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ITAT quashed the shifting the base of markup, and the addition by AO

Assessee, an Indian Company, a subsidiary of a Mauritian company, provided buying services to its AEs. It paid service charges at costs with a 8% markup. TPO noticed that assessee was allowed commission @8% on costs incurred for its sourcing activities. TPO changed base from costs incurred to FOB value of exports on which 8% markup was charged. DRP restricted it to 6%. ITAT quashed the shifting the base of markup, and the addition by AO.

1. The assessee, an Indian Company, was a subsidiary Li & Fung (South Asia) Ltd. incorporated in Mauritius, and engaged in the business of providing buying services to its associated enterprises (Aes). It paid service charges for such services at costs with a 8% markup. An international transaction of `Provision of buying services' was reported for of Rs.116,95,42,324/-. The assessee applied the Transactional Net Marginal Method (TNMM) as the most appropriate method with its Profit Level Indicator (PLI) of Operating Profit / Total Costs (OP/TC) at 8%. TPO treated the assessee as a tested party and noticed that it was allowed commission @8% on the `Costs' incurred for its sourcing activities. TPO changed the base from `Costs' incurred to the `FOB value of exports'. The assessee was seen to have incurred `Costs' in providing such services at Rs.108.89 crore, on which 8% markup was charged to have gross revenue at Rs.116.95 crore, which was declared as the value of the international transaction. He further observed that in an earlier year in which he did similar exercise of substituting the base of `Cost' with the `FOB value of goods exported' for applying 8% markup,

2. Dispute Resolution Panel (DRP) restricted it to 6%.

3. TPO determined the amount of transfer pricing adjustment at Rs.59.19 crore. AO made an addition of Rs.59.19 crore.

4. DRP confirmed AO's order.

5. On appeal, the ITAT held as under:

13. In view of the foregoing discussion, we are satisfied that the action of the AO/TPO in taking/proposing addition/adjustment on account of transfer pricing, cannot be upheld for the reason that the shifting of the base on which markup has been applied has been turned down by the Hon'ble Delhi High Court in assessee's own case; the mechanism followed by the TPO for calculating the transfer pricing adjustment has no legal legs to stand on; and further the assessee's profit margin is at ALP under the TNMM on the basis of figures mentioned in the TPO's order, whose correctness has not been disturbed by the TPO. Ex consequenti, the addition is hereby deleted.

