IN HIGH COURT OF DELHI AT NEW DELHI Reserved on: 17.03.2015 Pronounced on: 23.04.2015 ITA 94/2015 COMMISSIONER OF INCOME TAX Appellant Through: Ms. Suruchii Aggarwal, Sr. Standing Counsel. Versus MARUBENI INDIA PVT. LTD. ..Respondent Through: Sh. Nageswar Rao, Sh. Sandeep. S. Karhail and Sh. Aniket. D. Aggarwal, Advocates. CORAM: HON'BLE MR. JUSTICE S. RAVINDRA BHAT HON'BLE MR. JUSTICE R.K. GAUBA MR. JUSTICE S. RAVINDRA BHAT 1. revenue, in this appeal, questions decision of Income Tax Appellate tribunal (ITAT) in ITA No. 5397/Del/2012 dated 03-06-2014. It is argued that impugned order erred in holding that Transactional Net Margin Method ( TNMM ) was most appropriate method for transfer pricing determination in arriving at arm s length price (ALP) to bench mark assessee/respondent s international transaction regarding ITA 94/2015 Page 1 provision of agency and marketing support services for AY 2008-09. This court had issued notice under Section 260-A of Income Tax Act, 1961 ( Act ) and heard counsel for parties. 2. brief facts of case are that assessee is wholly owned subsidiary of Marubeni Corporation, Japan ("MCJ"). It provides agency services on behalf of MCJ and other group companies across globe; liaises between departments of MCJ group companies and their suppliers/customers in India. assessee also co-ordinates import and export of goods and services; inter alia it is independently engaged in trading. For AY 2008-09, five international transactions were reported by it. controversy in this appeal is with respect to one international transaction, i.e. provision of Agency and marketing support services. assessee was compensated `32,18,11,018/- during assessment year. It selected Transactional Net Margin Method (TNMM) as most appropriate method with Profit Level Indicator (PLI) of OP/OC and reported profit rate of 16.87% in respect of its international transactions, with same PLI of OP/OC of certain unrelated comparables at 13.81% on basis of multiple years' data. assessee claimed that its international transactions were at arm's length price (ALP) falling within +/- 5% range. 3. TPO, by his order noted that assessee provided some crucial services to its Associates Enterprises (AEs) which formed basis of sourcing activities carried out by AEs from or to India. TPO held that 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 ITA 94/2015 Page 2 AEs. It was held that besides providing agency support and acting in capacity of liaising agent for various AEs, assessee helped them to make conscious sale and purchase decisions. TPO noticed that assessee made sizeable investments in exploring and analyzing Indian market. Its contention that it bore limited risk, performing basic functions of agency, were not accepted by TPO, who held that its functions were critical in assuming significant risk and using both its tangibles and intangibles created over period of time. It was held that assessee developed several unique intangibles which gave advantage to its AEs though cost incurred for their development and use was not taken into consideration in receiving compensation. It was also held that assessee performed all critical functions in process of rendering services to its AEs by assuming significant risks. TPO therefore held that assessee was inadequately compensated by its AEs and Profit Split Method (PSM) had to be applied for determining ALP of international transactions under this segment. In reaching this conclusion, TPO relied on order passed by Delhi Bench of ITAT in M/s Li & Fung (India) Pvt. Ltd. v. DCIT (2012) 143 TTJ (Delhi) 201. It was held that since 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, assessee was required to be compensated in total profits on FOB value of goods transacted by foreign AEs. Relying on M/s Li & Fung India Pvt. Ltd. (supra), where ratio of 80:20 was applied, TPO applied ratio of 70:30 in favour of assessee by holding that 70% of total profit earned by its AEs from goods traded from or to India should have been given to assessee. He ITA 94/2015 Page 3 considered total volume of trading transactions of MCJ group on global basis at `4,35,000 crores and odd; worked out OP/OC of MCJ group on global level at 1.78%; determined FOB value of goods outsourced from India at ` 24,208 crores; applied ratio at 1.78% on such FOB value to determine total operating profits attributable to Indian turnover at `43.05 crores; and thereafter determined assessee's 70% share in such profits at ` 30.14 crores. TPO thus proposed transfer pricing adjustment at ` 30.14 crores. In alternative approach, he proceeded to benchmark assessee's international transactions under TNMM by treating it as commission agent. Nine comparables were chosen giving arithmetic mean margin of profit at 42.13% on cost. adjustment of `30.14 crores on basis of PSM was applied by relying on Tribunal s order in M/s Li & Fung (supra). 