IT APPEAL NO. 3008 (DELHI) OF 2009
[ASSESSMENT YEAR 2003-04]

N.K. SAINI, ACCOUNTANT MEMBER 
AND SMT. BEENA A. PILLAI, JUDICIAL MEMBER

Percy Pardiwalla, Sr. Adv., Divyanshu Agrawal, FCA and A.R. Singh, Advocate for the Appellant. 
Neeraj Kumar, Sr. DR for the Respondent.

ORDER

Smt. Beena A. Pillai, Judicial Member - The present appeal has been filed by the assessee against the order dated 27/04/2009 passed by the lower net CIT (A) 20, New Delhi for assessment year 2003-04 on the following grounds of appeal:

"1.	That on the facts and in the circumstances of the case and in law, the orders passed by the Ld. Assistant Commissioner of Income-tax ('Ld. AO') and the Ld. Commissioner of Income Tax (Appeals) [Ld. CIT(A')], are bad in law and void-ab-initio.
2.	That the Ld. CIT(A) grossly erred on facts and in law in concluding that the reference made by the Ld. AO to the Ld. Transfer Pricing Officer (Ld. TPO), under section 92CA(3) of the Income tax Act, 1961 (act') was validly made. The Ld. CIT(A) completely failed to appreciate that the Ld. AO had not recorded any reasons under section 92CA of the Act which made it expedient and necessary for him to make a reference under that provision.
3.	That the Ld. CIT(A) grossly erred on facts and in law in confirming an adjustment of Rs. 1,24,63,602/-out of the total adjustment of Rs. 1,24,97,000/- made by the Ld. TPO in respect of the international transactions entered into by the Appellant with its overseas associated enterprises (AEs).
4.	That the Ld. CIT(A) has grossly erred on facts and in law by confirming the AO's/ TPO's action of rejecting Resale Price Method (RPM) as the Most Appropriate method and substituting the same with Transaction Net Margin Method (TNMM) and correspondingly rejecting Gross profit/Sales (GP/Sales) as the relevant Profit Level Indicator (PLI) and substituting the same with Operating Profit/Sales (OP/Sales) to ascertain the arm's length price in the Appellant's case based on several subjective presumptions, without taking due cognizance of the submissions/arguments/data provided by the Appellant.
	4.1 That the Ld. CIT(A) has grossly erred on facts and in law in upholding the TPO's action of not accepting Gross Profit Margin as a relevant PLI on the ground that the Annual Accounts prepared in accordance with the Indian Generally Accepted Accounting Practices ('Indian GAAP') do not separately compute the Gross/Profit margin of an enterprise.
	4.2 That the Ld. CIT(A) has grossly erred on facts and in law in not appreciating that the only international transaction of import of goods is captured in the cost of goods sold and therefore can be appropriately compared by computing the margins at gross level.
	4.3 That the Ld CIT (A) has grossly erred on facts and in law in misinterpreting the concept of supply chain and not accepting RPM on the ground that difference in supply chain effects the gross margin and comparability analysis.
	4.4 That the Ld. CIT(A) erred on facts and in law in not appreciating that the Appellant's international transactions do not impact its cost below the gross margin and that the cost below the gross margin are third party costs and therefore an adjustment based on operating margins also presumes that the third party expenses are not at arm's length.
	4.5 That the Ld. CIT(A) erred on facts and in law in only making general statements regarding the inapplicability of RPM.
	4.6 That the Ld. CIT(A). erred on facts and in law in not appreciating that under TNMM appropriate adjustments would have to be made for differences in the intensity of the functions relating to marketing, selling, distribution etc. as these would impact operating margins and by making such adjustments, the analysis would tantamount to establishing a de-facto gross margin analysis.
	4.7 That the Ld. CIT(A) erred on facts in holding that the Appellant is engaged in substantial Brand promotion and advertising expenditure as compared to the comparables therefore should have earned higher gross margin without appreciating the fact that the Appellant had earned gross margin which is even higher than the highest gross margin earned by the comparables.
	4.8 That the Ld. CIT(A) erred on facts and in law in not appreciating the basic business model adopted by Bose India and in erroneously confirming the TPO's action in applying TNMM as the more appropriate method.
	4.9 That the Ld. CIT(A) erred on facts and in law in not appreciating the that during the relevant assessment year, the Appellant was in the market development stage of its business cycle and had accordingly achieved low sales volume and low contribution to absorb the selling and administrative expenses even though it had earned healthy gross margins during the year and that the appellant has constantly earned higher net margins with similar gross margin level.
5.	That the Ld. CIT(A) has grossly erred on facts and in law in confirming the action of the Ld. TPO in applying TNMM and OPI sales as the PLI, as against RPM as most appropriate method and GPI Sales as an appropriate PLI accepted by the Ld. TPO in the Appellant's case for the subsequent financial years i.e. FY 2003-04 and FY 2004-05.
6.	That the Ld. CIT(A) has grossly erred on facts and in law in rejecting the multiple year data and using current year data for comparable companies, i.e., data for financial year 2002-03.
	6.1 That the Ld. CIT(A) erred on facts and in law in not appreciating that without prejudice to the above ground no. 6 , even the current year data for comparables can be taken only upto the date specified for the compliance of the Transfer pricing documentation i.e. the due date of filing the Return of income.
7.	That the Ld. CIT(A) grossly erred on facts and law in confirming the action of the Ld. TPO/AO of denying the benefit of (+1-) 5% mentioned in the proviso to section 92C(2) of the Act to the Appellant.
8.	That the Ld. CIT(A) grossly erred on facts and in law in disregarding judicial pronouncements In India While confirming the TP adjustment.
	The above grounds of appeal are without prejudice to each other."

