Li & Fung (India) Pvt. Ltd., New Delhi v. DCIT, New Delhi

ITA 5156/DEL/2010 | 2006-2007
Pronouncement Date: 30-09-2011 | Result: Partly Allowed

Appeal Details

RSA Number 515620114 RSA 2010
Assessee PAN AAACL1663M
Bench Delhi
Appeal Number ITA 5156/DEL/2010
Duration Of Justice 10 month(s) 7 day(s)
Appellant Li & Fung (India) Pvt. Ltd., New Delhi
Respondent DCIT, New Delhi
Appeal Type Income Tax Appeal
Pronouncement Date 30-09-2011
Appeal Filed By Assessee
Order Result Partly Allowed
Bench Allotted D
Tribunal Order Date 30-09-2011
Date Of Final Hearing 21-02-2011
Next Hearing Date 21-02-2011
Assessment Year 2006-2007
Appeal Filed On 22-11-2010
Judgment Text
IN THE INCOME TAX APPELLATE TRIBUNAL (DELHI BENCH D : NEW DELHI) BEFORE SHRI C.L. SETHI JUDICIAL MEMBER AND SHRI B.C. MEENA ACCOUNTANT MEMBER ITA NO.5156/DEL./2010 (ASSESSMENT YEAR : 2006-07) M/S. LI & FUNG (INDIA) PVT. LTD. VS. DCIT CIRCLE 4 (1) 202 206 DUA ASSOCIATES NEW DELHI. TOLSTOY HOUSE 15 TOLSTOY MARG NEW DELHI 110 001. (PAN : AAACL1663M) (APPELLANT) (RESPONDENT) ASSESSEE BY : SHRI AJAY VOHRA & NEERAJ JAIN ADVOCA TES REVENUE BY : SHRI JAYANT MISHRA DR ORDER PER B.C. MEENA ACCOUNTANT MEMBER : THIS APPEAL FILED BY THE ASSESSEE ARISES OUT OF THE ORDER DATED 08.10.2010 PASSED U/S 144C/143(3) OF THE INCOME-TAX ACT 1961. 2. THE RETURN OF INCOME WAS FILED FOR THE ASSESSMEN T YEAR 2006-07 ON 1.12.2006 DECLARING INCOME OF RS.3 08 26 448/-. TH E RETURN WAS DULY PROCESSED U/S 143(1). THE CASE WAS SELECTED FOR SC RUTINY. NOTICE U/S 143(1) WAS ISSUED ON 23.11.2007. A DRAFT ASSESSMENT ORDE R U/S 144C WAS MADE AND A COPY WAS FORWARDED TO THE ASSESSEE ON 21.12.2009. THE ASSESSEE PREFERRED AN APPEAL AGAINST THE DRAFT ORDER BEFORE THE DISPUT E RESOLUTION PANEL-II NEW ITA NO.5156/DEL./2010 2 DELHI (HEREINAFTER REFERRED TO AS DRP). THE DRP IS SUED THE DIRECTIONS U/S 144C. THE ASSESSING OFFICER PASSED THE FINAL ORDER ON THE BASIS OF THE DIRECTIONS ISSUED BY DRP U/S 144C. THE ASSESSEE IS A COMPANY INCORPORATED UNDER THE COMPANIES ACT 1956. THE ASSESSEE IS A S UBSIDIARY COMPANY OF LI & FUNG (SOUTH ASIA) LIMITED A COMPANY INCORPORATED IN MAURITIUS WHICH IS A PART OF THE LI & FUNG GROUP. LI & FUNG GROUP WOR LD WIDE WHICH HAS A NETWORK WORLD OVER IN EXPORT TRADING. THE ASSESSE E IS PROVIDING BUYING / SOURCING SERVICES TO CLIENTS LOCATED WORLD OVER. D URING THE FINANCIAL YEAR 2005-06 RELEVANT TO ASSESSMENT YEAR 2006-07 THE AS SESSEE ENTERED INTO THE INTERNATIONAL TRANSACTIONS FOR ITS AFFILIATED LI & FUNG (TRADING) LIMITED HONG KONG. AS DECLARED THE ASSESSEE RECEIVED SERVICE C HARGES FOR PROVIDING BUYING SERVICES AS COST PLUS MARK UP OF 5%. AS PER THE PROVISIONS OF SECTION 92D OF THE INCOME-TAX ACT READ WITH RULE 10B OF INC OME-TAX RULES THE ASSESSEE MAINTAINED AND DETERMINED ARMS LENGTH PRIC E (HEREINAFTER REFERRED TO AS ALP) OF THE INTERNATIONAL TRANSACTION OF PROV ISION OF BUYING SERVICES APPLYING TRANSACTIONAL NET MARGIN METHOD (HEREINAFT ER REFERRED TO AS TNMM) AND ASSESSEE IDENTIFIED THIS METHOD AS THE MO ST APPROPRIATE METHOD FOR SUCH TRANSACTIONS. 3. ON THE REFERENCE TO THE TRANSFER PRICING OFFICER (HEREINAFTER REFERRED TO AS TPO) THE TPO HELD THAT COST PLUS COMPENSATION @ 5% OF COST OF THE ASSESSEE IS NOT AT ARMS LENGTH AND HE DECIDED THAT IT IS NOT REFLECTING THE PROFIT ITA NO.5156/DEL./2010 3 ATTRIBUTABLE TO THE ASSESSEE. THE TPO HELD THIS CO ST PLUS 5% IS NOT AT ARMS LENGTH FOR THE FOLLOWING REASONS :- A) THE APPELLANT HAS PERFORMED ALL THE CRITICAL FU NCTIONS ASSUMED SIGNIFICANT RISKS AND USED BOTH TANGIBLES A ND UNIQUE INTANGIBLES DEVELOPED BY IT OVER A PERIOD OF TIME. B) THERE IS NO EVIDENCE THAT THE AE HAS EITHER TECH NICAL CAPACITY OR MANPOWER TO ASSIST THE APPELLANT AND TH AT IN THE ABSENCE OF ANY CREDIBLE EVIDENCE SUCH GENERAL REMA RKS TO SOMEHOW PROVE THE INVOLVEMENT OF THE AE CANNOT BE A CCEPTED (REFER PAGE. C) THE APPELLANT HAS DEVELOPED SEVERAL UNIQUE INTAN GIBLES WHICH HAVE GIVEN AN ADVANTAGE TO THE AE IN THE FORM OF THE LOW COST OF THE PRODUCT QUALITY OF THE PRODUCT AND ENH ANCED THE PROFITABILITY OF THE AE. THESE INTANGIBLES HAVE INC REASED PROFIT POTENTIAL OF THE AE THOUGH COST FOR DEVELOPMENT AND USE OF INTANGIBLES WAS NOT TAKEN FOR COMPUTATIONS OF ROUTI NE MARKUP OF 5% CONSIDERED BY THE APPELLANT. D) THE APPELLANT HAS DEVELOPED THE SUPPLY CHAIN MANAGEMENT WHICH MANAGES THE LINK BETWEEN AND ORGAN IZATION AND ITS SUPPLIERS AND CUSTOMER TO ACHIEVE STRATEGIC AND PRICING ADVANTAGE. E) THE APPELLANT HAS DEVELOPED AND OWNED HUMAN CAPI TAL INTANGIBLE AT ITS OWN COST AND ALL THE RELATED RISK S IN CREATION AND MAINTENANCE OF HUMAN INTANGIBLE ARE BORNE BY TH E APPELLANT. F) THE AE HAS RECOGNIZED THAT INDIA OFFERS BOTH COS T AND OPERATIONAL ADVANTAGE SUCH AS LOWER SALARIES FOR TH E EMPLOYEES LOW COST MATERIAL AND LOW COST MANUFACTURE. ACCORDI NGLY THE APPELLANT HAS NEITHER QUANTIFIED LOCATIONAL SAVING NOR THE AE HAS ATTRIBUTED ANY PART OF THE ADDITIONAL PROFIT ON ACCOUNT OF LOCATIONAL SAVING TO THE APPELLANT IN INDIA. ITA NO.5156/DEL./2010 4 THE TPO APPLIED THE MARK UP OF 5% OF FOB VALUE OF E XPORTS. THE TOTAL EXPORTS WERE OF RS.1202.96 CRORES AND ACCORDINGLY H E COMPUTED NET OPERATING INCOME ON THE FOB VALUE OF EXPORTS AT RS.60 14 80 0 00/-. THE ASSESSEE APPROACHED THE DRP AND THE DRP HAS GIVEN THE FOLLOW ING DIRECTIONS :- 'INTERNATIONAL TRANSACTIONS HAVE TO BE JUDGED AT A DIFFERENT LEVEL AS OPPOSED TO TRANSACTIONS COVERED BY THE DOMESTIC LAW. THE OECD ALSO RECOGNIZES THE FACT THAT RELATED PARTIES MAY FASHION THEIR TRANSACTIONS IN SUCH A MANNER THAT MAY CALL F OR LOOKING AT THE SUBSTANCE OF TRANSACTIONS OVER THE FORM THEY AR E GIVEN. THE RELEVANT PORTIONS OF THE OECD GUIDELINES ISSUED ON 22.07.20 I 0 ARE AS BELOW: [QUOTE] 1.67. ASSOCIATED ENTERPRISES ARE ABLE TO MAKE A SUC H GREATER VARIETY OF CONTRACTS AND ARRANGEMENTS THAN CAN INDE PENDENT ENTERPRISES BECAUSE THE NORMAL CONFLICT OF INTEREST WHICH WOULD EXIST BETWEEN INDEPENDENT PARTIES IS OFTEN ABSENT. ASSOCIATED ENTERPRISES MAY AND FREQUENTLY DO CONCLUDE ARRANGEM ENTS OF A SPECIFIC NATURE THAT ARE NOT OR ARE VERY RARELY ENC OUNTERED BETWEEN INDEPENDENT PARTIES. THIS MAY BE DONE FOR V ARIOUS ECONOMIC LEGAL OR FISCAL REASONS DEPENDENT ON THE CIRCUMSTANCES IN THE PARTICULAR CASE. MOREOVER CON TRACTS WITHIN AN MNE COULD BE QUITE EASILY ALTERED SUSPENDED EX TENDED OR TERMINATED ACCORDING TO THE OVERALL STRATEGIES OF T HE MNE AS A WHOLE AND SUCH ALTERATIONS MAY EVEN BE MADE RETROA CTIVELY. IN SUCH INSTANCES TAX ADMINISTRATIONS WOULD HAVE TO DE TERMINE WHAT THE UNDERLYING REALITY IS BEHIND A CONTRACTUAL ARRANGEMENT IN APPLYING THE ARM'S LENGTH PRINCIPLE. 1.68 IN ADDITION TAX ADMINISTRATIONS MAY FIND IT U SEFUL TO REFER TO ALTERNATIVELY STRUCTURED TRANSACTIONS BETWEEN IN DEPENDENT ENTERPRISES TO DETERMINE WHETHER THE CONTROLLED TRA NSACTION AS STRUCTURED SATISFIED THE ARM'S LENGTH PRINCIPLE. WH ETHER EVIDENCE FROM A PARTICULAR ALTERNATIVE CAN BE CONSI DERED WILL DEPEND ON THE FACTS AND CIRCUMSTANCES OF THE PARTIC ULAR CASE INCLUDING THE NUMBER AND ACCURACY OF THE ADJUSTMENT S NECESSARY TO ACCOUNT FOR DIFFERENCES BETWEEN THE CO NTROLLED ITA NO.5156/DEL./2010 5 TRANSACTION AND THE ALTERNATIVE AND THE QUALITY OF ANY OTHER EVIDENCE THAT MAY BE AVAILABLE. [UNQUOTE] THEREFORE THE ASSESSEE'S CLAIMS THAT IT DOES NOT B EAR THE RISKS OF A NORMAL TRADER HAVE TO BE TESTED IN THIS LIGHT. AC CORDINGLY WE ARE INCLINED TO ACCEPT THE TPO'S CONCLUSION THAT TH E FOB VALUE OF GOODS SHOULD FORM PART OF THE COST BASE FOR CALC ULATING THE REMUNERATION THAT SHOULD ACCRUE TO THE ASSESSEE. TH AT LEADS TO THE NEXT QUESTION AS TO WHAT SHOULD BE THE CORRECT MARKUP THAT SHOULD BE APPLIED. THE TPO HAS APPLIED THE MARKUP O F 5% BECAUSE THE ASSESSEE IS OPERATING ON A COST PLUS 5% MODEL. HOWEVER WHEN WE ARE INCREASING THE COST BASE MANIF OLD THE APPLICATION OF A MARKUP OF 5% WILL BE EXCESSIVE. WE ACCORDINGLY HOLD THAT GIVEN THE FACTS AND CIRCUM STANCES OF THE CASE A MARKUP OF 3% WILL BE REASONABLE. THIS WI LL ADEQUATELY COVER THE VALUABLE INTANGIBLES THAT HAVE BEEN DEVELOPED AND USED BY THE ASSESSEE AS ALSO THE LOCA TION SAVING THAT THE ASSESSEE IS PASSING ON TO ITS AE.' 4. AFTER CONSIDERING THE ASSESSEES PLEADINGS BEFOR E THE DRP THEY UPHOLD THE TPOS CONCLUSION THAT FOB VALUE OF GOODS EXPORT ED SHOULD FORM PART OF THE COST BASE FOR CALCULATING THE REMUNERATION THAT SHOULD ACCRUE TO THE ASSESSEE. HOWEVER THE DRP CONSIDERED THE MARK UP OF THE 5% AS EXCESSIVE AND CONSIDERED 3% AS REASONABLE. THEY HAVE ALSO NO TED THAT 3% MARK UP WILL ADEQUATELY COVER THE VALUABLE INTANGIBLES THAT HAVE BEEN USED AND DEVELOP BY THE ASSESSEE AS ALSO THE LOCATION SAVING THAT THE A SSESSEE IS PASSING ON TO ITS ASSOCIATED ENTERPRISES (AE) AND ON THAT BASIS THE ADDITION WAS MADE OF RS.33 59 69 186/-. 