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Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016Income Tax Appellate Tribunal - DelhiLi & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016IN THE INCOME TAX APPELLATE TRIBUNALDELHI BENCH 'I', NEW DELHIBEFORE SHRI R. S. SYAL, ACCOUNTANT MEMBERAND SHRI KULDIP SINGH, JUDICIAL MEMBERI.T.A. No.386/Del/2014(Assessment Year 2009-10)Li & Fung (India) Pvt. Ltd.,202-206, Tolstoy House,15, Tolstoy Marg,New Delhi-110 001GIR / PAN :AAACL1663M(Appellant)Vs.DCIT, Circle 4(1),New Delhi(Respondent)Appellant by: Shri Porus Kaka, Sr. Adv.Shri Manish Kant, Adv.Respondent by : Shri Amrendra Kumar, CIT DRDate of hearing: 22.03.2016Date of pronouncement: 23.03.2016ORDERPER R. S. SYAL, AM:This appeal by the assessee is directed against the final assessment order passed by the AssessingOfficer (AO) u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called'the Act') on 28.10.2013 in relation to the assessment year 2009-10. The solitary issue raised in thisappeal is against the addition of Rs.59,19,00,000/- made by the Assessing Officer on account oftransfer pricing adjustment.2. Briefly stated, the facts of this case are that the assessee, an Indian Company, is a subsidiary Li &Fung (South Asia) Ltd. incorporated in Mauritius. The holding company is a part of Li & Funggroup, which is one of the world leaders in export trading, having a worldwide network. Theassessee is engaged in the business of providing buying services to its associated enterprises (AEs).The assessee is paid service charges for such services at costs with a 8% markup. An internationaltransaction of `Provision of buying services' was reported in Form No. 3CEB with transacted valueof Rs.116,95,42,324/-. The assessee applied the Transactional Net Marginal Method (TNMM) as themost appropriate method with its Profit Level Indicator (PLI) of Operating Profit / Total Costs(OP/TC) at 8%. Twenty five companies were chosen as comparable with their average PLI at 9.30%.The assessee claimed that its profit margin at 8% was within permissible range of the profit marginof comparables, and hence the international transaction was at arm's length price (ALP). TheAssessing Officer made reference to the Transfer Pricing Officer (TPO) for determining the ALP ofthis international transaction. The TPO treated the assessee as a tested party and noticed that it wasallowed commission @ 8% on the `Costs' incurred for its sourcing activities. He opined that theIndian Kanoon - http://indiankanoon.org/doc/181428987/1Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016compensation ought to have been expressed as a percentage on FOB price of goods sourced throughthe assessee. Accepting the TNMM as the most appropriate method, the TPO changed the base from`Costs' incurred to the `FOB value of exports'. The assessee was seen to have incurred `Costs' inproviding such services at Rs.108.89 crore, on which 8% markup was charged to have gross revenueat Rs.116.95 crore, which was declared as the value of the international transaction. The TPOsubstituted the `cost' base with the `FOB value of exports'. The amount of new base was calculatedat Rs.2935.69 crore by adding value of goods exported at Rs.2826.8 crore to the costs incurred bythe assessee at Rs.108.89 crore. He further observed that in an earlier year in which he did similarexercise of substituting the base of `Cost' with the `FOB value of goods exported' for applying 8%markup, the Dispute Resolution Panel (DRP) restricted it to 6%. This reduced markup of 6% wasapplied by him on the new base of FOB value of goods exported at Rs.2935.69 crore, to work out theamount of `Net operating income' at Rs.176.14 crore. After reducing `Operating income shown bythe assessee' at Rs.116.95 crore from the amount of `Net Operating income' as calculated by him atRs.176.14 crore, he determined the amount of transfer pricing adjustment at Rs.59.19 crore. The AOmade an addition of Rs.59.19 crore in the draft assessment order. The assessee remainedunsuccessful before the DRP. The said addition of Rs.59.19 crore came to be made in the finalassessment order passed by the Assessing Officer. The assessee is aggrieved against this addition.3. We have heard rival submissions and perused the relevant material on record. There is no quarrelon the fact that the assessee rendered services of buying to its AEs for which it was remuneratedwith costs incurred with markup at the rate of 8%. This has been substituted by the TPO with 6%markup on `FOB value of goods exported'. Accepting the application of TNMM as the mostappropriate method with PLI of OP/TC, the TPO has worked out the amount of transfer pricingadjustment as under : -"Net operating income (as calculated above) Rs.176.14 Operating income shown byassessee Rs.116.95 Difference Rs.59.19 crore"4. Chapter-X of the Act contains special provisions relating to avoidance of tax. Section 92, which isthe first section of this Chapter, provides for computation of income from an internationaltransaction having regard to arm's length price. Sub- section (1) of the section provides that : "Anyincome arising from an international transaction shall be computed having regard to the arm'slength price'. Section 92C of the Act enshrines provisions relating to computation of arm's lengthprice. Sub-section (1) of the section states that the arm's length price in relation to an internationaltransaction shall be determined by any of the methods listed herein which include, inter alia, thetransactional net margin method. Sub-section (2) of section 92C provides that the most appropriatemethod referred to in sub-section (1) shall be applied for the determination of ALP `in the manneras may be prescribed'. Admittedly, the assessee applied the TNMM as the most appropriate methodwith the PLI of OP/TC, which has not disturbed by the TPO. Calculation of ALP under the TNMMhas been given under Rule 10B(1)(e) of the Income-tax Rules, 1962, which has to be necessarilydone `in the manner ... prescribed'. This rule states that for the purposes of section 92C(2), the ALPin relation to the international transaction shall be determined as under :`(e) transactional net margin method, by which,--Indian Kanoon - http://indiankanoon.org/doc/181428987/2Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016(i) the net profit margin realised by