Aia Engineering Ltd.,, Ahmedabad vs Department Of Income Tax

ी एन0एस0 सैनी, लेखा सद य एवं ी कुल भारत, या%यक सद य के सम& BEFORE SHRI N.S. SAINI, ACCOUNTANT MEMBER AND SHRI KUL BHARAT, JUDICIAL MEMBER आयकर अपील सं./ ITA No.3036/Ahd/2010 %नधा)रण वष)/Assessment Year: 2005-06

ACIT, M/s AIA Engineering Ltd., Circle-1, Vs 115, G.V.M.M. Estate, Ahmedabad. Odhav Road, Odhav, Ahmedabad. PAN : AABCA 2777 J

अपीलाथ,/ (Appellant) -.यथ,/ (Respondent)

Revenue by : Shri M.K. Singh, Sr. D.R. Assessee(s) by: Shri Tushar Hemani, A.R.

सन ु वाई क तार ख/ Dateof Hearing : 07/04/2015 घोषणा क तार ख / Date of Pronouncement: 17/04/2015

आदे श/O R D E R

PER SHRI N.S. SAINI, ACCOUNTANT MEMBER:

This is an appeal filed by the Revenue against the order of the Commissioner of Income-Tax (Appeals)-VIII, Ahmedabad dated 16.08.2010.

2. The sole ground of appeal raised by the Revenue in this appeal reads as under :-

"1. The CIT(A) erred in law and on facts in deleting the entire adjustments made in the Arms Length Price aggregating to Rs.2,87,76,983/-

On the facts and in the circumstances of the case and in law, the CIT(A) ought to have upheld the order of the Assessing Officer since the assessee has failed to disclose his true income."

ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 2

3. The Departmental Representative has filed a written submission during the course of hearing which reads as under :-

"Ground No.1:

The CIT(A) erred in law and on facts in deleting the entire adjustments made in the arms length price aggregating to Rs.2,87,76,983/-. On the facts and in the circumstances of the case ad in law, the CIT(A) ought to have upheld the order of assessing officer since the assessee has failed to disclose his rue income.

TPO's Comments:

1. This is departmental appeal filed against the decision of CIT(A). The facts of the case in brief are as under :-

(i) The assessee is primarily engaged in the manufacturing of grinding media, liners for mills, diaphragms, hammers and crushers, heat resistant cast steel, vertical spindle mill spares, mil control systems, etc. It distributes its products in the international markets through its subsidiaries. The subsidiaries are situated in Middle East, UK and USA. The subsidiary situated in Middle East is responsible for sales in Far East, Middle East and Asian countries; the subsidiary situated in UK is responsible for sales in Europe, Russia, Africa, Turkey and other erstwhile CIS countries; and the subsidiary situated in USA is responsible for sales in North America.

(ii) The international transaction entered between the assessee and its subsidiaries during the Financial Year 2004-05 are :-

Sr. Nature of Name of Value of transaction Method No. transaction Associated Receipt(Rs.) Paid (Rs.) Enterprise

1. Export of Vega 264,472,942 TNMM finished Industries goods (Middle East) F.Z,E., UAE Vega 149,431,053 TNMM Industries Ltd. (USA) Vega 320,753,086 TNMM Industries Ltd. (UK) ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 3

2. Payment of Vega 8,397,693 TNMM sales Industries commission Ltd. (UK)

3. Recovery of Vega 37,7350 At Cost expenses Industries Ltd. (Middle East) F.Z.E., UAE Vega 7,965 At Cost Industries Ltd. (USA) Vega 139,959 At Cost Industries Ltd. (UK)

(iii) The main international transaction was of sale of goods to its AEs of Rs.73.46 crores and the assessee had selected TNM method for benchmarking the ALP. Assessee aggregated the international transaction of payment of commission with sale of goods transaction and operating profit on sales was selected as profit level indicator. Assessee had selected 8 external comparables and used data of financial year 2004-05 to the extent available and data of two earlier years for determining the average PLI margin of the comparables. Accordingly, arithmetic mean of PLI of the comparables was worked out to 6.51% (OP/Sales). The assessee had worked out its PLI margin at 13.38% (OP/Sales) and claimed that the PLI margin of the assessee was better than the PLI margin of the comparables and therefore, it claimed that the international transaction of sale of goods and payment of commission was at ALP. In respect of recovery of expenses transaction, it was claimed that the transactions are at actual cost and hence same are at ALP.

