GE BE Private Limited, Bangalore V. DCIT, Bangalore

ITA 846/BANG/2010

• Counselvise Citation: 84621114 RSA 2010
• Duration Of Justice: 3 year(s) 5 month(s) 8 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 06-12-2013
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: A
• Next Hearing Date: 05-07-2012
• Assessment Year: misc
• Appeal Filed On: 28-06-2010
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Assessee Lawyers: N VENKATARAMAN
• Keywords: Related party transaction; Business income; Depreciation; Transfer pricing; International transaction
• Section: 92E; 80HHC; 10B; 92

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL B BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER ITA NO.815/BANG/2010 ASSESSMENT YEAR : 2004-05 THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 11(3), BANGALORE. VS. M/S. GE BE PVT. LTD., 60, EPIP, WHITEFIELD, BANGALORE 560 066. PAN : AAACG 6714A APPELLANT RESPONDENT ITA NO.846/BANG/2010 ASSESSMENT YEAR : 2004-05 M/S. GE BE PVT. LTD., 60, EPIP, WHITEFIELD, BANGALORE 560 066. PAN : AAACG 6714A VS. THE DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 11(3), BANGALORE. APPELLANT RESPONDENT REVENUE BY : SHRI FARAHAT HUSSAIN QURESHI, CIT-II(D R) ASSESSEE BY : SHRI N. VENKATARAMAN, SR. ADVOCATE DATE OF HEARING : 30.08.2013 DATE OF PRONOUNCEMENT : 06.12.2013 O R D E R PER BENCH : ITA NO.815/B/10 IS AN APPEAL BY THE REVENUE, WHI LE ITA NO.846/B/11 IS AN APPEAL BY THE ASSESSEE. BOTH THE SE APPEALS ARE ITA NOS.815 & 846/BANG/2010 PAGE 2 OF 59 DIRECTED AGAINST THE ORDER DATED 31.03.2010 OF THE CIT(APPEALS)-IV, BANGALORE RELATING TO A.Y. 2004-05. 2. FIRST WE SHALL TAKE UP FOR CONSIDERATION THE AP PEAL BY THE ASSESSEE IN ITA NO.846/BANG/2010 . 3. GROUNDS NO.1 TO 6 RAISED BY THE ASSESSEE IS WITH REGARD TO THE ADDITION MADE BY THE AO CONSEQUENT TO THE ADJUSTMEN T SUGGESTED BY THE TPO PURSUANT TO THE PROVISIONS OF SECTION 92 OF THE ACT. 4. THE MATERIAL FACTS WHICH ARE RELEVANT FOR ADJUDI CATION OF THE AFORESAID GROUNDS OF APPEAL ARE AS FOLLOWS. THE A SSESSEE IS A JOINT VENTURE BETWEEN GE MAURITIUS LTD. AND BHARAT ELECTR ONICS LTD. ( BEL ). THE ASSESSEE IS ENGAGED IN THE BUSINESS OF MANUFACT URE OF X-RAY AND CT TUBES, HV TANKS, DETECTORS, PARTS AND ACCESSORIES F OR MEDICAL DIAGNOSTIC IMAGING EQUIPMENT, DISTRIBUTION OF TUBES, PARTS AND ACCESSORIES AND PROVISION OF ENGINEERING SERVICES TO ITS AE AS CONT RACT MANUFACTURER. DURING THE PREVIOUS YEAR, THE ASSESSEE CARRIED OUT THE FOLLOWING INTERNATIONAL TRANSACTIONS WITH ITS AE:- IMPORT OF RAW MATERIALS FOR CONTROL MANUFACTURING ACTIVITY : RS.159,74,15,702 PURCHASE OF FIXED ASSETS FOR CONTRACT MANUFACTURING ACTIVITY : RS. 4,94,76,50 9 SALE OF MANUFACTURED GOODS : RS.373,12,86,546 PROVISION OF ENGINEERING SERVICES : RS. 4,19,96 ,848 PAYMENT OF TRAINING FEES : RS. 67,972 REIMBURSEMENT OF EXPENSES : RS. 6,78,964 RECOVERY OF EXPENSES : RS. 39,99,681 ITA NOS.815 & 846/BANG/2010 PAGE 3 OF 59 5. THE AO REFERRED THE DETERMINATION OF ARMS LENGT H PRICE (ALP) IN RESPECT OF INTERNATIONAL TRANSACTIONS ENTERED INTO BY THE ASSESSEE. THE SUBJECT MATTER OF THE DISPUTE IN GROUNDS NO.1 TO 6 REFERRED TO ABOVE IS WITH REGARD TO DETERMINATION OF ALP IN RESPECT OF I NTERNATIONAL TRANSACTION OF SALE OF MANUFACTURED GOODS BY THE ASSESSEE TO IT S AE. AS ALREADY STATED, THE ASSESSEE IS A CONTRACT MANUFACTURER FOR THE GEMS GROUP, WHICH IS ADMITTEDLY AN AE. THE PRICE CHARGED IN RE SPECT OF SALE OF MANUFACTURED GOODS WAS RS.373,12,86,546. THE ASSES SEE CLAIMED THAT THE PRICE IT RECEIVED ON SALE OF MANUFACTURED GOODS TO ITS AE WAS AT ARMS LENGTH AND IN SUPPORT THEREOF FILED TRANSFER PRICIN G (TP) REPORT. IN ANNEXURE-C TO THE AFORESAID REPORT, THE ASSESSEE HA S GIVEN A LIST OF AES WITH WHICH THE ASSESSEE HAS ENTERED INTO INTERNATIO NAL TRANSACTIONS DURING THE PREVIOUS YEAR RELEVANT TO A.Y. 2004-05. THE ASSESSEE ADOPTED THE COST PLUS METHOD AS THE MOST APPROPRIAT E METHOD FOR DETERMINING THE ALP. THE ASSESSEE IDENTIFIED 19 C OMPARABLES. THE ARITHMETIC MEAN OF THE MARGIN (GROSS MARGIN TO COST OF PRODUCTION) OF THESE COMPANIES WAS 15.72% (PAGE 31 OF THE TP STUDY OF THE ASSESSEE). THE GROSS MARGIN BASED ON COST OF PRODUCTION OF THE ASSESSEE WAS 16.24%. THE ASSESSEE THUS CLAIMED THAT THE CONSIDE RATION RECEIVED BY THE ASSESSEE FROM ITS AE IN RESPECT OF INTERNATIONA L TRANSACTION WAS MORE THAN THE ARITHMETIC MEAN OF THE COMPARABLE COMPANIE S CHOSEN BY THE ASSESSEE WHICH WAS 15.72% AND THEREFORE THE PRICE R ECEIVED BY THE ASSESSEE ON SALE OF MANUFACTURED PRODUCTS IS AT ARM S LENGTH, THEREFORE NO ADJUSTMENT NEEDS TO BE MADE. ITA NOS.815 & 846/BANG/2010 PAGE 4 OF 59 6. THE TPO, TO WHOM THE DETERMINATION OF ALP WAS RE FERRED TO BY THE AO, ISSUED A SHOW CAUSE NOTICE DATED 12.10.2006. T HE TPO WAS OF THE VIEW THAT THE COMPARABLES SELECTED BY THE ASSESSEE IN ITS TP STUDY RELATED TO AUTOMOBILE PARTS MANUFACTURERS. HE WAS OF THE VIEW THAT THE INDUSTRY SEGMENT VASTLY DIFFERS FROM THAT OF THE AS SESSEE WHICH WAS MANUFACTURER OF MEDICAL EQUIPMENT. MORE OVER, THE TPO WAS OF THE VIEW THAT THERE WERE MANUFACTURERS OF MEDICAL EQUIPMENTS , WHO WERE NOT TAKEN AS COMPARABLES BY THE ASSESSEE. THE TPO THER EFORE HELD THAT THE ASSESSEE HAS NOT CHOSEN COMPARABLES USING AN OBJECT IVE, CONSISTENT, LOGICAL AND TRANSPARENT CRITERIA. ACCORDINGLY THE COMPARABLES CHOSEN BY THE ASSESSEE IN ITS TP STUDY WERE REJECTED BY THE T PO. THEREAFTER THE TPO ON HIS OWN IDENTIFIED 4 COMPARABLE COMPANIES. THE DETAILS OF THESE COMPANIES ARE GIVEN AS ANNEXURE TO THE SHOW CAUSE N OTICE DATED 12.10.2006 ISSUED BY THE TPO. IT IS NOT IN DISPUTE THAT THESE FOUR COMPANIES WERE IN THE BUSINESS OF MANUFACTURE OF EI THER SURGICAL EQUIPMENT, MEDICAL EQUIPMENT OR PACE MAKERS. THE C OST PLUS MARGIN OF THE COMPARABLES CHOSEN BY THE TPO (ARITHMETIC MEAN) WAS 44.527%. IN ONE OF THE SUBMISSIONS (DATED 10.11.2006) FILED BY THE ASSESSEE BEFORE THE TPO, THE ASSESSEE TOOK A STAND THAT TNMM MAY BE ADOPTED AS THE MOST APPROPRIATE METHOD BY RETAINING THE SAME COMPA RABLES CHOSEN BY THE TPO. THE FOLLOWING WERE THE RELEVANT SUBMISSIO NS MADE BY THE ASSESSEE: 7. CONSIDERATION OF ALTERNATE METHOD WE WISH TO BRING TO YOUR KIND ATTENTION, PARAGRAPH 2.38 OF THE OECD TP GUIDELINES, WHICH PROVIDE FOR AN APPLICATIO N OF ITA NOS.815 & 846/BANG/2010 PAGE 5 OF 59 ALTERNATE METHOD TO SUBSTANTIATE THE RESULTS OF THE COST PLUS METHOD IN THE FOLLOWING CIRCUMSTANCES: IF EXPENSES REFLECT A FUNCTIONAL DIFFERENCE, WHIC H HAS NOT BEEN TAKEN INTO ACCOUNT IN APPLYING THE METHOD, AN ADJUS TMENT TO THE COST PLUS MARK UP MAY BE REQUIRED. IF EXPENSES REFLECT ADDITIONAL FUNCTIONS THAT ARE DISTINCT FROM THE ACTIVITIES TESTED BY THE METHOD, SEPARATE COMPE NSATION FOR THAT FUNCTION MAY NEED TO BE DEEMED. SINCE, THE COMPARABLES CHOSEN BY YOUR HONOUR PERFOR M FUNCTIONS WHICH ARE BEYOND THAT OF A CONTRACT MANUF ACTURER, THE RESULT OBTAINED BY THE ASSESSEE THROUGH THE APPLICA TION OF THE COST PLUS METHOD MAY ALSO HAVE TO BE SUBSTANTIATED THROUGH THE APPLICATION OF THE TRANSACTIONAL NET MARGIN METHOD. WITHOUT PREJUDICE TO OUR SUBMISSION THAT CPM IS APP LICABLE AND THAT THE COMPARABLES CHOSEN BY THE TESTED PARTY SAT ISFY THE CRITERIA AS PROPOUNDED IN THE TRANSFER PRICING REGU LATIONS, WE WISH TO SUBMIT THAT THE NET MARGIN OF GE BE: - IS HIGHER THAN THE ARITHMETIC MEAN OF THE NET MARGI NS OF THE COMPARABLES USED BY THE ASSESSEE; AND - IS WITHIN +/- 5% VARIATION FROM THE ARITHMETIC MEAN OF THE UNADJUSTED NET MARGINS OF THE COMPANIES CHOSEN BY YOUR HONOUR. 7. THE TPO DEALT WITH THE ALTERNATIVE CLAIM MADE BY THE ASSESSEE AS FOLLOWS:- 5.9.2.1 METHODOLOGY TAXPAYER ITSELF HAS CHOSEN COST PLUS METHOD AS THE MOST APPROPRIATE METHOD IN THE INSTANT CASE. SEC.92C MAN DATES THE ALP NEEDS TO BE COMPUTED USING THE MOST APPROPRIATE METHOD FROM AMONG THE METHODS PRESCRIBED: (1) THE ARMS LENGTH PRICE IN RELATION TO AN INTER NATIONAL TRANSACTION SHALL BE DETERMINED BY ANY OF THE FOLLO WING METHODS, BEING THE MOST APPROPRIATE METHOD. NO FACT OR EVIDENCE IS BROUGHT ON RECORD BY THE TAX PAYER TO SHOW THAT CPM CEASES TO BE THE MOST APPROPRIATE MET HOD OR TO JUSTIFY SWITCHING OVER TO A LESS DIRECT METHOD TNMM . CPM IS ITA NOS.815 & 846/BANG/2010 PAGE 6 OF 59 THE SECOND MOST ACCURATE METHOD (AFTER CUP) TO DETE RMINE PRICING WHEN AN ENTERPRISE MANUFACTURES & SELLS TO AFFILIATES. THE ARMS LENGTH SALES PRICE IS DETERMINED BY ADDING THE NORMAL GROSS MARK UP ON COST TO THE COSTS INCURRED. THUS IT IS AFFECTED ONLY BY THE COST OF PRODUCTION. TNMM IS IN FLUENCED BY A LOT OF OTHER FACTORS SUCH AS OPERATIONAL EFFIC IENCIES. THUS THE MARGIN DIFFERENCE BETWEEN TWO ENTERPRISES MAY N OT JUST BE ONE ACCOUNT OF PRICE DIFFERENCES. ON THE OTHER HAND , SIMILAR MARGINS CANNOT SOLELY BE ATTRIBUTED TO SIMILAR PRIC ING EITHER, AS THE DIFFERENCES IN THE OVERHEAD LEVELS WOULD HAVE N EUTRALIZED THE PRICE DIFFERENCES . FOR EXAMPLE, SUPPOSE THE TESTED PARTY MAY EARN AS HIGH A NET MARGIN AS THE COMPARABLE, SI MPLY BECAUSE OF HIGHER OPERATIONAL EFFICIENCY, EVEN IF T HE PRODUCTS ARE SOLD AT A LOWER RATE TO THE AFFILIATE CUSTOMERS . IN SUCH A SITUATION, IT CANNOT BE SAID THAT THE PRICE CHARGED IS AT ARMS LENGTH BECAUSE, THE NET MARGINS ARE IDENTICAL, AS T HE TESTED PARTY IS FORCED TO PART WITH THE BENEFITS OF COST SAVINGS ON ITS PART TO THE CUSTOMER, WHICH AN INDEPENDENT ENTERPRISE WOULD NOT DO. THUS, IF THE RESULTS OF TNMM DO NOT TALLY WITH THE RESULTS OF COST PLUS METHOD THE LATTER BEING THE MORE DIRECT M ETHOD SHOULD BE RELIED UPON . THIS BEING SO, THERE IS NO REASON TO SWITCH OVER FROM A DIRECT METHOD TO AN INDIRECT MET HOD. 8. THEREAFTER THE TPO PROCEEDED TO DETERMINE THE AL P AS FOLLOWS:- 5.10.3 COMPARABLES THE FOLLOWING FOUR COMPARABLES WERE IDENTIFIED IN T HE SHOW CAUSE LETTER-DATED 13.10.06: SL. NO. NAME OF THE COMPARABLE % OF GP OVER COSTS 1 CONTENTIAL SURGICAL SUTURE LTD 74.167 2 POLYMEDICURE LTD. 27.646 3 SOUTH INDIA SURGICAL CO. LTD. 37.833 4 SHREE PACETRONIX LTD. 38.462 AVG. 44.527 OUT OF THIS SHREE PACETRONIX LTD. IS REJECTED AS PER THE TAXPAYERS REQUEST SINCE IT HAD RELATED PARTY TRANS ACTIONS. THE FINAL LIST IS AS FOLLOWS: SL. NO. NAME OF THE COMPARABLE % OF GP OVER COSTS 1 CONTENTIAL SURGICAL SUTURE LTD 74.167 2 POLYMEDICURE LTD. 27.646 ITA NOS.815 & 846/BANG/2010 PAGE 7 OF 59 3 SOUTH INDIA SURGICAL CO. LTD. 37.833 AVG. 46.55% 5.10.4 ADJUSTMENT TOWARDS SALES FUNCTIONS AS DISCUSSED, THE NORMAL SPENDING ON MARKETING. ADV ERTISING & DISTRIBUTION COMES TO 8% OF THE SALES. THEREFORE AN 8% ADJUSTMENT IS GIVEN TO ALP COMPUTED TO NEUTRALIZED THE IMPACT OF THESE FUNCTIONS: COST INCURRED FOR CONTRACT MAN UFACTURING ACTIVITY A RS.320,99,16,579 NORMAL MARK UP ON COST (ARITHMETIC MEAN OF COMPARABLES) B 46.55% ARMS LENGTH PRICE COMPUTED BASED ON NORMAL GROSS MARKUP @ 146.55% C=A+A*B RS.470,41,32,747 ADJUSTMENT TOWARDS MARKETING, ADVERTISEMENT & DISTRIBUTION @ 8% OF SALES D=C*8% RS.37,63,30,620 ARMS LENGTH PRICE AS ADJUSTED E=C-D RS.432,78,02,1 27 5.10.5 ADJUSTMENT FOR DEBTORS RISK, BUSINESS RISKS TAXPAYER HAS SUBSEQUENT TO THE ISSUE OF THE SHOW CA USE NOTICE CLAIMED ADJUSTMENTS TOWARDS, DIFFERENCES IN THE RIS K LEVEL BORNE BY THE TESTED PARTY & THE COMPARABLES. THESE CLAIMS ARE ON THE PREMISE THAT GEBE BEING A CONTRACT MANUFACTURER IS PROTECTED FROM VARIOUS BUSINESS RISKS, WHICH ARE BORNE BY IND EPENDENT MANUFACTURERS. SINCE THE MARKETS ARE EXPECTED TO GI VE EXTRA RETURNS FOR EXTRA RISKS, THE COMPANY HAS CLAIMED A ADJUSTMENT TO THE MARGINS EARNED BY THE COMPARABLES. THE CLAIM OF THE TAXPAYER HAS BEEN CONSIDERED. AS S TATED EARLIER, WHILE DISCUSSING THE FAR PROFILE OF THE CO MPANY, THE ACCOUNTS OF GEBE SHOW, ITEMS SUCH AS FOREX LOSS, FI NANCIAL COSTS ETC. THIS SHOWS THAT THE COMPANY IS EXPOSED T O AS MUCH BUSINESS RISKS AS ANY OTHER COMPARABLE. THE ONLY AS SURANCE IT HAS IS THAT ITS PRODUCE WILL BE LIFTED BY THE AFFIL IATES. FOR THIS AN ADJUSTMENT TOWARDS MARKETING FUNCTION IS ALREADY GI VEN. UNDER THE CIRCUMSTANCES NO FURTHER ADJUSTMENT IS CALLED F OR. ITA NOS.815 & 846/BANG/2010 PAGE 8 OF 59 COST INCURRED FOR CONTRACT MANUFACTURING ACTIVITY A RS.320,99,16,579 NORMAL MARK UP ON COST (ARITHMETIC MEAN OF COMPARABLES) B 46.55% ARMS LENGTH PRICE COMPUTED BASED ON NORMAL GROSS MARKUP @146.55% C=A+A*B RS.470,41,32,747 ADJUSTMENT TOWARDS MARKETING, ADVERTISEMENT & DISTRIBUTION @ 8% OF SALES D=C*8% RS.37,63,30,620 ARMS LENGTH PRICE AS ADJUSTED E=C-D RS.432,78,02,127 PRICE ACTUALLY CHARGED F RS.373,12,86,546 SHORTFALL BEING ADJUSTMENT U/S. 92CA G=E-F RS.59,65,15,581 9. THUS THE ADDITION BY WAY OF ADJUSTMENT TO ALP OF THE AFORESAID SUM WAS MADE. THE SAME WAS ADDED TO THE TOTAL INC OME OF THE ASSESSEE. 10. AGAINST THE AFORESAID ADDITION MADE BY THE AO, THE ASSESSEE PREFERRED APPEAL BEFORE THE CIT(A). ONE OF THE CON TENTION TAKEN BY THE ASSESSEE BEFORE THE CIT(A) WAS REGARDING THE MOST A PPROPRIATE METHOD THAT NEEDS TO BE APPLIED IN THE PRESENT CASE. IN T HIS REGARD, THE ASSESSEE RAISED THE FOLLOWING CONTENTIONS:- 1.4. THE APPELLANT SUBMITS THAT IN CASE IF YOUR G OOD SELF CONSIDERS THAT THE COMPARABLES USED IN THE TP STUDY DO NOT HAVE THE DESIRED DEGREE OF COMPARABILITY FOR APPLYI NG CPM AS THE MOST APPROPRIATE METHOD, WE SUBMIT THAT IT WOUL D BE MORE APPROPRIATE TO USE TNMM AS THE MOST APPROPRIATE MET HOD INSTEAD OF REJECTING THE COMPARABLES USED IN THE TP STUDY. ITA NOS.815 & 846/BANG/2010 PAGE 9 OF 59 1.5. IN THIS REGARD WE SUBMIT THAT PARA 3.27 OF TH E OECD TP GUIDELINES STATE THAT NET MARGINS USED IN THE TNMM ARE LESS AFFECTED BY TRANSACTIONAL DIFFERENCES THAN IS THE C ASE WITH PRICE, AS USED IN THE CUP METHOD. THE NET MARGINS ALSO MAY BE MORE TOLERANT TO SOME OF THE FUNCTIONAL DIFFERENCES BETW EEN CONTROLLED AND UNCONTROLLED TRANSACTIONS THAN GROSS MARGINS (I.E., USED IN THE RPM AND THE CPM). AND, THE DIFFE RENCES IN THE FUNCTIONS PERFORMED BETWEEN ENTERPRISES ARE OFT EN REFLECTED IN VARIATIONS IN OPERATING EXPENSES. CONSEQUENTLY, ENTERPRISES MAY HAVE A WIDE RANGE OF GROSS PROFIT MARGINS BUT S TILL EARN BROADLY SIMILAR LEVELS OF NET PROFITS. 