C\/TAXAP\/751\/2019 JUDGMENT
\nIN THE HIGH COURT OF GUJARAT AT AHMEDABAD
\nR\/TAX APPEAL NO. 751 of 2019
\nWith
\nR\/TAX APPEAL NO. 752 of 2019
\nWith
\nR\/TAX APPEAL NO. 753 of 2019
\nFOR APPROVAL AND SIGNATURE:
\nHONOURABLE MR. JUSTICE J.B.PARDIWALA
\nand
\nHONOURABLE MR. JUSTICE BHARGAV D. KARIA
\n================================================================
\n1 Whether Reporters of Local Papers may be allowed to
\nsee the judgment ?
\nNO
\n2 To be referred to the Reporter or not ? NO
\n3 Whether their Lordships wish to see the fair copy of the
\njudgment ?
\nNO
\n4 Whether this case involves a substantial question of law
\nas to the interpretation of the Constitution of India or any
\norder made thereunder ?
\nNO
\n================================================================
\nTHE PRINCIPAL COMMISSIONER OF INCOME TAX, VADODARA 1
\nVersus
\nGULBRANDSEN CHEMICALS PVT. LTD.
\n================================================================
\nAppearance:
\nMR.VARUN K.PATEL(3802) for the Appellant(s) No. 1
\nMR S.N. SOPARKAR, SR. ADV WITH MR B S SOPARKAR(6851) for the
\nOpponent(s) No. 1
\n================================================================
\nCORAM: HONOURABLE MR. JUSTICE J.B.PARDIWALA
\nand
\nHONOURABLE MR. JUSTICE BHARGAV D. KARIA
\nDate : 03\/02\/2020
\nORAL JUDGMENT
\n(PER : HONOURABLE MR. JUSTICE BHARGAV D. KARIA)
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\n(PER : HONOURABLE MR. JUSTICE BHARGAV D. KARIA)
\n1.These Tax Appeals under Section 260A of the
\nIncome Tax Act, 1961 (for short \u2018the Act,
\n1961\u2019) are at the instance of the Revenue and
\nare directed against the orders passed by the
\nIncome Tax Appellate Tribunal, Ahmedabad \u2018D\u2019
\nBench, Ahmedabad (for short \u2018the Tribunal\u2019).
\n2.Tax Appeal No. 751 of 2019 is arising out of
\nthe order of the Tribunal dated 12.02.2019 in
\nITA No. 2276\/AHD\/2013 for A.Y. 200809.
\n3.Tax Appeal Nos. 752 of 2019 and 753 of 2019
\nare arising out of the common order of the
\nTribunal dated 12.02.2019 for A.Y. 200708
\nin
\nITA No. 760\/AHD\/2012 filed by the revenue and
\nITA No. 874\/AHD\/2012 filed by the assessee.
\n4.Since common issues are arising in these
\nappeals, the same were heard analogously and
\nare being disposed of by this common order.
\nFor the sake of convenience, Tax Appeal No.
\n753 of 2019 is treated as the lead matter.
\n5. The revenue has proposed the following three
\nquestions of law as substantial questions of
\nlaw for the consideration of this Court so
\nfar as Tax Appeal Nos. 752 of 2019 and 753 of
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\n2019 are concerned, which pertains to A.Y.
\n200708:
\n(a) Whether in the facts and
\ncircumstances of the case, the learned
\nITAT has erred in law and on facts in
\ndeleting the upward adjustment of
\nRs.2,78,02,502\/made
\nby the AO\/TPO and
\nconfirmed by CIT (A) on account of
\nTransfer Pricing adjustments in respect
\nof international transactions of sale of
\nchemical products by the assessee to its
\nAssociated Enterprises (Aes)?
\n(b) Whether in the facts and
\ncircumstances of the case, the learned
\nITAT has erred in law and on facts in
\nrejecting the TPO\u2019s approach of
\nrejecting the Transactional Net Margin
\nMethod (TNMM) and adopting Comparable
\nUncontrolled Price (CUP) Method as Most
\nAppropriate Method (MAM)?
\n(c) Whether in the facts and
\ncircumstances of the case, the learned
\nITAT has erred in law and on facts in
\nallowing following appropriate
\nadjustments claimed by the assessee for
\nmaterial differences in contractual
\nterm, underlying commercial
\ncircumstances, functions, risk and other
\neconomic factors between assessee\u2019s
\ntransactions with AEs vis\u00e0vis
\nassessee\u2019s transactions with non AEs
\nwhile applying the Comparable
\nUncontrolled Price (CUP) method:
\nvi. Adjustment on account of business
\nvolumes difference.
\nvii. Adjustment for advance payment
\nreceived from AE.
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\nviii. Adjustment for marking and
\nselling expenses not required to be
\nincurred for AE sales vis\u00e0vis
\nnon AE
\nsales.
\nix. Adjustment for credit risk not
\nrequired to be borne by the assessee for
\nAE sales vis\u00e0vis
\nnon AE sales.
\nx. Adjustment for interest free ECB loan
\nreceived from AE?
\n6. Brief facts of the case are as under:
\n6.1. It appears from the material on record
\nthat the respondent \u2013 assessee filed his
\nreturn of income for A.Y. 200708
\non
\n05.11.2007 declaring the income at
\nRs.99,43,677\/.
\nThe case of the assessee
\nwas selected for scrutiny assessment and
\na notice under Section 143(2) and 142 (1)
\nof the Act, 1961 were issued.
\n6.2. The Assessing Officer referred the case to
\nthe Transfer Pricing Officer (TPO) under
\nSection 92CA(1) of the Act, 1961. The TPO
\npassed an order dated 19.10.2010 under
\nSection 92CA (3) of the Act, 1961
\ndetermining the total transfer pricing
\nadjustment of Rs.3,91,40,456\/by
\ndiscarding the Transactional Net Margin
\nMethod (TNMM) and adopted Comparable
\nUncontrolled Price (CUP) method as Most
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\nAppropriate Method (MAM) by the assessee
\nin respect of the international
\ntransactions.
\n6.3. On the basis of the order passed by the
\nTPO, the Assessing Officer adopted the
\nupward transfer pricing calculated by the
\nTPO and passed the assessment order.
\n6.4. The Assessing Officer adopted the CUP
\nmethod as Most Appropriate Method (MAM),
\ndue to following reasons as recorded by
\nthe Tribunal in the impugned order:
\n\u201c5. The material facts and circumstances
\nof the case are like this. The assessee
\ncompany is a wholly owned subsidiary of
\nEW Limited, Mauritiusa
\ngroup entity of
\nGulbrandsen Inc, USA and Gulbrandsen EU
\nLimited UK inasmuch as the shareholders
\nof EW Limited, i.e. Peter Gulbrandsen
\nand Donald Gulbrandsen, are also
\nmajority shareholders of Gulbrandsen
\nInc, USA and Gulbrandsen EU Limited UK.
\nThe assessee is engaged in the
\nmanufacturing of chemicals for its
\ndivergent industrial customers, its
\nproduct range includes Aluminium
\nChloride Anhydrous (ANH), Meno N Butyl
\nTrichloride (MBTC), Stannic Chloride
\n(TTC), Dibutyl Tin Oxide (DBTO)\/ Dibutyl
\nTin Tin Dilaurate (DBTAA) and Tri Chloro
\nBenzene and these products are supplied
\nto the industries including
\npetrochemical industry, pharmaceutical
\nand chemical intermediate users. The
\nassessee has also sold these products to
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\nits AEs, namely Gulbrandsen Chemicals
\nInc, USA, and Gulbrandsen EU Limited,
\nUK. During the course of assessment
\nproceedings, the matter regarding
\nascertainment of arm\u2019s length price was
\nreferred to the Transfer Pricing
\nOfficer. The Transfer Pricing Officer
\nnoticed that the assessee had, deviating
\nfrom the stand taken in the earlier
\nyears in which internal CUP method was
\nadopted for benchmarking the sale to the
\nAEs, computed the arm\u2019s length price of
\nthese transactions on the basis of
\nTransactional Net Margin Method (TNMM).
\nIn effect thus, the assessee moved, in
\nthe current year, from internal CUP to
\nTNMM. This, however, did not find favour
\nwith the TPO. The TPO was of the view,
\nfor the detailed reasons set out in his
\norder, that, given the facts of the
\ncase, the internal CUP was the most
\nappropriate method and it has been used
\nall along in the earlier years. The
\nreasoning adopted by the TPO was like
\nthis. It was noted that the assessee had
\nsold 40% of its products to the
\nassociated enterprises, and earned
\nmargin of PBIT\/Cost at 2.07%, as against
\nthe sale of 70% of its products in the
\nimmediately preceding year and earning
\nmargin of PBIT\/Cost at 3.26%.
\nThe TPO
\ncomputed the total cost per kg for each
\ntype of chemicals and compared it with
\naverage sale rate to AEs so as to
\ncompute the GP\/Cost (%) and noted that
\n\u201cthe assessee has charged very nominal
\nmargin to the AEs\u201d. Coming to the
\nInternal TNMM adopted by the assessee
\nand the TPO\u2019s view that the basis of
\nallocating the overheads was not clear,
\nit was explained by the assessee that
\nrevenue and expenses have been allocated
\non actual basis wherever these are
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\ndirectly allocable, and wherever these
\nare not directly allocable, the
\nallocation has been done on the basis of
\nappropriate allocation key such as
\nration of sales quantity, sales revenue,
\ntotal revenue. It was also explained
\nthat the segmental details have been
\nreconciled with entity level audited
\naccounts. The assessee further submitted
\nthat \u201cin case if in your view there are
\nany inappropriate cost allocations, we
\nwould appreciate if you can kindly let
\nus know which cost allocations are not
\nappropriate and why these are not
\nappropriate so that we can accordingly
\nclarify and explain on those aspects\u201d.
\nWhile the TPO did not have any specific
\ncomment on this request, he simply
\nrejected the explanation of assessee as
\n\u201cnot accepted\u201d. It was also explained to
\nthe TPO that the CUP method is not
\nreally appropriate to the facts of this
\ncase as the assessee has long term
\nbusiness arrangements with the AEs,
\nwhereas there are no such long term
\narrangements with non AEs and that the
\ncontractual, economic, commercial,
\nfunctional and risk profile differences,
\nbetween the AE transactions vis\u00e0vis
\nnon AE transactions, make the comparison
\nof prices irrelevant. The attention was
\ninvited to the fact that, as also stated
\nin OECD Guidelines for Multinational
\nEnterprises and Tax Administrators,
\napplication of CUP method \u201crequires high
\ndegree of comparability not only in the
\nproducts sold and services provided but
\nalso in the economic circumstances in
\nwhich the respective AE and non AE
\ntransactions take place\u201d. It was thus
\nsubmitted that the economic
\ncircumstances in which sales have taken
\nplace with the AEs are not at all
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\ncomparable with the economic
\ncircumstances in which non AE sales have
\ntaken place. It was also explained that
\nthe AEs, to which the assessee has sold
\nthe products, are resellers whereas non
\nAEs are end consumers, and that while
\nthese AEs are located in US and UK, the
\nnon AE customers are in Asia and Middle
\nEast. Emphasis thus was placed on the
\nfact that the geographical location of
\nmarkets was different and the comparison
\nwas thus inappropriate. It was also
\nhighlighted that the volume of sales to
\nthe AEs was substantially higher than
\nsales to non AEs. The attention was also
\ninvited to the fact that while AEs make,
\non an average, 17 months advance payment
\nfor the purchases while non AEs are
\nextended 6090
\ndays credit period. It
\nwas thus contended that there was no
\ncredit risk to AE sales. The assessee
\nfurther pointed out that the AEs also
\nreimburse the assessee the basic
\nresearch and development costs with 110%
\nmark up under long term business
\narrangement, over and above the sale
\nprice, and that the assessee has also
\nbenefited from interest free ECB loans
\nfrom the AEs. None of these submissions
\nimpressed the TPO. The TPO noted the
\nobjections of the assessee for the
\napplication of Internal CUP but rejected
\nthe same mainly on the ground that
\n\u201csince 200304,
\nthe assessee company has
\nbeen using internal CUP as the most
\nappropriate method\u201d and \u201cthe assessee
\ncompany has shifted from internal CUP
\nmethod to internal TNMM without giving
\nany appropriate reasons. So the
\ncontention of the assessee is rejected\u201d.
\nAs regards the justification of TNMM on
\nthe ground that the volume of sales to
\nthe AEs is several times higher than the
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\nsale to non AEs, the TPO observed that
\n\u201cit means that the assessee has sold
\nhuge volume to AEs at a lower rate and
\nshifted the huge profits from India to
\nother countries\u201d and, therefore, \u201cthe
\ncontention of the assessee is not
\nacceptable\u201d. As regards the credit
\nperiod and advance payments, the TPO
\nobserved, on a superficial note again,
\n\u201ccontention of the assessee is
\nconsidered but is not acceptable because
\nin USA and UK market, the price of TTC,
\nMBTC and DBTC are higher than non AE
\nprice rate\u201d. As regards guaranteed
\npurchase of 50% production, the TPO
\nobserved that \u201cit is seen that the
\nassessee has been earning profits only
\nfrom the non AE transactions (and) at
\nleast 50% guaranteed selling to AEs mean
\nthat the assessee is making loss and
\nshifting the profits from India to other
\ncountries\u201d. On reimbursement of R&D
\ncosts also, the Assessing Officer did
\nonly observe, in rather general terms,
\nthat the plea is \u201cnot acceptable because
\nthe assessee has sold the products to
\nits AEs at very lower rate and shifted
\nthe profits from India to outside India\u201d
\nThe same was the comment in respect of
\ninterest free ECB loans from the AEs. As
\nfor the need of adjustment on account of
\nvarious factors, the TPO simply observed
\nthat \u201cthe assessee has charged very
\nnominal margin to its AEs (and)
\ntherefore, there is no any issue for any
\nadjustment\u201d. He then proceeded to make
\nthe adjustment by observing as follows:
\n10. Computation of Arm\u2019s Length Price
\nProduct Sales to AE
\nQuantity
\n(kgs)
\nSales to
\nAE: Avg.
\nrate
\nSales to
\nnonAE
\nUncontrolled
\nprice rate
\nDifference Adjustment
\nTTC 113800 227 253 26 2958800
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\nMBTC 351036 371.41 465.18 93.77 32316646
\nDBTO 56852 351.84 409.27 57.43 3265010
\nTotal Transfer Pricing Adjustment Rs.3,91,40,456\/6.5.