2. At the outset .Ld. Counsel for the assessee submitted that ground Nos. 1, 3 and 8 are general in nature and ground Nos. 2, 6 and 7 are against assessee. He submitted that the only issue that requires consideration is in respect of ground Nos. 4 and 5 which relates to the most appropriate method to be used in the case of the assessee, for computing the arm's length price in respect of international transaction entered into by assessee with its AE.

2.1 In view of the above submission we dismiss ground Nos. 2, 6 and 7 raised by the assessee.

3. The brief facts of the case for determining only issues for consideration in respect of most appropriate method for determining the ACP in the case of the assessee are as under:

3.1 The assessee filed its return of income for the year under consideration on 02/12/2003 showing a loss of Rs. 1,03,18,818/-. The case was processed under section 143(1) of the Act and subsequently it was selected for scrutiny. Notices under section 143(2) was issued to the assessee along with detailed questionnaire in response to which the representatives of the assessee filed various details as called for. During the assessment proceedings the ld. AO observed that assessee had entered into international transactions with respect to the purchase of goods and spare parts. A reference was made to the transfer pricing officer under section 92CA (3) in respect of the international transactions entered into by the assessee. The ld.TPO accordingly issued notice under section 92CE to the assessee and called for various details relating to the functions and economic analysis under rule 10D of income tax rules.

3.2 Ld.TPO observed that assessee is engaged in the business of distribution of sound and audio assistance for individual customers and public places. This division provides products and design services tailored to customer specific requirements. It was also observed that the assessee was a wholly owned subsidiary of Bose Corporation. USA which was established in 1995. The ld.TPO detailed the international transaction undertaken by the assessee during the year under consideration as below:

S.N.	Description of transaction	Method	Value (Rs.)
1	Purchase of finished goods and spare parts.	RPMs	4.58 cr.
2	Service support income	RPM .	1.59 cr.

3.3 The ld. TPO observed that for the purposes of determining arm's length price(ALP) of these transactions, assessee applied resale price method (RPM) as the most appropriate method (MAM). The profit level indicator (PLI) adopted by the assessee was gross profit/sales (GP/S) and the assessee had made itself the tested party for the purposes of the international transactions.

3.4 Ld. TPO observed that the assessee used aggregate approach in view of the transactions undertaken, and selected the following companies as comparables:

S. N.	Name	Functions performed	Gross margin (%)
1	ACI Infocom Ltd.	Distribution & Marketing of IT products and services.	4%
2	Adam Comsof Ltd.	Trading in computer hardware	33%
3	Ascho Industries Ltd.	Trading in analytical instruments	39%
4	Compuage Infocom Ltd.	Distribution of IT products	6%
5	Dynacons Systems & Solutions Ltd.	Retailer of computer software and support services	11%
6	Priya Limited	Trading in computer systems & dyes	8%
7	Unipact Computers Ltd.	Trading in computer integrated systems & peripherals	46%
	Mean		21%

3.5 By adopting RPM and using GP/Sales as the PLI, the margin of the comparables selected by the assessee was determined to be at 21% vis-a-vis margin of assessee being 50%. The assessee thus considered the international transaction to be at arm's length.

