DCIT Circle-14 (1), v. Panasonic India (P) Ltd,

ITA 1373/DEL/2008 | 2002-2003
Pronouncement Date: 24-09-2010 | Result: Dismissed

Appeal Details

RSA Number 137320114 RSA 2008
Assessee PAN AAACN1498G
Bench Delhi
Appeal Number ITA 1373/DEL/2008
Duration Of Justice 2 year(s) 5 month(s) 12 day(s)
Appellant DCIT Circle-14 (1),
Respondent Panasonic India (P) Ltd,
Appeal Type Income Tax Appeal
Pronouncement Date 24-09-2010
Appeal Filed By Department
Order Result Dismissed
Bench Allotted F
Tribunal Order Date 24-09-2010
Assessment Year 2002-2003
Appeal Filed On 11-04-2008
Judgment Text
IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH F : NEW DELHI BEFORE SHRI I.P. BANSAL JM AND SHRI R.C.SHARMA AM ITA NO.1417/DEL/2008 ASSESSMENT YEAR : 2002-03 M/S PANASONIC INDIA PVT. LTD. C/O S.R. DINODIA & CO. C-37 CONNAUGHT PLACE NEW DELHI PAN NO.AAACN 1498G VS. INCOME-TAX OFFICER WARD 14(4) NEW DELHI. (APPELLANT) (RESPONDENT) AND ITA NO.1373/DEL/2008 ASSESSMENT YEAR : 2002-03 INCOME-TAX OFFICER WARD 14(4) NEW DELHI. VS. M/S PANASONIC INDIA PVT. LTD. C/O S.R. DINODIA & CO. C-37 CONNAUGHT PLACE NEW DELHI PAN NO.AAACN 1498G (APPELLANT) (RESPONDENT) ASSESSEE BY : SHRI PRADEEP DINODIA MS.PALLAVI DINO DIA & SHRI R.K. KAPOOR CAS. DEPARTMENT BY : SHRI SANJAY SHARMA CIT-DR ORDER PER R.C.SHARMA AM : THESE ARE THE CROSS APPEALS FILED BY THE ASSESSEE A ND THE REVENUE AGAINST THE ORDER OF CIT(A) DATED 31.01.2008 FOR THE ASSESSMENT YEAR 2002-03 IN THE MATTER OF ORDER PASSED U/S 143(3) OF THE INCOME TAX ACT 1 961. ITA-1417 & 1373/D/2008 2 2. FACTS IN BRIEF ARE THAT THE ASSESSEE NATIONAL P ANASONIC INDIA PVT.LTD. (NPIPL) IS PART OF THE MATSUSHITA GROUP OF COMPANIE S. THE GROUP IS ONE OF THE WORLDS LEADING MANUFACTURERS OF CONSUMER ELECTRONI CS PRODUCTS. THESE PRODUCTS ARE SOLD UNDER THE BRAND NAMES NATIONAL PANASON IC TECHNICS AND QUASAR. NATIONAL PANASONIC INDIA PRIVATE LIMITED (NPIPL) IS A WHOLLY OWNED SUBSIDIARY OF MATSUSHITA ELECTRIC INDUSTRIAL COMPANY LIMITED JAPAN (MEI). 99.99% OF THE SHARES OF THE ASSESSEE COMPANY ARE HELD BY MEI JAP AN AND THE REMAINING .01% ARE HELD BY MATSUSHITA ASIA PRIVATE LIMITED SINGAP ORE. THE BUSINESS OF THE ASSESSEE COMPANY IS ORGANIZED UNDER THREE DISTINCT SEGMENTS. AS PER THE TP REPORT THE FOLLOWING ARE THE THREE CLASSES OF INTE RNATIONAL TRANSACTIONS (TABLE-3) DESCRIBED IN PARA 2.5 OF THE REPORT :- TABLE-3 TRADING FUNCTION COMMISSION & MARKETING AGENCY SERVICES ADVERTISING EXPENSES REIMBURSEMENT IMPORT OF CPD & SPD PRODUCTS BY NPIPL FROM MEI GROUND ENTITIES RENDERING SALES AGENCY SERVICES BY NPIPL TO MEI GROUP ENTITIES IN RESPECT OF INDUSTRIAL SALES DIVISION PRODUCTS AGAINST RECEIPT OF COMMISSION PAYMENTS. REIMBURSEMENT RECEIVED BY NPIPL FROM MEI GROUP ENTITIES FOR CERTAIN ADVERTISING EXPENSES. REIMBURSEMENT OF TRAVELING EXPENSES BY MEI GROUP ENTITIES TO NPIPL. REIMBURSEMENT OF MARKET DEVELOPMENT EXPENSES INCURRED FOR THE INDUSTRIAL PRODUCTS BY MEI GROUP ENTITIES TO NPIPL. PAYMENT OF PANANET ADDITIONAL INCOME ITA-1417 & 1373/D/2008 3 SUPPORT BY NPIPL TO MEI. RECEIVED BY NPIPL FOR PROVIDING WARRANTY SERVICES TO PANASERT MACHINES SOLD TO CUSTOMERS IN INDIA FROM MEI GROUP ENTITIES. SERVICE FEE RECEIVED BY NPIPL FOR SUPERVISING AUTHORIZED SERVICE CENTERS AND REIMBURSEMENT OF COST OF REPAIR AND REPLACEMENT BY MEI GROUP ENTITIES TO NPIPL. 3. DURING THE COURSE OF SCRUTINY ASSESSMENT DETAIL ED INFORMATION CLARIFICATION ALONGWITH JUSTIFICATION OF ALLOWABILITY OF VARIOUS EXPENSES WAS CALLED BY THE AO AND THE SAME WERE DULY FILED BY THE ASSESSEE. THE AO FRAMED ASSESSMENT U/S 143(3) AT AN INCOME OF RS.68.29 LAKHS AS AGAINST R ETURNED LOSS OF RS.4.73 CRORES AFTER MAKING VARIOUS ADDITIONS AND DISALLOWANCES. THE AO ALSO MADE A REFERENCE TO THE TRANSFER PRICING OFFICIAL TO DETERMINE THE N ET EFFECT OF ALL THE TRANSACTIONS OF THE ASSESSEE WITH ITS ASSOCIATED ENTERPRISES. THE AO FOUND THAT ASSESSEE IS A SUBSIDIARY COMPANY OF M/S MATSUSHITA ELECTRIC INDUS TRIAL COMPANY LIMITED (MEI). THE MAIN OBJECT OF THE COMPANY WAS SELLING AND DISTRIBUTING DOMESTIC AS WELL AS EXPORT MARKET THE PRODUCTS HAVING THE MATSU SHITA BRAND NAME OF NATIONAL PANASONIC MANUFACTURED BY MATSUSHITA GROUP AND ITS VARIOUS COLLABORATION COMPANIES. FROM THE RECORD WE FOUND THAT THE BUSI NESS OF THE ASSESSEE WAS ORGANIZED UNDER THREE SEGMENTS (I) CONSUMER PRODU CT DIVISION (CPD) (II) SYSTEM PRODUCT DIVISION (SPD) AND (III) INDUSTRIAL SALES DIVISION (ISD). CPD ITA-1417 & 1373/D/2008 4 AND SPD DIVISIONS WERE PERFORMING TRADING FUNCTIONS AND THE ISD DIVISION WAS PERFORMING COMMISSION AGENCY FUNCTIONS. THE ASSESS EE COMPANY HAD ALSO UNDERTAKEN TRANSFER PRICING ANALYSIS FOR THESE FUNC TIONS. FOR THIS PURPOSE THE RESULTS OF CPD AND SPD WERE AGGREGATED AND THE RESU LTS OF ISD WERE CONSIDERED SEPARATELY. HOWEVER THE TPO WHILE SCRUTINIZING TH E ASSESSEES ACCOUNTS ON SEGMENTAL BASIS RE-WRITTEN THE ACCOUNTS OF THREE S EGMENTS CPD SPD AND ISD. ON THE BASIS OF RE-WRITTEN ACCOUNTS THE TPO RECOMM ENDED TRANSFER PRICING ADJUSTMENT OF RS.1.12 CRORES IN RESPECT OF IMPORTED FINISHED GOODS FOR THE CPD SEGMENT. AN ADJUSTMENT TO THE TUNE OF RS.1.15 CROR ES WAS ALSO RECOMMENDED IN RESPECT OF REMUNERATION EARNED FROM PARENT COMPANY PERTAINING TO ISD DIVISION. IN THE ECONOMIC ANALYSIS CARRIED OUT BY THE ASSESSE E THE ACTIVITIES OF THE SUPERVISION OF AUTHORIZED SERVICE CENTERS WERE AGGR EGATED WITH THE MAIN ACTIVITY OF TRADING FUNCTION FOR THE PURPOSE OF BENCHMARKING ANALYSIS. THE TNMM METHOD WAS FOUND TO BE MOST APPROPRIATE METHOD FOR TESTING PROFITABILITY OF TRADING FUNCTIONS. THE NET OPERATING PROFIT MARGIN ON SALES WAS CHOSEN AS A PROFIT LEVEL INDICATOR FOR BENCHMARKING ANALYSIS FOR THE T RADING FUNCTION. THEN TNMM WAS ALSO FOUND TO BE MOST APPROPRIATE METHOD TO TES T THE PROFITABILITY OF COMMISSION AND MARKETING AGENCY SERVICES OF ISD DIV ISION. IN RESPECT OF MARGIN SHOWN ON SPD THE AO FOUND THAT SAME WAS MORE THAN ARMS LENGTH MARGIN OF 2.48% THEREFORE INTERNATIONAL TRANSACTION PERTAINI NG TO SPD WAS HELD TO BE AT ARMS LENGTH. IN RESPECT OF IMPORTED GOODS UNDER C PD THE AO OBSERVED THAT THE LOSS MARGIN SHOWN WAS BELOW THE ARMS LENGTH MARGIN . THE AO THEREFORE OBSERVED THAT THE TRANSFER PRICE OF THE IMPORTED FI NISHED GOODS UNDER THE CPD HAS TO BE ADJUSTED DOWNWARDS. ACCORDINGLY ARMS LENGT H PRICE WAS DETERMINED AT THE PRICE DECLARED IN FORM 3CEB MINUS THE ADJUSTMENT AM OUNT I.E. RS.74704584 RS.11237019 = RS.63467565. THE ARMS LENGTH PRICE IN RESPECT OF REMUNERATION RECEIVED UNDER ISD DIVISION WAS ALSO ENHANCED BY TH E AO BY AN AMOUNT EQUIVALENT TO THE DIFFERENCE OF OPERATING LOSS MARG IN AND THE MEAN MARGIN OF THE COMPARABLE COMPANIES CHOSEN. THIS DIFFERENCE WORKS OUT TO BE 6.11% - (-) 28.8% ITA-1417 & 1373/D/2008 5 = 34.91% OF THE TOTAL COSTS. THE TOTAL COSTS HAVE BEEN WORKED OUT TO BE RS.33131321.34.91% OF THIS AMOUNT COMES TO RS.11566 144/-. THUS THE TOTAL INCOME OF THE ASSESSEE WAS ENHANCED BY THE AO BY FO LLOWING AMOUNTS:- FOR CPD IMPORTS - RS.11237019 FOR ISD - RS.11566144 TOTAL - RS.22803163 THESE ADDITIONS HAVE BEEN DEALT BY CIT(A) AS UNDER: 4.1 DURING THE ASSESSMENT PROCEEDINGS THE AO NOTIC ED THE FOLLOWING INTERNATIONAL TRANSACTIONS (TABLE-1) ENTERED INTO BY THE APPELLANT DURING THE FINANCIAL YEAR 2001-02 AS REP ORTED IN FORM 3CEB FILED ALONG WITH THE RETURN OF INCOME: TABLE-1 NATURE OF TRANSACTION METHOD VALUE (IN RS.) PURCHASE OF FINISHED GOODS TNMM 44 92 32 055 PURCHASE OF SPARES TNMM 56 39 260 COMMISSION & SERVICE INCOME TNMM 2 04 93 071 PAYMENT FOR PANANET SERVICES TNMM 1 56 936 REIMBURSEMENTS RECEIVED TNMM 15 97 82 249 4.2 A REFERENCE WAS MADE BY THE AO U/S 92CA(1) OF T HE ACT TO THE TPO FOR COMPUTATION OF ALP IN RESPECT OF THESE INTERNATIONAL TRANSACTIONS. THE TPO OBSERVED THAT THE BUSINESS O F THE COMPANY WAS ORGANIZED UNDER THREE DISTINCT SEGMENTS (I) CON SUMER PRODUCT DIVISION [CPD] (II) SYSTEM PRODUCTS DIVISION [SPD] & (III) INDUSTRIAL SALES DIVISION [ISD]. THE FIRST TWO DIV ISIONS PERFORMED TRADING FUNCTIONS WHEREAS THE THIRD ONE PERFORMED C OMMISSION AGENCY FUNCTIONS. THE APPELLANT HAD CONDUCTED TRAN SFER PRICING ANALYSIS FOR THESE TWO FUNCTIONS SEPARATELY. FOR T HIS PURPOSE THE RESULTS OF CPD 7 SPD WERE AGGREGATED AND THE RESULT S OF ISD WERE CONSIDERED SEPARATELY. THE TPO HOWEVER ANALYZED THE ACCOUNTS OF THE APPELLANT ON SEGMENTAL BASIS AND REDREW THE ACC OUNTS OF THE THREE SEGMENTS CPD SPD & ISD SEPARATELY. FURTHER CPD W AS BIFURCATED INTO CPD (LOCAL) & CPD (IMPORTED GOODS). ON THE BA SIS OF THE REDRAWN SEGMENTAL ACCOUNTS THE TPO RECOMMENDED TRA NSFER PRICING ADJUSTMENT OF RS.1 12 37 019/- IN RESPECT OF IMPORT ED FINISHED GOODS ITA-1417 & 1373/D/2008 6 IN THE CPD (IMPORTED GOODS) SEGMENT. A QUANTUM OF TP ADJUSTMENT TO THE TUNE OF RS.1 15 66 144/- WAS ALSO RECOMMENDE D IN RESPECT OF REMUNERATION RECEIVED BY THE APPELLANT FROM ITS PAR ENT COMPANY PERTAINING TO ISD DIVISION. TRANSFER PRICING REPORT 4.3 THE STARTING POINT OF TPOS ENDEAVOR TO DETERMI NE THE ALP IS THE TRANSFER PRICING REPORT (TP REPORT) PREPAR ED BY THE APPELLANT. THIS REPORT PROVIDES AN ANALYSIS OF FUN CTIONS PERFORMED ASSETS USED AND RISK ASSUMED BY THE APPELLANT AND E XAMINES WHETHER RETURN IS COMMENSURATE WITH THE FUNCTIONS PERFORMED ASSETS USED AND RISK ASSUMED. AS PER THE PROVISIONS OF THE ACT A BENCH-MARKING ANALYSIS IS DONE BY FIRST SELECTING THE COMPARABLE UNCONTROLLED CASES THEN MY COMPUTING THE ALP WITH DATA PERTAINING TO T HESE COMPARABLES USING THE MOST APPROPRIATE METHOD AND FINALLY BY ASCERTAINING WHETHER THE INTRA-GROUP TRANSACTIONS C ONFORM TO THE ARMS LENGTH STANDARDS PRESCRIBED BY THE ACT OR NOT . A. BUSINESS PROFILE : 4.4 BEFORE ADJUDICATING ON THE TP ISSUES IT WOULD BE APPROPRIATE TO SKETCH THE BUSINESS PROFILE OF THE APPELLANT AS DESCRIBED IN THE TP REPORT: (I) NATIONAL PANASONIC INDIA PVT. LTD. (NPIPL OR ASSESS EE OR TAXPAYER COMPANY) IS PART OF THE MATSUSHITA GROUP OF COMPANI ES. THE GROUP IS ONE OF THE WORLDS LEADING MANUFACTURERS OF CONS UMER ELECTRONICS PRODUCTS. THESE PRODUCTS ARE SOLD UNDER THE BRAND NAMES NATIONAL PANASONIC TECHNICS AND QUASAR. (II) NATIONAL PANASONIC INDIA PRIVATE LIMITED (NPIPL) IS WHOLLY OWNED SUBSIDIARY OF MATSUSHITA ELECTRIC INDUSTRIAL COMPAN Y LIMITED JAPAN (MEI). 99.99% OF THE SHARES OF THE ASSESSEE COMPAN Y ARE HELD BY MEI JAPAN AND THE REMAINING .01% ARE HELD BY MATSU SHITA ASIA PRIVATE LIMITED SINGAPORE. (III) THE BUSINESS OF THE TAXPAYER COMPANY IS ORGANIZED U NDER THREE DISTINCT SEGMENTS (TABLE-2) : ITA-1417 & 1373/D/2008 7 TABLE-2 DIVISION SUB-DIVISION PRODUCTS BRAND NAME FUNCTIONS PERFORMED REMARKS (I) CONSUMER PRODUCT DIVISION (CPD) (I) HOUSEHOLDS APPLIANCES MICROWAVES WASHING MACHINES HOME SHOWERS NATIONAL TRADING/ DISTRIBUTION (II) CONSUMERS ELECTRONIC COLOR TELEVISION PLASMA T.V. AUDIO- VIDEO SYSTEMS AND MOVIE CAMERAS PANASONIC TRADING/ DISTRIBUTION (II) SYSTEM PRODUCTS DIVISION (SPD) OFFICE AUTOMATION AND TELE- COMMUNICATIONS FAX MACHINE TELEPHONE INSTRUMENTS ETC. PANASONIC TRADING/ DISTRIBUTION (III) INDUSTRIAL SALES DIVISION (ISD) ELECTRONICS COMPONENTS BATTERIES WELDING EQUIPMENTS AND MEASURING INSTRUMENTS COMMISSION & MARKETING AGENCY ALSO PROVIDES AFTER SALES SERVICE FOR PRODUCTS SOLD BY MEI JAPAN AND OTHER AFFILIATES TO INDIAN CUSTOMERS B. NATURE OF INTERNATIONAL TRANSACTIONS : ITA-1417 & 1373/D/2008 8 4.5 AS PER THE TP REPORT THE FOLLOWING ARE THE THR EE CLASSES OF INTERNATIONAL TRANSACTIONS (TABLE-3) DESCRIBED IN PARA 2.5 OF THE REPORT: TABLE-3 TRADING FUNCTION COMMISSION & MARKETING AGENCY SERVICES ADVERTISING EXPENSES REIMBURSEMENT IMPORT OF CPD & SPD PRODUCTS BY NPIPL FROM MEI GROUND ENTITIES RENDERING SALES AGENCY SERVICES BY NPIPL TO MEI GROUP ENTITIES IN RESPECT OF INDUSTRIAL SALES DIVISION PRODUCTS AGAINST RECEIPT OF COMMISSION PAYMENTS. REIMBURSEMENT RECEIVED BY NPIPL FROM MEI GROUP ENTITIES FOR CERTAIN ADVERTISING EXPENSES. REIMBURSEMENT OF TRAVELING EXPENSES BY MEI GROUP ENTITIES TO NPIPL. REIMBURSEMENT OF MARKET DEVELOPMENT EXPENSES INCURRED FOR THE INDUSTRIAL PRODUCTS BY MEI GROUP ENTITIES TO NPIPL. PAYMENT OF PANANET SUPPORT BY NPIPL TO MEI ADDITIONAL INCOME RECEIVED BY NPIPL FOR PROVIDING WARRANTY SERVICES TO PANASERT MACHINES SOLD TO CUSTOMERS IN INDIA FROM MEI GROUP ENTITIES. SERVICE FEE RECEIVED BY NPIPL FOR SUPERVISING AUTHORIZED SERVICE CENTERS AND REIMBURSEMENT OF COST OF REPAIR AND REPLACEMENT BY MEI GROUP ENTITIES TO NPIPL. C. T.P. REPORT & FUNCTION ASSETS & RISK (FAR) ANA LYSIS : 4.6 AS PER THE FUNCTIONAL ANALYSIS CARRIED OUT AT PARA 3 TO 3.4 IN THE T.P. REPORT THE FOLLOWING ARE THE DETAILS RELA TING TO THE MAJOR FUNCTIONS PERFORMED IN RESPECT OF VARIOUS INTERNATI ONAL TRANSACTIONS ITA-1417 & 1373/D/2008 9 ALONG WITH RISK ASSUMED ( PARA 3.1.2 ) AND ASSETS DEPLOYED BY THE APPELLANT (TABLE-4) : TABLE-4 TRADING FUNCTIONS IMPORT OF PRODUCTS PAYMENT FOR PANANET SUPPORT REIMBURSEMENT OF ADMINISTRATIVE EXPENSES SUPERVISION OF AUTHORIZED SERVICE CENTERS (ASC) FUNCTIONS IMPORT PRODUCTS FROM MEI GROUP ENTITIES. OBTAINING CUSTOM CLEARANCE. MAINTENANCE OF WAREHOUSE FACILITIES FOR STOCKS. SELLING AND DISTRIBUTION FUNCTIONS. PRICE DETERMINATION. UNDERTAKING PUBLICITY AND ADVERTISEMENT CAMPAIGNS WITH FULL DESCRIPTION PAYMENT FOR USE OF PANANET SOFTWARE ON THE BASIS OF NUMBER OF HOURS USED. RECEIPT OF REIMBURSEMENT FOR ADMINISTRATIVE AND TRAVELING EXPENSES INCURRED BY NPIPL FOR ITS DEALERS IN INDIA. APPOINTMENT OF ASCS. DISTRIBUTIN OF SERVICE MANUAL TO ASCS. PROVIDING TECHNICAL SUPPORT TO