ITO, New Delhi V. M/s. Federal Mogul Automotive Product (India) Pvt. Ltd., New Delhi

ITA 599/DEL/2012

• Counselvise Citation: [2017] 128 COUNSELVISE.COM (IT) 3163 (ITAT-DELHI)
• Duration Of Justice: 5 year(s) 3 month(s) 8 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 12-05-2017
• Appeal Filed By: Department
• Order Result: Partly Allowed
• Bench Allotted: I1
• Next Hearing Date: 15-06-2016
• Assessment Year: 2005-2006
• Appeal Filed On: 03-02-2012
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Assessee Lawyers: HIMANSHU SHEKHAR SINHA
• Keywords: Transfer pricing; International transaction; Wholly owned subsidiary
• Section: 92C; 92B; 92A; 92E; 10B; 11

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH I-1 NEW DELHI BEFORE SHRI N.K. SAINI, ACCOUNTANT MEMBER AND SHRI SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER ITA NO. 599/DEL/2012 AY: 20 05-06 ITO, VS FEDERAL MOGUL AUTOMOTIVE PRODUCT (INDI A) PVT.LTD., WARD 11(2), REVENUE-77A, GREATER KA ILASH-I, NEW DELHI. NEW DELHI-110048 (PAN: AAACF4128M) (APPELLANT) (RESPONDENT) APPELLANT BY : SHRI NEERAJ KUMAR, SR. DR RESPONDENT BY : SHRI HIMANSHU SHEKHAR SINHA, ADV. ORDER PER SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER THIS APPEAL HAS BEEN PREFERRED BY THE REVENUE AGAI NST THE ORDER OF LD. CIT(A)-XX, NEW DELHI DATED 23.12.2011 AND PE RTAINS TO AY 2005-06. 2.0 THE ASSESSEE COMPANY IS A 100% SUBSIDIARY OF FE DERAL MOGUL PTY. LTD, AUSTRALIA. FEDERAL MOGUL CORPORATION, USA IS THE PARENT COMPANY OF THE GROUP. THE ASSESSEE COMPANY IS ENGAG ED IN MANUFACTURING SPARK PLUGS AND ALSO UNDERTAKES MARKE TING AND DISTRIBUTION OF A RANGE OF OTHER PRODUCTS. 2.01 RETURN OF INCOME FOR A.Y 2005-06 WAS FILED B Y THE ASSESSEE COMPANY ON 30.10.2006 DECLARING INCOME OF RS NIL. T HE CASE WAS PROCESSED U/S 143(1) OF THE INCOME TAX ACT, 1961 ( THE ACT). I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 2 SUBSEQUENTLY, THE CASE WAS SELECTED FOR SCRUTINY AN D NOTICE U/S 143(2) OF THE ACT WAS ISSUED. 2.02 THE ASSESSEE COMPANY WAS DERIVING INCOME FROM ITS ASSOCIATE CONCERNS ABROAD AND DURING THE YEAR UNDER CONSIDERATION, IT HAD REPORTED INTERNATIONAL TRANSACTIONS AMOUNTIN G TO RS 13,85,70,706/-. THE ASSESSEE HAD ENTERED INTO THE F OLLOWING INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATED ENTE RPRISE (AE), IN THE ASSESSMENT YEAR UNDER CONSIDERATION: S. N. NATURE OF TRANSACTION METHOD USED BY ASSESSEC VALUE OF TRANSACTION METHOD PLI RECEIPT PAID 1. IMPORT OF RAW MATERIAL, COMPONENTS AND TOOLS TNMM OP/SALES - 81,481,084/- 2. EXPORT SEMIFINISHED & FINISHED GOODS CPM GP/COGS SALE VALUE 39,558,533/- - 3. PROVISION OF MARKETING SUPPORT SERVICES TNMM OP/SALES 16,501,326 /- 4. PROVISION FOR PROFESSIONAL SERVICES TNMM OP/SALES 1,029,763/- TOTAL VALUE OF INTERNATIONAL TRANSACTIONS: RS. 13,8 5,70,706/- 2.03 IN RESPECT OF THE INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE WITH ITS ASSOCIATED ENTE RPRISE DURING THE F.Y 2004-05, THE ASSESSEE HAD SELECTED TNMM WIT H OPERATING REVENUE COMPUTED IN RELATION TO TOTAL COST AS A PLI FOR IMPORT OF RAW MATERIAL, COMPONENTS AND TOOLS, PROVISION OF MA RKETING I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 3 SUPPORT SERVICES AND PROVISION FOR PROFESSIONAL SER VICES. ALL THE ABOVE TRANSACTIONS HAVE BEEN CONSIDERED TO BE CLOSE LY LINKED TO THE IMPORT OF RAW MATERIAL AND COMPONENTS AND FINIS HED GOODS AND HENCE A COMBINED APPROACH WAS FOLLOWED BY THE A SSESSEE. TNMM HAS BEEN APPLIED TO THESE TRANSACTIONS. THE PL I OF THE ASSESSEE WAS 6.17 PERCENT WHEREAS THE AVERAGE PLI O F BROAD COMPARABLES WAS 5.99 PERCENT. 2.04 FURTHER, THE ASSESSEE SELECTED CPM AS THE MOS T APPROPRIATE METHOD FOR THE INTERNATIONAL TRANSACTIO N PERTAINING TO EXPORT OF SEMI-FINISHED & FINISHED GOODS WITH GR OSS PROFIT MARK-UP (GP) AS THE APPROPRIATE PLI, TO DEMONSTRATE ITS ADHERENCE TO THE ARM'S LENGTH PROVISIONS CONTAINED IN THE INCOME TAX ACT, 1961. AS PER THE TP STUDY DOCUMENTA TION, THE VALUE OF EXPORTS OF FINISHED GOODS BY THE ASSESSEE WAS RS. 39,558,533/- WHEREAS THE SAME OF BROAD COMPARABLES WAS RS. 41,079,506/-. THE ASSESSEE EXERCISED THE OPTION OF AVAILING (+/- 5) PERCENT ON THE ABOVE AND AS A RESULT, THE RANGE OF INTERNATIONAL TRANSACTION FELL BETWEEN RS. 39,025,5 31/- AND RS. 43,133,481/-. THUS, ACCORDING TO THE ASSESSEE, ITS TRANSACTIONS WITH THE AES WERE AT ARM'S LENGTH. I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 4 2.05 FURTHER, AS PER THE VERSION OF THE ASSESSEE, COST RECHARGES WERE STATED TO BE ON COST TO COST BASIS A ND THEREBY NO BENCHMARKING WAS REQUIRED FOR THIS PARTICULAR INTER NATIONAL TRANSACTION. 2.06 THE CASE WAS REFERRED TO THE ADDL. COMMISSIO NER OF INCOME TAX, TRANSFER PRICING OFFICER-I(5) BY THE DC IT, CIRCLE 11(1), NEW DELHI FOR EXAMINING WHETHER OR NOT THE R EPORTED INTERNATIONAL TRANSACTIONS WERE AT ARMS LENGTH PRI CES AS CONTEMPLATED IN SECTION 92C OF THE ACT. THE LD. TPO REPORTED, VIDE HIS ORDER U/S 92C A(3) OF THE ACT, DATED 27.10 .2008, THAT THE ASSESSEE HAD NOT TRANSACTED WITH ITS ASSOCIATED CON CERNS AT AN ARMS LENGTH PRICE AND REQUIRED THE AO TO ENHANCE T HE INCOME OF THE ASSESSEE BY RS 2,29,40,792/-. SUBSEQUENTLY, THE ASSESSEE COMPANY WAS ASKED TO SHOW CAUSE AS TO WHY SUCH AN ENHANCEMENT IN ITS INCOME MAY NOT BE MADE IN THE LI GHT OF THE ORDER OF THE LD. TPO U/S 92CA(3) OF THE ACT. 2.07 THE LD. TRANSFER PRICING OFFICER-I(5), NEW D ELHI EXAMINED THE INTERNATIONAL TRANSACTIONS OF THE ASSE SSEE COMPANY AND IN HIS ORDER U/S 92CA(3) OF INCOME TAX ACT, 196 1,DATED 27.10.2008 AND CONCLUDED THAT IN RESPECT OF IMPORT OF RAW MATERIAL & COMPONENTS AND FINISHED GOODS, THE ASSES SEE HAD I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 