the enterprise from an international transactionentered into with an associated enterprise is computed in relation to costs incurred orsales effected or assets employed or to be employed by the enterprise or havingregard to any other relevant base ;(ii) the net profit margin realised by the enterprise or by an unrelated enterprise froma comparable uncontrolled transaction or a number of such transactions is computedhaving regard to the same base ;(iii) the net profit margin referred to in sub-clause(ii) arising in comparable uncontrolled transactions is adjusted to take into accountthe differences, if any, between the international transaction and the comparableuncontrolled transactions, or between the enterprises entering into suchtransactions, which could materially affect the amount of net profit margin in theopen market ;(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) isestablished 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 anarm's length price in relation to the international transaction.'5. A bare perusal of sub-clause (i) of Rule 10B(1)(e) brings out that the net profit margin realized bythe enterprise from an international transaction is to be computed in relation to a particular base.Sub-clause (ii) provides that the net profit margin realized by the enterprise from the comparableuncontrolled transaction is computed having regard to the same base. Sub- clause (iii) provides thatthe net profit margin realized by a comparable company, determined as per sub-clause (ii) above, isadjusted to take into account the differences, if any, between the international transaction and thecomparable uncontrolled transactions, which could materially affect the amount of net profit marginin the open market. It is this adjusted net profit margin of the unrelated transactions or of thecomparable companies, as determined under sub-clause (iii), which is used as benchmark for thepurposes of making comparison with the net profit margin realized by the assessee from itsinternational transaction as per sub-clause (i). Sub-clause (iv) states that the net profit marginrealized by the enterprise, as referred in sub clause(i), is established to be the same as a net profit margin referred in sub-clause (iii) of thecomparables. Sub-clause (v) states that the net profit margin thus established is then taken intoaccount to arrive at an arm's length price in relation to international transaction.6. On going through the above sub-clauses of Rule 10B(1)(e), it becomes vivid that as per the firststep, the `net profit margin realized' by the enterprise from an international transaction is to becomputed. Use of the word 'net profit margin realized' in the provision richly indicates that it is thecalculation of actual operating profit margin of the assessee earned from international transaction,Indian Kanoon - http://indiankanoon.org/doc/181428987/3Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016which cannot be any hypothetical or adjusted figure. Amount of actual net profit margin realized canbe calculated from the assessee's Profit and loss account with the starting point of operating grossrevenue from which the amount of operating expenses are reduced to find out the amount ofoperating profit and the resultant percentage of operating profit with reference to a defined base.When we consider sub-clauses (ii) and (iii), it turns out that, firstly, the net operating marginactually realized from the comparable uncontrolled transaction is computed, which is determined inthe same way as that of the assessee as per clause(i), that is, actual figures without making any adjustment. Then sub-clause (iii) talks of adjusting theactually realized margin of comparables to bring the same at par with the international transactionundertaken by the assessee, so as to iron out the effects of differences between the internationaltransaction and comparable uncontrolled transactions. On going through all the sub-clauses of Rule10B(1)(e), the position which emerges is that the net profit margin realized by the assessee from itsinternational transaction is taken as such, which is then compared with the rate of operating profitmargin of comparables for seeing if the assessee's profit margin is at arm's length.7. Adverting to the facts of the instant case, we do not find any dispute about the assessee actuallyearning 8% markup on the `Costs' incurred. The assessee incurred total costs to tune of Rs.101.89crores. Markup of 8% on such cost comes to Rs.8.06 crore, resulting into gross revenue receipt atRs.116.95 crores. When we turn to the calculation of the ALP made by the TPO, it emerges that hehas determined this amount as the second figure. Sub-clauses (ii) and (iii) of Rule 10B (1)(e) talk ofdetermination of net profit margin realized by the comparables with reference to the same base asadopted under sub-clause (i) for calculation of the assessee's profit margin. What the TPO has donein the instant case is that he computed `Net operating income' as the first figure at Rs.176.14 crore,by applying 6% markup on FOB value of goods exported by the assessee at Rs.2935.69 crore. Afterreducing `Operating income shown by assessee' at Rs.116.95 crore from the amount of `Netoperating income' of Rs.176.14 crore, the TPO proposed transfer pricing adjustment at Rs.59.19crore.8. We find such calculation done by the TPO, neither here nor there. Under sub-clause (i), he wassupposed to work out the rate of operating profit margin realized by the assessee to be computed bydividing the amount of operating profit with total costs as multiplied by 100. As against that, he hassimply taken the amount of gross revenue at Rs.116.95 crore, which includes not only the amount ofoperating profit but also the operating costs incurred by the assessee in providing the services. Thecourse of action adopted by the TPO is not in accordance with law.9. Then under clauses (ii) and (iii) of rule 10B(1)(e), the TPO was required to determine the rate ofprofit margin of the comparables to constitute the benchmark. As against that, the TPO has nottaken any profit rate of any comparable. He once again adjusted the figures of the assessee bychanging the base of `costs' incurred to the `FOB value of exports' and rate of markup from 8% to6%. We fail to comprehend as to how this amount of Rs.176.14 crore can be construed as theoperating