Indian Additives Limited, CHENNAI V. ACIT, CHENNAI

ITA 703/CHNY/2009

• Counselvise Citation: [2011] 134 COUNSELVISE.COM (IT) 4913 (ITAT-CHENNAI)
• Duration Of Justice: 2 year(s) 1 month(s) 5 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 17-06-2011
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: A
• Next Hearing Date: 07-06-2011
• Assessment Year: 2004-2005
• Appeal Filed On: 12-05-2009
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: M VISWANATHAN
• Keywords: Depreciation; Transfer pricing; International transaction; Cost of acquisition; Revenue expenditure; Capital expenditure; Set aside
• Section: 92C

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL BENCH A CHENNAI (BEFORE SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER AND SHRI GEORGE MATHAN, JUDICIAL MEMBER) .. I.T.A. NO. 703/MDS/2009 ASSESSMENT YEAR : 2004-05 M/S INDIAN ADDITIVES LIMITED, EXPRESS HIGHWAY, MANALI, CHENNAI 600 068. PAN : AAACI1445G (APPELLANT) V. THE ASSISTANT COMMISSIONER OF INCOME TAX, COMPANY CIRCLE II(3), CHENNAI 600 034. (RESPONDENT) I.T.A. NO. 951/MDS/2009 ASSESSMENT YEAR : 2004-05 THE ASSISTANT COMMISSIONER OF INCOME TAX, COMPANY CIRCLE II(3), CHENNAI 600 034. (APPELLANT) V. M/S INDIAN ADDITIVES LIMITED, EXPRESS HIGHWAY, MANALI, CHENNAI 600 068. (RESPONDENT) ASSESSEE BY : SHRI M. VISWANATHAN REVENUE BY : SHRI SHA JI P. JACOB O R D E R PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER : THESE ARE APPEALS FILED BY THE ASSESSEE AND REVENU E RESPECTIVELY, FOR ASSESSMENT YEAR 2004-05, BOTH DIR ECTED AGAINST AN I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 2 ORDER DATED 27.3.2009 OF COMMISSIONER OF INCOME TAX (APPEALS)-XI, CHENNAI. 2. ASSESSEE IN ITS APPEAL HAS RAISED ONLY ONE ISSUE WHICH IS AGAINST THE DIRECTION OF THE CIT(APPEALS) THAT 75% OF THE ROYALTY EXPENDITURE ALONE SHOULD BE ALLOWED AS REVENUE EXPE NDITURE AND THE BALANCE HAS TO BE CONSIDERED AS CAPITAL EXPENDITURE . REVENUE IN ITS APPEAL HAS ALSO RAISED A RELATED ISSUE THAT THE CIT (APPEALS) ERRED IN ALLOWING 75% OF RUNNING ROYALTY CLAIMED, AS REVENUE EXPENDITURE. ONLY OTHER ISSUE ARISING IN REVENUES APPEAL IS REG ARDING DELETION OF ADDITION OF ` 1,22,19,429/- MADE ON ACCOUNT OF REVISION OF ARMS LENGTH PRICE. 3. WE WILL FIRST TAKE UP THE ISSUE REGARDING ROYALT Y. ASSESSEE HAD CLAIMED A SUM OF ` 2,75,24,000/- AS REVENUE OUTGO ON AMOUNTS PAID TO ONE M/S CHEVRON ORONITE COMPANY LLC, USA (COCL). AS PER THE ASSESSEE, THIS WAS RUNNING ROYALTY. THE A.O., HOWE VER, WAS OF THE OPINION THAT THIS WAS A CAPITAL EXPENDITURE, SINCE ASSESSEE HAD I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 3 ACQUIRED A RIGHT TO USE TECHNOLOGY AND TECHNICAL KN OW HOW FROM M/S COCL. HOWEVER, THE A.O. ALLOWED DEPRECIATION THERE OF. 4. IN ASSESSEES APPEAL BEFORE THE CIT(APPEALS), AR GUMENT OF THE ASSESSEE WAS THAT IT WAS A REVENUE EXPENDITURE AND SUCH PAYMENTS MADE TO M/S COCL WERE SEPARATE AND DISTINCT FROM LU MP SUM PAYMENTS OF ROYALTIES GIVEN TO M/S COCL. LD. CIT(A PPEALS) AFTER CONSIDERING SUBMISSION OF THE ASSESSEE, HELD THAT 7 5% OF THE PAYMENTS COULD BE CONSIDERED AS REVENUE EXPENDITURE AND ONLY 25% COULD BE DISALLOWED AS CAPITAL EXPENDITURE. FOR TH IS, HE PLACED RELIANCE ON THE ORDER OF HIS PREDECESSOR FOR ASSESS MENT YEAR 1999- 2000 IN ASSESSEES OWN CASE. 5. NOW BEFORE US, AS ALREADY MENTIONED, BOTH PARTIE S ARE AGGRIEVED. ASSESSEE IS AGGRIEVED THAT 25% OF THE P AYMENT WAS CONSIDERED AS CAPITAL EXPENDITURE, WHEREAS, REVENUE IS AGGRIEVED THAT 75% OF THE PAYMENT WAS ALLOWED AS REVENUE EXPE NDITURE BY THE CIT(APPEALS). LEARNED A.R. SUBMITTED THAT THIS TRI BUNAL IN ASSESSEES OWN CASE, ALLOWED THE CLAIM OF THE ASSES SEE AS REVENUE I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 4 EXPENDITURE FOR ASSESSMENT YEAR 1999-2000 TO 2002-0 3. COPY OF THE ORDER OF THIS TRIBUNAL IN I.T.A. NOS. 2138/MDS/2998 & 700 TO 702/MDS/2009 AND IN I.T.A. NOS. 2238/MDS/2008 & 971 TO 973/MDS/2009 DATED 13 TH NOVEMBER, 2009 WAS FILED. 