(iv) During the course of TP proceedings TPO examined the financial statements of subsidiaries obtained from the assessee and found that there were wide variations between the operating profits to sales earned by them. Similarly, it was noticed by the TPO that there was wide variation between the ratio of direct expenses o the sales, despite the fact that all the subsidiaries were carrying out similar activities of distribution of assessee's product. The TPO observed that the ratio of operating profit to sales in respect of AE in UAE was 6.31%; in respect of AE in UK, it was (-)2.16% and in respect of AE in USA the same was found at (-)2.26%. Similarly the direct expenditure incurred by AE in UAE was found 10.9%; in respect of AE in UK, it was 14.15% and in respect of AE in USA the same was found at 18.88%. Thus it was found that distribution efforts were more at UK and USA ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 4

subsidiaries, however profit retained at UAE was very high. Therefore a show cause notice was issued proposing to make adjustment to UAE subsidiary.

(v) In response to the show cause notice, the assessee contended that it is selling same items of finished products at the same rate to all the AEs and the higher gross margin and net operating profit is due to activates of these subsidiaries resulting in higher profits to them and assessee had submitted several bills in support of its claim. On examination of the said ills TPO found that whenever there were high margins, transactions were routed through Vega (UAE) to retain more profits in the Vega (UAE) entity as Income tax rates are effectively NIL in UAE. It was further noted by the TPO that Vega (UAE) was selling products in whole Asia region, Australia, New Zealand, Europe, South Africa and Pacific Island in Pacific sea, whereas it should be selling in UAE region or near areas. Sales to Bangladesh and South East Asia can be better handled from India rather than from UAE. In Vega (UAE) there were only three employees in year 2004s and here were only 6 employees in 2005. Thus it was not clear to the TPO as to how they were able to handle such large geographic area and how they were able to distribute he products.

It was further observed by the TPO that in respect of sales made to Vega (UAE), the assessee company was directly dispatching products to the clients of the Vega (UAE), except if they are to be delivered in UAE, which clearly shows that, these transactions were merely routed through Vega (UAE) and this entity was not carrying out any distribution activities in this regard. The TPO further noticed that the ratio of operating profits to the total cost of the above subsidiaries was 57.70% (Vega UAE), 31.70% (Vega UK) and 18.56% (Vega USA). Thus it was found that Vega UAE retained higher margin as compared to Vega UK and Vega USA. Further it was noted that Vega UK was showing higher profit due to commission payment of Rs.83,97,693/- received from the assessee in respect of its direct sales to one Italian entity. Since the Vega UK had not undertaken any commission related activity and had not taken any risk, the payment of commission to Vega UK was not appropriate as the Vega UK was no agreement to show that Vega UK was having jurisdiction over Europe area. Therefore TPO treated ALP of commission expenses at NIL in the hands of assessee and excluded the commission from income of Vega UK.

Thus he worked out the operating margin/operating cost at 19.89% which was found in line with Vega USA and other market entities who are carrying out similar distribution functions. Accordingly the ALP of sales to subsidiaries was benchmarked to 19.89%. Based on the above exercise, price charged to Vega ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 5

USA and Vega UK (except adjustment of commission) was not disturbed. However, the sale price to Vega UAE was adjusted to arrive at OP/operating cost of 19.89%. Thus adjustment of Rs.2,03,79,290/- was proposed. In view of the above facts, total adjustment of Rs.2,87,76,983/- was proposed vide order u/s 92CA(3) dated 22/10/2008. The AO passed order u/s 143(3) by making addition of Rs.2,87,76,983/- as per order passed by the TPO.

2. The assessee contested the assessment order before the Ld. CIT(A). The Ld. CIT(A) vide order dated 16/08/2010, deleted the entire addition made by the TPO/AO. The findings of Ld. CIT(A) and comments of the TPO thereon as under :-

2.1 In para 7.1, the CIT(A) has given a finding that TPO wrongly compared the FOB sale price charged by Vega UK to Cemex Venezuela with the CIF price of sales made by Vega UAE. Further it is mentioned that effective from February 2005 Venezuela territory has been shifted from Vega UK to Vega UAE. Further it is mentioned that appellant has provided details of all the employees at each of the territory and the actual expenses incurred for marketing and sales promotion as well as distribution by the said territory, hence I find no reason to doubt marketing functions performed by the subsidiary companies. It is further mentioned that direct dispatches made by the appellant to the customers of the respective subsidiary companies is only a mode of dispatch and does not necessarily lead to the adverse inference about mere routing of the transactions through Vega UAE carrying out the distribution activity.