5 DECLARED OPERATING PROFIT MARGIN OF 1.17% AS AGAINS T THE ARMS LENGTH MARGIN OF COMPARABLE WORKED OUT BY THE TPO A T 5.99% THEREBY RESULTING IN AN ADJUSTMENT TO ITS INCOME TO THE TUNE OF RS 1,70,45,591/-. SIMILARLY, IN RESPECT OF EXPORT O F SEMI FINISHED GOODS, THE PROFIT TO BE EARNED AS WORKED OUT BY THE TPO WAS 37.48% AS AGAINST 19.65% G P MARGIN ON COST WORKED OUT BY THE ASSESSEE, THEREBY RESULTING IN AN ADJUSTMENT TO THE INCOME BY RS 58,95,201/-. THUS, IN THE SAID ORDER, THE LD. TRANS FER PRICING OFFICER (TPO) DIRECTED THE A.O TO ENHANCE THE TOTAL INCOME OF THE ASSESSEE FOR A.Y 2005-06 BY RS. 2,29,40,792/-. IN ARRIVING AT THIS VALUE OF THE ARMS LENGTH PRICE OF THE INTERNATIONA L TRANSACTIONS, THE LD. TPO STUDIED THE VALUATION ADOPTED BY THE AS SESSEE AND AFTER AN ANALYSIS OF THE TRANSFER PRICING APPROACH OF THE ASSESSEE, HE FOUND THAT THE ASSESSEE HAD EARNED COMMISSION IN COME OF RS 1.65 CRORES WHILE NONE OF THE COMPARABLES HAD EARNE D COMMISSION INCOME. THE LD. TPO ALSO OBSERVED THAT T HE GOODS SOLD TO THE ASSOCIATED ENTERPRISE AND NON AE WERE N OT SIMILAR AND HENCE THE COMPARISON MADE BY THE ASSESSEE COMPA NY WAS NOT ACCEPTABLE. WHILE THE ASSESSEE WAS VALUING THE INTERNATIONAL TRANSACTIONS PERTAINING TO THE SALE OF FINISHED AND SEMI FINISHED GOODS AT COST PLUS METHOD, THE GROSS PROFIT MARK I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 6 UP OF THE COMPARABLES WITH RESPECT TO COST OF GOOD S SOLD WORKED OUT TO 37.48% AS AGAINST THE FIGURE OF 19.65% ADOPT ED BY THE ASSESSEE COMPANY. IN RESPONSE TO THE SHOW CAUSE NOT ICE OF THE LD. TPO FOR ENHANCEMENT OF ITS ARMS LENGTH PRICE, THE ASSESSEE CITED THE GROUND OF LOWER UTILIZATION OF INSTALLED CAPACITY WHICH WAS PROJECTED TO INCREASE TO 55% AS AGAINST THE VAL UE OF 41% FOR THE YEAR UNDER CONSIDERATION WHICH WAS REJECTED BY THE LD. TPO OBSERVING THAT THE ASSESSEE WAS NOT IN THE INITIAL YEAR OF ITS OPERATIONS AND ITS PROJECTED CAPACITY UTILISATION F ROM 2001 TO 2008 WAS ALSO FAR-FETCHED. THE LD. TPO MADE THE ENH ANCEMENT AS MENTIONED ABOVE. 2.08 SUBSEQUENTLY, THE AO, FOLLOWING THE REASONING OF THE LD. TPO IN HIS ORDER DATED 28.11 2008, ENHANCED THE INCOME OF THE ASSESSEE BY RS 2,29,40,792/-. 2.09 AGGRIEVED, THE ASSESSEE PREFERRED AN APPEAL B EFORE THE LD. CIT (A) WHO WAS PLEASED TO ALLOW ASSESSEES GRO UNDS PERTAINING TO THE TRANSFER PRICING ADJUSTMENTS AS D ETAILED ABOVE. 2.10 NOW THE DEPARTMENT HAS APPROACHED THE ITAT AN D HAS RAISED THE FOLLOWING GROUNDS OF APPEAL- I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 7 1. ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CA SE, THE LEARNED CIT (A) HAS ERRED IN DELETING THE ADDIT ION OF RS. 34,72,826/- ON ACCOUNT OF NOTIONAL FOREIGN EXCHANGE FLUCTUATION LOSS. 2. THE LEARNED CIT (A) HAS ERRED IN DELETING THE ADDITION OF RS. 2,29,40,792/- ON ACCOUNT OF UPWARD ADJUSTMENT OF ARMS LENGTH PRICE AS CALCULATED BY T HE TPO. 3. THE CIT(A) HAS ERRED IN IGNORING THE FACT THAT THE TPO HAS CALCULATED THE PLI FOR THE PURPOSES OF CALCULATING THE ALP BY REDUCING THE COMMISSION INCOME AND PROFESSIONAL SERVICE INCOMES OF RS. 1,65,01,326/- AND RS. 10,29,763/- RESPECTIVELY. 4. THE APPELLANT CRAVES LEAVE TO ADD, ALTER OR AME ND ANY GROUND OF APPEAL RAISED ABOVE AT THE TIME OF HEARING. 3. THE LD. SR. DR PLACED RELIANCE ON THE ORDERS OF THE LD. TPO AND THE AO AND VEHEMENTLY ARGUED THAT THE ADJUSTMEN TS MADE BY THE TPO WERE DELETED BY THE LD. CIT (A) WITHOUT ANY CONCRETE FINDINGS WHICH COULD NEGATE THE OBSERVATIONS OF THE LD. TPO. IT WAS SUBMITTED THAT THE LD. TPO HAD GIVEN REASONS FO R REJECTION OF THE ANALYSIS UNDERTAKEN BY THE ASSESSEE AND HAD ALS O DISCUSSED THE BASIS ON WHICH HE HAD MADE THE FRESH ANALYSIS. IT WAS FURTHER SUBMITTED THAT AS REGARDS THE COMMISSION INCOME, TH E LD. TPO HAD ESTABLISHED THAT THE CASE OF COMPARABLES WITH T HAT OF THE ASSESSEE COULD NOT BE STRICTLY COMPARED AS COMMISSI ON INCOME HAD NOT BEEN EARNED BY ANY OF THESE COMPANIES AND T HAT IN VIEW I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 8 OF THAT THE METHOD OF VALUATION ADOPTED BY THE ASSE SSEE WAS DEFECTIVE. IT WAS ALSO SUBMITTED THAT THE LD. TPO H AD BY WAY OF A REASONED ORDER DISPOSED OFF THE OBJECTION OF THE AS SESSEE WITH REGARD TO THE CAPACITY UTILIZATION. THUS, THE LD. T PO HAD EXAMINED THE RELEVANT ISSUES AND HAD THROUGH A REAS ONED ORDER SETTLED THE ISSUES RAISED BY THE ASSESSEE WHILE LAY ING DOWN THE BASIS FOR THE VALUE ADOPTED BY HIM IN VALUATION OF THE INTERNATIONAL TRANSACTIONS BUT THE LD. CIT (A) HAD NOT GIVEN DUE WEIGHTAGE TO THE FINDINGS OF THE LD. TPO AND HAD SI MPLY ACCEPTED THE CONTENTIONS OF THE ASSESSEE WITHOUT A PROPER BA SIS. 4. THE LD. AR SUBMITTED THAT THE ASSESSEE COMPLIED WITH ITS STATUTORY OBLIGATION TO MAINTAIN THE NECESSARY TRAN SFER PRICING DOCUMENTATION AS PRESCRIBED UNDER THE INDIAN TRANSF ER PRICING REGULATIONS CONTAINED IN SECTIONS 92, AND 92A TO 92 F OF THE ACT READ WITH RULES 10A TO 10E OF THE INCOME TAX RULES, 1962 (RULES). IT WAS SUBMITTED THAT THE TRANSFER PRICI NG DOCUMENTATION MAINTAINED BY THE COMPANY ESTABLISHES THAT THE INTERNATIONAL TRANSACTIONS OF THE ASSESSEE WITH ITS ASSOCIATED ENTERPRISES ADHERE TO THE ARM'S LENGTH PRINCIPLE AS ELUCIDATED IN THE INDIAN TRANSFER PRICING REGULATIONS. IT WAS SUB MITTED THAT IN THE SAID TRANSFER PRICING DOCUMENTATION MAINTAINED BY THE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 9 ASSESSEE SELECTED TNMM AS THE MOST APPROPRIATE MET HOD TO ESTABLISH THE ARM'S LENGTH CHARACTER OF IMPORT OF R AW MATERIAL, COMPONENTS AND TOOLS, PROVISION OF MARKETING SUPPOR T SERVICES AND PROVISION OF PROFESSIONAL SERVICES WITH THE ASS OCIATED ENTERPRISES. 