6. LEARNED D.R. FAIRLY ADMITTED THAT THIS ISSUE STO OD DECIDED IN FAVOUR OF ASSESSEE. 7. WE HAVE PERUSED THE ORDERS AND HEARD THE RIVAL C ONTENTIONS. WE FIND THAT THE SAME ISSUE REGARDING ROYALTY PAYME NT MAD TO M/S COCL WAS CONSIDERED BY THIS TRIBUNAL IN THE ORDERS REFERRED SUPRA. IT WAS HELD BY THIS TRIBUNAL AT PARA 2.17 OF ITS ORDER DATED 13 TH NOVEMBER, 2009, AS UNDER:- 2.17 IN THE FACTS AND CIRCUMSTANCES OF THE CASE, WHEN THE ROYALTY PAYMENTS SHALL BE COMPUTED AT A PARTICULAR PER CENTAGE OF SALES PRICED, AND IF THERE WAS NO SALES, NO ROYALTY W OULD BE PAYABLE. MERELY BECAUSE GOODS WERE PRODUCED IN INDIA BY THE ASSESSEE ACQUIRING THE TECHNICAL PROCESS FROM THE F OREIGN COLLABORATOR, IT CANNOT BE SAID THAT THE ROYALTY PAYME NT IS REFERABLE TO THE PRODUCTION HOUSE / MANUFACTURING O F THE PRODUCTS. THE TECHNICAL KNOW-HOW FOR THE MANUFACTU RING PROCESS WAS ACQUIRED BY THE ASSESSEE AGAINST A LUMP SUM PAYME NT OF ROYALTY AND SUBSEQUENT TO THAT, IF THERE IS NO SALE O F THE PRODUCT MANUFACTURED BY THE ASSESSEE, THEN THERE WOULD BE NO ROYALTY I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 5 PAYABLE. THUS, THE RUNNING ROYALTY PAYABLE HAS NO NEXU S OR DIRECT CONNECTION WITH THE MANUFACTURE OF THE PRODUCT. TH E LIABILITY TO PAY THE ROYALTY ARISES ONLY WHEN THERE IS A SALE. THER EFORE, WE ARE OF THE VIEW THAT THE RUNNING ROYALTY CANNOT BE SA ID TO BE A CAPITAL EXPENDITURE. WE DO NOT FIND ANY RATIONALE I N BIFURCATION OF THE RUNNING ROYALTY AND TREATING ONE PART AS CAPIT AL AND THE OTHER PART AS REVENUE BY THE LEARNED COMMISSIONER OF INCOME TAX (APPEALS) WITHOUT ANY BASIS. THE DECISION RELIE D UPON BY THE LEARNED COMMISSIONER OF INCOME TAX (APPEALS) IS ON THE FACTS THAT THE ASSESSEE COULD CONTINUE TO USE THE TECHNOL OGY EVEN AFTER THE EXPIRY OF THE PERIOD OF PAYMENT OF ROYALTY. THEREFORE, WHEN THE LUMP SUM ROYALTY WAS SEPARATELY AGREED AND PA ID, THEN THE RUNNING ROYALTY, IN THE FACTS AND CIRCUMSTANCES, WOULD ONLY BE A REVENUE EXPENDITURE PAID FOR THE USE OF THE LICEN CE, TRADE MARK AND TECHNICAL INFORMATION FOR A PARTICULAR PERIOD. ACCORDINGLY, THIS ISSUE IS DECIDED IN FAVOUR OF THE ASSESSEE AND AGAINST THE REVENUE. 8. RESPECTFULLY FOLLOWING THE ORDER OF THIS TRIBUNA L FOR THE EARLIER ASSESSMENT YEARS, CLAIM OF THE ASSESSEE HAS TO BE A LLOWED FOR THE IMPUGNED ASSESSMENT YEAR AS WELL. HENCE, APPEAL OF THE ASSESSEE FOR ASSESSMENT YEAR 2004-05 STANDS ALLOWED, WHEREAS , THE RELATED GROUND OF THE REVENUE STANDS DISMISSED. 9. COMING TO THE ONLY OTHER ISSUE, WHICH IS RAISED BY THE REVENUE REGARDING ADJUSTMENT TOWARDS ARMS LENGTH PRICE, SHO RT FACTS APROPOS ARE THAT ASSESSEE HAD ENTERED INTO CERTAIN TRANSACT IONS WITH RELATED I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 6 PARTIES WHICH, INTER ALIA, INCLUDED PURCHASE OF RAW MATERIALS, PURCHASE OF FINISHED GOODS, SALE OF FINISHED GOODS, LIAISON ACTIVITIES, ROYALTY AND TECHNICAL SERVICES CHARGES. SUCH RELATED PARTIES B EING SITUATED IN SINGAPORE, FRANCE AND USA, ASSESSING OFFICER MADE A REFERENCE UNDER SECTION 92CA OF INCOME-TAX ACT, 1961 (HEREINA FTER CALLED THE ACT) TO THE TRANSFER PRICING OFFICER (TPO). IT IS TO BE NOTED THAT ASSESSEE HAD FILED FORM NO.3CEB CERTIFIED BY ITS ST ATUTORY AUDITORS AS PRESCRIBED UNDER RULE 10E OF INCOME-TAX RULES, 1 962, FOR THE INTERNATIONAL TRANSACTIONS ENTERED INTO BY IT, DURI NG THE RELEVANT PREVIOUS YEAR. ASSESSEE IS A JOINT VENTURE OF M/S COCL, USA AND CHENNAI PETROLEUM CORPORATION LIMITED, BOTH HOLDING EQUAL NUMBER OF SHARES NUMBERING 11,83,401 OF WHICH FACE VALUE W AS ` 100/- EACH. ASSESSEE