ASCS. ADMINISTERING SUPPLY OF SPARE PARTS AND TOOLS TO ASCS. TO COLLECT RECORDS OF SERVICE CLAIMS FROM ASCS. REPORTING OF SERVICE ACTIVITIES OF ASCS. REPLYING TO COMPLAINTS QUESTIONS & INQUIRIES FROM CUSTOMERS. RISK CONTRACT RISK WITH DEALER AND DISTRIBUTORS. INVENTORY RISK. MARKET RISK. QUALITY AND WARRANTY RISK. FOREIGN EXCHANGE FLUCTUATION RISK. NO DETAILS IN THE TP REPORT NO DETAILS IN THE TP REPORT NO DETAILS IN THE TP REPORT ITA-1417 & 1373/D/2008 10 ASSETS DEPLOYED OWNS ASSETS TO PERFORM IMPORTING WEREHOUSING ADMINISTRATION AND DISTRIBUTION FUNCTIONS. NO INTANGIBLE ASSETS. NO DETAILS IN THE TP REPORT NO DETAILS IN THE TP REPORT NO DETAILS IN THE TP REPORT COMMISSION & MARKETING AGENCY SERVICES FUNCTIONS PRODUCT PRESENTATION AND SALES REPRESENTATION SERVI CES TO CUSTOMERS; CONDUCT MARKET RESEARCH AND SURVEY IN INDIA; UNDERTAKE MARKET/PRODUCT DEVELOPMENT IN INDIA; EXPLORE SALES AND DISTRIBUTION CHANNELS FOR ISD PRO DUCTS; INCREASE AWARENESS AND USE OF ISD PRODUCTS IN INDIA ; AND AFTER SALES SERVICES AND MAINTENANCE UNDER WARRANTY . RISK FOREIGN EXCHANGE FLUCTUATION RISK ASSETS DEPLOYED USES THE EXISTING ASSETS FOR DISCHARGING THIS FUNCT ION D. T.P. REPORT ECONOMIC & BENCHMARKING ANALYSIS : 4.7 THE ECONOMIC ANALYSIS CARRIED OUT BY THE APPELL ANT CONTAINED IN PARA 4 TO 4.6 OF THE T.P. REPORT HAD DRAWN THE FOLLOWING CONCLUSIONS: (I) THE ACTIVITIES OF SUPERVISION OF AUTHORIZED SERVICE CENTERS ARE AGGREGATED WITH THE MAIN ACTIVITY OF THE TRADING FU NCTION OF NPIPL FOR THE PURPOSE OF BENCHMARKING ANALYSIS. (II) TNMM WAS FOUND TO BE THE MOST APPROPRIATE METHOD (M AM) TO TEST THE PROFITABILITY OF NPIPLS TRADING FUNCTIONS . (III) NPIPL IS TAKEN AS A TESTED PARTY. (IV) NPIPLS FUNCTIONAL AND RISK PROFILE SEEMS MORE AKIN TO THAT OF A TYPICAL DISTRIBUTOR. (V) NET OPERATING PROFIT MARGIN ON SALES (NPM) WHICH IS A RATIO OF NET PROFIT TO TOTAL SALES IN CHOSEN AS THE PROFIT LEVEL INDICATOR FOR THE BENCHMARKING ANALYSIS FOR THE TRADING FUNCTION. (VI) TNMM WAS FOUND TO BE THE MOST APPROPRIATE METHOD (M AM) TO TEST THE PROFITABILITY OF NPIPLS COMMISSION & MARK ETING AGENCY SERVICES. (VII) NPIPL IS TAKEN AS A TESTED PARTY FOR BENCHMARKING T HE AGENCY FUNCTION. ITA-1417 & 1373/D/2008 11 (VIII) NPIPLS FUNCTIONAL AND RISK PROFILE SEEMS MORE AKIN TO THAT OF A SERVICE PROVIDER. (IX) NET COST PLUS MARGIN (NCP) WHICH IS A RATIO OF NET PROFIT TOTAL COST IS CHOSEN AS THE PROFIT LEVEL INDICATOR FOR THE BENCHM ARKING ANALYSIS. (X) NPIPL WAS NOT IN THE BUSINESS OF PROVIDING SERVICES TO UNRELATED PARTIES IN RESPECT OF ADVERTISING CAMPAIGN. ANY BE NEFIT ON ACCOUNT OF THE CAMPAIGN ACCRUING TO THE MEI GROUP WAS PUREL Y INCIDENTAL. HENCE THE REIMBURSEMENT COST ON ACCOUNT OF ADVERTI SING EXPENSES WOULD NOT WARRANT ANY MARK UP. ACCORDINGLY NO SEP ARATE BENCHMARKING ANALYSIS IS REQUIRED TO BE DONE FOR TH IS TRANSACTION. E. MULTI-YEAR DATA : 4.8 FOR CARRYING OUT THE COMPARABILITY ANALYSIS TH E APPELLANT HAD FOCUSED ON THE OPERATING RESULTS OF COMPARABLES OVE R THE THREE FINANCIAL YEARS 1999-2000 2000-01 & 2001-02. THI S WAS STATED TO HAVE BEEN DONE TO MINIMIZE THE IMPACT OF ABNORMAL F ACTORS ON THE OUTCOMES OF THE COMPARABLE DATA. F. SELECTION OF COMPARABLES : TRADING FUNCTION : 4.9 THE APPELLANT IDENTIFIED A SET OF NINE UNCONTRO LLED COMPARABLE COMPANIES FROM PROWESS DATABASE BY WAY OF THREE DIF FERENT SEARCHES. IN THE FIRST SEARCH COMPANIES CLASSIFIED UNDER THE BROAD HEAD OF ELECTRONICS WERE CONSIDERED AS PER THE SELECTION PR OCESS DETAILED IN TABLE-5 OF THIS ORDER BY ADOPTING A FORMULA BASED SEARCH STRATEGY BY APPLYING VARIOUS QUANTITATIVE AND QUALITATIVE FILTE RS TO THE SET OF POTENTIAL COMPARABLES WITHIN THIS SEGMENT: TABLE 5 : SELECTION PROCESS CRITERIA NO.OF COMPANIES PASSING THE CRITERION EXPLANATION STARTING POINT 116 COMPANIES IN THE ELECTRONICS SEG MENT HAVING THE REQUISITE FINANCIAL INFORMATION. MANUFACTURING SALES TO TOTAL SALES RATIO OF < 25% TO BE RETAINED 27 TO EXCLUDE COMPANIES THOSE ARE PRIMARILY INTO MANUFACTURING. TRADING SALES TO TOTAL 12 TO EXCLUDE COMPANIES THOS E ARE NOT ITA-1417 & 1373/D/2008 12 SALES RATIO OF > 75% TO BE RETAINED PRIMARILY ENGAGED IN DISTRIBUTION/TRADING ACTIVITIES. RESEARCH & DEVELOPMENT EXPENSES TO SALES RATIO < 5% TO BE RETAINED. 12 TO ELIMINATE COMPANIES UNDERTAKING SIGNIFICANT RESEARCH AND DEVELOPMENT ACTIVITIES. QUALITATIVE ANALYSIS 1 TO ELIMINATE COMPANIES COMPANIES HAVING RELATED PARTY SALES. COMPANIES NOT DEALING IN SIMILAR PRODUCT OR HAVING SIMILAR BUSINESS AND FUNCTIONAL PROFILE COMPANIES HAVING MORE THAN 10% OF AVERAGE LOSS. IN THE SECOND SEARCH THE CRITERION OF SELECTION WA S EXTENDED TO INCLUDE COMPANIES ENGAGED IN THE TRADE OF ELECTRICAL MACHINERY. TABL E NO.6 OF THIS ORDER SUMMARIZES THE SELECTION PROCESS. TABLE-6 CRITERIA NO. OF COMPANIES PASSING THE CRITERION EXPLANATION STARTING POINT 894 COMPANIES IN THE ELECTRONICS AND ELECTRICAL GOODS SEGMENT HAVING THE REQUISITE FINANCIAL INFORMATION. MANUFACTURING SALES TO TOTAL SALES RATIO OF <25% TO BE RETAINED. 385 TO EXCLUDE COMPANIES THOSE ARE PRIMARILY INTO MANUFACTURING. TRADING SALES TO TOTAL SALES RATIO OF >75% TO BE RETAINED 56 TO EXCLUDE COMPANIES THOSE ARE NOT PRIMARILY ENGAGED IN DISTRIBUTION/TRADING ACTIVITIES. RESEARCH & DEVELOPMENT EXPENSES TO SALES RATIO <5% TO BE RETAINED. 56 TO ELIMINATE COMPANIES UNDERTAKING SIGNIFICANT RESEARCH AND DEVELOPMENT ACTIVITIES. QUALITATIVE ANALYSIS 3 TO ELIMINATE COMPANIES *COMPANIES HAVING RELATED PARTY SALES. *COMPANIES NOT DEALING IN SIMILAR PRODUCT OR HAVING SIMILAR BUSINESS AND FUNCTIONAL PROFILE. *COMPANIES HAVING MORE THAN 10 OF AVERAGE LOSS. ITA-1417 & 1373/D/2008 13 *ABNORMAL FACTORS AFFECTING PROFITABILITY. *INSUFFICIENT INFORMATION SUCH AS ABSENCE OF DIRECTORS REPORT. IN THE THIRD SEARCH THE CRITERION OF SELECTION WAS EXTENDED TO INCLUDE COMPANIES ENGAGED IN THE TRADE OF ELECTRICAL MACHINERY. TABL E NO.7 OF THIS ORDER SUMMARIZES THE SELECTION PROCESS. TABLE-7 CRITERIA NO. OF COMPANIES PASSING THE CRITERION EXPLANATION STARTING POINT 730 COMPANIES IN THE ELECTRONICS ELECTRICAL & NON-ELECTRICAL GOODS SEGMENT HAVING THE REQUISITE FINANCIAL INFORMATION. MANUFACTURING SALES TO TOTAL SALES RATIO OF <25% TO BE RETAINED. 294 TO EXCLUDE COMPANIES THOSE ARE PRIMARILY INTO MANUFACTURING. TRADING SALES TO TOTAL SALES RATIO OF >75% TO BE RETAINED 167 TO EXCLUDE COMPANIES THOSE ARE NOT PRIMARILY ENGAGED IN DISTRIBUTION/TRADING ACTIVITIES. RESEARCH & DEVELOPMENT EXPENSES TO SALES RATIO <5% TO BE RETAINED. 166 TO ELIMINATE COMPANIES UNDERTAKING SIGNIFICANT RESEARCH AND DEVELOPMENT ACTIVITIES. QUALITATIVE ANALYSIS 6 TO ELIMINATE COMPANIES *COMPANIES HAVING RELATED PARTY SALES. *COMPANIES NOT DEALING IN SIMILAR PRODUCT OR HAVING SIMILAR BUSINESS AND FUNCTIONAL PROFILE. *COMPANIES HAVING MORE THAN 10% OF AVERAGE LOSS. *INSUFFICIENT INFORMATION SUCH AS ABSENCE OF DIRECTORS REPORT. THE FINAL SET OF COMPARABLES OBTAINED BY WAY OF TH E THREE DIFFERENT SEARCHES ALONG WITH THE WEIGHTED AVERAGE OF NET PROFIT MARGI NS IS DETAILED IN TABLE NO.8 BELOW:- ITA-1417 & 1373/D/2008 14 TABLE-8 S NO. COMPANY NAME IDENTIFIED IN THE SEARCH NUMBER BUSINESS PROFILE 2000 2001 2002 WEIGHTED AVERAGE 1 AMZEL AUTOMATIVE LIMITED SEARCH 3 TRADING BUSINESS OF EXIDE CAR BATTERIES 5.37 1.13 NA 3.22 2 GOLD ROCK INVESTMENTS LTD. SEARCH 3 ENGAGED IN TRADING OF ELECTRICAL GOODS. 6.02 5.31 NA 5.59 3 K DHANDAPANI & CO. LTD. SEARCH 2 & 3 CARRIES ON DEALERSHIP IN ELECTRICAL COMPONENTS FOR SIEMENS INDIA LTD.GEC ALSTHOM & FINOTEX CABLES LTD. SUPPLIES SWITCHBOARDS SWITCHES & DISTRIBUTION BOARDS FOR INDUSTRIAL APPLICATION AND ELECTRICAL INSTALLATION CONTRACTS. 2.23 0.30 NA 1.25 4 KHAITAN (INDIA) LTD. SEARCH 3 ENGAGED IN TRADING OF FANS. ALSO TRADES IN MONOBLOC PUMPS FHP MOTORS POWER DRIVEN PUMPS & OTHER HOME APPLIANCES. 1.13 1.94 4.49 2.49 5 REDINGTON SEARCH 2 TRADING OF 2.43 2.27 NA 2.33 ITA-1417 & 1373/D/2008 15 (INDIA) LTD. & 3 COMPUTERS & PERIPHERALS. CONCENTRATING IN SMALL OFFICE HOME OFFICE SEGMENTS OF PERSONAL COMPUTERS. 6 REMI SALES & ENGG. LTD. SEARCH 3 TRADING IN FANS ELECTRIC MOTORS & SCIENTIFIC INSTRUMENTS. 3.54 3.39 NA 3.45 7 ACI INFOCOM LTD. SEARCH 1 & 2 TRADES IN FLOPPY DISK DRIVES HARD DISK DRIVES & OTHER COMPUTER EQUIPMENTS. (0.97) NA NA (0.97) TOTAL 17.36 ARITHMETIC MEAN 2.48% THE NET PROFIT MARGIN OF THE ASSESSEE ON THE BASIS OF THE WEIGHTED AVERAGE FOR THE THREE FINANCIAL YEARS 1999-2000 2000-01 & 2001-02 WORKED OUT TO 6.15% COMPUTED (TABLE-9) IN THE FOLLOWING MANNER: TABLE-9 TRADING FUNCTION (RUPEES000) PARTICULARS 31-MARCH-02 31-MAR-01 31-MAR-00 WEIGHTE D AVERAGE INCOME FROM OPERATION 9 25 934 7 13 907 4 25 271 OTHER INCOME 1 150 0 0 TOTAL OPERATING INCOME 9 27 084 7.13.907 4 25 271 20 66 262 ITA-1417 & 1373/D/2008 16 EXPENDITURE COST OF SALES 6 84 856 5 42 125 3 05 761 DIRECT SELLING EXPENSES 1 04 984 76 006 59 604 GENERAL & ADMINISTRATIVE EXPENSES 69 925 56 381 39 553 TOTAL OPERATING COST 8 59 765 6 74 512 4 04 918 19 39 195 TOTAL OPERATING PROFITS 67 319 39 395 20 353 1 27 067 NPM 7.26% 5.52% 4.79% 6.15% IT WAS CONCLUDED IN THE TP REPORT THAT THE ASSESSEE HAD EARNED NET PROFIT MARGIN OF 6.15% WHICH EXCEEDED THE ARMS LENGTH PROFIT MARGIN OF 2.48% THE OUTCOME OF NPIPLS INTERNATIONAL TRANSACTIONS SATISFIED THE AR MS LENGTH STANDARD. THE ORDER OF TPO WAS AS UNDER. T.P.OS ORDER 5. DURING THE TP PROCEEDINGS THE TPO OBSERVED THA T THE COMBINED RESULTS OF THE TWO SEGMENTS NAMELY CPD AND SPD WERE BENCHMARKED AGAINST THE MARGINS OF THE COMPARABLES. IT WAS ALSO NOTICED THAT CPD DIVISION HAD MADE AN OPERATING LOS S OF RS. 2.72 CRORES AS AGAINST AN OPERATING PROFIT OF RS. 5.79 CRORES M ADE3 BY THE SPD DIVISION. THE TPO ALSO NOTICED THAT THE SEGMENTAL A CCOUNTS OF CPD & SPD INCLUDED THE SUM OF RS 15.3 CRORES AS REIMBURSE MENTS RECEIVED FROM ASSOCIATED ENTERPRISES FOR CERTAIN AD VERTISING EXPENSES INCURRED BY THE APPELLANT. REMOVING THE REIMBURSEME NT AS OPERATING INCOME THE CPD WOULD MAKE AN OPERATING LOSS OF RS 16.59 CRORES AND THE SPD AN OPERATING PROFIT OF RS. 4.35 CRORES. AN OPPORTUNITY WAS GIVEN BY THE TPO TO THE APPELLANT TO EXPLAIN AS TO WHY THE OPERATING MARGINS OF THE TWO DIVISIONS CPD & SPD SHOULD NOT B E RECOMPUTED BY EXCLUDING THE ADVERTISEMENT REIMBURSEMENT. IN RESPO NSE TO THE QUERY THE APPELLANT SUBMITTED THAT THE REIMBURSED AMOUNT WAS EXCLUSIVELY ITA-1417 & 1373/D/2008 17 SPENT ON MEETING ADVERTISING AND MARKETING EXPENSES AND THEREFORE THAT SHOULD BE TREATED AS OPERATING INCOME. FURTHER WHI LE EXAMINING THE SEGMENTAL ACCOUNTS THE TPO OBSERVED THAT MOST OF T HE GOODS IN SPD WERE IMPORTED FROM THE A.ES AS AGAINST ONLY 5% IN T HE CPD. THE CONCLUSIONS DRAWN BY THE TPO IN THESE REGARDS ARE D ISCUSSED IN THE SUBSEQUENT SUB-PARAS. A. AGGREGATION OF CPD & SPD DIVISIONS 5.1 ACCORDING TO THE TPO THE AGGREGATION OF THE RE SULTS OF THE TWO DIVISIONS WAS NOT APPROPRIATE. FACTS DO NOT SUPPORT THE CONTENTION THAT THE CPD AND SPD ARE SO CLOSELY INTERLINKED THAT NO SEPARATE EVALUATION IS POSSIBLE. THIS FACT IS EVIDENT FROM THE SEGMENTA L ACCOUNTS PREPARED BY THE APPELLANT ITSELF. AS TRANSACTIONS BETWEEN THE A PPELLANT AND THE RELATED PARTIES CONSTITUTE ONLY 5% OF THE TOTAL TRA NSACTIONS OF CPD DIVISION IT WOULD BE FAIR TO ANALYZE THE TRANSACTI ON OF THE APPELLANT WITH THE AE AS CPD IMPORTED SEPARATELY. THE TPO CITED THE FOLLOWING REASONS FOR COMING TO THE CONCLUSION THAT CPD (LOCA L) CPD (IMPORTED) & SPD DIVISIONS HAVE TO BE EVALUATED SEPARATELY: I. THOUGH RULE 10A OF THE RULES CLARIFIES THAT TRANSA CTION INCLUDES A NUMBER OF CLOSELY LINKED TRANSACTIONS THE TRANSACT IONS N THE TWO DIVISIONS CPD & SPD ARE NOT CLOSELY LINKED. II. TRADING OF CONSUMER GOODS LIKE TV SETS WASHING MAC HINES AND CAMERAS CANNOT BE SAID TO BE CLOSELY INTERLINKED OR INTEGRATED WITH THE TRADING OF OFFICE AUTOMATION AND TELECOM PRODUCTS. III. THE MARKETING STRATEGY AND THE TARGET CONSUMER GROU P DIFFER WIDELY FOR THE TWO SEGMENTS. THE DYNAMICS OF THE TWO SEGMENTS ARE VASTLY DISSIMILAR. IV. THE DIFFERENCE IN GROSS MARGINS BETWEEN THE SPD (26 %) AND CPD (19%) SEGMENTS REFLECTS THE DISTINCTIONS. V. THE RATIO OF SELLING EXPENSES TO NET SALES FOR CPD IS 18.63% AS AGAINST 14% FOR SPD. VI. IT IS INAPPROPRIATE TO SAY THAT IMPORT OF CONSUMER GOODS IS CLOSELY INTERLINKED WITH IMPORT OF OFFICE PRODUCTS. VII. THE VERY PURPOSE OF TRANSFER PRICING ANALYSIS IS TO SEGREGATE CONTROLLED TRANSACTIONS FROM UNCONTROLLED TRANSACTIONS AND THE N TO EVALUATE THE ITA-1417 & 1373/D/2008 18 CONTROLLED TRANSACTIONS SEPARATELY. THUS AGGREGATI ON OF UNRELATED AND RELATED PARTY TRANSACTIONS WOULD DISTORT THE EVALUA TION PROCESS. CPD WITH VERY INSIGNIFICANT PROPORTION OF RELATED PARTY TRANSACTIONS CANNOT BE AGGREGATED WITH SPD. VIII. IF AGGREGATION OF RESULTS IS DONE FOR THE TWO DIVIS IONS CPD & SPD THEN THE NET LOSSES FROM THE CONTROLLED TRANSACTIONS COU LD BE JUSTIFIED THROUGH PROFITS FROM ANOTHER SET OF CONTROLLED TRANSACTIONS THEREBY MAKING THE ANALYSIS MEANINGLESS. C. REDRAWING OF SEGMENTAL ACCOUNTS 5.3 THE TPO HAD REDRAWN THE SEGMENTAL ACCOUNTS PER TAINING TO CPD (IMPORTED GOODS) AND SPD IN THE LIGHT OF HIS FINDINGS DISCUSSED IN THE PRECEDING PARAS AND FOLLOWING THE METHODOLOG Y DETAILED BELOW: A) THE GROSS PROFITS OF CPD (IMPORTED) CPD (LOCAL) AN D SPD HAVE BEEN TAKEN STRAIGHT FROM THE ACCOUNTS WITHOUT ANY ALLOCA TION AS FURNISHED BY THE APPELLANT; B) THE MARKETING ASSISTANCE RECEIVED BY THE ASSESSEE F ROM ITS AES HAS BEEN EXCLUDED FROM OTHER OPERATING INCOME; C) THE EXPENSES PERTAINING