\nBeing aggrieved by the upward Arm\u2019s Length
\nPrice adjustment (ALP) made by the
\nAssessing Officer on the basis of the
\norder passed by the TPO, the assessee
\ncarried the matter in appeal before the
\nCIT (A).
\n6.6. However, CIT (A) confirmed the order
\npassed by the Assessing Officer observing
\nthat, \u2018regardless of merits into
\nadjustments made by the appellant, the
\nfact remains that adjustment to make
\ncontrol and uncontrolled transactions
\ncomparable were possible in appellant\u2019s
\ncase. It was also observed that, \u201cfurther,
\nit is an accepted position that CUP is a
\nsuperior method to other methods, if
\navailable.\u201d The CIT (A) relying upon the
\ndecision of the Tribunal in case of Serdia
\nPharmaceuticals India Pvt. Ltd. v. ACIT by
\nMumbai ITAT reported in (2011) 44 SOT 391
\n(Mum.) and held that the adjustments were
\npossible but same were rejected on the
\nmerits including in respect of volume
\ndiscount, credit terms, marketing and
\nselling function and consequent costs,
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\ncredit risk, reimbursement of R & D costs,
\ninterest from ECB loan and all such
\nfactors. As the TPO observed that there is
\na huge difference between the sale price
\nof Meno N Butyl Trichloride i.e. MBTC to
\nits USA based AE and UK based AE, inasmuch
\nas the same product was sold to USA based
\nAE for Rs.412.95 and to UK based AE for
\nRs.370.13. According to the CIT (A) such
\ndifference indicated that sales to USA
\nbased AE was much above the ALP. The CIT
\n(A) therefore, observed that, \u2018the
\nappellant has not explained the vast
\ndifference between the prices charged for
\nthe same chemical from two AEs in the same
\nperiod.\u2019 And therefore, \u2018the adjustment
\nclaimed by the appellant and the
\ncalculation done by the appellant to
\narrive at ALP after adjustments is not
\nacceptable\u2019 and \u2018determination by the TPO
\nof ALP of transactions to be average sale
\nprice to nonAEs
\nover the year, without
\ncarrying out adjustments is upheld\u2019. The
\nCIT (A) however, reduced the ALP
\nadjustment to Rs.2,78,02,502\/by
\nobserving as under:
\n\u201c3.3.2 Appellant\u2019s contentions in
\npara 3.2.2 of its submissions regarding
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\nmistakes in quantification of transfer
\npricing addition under CUP method by
\nId. TPO are now taken up. It is pointed
\nout by the appellant that for the
\nproducts MBTC and DBTO, TPO compared
\nconsolidated average price for both the
\nAEs with nonAE
\naverage price. Each
\nsale transaction to the AEs constituted
\na separate international transaction,
\narm\u2019s length price of which was
\nrequired to be determined in accordance
\nwith Section 92 of the I.T. Act. The
\nComparable Uncontrolled Price (CUP) for
\neach of the 4 chemicals was determined
\nby the TPO to be the average sale price
\ncharged by appellant to nonAEs.
\nEach
\ntransaction of sale of chemicals to the
\nAEs needed to be benchmarked with
\nreference to the CUP and if the CUP
\nexceeded the sale price to AE for a
\nparticular transaction, only then
\ntransfer pricing adjustment was
\nwarranted. TPO\u2019s approach in working
\nout adjustment on the basis of
\nconsolidated average sale price for
\nboth AEs for MBTC & DBTO was therefore
\nerroneous; AEwise
\naggregation of
\ntransactions for each chemical for the
\npurpose of benchmarking and working out
\ntransfer pricing adjustment is however
\nacceptable in this case, since it does
\nnot result into an outcome different
\nfrom transactionwise
\nbenchmarking.
\nThus, only AEwise
\nsegregation of sale
\ntransactions for each chemical needs to
\nbe done. Appellant\u2019s submissions in
\nrespect of DBTA sale also have merit
\nand are accepted. Accordingly, transfer
\npricing adjustment of Rs.2,78,02,502\/worked
\nout by the appellant is directed
\nto be substituted in place of
\nadjustment of Rs.3,91,40,456\/worked
\nout by TPO subject to verification by
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\nthe AO of arithmetical correctness of
\nthe working done by the appellant.\u201d
\n6.7. The assessee being aggrieved and
\ndissatisfied by the order passed by the
\nCIT (A) carried appeal before the
\nTribunal, whereas, the Revenue also filed
\na crossappeal
\nfor the reduction of ALP
\nadjustment made by the CIT (A). The
\nTribunal considered the question as to
\nwhich is the most appropriate method for
\nascertainment of Arm\u2019s Length Price in the
\nfacts of the case. The Tribunal considered
\nthe well established principle that as
\nlong as it is reasonably possible to apply
\ndirect method of ascertaining the Arm\u2019s
\nLength Price of a transaction, such a
\ndirect method will have an edge over
\napplication of an indirect method of
\nascertaining the Arm\u2019s Length Price. The
\nTribunal relied upon the decision of the
\ncoordinate Bench of the Tribunal in case
\nof ACIT v. MSS India Ltd. reported in
\n(2009) 32 SOT 132 (Pune) and Serdia
\nPharmaceuticals India Pvt. Ltd. (supra)
\nand has observed as under:
\n\u201c\u2026Going by this principle, all other
\nthings being equal, a direct method like
\nComparable Uncontrolled Price (CUP)
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\nmethod will have an edge over an
\nindirect method like Transactional Net
\nMargin Method (TNMM). That does not, and
\ncannot, however mean that whatever be
\nthe fact situation, CUP is always a
\npreferred method because of one of the
\nessential prerequisite for application
\nof any method of ascertaining the ALP is
\nthe inputs necessary for that purpose.
\nWhatever may be inherent edge of the
\ndirect methods of determining arm\u2019s
\nlength price of an international
\ntransaction over indirect methods of
\ndetermining the arm\u2019s length price of
\ninternational transactions, selection of
\nthe most appropriate method for
\ndetermining arm\u2019s length price under the
\ntransfer pricing provisions, in a
\nparticular fact situation, is not an
\nacademic exercise which can be decided
\nde hors the peculiar facts of that
\nsituation, and, therefore, there cannot
\nbe any straightjacket
\nformulas holding
\napplication of a particular method in
\ncase of a particular type of product or
\nservice. While rule 10B(1) of the Income
\nTax Rules 1962, provides that arm\u2019s
\nlength price in relation to an
\ninternational transaction shall be
\ndetermined by any of the methods, \u201cbeing
\nthe most appropriate method\u201d, set out
\ntherein, Rule 10 C(1) provides the
\nmechanism for selecting the most
\nappropriate method \u201cwhich is best suited
\nto the facts and circumstances of each
\nparticular transaction\u201d and \u201cwhich
\nprovides the most reliable measure of
\narm\u2019s length price of the international
\ntransaction\u201d. Rule 10C(2) further
\nprovides that in selecting the most
\nappropriate method as specified in rule
\n10C(1), certain factors are to be taken
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\ninto account:
\n(a) the nature and class of the
\ninternational transaction;
\n(b) the class or classes of associated
\nenterprises entering into the
\ntransaction and the functions performed
\nby them taking into account assets
\nemployed or to be employed and risks
\nassumed by such enterprises;
\n(c) the availability, coverage and
\nreliability of data necessary for
\napplication of the method;
\n(d) the degree of comparability existing
\nbetween the international transaction
\nand the uncontrolled transaction and
\nbetween the enterprises entering into
\nsuch transactions; (e) the extent to
\nwhich reliable and accurate adjustments
\ncan be made to account for differences,
\nif any, between the international
\ntransaction and the comparable
\nuncontrolled transaction or between the
\nenterprises entering into such
\ntransactions;
\n(f) the nature, extent and reliability
\nof assumptions required to be made in
\napplication of a method
\n[Emphasis, by underlining, supplied by
\nus]
\n10.What is clear from the above analysis
\nis that a method of determining arm\u2019s
\nlength price, to be held as a \u2018most
\nappropriate method\u2019 (MAM), should be, as
\nprovided in rule 10C(1), a method \u201cwhich
\nis best suited to the facts and
\ncircumstances of each particular
\ntransaction\u201d and a method and \u201cwhich
\nprovides the most reliable measure of
\narm\u2019s length price of the international
\ntransaction\u201d. Under rule 10C(2)(c), \u201cthe
\navailability, coverage and reliability
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\nof data necessary for application of the
\nmethod\u201d is one of the crucial factors
\ndetermining suitability of a method of
\ndetermination of arm\u2019s length price in a
\nparticular fact situation. Similarly, it
\nis also important to determine whether
\naccurate adjustments can be made for the
\ndifferences between the international
\ntransactions and the comparable
\nuncontrolled transactions, and unless
\nsuch adjustments can be made the related
\nmethod cannot be said to be most
\nappropriate method. We have already seen
\nas to how, in the CIT(A)\u2019s analysis,
\nsuitable adjustments could not be made
\neven though in his opening observations
\nin the operative portion of the order,
\nhe stated that suitable adjustments can
\nindeed be made. The inability to make
\nsuitable adjustments, therefore, does
\ntake the method outside the ambit of
\nmost appropriate method. Quite clearly,
\ntherefore, unless suitable reliable data
\ninputs necessary for application of a
\nparticular method, as CUP in this case,
\nare available, CUP method cannot be said
\nto be most appropriate methods on the
\nfacts of this case. Let us, therefore,
\nfirst examine whether sufficient inputs
\nwere indeed available.
\n11. At the outset, it is important to
\nnote that what has been relied upon by
\nthe TPO is Internal CUP data but then
\nrather than taking the comparable
\nuncontrolled price of the transaction,
\nthe TPO has compared average of intraAE
\ntransactions and independent
\ntransactions. This approach, though in
\nthe case of application of Cost Plus
\nMethod, has been rejected by a
\ncoordinate bench of this Tribunal in the
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\ncase of ACIT Vs Tara Ultimo Pvt Ltd
\n[(2012) 143 TTJ 91 (Mum)], though the
\nsame reasoning will be equally
\napplicable in respect of the CUP as well
\nas the computation mechanism, in that
\nrespect, is materially similar. In this
\ncase, speaking through one of us (i.e.
\nthe Vice President), the coordinate
\nbench had observed as follows:
\nThe way this rule works, the benchmark
\ngross profit is to be applied on each
\ntransaction with the AEs , while, for
\ncomputing the benchmark, one could take
\ninto account a series of same or similar
\ntransactions. In other words, while
\nsetting the benchmark, one can take into
\naccount several transactions with
\nunrelated enterprise on what can be
\ntermed as ‘global basis’, essentially in
\nrespect of same or similar property or
\nservices though, the benchmark so
\narrived at cannot be applied on the
\nglobal basis i.e. the average of gross
\nprofit earned from same or similar
\ntransactions with AEs. The application
\nof CPM has to be on transaction basis
\nrather than on global basis, and this
\nfundamental scheme of cost plus method
\nis also evident from the plain wordings
\nof Rule 10 B as well. Any other view of
\nthe matter will result in incongruities.
\nFor example, if our average mark up to
\nunrelated enterprises is 20 per cent.
\nand we charge a markup
\nof 2 per cent in
\none transaction with AE and 38 per cent
\nin another transaction with the AE, both
\nthese transactions, by applying the mark
\nup on global basis, will meet the test
\nof ALP whereas in the first case, the
\nmark up charged is certainly not a markup
\nresulting in an ALP. In this
\nparticular case, for example, the normal
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\nmark up in transactions with has been
\ncomputed at 16.31 per cent. and the
\naverage of mark up on sales to AEs
\nhaving been taken at 17.08 per cent.
\nentire sales to AEs has been taken at
\nALP, but, the mark up in the many cases
\nis clearly less than benchmark. To give
\none example, at page 221 of the paperbook,
\nmargin of 14.15 per cent (4
\ninvoices), 13.95 per cent. 13.81 per
\ncent. 14 per cent (4 invoices), 14.14
\nper cent (2 invoices), and 14.16 per
\ncent is given by assessee’s own
\ncomputation, and, on the same page, on
\none invoice, the assessee has shown a
\nmargin as high as 27 per cent. The cost
\nplus method, therefore, has not been
\ncorrectly applied. In any case, one of
\nthe most important input, i.e. diamond,
\nhas been imported at a price for which
\nno ALP documentation is available and
\nthe price of imports have been taken
\ninto account in computation of costs as
\nwell. The costs of inputs have not been
\nverified either. No efforts are made to
\nshow that the terms of sale to the AEs
\nand all other relevant factors are
\nmaterially similar visavis
\nthe
\ntransactions with independent
\nenterprises. The CPM is applied by
\ncomparing gross profit on sales, whereas
\nthe method requires comparison of mark
\nup on costs on transactions with AEs
\nvisavis
\nmark up on costs on
\ntransactions with non AEs [Emphasis, by
\nunderlining, supplied by us now]
\n12. It is also important to note that
\nthe TPO has justified application of
\ninternal CUP on the basis of deviations
\nin prices at which products are sold to
\ndifferent AEs and, by implication, using
\none intra AE price to bench the other
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\nintra AE price. That is wholly
\nincorrect. It is well settled in law
\nthat it is only an uncontrolled price
\nwhich can be compared with controlled
\nprice and used for any benchmarking.
\nThis position has been well summarized
\nin a coordinate bench decision in the
\ncase of Sabic Innovative Plastic India
\n(P.) Ltd. v. Dy. CIT [2013] 59 SOT
\n138\/35 taxmann.com 177 (Ahd.), and we
\nare in considered agreement with the
\nsame.
\n13. When comparing the prices of
\nproducts sold in intra AE transactions
\nvis\u00e0vis
\nindependent transactions, it
\nis not sufficient to compare the prices
\nde hors the economic circumstances in
\nwhich the respective AE and non AE
\ntransactions take place. This principle
\nis beyond any doubt or controversy. In
\nthe OECD Guidelines for Multinational
\nEnterprises and Tax Administrators, it
\nis clearly stated that application of
\nCUP method \u201crequires high degree of
\ncomparability not only in the products
\nsold and services provided but also in
\nthe economic circumstances in which the
\nrespective AE and non AE transactions
\ntake place\u201d. In the UN Transfer Pricing
\nManual, it is observed that \u201cdegree of
\ncomparability between controlled and
\nuncontrolled transactions is typically
\ndetermined on the basis of a number of
\nattributes of the transactions or
\nparties that could materially affect
\nprices or profits and the adjustment
\nthat can be made to account for
\ndifferences\u201d and then it is observed
\nthat \u201cthese attributes, which are
\nusually referred to as the five
\ncomparability factors, include: (i)
\nCharacteristics of the property or
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\nservice transferred; (ii) Functions
\nperformed by the parties taking into
\naccount assets employed and risks
\nassumed, in short referred to as the
\n\u201cfunctional analysis\u201d (iii) Contractual
\nterms; (iv) Economic circumstances; and
\n(v) Business strategies pursued\u201d.
