Delhi High Court
Commissioner Of Income Tax vs Marubeni India Pvt. Ltd. on 23 April, 2015
Author: S.Ravindra Bhat
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* IN THE 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. The revenue, in this appeal, questions a decision of the Income Tax
Appellate tribunal (ITAT) in ITA No. 5397/Del/2012 dated 03-06-2014. It is
argued that the impugned order erred in holding that the Transactional Net
Margin Method ("TNMM") was the most appropriate method for transfer
pricing determination in arriving at the arm's length price (ALP) to bench
mark the 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 the Income Tax Act, 1961
("the Act") and heard counsel for the parties.
2. The brief facts of the case are that the assessee is a wholly owned
subsidiary of Marubeni Corporation, Japan ("MCJ"). It provides agency
services on behalf of MCJ and other group companies across the globe;
liaises between departments of MCJ group companies and their
suppliers/customers in India. The 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.
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 `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 (ALP) falling within +/- 5% range.
3. The TPO, by his order noted that the assessee provided some crucial
services to its Associates Enterprises (AEs) which formed the basis of
sourcing activities carried out by the AEs from or to India. 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
ITA 94/2015 Page 2
the AEs. It was held that besides providing agency support and acting in the
capacity of liaising agent for various AEs, the assessee helped them to make
conscious sale and purchase decisions. The TPO noticed that the assessee
made sizeable investments in exploring and analyzing the Indian market. Its
contention that it bore limited risk, performing basic functions of agency,
were not accepted by the TPO, who 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. It was also held that the assessee performed all the critical
functions in the process of rendering services to its AEs by assuming
significant risks. 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. In reaching this conclusion, the TPO relied on an order passed by
the Delhi Bench of the ITAT in M/s Li & Fung (India) Pvt. Ltd. v. DCIT
(2012) 143 TTJ (Delhi) 201. 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. 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 the 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 the total operating profits attributable to Indian turnover at `43.05
crores; and thereafter determined the assessee's 70% share in such profits at
` 30.14 crores. The TPO thus proposed transfer pricing adjustment at `
30.14 crores. 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 by relying on the Tribunal's order in M/s Li &
Fung (supra).
4. The assessee unsuccessfully objected to the addition, before the
Dispute Resolution Panel (DRP) against the draft order passed by the
Assessing Officer. The DRP approved the application of PSM by relying on
the decision of the Tribunal in the case of M/s Li & Fung (supra). Aggrieved
by the addition of ` 30.14 crores, the assessee approached the ITAT.
5. By the impugned order, the ITAT noticed that there was no dispute on
any international transaction other than that of `Provision of Agency and
marketing support services' to the tune of ` 32.18 crores. The ITAT noted
the supply transactions structure of the assessee's business on the basis of
materials on record, given to the TPO by letter dt. 5.10.2011 inter alia,
containing a chart. The chart/table showed three types of parties involved in
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each transaction, viz., Customer/Vendor from India, AEs and the assessee.
The assessee acted as a mediator between its AEs and customer/vendor from
India. The facts showed that on the one hand, the 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 the vendors/customer from India
extend to contracting, pricing, scheduling, negotiating, inventory etc. On the
other hand, the assessee was acting as a mediator between the AEs and the
vendors/customers and 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. The TPO, held the ITAT, did not dispute any of these
facts or the Table and instead baselessly 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 TPO did not elaborate 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.
6. It was held that the ITAT's order in Li and Fung (supra) influenced
the decision (of the TPO) that the assessee should get 70% share in the
overall profits of the transactions carried out by the AEs which have source
or destination in India. This was not based on any material or evidence. The
use by the assessee of its intangible assets vis-à-vis international transactions
ITA 94/2015 Page 5
was not proved; likewise no document showed the risk assumed or that its
task was anything "beyond mediating between the AEs and
customers/vendors in India". The assessee only supplied information to the
AEs and mediated between them and Indian enterprises in the transactions
arranged independently between them. There was, as a result, no question
of its assuming higher risk or using its highly valued intangibles. The ITAT
held that the TPO repeatedly reiterated that the assessee played a crucial role
in the transactions between AEs and Indian parties by using valuable
intangibles which has benefited the group as a whole, but never
substantiated those conclusions. On the basis of its appreciation of the facts
and the decision of this Court in M/s Li & Fung India Pvt. Ltd. v. CIT (2014)
361 ITR 85 (Del) (which reversed the decision in Li & Fung, by the ITAT,
relied on by the TPO) the ITAT held that:
"8. Considering the entirety of the facts and circumstances
prevailing in the present case, we find that the findings returned
by the TPO - the assessee assuming substantial risks; doing
critical functions for its AEs; and allowing the user of its highly-
valued intangibles to such AEs - are all in air without any
bedrock. Further, the conclusion drawn by the authorities in
applying the PSM by basing their finding on the strength of the
order of the Tribunal in the case of M/s Li & Fung (supra)
cannot be sustained because of its reversal by the Hon'ble Delhi
High Court. Ergo, we set aside the impugned order in making the
transfer pricing adjustment of Rs.30.14 crore."