WAS MANUFACTURING ADDITIVES AND SUPPLYING IT TO FUEL AND LUBRICANT COMPANIES. SUCH ADDITIVES WERE BLENDED W ITH LUBRICANTS BY ITS BUYERS AND THEN SOLD. ASSESSEE IS LICENSED TO MANUFACTURE AND SUPPLY ORONITE FUEL AND LUBRICANT PRODUCTS. SINCE 50% OF THE SHARE HOLDING OF THE ASSESSEE RESTED WITH COCL, USA, THE OTHER SUBSIDIARY COMPANIES OF COCL IN SINGAPORE AND FRANCE ALSO BECA ME I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 7 ASSOCIATED ENTERPRISES. DURING THE RELEVANT PREVIO US YEAR, ASSESSEE PURCHASED RAW MATERIALS AND FINISHED GOODS FROM COC L, SINGAPORE AND FINISHED GOODS ALONE FROM COCL, FRANCE. IT HAD ALSO EFFECTED SALE OF FINISHED GOODS TO COCL, SINGAPORE. IN ADDI TION, IT WAS HAVING CERTAIN TRANSACTIONS WITH COCL, SINGAPORE FOR LIAIS ON ACTIVITIES, AND ALSO TRANSACTIONS RELATING TO ROYALTY AND TECHNICAL SERVICE WITH COCL, USA. PURCHASE OF RAW MATERIALS FROM COCL, SINGAPOR E, WAS OF THE VALUE OF ` 13,55,90,154, WHICH WAS IN ADDITION TO PURCHASE OF FINISHED GOODS ` 4,66,66,369/- FROM THE SAME ASSOCIATED ENTERPRISE. PURCHASE OF FINISHED GOODS FROM COCL, FRANCE CAME T O ` 63,48,769/-. THESE TOGETHER, TOTALLED TO ` 18,86,05,292/-. AS PER THE ASSESSEE, THE PURCHASE OF RAW MATERIALS FROM COCL, SINGAPORE OF ` 13,55,90,154/- CONSISTED OF TWO SPECIFIC ITEMS ON W HICH COMPARABLES EXISTED AND ARMS LENGTH PRICE WAS COMPUTED AND GIVE N IN FORM NO. 3CEB FILED. IT HAD WORKED OUT ARMS LENGTH PRICE VI S--VIS THE ABOVE PURCHASE OF ` 13,55,90,154/- AT ` 18,16,05,784/- BASED ON COMPARABLE THIRD PARTY TRANSACTIONS LISTED IN ANNEX URE 2(B) OF THE SAID FORM. THE COMPARISON OF PRICE OF THESE TWO RA W MATERIALS, WERE I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 8 WITH PURCHASE EFFECTED BY M/S HERDILLA SCHENECTADY AND M/S LUBRIZOL INDIA PVT. LTD. THUS, IN SO FAR AS THESE TWO RAW M ATERIALS WERE CONCERNED, ASSESSEE HAD ADOPTED A COMPARABLE UNCONT ROLLED PRICE (CUP) METHOD FOR FIXING THE ARMS LENGTH VALUE. SIN CE SUCH VALUE WAS HIGHER THAN THE PRICES PAID BY THE ASSESSEE TO ITS ASSOCIATED ENTERPRISES, NO ADJUSTMENT WHATSOEVER WAS MADE. VI S--VIS PURCHASE OF FINISHED GOODS FROM COCL SINGAPORE AND FRANCE, ASSESSEE ADOPTED RESALE PRICE METHOD BY WORKING OUT THE INTERNAL GROSS PROFIT MARGIN AS GIVEN BY IT AT ANNEXURE-2(D) OF FORM 3CEB. THOUGH THE ASSESSEE HAD TRANSACTIONS OF SALE OF FIN ISHED GOODS, LAISION, ROYALTY AND TECHNICAL SERVICES WITH ASSOCI ATED ENTERPRISES, ONLY THE ABOVE TRANSACTIONS OF PURCHASE OF RAW MATE RIALS AND FINISHED GOODS WERE CONSIDERED BY THE TPO, UNDER THE TRANSAC TIONAL NET MARGIN (TNM) METHOD HE ADOPTED FOR COMPUTING THE AR MS LENGTH PRICE. IN OTHER WORDS, AS FAR AS OTHER TRANSACTION S WERE CONCERNED, THE TPO ACCEPTED THE ARMS LENGTH PRICE WORKED OUT B Y THE ASSESSEE FOR COMPARISON. DURING THE COURSE OF PROCEEDINGS, BEFORE THE TPO, ASSESSEE GAVE SUBMISSIONS JUSTIFYING THE METHOD FOL LOWED BY IT IN I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 9 VALUING THE INTERNATIONAL TRANSACTIONS. THE TPO WA S OF THE OPINION THAT THE PRICES CHARGED IN RESPECT OF INTERNATIONAL TRANSACTIONS RELATING TO PURCHASE OF RAW MATERIALS AND FINISHED GOODS WER E NOT IN ACCORDANCE WITH SUB-SECTION (1) AND (2) OF SECTION 92C OF THE ACT. ACCORDING TO THE TPO, ASSESSEE HAD PURCHASED 15 ITE MS OF RAW MATERIALS FROM ASSOCIATED ENTERPRISES, BUT, ONLY TW O ITEMS WERE CONSIDERED WHILE ADOPTING CUP METHOD OF COMPARISON. ASSESSEE HAD SUBMITTED BEFORE THE TPO THAT NO COMPARABLE DET AILS WERE AVAILABLE REGARDING 13 ITEMS OUT OF 15 ITEMS SUPPLI ED BY THE ASSOCIATED ENTERPRISES SINCE THESE WERE PROPRIETORY IN NATURE. TPO BEING NOT SATISFIED WITH THE METHODOLOGY ADOPTED BY THE ASSESSEE, MADE A SEARCH IN THE INTERNET AND IDENTIFIED ONE CO MPANY NAMED M/S INTERFLON INDIA PVT. LTD. (IIP) AS