\nClearly, therefore, the significant
\nvariations in economic circumstances and
\ncontractual terms can take seemingly
\ncomparable transactions outside the
\nambit of comparability.\u201d
\n6.8. After considering the aforesaid
\nprinciples, the Tribunal applied the same
\nto the facts of the case, as under:
\n\u201c14. We have noted huge and crucial
\nvariations in payment terms of the
\ntransactions with the AEs visavi
\ntransactions with non AEs. The CIT(A)
\nhas rejected the adjustments in this
\nrespect on account of irrelevant factors
\nsuch as assessee claiming only 8%
\nadjustment in the financial year 200506,
\nas against 20% adjustment sought in
\nthis year, even though the transactions
\nwere under the same agreement. That is
\nimmaterial. What is material is that
\nthere is huge difference in the payment
\nterms. The CIT(A) has also noted the
\ndeviations in the advance payment terms
\nof 120 days under the agreement and the
\nactual advance payment of 17 months on
\naverage. He has also noted that in three
\ninvoices on nonAEs
\nthe credit period
\nwas 60 days but then he declines to
\ntreat these evidence as support for the
\nclaim that in all cases similar credits
\nwere given. However, what is clear that
\nthere is clearly significant variation
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\nin payment terms. As a matter of fact,
\nat page 29, learned CIT(A) himself notes
\nthat \u201cas per the agreement, advance
\npayment was to facilitate appellant\u2019s
\npurchases, working capital etc which, in
\nturn, ensured uninterrupted supply to
\nthe AE\u201d. He does accept that he was
\ngiven analysis sheet showing 17 months
\nadvance payment but rejects it as
\nagreement refers to only 120 days
\nadvance payment. That does not belittle
\nthe fact that whatever may have been
\npayment terms under the intra AE
\nagreement, the payment was actually
\nreceived substantially in advance. The
\nquestion we must ask ourselves is that
\nwhether such substantial advance
\npayments, which ensure availability of
\nworking capital to the assessee, can be
\ncompared with normal business
\ntransactions allowing, on the contrary,
\ncredit period to the customers. The
\nanswer is clearly in negative as the
\neconomic circumstances in which these
\ntwo sets of transactions operate are
\nsubstantially different. The very
\ncharacter of these transactions is
\ndifferent.
\n15. It is also important to bear in
\nmind the undisputed fact that the AE had
\nan obligation to buy at least 50% of its
\nproducts and the assessee was reseller
\nrather than an end user. These
\ncontractual terms and the difference in
\nfunctions also seriously affect the
\ncomparability. The reasons given by the
\nCIT(A) for rejecting these variations
\nare wholly superficial and devoid of any
\nlegally sustainable merits. The
\nvariations in quantities between the AEs
\nand the non AEs cannot be ignored
\neither. There is no dispute that there
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\nis huge variations in quantities sold to
\nthe AEs vis\u00e0vis
\nthe quantities sold to
\nthe nonAEs
\nbut the CIT(A) has rejected
\nthe plea on the basis that \u201cthere is no
\nconsistent pattern or correlation
\nbetween the volume and sale prices\u201d and
\nthat \u201cthere is no reference to any
\nvolume discount in the agreement\u201d. That
\nis again a superficial approach. Whether
\nthere is a mention of the volume
\ndiscount or not or whether there is
\nalways a direct relation between the
\nprices and volumes, the fact remains
\nthat the transactions with such huge
\nvariations, as in this case, cannot be
\nconsidered to be comparable transactions
\nand that is the consistent approach in
\nbenchmarking analysis. The scale of
\ntransactions is an important economic
\nfactor affecting the comparability. We
\nhave also noted that the AEs have
\nreimbursed R&D costs, with mark up, to
\nthe assessee. The AEs have also given
\ninterest free ECB loans. These are also
\nequally important factors. When we take
\nthe transactions with the AEs in the
\nlight of these surrounding economic and
\ncontractual realities, in our considered
\nview, the transactions with non AEs, on
\nthe facts of this case and as a whole,
\nare not comparable at all. We cannot
\nconsider the price of the product in
\nisolation with all these factors, and
\nthat is the reason why the comparability
\nunder CUP ceases to be relevant as these
\nfactors are clearly missing in non AE
\ntransactions. We have also noted that
\nRule10 B(1)(a)(ii) itself provides that
\n\u201csuch price is adjusted to account for
\ndifferences, if any, between the
\ninternational transaction and the
\ncomparable uncontrolled transactions or
\nbetween the enterprises entering into
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\nsuch transactions, which could
\nmaterially affect the price in the open
\nmarket\u201d but then while CIT(A) uphold the
\napplication of CUP method on the ground
\nthat adjustments can indeed be made, he
\nrejects the adjustments on merits. That
\nis clearly incongruous. When he admits
\nthat no adjustments can be made on
\nmerits, the very foundation of his
\ndecision to uphold application of CUP
\nmethod ceases to hold good. In any case,
\nhaving perused the material on record,
\nwe are of the considered view that
\naccurate adjustments cannot be made to
\nnullify the impact of absolutely
\nfundamental variations in the terms of
\nthe intra AE and non AE transactions,
\nand since accurate adjustments cannot be
\nmade, for this reason alone, CUP method
\nceases to be workable on the facts of
\nthis case. The contradiction in the
\napproach is also evident from the fact
\nthat the CIT(A) has upheld application
\nof CUP method on the sole basis that
\naccurate adjustments can be made to take
\ncare of variations in the intra AE and
\nindependent transactions but then one of
\nthe points made before us, in the
\nwritten submissions, is that \u201cif total
\nadjustment of 36% claimed in those years
\nwas allowed, prices would come down to
\nsuch unrealistic levels that one of the
\ninternational transaction, including
\nsales to non AEs, were made anywhere
\nneat them\u201d. Clearly, there is no meeting
\nground between these diametrically
\nopposed stands by the authorities. As
\nregards the decision of coordinate bench
\nin the case of Serdia Pharmaceuticals
\n(supra), that was a case in which no
\ndispute was raised with respect to the
\ncomparables cases except on account of
\nquality for which suitable adjustment
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\nC\/TAXAP\/751\/2019 JUDGMENT
\nwas allowed. This precedent, therefore,
\ndoes not offer any help to the case of
\nthe revenue.
\n16. A lot of emphasis has been placed on
\nthe fact that the assessee on its own
\nwas using the Internal CUP method in
\npast, and, there was, thus, no good
\nreason to deviate from the same. It is
\nfor this main reason that the
\napplication of TNMM has been declined by
\nthe authorities below. Nothing, however,
\nturns on this plea. What is before us is
\nthe question as to which method is most
\nappropriate method for ascertaining the
\narm\u2019s length in the present year. We do
\nnot see how this question is to be
\nadjudicated simply on the basis of what
\nhas been accepted by the assessee, on
\nhis own, as the most appropriate method
\nin the earlier years. Such a choice of
\nmethod in the earlier years, in our
\nhumble understanding, cannot act as an
\nestoppel against the assessee. In our
\nconsidered view, the decision as to what
\nis the most appropriate method on the
\nfacts of this case is to be taken in the
\nlight of the facts and material on
\nrecord before us in the present year.
\nThe past conduct of the assessee, with
\nregard to the selection of the most
\nappropriate method for ascertaining
\narm\u2019s length price for the present
\nassessment year, is not really decisive.
\nWe, therefore, reject this plea of the
\nrevenue authorities as well.\u201d
\n6.9. The Tribunal thereafter referred to the
\ndecision of the Coordinate Bench relied on
\nbehalf of the assessee in the case of DCIT
\nv. Dishman Pharmaceuticals & Chemicals
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\nC\/TAXAP\/751\/2019 JUDGMENT
\nLtd. reported in 45 SOT 37 (2011),
\nwherein, the Tribunal considering the
\nfactors relating to the determination of
\nMost Appropriate Method for computing ALP
\nadjustments and came to the conclusion
\nthat CUP method cannot be applied in each
\nand every case. The Tribunal, therefore,
\nin the facts of the case, held as under:
\n\u201c19. In view of the above discussions
\nand following the consistent view
\nbeing taken by the coordinate benches,
\nin our considered view, the
\napplication of CUP method was indeed
\nnot justified on the facts of the
\npresent case. The intra AE
\ntransactions, on the facts of this
\ncase, were so fundamentally different
\nin character in economic circumstances
\nand contractual terms, that these
\ncannot be compared with the
\nindependent transactions entered into
\nby the assessee. We, therefore, reject
\nthe stand of the authorities below on
\nthis issue.
\n20. We have noted that the assessee
\nhas applied TNMM by comparing the
\nprofits on transactions with AEs and
\nthe non AEs and no specific defects
\nhave been pointed out in the
\nallocation of costs in the segmental
\naccounts which are duly reconciled
\nwith entity level consolidated
\naccounts. We have also noted that
\ndealing with the Internal TNMM adopted
\nby the assessee the TPO had expressed
\nthe view that the basis of allocating
\nthe overheads was not clear, in
\nresponse to which it was explained by
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\nC\/TAXAP\/751\/2019 JUDGMENT
\nthe assessee that revenue and expenses
\nhave been allocated on actual basis
\nwherever these are directly allocable,
\nand wherever these are not directly
\nallocable, the allocation has been
\ndone on the basis of appropriate
\nallocation key such as ration of sales
\nquantity, sales revenue, total
\nrevenue. It was also explained that
\nthe segmental details have been
\nreconciled with entity level audited
\naccounts. The assessee had further
\nsubmitted that \u201cin case if in your
\nview there are any inappropriate cost
\nallocations, we would appreciate if
\nyou can kindly let us know which cost
\nallocations are not appropriate and
\nwhy these are not appropriate so that
\nwe can accordingly clarify and explain
\non those aspects\u201d. We have noted that
\nthe TPO did not have any specific
\ncomment on this request and he simply
\nrejected the explanation of assessee
\nas \u201cnot accepted\u201d. In appeal also, no
\nspecific adjustments were suggested to
\nthe allocations made in the segmental
\naccounts and the discussions were
\nconfined to generalities. In these
\ncircumstances, we see no reasons to
\ndisturb the internal TNMM adopted by
\nthe assessee. We, therefore, delete
\nthe impugned ALP adjustment of Rs
\n2,78,02,502.\u201d
\n6.1. Learned Standing Counsel appearing for the
\nrevenue Mr. Varun K. Patel submitted that the
\nTribunal has committed an error in law and on
\nfacts in rejecting the approach of the TPO of
\nadopting Comparable Uncontrolled Price (CUP)
\nmethod as Most Appropriate Method (MAM) and
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\nfurther erred in allowing various adjustments
\nclaimed by the assessee for material
\ndifferences in contractual term, underlying
\ncommercial circumstances, functions, risk and
\nother economic factors between the
\ntransactions of assessee with AEs vis\u00e0vis
\nthe transactions of the assessee with nonAEs
\nwhile applying the CUP method as under:
\ni. Adjustment on account of business
\nvolumes difference.
\nii. Adjustment for advance payment received
\nfrom AE.
\niii. Adjustment for making and selling
\nexpenses not required to be incurred for
\nAE sales vis\u00e0vis
\nnon AE sales.
\niv. Adjustment for credit risk not required
\nto be borne by the assessee for AE sales
\nvis\u00e0vis
\nnon AE sales.
\nv. Adjustment for interest free ECB loan
\nreceived from AE.
\n6.2. Mr. Varun Patel further submitted that,
\nIndian Transfer Pricing Regulations as well
\nas OECD guidelines state that the
\ntransactional profit method should ideally be
\napplied on a transaction to transaction
\nbasis, but in appropriate situation
\ntransactions may be grouped or aggregated. It
\nwas submitted that, the relevant controlled
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\ntransactions may best be aggregated if it is
\nimpractical to analyze all profits of each
\nindividual transactions or if such
\ntransactions are so interrelated
\nthat this
\nis the most reliable means of benchmarking
\nthe outcome of the transaction against the
\narm\u2019s length outcome. Reference was made to
\nRule 10A (d) of the Income Tax Rules, 1962
\n(for short \u2018the Rules\u2019), wherein, it is
\ndefined that \u201ctransaction\u201d includes a number
\nof closely linked transactions. It was
\ntherefore submitted that if the appropriate
\nmethod adopted by the assessee by applying
\nTNMM is to be given any credence then in case
\nof any enterprise all its international
\ntransaction would be closely interlinked
\nbecause all the transaction of an enterprise
\nin one way or the other are connected to the
\noverall operation and objective of the
\ncompany, and the basis of comparability and
\nanalysis on a transaction to transaction
\nbasis would lose its meaning.
\n6.3. It was further submitted that by following
\nthe TNMM and by clubbing all the
\ninternational transactions for all the
\nproducts, the assessee has failed to follow
\nthe Letter and Intent of TNMM as described in
\nlaw.
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\n6.4. Learned advocate for the Revenue, in support
\nof his submission referred to the decision of
\nthe ITAT Ahmedabad \u2018D\u2019 Bench in case of
\nEffective Teleservices (P.) Ltd. v. Deputy
\nCommissioner of Income Tax reported in
\n(2019) 19 taxman.com 98 (AhmedabadTrib.).
\nHe
\nrelied upon the following observations made
\nby the Tribunal as under:
\n\u201c6. We have heard the rival contentions
\nof both the parties and perused the
\nmaterials available on record. At the
\noutset we note that similar issue related
\nto internal CUP method was raised in
\nassessee\u2019s own appeal in Effective
\nTeleservices (P.) Ltd. v. Asstt. CIT
\n(2019) 90 taxman.com 390 (Hyd.Trib.)
\nwhere issue was decided in favour of
\nassessee by the ITAT vide order dated 16012018
\nby observing as under:
\n\u201c10. We have given thoughtful
\nconsideration to the orders of the
\nauthorities below. We find that the
\nassessee is eligible for tax holiday u\/s.
\n10A of the Act, therefore, we do not find
\nany merit in holding that the assessee
\nmanipulated the prices and shifted the
\nprofits to the overseas jurisdiction for
\navoiding taxes in India. Moreover, the
\ntaxes rates in the USA are higher than
\nthe tax rates prevailing in India.