5. THE GROUNDS OF APPEAL READ AS UNDER :- ITA NO.5156/DEL./2010 6 1. THAT THE ASSESSING OFFICER ERRED ON FACTS AND I N LAW IN COMPLETING THE ASSESSMENT UNDER SECTION 144C/143(3) OF THE INCOME-TAX ACT 1961 ('THE ACT') AT AN INCOME OF RS.36 67 95 634 AS AGAINST THE INCOME OF RS.3 08 26 448 RETURNED BY THE APPELLANT. 1. THAT THE ASSESSING OFFICER ERRED ON FACTS AND IN LAW IN MAKING AN ADJUSTMENT OF RS.33 59 69 186 TO THE ARM 'S LENGTH PRICE OF THE' INTERNATIONAL TRANSACTION OF PROVISIO N OF BUYING SERVICES ON THE BASIS OF THE ORDER PASSED UNDER SEC TION 92CA(3) OF THE ACT BY THE TRANSFER PRICING OFFICER ('THE TPO'). 1.2 THAT THE ASSESSING OFFICER ERRED ON FACTS AND IN LAW IN ARBITRARILY DETERMINING THE ARM'S LENGTH PRICE OF R ENDERING OF BUYING SERVICES UNDERTAKEN BY THE APPELLANT AT 3% O F THE FOB VALUE OF EXPORT MADE BY UNRELATED PARTY VENDOR. 1 .3 THAT THE ASSESSING OFFICER! TPO ERRED ON FACT S AND IN LAW IN NOT APPRECIATING THAT THE INTERNATIONAL TRANSACT ION OF PROVISION OF BUYING SERVICES WAS AT ARM'S LENGTH AN D NO ADJUSTMENT TO THE PRICE THEREOF WAS CALLED FOR BEIN G MADE. 1.4 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACTS AND IN LAW IN ARBITRARILY INCLUDING THE FOB VALUE OF EXPORTS I N THE COST BASE (I.E. SALES MADE THROUGH THE APPELLANT) OF THE APPELLANT FOR THE PURPOSE OF COMPUTING THE ARM'S LENGTH PROFIT MA RGIN OF THE APPELLANT. 1.5 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACTS AND IN LAW IN NOT APPRECIATING THAT IN TERMS OF RULE 10B(1)(E) OF THE INCOME-TAX RULES IT WAS IMPERMISSIBLE TO CONSIDER THE COST INCURRED BY UNRELATED ENTERPRISE TO COMPUTE NET PRO FIT MARGIN OF THE APPELLANT WHILE APPLYING TNMM. 1.6 THAT THE ASSESSING OFFICER / TPO ERRED ON FACT S AND IN LAW IN NOT APPRECIATING THAT THE APPELLANT DOES NOT UND ERTAKE SIGNIFICANT FUNCTIONS OF MANUFACTURE AND SALE OF GA RMENTS NOR DOES NOT EMPLOY THE ASSETS AND ASSUME RISKS IN RELA TION TO SUCH ACTIVITIES AND IT WAS INAPPROPRIATE TO CONSIDER THE COST OF SUCH THIRD PARTY VENDORS AS PART OF THE COST OF THE APPE LLANT TO ITA NO.5156/DEL./2010 7 DETERMINE THE ARM'S LENGTH PRICE OF THE INTERNATION AL TRANSACTIONS OF RENDERING BUYING SERVICES. 1.7 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACTS AND IN LAW IN HOLDING THAT THE APPELLANT HAS BORNE ALL THE MAJ OR RISKS ASSOCIATED WITH THE FUNCTIONS PERFORMED BY THE APPE LLANT AND THAT SINCE SIGNIFICANT VALUE ADDED BENEFIT AND STRA TEGIC ADVANTAGES HAVE BEEN PROVIDED TO THE AE BY THE APPE LLANT THE APPELLANT SHOULD BE ALLOWED TO SHARE THE BENEFIT IN THE COST PLUS ARRANGEMENT. 1 .8 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACT S AND IN LAW IN HOLDING THAT THE APPELLANT IS THE OWNER OF SUPPL Y CHAIN MANAGEMENT AND HUMAN ASSET INTANGIBLES IN INDIA AND WAS ENTITLED TO A RETURN/ MARK-UP INCLUDING COST OF GOO DS SOURCED BY IT COST OF DEVELOPMENT AND USE OF INTANGIBLES. 1.9 THAT THE ASSESSING OFFICER! TPO ERRED ON FACTS AND IN LAW IN HOLDING THAT NO EVIDENCE HAS BEEN PROVED THAT TH E AE HAS EITHER TECHNICAL CAPACITY OR MANPOWER TO ASSIST THE APPELLANT WITHOUT APPRECIATING THAT THE FUNCTIONS OF THE AE W ERE ELABORATED IN THE TRANSFER PRICING DOCUMENTATION. 1.10 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACTS AND IN LAW IN DISREGARDING THE FUNCTIONAL ASSET AND RISK PROF ILE OF THE APPELLANT AS SUBMITTED IN ITS TRANSFER PRICING DOCU MENTATION ON THE BASIS OF PRECONCEIVED NOTIONS AND WITHOUT ANY B ASIS OR EVIDENCE. 1.11 THAT THE ASSESSING OFFICER/ TPO ERRED ON FACT S AND IN LAW IN NOT APPRECIATING THAT THE APPELLANT IS A LOW RIS K CAPTIVE CONTRACT SERVICE PROVIDER AND DOES NOT BEAR SIGNIFI CANT BUSINESS AND OPERATIONAL RISKS. 1.12 THAT THE ASSESSING OFFICER / TPO ERRED ON FACT S AND IN LAW IN NOT APPRECIATING THAT SINCE THE APPELLANT IS ME RELY RENDERING BUYING SUPPORT SERVICES TO THE ASSOCIATED ENTERPRIS E UNDER RISK FREE MODEL FOR EXPORT OF GOODS BY UNRELATED PARTY V ENDOR TO THE OVERSEAS CUSTOMERS NO BENEFIT ALLEGEDLY ON ACCOUNT OF LOCATION SAVING COULD BE ATTRIBUTED TO THE APPELLANT. ITA NO.5156/DEL./2010 8 1.13 WITHOUT PREJUDICE THAT THE ASSESSING OFFICER / TPO ERRED ON FACTS AND IN LAW IN NOT APPRECIATING THAT THE APPELLANT HAS RECEIVED NEARLY 80% OF THE ENTIRE CONSIDERATION RECEIVED BY THE ASSOCIATED ENT ERPRISE FOR RENDERING SOURCING SERVICES AND THE ASSOCIATED ENTE RPRISE HAS RETAINED ONLY 20% OF THE TOTAL CONSIDERATION ON ACC OUNT OF FUNCTIONS PERFORMED ASSETS UTILIZED AND RISKS ASSU MED AT THEIR OWN THERE COULD NOT BE ANY ALLEGATION AS TO TRANSF ER OF PROFIT FROM INDIA. 1.14 WITHOUT PREJUDICE THAT THE ASSESSING OFFICER / TPO ERRED ON FACTS AND IN LAW IN NOT APPRECIATING THAT WHILE THE APPELLANT HAS EARNED OP ERATING PROFIT MARGIN OF 5.46% THE ASSOCIATED ENTERPRISE HAD EARN ED A MEAGER PROFIT MARGIN OF 0.99% AND THEREFORE ADDITION ON ACCOUNT OF ALLEGED DIFFERENCE IN ARM'S LENGTH PRICE OF INTERNA TIONAL TRANSACTIONS IS NOT WARRANTED. 1.15 WITHOUT PREJUDICE THAT THE ASSESSING OFFICER / TPO ERRED ON FACTS AND IN LAW IN NOT APPRECIATING THAT THE ADJUSTMENT ON ACCOUNT OF THE ALLEGED DIFFERENCE IN ARM'S LENGTH PRICE COULD NOT EXCEED T HE TOTAL AMOUNT OF REVENUE RETAINED BY THE ASSOCIATED ENTERP RISE IN RESPECT OF SUCH INTERNATIONAL TRANSACTIONS OF RENDE RING BUYING SERVICES AFTER REDUCING THE APPROPRIATE COST IN REL ATION THERETO. 1.16 WITHOUT PREJUDICE THAT THE TPO ERRED IN LAW IN NOT ALLOWING VARIATION TO THE EXTENT OF (+/-)5% WHILE DETERMINING THE ARM'S LENGTH PRICE OF THE 'INTERNATIONAL TRANSA CTIONS' THE APPELLANT CRAVES LEAVE TO ADD ALTER AMEND OR VARY FROM THE AFORESAID GROUNDS OF APPEAL BEFORE OR AT THE TIME O F HEARING. 6. THE LEARNED AR FOR THE ASSESSEE PLEADED THAT THE APPELLANT IS A COMPANY INCORPORATED UNDER THE COMPANIES ACT 1956 ENGAGED IN THE BUSINESS OF PROVIDING BUYING AND SOURCING SERVICES TO THE CUSTOMERS ABROAD. THE APPELLANT IS A SUBSIDIARY COMPANY OF LI & FUNG (SOUTH ASIA) LTD. A ITA NO.5156/DEL./2010 9 COMPANY INCORPORATED IN MAURITIUS AND IS A PART OF THE LI & FUNG GROUP WHICH IS ONE OF THE WORLD LEADERS IN EXPORT TRADING HAVING A WORLDWIDE NETWORK SUBSTANTIAL EXPERIENCE KNOW-HOW AND MARKE T PRESENCE. THE APPELLANT PROVIDES BUYING/SOURCING SERVICES TO THE GROUP COMPANIES FOR SUPPLY OF HIGH VOLUME TIME SENSITIVE CONSUMER GOOD S. THE APPELLANT IS PAID SERVICE CHARGES FOR THE BUYING/SOURCING SERVICES RE NDERED TO THE GROUP COMPANIES AT COST PLUS MARKUP OF 5%. FOR THE PREVIO US YEAR RELEVANT TO ASSESSMENT YEAR 2006-07 THE APPELLANT FILED IT'S R ETURN OF INCOME ON 01-12- 2006 DECLARING INCOME OF RS.3 08 26 448. THE ASSES SMENT WAS HOWEVER COMPLETED VIDE ORDER DATED 08.10.2010 PASSED UNDER SECTION 143(3) READ WITH SECTION 144C OF THE INCOME TAX ACT 1961 (THE 'ACT' ) AT AN INCOME OF RS.36 67 95 634 AFTER MAKING AN ADDITION OF RS.33 59 69 186 ON ACCOUNT OF DIFFERENCE IN THE ARM'S LENGTH PRICE OF THE INTERNA TIONAL TRANSACTIONS UNDERTAKEN BY THE APPELLANT. HE FURTHER SUBMITTED T HAT DURING THE FINANCIAL YEAR 2005-06 THE APPELLANT ENTERED INTO THE INTERN ATIONAL TRANSACTION OF PROVISION OF BUYING SERVICES FOR SOURCING OF GARMEN TS HANDICRAFTS LEATHER PRODUCTS ETC. IN INDIA FOR ITS AFFILIATE LI & FUNG (TRADING) LIMITED HONG KONG. THE APPELLANT IS PAID SERVICE CHARGES FOR PRO VIDING BUYING SERVICES COMPUTED AT COST PLUS MARK UP OF 5 PER CENT. IN TH E TRANSFER PRICING DOCUMENTATION MAINTAINED IN TERMS OF SECTION 92D OF THE ACT READ WITH RULE 10B OF THE INCOME-TAX RULES DETERMINED ARM'S LENGT H PRICE OF THE ITA NO.5156/DEL./2010 10 INTERNATIONAL TRANSACTION' OF PROVISION OF BUYING SERVICES APPLYING TRANSACTIONAL NET MARGIN METHOD ('TNMM') BY COMPAR ING OPERATING PROFIT MARGIN OF THE APPELLANT WITH THAT OF THE COMPARABLE COMPANIES AS UNDER: WEIGHTED AVERAGE OP/ OC % OF 26 COMPARABLE COMPANIES 4.07% OP/ OC % OF THE