High Polymer Labs Ltd., New Delhi vs Department Of Income Tax

This appeal by the Revenue is directed against the order passed by

the CIT(A) on 5.3.2010 in relation to the assessment year 2004-05. ITA No.2120/Del/2010

2. The first effective ground is against the deletion of addition of

Rs.1,40,05,896/-, being the transfer pricing adjustment on account of

international transactions.

3. Briefly stated, the facts of the case are that the assessee is an Indian

company engaged in the production of various chemicals, such as,

Blowing Agents, which include Polymer Additives, Speciality

Chemicals and Industrial Chemicals. The assessee has a subsidiary in

USA which acts as its marketing agent. The assessee reported an

international transaction of sale of Blowing Agents & Antioxidants to its

Associated enterprise (AE) with the transacted value of Rs.5,36,16,103/.

This international transaction reported by the assessee in Form No.3CEB

consisted of sale of Blowing Agent worth 297617 kgs. and that of

Antioxidants worth 4360 kgs. In order to demonstrate that this

international transaction was at arm's length price (ALP), the assessee

employed Comparable Uncontrolled Price (CUP) method. In the

proceedings initiated by the Transfer Pricing Officer (TPO), on a

reference made by the Assessing Officer (AO), the assessee submitted

2 ITA No.2120/Del/2010

that the price charged from its AE for the products sold was higher than

the price for similar products charged from unrelated customers,

wherever applicable. It was explained that the formulations done by the

assessee are proprietary in nature and the final products vary as per

requirements of various customers. To cater to the requirements of

various customers, the assessee stated that sometimes, it needs to alter

the chemical compositions and undertake research, so that the final

product suits the customers' processing parameters. The formations of

the products were stated to be varying by application depending upon

the processing technique, polymer used and articles manufactured. It

was also put forth that the price charged from the AE in some cases was

even lower than the prices charged from the unrelated enterprises. The

TPO observed that the assessee group was basically organized in three

divisions, namely, Polymer Additives Division; Speciality Chemicals

Division; and Industrial Chemical Division. The products sold by the

assessee to its AE belonged to the Polymer Additives Division and

Industrial Chemical Division. On the basis of the submissions advanced

on behalf of the assessee and the material gathered during the course of 3 ITA No.2120/Del/2010

proceedings, the TPO inferred that (i) the price charged from the AE in

various transactions was lower than the priced charged from unrelated

enterprises for similar items and, (ii) in case of material difference

between the control and uncontrolled transactions, the assessee failed to

establish or quantify any adjustment which could affect the

determination of the ALP on this count. The TPO analyzed the sale of

various products made by the assessee to its AE in a Table drawn on

page 6 of his order giving details of Date of invoice, Products sold,

Quantity, Rate per kg., and Total value. On making a comparison with

the sales made to the unrelated enterprises, the TPO observed that the

prices charged by the assessee from its AE of all the products sold,

except ADC-L-5, DBH, OBSH and TSSC, was at ALP requiring no

interference. He analysed sale of the above four products, one by one,

which formed the basis for the recommendation for a transfer pricing

adjustment. The addition so proposed by the TPO was made by the

AO. The ld. CIT(A) was pleased to delete the addition, against which the

Revenue has come up in appeal before us. We shall deal with such

4 ITA No.2120/Del/2010

additions/deletions individually to ascertain if the AO was right in

making the additions or the ld. CIT(A) in deleting these additions.

Blowing Agents ADC-L-5

4. The first product is Blowing Agents ADC-L-5, a modifier, called

Chemical Blowing Agent for plastic and rubber. The assessee sold 3622

kgs. of this Blowing Agent to its AE at a total value of Rs.34,86,003/-,

thereby giving the average selling rate of Rs.96.23 per kg. There were

three international transactions with the rates charged at Rs.97/-, Rs.98/-

and Rs.87/- per kg. respectively. It was observed by the TPO that the

same item was sold by the assessee to Maricell SRI, Italy, at a price of

Rs.126 per kg. The first sale was made by the assessee to its AE on

14.10.2003, then on 6.12.2003. The assessee sold the same product to

M/s Maricell SRI, Italy, on 17.12.2003. Noticing not much variation in

the sale volume made to AE and Italy party, the TPO treated the price of

Rs.126 per kg. as the ALP of this transaction. That is how the

differential amount between the ALP and the actual price charged

amounting to Rs.10,78,347/- was proposed as a transfer pricing

5 ITA No.2120/Del/2010

adjustment. The AO made the addition which came to be deleted in the

first appeal.

