Huawei Telecommunications (India) ... vs Assessee

Assessee by : Shri Rohit Tiwari, CA Department by : Shri Subhakant Sahu, Addl. CIT & Shri Vijay Choudhary, JCIT

ORDER PER R.S. SYAL, AM:

This appeal by the assessee arises out of the final assessment order

passed by the Assessing Officer (AO) u/s 143(3)/144C read with section ITA No.1384/Del/2012

254 of the Income-tax Act, 1961 (hereinafter also called 'the Act') on

30.1.2012 in relation to the assessment year 2006-07.

2. The only dispute raked up in this appeal is against the addition of

Rs.4,21,48,306/- made by the Assessing Officer (AO) on account of

transfer pricing adjustment.

3. Briefly stated, the facts of the case are that the assessee was

incorporated in India in 2002 for the purpose of manufacturing telecom

equipments. The assessee is a subsidiary of Huawei Tech Investment

Company Ltd., a company incorporated in Hong Kong, which is ultimately

owned by Huawei Technologies Company Ltd., China. The assessee

reported four international transactions in Form No.3CEB. The Assessing

Officer (AO) referred the matter of determination of the arm's length price

(ALP) of the international transactions reported by the assessee to the

Transfer Pricing Officer (TPO). The entire controversy in the instant

appeal is against the international transaction of 'Provision of Marketing

support services' with the transacted value of Rs.28,89,60,870/-. The

assessee applied Transactional Net Margin Method (TNMM) as the most

2 ITA No.1384/Del/2012

appropriate method for demonstrating that this international transaction

was at ALP. Profit level indicator (PLI) was chosen as Operating

Profit/Total Cost (OP/TC). The assessee calculated OP/TC of this

international transaction at 17.90%, which has been extracted from page 10

of the TPO's order, as under : -

Table I.

Operating expenses Rs.245,906,097 (A) Add: Non operating provision for tax Rs.11,592,050 Provision for FBT Rs.13,363,746 Total expenses Rs.270,861,893 Add: 7% mark up Rs.19,071,560 Total Revenue Rs.289,933,453 (B) Operating profit (B-A) Rs.44,027,356 (C) Margin on cost (C/A) 17.90%

4. The TPO did neither dispute the application of TNMM as the most

appropriate method nor reject the PLI of OP/TC. However, in his opinion,

the calculation done by the assessee was made by artificially inflating its

operating profit. He opined that the non-operating expenses could not be

3 ITA No.1384/Del/2012

considered for calculation of mark-up and, hence, the mark-up should be

calculated only on operating expenses. He, therefore, recast the operating

revenue of the assessee, on page 11 of his order, as under:-

Table II.

Operating expenses : Rs.245,906,097

Add 7% Mark up : Rs.17,213,426

Operating Revenue : Rs.263,119,523

5. The assessee had chosen 11 companies as comparable, which have

been enlisted on page 167 of the paper book. The TPO shortlisted

following four companies as comparable with the arithmetic mean of their

OP/TC computed at 25.31%, as per page 27 of his order :-

Table III.

S.No. Name OP/TC (%) 1. Engineers India Ltd. 20.96 2. RITES Ltd. 40.82 3. CRISIL (Information & 14.23 Advisory Services Segment) 4. WAPCOS Ltd. 25.23 Arithmetic Mean 25.31 4 ITA No.1384/Del/2012

6. He worked out the amount of transfer pricing adjustment at page 27

of his order in the following manner :-

Table IV.

Total cost of the assessee : Rs.245,906,097/-

ALP at a margin of 25.31% : Rs.308,144,930/-

Revenue Shown (as per Table III): Rs.263,119,523/-

Difference : Rs.45,025,407/-

7. The assesee approached the Dispute Resolution Panel (DRP) raising

objections against certain aspects of the determination of the ALP by the

TPO. The DRP vide its order dated 19.12.2011, inter alia, directed to

include two more companies in the list of comparables, namely, IDC Ltd.,

and TSR Darashaw Ltd. (Segmental). In the final assessment order passed

by the AO, an addition on account of transfer pricing adjustment was made

at Rs.4.21 crore. The assessee is aggrieved against this addition.