The ITAT lastly concluded that there was no reference to the names of
comparables in the TPO's order while working out the alternative, PSM and
that
ITA 94/2015 Page 6
"the TPO embarked upon the PSM throughout the length and
breadth of his order. The alternative approach of TNMM was
not given any serious consideration. Even there is no discussion
about the comparables chosen by the assessee and how they
were acceptable or not. Under such circumstances, we are of
the considered opinion that the ends of justice would meet
adequately if the impugned order is set aside and the matter is
restored to the TPO/Assessing Officer for a fresh determination
of the ALP of the disputed international transactions of
`Provision of Agency and marketing support services'
amounting to Rs.32.18 crore. We order accordingly. Needless
to say, the assessee will be allowed a reasonable opportunity of
being heard in such de novo determination of the ALP."
7. It is contended by Ms. Suruchi Agarwal on behalf of the revenue that
the ITAT fell into error in holding that the TNMM was the most appropriate
method and rejecting the PSM adopted by TPO and confirmed by the DRP.
Stating that the assessee had assumed significant risks and was the crucial
decision maker in respect of its AEs' business functioning and commercial
decisions, it was urged that the lower authorities correctly surmised that
these went into significantly contributing to the profits and income of the
AEs. It was also argued that the ITAT should not have been influenced by
the decision of this Court in Li Fung, which was rendered in the peculiar
circumstances whereby the figures provided by that assessee were never
challenged and the TP exercise was accepted.
8. It was next argued that the ITAT erred in holding that FOB value of
the goods sourced from India should be taken as the cost base for the
purpose of computing ALP to benchmark the international transaction in
respect of agency and marketing support services. 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
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 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" in the related party
segment, rather than the actual functional
profile of a "service provider". All these went into making the PSM as the
most appropriate method.
9. The TPO, in his order, after discussing the rival contentions and
further elaborately noticing various decisions, recorded practically no
reasons why the 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 an incantation of the statute and
conditions spelt out in the rules. To hold that the PSM should be applied, it
was stated that:
"The assessee has submitted its reply on 05.10.2011 towards the
use of Profit Split Method. The main contentions of the assessee
is that the key 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. The assessee
has also quoted from rule 10B (1) (d) and para 2.109 of OECD
Transfer Pricing Guidelines.
7.3 The argument of the Assessee is not tenable in view of the
fact that the Assessee is creating unique intangibles which have
given an advantage to the AE in the form of the low cost of the
product, quality of the product and enhanced the profitability of
the AE. These intangibles have increased profit potential of the
AE though cost for development and use of intangibles was not
ITA 94/2015 Page 8
taken for computations of routine markup earned by the
appellant.
The reply of the assessee is without any basis. As mentioned in
the preceding paragraphs, assessee is doing a 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 an issue came up before the Hon'ble ITAT in the
case of a 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 the above, it is therefore, held that the assessee has
actually developed and used the supply chain and human
intangible. The assessee is providing all critical functions and
the majority of work related to these exports is performed by
assessee itself. Associate enterprise had no capacity to execute
the work on its own. The critical and all crucial work is done by
assessee himself. It has further been held by the Hon'ble ITAT
that the AE is paying back to the assessee only on the basis of
cost plus mark up. Such an arrangement cannot be said at arm's
length. In the considered view of Hon'ble ITAT, since the
majority and crucial services are rendered by assessee, the
distribution of compensation received by AE at certain
percentage of the FOB value of the exports between the assessee
and the associated enterprise should be in the ratio of 80 : 20.
The assessee must get 80% of the total receipt by AE from the
ultimate purchasers. The ratio of judgment squarely applies to
the facts of the case of the assessee.
In view of the above mentioned fact that majority and crucial
services rendered by assessee, the Assessee is not being
compensated on an arm's length basis. Accordingly, the
distribution of compensation, received by AE on the FOB value
of the goods sourced from India, between the assessee and the
associated enterprise should be in the ratio of 70 : 30. The
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assessee must get 70% of the profit earned from the goods
sourced from India.