\nMoreover, the AE of the appellant company
\nhas incurred losses in providing end to
\nend services to third parties. If the
\nassessee had directly undertaken
\ncontracts with the third parties in USA,
\nit would also have incurred operating
\nlosses as against operating profits
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\nC\/TAXAP\/751\/2019 JUDGMENT
\nearned while undertaking transactions
\nwith AEs.
\n11. We find that the appellant company
\nhas earned average hourly rate from its
\nAE business at Rs. 274.39 per hour. As
\nagainst the same, the average hourly rate
\nfrom Non AE business was Rs. 108.82 per
\nhour. Thus, the average hourly rate
\nearned from AE business was more than Non
\nAE business. The only reason for
\nrejecting the assessee\u2019s contention is
\nthat the pricing mechanism in case of AE
\nas well as Non AEs was different;
\ntherefore, CUP is not applicable. In our
\nconsidered opinion, merely because
\npricing mechanism is different, internal
\nCUP should not have been rejected.
\n12. We find that the TPO has mentioned in
\nthe order that the risk profile of AE and
\nnon AE is entirely different. In our
\nconsidered opinion, reasonable accurate
\nadjustment cannot be made for such risk
\ndifferences and if the risk adjustment is
\nmade, the same would further reduce the
\naverage hourly rate charged from AE which
\nis, as mentioned elsewhere, lower than
\nthe average hourly rate charged from AE.
\nTherefore, in our understanding of the
\nfacts, internal CUP should have been
\naccepted as most appropriate method.\u201d
\n6.1 Similarly, the identical issue
\nrelated to internal TNMM method was also
\nraised in assessee\u2019s own appeal of
\nassessment year 200910
\nin Effective
\nTeleservices (P.) Ltd. (supra) where
\nissue was decided in favour of assessee
\nby the ITAT vide order dated 16012018
\nby observing as under:
\n\u201c13. For the sake of completeness of the
\nadjudication, rejection of internal TNMM
\nanalysis undertaken by the appellant
\nduring the course of transfer pricing
\nassessment should not have been rejected.
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\nC\/TAXAP\/751\/2019 JUDGMENT
\nWe find that the appellant company has
\nprovided identical services to AE as well
\nas non AEs and functions performed,
\nassets used and risks assumed in AE as
\nwell as non AE business were similar.
\nTherefore, in our considered opinion,
\neven internal TNMM can be considered as
\nmost appropriate method. We find that the
\noperating margin of the appellant from
\nthe AE segment was derived at 30.90% and
\nthe operating margins in the non AE
\nsegment was derived at Rs. 74.92%.
\n14. The TPO rejected the internal TNMM
\nanalysis on the basis that as the
\nappellant has made operating loss in non
\nAE business, the transactions with non
\nAEs are not at independent rates and they
\nhave been undertaken only to increase
\ncapacity utilization. The total turnover
\nof Non AE segment of Rs. 5.67 lacs as
\nagainst the turnover of Rs. 1909.60 lacs
\nin the case of international transactions
\nwith AE. The ld. CIT(A) confirmed the
\nrejection by holding that the turnover of
\nthe third party segment is very much less
\ncompared to that with AE. The ld. CIT(A)
\nfurther held that the appellant has not
\nproved the allocation of the common cost
\nbetween AE and non AEs and whether they
\nare scientific and at arm\u2019s length. We
\nfind that the TPO has nowhere disputed
\nthe common cost allocation made by the
\nappellant. We also find that the ld.
\nCIT(A) has also never raised any doubt on
\nthe allocation. Insofar as the difference
\nin the turnover, we find that the
\nTribunal Delhi Bench in the case of
\nLummus Technology Heat Transfer BV Vs.
\nDCIT 42 taxmann.com 342 has held as
\nunder:5.
\nRule 10B(l)(e) of the Income Tax
\nRules, which deals with the Transactional
\nNet Margin Method, provides requires that
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\n“the net profit margin realised by the
\nenterprise (i.e. the assessee) from an
\ninternational transaction entered into
\nwith an associated enterprise is computed
\nin relation to costs incurred or sales
\neffected or assets employed or to be
\nemployed by the enterprise or having
\nregard to any other relevant base” is
\ncompared with ” the net profit margin
\nrealised by the enterprise ( i.e. the
\nassessee) or by an unrelated enterprise
\nfrom a comparable uncontrolled
\ntransaction or a number of such
\ntransactions is computed having regard to
\nthe same base” of
\ncourse, subject to
\ncomparability adjustments which could
\naffect the amount of net profit margin in
\nuncontrolled conditions. It is not at all
\nnecessary, as the authorities below seem
\nto suggest, that such net profit
\ncomputations, in the case of internal
\ncomparables (i.e. assessee’s transactions
\nwith independent enterprise), are based
\non the audited books of accounts or the
\nbooks of accounts regularly maintained by
\nthe assessee. hi our considered view, all
\nthat is necessary for the purpose of
\ncomputing arm’s length price, under TNMM
\non the basis of internal comparables, is
\ncomputation of net profit margin, subject
\nto comparability adjustments affecting
\nnet profit margin of uncontrolled
\ntransactions, on the same parameters for
\nthe transactions with AEs as well as Non
\nAEs, i.e. independent enterprises, and as
\nlong as the net profits earned from the
\ncontrolled transactions are the same or
\nhigher than the net profits earned on
\nuncontrolled transactions, no ALP
\nadjustments are warranted. It is not at
\nall necessary that such a computation
\nshould be based on segmental accounts in
\nthe books of accounts regularly
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\nmaintained by the assessee and subjected
\nto audit. We are, therefore, of the view
\nthat the authorities below were in error
\nin rejecting the segmental results on the
\nground that the segmental accounts were
\nnot audited and that these segmental
\naccounts were not maintained in the
\nnormal course of business. As regards
\nvague generalizations by the TPO to the
\neffect that these accounts are
\nmanipulated, that allocation basis of
\nexpenses is unfair and that these
\naccounts conceal true profitability, we
\nfind that these observations are too
\nsweeping and generalized the observations
\nto have any merits. In any event, learned
\ncounsel for the assessee has
\npainstakingly taken us through the
\nsegmental accounts, pointed out the basis
\nof allocation of the expenses. We have
\nnoted that the allocation of expense is
\non the man hour basis, which is quite
\nfair and reasonable, and that every
\nperson has to punch in hours on a
\nspecific project. We have also noted that
\nall these details and expense allocation
\nbasis were also before the TPO and even
\nthen, no specific defects were pointed
\nout by the TPO. Taking into account all
\nthese factors, as also entirety of the
\ncase, we are of the considered view that
\nthe TPO indeed erred in rejecting the
\nsegmental accounts and thus declining to
\naccept the internal comparable. We are
\nalso of the view that the size of the
\nuncontrolled transaction or transactions
\nbeing smaller, by itself, does not make
\nthese transactions incomparable with the
\ntransactions in controlled conditions.
\nSize of the comparable does matter in
\nentity level comparison because scale of
\noperations substantially vary and so does
\nthe underlying profitability factor, but
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\nin a transaction level comparison within
\nthe same entity, mere difference in size
\nof the uncontrolled transactions does not
\nrender the transaction incomparable. If
\nthe size of uncontrolled transaction is
\ntoo big, it may call for an adjustment
\nfor volume business. If the size of the
\nuncontrolled transaction is too small, it
\nmay provoke an inquiry by the TPO to
\nensure that it is not a contrived
\ntransaction outside the normal course of
\nbusiness or with regard to other
\nsignificant factors surrounding smallness
\nof such transaction. However, in our
\nconsidered view, in none of these cases,
\na comparable can be rejected on the basis
\nof its size per se. In this view of the
\nmatter, the authorities below were
\nclearly in error in rejecting the
\ninternal comparable, i.e. profitability
\nof assessee’s transactions with non AEs,
\non the ground that the volume of business
\nwith non AEs was too small visavis
\nbusiness with AEs. In view of these
\ndiscussions, as also bearing in mind
\nentirety of the case, the assessee was
\nquite justified in adopting internal TNMM
\nand comparing the profit earned on its
\ntransactions with AEs with profit earned
\nwith nonAEs.
\nAccordingly, the ALP
\nadjustment of Rs. 2,72,42,940\/deserves
\nto be deleted. We order so. The assessee
\ngets the relief accordingly. 15. The
\nTribunal Hyderabad Bench in the case of
\nNTT Data Global Delivery Services
\nLimited. 63 taxmann.com 92 had taken a
\nsimilar view and followed the findings
\ngiven in the case of Lummus Technology
\nHeat Transfer BV (supra).\u201d
\n6.2 Respectfully following the same we
\nare of the view that assessee rightly
\nbenchmarked the transaction by choosing
\nthe internal CUP method as most
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\nappropriate method and alternatively also
\nrightly benchmarked the internal TNMM
\nmethod as most appropriate method to
\ndetermine the ALP. Accordingly, the
\nappeal of the assessee is allowed.\u201d
\n6.5. It was also submitted that the Tribunal has
\nfailed to consider that the assessee has not
\ntaken into account very important factor for
\ndetermination of the ALP on the basis of the
\ndetermination of the price in different
\ngeographies as compared to sale of products
\nto associate enterprise of the assessee, then
\nnonassociated
\nenterprises of the assessee
\nsituated in the different parts of the world.
\nIt was submitted that, nonAE
\nsituated in
\nnondeveloped
\ncountries or charge at a lesser
\nprice in the sale of products to AE situated
\nin countries, viz. USA which are developed
\ncountries. The difference on this account
\nneeds to be considered, which has not been
\ntaken into account by the assessee. It was
\nfurther submitted that, in economics,
\nPurchasing Power Parity (PPP) is a condition
\nbetween countries where an amount of money
\nhas the same purchasing power in different
\ncountries. Considering the PPP, instead of
\nmaking any reduction in NonAE
\nprice due to
\nadjustments, the assessee was required to
\nincrease the NonAE
\nprice which is not being
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\ntaken into account for the purposes of
\ncalculation of ALP.
\n6.6. It was therefore submitted that, the ALP of
\nsales to the AE in respect of ANH and MBTC
\nare benchmarked using CUP as Most Appropriate
\nMethod by the TPO.
\n6.7. It was further submitted that, the assessee
\nhas failed to discharge the onus by carrying
\nout the benchmarking in using the most
\nappropriate method and in such scenario; the
\nbenchmarking carried out by the TPO
\nrepresents the best possible approach.
\n7.1. On the other hand, learned Senior Advocate
\nMr. S.N. Soparkar assisted by learned
\nadvocate Mr. B.S. Soparkar submitted that,
\nthe questions of law proposed by the revenue
\nare in realm of questions of facts and as the
\nTribunal being the final fact finding
\nauthority has arrived at a conclusion on the
\nbasis of the material produced before it that
\nthe TNMM applied by the assessee is the Most
\nAppropriate Method (MAM) for the purpose of
\ncomputation of ALP, and therefore, no
\ninterference is required to be made in the
\nfindings given by the Tribunal.
\n7.2. It was further submitted by the learned
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\nSenior Advocate appearing for the assessee \u2013
\nrespondent that the Tribunal on the facts of
\nthe present case has held that the assessee
\nhas applied TNMM by comparing the profits on
\ntransactions with the AE and the NonAEs
\nand
\nno specific defects have been pointed out in
\nthe allocation of costs in the segmental
\naccounts which are duly reconciled with
\nentity level consolidated accounts, and in
\nsuch circumstances, the method adopted by the
\nassessee was considered as Most Appropriated
\nMethod. It was also submitted that the
\nTribunal has also given a finding that the
\napplication of CUP method was not justified
\non the facts of the present case, as the
\nintra AE transactions were fundamentally
\ndifferent in character in economic
\ncircumstances and contractual terms and these
\ncannot be compared with the independent
\ntransactions entered into by the assessee.
\n7.3. It was therefore submitted that, the
\ndifference of opinion between the Tribunal
\nand that of CIT (A) and TPO as to
\nappropriateness of one or other methods
\ncannot perse
\nbe a ground for interference
\nbecause appropriateness of the method unless
\nshown by the contrary to Rules, specially
\nRule 10B and 10C of the Rules, the same
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\ncannot be considered as substantial question
\nof law under Section 260A of the Act, 1961.
\nIn support of his submissions, learned Senior
\nAdvocate placed reliance upon the decision of
\nthe Delhi High Court in the case of
\nPrincipal Commissioner of IncomeTax6
\nv.
\nMake My Trip India (P.) Ltd. reported in
\n(2017) 399 ITR 297 (Delhi).
\n7.4. Learned Senior Advocate further relied upon
\nthe decision of the Coordinate Bench of this
\nCourt in the case of Principal Commissioner
\nof Incometax,
\nGandhinagar v. Tudor India
\n(P.) Ltd. reported in (2019) 11 taxman.com
\n450 (Gujarat) to submit that the entire
\nscheme of the transfer pricing has been
\nconsidered by this court and as such the
\nTribunal has come to the conclusion on the
\nbasis of the material on record as per the
\nprovision for the transfer pricing in the
\nact,1961. It was therefore submitted that no
\ninterference is required to be made in the
\nimpugned order of the Tribunal as no
\nsubstantial question of law arises there
\nfrom.
\n8. Having heard the learned advocates appearing
\nfor the receptive parties and having gone
\nthrough the material on record, it appears
\nfrom the facts of the case that the Tribunal
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\nconsidering the material on record has given
\nthe finding of fact that the TNMM applied by
\nthe assessee is the correct method and the
\napplication of CUP method was not justified,
\nin view of the fact that intra AE transactions
\nwere fundamentally different in character in
\neconomic circumstances and contractual terms
\nand these cannot be compared with the
\nindependent transactions entered into by the
\nassessee.
\n9. The Tribunal has further discarded the view of
\nthe TPO dealing with the internal TNMM adopted
\nby the assessee with regard to the basis of
\nallocating the overrates being not clear, by
\nobserving that the revenue and expenses have
\nbeen allocated on actual basis wherever the
\nsame were directly allocable and wherever the
\nsame were not directly allocable, allocation
\nwas made on the basis of the appropriate
\nallocation key such as ratio of sales
\nquantity, sales revenue and total revenue. The
\nTribunal also found that the segmental details
\nhave been reconciled with entity level audited
\naccounts. It was also found that the TPO did
\nnot have any objection with regard to the
\nallocation made by the assessee, but
\nexplanation given by the assessee was simply
\nrejected as \u201cnot accepted\u201d. The CIT (A) also
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\ndid not refer to any flow to the allocations
\nmade in the segmental accounts and discussed
\nthe issue on generalities only. In such
\ncircumstances, the Tribunal after considering
\nin detail the facts of the case as stated in
\nparas14
\nand 15 of the impugned order
\nreproduced hereinabove, has come to the
\nconclusion that the internal TNMM adopted by
\nthe assessee is just and proper.