5. We have heard the rival submissions and perused the relevant

material on record. There is no dispute on the fact that the assessee used

the CUP method for demonstrating that its international transactions of

exports made to AE were at ALP. The TPO, too, did not dispute the

application of CUP as the most appropriate method. However, the

extant addition was made by observing that the price charged by the

assessee from its AE was less than that charged from Italy party for the

same product. During the course of hearing, our attention was drawn

towards the product ADC-L-5 having been sold by the assessee to

various related and unrelated parties in the form of a Table given on

page 49 of the paper book. From such tabulation, it can be seen that the

assessee sold this product to its AE, firstly, on 14.10.2003, then on

6.12.2003 and, lastly, on 22.03.2004 @ Rs.97/-, 98/- and Rs.87/- per kg.

respectively. Apart from that, the assessee also sold this product in

Bangladesh to certain parties at the rates varying between Rs.94/- to

6 ITA No.2120/Del/2010

Rs.97/- and there are two sales instances by the assessee to Italy parties

on 28.5.2003 and 17.12.2003 @ Rs.103/- and Rs.126/- per kg.

respectively. The TPO adopted the highest rate of Rs.126/- per kg., as

the ALP of the international transaction of the assessee with its AE. On

the other hand, the assessee insisted for making comparison with the

sales made to Bangladesh party with the rates varying from Rs.94/- to

Rs.97/- per kg. The ld. Counsel for the assessee, in an attempt to justify

the price charged from AE at ALP, submitted that the sale price of this

product largely depends on the formulations and specifications given by

individual customers which entails varying costs and the resultant

varying sales prices. He tried to justify the price charged from its AE at

ALP by claiming it as comparable with the sales made to Bangladesh

parties. However, no material was placed on record to show that the

product supplied to Italy party was a better version of this product with

higher formulations/specifications vis-à-vis those supplied to

Bangladesh parties on the one hand and its AE in the USA on the other.

7 ITA No.2120/Del/2010

6. Before proceeding further, it is relevant to note that section 92(1)

provides that any income arising from an international transaction shall

be computed having regard to the arm's length price. Section 92C deals

with the computation of the ALP. Sub-section (1) of section 92C enlists

five specific and one general method for determining the ALP of an

international transaction. This sub-section provides that the ALP of an

international transaction shall be determined by any of the given

methods, being the most appropriate method, having regard to the

nature of transaction or class of transaction or class of associated persons

or functions performed or such persons or such other relevant factors, as

the Board may prescribe. Rule 10B of the Income-tax Rules, 1962,

contains modus operandi for the determination of the ALP of an

international transaction under these specified methods. The first

prescribed method is Comparable uncontrolled price (CUP) method.

Clause (a) of Rule 10B(1), dealing with the mechanism for the

determination of ALP under CUP method, provides as under:-

"(a) comparable uncontrolled price method, by which,--

8 ITA No.2120/Del/2010

(i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified ;

(ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market ;

(iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or services provided in the international transaction ;"

7. A bare perusal of the prescription of Rule 10B(1)(a) divulges that

the first step in the determination of the ALP under the CUP method is

to identify the price charged for property transferred in a comparable

uncontrolled transaction or a number of such transactions. Second step

provides for adjusting the price computed as per the first step due to

differences, if any, between the international transaction and comparable

uncontrolled transaction which could materially affect the price in the

open market. The price so adjusted is taken as ALP in respect of the

property transferred under the third step. Thus, it is patent that the

international and uncontrolled transactions are compared with each other

to find out the differences in them, if any, and thereafter adjustments are

made in the price of the uncontrolled transaction due to such differences.