A COMPARABLE ENT ITY. THE FINANCIAL ACCOUNTS OF THE SAID COMPANY WERE FURNISHED TO THE ASSESSEE AND IT WAS REQUIRED TO COMPUTE ARMS LENGTH PRICE IN RELATI ON TO ITS INTERNATIONAL TRANSACTION BASED ON TRANSACTIONAL NE T MARGIN METHOD. ASSESSEE, HOWEVER, WAS OF THE OPINION THAT M/S IIP WAS DOING BUSINESS IN SMALL QUANTITIES AND IT HAD VERY SMALL TURNOVER WHEN I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 10 COMPARED TO ASSESSEE. FURTHER, AS PER THE ASSESSEE , M/S IIP WAS SUPPLYING ONLY FROM THE OLD STOCK AND NONE OF ASSES SEES CUSTOMERS HAD PURCHASED ANY ITEM FROM M/S IIP. TPO ADDRESSED A LETTER TO M/S IIP FOR THE DETAILS OF ITS OWNERSHIP AND FOR ASCERT AINING POSSIBILITY OF ANY TRANSACTION WITH ITS ASSOCIATED ENTERPRISES, WH EREUPON M/S IIP REPLIED THAT IT WAS AN INDEPENDENT COMPANY HELD BY INDIAN PROMOTERS AND HAD NO RELATED PARTIES TRANSACTIONS AT ALL. NE VERTHELESS, IT WAS ALSO CONFIRMED BY M/S IIP THAT IN THE RELEVANT PREV IOUS YEAR, IT HAD ONLY SMALL CUSTOMERS AND ONLY ONE MAJOR CUSTOMER WA S M/S BENNET COLMAN & CO. LTD., MUMBAI. THE TPO REJECTED THE CO NTENTION OF THE ASSESSEE THAT ITS TURNOVER COULD NOT BE COMPARED WI TH THAT OF M/S IIP, FOR, ACCORDING TO HIM, THIS WAS NOT A CRITERIA TO B E ADOPTED FOR SELECTING A COMPARABLE CONCERN. THEREAFTER HE MADE THE FOLLOWING COMPARISON BETWEEN FINANCIAL RESULTS OF ASSESSEE AN D M/S IIP:- INDIAN ADDITIVES LTD.(ASSESSEE) MAR 2004 INTERFLON (INDIA) PVT. LTD. 2004 RS. CRORE (NON- ANNUALISED) 12 MTHS INCOME SALES 1203600000 SALES 1400227 I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 11 OTHER INCOME 5600000 OTHER INCOME 220629 TOTAL INCOME 1209200000 TOTAL INCOME 1620856 EXPENDITURE EXPENDITURE RAW MATERIALS, STORES, ETC. 779300000 COST OF MATERIALS 412349 WAGES & SALARIES 62500000 EMPLOYEE COST 186846 ENERGY (POWER & FUEL) 41500000 PACKING COST 55231 INDIRECT TAXES (EXCISE, ETC.) 176000000 ADVERTISING & MARKETING EXPENSES 0 DISTRIBUTION EXPENSES 0 OTHERS 97000000 OTHER EXP 608844 DEPRECIATION 54000000 DEPRECIATION 85265 STOCKS - 19300000 STOCK 162126 TOTAL EXPENDITURE 1191000000 TOTAL EXPENDITURE 1510661 OPERATING PROFIT 18200000 OPERATING PROFIT 110195 OP/SALES 1.512130276 OP/SALES 7.869795397 THEREAFTER, HE PROCEEDED TO DO A FUNCTIONAL, RISK A ND ASSET ANALYSIS (FAR) OF THE TWO COMPANIES AND CAME TO A CONCLUSION THAT BOTH THE ENTITIES WERE PERFORMING SIMILAR FUNCTIONS, UNDERTA KING SIMILAR RISKS AND HAVING SIMILAR ASSETS. A.O., THEREAFTER APPLIE D THE PROFIT MARGIN OF 7.87% OF M/S IIP, ON THE PURCHASE COST OF RAW MA TERIALS AND FINISHED GOODS TOTALLING TO ` 18,86,05,292 AFTER AGGREGATING IT WITH PROFIT MARGIN OF 1.51% OF THE ASSESSEE-COMPANY, AND ARRIVED AT AN I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 12 ARMS LENGTH PURCHASE PRICE OF ` 17,63,85,863/-. COMPUTATION MADE BY THE TPO IS REPRODUCED HEREUNDER:- COMPUTATION OF ARMS LENGTH PRICE : PURCHASE PRICE OF RAW MATERIALS & FINISHED GOODS (A) : 18,86,05,292 PROFIT MARGIN OF ASSESSEE COMPANY (B) @ 1.51% : 28,47,940 SALE PRICE RELATABLE TO AE PURCHASES (A+B) (C) : 191453232 ARMS LENGTH PROFIT MARGIN @ 7.87% (D) : 15067369 ARMS LENGTH PURCHASE PRICE (C-D) (E) : 176385863 DIFFERENCE IN PRICE (A-E) (F) : 12219429 HE, THEREFORE, DIRECTED THE A.O. TO ADJUST THE TOTA L INCOME OF THE ASSESSEE UPWARDLY BY A SUM OF ` 1,22,19,429/-. 