4.1 IT WAS FURTHER SUBMITTED THAT THE APPLICATION O F TNMM WAS BASED ON AN ANALYSIS OF THE PROFITABILITY OF THE AS SESSEE AND WAS COMPARED WITH PROFITABILITY ACHIEVED BY INDEPENDENT COMPARABLE COMPANIES OPERATING IN A SIMILAR, BUT UNCONTROLLED BUSINESS ENVIRONMENT IN INDIA. IN ORDER TO COMPARE THE PROFI T MARGIN REALISED BY THE ASSESSEE, WITH THE PROFIT MARGIN RE ALISED BY COMPARABLE UNCONTROLLED COMPANIES, THE RATIO OF NET OPERATING MARGIN (COMPUTED BY TAKING OPERATING PROFIT AS A PE RCENTAGE OF OPERATING REVENUE, I.E. OP/OR) WAS CONSIDERED AS TH E PROFIT LEVEL INDICATOR (PLI). IT WAS SUBMITTED THAT BASED ON T HE ANALYSIS CARRIED OUT, IN CASE OF TNMM THE ARITHMETIC MEAN OF THE COMPARABLE COMPANIES WORKED OUT TO BE 5.99 PERCENT. THE ASSESSEES OPERATING MARGIN ON OPERATING REVENUE WO RKED OUT TO 6.17 PERCENT, WHICH IS HIGHER THAN THE AVERAGE / AR ITHMETIC MEAN OF THE NET MARGINS OF THE COMPARABLE COMPANIES AND, THEREFORE, I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 10 ALL THE INTERNATIONAL TRANSACTIONS WITH ASSOCIATED ENTERPRISES ON WHICH TNMM WAS APPLIED WERE CONSIDERED TO BE AT ARM S LENGTH. 4.2 THE LD. AR FURTHER SUBMITTED THAT IN CASE OF EX PORT OF SEMI- FINISHED GOODS, THE ASSESSEE HAS SELECTED COST PLUS METHOD (CPM) AS THE MOST APPROPRIATE METHOD TO BENCHMARK THE TRANSACTION. THE APPLICATION OF CPM WAS BASED ON AN ANALYSIS OF THE GROSS MARGIN EARNED BY ASSESSEE FROM SALE TO TH E ASSOCIATED ENTERPRISES AND SALE TO UNRELATED PARTIES WHEREIN T HE GROSS MARGINS EARNED BY THE ASSESSEE FROM SALES TO ASSOCI ATED ENTERPRISES WORKED OUT TO 19.32 PERCENT AND SALES M ADE TO UNRELATED PARTY WORKED OUT TO BE 24.25 PERCENT. TRA NSLATING THE PERCENTAGE MARGINS EARNED BY THE COMPARABLES INTO A MOUNT, VALUE OF ARMS LENGTH PRICE WORKS OUT TO BE 41,079, 506/-. IT WAS SUBMITTED THAT THE ASSESSEE CAN, AT ITS OPTION, ADO PT A PRICE THAT DIFFERS FROM THE ARITHMETIC MEAN OF THE ARMS LENGT H PRICES BY AN AMOUNT NOT EXCEEDING 5 PER CENT OF SUCH MEAN, AS TH E ARMS LENGTH PRICE. ACCORDINGLY, ALLOWING FOR A +/- 5 PER CENT VARIANCE FROM THE MEAN TRANSFER PRICE, THE RANGE OF TRANSFER PRICE OF THE COMPARABLE UNCONTROLLED TRANSACTION WOULD FALL BETW EEN RS.39,025,531/- AND RS. 43,133,481/-. IT WAS SUBMIT TED THAT THE SALES VALUE OF THE ASSESEES EXPORT OF SEMI FINISHE D GOODS IS RS. I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 11 39,558,533/- AND SINCE THE SALES VALUE IS WITHIN TH E ARMS LENGTH PRICE RANGE, THE PRICE CHARGED FOR EXPORT OF SEMI-F INISHED & FINISHED GOODS TO ASSOCIATED ENTERPRISES WAS CONSID ERED TO BE AT ARMS LENGTH. 4.3 THE LD. AR SUBMITTED THAT THE LD. TPO, IN CASE OF INTERNATIONAL TRANSACTIONS WHERE TNMM WAS CONSIDERE D AS THE MOST APPROPRIATE METHOD, HAS TREATED THE COMMISSION INCOME AS NON OPERATING AND EXCLUDED THE SAME FROM THE MARGIN COMPUTATION OF THE ASSESSEE AND RECOMPUTED THE MARG IN FOR COMPARISON PURPOSES AT 1.17 PERCENT. IT WAS ALSO SU BMITTED THAT FURTHER, IN CASE OF EXPORT OF SEMI-FINISHED AND FIN ISHED GOODS, THE LD. TPO DISREGARDED INTERNAL CPM CONTENDING THAT TH E GOODS SOLD TO THE ASSOCIATED PARTIES AND UNRELATED PARTIES ARE NOT SIMILAR. THE LD. TPO CONSIDERED EXTERNAL CPM AS THE MOST APP ROPRIATE METHOD WHEREIN THE RELIANCE WAS MADE ON THE SEARCH MADE BY THE ASSESSEE FOR IMPORT OF RAW MATERIAL, COMPONENTS AND GOODS. THE LD. AR SUBMITTED THAT THE LD. TPO COMPARED GROS S MARGIN EARNED BY THE ASSESSEE FROM EXPORT OF SEMI FINISHED GOODS AND FINISHED GOODS WITH GROSS MARGIN EARNED BY THE COMP ARABLE COMPANIES SELECTED BY THE ASSESSEE FOR TNMM, THEREB Y TOTALLY I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 12 DISREGARDING THE APPLICABILITY OF BOTH THE METHODS AS PRESCRIBED UNDER TRANSFER PRICING RULES. 4.4 ON THE ISSUE OF DISALLOWANCE OF LOSS ON ACCOUNT OF FLUCTUATION OF FOREIGN EXCHANGE AMOUNTING TO RS 34, 72,826/-, THE LD. AR SUBMITTED THAT DURING THE YEAR UNDER CONSIDE RATION, THE ASSESSEE HAD DEBITED TO ITS PROFIT AND LOSS ACCOUNT AN AMOUNT OF RS 34,72,826/- AS FOREIGN EXCHANGE FLUCTUATION (NET ). DURING THE COURSE OF ASSESSMENT PROCEEDINGS, THE ASSESSEE WAS ASKED TO SUBMIT THE DETAILS OF THE SAME AND ALSO TO JUSTIFY THE ALLOWABLY OF THE SAME. IT WAS SUBMITTED THAT THE ASSESSEE FILED THE DETAILS VIDE LETTER DATED 3 DECEMBER 2008 AND ALSO EXPLAINED THE REASON FOR CLAIMING THE SAID LOSS AS ALLOWABLE IN THE COMPUTAT ION OF TOTAL INCOME. THE ASSESSEE HAD MENTIONED IN THE LETTER TH AT THE LOSS HAS BEEN INCURRED ON ACCOUNT OF SETTLEMENT OF TRADE DEBTORS/ CREDITORS AND RESTATEMENT OF BALANCES DUE FROM TRAD E DEBTORS/ CREDITORS AS ON 31 MARCH 2005. THUS, IT WAS EXPLAIN ED BY THE ASSESSEE THAT THE LOSS INCURRED IS ON ACCOUNT OF BO TH PAYMENT AND REINSTATEMENT. IT WAS FURTHER SUBMITTED THAT IN THE ASSESSMENT ORDER, THE AMOUNT OF RS. 34,72,826/- WAS DISALLOWED BY THE ASSESSING OFFICER ON THE GROUND THAT THE FOR EIGN EXCHANGE LOSS INCURRED BY THE ASSESSEE ON MERE RESTATEMENT O F THE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 13 LIABILITIES IS NOT ALLOWABLE BEING CONTINGENT AND N OTIONAL IN NATURE. THE LD. AR SUBMITTED THAT THE AO COMPLETELY DISREGARDED THE SUBMISSION MADE BY THE ASSESSEE THAT THE LOSS A LSO INCLUDED THE LOSS ON ACCOUNT OF SETTLEMENT OF TRADE DEBTORS AND CREDITORS. IT WAS FURTHER SUBMITTED THAT WHILE DISALLOWING THE SAME, THE AO ALSO DISREGARDED THE JUDGMENT OF HONORABLE DELHI HI GH COURT IN THE CASE OF CIT VS WOODWARD GOVERNOR INDIA P LTD (2 94 ITR 451). 