\n10. In decision of Principal Commissioner of
\nIncometax,
\nGandhinagar v. Tudor India (P.)
\nLtd. (supra) this Court has considered the
\nentire scheme of the transfer pricing and has
\nobserved as under:
\n\u201c11. The Karnataka High Court, in the case of
\nPr. Commissioner of Income Tax, Bangalore & Ors.
\nvs. Softbrands India P. Ltd., reported in (2018)
\n406 ITR 513 had the occasion to consider the
\nspecial provisions relating to the Avoidance of
\nTax in ChapterX
\nof the Act comprising of
\nSections 92 to 94B
\nwith regard to the
\nassessment to be done for the computation of
\nincome from international transactions on the
\nprinciples of \u201cArm’s Length Price\u201d (ALP) and the
\nrelevant Rules for computation of such income
\nunder the aforesaid provisions of ChapterX
\nin
\nthe form of Rule 10A
\nto 10E
\nin the Income Tax
\nRules, 1962. We may quote the relevant portion
\nof the judgment;
\n\u201cPerspective of International Trade and
\nTransactions:
\n4. With the ever increasing international
\nTrade and transactions, particularly, in the
\nSoftware Industries and Bangalore, being the
\nSilicon Valley of India where many big,
\nsmall and medium size Software Industries
\nhave their Offices and Units in this
\nSoftware Industry, and Bengaluru is a hub of
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\nthis Service Industry and essentially the
\nIndian Companies have business linkages with
\nlarge Companies spread worldwide
\nparticularly in the Western Hemisphere of
\nthe Globe.
\n5. The implementation of the Tax laws in
\nthis field in a smooth, clear and quick
\nmanner is of utmost importance to build an
\nimage of an efficient Tax Administration
\nboth at Departmental level and in Judicial
\nCourts so that the economic activity in such
\nborderless trade thrives and enures to the
\nbenefit of the Indian economy at large and
\nSoftware Industry in particular.
\nWhile the special provisions have been made
\nfor computation of ‘Arm’s Length Price’ to
\narrive at a fair assessment of income
\ntaxable in the hands of the Indian Resident
\nCompanies and these special provisions also
\nprovide for an elaborate and indepth
\nanalysis of huge data of the comparable
\ncases of other similarly situated Companies
\nto arrive at a fair ‘Arm’s Length Price’ and
\nfor that, Special Cells and designated
\nAuthorities have been created under the
\nIncome Tax Act, 1961, but still retaining
\nthe normal provisions for assessments of
\nappeals in the Indian Income Tax Act about
\nthe remedial Forums or the appeal mechanisms
\nand the Income Tax Appellate Tribunal
\nconstituted under Section 253 of the Act
\ncontinues to be the final fact finding body
\nunder the Act even with regard to the
\nassessments of the international
\ntransactions under the Special Chapter X as
\naforesaid and the appeal to the
\nConstitutional Courts as provided in Section
\n260A
\nto High Court and Section 261 to the
\nHon’ble Supreme Court are applicable to
\nthese special assessments under Chapter X as
\nwell. \u201c
\n12. In para11
\nof the judgment, the Hon’ble
\nCourt diluted upon the following three
\nquestions;
\n\u201c[I] The analysis of the provisions relating to
\nthe Transfer Pricing\/ determination of the
\n‘Arm’s Length Price’;
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\n[II] The Scheme of procedure of assessment and
\nappeals to the Tribunal and High Court\/Supreme
\nCourt.
\n[III] The scope of interference by High Court
\nunder Section 260A
\nof the Act in these type of
\ncases. \u201c
\n13. The Court, thereafter, expressed its prima
\nfacie opinion as regards the transfer pricing
\nadjustments.
\n\u201cPrima Facie Opinion:
\n15. We are of the considered opinion that
\nthis entire exercise of making Transfer
\nPricing Adjustments on the basis of the
\ncomparables is nothing but a matter of
\nestimate of a broad and fair guesswork
\nof
\nthe Authorities based on relevant material
\nbrought before the Authorities including the
\nAppellate Tribunal, but nonetheless the
\nTribunal being the final fact finding body
\nremains so for this Special Chapter X also
\nand therefore, unless this Court is
\nsatisfied that a substantial question of
\nlaw is arising from the order of the
\nTribunal, the appeal under Section 260A
\ncannot be entertained at the instance by
\neither the Revenue or the Assessee and the
\nexercise of fact finding or ‘Arm’s Length
\nPrice’ determination or ‘Transfer Pricing
\nAdjustments’ should be allowed to become
\nfinal with a quietus at the hands of the
\nfinal fact finding body, i.e. the Tribunal.\u201d
\n14. The Court, thereafter, undertook a
\ncomparative analysis of Section 260A
\nof the
\nAct, 1961, Section 100 and Section 103 of the
\nCPC and proceeded to observe as under:
\n\u201c16. We would analyze the provisions of
\nSection 260A
\nof the Act in a little more
\ndetail but we are of the firm opinion that
\nthe entry into the High Court under Section
\n260A
\nof the Act is locked with the words
\n“Substantial questions of law” and the key
\nto open that lock to maintain such appeal
\ncan only be the perversity of the findings
\nof the Tribunal in these type of cases and
\nthe perversity in the findings not only
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\naverred by the appellant before this Court
\nbut, established on the basis of cogent
\nmaterial which was available before the
\nAuthorities below including the Tribunal and
\nthe findings arrived at by the Tribunal can
\nbe so held to be perverse within the well
\nsettled parameters for determining the same
\nas perverse. It is not allowed to either of
\nthe parties, i.e. the Assessee or the
\nRevenue to invoke the jurisdiction of this
\nCourt under Section 260A
\nof the Act merely
\nbecause the Tribunal comes to reverse or
\nmodify the findings given by the lower
\nAuthority, viz. Transfer Pricing Officer
\n(TPO) or Dispute Resolution Panel (DRP)
\nwhich comprises of three Commissioners and
\nthe Revenue or the assessee may feel
\ndissatisfied, because of the reversal or
\nmodification of such findings by the
\nTribunal resulting in leaving out of certain
\ncomparables or adding on of certain
\ncomparables for determining the ‘Arm’s
\nLength Price’ in the hands of the Assessee
\nCompany.
\n17. Unless such perversity in the findings
\nof the Tribunal is established we are of the
\nopinion that the appeals under Section 260A
\nof the Act cannot and should not be
\nentertained at the instance of either of the
\nparties and the present cases before us, we
\nfind that the Tribunal has given cogent
\nreasons and detailed findings upon
\ndiscussing each case of comparable corporate
\nproperly and therefore, we find ourselves
\nunable to call such findings of the Tribunal
\nperverse in any manner so as to require our
\ninterference under Section 260A
\nof the Act.
\n18. We now take up the analysis of Section
\n260A
\nof the Act which we have already said
\nis in pari materia with Sections 100 and 103
\nof the Civil Procedure Code.
\n19. The said provisions are quoted below for
\nready reference and comparison.
\nSection 260A
\nof the Income Tax Act, 1961
\nreads as under:
\n“260A Appeal
\nto High Court:
\n(1) An appeal shall lie to the High Court
\nfrom every order passed in appeal by the
\nAppellate Tribunal [before the date of
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\nestablishment of the National Tax
\nTribunal], if the High Court is satisfied
\nthat the case involves a substantial
\nquestion of law.
\n(2) [The [Principal Chief Commissioner or]
\nChief Commissioner or the [Principal
\nCommissioner or] Commissioner or an
\nassessee aggrieved by any order passed by
\nthe Appellate Tribunal may file an appeal
\nto the
\nHigh Court and such appeal under this subsection
\nshall be]
\n(a) filed within one hundred and twenty
\ndays from the date on which the order
\nappealed against is [received by the
\nassessee or the [Principal Chief
\nCommissioner or] Chief Commissioner or
\n[Principal Commissioner or] Commissioner];
\n(b) [*******]
\n(c) in the form of a memorandum or appeal
\nprecisely stating therein the substantial
\nquestion of law Involved.
\n[(2A) The High Court may admit an appeal
\nafter the expiry of the period of one
\nhundred and twenty days referred to in
\nClause (a) of subsection
\n(2), if it is
\nsatisfied that there was sufficient cause
\nfor not filing the same
\nwithin that period.]
\n(3) Where the High Court is satisfied that
\na substantial question of law is involved
\nin any case, it shall formulate that
\nquestion.
\n(4) The appeal shall be heard only on the
\nquestion so formulated, and the
\nrespondents shall, at the hearing of the
\nappeal, be allowed to argue that the case
\ndoes not involve such question:
\nProvided that nothing in this subsection
\nshall be deemed to take away or abridge
\nthe power of the Court to hear, for
\nreasons to be recorded, the appeal on any
\nother substantial question of law not
\nformulated by it, if it is satisfied that
\nthe case involves such question.
\n(5) The High Court shall decide the
\nquestion of law so formulated and deliver
\nsuch judgment thereon containing the
\ngrounds on which such decision is founded
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\nand may award such cost as it deems fit.
\n(6) The High Court may determine any issue
\nwhich (
\na) has not been determined by the
\nAppellate Tribunal;
\nor
\n(b) has been wrongly determined by the
\nAppellate Tribunal, by reason of a
\ndecision on such question of law as is
\nreferred to in subsection
\n(1).
\n[(7) Save as otherwise provided in this
\nAct, the provisions of the Code of Civil
\nProcedure, 1908 (5 of 1908), relating to
\nappeals to the High Court shall, as far as
\nmay be, apply in the case of appeals under
\nthis Section.]
\nSections 100 and 103 of the Code of Civil
\nProcedure, 1908 read thus:
\n“Section 100 Second
\nAppeal.
\n(1) Save as otherwise expressly provided
\nin the body of this Code or by any other
\nlaw for the time being in force, an appeal
\nshall lie to the High Court from every
\ndecree passed in appeal by any Court
\nsubordinate to the High Court, if the High
\nCourt is satisfied that the case involves
\na substantial question of law.
\n(2) An appeal may lie under this section
\nfrom an appellate decree passed exparte.
\n(3) In an appeal under this section, the
\nmemorandum of appeal shall precisely state
\nthe substantial question of law involved
\nin the appeal.
\n(4) Where the High Court is satisfied that
\na substantial question of law is involved
\nin any case, it shall formulate the
\nquestion.
\n(5) The appeal shall be heard on the
\nquestion so formulated and the respondent
\nshall, at the hearing of the appeal, be
\nallowed to argue that the case does not
\ninvolve such question:
\nProvided that nothing in this subsection
\nshall be deemed to take away or abridge
\nthe power of the Court to hear, for
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\nreasons to be recorded, the appeal on any
\nother substantial question of law, not
\nformulated by it, if it is satisfied that
\nthe case involves such question.”
\nSection 103 Power
\nof High Court to
\ndetermine issues of fact In
\nany second appeal, the High Court may,
\nif the evidence on the record is
\nsufficient, determine any issue necessary
\nfor the disposal of the appeal, (
\na) which has not been determined by the
\nlower Appellate Court or both by the Court
\nof first instance and the lower Appellate
\nCourt, or
\n(b) which has been wrongly determined by
\nsuch Court or Courts by reason of a
\ndecision on such question of law as is
\nreferred to in section 100.”
\nWhat is a Substantial Question of Law?
\n20. From a bare comparison of the provisions
\nquoted above and as discussed in various
\njudgments of the Constitutional Courts,
\nwhich we will refer in brief herein below,
\nit is clear that the Scheme of both Section
\n260A
\nin Income Tax Act, 1961 and Section
\n100 r\/w. Section 103 of the Code of Civil
\nProcedure are in pari materia and in same
\nterms.
\n21. The existence of a substantial question
\nof law is sine qua non for maintaining an
\nappeal before the High Court. While the
\nappeal to High Court under Section 260A
\nof
\nthe Act may be a First appeal in the sense
\nfrom the order of final fact finding by the
\nTribunal under the Income Tax Act, whereas
\nthe Second Appeal on substantial question
\nof law before High Court under Section 100
\nwould lie against the Judgment and Decree of
\nthe first Appellate Court disposing of an
\nappeal against the Judgment and Decree of a
\nTrial Court, but nonetheless it is the third
\nround of consideration at the level of the
\nHigh Court, where the facts and law both
\nhave been screened, discussed and analyzed
\nby the Authorities or the Courts below and
\ntherefore the tenor and color of the words
\n“substantial question of law” in both these
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\nenactments remains the same.
\n22. The High Court has power to not only
\nformulate the substantial questions of law
\nand rather it has the duty to do so and can
\nalso frame additional substantial questions
\nof law at a later stage, if such a
\nsubstantial question of law is involved in
\nthe appeal before it under these provisions
\nand the appeal should be heard and decided
\nonly on such substantial questions of law
\nafter allowing the parties to address their
\narguments on the same. The extended power
\ngiven to the High Courts to decide even an
\nissue under Subsection
\n(6) of Section 260A
\nof the Income Tax Act, which is in pari
\nmateria with Section 103 of the Civil
\nProcedure Code and which says that the High
\nCourts may determine any issue which (a)has
\nnot been determined by the Tribunal or (b)
\nhas been wrongly determined by the Tribunal,
\ncan be so determined by the High Court, only
\nif the High Court comes to the conclusion
\nthat ‘by reason of the decision on
\nsubstantial question of law rendered by it’,
\nsuch a determination of issue of fact also
\nwould be necessary and incidental to the
\nanswer given by it to the substantial
\nquestion of law arising and formulated by
\nit.
\n23. The argument raised by the learned
\ncounsel for the Respondent Assessee before
\nus by making a disjuncted reading of Clause
\n(a) and Clause (b) of SubSection
\n(6) of
\nSection 260A
\nof the Income Tax Act, 1961 to
\nsubmit that the High Court can touch upon
\nthe issues of facts also in an appeal under
\nthis provision bereft of substantial
\nquestion of law, is a misconceived argument.