3.6 Ld. TPO issued notice to the assessee as to why transactional net margin method (TNMM) may not be used as MAM to ascertain the ALP of the international transaction undertaken by the assessee with its AE. After considering the submissions by assessee, the ld. TPO on basis of various objections rejected the RPM selected by the assessee and applied TNMM to determine the arm's length price of the international transactions entered into by the assessee with its AE. The ld.TPO however accepted the search adopted by the assessee in respect of the comparables selected and used the same set of comparables in computing the arm's length margin under the TNMM. The TPO determined the arm's length price of the assessee at Rs.37,31,000/-.

4. Aggrieved by the order passed by the ld. TPO the assessee preferred an appeal before the Id. CIT (A). The ld.CIT (A) upheld the order passed by the ld. TPO.

4.1 Aggrieved by the order of the ld. CIT(A) the assessee is in appeal before us now.

5. The ld. Counsel for assessee submitted that assessee is a distributor of Bose audio products in India. He submitted that assessee is subjected to all normal business risks associated with carrying out its operations and it is responsible for its own market for the product. He further submitted that neither the Ld. TPO nor CIT(A) has disputed the functions carried out by the assessee as a distributor. The Ld. Counsel submitted that without any adjustment the mean margin of the comparables selected by the assessee comes to 21% and by applying TNMM the margin of these comparables comes to 2.61%. The ld. Counsel for assessee submitted that in the subsequent years and immediately preceding assessment year the Ld. TPO accepted RPM to be MAM. He further submitted that all the comparable companies perform the basic function of trading and distribution of various products. He referred to page 175 of the paper book where the trend in the gross margin and operating margin ratio has been tabulated which is as under:

Particulars	FY 2001-02	FY 2002-03	FY 2003-04	FY 2004-05
OP/ Sales	-7%	-7%	4%	15%
GP/Sales	51%	50%	50%	55%

5.1 From this table the Ld. counsel submitted that the assessee has been consistently earning high gross margins over the years, and all other expenses especially the selling, general and administrative expenses are incurred by the assessee in its capacity as a distributor.

5.2 To substantiate the arguments that assessee is a distributor the ld. Counsel referred to page 221 of the paper book which is an order passed by Customs Department in respect of the valuation of imported goods by the assessee from its AE. He submitted that the said order testifies that the prizes declared by the assessee commensurate with the export price lists published. He placed his reliance upon the following case laws of various benches of this Tribunal where it has been held that RPM is the MAM when the functional profile of an assessee is that of a Trader/Distributor:

?	ITO v. L'oreal India (P.) Ltd. [2012] 24 taxmann.com 192/53 SOT 263 (Mum.)(URO). The decision has been upheld by Hon'ble Bombay High Court in CIT .. L'oreal India P.Ltd. [2015] 228 Taxman 360/53 taxmann.com 432 (Bom.) *
?	Luxottica India Eyewear (P.) Ltd. v. Dy. CIT in ITA No. 1115/del/2014 for assessment year 2009-10.
?	Dy. CIT v. Delta power Solution India (P.) Ltd. [2016] 68 taxmann.com 247 (Delhi-Trib.).

6. On the contrary the Ld. DR submitted that in the previous and the subsequent assessment years as there was no Transfer Pricing addition made by the TPO, does not mean at the Department has accepted RPM to be MAM. He submitted that assessee is not carrying on as a pure distributor/Trader as from the transfer pricing study, one third of business, of assessee is from professional sale, for the year under consideration. The ld. DR referred to pages 50, 51 and 52 of the paper book.

6.1 He submitted that for the subsequent assessment Years , being 2005-06 and 2006-07 the assessee had declared profit because of which, no further TP additions were made, and for assessment year 2007-08, as the AMP issue came into existence there could not be any possibility of making any other adjustment. He thus submitted merely because there has been no adjustment that has been made by Ld. TPO, it cannot be concluded that the Department has accepted RPM to be MAM. He submitted that under such scenario there is no consistency in case of assessee for accepting RPM to be the MAM by the Department.