4.5 THE LD. AR ALSO FILED WRITTEN SUBMISSIONS WHICH ARE BEING REPRODUCED BELOW- A. THE ASSESSEE TRANSACTIONS ARE AT ARMS LENGTH AS PER THE COMBINED TRANSACTIONS APPROACH 1. THE APPROACH OF THE ASSESSEE IS IN LINE WITH THE AP PROACH PRESCRIBED IN THE INCOME TAX RULES, 1962 THE ASSESSEE SUBMITS THAT RULE 10A (D) OF THE INCOM E TAX RULES 1962 (THE RULES) PROVIDE THAT, A TRANSAC TION INCLUDES A NUMBER OF CLOSELY LINKED TRANSACTIONS. THIS IMPLIES THAT A NUMBER OF TRANSACTIONS CAN BE AGGREG ATED TOGETHER AND CONSTRUED AS A SINGLE TRANSACTION FOR DETERMINING THE ALP FOR THE COMBINED TRANSACTIONS. 2. THE APPROACH OF THE ASSESSEE IS ALSO IN LINE WITH T HE APPROACH PRESCRIBED IN OECD GUIDELINES I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 14 THE ASSESSEE SUBMITS THAT PARA 3.9 OF OECD GUIDELIN ES STATE THE FOLLOWING - THERE ARE OFTEN SITUATIONS WHERE SEPARATE TRANSACTIONS ARE SO CLOSELY LINKED OR CONTINUOUS TH AT THEY CANNOT BE EVALUATED ADEQUATELY ON A SEPARATE BASIS. EXAMPLES MAY INCLUDE 1. SOME LONG TERM CONTRACTS FOR THE SUPPLY OF COMMODITIES OR SERVICES , 2. RIGHTS TO USE INTANGIBLE PROPERTY, AND 3. PRICING A RANGE OF CLOSELY LINKED PRODUCTS (E.G. IN A PRODUCT LINE) WHEN IT IS IMPRACTICAL TO DETERMINE PRICING FOR EACH INDIVIDUAL PRODUCT OR TRANSACTION. ANOTHER EXAMPLE WOULD BE THE LICENSING OF MANUFACTURING KNOW-HOW AND THE SUPPLY OF VITAL COMPONENTS TO AN ASSOCIATED MANUFACTURER; IT MAY BE MORE REASONABLE TO ASSESS THE ARM'S LENGTH TERMS FOR THE TWO ITEMS TOGETHER RATHER THAN INDIVIDUALLY. SUCH TRANSACTIONS SHOULD BE EVALUATED TOGETHER USING THE MOST APPROPRIATE ARM'S LENGTH METHOD OR METHODS. THE ASSESSEE SUBMITS THAT THE ABOVE EXTRACT SPECIFI CALLY MENTIONED THAT IN CASE THE TRANSACTIONS OF THE ASSE SSEE ARE SO CLOSELY LINKED THAT A SEGREGATED ANALYSIS IS NOT POSSIBLE, AN AGGREGATED APPROACH WILL BE CONSIDERED MORE APPROPRIATE. 3. THE APPROACH OF THE ASSESSEE IS WELL SUPPORTED BY INTERNATIONAL JURISPRUDENCE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 15 IN THE CASE CANADIAN CASE LAW OF MNR V. GRANITE BAY TIMBER CO. LTD., 58 DTC 1066 (EX CT), BRIEFLY AFFD 59 DTC 1262 (SCC), JUSTICE THURLOW STATED - IN MY OPINION, THE EXPRESSION ONE OR MORE TRANSACTIONS IN S. 8(3) IS WIDE ENOUGH TO EMBRACE ALL TYPES OF VOLUNTARY PROCESSES OR ACTS BY WHICH PROPE RTY OF ONE PERSON MAY BECOME VESTED IN ANOTHER WITHOUT REGARD FOR THE REASON OR OCCASION FOR SUCH PROCESSE S OR ACTS AND REGARDLESS ALSO OF WHETHER THE PROCESS IS UNDERTAKEN OR THE ACT IS DONE FOR CONSIDERATION IN WHOLE OR IN PART OR FOR NO CONSIDERATION AT ALL. IT MAY NOT BE WIDE ENOUGH TO EMBRACE A TRANSMISSION OR DEVOLUTION UPON DEATH BUT AS USED IN S. 8(3), I THI NK IT IS WIDE ENOUGH TO INCLUDE ANY VOLUNTARY TRANSFER OF PROPERTY BETWEEN EXISTING PERSONS FALLING WITHIN TH E CLASS REFERRED TO AS PERSONS NOT DEALING AT ARMS LENGTH. IN LIGHT OF THE ABOVE INTERPRETATION APPROACH TAKEN BY THE COURT, IT IS CLEAR THAT THE WORD 'TRANSACTION' HAS A VERY BROAD MEANING. IN THIS REGARD, RULE 10A (D) PROVIDES THAT , A TRANSACTION INCLUDES A NUMBER OF CLOSELY LINKED TRANSACTIONS. HENCE, IT IS CLEAR THAT THE APPROACH OF THE ASSESSEE REPRESENTS A TRANSACTION BY TRANSACTION AP PROACH AS IT HAS TREATED CLOSELY LINKED TRANSACTIONS AS A UNITARY TRANSACTION 4. THE ASSESSEES CONTENTION FINDS SUPPORT IN THE GUID ANCE NOTE ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTAN TS OF I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 16 INDIA (ICAI) THE ASSESSEES APPROACH IS IN LINE WITH THE GUIDANC E NOTE ISSUED BY THE ICAI. IN RELATION TO BENCHMARKING OF CLOSELY LINKED TRANSACTIONS, THE GUIDANCE NOTE STATES - 5.7 THE FACTORS REFERRED TO ABOVE ARE TO BE APPLIE D CUMULATIVELY IN SELECTING THE MOST APPROPRIATE METH OD. THE REFERENCE THEREIN TO THE TERMS BEST SUITED AN D MOST RELIABLE MEASURE INDICATES THAT THE MOST APPROPRIATE METHOD WILL HAVE TO BE SELECTED AFTER A METICULOUS APPRAISAL OF THE FACTS AND CIRCUMSTANCES OF THE INTERNATIONAL TRANSACTION. FURTHER, THE SELECTI ON OF THE MOST APPROPRIATE METHOD SHALL BE FOR EACH PARTICULAR INTERNATIONAL TRANSACTION. THE TERM TRANSACTION ITSELF IS DEFINED IN RULE 10A(D) TO I NCLUDE A NUMBER OF CLOSELY LINKED TRANSACTIONS. THEREFORE, THOUGH THE REFERENCE IS TO APPLY THE MOST APPROPRIA TE METHOD TO EACH PARTICULAR TRANSACTION, KEEPING IN V IEW, THE DEFINITION OF THE TERM TRANSACTION, THE MOST APPROPRIATE METHOD MAY BE CHOSEN FOR A GROUP OF CLOSELY LINKED TRANSACTIONS. TWO OR MORE TRANSACTIONS CAN BE SAID TO BE LINKED WHEN THESE TRANSACTIONS EMANATE FROM A COMMON SOURCE BEING AN ORDER OR A CONTRACT OR AN AGREEMENT OR AN ARRANGEMENT AND THE NATURE, CHARACTERISTICS AND TERMS OF THESE TRANSACTIONS ARE SUBSTANTIALLY FLOWING FROM THE SAID COMMON SOURCE. FOR EXAMPLE, A MASTER PURCHASE ORDER IS ISSUED STATING THE VARIOUS TERMS AND CONDITIONS AND SUBSEQUENTLY, INDIVIDUALS ORDERS ARE RELEASED FOR I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 17 SPECIFIC QUANTITIES. THE VARIOUS PURCHASE TRANSACTI ONS ARE CLOSELY LINKED TRANSACTIONS. 5.8 IT MAY BE NOTED THAT IN ORDER TO BE CLOSELY LIN KED TRANSACTIONS, IT IS NOT NECESSARY THAT THESE TRANSACTIONS NEED BE IDENTICAL OR EVEN SIMILAR. FOR EXAMPLE, A COLLABORATION AGREEMENT MAY PROVIDE FOR IMPORT OF RAW MATERIALS, SALE OF FINISHED GOODS, PROVISION OF TECHNICAL SERVICES AND PAYMENT OF ROYALTY. DIFFERENT METHODS MAY BE CHOSEN AS THE MOST APPROPRIATE METHODS FOR EACH OF THE ABOVE TRANSACTIONS WHEN CONSIDERED ON A STAND ALONE BASIS . HOWEVER, UNDER PARTICULAR CIRCUMSTANCES, ONE SINGLE METHOD MAY BE CHOSEN AS THE MOST APPROPRIATE METHOD COVERING ALL THE ABOVE TRANSACTIONS AS THE SAME ARE CLOSELY LINKED. BASED ON THE ABOVE, THE ASSESSEE SUBMITS THAT THE A SSESSEE WAS JUSTIFIED IN APPLYING THE APPROACH OF AGGREGATI ON OF TRANSACTIONS . 