TPO's comments:-

It is seen from page No.6 of the appeal order, on which assessee's submission about difference FOB and CIF price as pointed out, that even if the assessee's contention is accepted, still there is difference in price charged by Vega UK (USD 1000.09 & 1340.56) and price charged by Vega UAE (USD 1257.27) because neither the assessee nor the Ld. CIT(A) has pointed the exact CIF price charged by Vega UK which is comparable with the transaction of Vega UAE of USD 1257.27. As far as the evidence for shifting of territory is concerned, the same was never furnished before the TPO. Thus the Ld. CIT(A) has relied on the evidence which was not furnished before the TPO. Regarding the ability to carry out the marketing functions, the TPO had raised doubts regarding Vega UAE considering only 4 to 6 employees which were found inadequate considering vide area of jurisdiction ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 6

of Vega UAE. However, Ld. CIT(A)'s finding all the subsidiaries were capable of carrying marketing function is based only expenses incurred ignoring the meager number of employees working with Vega UAE. The finding of Ld. CIT(A) about the direct dispatches is also incorrect as the TPO had clearly pointed that all the distribution activities for the territory other than UAE were carried out the assessee itself but the sales were routed through Vega UAE (now Vega ME). Therefore the decision of the Ld. CIT(A) is not acceptable.

2.2 In para 7.2, the Ld. CIT(A) has given finding that "the TPO has not been able to establish as to how this sales commission is not justifiable and has merely inferred without any base that Vega UK has not carried out any marketing activity related to these sales and has not taken any risk in this regard. I also find that contrary to the provisions of section 92CA(3) and the settled legal position in this regard, the TPO/AO do not seem to have accorded an opportunity of being heard on this particular issue after issuing a specific show cause notice to appellant. Further based on the premises that in the case of Cemex Venezuela (referred to above), Vega UAE has also carried out sales in Europe and no commission has been paid to Vega UK on this particular transaction, he has wrongly concluded that no such commission should have been paid to Vega UK. From the submissions made by the appellant the fact of shifting of the territory of Venezuela from Vega UK to Vega UAE is quite clear. As such therefore I do not find merit in TPO's adjustment of the transfer price of the appellant in respect of the commission paid to Vega UK to zero."

TPO's comments :-

As discussed in para 1 above, on the basis of certain discrepancies in margins earned by the assessee particularly high margins earned by the subsidiary in No Tax jurisdiction, a show cause notice u/s 92CA(3) was issued proposing an adjustment in the case of Vega UAE and after considering the reply of the show cause notice, final order was passed pointing out the flaws in the reply of the assessee. Thus the TPO had provided reasonable opportunity of being heard before making the adjustment. As far the assessee's claim of shifting is concerned, the same was never produced before the assessee and Ld. CIT(A) did not provide opportunity to the TPO/AO for examining the said evidence. Therefore the decision of Ld. CIT(A) is not acceptable. 2.3 In para 7.3 of the appeal order, the Ld. CIT(A) has given the finding on the basis of inference drawn in para 7.1 & 7.2 that treating the ALP of commission payment as ZERO (NIL) and ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 7

benchmarking the OP/TC ratio of Vega UAE to 19.89% is incorrect.

TPO's Comments :-

As explained in the comments in para 2.1 & 2.2 above, the findings of the Ld. CIT(A) are found to be incorrect. Therefore, finding given in para 7.3 of appeal order are not acceptable.

2.4 In par 7.4 of the appeal order the Ld. CIT(A) given a finding that "I also find a considerable merit in the appellant's objection to this particular methodology of adopting the ratio of OP/TC as profit level indicator by the TPO. Further even while computing the total cost the TPO has ignored the cost of purchases without giving any logical reasoning for such exclusion. It also becomes apparent that neither TPO nor AO has evaluated the four pre-

conditions given in section 92C(3) nor they have given a finding to the effect that at least one of those four pre-conditions has been satisfied after recording the reasons in support of the findings. Again it becomes apparent that while TPO has accepted the transactional net margin method (TNMM), he has wrongly used the controlled party i.e. Vega UK for the purpose of Benchmarking the profits earned by Vega UAE which is against the provisions of section 92(1) read with rule 10B(1)(e) r.w. Rule 10A of the Income Tax Rules."

TPO'S Comments :-

The observation of Ld. CIT(A) that the TPO did not consider the cost of purchases for computation of OP/TC is incorrect. The TPO ink parq-5 on page 5 has given a table explaining the various ratios of profits and expenses in respect of all the three subsidiaries. At serial No.5 the TPO has mentioned the operating cost i.e. selling/distribution and administrative expenses. At serial No.5, TPO has mentioned net operating profit earned by all the subsidiaries and at serial No.7 the ratio of operating profit (Net operating profit mentioned at serial No.6) to operating cost (selling, distribution and administrative expenses mentioned at serial No.5). The TPO has used the term TC for operating cost as can be seen from the above referred table. Accordingly, the TPO had worked out the ratio of OP/TC at 57.77% (UAE AE), 31.90% (UK AE) and 18.56% (USA AE). From the above, it is clear that purchase expenses are not part of selling, distribution and administrative expenses and therefore, there was no error in the computation of TPO as inferred by ld. CIT(A).