TO MARKETING OF IMPORTED GO ODS (RS. 70.5 LACS) HAS BEEN IDENTIFIED BY THE ASSESSEE FROM ITS BOOKS AND RECORDS; THIS HAS BEEN BOOKED UNDER CPD (IMPORTS); D) THE REMAINING OPERATING EXPENSES (WITHOUT INTEREST AND FINANCE EXPENSES) HAVE BEEN ALLOCATED IN PROPORTION OF SALE S OF CPD (IMPORTED) TO TOTAL SALES OF CPD; THIS WORKS OUT TO 4.76%; E) THE ALLOCATION OF ADMN. EXPENSES HAVE BEEN MADE IN PROPORTION TO SALES BETWEEN CPD AND SPD; WITHIN CPD 4.76% HAS BEEN ATTR IBUTED TO IMPORTED GOODS SEGMENT; F) THE OPERATING PROFIT/LOSS MARGINS HAVE BEEN WORKED OUT AFTER DEDUCTING THE OPERATING EXPENDITURE FROM OPERATING REVENUES. THE CORRECT OPERATING PROFIT IN RESPECT OF EACH DIV ISION (TABLE-13) AS PER THE TPOS ORDER IS REPRODUCED BELOW: TABLE-13 ITA-1417 & 1373/D/2008 19 CPD (ONLY IMPORTED FROM AES) (RS.) SPD (RS.) NET SALES 132 982 473 777 133 469 OTHER OPERATING INCOME 179 443 1 301 080 TOTAL OPERATING REVENUES 133 161 916 778 434 549 COST OF GOODS SOLD 104 476 649 575393430 ADVT. EXPENSES 7 054 248 21 975 346 SELLING EXPENSES (OTHER THAN ADVT.) 20 395 201 93 538 482 OTHER OPERATING EXPENSES 7 005 786 30 731 073 ADMINISTRATION EXPENSES 2 172 687 12 874 141 TOTAL OPERATING EXPENSES 141 102 571 734 512 472 OPERATING PROFIT (OP) (-)7940655 43 922 077 OPERATING PROFIT MARGIN ON SALES (OP/SALES) (-)5.97% 5.65% D. COMPUTING OF ARMS LENGTH PRICE 5.4 ON THE BASIS OF REDRAWN SEGMENTAL ACCOUNTS THE TPO HAD DRAWN THE FOLLOWING CONCLUSIONS RELATING TO TRANSFE R PRICE ADJUSTMENTS TO BE MADE IN THE RESPECT OF EACH OF THE DIVISIONS: I. NO TP ADJUSTMENT WAS PROPOSED IN THE RESPECT OF SPD AS THE OPERATING PROFIT MARGIN OF SPD (5.65%) WAS MORE THAN THE ARM S LENGTH MARGIN OF 2.48% THE THREE-YEAR WEIGHTED AVERAGE NET PROFIT M ARGIN OF THE COMPARABLES. II. IN RESPECT OF CPD (IMPORTED GOODS) SEGMENT T HE LOSS MARGIN OF (-)5.97% WAS FOUND TO BE BELOW THE ARMS LENGTH MAR GIN OF 2.48%. ACCORDINGLY IT WAS HELD THAT THE APPELLANT AND OVE RPAID FOR THE IMPORTED GOODS TO ITS ASSOCIATED ENTERPRISES TO THE EXTENT OF RS. 1 12 37 019/-. THIS AMOUNT WAS CALCULATED BY MULTIP LYING THE NET SALES VALUE OF THE DIVISION OF RS. 132 982 473/- WITH 8.4 5% BEING THE DIFFERENCE BETWEEN THE ARMS LENGTH MARGIN OF 2.48% AND LOSS MARGIN OF 5.97% REALIZED IN THIS SEGMENT BY THE APPELLANT. ITA-1417 & 1373/D/2008 20 III. THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSAC TION RELATING TO THE IMPORT OF FINISHED PRODUCTS FROM THE A.E. WAS COMPU TED AT RS. 6 34 67 565/- AS THE DIFFERENCE BETWEEN THE BOOK VA LUE OF THE TRANSACTION OF RS. 7 47 04 584/- AND THE TP ADJUSTM ENT OF RS. 1 12 37 019/-. THE BENEFIT OF +-5% UNDER THE PROVISO TO SECTION 92 C(2) OF THE ACT WAS NOT ALLOWED TO THE APPELLANT AS THE TP ADJUSTMENT OF RS . 1 12 37 019/- WAS MORE THAN +5% VARIATIONS FROM THE ALP ALLOWED UNDER THE LAW F OR A PURCHASE TRANSACTION. 4 . ASSESSEES SUBMISSIONS BEFORE THE CIT(A) WERE SUMM ARIZED BY THE CIT(A) IN HIS ORDER AS UNDER: 7. DURING THE APPELLATE PROCEEDINGS THE FOLLOWING SUBMISSIONS WERE MADE IN SUPPORT OF THE GROUNDS OF APPEAL NO. 9 TO 9 .2: I. THE APPELLANT HAD RAISED OBJECTIONS AND POINTED OUT SERIOUS LAPSES AND SHORTCOMINGS IN THE ORDER PASSED BY THE TPO U/S 92C A(3) OF THE I.T. ACT. IT WAS INTER ALIA HIGHLIGHTED THAT THE COMPARI SONS OF PROFITS MADE BY THE TPO BY SPLITTING THE ACTIVITIES OF THE APPELLAN T WERE UNREALISTIC AND NON-COMPARABLE. HOWEVER HE HAD COMPLETELY IGNORED ALL SUCH SUBMISSIONS AND MADE ADDITIONS AS PER ORDER OF TPO U/S 92CA(3) OF THE I.T. ACT. II. IN THE TP REPORT FILED BY THE APPELLANT COMPARABLE S WERE CHOSEN AFTER AN EXTENSIVE EXERCISE AND MANY ATTEMPTS WERE MADE T O FIND THE COMPARABLES. AFTER ALL THESE EFFORTS A NET PROFIT OF 2.48% WAS ADOPTED AS THE ARMS LENGTH MARGIN FOR BENCHMARKING THE TRA DING ACTIVITY OF THE APPELLANT. III. THE TPO ON THE CONTRARY HAD BIFURCATING THE TRADING ACTIVITY OF THE ASSESSEE INTO TWO SEPARATE DIVISIONS OF CPD & SPD A S AGAINST THE CONSOLIDATED TRADING ACTIVITY REPORTED AND COMPARED BY THE APPELLANT IN ITS TPO ANALYSIS REPORT. IV. THE TPO HAD GIVEN MANY REASONS FOR BIFURCATING THE ACTIVITY OF THE ASSESSEE INTO TWO DIFFERENT DIVISIONS BUT SAFELY AS SUMED THE CONSOLIDATED PROFIT MARGIN OF 2.48% OF THE COMPARAB LES AS THE COMMON NET MARGIN INDICATOR AS WAS REPORTED BY THE ASSESSE E IN ITS TP ANALYSIS ITA-1417 & 1373/D/2008 21 REPORT. ALTERNATIVELY HE SHOULD HAVE FOUND OUT COM PARABLES AND ADOPTED A LOWER MARGIN FOR THE CPD DIVISION OF THE ASSESSEE. V. THE TPO HAD SIMPLY REWORKED THE FINANCIALS OF THE A SSESSEE WITH REGARD TO CERTAIN ITEMS WITHOUT MAKING ANY CORRESPONDING A DJUSTMENTS IN THE PLI OF THE COMPARABLE CASES OR WITHOUT FINDING ANY FURTHER COMPARABLE DATA. THE APPROACH ADOPTED BY THE TPO IS ARBITRARY AND NOT AS PER THE PRESCRIBED RULE 10B OF THE RULES AND NEEDS TO BE RE JECTED. THE ORDER OF TPO THUS ON THIS SCORE IS DEFECTIVE AND NEEDS TO BE MODIFIED AND THE ADDITION OF RS. 1 12 37 019/- BE DELETED. VI. IN FACT IF TRANSACTIONS OF BOTH THE DIVISIONS HAVI NG INTERNATIONAL TRANSACTIONS AS FOUND OUT BY THE TPO IN HIS ORDER A RE CONSOLIDATED AS ONE TRADING ACTIVITY (APART FROM AND WITHOUT PREJUD ICE TO SOME ADJUSTMENTS WHICH HE HAS MADE ON WHICH OUR OBJECTIO NS ARE CONTAINED IN THE PARAGRAPHS HEREIN BELOW) THE NET MARGIN & A LP WILL BE DETERMINED AS UNDER; CONSOLIDATED SUMMARISED POSITION NET SALES 910 115 942 OTHER OPERATING INCOME 1 480 523 TOTAL OPERATING RESERVES 911 596 465 COST OF GOODS SOLD 679 868 079 ADV. EXP 29 029 594 SELLING EXP. (OTHER THAN ADV.) 113 933 683 O THER OPERATING EXPENSE 37 736 859 ADMINISTRATION EXP. 15 046 828 TOTAL OPERATING EXP. 875 615 043 OPERATING PROFIT 35 981 422 OPERATING PROFIT MARGIN ON SALES 3.95 % ITA-1417 & 1373/D/2008 22 (VII) THE CONSOLIDATED NET PROFIT MARGIN OF 3.95% COMPUTE D ABOVE EXCEEDS THE ARMS LENGTH MARGIN OF 2.48% AND THEREFORE ASS ESSEES INTERNATIONAL TRANSACTIONS SHOULD HAVE BEEN CONCLUDED TO BE AT AR MS LENGTH. (VIII) THE TPO HAS SUBSTANTIALLY REDUCED THE OTHER OPERATI NG INCOME BY EXCLUDING THE ADVERTISEMENT ASSISTANCE RECEIVED BY THE ASSESSEE FROM ITS AES ON THE GROUNDS THAT SUCH FINANCIAL ASSISTANCE DO NOT FORM PART OF OPERATIONS OF THE ASSESSEE. SUCH AN APPROACH OF TH E TPO IS ARBITRARY AND BASED ON WRONG ASSUMPTIONS. (IX) THE FINANCIAL ASSISTANCE RECEIVED IS EITHER TO BE A DDED TO OPERATING INCOME OR THE EXPENSES OF THE ASSESSEE ON ADVERTISE MENT SELLING EXPENSES HAVE GOT TO BE REDUCED FOR THE SIMILAR AMO UNT. EITHER WAY SUCH RECEIPT BEING OF REVENUE NATURE AS HAS BEEN H ELD BY THE TAX AUTHORITIES IN EARLIER YEARS HAS TO BE ACCOUNTED F OR. THIS RECEIPT CANNOT BE LEFT OUT OF COMPUTATION. (X) THE TPO HAS CONCLUDED AND RECOMMENDED AN ADDITION O F RS.1 12 37 019/- IN THE TRADING ACTIVITY OF THE ASS ESSEE AS ACCORDING TO HIM THE ASSESSEE HAS OVERPAID ON THE IMPORTED GOODS IN THE CPD DIVISION @ 8.45% OF THE SALES. IN ABSENCE OF ANY E VIDENCE SUCH AN ALLEGATION THAT ASSESSEE HAS OVERPAID IS HIGHLY UNR EASONABLE BASED ON SURMISES WHICH DO NOT HOLD WELL ON THE FACTS OF THE ASSESSEES CASE. (XI) THE TPO HAD CALLED FOR EXHAUSTIVE INFORMATION INCL UDING THE PRICE PAID BY THE ASSESSEE TOWARDS THE LOCAL PURCHASES. A COM PLETE LIST OF PURCHASES OF THE SAME/IDENTICAL ITEMS WHICH WERE IM PORTED WAS FURNISHED ALONG WITH THE PURCHASE COST. IT WAS ALS O EXPLAINED THAT THE ITA-1417 & 1373/D/2008 23 PRICE PAID FOR THE IMPORTED GOODS WERE VERY COMPETI TIVE AND IN NO CASE HIGHER THAN THAT PAID TO THE LOCAL SELLERS INCLUDIN G THE UNRELATED PARTIES. (XII) THE ASSESSEE HAD SUBMITTED BEFORE THE TPO THAT CUST OM DUTY WAS PAID ON ALL THE IMPORTS. IN FACT THE CUSTOMS DEPARTMEN T HAD CHARGED THE ASSESSEE WITH UNDER INVOICING THE GOODS BUT LATER O N SVB (SPECIAL VALUATION BENCH) CLEARED THE ASSESSEE OF SUCH CHARG ES AND ORDERED REFUND OF THE DUTY CHARGED. HENCE ANY ALLEGATION BY THE TAX AUTHORITIES THAT ASSESSEE HAD OVERPAID FOR ITS IMPORTED GOODS I S UNCALLED FOR AND CONTRARY TO THE FINDINGS OF CUSTOMS DEPARTMENT OF T HE GOVERNMENT OF INDIA. (XIII) IT WAS EXPLAINED TO THE TPO THAT THE ISD DIVISION O F THE ASSESSEE WAS A SELF-CONTAINED INDEPENDENT DIVISION EXPLORING THE P OSSIBILITY OF EARNING HIGHER COMMISSION FROM AGENCY SERVICES. IN FACT I N THE INITIAL YEARS ASSESSEE HAD MADE PROFITS BUT IN THE YEAR UNDER CON SIDERATION DID NOT GET THROUGH ENOUGH COMMISSION INCOME WHICH RESULTED IN LOWER INCOME. (XIV) THE TPO HAS TOTALLY MISDIRECTED HIMSELF IN NOT APPR ECIATING THAT FIXED EXPENSES/ESTABLISHMENT EXPENSES CANNOT BE VARIED ON DAY TO DAY BASIS. THE ASSESSEE HAD TO INCUR FIXED EXPENSES AS IN THE EARLIER YEARS BUT THE DECLINE IN THE VARIABLE REVENUE RESULTED IN LOWER N ET MARGIN DURING THE YEAR UNDER CONSIDERATION. (XV) WITHOUT PREJUDICE THE FURTHER ALLOCATION OF UNALLO CATED EXPENSES ARE WHOLLY UNJUSTIFIED AS ALL THE EXPENSES SUCH AS REN T SALARIES TRAVELING ETC. WERE ALREADY FULLY ALLOCATED TO THE ISD DIVISI ON. THE UNALLOCATED EXPENSES WERE EXPLAINED TO BE PERTAINING TO THE TRA DING ACTIVITY OF THE ASSESSEE AND THE SAME WERE REQUIRED TO BE ALLOCATED TO TRADING ACTIVITY ITA-1417 & 1373/D/2008 24 ONLY. ACCORDINGLY THE TPO HAS MISDIRECTED HIMSELF IN ALLOCATING THE EXPENSES NONE OF WHICH PERTAINED TO ISD DIVISION. (XVI) THUS A CUMULATIVE READING OF ALL THE AFORESAID FAC TS AND LEGAL SUBMISSIONS MADE HEREIN ABOVE IT WOULD BE APPRECIA TED THAT THE TP ADJUSTMENT OF RS.1 15 66 144/- MADE BY THE AO/TPO I N RESPECT OF THE ISD HAS NO LEGAL BASIS TO STAND UPON AND THE SAME I S REQUIRED TO BE DELETED. 5 . THE CIT(A) THEN CONSIDERED THE REMAND REPORT RECEI VED FROM THE TPO AND THE ASSESSEES OBJECTION TO BIFURCATION OF ITS INTE RNATIONAL TRANSACTIONS INTO CPD AND SPD DIVISIONS. THE ASSESSEE THEN GAVE A REJOIND ER TO THE TPOS REMAND REPORT APART FROM OTHER ISSUES THE ASSESSEE RAISE D THE ISSUE THAT EVEN IF THE BIFURCATION IS ACCEPTED AS STATED BY THE TPO THEN FURTHER ADJUSTMENT IS REQUIRED TO BE MADE IN THE COMPARABLES TO TEST THE PLI OF TH E TESTED PARTY I.E. THE ASSESSEE. THIS IS GIVEN AT PAGE 25 (XIII) (XIV) (XV) AND (X VI) OF THE CIT(A)S ORDER AS UNDER:- (XIII) THE FOLLOWING ADDITIONAL RISK FACTORS IDENT IFIED BY THE TPO TO JUSTIFY THE BIFURCATION OF ASSESSEES TRADING ACTIV ITY INTO CPD & SPD IN PARA 7 OF HIS ORDER BUT HAD CHOSEN NOT TO MADE ANY ADJUSTMENT TO THE PROFIT LEVEL INDICATORS OF THE COMPARABLES. A) THE MARKETING STRATEGY AND TARGET CONSUMER GROUP DI FFER WIDELY FOR THE TWO SEGMENTS. B) THE DYNAMICS OF THE TWO SEGMENTS ARE VASTLY DISSIMI LAR. C) THE DIFFERENCE IN GROSS MARGINS BETWEEN SPD (26%) A ND CPD (19%) SEGMENT SHOWS THE DIFFERENTIATION IN THIS RES PECT. D) THE RATIO OF SELLING EXPENSES TO NET SALES FOR CPD IS 18.63% AS AGAINST 14% FOR SPD. ITA-1417 & 1373/D/2008 25 (XIV) IF THE ADJUSTMENTS ARE MADE TO THE PROFIT LEVEL IND ICATOR OF 2.48% OF THE COMPARABLES ONLY FOR (C) & (D) ABOVE THE PROFIT O F CPD WILL WORK OUT TO BE AS UNDER: - PROFIT LEVEL INDICATOR - 2.48% - UNRELATED COMPARABLE. - ADJUSTMENT FOR G.P. (-) 7.00% - ADJUSTMENT FOR SELLING EXPENSES (-) 4.63% -------------- ----------- COMPARABLE PROFIT LEVEL (-) 9.15% INDICATOR OF CPD ======= (XV) THE PROFIT DETERMINED BY THE TPO OF (-) 5.97% IS WE LL ABOVE THE ADJUSTED PLI OF CPD FOR THE COMPARABLES AT (-) 9.15 % AND THEREFORE THE TRANSACTIONS OF THE ASSESSEE COULD ONLY BE CONCLUDE D TO BE AT ARMS LENGTH. 6 . CIT(A) FINALLY ADJUDICATED ON THE SAID ISSUE AT PA GES 32 33 AND 34 IN PARAS 9.3 9.3.1 9.3.2 9.3.3 AND 9.3.4 WHEREIN HE HELD . 9.3 THERE IS NO DISPUTE BETWEEN THE APPELLANT AND THE TPO/AO REGARDING USING TNMM AS THE MOST APPROPRIATE METHOD (MAM) THE USE OF NET PROFIT MARGIN ON SALES AS THE PLI FOR TH E TRADING FUNCTION AND THE USE OF THE APPELLANT AS THE TESTED PARTY. T HEREFORE THESE ISSUES ARE NOT DISCUSSED IN THIS ORDER. 9.3.1 THE FIRST BONE OF CONTENTION BETWEEN THE APPE LLANT AND THE TPO/AO RELATES TO THE USE OF AGGREGATE VERSUS SEGME NTAL DATA ACROSS THE TWO DIVISIONS CPD & SPD. 9.3.2 PARA 1.42 OF THE OECD GUIDELINES DEALS WITH T HE ISSUE OF EVALUATION OF SEPARATE AND COMBINED TRANSACTIONS. T HE RELEVANT EXTRACT UNDERLYING THE BASIC PRINCIPLE IS REPRODUCED BELOW: ITA-1417 & 1373/D/2008 26 1.42 IDEALLY IN ORDER TO ARRIVE AT THE MOST PREC ISE APPROXIMATION OF FAIR MARKET VALUE THE ARMS LENGTH PRINCIPLE SHOUL D BE APPLIED ON A TRANSACTION BY TRANSACTION BASIS. HOWEVER THER E ARE OFTEN SITUATIONS WHERE SEPARATE TRANSACTIONS ARE SO CLOSE LY LINKED OR CONTINUOUS THAT THEY CANNOT BE EVALUATED ADEQUATELY ON A SEPARATE BASIS. FOLLOWING THIS PRINCIPLE WHETHER AGGREGATION OF TH E TRANSACTIONS IS TO BE DONE OR NOT WOULD DEPEND ON THE VERY NATURE OF T HE TRANSACTIONS. 