Mitsubishi Corporation India (P) Ltd. v. Dy. CIT

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The Tax Publishers2014 TaxPub(DT) 4197 (Del-Trib) : (2014) 166 TTJ 0385 : (2014) 111 DTR 0211 : (2015) 044 ITR (Trib) 0416 Mitsubishi Corporation India (P) Ltd. v. Dy. CIT INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALPCommission agent vis-a-vis 'akin to trading activities'--Aggrieved with the ALP adjustment consequently proposed by the AO, on the basis of the TPO's order, assessee carried the grievance before the Dispute Resolution Panel but without any success. Accordingly, the AO framed the assessment by making addition in respect of, inter alia, this ALP adjustment. *Held:* If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate' Bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact. Obviously, a trading activity can only be a trading activity and not “akin to” trading activity. The appropriate adjustments, therefore, will have to be necessarily made in the comparables, vis-a-vis functional profile of the assessee, even when comparables are in respect of trading activity. It is important to bear in mind the fact that the finding that the activities of the assessee are “akin to trading” was given in the context of question before the bench as to whether the activities were in the nature of trading or in the nature of commission agent. If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate's Bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact. [Para 32] Clearly, there is still a difference between normal trading and sogo shosha trading, and one vital aspect of this difference is that in the present sogo shosha trading there are no inventories at all. Any comparison exercise, which takes into account the impact of inventories or cost of inventories, will, therefore, end up making the comparison useless. [Para 33] Income Tax Act, 1961 Section 92C Income Tax Rules, 1962 Rule 10B INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALPDetermination of PLI without inventory cost being conflict in economic principles--Once it is not in dispute, that the trading activity involved carried on by the assessee is a back to back operation, without any value addition to inventories or without any functions performed on the inventories, and is, that sense, without any risks associated with inventories, the cost of inventory being included in the cost base of the assessee cannot be justified on the economic principles, even as this cost of sales may have to be entered into books of accounts in compliance to the accounting principles and accounting standards. *Held:* The determination of ALP is an exercise based on economic principles and even if there is a conflict in economic principles and accounting principles, so far as determination of arm's length price is concerned, the accounting principles have to make way for economic principles. In the cases in which no economic risk for inventories is assumed, in which these inventories do not even find their way to the current assets, and in which no functions are performed in respect of these inventories, except to facilitate trading in respect of the same, the very raison d'Ãªtre for the cost of inventories being included in the cost base ceases to exist. The FAR analysis set out in the TPO's order, does not support the inclusion of inventory costs in the cost base either. [Para 35] However, there does seem to be an incongruity in the sense that, on one hand, cost of sales is accounted for in the books of accounts, and yet this cost is being sought to be excluded from the profit level indicator analysis. This exercise of excluding cost of inventories from profit level indicator analysis does indeed seem to be running contrary to the accounting treatment. The question then arises that while under the accounting principles, cost of goods sold is to be accounted for in the books of accounts, can its exclusion in the PLI computation model be justified on the economic principles. [Para 36] The determination of ALP is an exercise based on economic principles and even if there is a conflict in economic principles and accounting principles, so far as determination of arm's length price is concerned, the accounting principles have to make way for economic principles. [Para 37] The reason is not difficult to seek. While accounting principles primarily contribute the financial information inputs and mechanism for financial analysis, economic principles lay down the foundational principles on the basis of which such inputs and mechanism are to be used in transfer pricing analysis. The very fundamental economic concept, which is foundation for the arm's length price determination, is that all business entities, irrespective of their inter se relationship, should make profit from a transaction and such a profit should be commensurate with “functions performed, risks assumed and assets utilizedâ€. This exercise, by definition, cannot exalt the accounting entries to a status that these accounting entries, dehors the FAR analysis, determine the arm's length price. Whatever be the call of accounting and legal principles, once we come to the conclusion that cost of inventories is not a material factor so far as FAR analysis is concerned, it is wholly justified to exclude the cost of inventories in formulae adopted for the ALP determination. [Para 38] That exclusion, however, proceeds on the assumption that there is a vital nexus between inventory levels and profitability. [Para 39] Income Tax Act, 1961 Section 92C SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2014 TaxPub(DT) 4197 (Del-Trib) : (2014) 166 TTJ 0385 : (2014) 111 DTR 0211 : (2015) 044 ITR (Trib) 0416

Mitsubishi Corporation India (P) Ltd. v. Dy. CIT

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALPCommission agent vis-a-vis 'akin to trading activities'--Aggrieved with the ALP adjustment consequently proposed by the AO, on the basis of the TPO's order, assessee carried the grievance before the Dispute Resolution Panel but without any success. Accordingly, the AO framed the assessment by making addition in respect of, inter alia, this ALP adjustment. Held: If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate' Bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact.