1.6. IN OUR SUBMISSIONS TO THE LD. TPO IT HAS BEEN CLEARLY ESTABLISHED THAT THE FUNCTIONAL PROFILES OF THE COM PANY AND THE COMPARABLES USED BY THE LD. TPO (ALLEGED COMPARABL ES) ARE VASTLY DIFFERENT. THE SIGNIFICANT VARIATION IN THE GROSS MARGINS AND THE NET MARGINS OF THE COMPARABLES USED BY THE LD. TPO IN THE TP ORDER IS EVIDENT FROM THE TABULATION BELOW: CENTENIAL SURGICAL SUTURE LTD. POLY MEDICURE LTD. SOUTH INDIA SURGICAL CO. LTD. GE BE GROSS MARGIN 79.41% 36.92% 27.44% 16.24% NET MARGIN 7.90% 17.5% 10.60% 12.16% 1.7. IT IS CLEARLY EVIDENT FROM THE TABLE ABOVE TH AT ALTHOUGH THERE IS A VAST VARIATION BETWEEN THE GROSS MARGINS OF THE ALLEGED COMPARABLES AND THE GROSS MARGIN OF GE BE, AT THE NET MARGIN LEVEL THE TWO SETS OF MARGINS ARE NOT DEVIAT ING SIGNIFICANTLY. THIS SIGNIFICANT VARIATION BETWEEN T HE GROSS AND NET LEVELS FORTIFIES THE FACT THAT THERE ARE SIGNIF ICANT DIFFERENCES IN THE FUNCTIONAL PROFILES OF THE ALLEGED COMPARABL ES AND GE BE. IN VIEW OF SUCH DIFFERENCES, ASSUMING WITHOUT A DMITTING, IF THE COMPARABLES SELECTED BY THE LD. TPO WERE SUPPOS EDLY USED TO DETERMINE THE ARMS LENGTH PRICE THE SAME CANNOT BE DONE WITHOUT UNDERTAKING APPROPRIATE ADJUSTMENTS FOR THE COST PLUS METHOD WHICH REQUIRES VERY CLOSE DEGREE OF FUNCTION AL SIMILARITY. 1.8. FURTHER, THE APPELLANT SUBMITS THAT TO ELIMIN ATE THE EFFECT OF THESE FUNCTIONAL DIFFERENCES AND THE SUBJ ECTIVITY INVOLVED IN THE COMPUTATION OF THE ADJUSTMENTS FOR THESE ITA NOS.815 & 846/BANG/2010 PAGE 10 OF 59 FUNCTIONAL DIFFERENCES, THE TNMM CAN BE USED TO TES T THE ARMS LENGTH NATURE OF THE INTERNATIONAL TRANSACTION. 1.9. IT IS THEREFORE SUBMITTED THAT IF THE CPM IS TO BE ADOPTED, THEN THE SET OF FILTERS (AND THE RESULTANT COMPARAB LES) ADOPTED BY THE APPELLANT IN ITS TP STUDY HAVE TO BE RESPECTED AS THEY PASS THE FUNCTIONAL EQUIVALENCE TEST. WITHOUT PREJUDICE TO THE TP STUDY, IF THE SET OF COMPARABLES IMPOSED BY THE LD. TPO WERE TO BE CONSIDERED, WHICH DO NOT HAVE THE SAME FUNCTI ONAL PROFILE AND NEED ADJUSTMENT FOR FUNCTIONAL DIFFERENCES FOR CPM, THE TNMM WHICH IS MORE TOLERANT TO FUNCTIONAL DIFFERENC ES, CAN ALTERNATIVELY BE USED TO DETERMINE THE ARMS LENGTH NATURE OF THE TRANSACTIONS. 1.10. IN RESPONSE TO OUR SUBMISSION TO USE TNMM AS THE ALTERNATE METHOD, THE REASONING OF THE LD. TPO IN R EJECTING THE SAME IS THAT THE COMPANY ITSELF HAS USED CPM AS THE MOST APPROPRIATE METHOD. 11. THE ASSESSEE RELIED ON THE OECD GUIDELINES AS W ELL AS THE GUIDELINES OF ICAI IN CHOOSING THE MOST APPROPRIATE METHOD. THE ASSESSEE ALSO SUBMITTED : 1.24. WE FURTHER SUBMIT THAT THE EXERCISE OF T RANSFER PRICING ASSESSMENT FOR DETERMINING ARMS LENGTH PRICE SHOUL D NOT BE DIRECTED TOWARDS MAKING AN ADJUSTMENT, BUT SHOULD B E CARRIED OUT BASED ON THE RATIONALES OF ECONOMIC AND COMMERC IAL PRINCIPLES. THIS IS ALSO SUPPORTED BY THE STATEMENT OF THE TAX TRIBUNAL IN THE CASE OF PHILIPS SOFTWARE, WHEREIN I T WAS HELD THAT THE ACTION OF THE LD. TPO WAS DIRECTED TOWARDS MAKING A HIGHER TP ADJUSTMENT. 1.25. FURTHER, IN OUR SUBMISSIONS WE HAVE ALSO CLE ARLY BROUGHT OUT THE FACT OF SIGNIFICANT FUNCTIONAL DISSIMILARIT IES BETWEEN THE COMPANY AND THE ALLEGED COMPARABLES. IN VIEW OF SUC H SIGNIFICANT FUNCTIONAL DISSIMILARITIES, CPM IS LIAB LE TO BE REJECTED AS THE MOST APPROPRIATE METHOD, AND THE TN MM HAS TO BE ADOPTED AS THE MOST APPROPRIATE METHOD, IF THE C OMPARABLES PROPOSED BY THE LD. TPO ARE CONSIDERED AS COMPARABL ES. 12. ON THE ABOVE SUBMISSIONS MADE BY THE ASSESSEE, THE CIT(A) HELD AS FOLLOWS:- ITA NOS.815 & 846/BANG/2010 PAGE 11 OF 59 6.3.4 AS LAID DOWN IN THE CASE OF AZTEC SOFTWARE (SUPRA), THE BURDEN TO ESTABLISH THAT INTERNATIONAL TRANSACTIONS WERE CARRIED OUT AT ALP IS ON THE TAXPAYER. MOREOVER, THE BURDE N TO SELECT THE MOST APPROPRIATE METHOD HAS ALSO BEEN HELD TO B E ON THE TAXPAYER. THE DECISION OF SELECTING THE MOST APPROP RIATE METHOD IS TO BE SUBSTANTIATED BY THE ASSESSEE BY AN APPROP RIATE DOCUMENTATION AS WELL AS BY SUBSTANTIATING WHY A PA RTICULAR METHOD IS CONSIDERED BEST SUITED TO THE FACTS AND C IRCUMSTANCES OF THE INTERNATIONAL TRANSACTION AND AS TO HOW IT P ROVIDES THE MOST RELIABLE RESULT OF THE ALP. IN VIEW OF THIS BA CKGROUND, I AM UNABLE TO ACCEPT THE PLEA OF THE APPELLANT THAT THE TPO ERRED IN REJECTING THE TNMM PROPOSED BY THE APPELLANT TO THE COMPARABLES SELECTED BY THE TPO. AS STATED ABOVE, I T IS IMPORTANT TO NOTE THAT THE APPELLANT HAD ITSELF ADO PTED CPM AS THE MOST APPROPRIATE METHOD IN ITS TP STUDY FOR THE PURPOSE OF JUSTIFYING THE TRANSFER PRICE OF ITS INTERNATIONAL TRANSACTIONS. SINCE CPM IS A PREFERABLE METHOD IN CASES LIKE THE PRESENT ONE WHERE THE TESTED PARTY IS A MANUFACTURER SELLING IT S PRODUCE TO AN AFFILIATE, THE TPO AGREED THAT CPM WAS THE MOST APPROPRIATE METHOD ON THE FACTS AND CIRCUMSTANCES OF THE INSTAN T CASE. I DO NOT FIND ANY ERROR OR INFIRMITY IN THE ACTION OF TH E TPO IN ACCEPTING CPM AS THE MOST APPROPRIATE METHOD IN CAS E OF THE APPELLANT. IN THIS CONNECTION, IT WOULD NOT BE OUT OF PLACE TO CONSIDER THE DECISION OF THE HONBLE ITAT, PUNE BEN CH IN THE CASE OF ACIT V. MSS INDIA (P) LTD. (2009) 123 TTJ ( PUNE) 657 ON THE APPLICABILITY OF CUP AND CPM VIS--VIS TNMM. THE FOLLOWING PROPOSITIONS EMERGE FROM PERUSAL OF THE S AID ORDER: A) ON A CONCEPTUAL NOTE, TRANSACTIONAL PROFIT METH ODS (I.E. TNMM AND PROFIT SPLIT METHOD) ARE TREATED AS METHOD S OF LAST RESORT WHICH ARE PRESSED INTO SERVICE ONLY WHEN THE STANDARD METHODS, WHICH ARE ALSO TERMED AS TRADITIONAL METH ODS (I.E. CUP METHOD, RESALE PRICE METHOD AND COST PLUS METHO D) CANNOT BE REASONABLY APPLIED. B) IN A SITUATION IN WHICH THE ASSESSEE HAS FOLLOW ED ONE OF THE STANDARD METHODS OF DETERMINING ALP, SUCH A MET HOD CANNOT BE DISCARDED IN PREFERENCE OVER TRANSACTIONA L PROFIT METHODS UNLESS THE REVENUE AUTHORITIES ARE ABLE TO DEMONSTRATE THE FALLACIES IN APPLICATION OF STANDARD METHODS. IN LIGHT OF THE ABOVE PRINCIPLES, IT WAS HELD THAT THE ASSESSEE HAVING DETERMINED ALP OF ITS INTERNATIONAL TRANSACT IONS WITH AES BY APPLYING CUP/CPM BY OFFERING THE COMPARISON OF GROSS PROFIT MARGIN ON TRANSACTIONS WITH UNRELATED COMPANIES, TPO WAS NOT JUSTIFIED IN REJECTING THE METHOD ADOPT ED BY ITA NOS.815 & 846/BANG/2010 PAGE 12 OF 59 ASSESSEE AND MAKING ADJUSTMENTS BY APPLYING TNMM ON THE GROUND THAT ASSESSEE HAD INCURRED LOSS IN TRANSACTI ONS WITH AES AND THAT THE METHOD EMPLOYED BY ASSESSEE WAS COMPLE X. FOLLOWING THE SAME ANALOGY, WHERE CPM HAS BEEN SELE CTED BY THE APPELLANT AND ACCEPTED BY THE TPO AS THE MOST A PPROPRIATE METHOD IN THE INSTANT CASE, IT IS FOR THE APPELLANT TO DEMONSTRATE THE FALLACIES IN APPLICATION OF CPM BEFORE PUTTING UP A CASE FOR APPLICATION OF TNMM. IT IS FOR THE APPELLANT TO SHO W THAT TNMM IS MORE APPROPRIATE THAN CPM AND SUCH AN APPROPRIATENESS OF METHOD MUST BE SHOWN ON THE TOUC HSTONE OF THE FACTORS SET OUT IN RULE 1OC(2). AS THE APPELLAN T HAS FAILED TO MAKE OUT A CASE FOR ADOPTION OF TNMM AS THE MOST AP PROPRIATE METHOD ON THE BASIS OF COGENT MATERIAL AND SOUND RE ASONING, THE TPO WAS JUSTIFIED IN REJECTING THE PROPOSAL OF THE APPELLANT IN THIS REGARD AND HER ACTION IN DOING SO IS HEREBY SU STAINED. 13. IN GROUNDS 3 & 4, THE ASSESSEE HAS SPECIFICALLY CHALLENGED THE ACTION OF THE REVENUE AUTHORITIES IN NOT APPLYING T HE TNMM AS THE MOST APPROPRIATE METHOD. 14. WE HAVE HEARD THE SUBMISSIONS OF THE LD. COUNSE L FOR THE ASSESSEE AND THE LD. DR. AT THE OUTSET, IT MAY BE APPROPRIATE TO SET OUT THE PROVISIONS OF RULE 10B(1)(C) WHICH LAYS DOWN TH E SITUATION IN WHICH THE COST PLUS METHOD HAS TO BE ADOPTED AS THE MOST APPROPRIATE METHOD. THESE RULES READ THUS:- DETERMINATION OF ARMS LENGTH PRICE UNDER SECTION 9 2C . 10B. (1) FOR THE PURPOSES OF SUB-SECTION (2) OF SEC TION 92C, THE ARMS LENGTH PRICE IN RELATION TO AN INTERNATIONAL TRANSACTION SHALL BE DETERMINED BY ANY OF THE FOLLOWING METHODS , BEING THE MOST APPROPRIATE METHOD, IN THE FOLLOWING MANNER, N AMELY : A). B). (C) COST PLUS METHOD, BY WHICH, ITA NOS.815 & 846/BANG/2010 PAGE 13 OF 59 (I) THE DIRECT AND INDIRECT COSTS OF PRODUCTION INCURRED BY THE ENTERPRISE IN RESPECT OF PROPERTY T RANSFERRED OR SERVICES PROVIDED TO AN ASSOCIATED ENTERPRISE, ARE DETERMINED; (II) THE AMOUNT OF A NORMAL GROSS PROFIT MARK-UP T O SUCH COSTS (COMPUTED ACCORDING TO THE SAME ACCOUNTI NG NORMS) ARISING FROM THE TRANSFER OR PROVISION OF THE SAME OR SIMILAR PROPERTY OR SERVICES BY THE ENTERPRISE, OR BY AN UN RELATED ENTERPRISE, IN A COMPARABLE UNCONTROLLED TRANSACTIO N, OR A NUMBER OF SUCH TRANSACTIONS, IS DETERMINED; (III) THE NORMAL GROSS PROFIT MARK-UP REFERRED TO IN SUB-CLAUSE (II) IS ADJUSTED TO TAKE INTO ACCOUNT TH E FUNCTIONAL AND OTHER DIFFERENCES, IF ANY, BETWEEN THE INTERNAT IONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSAC TIONS, OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACT IONS, WHICH COULD MATERIALLY AFFECT SUCH PROFIT MARK-UP IN THE OPEN MARKET; (IV) THE COSTS REFERRED TO IN SUB-CLAUSE (I) ARE I NCREASED BY THE ADJUSTED PROFIT MARK-UP ARRIVED AT UNDER SUB -CLAUSE (III); (V) THE SUM SO ARRIVED AT IS TAKEN TO BE AN ARMS LENGTH PRICE IN RELATION TO THE SUPPLY OF THE PROPE RTY OR PROVISION OF SERVICES BY THE ENTERPRISE; 15. THE LD. COUNSEL FOR THE ASSESSEE ALSO POINTED O UT THAT THE ALP HAS TO BE DETERMINED BY ADOPTING THE MOST APPROPRIATE M ETHOD IN RELATION TO THE INTERNATIONAL TRANSACTION. RULE 10B(2) & (3) W ITH REGARD TO COMPARABILITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRANSACTION PROVIDES AS FOLLOWS:- (2) FOR THE PURPOSES OF SUB-RULE (1), THE COMPARABI LITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRAN SACTION SHALL BE JUDGED WITH REFERENCE TO THE FOLLOWING, NAMELY: (A) THE SPECIFIC CHARACTERISTICS OF THE PROPERTY TRANSFERRED OR SERVICES PROVIDED IN EITHER TRANSACT ION; (B) THE FUNCTIONS PERFORMED, TAKING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND THE RISKS ASS UMED, BY THE RESPECTIVE PARTIES TO THE TRANSACTIONS; ITA NOS.815 & 846/BANG/2010 PAGE 14 OF 59 (C) THE CONTRACTUAL TERMS (WHETHER OR NOT SUCH TER MS ARE FORMAL OR IN WRITING) OF THE TRANSACTIONS WHICH LAY DOWN EXPLICITLY OR IMPLICITLY HOW THE RESPONSIBILITIES, RISKS AND BENEFITS ARE TO BE DIVIDED BETWEEN THE RESPECTIVE P ARTIES TO THE TRANSACTIONS; (D) CONDITIONS PREVAILING IN THE MARKETS IN WHICH THE RESPECTIVE PARTIES TO THE TRANSACTIONS OPERATE, INC LUDING THE GEOGRAPHICAL LOCATION AND SIZE OF THE MARKETS, THE LAWS AND GOVERNMENT ORDERS IN FORCE, COSTS OF LABOUR AND CAP ITAL IN THE MARKETS, OVERALL ECONOMIC DEVELOPMENT AND LEVEL OF COMPETITION AND WHETHER THE MARKETS ARE WHOLESALE O R RETAIL. (3) AN UNCONTROLLED TRANSACTION SHALL BE COMPARABLE TO AN INTERNATIONAL TRANSACTION IF (I) NONE OF THE DIFFERENCES, IF ANY, BETWEEN THE TRANSACTIONS BEING COMPARED, OR BETWEEN THE ENTERPR ISES ENTERING INTO SUCH TRANSACTIONS ARE LIKELY TO MATER IALLY AFFECT THE PRICE OR COST CHARGED OR PAID IN, OR THE PROFIT ARI SING FROM, SUCH TRANSACTIONS IN THE OPEN MARKET; OR (II) REASONABLY ACCURATE ADJUSTMENTS CAN BE MADE T O ELIMINATE THE MATERIAL EFFECTS OF SUCH DIFFERENCES. 16. THE LD. COUNSEL FOR THE ASSESSEE SUBMITTED THA T A CAPTIVE MANUFACTURER WORKS ON COST OF PRODUCTION PLUS HIS M ARGIN AND DOES NOT PERFORM POST COST OF PRODUCTION FUNCTION SUCH AS SE LLING, ADMINISTRATIVE COST ASSOCIATED TO SELLING, DISTRIBUTION, LICENSING , ETC. WHEREAS A FULL- FLEDGED THIRD PARTY MANUFACTURER IS ONE WHO DOES NO T STOP WITH MERE MANUFACTURING OR PRODUCTION OF GOODS, BUT IT ALSO P ERFORMS POST COST OF PRODUCTION FUNCTIONS REFERRED TO ABOVE. WHEN IT DOE S SO, IT IS FUNDAMENTAL ECONOMIC PRESUMPTION THAT THE RETURN OR THE MARGINS WILL NOT BE EARNED OR CONFINED ONLY TO THE COST OF PRODUCTION. THERE WILL BE MARGINS OR PROFIT OR RETURNS EVEN ON ACTIVITIES ASSOCIATED WITH POST COS T OF PRODUCTION I.E. THE SELLING FUNCTION. HOWEVER EVEN THE MARGINS OR RETU RNS OR PROFIT OF COP ITA NOS.815 & 846/BANG/2010 PAGE 15 OF 59 GETS ASSIMILATED OR CAPTURED AS A PART OF SELLING F UNCTIONS ONLY AT THE NET MARGIN LEVEL AND DOES NOT GET FACTORED AT THE GROSS MARGIN LEVEL OR AS PART OF COST OF PRODUCTION. CONSEQUENTLY BY SHEER FORCE OF LAW AND ACCOUNTING PRACTICES, A COMPARABLE FOR A COST PLUS METHOD CAN ONLY BE A COMPARABLE WHO IS EITHER CONFINED TO ACTIVITIES OF COST OF PRODUCTION OR GROSS MARGIN LEVEL. OTHERWISE IF THE OPERATIONS TRA VEL BEYOND THE GROSS MARGIN LEVEL, THE ADDITIONAL FUNCTIONS, ACTIVITIES AND THE ASSOCIATED COSTS AND RETURNS THERETO SHOULD BE CLEARLY VISIBLE OR DI SCERNIBLE. IN A COST PLUS METHOD, THE TESTED PARTY CANNOT BE A PERSON WHO IS AT GROSS MARGIN LEVEL OR COST OF PRODUCTION LEVEL VIS A VIS A COMPARABLE, WHO PERFORMS BOTH THE FUNCTIONS I.E. MANUFACTURING AND SALES POSSESSED OF FUNCTIONS ATTRIBUTABLE TO NET MARGINS, SUCH A COMPARABLE BECOMES AN IRRELE VANT OR OUT OF PLACE COMPARABLE FOR A COST PLUS METHOD. 