10. IN ITS APPEAL BEFORE THE CIT(APPEALS), ARGUMENT OF THE ASSESSEE WAS THAT RAW MATERIALS PURCHASED FOR ` ` 13,55,90,154/- FROM COCL, SINGAPORE, HAD TWO COMPARABLES AND BASED ON SUCH COMPARABLES, THE ARMS LENGTH PRICE WAS DETERMINED A DOPTING CUP METHOD. AS PER THE ASSESSEE, SUCH ARMS LENGTH PRIC E WAS MUCH HIGHER THAN WHAT WAS PAID BY THE ASSESSEE AND HENCE , THERE WAS NO QUESTION OF ANY ADJUSTMENT WHATSOEVER. FURTHER, AS PER THE I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 13 ASSESSEE, TPO HAD MADE ADJUSTMENT ON PURCHASE PRICE S OF TWO RAW MATERIALS ON WHICH COMPARABLES WERE EXISTING, ON A REASONING THAT THERE WERE NO COMPARABLES FOR OTHER RAW MATERIALS P URCHASED, WHICH WERE PROPRIETARY IN NATURE. IN SO FAR AS PURCHASE OF FINISHED GOODS WAS CONCERNED, EXPLANATION OF THE ASSESSEE WAS THAT THESE WERE ALL PROPRIETARY GOODS MANUFACTURED BY COCL, SINGAPORE A ND FRANCE AND NEVER PRODUCED BY ANY OTHER COMPANY NOR AVAILAB LE IN OPEN MARKET. THEREFORE, ACCORDING TO ASSESSEE, IT HAD A DOPTED RESALE PRICE FOR FINDING THE ARMS LENGTH PRICE. ASSESSEE POINTED OUT BEFORE LD. CIT(APPEALS) THAT RESALE OF SUCH FINISHED GOODS WERE EFFECTED ONLY TO THIRD PARTIES AND HENCE, REDUCING GROSS PROFIT F ROM SUCH RESALE PRICES WAS A GOOD AND CORRECT METHOD FOR FIXING ARM S LENGTH PRICE. VIS--VIS COMPARISON MADE BY THE TPO WITH M/S IIP, ASSESSEE POINTED OUT THAT THE SAID M/S IIP WAS 100% INDIAN C OMPANY, WHEREAS, ASSESSEE WAS AN EQUAL COLLABORATION BETWEE N A PUBLIC SECTOR UNDERTAKING AND FOREIGN COMPANY. ASSESSEE A LSO BROUGHT TO THE ATTENTION OF LD. CIT(APPEALS) THAT M/S IIP WAS ONLY DOING PURCHASE OF MATERIAL AND SELLING IT AFTER REPACKAGING. AS P ER THE ASSESSEE, I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 14 SALES EFFECTED BY M/S IIP WERE ONLY TO VERY SMALL C USTOMERS. ASSESSEE POINTED OUT TO LD. CIT(APPEALS) THAT M/S I IP WAS SUPPLYING ADDITIVES AND LUBRICANTS TO FOOD INDUSTRIES, WHEREA S, ADDITIVES AND LUBRICANTS SUPPLIED BY THE ASSESSEE WERE FOR AUTOMO BILE INDUSTRIES. HENCE, ACCORDING TO IT, BOTH THE COMPANIES WERE ENG AGED IN TOTALLY DIFFERENT TYPE OF BUSINESS. IN A NUTSHELL, ITS ARG UMENT WAS THAT M/S IIP WAS NEITHER COMPARABLE IN TERMS OF INDUSTRY SERVICE D, PRODUCTS DEALT WITH AND SIZE OF BUSINESS OPERATIONS. RELIANCE WAS PLACED ON THE DECISION OF HON'BLE DELHI HIGH COURT IN THE CASE OF SONY INDIA LTD. (288 ITR 52) AND THAT OF SPECIAL BENCH OF THIS TRIB UNAL IN THE CASE OF AZTEC SOFTWARE AND TECHNOLOGY SERVICES [294 ITR (AT ) 32]. 11. LD. CIT(APPEALS) AFTER GOING THROUGH THE SUBMIS SION OF THE ASSESSEE, CAME TO A CONCLUSION THAT M/S IIP WAS DOI NG BUSINESS IN FOOD INDUSTRY, WHEREAS, ASSESSEE WAS IN AUTOMOBILE INDUSTRY AND HENCE, THESE TWO COMPANIES COULD NOT BE COMPARED AT ALL. ACCORDING TO HIM, THE SIZE OF OPERATIONS ALSO HAD GREAT BEARI NG AND M/S IIP WAS HAVING ONLY INSIGNIFICANT TURNOVER WHEN COMPARED TO THAT OF THE ASSESSEE. LD. CIT(APPEALS) ALSO NOTED THAT FOR SUB SEQUENT I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 15 ASSESSMENT YEAR 2005-06, THE TPO HAD HELD THAT NO A DJUSTMENT WAS NECESSARY IN THE INTERNATIONAL TRANSACTION ENTERED INTO BY THE ASSESSEE. FOR THESE REASONS, HE DELETED THE ADDITI ON MADE BY THE A.O. BASED ON THE ORDER OF THE TPO. 12. NOW BEFORE US, LEARNED D.R., STRONGLY ASSAILING THE ORDER OF LD. CIT(APPEALS), SUBMITTED THAT M/S IIP WAS DOING A CO MPARABLE BUSINESS AND SUPPLYING ADDITIVES. ACCORDING TO HIM , ASSESSEE HAD NOT GIVEN ANY GOOD COMPARABLE CASE FOR THE RAW MATE RIALS PURCHASED FROM ITS ASSOCIATED ENTERPRISES ABROAD, CLAIMING TH AT 13 OUT OF 15 ITEMS PURCHASED WERE OF PROPRIETARY NATURE. ACCORD ING TO LEARNED D.R., ASSESSING OFFICER HAD FOUND THE CASE OF M/S I IP TO BE SIMILAR AND MADE A FAR ANALYSIS AND PROPERLY CAME TO A CONC LUSION THAT TRANSACTION NET MARGIN METHOD WAS APPROPRIATE FOR V ALUING THE INTERNATIONAL TRANSACTIONS OF THE ASSESSEE. 