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Regarding the observation of ld. CIT(A) about the applicability of provisions of section 92C(3), it is stated that the provisions of section 92C(3)(a) is applicable in this case. As per the provisions of section 92C(3)(a), in case the price charged or paid in an international transaction is not determined in accordance with sub-sections 1 and 2 of section 92C then this provision can be invoked. From the perusal of sub-section 1 and 2 of section 92C read with rule 10C, it can be seen that the price charged or paid in the international transaction is required to be bench marked using the most appropriate method which is defined to be the method which is defined to be the method which is best suited to the fact and circumstances of each particular international transactions and which provided the almost reliable measure of arm's length price. In this regard, it can be seen that though the TPO has not charged the most appropriate method selected by the assessee i.e. TNMM but the TPO proposed to change the tested party as can be seen from para 5 (page 4 & 5) of the transfer pricing order that the TPO had given the basis for proposing the adjustment in the case of AEs. The intention of the TPO of changing tested party is clear from the show cause notice.

It may be mentioned that assessee had selected itself as a tested party; however, it is seen from the FAR analysis of the assessee that AIA Engineering, in light of its long history, development of company brand, research and development activities, manufacturing, marketing and brand intangibles, is much more complex entity as compared to Vega UAE (Vega ME). AIA Engineering takes the entrepreneurial risk and is subject to a number of other risks normally incidental to manufacturing of technologically unique products in which global competition is available. Conversely, Vega UAE (Vega ME) is a simple entity having no manufacturing activity, no inventory holding, no research & development activity and is without any intangibles. Vega UAE (Vega ME), being a much simpler entity, should have been an automatic choice for being selected as a comparable. Hence, the TPOs proposal to make adjustment in the hands of Vega UAE as mentioned in the show cause notice was correct step.

As far as the comparability as per Rule 10B(1)(e) is concerned, the TPO had given conclusion in para-6 (page-7) of the TP order that the OP/TC margin of 19.89% is in line with the other market entities who are carrying out similar distribution functions. Therefore, the observation of ld. CIT(A) is incorrect.

3. Without prejudice to the above submission, it may be pointed out that for AY 2006-07, Hon'ble ITAT Ahmedabad has ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 9

deleted the adjustment made on the similar issue. However, Hon'ble Gujarat High Court vide order dated 16/08/2012 in Tax Appeal No.475 of 2012 has admitted the following substantial questions of law.

1. Whether the Appellate Tribunal has substantially erred in law and on facts in holding that Vega UAE is a company when at least two share holders are required as per UAECCL and as per Article 151 of the Constitution of UAE, the constitution shall have precedence over constitution of Emirates ?

2. Whether the Appellate Tribunal has substantially erred in law and on facts in holding that the Vega UAE has to be accepted as a company within the definition of section 2(17) of the Income Tax Act, 1961 when 100% of its share are held by AIA Engineering Ltd. ?

3. Whether the Appellate Tribunal has substantially erred in law and on facts in holding that no TP adjustment is called for in respect of Vega UAE when Vega UAE was not a distributor because it did not have inventory risk, did not have warehousing facility and products were dispatched directly by the assessee company to the customers, and it was only a service provider ?

4. Whether the Appellate Tribunal has substantially erred in law and on facts in holding that no TP adjustment is required in respect of commission payment to Vega UK ?

5. Whether the Appellate Tribunal has substantially erred in law and on facts in holding that Rule 8D is not applicable in working out the disallowance under section 14A and confirming only Rs.11,48,609/- against Rs.1,23,58,175/- worked out in the assessment order ?

6. Whether the Appellate Tribunal has substantially erred in law on facts in holding that tax was not deductible from the payment made by the company to the non-resident Mr. Eur Ivan Monje Castro Bolivia ?"

4. On the other hand, the Authorised Representative of the assessee supported the order of CIT(A) and submitted that the facts of the case are that arithmetic mean of net operating profit margin of the comparable companies on the basis of the current year was 6.51% as ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 10