5. GIVEN THE FACT AND CIRCUMSTANCES OF THE CASE, IT WA S PRACTICALLY NOT POSSIBLE TO PERFORM THE ANALYSIS TH E ASSESSEE UNDERTOOK SEVERAL TYPES OF INTERNATIONAL TRANSACTIO NS WITH VARIOUS AES. AVAILABILITY OF COMPARABLE DATA IN ALL THE TRANSACTIONS IN ITSELF WOULD BE A CHALLENGE, IN CAS E SEPARATE ANALYSIS WAS TO BE ADOPTED. 6. JURISPRUDENCE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 18 IN THE CASE OF 'DRESSER VALVE INDIA PVT. LTD. VS. THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-8 (1), MUMBAI (I .T.A. NO.1945/MD6/2010), HON'BLE MUMBAI ITAT HELD 13. WE ARE OF THE CONSIDERED VIEW THAT IN RESPECT OF THE COMMISSION INCOME AND RECOVERY OF SOURCING EXPENSES, SUCH AN UNIVERSAL COMPARISON IS NOT JUSTIFIED. THIS IS BECAUSE IN RESPECT OF THE ASSESS EE- COMPANY THESE TWO ITEMS ARE UNIQUE RECEIPTS WITH IT S LIMITED SCOPE OF OPERATION... 14. WE ALSO FIND THAT THE TURNOVER QUANTUM OF THESE TWO ITEMS FORMS A VERY NOMINAL PART OF THE TOTAL TURNOVER OF THE ASSESSEE-COMPANY REPORTED AGAINST I TS INTERNATIONAL TRANSACTIONS WITH AES. THE ASSESSEE H AS REPORTED THE PURCHASE OF PARTS FOR MORE THAN RS. 6 CRORES. PURCHASES OF FINISHED GOODS HAVE BEEN ACCOUNTED FOR MORE THAN RS. 80 LAKHS, SALE OF VALVE S AND COMPONENTS ACCOUNTED FOR MORE THAN RS. 23 CRORES. OTHER ITEMS OF SERVICING OF VALVES, INTERES T ON EXTERNAL COMMERCIAL BORROWING, REIMBURSEMENT OF EXPENSES PAID AND RECEIVED WERE ACCOUNTED FOR AROUND RS. 1.20 CRORES. IT IS AGAINST THE ABOVE COMPONENTS OF TURNOVER, THE ASSESSEE HAS REPORTED COMMISSION RECEIPT OF RS. 39,23,631/- AND RECOVERY OF GLOBAL SOURCING EXPENSES OF RS. 51,34,029/-. WE FIN D THAT THESE TWO AMOUNTS DO NOT GO TO INFLUENCE THE INTERNATIONAL PRICING OF THE ASSESSEE-COMPANY IN AN Y MANNER. THE IMPACT OF THESE TWO ITEMS ON THE VOLUME I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 19 OF ITS INTERNATIONAL TRANSACTIONS IS VERY NOMINAL, INCAPABLE OF CREATING ANY EFFECT. 15. THEREFORE, WE DO NOT FIND ANY COMPULSION IN T HE PRESENT CASE TO UPSET THE RATES OF THESE TWO TRANSACTIONS AS REPORTED BY THE ASSESSEE-COMPANY. THE FIRST REASON IS THAT THE COMPARATIVE TURNOVER O F THESE TWO ITEMS IS VERY NOMINAL AND NOT HAVING ANY APPARENT IMPACT IN THE TOTAL PRICING PATTERN OF INTERESTED INTERNATIONAL TRANSACTIONS. SECONDLY, NO COMPARABLE DATA IS AVAILABLE TO THE TPO DIRECTLY ON THE TWO ITEMS UNDER DISPUTE. THIRDLY, THE TPO HAS WORKED OUT THE ALP RATE IN THESE TWO CASES BY MAKING COMPARISONS WITH THE OPERATING PROFIT RATIO OF MANUFACTURING AND TRADING ACTIVITIES, WHICH CANNOT BE JUSTIFIED. THE APPROACH FOLLOWED BY ASSESSEE HAS ALSO BEEN UPH ELD IN THE CASE OF ACIT VS. LUMAX INDUSTRIES LIMITED [TS-152-I TAT- 2013(DEL)-TP] WHEREIN THE HONBLE DELHI ITAT HELD - 33. THE TPO HAS MADE THE DISALLOWANCE IN QUESTION MAINLY ON THE BASIS OF THE BENEFIT TEST. IN THIS RE GARD, IT IS SEEN THAT THE PAYMENT OF ROYALTY CANNOT BE EXAMINED DIVORCED FROM THE PRODUCTION AND SALES. ROYALTY IS INEXTRICABLY LINKED WITH THESE ACTIVITIE S. IN THE ABSENCE OF PRODUCTION AND SALE OF PRODUCTS, THE RE WOULD BE NO QUESTION ARISING REGARDING PAYMENT OF ANY ROYALTY. RULE 10A(D) OF THE ITAT RULES DEFINES TRANSACTION AS A NUMBER OF CLOSELY LINKED I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 20 TRANSACTIONS. ROYALTY, THEN, IS A TRANSACTION CLOSE LY LINKED WITH PRODUCTION AND SALES. IT CANNOT BE SEGREGATED FROM THESE ACTIVITIES OF AN ENTERPRISE, BEING EMBEDDED THEREIN. THAT BEING SO, ROYALTY CANNOT BE CONSIDERED AND EXAMINED IN ISOLATION ON A STANDALONE BASIS. ROYALTY IS TO BE CALCULATED ON A SPECIFIED AGREED BASIS, ON DETERMINING THE NET SALE S WHICH, IN THE PRESENT CASE, ARE REQUIRED TO BE DETERMINED AFTER EXCLUDING THE AMOUNTS OF STANDARD BOUGHT OUT COMPONENTS, ETC., SINCE SUCH NET SALES D O NOT STAND RECORDED BY THE ASSESSEE IN ITS BOOKS OF ACCOUNT. THEREFORE, IT IS OUR CONSIDERED OPINION TH AT THE ASSESSEE WAS CORRECT IN EMPLOYING AN OVERALL TNMM FOR EXAMINING THE ROYALTY.' THE ASSESSEE ALSO PLACES RELIANCE ON THE CASE OF DEMAG CRANES & COMPONENTS (INDIA) PVT. LTD. VS. DCIT (ITA NO. 1683/PN/2011), WHEREIN THE HONBLE PUNE ITAT PRINCIPALLY UPHELD THE AGGREGATION OF CLOSELY LINKED TRANSACTIO NS PLACING ITS RELIANCE ON THE PROVISIONS OF THE INCOME TAX ACT RE AD WITH INCOME TAX RULES, OECD GUIDELINES AND GUIDANCE NOTE ISSUED BY THE ICAI. 5. WE HAVE HEARD THE RIVAL SUBMISSIONS AND HAVE PER USED THE RELEVANT MATERIAL. AS FAR AS GROUND NO. 1 OF THE AP PEAL IS CONCERNED, IT IS SEEN THAT THE ASSESSEE HAD DEBITED TO ITS PROFIT AND LOSS ACCOUNT AN AMOUNT OF RS 34,72,826/- AS FOR EIGN I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 21 EXCHANGE FLUCTUATION (NET). IT HAS BEEN THE CONTENT ION OF THE ASSESSEE THAT THE LOSS HAD BEEN INCURRED ON ACCOUNT OF SETTLEMENT OF TRADE DEBTORS/ CREDITORS AND RESTATEM ENT OF BALANCES DUE FROM TRADE DEBTORS/ CREDITORS AS ON 31 MARCH 2005. THUS, THE LOSS INCURRED WAS ON ACCOUNT OF BOTH, PAY MENT AND REINSTATEMENT. HOWEVER, THE AMOUNT OF RS 34,72,82 6/- WAS DISALLOWED BY THE AO ON THE GROUND THAT FOREIGN EXC HANGE LOSS INCURRED BY THE ASSESSEE ON MERE RESTATEMENT OF THE LIABILITIES WAS NOT ALLOWABLE BEING CONTINGENT AND NOTIONAL IN NATURE. THE ASSESSING OFFICER DISREGARDED THE ASSESSEES EXPLAN ATION THAT THE LOSS ALSO INCLUDED THE LOSS ON ACCOUNT OF SETTLEMEN T OF TRADE DEBTORS AND CREDITORS. HOWEVER, THE LD. CIT (A) ALL OWED THE ASSEESSEES GROUND BY HOLDING THAT THE UNDERLYING L IABILITY WAS ON ACCOUNT OF REVENUE TRANSACTION AND HENCE THE FOREX LOSS ALSO TOOK COLOUR OF REVENUE LOSS. THE LD. CIT (A) ALSO R ELIED ON THE JUDGMENT OF THE HONBLE APEX COURT IN THE CASE OF C IT VS. WOODWARD GOVERNOR REPORTED IN 312 ITR 254 (SC) WHIL E ALLOWING THE ASSESSEES GROUND. 