\n24. In our opinion, both the Clause (a) and
\nClause (b) of SubSection
\n(6) of Section
\n260A
\nof the Act are circumscribed by the
\nwords ‘by reason of the decision on such
\nquestion of law as is referred to in Subsection
\n(1)’. Therefore, even if an issue
\nwhich has not been determined by the
\nTribunal, which was required to be so
\ndetermined in terms of the answer to the
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\nsubstantial question of law given by the
\nHigh Court, such an issue not determined by
\nthe Tribunal could also be decided by the
\nHigh Court with reference to Clause (a) and
\nmore so, if such an issue has been wrongly
\ndecided according to the answer given by the
\nHigh Court to such a substantial question of
\nlaw, then also the High Court can set it
\nright to fall in line with the answer given
\nby the High Court to such a substantial
\nquestion of law raised before it and
\ndetermined by it in terms of Clause (b)
\nthereof.
\n25. Subsection
\n(6) of Section 260A
\nof the
\nAct, therefore, does not give any extended
\npower, beyond the parameters of the
\nsubstantial question of law to the High
\nCourt to disturb the findings of fact given
\nby the Tribunal below.
\n26. Subsection
\n(7) inserted in Section 260A
\nof the Act by the Finance Act of 1999 with
\neffect from 01\/06\/1999 after a period of
\nabout 8 months of substituting the new
\nprovisions of Section 260A
\nto the Act as
\nthey now stand by Finance Act of 1998, with
\neffect from 01\/10\/1998 was only to clarify
\nand support that the parameters of Sections
\n100 & 103 of the Civil Procedure Code and
\nother provisions of Civil Procedure Code
\nrelating to appeals of High Court shall
\napply to the appeals under Section 260A
\nof
\nthe Income Tax Act also.
\n27. The insertion of Subsection
\n(7) in
\nSection 260A
\nof the Act does not give any
\nnew or extended powers to the High Court and
\nthe preexisting
\nprovisions from Subsection
\n(1) to Subsection
\n(6) in Section 260A
\nof
\nthe Act already had all the trappings of
\nSections 100 and 103 of the Civil Procedure
\nCode.
\nCase Laws on Substantial Question of Law:
\n28. In the leading and the first and
\nforemost case on the interpretation of
\nSection 100 of the Code of Civil Procedure
\nCode, the Constitution Bench of the Hon’ble
\nSupreme Court in the case of Sir Chunilal V.
\nMehta and Sons Limited Vs. Century Spinning
\nand Manufacturing Co. Limited AIR 1962 SC
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\n1314, held in para.6 as under:
\n“6. We are in general agreement with
\nthe view taken by the Madras High Court
\nand we think that while the view taken
\nby the Bombay High Court is rather
\nnarrow the one taken by the former High
\nCourt of Nagpur is too wide. The proper
\ntest for determining whether a question
\nof law raised in the case is
\nsubstantial would, in our opinion, be
\nwhether it is of general public
\nimportance or whether if directly and
\nsubstantially affects the rights of the
\nparties and if so whether it is either
\nan open question in the sense that it
\nis not finally settled by this Court or
\nby the Privy Council, or by the Federal
\nCourt or is not free from difficulty or
\ncalls for discussion of alternative
\nviews. If the question is settled by
\nthe highest Court or the general
\nprinciples to be applied in determining
\nthe question are well settled and there
\nis a mere question of applying those
\nprinciples or that the plea raised is
\npalpably absurd the question would not
\nbe a substantial question of law.”
\n29. In the case of Santosh Hazari Vs.
\nPurushottam Tiwari (Deceased) by LRs.,
\n[2001] 3 SCC 179, another Three Judges’
\nBench of the Honble Supreme Court explained
\nthe meaning of the substantial questions of
\nlaw in paras.11 and 12 in the following
\nmanner.
\n“11. Even under the old Section 100 of
\nthe Code (pre1976
\namendment), a pure
\nfinding of fact was not open to
\nchallenge before the High Court in
\nsecond appeal. However the Law
\nCommission noticed a plethora of
\nconflicting judgments. It noted that in
\ndealing with second appeals, the courts
\nwere devising and successfully adopting
\nseveral concepts such as, a mixed
\nquestion of fact and law, a legal
\ninference to be drawn from facts
\nproved, and even the point that the
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\ncase has not been properly approached
\nby the courts below. This was creating
\nconfusion in the minds of the public as
\nto the legitimate scope of second
\nappeal under Section 100 and had
\nburdened the High courts with an
\nunnecessarily large number of second
\nappeals. Section 100 was, therefore,
\nsuggested to be amended so as to
\nprovide that the right of second appeal
\nshould be confined to cases where a
\nquestion of law is involved and such
\nquestion of law is a substantial one.
\n(See Statement of Objects and Reasons.)
\nThe Select Committee to which the
\nAmendment Bill was referred felt that
\nthe scope of second appeals should be
\nrestricted so that litigations may not
\ndrag on for a long period. Reasons, of
\ncourse, are not required to be stated
\nfor formulating any question of law
\nunder subsection
\n(4) of Section 100 of
\nthe Code; though such reasons are to be
\nrecorded under proviso to subsection
\n(5) while exercising power to hear on
\nany other substantial question of law,
\nother than the one formulated under
\nsubsection
\n(4).
\n12. The phrase “substantial question of
\nlaw”, as occurring in the amended
\nsubstantial, as qualifying “question of
\nlaw”, means of
\nhaving substance,
\nessential, real, of sound worth,
\nimportant or considerable. It is to be
\nunderstood as something in
\ncontradistinction with technical,
\nof
\nno substance or consequence, or
\nacademic merely. However, it is clear
\nthat the legislature has chosen not to
\nqualify the scope of “substantial
\nquestion of law” by suffixing the words
\n“of general importance” as has been
\ndone in many other provisions such as
\nSection 109 of the Code or Article
\n133(1)(a) of the Constitution. The
\nsubstantial question of law on which a
\nsecond appeal shall be heard need not
\nnecessarily be a substantial question
\nof law of general importance. In Guran
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\nDitta v. T. Ram Ditta”, the phrase
\n“substantial question of law” as it was
\nemployed in the last clause of the then
\nexisting Section 110 CPC (since omitted
\nby the Amendment Act, 1973) came up for
\nconsideration and their Lordships held
\nthat it did not mean a substantial
\nquestion of general importance but a
\nsubstantial question of law which was
\ninvolved in the case as between the
\nparties. In Sir Chunilal V. Mehta &
\nSons Ltd. v. Century Spg. And Mfg. Co.
\nLtd. the Constitution Bench expressed
\nagreement with the following view taken
\nby a Full Bench of the Madras High
\nCourt in Rimmalapudi Subba Rao v. Noony
\nVeeraju.”
\n30. In the case of Hero Vinoth (Minor) Vs.
\nSeshammal [2006]5 SCC 545, the Two Judges’
\nBench of the Hon’ble Supreme Court following
\nthe earlier precedents, summarises the
\nprinciples in the following manner.
\nThe relevant portion of the said judgment at
\npara.24 is quoted below for ready reference:
\n“24. The principles relating to Section
\n100 CPC relevant for this case may be
\nsummarized thus:
\n(i) An inference of fact from the
\nrecitals or contents of a document is a
\nquestion of fact.
\nBut the legal effect of the terms of a
\ndocument is a question of law.
\nConstruction of a document involving
\nthe application of any principle of
\nlaw, is also a question of law.
\nTherefore, when there is
\nmisconstruction of a document or wrong
\napplication of a principles of law in
\nconstruing a document, it gives rise to
\na question of law.
\n(ii) The High Court should be satisfied
\nthat the case involves a substantial
\nquestion of law, and not a mere
\nquestion of law. A question of law
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\nhaving a material bearing on the
\ndecision of the case (that is, a
\nquestion, answer to which affects the
\nrights of parties to the suit) will be
\na substantial question of law, if it is
\nnot covered by any specific provisions
\nof law or settled legal principle
\nemerging from binding precedents, and
\ninvolves a debatable legal issue. A
\nsubstantial question of law will also
\narise in a contrary situation; where
\nthe legal position is clear, either on
\naccount of express provisions of law or
\nbinding precedents, but the Court below
\nhas decided the matter, either ignoring
\nor acting contrary to such legal
\nprinciple. In the second type of cases,
\nthe substantial question of law arises
\nnot because the law is still debatable,
\nbut because the decision rendered on a
\nmaterial question, violates the settled
\nposition of law.
\n(iii) The general rule is that High
\nCourt will not interfere with the
\nconcurrent findings of the courts
\nbelow. But it is not an absolute rule.
\nSome of the wellrecognised
\nexceptions
\nare where (i) the courts below have
\nignored material evidence or acted on
\nno evidence; (ii) the courts have drawn
\nwrong inferences from proved facts by
\napplying the law erroneously; or (iii)
\nthe courts have wrongly cast the burden
\nof proof. When we refer to “decision
\nbased on no evidence”, it not only
\nrefers to
\ncases where there is a total dearth of
\nevidence, but also refers to any case,
\nwhere the evidence, taken as a whole,
\nis not reasonably capable of supporting
\nthe finding.”
\n31. In the case of Vijay Kumar Talwar Vs.
\nCommissioner of Income Tax, Delhi, [2011] 1
\nSCC 673, comparing the provisions of Section
\n260A
\nof the Act with Section 100 of the
\nCivil Procedure Code, the Hon’ble Supreme
\nCourt held that in the absence of
\ndemonstrated perversity in the findings of
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\nthe Tribunal, the Court cannot interfere and
\na finding of fact may give rise to a
\nsubstantial question of law, only if it is
\nperverse.
\nParagraphs 23 and 25 of the said judgment is
\nquoted below for ready reference:”
\n23. A finding of fact may give rise to
\na substantial question of law, inter
\nalia, in the event the findings are
\nbased on no evidence and\/or while
\narriving at the said finding, relevant
\nadmissible evidence has not been taken
\ninto consideration or inadmissible
\nevidence has been taken into
\nconsideration or legal principles have
\nnot been applied in appreciating the
\nevidence, or when the evidence has been
\nmisread. (See Madan Lal v. Gopi
\nNarendra Gopal Vidyarthi V. Rajat
\nVidyarthi, Commr. Of Customs v. Vijay
\nDasharath Patel, Metroark Ltd. v. CCE
\nand W.B. Electricity Regulatory
\nCommission v. CESC Ltd.).
\n25. We are of the opinion that on a
\nconspectus of the factual scenario,
\nnoted above, the conclusion of the
\nTribunal to the effect that the
\nassessee has failed to prove the source
\nof the cash credits cannot be said to
\nbe perverse, giving rise to a
\nsubstantial question of law. The
\nTribunal being a final factfinding
\nauthority, in the absence of
\ndemonstrated perversity in its finding,
\ninterference therewith by this Court is
\nnot warranted.”
\n15. The Court, thereafter, proceeded to explain
\nthe scheme of assessment of the Transfer Pricing
\nCases.
\n\u201cScheme of Assessment of the Transfer
\nPricing Cases:
\n32. Let us briefly now discuss the Scheme of
\nassessment under Chapter X relating to
\nTransfer Pricing cases of International
\nTaxation under these provisions in income
\narising from international transactions
\nwhich shall be computed having regard to the
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\n‘Arm’s Length Price’ (Sec.92).
\n33. Section 92A
\ndefines an ‘Associate
\nEnterprise’ viz., the Company which
\nparticipates directly or indirectly, or
\nthrough one or more intermediaries, in its
\nManagement or control or Capital of the
\nother Enterprise by holding more than 26% of
\nthe share holding in such other
\nEnterprises and satisfy the other criterias
\nas stated in Section 92A
\nof the Act.
\n34. The word ‘International Transaction’ is
\ndefined in Section 92B
\nof the Act.
\n35. The most important provision concerning
\nus in this batch of cases is Section 92C
\nof
\nthe Act which provides for ‘Computation of
\nArm’s Length Price’ and the said provision
\nstipulates that the ‘Arm’s Length Price’ in
\nrelation to the international transactions
\nshall be determined by following any of
\nthese methods enumerated in Section 92C
\nof
\nthe Act which is considered to be the ‘Most
\nAppropriate Method’ by the Authorities under
\nthe Act. The methods provided are:
\nClause (a): Comparable Uncontrolled
\nPrinciples Method (CUP);
\nClause (b): Resale Price Method (RP)
\nClause (c): Cost Plus Method (CP)
\nClause (d): Profit Split Method (PS)
\nClause (e): Transactional Net Margin Method
\n(TNMM); and
\nClause (f): such other Method as may be
\nprescribed by the Board.
\n36. It appears from the true facts of the
\nvarious cases before us and the arguments of
\nthe learned counsels that the TNNM Method
\nappears to be the most popular and widely
\nadopted Method for determining the ‘Arm’s
\nlength price’ in which the Operating Profit
\nMargin of comparable
\nCompanies are considered by the Authorities
\nand applied to the cases of the Assessees to
\ndetermined the ‘Arm’s Length Price’ and make
\nTransfer Pricing Adjustments.
\nRules 10A,
\n10AB,
\n10B,
\n10C
\n& 10CA
\nof the
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\nIncome Tax Rules, 1962 prescribe the manner
\nfor working out ‘Arm\u2019s Length Price’ under
\naforesaid prescribed Methods.
\n37. Section 92CA
\nof the Act envisages that
\nthe Assessing Authority, if he considers
\nnecessary or expedient so to do, he can with
\nthe previous approval of the Principal
\nCommissioner, refer the computation of
\n‘Arm’s Length Price’ to Transfer Pricing
\nOfficer (TPO), another Departmental
\nAuthority only, who is supposed to have
\nspecial knowledge and training for computing
\nthe ‘Arm’s Length Price’ in the
\ninternational transactions. The Report of
\nthe Transfer Pricing Officer is binding on
\nthe Assessing Authority as per Section 92CA
\n(4) of the Act, but where the Assessee
\nraises an objection against the Draft
\nAssessment Order of the Assessing Authority
\nbased on such Report of the Transfer Pricing
\nOfficer, the Assessee Company within 30 days
\ncan either accept the said Draft Order or
\nfile its objections before the Dispute
\nResolution Panel (DRP) and the Assessing
\nOfficer as per Section 144C
\nof the Act.
\nThe said Dispute Resolution Panel comprises
\nof a Collegium of three Principal
\nCommissioners or Commissioners of Income Tax
\nconstituted by the Board as defined in
\nSection 144C
\n(15) of the Act and it has to
\ncomply with the principles of natural
\njustice by giving an opportunity of hearing
\nto the Assessees. The order passed by the
\nAssessing Authority in pursuance of the
\ndirections of the Dispute Resolution Panel
\n(DRP) is directly appealable to the Income
\nTax Tribunal under Section 253 (1) (d) of
\nthe Act. Section 254 of the Act empowers the
\nAppellate Tribunal to pass such orders on
\nthe appeals ‘as it thinks fit’ after giving
\nan opportunity of hearing to both the
\nparties.