APPELLANT 5.17% HAVING REGARD TO THE AFORESAID ANALYSIS SUCH INTER NATIONAL TRANSACTIONS ENTERED INTO BY THE APPELLANT ARE CONSIDERED TO BE AT ARM'S LENGTH AS PER THE TRANSACTIONAL NET MARGIN METHOD WHICH IS IDENTIFIE D AS THE MOST APPROPRIATE METHOD FOR SUCH TRANSACTIONS IN TERMS OF SECTION 92 OF THE ACT. THE TRANSFER PRICING OFFICER ('TPO') IN HIS ORDER DATED 28.10.20 09 HOWEVER HELD THAT THE COST PLUS COMPENSATION @ 5% OF COST OF THE APPELLAN T IS NOT AT ARM'S LENGTH BECAUSE IT DOES NOT INCLUDE PROFIT ATTRIBUTABLE TO THE APPELLANT DUE TO THE FOLLOWING REASONS- A) THE APPELLANT HAS PERFORMED ALL THE CRITICAL FUN CTIONS ASSUMED SIGNIFICANT RISKS AND USED BOTH TANGIBLES A ND UNIQUE INTANGIBLES DEVELOPED BY IT OVER A PERIOD OF TIME. B) THERE IS NO EVIDENCE THAT THE AE HAS EITHER TECH NICAL CAPACITY OR MANPOWER TO ASSIST THE APPELLANT AND TH AT IN THE ABSENCE OF ANY CREDIBLE EVIDENCE SUCH GENERAL REMARKS TO SOMEHOW PROVE THE INVOLVEMENT OF THE AE CANNOT BE ACCEPTED (REFER PAGE. C) THE APPELLANT HAS DEVELOPED SEVERAL UNIQUE INTAN GIBLES WHICH HAVE GIVEN AN ADVANTAGE TO THE AE IN THE FORM OF THE LOW COST OF THE PRODUCT QUALITY OF THE PRODUCT AND ITA NO.5156/DEL./2010 11 ENHANCED THE PROFITABILITY OF THE AE. THESE INTANGI BLES HAVE INCREASED PROFIT POTENTIAL OF THE AE THOUGH CO ST FOR DEVELOPMENT AND USE OF INTANGIBLES WAS NOT TAKEN FO R COMPUTATIONS OF ROUTINE MARKUP OF 5% CONSIDERED BY THE APPELLANT. D) THE APPELLANT HAS DEVELOPED THE SUPPLY CHAIN MANAGEMENT WHICH MANAGES THE LINK BETWEEN AND ORGANIZATION AND ITS SUPPLIERS AND CUSTOMER TO ACHI EVE STRATEGIC AND PRICING ADVANTAGE. E) THE APPELLANT HAS DEVELOPED AND OWNED HUMAN CAPI TAL INTANGIBLE AT ITS OWN COST AND ALL THE RELATED RISK S IN CREATION AND MAINTENANCE OF HUMAN INTANGIBLE ARE BO RNE BY THE APPELLANT. F) THE AE HAS RECOGNIZED THAT INDIA OFFERS BOTH COS T AND OPERATIONAL ADVANTAGE SUCH AS LOWER SALARIES FOR TH E EMPLOYEES LOW COST MATERIAL AND LOW COST MANUFACTU RE. ACCORDINGLY THE APPELLANT HAS NEITHER QUANTIFIED LOCATIONAL SAVING NOR THE AE HAS ATTRIBUTED ANY PAR T OF THE ADDITIONAL PROFIT ON ACCOUNT OF LOCATIONAL SAVI NG TO THE APPELLANT IN INDIA. ON ACCOUNT OF THE AFORESAID THE TPO APPLIED THE MA RK-UP OF 5% TO THE FOB VALUE OF EXPORTS BEING 1202.96 CRORES AND ACCORDING LY COMPUTED AN ADDITION OF RS.57 65 61 186 TO THE INCOME OF THE APPELLANT AS UNDER: DESCRIPTION RUPEES NET OPERATING INCOME (5% ON THE FOB VALUE OF EXPORTS RS.1 202.96 CRORES) A 601 480 000 OPERATING INCOME SHOWN BY THE ASSESSEE B 24 918 814 DIFFERENCE A-B 576 561 186 ITA NO.5156/DEL./2010 12 THE DISPUTE RESOLUTION PANEL HOWEVER VIDE ORDER D ATED 30-09-2010 ISSUED FOLLOWING DIRECTIONS IN TERMS OF SECTION 144C(5) OF THE ACT: 'INTERNATIONAL TRANSACTIONS HAVE TO BE JUDGED AT A DIFFERENT LEVEL AS OPPOSED TO TRANSACTIONS COVERED BY THE DOMESTIC LAW. THE OECD ALSO RECOGNIZES THE FACT THA T RELATED PARTIES MAY FASHION THEIR TRANSACTIONS IN S UCH A MANNER THAT MAY CALL FOR LOOKING AT THE SUBSTANCE O F TRANSACTIONS OVER THE FORM THEY ARE GIVEN. THE RELE VANT PORTIONS OF THE OECD GUIDELINES ISSUED ON 22.07.201 0 ARE AS BELOW: [QUOTE] 1.67. ASSOCIATED ENTERPRISES ARE ABLE TO MAKE A SUC H GREATER VARIETY OF CONTRACTS AND ARRANGEMENTS THAN CAN INDEPENDENT ENTERPRISES BECAUSE THE NORMAL CONFLICT OF INTEREST WHICH WOULD EXIST BETWEEN INDEPENDENT PART IES IS OFTEN ABSENT. ASSOCIATED ENTERPRISES MAY AND FREQUE NTLY DO CONCLUDE ARRANGEMENTS OF A SPECIFIC NATURE THAT ARE NOT OR ARE VERY RARELY ENCOUNTERED BETWEEN INDEPENDENT PARTIES. THIS MAY BE DONE FOR VARIOUS ECONOMIC LEG AL OR FISCAL REASONS DEPENDENT ON THE CIRCUMSTANCES IN TH E PARTICULAR CASE. MOREOVER CONTRACTS WITHIN AN MNE COULD BE QUITE EASILY ALTERED SUSPENDED EXTENDED OR TERMINATED ACCORDING TO THE OVERALL STRATEGIES OF T HE MNE AS A WHOLE AND SUCH ALTERATIONS MAY EVEN BE MADE RETROACTIVELY. IN SUCH INSTANCES TAX ADMINISTRATION S WOULD HAVE TO DETERMINE WHAT THE UNDERLYING REALITY IS BE HIND A CONTRACTUAL ARRANGEMENT IN APPLYING THE ARM'S LENGT H PRINCIPLE. 1.68 IN ADDITION TAX ADMINISTRATIONS MAY FIND IT U SEFUL TO REFER TO ALTERNATIVELY STRUCTURED TRANSACTIONS BETW EEN INDEPENDENT ENTERPRISES TO DETERMINE WHETHER THE CONTROLLED TRANSACTION AS STRUCTURED SATISFIED THE ARM'S LENGTH PRINCIPLE. WHETHER EVIDENCE FROM A PARTICULA R ALTERNATIVE CAN BE CONSIDERED WILL DEPEND ON THE FA CTS AND CIRCUMSTANCES OF THE PARTICULAR CASE INCLUDING THE NUMBER AND ACCURACY OF THE ADJUSTMENTS NECESSARY TO ACCOUNT FOR DIFFERENCES BETWEEN THE CONTROLLED ITA NO.5156/DEL./2010 13 TRANSACTION AND THE ALTERNATIVE AND THE QUALITY OF ANY OTHER EVIDENCE THAT MAY BE AVAILABLE. [UNQUOTE] THEREFORE THE ASSESSEE'S CLAIMS THAT IT DOES NOT B EAR THE RISKS OF A NORMAL TRADER HAVE TO BE TESTED IN THIS LIGHT. ACCORDINGLY WE ARE INCLINED TO ACCEPT THE TPO'S CONCLUSION THAT THE FOB VALUE OF GOODS SHOULD FORM PART OF THE COST BASE FOR CALCULATING THE REMUNERATION T HAT SHOULD ACCRUE TO THE ASSESSEE. THAT LEADS TO THE NE XT QUESTION AS TO WHAT SHOULD BE THE CORRECT MARKUP TH AT SHOULD BE APPLIED. THE TPO HAS APPLIED THE MARKUP O F 5% BECAUSE THE ASSESSEE IS OPERATING ON A COST PLUS 5% MODEL. HOWEVER WHEN WE ARE INCREASING THE COST BAS E MANIFOLD THE APPLICATION OF A MARKUP OF 5% WILL BE EXCESSIVE. WE ACCORDINGLY HOLD THAT GIVEN THE FACTS AND CIRCUMSTANCES OF THE CASE A MARKUP OF 3% WILL BE REASONABLE. THIS WILL ADEQUATELY COVER THE VALUABLE INTANGIBLES THAT HAVE BEEN DEVELOPED AND USED BY TH E ASSESSEE AS ALSO THE LOCATION SAVING THAT THE ASSES SEE IS PASSING ON TO ITS AE.' ACCORDINGLY THE ADDITION ON ACCOUNT OF THE ALLEGED DIFFERENCE IN THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS OF PROVI SION OF BUYING / SOURCING SERVICES WAS COMPUTED AT RS.33 59 69 186 AS FOLLOW S: DESCRIPTION RUPEES NET OPERATING INCOME (3% OF THE FOB VALUE OF EXPORTS I.E. 3% OF RS.1202.96 CRORES) 36 08 88 000 OPERATING INCOME SHOWN BY THE ASSESSEE 2 49 18 814 DIFFERENCE OF THE ABOVE 33 59 69 186 ITA NO.5156/DEL./2010 14 THE ADDITION OF RS.33 59 69 186 MADE ON ACCOUNT OF DIFFERENCE IN THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS OF BUYIN G / SOURCING SERVICES AS AFORESAID IS UNLAWFUL AND NOT SUSTAINABLE FOR THE REASONS THAT THE I.T.O. APPLIED TNMM METHOD AGAINST THE T.P. REGULATIONS. FOR THE PURPOSE OF DETERMINING THE ARM'S LENGTH PRICE IN RELATION TO T HE INTERNATIONAL TRANSACTIONS IN TERMS OF SUB-SECTION (2) OF SECTION 92C OF THE A CT RULE 10B OF THE RULES PROVIDES THE MANNER OF APPLICATION OF THE VARIOUS P RESCRIBED METHODS. CLAUSE (E) OF SUB-RULE (1) OF RULE 10B OF THE RULES PROVID ES FOR APPLICATION OF TRANSACTIONAL NET MARGIN METHOD AS UNDER :- '(E) TRANSACTIONAL NET MARGIN METHOD BY WHICH -- (I) THE NET PROFIT MARGIN REALISED BV THE ENTERPRIS E FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH AN ASSOCIATED ENTERPRISE IS COMPUTED IN RELATION TO COSTS INCURRED OR SALES EFFECTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY THE ENTERPRISE OR HAVING REGARD TO ANY OTHER RELEVANT BASE; (II) THE NET PROFIT MARGIN REALISED BY THE ENTERPRI SE OR BY AN UNRELATED ENTERPRISE FROM A COMPARABLE UNCONTROLLED TRANSACTION OR A NUMBER OF SUCH TRANSACTIONS IS COMPUTED HAVING REGARD TO THE SAME BASE; (III) THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAU SE (II) ARISING IN COMPARABLE UNCONTROLLED TRANSACTIONS IS ADJUSTED TO TAKE INTO ACCOUNT THE DIFFERENCES IF ANY BETWEEN THE INTER NATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS OR BETWEEN THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS WHICH COULD MATERIALLY AFFECT THE AMOUNT OF NET PROFIT MARGIN IN THE OPEN MARKET; ITA NO.5156/DEL./2010 15 (IV) THE NET PROFIT MARGIN REALISED BY THE ENTERPRI SE AND REFERRED TO IN SUB-CLAUSE (I) IS ESTABLISHED TO BE THE SAME AS THE NET PROFIT MARGIN REFERRED TO IN SUB-CLAUSE (III); (V) THE NET PROFIT MARGIN THUS ESTABLISHED IS THEN TAKEN INTO ACCOUNT TO ARRIVE AT AN ARM'S LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION. ' TNMM EXAMINES THE NET PROFIT MARGIN RELATIVE TO AN APPROPRIATE BASE (E.G. COST SALES ASSETS) THAT A TAXPAYER REALIZES FROM A CONTROLLED TRANSACTION (OR TRANSACTIONS THAT ARE APPROPRIATE TO AGGREGATE UNDE R THE TRANSFER PRICING PRINCIPLES). THE METHOD COMPARES THE PROFITABILITY OF EITHER OF THE