17. THE NEXT SUBMISSION OF THE LEARNED COUNSEL FOR THE ASSESSEE WAS THAT THE TERM DIRECT OR INDIRECT COSTS ARE NOT EXPL ICITLY DEFINED AND IS LEFT TO THE INDUSTRY PRACTICE AND COST ACCOUNTING STANDARDS CAS-4. THERE IS NO LEGAL REQUIREMENT FOR ENTITIES TO MAINTAIN THEIR COST RECORDS. IT IS THEREFORE SELF-EVIDENT THAT THE COST OF PRODUCTION OF COMPARABLE COMPANIES WOULD NEVER BE AVAILABLE IN THE PUBLIC DO MAIN. IN THE ABSENCE OF A STATUTORY COMPULSION, DISCRETION IS VESTED WIT H THE MANUFACTURERS IN DEFINING OR STRUCTURING DIRECT AND INDIRECT COSTS O F THEIR BUSINESS WHICH MAY EVEN VARY WITH THE INDUSTRY NORM OR PRACTICE. IN THE ABSENCE OF STANDARDIZATION OR STATUTORY COMPULSION OR PRESCRIB ED DEFINITIONS FOR DIRECT AND INDIRECT COSTS, THE ELEMENTS OR FUNCTIONS WHICH CON STITUTE THE COST OF PRODUCTION CAN BE AT VARIANCE. SECONDLY IN ABSENCE OF A TRANS PARENT DISCLOSURE, THE ITA NOS.815 & 846/BANG/2010 PAGE 16 OF 59 INCONSISTENCIES IN THE ACCOUNTING TREATMENTS OF COS TS BY THE RESPECTIVE ENTITIES CANNOT BE FOUND OUT. AS A RESULT COST PLUS METHODOL OGY CANNOT BE RESORTED TO, UNLESS OTHERWISE THE DATA RELATED TO ALL THE COST O R FUNCTIONS ARE AVAILABLE IN THE PUBLIC DOMAIN. 18. THE NEXT SUBMISSION WAS THAT RULE 10(B) (1) (C) OBLIGATES DETERMINATION OF DIRECT AND INDIRECT COST OF PRODUC TION INCURRED BY THE ENTERPRISE IN RESPECT OF PROPERTY TRANSFERRED OR SE RVICES PROVIDED. IT OBLIGATES ARRIVING AT THE NORMAL GROSS PROFIT MARKU P TO SUCH COSTS AND STIPULATES THAT THE SAME SHOULD BE COMPUTED ACCORDI NG TO THE SAME ACCOUNTING NORMS. ANY UNCERTAINTY OF THE FIRST TWO ELEMENTS CANNOT BE ADJUSTED OR RECONCILED IN ANY MANNER. ADJUSTMENTS A RE LIMITED TO ONLY FUNCTIONAL AND OTHER DIFFERENCES AND NOT IN EITHER RECONCILING THE DIRECT AND INDIRECT COSTS OR REWORKING THE COMPUTATION WHE N THE ACCOUNTING NORMS ARE NOT THE SAME. 19. IT WAS FURTHER SUBMITTED THE CIT(A) WRONGLY P LACED RELIANCE ON THE DECISION OF THE HONBLE PUNE TRIBUNALS DECISION IN THE CASE OF ACIT V. MSS INDIA (P) LTD. (2009) 123 TTJ (PUNE) 657. IT W AS POINTED OUT THAT IN THE AFORESAID CASE COST PLUS METHOD WAS HELD TO BE THE MOST APPROPRIATE METHOD IN LIGHT OF AVAILABILITY OF INTERNAL COMPARABILITY ANALYSIS OF MSS INDIA WHICH IS ABSENT IN THE CASE OF THE APPELLANT. FURTHER, IN THE SAID CASE ALSO THE TPO HIMSELF HAS NOTED THAT COST PLUS METHOD CANNOT BE APPLIED AS THE RELEVANT DATA FOR APPLYING THIS METH OD IS NOT AVAILABLE IN THE PROWESS DATABASE OR CAPITALLINE DATABASE AND TH US HAS RESORTED TO ITA NOS.815 & 846/BANG/2010 PAGE 17 OF 59 TNMM. A HOLISTIC VIEW OF THIS CASE, WHICH IS ALSO R ELIED ON BY THE LEARNED COMMISSIONER APPEALS SUPPORTS THE PLEA OF THE ASSES SEE. 20. REFERENCE WAS MADE TO PARAS 2.44, 2.45, 2.46 & 2.48 OF THE OECD TP GUIDELINES WHICH STATE AS FOLLOWS: PARA 2.44 IN ADDITION, WHEN APPLYING THE COST PLUS METHOD ONE SHOULD PAY ATTENTION TO APPLY A COMPARABLE MARK UP TO A COMPAR ABLE COST BASIS. PARA 2.45 FOR THIS PURPOSE, IT IS PARTICULARLY IMPORTANT TO C ONSIDER DIFFERENCES IN THE LEVEL AND TYPES OF EXPENSES OPERATING EXPE NSES AND NON- OPERATING EXPENSES INCLUDING FINANCING EXPENDITURES ASSOCIATED WITH FUNCTIONS PERFORMED AND RISKS ASSUMED BY THE P ARTIES OR TRANSACTIONS BEING COMPARED. CONSIDERATION OF THESE DIFFERENCES MAY INDICATE THE FOLLOWING: ...B) IF THE EXPENSES REFLECT ADDITIONAL FUNCTIONS THAT ARE DISTINCT FROM THE ACTIVITIES TESTED BY THE METHOD, SEPARATE COMPENSATION FOR THOSE FUNCTIONS MAY NEED TO BE DETERMINED. SUCH FUN CTIONS MAY FOR EXAMPLE AMOUNT TO THE PROVISION OF SERVICES FOR WHI CH AN APPROPRIATE REWARD MAY BE DETERMINED. SIMILARLY, EX PENSES THAT ARE THE RESULT OF CAPITAL STRUCTURES REFLECTING NON-ARM S LENGTH ARRANGEMENTS MAY REQUIRE SEPARATE ADJUSTMENT. IN ANY OF THE ABOVE CIRCUMSTANCES IT MAY BE APPROPR IATE TO SUPPLEMENT THE COST PLUS AND RESALE PRICE METHODS B Y CONSIDERING THE RESULTS OBTAINED FROM APPLYING OTHER METHODS. PARA 2.46 ANOTHER IMPORTANT ASPECT OF COMPARABILITY IS ACCOUN TING CONSISTENCY . WHERE THE ACCOUNTING PRACTICES DIFFER IN THE CONT ROLLED TRANSACTION AND THE UNCONTROLLED TRANSACTION, APPRO PRIATE ADJUSTMENTS SHOULD BE MADE TO THE DATA USED TO ENSU RE THAT THE SAME TYPE OF COSTS ARE USED IN EACH CASE TO ENSURE CONSISTENCY. THE GROSS PROFIT MARK UPS MUST BE MEASURED CONSISTENTLY BETWEEN THE ASSOCIATED ENTERPRISE AND THE INDEPENDENT ENTERPRIS E . IN ADDITION, THERE MAY BE DIFFERENCES ACROSS ENTERPRISES IN THE TREATMENT OF COSTS THAT AFFECT GROSS PROFIT MARK UPS THAT WOULD NEED T O BE ACCOUNTED FOR IN ORDER TO ACHIEVE RELIABLE COMPARABILITY. ITA NOS.815 & 846/BANG/2010 PAGE 18 OF 59 PARA 2.48 : ' THE DISTINCTION BETWEEN GROSS AND NET MARGIN ANALYSES MAY BE UNDERSTOOD IN THE FOLLOWING TERMS. IN GENERAL, THE COST PLUS METHOD WILL USE MARGINS COMPUTED AFTER DI RECT AND INDIRECT COSTS OF PRODUCTION, WHILE A NET MARGIN ME THOD WILL USE MARGINS COMPUTED AFTER OPERATING EXPENSES OF THE EN TERPRISE AS WELL. IT MUST BE RECOGNIZED THAT BECAUSE OF THE VAR IATIONS IN PRACTICE AMONG COUNTRIES, IT IS DIFFICULT TO DRAW ANY PRECIS E LINES BETWEEN THE THREE CATEGORIES DESCRIBED ABOVE.' 21. REFERENCE WAS TO THE GUIDANCE NOTE ON REPORT O N INTERNATIONAL TRANSACTIONS UNDER SECTION 92E OF THE INCOME TAX AC T, 1961 (TRANSFER PRICING) ISSUED BY ICAI (GUIDANCE NOTE) STATES ON PAGE 79 AS FOLLOWS: DETERMINE NORMAL GROSS PROFIT MARK-UP ON COSTS IN THE COMPARABLE UNCONTROLLED TRANSACTIONS. SUCH COSTS SH OULD BE COMPUTED ACCORDING TO THE SAME ACCOUNTING NORMS. IN OTHER WORDS, THE COMPONENTS OF COSTS OF COMPARABLE UNCONT ROLLED TRANSACTION SHOULD BE THE SAME AS THOSE OF INTERNAT IONAL TRANSACTION. IT WAS POINTED OUT THAT THE GUIDANCE NOTE FURTHER S TATES THAT, ADJUST THE GROSS PROFIT MARK-UP TO ACCOUNT FOR FUNCTIONAL AND OTHER DIFFERENCES BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPA RABLE UNCONTROLLED TRANSACTION. SUCH ADJUSTMENT SHOULD ALSO BE MADE FO R ENTERPRISE LEVEL DIFFERENCE. 22. ATTENTION WAS DRAWN TO THE OECD TRANSFER PRICING GU IDELINES IN PAGE 75 PARA 2.53 HAS ALSO GIVEN AN EXAMPLE TO EXPL AIN THE CRUCIAL POINTS TO BE BORNE IN MIND WHILE APPLYING THE CPM A ND IT STATES AS FOLLOWS: A IS A DOMESTIC MANUFACTURER OF TIMING MECHANISMS FOR MASS MARKET CLOCKS. A SELLS THIS PRODUCT TO ITS FOREIGN SUBSIDIARY B. A EARNS A 5 PERCENT GROSS PROFIT MARK UP WITH RESPECT TO ITS MANUFACTURING OPERATION. X, Y, AND Z ARE INDEPENDEN T DOMESTIC ITA NOS.815 & 846/BANG/2010 PAGE 19 OF 59 MANUFACTURERS OF TIMING MECHANISMS FOR MASS-MARKET WATCHES. X, Y, AND Z SELL TO INDEPENDENT FOREIGN PURCHASERS. X, Y, AND Z EARN GROSS PROFIT MARK UPS WITH RESPECT TO THEIR MA NUFACTURING OPERATIONS THAT RANGE FROM 3 TO 5 PERCENT. ACCOUNTS FOR SUPERVISORY, GENERAL, AND ADMINISTRATIVE COSTS AS O PERATING EXPENSES, AND THUS THESE COSTS ARE NOT REFLECTED IN COST OF GOODS SOLD. THE GROSS PROFIT MARK UPS OF X, Y, AND Z, HOW EVER, REFLECT SUPERVISORY, GENERAL, AND ADMINISTRATIVE COSTS AS P ART OF COSTS OF GOODS SOLD. THEREFORE, THE GROSS PROFIT MARK UPS OF X, Y, AND Z MUST BE ADJUSTED TO PROVIDE ACCOUNTING CONSISTENCY. THIS IMPLIES THAT ACCOUNTING CONSISTENCY IS REQUIRED BET WEEN THE CONTROLLED AND UNCONTROLLED TRANSACTIONS. APPLICATI ON OF DIFFERENT ACCOUNTING PRINCIPLES TO THE CONTROLLED A ND THE UNCONTROLLED TRANSACTIONS MAY RESULT IN INCONSISTEN T CALCULATION OF THE GROSS PROFITS. 23. REFERENCE WAS ALSO MADE TO THE CANADIAN TRANSFER PR ICING REGULATIONS ON APPLICATION OF CPM, WHICH STATES THA T (PARA NO. 83) IT IS MOST IMPORTANT THAT THE COST BASE OF THE TRAN SACTION OF THE TESTED PARTY TO WHICH A MARK-UP IS TO BE APPLIED BE CALCULATED IN THE SAME MANNER ASAND REFLECTS SIMILAR FUNCTIONS, RISKS, AND ASSETS ASTHE COST BASE OF THE COMPARABLE TRANSACTI ONS. 24. IT WAS SUBMITTED THAT IN THE LIGHT OF THE ABOV E ANALYSIS, CPM METHOD RESORTED TO BY THE REVENUE IN THE INSTANT CA SE IS NOT THE MOST APPROPRIATE METHOD, AS THE ASSESSEE PRODUCES TO SE LL ONLY TO AES AND DOES NOT SELL TO THIRD PARTY AND IN THE PROCESS NOT IN POSSESSION OF INTERNAL COMPARABLE COST DATA. 25. IT WAS SUBMITTED THAT ALTERNATIVELY TNMM IS TH E MOST APPROPRIATE METHOD FOR THE FOLLOWING REASONS; TNMM OPERATES AT THE NET LEVELS WHEREIN THE MARGINS ARE MORE TOLERANT TO FUNCTIONAL DIFFERENCE THAN AT GROSS LEV ELS; IF THERE EXIST ANY DIFFERENCE IN THE FUNCTIONS THE SAME GETS REFLECTED IN THE OPERATING EXPENSES; ITA NOS.815 & 846/BANG/2010 PAGE 20 OF 59 ADJUSTMENTS FOR DIFFERENCES IN THE MARKETING & ADVE RTISEMENT EXPENSES DO NOT RESULT IN ACCURATE ADJUSTMENT FOR T HE ADDITIONAL FUNCTIONS PERFORMED BY THE COMPARABLE COMPANIES VIS --VIS THE APPELLANTS WITH THE APPLICATION OF CPM; DATABASE LIMITATION ON ACCOUNT OF COST OF PRODUCTIO N (COP) CAN ALSO BE EFFICIENTLY MANAGED WITH THE USE OF INFORMA TION AT THE NET LEVEL; DIFFERENCES, IF ANY, IN THE COST STRUCTURES ALSO EV ENS OUT AT THE NET LEVELS; THE ABSENCE OF COMPARABLES FROM THE SAME INDUSTRY C ALLS FOR THE SELECTION OF A BROADER SET OF COMPARABLES THEREBY M AKING A PERFECT CASE FOR TESTING THE MARGINS AT THE NET LEV EL WITH THE APPLICATION OF TNMM. TNMM SHOULD BE CONSIDERED AS THE MAM WHERE OPERATIN G EXPENSES REPRESENT ADDITIONAL FUNCTIONS BUT IT IS N OT CLEAR HOW THESE ADDITIONAL FUNCTIONS ARE ACCOUNTED FOR AT THE GROSS MARGIN LEVEL, SINCE TNMM INCLUDES THIS IN ITS RESULT. 26. IN THIS REGARD, OUT ATTENTION WAS DRAWN TO PAR AGRAPH 2.62 & 2.69 & 2.4 OF THE OECD TRANSFER PRICING GUIDELINES WHICH S TATES AS FOLLOWS: PARA 2.62 OF THE OECD GUIDELINES : 'ONE STRENGTH OF THE TRANSACTIONAL NET MARGIN METHO D IS THAT PROFIT LEVEL INDICATORS (E.G. RETURN ON ASSETS, OPE RATING INCOME TO SALES, AND POSSIBLY OTHER MEASURES OF NET PROFIT ) ARE LESS AFFECTED BY TRANSACTIONAL DIFFERENCES THAN IS THE C ASE WITH PRICE, AS USED IN THE CUP METHOD. NET PROFIT LEVEL INDICAT ORS ALSO MAY BE MORE TOLERANT TO SOME FUNCTIONAL DIFFERENCES BETWEEN THE CONTROLLED AND UNCONTROLLED TRANSACTIONS THAN GROSS PROFIT MARGINS . DIFFERENCES IN THE FUNCTIONS PERFORMED BETWEEN ENTERPRISES ARE OFTEN REFLECTED IN VARIATIONS IN O PERATING EXPENSES. CONSEQUENTLY, ENTERPRISES MAY HAVE A WIDE RANGE OF GROSS PROFIT MARGINS BUT STILL EARN BROADLY SIMILAR LEVELS OF NET OPERATING PROFIT INDICATORS . ITA NOS.815 & 846/BANG/2010 PAGE 21 OF 59 PARA 2.69 OF OECD GUIDELINES : 'PRICES ARE LIKELY TO BE AFFECTED BY DIFFERENCES IN PRODUCTS, AND GROSS MARGINS ARE LIKELY TO BE AFFECTED BY DIFF ERENCES IN FUNCTIONS, BUT OPERATING PROFITS ARE LESS ADVERSELY AFFECTED BY SUCH DIFFERENCES ' PARAGRAPH 2.4 OF OECD GUIDELINES : THERE ARE SITUATIONS WHERE TRANSACTIONAL PROFIT MET HODS ARE FOUND TO BE MORE APPROPRIATE THAN TRADITIONAL TRANS ACTION METHODS. ONE EXAMPLE IS WHERE, CONSIDERING THE FUN CTIONAL ANALYSIS OF THE CONTROLLED TRANSACTION UNDER REVIEW AND AN EVALUATION OF THE COMPARABLE UNCONTROLLED TRANSACTI ONS, IT IS FOUND THAT A NET MARGIN ANALYSIS IS MORE RELIABLE T HAN A GROSS MARGIN ANALYSIS, E.G. BECAUSE THERE ARE MATERIAL DI FFERENCES IN FUNCTIONS BETWEEN THE TESTED AND THE UNCONTROLLED T RANSACTION WHICH ARE REFLECTED ONLY IN OPERATING EXPENSES BELO W THE GROSS MARGIN LEVEL. THE OECD PARA 2.62 : . NET PROFIT INDICATORS ALSO MAY BE MORE TOLERANT TO SOME FUNCTIONAL DIFFERENCES BETWEEN THE CONTROLLED AND U NCONTROLLED TRANSACTIONS THAN GROSS PROFIT MARGINS. DIFFERENCES IN THE FUNCTIONS PERFORMED BETWEEN ENTERPRISES ARE OFTEN R EFLECTED IN VARIATIONS IN OPERATING EXPENSES. CONSEQUENTLY, THI S MAY LEAD TO A WIDE RANGE OF GROSS PROFIT MARGINS BUT STILL B ROADLY SIMILAR LEVELS OF NET OPERATING PROFIT INDICATORS. IN ADDITION, IN SOME COUNTRIES THE LACK OF CLARITY IN THE PUBLIC DATA WI TH RESPECT TO THE CLASSIFICATION OF EXPENSES IN THE GROSS OR OPER ATING PROFITS MAY MAKE IT DIFFICULT TO EVALUATE THE COMPARABILITY OF GROSS MARGINS, WHILE THE USE OF NET PROFIT INDICATORS MAY AVOID THE PROBLEM. 