profit margin of the uncontrolled transactions/comparables. This amount is nothing but arevised compensation amount, which in the opinion of the TPO should have been earned by theassessee. By no standard, this amount can be construed as the arm's length profit rate, as it is not aIndian Kanoon - http://indiankanoon.org/doc/181428987/4Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016profit rate of any uncontrolled transaction/comparables. This is a derivative from the simplerewriting of the compensation amount of the assessee by the TPO.10. Interestingly, the amount of the transfer pricing adjustment has been calculated by reducing theactual gross receipts of the assessee from its AE at Rs.116.95 crore (`Costs' incurred at Rs.108.89crore plus 8% markup at Rs.8.06 crore) from the amount of profit margin calculated by the TPO atRs.176.14 crore (by applying 6% on FOB value of goods exported at Rs.2935.69 crore). We areunable to understand as to how the revenue receipts of the assessee on one hand, which obviouslyinclude costs incurred, can be compared with the net operating income on the other hand. It goeswithout saying that a valid comparison can be made of similar components. One can compare profitmargin of the assessee with the profit margin of the comparables under the TNMM or the pricecharged by the assessee with the price charged by the comparables under the CUP method etc. Thusthe comparison is always of the profit with profit or price with price. Under no circumstance, theamount of transfer pricing adjustment can be calculated by picking up `profit margin' of the asseseeor comparables and then comparing it with the `price' charged by the comparables or the assessee,as has been done in the extant case. Such calculation of the transfer pricing adjustment by the TPOhas resulted into landing in a piquant situation, in which `ideal profit' has been compared with the`actual price charged' for the purposes of making a transfer pricing adjustment, which is patentincorrect. We have noted above that the assessee applied the TNMM under which the ALP can bedetermined by comparing the adjusted profit margin realized by comparables as per sub- clauses (ii)and (iii) with the realized profit margin of the assessee as per sub-clause (i) of Rule 10B (1)(e). As theTPO has computed ALP of the international transaction with the help of a method unknown to law,which calculation is again flawed because of making comparison of `profit' with the `gross revenue',we cannot countenance the same. The right course for the TPO was to compute assessee's profitmargin realized under the TNMM as per Rule 10B(1)(e)(i) from its annual accounts without anyadjustment and then compare it with the adjusted net operating profit margin of the comparableswith the same base. This would have led to the determination of ALP of this internationaltransaction.11. Ordinarily, we would have set aside the assessment order in the present circumstancesremanding the matter to the AO/TPO for a de novo calculation of the ALP of the internationaltransaction as per the TNMM accepted by him as the most appropriate method. But, we aredesisting from adopting such a course because the assessee has demonstrated to the TPO that thisinternational transaction is at ALP under the TNMM, which is manifest from page 5 of the order ofthe TPO, showing that the assessee calculated its OP/TC at 8% and average OP/TC of 25 comparablecompanies at 9.30%. Correctness of these figures recorded in the order has not been disputed by theTPO. If we ignore the exercise done by the TPO, which is clearly not in conformity with any of theprescribed methods, what remains for consideration under TNMM is, the assessee's profit margin at8%, which is within the permissible range of the profit margin of comparables at 9.30%,necessitating no transfer pricing adjustment.12. Be that as it may, it is noted that the TPO determined ALP of the assessee's internationaltransaction for the year under consideration in the same manner as was done by him for the earlieryears. Though the tribunal affirmed the shifting of the base of the assessee from `Costs' incurred toIndian Kanoon - http://indiankanoon.org/doc/181428987/5Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016the `FOB value of exports' and sustained the addition, but the Hon'ble Delhi High Court was pleasedto delete such addition in Li & Fung India Pvt. Ltd. Vs CIT (2013) 87 CCH 105 Del. HC by holdingthat : `the TPO's arbitrary exercise of adjusting the cost plus mark up of 5% on the FOB value ofexports finds no mention in the IT Act nor the Rules'. Similar view has been taken by the Hon'bleDelhi High Court in the assesse's own case for the assessment years 2007-08 and 2008-09.13. In view of the foregoing discussion, we are satisfied that the action of the AO/TPO inmaking/proposing addition/adjustment on account of transfer pricing, cannot be upheld for thereason that the shifting of the base on which markup has been applied has been turned down by theHon'ble Delhi High Court in assessee's own case; the mechanism followed by the TPO for calculatingthe transfer pricing adjustment has no legal legs to stand on; and further the assessee's profitmargin is at ALP under the TNMM on the basis of figures mentioned in the TPO's order, whosecorrectness has not been disturbed by the TPO. Ex consequenti, the addition is hereby deleted.14. In the result, this appeal of the assessee is allowed.Order pronounced in the open court on 23rd March, 2016.Sd./-Sd./-(KULDIP SINGH)(R. S. SYAL)JUDICIAL MEMBERACCOUNTANT MEMBERDate: 23.03. 2016Sp.Copy forwarded to:-1. The appellant2. The respondent3. The CIT4. The CIT (A)-, New Delhi.5. The DR, ITAT, Loknayak Bhawan, Khan Market, New Delhi.True copy.By Order(ITAT, New Delhi)S.No.Details1Draft dictated on2Draft placed before authorDraft proposed & placed before the3Second MemberDraft discussed/approved by Second4Indian Kanoon - http://indiankanoon.org/doc/181428987/DateInitials22/3/1623/3/16DesignationSr. PS/PSSr. PS/PSJM/AMAM/AM6Li & Fung (India) Pvt. Ltd., New ... vs Assessee on 23 March, 2016MemberApproved Draft comes to the Sr.567910Sr. PS/PSPS/PSKept for pronouncementFile sent to Bench ClerkDate on which the file goes to HeadSr. PS/PSSr. PS/PSClerkDate on which file goes to A.R.Date of Dispatch of order*Indian Kanoon - http://indiankanoon.org/doc/181428987/7