9.3.3 IN THE PRESENT CASE THE APPELLANT HAS COMBIN ED ALL THE TRANSACTIONS RELATING TO THE TRADING FUNCTIONS ACRO SS THE TWO DIVISIONS CPD & SPD. THE REASON FOR AGGREGATING THESE TRANSAC TIONS HAS BEEN CITED AS THE INTEGRATED BUSINESS MODEL UNDER WHICH SIMILAR TRADING FUNCTION IS DISCHARGED THROUGH BOTH THE DIVISIONS. THE TPO HOWEVER RECORDED A FINDING THAT AGGREGATION OF THE RESULTS OF THE TWO DIVISIONS WOULD RENDER THE TRANSFER PRICING ANALYSIS MEANINGL ESS AS THE LOSSES FROM ONE SET OF INTERNATIONAL TRANSACTION WERE SOUG HT TO BE JUSTIFIED THROUGH PROFITS FROM ANOTHER SET OF INTERNATIONAL T RANSACTIONS. FOR COMING TO THIS CONCLUSION THE TPO HAD CITED A NUMB ER OF REASONS ARE SUMMARIZED IN PARA 5.1 AND 7.1 OF THIS ORDER. I AM IN AGREEMENT WITH THE FINDING OF THE TPO REGARDING THE NECESSITY FOR SEPARATELY ANALYZING THE RESULTS OF THE CPD AND SPD FOR THE REASONS CITE D BY HIM IN THE TP ORDER. THE FOLLOWING ARE THE ADDITIONAL REASONS FOR CONCURRING WITH THE FINDING OF THE TPO IN RESPECT OF SEGREGATION OF DIV ISION-WISE DATA: (I) THE AUDITOR OF THE APPELLANT CATEGORICALLY MADE SEG MENTAL REPORTING IN NOTE 15 TO THE NOTES TO THE ACCOUNTS. THE BIFURCATI ON OF THE TWO DIVISIONS CPD & SPD WITHIN THE TRADING FUNCTION WAS MADE ON THE BASIS OF CUSTOMERS AND PRODUCT LINES BY FOLLOWING T HE ICAI GUIDELINES. (II) THE CPD SECTION HAD BOTH LOCAL AND IMPORTED SUB-SEG MENTS. SINCE RELATED PARTY TRANSACTIONS OF CPD DIVISION CONSTITU TED ONLY 5% OF TOTAL TRANSACTION OF THE CPD DIVISION FURTHER BIFURCATIO N OF CPD INTO CPD (LOCAL) & CPD (IMPORTED) LENT MORE CREDIBILITY TO T HE BENCHMARKING ANALYSIS (III) THE DYNAMICS OF THE TWO DIVISIONS CPD & SPD ARE VAS TLY DISSIMILAR AS THE DRIVERS OF CONSUMER PRODUCTS AND OFFICE AUTO MATION PRODUCTS ARE VERY DIFFERENT. THE CONSUMER DURABLES LIKE THE PRODUCTS HANDLED BY THE SPD HAVE DIFFERENT TARGET CUSTOMERS GROWTH POTENTIAL AND FOLLOW DIFFERENT STRATEGIES. ITA-1417 & 1373/D/2008 27 (IV) TWO OR MORE OPERATING SEGMENTS CAN BE AGGREGATED ON LY IF THE SEGMENTS HAVE THE SAME CHARACTERISTICS IN EACH OF T HE FOLLOWING AREAS: THE NATURE OF THE PRODUCTS AND SERVICES PROVIDED THE NATURE OF THE PRODUCTION PROCESS THE TYPE OR CLASS OF CUSTOMER THE METHODS OF PRODUCT OR SERVICE DISTRIBUTION IF APPLICABLE THE NATURE OF THE REGULATORY ENVIRON MENT CPD AND SPD DO NOT SHARE THE SAME BASIC CHARACTERIS TICS IN EACH OF THESE AREAS EVEN IF THEY SHARE SOME CHARACTERISTIC S IN SOME OF THESE AREAS. (V) THE APPELLANT ITSELF HAS ADMITTED THE DISTINGUISHIN G FEATURES OF THE TWO DIVISIONS [REFER PARA 7.2(V) OF THIS ORDER]. THE SPD PRODUCT LINE IS CHARACTERIZED BY HIGH TECHNOLOGY AND SUPPORTED BY P ROPRIETARY INTELLECTUAL PROPERTY AND THEREFORE THAT SEGMENT I S UNIQUE AND HIGH QUALITY FEATURE DRIVEN. ON THE OTHER HAND CPD PROD UCT LINE IS YET TO CREATE ITS MARKET PRESENCE. (VI) THE SPIRIT OF TRANSFER PRICING ANALYSIS UNDER THE T NMM METHOD BY CHOOSING A SET OF NARROWLY DEFINED TRANSACTIONS IS SATISFIED IN TERMS OF RULE 10B(1)(E)(I) ONLY WHEN THE AGGREGATION IS DONE OF VERY SIMILAR TRANSACTIONS. CPD (LOCAL) CPS (IMPORTED) & SPD ARE WELL DEFINED DIVISIONS IN THE SPIRIT OF TNMM FOR THE PURPOSE OF AGGREGATION BUT THE TRANSACTIONS ACROSS SEGMENTS CANNOT BE AGGREGATED D UE TO THEIR DIVERSE CHARACTERISTICS. THE TRADING FUNCTION OF THE TWO DI VISIONS OF CPD & SPD BROADLY MAY BE THE SAME BUT THE VALUE DRIVERS A RE DIFFERENT. 9.3.4. IN VIEW OF THE FOREGOING ANALYSIS I AM O F THE CONSIDERED VIEW THAT THE THREE CLASSES OF TRANSACTIONS UNDERTAKEN BY THE APPELLANT WITH ITS AES CANNOT BE AGGREGATED FOR THE PURPOSE OF BEN CHMARKING ANALYSIS. DUE TO THE DISTINCT DIFFERENCES BETWEEN T HE DYNAMICS OF THE TWO DIVISIONS THE MAIN RULE AND NOT THE EXCEPTIO N ENUNCIATED IN PARA 1.42 OF THE OECD GUIDELINES IS APPLICABLE TO THE FA CTS OF THIS CASE. THE TRANSACTIONS OF THE TWO DIVISIONS CANNOT BE SAI D TO BE CLOSELY INTERLINKED. 7. BEFORE THE TRIBUNAL FOLLOWING GROUNDS HAVE BEEN TAKEN BY THE ASSESSEE. I.T.A. NO.1417/D/08- APPEAL OF THE ASSESSEE: ITA-1417 & 1373/D/2008 28 1. THAT THE LEARNED CIT(A) HAS GROSSLY ERRED IN LAW AN D ON THE FACTS AND IN THE CIRCUMSTANCES OF THE APPELLANTS C ASE IN HOLDING THAT THE SEGREGATION OF TRADING FUNCTIONS P ERTAINING TO THE CPD AND SPD DIVISIONS OF THE ASSESSEE WERE PROP ERLY DONE BY TPO ALTHOUGH: I) FUNCTION PERFORMED RISK ASSUMED AND ASSETS EMPLOYE D BY BOTH THE DIVISIONS WERE IDENTICAL. II) METHOD EMPLOYED FOR DETERMINING THE ARMS LENGTH I. E. TNMM WAS PROPER. III) THE PLI OF THE COMPARABLES WAS RIGHT. 2. THAT THE ORDER PASSED BY THE CIT(A) IS BAD IN LAW A ND ON THE FACTS AND IN THE CIRCUMSTANCES OF THE APPELLANTS C ASE ON THE ASPECT OF TRANSFER PRICING IN WHICH ADDITION OF `1 98 40 745/- HAS BEEN CONFIRMED BY CIT(A) U/S 92CA(3) OF THE INC OME-TAX ACT. 3. THAT THE CIT(A) HAS GROSSLY ERRED IN HOLDING THAT S EGREGATION OF CPD AND SPD DIVISION OF THE ASSESSEE WHICH ARE TWO TRADING DIVISIONS WAS PROPER MERELY ON THE GROUND THAT /THE TARGET CUSTOMERS OF THESE TWO DIVISIONS WERE DIFFER ENT. 4. THE CIT(A) OUGHT TO HAVE HELD THAT UNDER THE TNMM M ETHOD IT IS THE BROAD FUNCTIONS WHICH ARE REQUIRED TO BE COMPARED AND IF MOST OF THE FUNCTIONS PERFORMED BY THE ASSES SEE AND THE COMPARABLE CASES ARE IDENTICAL THE SAME CANNOT BE REJECTED ON AN ISOLATED REASON THAT THE TARGET CUSTOMERS AND PRODUCT LINES OF CPD AND SPD ARE DIFFERENT. 5. THE CIT(A) HAS GROSSLY ERRED IN LAW IN MIS-INTERPRE TING THE OECD GUIDELINES PERTAINING TO AGGREGATION VS. SEGRE GATION OF THE FUNCTIONS. 6. THE CIT(A) HAS GROSSLY ERRED ON THE FACTS OF THE AP PELLANTS CASE IN HOLDING THAT THERE EXIST A DISTINCT DIFFERE NCE BETWEEN THE DYNAMICS OF THE TWO DIVISIONS OF THE ASSESSEE I .E. CPD AND SPD. 7. THE CIT(A) OUGHT TO HAVE HELD THAT ONCE HAVING ACCE PTED THE TNMM METHOD HAVING ACCEPTED THE COMPARABLES AND TH E ITA-1417 & 1373/D/2008 29 PLI OF THE COMPARABLE THE CIT(A) SHOULD NOT HAVE R EJECTED ASSESSEES TRADING FUNCTIONS ON MERELY CONJECTURES SURMISES AND ERRONEOUS CONSIDERATIONS. 8. THE ORDER OF THE CIT(A) IS FULL OF CONTRADICTIONS I NASMUCH AS THAT ON THE ONE HAND HE HAS ACCEPTED THE COMPARABLE S FOUND BY THE ASSESSEE IN ITS TRANSFER PRICING STUDY AND O N THE OTHER HAND HE HAS PARTIALLY REJECTED THE SAME WHEN IT COM ES TO AGGREGATION AND SEGREGATION OF THE TWO TRADING DIVI SIONS OF THE ASSESSEE. 9. THE CIT(A) HAS GROSSLY ERRED IN HOLDING THAT APPELL ANTS RELIANCE ON THE SPECIAL VALUATION CELL OF THE CUSTO MS DEPARTMENT WAS NOT PROPER AND HE HAS FURTHER ERRED IN REJECTING THE SAME. 10. THE CIT(A) HAS ERRED ON LAW AND ON THE FACTS OF THE CIRCUMSTANCES IN THE APPELLANTS CASE IN CONFIRMING THE VIEW OF THE ASSESSING OFFICER/TPO FOR TREATING THE REIMB URSEMENT OF ADVERTISEMENT EXPENSES BY ASSESSEES AE AS A NON - OPERATING REVENUE RECEIPT. 11. THE CIT(A) HAS GROSSLY ERRED IN HOLDING THAT THE REIMBURSEMENT OF EXPENSES CANNOT BE CONSIDERED EITH ER AS A REVENUE RECEIPT OR IN HOLDING THAT THE SAME ARE NOT TO BE NETTED OFF AGAINST THE EXPENDITURE INCURRED ON TH E ADVERTISEMENT BY THE ASSESSEE. 12. THAT THE CIT(A) HAS FAILED TO TAKE A HOLISTIC VIEW OF THE MATTER PERTAINING TO THE REIMBURSEMENT OF ADVERTISE MENT EXPENSES INASMUCH AS THAT THE PURE REIMBURSEMENT CO ULD NOT FALL WITHIN THE PURVIEW OF TRANSFER PRICING. 13. THE CIT(A) HAS GROSSLY ERRED IN LAW AND ON THE FACT S OF THE APPELLANTS CASE IN NOT ENTERTAINING THE PLEAS OF T HE ASSESSEE FOR ALLOWING AN ADJUSTMENT ON ACCOUNT OF HUGE ADVER TISEMENT COST INCURRED BY THE ASSESSEE WHEREAS THE COMPARABL E CASES HAD NOT INCURRED THE SIMILAR AMOUNT OF ADVERTISEMEN T COSTS FOR DETERMINING THE NPM. 14. THE CIT(A) HAS GROSSLY ERRED IN HOLDING THAT ALLOCA TION OF THE UNALLOCATED EXPENSES AND INCOME TO THE ISD DIVISION OF THE ASSESSEE WAS PROPER BY THE TPO. ITA-1417 & 1373/D/2008 30 15. THAT THE AFORESAID GROUNDS OF APPEAL ARE WITHOUT PR EJUDICE TO ONE ANOTHER. 8. RIVAL CONTENTIONS HAVE BEEN CONSIDERED IN THE LI GHT OF JUDICIAL PRONOUNCEMENTS CITED AT BAR BY LD AR AND DR. GROUND NO. 1 TO 8 DEALS WITH THE CONTROVERSIAL ISSUE OF SEGREGATION VS. AGGREGATION WITH REGARD TO THE CONSUMER PRODUCT DIVISION (CPD) AND THE SYSTEMS PRODUCT DIVI SION (SPD) OF THE ASSESSEE. FROM THE RECORD WE FOUND THAT THE BUSINESS OF THE ASSESSEE WAS ORGANIZED UNDER THREE SEGMENTS (I) CONSUMER PRODUCT DIVISION (CPD ) (II) SYSTEM PRODUCT DIVISION (SPD) AND (III) INDUSTRIAL SALES DIVISION (ISD). CPD AND SPD DIVISIONS WERE PERFORMING TRADING FUNCTIONS AND THE ISD DIVIS ION WAS PERFORMING COMMISSION AGENCY FUNCTIONS. THE ASSESSEE COMPANY HAD ALSO UNDERTAKEN TRANSFER PRICING ANALYSIS FOR THESE FUNCTIONS. FOR THIS PURPOSE THE RESULTS OF CPD AND SPD WERE AGGREGATED AND THE RESULTS OF ISD WERE CONSIDERED SEPARATELY. HOWEVER THE TPO WHILE SCRUTINIZING THE ASSESSEES ACCOUNTS ON SEGMENTAL BASIS RE-WRITTEN THE ACCOUNTS OF THREE SEGMENTS CPD SPD AND ISD. ON THE BASIS OF RE- WRITTEN ACCOUNTS THE TPO RECOMMENDED TRANSFER PRIC ING ADJUSTMENT OF RS.1.12 CRORES IN RESPECT OF IMPORTED FINISHED GOODS FOR TH E CPD SEGMENT. AN ADJUSTMENT TO THE TUNE OF RS.1.15 CRORES WAS ALSO RECOMMENDED IN RESPECT OF REMUNERATION EARNED FROM PARENT COMPANY PERTAINING TO ISD DIVISI ON. IN THE ECONOMIC ANALYSIS CARRIED OUT BY THE ASSESSEE THE ACTIVITIES OF THE SUPERVISION OF AUTHORIZED SERVICE CENTERS WERE AGGREGATED WITH THE MAIN ACTIVITY OF T RADING FUNCTION FOR THE PURPOSE OF BENCHMARKING ANALYSIS. TNMM AS ADOPTED BY ASSESS EE WAS FOUND TO BE MOST APPROPRIATE METHOD BY THE TPO AND CIT(A) TO TEST TH E PROFITABILITY OF COMMISSION AND MARKETING AGENCY SERVICES OF ISD DIVISION. IN R ESPECT OF MARGIN SHOWN ON SPD THE AO FOUND THAT SAME WAS MORE THAN ARMS LEN GTH MARGIN OF 2.48% THEREFORE INTERNATIONAL TRANSACTION PERTAINING TO S PD WAS HELD TO BE AT ARMS LENGTH. IN RESPECT OF IMPORTED GOODS UNDER CPD TH E AO OBSERVED THAT THE LOSS MARGIN SHOWN WAS BELOW THE ARMS LENGTH MARGIN. TH E AO THEREFORE OBSERVED ITA-1417 & 1373/D/2008 31 THAT THE TRANSFER PRICE OF THE IMPORTED FINISHED GO ODS UNDER THE CPD HAS TO BE ADJUSTED DOWNWARDS. ACCORDINGLY ARMS LENGTH PRIC E WAS DETERMINED AT THE PRICE DECLARED IN FORM 3CEB MINUS THE ADJUSTMENT AMOUNT I .E. RS.74704584 RS.11237019 = RS.63467565. THE ARMS LENGTH PRICE IN RESPECT OF REMUNERATION RECEIVED UNDER ISD DIVISION WAS ALSO ENHANCED BY TH E AO BY AN AMOUNT EQUIVALENT TO THE DIFFERENCE OF OPERATING LOSS MARG IN AND THE MEAN MARGIN OF THE COMPARABLE COMPANIES CHOSEN. THIS DIFFERENCE WORKS OUT TO BE 6.11% - (-) 28.8% = 34.91% OF THE TOTAL COSTS. THE TOTAL COSTS HAVE BEEN WORKED OUT TO BE RS.33131321.34.91% OF THIS AMOUNT COMES TO RS.11566 144. THUS WE FOUND THAT AN ADDITION OF RS.2.28 CRORES WAS MADE BY THE TPO A ND THE CIT(A) HAS CONFIRMED THE SAME. FROM THE RECORD WE FOUND THAT WHILE DOI NG SO THE AO HAS TOTALLY IGNORED THE REIMBURSEMENT OF ADVERTISING EXPENSES F ROM ITS ASSOCIATED ENTERPRISES (AE) WHICH AMOUNTED TO RS.15.30 CRORES. THE PLEA O F THE TPO WAS THAT SUCH REIMBURSEMENT OF ADVERTISING EXPENSES WAS NOT OPERA TING INCOME TO BE CONSIDERED FOR THE PURPOSE OF TRANSFER PRICING. HOWEVER FOR THE PURPOSE OF REGULAR INCOME TAX PROCEEDINGS THE AO HAS DULY INCLUDED AS TAXABL E INCOME SUCH REIMBURSEMENT AND HELD THE SAME AS REVENUE INCOME SINCE INCEPTION OF THE COMPANY I.E. AY 1994-95 ONWARDS. THE LEGISLATIVE INTENT FOR INTROD UCING NEW PROVISIONS PERTAINING TO DETERMINATION OF ARMS LENGTH PRICE BETWEEN THE TWO ASSOCIATED ENTERPRISES IS TO PREVENT THE TRANSFER BETWEEN THE ASSOCIATED ENTERPR ISES OF A HIGH TAX JURISDICTION TO A LOWER TAX JURISDICTION. SINCE THE REVENUE INCOME RECEIVED BY THE ASSESSEE COMPANY WAS MUCH MORE THAN THE ADDITION MADE IN THE ARMS LENGTH PRICE IN THE INTERNATIONAL TRANSACTIONS THERE IS NO JUSTIFICATI ON FOR MAKING ANY ADDITION. DURING THE ASSESSMENT PROCEEDINGS THE AO NOTICED T HE FOLLOWING INTERNATIONAL TRANSACTIONS ENTERED INTO BY THE ASSESSEE DURING TH E FINANCIAL YEAR 2001-02 AS REPORTED IN FORM 3CEB FILED ALONGWITH THE RETURN O F INCOME:- ITA-1417 & 1373/D/2008 32 NATURE OF TRANSACTION METHOD VALUE (IN RS.) PURCHASE OF FINISHED GOODS TNMM 44 92 32 055/- PURCHASE OF SPARES TNMM 56 39 260/- COMMISSION & SERVICE INCOME TNMM 2 04 93 071/- PAYMENT FOR PANANET SERVICES TNMM 1 56 936/- REIMBURSEMENTS RECEIVED TNMM 15 97 82 249/- 9. A REFERENCE WAS MADE BY THE AO U/S 92CA(1) OF TH E ACT TO THE TPO FOR COMPUTATION OF ALP IN RESPECT OF THESE INTERNATIONA L TRANSACTIONS. THE TPO OBSERVED THAT THE BUSINESS OF THE COMPANY WAS ORGAN IZED UNDER THREE DISTINCT SEGMENTS (I) CONSUMER PRODUCT DIVISION (CPD) (II) S YSTEM PRODUCTS DIVISION (SPD) AND (III) INDUSTRIAL SALES DIVISION (ISD). T HE FIRST TWO DIVISIONS PERFORMED TRADING FUNCTIONS WHEREAS THE THIRD ONE PERFORMED C OMMISSION AGENCY FUNCTIONS. THE ASSESSEE HAD CONDUCTED TRANSFER PRICING ANALYSI S FOR THESE TWO FUNCTIONS SEPARATELY. FOR THIS PURPOSE THE RESULTS OF CPD & SPD WERE AGGREGATED AND THE RESULTS OF ISD WERE CONSIDERED SEPARATELY. THE TPO HOWEVER ANALYZED THE ACCOUNTS OF THE ASSESSEE ON SEGMENTAL BASIS AND RED REW THE ACCOUNTS OF THE THREE SEGMENTS CPD SPD & ISD SEPARATELY. FURTHER CPD W AS BIFURCATED INTO CPD (LOCAL) & CPD (IMPORTED GOODS). ON THE BASIS OF TH E REDRAWN SEGMENTAL ACCOUNTS THE TPO RECOMMENDED TRANSFER PRICING ADJU STMENT OF RS.1 12 37 019/- IN RESPECT OF IMPORTED FINISHED GOODS IN THE CPD (I MPORTED GOODS) SEGMENT. A QUANTUM OF TP ADJUSTMENT TO THE TUNE OF RS.1 15 66 144/- WAS ALSO RECOMMENDED IN RESPECT OF REMUNERATION RECEIVED BY THE ASSESSEE FROM ITS PARENT COMPANY PERTAINING TO ISD DIVISION. IN THE INSTANT CASE IN THE TP REPORT FILED BY THE ASSESSEE BEFORE THE AO THE COMPARABLES WERE CHOSEN AFTER EXTENSIVE EXERCISE AND A NET PROFIT OF 2.8% WAS ADOPTED AS THE ARMS LENGT H MARGIN FOR BENCHMARKING THE TRADING ACTIVITY OF THE ASSESSEE. HOWEVER THE TPO HAS BIFURCATED THE TRADING ACTIVITY INTO TWO SEPARATE DIVISIONS OF CPD AND SPD AS AGAINST CONSOLIDATED TRADING ACTIVITY. HOWEVER THE TPO HIMSELF HAS ASS UMED THE CONSOLIDATED PROFIT ITA-1417 & 1373/D/2008 33 MARGIN OF 2.48% OF THE COMPARABLES AS THE COMMON NE T MARGIN INDICATOR. THE TPO HAD ALSO REWORKED THE FINANCIAL OF THE ASSESSEE WITHOUT MAKING ANY CORRESPONDING ADJUSTMENT IN THE PLI OF THE COMPARAB LE CASES. THIS APPROACH OF THE TPO WAS NOT AS PER THE PRESCRIBED RULE 10B. IF THE TRANSACTIONS OF BOTH THE DIVISIONS HAVING INTERNATIONAL