9 ITA No.2120/Del/2010

Sub-rule (2) of Rule 10B provides that 'for the purposes of sub-rule (1)',

the comparability of an international transaction with an uncontrolled

transaction shall be judged with reference to the following, namely --

(a) the specific characteristics of the property transferred or services

provided in either transaction ; (b) the functions performed, taking

into account assets employed or to be employed and the risks assumed,

by the respective parties to the transactions ; (c) the contractual terms

(whether or not such terms are formal or in writing) of the transactions

which lay down explicitly or implicitly how the responsibilities, risks

and benefits are to be divided between the respective parties to the

transactions ; (d) conditions prevailing in the markets in which the

respective parties to the transactions operate, including the geographical

location and size of the markets, the laws and Government orders in

force, costs of labour and capital in the markets, overall economic

development and level of competition and whether the markets are

wholesale or retail. Sub-rule (3) of Rule 10B stipulates that an

uncontrolled transaction shall be comparable to an international

transaction if (i) none of the differences, if any, between the 10 ITA No.2120/Del/2010

transactions being compared, or between the enterprises entering into

such transactions are likely to materially affect the price or cost charged

or paid in, or the profit arising from, such transactions in the open

market ; or (ii) reasonably accurate adjustments can be made to

eliminate the material effects of such differences.

8. On a conjoint reading of sub-rules (1), (2) and (3) of Rule 10B, it is

manifest that the international transaction and the uncontrolled

transaction with which comparison is sought to be made for determining

the ALP, in the first instance, must have overall similar products. It is

obvious that if the products are different, then, there can be no question

of making an effective comparison between the prices charged. Once

the products under both the transactions are broadly similar but there is a

difference in them because of certain specific characteristics; and/or the

products in both the transactions are identical, but still there are certain

differences due to the contractual terms or the geographical location,

etc., then, a reasonably accurate adjustment should be made in the price

of the uncontrolled transaction for eliminating the material effects of

11 ITA No.2120/Del/2010

such differences so as to bring the international transaction and the

comparable uncontrolled transaction on the same pedestal. If due to one

reason or the other, no reasonable accurate adjustment can be made due

to such differences, then, such uncontrolled transaction should not be

considered as a comparable transaction. If, after eliminating such

transaction(s), there remains no other comparable uncontrolled

transaction, then, the CUP method cannot be considered as the most

appropriate method which should be discarded and substituted with

another more suitable method.

9. Adverting to the facts of the instant case, we find that both the

assessee as well as the TPO/CIT(A) have adopted incorrect approach in

determining the ALP under the CUP method. We now espouse the

contention of the ld. AR that the price of ADC-L-5 charged by the

assessee from its AE was different because of different

formulations/specifications given by the Italy party. On a specific query

raised from the Bench to point out the difference in the specifications of

the ADC-L-5 sold to the AE and non-AEs in Italy or Bangladesh and

12 ITA No.2120/Del/2010

the further effect of such differences of the price charged, the ld. AR

could not give any convincing reply. A generalized statement was made

that the price charged from the AEs conformed to the price charged from

non-AEs, if the specifications of the two transactions had been similar.

No material worth the name was placed on record to show, firstly, the

difference in the specifications of the two sets of transactions and,

secondly, the extent of adjustment in the price from uncontrolled

transactions to be made on account of such differences. Coming to the

TPO, we find that the assessee sold this product on 18 occasions during

the year including three to its AE at the rates varying between Rs.87/- to

Rs.126/-. The TPO simply picked up the highest rate of Rs.126/- as the

ALP. The ld. CIT(A) deleted this addition by observing that the exports

to Bangladesh were larger in volume and had a lower price than that

charged from its AE. He also failed to record any reason as to why the

transactions with Italy party were not required to be considered as

benchmark or the extent of adjustment to be made in respect of price

charged by the assessee from Italy/Bangladesh parties due to difference

in the formulations/specifications of products. When the mandate of 13 ITA No.2120/Del/2010

Rule 10B is vivid which provides for, firstly, bringing the product sold

to a non-AE at par with the product sold to AE by making adjustment

due to the differences in the characteristics of the products sold and then

to make adjustments on account of contractual terms and geographical

location, etc., then, there can be no logic in determining the ALP under

the method by breaching the express provision of Rule 10B. In our

considered opinion, the view taken by the ld. CIT(A), which does not

conform with the mandate of the Rule, cannot be sustained. Under such

circumstances, we overturn the impugned order on this issue and send

the matter back to the file of AO/TPO for a fresh determination of ALP

of this transaction under the CUP method in accordance with our above

directions/observations. Needless to say, the assessee will be allowed a

reasonable opportunity of hearing in such fresh proceedings.