13. PER CONTRA, LEARNED A.R. SUBMITTED THAT THE TPO HAD APPLIED THE PROFIT MARGIN WORKED OUT FROM THE FINANCIALS OF M/S IIP, ON COST OF RAW MATERIALS AND FINISHED GOODS PURCHASED. AS PER THE LEARNED I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 16 A.R., APPLICATION OF TNM METHOD WAS UNCALLED FOR WH EN THE ASSESSEE HAD GIVEN THE SPECIFIC COMPARABLES AND ADOPTED CUP METHOD. ACCORDING TO HIM, WITHOUT REJECTING THE COMPARABLES GIVEN BY THE ASSESSEE, THE TPO HAD ARBITRARILY ADOPTED TNM METHO D THAT TOO BASED ON THE FINANCIALS OF A SMALL COMPANY NOT AT A LL COMPARABLE WITH THAT OF THE ASSESSEE. RELYING ON THE COMPARISON TA BLE OF FINANCIALS, GIVEN AT PARA 7.4 OF TPOS ORDER, LEARNED A.R. SUBM ITTED THAT IF THE OTHER INCOME OF ` 2,20,629/- WAS EXCLUDED FROM THE PROFITS OF M/S II P, IT WOULD RESULT IN NEGATIVE MARGIN. ACCORDING TO H IM, NOT ONLY WAS THE TURNOVER OF M/S IIP NEGLIGIBLY SMALL, BUT IT WAS AL SO CATERING TO DIFFERENT INDUSTRIAL FIELD. LEARNED A.R. ARGUED TH AT TPO HAD ADOPTED THE TNM METHOD WITHOUT MAKING PROPER ANALYSIS AND W ITHOUT REJECTING THE CUP AND RESALE PRICE METHOD ADOPTED B Y THE ASSESSEE. ACCORDING TO HIM, CIT(APPEALS) WAS JUSTI FIED IN DELETING THE ADDITION MADE. 14. WE HAVE PERUSED THE ORDERS AND HEARD THE RIVAL CONTENTIONS. TPO HAD RELIED ON FINANCIALS OF M/S IIP WHICH HE CO NSIDERED TO BE A COMPARABLE COMPANY AND WORKED OUT THE PROFIT MARGIN WHICH CAME TO I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 17 7.87% AND APPLIED IT ON PURCHASE PRICE PAID BY THE ASSESSEE FOR RAW MATERIALS AND FINISHED GOODS PURCHASED BY IT FROM I TS ASSOCIATED ENTERPRISES AFTER AGGREGATING THE PROFIT MARGIN THE RETO. IN THE FIRST PLACE, WHAT WE FIND IS THAT THE TPO HAD APPLIED TRA NSACTION NET MARGIN METHOD ON THE PURCHASE PRICES OF RAW MATERIA LS AND FINISHED GOODS AS UNDER:- PURCHASE PRICE OF RAW MATERIALS FROM M/S COCL, SINGAPORE : ` 135590154 PURCHASE PRICE OF FINISHED GOODS FROM M/S COCL, SINGAPORE : ` 46666369 PURCHASE PRICE OF FINISHED GOODS FROM M/S COCL, FRANCE : ` 6348769 TOTAL (A) : ` 188605292 PROFIT MARGIN OF ASSESSEE-COMPANY (1.51%) (B) : ` 2847940 PRICE ATTRIBUTABLE TO AE AS PER ASSESSEE (A+B) : ` 191453232 PROFIT MARGIN OF 7.87% (TAKEN FROM THE FINANCIALS OF M/S IIP) IF APPLIED TO A+B : ` 15067369 ARMS LENGTH PRICE (A+B) PROFIT MARGIN ` 15067369/- : ` 176385863 DIFFERENCE IN PRICE (A ` 176385863) : ` 12219429 WE FIND ONE MAJOR ERROR COMMITTED BY THE TPO IN ABO VE WORK OUT. AGAINST THE PURCHASE OF RAW MATERIALS FOR ` 135590154/- AS APPEARING IN FORM NO.3CEB SUBMITTED BY THE ASSESSEE RELATING TO ITS I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 18 INTERNATIONAL TRANSACTIONS, IT HAD SPECIFICALLY STA TED THAT THESE WERE TWO ITEMS, NAMELY, DODECYL PHENOL AND ZINC DI THIO PHOSPHATES FROM THE AES. ASSESSEE HAD ALSO COMPUTED ARMS LENG TH VALUE OF SUCH PURCHASE BY ADOPTING CUP METHOD AND FOR SUCH C UP METHOD, IT HAD GIVEN SPECIFIC COMPARABLES OF TWO UNRELATED PAR TIES, NAMELY, HERDILLIA SCHENECTADY AND LUBRIZOL INDIA PVT. LTD. VIDE ANNEXURE-2(B) OF THE SAID FORM, DULY CERTIFIED BY ITS AUDITORS. THE TPO DID NOT GIVE ANY REASON WHY HE REJECTED THE CUP METHOD ADOPTED B Y THE ASSESSEE WHEN ASSESSEE COULD SHOW THAT SUCH CUP MET HOD WAS BASED ON PRICES CHARGED OR PAID IN A COMPARABLE UNC ONTROLLED TRANSACTION. ON THE OTHER HAND, WE FIND THAT THE T PO HAD REJECTED THE METHOD ADOPTED BY THE ASSESSEE ON A FINDING THA T OUT OF 15 RAW MATERIALS IMPORTED, ASSESSEE COULD NOT GIVE COMPARI SON IN 13 ITEMS, BUT, ONLY FOR THE ABOVE TWO ITEMS. IF THAT WAS SO , THEN THE ADJUSTMENT THAT SHOULD HAVE BEEN CARRIED OUT WAS ON SUCH 13 IT EMS OF RAW MATERIALS ON WHICH NO COMPARABLES WERE GIVEN BY THE ASSESSEE AND NOT FOR THE TWO ITEMS OF RAW MATERIALS WHERE THE AS SESSEE COULD GIVE SPECIFIC COMPARABLES ADOPTING CUP METHOD. EVEN FOR THOSE 13 I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 19 ITEMS, ASSESSEE HAS SPECIFICALLY MENTIONED THAT THE SE WERE NOT AVAILABLE IN THE MARKET AND NO COMPARABLE WERE THER E AT ALL. THUS, WE DO NOT FIND ANY PROPER REASON WHY THE TPO COULD REJECT THE METHOD