27. ATTENTION WAS ALSO INVITED TO THE AUSTRALIAN T RANSFER PRICING GUIDELINES PROVIDE THAT: [TR 97/20 3.52. ON PROFIT METHODS] .IT MIGHT NOT BE POSSIBLE OR PRACTICABLE TO USE T RADITIONAL METHODS BECAUSE: ITA NOS.815 & 846/BANG/2010 PAGE 22 OF 59 I. THERE IS INSUFFICIENT RELIABLE DATA TO ANALYZE COMP ARABILITY SO AS TO DETERMINE AN ARM'S LENGTH OUTCOME OTHER THAN THROUGH A PROFIT SPLIT OR A PROFIT COMPARISON AT THE NET PR OFIT LEVEL. FOR EXAMPLE, IF SELLING, GENERAL AND ADMINISTRATIVE COSTS THAT ARE TREATED AS PART OF COSTS OF GOODS SOLD FOR AN I NDEPENDENT ENTERPRISE CANNOT BE IDENTIFIED SO AS TO ADJUST THE GROSS MARGIN IN A RELIABLE APPLICATION OF COST PLUS, IT M AY BE NECESSARY TO EXAMINE NET MARGINS IN THE ABSENCE OF MORE RELIABLE COMPARISONS; II. THE PRODUCT OR SERVICE IN QUESTION IS UNIQUE OR CO NTAINS OUT- OF-THE-ORDINARY INTANGIBLES; III. WHILE THEORETICALLY SOUND, THE TRADITIONAL METHODS MAY NOT BE PRACTICABLE BECAUSE OF THE COMPLEXITY OF THE BUS INESS SITUATION OR THE EXTENT AND DIVERSITY OF THE TAXPAY ER'S CROSS- BORDER DEALINGS WITH ASSOCIATED ENTERPRISES; IV. IN MANY CASES, THERE IS A VARIETY OF TRANSACTIONS ( TRANSFERS OF TANGIBLE AND INTANGIBLE GOODS AND SERVICES) BACK AN D FORTH BETWEEN THE ASSOCIATED ENTERPRISES, SOME OF WHICH M AY INVOLVE OVERLAPS, AND THERE MAY BE NO COMPARABLES F OR THE COMBINATION OF TRANSACTIONS. IN THESE CASES, PROFIT METHODS MAY BE A MORE RELIABLE WAY TO SET OR REVIEW THE TRA NSFER PRICING USED IN THE DEALINGS BETWEEN THE ASSOCIATED ENTERPRISES, OR TO CHECK FINDINGS MADE USING TRADIT IONAL METHODS IF THERE IS DOUBT ABOUT THE RELIABILITY OF THE DATA USED OR THE OUTCOME PRODUCED; 28. IT WAS SUBMITTED THAT CONSIDERING THE AFOREMEN TIONED LEGAL PRINCIPLES, THAT TNMM SHOULD BE APPLIED INSTEAD OF CPM. THE NET MARGINS EARNED BY ASSESSEE ARE COMPARABLE TO THE CO MPARABLES PROVIDED IN THE TRANSFER PRICING DOCUMENTATION AND EVEN THE ONES PROPOSED BY THE TPO. 29. THE LD. COUNSEL FOR THE ASSESSEE ALSO HIGHLIGHT ED AS TO HOW APPLYING THE COST PLUS METHOD WOULD GIVE ABSURD RES ULTS AS UNDER: ITA NOS.815 & 846/BANG/2010 PAGE 23 OF 59 GROSS MARGINS AND THE NET MARGINS EARNED BY THE COM PARABLE COMPANIES AND THE ASSESSEE IS AS FOLLOWS : COMPANY NAME FINANCIAL YEAR GP / COP (AS PER THE ORDER GIVING EFFECT TO THE CIT(A)S ORDER) OPERATING PROFIT/TOTAL COST CENTENIAL SURGICAL SUTURE LTD. 200403 74.17% 7.90% POLY MEDICURE LTD. 200403 27.65% 17.50% SOUTH INDIA SURGIC ALS COMPANY LIMITED 200403 37.83% 10.60% ARITHMETIC MEAN 46.55% 12.00% GE BE 16.24% 12.16% IT WAS SUBMITTED THAT THE ABOVE FIGURES WOULD SHOW THAT AT THE GROSS MARGIN LEVEL THE EARNINGS OF THE ASSESSEE ARE LESS THAN THE COMPARABLE COMPANIES WHILE AT THE NET MARGIN LEVEL THE MARGIN OF THE ASSESSEE IS HIGHER. IT WAS SUBMITTED THAT THE ABOVE COMPARISON OF THE GROSS AND NET PROFIT LEVEL INDICATORS (PLIS) ONLY FURTHER DEMONST RATES THE IRRATIONALITY OF THE APPLICATION OF CPM TO THE FACTS OF THE PRESENT CASE. 30. IT WAS SUBMITTED THAT THE FOLLOWING WILL BE TH E REVISED PROFIT MARGIN OF THE ASSESSEE AFTER GIVING EFFECT TO THE DIRECTIO NS OF THE TPO GE BES NET MARGIN BASED ON THE GP / COP AS PER TPO PARTICULARS AMOUNT (INR) SALES 3,731,286,546 ADD: TP ADJUSTMENT TO INCOME AS MADE BY THE LEARNED TPO (AS PER TP ORDER) 596,515,581 TOTAL INCOME REVISED AFTER THE TP ADJUSTMENT MADE BY THE LEARNED TPO A 4,327,802,127 LESS: COST OF PRODUCTION MATERIALS COST 2,960,589,360 PERSONNEL COST 19,078,438 CONSUMABLES 45,584,322 DEPRECIATION 108,652,580 ITA NOS.815 & 846/BANG/2010 PAGE 24 OF 59 PARTICULARS AMOUNT (INR) REPAIRS AND MAINTENANCE 37,932,517 TRANSPORT AND PACKING 5,144,710 EXCISE DUTY 5,623,804 POWER AND FUEL 54,102,259 INSURANCE 3,874,650 ADD: OPENING WIP 56,967,585 LESS: CLOSING WIP (87,633,645) COST OF PRODUCTION B 3,209,916,579 GROSS MARGIN C = A-B 1,117,885,548 GROSS MARGIN / COP AS CONSIDERED BY THE LEARNED TPO D = C/ B 34.83% LESS: OTHER OPERATING EXPENSES OF GE BE OPENING STOCK OF FINISHED GOODS 16975272 CLOSING STOCK OF FINISHED GO ODS (4,150,577) SALARY EXPENSE 34,258,518 OTHER DEPRECIATION 24,832,551 REPAIRS AND MAINTENANCE-OTHERS 2,722,192 SUBCONTRACTING CHARGES 12,132,002 COMMUNICATION EXP 8,092,662 TRAVEL & CONVEYANCE 8,027,514 LEGAL & PROFESSIONAL FEE 7,111,653 RENT 2,465,865 RATES & TAXES 897,175 FOREIGN EXCHANGE LOSS- NET 430,831 MISCELLANEOUS EXPENSES 5,168,941 TOTAL OTHER OPERATING EXPENSES E 122,397,796 TOTAL OPERATING EXPENSES F = B + E 3,332,314,375 NET OPERATING PROFIT RECOMPUTED G = A- F 995,487,7 52 OPERATING PROFIT/TOTAL COST (OP/TC ) H = G / F 29.87% IT WAS SUBMITTED THAT FROM THE ABOVE CALCULATION IT WOULD BE CLEAR THE LEARNED TPO HAS CONTEMPLATED AN INCREASE IN THE REV ENUE TO ARRIVE AT THE DESIRED GROSS PROFIT OF APPROXIMATELY 35%, GIVEN TH E ACTUAL OPERATING EXPENSE OF THE ASSESSEE, THE NET MARGIN OF THE COMPANY IS THUS PROPOSED TO BE CONSIDERED AT ABOUT A WHOPPING 30% . IT WAS ITA NOS.815 & 846/BANG/2010 PAGE 25 OF 59 SUBMITTED THAT THE ABOVE COMPUTATION CLEARLY DEMONS TRATES THE FUNDAMENTAL ABSURDITY IN THE APPROACH FOLLOWED BY T HE LEARNED TPO AND APPLYING CPM VIS--VIS TNMM WHICH IS THE MOST APPRO PRIATE METHOD. IT WAS FURTHER ARGUED THAT BASED ON THE ABOVE COMPUTAT ION OF THE NET MARGIN OF THE ASSESSEE WHICH IS ARRIVED AT APPROXIM ATELY 30%, IT WOULD BE REASONABLE TO ASSUME THAT THE COMPARABLE COMPANI ES IDENTIFIED BY THE LEARNED TPO MUST ALSO ACHIEVE SIMILAR NET PROFI T LEVELS. HOWEVER, THE OP / TC OF THE COMPARABLE COMPANIES IS AT ABOUT 12% AS PROVIDED IN THE TABLE IN TABLE GIVEN IN PARAGRAPH 30 ABOVE. IT WAS SUBMITTED THAT THE ABOVE CLEARLY DEMONSTRATES THAT THE APPLICATION OF CPM IS NOT ONLY WITHOUT ANY PROPER REASONING OR BASIS AND ONLY WITH THE OBJECTIVE OF MAKING THE ASSESSMENT PROCEEDINGS ONEROUS FOR THE A SSESSEE OR TO IMPOSE UNWARRANTED TAX LIABILITY ON THE ASSESSEE. 31. THE GIST OF THE WRITTEN SUBMISSIONS FILED BY T HE LD. DR CAN BE SUMMED UP THUS: I) THE ASSESSEE HAD ITSELF CONSIDERED CPM AS THE MA M. THE TPO ALSO ACCEPTED IT AS MAM. THEREFORE, THERE IS N O REASON FOR THE ASSESSEE TO AGITATE BEFORE THE HONBLE ITT AT LEAST IN AY 04-05 THAT MAM IS TNMM AND NOT CPM. THE PRIMARY RESPONSIBILITY OF IDENTIFYING THE MAM IS ON THE ASS ESSEE AND HE HAD CHOSEN CPM AS THE MAM AND THEREFORE THE ASSE SSEE CANNOT TAKE A GROUND THAT CPM IS NOT THE RIGHT METH OD. II) ONE OF THE ASSESSEES PLEA WAS THAT FUNCTION AL SIMILARITY IS TO BE FIRST SEEN BEFORE CHOOSING AN APPROPRIATE METHOD AND ITA NOS.815 & 846/BANG/2010 PAGE 26 OF 59 THAT THE TPO IN CHOOSING CPM HAS GIVEN WEIGHTAGE TO PRODUCT SIMILARITY RATHER THAN FUNCTIONAL SIMILARITY. THE ASSESSEE HAD FURTHER POINTED OUT THAT THE COMPARABLE CHOSEN BY T HE TPO WERE MANUFACTURING MEDICAL CONSUMABLES VIZ., DISPOS AL SYRINGES, DISPOSABLE SUTURES, DISPOSABLE NEEDLES ET C., AND THAT THE SAME CANNOT BE COMPARED WITH CONTRACT MANUFACTURING OF TUBES, INSERTS, DETECTORS, TANKS A ND OTHER PARTS AND ACCESSORIES FOR MEDICAL DIAGNOSTIC IMAGIN G EQUIPMENT WHICH THE ASSESSEE MANUFACTURES AND WHICH ARE INCORPORATED BY THE AE INTO EQUIPMENT WHICH ARE CAP ITAL GOODS. ON THE ABOVE SUBMISSION, THE LEARNED DR HAS SUBMITTED THAT IT CANNOT BE SAID THAT PRODUCT SIMIL ARITY HAS NO RELEVANCE. PRODUCT SIMILARITY IS ALSO IMPORTANT. IF THERE IS NO PRODUCT SIMILARITY THEN EVEN THOUGH THERE MAY BE FU NCTIONAL SIMILARITY THEN CPM MAY NOT BE THE RIGHT METHOD. W ITHOUT PREJUDICE TO THE ABOVE SUBMISSION, IT WAS ALSO SUBM ITTED THAT IN THE PRESENT CASE, THE TPO HAS GIVEN DUE WEIGHTAG E TO FUNCTIONAL SIMILARITY ALSO. III) THE ASSESSEE HAD RELIED ON PARA 1.41 OF THE O ECD GUIDELINES WHICH PROVIDES THAT COMPARABILITY EVEN W HERE PRODUCTS ARE DIFFERENT CAN BE UNDERTAKEN BUT THE FU NCTIONS UNDERTAKEN SHOULD BE SIMILAR. ON THE ABOVE SUBMISS ION OF THE ASSESSEE THE LEARNED DR HAS SUBMITTED THAT THE TPO HAS ITA NOS.815 & 846/BANG/2010 PAGE 27 OF 59 CONSIDERED BOTH PRODUCT AS WELL AS FUNCTIONAL SIMIL ARITY OF COMPARABLE. IV) THE ASSESSEE HAD SUBMITTED THAT INDIAN ACCOUNT ING STANDARDS DO NOT GIVE CLEAR CUT REQUIREMENT FOR DIS CLOSURE OF GROSS PROFITS AND THEREFORE THERE WILL BE DIFFICULT Y IN COMPUTATION OF THE COST OF PRODUCTION AND GROSS PRO FIT. THE ASSESSEE HAS RELIED ON PARA 2.44 TO 2.46 AND 2.48 O F THE OECD TP GUIDELINES AS TO HOW THE DETAILS OF COST OF PRODUCTION AND GROSS PROFIT ARE IMPORTANT BEFORE AP PLYING CPM. ON THE ABOVE SUBMISSION, THE LEARNED DR HAS CONTENDED THAT UNDER PARA 2.46 OF THE OECD TP GUIDE LINES WHERE THE ACCOUNTING PRACTICES DIFFER IN THE CONTRO LLED TRANSACTION AND THE UNCONTROLLED TRANSACTION, APPRO PRIATE ADJUSTMENTS SHOULD BE MADE TO THE DATA USED TO ENSU RE THAT THE SAME TYPE OF COSTS ARE USED IN EACH CASE TO ENS URE CONSISTENCY. THE LEARNED DR THUS SUBMITTED THAT CP M CANNOT BE REJECTED OUTRIGHT BUT HAS TO BE APPLIED AFTER GI VING APPROPRIATE ADJUSTMENTS TO THE DATA ON COSTS OF THE CONTROLLED AND UNCONTROLLED TRANSACTIONS. V) THE ASSESSEE HAD SUBMITTED THAT THE DIFFERENCE IN FUNCTIONS PERFORMED BY THE ASSESSEE AND THE COMPARA BLE SELECTED BY THE TPO WOULD BE CLEAR FROM AN ANALYSIS OF THE RESPECTIVE COST PATTERN AND HAD IN THIS REGARD HIGH LIGHTED THAT THE ASSESSEES RATIO RAW MATERIAL COST TO SALES IS HIGHER AT ITA NOS.815 & 846/BANG/2010 PAGE 28 OF 59 80.57% COMPARED TO 50.57 OF THE COMPARABLE. ON THE ABOVE SUBMISSION, THE LEARNED DR HAS SUBMITTED BEFORE US THAT THE ABOVE ARGUMENT SHOWS THAT THE ASSESSEE HAS ACCEPTED THE FACT THAT THE PRODUCTS OF THE COMPARABLE AND THAT O F THE ASSESSEE ARE COMPARABLE AND THEREFORE THE COST PATT ERN OF THE COMPARABLE AND THAT OF THE ASSESSEE ARE NOT RELEVAN T. VI) THE ASSESSEE HAD SUBMITTED THAT IT IS A CONTRA CT MANUFACTURER AND DOES NOT PERFORM FUNCTIONS LIKE MA RKETING, SELLING AND DISTRIBUTION THAT ARE PERFORMED BY THE COMPANIES CHOSEN BY THE TPO WHILE APPLYING CPM. ON THE ABOVE SUBMISSION THE LEARNED DR HAS SUBMITTED BEFORE US T HAT EXPENSES ON MARKETING, SELLING AND DISTRIBUTION ARE EXPENSES WHICH WILL BE RELEVANT ONLY WHEN COMPUTING NET PROF IT AND THEREFORE THOSE EXPENSES ARE IRRELEVANT WHILE APPLY ING CPM. IT IS FURTHER SUBMITTED THAT SIMILARITY OF FUNCTION S TO THE GROSS PROFIT LEVEL WILL ONLY BE RELEVANT. IN THIS REGARD THE LEARNED DR HAS ALSO SUBMITTED THAT WHILE CONFIRMING THE ORDER OF THE AO MAKING ADDITION CONSEQUENT TO ADJUSTMENT OF ALP, TH E CIT(A) HAS DIRECTED THE AO TO MAKE ADJUSTMENT TO PROFIT MA RGINS ON ACCOUNT OF MARKETING, SELLING AND DISTRIBUTION EXPE NSES, THE SAME CANNOT AFFECT GROSS MARGINS. VII) ON THE SUBMISSIONS OF THE ASSESSEE AS TO WHIC H METHOD IS SUPERIOR WHETHER CPM OR TNMM, THE LEARNED DR HAS SUBMITTED THAT THE ISSUE IS AS TO WHICH METHOD IS M OST ITA NOS.815 & 846/BANG/2010 PAGE 29 OF 59 APPROPRIATE TO THE FACTS OF THE PRESENT CASE AND NO T WHICH METHOD IS SUPERIOR. VIII) THE LEARNED DR ALSO SUBMITTED THAT THE TP DO CUMENTS HAVE BEEN PREPARED BY THE ASSESSEE BONAFIDE AND GOO D FAITH AND THEREFORE REJECTION THEREOF IS NOT WARRANTED, I N SO FAR AS MAM IS CONCERNED. 32. WE HAVE GIVEN A CAREFUL CONSIDERATION TO THE RI VAL SUBMISSIONS. WE SHALL FIRST RECAPITULATE THE SEQUENCE OF EVENTS. THE DISPUTE RAISED BY THE ASSESSEE IN GR.NO.1 TO 7 RELATE TO THE DETERMIN ATION OF ARMS LENGTH PRICE (ALP) IN RESPECT OF THE INTERNATIONAL TRANSAC TION OF SALE OF MANUFACTURED GOODS BY THE ASSESSEE TO ONE ITS ASSOC IATED ENTERPRISE (AE). THE ASSESSEE MANUFACTURES COMPONENTS OF MEDI CAL DEVICES AND SELLS IT TO ITS AE. THE PRICING IS CLAIMED TO BE B ASED ON THE GE GLOBAL PRICING POLICY. THE ASSESSEE SOURCES RAW MATERIAL AND COMPONENTS, PERFORMS THE MANUFACTURING FUNCTIONS AND SUPPLIES T HE ENTIRE PRODUCE TO ITS AE. TO JUSTIFY THE PRICE THAT IT RECEIVES FROM ITS AE IS AT ARMS LENGTH THE ASSESSEE FILED A TRANSFER PRICING STUDY REPORT. THE ASSESSEE CLAIMED THAT IT PERFORMED FUNCTIONS AND UNDERTOOK R ISKS THAT ARE NORMALLY PERFORMED BY A CONTRACT MANUFACTURER. THE ASSESSEE CHOSE COST PLUS METHOD (CPM) AS THE MOST APPROPRIATE METHOD (MAM) F OR DETERMINATION OF ALP. THE ASSESSEE IDENTIFIED 19 COMPARABLE COMP ANIES WHICH WERE IN THE BUSINESS OF MANUFACTURE OF (I) STEEL FORGING S, (II) AUTOMOTIVE BRAKE SYSTEMS, (III) COMPRESSORS; (IV) COLOUR TV PICTURE TUBES, (V) AXLE SHAFTS, (VI) AUTOMOTIVE GEARS; (VII) REAR FORK ASSEMBLY; (V III) SHEET METAL ITA NOS.815 & 846/BANG/2010 PAGE 30 OF 59 COMPONENTS, ASSEMBLIES AND SUB-ASSEMBLIES,(IX) AUTO HEAD LIGHTS, (X) FUEL TANKS, AXLE HOUSING; (X) STEERING GEARS; (XI) WHEELS FOR AUTOMOBILES; (XII) DESIGN ENGINES; (XIII) STEERING GEAR ASSEMBLY ; (XIV) AUTOMOTIVE AIR- CONDITIONING SYSTEMS; (XV) STEEL METAL PARTS. THE ARITHMETIC MEAN OF THE COMPARABLE COMPANIES WAS 15.72% GROSS MARK-UP ON CO ST. THE ASSESSEES GROSS MARK-UP ON COST WAS 16.24% AND THE REFORE IT WAS CLAIMED THAT THE PRICE RECEIVED FROM THE AE BY THE ASSESSEE IN RESPECT OF THE INTERNATIONAL TRANSACTION WAS AT ARMS LENGTH. 33. THE TPO ACCEPTED THE METHODOLOGY ADOPTED BY THE ASSESSEE VIZ., CPM AS THE MAM. THE PROFIT LEVEL INDICATOR (PLI) C HOSEN BY THE ASSESSEE VIZ., GROSS PROFIT ON COST WAS ALSO ACCEPT ED BY THE TPO. THE TPO WAS OF THE VIEW THAT THE COMPARABLE CHOSEN BY T HE ASSESSEE WERE NOT FROM THE MEDICAL EQUIPMENT INDUSTRY SEGMENT AND IN TERMS OF RULE 10B(2) (A) THE COMPARABILITY OF AN INTERNATIONAL TR ANSACTION WITH AN UNCONTROLLED TRANSACTION SHALL BE JUDGED WITH REFER ENCE TO THE SPECIFIC CHARACTERISTICS OF THE PROPERTY TRANSFERRED OR SERV ICES PROVIDED IN EITHER TRANSACTION . THE TPO THEREFORE WAS OF THE VIEW THAT PRODUCT COMPARABILITY IS VERY IMPORTANT. THE TPO REFERRED TO PARA 2.18 OF THE OECD GUIDELINES ON TRANSFER PRICING WHEREIN IT IS P ROVIDED THAT ALTHOUGH BROADER PRODUCT DIFFERENCES CAN BE ALLOWED IN THE R ESALE PRICE METHOD, THE PROPERTY TRANSFERRED IN THE CONTROLLED TRANSACT ION MUST STILL BE COMPARED TO THAT BEING TRANSFERRED IN THE UNCONTROL LED TRANSACTION. THE GUIDELINES ALSO LAYS DOWN THAT CLOSER COMPARABILITY OF PRODUCTS WILL PRODUCE BETTER RESULT. THE TPO ALSO REFERRED TO AN AUSTRALIAN TAX RULING ITA NOS.815 & 846/BANG/2010 PAGE 31 OF 59 TR 97/20 WHICH ALSO LAYS DOWN THAT TO ACHIEVE AN AC CEPTABLE LEVEL OF RELIABILITY, GREATER CARE IS NEEDED TO ENSURE THAT THE INDUSTRY SEGMENT OR GROUP OF SEGMENTS BEING COMPARED ARE SUFFICIENTLY S IMILAR, ESPECIALLY IN RELATION TO FUNCTIONS PERFORMED AND LEVELS OF PROFI TABILITY. 34. THE ASSESSEE JUSTIFIED ITS ACTION IN CHOOSING C OMPARABLE COMPANIES FROM AUTO ANCILLARY AND OTHER INDUSTRIES FOR THE REASON THAT THOSE COMPANIES ALSO SUPPLY COMPONENTS/SEMI-FINISHE D GOODS TO ORIGINAL EQUIPMENT MANUFACTURERS (OEMS) AND WAS THEREFORE AK IN TO CONTRACT MANUFACTURING. THOSE COMPANIES ALSO DID NOT PERFOR M FUNCTIONS LIKE MARKETING AND ADVERTISEMENT. THE TPO ON THE ABOVE STAND OF THE ASSESSEE REFERRED TO PARA 1.20 OF OECD GUIDELINES W HEREIN IT HAS BEEN LAID DOWN THAT COMPARABILITY SHOULD BE BASED ON FUN CTIONS PERFORMED AND NOT ON THE BASIS OF FUNCTIONS NOT PERFORMED. THE T PO ALSO REFERRED TO THE ADVERTISING AND MARKETING FUNCTIONS WHICH WERE NOT BEING PERFORMED BY THE ASSESSEE AS WELL AS THE COMPARABLE COMPANIES ID ENTIFIED BY THE ASSESSEE AS HAVING NO RELEVANCE BECAUSE OF THE GROS S MARK UP ON COST WHICH IS THE PLI ADOPTED BY THE ASSESSEE AND THEREF ORE FOR COMPARABILITY AT THE LEVEL OF GROSS MARK UP ON COST OF THE PRODUC TS SOLD, THOSE EXPENSES WERE IMMATERIAL. 