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1. The assessee, an Indian Company, was a subsidiary Li & Fung (South Asia) Ltd. incorporated in Mauritius, and engaged in the business of providing buying services to its associated enterprises (Aes). It paid service charges for such services at costs with a 8% markup. An international transaction of `Provision of buying services' was reported for of Rs.116,95,42,324/-. The assessee applied the Transactional Net Marginal Method (TNMM) as the most appropriate method with its Profit Level Indicator (PLI) of Operating Profit / Total Costs (OP/TC) at 8%. TPO treated the assessee as a tested party and noticed that it was allowed commission @8% on the `Costs' incurred for its sourcing activities. TPO changed the base from `Costs' incurred to the `FOB value of exports'. The assessee was seen to have incurred `Costs' in providing such services at Rs.108.89 crore, on which 8% markup was charged to have gross revenue at Rs.116.95 crore, which was declared as the value of the international transaction. He further observed that in an earlier year in which he did similar exercise of substituting the base of `Cost' with the `FOB value of goods exported' for applying 8% markup, 2. Dispute Resolution Panel (DRP) restricted it to 6%. 3. TPO determined the amount of transfer pricing adjustment at Rs.59.19 crore. AO made an addition of Rs.59.19 crore. 4. DRP confirmed AO's order. 5. On appeal, the ITAT held as under: 13. In view of the foregoing discussion, we are satisfied that the action of the AO/TPO in taking/proposing addition/adjustment on account of transfer pricing, cannot be upheld for the reason that the shifting of the base on which markup has been applied has been turned down by the Hon'ble Delhi High Court in assessee's own case; the mechanism followed by the TPO for calculating the transfer pricing adjustment has no legal legs to stand on; and further the assessee's profit margin is at ALP under the TNMM on the basis of figures mentioned in the TPO's order, whose correctness has not been disturbed by the TPO. Ex consequenti, the addition is hereby deleted.

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ITAT quashed the shifting the base of markup, and the addition by AO