5.01 THE LD. AR HAS PLACED RELIANCE ON AS 11 IN SU PPORT OF THE CONTENTION THAT FOREX LOSS WAS REVENUE IN NATUR E. IT HAS BEEN SUBMITTED BY THE LD. AR THAT WHENEVER EXPORT S ALES ARE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 22 MADE BY THE ASSESSEE, THE EXPORT INVOICE IS CONVERT ED INTO INR BY APPLYING THE EXCHANGE RATE PREVAILING AS ON THE DAT E OF EXPORT. IF THE EXPORT PROCEEDS ARE REALIZED FROM THE CUSTOMER BEFORE THE END OF THE FINANCIAL YEAR IN WHICH SALE WAS MADE TH EN THE DIFFERENCE BETWEEN SALE PRICE (IN INR) AND AMOUNT A CTUALLY RECEIVED FROM THE CUSTOMER IS DEBITED/CREDITED TO P ROFIT AND LOSS ACCOUNT AS FOREIGN EXCHANGE LOSS OR GAIN, AS THE CA SE MAY BE. IT HAS BEEN FURTHER SUBMITTED BY THE LD. AR THAT, IF, HOWEVER, THE PROCEEDS ARE NOT REALIZED FROM THE CUSTOMER BEFORE THE END OF RELEVANT FINANCIAL YEAR, THE AMOUNT RECOVERABLE FRO M PARTIES IN FOREIGN CURRENCY IS CONVERTED INTO INR BY APPLYING THE EXCHANGE RATES PREVAILING AT THE YEAR END. THE DIFFERENCE BE TWEEN AMOUNT RECEIVABLE (IN INR) AND AMOUNT SO REINSTATED IS DEB ITED/ CREDITED TO PROFIT AND LOSS ACCOUNT AS FOREIGN EXCHANGE LOSS /GAIN, AS THE CASE MAY BE. IT HAS ALSO BEEN SUBMITTED THAT THE SA ID ACCOUNTING TREATMENT IS MUTATIS MUTANDIS APPLIED WHENEVER THE GOODS OR SERVICES ARE IMPORTED FROM OUTSIDE INDIA. THE LD. AR HAS ALSO SUBMITTED THAT PROVISIONS OF SECTION 145(1 ) OF THE ACT ALSO REQUIRE AN ASSESSEE TO COMPUTE ITS TAXABLE PRO FITS IN ACCORDANCE WITH THE METHOD OF ACCOUNTING (MERCANTIL E OR CASH) WHICH IS CONSISTENTLY FOLLOWED BY THE ASSESSEE. IT HAS BEEN I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 23 SUBMITTED THAT THE ASSESSEE IS CONSISTENTLY FOLLOWI NG MERCANTILE SYSTEM OF ACCOUNTING AND ACCORDINGLY ANY LOSS ON EX CHANGE VARIATION IS RECOGNIZED IN THE BOOKS OF ACCOUNTS AS WHEN THE SAME IS ACCRUED. THE ACCOUNTING TREATMENT AS EXPLA INED BY THE LD. AR HAS NOT BEEN CONTROVERTED BY THE DEPARTMENT AT ANY STAGE OF THE PROCEEDINGS. 5.02 THE RELEVANT EXTRACT OF AS-11 IS REPRODUCED B ELOW- PARA 11 - AT EACH BALANCE SHEET DATE, FOREIGN CURRENCY MONETARY ITEMS SHOULD BE REPORTED USING TH E CLOSING RATE. PARA 13 - EXCHANGE DIFFERENCES ARISING ON THE SETTLEMENT OF MONETARY ITEMS OR ON REPORTING AN ENTERPRISE'S MONETARY ITEMS AT RATES DIFFERENT FROM THOSE AT WHICH THEY WERE INITIALLY RECORDED DURING THE PERIOD, OR REPORTED IN PREVIOUS FINANCIAL STATEMENT S, SHOULD BE RECOGNIZED AS INCOME OR AS EXPENSES IN TH E PERIOD IN WHICH THEY ARISE, WITH THE EXCEPTION OF EXCHANGE DIFFERENCES DEALT WITH IN ACCORDANCE WITH PARAGRAPH 15. 5.03 WE AGREE WITH THE CONTENTIONS OF THE LD. AR T HAT SUCH ACCOUNTING TREATMENT OF REINSTATING THE MONETARY ASSETS/LIABILITIES IS IN ACCORDANCE OF ACCOUNTING S TANDARD 11 (AS- 11) ACCOUNTING FOR EFFECTS OF CHANGES IN FO REIGN I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 24 EXCHANGE RATES ISSUED BY THE INSTITUTE OF CHARTERE D ACCOUNTANTS OF INDIA (ICAI) WHICH MANDATES FOR EV ERY COMPANY TO REINSTATE ITS FOREIGN EXCHANGE MONETARY ASSETS A ND LIABILITIES AT THE RATE PREVAILING ON THE LAST DAY OF THE FINAN CIAL YEAR. IT IS ALSO UNDISPUTED THAT SUCH ACCOUNTING POLICY HAS BEE N CONSISTENTLY FOLLOWED BY THE ASSESSEE. THE ASSESSEE IS FOLLOWING MERCANTILE SYSTEM OF ACCOUNTING CONSISTENTLY. THE F OREX LOSS IS DUE TO THE REINSTATEMENT OF ACCOUNTS AT THE END OF THE FINANCIAL YEAR AS PER THE ACCOUNTING STANDARD 11 ISSUED BY TH E INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA. IT IS UNDISPUTED THAT THE UNDERLYING LIABILITY WAS ON ACCOUNT OF REVENUE TRAN SACTION- INCOME ON ACCOUNT OF SETTLEMENT OF CREDITORS/ DEBTO RS. THEREFORE, THE FOREX LOSS IS ALSO TAKES THE COLOUR OF REVENUE LOSS. FURTHER, THE ISSUE HAS BEEN SETTLED BY THE JUDGMENT OF THE H ON'BLE SUPREME COURT IN THE CASE OF WOODWORD GOVERNOR [200 9] 312 ITR 254 SC. THE CASE OF THE ASSESSEE SQUARELY FALLS WITHIN THE AMBIT OF THE DECISION OF THE HON'BLE SUPREME COURT. THEREFORE, WE FIND NO REASON TO INTERFERE WITH THE FINDINGS OF THE LD. CIT (A) ON THIS ISSUE AND WE UPHOLD THE SAME. ACCORDINGLY, GROUND NO. 1 OF THE DEPARTMENTS APPEAL IS DISMISSED. I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 25 5.1 AS FAR AS GROUND NOS. 2 AND 3 OF THE DEPARTMENT S APPEAL ARE CONCERNED, IT IS SEEN THAT THE ASSESSEE HAD USE D TNMM FOR BENCHMARKING THE TRANSACTION OF IMPORT OF RAW MATER IAL, COMPONENTS AND TOOLS AND PROVISION OF MARKETING SUP PORT SERVICES AND PROVISION OF PROFESSIONAL SERVICES USI NG COMBINED TRANSACTIONAL ANALYSIS. WHILE DOING SO OPERATING PR OFIT / OPERATING REVENUE (OP/ OR) WAS TAKEN AS PROFIT LEVE L INDICATOR (PLI). FOR EXPORT OF SEMI-FINISHED AND FINISHED GOO DS COST PLUS METHOD (CPM) WAS TAKEN AS THE MOST APPROPRIATE METH OD USING GP/ COST OF GOODS SOLD AS THE PLI. FOR THIS CPM, IT WAS THE INTERNAL BENCHMARKING AS THE ASSESSEE HAD SOLD THE SIMILAR GOODS TO UNRELATED PARTIES AS WELL. THE LD. TPO ACC EPTED THE COMPARABLES UNDER TNMM ANALYSIS. HOWEVER, HE REJECT ED THE INTERNAL CPM. USING THE SAME SET OF COMPARABLES, TA KING THE FINANCIALS AT THE GROSS PROFIT LEVEL THE BENCHMARKI NG WAS MADE USING EXTERNAL CPM FOR EXPORT OF SEMI-FINISHED AND FINISHED GOODS. THE LD. TPO ACCEPTED THE MOST APPROPRIATE ME THOD, COMPARABLES AS SELECTED BY THE ASSESSEE AND THE PLI AS USED BY THE ASSESSEE IN ITS TP STUDY. THE LD. TPO EVEN ACCE PTED THE MULTIPLE YEAR DATA AS PROVIDED IN THE TP STUDY. HE HAD TAKEN THE COMPANY-WIDE DATA AS PROVIDED IN THE AUDITED PROFIT AND LOSS I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 26 ACCOUNT OF THE ASSESSEE AND THE TP STUDY. HOWEVER, THE LD. TPO DID NOT INCLUDE THE COMMISSION INCOME AND INCOME FR OM PROFESSIONAL SERVICES EARNED BY THE ASSESSEE BY STA TING AS NONE OF THE COMPARABLE HAS EARNED COMMISSION INCOME. AS A RESULT OF THIS EXERCISE, THE OP/OR OF THE ASSESSEE WAS REDUCE D TO 1.17% FROM 6.17%. 