|CORAM:||I. C. Sudhir (JM), T. S. Kapoor (AM)|
|CATCH WORDS:||Berry Ratio, sogo shosha, Transfer Pricing|
|COUNSEL:||Rano Jain, Ved Jain|
|DATE:||August 20, 2015 (Date of pronouncement)|
|DATE:||August 27, 2015 (Date of publication)|
|FILE:||Click here to download the file in pdf format|
|Transfer Pricing: Transactions of providing support services to “Sogo shosha” entities cannot be characterized as trading transaction for purposes of comparison and determining ALP and the cost of sales cannot be included|
The assessee company is a wholly owned subsidiary of Mitsui & Co. Ltd., Japan. Mitsui & Co. Ltd., Japan is one of the leading sogo shosha establishment in Japan. Sogo shosha means general trading and these companies are general trading companies. These companies play an important role in linking buyers and sellers for wide range of products. The range is very wide that it includes grain and oil, machinery, equipment, etc. The assessee company being a subsidiary of the Mitsui & Co. Ltd., Japan provided support services to the various group entities of Mitsui & Co. Ltd., Japan. This support services is the main activity whereby it acts as a facilitator for the transactions entered into by Mitsui & Co. Ltd., Japan and other group entities of the Mitsui & Co. Ltd., Japan. The assessee used TNMM (Transactional Net Margin Method) as the most appropriate method and the Profit Level Indicator (PLI) selected was ‘Berry Ratio’ against operating expenses. The assessee claimed that the average berry ratio come out to 1.34 as against 1.09 computed on the basis of the 20 comparables set out in the transfer pricing study and hence the transactions entered into by the assessee company was at arm’s length price. The TPO was also of the view that the way the assessee has computed arm’s length price by using berry ratio as PLI, the entire international transactions relating to sales and services of the commodities have remained out of the PLI. He held that the cost of sale is to be included in the denominator of the PLI used. It was also held that as per the Income Tax Rules operating expenses cannot be the basis as these expenses do not include cost of sales. The TPO invoked Rule 10B(1)(e)(i) to hold that net profit margin realized by an assessee from an international transaction entered into with associated enterprises is to be computed in relation to costs incurred, sales effected or assets employed by the assessee. It was also held that as regards the support services provided by the assessee is concerned, the right course will be to treat such services as equivalent to trading and the income received by the assessee from such support services is to be considered as income from trading and comparison need to be made accordingly. This was upheld by the DRP. On appeal by the assessee to the Tribunal HELD allowing the appeal:
(i) The activities of purchase and sale i.e. trading involves risk and finance whereas in the activity of support services i.e. intending transactions the assessee has neither to incur any financial obligation nor carries any significant risk. The nature of two activities is absolutely different. The activities of trading i.e. purchase and sale are highly insignificant as compared to activity of support service which constitutes the core business activities of the assessee. The TPO and DRP are wrong in applying the trading margins ignoring the facts of the case that the assessee being a service provider the trading margins cannot be applied. Further, the TPO DRP have gone wrong in including the cost of sales in OP/TC ignoring the fact the value of the sale under no circumstances effects the activities of the assessee company, a service provider. For support services the correct method is the TNMM and the assessee has computed the same on the basis of OP/TC. The OECD guidelines also supports this contention that in TP study business transactions cannot be recharacterized. The support service or intending provided by the assessee company is nothing but a trading facilitation both in form and substance.
(ii) The trading activities are undertaken by Mitsui Japan not by Mitsui India. If it is import of goods for buyers in India, the Mitsui Japan has a contract with the Japanese suppliers and Mitsui Japan also enters into contract with the buyers in India. Similarly for exports from India, Mitsui Japan enters into a contract with Indian supplier directly for the purchase and sales transactions. Thus the role of Mitsui India, the assessee company is a mere facilitator, a mere service provider. Mitsui India does not take title or possession of the merchandise at any moment and bears no price risk. Mitsui India does not take inventory risk, it does not take warranty risk, it does not take credit risk. It does not employ its capital. In purchase and sale, inventory, advances, debtors, Mitsui India’s main function is to maintain contact with the suppliers to ensure timely delivery of merchandise to the customers in the quality and grade desired, communicating with Mitsui India or its affiliates, gathering information on demand and supply conditions of the commodities. The above functions are entirely different than the trading business. In trading activities, one ventures himself. Buys and sells goods in it’s account. It takes price risk, inventory risk, it deploys capital in inventory, debtors. It takes risk in warranty, credit, etc. Thus the functions performed, assets deployed and risk assumed in trading are entirely different than that of business support services. The TPO has gone wrong in holding that margins earned in trading are in identical circumstances as while providing support services.
(iii) As regards the issue of inclusion of cost of sales in the denominator, the reasoning given by the TPO that compensation model in the case of the assessee should be expressed as a percentage of FOB price of goods serviced through the assessee is also wrong. The comparison model as a percentage of the value of the goods can be good where the service provider has knowledge of the product, knowledge of the quality, its usage and has developed competency. In this regard this model can’t be applied to an entity which is just providing support services to an entity who in turn has core competency of that business, its product, design, etc. There is a difference in carrying on the business oneself and providing support service to the one who is doing the business. That reasoning given by the TPO for adding cost of goods sold while computing margin is not correct. Rule 10B(e)(i) specifically provides that net profit margin in relation to transaction entered into with an AE is computed in relation to costs incurred, or sales effected or assets employed or to be employed by the enterprise. The cost incurred here will mean the cost incurred by the enterprise which will in the case of the assessee mean the cost incurred in providing services. Since no sales have been effected by the assessee company it is not appropriate to take cost of sales for computing margin. Even otherwise the compensation model to determine the arm’s length price based on a single rate of commission on total FOB value of all types of goods to be sold will not be appropriate. The percentage of brokerage or commission for procuring business in respect of luxury goods or commodities is higher as compared to the percentage of commission or brokerage for high value products like gold, bullion. Similarly the percentage of commission or brokerage for consumer products is always higher as compared to the industrial products. Thus even where commission rate based on value of goods sold to be applied the nature and type of product n respect of which such services have been rendered have to be taken into consideration and then a comparison needs to be made with the commission rate prevalent in respect of such product goods. In the present case the nature of products and items varies a lot. The TPO without even looking at any of these items details has in a most arbitrary manner considered trading as one and the same to support services and applied trading margin in different nature of the product and items to the support services taking turnover of the AE as the basis. The TPO was not justified in re-characterizing the transaction of business support services as that into trading and applying the profit margin in the trading as the PLI (Sojitz India (P) Ltd. vs. DCIT 24 ITR (Trib) 474 (Del), Li and Fung India Pvt. Ltd. vs. CIT 361 ITR 85 (Delhi) and Mitsubhishi Corporation India (P) Ltd. vs. DCIT, ITA No. 5042/Del/11 dated 21.10.2014 followed)