against net operating profit margin of 13.38% of the assessee for the present year as will be observed from page no.19 of CIT(A)'s order. Upon comparison of net operating profit margin of Vega UAE, Vega U.K. and Vega US with arithmetic mean of the comparable companies, it was found that the arithmetic mean of comparable companies is higher in respect of all the three Vega entities as will be observed from page 11 para 6.5 read with page 20 top para of CIT(A)'s order. He submitted that percentage of employee cost to total turnover of Vega US is highest i.e. 5.91% and it is lowest for the Vega UAE i.e. 2.55%. Similarly, percentage of administrative expenses to turnover is highest for Vega, US and Vega UK @ 9.44% and 5.39% respectively and it is only 3.89% for Vega UAE. If the operating cost is higher in Vega US, it cannot be said that the profit margin of other Vega entities i.e. Vega UK and Vega UAE should be at par with the profit margin of Vega US and hence, Transfer Pricing adjustment proposed by TPO and confirmed by DRP on the basis of operating cost/operating profit of Vega US is not sustainable. It was further submitted that with respect to commission payment to Vega UK, it is submitted that the sole purpose of making the adjustment was to make operating profit/operating cost ratio of Vega UK comparable to operating profit/operating cost ratio of Vega US. While deciding the Transfer Pricing adjustment issue in respect of Vega UAE, it was held that on the basis of operating profit/operating cost ratio of Vega US, it cannot be held that some Transfer Pricing adjustment can be made as stated in page 18 of CIT(A)'s order. In view of the above, it was submitted that the present appeal of the Revenue may be dismissed.

5. The Authorised Representative further submitted that the issue at hand is decided in the case of the assessee itself by this Bench of the Tribunal in favour of the assessee in A.Y. 2006-07 in ITA ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 11

No.580/Ahd/2011, order dated 19.01.2012, in ground no.2 and 3 of the appeal raised therein.

6. We have heard the rival submissions and perused the orders of the lower authorities and materials available on record. Both the parties have agreed before us that the issue is covered in favour of the assessee by the order of the Tribunal in assessee's own case in the A.Y. 2006-07 vide order dated 19.01.2012 in ITA No.580/Ahd/2011. We find that the Tribunal in A.Y. 2006-07 held as under :-

"15. Grounds No.2 & 3 are regarding TP adjustment made by the A.O. of Rs.4,32,70,240/- in respect of sales made to Vega UAE and of Rs.95,56,360/- in respect of commission payment to Vega UK. There is one more contention raised by the assessee in respect of both these issues that benefit of 5% range should have been allowed as provided in proviso to Section 92C(2) of the Income tax Act, 1961.

16. It is noted by the DRP on page 19 of its order that TPO during the course of proceedings required the assessee to furnish the gross and net margin of Vega entity. The same was submitted by the assessee before the TPO and it has been reproduced by the DRP as per which gross profit percentage of Vega UAE is @ 14.5%, Vega UK @ 14.2% and Vega US @ 9.1%. Similarly, net operating profit percentage has been shown as Vega UAE @

7.4%, Vega UK @ 4.9% and Vega US @ 2.9%. This contention was raised by the assessee before the TPO that the difference in the gross and net margins of various Vega entities is because of difference in ultimate sale price and the level of operating expenses and not for this reason that different purchase price had been paid to the assessee. A working has been submitted regarding total operating expenses of these three Vega entities and its percentage to turnover. As per this, the percentage of total operating expenses to turnover of Vega UAE was worked out @ 7.7%, of Vega UK @ 14.5% and Vega US @ 11.8%. The assessee had also furnished separate working of the percentage of total employees cost to turnover which is worked out @ 1.3% for Vega UAE, 3.6% for Vega UK and @ 6.5% for Vega US. This submission was also made that true PLI for distributor can only be the Net Operating Profit margin i.e. NOPM and the same was given along with arithmetic mean of comparable companies. As ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 12

per the chart reproduced by the DRP on page 23 of its order, net operating profit margin of Vega UAE is worked out @ 7.4% whereas arithmetic mean of the comparable companies has been worked out @ 8.5%. Similarly NOPM margin of Vega UK has been worked out @ 4.9% and that of the comparable companies @ 6.5% and similarly for Vega US, NOPM margin was worked out @ 2.9% and that of comparable companies was worked out @ 5.9%. It was submitted by the assessee before the DRP that the TPO's conclusion based on comparison of operating profit to total cost is improper and hence, cannot be relied upon. The TPO had characterized the Vega UAE as only marketing entity but as per the assessee, this is not correct. Vega UAE is a full fledged distributor. The relevant paras of the order of DRP are Paras 22- 25 of DRP order and the same are reproduced below:

"22. The assessee has further objected to the action of the TPO in proposing the adjustment to the income of the assessee in respect of goods sold to Vega UAE by considering the controlled transactions of the assessee as comparable for benchmarking the international transaction. The assessee has contended that this action of the TPO is not in consonance with Rule 10B(1)(e)(ii) of the Rules. In this regard, it is seen that various defects were noticed by the TPO in the transfer pricing analysis conducted by the assessee and therefore the TPO had rightly rejected the said transfer pricing analysis conducted by the assessee. Further, in the transfer pricing analysis conducted by the assessee keeping the Associated Enterprises as tested o> parties which was submitted later by the assessee vide letter dated 13.03.2009, the assessee had taken comparables whose functions and risk profiles were not similar to that of Vega UAE and the said transfer pricing analysis was also rightly not considered by the TPO. In such eventuality, when the transfer pricing analysis conducted by the assessee was defective and the comparables selected by the assessee have not been found to be appropriate, benchmarking has to be carried out by the TPO based on the limited information that may be provided by the assessee to the TPO. Under the circumstances, the TPO had to resort to the comparison of operating profit to the total cost of the subsidiaries/entities of the assessee company and the said ratio for the US entity computed at 26.49% was rightly applied by the TPO to Vega UK and Vega UAE, It may be mentioned here that the focus of transfer price of determination is on the reasonableness of the result and not the details of the methodology employed, if the ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 13

comparability and reliability level is of high degree, there could be no objection in taking transactions with related parties as truly comparables. In view of the above, the TPO was justified in comparing the operating profit to the total cost of the three subsidiaries/entities of the assessee company. Hence, the upward adjustment of Rs.4,32,70,2407- made by the TPO in the sale price to Vega UAE is hereby upheld.

23. The assessee has further objected to the addition of Rs,95,56,3607- proposed by the TPO by making downward adjustment in respect of sales commission paid to Vega UK. The assessee has submitted that the said adjustment has been made by the TPO without providing an opportunity of being heard and without examining the relevant facts. The assessee has further objected to the action of the TPO in concluding that Vega UK had not carried out its functions in respect of which the commission was paid by the assessee to Vega UK.

24. We do not agree with the claim of the assessee that while making the said adjustment, no opportunity of hearing was allowed by the TPO. A questionnaire dated 06.05.2008 was issued by the TPO and the hearing was fixed on 04.06.2008. The second notice was issued on 07.01.2009 and the hearing was fixed on 21.01.2009. The third notice was issued on 21.07.2009 and the hearing was fixed on 28.07.2009. We are therefore satisfied that adequate opportunity of hearing was allowed by the TPO to the assessee before passing the order.

25. The TPO has made downward adjustment of Rs.95,56,3607- out of the total claim of commission of Rs.3,03,95,4057- shown to have been paid by the assessee to M/s. Vega UK, on the ground that the said subsidiary has not carried out all the functions related to commission earning activities and the geographical territory has also not been assigned to it. As already discussed earlier in this order, we have upheld the finding of the TPO that there was no proper distribution of territories amongst the assessee's subsidiaries/entities. Since there is no clear-cut demarcation of the geographical territories amongst the three subsidiaries of the assessee, the TPO is justified in holding that all the functions related to commission earning activities have not been carried out by Vega UK and therefore the downward adjustment of Rs.95,56,360/-

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made by the TPO in the commission income earned by M/s. Vega UK is upheld."

17. It is also submitted by the Ld. Counsel for the assessee that the assessee is engaged in the business of manufacturing of grinding media, liners for mills, diaphragms, hammers and crushers, heat resistant cast steel, vertical spindle mill spares, mill control systems etc. It was also submitted that assessee has three overseas subsidiaries, namely, Vega Industries Limited UK (Vega UK), Vega Industries Limited, USA (Vega US) and Vega Industries (Middle East) FZE, UAE (Vega UAE). It is also submitted that the assessee primarily sells its products in the domestic market whereas marketing and distribution of its products in the international markets is undertaken by Vega entities in their specified jurisdictions. This is also submitted that Vega UK was additionally responsible for sales in Europe, Russia, Africa, Turkey and other erstwhile Commonwealth of Independent States, (CIS countries), Vega US was responsible for sales in North America and Vega UAE was responsible for sales in Far East, Middle East and Asian countries. It is further submitted that specifically, the revenue proceeded on the aspect assuming that Vega UAE was neither bearing any inventory risk nor conduct risk and hence is entitled only to a markup on value added expenses incurred by it. It was submitted that the activities carried out by various Vega entities in their respective jurisdiction are as under:

(a) Estimation of market size and sales forecast;

(b) Customer visits;

(c) Quotation / offer to the customer;

(d) Interaction with customers for pricing and performance of products;

(e) Customer order/ Contract;

(f) Supply of material;