8. We have heard both the sides and perused the relevant material on

record. Before proceeding further, we want to make it clear that there is no 5 ITA No.1384/Del/2012

dispute on the application of the TNMM as the most appropriate method

and the adoption of the PLI as Operating profit to Total Costs on the

international transaction of `Provision of marketing support services'.

There is a three-fold attack to the computation of the ALP. First is the

determination of the assessee's profit margin by the TPO; second is the

selection of some comparables; and third is against not allowing risk

adjustment. We will deal with these issues, one by one.

9. First we espouse the aspect of determination of the assessee's profit

margin from the international transaction of `Provision of marketing

support services'. The ld. AR agitated the computation of the assessee's

OP/TC. More specifically and to narrow down the core of controversy, it

is on the computation by the TPO of 'Revenue shown' as per Table II

above calculated at Rs.26,31,19,523/-. The assessee's contention is that

this amount has been erroneously taken by the TPO.

10. It can be seen that the assessee was compensated by its AE for

rendering marketing support services at direct and indirect costs incurred

with a mark-up of 7% on such total costs. The total amount received by

6 ITA No.1384/Del/2012

the assessee is to the tune of Rs.28,89,60,870/-. This figure of revenue was

computed by applying mark-up of 7% on both operating and non-operating

costs incurred by the assessee in providing the marketing support services.

The amount of operating expenses in the total costs was computed by the

assessee at Rs.24,59,06,097/- and the TPO has not disputed this

calculation. Rather, the TPO has himself adopted the figure of operating

costs at this level which is evident from Table II above reproduced from

his order. This is the figure of operating expenses which the assessee has

taken in the computation of its OP/TC margin at 17.90%. The TPO took up

the same figure of operating expenses and thereafter added 7% mark-up

for working out the amount of `Operating Revenue' at Rs.26,31,19,523/-,

which amount forms the bedrock for the transfer pricing adjustment of

Rs.4,50,25,407/- (Rs.30,81,44,930/- minus Rs.26,31,19,523/-). It is

observed that as against the assessee's mark-up of 7% earned from its AEs

on total costs incurred, its OP/TC came at 17.90%. The TPO computed

average of OP/TC of comparable comparables at 25.31%. Now the

question arises as to whether the TPO was right in taking the figure of

revenue at Rs.26,31,19,523/- by considering the profit rate of 7% ( being 7 ITA No.1384/Del/2012

the mark-up allowed by the AE on total costs incurred). The contention of

the assessee is that the amount of Revenue should be taken as the actual

amount received from its AEs and not this fractured amount.

11. Section 92 of the Act deals with the computation of income from

international transaction having regard to arm's length price. Sub-section

(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 arm's length price. Sub-section (1) stipulates

that the arm's length price in relation to 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 by such persons or such

other relevant factors as the Board may prescribe. One of the methods

specified under sub-section (1) is the transactional net margin method. The

mechanism for determination of the ALP under TNMM is given in rule

10B(1)(e) of the Income-tax Rules, 1962. Sub-clause (i) of this Rule

provides for determining the net operating profit margin realized by the

8 ITA No.1384/Del/2012

enterprise from an international transaction in relation to some base, which

also includes, costs incurred. Sub-clause (ii) states that the net profit

margin realized by the enterprise or by an unrelated enterprise from a

comparable uncontrolled transaction or a number of such transactions is

computed having regard to the same base. Under sub-clause (iii), the net

profit margin as per sub-clause (ii) is adjusted to take into account the

differences between the international transaction and the comparables.