5.1.1 IT HAS BEEN THE CONTENTION OF THE ASSESSEE T HAT THE RENDERING OF MARKETING SUPPORT SERVICES AND PROVISI ON OF PROFESSIONAL SERVICES ARE INTRINSIC TO THE ENTIRE B USINESS MODEL AND THAT IT WAS NOT FEASIBLE TO CONSIDER THE SERVIC ES AS A SEPARATE BUSINESS SEGMENT. IT HAS ALSO BEEN CONTENDED THAT T HERE IS NO SEPARATELY IDENTIFIED TEAM WHICH CARRIES OUT MARKET ING SUPPORT SERVICES AND, THEREFORE, IT WILL BE INAPPROPRIATE T O SEGREGATE COST INCURRED FOR MANUFACTURING AND COST INCURRED FOR MA RKETING SUPPORT SERVICES. IT HAS BEEN SUBMITTED THAT THE CO NSIDERATION FOR MARKETING SUPPORT SERVICES IS NOT A COST-PLUS PRICI NG MODEL BUT A FIXED PERCENTAGE OF SALES AND IF IT WAS A SEPARATE BUSINESS SEGMENT, AN APPROPRIATE COST PLUS MARKUP APPROACH W OULD HAVE BEEN ADOPTED BY THE ASSESSEE. ON THE ISSUE OF PROVI SION FOR LEGAL SERVICES, IT IS THE ASSESSEES CONTENTION THAT SINC E IT HAS BEEN CHARGEABLE @ COST +10% BASIS, ON MATCHING PRINCIPLE , THE LD. I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 27 TPO SHOULD HAVE EXCLUDED THE COST PERTAINING TO PRO VISION OF SUCH SERVICES IN CASE THE INCOME IS REDUCED FOR COM PUTATION OF OPERATING PROFIT. HOWEVER, THE MAIN THRUST OF THE A SSESSEE IS THAT ALL THE TRANSACTIONS WITH THE ASSOCIATED ENTERPRISE WERE CLOSELY LINKED TRANSACTIONS AND NEEDED TO BE AGGREGATED FOR THE PURPOSE OF DETERMINING THE ALP. THE LD. AUTHORISED REPRESEN TATIVE HAS HAS PLACED RELIANCE ON THE OECD GUIDELINES AS WELL AS THE ORDER OF THE ITAT PUNE BENCH IN THE CASE OF DEMAG CRANES & COMPONENTS VERSUS DCIT IN ITA NO. 1683/P.M./2011 AN D ALSO ON THE GUIDANCE NOTE ON REPORT UNDER SECTION 92E OF THE INCOME TAX ACT, 1961 ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA IN SUPPORT OF HIS CONTENTION THAT A NUMBER OF TRANSACTIONS CAN BE AGGREGATED AND THAT THEY CONSTITUTE A SINGLE TRANSACTION FOR THE PURPOSE OF DETERMINING THE ALP PROVIDED THA T SUCH TRANSACTIONS ARE CLOSELY LINKED AND WHERE IT WOULD BE INAPPROPRIATE TO ANALYSE THE TRANSACTIONS INDIVIDUA LLY. 5.1.2 THE HONBLE PUNE BENCH IN THE CASE OF DEMA G CRANES AND COMPONENTS (SUPRA), ON WHICH THE LD. AR HAS RELIED, HAS EXAMINED THE ISSUE OF AGGREGATION AS UNDER 30. WE HAVE CAREFULLY CONSIDERED THE RIVAL SUBMISS IONS. SECTION 92B OF THE ACT PROVIDES THE MEANING OF EXPRESSION I NTERNATIONAL I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 28 TRANSACTION BETWEEN TWO OR MORE ASSOCIATED ENTERPRI SES. RULE 10 A(D) OF THE RULES EXPLAINS THE MEANING OF THE EXPRE SSION TRANSACTION FOR THE PURPOSES OF COMPUTATION OF AL P AS TO INCLUDE A NUMBER OF CLOSELY LINKED TRANSACTIONS. 10B OF THE RULES PRESCRIBES THE MANNER IN WHICH THE ALP IN RELATION TO AN INTERNATIONAL TRANSACTION IS TO BE DETERMINED BY FO LLOWING ANY OF THE METHODS PRESCRIBED. SHORN OF OTHER DETAILS, IT WOULD SUFFICE TO OBSERVE THAT ON THE COMBINED READING OF RULE 10 A ( D) AND 10 B OF THE RULES, A NUMBER OF TRANSACTIONS CAN BE AGGREGAT ED AND CONSTRUED AS A SINGLE TRANSACTION FOR THE PURPOSE S OF DETERMINING THE ALP, PROVIDED OF COURSE THAT SUCH TRANSACTIONS ARE CLOSELY LINKED. OSTENSIBLY THE RATIONAL OF AGGREGATING CL OSELY LINKED TRANSACTIONS TO FACILITATE DETERMINATION OF ALP ENV ISAGED A SITUATION WHERE IT WOULD BE INAPPROPRIATE TO ANALYS E THE TRANSACTIONS INDIVIDUALLY. THE PROPOSITION THAT A N UMBER OF TRANSACTIONS CAN BE AGGREGATED AND CONSTRUED AS A C OMPOSITE TRANSACTION IN ORDER TO COMPUTE ALP ALSO FINDS ECHO IN THE OECD GUIDELINES UNDER CHAPTER III WHEREIN THE FOLLOWING EXTRACT IS RELEVANT IDEALLY, IN ORDER TO ARRIVE AT THE MOST PRECISE APPROXIMATION OF ARMS LENGTH CONDITIONS, THE ARMS LENGTH PRINCIPLE SHOULD BE APPLIED ON A TRANSACTION -BY- TRANSACTION BASIS. HOWEVER, THERE ARE OFTEN SITUATI ONS WHERE SEPARATE TRANSACTIONS ARE SO CLOSELY LINKED O R CONTINUOUS THAT THEY CANNOT BE EVALUATED ADEQUATELY ON A SEPARATE BASIS. EXAMPLES MAY INCLUDE 1. SOME LONG TERM CONTRACTS FOR THE SUPPLY OF COMMODITIES O R SERVICES, 2. RIGHTS TO USE INTANGIBLE PROPERTY, AND 3. PRICING A RANGE OF CLOSELY LINKED PRODUCTS (E.G. IN A PRODUCT LINE) WHEN IT IS IMPRACTICAL TO DETERMINE PRICING I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 29 FOR EACH INDIVIDUAL PRODUCT OR TRANSACTION. ANOTHER EXAMPLE WOULD BE THE LICENSING OF MANUFACTURING KNOW-HOW AND THE SUPPLY OF VITAL COMPONENTS TO AN ASSOCIATED MANUFACTURER; IT MAY BE MORE REASONABLE TO ASSESS THE ARM'S LENGTH TERMS FOR THE TWO ITEMS TOGETHER RATHER THAN INDIVIDUALLY. SUCH TRANSACTIONS SHOULD BE EVALUATED TOGETHER USING THE MOST APPROPRIATE ARM'S LENGTH METHOD. A FURTHER EXAMPLE WOULD BE THE ROUTING OF A TRANSACTION THROUGH ANOTH ER ASSOCIATED ENTERPRISE; IT MAY BE MORE APPROPRIATE T O CONSIDER THE TRANSACTION OF WHICH THE ROUTING IS AP ART IN ITS ENTIRETY, RATHER THAN CONSIDER THE INDIVIDUA L TRANSACTIONS ON A SEPARATE BASIS. 