ADOPTED BY THE ASSESSEE AND APPLY THE TNM ME THOD BASED ON THE FINANCIAL OF M/S IIP. AGAIN, IF WE LOOK AT FINANCIAL OF M/S IIP REPRODUCED BY US AT PARA 9 ABOVE, ITS SALES WERE OF ` 14 LAKHS AND ODD AGAINST THE SALES IN EXCESS OF ` 120 CRORES OF THE ASSESSEE. THE SAID M/S IIP HAD NOT PAID ANY EXCISE DUTY AND INDIR ECT TAXES, BUT, HAD INCURRED ONLY PACKING COST IN ADDITION TO COST OF M ATERIALS. AS AGAINST THIS, ASSESSEE HAD PAID INDIRECT TAXES OF ABOUT ` 60 LAKHS. OBVIOUSLY, M/S IIP WAS NOT ENGAGED IN ANY MAJOR MANUFACTURING ACTIVITY NOR IT HAD A COMPARABLE TURNOVER. THERE WERE SUBSTANTIAL DIFFERENCES IN THE FINANCIAL DATA OF THE TWO COMPANIES WHICH CONSIDERA BLY ERODED THE DEGREE OF COMPARABILITY BETWEEN THE TWO. THUS, THE TPO NOT ONLY ADOPTED THE TNM METHOD WITHOUT REJECTING THE CUP ME THOD FOLLOWED BY THE ASSESSEE, BUT ALSO MADE ADDITION BASED ON TH E FINANCIAL RESULTS OF AN UNCOMPARABLE ENTITY. I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 20 15. NOW, COMING TO THE OTHER ITEMS WHICH WERE PURCH ASED NAMELY FINISHED GOODS, ASSESSEE HAD ADOPTED RESALE PRICE M ETHOD FOR FIXING THE ALP. THE PURCHASES OF FINISHED GOODS WERE FROM M/S COCL, SINGAPORE AND COCL, FRANCE AND FOR ARRIVING AT ARMS LENGTH PRICE, ASSESSEE ADOPTED THE RESALE PRICE METHOD BY DEDUCTI NG A GROSS PROFIT MARGIN OF 12.746% FROM THE RESALE PRICE OF SUCH FIN ISHED GOODS TO UNRELATED PARTIES. THE WORKING OF GROSS PROFIT HAS BEEN GIVEN IN ANNEXURE-2(D) OF FORM 3CEB SUBMITTED BY THE ASSESSE E. GROSS PROFIT MARGIN OF 12.746% HAS BEEN WORKED OUT BY THE ASSESSEE FROM ITS OWN FINANCIALS BY AVERAGING THE RESULTS FOR FIN ANCIAL YEARS 2002-03 AND 2003-04. IN OTHER WORDS, IT HAS AVERAGED THE G ROSS PROFIT OF TWO YEARS AND DEDUCTED SUCH AVERAGE GROSS PROFIT RATE F ROM THE RESALE PRICE, TO ARRIVE AT ARMS LENGTH PRICE. NOW, IF WE LOOK AT RESALE PRICE METHOD GIVEN IN CLAUSE (B) OF SUB-RULE (1) OF RULE 10B, THE PRICE AT WHICH THE GOODS ARE SOLD TO UNRELATED PARTIES HAS T O BE ADJUSTED BY THE AMOUNT OF NORMAL GROSS PROFIT MARGIN AND SUCH N ORMAL GROSS PROFIT MARGIN HAS TO COME OUT OF COMPARABLE OF UNCO NTROLLED TRANSACTIONS, WHETHER THAT OF ASSESSEE OR OF ANOTHE R SIMILARLY PLACED I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 21 ENTITY. CAN WE SAY THAT ASSESSEE HAS WORKED OUT TH E GROSS PROFIT MARGIN BASED ON ANY COMPARABLE UNCONTROLLED TRANSAC TION? ASSESSEE HAD MADE A WORKING BASED ON ITS OWN GROSS PROFIT RATE INCLUDING THAT OF THE TRANSACTIONS RELATED TO THE A ES AND WE CANNOT UNDERSTAND HOW AN ADJUSTMENT MADE ON SUCH GROSS PRO FIT RATE, AVERAGED FOR TWO YEARS COULD RESULT IN ANY VARIATIO N. IT IS ONLY A REVERSE WORKING OF ITS OWN RESULTS. THE PRIMARY PR INCIPLE BEHIND DETERMINING THE ARMS LENGTH PRICE IS THAT THE COMPA RISON SHOULD COME FROM UNCONTROLLED TRANSACTIONS. WHEN THE COMPARISO N DOES NOT COME FROM UNCONTROLLED TRANSACTIONS, THEN SUCH COMPARISO N CANNOT GIVE ANY RATIONALE RESULTS. NO DOUBT, IN SO FAR AS PURC HASE OF RAW MATERIALS FROM ASSOCIATED ENTERPRISES ARE CONCERNED , THOUGH THE TPO COMMITTED A MISTAKE IN APPLYING TNM METHOD BASI NG HIMSELF ON THE WORKING RESULTS OF AN UNCOMPARABLE ENTITY, AS A LREADY HELD BY US, WE FIND THAT NO CONSIDERATION WHATSOEVER HAS BEEN G IVEN BY ANY OF THE AUTHORITIES BELOW REGARDING THE CORRECTNESS OR APPROPRIATENESS OF THE RESALE PRICE METHOD ADOPTED BY THE ASSESSEE IN COMPUTING THE ARMS LENGTH PRICE RELATABLE TO PURCHASE OF FINISHED GOODS. THE MOST I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 22 IMPORTANT STEP WHEN RESALE PRICE METHOD IS ADOPTED FOR DETERMINING THE ARMS LENGTH PRICE OF PURCHASES FROM ASSOCIATED ENTERPRISES IS THE REDUCTION OF GROSS PROFIT MARGIN FROM THE RESALE PR ICE. SUCH GROSS PROFIT MARGIN CAN BE DETERMINED IN ANY OF THE TWO M ETHODS. FIRST