Polymerization Catalysts named DBH.

10. The assessee sold 13500 kgs. of this product to its AE at a total

price of Rs.18,15,205/-, giving the average unit sale price of Rs.134/-

per kg. The assessee also sold this product to Belgium and Japanese

14 ITA No.2120/Del/2010

parties. Total seven transactions of this product were undertaken by the

assessee which have been tabulated on page 50 of the paper book, with

the price ranging from Rs.134/- per kg. to Rs.195/- per kg., being the

lowest price charged by the assessee from its AE and the highest from

the Belgium party. The TPO took up the highest price of Rs.195/- per

kg. as benchmark and, accordingly, proposed transfer pricing adjustment

of Rs.8,17,295/- . The addition so made by the AO came to be deleted in

the first appeal.

11. After considering the rival submissions and perusing the relevant

material on record, it is observed from the impugned order that the ld.

CIT(A) has recorded a categorical finding that this product exported to

non-AE is different in formulations and costs from product exported to

AE. Similar contention was put forth by the ld. AR before us in

justifying the reasons for the price charged at Rs.134/- per kg. from its

AE, being the lowest price charged in comparison with all the

uncontrolled transactions. Here again, the ld. AR put forward the same

submissions that the specifications of this product sold to non-AEs were

15 ITA No.2120/Del/2010

different from those sold to its AE. Neither any difference in such

specifications was specifically pointed out nor the effect of such

differences was brought to our notice. Here again, we find that neither

the assessee brought on record any comparable uncontrolled transaction

to justify the price charged from its AE nor the authorities below could

justify their viewpoint in making or deleting the addition as per the

parameters of Rule 10B. The position before us on this product is

similar to ADC-L-5 discussed above. Following the view taken

hereinabove, we set aside the impugned order on this score and send the

matter to the file of AO/TPO for a fresh determination of the ALP of this

transaction in accordance with our above guidelines.

Blowing Agent named TSSC.

12. The assessee sold this product to its US AE on different dates

during the year at the price charged varying from Rs.233/- per kg. to

Rs.266 per kg. Only one transaction of this product with a non-related

Japanese party for sale of 1 kg. at Rs.125/- was undertaken. As against

that, the assessee sold 73710 kgs. to its AE at the average rate of

16 ITA No.2120/Del/2010

Rs.253.10 per kg. The TPO refused to consider the sale to a non-related

enterprise of 1 kg., as a benchmark. In the absence of any other

comparable transaction of the same product, the TPO picked up the sale

transaction of ZBS with some unrelated party with the average rate of

Rs.318.86 per kg. That is how, he proposed transfer pricing adjustment

of Rs.48,46,928/- on this score. Such addition made by the AO was

deleted in the first appeal by giving the same reasoning as given for the

earlier products.

13. We have heard the rival submissions and perused the relevant

material on record. It is noticed from page 54 of the paper book that the

assessee sold 73710 kgs. of this product to its AE and only 1 kg. of sale

to a Japanese party at Rs.125/- per kg. It is obvious that the transaction

of sale of 1 kg. to non-AE is a solitary and exceptional in nature and

hence cannot constitute the bedrock for making comparison with 73710

kgs. sold to AE. If we exclude this lonely exceptional transaction of sale

to non-AE, there remains no other comparable uncontrolled transaction,

17 ITA No.2120/Del/2010

which can be compared with the international transaction under

consideration.