TRANSACTIONS AS FOUN D BY THE TPO IN HIS REPORT ARE CONSOLIDATED AS ONE TRADING ACTIVITY THE OPERATING PROFIT MARGIN OF SALES WAS WORKED OUT AT 3.95% WHICH EXCEEDS THE ARMS LENGTH MARGIN OF 2.48%. THUS ASSESSEES INTERNATIONAL TRANSACTION WORKS OUT TO B E AT ARMS LENGTH. THE REIMBURSEMENT OF ADVERTISING EXPENSES BY THE PARENT COMPANY WAS REQUIRED TO BE EITHER ADDED IN THE OPERATING INCOME OR THE EXPENSE S OF THE ASSESSEE ON ADVERTISING SELLING EXPENSES HAVE GOT TO BE REDUCE D BY THE SIMILAR AMOUNT. SINCE THE EXPENDITURE ON ADVERTISING ACTUALLY INCURRED BY THE ASSESSEE WAS OF REVENUE NATURE THE REIMBURSEMENT OF SUCH EXPENSES WAS ALSO OF THE REVENUE NATURE. EVEN IN THE EARLIER YEARS THE DEPARTMENT HAS TREATED SU CH RECEIPTS AS OF REVENUE NATURE THE SAME CANNOT BE LEFT OUT OF COMPUTATION WHILE DE TERMINING THE ARMS LENGTH PRICE PAID BY THE ASSESSEE OR THE INCOME EARNED BY IT FROM ITS ASSOCIATED ENTERPRISES. WE FOUND THAT DURING THE COURSE OF HE ARING THE TPO HAS CALLED FOR EXHAUSTIVE INFORMATION INCLUDING THE PRICE PAID BY THE ASSESSEE ON ACCOUNT OF LOCAL PURCHASES THE ASSESSEE HAD FURNISHED THE DET AILED INFORMATION WITH REGARD TO COMPARABLE LIST OF PURCHASES OF IDENTICAL ITEMS WHI CH WERE IMPORTED ALONGWITH THEIR PURCHASE COST. IT WAS ALSO EXPLAINED THAT TH E PRICE PAID FOR IMPORTED GOODS WAS VERY COMPETITIVE AND IN NO CASE HIGHER THAN THE PRICE PAID TO THE LOCAL SELLERS. HOWEVER WITH REGARD TO ALLOCATION OF UNALLOCATED E XPENSES THE CIT(A) HAS ALREADY ALLOWED ALLOCATION OF RS.87 48 348/- IN THE PROPORTION OF NET SALES OF VARIOUS SEGMENTS VIZ. CPD(LOCAL) CPD (IMPORTED) SPD AND ISD THE CIT(A) HAS DIRECTED THE AO TO TAKE THE SAME INTO ACCOUNT W HILE FINALIZING THE SEGMENTAL ACCOUNTS OF THESE DIVISIONS. AGAINST THE ADJUSTMEN T PROPOSED IN THE COST OF CPD IMPORTS AND ISD DIVISION THE ASSESSEE IS IN APPEAL BEFORE US. FROM THE RECORD WE FOUND THAT ADVERTISEMENT REIMBURSEMENT WAS PART OF THE PACKAGE DEAL WHEREIN ITA-1417 & 1373/D/2008 34 ASSESSEE COMPANY WAS BEING COMPENSATED FOR MARKETIN G OF ALL PRODUCTS AS WELL AS ESTABLISHING AS WELL AS NEW THE GAIN OF WHICH WILL ACCRUE TO THE INDIAN COUNTERPART IN THE FORM OF ADDITIONAL SALES. THERE IS NO DISPU TE TO THE WELL-SETTLED LEGAL PROPOSITION THAT MARKETING AND ADVERTISING EXPENSES PLAY A VITAL ROLE IN FACING THE COMPETITION FROM FOREIGN BRANDS AND DRIVING THE SAL ES. THE SALES OF CPD AND SPD DIVISIONS BOTH ARE DEPENDENT ON THE ADVERTISING EXP ENSES INCURRED BY THE ASSESSEE WE THEREFORE DO NOT FIND ANY JUSTIFICATION IN NOT A LLOWING SETTING OFF SUCH REIMBURSEMENT OF ADVERTISING EXPENSES INSOFAR AS IT WAS A PART OF PACKAGE DEAL. IGNORING SUCH REIMBURSEMENT WOULD LEAD TO ERRONEOUS CONCLUSION. AS PER RECORDS THE REIMBURSEMENT WAS AN INTENTIONAL SET OFF RECEIV ED BY THE ASSESSEE FOR CREATING MARKET FOR ITS PRODUCTS. THE ASSESSEE HAS HISTORIC ALLY BEEN GETTING REIMBURSEMENT OF ABOUT 2/3 RD OF ITS TOTAL ADVERTISEMENT AND PRODUCE PROMOTION E XPENSES FROM ITS ASSOCIATED ENTERPRISES WHOSE PRODUCTS THE ASSESSEE MARKETS IN INDIA. THEREFORE THE REIMBURSEMENT OF THESE EXPENSES SHOULD BE TAKEN INTO ACCOUNT IN THE LIGHT OF PROVISIONS OF RULES 10B(2)(C) OF THE RULES. AS PER CLAUSE (C) OF RULE 10B(2) THE ASSESSEE WAS DULY ENTITLED TO SET OFF AGAINST THE H ISTORICAL AMOUNT RECEIVED AS REIMBURSEMENT OF ADVERTISING EXPENSES ON ITS IMPORT ED PRODUCTS. WE FOUND THAT THE RISK OF BEARING ADVERTISEMENT COST TO SELL GOOD S IMPORTED FROM ITS ASSOCIATED ENTERPRISES WAS ALMOST MET BY ITS AES AND THEREFORE TO THAT EXTENT THE ADJUSTMENT MADE BY THE TPO IN EXCLUDING THE REIMBURSEMENT FROM INCOME WAS UNWARRANTED. WITH REGARD TO EARNING OF ISD DIVISION THE TPO HAS IGNORED THE FACT THAT AFTER HAVING CREATED AN INFRASTRUCTURE IN THE EARLIER YEA RS WHEREIN ISD DIVISION HAS MADE PROFITS IT WAS NOT POSSIBLE TO CLOSE DOWN SUCH UNI T OVERNIGHT. THE EARNING OF COMMISSION INCOME WAS LOWER BECAUSE OF LOWER BUSINE SS DONE BY THE PRINCIPAL IN INDIAN TERRITORY ON WHICH ASSESSEE WAS GETTING COMM ISSION INCOME. WE FOUND THAT HERE IS NO INCREASE IN THE EXPENSES OF ISD DIVISION EARNING OF INCOME WAS LESS ONLY DUE TO THE LESS SALES WHICH RESULTED INTO LOS S. ITA-1417 & 1373/D/2008 35 10. THE ADVERTISEMENT EXPENSES INCURRED BY THE ASSE SSEE WAS IN THE NORMAL COURSE OF ITS BUSINESS OPERATION AND THIS FORMED PA RT OF OPERATING EXPENSES OF THE ASSESSEE. WHEN THE ASSESSEE WAS IN RECEIPT OF REIM BURSEMENT OF SUCH EXPENSES FROM THE ASSOCIATED ENTERPRISES WHICH REIMBURSEMENT AS PER THE ACCOUNTING POLICY OF THE ASSESSEE HAD BEEN SHOWN UNDER THE SEPARATE H EAD OF OPERATING REVENUE INSTEAD OF NETTING OF THE OPERATING EXPENSES THERE WAS NO JUSTIFICATION FOR TREATING THE SAME AS NON-OPERATING RECEIPT. EVEN THE REIMBU RSEMENT OF ADVERTISEMENT EXPENSES AS REVENUE RECEIPT WAS CERTIFIED BY ITS AU DITORS AS PER THE GUIDELINES OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA. T HUS THE REIMBURSEMENT WAS OPERATING REVENUE AND THE TPO WAS NOT JUSTIFIED IN IGNORING THE SAME WHILE ARRIVING AT THE ARMS LENGTH PRICE AND WHILE RECOGN IZING THE INCOME OF ISD DIVISION. EVEN IN DOUBLE ENTRY SYSTEM OF BOOK KEEP ING THE INCOME AND EXPENSES HAVE TO BE BALANCED OUT EITHER THROUGH NETTING OF F ROM OPERATING EXPENSES OR THROUGH INCLUDING IN THE OPERATING INCOME OF THE PR OFIT & LOSS ACCOUNT THE TREATMENT GIVEN BY THE ASSESSEE WHICH WAS DULY APPR OVED BY THE AUDITORS WAS CORRECT AND HAS TO BE CONSIDERED WHILE MAKING ADJUS TMENT ON ACCOUNT OF TRANSFER PRICING. ONLY BECAUSE THE COMPARABLE SELECTED BY T HE TPO WAS NOT IN RECEIPT OF SUCH REIMBURSEMENT THE ASSESSEES CASE CANNOT BE S AID TO BE AT PAR WITH THOSE WHEN FACT WAS ON RECORD THAT ASSESSEE HAS GOT HUGE REIMBURSEMENT OF SUCH EXPENSES. WE FOUND THAT COMPARABLES WERE NOT INCUR RING THE SAME LEVELS OF ADVERTISEMENT EXPENSES THEREFORE THEY WERE NOT IN RECEIPT OF SUCH REIMBURSEMENT THE SAME CANNOT BE MADE BASIS FOR IGNORING THE ACTU AL REIMBURSEMENT RECEIVED BY THE ASSESSEE. THUS WE FOUND THAT ALL THE VARIATIO N OF THE PLI WITH THE TESTED PARTY WITH THE PLI OF COMPARABLES HAVE OCCURRED ON THIS S OLE ACCOUNT WHICH NEEDED ADJUSTMENT WHILE ARRIVING AT PRICE PAID BY THE ASSE SSEE TO ITS ASSOCIATED ENTERPRISES OR THE INCOME EARNED BY THE ASSESSEE FROM THE ASSOC IATED ENTERPRISES. MERE BOOK ENTRY OF SUCH REIMBURSEMENT AS INCOME INSTEAD OF N ETTING OF EXPENSES WILL NOT ALTER THE CHARACTER OF RECEIPT WHICH IS REVENUE IN NATURE AND THE DEPARTMENT ITSELF HAS CONSIDERED SUCH REIMBURSEMENT AS REVENUE INCOME OF THE ASSESSEE IN EARLIER ITA-1417 & 1373/D/2008 36 YEARS. DURING THE COURSE OF ARGUMENTS BEFORE US BO TH THE SIDES AGREED AND THIS IS ALSO REITERATED BY THE CIT(A) THAT THERE IS NO DISP UTE BETWEEN THE ASSESSEE AND THE REVENUE REGARDING. (I) USE OF TNMM AS THE MOST APPR OPRIATE METHOD (MAM) AND (II) THE USE OF NET PROFIT MARGIN ON SALE AS THE PR OFIT LEVEL INDICATOR I.E. PLI FOR THE TRADING FUNCTIONS AS THE ASSESSEE IS ONLY DOING TRA DING FUNCTIONS AND IS NOT ENGAGED IN THE MANUFACTURING BUSINESS WHATSOEVER AND (III) THE USE OF THE ASSESSEE AS THE TESTED PARTY. THE ASSESSEE HAS NO DIFFICULTY IN ACC EPTING THE FIRST OBSERVATION OF THE CIT(A) THAT IDEALLY EACH INTERNATIONAL TRANSACTION SHOULD BE TESTED WITH A COMPARABLE TRANSACTION OF UNCONTROLLED PARTIES TO A RRIVE AT ARMS LENGTH PRICE BUT IT WAS SUBMITTED THAT THIS IDEAL SITUATION RARELY E XISTS. NORMALLY THE TRANSACTIONS OF A TAX-PAYER HAVE TO BE AGGREGATED TO TEST THEM FOR ARMS LENGTH PRICE WHERE THESE TRANSACTIONS ARE CLOSELY LINKED AND/OR ARE CONTINU OUS TRANSACTIONS AND THE SAME CANNOT BE ADEQUATELY VALUED ON A SEPARATE BASIS. IN FACT THE ASSESSEE ALSO AGREED WITH THE OECD GUIDELINES REITERATED BY CIT(A) IN P ARA 9.3.2 OF HIS ORDER. THE BASIC DIFFERENCE BETWEEN THE ASSESSEE AND THE REVE NUE BEFORE US RELATES TO THE REASONS FOR SEGREGATION VIS--VIS AGGREGATION. THE REASONS FOR THE SAME HAVE BEEN REPRODUCED ABOVE AND ARE MENTIONED AT PAGE 33 OF CI T(A)S ORDER. THE BASIC OBJECTION THAT THE ASSESSEE HAS IS THAT THE REASONS GIVEN ARE EXTRANEOUS TO CHAPTER X CONTAINED IN THE ACT READ WITH RULES THEREUNDER. ONCE A PARTICULAR LAW HAS BEEN ENACTED BY PARLIAMENT THEN THE SAME CANNOT BE GIVE N GO-BYE BY RESORTING TO ANALYSIS DE-HORSE CHAPTER X AND THE RULES MADE THER EUNDER. AGGREGATION AND SEGREGATION BOTH DEPEND UPON THE ANALYSIS TO BE MA DE UNDER THE ACT AND THE RULES THEREUNDER AND NOT BY BRINGING EXTRANEOUS FACTORS. CONTENTION OF LEARNED AR WAS THAT THE PROVISIONS OF CHAPTER X AND THE RULES MADE THEREUNDER WOULD OVER-RIDE ANY GUIDELINES WHETHER OF OECD ACCOUNTING STANDA RDS OR OTHER STATUTORY PROVISIONS UNDER OTHER ACT. ITA-1417 & 1373/D/2008 37 11 . AS PER OUR CONSIDERED VIEW THAT WHERE SPECIFIC RUL ES OF LAW EXIST IN THE STATUTE ON A PARTICULAR SUBJECT THEN THEY WOULD HO LD THE FIELD OVER ALL OTHER TREATIES COMMENTARIES LIKE THE OECD OTHER ACTS COMPANIES ACT ETC. CHAPTER X AND RULES MADE THEREUNDER ARE A SELF CONTAINED CODE AND ANSWERS TO ALL QUESTIONS MUST BE FOUND IN THE WRITTEN LAW CONTAINED IN THE A CT AND STATUTE. THE APEX COURT IN THE AZADI BACHAO ANDOLAN CASE REPORTED AS 263 I TR 706 (SC) HAS REITERATED THIS WELL KNOWN AND ACCEPTED CONCEPT OF INTERPRETA TION OF TAX LAWS IN INDIA. LD. AR HAS RIGHTLY POINTED OUT DURING THE COURSE OF HEA RING THAT IF THE TPO AND THE CIT(A) WERE OF THE OPINION THAT THESE TWO DIVISIONS VIZ. CPD AND SPD WERE SEPARATE DIVISIONS AND REQUIRED A DIFFERENT CRITERI A FOR DETERMINING THE ARMS LENGTH PRICE THEN THEY COULD NOT HAVE COMPARED BO TH THE DIVISIONS RESULTS AS HAS BEEN DONE BY THEM WITH THE SAME SET OF COMPARABLES; THERE IS OBVIOUSLY A CONTRADICTION BETWEEN THE TWO. IF THE TPO AND THE CIT(A) WERE SERIOUS IN SEGREGATING THE TWO THEN THEY SHOULD HAVE APPLIED DIFFERENT SET OF COMPARABLES FOR BOTH. THEREFORE THE FIRST POINT MADE ON MERITS WHI CH DESERVE TO BE ACCEPTED IS THAT IF FOR THE SAKE OF ARGUMENT IT IS ACCEPTED THAT THE TWO DIVISIONS HAVE SEPARATE CHARACTERISTICS THEN OBVIOUSLY DIFFERENT COMPARABL ES SHOULD HAVE BEEN USED. WE FURTHER HOLD THAT IF THE TWO ARE TO BE TREATED SEPA RATELY BUT SAME SET OF COMPARABLES ARE USED AS DONE BY THE TPO & CIT(A) THEN THE PLI OF COMPARABLE FOR THE CPD DIVISION WOULD HAVE TO BE ADJUSTED AS PROVIDED IN R ULE 10(B(1)(E)(III) ACCORDING TO WHICH FOLLOWING IS THE CORRECT WORKING. PLI 2.48% OF UNRELATED COMPARABLES. PLI OF UNRELATED COMPARABLES. 2.48% ADJUSTMENTS 1. DIFFERENCE IN GP AS GIVEN BY THE TPO & CIT (A) (SPD 26% - CPD 19%) (-) 7.00% ITA-1417 & 1373/D/2008 38 2. SELLING EXPENSES DIFFERENCE (CPD 18.63% - 14% SPD) (-) 4.63% --------- ADJUSTED COMPARABLE PLI (-) 9.15% --------- PLI OF CPD DIVISION AS WORKED OUT BY TPO (-) 5.97% PLI OF COMPARABLES (-) 9.15% THEREFORE IN OUR OPINION THE TRADING TRANSACTIONS ARE AT ARMS LENGTH AND NO ADJUSTMENT IS REQUIRED. 12. FROM THE RECORD WE FOUND THAT T HE CIT(A) HAS GIVEN FIVE CRITERIA FOR SEGREGATING THE TWO DIVISIONS. OUT OF THESE FIVE CR ITERIA THREE CRITERIA ARE ABSOLUTELY THE SAME IN BOTH THE DIVISIONS I.E. NATU RE OF PRODUCT IS THE SAME VIZ. ELECTRICAL/ELECTRONIC GOODS SECONDLY DISTRIBUTION CHANNEL IS THE SAME I.E. THE SAME DEALERS WERE USED FOR SALE OF THESE PRODUCTS; AND T HIRDLY REGULATORY ENVIRONMENT IS THE SAME I.E. THEY BOTH FALL UNDER THE BROAD CATEGO RY OF ELECTRICAL/ELECTRONIC GOODS. THE FOURTH CRITERIA IS THAT OF PRODUCTION PROCESS. THIS IS ABSENT. ADMITTEDLY THE APPELLANT IS ONLY A TRADING COMPANY AND DOES NOT UN DERTAKE ANY PRODUCTION OR MANUFACTURING ACTIVITY. THEREFORE OUT OF FIVE THE RE IS NO DIFFERENCE AS FAR AS THE FOUR CRITERIA ARE CONCERNED. THEREFORE CIT(A)S A NALYSIS RELATING TO SEGREGATION WAS INCORRECT. THE ONLY DIFFERENCE RELATES TO THE F IFTH CRITERIA VIZ. DIFFERENT SET OF CUSTOMERS. THIS IS AGAIN A NON-STARTER AS THE CUSTO MERS FOR ALL THE FIVE COMPARABLES VIS--VIS THE TESTED PARTY I.E THE ASSESSEE ARE DIF FERENT. THIS ITSELF HAS NOT WEIGHED UPON NEITHER THE TPO NOR THE CIT(A) AND NOR HAS IT BEEN ARGUED BY THE CIT-DR THAT THIS SHOULD BE USED TO REJECT THE COMPARABLES OR THE ANALYSIS DONE BY THE APPELLANT AND THE TPO AS GIVEN AT PAGE 8 OF CIT(A) S ORDER TABLE 8 VIZ. (1) AMAZEL AUTOMATIVE COMPANY LTD. TRADING IN EXIDE B ATTERIES (2) GOLD ROCK ITA-1417 & 1373/D/2008 39 INVESTMENT LTD. DEALING IN ELECTRICAL GOODS (3) K .DHANDAPANI & COMPANY LTD. DEALING IN ELECTRICAL COMPONENTS FOR SIEMENS INDIA LTD. GEC AISTHOM & FINOLEX CABLES SUPPLYING SWITCHBOARDS SWITCHES AN D DISTRIBUTION BOARDS FOR INDUSTRIAL APPLICATION ETC. (4) KHAITAN INDIA LTD. TRADING IN FANS MONOBLOC PUMPS ETC. (5) RINGTON INDIA LTD. TRADING IN COMPUTERS AND PERIPHERALS OFFICE AND HOME SEGMENTS (6) REMI SALWS & ENGG. LTD TRADING IN FA NS ELECTRIC MOTORS AND SCIENTIFIC INSTRUMENTS; AND (7) ACI INFOCM LTD. TR ADING IN FLOPPY DISK DRIVES HARD DISK DRIVES AND OTHER COMPUTER EQUIPMENTS. ALL THES E COMPARABLES WHICH HAVE BEEN HELD TO BE CORRECT BY ALL THE AUTHORITIES BELO W AS WELL AS NOT OBJECTED TO BY CIT-DR WOULD SHOW THAT THE CUSTOMER IS NOT RELEVANT TO COMPARE THE RESULTS OF THE ASSESSEE I.E. THE TESTED PARTY WITH THAT OF THE COM PARABLES. IF THIS IS NOT AN IMPORTANT CRITERIA FOR REJECTING COMPARABLES THEN IT CANNOT BE AN IMPORTANT CRITERIA FOR SEGREGATION OF RESULTS OF THE ASSESSEE. WE ARE THE VIEW THAT THE REASONS GIVEN BY BOTH TPO AND CIT(A) WITH REGARD TO THE DIFFERENC E BETWEEN THE TWO DIVISIONS FOR PURPOSES OF SEGREGATION ARE LEGALLY AND FACTUAL LY INCORRECT AND CANNOT BE ACCEPTED. RULE 10B(2) VERY CLEARLY LAYS DOWN AS UND ER:- R.10B(2) FOR THE PURPOSES OF SUB-RULE (1) THE COMP ARABILITY OF AN INTERNATIONAL TRANSACTION WITH AN UNCONTROLLED TRANSACTION SHALL BE JUDGED WITH REFERENCE TO THE FOLLOWING NAMELY:- (B) THE FUNCTIONS PERFORMED TAKING INTO ACCOUNT ASSETS EMPLOYED OR TO BE EMPLOYED AND THE RISKS ASSUMED BY THE RESP ECTIVE PARTIES TO THE TRANSACTIONS; 13 . IT IS STATUTORILY LAID DOWN AS TO HOW AN INTERNAT IONAL TRANSACTION IS TO BE COMPARED WITH UNCONTROLLED TRANSACTION. WE FOUND TH AT THE CRITERIA USED FOR SEGREGATION IS INCORRECT AND FACTUALLY INACCURATE DESPITE THE FACT THAT UNDER THE TRANSFER PRICING REGULATIONS THE ONLY REASON WHICH CAN BE USED FOR SEGREGATION IS THE FAR ANALYSIS AS PROVIDED IN RULE 10B(2)(B). THE FAR IS THE SAME FOR THE TRADING FUNCTIONS FOR BOTH THE DIVISIONS IS AN ADMI TTED FACT. REFER TO PAGE 4 TABLE 4 OF THE CIT(A)S ORDER. ITA-1417 & 1373/D/2008 40 4.6 AS PER THE FUNCTIONAL ANALYSIS CARRIED OUT AT PARA 3 TO 3.4 IN THE T.P. REPORT THE FOLLOWING ARE THE DETAILS RELATING TO THE MAJOR FUNCTIONS PERFORMED IN RESPECT OF VARIOUS INTERNATI ONAL TRANSACTIONS ALONG WITH RISK ASSUMED ( PARA 3.1.2 ) AND ASSETS DEPLOYED BY THE APPELLANT (TABLE-4) :- TABLE-4 TRADING FUNCTIONS IMPORT OF PRODUCTS FUNCTIONS IMPORT PRODUCTS FROM MEI GROUP ENTITIES. OBTAINING CUSTOM CLEARANCE. MAINTENANCE OF WAREHOUSE FACILITIES FOR STOCKS. SELLING AND DISTRIBUTION FUNCTIONS. PRICE DETERMINATION. UNDERTAKING PUBLICITY AND ADVERTISEMENT CAMPAIGNS WITH FULL DESCRIPTION RISK CONTRACT RISK WITH DEALER AND DISTRIBUTORS. INVENTORY RISK. MARKET RISK. QUALITY AND WARRANTY RISK. FOREIGN EXCHANGE FLUCTUATION RISK. ASSETS DEPLOYED OWNS ASSETS TO PERFORM IMPORTING WAREHOUSING ADMINISTRATION AND DISTRIBUTION FUNCTIONS. NO INTANGIBLE ASSETS. 