IS THE GROSS PROFIT MARGIN OF THE ASSESSEE ITSELF. BU T WHEN GROSS PROFIT MARGIN OF THE ASSESSEE ITSELF IS CONSIDERED, THEN S UCH GROSS PROFIT MARGIN HAS TO BE WORKED OUT EXCLUDING THE PURCHASES FROM THE ASSOCIATED ENTERPRISES AND SALES THEREOF. OTHERWIS E, AS ALREADY POINTED OUT BY US, IT WILL BE MEANINGLESS. HOWEVER , HERE MORE THAN 70% OF ASSESSEES SALES WERE OUT OF PURCHASES SOURC ED FROM ASSOCIATED ENTERPRISES, AND HENCE WORKING OUT THE G ROSS PROFIT MARGIN INTERNALLY, AFTER EXCLUDING SUCH TRANSACTIONS, WOUL D BE INAPPROPRIATE DUE TO NEGLIGIBLE QUANTITIES OF BALANCE PURCHASES A ND SALES. HENCE, IN SUCH CASES, THE GROSS PROFIT MARGIN SHOULD BE TA KEN FROM COMPARABLE UNCONTROLLED TRANSACTIONS ENTERED INTO B Y SIMILARLY PLACED CONCERNS. THUS, THE ASSESSEE HAS COMMITTED TWO FUN DAMENTAL MISTAKES IN WORKING OUT THE ARMS LENGTH PRICE BASED ON RESALE PRICE METHOD. IT WENT BY ITS INTERNAL GROSS PROFIT RATE AVERAGED OVER TWO I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 23 YEARS, THAT TOO WITHOUT EXCLUDING THE PURCHASES AND SALES FROM THE ASSOCIATED ENTERPRISES. NEITHER THE A.O. NOR THE T PO WENT INTO THIS ASPECT BUT SIMPLY APPLIED TNM METHOD, THAT TOO BASE D ON A SINGLE COMPARABLE, WHICH AS ALREADY MENTIONED BY US WAS NO T COMPARABLE AT ALL, ON ACCOUNT OF VOLUME AND NATURE OF ACTIVITY . THEREFORE, IN OUR OPINION, THE DETERMINATION OF ARMS LENGTH PRICE AND ADJUSTMENTS REQUIRED, IF ANY, ON TOTAL INCOME OF THE ASSESSEE, REQUIRES A RELOOK BY THE A.O., IN SO FAR AS IT RELATES TO PURCHASE OF FI NISHED GOODS FROM M/S COCL, SINGAPORE AND COCL, FRANCE ARE CONCERNED. WE , THEREFORE, SET ASIDE THIS ISSUE AND REMIT IT BACK TO THE A.O. FOR PROCEEDING IN ACCORDANCE WITH LAW. HOWEVER, SO FAR AS THE PURCHA SE OF RAW MATERIALS ARE CONCERNED, DETERMINATION OF ARMS LENG TH PRICE BY THE ASSESSEE CANNOT BE FAULTED, SINCE IT HAD PROCEEDED BASED ON COMPARABLE UNCONTROLLED TRANSACTIONS OF TWO CONCERN S, BASED ON THE CUP METHOD, WHICH WAS REJECTED BY THE TPO AND A.O. FOR WRONG REASONS. FURTHER, NOT ONLY THE TPO HAD UNILATERALL Y ADOPTED TNM METHOD, BUT MADE COMPARISONS WITH THE WORKING RESUL TS OF A CONCERN WHICH WAS NOT COMPARABLE AT ALL. HENCE, LD. CIT(AP PEALS) WAS I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 24 JUSTIFIED IN SETTING ASIDE THE ADJUSTMENT ON ARMS L ENGTH PRICE FOR PURCHASES OF RAW MATERIALS. WE FIND NO REASON TO I NTERFERE ON THIS ASPECT. THUS, IN SO FAR AS THE ADJUSTMENTS MADE ON PURCHASE OF RAW MATERIALS FROM ASSOCIATED ENTERPRISES IS CONCERNED, WE SUSTAIN THE DELETION OF ADDITION MADE BY LD. CIT(APPEALS). BUT , IN SO FAR AS DETERMINATION OF ARMS LENGTH PRICE ON PURCHASE OF F INISHED GOODS ARE CONCERNED, WE ARE OF THE OPINION THAT THE MATTER RE QUIRES RE-VISIT BY THE ASSESSING OFFICER FOR THE REASONS MENTIONED ABO VE. IN THE RESULT, WE SET ASIDE THE ISSUE RELATING TO THE DETERMINATIO N OF ARMS LENGTH PRICE OF PURCHASE OF FINISHED GOODS, BACK TO THE FI LE OF THE A.O., WHEREAS, IN SO FAR AS DETERMINATION OF ARMS LENGTH PRICE OF THE PURCHASE OF RAW MATERIALS IS CONCERNED, WE UPHOLD T HE ORDER OF LD. CIT(APPEALS). THE A.O. SHALL, WHILE DETERMINING TH E ARMS LENGTH PRICE OF THE PURCHASE OF FINISHED GOODS, PROCEED IN ACCORDANCE WITH LAW. 16. APPEAL FILED BY THE REVENUE IS PARTLY ALLOWED F OR STATISTICAL PURPOSES. I.T.A. NO. 703/MDS/09 I.T.A. NO. 951/MDS/09 25 17. TO SUMMARISE THE RESULTS, APPEAL OF THE ASSESSE E IS ALLOWED, WHEREAS, THAT OF REVENUE IS PARTLY ALLOWED FOR STAT ISTICAL PURPOSES. THE ORDER WAS PRONOUNCED IN THE COURT ON 17 TH JUNE, 2011. SD/- SD/- (GEORGE MATHAN) (ABRAHAM P. GEORGE) JUDICIAL MEMBER ACCOUNTANT MEMBER CHENNAI, DATED THE 17 TH JUNE, 2011. KRI. COPY TO: ASSESSEE/ASSESSING OFFICER/CIT(A)-XI, CHE NNAI-34/ CIT, CHENNAI-I, CHENNAI-34/D.R./GUARD FILE