(g) Installation of product and

(h) Billing and Collection

18. It is also submitted that Vega UAE bears inventory risk also. It is further submitted that in arriving at the conclusion, the TPO and DRP have mainly proceeded on this basis that in certain cases, the goods were directly delivered by the assessee to the parties on customer's destination and the same were not stored by Vega UAE in its warehouse. In this regard, it was submitted by the Ld. Counsel for the assessee that the sales made by the assessee to Vega UAE are on free on board (FOB) basis and once the goods leave the Indian custom station, the inventory risk with regard to the said goods are categorically borne by Vega UAE and ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 15

even the insurance cost for covering the risks associated with the transit of gods up to the customers' chosen destination are borne by Vega UAE. It is further submitted that as per the audited financial statements of Vega UAE as available on page 421 of the paper book-II, inventory of finished goods is appearing in the current assets of Vega UAE. It is further submitted that as per para 11 of the agreement available on page 594 - 595 of the paper book-III, it is stated that the assessee would be responsible to replace/repair defective products manufactured by it only if the assessee receives an intimation from the distributor viz. Vega UAE that the assessee's products are defective within a period of two weeks after the date of delivery to the distributor and/or the end customer and hence, if the distributor Vega UAE is unable to intimate the defects in such product within a period of sales within two weeks, Vega UAE is exposed to inventory risk. Regarding credit risk also, it was submitted that as per the distributor agreement between the assessee company and Vega UAE as available on page 576 of the paper book, it is clearly mentioned that the distributor shall be responsible for all the payments from its customers and hence, bad debts if any, shall be to the cost of the distributor. Regarding the observation of the TPO that Vega UAE does not provide for bad debs whereas the assessee company has provided for bad debts in financial year 2005-06, it was submitted that provision in financial year 2005-06 has been made in respect of indigenous sale in the domestic market but in financial year 2007-08, Vega UAE has made provision for bad debts on account of unrecoverable amount from its end customer in overseas market. It is submitted that under these facts, Vega UAE must be categorized as a distributor and not as a market service provider.

19. As against this, it was submitted by the Ld. D.R. that Vega UAE is not a distributor as it does not have inventory risk and the products are being dispatched directly by the assessee company and Vega does not have warehousing facility. He further submitted that Vega did not bear any credit risk as amounts are being paid to assessee after receipt by Vega from customers. He further submitted that as per the annual repot, assessee has stated that the assessee company has sales offices in UAE, UK, USA, Australia, and Philippines and two warehouses in USA and one warehouse in UK. He further submitted that manpower of Vega has been created by the parent company by transferring the part of its own employees and it does not have any person to look after distribution and logistics but consists only of technical persons. He further submitted that Vega UAE does not have capacity to handle technical issues and fixation of final pricing.

ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 16

20. In the rejoinder, it was submitted by the Ld. Counsel for the assessee that the assessee has amply demonstrated that pursuant to its proper and validly executed distributor agreement, the role of Vega UAE was of a distributor for its product as clearly defined. It is also submitted that the assessee has also demonstrated consistency with the distributor agreement in its conduct with all its distributors including Vega UAE. He further submitted that the assessee has demonstrated clearly that Vega UAE actually bears the entire inventory risk and the credit risk including providing for bad debts of unrecoverable amounts from its end customers. He further submitted that since the title to the goods actually passes to the distributor on their delivery at Indian ports on FOB basis, the facts of goods being dispatched directly to some customers in keeping with commercial and industry practices is not determinative and does not support the incorrect re-characterization of Vega UAE as marketing service provider. He further submitted that Vega UAE as a distributor has consistently shown purchases, sales and inventories in its own audited annual financial statements and in the year in which need arose to provide for bad debts, Vega UAE has done so, demonstrating that it bears credit risk and bad debs risk. He further submitted that admittedly, the assessee has several offices and warehouses in various countries but it does not take the case of the revenue any further as on the very same page of the annual report. The Managing Director of the Assessee Company has clearly stated that the assessee company market and sell its products internationally through its subsidiaries located in UK, USA and Middle East under Vega brand. Regarding this allegation that most of the import of the assessee company were transfer from Vega UAE, it was submitted that it cannot change the character of Vega UAE from distributor to marketing service provider.

21. We have considered the rival submissions, perused the material on record and have gone through the orders of authorities below. We find that this is one of the objections of the revenue that Vega UAE is not a distributor but market service provider and merely on this basis, the TP analysis conducted by the assessee had been rejected by the TPO. He has adopted the transfer pricing adjustment on the basis of operating cost/operating profit percentage of Vega UAE, Vega UK and Vega US. Regarding this aspect that as to whether Vega UIAE is a distributor or simply marketing service provider, we find that the objection of the revenue on this aspect is not sustainable in view of the facts of the present case because we find that the assessee company has executed proper distributor agreement with Vega ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 17

UAE and it has been adhered to also and since the objection of the revenue that Vega UAE is not bearing any inventory and credit risk, we find that as per the facts of the present case, both these objections are not correct and Vega UAE is carrying both the inventory risk as well as credit risk and therefore, we hold that Vega UAE is not a marketing service provider in the facts of the present case but it is a distributor of the assessee company. Once it is accepted that Vega UAE is a distributor, ALP has to be determined on the basis of profit on sale of goods by the assessee company as compared to the comparable companies. The assessee has demonstrated that the arithmetic mean of 3 years weight age average NOPM of 12 comparable companies was 7.92% as against NOPM of 18.89% of the assessee for the present year. Later on the assessee has also furnished the revised arithmetic mean of NOPM of the comparable companies on the basis of current year data only and it was 7.04% whereas mean of 3 years weight age average NOPM of 12 comparable companies was 7.92% as against NOPM of 18.89% of the assessee for the present year.