14. THESE DETAILS ARE ALSO GIVEN AT PAGES 89-90 OF THE PAPER BOOK OF THE TRANSFER PRICING REPORT SUBMITTED BY THE ASSESSEE O N THIS ISSUE SUBMITTING THAT THE FUNCTIONS PERFORMED RISKS ASSUMED AND THE ASSETS DEPLOYED ARE ABSOLUTELY THE SAME IN ALL ITS TRADING FUNCTIONS WHICH CLEARLY IND ICATE THE FACT THAT SEGREGATION FOR ANY OTHER REASON IS NOT PERMITTED AS PER STATUTORY RULE 10B(2)(B) OF THE RULES WHICH ARE PART OF THE TRANSFER PRICING REGULATIONS CONTAINED IN CHAPTER X OF THE ITA-1417 & 1373/D/2008 41 INCOME TAX ACT AND THE RULES MADE THEREUNDER. THER EFORE THE TEST FOR FINDING WHETHER SEGREGATION IS REQUIRED IS PROVIDED IN THE RULES THEMSELVES AND AS IS BORNE OUT FROM THE FACTS OF THE CASE RULE 10B(2(B) CLEARLY IS IN FAVOUR OF THE PROPOSITION THAT SEGREGATION SHOULD NOT BE DONE. IN ADDITION THE COMPARABLES USED ARE ALSO THE SAME FOR BOTH THE DIVISIONS. IT ALSO L ENDS WEIGHT TO RETURNING THE FINDING THAT SEGREGATION WAS NOT CALLED FOR. WE HAV E GIVEN OUR CAREFUL CONSIDERATION TO THE ISSUE AND THE ORDER OF THE AUT HORITIES BELOW AND THE SUBMISSIONS OF BOTH THE PARTIES BEFORE US. THE ABOV E EXPRESSION IS ALSO FOUND IN THE RULES ITSELF. THEREFORE THERE IS NO POSSIBILIT Y OF DE-LINKING THE CLOSELY LINKED TRANSACTIONS FOR TRANSFER PRICING ANALYSIS. AS ALRE ADY STATED ABOVE THE TEST FOR THE PROPOSITION WHETHER THE TRANSACTION IS CLOSELY LINK ED OR NOT IS GIVEN IN RULE 10B(2)(B) . THEREFORE THE GROUNDS RAISED ON THE ISSUE OF SEGR EGATIONS VS. DE- SEGREGATION AS PER THE PROVISIONS OF LAW SEGREG ATION WAS NOT CALLED FOR. THE SENIOR DR IN HIS DEFENCE OF THE ORDER OF CIT(A) HAS REITERATED THE REASONS GIVEN BY TPO AND THE CIT(A). HE ALSO REITERATED PARA 1.42 OF OECD GUIDELINES ON TRANSFER PRICING AS REPRODUCED BY CIT(A) IN PARA 9. 3.2 OF HIS ORDER. THE SENIOR DR ALSO RAISED DOUBT ABOUT THE TRANSFER PRICING REPORT GIVEN AT PAGE 110 OF THE PAPER BOOK BY THE ASSESSEE. THE ASSESSEE IN HIS REJOINDE R TO THE DRS SUBMISSIONS HAS STATED THAT THE AUDITED ACCOUNTS FILED BY THE ASSES SEE INCLUDING STATUTORY DOCUMENTS IN FORM 3CEB TAX AUDIT REPORT UNDER RUL E 44AB TRANSFER PRICING DOCUMENTATION UNDER RULE 92D HAVE ALL BEEN ACCEPTED BY TPO AO AND CIT(A). NONE OF THE AUTHORITIES BELOW HAVE DOUBTED THE VERA CITY OF THE ACCOUNTS OR THE FIGURES GIVEN IN THE TPOS REPORT. IN FACT PAGE 11 0 HAS BEEN VERIFIED BY TPO AND BILL-WISE DETAILS HAVE BEEN GIVEN BY THE ASSESSEE T O THE TPO VIDE HIS LETTER DATED 21.12.2004. AGAIN TPO WANTED TO HAVE FURTHER DETAI LS WHICH WERE GIVEN TO HIM AS AT PAGES 384-389 OF THE PAPER BOOK. THE RECONCIL IATION OF THE FIGURES WAS ASKED FOR AND THE SAME WAS GIVEN AT PAGE 390 OF TH E PAPER BOOK IN WHICH INCOME OF RS. 92.59 CRORES WAS RECONCILED AND ALSO THE OP ERATING PROFIT OF RS. 6.73 CRORES WAS RECONCILED. THE TPO THEN WENT FURTHER AND HAD ALSO TAKEN LINE BY LINE ITA-1417 & 1373/D/2008 42 RECONCILIATION FOR ALL SEGMENTS AND THE AUDITED BAL ANCE SHEET WAS ALSO MADE AVAILABLE TO HIM AT PAGES 428-435 OF THE PAPER BOOK . THE SEGMENT-WISE DETAILS OF SALES AND PURCHASE AT GP LEVEL WERE ALSO MADE AVAIL ABLE TO HIM AT PAGE 485. ALL THESE WERE ALSO POINTED OUT TO US BY THE AR DURING THE COURSE OF HEARING AND THE SENIOR DR COULD NOT REBUT ANY FACTUAL ASPECTS THERE OF. ON A CAREFUL CONSIDERATION THEREOF NO DISCREPANCY IS FOUND IN THE FIGURES AS REPORTED BY THE ASSESSEE. IN ANY CASE TPO AS WELL AS THE CIT(A) HAVE RE-DRAWN THE ACCOUNTS AS HAS BEEN CATEGORICALLY FOUND BY CIT(A) AT PAGES 13 AND 14 PARA 5.3. OF HIS ORDER AS REPRODUCED ABOVE. WE THEREFORE HOLD THAT ON THE F ACTS AND CIRCUMSTANCES OF THE CASE AND AS PER THE PROVISIONS LAID DOWN IN THE TRA NSFER PRICING REGULATIONS IN INDIA THE ASSESSEE SUCCEEDS ON THESE GROUNDS. THE SEGREGATION WAS TOTALLY ARTIFICIAL AND UNCALLED FOR AND THE AUTHORITIES BEL OW WERE NOT JUSTIFIED IN SEGREGATING THEM. THE TRADING FUNCTIONS HAVING THE SAME FAR AND HAVING CLOSELY LINKED TRANSACTIONS WERE TO BE TAKEN AS A WHOLE AND NOT SEPARATELY THEREBY CREATING ARTIFICIAL LOSS IN ONE SEGMENT AND PROFIT IN THE OTHER. BOTH HAVE TO BE TAKEN AS A WHOLE AND THE ADDITIONS MADE BY TPO AND CONFIR MED BY CIT(A) FOR DOING THIS SEGREGATION ARE REQUIRED TO BE DELETED. 15 . GROUNDS NOS. 10 11 12 AND 13 RAISED BY THE APPELL ANT ARE IN RESPECT OF TREATING THE REIMBURSEMENT OF ADVERTISEMENT EXPENSE S BY ASSESSEES A.E. AS A NON- OPERATING REVENUE RECEIPT. 16 . THE ISSUES WITH REGARD TO THESE GROUNDS DEAL WITH THE CONCEPT OF HOW OPERATING PROFIT SHOULD BE CALCULATED FOR WORKING O UT THE PROFIT IN A TNMM METHOD. THE TRANSFER PRICING OFFICER ON PAGE 5 PAR A 7.1.1 STATES THAT RE- IMBURSEMENT OF ADVERTISEMENT EXPENDITURE IS NOT OPE RATING INCOME. HE FURTHER GOES ON TO SAY IN PARA 7.1.3 THAT THE COMPARABLE CO MPANIES CHOSEN HAVE NOT RECEIVED SIMILAR RE-IMBURSEMENT BUT ALL OF THEM HAV E SPENT ON ADVERTISING AND MARKETING. IN PARA 7.1.4 THE TPO FURTHER STATES TH AT AS ADVERTISEMENT INCOME HAS ITA-1417 & 1373/D/2008 43 BEEN RECEIVED FROM SOURCES EXTRANEOUS TO THE BUSINE SS OF THE APPELLANT THEREFORE THIS INCOME CANNOT BE TREATED AS OPERATING INCOME. THE CIT (A) IN HIS ORDER DEALS WITH THESE ISSUES IN PARA 5.2 PAGE 12 PARA 7.3 ON PAGES 26 27 AND 28. ON PAGE 28 PARA 8(V) THE CIT(A) RAISED THE QUESTION WHICH NEE DED TO BE ANSWERED IN THE APPELLATE PROCEEDINGS BEFORE HIM WHICH IS REPRODUCE D AS UNDER:- (IV) UNDER THE GIVEN CIRCUMSTANCES WHETHER THE TPO WAS RIGHT IN EXCLUDING THE REIMBURSEMENT OF ADVERTISEMENT AND SALES PROMOT ION EXPENSES AS NON-OPERATING REVENUE? 17 . HE THEN WENT ON TO GIVE HIS FINDINGS IN PARA 9.5 PAGES 34 35 AND 36. THE CIT(A) LARGELY CONCURRED WITH VIEW OF THE TPO AND T HE REASONS GIVEN BY THE TPO. HE WENT ON FURTHER TO STATE THAT AS THERE WAS NO LE GAL OBLIGATION FOR THE AES TO REIMBURSE THE ADVERTISEMENT EXPENSES AND TO THAT EX TENT REIMBURSEMENT WAS AD HOC IN NATURE AS THEY DID NOT FLOW FROM ANY FORMAL AGREEMENT BETWEEN THE APPELLANT AND THE AE AND THEREFORE COULD NOT BE MAD E A PART OF THE OPERATING INCOME. THE CIT(A) FURTHER STATED THAT NO LINKAGES WERE DOCUMENTED WHEREIN THE QUANTUM OF MARKETING SUPPORT SUBSIDY WOULD HAVE INF LUENCED THE PRICES OF EXPORTS OR IMPORTS OR ROYALTY. HE THEN CONCLUDED THAT MARK ETING SUPPORT SUBSIDY PARTAKE THE CHARACTER OF FINANCING RATHER THAN OPERATING IN NATURE. 18 . THE LEARNED SR. D.R. ITAT STATED THAT REIMBURSEMEN T OF ADVERTISEMENT EXPENDITURE WOULD NOT FALL WITHIN THE DEFINITION OF OPERATING INCOME. THE ASSESSEES CASE WHICH IS ALSO SUMMARIZED BY THE CIT (A) IN PARA 7.3. PAGES 26 27 AND 28 IS AS FOLLOWS:- (I) ALL ADVERTISEMENTS ARE CARRIED OUT BY VARIOUS LOCAL BRANCHES OF PANASONIC INDIA LTD. FOR ACTIVITY ALL OVER INDIA IN THE LOCAL LANGUAGES ITA-1417 & 1373/D/2008 44 JUST TO ACHIEVE SALES OF THE PRODUCTS BEING SOLD BY THE ASSESSEE IN THE INDIAN MARKET. (II) THE ASSESSEE HAD TO INCUR HUGE ADVERTISEMENT COSTS BECAUSE THE ASSESSEE OPERATED IN A HIGHLY COMPETITIVE ENVIRONMENT AGAINS T THE MARKET LEADERS SUCH AS SONY SAMSUNG LG AND MANY LOCAL BRANDS OF INDIAN ORIGIN SUCH AS VIDEOCON ETC. (III) IN ORDER TO FINANCE ITS OPERATIONS THE PARENT COMPANY HAD BEEN GIVING FINANCIAL HELP BY WAY OF REIMBURSING ABOUT 2/3 RD OF ITS ADVERTISEMENT BILL. (IV) ALTHOUGH THE ASSESSEE HAD ADVERTISED UNDER THE NAME `PANASONIC AND HAS USED BRAND NAME OF `NATIONAL FOR TRYING TO MAKE SALES IN INDIA YET NO ROYALTY FOR BRAND NAME USAGE HAS BEEN PAID TO ANY OF ITS A.ES OR PARENT COMPANY MEI JAPAN AS IS NORMAL IN SUCH CASES. (V) IT IS A SETTLED PREPOSITION OF LAW THAT ENTRY IN TH E BOOKS OF ACCOUNTS DOES NOT COME IN THE WAY OF DETERMINING THE TRUE NATURE OF A TRANSACTION AND THE TRUE NATURE OF THE RECEIPTS OF ADVERTISEMENT EX PENSES IS PURE AND SIMPLE REIMBURSEMENTS TO PART FINANCE ASSESSEES RO UTINE OPERATIONS AND MEETING PART OF ASSESSEES ADVERTISEMENT BILL FOR I TS LOCAL OPERATIONS AS IT WAS UNABLE TO SUPPORT ITS OWN EXPENSES FROM ITS SALES. (VI) EXPENSES INCURRED BY THE ASSESSEE ON ADVERTISEMENT AND SALES PROMOTION FOR ACHIEVING SALES TARGETS IN INDIA ARE CLAIMED FR OM THE PARENT COMPANY BY RAISING SIMPLE DEBIT NOTES WITH DETAILS OF THE A DVERTISEMENT E4XPENSES INCURRED. (VII) THESE INTERNATIONAL TRANSACTIONS ARE PURE AND SIMPL E FINANCIAL HELP BY A PARENT A.E. IN JAPAN TO ITS SUBSIDIARY A.E. AILING IN INDIA TO COPE UP WITH THE HIGH COSTS OF ADVERTISEMENT TO SURVIVE IN THE LOCAL INDIAN HIGHLY COMPETITIVE MARKET AND IT HAS NO OTHER IMPLICATIONS EXCEPT THAT THE LARGER PART OF THE COST OF ADVERTISEMENT HAS BEEN S HARED BY THE PARENT ITA-1417 & 1373/D/2008 45 COMPANY WITHOUT ANY CORRESPONDING OR RECIPROCAL BEN EFIT TO THE PARENT COMPANY. (VIII) THE ADVERTISEMENT EXPENSES THAT HAVE BEEN INCURRED BY THE ASSESSEE ARE IN THE COURSE OF ITS BUSINESS OPERATIONS AND THUS F ORM PART OF THE OPERATING EXPENSES OF THE ASSESSEE. HOWEVER WHEN THE SAME EXPENSES ARE REIMBURSED BY WAY OF FINANCIAL SUPPORT FROM THE A.E. WHICH REIMBURSEMENTS AS PER THE ACCOUNTING POLICY OF THE ASSESSEE HAVE BEEN SHOWN UNDER THE SEPARATE HEAD OF OPERATING REVENUE INSTEAD OF NETTING OFF THE OPERATING EXPENSES THE TPO HAS TREATED THE SAME AS NON- OPERATING RECEIPT. (IX) THE ACCOUNTING STANDARDS AS APPLICABLE TO THE ASSES SEE UNDER THE ICAI GUIDELINES WHICH HAVE BEEN CERTIFIED BY THE FINANC IAL AUDITORS HAVE TREATED SUCH REIMBURSEMENTS AS OPERATING REVENUE AN D HAVE FOUND NO MISTAKE IN THE ACCOUNTING TREATMENT GIVEN TO SUCH R EVENUES. (X) SINCE IN A DOUBLE-ENTRY BOOK-KEEPING SYSTEM THE I NCOME AND OR EXPENSE HAVE TO BE BALANCED OUT EITHER THROUGH NETT ING OFF FROM OPERATING EXPENSES OR THROUGH INCLUDING IN THE OPER ATING INCOME OF THE PROFIT AND LOSS ACCOUNT THE TREATMENT GIVEN BY THE ASSESSEE AND APPROVED BY THE STATUTORY AUDITORS IS CORRECT AND D OES NOT REQUIRE ANY MODIFICATION AS HAS BEEN DONE BY THE TPO. (XI) ONE REASON GIVEN BY THE TPO FOR EXCLUDING THE ADVER TISEMENT SUPPORT FROM THE FINANCIALS AS NON-OPERATING INCOME IS THAT COMPARABLES HAVE NOT REPORTED SUCH RECEIPTS. HOWEVER THE TPO WHILE MAKING THIS CONCLUSION SEEMS TO HAVE COMPLETELY IGNORED THE FAC T THAT THE COMPARABLES ARE NOT INCURRING THE SAME LEVEL OF ADV ERTISEMENT EXPENSES. THE COMPARABLES HAVE ALMOST NIL ADVERTISEMENT EXPEN SE AS AGAINST ABOVE 10% IN ASSESSEES CASE. PERHAPS ALL THE VARI ATIONS IN THE PLI OF ITA-1417 & 1373/D/2008 46 TESTED PARTY WITH THE PLI OF COMPARABLES HAVE OCCUR RED ON THIS SOLE ACCOUNT WHICH NEEDED ADJUSTMENTS IN FAVOUR OF ASSE SSEE. 19 . LEARNED AR DURING HIS SUBMISSIONS BEFORE THE ITAT ALSO BROUGHT TO THE ATTENTION OF THE TRIBUNAL ON PAGES 43 AND 44 PARA 1 2 OF THE CIT(A)S ORDER WHEREIN THE ADVERTISEMENT EXPENDITURE OF RS.23 15 1 8 053/- WAS DISALLOWED. HOWEVER ASSESSEES SUBMISSIONS AFTER TAKING A REMA ND REPORT WERE ACCEPTED BY THE CIT(A) IN PARAS 12.3 12.4 AND 12.5 WHICH ARE R EPRODUCED AS UNDER:- 12.3 IN THE REJOINDER TO THE REMAND REPORT IT WAS SUBMI TTED THAT THE DELHI BENCH OF THE TRIBUNAL HAS IN THE APPELLANTS OWN CASE FOR A.Y: . 1998-99 IN ITA NO. 3238(DEL)/2002 DATED 20.01.2006 DELETED ALL THE DISALLOWANCES MADE BY THE A.O. INCLUDING DISALLOWAN CES ON ACCOUNT OF TRADE DISCOUNT CASH DISCOUNT ADVERTISEMENT AND S ALES PROMOTION EXPENSES. A COPY OF THE ORDER WAS ALSO ENCLOSED. I T WAS FURTHER SUBMITTED THAT THE AO HAD BASED ALL THE DISALLOWANC ES ON THE ASSESSMENT ORDER FOR THE A.Y. 1998-99. SINCE THE V ERY BASIS HAS BEEN KNOCKED OUT IN APPEAL ALL THE DISALLOWANCES ARE TO BE ALLOWED IN THIS APPEAL. RELIANCE IS ALSO PLACED ON ANOTHER DECISION OF THE JURISDICTIONAL TRIBUNAL IN THE CASE OF M/S. BECON DICKINSON INDIA PVT. LTD. WHERE IT HAS BEEN HELD THAT IF EXPENDITURES INCURRED BY TAXP AYER WHOLLY AND EXCLUSIVELY FOR THE PURPOSE OF ITS OWN BUSINESS EV EN IF ANY BENEFIT ACCRUES TO A THIRD PARTY IT CANNOLT BE HELD THAT T HE EXPENDITURE DID NOT HAVE ANY NEXUS WITH THE TAXPAYERS BUSINESS. DURIN G THE COURSE OF APPELLATE PROCEEDINGS COPIES OF THE JURISDICTIONAL ITATS ORDERS IN THE APPELLANTS OWN CASE FOR THE A.Y.S 1999-2000 2000- 01 & 2001-02 WERE ALSO FURNISHED WHERE RELYING ON THE ORDER FOR THE A.Y. 1998-99 ALL THE DISALLOWANCES WERE ALLOWED. 