRM THAT WE ARE IN AGREEMENT WITH THE REASONING DISCUSSED BY THE REVE NUE IN THE RESPECTIVE ORDERS WHICH WE HAVE CONCISED HEREIN ABO VE. WE ALSO MAKE IT CLEAR THAT SINCE THE ASSESSEE HAD INCURRED ABNORMAL EXPENSES FOR SPECIFIC ACTIVITIES CONDUCTED BY THE A SSESSEE FOR THE PREDOMINANT BENEFIT OF THE ASSESSEES AES, THE DECI SIONS CITED BY THE LD. A.R. ARE REJECTED BECAUSE IN THOSE CASES ON LY ROUTINE EXPENSES WERE INCURRED UNLIKE THE CASE OF THE ASSES SEE. 6.1. GROUND NO.(VIII):- NOT PROVIDING ADJUSTMENTS ON ACCOUNT OF DIFFERENCES IN WORKING CAPITAL :- THE GRIEVANCE OF THE ASSESSEE IS THAT TH E LD. TPO HAS NOT PROVIDED WORKING CAPITAL ADJUSTMENTS WHICH MATE RIALLY AFFECT THE ITA NO.441/MDS/2015 27 PROFIT OF THE ASSESSEE. THE LD. DRP AGREED WITH TH E VIEW THAT ADJUSTMENTS HAS TO BE GRANTED FOR ELIMINATING MATER IAL EFFECTS, IF ANY, ARISING OUT DIFFERENCE IN WORKING CAPITAL BETWEEN T HE TESTED PARTY AND COMPARABLES. IT WAS THE CONTENTION OF THE ASSESSEE THAT IT WAS HAVING NEGATIVE WORKING CAPITAL AS AGAINST SUBSTANTIAL POS ITIVE WORKING CAPITAL ENJOYED BY THE COMPARABLES. LD. DRP OBSERVE D THAT THE ASSESSEE HAS NOT DEMONSTRATED AS TO HOW THE NEGATIV E WORKING CAPITAL OF THE ASSESSEE HAS AFFECTED ITS MARGIN. SI NCE THE ASSESSEE WAS NOT ABLE TO JUSTIFY THE ADJUSTMENTS THAT WERE R EQUIRED TO BE MADE ON ACCOUNT OF NEGATIVE WORKING CAPITAL THE LD. DRP DID NOT GIVE EFFECT TO WORKING CAPITAL ADJUSTMENTS. BEFORE US ALSO THE LD. A.R WAS NOT ABLE TO JUSTIFY ITS STAND ON WORKING CAPITAL ADJUST MENTS IN THE CASE OF THE ASSESSEE WITH ANY TANGIBLE MATERIALS ON RECORD. THEREFORE, WE DO NOT HAVE ANY OTHER OPTION BUT TO REJECT THE CLAIM O F THE ASSESSEE. IT IS ORDERED ACCORDINGLY. ITA NO.441/MDS/2015 28 7.1 GROUND NO.(IX):- ADJUSTMENTS ON ACCOUNT OF FOR EIGN EXCHANGE FLUCTUATIONS:- THE LD. DRP WAS OF THE VIEW THAT THE QUANTUM OF D ERIVATIVE LOSSES/GAINS IS INDEPENDENT TO THE EXTENT OF THE SE RVICES RENDERED AND IS DETERMINED ENTIRELY OUTSIDE THE PARAMETERS O F THE SERVICE PROVIDERS ACTUAL BUSINESS. THE LD. DRP FURTHER OB SERVED THAT AS FAR AS THE ADJUSTMENT ON ACCOUNT OF FOREIGN EXCHANGE FL UCTUATIONS, THE ASSESSEE CLAIMED THAT THE FOREIGN EXCHANGE FLUCTUAT IONS WHICH ARE INBUILT IN THE PURCHASE FROM AES TO ARRIVE AT THE M ARGIN OF THE ASSESSEE. THE LD.DRP FURTHER OPINED THAT THE ESSEN CE OF TRANSFER PRICING IS IN THE ARMS LENGTH