CONTROLLED PARTIES WITH THE PROFITABILITY OF THE UNCONTROLLED COMPARABLE(S). FOR APPLICATION OF TNMM IN TERMS OF RULE 10B(I)(E) OF T HE INCOME-TAX RULES ('THE RULES') NET PROFIT MARGIN REALIZED BY THE EN TERPRISE FROM AN INTERNATIONAL TRANSACTION ENTERED INTO WITH THE ASS OCIATED ENTERPRISE IS COMPUTED IN RELATION TO COST INCURRED OR SALES AFFE CTED OR ASSETS EMPLOYED OR TO BE EMPLOYED BY THE ENTERPRISE. FOR APPLYING TNMM T HEREFORE IT WOULD BE NOTED NET PROFIT MARGIN REALIZED FROM THE INTERNAT IONAL TRANSACTIONS BY THE APPELLANT IS TO BE COMPUTED ONLY WITH REFERENCE TO COST INCURRED BY THE APPELLANT ITSELF. THERE IS NO PROVISION UNDER RULE 10B(1)(E) OF THE RULES TO CONSIDER OR IMPUTE COST INCURRED BY THIRD PARTIES O R UNRELATED ENTERPRISES TO COMPUTE NET PROFIT MARGIN OF THE APPELLANT ENTERPRI SE FOR APPLICATION OF TNMM. THE TPO IN THE IMPUGNED ORDER ENHANCED THE COST BASE OF THE APPELLANT ENTERPRISE ARTIFICIALLY BY CONSIDERING TH E COST OF MANUFACTURE AND ITA NO.5156/DEL./2010 16 EXPORT OF FINISHED GOODS I.E. READYMADE GARMENTS BY THIRD PARTY VENDERS (WHICH COST IS CERTAINLY NOT THE COST INCURRED BY T HE APPELLANT) WHICH IS CLEARLY INCONSISTENT WITH THE MANNER OF APPLICATION OF TNMM AS PROVIDED IN RULE 10B(1)(E) OF THE RULES. THE TPO'S CONTENTION OF ENHANCING THE COST BASE OF THE APPELLANT ARTIFICIALLY BY CONSIDERING THE CO ST OF MANUFACTURE AND EXPORT OF FINISHED GOODS I.E. READYMADE GARMENTS BY THIR D PARTY VENDERS (WHICH COST IS CERTAINLY NOT THE COST INCURRED BY THE APPELLANT ) CLEARLY AMOUNTS TO IMPUTING NOTIONAL ADJUSTMENT / INCOME IN THE HANDS OF THE APPELLANT ON THE BASIS OF A FIXED PERCENTAGE OF THE FOB VALUE OF EXP ORT MADE BY UNRELATED PARTY VENDORS. THEREFORE THE VALUE OF EXPORTS BY TH E THIRD PARTY VENDORS TO THIRD PARTY CUSTOMERS DOES NOT PROVIDE ANY BENCHMAR K OR BASIS FOR DETERMINING ARM'S LENGTH PRICE. RELIANCE IS ALSO P LACED ON THE DECISION OF THE HON'BLE DELHI BENCH OF THE TRIBUNAL IN THE CASE OF DCIT VS. M/S. CHEIL COMMUNICATION INDIA PVT. LTD. : (ITA NO. 712/DEL/10 ) WHEREIN IT HAS BEEN HELD THAT FOR APPLICATION OF TN MM PAYMENT MADE B Y THE ASSESSEE TO 3RD PARTY VENDERS / MEDIA AGENCY FOR AND ON BEHALF OF T HE PRINCIPAL (WHICH HAS BEEN REIMBURSED BY THE AE) NOT TO BE INCLUDED IN T HE TOTAL COST FOR DETERMINING THE PROFIT MARGIN AND THE MARK-UP IS TO BE APPLIED TO THE COST INCURRED BY THE ASSESSEE COMPANY. THE RELEVANT EXT RACT OF THE ORDER IS AS UNDER: 40. THE RIVAL CONTENTIONS OF BOTH THE PARTIES HAVE BEEN CONSIDERED AND ORDERS OF THE AUTHORITIES BELOW HAVE CAREFULLY ITA NO.5156/DEL./2010 17 BEEN PERUSED. THE ONLY QUESTION THAT FALLS FOR OUR CONSIDERATION IS WITH REGARD TO THE METHOD OF COMPUTING PROFIT/TC MARGIN WHETHER ON GROSS BASIS AS DONE BY THE TPO OR NET BA SIS AS WORKED OUT BY THE ASSESSEE. IN THIS CASE THE ASSESS EE HAS APPLIED TNM METHOD TO DETERMINE ARM'S LENGTH PRICE WHICH H AS ALSO BEEN ACCEPTED BY THE REVENUE AUTHORITIES. THE COMPA RABLES CITED BY THE ASSESSEE HAS ALSO BEEN ACCEPTED BY THE TPO AS APPROPRIATE. IT IS ALSO FOUND BY US THAT IN THE REG ULAR FINANCIAL ACCOUNTS MAINTAINED BY THE COMPARABLE COMPANIES TH E COM PARABLES RECOGNIZE REVENUE ON A NET BASIS. THE ASSE SSEE HAS ALSO RECOGNIZED REVENUES ON A NET BASIS IN ITS FINANCIAL ACCOUNT WHICH HAD BEEN DULY AUDITED BY THE AUDITOR. THE ASS ESSEE HAS COMPUTED THE MARGIN OF OPERATIVE PROFIT ON THE TOTA L COST ON THE BASIS OF NET REVENUE BY WAY OF MARKUP RECEIVED FROM THE ASSOCIATE CONCERN. THE PAYMENT MADE BY THE ASSESSEE TO THIRD PARTY VENDOR/MEDIA AGENCIES FOR AND ON BEHALF OF TH E PRINCIPAL HAS NOT BEEN INCLUDED IN THE TOTAL COST FOR DETERMI NING THE PROFIT MARGIN THOUGH ON THE OTHER HAND THE TPO HAS INCL UDED THE PAYMENT REIMBURSED BY THE ASSESSEE'S ASSOCIATE ENTE RPRISE TO THE ASSESSEE ON ACCOUNT OF PAYMENT MADE TO THIRD PARTY VENDOR/MEDIA AGENCIES. IT IS NOT IN DISPUTE THAT TH E ASSESSEE IS ENGAGED IN UNDERTAKING ADVERTISING SERVICES FOR ITS CUSTOMERS/ASSOCIATE ENTERPRISES IN THE CAPACITY OF AN AGENT. AS PART OF ITS BUSINESS OPERATION THE ASSESSEE FACILI TATES PLACEMENT OF ADVERTISEMENT FOR ITS ASSOCIATE ENTERPRISE IN TH E PRINT/ELECTRONIC ETC. MEDIA AND FOR THAT PURPOSE T HE ASSESSEE IS REQUIRED TO MAKE PAYMENT TO THIRD PARTIES FOR RENDE RING OF ADVERTISEMENT SPACE ON BEHALF OF ITS CUSTOMERS OR A SSOCIATED ENTERPRISES. IT IS THUS CLEAR THAT THE ASSESSEE'S BUSINESS IS NOT SALE OF ADVERTISING SLOTS TO ITS CUSTOMERS OR ASSOC IATE CONCERN. FOR PERFORMING THE FUNCTIONS FOR AND ON BEHALF OF A SSOCIATED ENTERPRISES THE ASSESSEE IS REMUNERATED BY ITS ASS OCIATED ENTERPRISES ON THE BASIS OF A FIXED COMMISSION/CHAR GES BASED ON EXPENSES OR COST INCURRED BY THE ASSESSEE FOR RELEA SE OF A PARTICULAR ADVERTISEMENT. IT IS ALSO TO BE NOTED TH AT ADVERTISING SPACE (BE IT MEDIA PRINT OR OUTDOOR) HAS BEEN LET OUT BY THIRD PARTY VENDORS IN THE NAME OF ULTIMATE CUSTOMERS AND BENEFICIARY OF ADVERTISEMENT. WE HAVE GONE THROUGH THE INVOICES AND PURCHASE ORDERS FROM THIRD PARTY VENDO RS AND FIND THAT THEY CONTAIN CUSTOMERS' NAME AND ALL THE TERM S OF ADVERTISEMENT ARE FINALIZED AFTER TAKING THE APPROV AL FROM THE CUSTOMERS. THE ASSESSEE SIMPLY ACTS AS AN INTERMEDI ARY BETWEEN ITA NO.5156/DEL./2010 18 THE ULTIMATE CUSTOMER AND THE THIRD PARTY VENDOR IN ORDER TO FACILITATE PLACEMENT OF THE ADVERTISEMENT. THE PAYM ENT MADE BY THE ASSESSEE TO VENDORS IS RECOVERED FROM THE RESPE CTIVE CUSTOMERS OR ASSOCIATE ENTERPRISES. IN THE EVENT CU STOMER FAILS TO PAY ANY SUCH AMOUNT TO THE ADVERTISEMENT AGENCY TH E BAD DEBT RISK IS BORNE BY THE THIRD PARTY VENDOR AND NOT BY THE ADVERTISING AGENCY I.E. THE ASSESSEE. IT IS THUS CLEAR THAT THE ASSESSEE HAS NOT ASSUMED ANY RISK ON ACCOUNT OF NON -PAYMENT BY ITS CUSTOMERS OR ASSOCIATED ENTERPRISES. AT THIS STAGE A USEFUL REFERENCE MAY BE MADE TO ITS 2009 TRANSFER PRICING GUIDELINES ACCEPTED BY THE OECD WHERE IT IS LAID DOWN THAT WHE N AN ASSOCIATE ENTERPRISES IS ACTING ONLY AS AN AGENT OR INTERMEDIARY IN THE PROVISION OF SERVICE IT IS IMPORTANT IN APP LYING THE COST PLUS METHOD THAT THE RETURN OR MARK-UP IS APPROPRIA TE FOR THE PERFORMANCE OF AN AGENCY FUNCTION RATHER THAN FOR T HE PERFORMANCE OF THE SERVICES THEMSELVES AND IN SUC H A CASE IT MAY BE NOT APPROPRIATE TO DETERMINE ARM'S LENGTH PR ICE AS A MARK-UP ON THE COST OF SERVICES BUT RATHER ON THE C OST OF AGENCY FUNCTION ITSELF OR ALTERNATIVELY DEPENDING ON THE TYPE OF COMPARABLE DATA BEING USED THE MARK-UP ON THE COST OF SERVICES SHOULD BE LOWER THAN WOULD BE APPROPRIATE FOR THE P ERFORMANCE OF THE SERVICES THEMSELVES. IN THIS TYPE OF CASES IT WILL BE APPROPRIATE TO PASS ON THE COST OF RENDERING ADVERT ISING SPACE TO THE CREDIT RECIPIENT WITHOUT A MARK UP AND TO AP PLY A MARK-UP ONLY TO THE COSTS INCURRED BY THE INTERMEDIARY IN P ERFORMING ITS AGENCY FUNCTION. THESE GUIDELINES ARE AS UNDER:- 3.41 IN APPLYING THE TRANSACTIONAL NET MARGIN METHO D VARIOUS CONSIDERATIONS SHOULD INFLUENCE THE CHOICE OF MARGIN USED. FOR EXAMPLE THESE CONSIDERATIONS WOUL D INCLUDE HOW WELL THE VALUE OF ASSETS EMPLOYED IN TH E CALCULATIONS IS MEASURED (E.G. TO SHAT EXTENT THERE IS INTANGIBLE PROPERTY THE VALUE OF WHICH IS NOT CAPTU RED ON THE BOOKS OF THE ENTERPRISE) AND THE FACTORS AFFECT ING WHETHER SPECIFIC COSTS SHOULD BE PASSED THROUGH MA RKED UP OR EXCLUDED ENTIRELY FROM THE CALCULATION. 41. IN THE PROPOSED REVISION OF CHAPTER I-ILL OF TH E TRANSFER PRICING GUIDELINES ISSUE DON 9TH SEPTEMBER 2009 - 9TH JANUARY 20 I 0 BY GECD IT HAS BEEN PRO VIDED IN PARA 2.134 AS UNDER:- ITA NO.5156/DEL./2010 19 '2.134 IN APPLYING A COST-BASED TRANSACTIONAL NET M ARGIN METHOD FULLY LOADED COSTS ARE OFTEN USED INCLUDIN G ALL THE DIRECT AND INDIRECT COSTS ATTRIBUTABLE TO THE A CTIVITY OR TRANSACTION TOGETHER WITH AN APPROPRIATE ALLOCATIO N IN RESPECT OF THE OVERHEADS OF THE BUSINESS. THE QUEST ION CAN ARISE WHETHER AND TO WHAT EXTENT IT IS ACCEPTAB LE AT ARM'S LENGTH TO TREAT A SIGNIFICANT PORTION OF THE TAXPAYER'S COSTS AS PASS THROUGH COSTS TO WHICH NO PROFIT ELEM ENT IS ATTRIBUTED (I.E. AS COSTS WHICH ARE POTENTIALLY EXC LUDABLE FROM THE DENOMINATOR OF THE NET PROFIT MARGIN INDIC ATOR). THIS DEPENDS ON THE EXTENT TO WHICH AN INDEPENDENT PARTY AT ARM'S LENGTH WOULD ACCEPT NOT TO BE REMUNERATED ON PART OF THE EXPENSES IT INCURS. THE RESPONSE SHOULD NOT BE BASED ON THE CLASSIFICATION OF COSTS AS 'INTERNAL' OR 'EXTERNAL' COSTS BUT RATHER ON A COMPARABILITY (IN CLUDING FUNCTIONAL) ANALYSIS AND IN PARTICULAR ON A DETERM INATION OF THE VALUE ADDED BY THE TESTED PARTY IN RELATION TO THOSE COSTS.' 