14. It has been noticed from the mandate of Rule 10B(1)(a) above that

the ALP under this method can be determined only by making a

comparison of the controlled transaction with similar uncontrolled

transaction(s). Such comparable uncontrolled transactions can be

internal as well as external. Usually, preference is given to internally

comparable transactions. If, however, internal comparables are not

available and the assessee seeks to apply CUP as the most appropriate

method, then, the onus is upon him to put forward certain externally

comparable uncontrolled transactions for enabling the TPO to make a

logical comparison with the international transaction undertaken by the

assessee. To summarize the position, if internally comparable

uncontrolled transaction is not available, then, it is obligatory to

compare the controlled transaction with some externally comparable

uncontrolled transaction in case an assessee seeks to apply the CUP as a

most appropriate method. It is practically impossible to apply CUP

18 ITA No.2120/Del/2010

method in the absence of any comparable uncontrolled transaction, may

be internal or external. If no comparable uncontrolled transaction is

available, then, the CUP cannot be applied as the most appropriate

method.

15. Coming to the facts of the instant case, we find that the assessee

has not placed on record any effective comparable uncontrolled

transaction to demonstrate that its international transactions with AE of

the same product were at ALP. The TPO chose an altogether different

product for making comparison under the CUP method, which is not

legally sustainable because of the inherent differences in the quality of

two products. The ld. CIT(A) also deleted the addition without making

any comparison with a valid comparable uncontrolled transaction. Under

such circumstances, we set aside the impugned order and remit the

matter to the file of AO/TPO for a fresh determination of ALP of the

sale of TSSC to its AE in accordance with our above observations. It

goes without saying that the assessee will be allowed a reasonable

opportunity of being heard in such fresh determination.

19 ITA No.2120/Del/2010

Chemical Blowing Agent OBSH

16. The assessee sold 75600 kgs. of this product to its AE at a total

value of Rs.1,45,85,074/-, giving the average unit sale price of Rs.192/-

per kg. The TPO observed that the assessee sold similar product to an

Italian company on two occasions @ Rs.290 and Rs.289/- per kg.

respectively. Considering the rate of Rs.289/- per kg. as its ALP, the

TPO proposed a transfer pricing adjustment of Rs.72,63,326/-, which

was made by the AO but deleted in the first appeal.

17. We have heard the rival submissions and perused the relevant

material on record. Page 52 of the paper book is a Tabulation of the

product OBSH sold by the assessee during the year to different parties,

including AE. This chart depicts the rate of Rs.189, Rs.191/-, Rs.197/-,

Rs.198/- charged by the assessee from its AE as against the rate charged

from non-AEs ranging between Rs.192 to Rs.290/- per kg. Here again,

the ld. AR tried to justify the price charged from its AE at ALP by

contending that such product sold to non-AEs was having different

formulations and specifications, which resulted in a difference in the sale

20 ITA No.2120/Del/2010

price. Neither such differences in the specifications were pointed out

nor their effect on the price charged was specifically shown. The TPO

too adopted Rs.289/-, being one of the highest prices as the ALP. The

ld. CIT(A) chose to delete the addition by accepting the assessee's

contentions which, in our considered opinion, do not properly justify the

ALP. Under such circumstances, we find that neither the assessee nor

the authorities below have dealt with the matter as per law. Following

the view taken in respect of the product Blowing Agent ADC-L-5 above,

we set aside the impugned order and remit the matter to the file of

AO/TPO for fresh determination of the ALP of the instant transaction in

conformity with our directions given hereinabove. Needless to say, the

assessee will be given a reasonable opportunity of being heard.

18. The only other ground which survives for our consideration is

against the admission of fresh evidence by the ld. first appellate

authority, which was not confronted to the TPO. In view of our above

decision in remitting the matter of determination of ALP to the file of

AO/TPO, this ground does not require any separate adjudication.

21 ITA No.2120/Del/2010

19. In the result, the appeal is allowed for statistical purposes.

The order pronounced in the open court on 20.05.2015.

Sd/- Sd/- [C.M. GARG] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated, 20th May, 2015. dk Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT (A) 5. DR, ITAT

AR, ITAT, NEW DELHI.

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