TNMM is a right method to arrive at ALP when assessee have not taken Substantial Risks

Citation of the Case:-

CIT vs. Marubeni India Pvt. Ltd,( Delhi High Court), ITA 94/2015, Date of Decision:- 23/04/2015

Brief of the Case

In the present facts of the case the Hon’ble High Court held that as the assessee have not taken substantial risks and was a mediator in the international transactions. Hence, Transactional Net Margin Method is a right method instead of Profit Split method.

Facts of the Case

The brief facts of the case are that the assessee is a wholly owned subsidiary of a foreign company and provides agency services on behalf of it and other group companies across the globe and also liaises between departments of group companies and their suppliers/customers in India. For AY 2008-09, five international transactions were reported by it. The controversy in this appeal is with respect to one international transaction, i.e. provision of Agency and marketing support services. The assessee was compensated Rs. 32,18,11,018/- during the assessment year. It selected the Transactional Net Margin Method (TNMM) as the most appropriate method with the Profit Level Indicator (PLI) of OP/OC and reported a profit rate of 16.87% in respect of its international transactions, with the same PLI of OP/OC of certain unrelated comparables at 13.81% on the basis of multiple years’ data. The assessee claimed that its international transactions were at arm’s length price falling within +/- 5% range.

Contention of The Revenue

The Revenue contented that the assessee had assumed significant risks in respect of its AEs’ business functioning and commercial decisions. Further, it was argued that the assessee’s submission on its business model, in the larger supply chain of “Sogo Shosha” Group of Companies, and the erroneous assumption that it was engaged in providing sourcing support services to AEs should not have been accepted at face value. Counsel argued that the TPO correctly held that the assessee was not compensated on account of location savings, a benefit which accrued to its AEs. Lastly, it was urged that the TPO held that the assessee’s functional profile was that of a “Trader” rather than “service provider”. Due to all this PSM was the most appropriate method.

Contention of the Assessee

The contentions of the Assessee are drawn from the para 9 of the Judgment in which TPO’s order is mentioned.

The main contentions of the assessee is that the main conditions in which profit split method can be applied is when both parties to the transaction are making significant contribution to the transactions, or that the operations of both the parties are highly integrated.

Held by Ld. TPO

The Ld. TPO, by his order noted that the assessee provided some crucial services to its Associates Enterprises (AEs). The TPO held that the assessee’s functions to its AEs were not only confined to providing marketing support services but also in arranging for feasibility studies, industry analysis and project evaluation for potential projects identified by the AEs. The TPO noticed that the assessee made sizeable investments in exploring and analyzing the Indian market. Further, it was held that its functions were critical in assuming significant risk and using both its tangibles and intangibles created over a period of time. It was held that the assessee developed several unique intangibles which gave advantage to its AEs though the cost incurred for their development and use was not taken into consideration in receiving compensation. The TPO therefore held that the assessee was inadequately compensated by its AEs and the Profit Split Method (PSM) had to be applied for determining the ALP of the international transactions under this segment. The ld. TPO relied M/s Li & Fung (India) Pvt. Ltd. v. DCIT (2012) 143 TTJ (Delhi) 201 where it was held that since the assessee developed and made available its supply chain and human intangibles to its AEs for conducting their business in India and also did majority of crucial and critical functions on their behalf, the assessee was required to be compensated in the total profits on FOB value of the goods transacted by foreign AEs. Relying on M/s Li & Fung India Pvt. Ltd. (supra), where a ratio of 80:20 was applied, the TPO applied a ratio of 70:30 in favour of the assessee by holding that 70% of the total profit earned by its AEs from the goods traded from or to India should have been given to the assessee. In the alternative approach, he proceeded to benchmark the assessee’s international transactions under TNMM by treating it as a commission agent. Nine comparables were chosen giving an arithmetic mean margin of profit at 42.13% on cost. An adjustment of `30.14 crores on the basis of PSM was applied.

Held by the Tribunal

The Hon’ble Tribunal held that the assessee was as a mediator and was responsible for supplying marketing information, liaising with vendors and coordination. The ITAT held that the assessee’s risk was limited and minimal with least capital employed, as opposed to the TPO’s findings that it (the assessee) performed all the crucial functions on behalf of the AEs. Further, it was held that the Lower authority without any concrete basis observed that the assessee undertook all the critical functions of its AEs. This finding was unsubstantiated especially with regard to any specific functions performed by the assessee. The lower authority did not explained any critical function except saying that the assessee was also engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs. Further, the Hon’ble ITAT observed that the use of assessee’s intangible assets were not proved and also there was no documentary evidence available by which it could be prove that the risk assumed was beyond mediation. As, a result there was no higher risk assumed. Accordingly, the Hon’ble Tribunal held that the application of PSM method can’t be substantiated and decided that there would be de novo determination of the ALP.

Held by the High Court

The Hon’ble High court held that the TPO discarded TNMM as the most appropriate method, holding that the assessee assumed significant risks, and relied on unique intangibles thus resulting in higher profits of the AE which should be attributed to it. The, assessee only merely mediated between the AEs and customers/vendors in India and supplied information. The observations that the AE’s decisions were taken by the assessee is a general one, unsupported by any independent material; which based on the TPO’s belief, rather than objective fact based analysis. Further, the Hon’ble High Court held that the assessee’s risk was limited and that the TPO’s findings that the assessee performed all the crucial functions on behalf of the AEs was not proved. The findings of TPO were unsubstantiated and generally made; the TPO never elaborated any critical function or decision of the assessee inuring to the AEs except saying that the assessee was engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs. Accordingly, the Judgement of ITAT was upheld and TNMM was considered to be the best method to arrive at Arm’s Length Price.

By Advocate Bharat Agarwal