42. FURTHER OECD IN ITS 2009 TRANSFER PRICING GUIDELINES HAS LAID DOWN AS UNDER:- '7.36 WHEN AN ASSOCIATED ENTERPRISE IS ACTING ONLY AS AN AGENT OR INTERMEDIARY IN THE PROVISION OF SERVICES IT IS IMPORTANT IN APPLYING THE COST PLUS METHOD THAT THE RETURN OR MARK-UP IS APPROPRIATE FOR THE PERFORMANCE OF AN AGENCY FUNCTION RATHER THAN FOR THE PERFORMANCE OF THE SERVICES THEMSELVES. IN SUCH A CASE IT MAY NOT BE APPROPRIATE TO DETERMINE ARM'S LENGTH PRICING AS A MARK- UP ON THE COST OF THE SERVICES BUT RATHER ON THE CO STS OF THE AGENCY FUNCTION ITSELF OR ALTERNATIVELY DEPEN DING ON THE TYPE OF COMPARABLE DATA BEING USED THE MARK-UP ON THE COST OF SERVICES SHOULD BE LOWER THAN WOULD BE APPROPRIATE FOR THE PERFORMANCE OF THE SERVICES THEMSELVES. FOR EXAMPLE AN ASSOCIATED ENTERPRISE M AY INCUR THE COSTS OF RENDING ADVERTISING SPACE ON BEH ALF OF GROUP MEMBERS COSTS THAT THE GROUP MEMBERS WOULD HAVE INCURRED DIRECTLY HAD THEY BEEN INDEPENDENT. I N SUCH A CASE IT MAY WELL BE APPROPRIATE TO PASS ON THESE COSTS TO THE GROUP RECIPIENTS WITHOUT A MARK-UP AND TO A PPLY A MARK-UP ONLY TO THE COSTS INCURRED BY THE INTERMEDI ARY IN PERFORMING ITS AGENCY FUNCTION. ' ITA NO.5156/DEL./2010 20 43. IN THE LIGHT OF THESE GUIDELINES IT WOULD BE THEREFORE CLEAR THAT A MARK-UP IS TO BE APPLIED TO THE COST I NCURRED BY THE ASSESSEE COMPANY IN PERFORMING ITS AGENCY FUNCTION AND NOT TO THE COST OF RENDERING ADVERTISI NG SPACE ON BEHALF OF ITS ASSOCIATE ENTERPRISES. WE FU RTHER FIND THAT THE METHOD ADOPTED BY THE ASSESSEE WHILE SUBMITTING TRANSFER PRICING STUDY BASED ON NET REVE NUE HAS BEEN ACCEPTED BY THE DEPARTMENT IN EARLIER YEAR AND THEREFORE THERE IS NO REASON TO DEPART FROM THAT S TAND ALREADY ACCEPTED BY THE DEPARTMENT IN EARLIER YEAR. IN THE LIGHT OF THE VIEW WE HAVE TAKEN ABOVE WE THEREFORE UPHOLD THE ORDER OF THE LEARNED CIT(A) ON THIS ISSU E AND REJECT THE GROUND RAISED BY THE REVENUE. THE VALUE OF EXPORT BY THE THIRD PARTY VENDORS TO T HIRD PARTY CUSTOMERS DOES NOT PROVIDE ANY BENCHMARK OR BASIS FOR DETERMINING THE ARM'S LENGTH PRICE. THE TPO FOR COMPUTING THE REMUNERATION FOR BUYING S ERVICES RENDERED BY THE APPELLANT ON A COST PLUS BASIS HAS SOUGHT TO INCLU DE IN THE COST OF THE SERVICES RENDERED BY THE APPELLANT THE ENTIRE COST OF GOODS SOLD / EXPORTED BY SUCH THIRD PARTY EXPORTERS / VENDORS. LEARNED AR FURTHER SUBMITTED THAT THIS WOULD ARTIF ICIALLY ENHANCE THE COST BASE OF THE APPELLANT FOR APPLYING THE OP/TC M ARGIN. IT WOULD BE APPRECIATED THAT THE COMPENSATION MODEL OF THE APPE LLANT SHOULD BE BASED ON FUNCTIONS PERFORMED BY IT AND THE OPERATING COSTS I NCURRED BY IT AND NOT ON THE COST OF GOODS SOURCED FROM THIRD PARTY VENDORS IN I NDIA. THUS ALLOCATING A MARGIN OF THE VALUE OF GOODS SOURCED BY THE THIRD P ARTY CUSTOMERS FROM EXPORTERS / VENDORS IN INDIA FOR COMPUTING THE PROF IT MARGIN OF THE APPELLANT IS INAPPROPRIATE AND UNJUSTIFIED. FOR APPLYING TNMM THEREFORE IT WOULD BE ITA NO.5156/DEL./2010 21 NOTED NET PROFIT MARGIN REALIZED FROM THE INTERNAT IONAL TRANSACTIONS BY THE ASSESSEE IS TO BE COMPUTED ONLY WITH REFERENCE TO COST INCURRED BY THE ASSESSEE ITSELF. THERE IS NO PROVISION UNDER RULE 1 0B(1)(E) OF THE RULES TO CONSIDER OR IMPUTE COST INCURRED BY THIRD PARTIES O R UNRELATED ENTERPRISES TO COMPUTE NET PROFIT MARGIN OF THE ASSESSEE ENTERPRIS E FOR APPLICATION OF TNMM. IT IS ALSO SUBMITTED THAT THE CONTENTION OF T HE TPO OF ENHANCING THE COST BASE OF THE ASSESSEE ENTERPRISE ARTIFICIALLY B Y CONSIDERING THE COST OF MANUFACTURE AND EXPORT OF FINISHED GOODS I.E. REA DYMADE GARMENTS BY THIRD PARTY VENDERS (WHICH COST IS CERTAINLY NOT THE COST INCURRED BY THE ASSESSEE) IS CLEARLY INCONSISTENT WITH THE MANNER OF APPLICATION OF TNMM AS PROVIDED IN RULE 10B(1)(E) OF THE RULES. THE AFORESAID ACTION O F THE TPO IT WOULD FURTHER BE APPRECIATED AMOUNTS TO IMPUTING NOTIONAL ADJUST MENT / INCOME IN THE HANDS OF THE ASSESSEE ON THE BASIS OF A FIXED PERCE NTAGE OF THE FOB VALUE OF EXPORT MADE BY UNRELATED PARTY VENDERS. THE APPEL LANT HAS IN THE TRANSFER PRICING DOCUMENTATION ESTABLISHED THE INTERNATIONA L TRANSACTIONS OF RENDERING BUYING SERVICES TO BE AT ARM'S LENGTH PRICE HAVING REGARD TO THE OPERATING PROFIT MARGIN EARNED BY COMPARABLE COMPANIES HAVING SIMILAR FUNCTIONAL PROFILE. THE COMPUTATION OF THE OPERATING PROFIT MA RGIN (OP/TC%) OF THE APPELLANT BY ENHANCING THE COST BASE I.E. BY INCREA SING THE COST OF THE SALES FACILITATED BY THE ASSESSEE WOULD LEAD TO AN ARBITR ARY ADJUSTMENT TO THE INCOME OF THE APPELLANT WHICH WAS NEVER INTENDED BY THE LE GISLATION. IT WOULD BE ITA NO.5156/DEL./2010 22 APPRECIATED THAT THE APPELLANT IS PERFORMING FUNCTI ONS OF A LIMITED RISK OFF SHORE SERVICE PROVIDER AND IS NOT ENGAGED IN MANUFA CTURING OF GARMENTS. THE APPELLANT NEITHER MADE INVESTMENT IN THE PLANT INV ENTORY WORKING CAPITAL ETC. NOR DOES IT HAVE EXPERTISE TO MANUFACTURE GAR MENTS. THE APPELLANT DOES NOT BEAR THE ENTERPRISE RISK FOR MANUFACTURE AND EX PORT OF GARMENTS. IN OTHER WORDS FUNCTIONAL AND RISK PROFILE OF THE APPELLANT ARE ENTIRELY DIFFERENT AND HAS NOTHING TO DO WITH THE MANUFACTURE AND EXPORT O F GARMENTS BY THE UNRELATED PARTY VENDORS. THE APPELLANT HAS MERELY R ENDERED BUYING / SOURCING SUPPORT SERVICES IN RELATION TO SUCH EXPORTS. THE R EMUNERATION RECEIVED BY THE APPELLANT ON A COST PLUS MARK-UP OF 5% ADEQUATELY R EPRESENTS THE FUNCTIONS PERFORMED ASSETS UTILIZED AND RISKS ASSUMED BY THE APPELLANT. IF THE TPO'S CONTENTION IS TO BE CONSIDERED IT WOULD AMOUNT TO T REATING THE APPELLANT AS PARTNER OF THE VENDERS / EXPORTERS IN THEIR MANUFAC TURING BUSINESS WHICH IS CERTAINLY NOT THE CASE. LEARNED AR PLEADED THAT THE ABOVE BASIS OF DETERMI NING THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS APPLYING TNMM WAS ACCEPTED IN THE TRANSFER PRICING ASSESSMENT CONSISTENTLY YEAR AFTER YEAR. THE TPO IN THE EARLIER YEARS IT IS RESPECTFULLY SUBMITTED DID NO T DISPUTE THE AFORESAID FUNCTIONAL ANALYSIS UNDERTAKEN BY THE APPELLANT. IN THE RELEVANT PREVIOUS YEAR TOO THE FACTS WITH REGARD TO THE OPERATIONS OF THE APPELLANT AND THE FUNCTIONS PERFORMED ASSETS UTILIZED AND RISKS ASSUMED BY THE APPELLANT REMAIN THE SAME ITA NO.5156/DEL./2010 23 AS IN THE EARLIER YEARS. IT IS THE RESPECTFUL SUB MISSION OF THE ASSESSEE THAT ALTHOUGH THERE IS NO RES JUDICATA IN INCOME-TAX PRO CEEDINGS THE SUPREME COURT IN THE CASE OF RADHASOAMI SATSANG VS. CIT: 19 3 ITR 321 HELD THAT WHERE A FUNDAMENTAL ASPECT PERMEATING THROUGH THE D IFFERENT ASSESSMENT YEARS IS ACCEPTED ONE WAY OR THE OTHER A DIFFERENT VIEW IN THE MATTER IS NOT WARRANTED UNLESS THERE BE ANY MATERIAL CHANGE IN F ACTS. THE RELEVANT OBSERVATIONS AT PAGE 329 OF THE JUDGMENT ARE REPROD UCED AS UNDER: 'WE ARE AWARE OF THE FACT THAT STRICTLY SPEAKING RES JUDICATA DOES NOT APPLY TO INCOME-TAX PROCEEDINGS. AGAIN EACH ASSESSMENT YEAR BEING A UNIT WHAT IS D ECIDED IN ONE YEAR MAY NOT APPLY IN THE FOLLOWING YEAR BUT WHERE A FUNDAMENTAL ASPECT PERMEATING THROUGH THE DIFFERENT ASSESSMENT YEARS HAS BEEN FOUND AS A FACT ONE WAY OR THE OTHER AND PARTIES HAVE ALLOWED THAT POSI TION TO BE SUSTAINED BY NOT CHALLENGING THE ORDER IT WOULD NOT BE AT ALL APPROPRIATE TO ALLOW THE POSITION TO BE CHAN GED IN A SUBSEQUENT YEAR. ' THE DELHI HIGH COURT IN THE CASE OF CIT VS. NEO POL YPACK (P) LTD: 245 ITR 492 ON THE RULE OF CONSISTENCY OBSERVED AS UNDER: 'WE ARE OF THE VIEW THAT NO FAULT CAN BE FOUND WITH THE ORDER OF THE TRIBUNAL DECLINING TO MAKE A REFERENCE ON THE PROPOSED QUESTION. IT IS TRUE THAT EACH ASSESSM ENT YEAR BEING INDEPENDENT OF THE OTHER THE DOCTRINE OF RES JUDICATA DOES NOT STRICTLY APPLY TO INCOME-TAX PROCEEDINGS BUT WHERE AN ISSUE HAS BEEN CONSIDERED AND DECIDED CONSISTENTLY IN A NUMBER OF EARLIER ASSESSM ENT YEARS IN A PARTICULAR MANNER FOR THE SAKE OF CONSI STENCY THE SAME VIEW SHOULD CONTINUE TO PREVAIL IN SUBSEQU ENT YEARS UNLESS THERE IS SOME MATERIAL CHANGE IN THE F ACTS. IN THE PRESENT CASE LEARNED COUNSEL FOR THE REVENUE H AS NOT ITA NO.5156/DEL./2010 24 BEEN ABLE TO POINT