35. ONE OF THE OBJECTION OF THE ASSESSEE BEFORE THE TPO WAS THAT THE COMPARABLE CHOSEN BY THE TPO HAD LOW EXPORT TURNOVE R. ON THE ABOVE OBJECTION OF THE ASSESSEE THE TPO HAS OBSERVED THAT TWO OF THE COMPARABLE COMPANIES CHOSEN BY THE TPO HAD EXPORT T URNOVER. ITA NOS.815 & 846/BANG/2010 PAGE 32 OF 59 36. THEREAFTER THE TPO CHOSE COMPARABLE COMPANIES I N THE MEDICAL EQUIPMENT COMPONENTS MANUFACTURING SECTOR. THE FOL LOWING FOUR COMPARABLES WERE IDENTIFIED BY THE TPO. SL.NO. NAME OF THE COMPARABLE % OF GP OVER COST S 1 CONTENTIAL SURGICAL SUTURE LTD 74.167 2 POLYMEDICURE LTD. 27.646 3 SOUTH INDIA SURGICAL CO. LTD. 37.833 4 SHREE PACETRONIX LTD. 38.462 AVG. 44.527 OUT OF THIS SHREE PACETRONIX LTD. WAS REJECTED AS P ER THE TAXPAYERS REQUEST SINCE IT HAD RELATED PARTY TRANSACTIONS. TH E FINAL LIST OF COMPARABLE COMPANIES WAS AS FOLLOWS: SL.NO. NAME OF THE COMPARABLE % OF GP OVER COST S 1 CONTENTIAL SURGICAL SUTURE LTD 74.167 2 POLYMEDICURE LTD. 27.646 3 SOUTH INDIA SURGICAL CO. LTD. 37.833 AVG. 46.55% THE ADJUSTMENT AND CONSEQUENT ADDITION TO THE ALP W AS MADE BY THE AO. 37. THE CIT(A) CONFIRMED THE REASONING OF THE TPO O N ALL THE ABOVE OBJECTIONS OF THE ASSESSEE. ON THE QUESTION OF PRO DUCT COMPARABILITY BEING IMPORTANT THE CIT(A) AGREED WITH THE VIEW OF THE TPO. HOWEVER WITH REGARD TO THE OBJECTION OF THE ASSESSEE THAT T HE COMPARABLE ITA NOS.815 & 846/BANG/2010 PAGE 33 OF 59 COMPANIES CHOSEN BY THE TPO DO NOT HAVE EXPORT SALE S, THE CIT(A) FOUND MERIT IN THE ARGUMENT ADVANCED BY THE ASSESSE E. HE FOUND THAT 2 OUT OF THE THREE COMPANIES CHOSEN BY THE TPO VIZ., CENTENIAL SURGICAL SUTURES LTD. AND SOUTH INDIA SURGICAL COMPANY LTD., HAD ONLY 6.79% AND 17.74% EXPORT SALES TO TOTAL SALES. THE CIT(A) FOU ND THAT THE TPO SELECTED THESE TWO COMPANIES AS COMPARABLE BASED ON THE QUANTITATIVE FILTER OF EXPORT EARNINGS WITHOUT PROVIDING ANY MIN IMUM THRESHOLD LEVEL OF SUCH EARNINGS. THE CIT(A) ALSO FOUND THAT THE ASSE SSEE WAS A 100% EOU AND ANY COMPARISON OF ITS GROSS MARGINS WITH CO MPANIES HAVING AN INSIGNIFICANT PROPORTION OF EXPORT SALES IS NOT LIK ELY TO YIELD MEANINGFUL RESULTS. HE ALSO FOUND THAT THE TPO HAS CONSISTENT LY ADOPTED THE QUANTITATIVE FILTER OF EXPORT REVENUE TO OPERATING REVENUE BEING GREATER THAN 25% IN ACCORDANCE WITH THE COMPARABILITY CRITE RIA LAID DOWN IN RULE 10B(2)(D). HE WAS OF THE VIEW THAT DOMESTIC COMPAN IES NORMALLY CANNOT BE TREATED AS COMPARABLE TO THOSE OPERATING IN THE OVERSEAS MARKETS BECAUSE OF THE DIFFERENCES IN GEOGRAPHIC LOCATIONS, CONDITIONS PREVAILING IN THE DOMESTIC AND EXPORT MARKETS, SIZE OF MARKETS , COST OF LABOUR AND CAPITAL, LEVEL OF COMPETITION AND OVERALL ECONOMIC DEVELOPMENT. THE CIT(A) THEREFORE FELT THAT THE TPO SHOULD BE DIRECT ED TO APPLY THE FILTER OF EXPORTS REVENUES TO OPERATING REVENUES BEING MORE T HAN 25% FILTER AND RE-COMPUTE ALP. THE CIT(A) HOWEVER GAVE A RIDER TO HIS OWN DIRECTION AS ABOVE BY ADDING THAT IF THE TPO CAN DEMONSTRATE THAT THERE WOULD BE NO DIFFERENCE IN PRICING AS WELL AS MARGINS BETWEEN THE DOMESTIC AND EXPORT SECTORS OF THE INDUSTRY THEN HE CAN IGNORE T HIS FILTER. ITA NOS.815 & 846/BANG/2010 PAGE 34 OF 59 38. THE FIRST ISSUE THAT NEEDS TO BE ADDRESSED IS W ITH REGARD TO THE CLAIM OF THE ASSESSEE THAT TNMM SHOULD BE ADOPTED A S THE MAM INSTEAD OF CPM. ON THE ABOVE ISSUE, THE REVENUE AUTHORITIE S PROCEEDED ON THE BASIS THAT ONCE THE ASSESSEE HAS CHOSEN A PARTICULA R METHOD AS MAM THEN HE CANNOT GO BACK ON IT. THE REVENUE AUTHORIT IES FURTHER RELIED ON A RULING OF THE PUNE BENCH OF ITAT IN THE CASE OF MSS INDIA (P) LTD. (SUPRA) WHEREIN IT WAS HELD THAT PROFIT METHODS ARE PRESSED INTO SERVICE ONLY WHEN THE TRADITIONAL METHOD WHICH INCLUDES CPM CANN OT BE REASONABLY APPLIED. ONCE THE STANDARD METHOD IS APPLIED IT CA NNOT BE DISCARDED IN PREFERENCE OVER TRANSACTIONAL PROFIT METHOD UNLESS THE REVENUE AUTHORITIES ARE ABLE TO DEMONSTRATE THE FALLACIES I N APPLICATION OF STANDARD METHOD. 39. THIS REASONING CANNOT BE ACCEPTED. THERE CANNO T BE ANY ESTOPPEL IN TAXATION MATTERS. IF THE ASSESSEE CAN SHOW THAT THE STAND HE ORIGINALLY TOOK WAS NOT SUSTAINABLE IN LAW AND SEEKS TO TAKE A DIFFERENT STAND EITHER IN THE COURSE OF PROCEEDINGS BEFORE THE ASSESSING O FFICER OR APPELLATE AUTHORITIES, THE CLAIM OF THE ASSESSEE HAS TO BE TE STED ON THE BASIS OF THE APPLICABLE PROVISIONS OF LAW. IT CANNOT BE REJECTE D SOLELY ON THE BASIS THAT IT WAS CONTRARY TO THE STAND WHICH THE ASSESSEE HAD TAKEN ORIGINALLY. AT THE SAME TIME, IT DOES ALSO MEAN THAT THE ASSESSEE COULD BE ALLOWED FREE LICENSE TO VARY THE FUNCTIONAL ANALYSIS AND THE MET HOD ADOPTED AT ANY TIME DURING THE APPELLATE PROCEEDINGS. THE ABOVE PROPOSITION FINDS SUPPORT IN T HE DECISION OF THE ITAT, PUNE, IN THE CASE OF ACIT VS MSS INDIA (SUPRA) REPO RTED IN 2009-TII-67- ITA NOS.815 & 846/BANG/2010 PAGE 35 OF 59 ITAT-PUNE-TECHNICAL SERVICES DATED 29.5.2009 IS REL EVANT. IN THIS CASE, THE ITAT HAD OBSERVED THAT A METHOD CHOSEN CA NNOT BE DISCARDED UNLESS THERE ARE COMPELLING REASONS FOR THE SAME. WHILE THIS RULING HAS BEEN GIVEN IN THE CONTEXT OF THE TPO CHANGING THE M ETHOD DURING THE TP AUDIT, IT WOULD, IN ALL FAIRNESS AND EQUITY, BE EQU ALLY APPLICABLE TO THE ASSESSEE AS WELL. THE RULING OF THE PUNE, ITAT IN THE CASE OF MSS IND IA PVT. LTD. (SUPRA) AT PARA 22 OF THE ORDER IS AS UNDER : THE CONSIDERATION AS TO WHICH METHOD WILL BE MOR E BENEFICIAL TO THE REVENUE AUTHORITIES IS CERTAINLY NOT GERMANE TO THE SELECTION OF MOST APPROPRIATE METHOD. WHILE THERE IS NO PARTICULAR O RDER OR PRIORITY OF METHODS WHICH THE ASSESSEE MUST FOLLOW, AND NO METH OD CAN INVARIABLY BE CONSIDERED TO BE MORE RELIABLE THAN OTHERS, ON A CONCEPTUAL NOTE, TRANSACTIONAL PROFIT METHODS (I.E. TRANSACTIONAL NE T MARGIN METHOD AND PROFIT SPLIT METHOD) ARE TREATED AS METHODS OF LAST RESORT WHICH ARE PRESSED INTO SERVICE ONLY WHEN THE STANDARD METHODS , WHICH ARE ALSO TERMED AS TRADITIONAL METHODS, (I.E. COMPARABLE U NCONTROLLED PRICE METHOD, RESALE PRICE METHOD AND COST PLUS METHOD) C ANNOT BE REASONABLY APPLIED. THE OECD GUIDELINES ALSO RECOG NIZE THIS FACT AND STATE THAT TRANSACTIONAL PROFIT METHODS MIGHT BE US ED TO APPROXIMATE ARMS LENGTH CONDITIONS WHEN TRADITIONAL METHODS CA NNOT BE RELIED / APPLIED ALONE OR EXCEPTIONALLY CANNOT BE APPLIED AT ALL. THE TRANSACTION PROFIT METHODS SHOULD BE APPLIED ONLY WHEN STANDARD OR TRADITIONAL METHODS ARE INCAPABLE OF BEING PROPERLY APPLIED IN THE FACTS OF A CASE. WHILE TRADITIONAL METHODS SEEK TO COMPUTE THE PRICE S AT WHICH INTERNATIONAL TRANSACTIONS WOULD NORMALLY BE ENTERE D INTO BY THE ASSOCIATED ENTERPRISE, BUT FOR THEIR INTERDEPENDENC E AND RELATIONSHIP, TRANSACTIONAL PROFIT METHODS SEEK TO COMPUTE THE PR OFITS THAT THE TESTED PARTY WOULD NORMALLY EARN ON SUCH TRANSACTIONS WITH UNRELATED PARTIES. IT IS ONLY AXIOMATIC THAT THE PROFITS EARNED BY AN ENT ERPRISE ARE DEPENDENT ON SEVERAL FACTORS, AND NOT ONLY ON THE PRICES AT WHICH TRANSACTIONS HAVE BEEN ENTERED INTO WITH THE ASSOCIATED ENTERPRISES. THE PROFIT BASED RESULTS, THUS, ADMIT POSSIBILITY OF VITIATION OF RE SULTS BY A NUMBER OF FACTORS, WHICH ARE NOT RELEVANT TO THE DETERMINATION OF PRIC ES AT WHICH INTERNATIONAL TRANSACTIONS ARE ENTERED INTO BY THE ASSOCIATED ENT ERPRISES. THESE METHODS, WHICH ARE A STEP REMOVED FROM THE METHODS OF COMPUTING THE PRICES AT WHICH INDEPENDENT TRANSACTIONS WOULD NORM ALLY TAKE PLACE IN RESPECT OF THE PRODUCT OR SERVICE MUST, THEREFORE, BE PUT TO SERVICE WHEN THE TRADITIONAL METHODS, WHICH SEEK TO COMPUTE PRIC ES IN INDEPENDENT SITUATIONS, FAIL OR ARE INCAPABLE OF BEING IMPLEMEN TED, AS THERE ARE A LARGE ITA NOS.815 & 846/BANG/2010 PAGE 36 OF 59 NUMBER OF SITUATIONS IN WHICH, FOR A VARIETY OF REA SONS, TRADITIONAL METHODS ARE SIMPLY UNWORKABLE. THE INPUTS NECESSARY FOR AP PLYING THE TRADITIONAL METHODS ARE NOT ALWAYS AVAILABLE AND THAT IS THE RE ASON THAT DESPITE BETTER RESULTS PRODUCED BY THESE METHODS, THESE MET HODS ARE NOT AS MUCH PUT TO USE. HOWEVER, WHENEVER NECESSARY INPUT S FOR APPLYING ONE OF THESE METHODS ARE AVAILABLE AND THERE IS NO DISP UTE ABOUT COMPARABILITY OF THOSE INPUTS, THERE IS NO GOOD REA SON TO RESORT TO TRANSACTIONAL PROFIT METHODS. IT WOULD THUS FOLLOW THAT IN A SITUATION IN WHICH THE ASSESSEE HAS FOLLOWED ONE OF THE STANDARD METHODS OF DETERMINING ALP, SUCH A METHOD CANNOT BE DISCARDED IN PREFERENCE OVER TRANSACTIONAL PROFIT METHODS, UNLESS THE REVENUE AU THORITIES ARE ABLE TO DEMONSTRATE THE FALLACIES IN APPLICATION OF STANDAR D METHODS. IN ANY EVENT, ANY PREFERENCE OF ONE METHOD OVER THE OTHER METHOD MUST BE JUSTIFIED BY THE TRANSFER PRICING OFFICER ON THE BA SIS OF COGENT MATERIAL AND SOUND REASONING. (PARA 22). 40. OF COURSE THE FACTS OF THE CASE IN MSS LTD. ARE LITTLE DIFFERENT FROM THAT OF THE FACTS IN THE INSTANT CASE. IN THE CASE OF MSS INDIA, INTERNAL COMPARABILITY ANALYSIS WAS AVAILABLE WHEREAS IT IS ABSENT IN THE CASE OF THE ASSESSEE. FURTHER, IN THAT CASE, THE TPO HAD N OTED THAT CPM CANNOT BE APPLIED AS THE RELEVANT DATA FOR APPLYING THE ME THOD WAS NOT AVAILABLE IN THE PROWESS DATABASE OR CAPITOLINE DATABASE AND THUS RESORTED TO TNMM. IN THE INSTANT CASE, IT IS NOT THE CASE OF E ITHER THE ASSESSEE OR REVENUE THAT RELEVANT DATA IS NOT AVAILABLE FOR APP LYING A PARTICULAR METHOD. HENCE IT IS ALL THE MORE NECESSARY TO SELE CT THE MAM BASED ON THE PRINCIPLES AND THE RULES ENACTED, RATHER THAN O N OTHER CONSIDERATIONS. THEREFORE THE PRINCIPLES ENUNCIATED IN THE CASE OF MSS LTD. (SUPRA), THAT CHANGINGTHE MAM IS NOT TENABLE UNLESS THERE ARE COG ENT REASONING FOR THE SAME IS SQUARELY APPLICABLE TO THIS CASE. 41. A REFERENCE CAN ALSO BE MADE TO THE PROVISIONS IN THE ACT WHICH DEALS WITH SELECTION OF THE MAM. MOST APPROPRIATE METHOD. SEC.92C AND RULE 10C(1) ARE RELEVANT IN THIS REGARD AND THEY PR OVIDE AS FOLLOWS: COMPUTATION OF ARMS LENGTH PRICE. 92C. (1) THE ARMS LENGTH PRICE IN RELATION TO AN I NTERNATIONAL TRANSACTION SHALL BE DETERMINED BY ANY OF THE FOLLO WING METHODS, BEING THE MOST APPROPRIATE METHOD, HAVING REGARD TO THE NATURE OF TRANSACTION OR CLASS OF TRANSACTION OR CLASS OF ASS OCIATED PERSONS OR ITA NOS.815 & 846/BANG/2010 PAGE 37 OF 59 FUNCTIONS PERFORMED BY SUCH PERSONS OR SUCH OTHER R ELEVANT FACTORS AS THE BOARD MAY PRESCRIBE24, NAMELY : (A) COMPARABLE UNCONTROLLED PRICE METHOD; (B) RESALE PRICE METHOD; (C) COST PLUS METHOD; (D) PROFIT SPLIT METHOD; (E) TRANSACTIONAL NET MARGIN METHOD; (F) SUCH OTHER METHOD AS MAY BE PRESCRIBED24 BY THE BOARD. (2) THE MOST APPROPRIATE METHOD REFERRED TO IN SUB- SECTION (1) SHALL BE APPLIED, FOR DETERMINATION OF ARMS LENGTH PRICE , IN THE MANNER AS MAY BE PRESCRIBED. RULE 10C. (1) FOR THE PURPOSES OF SUB-SECTION (1) OF SECTION 92C, THE MOST APPROPRIATE METHOD SHALL BE THE METHOD WHI CH IS BEST SUITED TO THE FACTS AND CIRCUMSTANCES OF EACH PARTI CULAR INTERNATIONAL TRANSACTION, AND WHICH PROVIDES THE MOST RELIABLE M EASURE OF AN ARMS LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION. (2) IN SELECTING THE MOST APPROPRIATE METHOD AS SPE CIFIED IN SUB-RULE (1), THE FOLLOWING FACTORS SHALL BE TAKEN INTO ACCO UNT, NAMELY: (A) THE NATURE AND CLASS OF THE INTERNATIONAL TRANS ACTION; (B) THE CLASS OR CLASSES OF ASSOCIATED ENTERPRISES ENTERING INTO THE TRANSACTION AND THE FUNCTIONS PERFORMED BY THEM TAK ING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND RISKS ASSUMED BY SUCH ENTERPRISES; (C) THE AVAILABILITY, COVERAGE AND RELIABILITY OF D ATA NECESSARY FOR APPLICATION OF THE METHOD; (D) THE DEGREE OF COMPARABILITY EXISTING BETWEEN TH E INTERNATIONAL TRANSACTION AND THE UNCONTROLLED TRANSACTION AND BE TWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS; (E) THE EXTENT TO WHICH RELIABLE AND ACCURATE ADJUS TMENTS CAN BE MADE TO ACCOUNT FOR DIFFERENCES, IF ANY, BETWEEN TH E INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSAC TION OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS; (F) THE NATURE, EXTENT AND RELIABILITY OF ASSUMPTIO NS REQUIRED TO BE MADE IN APPLICATION OF A METHOD. 