Obviously, a trading activity can only be a trading activity and not “akin to” trading activity. The appropriate adjustments, therefore, will have to be necessarily made in the comparables, vis-a-vis functional profile of the assessee, even when comparables are in respect of trading activity. It is important to bear in mind the fact that the finding that the activities of the assessee are “akin to trading” was given in the context of question before the bench as to whether the activities were in the nature of trading or in the nature of commission agent. If trading activity and commission agent activity are two ends of a broad spectrum of activities dealing in goods and commodities, and these ends are plotted by mark X and mark Y, sogo shosha activity, is somewhere between these two extremes and between the point X and point Y. The location of this point, as implicit in coordinate's Bench observation that sogo shosha is akin to trading and it cannot be bracketed with commission agent or broker, is closer to point X. There can be no dispute with this proposition at this stage; that is an uncontroverted finding of fact. [Para 32] Clearly, there is still a difference between normal trading and sogo shosha trading, and one vital aspect of this difference is that in the present sogo shosha trading there are no inventories at all. Any comparison exercise, which takes into account the impact of inventories or cost of inventories, will, therefore, end up making the comparison useless. [Para 33]

Income Tax Act, 1961 Section 92C

Income Tax Rules, 1962 Rule 10B

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALPDetermination of PLI without inventory cost being conflict in economic principles--Once it is not in dispute, that the trading activity involved carried on by the assessee is a back to back operation, without any value addition to inventories or without any functions performed on the inventories, and is, that sense, without any risks associated with inventories, the cost of inventory being included in the cost base of the assessee cannot be justified on the economic principles, even as this cost of sales may have to be entered into books of accounts in compliance to the accounting principles and accounting standards. Held: The determination of ALP is an exercise based on economic principles and even if there is a conflict in economic principles and accounting principles, so far as determination of arm's length price is concerned, the accounting principles have to make way for economic principles.

In the cases in which no economic risk for inventories is assumed, in which these inventories do not even find their way to the current assets, and in which no functions are performed in respect of these inventories, except to facilitate trading in respect of the same, the very raison d'Ãªtre for the cost of inventories being included in the cost base ceases to exist. The FAR analysis set out in the TPO's order, does not support the inclusion of inventory costs in the cost base either. [Para 35] However, there does seem to be an incongruity in the sense that, on one hand, cost of sales is accounted for in the books of accounts, and yet this cost is being sought to be excluded from the profit level indicator analysis. This exercise of excluding cost of inventories from profit level indicator analysis does indeed seem to be running contrary to the accounting treatment. The question then arises that while under the accounting principles, cost of goods sold is to be accounted for in the books of accounts, can its exclusion in the PLI computation model be justified on the economic principles. [Para 36] The determination of ALP is an exercise based on economic principles and even if there is a conflict in economic principles and accounting principles, so far as determination of arm's length price is concerned, the accounting principles have to make way for economic principles. [Para 37] The reason is not difficult to seek. While accounting principles primarily contribute the financial information inputs and mechanism for financial analysis, economic principles lay down the foundational principles on the basis of which such inputs and mechanism are to be used in transfer pricing analysis. The very fundamental economic concept, which is foundation for the arm's length price determination, is that all business entities, irrespective of their inter se relationship, should make profit from a transaction and such a profit should be commensurate with “functions performed, risks assumed and assets utilizedâ€. This exercise, by definition, cannot exalt the accounting entries to a status that these accounting entries, dehors the FAR analysis, determine the arm's length price. Whatever be the call of accounting and legal principles, once we come to the conclusion that cost of inventories is not a material factor so far as FAR analysis is concerned, it is wholly justified to exclude the cost of inventories in formulae adopted for the ALP determination. [Para 38] That exclusion, however, proceeds on the assumption that there is a vital nexus between inventory levels and profitability. [Para 39]

Income Tax Act, 1961 Section 92C