OUT EVEN A SINGLE DISTINGUISHING FEATURE IN RESPECT OF THE ASSESSMENT YEAR IN QUESTION WHICH COULD HAVE PROMPTED THE ASSESSING OFFICER TO TAKE A VIEW DIFFERENT FROM THE EARLIER ASSESSMENT YEARS IN WHI CH THE SAME INCOME WAS BROUGHT TO TAX AS INCOME FROM BUSINESS'. (EMPHASIS SUPPLIED) IN THE FOLLOWING DECISIONS TOO THE COURTS HAVE HE LD THAT THOUGH THE DOCTRINE OF RES-JUDICATA DOES NOT STRICTLY APPLY TO THE INCO ME-TAX PROCEEDINGS BUT IN ORDER TO MAINTAIN CONSISTENCY THE REVENUE CANNOT B E PERMITTED TO RAKE UP SETTLED ISSUES. DIT (E) V. APPAREL EXPORT PROMOTION COUNCIL: 244 IT R 734 (DEL) CIT V. GIRISH MOHAN GANERIWALA: 260 ITR 417 (P&H) CIT V. DALMIAL PROMOTERS DEVELOPERS (P) LTD: 200 CT R 426 (DEL.) CIT VS. A.KJ. SECURITY PRINTERS: 264 ITR 276(DEL) MIS ESCORTS CARDIAC DISEASES HOSPITAL: 2007-TIOL-52 -DEL- HC-IT VESTA INVESTMENT & TRADING CO. (P) LTD: 70 ITD 200 (CHD.) UDAIPUR DISTILLERY CO. LTD V. JCLT: 100 ITD 422 (JO DH.) IN VIEW OF THE AFORESAID THE APPLICATION OF TNMM B Y THE TPO BY ENHANCING THE COST BASE OF THE APPELLANT BY CONSIDERING FOB V ALUE OF EXPORT BY UNRELATED PARTY VENDORS IS INCONSISTENT WITH THE TRANSFER PRI CING REGULATIONS AND ADDITION MADE ON THIS ACCOUNT THEREFORE IS LIABLE TO BE DELETED. LEARNED AR ALSO PLEADED THAT NO AGREEMENTS ENTERED BY THE APPELLANT WITH THE VENDORS FROM WHOM GOODS ARE SOURCED. THE TPO WHILE OBSERVING THAT FOR COMPUTATION OF OP/TC MARGIN OF THE APPELLA NT THE TOTAL COST COMPONENT SHOULD ALSO INCLUDE COST OF THE SALES DI D NOT APPRECIATE THE FACTS OF ITA NO.5156/DEL./2010 25 THE CASE OF THE BUSINESS OF THE APPELLANT. THE APPE LLANT IT IS REITERATED IS AN OFFSHORE SERVICE PROVIDER AND RENDERING BUYING / SO URCING SERVICES TO THE THIRD PARTY CUSTOMERS OF THE ASSOCIATED ENTERPRISE VIZ. LI & FUNG (TRADING). UNDER THE ARRANGEMENT GOODS AND MERCHANDIZE ARE SOURCED BY THIRD PARTY CUSTOMERS FROM EXPORTERS / VENDERS IN INDIA. SUCH EXPORTERS / VENDERS TOO ARE UNRELATED PARTIES AND THE ASSESSEE COMPANY HAS BUYING / SOURC ING SERVICE PROVIDER ONLY PROVIDE NECESSARY SUPPORT SERVICES OF PURCHASE OF G OODS AND MERCHANDIZE. IN OTHER WORDS PURCHASES ARE MADE BY THIRD PARTY CUST OMERS OUTSIDE INDIA FROM THE VARIOUS THIRD PARTY EXPORTERS / VENDORS IN INDI A. IN THE PRESENT CASE IT WOULD BE APPRECIATED NEITHER THE ASSOCIATED ENTERP RISE NOR THE APPELLANT IS INVOLVED IN THE TRANSACTION OF PURCHASE OR SALE OF SUCH GOODS EXCEPT TO THE EXTENT OF RENDERING BUYING / SOURCING SUPPORT SERVI CES. IN VIEW OF THE AFORESAID IT WOULD BE APPRECIATED THAT THE CONTRAC T FOR PURCHASE OF GOODS AND MERCHANDIZE WAS BETWEEN THIRD PARTY OVERSEAS CUSTOM ERS AND THE VENDORS / EXPORTERS IN INDIA. THE ASSOCIATED ENTERPRISE AND A LSO THE APPELLANT IS ENGAGED IN RENDERING SOURCING SUPPORT SERVICES IN RELATION TO SUCH EXPORT. THERE ARE NO DIRECT CONTRACTS ENTERED INTO BETWEEN THE APPELL ANT AND THE THIRD PARTY VENDORS THEREFORE IT CANNOT BE CONSTRUED THAT THE ASSESSEE IS SUPPOSED TO SHARE THE PROFIT MARGIN ON THE FOB VALUE ON EXPORT MADE BY SUCH VENDORS. IN VIEW OF THE AFORESAID IT IS RESPECTFULLY SUBMIT TED THAT THE TPO'S CONTENTION TO COMPUTE THE ARM'S LENGTH PRICE OF THE APPELLANT BY ALLOCATING 5% OF FOB ITA NO.5156/DEL./2010 26 VALUE OF EXPORTS MADE BY THIRD PARTY VENDORS TO THE AE IS INAPPROPRIATE AND NOT SUSTAINABLE. LEARNED AR ALSO PLEADED THAT LOCATION SAVINGS ARE ATTRIBUTABLE TO THE END PURCHASER ONLY. THE TPO WHILE HOLDING THAT THE ARM'S LENGTH PRICES OF INTERNATIONAL TRANSACTIONS OF RUNNING BUYING / SOU RCING SERVICES BY THE APPELLANT OUGHT TO BE 5% OF THE FOB VALUE OF EXPORT S CLEARLY MISUNDERSTOOD THE BUSINESS MODEL AND THE INTERNATIONAL TRANSACTIO NS UNDERTAKEN BY THE APPELLANT. THE TPO DID NOT APPRECIATE THE FACT THAT THE TRANSACTION OF EXPORT OF FINISHED GOODS NAMELY READYMADE GARMENTS IS BEING UNDERTAKEN BY THIRD PARTY VENDORS / EXPORTERS TO THE OVERSEAS CUSTOMERS . NEITHER THE ASSOCIATE ENTERPRISES NOR THE APPELLANT IS PARTY TO THE TRANS ACTION OF SUCH EXPORT. THE ASSOCIATE ENTERPRISES HAS ONLY UNDERTAKEN TO PROVID E SOURCING SUPPORT SERVICES IN RELATION TO SUCH EXPORT MADE BY THE VENDORS WHI CH SERVICES HAS PARTLY BEEN PERFORMED BY THE APPELLANT IN INDIA. NEITHER THE APPELLANT NOR THE ASSOCIATE ENTERPRISES IT WOULD BE APPRECIATED GAINED ADVANT AGE ON ACCOUNT OF LOCATION SAVING ASSOCIATED WITH THE EXPORT OF GOODS VIZ. GA RMENTS BY THE EXPORTERS TO THE OVERSEAS CUSTOMERS. SUCH ADVANTAGE ON ACCOUNT O F LOCATION SAVING IS THEREFORE AT BEST BE ATTRIBUTED TO THE VENDORS / E XPORTERS AND THE THIRD PARTY OVERSEAS CUSTOMERS. IN THE US REGULATIONS TOO THE LOCATION SAVING IS APPLIED BETWEEN THE BUYER AND THE SELLER LOCATED IN DIFFERE NT JURISDICTION AS WOULD BE ITA NO.5156/DEL./2010 27 APPRECIATED FROM THE US REGULATIONS [1.482-(1)(D)(4 )(II)(C)] WHICH READ AS UNDER: '(C) LOCATION SAVINGS. IF AN UNCONTROLLED TAXPAYER OPERATES IN A DIFFERENT GEOGRAPHIC MARKET THAN THE CONTROLLED TAXPAYER ADJUSTMENTS MAY BE NECESSARY T O ACCOUNT FOR SIGNIFICANT DIFFERENCES IN COSTS ATTRIB UTABLE TO THE GEOGRAPHIC MARKETS. THESE ADJUSTMENTS MUST BE BASED ON THE EFFECT SUCH DIFFERENCES WOULD HAVE ON THE CONSIDERATION CHARGED OR PAID IN THE CONTROLLED TRANSACTION GIVEN THE RELATIVE COMPETITIVE POSITION S OF BUYERS AND SELLERS IN EACH MARKET. THUS FOR EXAMPL E THE FACT THAT THE TOTAL COSTS OF OPERATING IN A CONTROL LED MANUFACTURER'S GEOGRAPHIC MARKET ARE LESS THAN THE TOTAL COSTS OF OPERATING IN OTHER MARKETS ORDINARILY JUST IFIES HIGHER PROFITS TO THE MANUFACTURER ONLY IF THE COST DIFFERENCES WOULD INCREASE THE PROFITS OF COMPARABL E UNCONTROLLED MANUFACTURERS OPERATING AT ARM'S LENGT H GIVEN THE COMPETITIVE POSITIONS OF BUYERS AND SELLE RS IN THAT MARKET.' THE TPO HAS WRONGLY APPLIED THE CONCEPT OF LOCATING SAVING IN THE CASE OF THE APPELLANT WHICH IS ONLY A SERVICE PROVIDER AND NOT THE EXPORTER OF GOODS FROM INDIA. IN VIEW OF THE AFORESAID SINCE NEITHER THE APPELLANT NOR THE ASSOCIATE ENTERPRISES COULD BE ALLEGED TO HAVE GAINED ANY ADV ANTAGE ON ACCOUNT OF LOCATION SAVING IN RESPECT OF SUCH EXPORT OF FINISH ED GOODS BY THE EXPORTERS / VENDORS THE ADJUSTMENT MADE BY THE TPO ON THE GROU ND OF LOCATION SAVING IS NOT SUSTAINABLE AND IS LIABLE TO BE DELETED. LEARNED AR ALSO PLEADED THAT THE AMOUNT OF ADJUSTM ENT COMPUTED BY THE TPO FAR EXCEEDING THE AMOUNT RETAINED BY THE AE . HE SUBMITTED THAT WITHOUT PREJUDICE IT IS RESPECTFULLY SUBMITTED THAT THE ADJUSTMENT COMPUTED BY ITA NO.5156/DEL./2010 28 THE TPO IN THE ORDER PASSED UNDER SECTION NCA(3) OF THE ACT AT BEST CANNOT EXCEED THE NET MARGIN I.E. GROSS REVENUE RECEIVED FROM THE END CUSTOMERS LESS AMOUNT PAID TO THE APPELLANT RETAINED BY THE A SSOCIATED ENTERPRISES IN RESPECT OF INTERNATIONAL TRANSACTIONS. THE APPELLA NT COMPANY RENDERING SOURCING SUPPORT SERVICES HAS FACILITATED EXPORTS B Y THE VENDORS/ SUPPLIERS OF NEARLY (USD 273.40 MILLION @ RS.44/$) RS.1 202.96 C RORES IN THE RELEVANT PREVIOUS YEAR. THE AE ENTERED INTO THE CONTRACT WI TH THE UNRELATED PARTY CUSTOMER FOR RENDERING BUYING SERVICES AT 4% TO 5% OF FOB VALUE OF EXPORTS. THE ASSESSEE HAS IN TURN RECEIVED SERVICES FEE (AT COST + 5%) OF RS.47.69 CRORES WHICH IS NEARLY 4% OF THE FOB VALUE OF THE E XPORT (BY THE VENDORS) FROM THE AE. HOWEVER THE TPO / ASSESSING OFFICER I N THE IMPUGNED ORDER HAS COMPUTED THE ARM'S LENGTH PRICE OF THE APPELLANT BY CONSIDERING A MARKUP OF 3% ON THE FOB VALUE OF EXPORTS (RS.L 202.96 CRORES) THAT HAVE BEEN FACILITATED BY THE APPELLANT COMPUTED AN ADJUSTMENT OF RS.33 59 69 186. IT WOULD ALSO BE APPRECIATED THAT OUT OF THE TOTAL SERVICE FEE OF RS .60.15 CRORES RECEIVED BY THE ASSOCIATED ENTERPRISE THE APPELLANT BY NO STRETCH OF IMAGINATION COULD BE EXPECTED TO EARN A PROFIT MARGIN OF ITS OWN OF 36.0 8 CRORES COMPUTED ON 3% OF THE FOB VALUE OF SUCH EXPORTS. IT WOULD ALSO BE N OTED THAT IF THE ADJUSTMENT MADE BY THE ASSESSING OFFICER / TPO IS TAKEN INTO A CCOUNT THE APPELLANT WOULD END UP RECEIVING HIGHER AMOUNT THAN WHAT HAS BEEN R ECEIVED BY THE AE FROM ITA NO.5156/DEL./2010 29 THE 3RD PARTY CUSTOMERS IN LIEU OF FACILITATING THE EXPORT OF FINISHED GOODS AS FOLLOWS: FOB VALUE OF EXPORTS 1202.96 CRORES AMOUNT RECEIVED BY THE ASSESSEE ..... A 48.19 CRORES (I.E. 4% OF THE FOB VALUE) ADJUSTMENT PROPOSED .................. B 33.60 CRORES TOTAL AMOUNT TO BE RECEIVED BY THE ASSESSEE 81.79 CRORES (I.E. 6.8% OF THE FOB VALUE) TOTAL AMOUNT RECEIVED BY THE AE 5% OF 1202.96 CRORES 60.148 CRORES IT WOULD ALSO BE NOTED THAT THE AE ON THE ENTIRE EX PORT OF RS.1202.96 CRORES HAS RETAINED NEARLY I % OF THE FOB VALUE OF EXPORT I.E. RS.12.46 CRORES. [ RS.1202.96 CRORES X 5% = RS.60.15 CRORES (-) RS.47. 