42. IN THIS REGARD, IT IS SEEN THAT IN THE TP STU DY SUBMITTED, THE ASSESSEE HAS ITSELF ADOPTED. THE COST PLUS METHOD (CPM) AS THE MOST ITA NOS.815 & 846/BANG/2010 PAGE 38 OF 59 APPROPRIATE METHOD (MAM). WHILE DOING SO, THE APP ELLANT HAS OBSERVED IN THE TP STUDY, AT PAGE 22, AS UNDER : COST PLUS METHOD THE COST PLUS METHOD (CPLM)EVALUATES THE ARMS LE NGTH CHARACTER OF A CONTROLLED TRANSACTION BY REFERENCIN G THE GROSS PROFIT MARK UP REALIZED IN COMPARABLE UNCONTROLLED TRANSACTIONS. THE ARMS LENGTH PRICE FOR THE CONTR OLLED TRANSFER IS THE CONTROLLED TAXPAYERS COST OF PRODUCING THE PROPERTY INVOLVED IN THE TRANSACTION, PLUS AN AMOUNT EQUAL T O THOSE COSTS MULTIPLIED BY THE APPROPRIATE PROFIT MARK UP. ONE ORDINARILY USES THE COST PLUS METHOD TO DETERMINE A RMS LENGTH PRICING FOR MANUFACTURING, ASSEMBLY, OR OTHER ACTIV ITIES RELATING TO THE PRODUCTION OF GOODS SOLD TO RELATED PARTIES. AS WITH THE RESALE PRICE METHOD, COMPARABILITY UNDER THE COST P LUS METHOD IS PARTICULARLY DEPENDENT UPON THE SIMILARITY OF FU NCTIONS, RISKS, AND CONTRACTUAL TERMS. AGAIN, CLOSE PHYSICAL SIMILARITY OF THE PRODUCTS IN VOLVED IN THE CONTROLLED AND UNCONTROLLED TRANSACTIONS IS NOT ORD INARILY NECESSARY TO ESTABLISH THE COMPARABILITY OF THE MAN UFACTURERS GROSS PROFIT MARK-UPS, ALTHOUGH SUBSTANTIAL DIFFER ENCES IN THE PRODUCTS MAY INDICATE SIGNIFICANT FUNCTIONAL DIFFER ENCES. SPECIFIC FACTORS THAT MAY BE RELEVANT TO THIS METHO D INCLUDE : THE COMPLEXITY OF THE MANUFACTURING OR ASSEMBLY; MANUFACTURING, PRODUCTION, PROCESS ENGINEERING, PRO CUREMENT, PURCHASING, AND INVENTORY CONTROL ACTIVITIES; TEST FUNCTIONS; SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES; FORE IGN CURRENCY RISKS; AND CONTRACTUAL TERMS (THE SCOPE AND TERMS O F WARRANTIES PROVIDED, SALES OF PURCHASE VOLUME, CRED IT TERMS, ETC.). APPLICABILTY TO CONTACT MANUFACTURING SERVICES IN THE CASE OF THE ABOVE REFERRED SERVICES PROVIDED BY GE BE, IT HAS A LONG TERM CONTRACTUAL OBLIGATION TO PROVID E SERVICES TO GEMS GLOBAL AND ITS AFFILIATES. AS THE SAID SERVIC ES ARE PROVIDED PREDOMINANTLY TO RELATED PARTIES, APPLICAT ION OF CPLM WOULD BE APPROPRIATE IN THIS CASE. FURTHER, BASED UPON THE SIMILARITY OF FUNCTIONS, RISKS, AND CONTRACTUAL TER MS, THE CPLM WOULD BE SUITABLE IN ARRIVING AT THE ARMS LENGTH P RICE. BASED UPON THE ABOVE, IT WOULD BE RELEVANT TO NOTE THAT A N EXTERNAL COMPARABILITY ANALYSIS HAS BEEN UNDERTAKEN TO SUBST ANTIATE THE ARMS LENGTH PRICE. ALSO, IN THE TP STUDY, THE APPELLANT HAS SPECIFICA LLY REJECTED TNMM AS THE MAM, BY OBSERVING AS FOLLOWS : ITA NOS.815 & 846/BANG/2010 PAGE 39 OF 59 APPLICABILITY TO CONTRACT MANUFACTURING SERVICES : TNMM IS GENERALLY CONSIDERED TO BE A RESIDUARY MET HOD AND IS RELIED UPON WHEN NO DIRECT COMPARABLES ARE AVAI LABLE. IN THE INSTANT CASE, DUE TO AVAILABILITY OF COMPARABLE S, CPLM COULD BE CONSIDERED AS THE MOST APPROPRIATE METHOD IN DETERMINING ARMS LENGTH PRICE WITH RESPECT TO CONT RACT MANUFACTURING SERVICES. ACCORDINGLY TNMM IS NOT CO NSIDERED AS MOST APPROPRIATE METHOD. 43. THE UN PRACTICAL TRANSFER PRICING MANUAL FOR D EVELOPING COUNTRIES, 2012 IN PARA 5.3.6 LAYS DOWN THE FOLLOWI NG CRITERIA FOR CHOOSING MAM. 5.3.6. SELECTION OF TRANSFER PRICING METHOD 5.3.6.1. THE MOST APPROPRIATE TRANSFER PRICING METH OD WILL BE SELECTED TAKING INTO ACCOUNT THE STRENGTHS AND WEAK NESSES OF THE METHOD, THE APPROPRIATENESS OF THE METHOD IN TH E LIGHT OF THE NATURE OF THE CONTROLLED TRANSACTION (BASED UPO N A FUNCTIONAL ANALYSIS), THE AVAILABILITY OF RELIABLE INFORMATION (ESPECIALLY ON UNCONTROLLED COMPARABLES) AND THE DE GREE OF COMPARABILITY BETWEEN THE CONTROLLED AND THE UNCONT ROLLED TRANSACTIONS(INCLUDING RELIABILITY OF COMPARABILITY ADJUSTMENTS NEEDED). 5.3.6.2.ONCE THE TAXPAYER HAS IDENTIFIED THE TRANSF ER PRICING METHODS THAT ARE POTENTIALLY APPLICABLE TO THE CONT ROLLED TRANSACTION, APPLICATION OF THE MOST APPROPRIATE ME THOD RULE INVOLVES A CAREFUL BALANCE IN WHICH THE FOLLOWING F ACTORS MAY BE TAKEN INTO ACCOUNT TO ASSESS THE RELATIVE ACCURA CY OF THE IDENTIFIED METHODS: I. THE EXTENT TO WHICH THE COMPARABILITY FACTORS (C HARACTERISTICS OF THE PROPERTY OR SERVICES, FUNCTIONAL ANALYSIS, C ONTRACTUAL TERMS, ECONOMIC CIRCUMSTANCES AND BUSINESS STRATEGI ES) OF UNCONTROLLED TRANSACTIONS OR ENTITIES ARE SIMILAR T O THE CONTROLLED TRANSACTIONS OR ENTITIES, GIVEN THE TYPE OF COMPARABILITY THAT IS REQUIRED UNDER EACH PRICING M ETHOD; II. THE AVAILABILITY AND RELIABILITY OF FINANCIAL A ND OTHER INFORMATION THAT IS KNOWN ABOUT THE COMPARABLE; III. RELIABILITY AND ACCURACY OF THE COMPARABILITY ADJUSTMENTS; AND ITA NOS.815 & 846/BANG/2010 PAGE 40 OF 59 IV. RELIABILITY OF PRESUMPTIONS AS WELL AS DEFICIEN CIES IN DATA AND PRESUMPTIONS. 44. THE OECD GUIDELINES ON TRANSFER PRICING IN PAR A 2.2 ALSO LAYS DOWN SIMILAR APPROACH TO BE ADOPTED FOR CHOOSING MA M. IT LAYS DOWN AS FOLLOWS: 2.2 THE SELECTION OF A TRANSFER PRICING METHOD ALW AYS AIMS AT FINDING THE MOST APPROPRIATE METHOD FOR A PARTICULA R CASE. FOR THIS PURPOSE, THE SELECTION PROCESS SHOULD TAKE ACC OUNT OF THE RESPECTIVE STRENGTHS AND WEAKNESSES OF THE OECD RECOGNIZED METHODS; THE APPROPRIATENESS OF THE METH OD CONSIDERED IN VIEW OF THE NATURE OF THE CONTROLLED TRANSACTION, DETERMINED IN PARTICULAR THROUGH A FUNCTIONAL ANALY SIS; THE AVAILABILITY OF RELIABLE INFORMATION (IN PARTICULAR UNCONTROLLED COMPARABLE) NEEDED TO APPLY THE SELECTED METHOD AND /OR OTHER METHODS; AND THE DEGREE OF COMPARABILITY BETW EEN CONTROLLED AND UNCONTROLLED TRANSACTIONS, INCLUDING THE RELIABILITY OF COMPARABILITY ADJUSTMENTS THAT MAY B E NEEDED TO ELIMINATE MATERIAL DIFFERENCES BETWEEN THEM. NO ONE METHOD IS SUITABLE IN EVERY POSSIBLE SITUATION, NOR IS IT NECESSARY TO PROVE THAT A PARTICULAR METHOD IS NOT SUITABLE U NDER THE CIRCUMSTANCES. (EMPHASIS SUPPLIED) IN THIS REGARD, IT MAY BE NECESSARY TO HIGHLIGHT H ERE THAT THERE ARE CERTAIN KEY DIFFERENCES BETWEEN OECD GUIDELINES AND INDIAN REGULATIONS IN RESPECT OF THE TRANSFER PRICING METH ODS. ONE OF THE DIFFERENCES IS THAT WHILE OECD GUIDELINES, IN EXCEP TIONAL CIRCUMSTANCES, PERMIT THE USE OF MORE THAN ONE TRAN SFER PRICING METHOD TO DEMONSTRATE THE ARMS LENGTH NATURE OF RE LATED PARTY TRANSACTIONS, THE INDIAN TP RULES ADVOCATE THE USE OF ONLY ONE TP METHOD THE MOST APPROPRIATE METHOD. HENCE THE ASSESSEE'S CONTENTION OF USING TNMM AS AN ALTERNATE APPROACH O R METHOD IS NOT IN TUNE WITH THE INDIAN TP RULES, EVEN THOUGH IT MA Y BE PERMISSIBLE AS PER OECD GUIDELINES. AS PER THE INDIAN TP RULES , THE ASSESSEE ITA NOS.815 & 846/BANG/2010 PAGE 41 OF 59 IS TO SELECT ONE METHOD AS THE MAM. THE INDIAN TP RULES DOES NOT GIVE ANY SCOPE OR LEVERAGE TO USE DIFFERENT TP METH ODS. 45. THE U.N. PRACTICAL TRANSFER PRICING MANUAL FOR DEVELOPING COUNTRIES, 2012 IN PARA 6.1.3.3 LAYS DOWN AS FOLLOW S: 6.1.3.3. ONCE A METHOD IS CHOSEN AND APPLIED TAXPA YERS ARE GENERALLY EXPECTED TO APPLY THE METHOD IN A CONSIST ENT FASHION. ASSUMING THAT AN APPROPRIATE TRANSFER PRIC ING METHOD IS BEING APPLIED, A CHANGE IN METHOD IS TYPICALLY R EQUIRED ONLY IF THERE ARE ANY CHANGES IN THE FACTS, FUNCTIONALIT IES OR AVAILABILITY OF DATA. THE ABOVE GUIDELINES PRESUPPOSES AN APPROPRIATE TR ANSFER PRICING METHOD BEING APPLIED. THE ABOVE GUIDELINES EMPHASISE ON CONSISTENCY BEING FOLLOWED IN APPLYING THE METHOD. IT ALSO PROVIDES THAT THE METHOD CAN BE CHANGED, ONLY IF THERE ARE A NY CHANGES IN THE FACTS, FUNCTIONALITIES OR AVAILABILITY OF DATA. AS SUMING THAT THERE COULD BE SITUATIONS WHERE ON ASSESSEE MAY BE REQUIRED TO CHANGE ITS CHOSEN MAM FOR THE SAME YEAR BETWEEN THE TIME OF HI S TP STUDY AND THE ASSESSMENT / APPELLATE PROCEEDINGS, SUCH A CHANGE CAN HAPPEN ONLY IF THERE ARE ANY CHANGES IN FACTS, FUN CTIONALITIES OR AVAILABILITY OF DATA. 46. IN THE INSTANT CASE, THE ASSESSEE HAS NOT MAD E OUT ANY CASE OR ADDUCED ANY EVIDENCE TO DEMONSTRATE THAT THERE H AS BEEN ANY CHANGE IN THE FACTS, FUNCTIONALITIES OR AVAILABILIT Y OF DATA. NOR IS IT THE ASSESSEE'S CASE THAT ANY OF THESE HAVE BEEN TAKEN W RONGLY IN THE TP STUDY THAT WARRANT A CHANGE OF METHOD HAS BECOME NE CESSARY. THE ONLY REASON FOR SEEKING CHANGE OF METHOD IS THAT TH E COMPARABLES ITA NOS.815 & 846/BANG/2010 PAGE 42 OF 59 CHOSEN BY THE TPO ARE DIFFERENT FROM THAT CHOSEN BY THE ASSESSEE AND THAT THE FUNCTIONAL PROFILE OF THE COMPARABLES ARE DIFFERENT. WHILE THE ASPECT OF FUNCTIONAL DIFFERENCE HAS BEEN DISCUS SED IN THE LATER PART OF THE ORDER, WE CAN CONCLUDE HERE THAT THE CH ANGE OF METHOD SOUGHT BY THE ASSESSEE IS NOT IN TUNE WITH THE INDI AN TP RULES, WHICH FINDS SUPPORT IN THE UN TP MANUAL. 47. THE NEXT ASPECT TO BE SEEN IS AS TO WHETHER IN THE CASE OF A CONTRACT MANUFACTURER MAM IS COST PLUS METHOD. THE UN PRACTICAL TRANSFER PRICING MANUAL FOR DEVELOPING COUNTRIES, 2 012, IN PARA 6.2.20.2 AND 6.1.3.3 LAYS DOWN SELECTION OF MAM AND THE REL EVANT GUIDELINES ARE AS UNDER: 6.2.20 WHEN TO USE THE COST PLUS METHOD 6.2.20.1. THE COST PLUS METHOD IS TYPICALLY APPLIED IN CASES INVOLVING THE INTERCOMPANY SALE OF TANGIBLE PROPERT Y WHERE THE RELATED PARTY MANUFACTURER PERFORMS LIMITED MANUFAC TURING FUNCTIONS OR IN THE CASE OF THE INTRA GROUP PROVISI ON OF SERVICES. THE METHOD USUALLY ASSUMES THE INCURRENCE OF LOW RI SKS, BECAUSE THE LEVEL OF THE COSTS WILL THEN BETTER REF LECT THE VALUE BEING ADDED AND HENCE THE MARKET PRICE. NOTE THAT IF THE CONTRACT IS BASED ON ACTUAL COSTS, THE CONTRACTUAL TERMS MAY INCLUDE INCENTIVES OR PENALTIES DEPENDING ON THE PE RFORMANCE OF THE CONTRACT MANUFACTURER. 6.2.20.2. THE COST PLUS METHOD IS ALSO GENERALLY US ED IN TRANSACTIONS INVOLVING A CONTRACT MANUFACTURER, A T OLL MANUFACTURER OR A LOW RISK ASSEMBLER WHICH DOES NOT OWN PRODUCT INTANGIBLES AND INCURS LITTLE RISKS. THE RE LATED CUSTOMER INVOLVED IN THE CONTROLLED TRANSACTION WILL GENERAL LY BE MUCH MORE COMPLEX THAN THE CONTRACT MANUFACTURER IN TERM S OF FUNCTIONS PERFORMED (E.G. CONDUCTING MARKETING AND SELLING FUNCTIONS, COORDINATION OF PRODUCTION AND SALES, GI VING INSTRUCTIONS TO THE CONTRACT MANUFACTURER ABOUT THE QUANTITY AND QUALITY OF PRODUCTION, AND PURCHASING RAW MATERIALS IN SOME CASES), RISKS INCURRED (E.G. MARKET RISK, CREDIT RI SK AND INVENTORY RISK) AND ASSETS OWNED (PRODUCT INTANGIBLES). THE C ONTRACT ITA NOS.815 & 846/BANG/2010 PAGE 43 OF 59 MANUFACTURER IS THUS THE LESS COMPLEX AND AS SUCH S HOULD BE THE TESTED PARTY IN THE TRANSFER PRICING ANALYSIS. 6.2.20.3 THE COST PLUS METHOD IS USUALLY NOT A SUI TABLE METHOD TO USE IN TRANSACTIONS INVOLVING A FULLY-FLE DGED MANUFACTURER WHICH OWNS VALUABLE PRODUCT INTANGIBLE S AS IT WILL BE VERY DIFFICULT TO LOCATE INDEPENDENT MANUFACTURE RS OWNING COMPARABLE PRODUCT INTANGIBLES. THAT IS, IT WILL BE HARD TO ESTABLISH A PROFIT MARK-UP THAT IS REQUIRED TO REMU NERATE THE FULLY FLEDGED MANUFACTURER FOR OWNING THE PRODUCT INTANG IBLES. IN A TYPICAL TRANSACTION STRUCTURE INVOLVING A FULL Y FLEDGED MANUFACTURER AND RELATED SALES COMPANIES (E.G. COMMISSIONAIRES), THE SALES COMPANIES WILL NORMALL Y BE THE LEAST COMPLEX ENTITIES INVOLVED IN THE CONTROLLED T RANSACTIONS AND WILL THEREFORE BE THE TESTED PARTY IN THE ANALYSIS. THE RESALE PRICE METHOD IS TYPICALLY MORE EASILY APPLIED IN SU CH CASES. 6.2.21 CASE EXAMPLES OF COST PLUS METHOD: 6.2.21.1. EXAMPLE 1 (I) LCO, A DOMESTIC MANUFACTURER OF COMPUTER COMPON ENTS, SELLS ITS PRODUCTS TO FS, ITS FOREIGN DISTRIBUTOR. UT1, UT2, AND UT3 ARE DOMESTIC COMPUTER COMPONENT MANUFACTURERS T HAT SELL TO UNCONTROLLED FOREIGN PURCHASERS; (II) RELATIVELY COMPLETE DATA IS AVAILABLE REGARDIN G THE FUNCTIONS PERFORMED AND RISKS BORNE BY UT1, UT2, AND UT3, AND THE CONTRACTUAL TERMS IN THE UNCONTROLLED TRANSACTIONS. IN ADDITION, DATA IS AVAILABLE TO ENSURE ACCOUNTING CONSISTENCY BETWEEN ALL THE UNCONTROLLED MANUFACTURERS AND LCO. AS THE AVAI LABLE DATA IS SUFFICIENTLY COMPLETE TO CONCLUDE THAT IT IS LIK ELY THAT ALL MATERIAL DIFFERENCES BETWEEN THE CONTROLLED AND UNC ONTROLLED TRANSACTIONS HAVE BEEN IDENTIFIED, THE EFFECT OF TH E DIFFERENCES IS DEFINITE AND REASONABLY ASCERTAINABLE, AND RELIABLE ADJUSTMENTS ARE MADE TO ACCOUNT FOR THE DIFFERENCES AN ARM'S LE NGTH RANGE CAN BE ESTABLISHED. 6.2.21.2. EXAMPLE 2 THE FACTS ARE THE SAME AS IN EXAMPLE 1 EXCEPT THAT LCO ACCOUNTS FOR SUPERVISORY, GENERAL, AND ADMINISTRATI VE COSTS AS OPERATING EXPENSES, WHICH ARE NOT ALLOCATED TO ITS SALES TO FS. THE GROSS PROFIT MARK-UPS OF UT1, UT2, AND UT3, HOW EVER, REFLECT SUPERVISORY, GENERAL, AND ADMINISTRATIVE EX PENSES BECAUSE THEY ARE ACCOUNTED FOR AS COSTS OF GOODS SO LD. ACCORDINGLY, THE GROSS PROFIT MARK UPS OF UT1, UT2, AND UT3 MUST BE ADJUSTED TO PROVIDE ACCOUNTING CONSISTENCY. IF DATA IS NOT SUFFICIENT TO DETERMINE WHETHER SUCH ACCOUNTING DIFFERENCES ITA NOS.815 & 846/BANG/2010 PAGE 44 OF 59 EXIST BETWEEN THE CONTROLLED AND UNCONTROLLED TRANS ACTIONS THE RELIABILITY OF THE RESULTS WILL DECREASE. 6.2.21.3. EXAMPLE 3 THE FACTS ARE THE SAME AS IN EXAMPLE 1 ABOVE, EXCEP T THAT UNDER ITS CONTRACT WITH FS, LCO USES MATERIALS CONS IGNED BY FS.UT1,UT2, ANDUT3, ON THE OTHER HAND, PURCHASE THE IR OWN MATERIALS, AND THEIR GROSS PROFIT MARK UPS ARE DETERMINED BY INCLUDING THE COSTS OF THE MATERIALS. THE FACT THAT LCO DOES NOT CARRY AN INVENTORY RISK BY PURCHASING ITS OWN MATER IALS WHILE THE UNCONTROLLED PRODUCERS CARRY INVENTORY IS A SIGNIFI CANT DIFFERENCE THAT MAY REQUIRE AN ADJUSTMENT IF THE DIFFERENCE HA S A MATERIAL EFFECT ON THE GROSS PROFIT MARK UPS OF THE UNCONTROLLED PRODUCERS. INABILITY TO REASONABLY ASCERTAIN TH E EFFECT OF THE DIFFERENCE ON THE GROSS PROFIT MARK-UPS WILL AFFEC T THE RELIABILITY OF THE RESULTS OF UT1, UT2 AND UT3. 6.2.21.4. EXAMPLE 4 (I) FS, A FOREIGN CORPORATION, PRODUCES APPAREL F OR PCO, ITS PARENT CORPORATION. FS PURCHASES ITS MATERIALS FROM UNRELATED SUPPLIERS AND PRODUCES THE APPAREL ACCORDING TO DES IGNS PROVIDED BY PCO. THE LOCAL TAXING AUTHORITY IDENTIF IES 10 UNCONTROLLED FOREIGN APPAREL PRODUCERS THAT OPERATE IN THE SAME GEOGRAPHIC MARKET AND ARE SIMILAR IN MANY RESPECTS TO FS; (II) RELATIVELY COMPLETE DATA IS AVAILABLE REGARDI NG THE FUNCTIONS PERFORMED AND RISKS BORNE BY THE UNCONTRO LLED PRODUCERS. IN ADDITION, DATA IS SUFFICIENTLY DETAIL ED TO PERMIT ADJUSTMENTS FOR DIFFERENCES IN ACCOUNTING PRACTICES . HOWEVER, SUFFICIENT DATA IS NOT AVAILABLE TO DETERMINE WHETH ER IT IS LIKELY THAT ALL MATERIAL DIFFERENCES IN CONTRACTUAL TERMS HAVE BEEN IDENTIFIED. FOR EXAMPLE, IT IS NOT POSSIBLE TO DETE RMINE WHICH PARTIES IN THE UNCONTROLLED TRANSACTIONS BEAR CURRE NCY RISKS. AS THE DIFFERENCES IN THESE CONTRACTUAL TERMS COULD MA TERIALLY AFFECT PRICE OR PROFITS, THE INABILITY TO DETERMINE WHETHE R DIFFERENCES EXIST BETWEEN THE CONTROLLED AND UNCONTROLLED TRANS ACTIONS WILL DIMINISH THE RELIABILITY OF THESE RESULTS. THEREFOR E, THE RELIABILITY OF THE RESULTS OF THE UNCONTROLLED TRANSACTIONS MUS T BE ENHANCED. AS A GENERAL RULE IT CAN BE SAID THAT THE ABOVE GUI DELINES ADVOCATE USE OF CPM IN THE CASE OF CONTRACT MANUFACTURERS. HOWEVER , THE PROVISIONS OF SEC.92C(2) OF THE ACT READ WITH RULE 10C(1) & (2) M AKE IT CLEAR THAT MAM ITA NOS.815 & 846/BANG/2010 PAGE 45 OF 59 HAS TO BE DETERMINED ON THE BASIS OF PARAMETERS LAI D DOWN THEREIN. ONE CAN THEREFORE CONCLUDE THIS DISCUSSION BY HOLDING T HAT AS A GENERAL RULE CPM WOULD BE THE MAM IN THE CASE OF CONTRACT MANUFA CTURERS BUT THAT WOULD BE SUBJECT TO THE SATISFACTION OF THE PARAMET ERS LAID DOWN IN RULE 10C(1) & 2 OF THE RULES. 