Later on, the assessee has also furnished the revised arithmetic mean of NOPM of the comparable cases on the basis of current year data only and it was 7.04% as against 7.92% on the basis of 3 year weight age average. The assessee has also furnished one alternative working on the basis of net operating profit margin of Vega UAE, Vega UK and Vega US and arithmetic mean of comparable companies. The arithmetic mean of comparable companies is higher in respect of all the three Vega entities and hence, on both these basis, no TP adjustment is called for. TP adjustment had been proposed by the TPO and confirmed by DRP on the basis of operating cost/operating profit margin of Vega UAE, Vega UK and Vega US. The same for Vega US was considered as base and difference of Vega UAE was proposed as TP adjustment by the TPO but while doing so, it has to be kept in mind that operating cost/operating profit margin depends on level of operating expenses incurred by the respective Vega entities and also the making of business earning by the respective Vega entities. We find that percentage of employee cost to total turnover of Vega US is highest i.e. 6.5% and it is lowest for Vega UAE i.e. 1.3%.

Similarly, percentage of administrative expenses to turnover is highest for Vega US and Vega UK @ 4.9% and it is only 2% for Vega UAE. If the operating cost is higher in Vega US, it cannot be said that the profit margin of other Vega Entities i.e. Vega UK and Vega UAE should be at par with the profit margin of Vega US and hence, TP adjustment proposed by TPO and confirmed by DRP on the basis of operating cost/operating profit of Vega US is not sustainable. Various allegations raised by the TPO for not accepting the TP analysis ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 18

carried out by the assessee are not found to be valid and hence, we hold that no TP adjustment is called for in respect of Vega UAE. The same is deleted. Hence, ground No.2 of the assessee is allowed.

22. Regarding ground No.3 i.e. regarding TP adjustment proposed by the TPO in respect of commission payment to Vega UK, We find that the same is also on the same basis that operating profit/operating cost ratio of Vega UK should be comparable to operating profit/operating cost ratio of Vega US. While deciding the TP adjustment issue in respect of Vega UAE, we have held that on the basis of operating profit/operating cost ratio of Vega US, it cannot be held that some TP adjustment can be made. Hence, with regard to this TP adjustment also, we hold that the same is not sustainable and, therefore, it is deleted. Ground no.3 of the assessee is also allowed."

7. The Departmental Representative submitted that the department has preferred an appeal before the Hon'ble High Court of Gujarat against the above decision of the Tribunal but the Departmental Representative could not produce any material to show that the above order of the Tribunal has been reversed or modified by the Hon'ble High Court or the operation of the above order has been suspended by the Hon'ble High Court. In absence of the same, in our considered view, we are duty bound to follow the above decision of the Co-ordinate Bench of the Tribunal passed in the case of the assessee itself and which squarely covers the controversy in question. We, therefore, following the above decision of the Tribunal, confirm the order of the CIT(A) and dismiss the ground of appeal of the Revenue.

8. In the result, appeal of the Revenue is dismissed. Order pronounced in the Court on Friday, the 17th of April, 2015 at Ahmedabad.

Sd/- Sd/- (KUL BHARAT) ( N.S. SAINI) JUDICIAL MEMBER ACCOUNTANT MEMBER Ahmedabad; Dated 17/04/2015 ITA No.3036/Ahd/2010 AIA Engineering Ltd For AY 2005-06 19

PBN/*

आदे श क0 -%त1ल2प अ3े2षत/Copy of the Order forwarded to :

1. अपीलाथ / The Appellant

2. यथ / The Respondent.

3. संबं धत आयकर आयु!त / Concerned CIT

4. आयकर आयु!त(अपील) / The CIT(A)-VIII, Ahmedabad

5. $वभागीय 'त'न ध, आयकर अपील य अ धकरण, अहमदाबाद / DR, ITAT, Ahmedabad

6. गाड- फाईल / Guard file.

ु ार/ BY ORDER, आदे शानस

उप/सहायक पंजीकार (Dy./Asstt.Registrar) आयकर अपील य अ धकरण, अहमदाबाद / ITAT, Ahmedabad