4. assessee unsuccessfully objected to addition, before Dispute Resolution Panel (DRP) against draft order passed by Assessing Officer. DRP approved application of PSM by relying on decision of Tribunal in case of M/s Li & Fung (supra). Aggrieved by addition of ` 30.14 crores, assessee approached ITAT. 5. By impugned order, ITAT noticed that there was no dispute on any international transaction other than that of `Provision of Agency and marketing support services' to tune of ` 32.18 crores. ITAT noted supply transactions structure of assessee s business on basis of materials on record, given to TPO by letter dt. 5.10.2011 inter alia, containing chart. chart/table showed three types of parties involved in ITA 94/2015 Page 4 each transaction, viz., Customer/Vendor from India, AEs and assessee. assessee acted as mediator between its AEs and customer/vendor from India. facts showed that on one hand, responsibilities of AEs extended to contracting, pricing, sourcing, scheduling, procuring, inventory management, logistics, marketing, credit management, quality and compliance of global laws etc.; those of vendors/customer from India extend to contracting, pricing, scheduling, negotiating, inventory etc. On other hand, assessee was acting as mediator between AEs and vendors/customers and responsible for supplying marketing information, liaising with vendors and coordination. ITAT held that assessee s risk was limited and minimal with least capital employed, as opposed to TPO s findings that it (the assessee) performed all crucial functions on behalf of AEs. TPO, held ITAT, did not dispute any of these facts or Table and instead baselessly observed that assessee undertook all critical functions of its AEs. This finding was unsubstantiated especially with regard to any specific functions performed by assessee. TPO did not elaborate any critical function except saying that assessee was also engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs. 6. It was held that ITAT s order in Li and Fung (supra) influenced decision (of TPO) that assessee should get 70% share in overall profits of transactions carried out by AEs which have source or destination in India. This was not based on any material or evidence. use by assessee of its intangible assets vis- -vis international transactions ITA 94/2015 Page 5 was not proved; likewise no document showed risk assumed or that its task was anything beyond mediating between AEs and customers/vendors in India . assessee only supplied information to AEs and mediated between them and Indian enterprises in transactions arranged independently between them. There was, as result, no question of its assuming higher risk or using its highly valued intangibles. ITAT held that TPO repeatedly reiterated that assessee played crucial role in transactions between AEs and Indian parties by using valuable intangibles which has benefited group as whole, but never substantiated those conclusions. On basis of its appreciation of facts and decision of this Court in M/s Li & Fung India Pvt. Ltd. v. CIT (2014) 361 ITR 85 (Del) (which reversed decision in Li & Fung, by ITAT, relied on by TPO) ITAT held that: 8. Considering entirety of facts and circumstances prevailing in present case, we find that findings returned by TPO - assessee assuming substantial risks; doing critical functions for its AEs; and allowing user of its highly- valued intangibles to such AEs - are all in air without any bedrock. Further, conclusion drawn by authorities in applying PSM by basing their finding on strength of order of Tribunal in case of M/s Li & Fung (supra) cannot be sustained because of its reversal by Hon'ble Delhi High Court. Ergo, we set aside impugned order in making transfer pricing adjustment of Rs.30.14 crore. ITAT lastly concluded that there was no reference to names of comparables in TPO's order while working out alternative, PSM and that ITA 94/2015 Page 6 TPO embarked upon PSM throughout length and breadth of his order. alternative approach of TNMM was not given any serious consideration. Even there is no discussion about comparables chosen by assessee and how they were acceptable or not. Under such circumstances, we are of considered opinion that ends of justice would meet adequately if impugned order is set aside and matter is restored to TPO/Assessing Officer for fresh determination of ALP of disputed international transactions of `Provision of Agency and marketing support services' amounting to Rs.32.18 crore. We order accordingly. Needless to say, assessee will be allowed reasonable opportunity of being heard in such de novo determination of ALP. 7. It is contended by Ms. Suruchi Agarwal on behalf of revenue that ITAT fell into error in holding that TNMM was most appropriate method and rejecting PSM adopted by TPO and confirmed by DRP. Stating that assessee had assumed significant risks and was crucial decision maker in respect of its AEs business functioning and commercial decisions, it was urged that lower authorities correctly surmised that these went into significantly contributing to profits and income of AEs. It was also argued that ITAT should not have been influenced by decision of this Court in Li Fung, which was rendered in peculiar circumstances whereby figures provided by that assessee were never challenged and TP exercise was accepted. 