48. IN THIS REGARD, WE WILL EXAMINE THE PARAMETERS LAID DOWN IN RULE 10C(1) AND 2 OF THE RULES, WHICH HAVE BEEN ALREADY QUOTED IN PRE-PARA 41 OF THIS ORDER. RULE 10C(1) STATES THAT THE MAM SHALL BE THE METHOD WHICH IS BEST SUITED TO THE FACTS AND CIRCUMSTANCES OF EACH PARTICULAR SET OF INTERNATIONAL TRANSACTIONS. AS EXPLAINED IN EAR LIER PARAGRAPHS AND FORTIFIED BY THE UN TP MANUAL GUIDELINES, IN CASE O F CONTRACT MANUFACTURERS LIKE THE ASSESSEE, CPM IS THE MAM. R ULE 10C(2) ENUMERATES SIX FACTORS THAT SHALL BE TAKEN INTO ACC OUNT IN SELECTING THE MAM. OUT OF THESE SIX FACTORS, WHILE THERE IS NO D ISPUTE IN FOUR OF THE FACTORS, THE OBJECTION OF THE ASSESSEE NEEDS TO BE ANALYSED IN THE LIGHT OF RULE 10C(2)(D) AND (E). IT IS THE CONTENTION OF TH E ASSESSEE THE COMPARABLES CHOSEN BY THE TPO, BEING FULL-FLEDGED M ANUFACTURERS, THE DEGREE OF COMPARABILITY REQUIRED IS NOT EXISTING BE TWEEN THE ASSESSEE'S INTERNATIONAL TRANSACTIONS VIS--VIS THE TRANSACTIO NS OF THE COMPARABLE COMPANIES. THIS OBJECTION HAS BEEN DULY TAKEN NOTE OF BY THE TPO AND HE HAS APPLIED RULE 10C(2)(E) GRANTING ADJUSTMENTS. WHILE THE ASSESSEE MAY WELL CONTEND THAT THE ADJUSTMENTS GRANTED ARE N OT RELIABLE AND ACCURATE, SEEKING A CHANGE OF THE METHOD ITSELF IS NOT WITHIN THE SCOPE AND COVERAGE OF RULE 10C. ITA NOS.815 & 846/BANG/2010 PAGE 46 OF 59 IN THIS REGARD, IT WOULD BE RELEVANT TO MENTION THA T THE ASSESSEE HAD EARLIER ADOPTED CPM AS THE MAM AND HAD SUGGESTE D TNMM ONY AS AN ALTERNATIVE APPROACH. FOR INSTANCE, IN THE SUBM ISSIONS MADE BEFORE THE CIT (APPEALS) BY LETTER DATED 9.2.2009 AT PAGES 115 AND 116 OF THE PAPER BOOK, THE ASSESSEE HAS STATED AS UNDER : COMPARABILITY ANALYSIS CONSIDERING COST PLUS METH OD > THE BASIC PARAMETER ON WHICH THE CPM OPERATES I S FUNCTIONAL SIMILARITY. THE APPELLANT IS A CONTRACT MANUFACTUR ER AND ACCORDINGLY THE COMPARABLES CHOSEN BY THE APPELLANT ARE PERFORM FUN CTIONS AKIN / SIMILAR TO THAT OF A CONTRACT MANUFACTURER. THE APPELLANT SUBMITS THAT THE COMPARABLES ARRIVED AT BY THE APPELLANT ARE PRIMARI LY SUPPLIERS OF COMPONENTS / SEMI FINISHED GOODS TO ORIGINAL EQUIPM ENT MANUFACTURERS (OEMS) AND THE FUNCTIONS OF SUCH COMPANIES ARE COMP ARABLE OR SIMILAR TO THOSE OF A CONTRACT MANUFACTURER. THE COMPARABLES DETERMINED BY THE COMPANY PRIMARILY PERFORM MANUFACTURING FUNCTIONS A ND THE PERFORMANCE OF OTHER FUNCTIONS (E.G. MARKETING & ADVERTISEMENT) IS NEGLIGIBLE AND INSIGNIFICANT, MUCH THE SAME AS IS THE CASE WITH TH E APPELLANT. THEREFORE, THE PROFIT MARGINS OF THESE COMPANIES ARE PRIMARILY REFLECTIVE OF THE RETURN ON THE MANUFACTURING FUNCTION. > HOWEVER, IT WOULD BE WORTHY TO NOTE THAT THE LD. TPO HAS GIVEN WEIGHTAGE TO PRODUCT SIMILARITY OVER THE FUNCTIONAL SIMILARITY THEREBY CONTRADICTING THE BASIC PREMISE OF APPLICATION OF C PM. BASE DON THIS, THE LD. TPO HAS CHOSEN THE SET OF COMPARABLES WHICH FAL L UNDER THE BROAD CATEGORY OF MEDICAL EQUIPMENTS AS CLASSIFIED IN T HE PROWESS DATABASE. THE COMPARABLES CHOSEN BY THE LD. TPO ARE ENGAGED I N THE MANUFACTURE OF MEDICAL CONSUMABLES VIZ. DISPOSABLE SYRINGES, DI SPOSABLE SUTURES, DISPOSABLE NEEDLES, ETC. ON THE OTHER HAND, THE AP PELLANT IS A CONTRACT MANUFACTURER ENGAGED IN MANUFACTURING TUBES, INSER TS, DETECTORS, TANKS AND OTHER PARTS AND ACCESSORIES FOR MEDICAL D IAGNOSTIC IMAGING EQUIPMENT. SUCH COMPONENTS ARE INCORPORATED BY TH E AFFILIATES INTO EQUIPMENT WHICH ARE IN THE NATURE OF CAPITAL GOODS. HENCE, ON THE ANALYSIS OF PRODUCT COMPARABILITY, THE COMPARABLES CHOSEN BY THE LD. TPO ARE NOT COMPARABLE WITH THE PRODUCTS OF GE BE AS TH E COMPARISON IS PRIMARILY BETWEEN CONSUMABLES VERSUS EQUIPMENTS. > ACCORDINGLY, COMPARABLES CHOSEN BY THE LD. TP O ALSO DO NOT MANUFACTURE THE SAME OR SIMILAR PRODUCTS AND HENCE WOULD NEED TO BE REJECTED EVEN IF THE PRODUCT COMPARABILITY CRITERIO N IS CONSIDERED TO BE RELEVANT TO THE APPLICATION OF THE CPM. EVEN OTHER WISE, THE SET OF COMPARABLES CHOSEN BY THE TPO ARE FUNCTIONALLY NOT COMPARABLE, BEING ITA NOS.815 & 846/BANG/2010 PAGE 47 OF 59 ENGAGED AS THEY ARE IN MARKETING AND DISTRIBUTION F UNCTIONS, WHILE NOT BEING PREDOMINANTLY CONTRACT MANUFACTURERS. > ASSUMING WITHOUT ADMITTING, THAT EVEN IF THE LD. TPO COMPARABLES ARE TO BE CONSIDERED FOR THE PURPOSES OF COMPARABIL ITY ANALYSIS BY APPLYING CPM AS APPROPRIATE METHOD, THE APPELLANT S UBMITS AS FOLLOWS : - THAT THERE ARE SIGNIFICANT DIFFERENCES IN THE FU NCTIONS PERFORMED BY THESE COMPARABLES PRIMARILY WITH RESPECT TO THE ADD ITIONAL MARKETING AND THE SELLING FUNCTION, VIS--VIS GE BE WHICH DOES NO T PERFORM ANY MARKETING OR SELLING ACTIVITY; - THIS IS EVIDENT FROM THE SIGNIFICANT MARKETING AND SELLING EXPENSES OF THESE COMPANIES WHICH FURTHER UNDERLINE THE DIFFERE NCES IN THE FUNCTIONS PERFORMED AS AGAINST GE BE WHICH HAS NO MARKETING O R SELLING EXPENSES; - THERE IS A RETURN ON THESE ADDITIONAL FUNCTION S PERFORMED BY THE LD. TPO COMPARABLES WHICH IS EMBEDDED IN THE SELLING PR ICE AND CONSEQUENTLY IN THE GROSS MARGINS OF THESE COMPANIE S; AND - THUS, IN ORDER TO COMPUTE APPROPRIATE GROSS MARK-UP COMPARABLE TO THE GROSS MARK-UP OF GE BE, AN ADJUSTMENT TO THE GR OSS MARGINS EARNED BY THESE COMPANIES IS WARRANTED FOR APPLYING THE CP M AS THE APPROPRIATE METHOD. > IT IS NOTEWORTHY THAT THE ABOVE RATIONALE IS ALSO APPRECIATED BY THE LD. TPO WHO HAS PROCEEDED TO PROVIDE SUCH AN ADJUSTMENT BY ELIMINATING THE SELLING AND MARKETING COST FORM THE SALES AND C ONSEQUENTLY ITS IMPACT ON THE GROSS PROFITS. HAVING SAID THIS, THE APPELL ANT SUBMITS THAT THE LD. TPO IS GROSSLY INCORRECT IN PROVIDING AN ADHOC ADJU STMENT OF 8% OF SALES FOR ELIMINATING THE FUNCTIONAL DIFFERENCES BETWEEN THE COMPARABLES SELECTED BY THE LD. TPO AND GE BE. > WHILE THE APPELLANT ALSO IS IN PRINCIPLE IN AG REEMENT WITH THE LD. TPOS PHILOSOPHY OF ADJUSTING THE GROSS MARK-UP, HOWEVER, YOUR GOODSELF WOULD APPRECIATE THAT IN ORDER THAT THE ADJUSTMENTS HAVE THE DESIRED EFFECT, THE ACTUAL PROPORTION OF MARKETING EXPENSES TO SALES OU GHT TO BE CONSIDERED FOR EACH COMPARABLE. THIS IS MORE SO NECESSARY BEC AUSE THE LEVEL OF THESE EXPENSES AS A PROPORTION OF SALES FOR EACH OF THE LD. TPO COMPARABLE VARIES. > IN THIS REGARD, THE APPELLANT WOULD LIKE TO MEN TION THAT CENTENIAL SURGICAL ( A COMPARABLE SELECTED BY THE LD. TPO) IS A CASE IN POINT, FOR THE REASON THAT ITS MARKETING EXPENSES AS A PROPORT ION OF SALES IS 30% AND THE ADJUSTMENT OF 8% TRIBUNAL SALES GRANTED BY THE LD. TPO WOULD BE GROSSLY INADEQUATE TO ELIMINATE THE EFFECT OF TH E MARKETING, DISTRIBUTION AND ADVERTISEMENT FUNCTION ON THE GROSS PROFITS. > THEREFORE THE APPELLANT SUBMITS THAT THE FINA NCIAL ANALYSIS BY THE LD. TPO TO ARRIVE AT THE APPROPRIATE GROSS MARGIN IS ER RONEOUS, AND THE ADJUSTMENT FOR THE DIFFERENCES IN THE MARKETING AND SELLING FUNCTIONS ITA NOS.815 & 846/BANG/2010 PAGE 48 OF 59 OUGHT TO BE RECOMPUTED BASED ON THE ACTUAL EXPENSES INCURRED BY THE COMPANIES. FURTHER, IN THE SAME WRITTEN SUBMISSIONS, AT PAGE 1 17 OF THE PAPER BOOK, IT IS SUBMITTED AS UNDER : ANALYSIS CONSIDERING ALTERNATIVE APPROACH USING TNM M > FURTHER, WITHOUT PREJUDICE TO OUR SUBMISSIONS ABOVE, THE APPELLANT SUBMITS THAT IF ONE WERE TO ARGUE THAT : - THE ADJUSTMENTS MENTIONED ABOVE ARE NOT TO BE CONSIDERED; OR - THAT THE COMPARABLES USED IN THE TP STUDY DO N OT HAVE THE DESIRED DEGREE OF COMPARABILITY FOR APPLYING CPM AS THE MOS T APPROPRIATE METHOD. - THEN ALTERNATIVELY IT WOULD BE APPROPRIATE TO USE THE TRANSACTIONAL NET MARGIN METHOD (TNMM) AS THE APPROPRIATE METHOD IN STEAD OF CONSIDERING ADHOC ADJUSTMENTS OR REJECTING THE COMP ARABLES USED IN THE TP STUDY. A CAREFUL PERUSAL AND ANALYSIS OF THE ASSESSEE'S SUBMISSIONS BEFORE THE CIT (APPEALS) (SUPRA) CLEARLY PLACES THE ASSESSEE'S STATED POSITION AS ONE THAT ACCEPTS CPM AS THE MAM, PROVID ED CERTAIN ADJUSTMENTS ARE MADE FOR THE DIFFERENCES IN THE MAR KETING AND SELLING FUNCTIONS, BASED ON THE ACTUAL EXPENSES INCURRED BY THE COMPANIES. WE, THEREFORE, CLEARLY FIND THAT IT IS BEFORE THE TRIBU NAL THAT THE ASSESSEE HAS CHANGED ITS STAND, STATING THAT TNMM IS THE MAM AND THAT IT WOULD BE ABSURD TO CONSIDER CPM TO BE THE MAM. TNMM WAS BRO ACHED AS AN ALTERNATIVE APPROACH ONLY DURING THE APPELLATE PROC EEDINGS. AS WE HAVE ALREADY HELD, THE CONCEPT OF ALTERNATE APPROACH OR USE OF MORE THAN ONE METHOD IS NOT RECOGNIZED IN INDIAN TP RULES. THE INDIAN TP RULES RECOGNIZE USE OF ONLY ONE METHOD THE MOST APPROPRIATE METHOD (MAM). BASED ON THE DISCUSSIONS IN THE PRE PARAGRAPH OF THIS ORDER, CPM IS THE MAM IN THIS CAS E. ITA NOS.815 & 846/BANG/2010 PAGE 49 OF 59 49. HAVING SAID SO, ONE SHOULD EMBARK UPON THE STA ND TAKEN BY THE ASSESSEE AS TO WHY TNMM IS THE MOST APPROPRIATE MET HOD TO BE ADOPTED FOR DETERMINING ALP IN THE CASE OF THE ASSESSEE. THE ARGUMENTS ADVANCED ON BEHALF OF THE ASSESSEE HAVE ALREADY BEE N SET OUT IN THE EARLIER PART OF THIS ORDER AND ARE NOT BEING REPEAT ED. THE ARGUMENTS PROCEED ON PURELY THEORETICAL BASIS WITHOUT CITING AS TO HOW THE REQUIRED DATA OF DIRECT AND INDIRECT COSTS OF PRODUCTION OF THE PROPERTY IN THE CASE OF THE COMPARABLE COMPANIES CHOSEN BY THE TPO ARE N OT AVAILABLE. NO SPECIFIC INSTANCE AS TO HOW IN THE CASE OF COMPARAB LE COMPANIES CHOSEN BY THE TPO, INDIRECT COSTS OF PRODUCTION HAS BEEN T AKEN AT THE NET PROFIT LEVEL. THE OTHER ARGUMENT WAS THAT THE ASSESSEE IS A CONTRACT MANUFACTURER AND THE COMPARABLE COMPANIES SELECTED SHOULD ALSO PERFORM A FUNCTION PERFORMED BY A CONTRACT MANUFACT URER. IF COMPARABLE COMPANIES PERFORM FUNCTIONS BEYOND THAT OF A CONTRA CT MANUFACTURER THEN THEY ARE NOT COMPARABLE. THIS ARGUMENT IS AGAIN GE NERAL IN NATURE WITHOUT ANY PARTICULARS ON THE THREE COMPARABLE COM PANIES CHOSEN BY THE TPO. 50. ONE OF THE PLEAS RAISED BY THE ASSESSEE WAS THA T FUNCTIONAL SIMILARITY IS TO BE FIRST SEEN BEFORE CHOOSING AN A PPROPRIATE METHOD AND THAT THE TPO IN CHOOSING CPM HAS GIVEN WEIGHTAGE TO PRODUCT SIMILARITY RATHER THAN FUNCTIONAL SIMILARITY. THE ASSESSEE HA D FURTHER POINTED OUT THAT THE COMPARABLE CHOSEN BY THE TPO WERE MANUFACT URING MEDICAL CONSUMABLES VIZ., DISPOSAL SYRINGES, DISPOSABLE SUT URES, DISPOSABLE NEEDLES ETC., AND THAT THE SAME CANNOT BE COMPARED WITH CONTRACT ITA NOS.815 & 846/BANG/2010 PAGE 50 OF 59 MANUFACTURING OF TUBES, INSERTS, DETECTORS, TANKS A ND OTHER PARTS AND ACCESSORIES FOR MEDICAL DIAGNOSTIC IMAGING EQUIPMEN T WHICH THE ASSESSEE MANUFACTURES AND WHICH ARE INCORPORATED BY THE AE INTO EQUIPMENT WHICH ARE CAPITAL GOODS. ON THE ABOVE SU BMISSION, THE LEARNED DR HAS SUBMITTED THAT IT CANNOT BE SAID THA T PRODUCT SIMILARITY HAS NO RELEVANCE. PRODUCT SIMILARITY IS ALSO IMPOR TANT. IF THERE IS NO PRODUCT SIMILARITY THEN EVEN THOUGH THERE MAY BE FU NCTIONAL SIMILARITY THEN CPM MAY NOT BE THE RIGHT METHOD. THE CONCLUSIONS O F THE CIT(A) IN THIS REGARD ARE FOUND TO BE CORRECT IN THE PRESENT CASE. THE TPO IN THE PRESENT CASE HAS GIVEN DUE WEIGHTAGE TO FUNCTIONAL SIMILARITY ALSO. THE ARGUMENT ON BEHALF OF THE ASSESSEE BY PLACING RELIA NCE ON PARA 1.41 OF THE OECD GUIDELINES WHICH PROVIDES THAT COMPARABILI TY EVEN WHERE PRODUCTS ARE DIFFERENT CAN BE UNDERTAKEN BUT THE FU NCTIONS UNDERTAKEN SHOULD BE SIMILAR IS NOT APPLICABLE IN THE PRESENT CASE AS THE TPO HAS CONSIDERED BOTH PRODUCT AS WELL AS FUNCTIONAL SIMIL ARITY OF COMPARABLE. THE DIFFERENCE IN FUNCTIONS PERFORMED BETWEEN THE A SSESSEE AND THE COMPARABLE, IF ANY, CALLS ONLY FOR ADJUSTMENTS TO B E MADE, WHICH IN THE PRESENT CASE CAN BE QUANTIFIED. THEREFORE THE CLAI M OF THE ASSESSEE THAT THE COMPARABLE CHOSEN HAS TO BE REJECTED CANNOT BE ACCEPTED. 51. THE ARGUMENT ON BEHALF OF THE ASSESSEE THAT IND IAN ACCOUNTING STANDARDS DO NOT GIVE CLEAR CUT REQUIREMENT FOR DIS CLOSURE OF GROSS PROFITS AND THEREFORE THERE WILL BE DIFFICULTY IN COMPUTATI ON OF THE COST OF PRODUCTION AND GROSS PROFIT IS AGAIN AN ARGUMENT IN THE AIR WITHOUT ANY SPECIFIC INSTANCE HAVING BEEN POINTED OUT REFERABLE TO THE THREE ITA NOS.815 & 846/BANG/2010 PAGE 51 OF 59 COMPARABLE COMPANIES CHOSEN BY THE TPO. IN ANY EVE NT SUCH DIFFERENCES AS LAID DOWN IN PARA 2.46 OF THE OECD TP GUIDELINES, WHERE THE ACCOUNTING PRACTICES DIFFER IN THE CONTROLLED T RANSACTION AND THE UNCONTROLLED TRANSACTION, APPROPRIATE ADJUSTMENTS S HOULD BE MADE TO THE DATA USED TO ENSURE THAT THE SAME TYPE OF COSTS ARE USED IN EACH CASE TO ENSURE CONSISTENCY. 