12.4 I HAVE CAREFULLY CONSIDERED ALL THE SUBMISSIONS MAD E BY THE APPELLANT AND ALSO PERUSED THE ORDERS OF THE DELHI TRIBUNAL IN THE APPELLANTS OWN CASE FOR THE A.Y.S 1998-99 1999-20 00 2000-01 & 2001-02. IT WAS ABUNDANTLY CLEAR FROM THE ORDERS OF THE TRIBUNAL THAT THERE WAS NO BASIS FOR THE AO TO MAKE THE DISALLOWA NCES RELATING TO TRADE DISCOUNT CASH DISCOUNT SALES PROMOTION AND ADVERTISEMENT. THE RELEVANT EXTRACT FROM THE ORDER FOR THE A.Y 1999-20 00 IS REPRODUCED BELOW: ITA-1417 & 1373/D/2008 47 6. WE ARE IN AGREEMENT WITH THE ABOVE OBSERVATIONS . WE FIND THAT THE TRANSACTIONS RELATING TO ADVERTISEMENT SALES PROMO TION COMMISSION TRADE DISCOUNT ETC. ARE NOT BETWEEN THE RESIDENT AN D THE NON-RESIDENT. THERE IS NO ARRANGEMENT WITH THE NON-RESIDENT TO HO LD THAT THE ARRANGEMENT PRODUCES TO THE RESIDENT LESS PROFIT TH AN THE ORDINARY PROFIT. I IS SETTLED LAW THAT IF DUE TO CERTAIN EXP ENDITURE INCURRED BY AN ASSESSEE A BENEFIT FLOWS TO THE THIRD PARTY IT CA NNOT BE A GROUND TO DISALLOW THE EXPENSES IN THE HANDS OF THE ASSESSEE WHO HAS LEGITIMATELY INCURRED THE EXPENSES WHOLLY AND EXCLU SIVELY FOR THE PURPOSE OF HIS BUSINESS. THUS THE ASSESSING OFFICER WAS NOT CORRECT IN INVOKING THE PROVISIONS OF SECTION 92 OF THE ACT. S IMILARLY SINCE WE FIND THAT THE EXPENSES ARE INCURRED WHOLLY AND EXCL USIVELY FOR THE PURPOSE OF BUSINESS THE SAME ARE ALLOWABLE IN FULL AND A PARTIAL DISALLOWANCE IS TO BE DELETED. ACCORDINGLY GROUNDS NO. 1 TO 3 RAISED BY ASSESSEE ARE ALLOWED AND GROUNDS NO. 1& 3 RAISED BY THE REVENUE ARE DISMISSED. 12.5. IN VIEW OF THE CATEGORICAL FINDING GIVEN BY T HE HONBLE TRIBUNAL IN THE APPELLANTS OWN CASE EXACTLY ON THE SAME ISSUES I DELETE THE DISALLOWANCES MADE BY THE AO RESPECTFULLY FOLLO WING THE TRIBUNALS ORDER. ACCORDINGLY GROUNDS OF APPEAL NO. 1.4 TO 5. 5 ARE ALLOWED. 20 . THE ADDITIONS WERE THEREFORE DELETED BY THE CI T(A) FOLLOWING THE ASSESSEES OWN CASE DECIDED BY THE TRIBUNAL IN AY 1 998-99 ONWARDS. THE REVENUE HAS ACCEPTED THIS PART OF THE CIT(A)S ORDE R AND HAS NOT APPEALED BEFORE THE TRIBUNAL ON ANY ISSUE OTHER THAN TRANSFER PRICI NG ISSUE. 21 . AS REGARDS THE NATURE OF EXPENDITURE LEARNED AR S HRI DINODIA BROUGHT TO OUR NOTICE P.B. VOL. II PAGE 436 WHICH GIVES DETAIL S OF CATEGORY OF EXPENDITURE VOUCHER NUMBER DATE DEBIT NOTE PARTY FROM WHOM R EIMBURSEMENT HAS BEEN CLAIMED AND RECEIVED AND THE DIVISION TO WHICH IT P ERTAINS. SO THE ENTIRE REIMBURSEMENT EXPENDITURE DETAILS HAVE BEEN GIVEN V OUCHER-WISE. LEARNED AR FURTHER SUBMITTED THAT IT IS A FINDING OF FACT RECO RDED BY THE TRIBUNAL IN PREVIOUS YEARS WHICH HAVE BECOME FINAL AS THERE HAS BEEN NO CHALLENGE BY THE REVENUE IN FURTHER APPEALS BEFORE THE HIGH COURT. SIMILARLY E VEN IN THE RELEVANT ORDER IT HAS BEEN ESTABLISHED BY THE ORDER OF CIT(A) THAT THE AD VERTISEMENT EXPENDITURE ITA-1417 & 1373/D/2008 48 INCURRED BY THE ASSESSEE IS LOCAL IN NATURE AND DOE S NOT HAVE ANY DIRECT OR INDIRECT BENEFIT WHICH IS DISALLOWABLE UNDER THE PROVISIONS OF INCOME TAX ACT FLOWING TO THE AE. THE QUESTION BEFORE US IS WHEN REIMBURSEMEN T IS MADE BY ANYBODY OF ANY SPECIFIC EXPENDITURE INCURRED FOR SPECIFIC PURPOSES WHETHER THE EXPENDITURE DESERVES TO BE TAKEN INTO ACCOUNT EITHER FOR COMPUT ATION OF INCOME OR FOR CALCULATING OPERATING PROFITS FOR PURPOSES OF TRANS FER PRICING ANALYSIS. AS FOUND BY THE TRIBUNAL IN A.Y. 1998-99 WHAT WE HAVE TO SEE I N CASES LIKE THIS IS WHAT IS THE SUBSTANCE OF THE TRANSACTION. A LOCAL EXPENDITURE INCURRED FOR BENEFIT OF LOCAL SALE WHICH DOES NOT ENURE ANY BENEFIT TO AE BUT IS STILL REIMBURSED BY THE AE CAN HAVE EITHER OF THE TWO EFFECTS ONE IT MAY REDUCE THE E XPENDITURE TO THE EXTENT OF REIMBURSEMENT AND THIS CONCEPT OF REDUCTION OF EXPE NDITURE TO THE EXTENT OF REIMBURSEMENT IS A WELL KNOWN CONCEPT UNDER VARIOUS PROVISIONS OF INCOME TAX ACT INCLUDING FOR PURPOSES OF CALCULATING WDV OF A DEPRECIABLE ASSET WHEREIN A REIMBURSEMENT IS MADE OR SUBSIDY RECEIVED IT WILL G O TO REDUCE THE COST OF THE ASSET OR IT MAY HAVE THE EFFECT OF INCREASING THE I NCOME. REIMBURSEMENT OF EXPENDITURE IMPLICITLY OR EXPLICITLY LINKED TO THE INCURRING OF REVENUE EXPENDITURE CAN HAVE NO OTHER CHARACTER THAN OF REVENUE RECEIPT AND AS THE RECEIPT IS DIRECTLY LINKED WITH THE BUSINESS OF THE ASSESSEE IT CANNOT BE DISREGARDED WHILE CALCULATING ITS INCOME EITHER FOR THE PURPOSE OF INCOME TAX ACT OR FOR THE PURPOSE OF CALCULATING HIS OPERATING INCOME. IT MAY BE LOOKED AT FROM ANY ANGLE WHATSOEVER EITHER IT WILL GO TO REDUCE THE EXPENDITURE THERE BY INCREASING THE INCOME OR IT MAY BECOME A PART OF OPERATING INCOME. THEREFORE IN OUR OPINION THE ASSESSEE HAS CORRECTLY TAKEN THE REIMBURSEMENT OF EXPENDITUR E OF RS.15 30 40 478/- AS A PART OF ITS OPERATING INCOME FOR TRANSFER PRICING A NALYSIS. 22 . A QUESTION WAS POSED BY LD. DR AS TO WHETHER THE ASSESSEE WAS IN EXPECTATION OF THIS REIMBURSEMENT WHILE DOING ITS B USINESS IN INDIA. THE TPO AND CIT(A) HAVE RAISED THE ISSUE IN THE ABSENCE OF FORM AL AGREEMENTS. THE ASSESSEE HAS FILED SAMPLE COPIES OF ADVERTISEMENT SUPPORT AG REEMENTS ENTERED INTO BY THE ITA-1417 & 1373/D/2008 49 APPELLANT WITH THE AES. SIMILARLY SOME DEBIT NOT ES WITH REGARD TO CLAIM OF REIMBURSEMENT OF EXPENDITURE HAVE BEEN FILED ON PAG ES 704 TO 724 OF PB VOL. III. THE LEARNED AR HAS FURTHER SUBMITTED THAT AS PER AS SESSEES PAST HISTORY IT HAS BEEN RECEIVING 2/3 RD OF ITS TOTAL ADVERTISEMENT EXPENDITURE BY WAY OF REIMBURSEMENT FROM ITS AES. ITS DETAIL HAS BEEN GI VEN IN PB VOL. II PAGE 474. THE ASSESSEE RECEIVED 68% OF HIS TOTAL EXPENDITURE BY WAY OF REIMBURSEMENT IN ASSESSMENT YEAR 2000-01 67% IN THE ASSESSMENT YEAR 2001-02 AND 66% IN ASSESSMENT YEAR 2002-03 I.E. THE YEAR UNDER APPEAL . LOOKED AT FROM THIS PERSPECTIVE THAT YEAR AFTER YEAR ALMOST 2/3 RD OF THE TOTAL EXPENDITURE IS BEING REIMBURSED AS COMPENSATION BY AES. IN OUR OPINION I T IS A REASONABLE EXPECTATION TO ASSUME SUCH REIMBURSEMENT WILL CONTINUE IN THE F UTURE AS WELL. SOME SAMPLE FORMAL AGREEMENTS ALSO PRODUCED BEFORE THE AUTHORIT IES BELOW AS WELL AS BEFORE US SHOW THAT REIMBURSEMENT OF EXPENDITURE WAS A NORMAL EXPECTATION OF THE ASSESSEE FROM ITS AES IN THE NORMAL COURSE OF ITS BUSINESS. 23 . RULE 10B(2)(C) STATES THE CONTRACTUAL TERMS (WHETHER OR NOT SUCH TERMS AR E 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 PARTIES TO THE TRANSACTIONS. . THE TRANSFER PRICING RULE ITSELF STATES THAT THE CONTRACTUAL TERMS MAY BE FORMAL OR MAY NOT BE F ORMAL MAY BE IN WRITING MAY NOT BE IN WRITING AND MAY BE IMPLICIT OR EXPLICIT. NOW HERE THE ASSESSEE HAS DEMONSTRATED BY FACT THAT IT WAS IN REASONABLE EXPE CTATION OF REIMBURSEMENT OF EXPENDITURE BY THE PAST CONDUCT OF ITS MOTHER COMPA NIES I.E. AES OF RECEIVING AT LEAST 2/3 RD OF ITS EXPENDITURE IN REIMBURSEMENT. THEREFORE AS PER THE RULE ITSELF THIS HAS TO BE TAKEN COGNIZANCE OF AND COULD NOT BE IGNORED ARBITRARILY. ONCE RULE 10B(2)(C) IS SEEN AND INVOKED THEN THE OBJECTIONS BOTH OF THE TPO AND CIT(A) WOULD NOT HOLD GROUND AND THE CONDUCT OF THE ASSESS EE IS BASED ON FACTS AND FIGURES FROM THE AY 1998-99 ON RECORD THE ORDER OF THE TRIBUNAL ON RECORD ACCEPTED BY THE REVENUE IT CAN BE CONCLUDED THAT T HE RECEIPT OF ADVERTISEMENT ITA-1417 & 1373/D/2008 50 REIMBURSEMENT WOULD FORM A PART OF OPERATING PROFIT EITHER BY WAY OF BY ADDING TO INCOME OR BY WAY OF REDUCTION OF ADVERTISING EXP ENDITURE TO THE EXTENT OF REIMBURSEMENT. BOTH HAVE THE SAME EFFECT OF INCREA SING OPERATING PROFITS TO THIS EXTENT. WE THEREFORE HOLD THAT THE TPO AND THE CIT( A) WRONG IN EXCLUDING REIMBURSEMENT OF ADVERTISEMENT EXPENSES WHILE CALCU LATING THE PLI OF THE APPELLANT. 24 . THE LAST POINT RAISED BY THE CIT(A) AND TPO IS THA T COMPARABLES DO NOT HAVE REIMBURSEMENT. AS SUBMITTED BY THE LEARNED AR THE COMPARABLES DO NOT HAVE ADVERTISEMENT EXPENSES OF THIS MAGNITUDE AT AL L. THEREFORE EVEN ON THE FIRST PRINCIPLES OF FAR ANALYSIS AS CONTAINED IN RULE 10B (2) EITHER THE ENTIRE ADVERTISEMENT EXPENDITURE THE COMPARABLES OPERATING PROFITS WOULD HAVE TO BE ADJUSTED TO BRING IT AT PAR WITH THE TESTED PARTY T O THE EXTENT OF REIMBURSEMENT IF NOT TO THE EXTENT OF ENTIRE ADVERTISEMENT EXPENDITU RE OF THE APPELLANT WOULD HAVE TO BE TAKEN OUT BECAUSE FOR THE PURPOSE OF COMPARIS ON BETWEEN COMPARABLE COMPANIES PLI AND THE TESTED COMPANYS PLI ELEMEN TS HAVE TO BE MORE OR LESS SIMILAR OR SAME. IT IS NOT POSSIBLE TO COMPARE A C OMPANY WHICH INCURS HEAVY ADVERTISEMENT EXPENDITURE WITH A COMPANY WHICH INCU RS ALMOST NIL OR VERY LITTLE EXPENDITURE. IF COMPARABLES HAVE TO BE RETAINED T HEN THIS ADJUSTMENT WOULD HAVE TO BE MADE. 25 . IN VIEW OF ABOVE DISCUSSION WE CAN SAFELY CONCLUD E THAT LOOKED AT FROM ANY ANGLE THE ADVERTISEMENT REIMBURSEMENT WOULD DE FINITELY FORM A PART OF THE OPERATING PROFITS OF THE ASSESSEE AND WOULD HAVE TO BE TAKEN INTO ACCOUNT FOR PURPOSES OF TRANSFER PRICING ANALYSIS. NOW WE RECAS T THE TABLE-17 GIVEN BY THE CIT ON PAGE 411 OF HIS ORDER IN TERMS OF OUR FINDIN G RECORDED HEREINABOVE TO FIND OUT IF ANY ADDITION IS REQUIRED ON ACCOUNT OF DIFFE RENCE IN PLIS OF COMPARABLES:- TABLE 17 (AMOUNT IN RS.) ITA-1417 & 1373/D/2008 51 PARTICULARS CPD (IMPORTED) (B) SPD (C) CPD(IMPORTE D)+SPD (B)+(C ) ISD (D) TOTAL (A)+(B)+(C )+(D) INCOME: NET SALES 132 982 473 777 133 469 910 115 942 1 228 831 3 569 519 600 OTHER INCOME OTHER OPERATING INCOME AS PER TPO 179 443 1 301 080 1 480 523 - 27 836 673 ALLOCATION OF UNALLOCATED OTHER INCOME (RS. 87 48 348) IN PROPORTION TO SALES 325 920 1 904 636 2 230 555 3 012 8 748 348 COGS 415 117 GROSS PROFIT (A) 816 726 ADVT. SUBSIDY (RS. 153 040 478) IN PROPORTION TO SALES 5 703 487 33 330 489 39 033 977 - 153 040 478 OTHER OPERATING INCOME AS PER TPO 22 765 791 TOTAL REVENUE 139 191 323 813 669 674 952 860 997 23 582 517 3 759 145 099 COGS 104 474 649 575 393 430 679 868 079 - 2 823 770 299 OPERATING EXP. - - 37 736 859 17 098 649 162 017 256 ADV. EXP. 7 054 248 21 975 346 29 029 594 - 504 886 414 SELLING EXP. 20 395 201 93 538 482 113 933 683 406 022 114 339 705 OTHER OPERATING EXPENSES 7 005 786 30 731 073 ADMN EXP. ITA-1417 & 1373/D/2008 52 2 172 687 12 874 141 15 046 828 - 15 046 828 PERSONNEL EXP. - - - 12 499 107 99 592 440 DEPRECIATION - 1 067 873 16 294 218 FINANCE CHARGES - - - - - ALLOCATION OF UNALLOCATED EXPS. IN PROPORTION TO SALES 76 759 448 573 525 332 - 2 059 669 OPERATING EXPENDITURE 141 179 330 734 961 045 876 140 375 31 071 651 3 738 006 829 OPERATING PROFIT/LOSS (1 988 007) 78 708 629 76 720 622 (7 489 134 ) 21 138 270 PLI AS OPERATING PROFIT TO SALES RATIO -1.49% 10.13% 8.43% PLIS OF COMPARABLE COMPANIES AS GIVEN IN TABLE 16 ON PAGE 40 OF CIT(A)'S ORDER. 3.58% ADDITION ON ACCOUNT OF DIFFERENCE IN PLIS OF COMPARABLES NIL PLI AS OPERATING PROFIT TO COST RATIO -23.79% WEIGHTED AVERAGE MEAN OF LAST THREE PREVIOUS YEAR AS ADOPTED BY ASSESSEE TO JUSTIFY THE LOSS- REWORKING OF 33.27% ITA-1417 & 1373/D/2008 53 TABLE ON PG 111 OF PAPER BOOK. PLIS OF COMPARABLE COMPANIES AS GIVEN IN TABLE 15 ON PAGE 40 OF CIT(A)'S ORDER. 2.95% ADDITION ON ACCOUNT OF DIFFERENCE IN PLIS OF COMPARABLES NIL 26. WE THEREFORE HOLD THAT IN VIEW OF THE CORRECT ANALYSIS AND WORKING AS GIVEN ABOVE ON THE COMPARISON BETWEEN THE ASSESSEE AND THE COMPARABLES AND BY CORRECTING THE TWO ERRORS COMMITTED BY THE TPO AND CIT(A) AND CONFINING THE FINANCIALS TO ONE YEAR ONLY AND NOT TO MULTIPLE YEA RS FOR THE TRADING FUNCTIONING OF ASSESSEE THE PLI OF THE ASSESSEE COMES TO 8.43% AN D THAT OF THE COMPARABLES 3.58%. AS THE PLI OF THE ASSESSEE IS HIGHER OF THE TWO THE INTERNATIONAL TRADING TRANSACTIONS ENTERED INTO BY THE ASSESSEE ARE HELD TO BE AT ARMS LENGTH PRICE AS PER TRANSFER PRICING REGULATIONS IN INDIA. ACCORDINGLY THE ADDITION MADE BY THE TPO AND UPHELD BY CIT(A) AMOUNTING TO RS.1 23 48 509/- IS ORDERED TO BE DELETED. 27 . NEXT GRIEVANCE OF THE ASSESSEE PERTAINS TO ALLOCA TION OF THE UNALLOCATED EXPENSES AND INCOME TO THE ISD DIVISION OF THE ASSE SSEE. AS DONE BY TPO. WE HAVE CONSIDERED RIVAL CONTENTIONS AND GONE THROUGH THE RELEVANT MATERIALS PLACED BEFORE US AND TOWARDS WHICH OUR ATTENTION WAS INVIT ED. FROM THE RECORD WE FIND THAT THE INDUSTRIAL SALES DIVISION OR ISD DIVISION OF THE ASSESSEE IS A COMMISSION AND MARKETING AGENCY WHICH PROVIDES AFTER SALES SER VICE FOR PRODUCTS SOLD BY MEI JAPAN AND OTHER AFFILIATES TO INDIAN CUSTOMERS AND ALSO GETS COMMISSION ON SALES OF MEI PRODUCTS IN INDIA. THE ASSESSEE APPOINTS VARIO US SERVICE CENTRES DISTRIBUTES SERVICE MANUALS TO THESE PROVIDES TECHNICAL SUPPOR T TO THESE AND ADMINISTERS SUPPLY OF SPARE PARTS AND IT REPORTS ALL THE SERVIC E ACTIVITIES OF THESE CENTRES IT DEALS WITH ALL COMPLAINTS QUESTIONS AND ANSWERS FR OM CUSTOMERS I.E. ISD DIVISION ITA-1417 & 1373/D/2008 54 IS THE SERVICE PART OF THE ASSESSEE. FOR THE ISD D IVISION THE CIT(A) HAS DISCUSSED THIS ISSUE ON PAGE 15 OF HIS ORDER. AS THERE WAS A LOSS IN THESE OPERATIONS THE QUESTION RAISED WAS WHY A LOSS IN A SERVICE INDUSTR Y. IN THE PREVIOUS YEAR THERE WAS EXPANSION OF BUSINESS AND THEREFORE IN EXPECTAT ION OF OTHER BUSINESS IT INCURRED EXTRA COSTS BUT DUE TO LACK OF ADEQUATE S ALES MADE BY THE AES IN INDIA COSTS COULD NOT BE RECOVERED. THE ASSESSEES SUBMI SSIONS IN THIS REGARD ARE CONTAINED IN PARA 7.2 (XIX) AND (XX) ON PAGE 26 OF CIT(A)S ORDER WHICH IS REPRODUCED BELOW:- (XIX) THE TPO MISDIRECTED HIMSELF IN CONCLUDING THA T THE RISKS OF RUNNING THE ESTABLISHMENT FOR EARNINGS IN THE ISD D IVISION WAS ON ASSESSEES ACCOUNT. AFTER HAVING CREATED AN INFRAST RUCTURE IN THE EARLIER YEARS WHEREIN THE ISD DIVISION HAD MADE PROFITS I T COULD NOT HAVE CLOSED IT DOWN OVERNIGHT. THE EARNINGS FROM COMMISS ION INCOME WERE LOWER BECAUSE OF THE LOWER BUSINESS DONE BY THE PRI NCIPALS IN THE INDIAN TERRITORY ON WHICH THE ASSESSEE WAS ENTITLED TO COMMISSION. IT IS SUBMITTED THAT THERE WAS NO INCREASE IN EXPENSES OF THE DIVISION. THE EARNING OF INCOME WAS LESS DURING THE YEAR WHIC H RESULTED INTO LOSS. 28 . THE CIT(A) RECORDED HIS FINDING IN PARA 9.8.2 PAGE 39 OF HIS ORDER WHICH IS REPRODUCED BELOW:- 9.8.2 I AM INCLINED TO AGREE WITH THE ARGUMENTS PU T FORWARD BY THE TPO THAT NO UNRELATED PARTY WOULD HAVE INCURRED SUC H A LOSS BY MAINTAINING A DEDICATED ESTABLISHMENT AND PERSONNEL TO PROVIDE SERVICES EXCLUSIVELY MARK-UP. THIS IS A CLEAR CUT E XAMPLE OF RELATED PARTIES IMPOSING SPECIAL CONDITIONS ON AN ENTITY T HEREBY ADVERSELY AFFECTING ITS PROFITABILITY AS DESCRIBED IN ARTICLE 9 OF THE OECD MODEL TAX CONVENTION. 