The assessee has raised a point that in the show cause notice,
while calculating the operating profit of AE, certain non
operating income was not deducted from the OP. The same is
found to be valid and the calculation is corrected, while doing
the final calculation. Based on the above discussion, the arm's
compensation of the assessee shall be computed as per Profit
Split Method..."
10. This Court in Li & Fung (supra) discussed why a similar approach
was contrary to law:
"42. Moreover, there is considerable merit in the submission that
the (finding of the) lower authorities, including the Tribunal,
misdirected themselves in holding that LFIL assumed substantial
risk. Whilst this court would neither state that LFIL performed
functions with a limited risk component, as it does not engage
itself in manufacturing of garments (which is LFIL's stance),
apart from the broad assumptions made by the Revenue, no
material on record testifies to that fact such that it can be the
basis for an arm's length price adjustment. Indeed, LFIL has
neither made investment in the plant, inventory, working capital,
etc., nor does it claim to have any expertise in the manufacture of
garments. More importantly, and given no material to the
contrary, LFIL does not bear the enterprise risk for manufacture
and export of garments. LFIL's functional and risk profile thus is
entirely different and has nothing to do with the manufacture and
export of garments by unrelated third party vendors. Simply put,
LFIL renders support services in relation to the exports, which
are manufactured independently. Thus, attributing the 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.
A contrary conclusion would amount to treating it (the appellant)
as the vendor/exporters partner in their manufacturing
business--a completely unwarranted inference.
ITA 94/2015 Page 10
43. Indeed, having done the work, LFIL has developed
experience and expertise which the Tribunal has held to be
human capital and supply chain intangibles. But such description
does not in any way reveal how the appellant bears any risk--
either enterprise or economic. LFIL's remuneration on a cost
plus mark-up of 5 per cent represents the functions performed,
assets utilized and risks assumed by it. Further, the Transfer
Pricing Officer's determination that LFIL bore significant risks is
not borne out from the records. In transactions in which LFIL
was a party, it did not bear any financial risk. To the 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 the costs borne by it. In
essence, it is a low risk contract service provider exclusively
rendering sourcing support to the associated enterprise. It does
not bear any significant operational risks for its functions,
rendered to the third party vendor/ customers. Rather, it is the
associated enterprise that undertakes substantial functions and
in fact assumes enterprise risks, such as market risk, credit risk,
etc. It also bears the letter of credit associated charges and other
expenses."
11. In the present case, there is no controversy with respect to four out of
the five transactions. 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. In a given case, concededly this can be argued if the facts can
logically support such a conclusion. However, the revenue cannot merely
state that significant risks, such as credit, operational, manpower and other
risks were borne or that the assessee's business was subjected to
fluctuations. It merely mediated between the AEs and customers/vendors in
India. Furthermore, it only supplied information to the AEs and mediated
ITA 94/2015 Page 11
between them and Indian enterprises in the transactions arranged
independently between them. The observations that the AE's decisions were
taken by the assessee is a general one, unsupported by any independent
material; it is anecdotal and based on the TPO's belief, rather than objective
fact based analysis. There was, as a result, no question of its assuming
higher risk or using its highly valued intangibles. This court also concurs
with the ITAT's finding that the assessee's risk was limited and minimal
with least capital employed, and that the TPO's findings that it (the assessee)
performed all the crucial functions on behalf of the AEs was not proved. The
TPO did not dispute the facts given by the assessee and held without
foundation that it undertook all the critical functions of its AEs. This finding
was 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. It
is quite evident that the TPO based his findings and conclusions on the
decision of the ITAT in Li Fung (supra), which was subsequently reversed
by this Court.
12. Resultantly, we hold that the ITAT's conclusion that the TNMM was
the most appropriate method and that the TPO had to make a fresh
determination of the ALP of the disputed international transactions of
`Provision of Agency and marketing support services' amounting to ` 32.18
crores based on the TNMM is reasonable, not calling for interference; no
substantial question of law arises for consideration, for the above reasons
ITA 94/2015 Page 12
and additionally, in view of the previous decision of this court in Li & Fung
(supra). The appeal therefore fails and is dismissed.
S. RAVINDRA BHAT
(JUDGE)
R.K. GAUBA
(JUDGE)
APRIL 23, 2015
ITA 94/2015 Page 13