52. THE ARGUMENT ON BEHALF OF THE ASSESSEE THAT A C ONTRACT MANUFACTURER AND DOES NOT PERFORM FUNCTIONS LIKE MA RKETING, SELLING AND DISTRIBUTION. THE EXPENSES ON MARKETING, SELLING AN D DISTRIBUTION ARE EXPENSES WHICH WILL BE RELEVANT ONLY WHEN COMPUTING NET PROFIT AND THEREFORE THOSE EXPENSES ARE IRRELEVANT WHILE APPLY ING CPM. SIMILARITY OF FUNCTIONS TO THE GROSS PROFIT LEVEL WILL ONLY BE RE LEVANT. IN SUCH CASES IT HAS TO BE DEMONSTRATED AS TO HOW LOWER NET PROFIT A ND HIGHER GROSS PROFIT TAKES A COMPARABLE COMPANY OUT OF THE COMPARABILITY . ALTERNATIVELY, IT CAN BE SHOWN AS TO WHY THE GROSS MARGIN OF THE COMP ARABLE COMPANY NEED TO BE REDUCED BECAUSE OF ITEMS WHICH ARE REQUI RED TO BE CONSIDERED WHILE DETERMINING THE GROSS MARGIN HAVE BEEN CONSID ERED ONLY FOR DETERMINING NET MARGIN IN THE CASE OF COMPARABLE CO MPANIES. IN THAT EVENT APPROPRIATE ADJUSTMENT TO THE GROSS MARGIN OF THE COMPARABLE COMPANIES CAN BE MADE. 53. IT THUS SEEN THAT THE ASSESSEE HAS NOT BEEN ABL E TO POINT OUT AS TO HOW CPM IS NOT THE MAM IN THE PRESENT CASE. IT CAN THEREFORE BE CONCLUDED THAT CPM, ON THE FACTS AND CIRCUMSTANCES OF THE PRESENT CASE, IS THE MAM. ITA NOS.815 & 846/BANG/2010 PAGE 52 OF 59 54. IT IS HOWEVER SEEN THAT THE TPO HAS NOT GIVEN ANY WEIGHTAGE TO THE VARIOUS ASPECTS POINTED OUT BY THE ASSESSEE WHI CH CALL FOR MAKING APPROPRIATE ADJUSTMENTS TO THE MARGINS OF THE COMPA RABLE COMPANIES, AS REQUIRED UNDER RULE 10B(1)( C )(III), (IC) & (V) OF THE RULES. THE COMPUTATION OF ADJUSTMENT AT 8% MADE BY TPO IS NOT BACKED BY PROPER REASONING OR RATIONALE. THE COMPARABLES SELECTED B Y THE TPO PERFORM ADDITIONAL FUNCTIONS IN THE NATURE OF SELLING & MAR KETING THUS EVIDENCING FUNCTIONAL DIFFERENCES WITH THE APPELLANT. THIS FA CT HAS BEEN ACKNOWLEDGED BY THE TPO, BUT WHILE GIVING ADJUSTMEN T, THE TPO HAS COMPUTED THE ADJUSTMENT AT AN ADHOC FIGURE OF 8%. IN VIEW OF THE DIFFERENCE IN FUNCTIONS, THE ASSESSEE IS ENTITLED T O ADJUSTMENTS WHICH ARE RELIABLE AND ACCURATE, AS STIPULATED IN RULE 10C(2) (E) OF THE RULES. IF SUCH ADJUSTMENTS ARE PROVIDED ON ACTUAL BASIS, THE DIFFERENCE IN THE FUNCTIONAL PROFILE WITH THE COMPARABLE COMPANIES GE TS QUANTIFIED AS PROVIDED IN RULE 10B(1)( C ) (III) AS APPLICABLE TO COST PLUS METHOD (CPM). IN THE ABSENCE OF SUCH ADJUSTMENT, A MERE A PPLICATION OF CPM ON COMPARABLES WITH DIFFERENT FUNCTIONAL PROFILE WI LL NOT BE INTUNE WITH THE TP RULES. THEREFORE, AS CPM IS ADOPTED AS THE MAM, THE ASSESSEE SHOULD BE ALLOWED ADJUSTMENT ON ACTUAL BASIS, WHICH WILL RELIABLE AND ACCURATE, AS STIPULATED IN RULE 10C(2). NEEDLESS T O ADD, THE TPO WILL AFFORD OPPORTUNITY OF HEARING TO THE ASSESSEE WITH LEAVE TO FILE DETAILED SUBMISSIONS IN THIS REGARDS, IF NECESSARY. THUS TH E ISSUES RAISED IN GROUNDS 1 TO 7 BY THE ASSESSEE ARE TREATED AS PARTL Y ALLOWED FOR STATISTICAL PURPOSES. ITA NOS.815 & 846/BANG/2010 PAGE 53 OF 59 55. GROUNDS NO.8 & 9 RAISED BY THE ASSESSEE READS A S FOLLOWS:- 8. THAT THE LEARNED CIT(A) ERRED IN CONFIRMING THE ACTION OF THE DEPUTY COMMISSIONER OF INCOME-TAX, CIRCLE 11(3) , BANGALORE (AO) IN HOLDING THAT PROFIT OF RS. 8,79 ,838 DERIVED FROM THE BUSINESS OF THE EXPORT ORIENTED UNIT (ECU ) BY EXPORTING SPARE PARTS, COMPONENTS ETC., WAS INELIGI BLE FOR DEDUCTION UNDER SECTION 10B OF THE ACT AND THEREBY REDUCING DEDUCTION UNDER THE SAID SECTION ALLOWABLE TO THE A PPELLANT. 9. THAT ON THE FACTS AND IN THE CIRCUMSTANCES OF TH E CASE THE LEARNED CIT(A) ERRED IN CONFIRMING THE ACTION OF TH E AO IN TREATING THE EXPORT OF SPARE PARTS, COMPONENTS AS A TRADING ACTIVITY. 56. THE FACTS THAT ARE MATERIAL FOR DECIDING THE AF ORESAID GROUNDS ARE AS FOLLOWS. THE ASSESSEE APART FROM CARRYING OUT C ONTRACT MANUFACTURING AND SELLING PRODUCTS TO ITS AE, ALSO EXPORTED SPARE S COMPONENTS / PARTS. THE ASSESSEE RECEIVED A SUM OF RS.54,77,838 ON EXPO RT OF SUCH SPARES. THE CORRESPONDING COST OF SPARES SO EXPORTED WAS RS .45,98,000. THE ASSESSEE EARNED A NET PROFIT OF RS.8,79,838 ON EXPO RT OF SPARES COMPONENTS. THE QUESTION BEFORE THE AO WAS AS TO WH ETHER THIS PROFIT HAS TO BE CONSIDERED AS PROFITS OF THE BUSINESS WHI LE COMPUTING DEDUCTION U/S. 10B OF THE ACT. ACCORDING TO THE AO AND THE CIT(A), THE CONDITION FOR GRANT OF DEDUCTION U/S. 10B IS ACTIVI TY OF MANUFACTURE AND SINCE INCOME DERIVED FROM TRADING IS NOT ELIGIBLE F OR DEDUCTION U/S. 10B OF THE ACT, THE INCOME FROM TRADING OF SPARES AND COMP ONENTS WAS EXCLUDED FROM THE PROFITS OF THE BUSINESS WHILE COMPUTING DE DUCTION U/S. 10B OF THE ACT. 57. BEFORE US, THE LD. COUNSEL FOR THE ASSESSEE POI NTED OUT THAT THE ISSUE AS TO WHETHER TRADING PROFITS HAVE TO BE EXCL UDED FROM THE PROFITS OF ITA NOS.815 & 846/BANG/2010 PAGE 54 OF 59 THE BUSINESS WHILE COMPUTING DEDUCTION U/S. 10B IS NO LONGER RES INTEGRA AND HAS BEEN SETTLED BY THE SPECIAL BENCH OF THE TR IBUNAL IN THE CASE OF MARAL OVERSEAS LTD. V. ACIT, 136 ITD 177 (SB)(INDOR E) WHEREIN THE SPECIAL BENCH HELD AS FOLLOWS:- 78. SECTION 10B OF SUB-SECTION (1) ALLOWS DEDUCT ION IN RESPECT OF PROFITS AND GAINS AS ARE DERIVED BY A 10 0% EOU. SECTION 10B(4) LAYS DOWN SPECIAL FORMULA FOR COMPUT ING THE PROFITS DERIVED BY THE UNDERTAKING FROM EXPORT. TH E FORMULA IS AS UNDER :- PROFIT OF THE BUSINESS OF THE UNDERTAKING X EXPORT TURNOVER TOTAL TURNOVER OF BUSINESS CARRIED OUT BY THE UNDE RTAKING 79. THUS, SUB-SECTION (4) OF SECTION 10B STIPULAT ED THAT DEDUCTION UNDER THAT SECTION SHALL BE COMPUTED BY APPORTIONING THE PROFITS OF THE BUSINESS OF THE UND ERTAKING IN THE RATIO OF TURNOVER TO THE TOTAL TURNOVER. THUS, NOTWITHSTANDING THE FACT THAT SUB-SECTION (1) OF SE CTION 10B REFERS THE PROFITS AND GAINS AS ARE DERIVED BY A 10 0%EOU, YET THE MANNER OF DETERMINING SUCH ELIGIBLE PROFITS HAS BEEN STATUTORILY DEFINED IN SUB-SECTION (4) OF SECTION 1 0B OF THE ACT. AS PER THE FORMULA STATED ABOVE, THE ENTIRE PROFITS OF THE BUSINESS ARE TO BE TAKEN WHICH ARE MULTIPLIED BY TH E RATIO OF THE EXPORT TURNOVER TO THE TOTAL TURNOVER OF THE BU SINESS. SUB- SECTION (4) DOES NOT REQUIRE AN ASSESSEE TO ESTABLI SH A DIRECT NEXUS WITH THE BUSINESS OF THE UNDERTAKING AND ONCE AN INCOME FORMS PART OF THE BUSINESS OF THE ELIGIBLE UNDERTAKING, THERE IS NO FURTHER MANDATE IN THE PROVISIONS OF SE CTION 10B TO EXCLUDE THE SAME FROM THE ELIGIBLE PROFITS. THE MO DE OF DETERMINING THE ELIGIBLE DEDUCTION UNDER SECTION 10 B IS SIMILAR TO THE PROVISIONS OF SECTION 80HHC INASMUCH AS BOTH THE SECTIONS MANDATES DETERMINATION OF ELIGIBLE PROFITS AS PER THE FORMULA CONTAINED THEREIN. THE ONLY DIFFERENCE IS THAT SECTION 80HHC CONTAINS A FURTHER MANDATE IN TERMS OF EXPLAN ATION (BAA) FOR EXCLUSION OF CERTAIN INCOME FROM THE PRO FITS OF THE BUSINESS WHICH IS, HOWEVER, CONSPICUOUS BY ITS ABS ENCE IN SECTION 10B. ON THE BASIS OF THE AFORESAID DISTINC TION, SUB- SECTION (4) OF SECTION 10A / 10B OF THE ACT IS A CO MPLETE COST PROVIDING THE MECHANISM FOR COMPUTING THE PROFITS OF THE BUSINESS ELIGIBLE FOR DEDUCTION UNDER SECTION 10B OF THE ACT. ONCE AN INCOME FORMS PART OF THE BUSINESS OF THE IN COME OF THE ELIGIBLE UNDERTAKING OF THE ASSESSEE, THE SAME CANNOT BE EXCLUDED FROM THE ELIGIBLE PROFITS FOR THE PURPOSE OF COMPUTING DEDUCTION UNDER SECTION 10B OF THE ACT. AS PER THE COMPUTATION MADE BY THE ASSESSING OFFICER HIMSELF, THERE IS NO DISPUTE THAT BOTH THESE INCOMES HAVE BEEN TREATE D BY THE ITA NOS.815 & 846/BANG/2010 PAGE 55 OF 59 ASSESSING OFFICER AS BUSINESS INCOME. THE CBDT CIR CULAR NO.564 DATED 5 TH JULY, 1990 REPORTED IN 184 ITR (ST.) 137 EXPLAINED THE SCOPE AND AMBIT OF SECTION 80HHC AND THE MODE OF DETERMINATION OF PROFITS DERIVED BY AN ASSE SSEE FROM THE EXPORT OF GOODS, ITAT, SPECIAL BENCH IN THE CAS E OF INTERNATIONAL RESEARCH PARK LABORATORIES LTD. (SUPR A), AFTER FOLLOWING THE AFORESAID CIRCULAR, HELD THAT STRAIGH T JACKET FORMULA GIVEN IN SUB-SECTION (3) HAS TO BE FOLLOWED TO DETERMINE THE ELIGIBLE DEDUCTION. THE HON'BLE SUPR EME COURT IN THE CASE OF P.R. PRABHAKAR V CIT (2006) 284 ITR 584/154 TAXMAN 503 HAD APPROVED THE PRINCIPLE LAID DOWN IN THE SPECIAL BENCH DECISION IN INTERNATIONAL RESEARCH PA RK LABORATORIES LTD. (SUPRA). IN THE ASSESSEE'S OWN C ASE THE ITAT IN THE PRECEDING YEARS, AFTER CONSIDERING THE DECISION IN THE CASE OF LIBERTY INDIA (SUPRA) HELD THAT PROVISI ONS OF SECTION 10B ARE DIFFERENT FROM THE PROVISIONS OF SECTION 80 -IA WHEREIN NO FORMULA HAS BEEN LAID DOWN FOR COMPUTING THE ELI GIBLE BUSINESS PROFIT. 80. IN VIEW OF THE ABOVE DISCUSSION, QUESTION NO. 2 IS ANSWERED IN AFFIRMATION AND IN FAVOUR OF THE ASSESS EE. ACCORDINGLY, THE ASSESSEE IS ELIGIBLE FOR CLAIM OF DEDUCTION ON EXPORT INCENTIVE RECEIVED BY IT IN TERMS OF PROVISI ONS OF SECTION 10B(1) READ WITH SECTION 10B(4) OF THE ACT. 58. SIMILAR VIEW WAS ALSO EXPRESSED BY THE MUMBAI I TAT IN THE CASE OF T. TWO INTERNATIONAL (P) LTD. V. ITO, 122 ITD 27 9 (MUM) AND ITAT BANGALORE IN THE CASE OF ACIT V. MOTOROLA INDIA ELECTRONICS PVT. LTD. IN ITA NO.1134 & 1139/BANG/2003, A.Y. 1998-99 & 2001- 02 BY ORDER DATED 28.11.2006 . 59. THE LD. DR, HOWEVER, POINTED OUT THAT THIS TRIB UNAL IN ASSESSEES OWN CASE FOR THE A.Y. 2002-03 IN ITA NO.3624/BANG/2 004 FOR THE A.Y. 2001-02 BY ORDER DATED 14.02.2007 HAS TAKEN A VIEW THAT PROFITS FROM TRADING ACTIVITY WILL NOT BE ELIGIBLE FOR DEDUCTION U/S. 10B OF THE ACT. 60. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AND AR E OF THE VIEW THAT THE DECISION RENDERED BY THE TRIBUNAL IN ASSESSEES OWN CASE FOR THE A.Y. ITA NOS.815 & 846/BANG/2010 PAGE 56 OF 59 2001-02 WILL NO LONGER BY BINDING IN VIEW OF THE DE CISION OF THE SPECIAL BENCH INDORE IN THE CASE OF MARAL OVERSEAS LTD. (SUPRA) . IT IS CLEAR FROM THE DECISION OF THE SPECIAL BENCH THAT AS FAR AS DEDUCTION U/S. 10B IS CONCERNED, IT IS THE PROFITS OF THE BUSINESS WHI CH HAVE TO BE CONSIDERED. SUCH PROFITS WILL INCLUDE EVEN PROFITS FROM TRADING ACTIVITY. THE SPECIAL BENCH HAS CLEARLY LAID DOWN THAT IN SECTION 80HHC, THE LEGISLATURE RESTRICTED THE MEANING OF THE WORDS PROFITS OF THE BUSINESS IN EXPLANATION (BAA) TO SECTION 80HHC, BUT IN SECTION 10B, NO SUCH RESTRICTION OR EXCLUSION IS LAID DOWN. THE SPECIAL BENCH THUS OPI NED THAT PROFITS OF THE BUSINESS WOULD INCLUDE ALL PROFITS HAVING NEXUS WIT H THE BUSINESS OF THE ASSESSEE. IN VIEW OF THE DECISION OF THE SPECIAL B ENCH REFERRED TO ABOVE, WE ARE OF THE VIEW THAT THE CLAIM OF THE ASSESSEE S HOULD BE ACCEPTED. ACCORDINGLY, GROUNDS 8 & 9 RAISED BY THE ASSESSEE A RE ALLOWED. 61. GROUNDS 10 & 11 ARE WITH REGARD TO EXCLUDING TH E TURNOVER ON ACCOUNT OF SPARES AND COMPONENTS FROM THE EXPORT TU RNOVER WITHOUT EXCLUDING THE SAME FROM THE TOTAL TURNOVER WHILE CO MPUTING DEDUCTION U/S. 10B OF THE ACT. THIS ISSUE IS NO LONGER RES INTEGRA AND HAS BEEN SETTLED BY THE DECISION OF THE HONBLE HIGH COURT OF KARNAT AKA IN THE CASE OF TATA ELXSI LTD. 348 ITR 98 (KAR) , WHEREIN THE HONBLE HIGH COURT HAS HELD THAT WHATEVER IS EXCLUDED FROM THE EXPORT TURNOVER SHOUL D ALSO BE CORRESPONDINGLY REDUCED FROM THE TOTAL TURNOVER WHI LE COMPUTING DEDUCTION U/S. 10B OF THE ACT. FOLLOWING THE DECIS ION OF THE HONBLE HIGH COURT OF KARNATAKA, WE DIRECT THE AO TO EXCLUDE THE TURNOVER FROM EXPORT ITA NOS.815 & 846/BANG/2010 PAGE 57 OF 59 OF SPARES & COMPONENTS BOTH FROM THE TOTAL TURNOVER AS WELL AS THE EXPORT TURNOVER. 62. IN THE RESULT, THE APPEAL BY THE ASSESSEE IS PARTLY ALLOWED . ITA NO.815/BANG/2010 63. GROUNDS 1, 6 & 7 ARE GENERAL IN NATURE AND CALL S FOR NO ADJUDICATION. 64. GROUNDS 2 & 3 RAISED BY THE REVENUE READS AS FO LLOWS:- 2. THE LEARNED CIT(A) HAS ERRED IN HOLDING THAT TH E INCOME FROM SCRAP SALES WOULD FORM PART OF THE PROFITS OF THE UNDERTAKING ELIGIBLE FOR DEDUCTION U/S. 10B OF THE ACT. 3. THE LEARNED CIT(A) HAS ERRED IN ALLOWING THE ASS ESSEES APPEAL FOLLOWING THE DECISION OF THE HONBLE ITAT I N THE ASSESSEES OWN CASE IN ITA NO.3624/BANG/2004 DATED 14/2/2007 WITHOUT APPRECIATING THAT THERE IS NO DIR ECT NEXUS BETWEEN THE SCRAP SALES AND THE MANUFACTURING ACTIV ITY. 65. IT IS NOT IN DISPUTE BEFORE US THAT IN ASSESSEE S OWN CASE, THIS TRIBUNAL HAS TAKEN A VIEW THAT INCOME FROM SALE OF SCRAP SHOULD FORM PART OF PROFITS OF THE UNDERTAKING ELIGIBLE FOR DEDUCTIO N U/S. 10B OF THE ACT. THE GRIEVANCE OF THE REVENUE IS THAT THERE IS NO NEXUS BETWEEN THE SCRAP SALES AND MANUFACTURING ACTIVITY. WE ARE OF THE VI EW THAT THERE IS NO MERIT IN THE GROUNDS RAISED BY THE REVENUE FOR THE REASON THAT THIS TRIBUNAL HAS ALREADY TAKEN A CONSCIOUS DECISION IN THE ORDER REFERRED TO IN GROUND NO.3 RAISED BY THE REVENUE. IN THE CIRCUMS TANCES, FOLLOWING THE DECISION OF THE TRIBUNAL IN ASSESSEES OWN CASE, WE UPHOLD THE ORDER OF ITA NOS.815 & 846/BANG/2010 PAGE 58 OF 59 THE LD. CIT(APPEALS) AND DISMISS GROUNDS NO.2 & 3 R AISED BY THE REVENUE. 66. GROUNDS NO.4 & 5 RAISED BY THE REVENUE READS TH US:- 4. THE LEARNED CIT(A) HAS ERRED IN HOLDING THAT 25 % EXPORT EARNINGS FILTER IS TO BE APPLIED EVEN THOUGH IT LEA VES ONLY ONE COMPANY AS A FINAL COMPARABLE. 5. THE LEARNED CIT(A) HAS ERRED IN HOLDING THAT ONE COMPARABLE WOULD BE SUFFICIENT FOR COMPARABILITY. 67. ON THE AFORESAID GROUNDS OF APPEAL, THE LD. COU NSEL FOR THE ASSESSEE SUBMITTED THAT THIS WILL HAVE NO IMPACT ON THE TP ADJUSTMENT, IF THOSE GROUNDS ARE ALLOWED. WE ARE OF THE VIEW THAT 25% EXPORT EARNING IS AN APPROPRIATE FILTER AND THE FACT THAT BY APPLY ING THAT FILTER ONLY ONE COMPANY IS LEFT AS A COMPARABLE, WILL NOT BE A GROU ND NOT TO APPLY THE AFORESAID FILTER. WE ARE THEREFORE OF THE VIEW THA T THE LD. CIT(A) WAS CORRECT IN APPLYING 25% EXPORT EARNINGS FILTER. GR OUNDS NO.4 & 5 ARE ACCORDINGLY DISMISSED. 68. THUS, THE APPEAL BY THE REVENUE IS DISMISSED . 69. IN THE RESULT, THE APPEAL BY THE ASSESSEE IS PARTLY ALLOWED AND APPEAL BY THE REVENUE IS DISMISSED . PRONOUNCED IN THE OPEN COURT ON THIS 6 TH DAY OF DEC., 2013. SD/- SD/- (N.V. VASUDEVAN ) ( JASON P . BOAZ ) JUDICIAL MEMBER ACCOUNTANT MEMBER DS / *REDDYGP