PRINCIPLE WHICH REQU IRES THE DETERMINATION OF TRANSFER PRICES BETWEEN AES TO REF LECT TERMS IN A HYPOTHETICAL SCENARIO WHERE IT IS REQUIRED TO ASSUM E AS IF THE TRANSACTION TAKES PLACE BETWEEN TWO UNRELATED PARTI ES. UNDER THE BASIC PRINCIPLES OF CONTRACTING, THE COSTS WHICH WO ULD BE REIMBURSED WITH A MARKUP SHOULD BE ONES WHICH ARE CONTROLLABLE AND CAN BE MONITORED, I.E. AT THE TIME OF ENTERING INTO THE AG REEMENT. ANY COST THAT MAY ARISE OUT OF THE FUTURE UNCERTAIN MOVEMENT OF THE NOMINAL EXCHANGE RATE IS NOT PREDICTABLE AND HENCE NON-CONT RACTIBLE. HENCE IT ITA NO.441/MDS/2015 29 WAS UPHELD BY THE LD.DRP THAT THE ASSESSEE WILL NOT BE ELIGIBLE FOR ADJUSTMENTS ON ACCOUNT OF FOREIGN EXCHANGE FLUCTUAT IONS. BEFORE US, THE LD. A.R ARGUED BY STATING THAT ADJUSTMENTS ON A CCOUNT OF FOREIGN EXCHANGE FLUCTUATIONS HAS TO BE MADE IN THE CASE OF TRANSFER PRICING MATTERS WHICH IS ALSO RECOGNIZED BY ACCOUNTING STAN DARDS-11. HE SUBMITTED THAT THE FOREIGN EXCHANGE VARIATIONS AFFE CT THE PURCHASE PRICE OF THE ASSESSEE THOUGH NOT EXPLICITLY SHOWN I N THE P&L A/C BUT IS REFLECTED IN THE PURCHASE COST OF THE ASSESSEE A ND THAT AFFECTS THE PROFIT MARGIN OF THE ASSESSEE SUBSTANTIALLY. THE LD . A.R. ALSO RELIED IN THE DECISION IN THE CASE OF HONDA TRADING CORP. IND IA PVT. LTD VS. ACIT DELHI REPORTED IN 46 ITD 591 WHEREIN THE TRIBU NAL HAS HELD THAT NECESSARY ADJUSTMENTS PERTAINING TO THE HUGE AND AB NORMAL FLUCTUATION IN THE FOREIGN EXCHANGE MAY BE ALLOWED TO THE ASSESSEE IN DETERMINING THE ALP OF THE INTERNATIONAL TRANSACTIO N. AFTER HEARING BOTH THE PARTIES WE ARE OF THE CONSIDERED VIEW THAT SINCE THE TRIBUNAL ON THE EARLIER OCCASION HAS ALREADY RECOGNIZED ADJU STMENTS TOWARDS FOREIGN EXCHANGE FLUCTUATIONS, THE SAME RATIO HAS T O BE APPLIED IN THE CASE OF THE ASSESSEE. ACCORDINGLY, WE HEREBY DIRECT THE LD. ITA NO.441/MDS/2015 30 ASSESSING OFFICER TO MAKE ADJUSTMENTS ON ACCOUNT OF FOREIGN EXCHANGE FLUCTUATIONS IN THE CASE OF THE ASSESSEE. 8. IN THE RESULT, THE APPEAL OF ASSESSEE IS PARTLY ALLOWED. ORDER PRONOUNCED ON 11 TH DECEMBER, 2015 AT CHENNAI. SD/- SD/- ( . . . ) ( N.R.S.GANESAN ) ( . '#$ %' ) (A.MOHAN ALANKAMONY) JUDICIAL MEMBER ACCOUNTANT MEMBER CHENNAI, DATED 11 TH DECEMBER, 2015. K S SUNDARAM. & (,/0 1 0#, /COPY TO: 1. $% /APPELLANT 2. ()$% /RESPONDENT 3. * 2, ( ) /CIT(A) 4. * 2, /CIT 5. 05 (,6! /DR 6. ' 7+ /GF