8. It was next argued that ITAT erred in holding that FOB value of goods sourced from India should be taken as cost base for purpose of computing ALP to benchmark international transaction in respect of agency and marketing support services. It was argued that assessee s submission on its business model, in larger supply chain of Sogo Shosha Group of Companies, and erroneous assumption that it ITA 94/2015 Page 7 was engaged in providing sourcing support services to AEs should not have been accepted at face value. Counsel argued that TPO correctly held that assessee was not compensated on account of location savings, benefit which accrued to its AEs. Lastly, it was urged that TPO held that assessee s functional profile was that of "Trader" in related party segment, rather than actual functional profile of "service provider". All these went into making PSM as most appropriate method. 9. TPO, in his order, after discussing rival contentions and further elaborately noticing various decisions, recorded practically no reasons why TNMM was not appropriate. His allusion to development of unique intangibles or assumption of significant risks was not based on any logic, much less materials. That order was incantation of statute and conditions spelt out in rules. To hold that PSM should be applied, it was stated that: assessee has submitted its reply on 05.10.2011 towards use of Profit Split Method. main contentions of assessee is that key conditions in which profit split method can be applied is when both parties to transaction are making significant contribution to transactions, or that operations of both parties are highly integrated. assessee has also quoted from rule 10B (1) (d) and para 2.109 of OECD Transfer Pricing Guidelines. 7.3 argument of Assessee is not tenable in view of fact that Assessee is creating unique intangibles which have given advantage to AE in form of low cost of product, quality of product and enhanced profitability of AE. These intangibles have increased profit potential of AE though cost for development and use of intangibles was not ITA 94/2015 Page 8 taken for computations of routine markup earned by appellant. reply of assessee is without any basis. As mentioned in preceding paragraphs, assessee is doing lot of functions relating to trading activities. It has gained unique knowledge of people, processes and has used this knowledge to help its AE thrive. Such issue came up before Hon'ble ITAT in case of sourcing company, M/s. Li & Fung (India) Pvt. Ltd., vs DCIT, Circle 4 (1), New Delhi in ITA No.5156/De1./2010 for AY 2006-07, whereby Hon'ble ITAT has held that ******** In view of above, it is therefore, held that assessee has actually developed and used supply chain and human intangible. assessee is providing all critical functions and majority of work related to these exports is performed by assessee itself. Associate enterprise had no capacity to execute work on its own. critical and all crucial work is done by assessee himself. It has further been held by Hon'ble ITAT that AE is paying back to assessee only on basis of cost plus mark up. Such arrangement cannot be said at arm's length. In considered view of Hon'ble ITAT, since majority and crucial services are rendered by assessee, distribution of compensation received by AE at certain percentage of FOB value of exports between assessee and associated enterprise should be in ratio of 80 : 20. assessee must get 80% of total receipt by AE from ultimate purchasers. ratio of judgment squarely applies to facts of case of assessee. In view of above mentioned fact that majority and crucial services rendered by assessee, Assessee is not being compensated on arm's length basis. Accordingly, distribution of compensation, received by AE on FOB value of goods sourced from India, between assessee and associated enterprise should be in ratio of 70 : 30. ITA 94/2015 Page 9 assessee must get 70% of profit earned from goods sourced from India. assessee has raised point that in show cause notice, while calculating operating profit of AE, certain non operating income was not deducted from OP. same is found to be valid and calculation is corrected, while doing final calculation. Based on above discussion, arm's compensation of assessee shall be computed as per Profit Split Method 10. This Court in Li & Fung (supra) discussed why similar approach was contrary to law: 42. Moreover, there is considerable merit in submission that (finding of the) lower authorities, including Tribunal, misdirected themselves in holding that LFIL assumed substantial risk. Whilst this court would neither state that LFIL performed functions with limited risk component, as it does not engage itself in manufacturing of garments (which is LFIL's stance), apart from broad assumptions made by Revenue, no material on record testifies to that fact such that it can be basis for arm's length price adjustment. Indeed, LFIL has neither made investment in plant, inventory, working capital, etc., nor does it claim to have any expertise in manufacture of garments. More importantly, and given no material to contrary, LFIL does not bear enterprise risk for manufacture and export of garments. LFIL's functional and risk profile thus is entirely different and has nothing to do with manufacture and export of garments by unrelated third party vendors. Simply put, LFIL renders support services in relation to exports, which are manufactured independently. Thus, attributing costs of such third party manufacture, when LFIL does not engage in that activity, and more importantly, when those costs are clearly not LFIL's costs, but those of third parties, is clearly impermissible. contrary conclusion would amount to treating it (the appellant) as vendor/exporters partner in their manufacturing business completely unwarranted inference. ITA 94/2015 Page 10 43. Indeed, having done work, LFIL has developed experience and expertise which Tribunal has held to be human capital and supply chain intangibles. But such description does not in any way reveal how appellant bears any risk either enterprise or economic. LFIL's remuneration on cost plus mark-up of 5 per cent represents functions performed, assets utilized and risks assumed by it. Further, Transfer Pricing Officer's determination that LFIL bore significant risks is not borne out from records. In transactions in which LFIL was party, it did not bear any financial risk. To contrary, its costs towards establishment, transportation, salaries, etc., were fully reimbursed and it was insulated from any economic or financial downside to any particular transaction. In other words, its remuneration was based entirely on costs borne by it. In essence, it is low risk contract service provider exclusively rendering sourcing support to associated enterprise. It does not bear any significant operational risks for its functions, rendered to third party vendor/ customers. Rather, it is associated enterprise that undertakes substantial functions and in fact assumes enterprise risks, such as market risk, credit risk, etc. It also bears letter of credit associated charges and other expenses. 11. In present case, there is no controversy with respect to four out of five transactions. TPO discarded TNMM as most appropriate method, holding that assessee assumed significant risks, and relied on unique intangibles thus resulting in higher profits of AE which should be attributed to it. In given case, concededly this can be argued if facts can logically support such conclusion. However, revenue cannot merely state that significant risks, such as credit, operational, manpower and other risks were borne or that assessee s business was subjected to fluctuations. It merely mediated between AEs and customers/vendors in India. Furthermore, it only supplied information to AEs and mediated ITA 94/2015 Page 11 between them and Indian enterprises in transactions arranged independently between them. observations that AE s decisions were taken by assessee is general one, unsupported by any independent material; it is anecdotal and based on TPO s belief, rather than objective fact based analysis. There was, as result, no question of its assuming higher risk or using its highly valued intangibles. This court also concurs with ITAT s finding that assessee s risk was limited and minimal with least capital employed, and that TPO s findings that it (the assessee) performed all crucial functions on behalf of AEs was not proved. TPO did not dispute facts given by assessee and held without foundation that it undertook all critical functions of its AEs. This finding was unsubstantiated and generally made; TPO never elaborated any critical function or decision of assessee inuring to AEs except saying that assessee was engaged in arranging for feasibility studies, industry analysis, and project evaluation for potential projects identified by its AEs. It is quite evident that TPO based his findings and conclusions on decision of ITAT in Li Fung (supra), which was subsequently reversed by this Court. 12. Resultantly, we hold that ITAT s conclusion that TNMM was most appropriate method and that TPO had to make fresh determination of ALP of disputed international transactions of `Provision of Agency and marketing support services' amounting to ` 32.18 crores based on TNMM is reasonable, not calling for interference; no substantial question of law arises for consideration, for above reasons ITA 94/2015 Page 12 and additionally, in view of previous decision of this court in Li & Fung (supra). appeal therefore fails and is dismissed. S. RAVINDRA BHAT (JUDGE) R.K. GAUBA (JUDGE) APRIL 23, 2015 ITA 94/2015 Page 13 Commissioner of Income-tax v. Marubeni India Pvt. Ltd