31. IN THIS BACKGROUND, CONSIDERING THE LEGISLATIVE INTENT MANIFESTED BY WAY OF RULE 10 A (D) READ WITH RULE 1 0 B OF THE RULES, IT CLEARLY EMERGES THAT IN APPROPRIATE CIRCU MSTANCES WHERE CLOSELY LINKED TRANSACTIONS EXIST, THE SAME SHOULD BE TREATED AS ONE COMPOSITE TRANSACTION AND COMMON TRANSFER PRICI NG ANALYSIS BE PERFORMED FOR SUCH TRANSACTIONS BY ADOPTING THE MOST APPROPRIATE METHOD. IN OTHER WORDS, IN A GIVEN CASE WHERE A NUMBER OF CLOSELY LINKED TRANSACTIONS ARE SOUGHT TO BE AGGREGATED FOR THE PURPOSE OF BENCHMARKING WITH COM PARABLE UNCONTROLLED TRANSACTIONS, SUCH AN APPROACH CAN BE SAID TO BE WELL ESTABLISHED IN THE TRANSFER PRICING REGULATION HAVING REGARD TO RULE 10 A (D) OF THE RULES. THOUGH IT IS NOT FEA SIBLE TO DEFINE THE PARAMETERS IN A WATERTIGHT COMPARTMENT AS TO WH AT TRANSACTIONS CAN BE CONSIDERED AS CLOSELY LINKED, S INCE THE SAME WOULD DEPEND ON FACTS AND CIRCUMSTANCES OF EACH CAS E. SO HOWEVER, AS PER AN EXAMPLE NOTED BY THE INSTITUTE O F CHARTERED ACCOUNTANTS OF INDIA (IN SHORT THE ICAI) IN ITS GUI DANCE NOTES ON TRANSFER PRICING IN PARA 13.7, IT IS STATED THAT TW O OR MORE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 30 TRANSACTIONS CAN BE SAID TO BE CLOSELY LINKED, IF T HEY EMANATE FROM A COMMON SOURCE, BEING AN ORDER OR CONTRACT OR AN AGREEMENT OR AN ARRANGEMENT, AND THE NATURE, CHARAC TERISTIC AND TERMS OF SUCH TRANSACTIONS SUBSTANTIALLY FLOW FROM THE SAID COMMON SOURCE. THE FOLLOWING EXTRACT FROM THE SAID GUIDANCE NOTES IS WORTHY OF NOTICE 13.7 THE FACTORS REFERRED TO ABOVE ARE TO BE APPLI ED CUMULATIVELY IN SELECTING THE MOST APPROPRIATE METH OD. THE REFERENCE THEREIN TO THE TERMS BEST SUITED AND M OST RELIABLE MEASURE INDICATES THAT THE MOST APPROPRIA TE METHOD WILL HAVE TO BE SELECTED AFTER METICULOUS AP PRAISAL OF THE FACTS AND CIRCUMSTANCES OF THE INTERNATIONAL TRANSACTION. FURTHER, THE SELECTION OF THE MOST APP ROPRIATE METHOD SHALL BE FOR EACH PARTICULAR INTERNATIONAL TRANSACTION. THE TERM TRANSACTION ITSELF IS DEFIN ED IN RULE 10 A (D) TO INCLUDE A NUMBER OF CLOSELY LINKED TRAN SACTIONS. THEREFORE, THOUGH THE REFERENCE IS TO APPLY THE MOS T APPROPRIATE METHOD TO EACH PARTICULAR TRANSACTION, KEEPING IN VIEW, THE DEFINITION OF THE TERM TRANSACTION, THE MOST APPROPRIATE METHOD MAY BE CHOSEN FOR A GROUP OF CLO SELY LINKED TRANSACTIONS. TWO OR MORE TRANSACTIONS CAN B E SAID TO BE LINKED WHEN THESE TRANSACTIONS EMANATE FROM A COMMON SOURCE BEING AN ORDER OR A CONTRACT OR AN AGREEMENT OR AN ARRANGEMENT IN THE NATURE, CHARACTE RISTICS AND TERMS OF THESE TRANSACTIONS ARE SUBSTANTIALLY F LOWING FROM THE SAID COMMON SOURCE. FOR EXAMPLE, A MASTER PURCHASE ORDER IS ISSUED STATING THE VARIOUS TERMS AND CONDITIONS AND SUBSEQUENTLY INDIVIDUAL ORDERS ARE R ELEASED FOR SPECIFIC QUANTITIES. THE VARIOUS PURCHASE TRANS ACTIONS ARE CLOSELY LINKED TRANSACTIONS. 13.8 IT MAY BE NOTED THAT IN ORDER TO BE CLOSELY LI NKED TRANSACTIONS, IT IS NOT NECESSARY THAT THE TRANSACT IONS NEED BE IDENTICAL OR EVEN SIMILAR.. I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 31 5.1.3 REVERTING TO THE FACTS OF THE PRESENT CASE, WE DO ACCEPT THE CONTENTIONS OF THE LD. AR THAT AGGREGATI ON/COMBINED TRANSACTIONS APPROACH CAN BE FOLLOWED BY THE TAXPAY ER AND THE SAME WILL BE IN ACCORDANCE WITH THE MANDATE OF RULE 10A (D) READ WITH RULE 10B. HOWEVER, IT IS OUR CONSIDERED O PINION THAT THE ONUS IS ESSENTIALLY ON THE ASSESSEE TO DEMONSTR ATE WITH AMPLE EVIDENCE THAT SUCH AN APPROACH IS JUSTIFIABLE IN ITS CASE. THE LD. DEPARTMENTAL REPRESENTATIVE HAS VEHEMENTLY ARGUED TO SUPPORT THE ORDER OF THE LD. TPO. HOWEVER, THE LD. TPO HAS NOT SPECIFICALLY COMMENTED ON THE COMBINED APPROACH ADO PTED BY THE ASSESSEE BUT HAS EXCLUDED THE INCOME FROM MARKE TING SUPPORT SERVICES AND PROFESSIONAL SERVICES FROM THE OPERATING INCOME OF THE ASSESSEE FOR THE PURPOSE OF COMPUTATI ON OF ARMS LENGTH PRICE. THE LD. TPO HAS COMMENTED THAT NONE O F THE COMPARABLES SELECTED BY THE ASSESSEE HAD EARNED COM MISSION INCOME WHEREAS THE ASSESSEE HAD SHOWN COMMISSION IN COME OF RS. 1,65,01,326/-. THE LD. CIT (APPEALS) HAS NOTED THAT BY ELIMINATING COMMISSION INCOME AND PROFESSIONAL SERV ICE INCOME THE LD. TPO HAD FAILED TO BENCHMARK THE INTERNATION AL TRANSACTION ITSELF WHICH HE WAS PURPORTING TO DO. T HE LD. CIT (APPEALS) HAS ALSO NOTED THAT THE COST RELATING TO THE EARNING OF I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 32 INCOME FROM PROFESSIONAL SERVICES HAS NOT BEEN EXCL UDED BY THE LD. TPO. ON THE OTHER HAND, THE ASSESSEE HAS ALSO N OT MADE OUT SPECIFIC CASE BY PRODUCING DUE EVIDENCES BEFORE US AS TO WHY THE RENDERING OF MARKETING SUPPORT SERVICES AND PROFESSIONAL SERVICES CAN BE CLASSIFIED AS CLOSELY LINKED TRANSACTIONS FOR THE PURPOSES OF RULE 10 A (D) OF T HE RULES. THEREFORE, IN OUR CONSIDERED OPINION, ON ONE HAND, THE APPROACH OF THE LD. TPO IN OUT RIGHTLY REJECTING TH E AGGREGATION OF THE TRANSACTIONS WAS FLAWED AS NO JUSTIFICATION HAS BEEN GIVEN BY THE LD. TPO FOR SUCH REJECTION. ON THE OTH ER HAND, AS STATED EARLIER, THE ASSESSEE ALSO HAS NOT BEEN ABLE TO MAKE OUT A STRONG CASE AS TO WHY THE RENDERING OF MARKETING SERVICES AND PROFESSIONAL SERVICES SHOULD BE CLASSIFIED AS CLOSE LY LINKED TRANSACTIONS. THEREFORE, CONSIDERING THE ENTIRETY O F FACTS AND CIRCUMSTANCES, WE ARE OF THE OPINION THAT THE ISSUE NEEDS TO BE REVISITED BY THE AO/TPO FOR RE-COMPUTING THE ALP IN RESPECT OF THE IMPUGNED INTERNATIONAL TRANSACTIONS AFTER DULY TAKING INTO CONSIDERATION THE MATERIAL SOUGHT TO BE RELIED UPON BY THE ASSESSEE IN RESPECT TO ADOPTING A COMBINED TRANSACT ION APPROACH AFTER CONSIDERING EACH OF THE TRANSACTIONS FOR THE PURPOSE OF DETERMINING AS TO WHETHER THE SAME ARE T O BE I.T.A. NO. 599/DEL/2012 ASSESSMENT YEAR 2005-06 33 BENCHMARKED AFTER AGGREGATION OR NOT. THE AO SHALL ALLOW THE ASSESSEE REASONABLE OPPORTUNITY TO SUBMIT MATERIAL AND SUBMISSIONS IN SUPPORT OF ITS THE STAND AND THEREAF TER PASS ORDER AFRESH ON THE ABOVE ASPECTS IN ACCORDANCE WIT H LAW. ACCORDINGLY, GROUND NUMBERS 2 AND 3 OF THE DEPARTME NTS APPEAL STAND ALLOWED FOR STATISTICAL PURPOSES. 6. IN THE FINAL RESULT, THE DEPARTMENT APPEAL STAND S PARTLY ALLOWED FOR STATISTICAL PURPOSES. ORDER IS PRONOUNCED IN THE OPEN COURT ON 12 TH MAY, 2017. SD/- SD/- (N.K. SAINI) (SUDHANSHU SR IVASTAVA) ACCOUNTANT MEMBER JUDICIAL MEMBER DATED: 12TH MAY 2017 GS COPY FORWARDED TO : 1. APPELLANT 2. RESPONDENT 3. CIT(A) 4. CIT 5. DR BY ORDER