29 . THE CIT(A) CONCLUDED IN PARA 0.8.5 PAGE 40 OF HIS ORDER WHICH IS REPRODUCED BELOW:- ITA-1417 & 1373/D/2008 55 9.8.5 IN VIEW OF THE FOREGOING ANALYSIS I AM OF T HE CONSIDERED VIEW THAT THE TPO HAS CORRECTLY RECORDED A FINDING THAT THE TP ADJUSTMENT IS TO BE MADE BY APPLYING THE ARMS LENGTH MARGIN WORK ED OUT ON THE BASIS OF THE RESULTS OF THE COMPARABLES. HOWEVER T HE TPO COMMITTED AN ERROR BY USING THE ARMS LENGTH MARGIN AT 6.11% WHICH IS A WEIGHTED AVERAGE OVER A PERIOD OF THREE YEARS. IN V IEW OF THE FINDING ALREADY GIVEN AT PARA 9.2 OF THIS ORDER THAT ONLY C ONTEMPORANEOUS DATA IS TO BE USED THE QUANTUM OF TP ADJUSTMENT IN RESP ECT OF THE COMMISSION AGENCY FUNCTION IS TO BE COMPUTED BY TAK ING THE ARMS LENGTH MARGIN OF THE COMPARABLES AT 2.95% FURNISHED BY THE APPELLANT (TABLE-15) DURING THE APPELLATE PROCEEDINGS AS PER THE DETAILS BELOW: TABLE-15 MARKETING AND COMMISSION COMPARABLE COMPANIES. S.NO. COMPANY NAME 31 ST MARCH 2002 1 PURAK VINIMAY LIMITED -7.38% 2 MARKETING CONSULTANTS AND AGENCIES LIMITED 5.28% 3 N I S SPARTA LIMITED 8.76% 4 INDIACOM DIRECTIORIES LIMITED 8.94% 5 CONCEPT MARKETING AND ADVERTISING LIMITED -5.00% 6 INTERADS LIMITED 7.09% AVERAGE OPERATING PROFIT MARGIN (%) 2.95% 30 . CONTENTION OF LD. AR WAS THAT THE ENTREPRENEURIAL RISK OF RUNNING A BUSINESS IS ALWAYS OF THE PERSON WHO CONDUCTS THE B USINESS AND CAN NEVER BE PASSED ON TO ANY OTHER PERSON INCLUDING AN AE. THE REFORE TO SAY THAT THE BUSINESS ITA-1417 & 1373/D/2008 56 OF THE ASSESSEE IN PROVIDING COMMISSION SERVICES IS RISK FREE IS WHOLLY INCORRECT STATEMENT OF FACTS. THERE WAS NO AGREEMENT WITH TH E AES NEITHER THERE IS ANYTHING TO THE CONTRARY POINTED OUT BY THE TPO OR THE CIT(A) OR THE SR. DR THAT THERE WAS ANY ARRANGEMENT BETWEEN THE ASSESSEE AND THE AES TO TAKE OVER THE RISK OF LOSS IN THIS BUSINESS BY THE AES. THEREFORE TH E BASIC PREMISES ON WHICH THIS ADJUSTMENT HAS BEEN MADE IS FACTUALLY INCORRECT. O N PAGE 111 OF PB-I THE TRANSFER PRICING STATED IN PARA 4.6 IN WHICH THE WEIGHTED A VERAGE PROFIT OF THREE YEARS HAS BEEN TAKEN AS AT 14.03% OF TOTAL OPERATING INCOME. THE LEARNED AR HAS SUBMITTED BEFORE THE TRIBUNAL THAT THIS WAS THE ONLY YEAR IN WHICH IT MADE A LOSS AND IN SUBSEQUENT YEAR ALSO IT HAS MADE PROFITS. THIS YEA R THE LOSS WAS UNIQUE IN THE SENSE THAT THE BUSINESS OF THE ISD DIVISION WAS LOW . THE ENTIRE BUSINESS OF THE ISD DIVISION IS TO NON-AES I.E. TO INDIAN CUSTOMER S. THEREFORE THE AE HAD NO CONTROL OVER THE VOLUME OF BUSINESS OF THE APPELLAN TS ISD DIVISION. IT WAS FURTHER SUBMITTED THAT AS PER PROVISO TO RULE 10B(4) THE DA TA TO BE USED IN ANALYZING THE COMPARABILITY OF AN UNCONTROLLED TRANSACTION WITH A N INTERNATIONAL TRANSACTION SHALL BE THE DATA RELATING TO THE FINANCIAL YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO: PROVIDED THAT DATA RELATING TO A PERIOD NOT BEING MORE THAN TWO YEARS PRIOR TO SUCH FINANCIAL YEAR MAY ALSO BE CONS IDERED IF SUCH DATA REVEALS FACTS WHICH COULD HAVE AN INFLUENCE ON THE DETERMINATION OF TRANSFER PRICES IN RELATION TO THE TRANSACTIONS BEING COMPARED. THUS THE ASSESSEE WAS ENTITLED TO TAKE INTO ACCOUNT DATA OF A PERIOD OF TWO YEARS PRIOR TO THE FINANCIAL YEAR UNDER REVIEW. THIS IS FOR THE SIMPLE FACT THAT IN SERVICE INDUSTR Y ONCE YOU HIRE PEOPLE IN EXPECTATION OF LARGER VOLUME OF BUSINESS IT IS NOT POSSIBLE TO REDUCE THE PEOPLE IMMEDIATELY FOR LACK OF BUSINESS. THE LOSS HAS TO BE BORNE TILL SUCH TIME THE VOLUME OF BUSINESS PICKS UP. THEREFORE FOR THE PU RPOSES OF TRANSFER PRICING THE PROVISO WILL COME TO PLAY AND THE DATA OF PREVIOUS TWO YEARS SHOULD ALSO BE TAKEN INTO ACCOUNT TO FIND OUT WHETHER THE TRANSACTIONS W ITH THE AE IS AT ARMS LENGTH OR NOT. THE SAME ARGUMENT WAS ALSO RAISED BEFORE THE AUTHORITIES BELOW. ATTENTION HAS BEEN DRAWN TO PAGES 470 AND 471 OF PB VOL.II. THE ISD DIVISION HAS ALSO ITA-1417 & 1373/D/2008 57 DOCUMENTARY EVIDENCE EVIDENCE WITH REGARD TO THE A GREEMENTS WITH THE AES WHICH ARE GIVEN FROM PAGES 411 TO 414 OF PB VOL. I. THE LEARNED AR SUBMITTED THAT DUE TO CONTINUE LOSS AND LOW VOLUME OF BUSINES S THIS DIVISION WAS CLOSED DOWN ON 31 ST MARCH 2003. THIS IS ALSO RECORDED ON PAGE 471 OF PB VOL.II. 31 . WE HAVE CONSIDERED RIVAL CONTENTIONS AND THE FACTS ON RECORD AND THE SUBMISSION OF BOTH PARTIES. IT IS MANIFEST THAT HIR ING AND FIRING OF PEOPLE IS A LONG- TERM AFFAIR AND CANNOT BE DONE OVERNIGHT. THE PROV ISO TO RULE 10B(4) WOULD COME INTO PLAY AND WOULD ALLOW THE ASSESSEE TO TAKE AVERAGE OF PREVIOUS TWO YEARS ALONG WITH THE CURRENT YEAR FOR WORKING PLI OF THE TESTED PARTY. SIMILARLY THREE YEARS AVERAGE WOULD ALSO BE TAKEN INTO ACCOU NT FOR ITS COMPARABLES SO THAT LIKE CAN BE COMPARED WITH THE LIKE. THE PROVISO TO RULE 10B(4) CLEARLY PERMITS THIS. IT IS ALSO SEEN FROM THE FACTS OF THE CASE G IVEN ON PAGE 29 OF THE ASSESSEES WRITTEN NOTE FILED BY COVERING LETTER OF 12 TH MARCH 2010 ON PAGE 29 THE ASSESSEE MADE A PROFIT OF RS.0.15 LAKHS IN THE NEXT YEAR AND THE ACTIVITY WAS CLOSED AT THE END OF THE NEXT YEAR. SIMPLY BECAUSE THERE IS LOSS IN ONE YEAR AND ADDITION TO THE ASSESSEES INCOME CANNOT BE MADE IN ACCORDANCE WITH TRANSFER PRICING REGULATIONS ESPECIALLY WHEN THIS LOSS HAS NOT BEEN INCURRED DUE TO ANY TRANSACTION WITH THE AE. IN THIS ISD DIVISION THERE IS NEITHER ANY SALE NOR ANY PURCHASES FROM THE AES. IT IS PURELY A LOCAL SERVICE ALLOCATED TO SERVICING GO ODS SOLD BY AES TO ITS CUSTOMERS IN INDIA PLUS COMMISSION ON THE GOODS SOLD BY THE A ES DIRECTLY IN INDIA. IT IS THEREFORE CLEAR THAT NO ADJUSTMENT ON THE ISD DIVI SION IS CALLED FOR AS THE PLI FOR THE THREE YEARS AVERAGE OF ASSESSEE IS HIGHER THAN THAT OF THE COMPARABLES. THE CHART AT PAGE 111 IS REWORKED AS UNDER IN LINE WITH OUR FINDINGS GIVEN HERE IN ABOVE. TABLE 18 COMMISSION AND MARKETING AGENCY SERVICES (ISD) (RUPEES IN '000) ITA-1417 & 1373/D/2008 58 PARTICULARS 31-MAR-02 31-MAR-01 31-MAR-00 WEIGHTED AVERAGE [AS PER CIT(A) ORDER PAGE 41 -TABLE 17] INCOME INCOME FROM OPERATIONS 1 229 231 - OTHER INCOME 22 769 30 367 30 629 TOTAL OPERATING INCOME 23 998 30 598 30 629 85 225 EXPENDITURE COST OF SALES 4 15 - - DIRECT SELLING EXPENSES 406 603 - GENERAL AND ADMINISTRATIO N EXPENSES 30 666 29 180 13 869 73 715 TOTAL OPERATING COSTS 31 487 29 783 13 869 75 139 TOTAL OPERATING PROFITS (7 489) 815 16 760 10 086 NCP -23.79% 2.74% 120.85% 33.27% REWORKING OF TABLE 4.6 ON PAGE 111 OF PAPER BOOK 32. THEREFORE THE PLI OF THE TESTED PARTY OF 33.27 % WHEN COMPARED TO THE PLI OF THE COMPARABLES AT PAGE 40 OF CIT(A)S ORDER T ABLE 15 - OF 2.95% CLEARLY SHOW THAT THE ASSESSEES TRANSACTIONS IN THE ISD D IVISION WERE DONE AT ARMS LENGTH AND ADDITION OF THE RS. 74 92 166/- IS DELET ED 33. NEXT ISSUE IS WITH REGARD TO ALLOCATION OF EXPE NSES. THE CIT(A) HAS DEALT WITH THIS ISSUE ON PAGE 36 PARA 9.6 OF HIS ORDER. THE TPO HAS ALLOCATED NON- ALLOCATED EXPENSES OF RS.6.05 CRORES TO THE THREE D IVISIONS CPD SPD AND ISD ITA-1417 & 1373/D/2008 59 WHEREAS THE ASSESSEE HAS ALLOCATED THIS ENTIRE EXPE NDITURE TO ITS TRADING FUNCTIONS I.E. TO CPD AND SPD. THE LD. AR CONTENDED THAT ALL OCATION OF RS.20 59 661 TO ISD IS NOT CORRECT AS THIS EXPENDITURE HAS NOTHING TO DO WITH THE SALES COMMISSION AND THE SERVICE PART OF THE ASSESSEE. THE ASSESSEE SUBMITTED VIDE ITS LETTER DATED 25 TH JANUARY 2005 ON PAGE 425 PB VOL.II THAT ISD IS AN INDEPENDENT DIVISION AND NO PART OF HEAD OFFICE EXPENDITURE COULD BE ALLOCAT ED TO IT AS IT DOES NOT NEED HEAD OFFICE SUPPORT. IN OUR VIEW THERE IS SUBSTANCE IN THE SUBMISSIONS OF THE LEARNED AR THAT OUT OF A TOTAL BUSINESS OF RS.361 CORES TH E ISD SERVICE AND COMMISSION INCOME IS ONLY RS.12 28 831/-. IT IS UNREASONABLE TO ALLOCATE RS.20 59 669/- AS EXPENDITURE ON SUCH A MEAGER GROSS RECEIPT. IN ANY CASE IN VIEW OF THE FACT THAT THREE YEARS AVERAGE IS BEING TAKEN ON THE ISD DIVIS ION ON THE BASIC FACTS OF THE CASE FOLLOWING THE PROVISO TO RULE 10B(A) EVEN IF I T IS TAKEN TO THE BASIS OF ISD DIVISION IT WILL NOT MAKE ANY DIFFERENCE. 34 . IN THE ABOVE ANALYSIS OF THE CONTROVERSY AT HAND A ND THE VARIOUS GROUNDS RAISED BY THE ASSESSEE WE CAN SAFELY CONCLUDE THAT NO ADDITION BASED ON CHAPTER X OF THE INCOME TAX ACT AND THE RULES THERETO CAN BE MADE IN THE ASSESSEES CASE FOR THE AY 2002-03. FURTHER ARGUMENTS RAISED BY THE AS SESSEE ALSO DESERVE TO BE SEEN THAT THE TOTAL ADJUSTMENT PROPOSED BY THE TPO AND N OW BY THE CIT(A) IS RS.1 98 40 745/- WHEREAS ACCORDING TO BOTH TPO AND THE CIT(A) THE TOTAL MONEY RECEIVED ALLEGEDLY WITHOUT ANY LINKAGES WITH THE BU SINESS OF THE ASSESSEE FROM THE AE IS RS.15 30 40 478/- WHICH IS MANY TIMES MORE T HAN THE BENEFIT ALLEGED TO HAVE BEEN TAKEN BY THE AES FROM THE ASSESSEE. IN O UR VIEW TRANSFER PRICING ANALYSIS AND ADDITION CANNOT BE MADE IN SUCH CIRCUM STANCES EVEN ON THE OVERALL VIEW OF THE CASE. WE ALSO FOUND THAT EVEN AFTER AL L THE ADJUSTMENTS AS PROPOSED WERE MADE BY THE TPO AND THE CIT(A) AS PER THE APPE AL EFFECT THE ASSESSEE IS STILL LEFT WITH A CARRY FORWARD BUSINESS LOSS AND THIS LO SS FOR THE CURRENT YEAR AMOUNTS TO RS.2 87 06 096/-. THEREFORE THE QUESTION OF TRANSF ERRING ANY PROFITS FROM HIGH TAX ITA-1417 & 1373/D/2008 60 JURISDICTION TO LOW TAX JURISDICTION WHICH IS THE F UNDAMENTAL PRINCIPLE OF TRANSFER PRICING ALSO DOES NOT APPEAL TO ANY LOGIC IN THIS C ASE. 35. IN THE APPEAL OF THE REVENUE THE ONLY GROUND RA ISED IS THAT LD. CIT(A) HAS ERRED IN LAW AND IN FACTS AND CIRCUMSTANCES OF THE CASE IN HOLDING THAT ONLY CURRENT YEAR DATA FOR 2003-04 IS TO BE USED FOR COMPUTATION OF THE ARMS LENGTH PRICE. THE GROUND RAISED BY THE REVENUE HAS ALREADY BEEN D ISCUSSED BY US WHILE DISPOSING OF THE ASSESSEES APPEAL IN WHICH WE HAVE REPRODUCED RULE 10B(4) AND PROVISO THERETO REFERRED TO IN PARA 41-43. THE CIT (A) IS RIGHT IN HOLDING THAT THE DATA TO BE USED IN ANALYZING THE COMPARABILITY OF A N UNCONTROLLED TRANSACTION WITH AN INTERNATIONAL TRANSACTION SHALL BE THE DATA RELA TING TO THE RELEVANT YEAR IN WHICH THE INTERNATIONAL TRANSACTION HAS BEEN ENTERED INTO . THE SR. DR WHO APPEARED ON BEHALF OF THE DEPARTMENT HAS NOT DISPUTED THIS PROP OSITION OF LAW NEITHER ANYTHING HAS BEEN BROUGHT TO OUR NOTICE BY THE SR. DR TO TAK E A CONTRARY VIEW. THEREFORE AS FAR AS THE TRADING OPERATIONS ARE CONCERNED USE OF SINGLE YEAR DATA IS CORRECT AND THIS HAS BEEN THE STAND BEFORE US BY BOTH THE PARTI ES. TO THIS EXTENT THE REVENUES APPEAL IS DISMISSED. 36. GROUND NO.9 THE ASSESSEE HAS ASSAILED THE ACTIO N OF CIT (A) IN HOLDING THAT ASSESSEES RELIANCE ON THE SPECIAL VALUATION C ELL OF THE CUSTOMS DEPARTMENT WAS NOT PROPER AND HE HAS FURTHER ERRED IN REJECTIN G THE SAME. 37. LEARNED ARS CONTENTION WAS THAT ALL ITS IMPORT S FROM AES ARE BASED ON VALUATION ACCEPTED BY THE CUSTOMS DEPARTMENT OF THE MINISTRY OF FINANCE GOVERNMENT OF INDIA AND IN ONE PARTICULAR CASE WHE RE A CHARGE WAS LEVIED OF UNDER-INVOICING ON THE ASSESSEE THE SPECIAL VALUAT ION BENCH OF THE CUSTOMS DEPARTMENT EXONERATED THE ASSESSEE THEREFORE THE V ALUATION MADE BY CUSTOM AUTHORITIES SHOULD BE GUIDING FACTOR FOR TPO WHILE MAKING ADJUSTMENT ON ACCOUNT OF ARMS LENGTH PRICE. WE DO NOT FIND ANY FORCE IN THIS GROUND AND ARE OF THE VIEW ITA-1417 & 1373/D/2008 61 THAT WHERE SPECIFIC RULES OF LAW EXIST IN THE STATU TE ON A PARTICULAR SUBJECT THEN THEY WOULD HOLD THE FIELD. CHAPTER X AND RULES MADE THEREUNDER ARE A SELF CONTAINED CODE AND ANSWERS TO ALL QUESTIONS MUST BE FOUND IN THE WRITTEN LAW CONTAINED IN THE ACT AND STATUTE. HERE WE ARE INCLI NED TO AGREE WITH LD CIT DR THAT THAT CUSTOMS VALUATION IS FOR DIFFERENT PURPOS ES AND CHAPTER X OF THE INCOME TAX ACT IS FOR DIFFERENT PURPOSES AND DIFFERENT CRI TERIA ARE BEING USED. 38. IN THE RESULT GROUND NO. 9 OF ASSESSEES APPEAL IS DISMISSED. 39. IN THE RESULT APPEAL OF THE REVENUE IS DISMISSE D WHEREAS APPEAL OF THE ASSESSEE IS ALLOWED IN PART. DECISION PRONOUNCED IN THE OPEN COURT ON 24 TH SEPTEMBER 2010. SD/- SD/- (I.P. BANSAL) (R.C.SHARMA) JUDICIAL MEMBER ACCOUNTANT MEMBER DATED : 24.09.2010. VK. COPY FORWARDED TO: - 1. M/S PANASONIC INDIA PVT. LTD. C/O S.R. DINODIA & COMPANY C-37 CONNAUGHT PLACE NEW DELHI. 2. INCOME TAX OFFICER WARD 14(4) NEW DELHI. 3. CIT 4. CIT(A) 5. DR ITAT DEPUTY REGISTRAR