6.2 He also submitted that the functions of the comparables on a broader perspective are not similar to that of the assessee and therefore TNMM was rightly applied to arrive at the net margin of the comparable companies.

7. We have carefully considered the submissions of the parties before us, the orders of the authorities below for assessee's own case in the previous and subsequent assessment years and the judgements relied upon by the Ld. Counsel for the assessee. The only question for consideration is in respect of MAM to be used to determining ALP of business activity carried on by assessee with its AE. Before deciding the issue it is sine qua non to discuss upon the functional profit of the assessee.

7.1 It is observed from TP study that the assessee has portrayed itself to be a wholly owned subsidiary of Bose Corporation, USA which is involved in routine buy-sell distributor of Bose products, carries out routine functions and assumes normal risks associated with carrying out of business. From the TP study it also appears that assessee is primarily a sales organization that is also involved in creating brand awareness in India. It has been stated therein that the product sold by the assessee is of high quality and performance oriented and is into two major lines of businesses being retail sales and professional sales. The marketing effort in both the business lines is different in that for the retail segment the company maintains specific demonstrations facilities in a few locations, however, in case of professional sales the sales team would approach prospective customers on referral basis. From the TP report it is further clear that the assessee does not own any significant intangibles, does not undertake any scientific research and development on its own account, that leads to the development of non-routine intangibles and Bose US (AE) holds title to the brand name and is involved in the primary responsibility of R&D. The AE has all the expertise to manufacture these high end audio products. Bose India the assessee here in does not hold the tent or any of the products developed by Bose US. It is also observed from the audit profit and loss account filed at pages 1-16 of paper book that the assessees Revenue recognition is from sale of goods.

7.2. As the issue involved for consideration is in respect of the MAM for determination of ALP, it will be useful to first set out the modus operandi of the RPM, being the method chosen by the assessee as the most appropriate method, given under Rule 10B(l)(b) as under:—

Resale Price Method, by which,—

(i)	the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified;
(ii)	such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;
(iii)	the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;
(iv)	the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;
(v)	the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise;

7.3 Sub-clause (i) of clause (b) of Rule 10B(1) deals with identifying the price at which the goods purchased from an AE is resold. Sub-clause (ii) of clause (b) of Rule 10B(1) talks of reducing the amount of normal gross profit margin of comparable uncontrolled transactions from such resale price of the assessee. Sub-clause (iii) states that the result of sub-clause (ii) is further reduced by the expenses incurred in connection with the purchase of goods and sub-clause (iv) provides that the amount so deduced under sub-clause (iii) is adjusted on account of differences in the international transaction and comparable uncontrolled transactions which materially affect the amount of gross profit margin in the open market. Finally, sub-clause (v) provides that the adjusted price found under sub-clause (iv) is taken as arm's length price in respect of purchase of goods from the AE. When we consider the methodology given under RPM, more specifically sub-clauses (i) and (v), it becomes patent that sub-clause (i) refers to property purchased by the enterprise is resold and sub-clause (v) refers to 'arm's length price in respect of the purchase of the property by the enterprise. A close scrutiny of the above two sub-clauses along with the remaining sub-clauses of rule 10B(l)(b) makes it clear beyond doubt that RPM is best suited for determining ALP of an international transaction in the nature of purchase of goods from an AE, which are resold as such to unrelated parties. Ordinarily, this method pre-supposes no or insignificant value addition to the goods purchased from foreign AE. In case the goods so purchased are used either as raw material for manufacturing finished products or are further subjected to processing before resale, then RPM cannot be characterized as a proper method for benchmarking the international transaction of purchase of goods by the Indian enterprise from the foreign AE.

7.4 Adverting to the facts of the instant case, we find that the assessee simply purchased Bose Products from its AE's and resold the same as such without any further value addition. Since the goods imported from AEs representing the international transaction, were neither processed further nor used as raw material for manufacturing any other product, in our considered opinion, RPM is the first choice as the most appropriate method for determination of ALP of the international transaction.