\n38. From the aforesaid Scheme of assessment
\nwith regard to international transactions,
\nit is clear that the process of
\ndetermination of ‘Arm’s Length Price’ has to
\nbe undertaken by the Expert Wing of the
\nIncome Tax Department which is manned by
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\nTransfer Pricing Officer
\n(TPO) and at the higher level by a Collegium
\nof three Commissioners in the form of
\nDispute Resolution Panel (DRP) whose orders
\non questions of facts are appealable before
\nthe highest fact finding body, viz., the
\nAppellate Tribunal.
\n39. The process of determination of ‘Arm’s
\nLength Price’ as observed above, necessarily
\ntakes into account the comparable cases of
\nother similarly situated or nearly similarly
\nsituated Corporate Entities whose data are
\nin public domain or on the Data Bases like
\nProwess and
\nCapital Line Data Base etc. \u201c
\n16. The Court, thereafter, proceeded to discuss
\nwhether any substantial question of law could be
\nsaid to be involved in the matter.
\n\u201cNo Substantial Question of Law Arises in
\nthese Cases:
\n40. The dispute essentially before us is the
\npairing and matching such comparables with
\nthe Transfer Pricing Analysis of the profit
\nmargins given by the Assessee himself during
\nthe course of determination of such ‘Arm’s
\nLength Price’.
\n41. The shades of arguments raised by both
\nthe sides before us in these appeals and
\nmost of which have been filed by the Revenue
\nare that either the wrong Filters have been
\napplied or Filters have been wrongly
\napplied, particularly qua Turnover Filter
\ngiving a far too wide or narrower range of
\ncomparables or even though comparable
\nEntities were functionally different
\nentities from the Entities in the list of
\nDepartmental comparables, as against the
\ncomparables sought to be provided by the
\nassessees but the Revenue Department
\ngenerally insists on their inclusion to get
\nhigh profit ratio leading to higher Transfer
\nPricing adjustments, whereas the assessee
\nwould like to keep the comparables in a
\nnarrower range to justify its Transfer
\nPricing Analysis and profits declared.
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\n42. In sum and substance, we find that such
\nan exercise having been undertaken by the
\nAuthorities below may have resulted not only
\nin high pitched Transfer Pricing Adjustments
\nin the declared profits of the Assessee, but
\na flood of such appeals go before the
\nTribunal itself where finally the inclusion
\nor exclusion of comparables has been
\ndetermined by the Tribunal on due analysis
\ngiving its own reasons.
\n43. The contention raised before us that in
\nview of some different views taken by the
\nTribunal by different Benches at different
\nplaces, the present appeals under Section
\n260A
\nof the Act deserve to be entertained
\nand admitted by this Court for laying down
\ncertain Guidelines about the Filters or Most
\nAppropriate Method to be adopted for
\ndetermination of the ‘Arm’s length price’,
\ndoes not, in our considered opinion falls
\nwithin the parameters of the substantial
\nquestion of law. None of the sides was able
\nto point out any perversity in the Orders of
\nthe Appellate Tribunal in this regard.
\n44. This Court cannot be expected to
\nundertake the exercise of comparison of the
\ncomparables itself which is essentially a
\nfact finding exercise. Neither the
\nsufficient Data nor factual informations nor
\nany technical expertise is available with
\nthis Court to undertake any such fact
\nfinding exercise in the said appeals under
\nSection 260A
\nof the Act. This Court is only
\nconcerned with the question of law and that
\ntoo a substantial one, which has a well
\ndefined connotations as explained above and
\nfindings of facts arrived at by the Tribunal
\nin these type of assessments like any other
\ntype of assessments in other regular
\nassessment provisions of the Act, viz.
\nSections 143, 147 etc. are final and are
\nbinding on this Court. While dealing with
\nthese appeals under Section 260A
\nof the
\nAct, we cannot disturb those findings of
\nfact under Section 260A
\nof the Act, unless
\nsuch findings are exfacie perverse and
\nunsustainable and exhibit a total
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\nnonapplication of mind by the Tribunal to
\nthe relevant facts of the case and evidence
\nbefore the Tribunal.
\n45. Otherwise if the High Court takes the
\npath of making such a comparative analysis
\nand pronounces upon the questions as to
\nwhich Filter is good and which comparable is
\nreally comparable case or not, it will drag
\nthe High Courts into a whirlpool of such
\nData analysis defeating the very purpose and
\npurport of the provisions of Section 260A
\nof the Act. Therefore what we observed above
\nappears to us to be the sustainable view
\nthat the key to the lock for entering into
\nthe jurisdiction of High Court under Section
\n260A
\nof the Act is the existence of a
\nsubstantial question of law involved in the
\nmatter. The key of exfacie
\nperversity of
\nthe findings of the Tribunal duly
\nestablished with the relevant evidence and
\nfacts. Unless it is so, no other key or for
\nthat matter, even the inconsistent
\nview
\ntaken by the Tribunal in different cases
\ndepending upon the relevant facts available
\nbefore it cannot lead to the formation of a
\nsubstantial question of law in any
\nparticular case to determine the aspects of
\ndetermination of ‘Arm’s Length Price’ as is
\nsought to be raised before us. \u201c
\n17. The Court, thereafter, expressed its concern
\nfor giving primacy to the Tribunal in the area
\nof fact finding.
\n\u201c46. Undoubtedly, the Income Tax Tribunal is
\nthe final and highest fact finding body
\nunder the Act. It is manned by Expert
\nMembers (Judicial Members are selected from
\nDistrict Judges or Advocates and Accountant
\nMembers selected from practicing Chartered
\nAccountants or persons of CIT level in the
\nDepartment). Therefore this quasijudicial
\nforum is expected and as some of the nicely
\narticulated Judgments and Orders from the
\nTribunal would indicate, the Orders passed
\nby the Tribunal should normally put an end
\nand quietus to the findings of facts and
\nfactual aspects of assessment. The lower
\nRevenue Authorities cannot be allowed to
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\nmake it their prestige issue, if their stand
\nis not upheld by the Tribunal and agitate
\nagainst their Orders before the higher
\nCourts by resort to Section 260A
\nor Section
\n261 of the Act merely because they are
\ndissatisfied with the findings of facts by
\nthe Tribunal.
\n47. In the case before us now, the pick of
\ncomparables, shortlisting
\nof them, applying
\nof filters, etc., are all fact finding
\nexercises and therefore the final Orders
\npassed by the Tribunal are binding on the
\nlower Authorities of the Department as well
\nas High Court.
\n48. The Tribunal of course is expected to
\nact fairly, reasonably and rationally and
\nshould scrupulously avoid perversity in
\ntheir Orders. It should reflect due
\napplication of mind when they assign reasons
\nfor returning the particular findings.
\n49. For instance, while dealing with
\ncomparables or Filters, if unequals
\nlike
\nSoftware Giant Infosys or Wipro are compared
\nto a newly established small size Company
\nengaged in Software service, it would
\nobviously be wrong and perverse. The very
\nword “comparable” means that the Group of
\nEntities should be in a homogeneous Group.
\nThey should not be wildly dissimilar or
\nunlike or poles apart. Such wild comparisons
\nmay result in the best judgment assessment
\ngoing haywire and directionless wild, which
\nmay land up the findings of the Tribunal in
\nthe realm of perversity attracting
\ninterference under Section 260A
\nof the Act.
\n\u201c
\n18. In the last, the Court concluded as under:
\n\u201cThe procedure of assessment under Chapter X
\nrelating to international transactions as
\nindicated above is already a lengthy one and
\ninvolves multiple Authorities of the
\nDepartment. A huge, cumbersome and tenacious
\nexercise of Transfer Pricing Analysis has to
\nbe undertaken by the Corporate Entities who
\nhave to comply with the various provisions
\nof the Act and Rules with a huge Data Bank
\nand in the first instance they have to
\nsatisfy that the profits or the income from
\ntransactions declared by them is at ‘Arm’s
\nlength’ which analysis is invariably put to
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\ntest and inquiry by the Authorities of the
\nDepartment and through the process of
\nTransfer Pricing Officer (TPO) and Dispute
\nResolution Panel (DRP) and the Tribunal at
\nvarious stages, the assessee has a
\ncumbersome task of compliance and it has to
\nsatisfy the Authorities that what has been
\ndeclared by them is true and fair disclosure
\nand much of the Transfer Pricing
\nAdjustments is not required but the Tax
\nAuthorities have their own view on the other
\nside and the effort on the part of the Tax
\nRevenue Authorities is always to extract
\nmore and more revenue. This process of
\nmaking huge Transfer Pricing Adjustments
\nresults in multilayer
\nlitigation at
\nmultiple Fora. After the lengthy process of
\nthe same, the matter reaches the Tribunal
\nwhich also takes its own time to decide such
\nappeals. In the course of this dispute
\nresolution, much has already been lost in
\nthe form of time, manhours
\nand money,
\nbesides giving an adverse picture of the
\nsluggish Dispute Resolution process through
\nthese channels. If appeals under Section
\n260A
\nof the Act were to be lightly
\nentertained by High Court against the
\nfindings of the Tribunal, without putting it
\nto a strict scrutiny of the existence of the
\nsubstantial questions of law, it is likely
\nto open the floodgates
\nfor this litigation
\nto spill over on the dockets of the High
\nCourts and up to the Supreme Court, where
\nsuch further delay may further cause serious
\ndamage to the demand of expeditious judicial
\ndispensation in such cases.
\nConclusion:
\n55. A substantial quantum of international
\ntrade and transactions depends upon the fair
\nand quick judicial dispensation in such
\ncases. Had it been a case of substantial
\nquestion of interpretation of provisions of
\nDouble Taxation Avoidance Treaties (DTAA),
\ninterpretation of provisions of the Income
\nTax Act or Overriding Effect of the Treaties
\nover the Domestic Legislations or the
\nquestions like Treaty Shopping, Base Erosion
\nand Profit Shifting (BEPS), Transfer of
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\nShares in Tax Havens (like in the case of
\nVodafone etc.), if based on relevant facts,
\nsuch substantial questions of law could be
\nraised before the High Court under Section
\n260A
\nof the Act, the Courts could have
\nembarked upon such exercise of framing and
\nanswering such substantial question of law.
\nOn the other hand, the appeals of the
\npresent tenor as to whether the comparables
\nhave been rightly picked up or not, Filters
\nfor arriving at the correct list of
\ncomparables have been rightly applied or
\nnot, do
\nnot in our considered opinion, give rise to
\nany substantial question of law.
\n56. We are therefore of the considered
\nopinion that the present appeals filed by
\nthe Revenue do not give rise to any
\nsubstantial question of law and the
\nsuggested substantial questions of law do
\nnot meet the requirements of Section 260A
\nof the Act and thus the appeals filed by the
\nRevenue are found to be devoid of merit and
\nthe same are liable to be dismissed.
\n57. We make it clear that the same
\nyardsticks and parameters will have to be
\napplied, even if such appeals are filed by
\nthe Assessees, because, there may be cases
\nwhere the Tribunal giving its own reasons
\nand findings has found certain comparables
\nto be good comparables to arrive at an
\n‘Arm’s Length Price’ in the case of the
\nassessees with which the assessees may not
\nbe satisfied and have filed such appeals
\nbefore this Court. Therefore we clarify that
\nmere dissatisfaction with the findings of
\nfacts arrived at by the learned Tribunal is
\nnot at all a sufficient reason to invoke
\nSection 260A
\nof the Act before this Court.
\n\u201c
\n19. The Delhi High Court, in the case of CIT vs.
\nEKL Appliances Ltd., reported in (2012) 345 ITR
\n241 (Delhi), in context with Section 92CA of the
\nAct, had observed as under:
\n\u201cIt seems to us that the decision taken by
\nthe Tribunal is the right decision. The TPO
\napplied the CUP method while examining the
\npayment of brand fee\/ royalty. The CUP
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\nmethod which in its expanded form is known
\nas “comparable uncontrolled price” method is
\nprovided for in Rule 10B(1)(a) of the Income
\nTax Rules, 1962. It is one of the methods
\nrecognised for determining the ALP in
\nrelation to an international transaction.
\nRule 10B(1) says that for the purposes of
\nSection 92C(2), the ALP shall be determined
\nby any one of the five methods, which is
\nfound to be the most appropriate method, and
\ngoes on to lay down the manner of
\ndetermination of the ALP under each method.
\nThe five methods recognized by the rule are
\n(i) comparable uncontrolled price method
\n(CUP), (ii) resale
\nprice method, (iii) cost
\nplus method, (iv) profit split method and
\n(v) transactional net marginal method
\n(TNMM). The manner by which the ALP in
\nrelation to an international transaction is
\ndetermined under CUP is prescribed in
\nclause (a) of the subrule
\n(1) of Rule 10B.
\nThe following three steps have been
\nprescribed: “(
\na) comparable uncontrolled price method,
\nby which,
\n(i) the price charged or paid for property
\ntransferred or services provided in a
\ncomparable uncontrolled transaction, or a
\nnumber of such transactions, is identified;
\n(ii) such price is adjusted to account for
\ndifferences, if any, between the
\ninternational transaction and the comparable
\nuncontrolled transactions or between the
\nenterprises entering into such transactions,
\nwhich could materially affect the price in
\nthe open market;
\n(iii) the adjusted price arrived at under
\nsubclause
\n(ii) is taken to be an arm’s
\nlength price in respect of the property
\ntransferred or services provided in the
\ninternational transaction;”
\nThe Organization for Economic Cooperation
\nand Development (\u201cOECD , for short) has \u201f
\nlaid down “transfer pricing guidelines” for
\nMultiNational
\nEnterprises and Tax
\nAdministrations. These guidelines give an
\nintroduction to the arm\u2019s length price
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\nprinciple and explains article 9 of the OECD
\nModel Tax Convention. This article provides
\nthat when conditions are made or imposed
\nbetween two associated enterprises in their
\ncommercial or financial relations which
\ndiffer from those which would be made
\nbetween independent enterprises then any
\nprofit which would, but for those
\nconditions, have accrued to one of the
\nenterprises, but, by reason of those
\nconditions, if not so accrued, may be
\nincluded in the profits of that enterprise
\nand taxed accordingly. By seeking to adjust
\nthe profits in the above manner, the arm\u2019s
\nlength principle of pricing follows the
\napproach of treating the members of a multinational
\nenterprise group as operating as
\nseparate entities rather than as inseparable
\nparts of a single unified business. After
\nreferring to article 9 of the model
\nconvention and stating the arm\u2019s length
\nprinciple, the guidelines provide for
\n“recognition of the actual transactions
\nundertaken” in paragraphs 1.36 to 1.41.