69 CRORES RECEIVED BY THE ASSESSEE = RS.12.46 CRORES]. THE TPO ERRONEOUSLY MADE ADJUSTMENT OF RS.33 59 69 186 ON ACCOUNT OF ALLEGED DIFFERENCE IN THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS OF RENDERING BUYING / SO URCING SERVICES BY THE APPELLANT WITHOUT APPRECIATING THAT OUT OF THE TOTA L SERVICE FEE OF 5% OF FOB VALUE OF EXPORT RECEIVED BY THE AE ONLY I % OF FOB VALUE OF EXPORT I.E. NEARLY RS.12.46 CRORES WAS RETAINED BY THE AE AND R S.47.69 CRORES BEING NEARLY 80% OF THE CONSIDERATION RECEIVED BY THE AE IS ALREADY PAID TO THE APPELLANT. IT IS FURTHER SUBMITTED THAT SUBSTANTI AL FUNCTIONS RELATING TO SUCH BUYING SERVICES ARE PERFORMED BY THE AE WHICH ALSO ASSUMES ENTERPRISE RISK SUCH AS MARKETING RISK CREDIT RISK ETC. THE ASSE SSEE COMPANY IT IS SUBMITTED ITA NO.5156/DEL./2010 30 OPERATES AS CONTRACT SERVICE PROVIDER AND DOES NOT UNDERTAKE SUCH ENTERPRISE RISK. IT IS FURTHER REITERATED THAT SUBSTANTIAL FUN CTIONS ARE PERFORMED BY THE AE AND SUBSTANTIAL ASSETS ARE UTILIZED AND RISKS ARE A SSUMED BY THE AE IN RELATION TO BUYING SERVICES RENDERED TO THE CUSTOMERS. IN AD DITION THE AE BEARS L/C OPENING CHARGES AND SEVERAL OTHER COSTS AT ITS END. IN OTHER WORDS WHILE THE APPELLANT IS RECEIVING 4% OF FOB VALUE OF EXPORT FO R RENDERING OF BUYING SERVICES THE AE IS RETAINING ONLY I % OR LESS OF T HE FOB VALUE OF EXPORT AT THEIR END. THE TPO/ASSESSING OFFICER HAS ERRONEOU SLY HELD THAT THE APPELLANT HAS DEVELOPED SEVERAL UNIQUE INTANGIBLES AND DEVELO PED A SUPPLY CHAIN MANAGEMENT HUMAN CAPITAL AT ITS OWN RISK WITHOUT A PPRECIATING THAT THE APPELLANT WAS ONLY A CAPTIVE OFFSHORE SERVICE PROVI DER NOT UNDERTAKING ANY INDEPENDENT ENTERPRISE RISK. SINCE THE FORMATION OF THE APPELLANT COMPANY ENTIRE COST WERE REIMBURSED BY THE ASSOCIATED ENTER PRISE WHICH WAS ALSO BEARING ALL ENTERPRISE RISKS WITH REGARD TO OPERATI ON UNDERTAKEN BY THE APPELLANT. FURTHER IT IS REITERATED THAT SUBSTA NTIAL FUNCTIONS ARE PERFORMED BY THE AE AND SUBSTANTIAL ASSETS ARE UTILIZED AND RISK S ARE ASSUMED BY THE AE IN RELATION TO BUYING SERVICES RENDERED TO THE CUSTOME RS. THE APPELLANT COMPANY IT IS RESPECTFULLY SUBMITTED HAS RECEIVED 80% OF TH E TOTAL CONSIDERATION RECEIVED BY THE AE FOR RENDERING BUYING SERVICES AN D THE AE HAS RETAINED ONLY 20% OF THE TOTAL CONSIDERATION. FOR THE AFORE SAID CUMULATIVE REASONS THE ITA NO.5156/DEL./2010 31 ADJUSTMENT COMPUTED BY THE TPO / ASSESSING OFFICER IN THE CASE OF THE APPELLANT IS UNLAWFUL AND IS LIABLE TO BE DELETED. 7. LEARNED DR RELIED ON THE ORDERS OF THE AUTHORITI ES BELOW. HE SUBMITTED THAT THE ASSESSEE WAS PERFORMING ALL THE CRITICAL F UNCTIONS WITH THE HELP OF TECHNICAL CAPACITY AND THE MANPOWER TO EXECUTE THE WORK. IN THE PROCESS THE ASSESSEE HAS DEVELOPED BOTH TANGIBLE AND UNIQUE INT ANGIBLE WHICH ARE VERY CRUCIAL FOR EXECUTING THE CRITICAL FUNCTIONS. THES E TANGIBLES AND UNIQUE INTANGIBLES ENABLE THE ASSESSEE TO GET THE ADVANTAG E OF AE IN THE FORM OF LOW COST PRODUCT TO CONTROL QUALITY OF PRODUCT AND BY DOING SO ENHANCE THE BUSINESS PROFITABILITY OF THE AE. THESE INTANGIBLE S HAVE INCREASED THE PROFIT POTENTIAL OF THE AE. THE ASSESSEE HAS ALSO DEVELOP ED A SUPPLY CHAIN MANAGEMENT WHICH IS CRUCIAL TO MANAGE THE LINK BETW EEN THE ULTIMATE CUSTOMER AND SUPPLY TO ACHIEVE THE VARIOUS ADVANTAG E LIKE PRICING ADVANTAGE STRATEGIC ADVANTAGE ETC. ETC. THE ASSESSEE OFFERS BOTH COST AND OPERATIONAL ADVANTAGE TO THE AE WHICH IS POSSIBLE ON ACCOUNT OF LOW SALARIES FOR EMPLOYEES IN INDIA LOW COST OF MATERIAL AND LOW CO ST OF MANUFACTURING. FURTHER HE ALSO PLEADED THAT SINCE THE AE IS RECEIV ING 5% OF THE FOB VALUE FROM THE PURCHASERS AND ASSESSEE IS PERFORMING CRUC IAL AND CRITICAL FUNCTIONS WITH THE HELP OF TANGIBLE AND UNIQUE INTANGIBLES DE VELOPS DURING A PERIOD OF TIME THE ASSESSEE MUST RECEIVE THE MAJORITY OF THE RECEIPTS WITH REGARD TO THE EXECUTION OF THE WORK. THEREFORE HE PLEADED THAT THE MARK UP SHOULD BE ITA NO.5156/DEL./2010 32 BASED ON FOB VALUE AND MAJORITY OF THE SAME MUST CO ME TO THE ASSESSEE IN TERMS OF THE ARMS LENGTH TRANSACTION AND HE PLEADE D TO SUSTAIN THE ORDERS OF THE AUTHORITIES BELOW. 8. WE HAVE HEARD BOTH THE SIDES IN DETAIL. THE FOL LOWING FACTS ARE UNDISPUTED. THE ASSESSEE IS A SUBSIDIARY COMPANY OF LI & FUND (SOUTH ASIA) LTD A COMPANY INCORPORATED IN MAURITIUS. ULTIMATELY THE ASSESSEE COMPANY IS A PART OF THE LI & FUND GROUP WHICH IS ENGAGED IN THE EXPORT TRADING AND SERVICES AND HAVING SUBSTANTIAL EXPERIENCE KNOW-HO W AND MARKET PRESENCE WITH A WORLD WIDE NETWORK. THE ASSESSEE PROVIDES B UYING / SOURCING SERVICES FOR SUPPLYING THE CONSUMER GOODS. FOR THE YEAR UND ER CONSIDERATION THE RETURN OF INCOME WAS FILED ON 01.12.2006 DECLARING INCOME AT RS.3 08 26 448/-. DURING THE RELEVANT PERIOD THE ASSESSEE HAS ENTERED INTO INTERNATIONAL TRANSACTION OF BUYING SERVICES FOR SO URCING OF GARMENTS/ HANDICRAFTS/ LEATHER PRODUCTS ETC. IN INDIA FOR IT S AFFILIATE LI & FUND (TRADING) LTD. HONG KONG. THE ASSESSEE HAS BEEN PAID SERVIC E CHARGES FOR PROVIDING THESE SERVICES COMPUTED ON THE BASIS OF COST PLUS MARK UP METHOD. IT WAS 5% OF COST INCURRED BY ASSESSEE. ASSESSEE WORKED OUT THE ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTION BY APPLYING TNMM (TRANS ACTIONAL NET MARGIN METHOD) BY COMPANY OPERATING PROFIT MARGIN OF 26 CO MPANIES AND ASSESSEES OP/OC TAKEN AT 5.17%. ITA NO.5156/DEL./2010 33 THE TPO DID NOT CONSIDER THE COST PLUS COMPENSATIO N @ 5% AT ARMS LENGTH BY HOLDING THAT ASSESSEE IS PERFORMING ALL C RITICAL FUNCTIONS ASSUMING SIGNIFICANT RISKS AND USED BOTH TANGIBLES AND UNIQU E INTANGIBLES DEVELOPED BY IT OVER A PERIOD OF TIME. THE ASSOCIATED ENTERPRIS E IS NOT HAVING TECHNICAL CAPACITY AND MANPOWER TO ASSIST THE ASSESSEE IN THI S REGARD. THE ASSESSEE HAS DEVELOPED SEVERAL UNIQUE INTANGIBLES WHICH HAS BEEN GIVEN ADVANTAGE IN THE FORM OF LOW COST OF PRODUCT QUALITY OF THE PRODUCT AND ENHANCED THE PROFITABILITY OF AE. THESE INTANGIBLES HAVE DEVELO PED PROFIT POTENTIAL OF AE. THE ASSESSEE HAS DEVELOPED THE SUPPLY CHAIN MANAGEM ENT WHICH GIVES CUSTOMER A STRATEGIC AND PRICING ADVANTAGE. THE ASS ESSEE HAS ALSO DEVELOPED ITS OWN HUMAN CAPITAL INTANGIBLE AT ITS OWN COST. THE COST FOR THE SAME IS BORN BY ASSESSEE. THE AE HAS RECOGNIZED THAT INDIA OFFERS BOTH COST AND OPERATIONAL ADVANTAGE ON ACCOUNT OF LOWER SALARIES FOR THE EMPLOYEES LOW COST MATERIAL AND LOW COST MANUFACTURE. THE ASSOCIATED ENTERPRISE IS CHARGING FROM THE PUR CHASERS ON THE BASIS OF FOB VALUE OF EXPORTS UP TO 5%. THE TOTAL EXPORT S EFFECTED BY THE ASSESSEE DURING THE YEAR WERE RS.1202.96 CRORES. ASSESSEE HAS BEEN PAID IN RESPECT OF THE INTERNATIONAL TRANSACTION EFFECTED IN THE FO RM OF EXPORTS ON THE BASIS OF COST PLUS 5%. THE LEARNED ARS PLEA THAT NO ADJUSTMENT HAS BEEN M ADE IN THE EARLIER YEARS. FOR THIS HE HAS SUBMITTED ASSE SSMENT ORDER FOR AY 2002-03 TO 2005-06 WHEREIN THE TRANSACTION NET MARGINAL MET HOD WITH OPERATING PROFIT ITA NO.5156/DEL./2010 34 OVER TOTAL COST (OP/TC) AS A PROFIT LEVEL INDICATOR HAS BEEN ACCEPTED. THIS TNMM METHOD HAS BEEN ACCEPTED IN THESE YEARS. REL IANCE IS ALSO PLACED ON THE DECISION OF HON'BLE SUPREME COURT IN THE CASE O F RADHASOAMI SATSANG VS. CIT CITED SUPRA AND CIT VS. NEW POLY PACK (P) LTD. 245 ITR 492 OTHER CASE LAWS. IN THIS REGARD WE HOLD THAT THE PRINCIPLE O F RES JUDICATA IS NOT APPLICABLE IN THE INCOME-TAX PROCEEDINGS. EACH ASSESSMENT YEA R IS A SEPARATE UNIT AND WHAT IS DECIDED IN ONE YEAR SHALL NOT IPSO FACTO AP PLY IN THE SUBSEQUENT YEARS. WE HAVE GONE THROUGH THE ORDERS PASSED IN THE EARLI ER YEARS WHICH HAS BEEN PLACED IN THE PAPER BOOK AT PAGES 293 TO 305 AND FO R ALL THESE ASSESSMENT YEARS STARTING FROM 2002-03 TO 2004-05 WE FIND THA T WHILE ACCEPTING PROFIT LEVEL INDICATOR NOTHING HAS BEEN SAID ABOUT THE BAS IS ON WHICH THE COMPENSATION HAS BEEN RECEIVED BY THE ASSOCIATED EN TERPRISE ON THE GOODS EXPORTED FROM INDIA THROUGH ASSESSEE. AS WE HAVE