Sub-clauses (iv) and (v) state that the net operating profit margin realized

by the assessee as per sub-clause (i) is established to be the same as the net

profit margin referred to in sub-clause (iii) and the net profit margin thus

established is then taken into account to arrive at an arm's length price in

relation to the international transaction. Having determined the ALP of an

international transaction as per rule 10B(1)(e), we come back to the

second proviso to section 92C(2) which provides that if the variation

between the arm's length price so determined and price at which the

international transaction has actually been undertaken does not exceed

such percentage of the latter, as may be notified by the Central

Government in the Official Gazette in this behalf, the price at which the 9 ITA No.1384/Del/2012

international transaction has actually been undertaken shall be deemed to

be the arm's length price. Per contra, if the variation between the ALP so

determined and price at which the international transaction has actually

been undertaken exceeds the stipulated cushion, then the difference calls

for addition towards transfer pricing adjustment. Two propositions are

relevant from the above discussion insofar as we are instantly concerned.

First is that under the TNMM the net operating profit margin of the

assessee as well as comparables is computed with reference to the same

base [sub-clauses (i) and (ii & iii) of rule 10B(1)(e)] and second is that the

addition, if any, is made by comparing the ALP and the price at which the

international transaction has actually been undertaken [second proviso to

section 92C(2)].

12. Coming to the first proposition, it is clear that as per rule 10B(1)(e),

the net operating profit margin of the assessee and that of comparables is

required to be calculated w.r.t. the same base. In the instant case, the

assessee as well as the TPO have adopted the base of `Operating Costs'.

With this base, the rate of the assessee's profit margin comes to 17.90%

10 ITA No.1384/Del/2012

(Table I) and the arithmetic mean of comparables at 25.31% (Table III). A

comparison is required to be made of these profit margins of the assessee

as well as the comparables. The second proposition is that the addition, if

any, is made by comparing the arm's length margin and the price at which

the international transaction has actually been undertaken. The price at

which the international transaction has actually been undertaken in the

extant case is Rs.28,89,60,870/-. It is this amount which is to be

considered for making addition, if any. It is but natural that the addition

towards transfer pricing adjustment can be made by viewing the ALP of

the international transaction and then it is compared with the actual

transacted value. The difference, if breaches the safe harbor, represents the

amount which the assessee ought to have received from its AE but not

realized. It is such shortfall, which calls for addition.

13. When we advert to the facts of the instant case, it is noticed that the

price of the international transaction is Rs.28,89,60,870/-, but the TPO has

substituted such price of the international transaction with a figure of

Rs.263,119,523 as per Table II above. By doing so, the TPO is seeking to

11 ITA No.1384/Del/2012

compare the profit rate (7%) realized by the assessee on total costs (both

operating and non-operating) with the profit rate (25.31%) of comparables

on operating costs alone, which is an invalid comparison because the base

of the assessee's international transaction and that of comparables has

become different, which under all circumstances must remain same as per

rule 10B(1)(e). As such, we hold that the authorities below were not

justified in working out the transfer pricing adjustment by considering the

amount of revenue at Rs.263,119,523, which ought to have been taken at

Rs.28,89,60,870/-.

14. We find from the asessee's Profit & Loss Account that the amount of

Revenue received from AEs stands at Rs.28,89,60,870/-. As against that,

the assessee calculated its margin at 17.90% by considering operating

revenue at Rs.28,99,33,453/-. It is self evident that the gross revenue

received by the assessee from its AE from this international transaction is

actually Rs.28,89,60.870/-, which the assessee erroneously took as

Rs.28,99,33,453/-, thereby increasing the revenue and the resultant

operating profit margin from the international transaction to this extent.

12 ITA No.1384/Del/2012

The ld. AR was fair enough to concede that the revenue should be

correctly taken at Rs.28,89,60,870/- instead of the inflated figure given in

its TP study report. It is observed that the TPO also followed the suit by

erroneously taking such an inflated figure of the revenue. We, ergo, set

aside the impugned order to this extent and direct the TPO to adopt the

correct figure of operating revenue at Rs.28,89,60,870/-.

15. The second aspect of the transfer pricing adjustment which has been

assailed by the assessee in the instant appeal is the inclusion of three

comparables in the final set of comparables viz., Engineers India Ltd.,

RITES Ltd., and WAPCOS Ltd. The ld. AR submitted that these three

companies are not functionally comparable with the assessee insofar as the

international transaction of provision of marketing support services is

concerned.

