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Nokia India (P) Ltd vs. DCIT (ITAT Delhi)

DATE: October 31, 2014 (Date of pronouncement)
DATE: November 3, 2014 (Date of publication)
AY: 2002-03
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(i) Method of applying Resale Price Method (RPM) method, (ii) high advertisement expenses has no bearing on the RPM, (iii) comparables with more than 25% of related party transactions (RPTs) have to be excluded, (iv) transactions which do not impact the profitability should be excluded from the formula, (v) potentially comparable companies cannot be expelled only on the ground of high or low turnover

(i) The assessee simply purchased mobile phones and accessories from Nokia group companies situated outside India and resold the same as such without any further value addition, mainly, to HCL Infosystems in India. Since the goods imported from the foreign AEs representing the international transaction under this segment were neither processed further nor used as raw material for manufacturing any other product, in our considered opinion, RPM is the first choice as the most appropriate method for determination of ALP of the international transaction under this segment.

(ii) The incurring of high advertisement and marketing expenses by the assessee vis-a-vis the other comparable companies does not in any manner affect the determination of ALP under the RPM. When we consider gross profit in numerator and net sales in denominator, all the expenses debited to the Profit & loss account automatically stand excluded. It is but natural that only those expenses can have bearing on the gross profit that are debited to the Trading account. As the amount of advertisement and marketing expenses falls ‘below the line’ and finds its place in the Profit and loss account, the higher or lower spend on it cannot affect the amount of gross profit and the resultant ALP under the RPM. If the assessee has incurred more expenses on advertisement and promotion, which, in the opinion of the ld. DR went on to brand building for an AE, then, the transfer pricing adjustment on account of such AMP expenses was separately called for.

(iii) In principle if any company though functionally comparable, but, has more than a specific percentage of the RPTs, then, the same should be ignored by treating it as a controlled transaction. However, the percentage of RPTs to make a company as ineligible for comparison, in our considered opinion, should be taken as more than 25% and not 15% as suggested on behalf of the assessee. The view adopting more than 25% RPTs making a company incomparable has been taken by various benches of tribunal including Aglient Technologies International P. Ltd. VS. ACIT (2013) 36 CCH 187 Del Trib ; Stream International Services Pvt. Ltd. VS. ADIT (IT) (2013) 152 TTJ (Mumbai) 553 ; and Actis Advisers Pvt. Ltd. VS. DCIT (2012) 20 ITR (Trib) 138 (Delhi). We, therefore, hold that a company can be considered as incomparable if its RPTs exceed 25%.

(iii) Ratio of the RPTs represents the proportion of transactions with the associated enterprises (numerator) vis-a-vis the total of transactions (denominator). In order to decide that what should constitute the contents of numerator and denominator for the purposes of finding out the percentage of RPTs, it is relevant to note the logic behind applying this filter. It is manifest that the aim of the transfer pricing regime is to ensure that the international transactions are recorded at arm’s length price. This is done under the TNMM by comparing the profit earned from the international transaction with that earned by the comparable independent parties in an uncontrolled situation. Thus, while choosing comparables, it must be ensured that the profit earned by them correctly reflects true profit as is earned by an enterprise from an independent third party. If such a chosen company, though functionally comparable, has also entered into
international transactions beyond a particular percentage with the related parties, it is quite possible that its overall profit may have been distorted due to such transactions rendering it as incomparable. That is why, this filter is applied to make certain that a company sought to be considered as comparable should have its profit uninfluenced by the impact of the related party transactions.

(iv) Transactions which do not impact the profitability, such as loan given or taken or other items finding place in the balance sheet, can have no place either in the numerator or the denominator of this formula. However, any income or expenditure resulting/relating from/to or likely to result/relate from/to such items of assets or liabilities, should not be confused with the per se international transactions finding place in the balance sheet of the company calling for exclusion.

(v) In CIT VS. Agnity India Technologies (P.) Ltd. (2013) 219 Taxman 26 (Del), the assessee was a captive unit providing software services to its associated enterprises. The Hon’ble High Court directed the exclusion of Infosys Ltd. from the list of comparables, which list otherwise included several companies with huge turnover. The exclusion was ordered on account of the giantness of this company, which was, in turn, determined by seeing the cumulative effect of several factors, including risk profile, nature of services, turnover, ownership of branded/proprietary products, onsite vs. offshore services, expenditure on advertisement and R&D etc. The higher turnover was only one of the criterion and not the sole criteria for the exclusion of this company. In view of the above discussion, we hold in principle that no potentially comparable company can be expelled from the list of comparables simply for the reason of high or low turnover.

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