A LREADY STATED EARLIER THE ASSOCIATED ENTERPRISE WAS RECEIVING THE COMPENSATIO N AS A PERCENTAGE OF THE FOB VALUE OF THE GOODS EXPORTED THROUGH THE ASSESSE E AND AS PER THE GUIDELINES OF THE OECD WHICH RECOGNIZES THAT THE RE LATED PARTY MAY FASTEN THEIR TRANSACTION IN SUCH A MANNER THAT MAY CALL FO R LOOKING AT THE SUBSTANCE OF TRANSACTIONS OVER THE FORM THEY ARE GIVEN. IN THIS CASE THE ASSOCIATED ENTERPRISE WAS RECEIVING THE COMPENSATION ON THE BA SIS OF FOB VALUE WHILE THE INDIAN ASSOCIATE (ASSESSEE) WAS COMPENSATED ONL Y BY COST PLUS 5% MARK UP. WHEN THE ASSOCIATED ENTERPRISE ARE RECEIVING THE COMPENSATION AT FOB ITA NO.5156/DEL./2010 35 VALUE AND THE ASSESSEE WHICH IS PROVIDING CRITICAL FUNCTIONS WITH THE HELP OF TANGIBLE AND UNIQUE INTANGIBLES DEVELOPED OVER THE YEARS AND WITH THE HELP OF SUPPLY CHAIN MANAGEMENT WHICH ARE IMPORTANT TO ACHI EVE THE STRATEGIC AND PRICING ADVANTAGE. ALL THESE HELP THE ASSOCIATED E NTERPRISE TO ENHANCE AND RETAIN THE BUSINESS AND ALSO CONTRIBUTES TOWARDS TH E LOCATIONAL SAVINGS ON ACCOUNT OF LOW COST SALARY LOW COST MATERIAL AND L OW COST MANUFACTURE IN INDIA. THEREFORE IN OUR CONSIDERED VIEW THE COST PLUS 5% MARK UP IS DEFINITELY NOT ON THE ARMS LENGTH WHILE WORKING OUT THE COMPENSATION FOR THE SERVICES RENDERED BY THE ASSESSEE TO THE ASSOCIATED ENTERPRISE. IN SUCH A SITUATION MARK UP ON THE FOB VALUE OF THE GOODS SO URCED THROUGH THE ASSESSEE SHALL BE THE MOST APPROPRIATE METHOD TO WO RK OUT THE CORRECT COMPENSATION AT ARMS LENGTH PRICE. THEREFORE THE RULES OF CONSISTENCY CANNOT BE APPLIED FOREVER WHEN SUCH FACTS HAVE NOT BEEN CO NSIDERED/DISCUSSED AT ALL IN THE EARLIER YEARS. IT IS ALSO PLEADED THAT THE ASSESSEE HAS RECEIVED 80-O DEDUCTION IN THE EARLIER YEARS IN RESPECT OF PROVIDING THESE PROFESS IONAL AND TECHNICAL SERVICES. IN THIS REGARD WE HOLD THAT EVERY ASSESSMENT YEAR IS A SEPARATE ASSESSMENT YEAR FOR INCOME-TAX PURPOSES AND THE PRINCIPLE OF R ES JUDICATA IS NOT APPLICABLE. FURTHER DURING THIS YEAR THE ASSESSEE HAS NOT CLAIMED OR ENTITLED FOR 80-O DEDUCTION. THEREFORE IT CANNOT BE A PLEA TO JUSTIFY THE TRANSACTION AT THE ARMS LENGTH. ITA NO.5156/DEL./2010 36 ASSESSEE CLAIMS THAT THERE IS NO PROVISION IN THE R ULE 10B(1)(E) TO INCLUDE THE COST INCURRED BY THIRD PARTIES OR UNREL ATED ENTERPRISE TO COMPUTE THE NET PROFIT MARGIN OF THE ASSESSEE. FOR THIS PR OPOSITION WE DO NOT AGREE IN VIEW OF THE FACT THAT ASSESSEE IS PROVIDING ALL CRI TICAL FUNCTIONS AND THE MAJORITY OF WORK RELATED TO THESE EXPORTS IS PERFOR MED BY ASSESSEE ITSELF. ASSOCIATE ENTERPRISE HAD NO CAPACITY TO EXECUTE THE WORK. THE ASSOCIATED ENTERPRISE IS CHARGING FROM THE THIRD PARTY ON THE BASIS OF FOB VALUE OF THE EXPORTS MADE POSSIBLE BY ASSESSEE. ASSESSEE IS PRO VIDING SOURCING SERVICES THROUGH ITS TANGIBLE AND INTANGIBLE CAPACITY TO THE SE THIRD PARTY CLIENTS IN THE FORM OF LOW COST PRODUCT RESULTING INTO PROFITABILI TY AND PRICING ADVANTAGE. THE ASSESSEES RELIANCE ON DCIT VS. CHEIL COMMUNICA TION INDIA PVT. LTD. CITED SUPRA IS NOT OF MUCH HELP AS IN THAT CASE T HE FACTS WERE DIFFERENT. IN THAT CASE THE ASSESSEE WAS PROVIDING TO THEIR PART Y/MEDIA AGENCY FOR AND ON BEHALF OF THE PRINCIPAL. IN THAT CASE THE ADVERTI SING SPACE HAS BEEN LET OUT TO THE THIRD PARTY VENDOR IN THE NAME OF ULTIMATE CUST OMER AND THE BENEFICIARY OF ADVERTISEMENT. THE ASSESSEE IN THAT CASE WAS SIMPL Y ACTING AS INTERMEDIARY BETWEEN ULTIMATE CUSTOMER AND THE THIRD PARTY VENDO R IN ORDER TO PLACEMENT OF ADVERTISEMENT. IN ASSESSEES CASE THE ASSOCIATED ENTERPRISE HAS BEEN RECEIVING THE MARK UP AS 5% OF THE FOB VALUE OF EXP ORTS EFFECTED BY ASSESSEE BY APPLYING ITS TANGIBLE AND INTANGIBLE CAPACITY. THE CRITICAL AND ALL CRUCIAL WORK IS DONE BY ASSESSEE. THE AE IS PAYING BACK TO THE ASSESSEE ONLY ON THE ITA NO.5156/DEL./2010 37 BASIS OF COST PLUS 5% MARK UP. SUCH AN ARRANGEMENT CANNOT BE SAID AT ARMS LENGTH. IN OUR CONSIDERED VIEW SUCH METHOD WILL G O AGAINST THE BASIC NORMAL BUSINESS SENSE AS INEFFICIENT AND HIGH COST SERVIC ES PROVIDED BY ASSESSEE SHALL FETCH MORE REVENUE TO THE ASSESSEE. SUCH AN ARRANG EMENT ON THE FACE OF IT CANNOT BE SAID TO BE AT ARMS LENGTH. THE AE IS GE TTING REMUNERATION ON FOB VALUE OF EXPORT FOR WHICH CRITICAL AND MAIN FUNCTIO NS ARE PERFORMED BY ASSESSEE. WE ALSO UPHOLD THAT THE ASSESSEE HAS DEV ELOPED A TECHNICAL CAPACITY AND OWNS MANPOWER WHICH HAD DEVELOPED HUMAN INTANGI BLES TO PERFORM ALL THE CRITICAL FUNCTIONS. THESE TANGIBLE AND UNIQUE I NTANGIBLE HAVE BEEN DEVELOPED OVER THE YEARS. IN VIEW OF THESE FACTS WE HOLD THAT TO ARRIVE AT ARMS LENGTH OF THESE TRANSACTIONS THE MARK UP MUS T BE ON THE BASIS OF FOB (FREE ON BOARD) VALUE OF THE EXPORTS. SINCE THE AE IS RECEIVING 5% OF FOB VALUE THEN THE TOTAL RECEIPT BY AE MUST BE RS.60.14 8 CRORES. THUS THE ATTRIBUTION BETWEEN ASSESSEE AND AE MUST BE FROM TH IS AMOUNT. AO MADE ADDITION OF RS.33.60 CRORES. IF IT IS ADD ED TO THE ACTUAL RECEIPTS OF ASSESSEE THEN IT IS MUCH MORE THAN THE TOTAL AMOUNT RECEIVED BY ASSOCIATED ENTERPRISE REGARD TO THESE EXPORTS. THU S THE WAY IN WHICH THIS ADJUSTMENT HAS BEEN MADE GIVES ABNORMAL / ABSURD RESULTS WHICH CANNOT BE SUSTAINED. THE ASSESSEE WAS PE RFORMING CRITICAL FUNCTIONS WITH THE HELP OF TANGIBLE AND UNIQUE INTANGI BLES DEVELOPED OVER THE ITA NO.5156/DEL./2010 38 PERIOD OF TIME AND WITH THE HELP OF SUPPLY CHAIN MA NAGEMENT WHICH THE ASSESSEE HAD DEVELOPED THE MAJORITY OF COMPENSATIO N BASED ON THE FOB VALUE OF THE EXPORTS MATERIALIZED THROUGH THE ASSES SEE MUST COME TO THE ASSESSEE. SO THE CORRECT COMPENSATION AT THE ARMS LENGTH PRICE BASED ON THE FOB COST OF THE GOODS SOURCED FROM INDIA NEEDS TO B E DECIDED. THE TOTAL EXPORT DURING THE YEAR WAS RS.1202.96 CRORES. AE R ECEIVED IN TOTAL OF RS.60.148 CRORES. THE ASSESSEES CLAIM THAT NO AGREEMENT WAS ENTERED BY THE ASSESSEE WITH THE VENTURES TO WHOM THE GOODS ARE SOURCED SHA LL NOT JUSTIFY THE COST PLUS MARK UP. THE ASSOCIATE ENTERPRISE ENTERED INTO THE AGREEMENTS FOR SOURCING THE GOODS AND THE COMPENSATION IS BASED ON THE FOB VALUE OF THE GOODS SOURCED FROM THE INDIA AND THE ASSESSEE PERFORMING ALL CRUCIAL AND CRITICAL FUNCTION TO FULFILL THE CONDITIONS TO EXECUTE THE A GREEMENTS. THEREFORE WE FIND NO MERITS IN THIS PLEA. THE OTHER CLAIM OF THE ASS ESSEE THAT LOCATION SAVINGS ATTRIBUTABLE TO THE END PURCHASER IS ALSO NOT JUSTI FIED AS THE ASSESSEE HAS DEVELOPED MANY UNIQUE INTANGIBLES AND ALSO HUMAN CA PITAL INTANGIBLES WHICH GIVES THE LOCATIONAL ADVANTAGE TO PROCURE LOW COST GOODS WHICH HELPS THE ASSOCIATED ENTERPRISE TO OBTAIN/RETAIN THE BUSINESS AND ALSO BENEFITS THE END PURCHASER. THESE TANGIBLES AND UNIQUE INTANGIBLES DEVELOPED OVER THE PERIOD OF TIME AND THE DEVELOPED SUPPLY CHAINS OF THE MANA GEMENT OWNED BY ASSESSEE BENEFITS THE ULTIMATE PURCHASER AND ALSO P ROVIDE LOCATIONAL SAVINGS TO ITA NO.5156/DEL./2010 39 THE ALL INCLUDING THE ASSOCIATED ENTERPRISE. AS WE HAVE ALREADY SAID THAT THE AMOUNT OF ADJUSTMENT COMPUTED BY THE TPO CANNOT EXC EED THE AMOUNT WHICH COULD HAVE BEEN RECEIVED BY THE ASSOCIATED ENTERPRI SE. THERE IS NOTHING ON THE RECORD FROM WHERE WE COULD GATHER THAT THE COMP ENSATION @ 5% ON FOB VALUE RECEIVED BY AE IS DEPRESSED OR ON LOWER SIDE. IN VIEW OF THESE FACTS WE ARE OF THE VIEW THAT THE AMOUNT OF ADJUSTMENT SO COMPUTED SHOULD NOT EXCEED THE AMOUNT RECEIVED BY THE ASSOCIATED ENTERP RISE. IN OUR CONSIDERED VIEW THE AO AS WELL AS THE DRP HAS PROCEEDED ON A WRONG FOOTING WHICH HAVE GIVEN ABSURD RESULTS OF ADJUSTMENTS. IN VIEW OF THE FACT THAT MAJORITY AND CRUCIAL SERVICES RENDERED BY ASSESSEE THE DIST RIBUTION OF COMPENSATION RECEIVED BY AE @ 5% OF THE FOB VALUE OF THE EXPORTS BETWEEN THE ASSESSEE AND THE ASSOCIATED ENTERPRISE SHOULD BE IN THE RATI O OF 80 : 20. THE ASSESSEE MUST GET 80% OF THE TOTAL RECEIPT BY AE FROM THE UL TIMATE PURCHASERS. AO IS DIRECTED TO COMPUTE THE ARMS LENGTH PRICE IN THE A BOVE MANNER. 9. IN THE RESULT THE APPEAL OF THE ASSESSEE IS PAR TLY ALLOWED. ORDER PRONOUNCED IN OPEN COURT ON THIS 30 TH DAY OF SEPTEMBER 2011. SD/- SD/- (C.L. SETHI) (B.C. MEENA) JUDICIAL MEMBER ACCOUNTANT MEMBER DATED THE 30 TH DAY OF SEPTEMBER 2011 TS ITA NO.5156/DEL./2010 40 COPY FORWARDED TO: 1.APPELLANT 2.RESPONDENT 3.CIT 4.CIT (A)-VIII NEW DELHI. 5.CIT(ITAT) NEW DELHI. AR ITAT NEW DELHI.