7.5 The Id. DR has vehemently argued against the application of RPM in the given circumstances as the most appropriate method by contending that the assessee incurred huge advertisement and marketing expenses and that one third sales made by the assessee is through professional sales. It has been further submitted by the Ld.DR that the solutions provided by the design team of assessee comprises both of Bose's and non-Bose products. In view of such, the ld. DR stated that the better course would be to apply TNMM which would consider operating profit.

7.6 We are unable to accept the contention advanced on behalf of the Revenue. The obvious reason for this is that the incurring of high advertisement and marketing expenses by the assessee. does not in any manner affect the determination of ALP under the RPM. It is but natural that only those expenses can have bearing on the gross profits that are debited to the Trading account. As the amount of advertisement and marketing expenses finds its place in the Profit and loss account, the higher or lower spend on it cannot affect the amount of gross profit and the resultant ALP under the RPM.

7.7 Further it has been submitted by Ld. Counsel for assessee that the professional sales made by the assessee is to unrelated, parties without any value addition as the Bose products purchased are covered by Bose agreed arrangements worldwide, which would either be purchased or stalked by the overseas entities of Bose, that are resold to India on request or the customer may insist on using certain products of their own choice. It is observed that in either scenario assessee is only into sale of Bose and non-Bose products to the customers in India. It is also observed from the order passed by the Ld. TPO for assessment years 2005 - 2006 and 2006 -2007 that the Ld. TPO has accepted RPM as the most appropriate method and gross profit/sales as the relevant profit level indicator for benchmarking international transactions of the assessee . on similar facts. For the year under consideration Ld. TPO appears to have made the transfer pricing adjustment only on account of losses incurred in the year under consideration. In such circumstances we hold assessee to be a Distributor and hold that RPM prima facie appears to be the most appropriate method in the facts and circumstances of the instant case.

8. It is observed that the Ld.TPO without rejecting the comparables has calculated the margins of such comparables by replacing RPM with TNMM on the ground that broad difference exists between the assessee and the comparables selected on account of functions, product, risk profile, etc. In observing so they Ld. TPO has not brought any material on record to substantiate the contention. The ld.TPO while framing assessment has accepted selection of comparables submitted by the assessee but did not accept the selection of MAM. He was of the opinion the comparables were more comparables at the operating levels and not at the gross level. Should TNMM be selected as an appropriate method, then the differences would be captured in expenses rather than the cost of purchases in order to equalize the operating expenses. This would tantamount to establishing a de facto gross margin analyses. If TNMM is adopted due to product differences, when the only related party transaction is imports then adjustments have to be made in such a manner that an arm's length standard can be estimated. However, Ld. TPO did not make any of the above mentioned economic adjustments so as to make the controlled and uncontrolled transactions comparable under TNMM. It is observed on perusal of the orders passed by the ld. TPO that the observations made therein are not based on any evidences. The ld.TPO also stated that the assessee is selling high-value products whereas the comparables are dealing in products that are fast moving and that resale margin is realised much quickly without any basis. The Ld. TPO has not assigned any reason for using TNMM to arrive at the margin of the comparables instead of RPM.

8.1 At this juncture, we note the mandate of Rule 10C which defines the 'Most appropriate method'. Sub-rule (1) of Rule 10C states that: "For the purposes of sub-section (1) of section 92C. the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arm's length in relation to the international transaction." Sub-rule (2) of Rule 10C lists certain factors which should be taken into account in selecting the most appropriate method as specified in sub-rule (1). These factors,. inter alia, include '(c), the availability, coverage and reliability of data necessary for application of the method'; and '(d) the degree of comparability existing between the international transaction and the uncontrolled transaction. . .. . . . . . .'

8.2 An overview of the factors prescribed for choosing the most appropriate method indicates that firstly, the data necessary for application of the given method should be available and secondly, the uncontrolled transactions should be functionally similar, if not identical. A company, in order to be ranked as comparable under the RPM, should preferably be engaged in doing similar activity as that of the assessee or at least of the same genus of the activity, with a different product. The Ld. TPO himself has categorised the comparables chosen by the assessee as traders akin to computer industry or engaged in trading of instruments. As the basic requirements under rule 10(c)(1) are fulfilled by these comparables and that the Ld. TPO has not brought on record any evidence to prove material difference between the assessee and the comparables so selected, we direct the Ld. TPO to calculate the margin of the comparables by using RPM.

9. Accordingly the appeal filed by the assessee stands partly allowed.