\nParagraphs 1.36 to 1.38 are important and
\nare relevant to our purpose. These
\nparagraphs are reproduced below: ”
\n1.36 A tax administration’s
\nexamination of a controlled transaction
\nordinarily should be based on the
\ntransaction actually undertaken by the
\nassociated enterprises as it has been
\nstructured by them, using the methods
\napplied by the taxpayer insofar as
\nthese are consistent with the methods
\ndescribed in Chapters II and III. In
\nother than exceptional cases, the tax
\nadministration should not disregard the
\nactual transactions or substitute other
\ntransactions for them. Restructuring of
\nlegitimate business transactions would
\nbe a wholly arbitrary exercise the
\ninequity of which could be compounded
\nby double taxation created where the
\nother tax administration does not share
\nthe same views as to how the
\ntransaction should be structured.
\n1.37 However, there are two particular
\ncircumstances in which it may,
\nexceptionally, be both appropriate and
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\nlegitimate for a tax administration to
\nconsider disregarding the structure
\nadopted by a taxpayer in entering into
\na controlled transaction. The first
\ncircumstance arises where the economic
\nsubstance of a transaction differs from
\nits form. In such a case the tax
\nadministration may disregard the
\nparties’ characterization of the
\ntransaction and recharacterise
\nit in
\naccordance with its substance. An
\nexample of this circumstance would be
\nan investment in an associated
\nenterprise in the form of interestbearing
\ndebt when, at arm’s length,
\nhaving regard to the economic
\ncircumstances of the borrowing company,
\nthe investment would not be expected to
\nbe structured in this way. In this case
\nit might be appropriate for a tax
\nadministration to characterize the
\ninvestment in accordance with its
\neconomic substance with the result that
\nthe loan may be treated as a
\nsubscription of capital. The second
\ncircumstance arises where, while the
\nform and substance of the transaction
\nare the same, the arrangements made in
\nrelation to the transaction, viewed in
\ntheir totality, differ from those which
\nwould have been adopted by independent
\nenterprises behaving in a commercially
\nrational manner and the actual
\nstructure practically impedes the tax
\nadministration from determining an
\nappropriate transfer price. An example
\nof this circumstance would be a sale
\nunder a longterm
\ncontract, for a lump
\nsum payment, of unlimited entitlement
\nto the intellectual property rights
\narising as a result of future research
\nfor the term of the contract (as
\npreviously indicated in paragraph
\n1.10). While in this case it may be
\nproper to respect the transaction as a
\ntransfer of commercial property, it
\nwould nevertheless be appropriate for a
\ntax administration to conform the terms
\nof that transfer in their entirety (and
\nnot simply by reference to pricing) to
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\nthose that might reasonably have been
\nexpected had the transfer of property
\nbeen the subject of a transaction
\ninvolving independent enterprises.
\nThus, in the case described above it
\nmight be appropriate for the tax
\nadministration, for example, to adjust
\nthe conditions of the agreement in a
\ncommercially rational manner as a
\ncontinuing research agreement.
\n1.38 In both sets of circumstances
\ndescribed above, the character of the
\ntransaction may derive from the
\nrelationship between the parties rather
\nthan be determined by normal commercial
\nconditions as may have been structured
\nby the taxpayer to avoid or minimize
\ntax. In such cases, the totality of its
\nterms would be the result of a
\ncondition that would not have been made
\nif the parties had been engaged in
\narm’s length dealings. Article 9 would
\nthus allow an adjustment of conditions
\nto reflect those which the parties
\nwould have attained had the transaction
\nbeen structured in accordance with the
\neconomic and commercial reality of
\nparties dealing at arm’s length.”
\nThe significance of the aforesaid guidelines
\nlies in the fact that they recognise that
\nbarring exceptional cases, the tax
\nadministration should not disregard the
\nactual transaction or substitute other
\ntransactions for them and the examination of
\na controlled transaction should ordinarily
\nbe based on the transaction as it has been
\nactually undertaken and structured by the
\nassociated enterprises. It is of further
\nsignificance that the guidelines discourage
\nrestructuring
\nof legitimate business
\ntransactions. The reason for
\ncharacterisation of such restructuring as an
\narbitrary exercise, as given in the
\nguidelines, is that it has the potential to
\ncreate double taxation if the other tax
\nadministration does not share the same view
\nas to how the transaction should be
\nstructured.
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\nTwo exceptions have been allowed to the
\naforesaid principle and they are (i) where
\nthe economic substance of a transaction
\ndiffers from its form and (ii) where the
\nform and substance of the transaction are
\nthe same but arrangements made in relation
\nto the transaction, viewed in their
\ntotality, differ from those which would have
\nbeen adopted by independent enterprises
\nbehaving in a commercially rational manner.
\nThere is no reason why the OECD guidelines
\nshould not be taken as a valid input in the
\npresent case in judging the action of the
\nTPO. In fact, the CIT (Appeals) has referred
\nto and applied them and his decision has
\nbeen affirmed by the Tribunal. These
\nguidelines, in a different form, have been
\nrecognized in the tax jurisprudence of our
\ncountry earlier. It has been held by our
\ncourts that it is not for the revenue
\nauthorities to dictate to the assessee as to
\nhow he should conduct his business and it is
\nnot for them to tell the assessee as to what
\nexpenditure the assessee can incur. We may
\nrefer to a few of these authorities to
\nelucidate the point. In Eastern Investment
\nLtd. v. CIT, (1951) 20 ITR 1, it was held by
\nthe Supreme Court that “there are usually
\nmany ways in which a given thing can be
\nbrought about in business circles but it is
\nnot for the Court to decide which of them
\nshould have been employed when the Court is
\ndeciding a question under Section 12(2) of
\nthe Income Tax Act”. It was further held in
\nthis case that “it is not necessary to show
\nthat the expenditure was a profitable one or
\nthat in fact any profit was earned”. In CIT
\nv. Walchand & Co. etc., (1967) 65 ITR 381,
\nit was held by the Supreme Court that in
\napplying the test of commercial expediency
\nfor determining whether the expenditure was
\nwholly and exclusively laid out for the
\npurpose of business, reasonableness of the
\nexpenditure has to be judged from the point
\nof view of the businessman and not of the
\nRevenue. It was further observed that the
\nrule that expenditure can only be justified
\nif there is corresponding increase in the
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\nprofits was erroneous. It has been
\nclassically observed by Lord Thankerton in
\nHughes v. Bank of New Zealand, (1938) 6 ITR
\n636 that “expenditure in the course of the
\ntrade which is unremunerative is none the
\nless a proper deduction if wholly and
\nexclusively made for the purposes of trade.
\nIt does not require the presence of a
\nreceipt on the credit side to justify the
\ndeduction of an expense”. The question
\nwhether an expenditure can be allowed as a
\ndeduction only if it has resulted in any
\nincome or profits came to be considered by
\nthe Supreme Court again in CIT v. Rajendra
\nPrasad Moody, (1978) 115 ITR 519, and it was
\nobserved as under: ”
\nWe fail to appreciate how expenditure
\nwhich is otherwise a proper expenditure
\ncan cease to be such merely because
\nthere is no receipt of income. Whatever
\nis a proper outgoing by way of
\nexpenditure must be debited
\nirrespective of whether there is
\nreceipt of income or not. That is the
\nplain requirement of proper accounting
\nand the interpretation of Section
\n57(iii) cannot be different. The
\ndeduction of the expenditure cannot, in
\nthe circumstances, be held to be
\nconditional upon the making
\nor earning of the income.”
\nIt is noteworthy that the above observations
\nwere made in the context of Section 57(iii)
\nof the Act where the language is somewhat
\nnarrower than the language employed in
\nSection 37(1) of the Act. This fact is
\nrecognised in the judgment itself. The fact
\nthat the language employed in Section 37(1)
\nof the Act is broader than Section 57(iii)
\nof the Act makes the position stronger.
\nIn the case of Sassoon J. David & Co. Pvt.
\nLtd. v. CIT, (1979) 118 ITR 261 (SC), the
\nSupreme Court referred to the legislative
\nhistory and noted that when the Income Tax
\nBill of 1961 was introduced, Section 37(1)
\nrequired that the expenditure should have
\nbeen incurred “wholly, necessarily and
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\nexclusively” for the purposes of business in
\norder to merit deduction. Pursuant to public
\nprotest, the word “necessarily” was omitted
\nfrom the section.
\nThe position emerging from the above
\ndecisions is that it is not necessary for
\nthe assessee to show that any legitimate
\nexpenditure incurred by him was also
\nincurred out of necessity. It is also not
\nnecessary for the assessee to show that any
\nexpenditure incurred by him for the purpose
\nof business carried on by him has actually
\nresulted in profit or income either in the
\nsame year or in any of the subsequent years.
\nThe only condition is that the expenditure
\nshould have been incurred “wholly and
\nexclusively” for the purpose of business and
\nnothing more. It is this principle that
\ninter alia finds expression in the OECD
\nguidelines, in the paragraphs which we have
\nquoted above.
\nEven Rule 10B(1)(a) does not authorise
\ndisallowance of any expenditure on the
\nground that it was not necessary or prudent
\nfor the assessee to have incurred the same
\nor that in the view of the Revenue the
\nexpenditure was unremunerative or that in
\nview of the continued losses suffered by the
\nassessee in his business, he could have
\nfared better had he not incurred such
\nexpenditure. These are irrelevant
\nconsiderations for the purpose of Rule 10B.
\nWhether or not to enter into the transaction
\nis for the assessee to decide. The quantum
\nof expenditure can no doubt be examined by
\nthe TPO as per law but in judging the
\nallowability thereof as business
\nexpenditure, he has no authority to disallow
\nthe entire expenditure or a part thereof on
\nthe ground that the assessee has suffered
\ncontinuous losses. The financial health of
\nassessee can never be a criterion to judge
\nallowability of an expense; there is
\ncertainly no authority for that. What the
\nTPO has done in the present case is to hold
\nthat the assessee ought not to have entered
\ninto the agreement to pay royalty\/ brand
\nfee, because it has been suffering losses
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\ncontinuously. So long as the expenditure or
\npayment has been demonstrated to have been
\nincurred or laid out for the purposes of
\nbusiness, it is no concern of the TPO to
\ndisallow the same on any extraneous
\nreasoning. As provided in the OECD
\nguidelines, he is expected to examine the
\ninternational transaction as he actually
\nfinds the same and then make suitable
\nadjustment but a wholesale disallowance of
\nthe expenditure, particularly on the grounds
\nwhich have been given by the TPO is not
\ncontemplated or authorised.
\nApart from the legal position stated above,
\neven on merits the disallowance of the
\nentire brand fee\/ royalty payment was not
\nwarranted. The assessee has furnished
\ncopious material and valid reasons as to why
\nit was suffering losses continuously and
\nthese have been referred to by us earlier.
\nFull justification supported by facts and
\nfigures have been given to demonstrate that
\nthe increase in the employees cost, finance
\ncharges, administrative expenses,
\ndepreciation cost and capacity increase have
\ncontributed to the continuous losses. The
\ncomparative position over a period of 5
\nyears from 1998 to 2003 with relevant
\nfigures have been given before the CIT
\n(Appeals) and they are referred to in a
\ntabular form in his order in paragraph
\n5.5.1. In fact there are four tabular
\nstatements furnished by the assessee before
\nthe CIT (Appeals) in support of the reasons
\nfor the continuous losses. There is no
\nmaterial brought by the revenue either
\nbefore the CIT (Appeals) or before the
\nTribunal or even before us to show that
\nthese are incorrect figures or that even on
\nmerits the reasons for the losses are not
\ngenuine.
\nWe are, therefore, unable to hold that the
\nTribunal committed any error in confirming
\nthe order of the CIT (Appeals) for both the
\nyears deleting the disallowance of the brand
\nfee\/ royalty payment while determining the
\nALP. Accordingly, the substantial questions
\nof law are answered in the affirmative and
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\nin favour of the assessee and against the
\nRevenue. The appeals are accordingly
\ndismissed with no order as to costs.\u201c
\n11. We are of the view that in view of above
\ndictum of law the findings of fact recorded by
\nthe Tribunal in the impugned order cannot be
\ntermed as perverse or contrary to the evidence
\non record. The Tribunal has taken into
\nconsideration the voluminous documentary
\nevidence on record for the purpose of coming
\nto the conclusion of adoption of TNMM by the
\nassessee as the Most Appropriate Method of
\narriving at ALP. The Delhi High Court in the
\ncase of Make My Trip India (P.) Ltd. (supra)
\nhas also held that difference of opinion as to
\nthe appropriateness of one or the other method
\ncannot be gone into in the appeal under
\nSection 260A of the Act, 1961 by observing as
\nunder:
\n\u201c5. The Court is of the opinion that
\nno substantial question of law
\narises. The difference of opinion
\nbetween the CIT (A) and the TPO, as
\nto the appropriateness of one or the
\nother methods, cannot per se be a
\nground for interference; the
\nappropriateness of the method unless
\nshown to be contrary to the Rules
\nspecially Rules 10B and 10C, in the
\nopinion of the Court, are hardly
\nissues that ought to be gone into
\nunder Section 260A of the Incometax
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\nAct.\u201d
\n12.In the overall view of the matter, we are
\nconvinced that the decision of the Tribunal is
\ncorrect and requires no interference and no
\nquestion of law much less any substantial
\nquestion of law can be said to have arisen
\nfrom the impugned order of the Tribunal. In
\nthe result, these appeals fail and are hereby
\ndismissed, with no order as to costs.
\n(J. B. PARDIWALA, J)
\n(BHARGAV D. KARIA, J)
\nPradhyuman\/\/
\nPage 71 of 71
\nDownloaded on : Sun Sep 20 22:14:01 IST 2020<\/p>\n","protected":false},"excerpt":{"rendered":"
The significance of the aforesaid guidelines lies in the fact that they recognise that barring exceptional cases, the tax administration should not disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. It is of further significance that the guidelines discourage restructuring of legitimate business transactions. The reason for characterisation of such restructuring as an arbitrary exercise, as given in the guidelines, is that it has the potential to create double taxation if the other tax administration does not share the same view as to how the transaction should be structured.<\/p>\n