16. In this regard, we find that the assessee entered into an Agreement

with its AE on 1.9.2002 for rendering marketing support services, a copy

of which is available on record. As per this Agreement, the assessee is

required to render services to its AEs as have been enumerated in

13 ITA No.1384/Del/2012

Appendix-1, which are in the nature of providing marketing assistance,

advice and other information to its AE. More specifically, these include

Market development; Liaising with the customers for obtaining feedback

on behalf of the company; Exploring new service lines/ventures for the

company in India; Providing information on potential customers; and

Conducting study on the viability of sourcing parts and components from

India and its neighbouring countries. It can be noticed from the order of

the TPO that in examining the comparability, inter alia, of the above

referred three companies, he relied on the proceedings for the assessment

year 2005-06. The TPO has discussed this aspect in para 5.2 of his order

for the year under consideration. By adopting the same reasons as given in

the order of the preceding year, he selected the above referred three

companies also as suitable comparables. It appears that some addition was

made on this score in the order for the immediately preceding assessment

year and the assessee challenged the same before the tribunal. The tribunal

has since disposed of the assessee's appeal for the immediately preceding

year and a copy of such order dated 4.4.2014 (in ITA No.3236/Del/2011)

is available on record. Vide this order, the tribunal has restored the matter 14 ITA No.1384/Del/2012

to the file of the AO for examining the comparability or otherwise of these

companies along with the question of allowability or otherwise of working

capital adjustment. It has been brought to our notice that the matter of the

preceding year is still pending before the TPO and no final decision has so

far been taken on the comparability or otherwise of these three companies.

Under such circumstances and respectfully following the precedent, we

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

TPO/AO for deciding the comparability or otherwise of the above referred

three companies in line with his decision pursuant to the tribunal order for

the AY 2005-06. Apart from considering the question of inclusion or

exclusion of these three companies in the final set of comparables, the TPO

will also go into the issue of working capital adjustment as has been

directed by the Tribunal in its aforequoted order.

17. The last aspect of the transfer pricing adjustment is against not

allowing any risk adjustment. During the course of proceedings before the

TPO, the assessee claimed risk adjustment by contending that it is a

captive service provider. The TPO examined risk matrix relevant to the

15 ITA No.1384/Del/2012

business of the assessee and the risk matrix as disclosed in the TP study

under Rule 10D. Thereafter, it was held that the assessee was not entitled

to any risk adjustment because it was not a risk free entity. Apart from

that, the TPO also declined to grant any such adjustment by noticing that

no computation of risk adjustment was filed by the assessee and, as such,

the onus in this regard was not discharged.

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

material on record. At the outset, we want to make a mention that the

assessee initially claimed risk adjustment before the Tribunal in the

proceedings for the AY 2005-06. However, such ground was not pressed.

Notwithstanding that, we find that the initial onus for claiming any

adjustment in the computation of ALP is always on the assessee. It is only

when such initial onus is discharged that the turn of the TPO comes for

ascertaining whether the claim so made by the assessee is correct or not.

Adverting to the facts of the instant case, we find that there is no material

worth the name justifying the claim of risk adjustment by comparatively

showing particular risks undertaken or not undertaken by the assessee vis-

16 ITA No.1384/Del/2012

à-vis the comparables. A generalized submission about the assessee

assuming low/no risk vis-à-vis its comparables, cannot be countenanced.

The assessee has to expressly exhibit that the specific risks undertaken by

the comparables were absent in its case and vice versa. In the absence of

any such working available either before the authorities below or us, we

are disinclined to direct the granting of any risk adjustment. This

contention of the ld. AR, therefore, fails.

19. To sum up, we set aside the impugned order and remit the matter to

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

international transaction of `Provision of marketing support services' in

line with our above directions. Needless to say, the assessee will be

allowed a reasonable opportunity of being heard.

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

The order pronounced in the open court on 01.07.2015.

Sd/- Sd/- [A.T. VARKEY] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated, 01st July, 2015. 17 ITA No.1384/Del/2012

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

AR, ITAT, NEW DELHI.

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