AI Structured Summary
Not yet generated for this judgment
Judgment
PER S.RIFAUR RAHMAN,AM:
The assessee and Revenue has filed cross appeals against the order of the Learned Commissioner of Income-tax (Appeals)-44, New Delhi [“Ld. CIT(A)”, for short]dated 28.06.2019 for the Assessment Year 2014-15.
Brief facts of the case are, assessee filed its original return of income for AY 2014-15 declaring total loss of Rs.1,10,77,56,872/- on 29.11.2014. Subsequently, assessee revised its return of income on 31.03.2016 by declaring loss of Rs.1,21,60,63,331/-. The case was selected for scrutiny under CASS and notices under section 143(2) and 142(1) of the Income-tax Act, 1961 (for short ‘the Act’) along with questionnaire were issued and served upon the assessee. In response, ld. AR of the assessee attended and submitted relevant information as called for from time to time.
During the year under consideration, assessee has entered into international transactions. Accordingly, a reference was made to Transfer Pricing Officer (TPO) u/s 92CA of the Act. Various transfer pricing documents containing functional and economical analysis were submitted and placed on record.
BACKGROUND OF THE ASSESSEE AND ITS GROUP ARE AS UNDER :
McCain Foods Limited (“McCain Canada") was founded in 1957 and began with the production facility in Florenceville, New Brunswick, Canada. McCain Foods has become one of the world's largest manufacturers of frozen French fries and potato specialties. McCain Canada, together with its affiliates worldwide has been referred to as the McCain Group. The product portfolio of the Group comprises fries, dollar chips, wedges, and potato patties and pancakes. It also provides pizzas with various toppings, such as pepperoni and beef along with a range of desserts, including cakes, fruit and cream pies. Its beverage section covers lemon iced tea and orange and grape juices. In addition, the Group offers a variety of potato products.
McCain Group operate across six continents with 41 sites, working with 3,200 farmers and using 6.5 million tonnes of potatoes every year. The business has grown significantly over the years, with more than 17,000 people employed and global sales of CDN $7 billion. McCain Group also owns The Day & Ross Transportation Group, which is one of the largest transportation companies in Canada.
McCain Group employs a comprehensive food safety and quality management program. This is built around strict manufacturing procedures, expert leadership, thorough employee training, ongoing process innovation, use of quality ingredients and both internal and independent auditing. Continuous quality improvement is core. All McCain facilities receive and pass an annual third party audit against one of the internationally recognized GFSI approved standards and an unannounced Good Manufacturing Practices (GMPs) inspection conducted by AIB International.
The broad business segments of McCain Group are as follows:
Food service: This segment includes independent restaurants and other non-quick service restaurants, as well as institutional channels such as hospitals, education and military.
Retail: This segment includes sales to retail grocery chains and stores on a local, regional and national basis. Depending on the size of the retailer, the retail customers either directly purchase McCain products from McCain Group or from distributors.
Transportation: McCain Group owns one of the largest trucking companies in Canada name Day & Ross Inc. The company was launched in 1950 and provides services including truck load brokerage less than truckload, international courier, global ocean freight, 4PL bundling, load brokerage and dedicated delivery.
Quick service restaurant: McCain Group has presence in most of the countries in the world and has immense experience of managing the McCain brand and maintaining business relationship with many famous quick service restaurants including McDonald's and KFC. McCain Group has a separate unit known as McDonald Business Unit to purely focus and strengthen the business relationship with McDonalds across the world.
McCain Foods (India) Private Limited ("McCain India”)
McCain India is private limited company operated under the laws of India since 1996. McCain Foods (India) is a wholly owned subsidiary of McCain Foods Limited, Canada. McCain India has been engaged in business of trading and manufacturing of frozen french fries and potato specialties in India and subcontinent countries. 9. The broad business segments of the McCain India have been encapsulated below:
Trading: Since its incorporation in 1996, McCain India has been engaged in the trading of frozen French fries and potato specialties. The Company imports French fries and other products from its respective associated enterprises and sells the same to various institutional buyers including McDonald's, KFC, Pizza Hut, Oberoi Group, Taj Group, etc. throughout the country. McCain India also exports frozen French fries and potato specialties to South East Asian countries.
Manufacturing: In the year 2007, the McCain India had setup a manufacturing facility in Mehsana in Gujarat engaged in manufacturing of French fries and potato specialties, potato flakes and Idli. The manufacturing segment of the McCain India is highly dependent upon the availability of specific varieties of potatoes.
Ownership Structure
The ownership structure of the assessee as on 31/03/2014 is given as under:-
McCain Foods Limited, Carco Investments Inc. Canada 99.99% shares 0.01% shares McCain Foods (India) Private Limited
Assessee has entered into following international transactions as reported in Form 3CEB of the Act as under :-
| S.No. | Nature of transaction | Method Used | Amount (Rs.) |
| i. | Import of goods | TNMM | 32,60,20,111 |
| ii. | Import of samples | TNMM | 5,00,013 |
| iii. | Sale of finished goods | TNMM | 16,68,94,305 |
| iv. | Purchase of fixed assets | Other method | 1,41,31,706 |
| v. | Payment of freight | TNMM | 7,54,67,841 |
| vi. | Payment of management fees | CUP | 13,77,85,900 |
| vii. | Payment of IT support expenses | Other method | 3,90,82,803 |
| viii. | Issue of share capital | Other method | 245,59,95,000 |
| ix. | Reimbursement of expenses received | CUP | 2,25,08,005 |
| x. | Reimbursement of expenses paid | CUP | 2,54,30,106 |
| xi. | Payment of promotion fees | CUP | 25,26,938 |
After considering the same, the TPO has benchmarked the import of goods (trading segment) and observed that assessee has used TNMM as Most Appropriate Method (MAM) and Associated Enterprises (AEs) as a tested party. The margin of the tested party as per the TP study is 5% while the average margin of the comparable is 7.04% and 5.89%. The TPO observed that during the AY 2013-14 for benchmarking the import of finished goods, assessee has selected RPM as MAM and assessee itself selected as tested party. With the above observation, TPO issued show-cause notice dated 11.09.2017 and the relevant notice was reproduced at page 5 of the TPO order, in the above notice, TPO has asked the assessee to explain why the method and tested party were changed when no facts have been changed in the current assessment year. In response, assessee has submitted its reply vide letter dated 11.10.2017. After considering the same, TPO rejected the submissions and arguments. He observed that the assessee has not selected appropriate tested party/ filters to select the comparable. The assessee has not conducted proper comparable analysis in respect of entities which were examined by it qualitatively after the use of quantitative filters and finally held that the transfer pricing study conducted by the assessee is defective and not reliable, arm’s length price was not determined correctly. Further, with regard to rejection of AE as the tested party, he observed that there was no annual reports are available nor the detailed calculation of the PLI in the documents was submitted by the assessee. The assessee has considered the average margin of the comparable identified at 7.05% for US region and 5.97% for UK region. In respect of the case of the comparables selected by the assessee, neither sufficient details are available to ascertain profitability nor sufficient details are available in public domain to carry out comparable analysis. Accordingly, he rejected the submissions of the assessee. TPO proceeded to benchmark by carrying out fresh TP study by employing fresh research and TPO proceeded to determine the ALP for trading segment as under :-
| COGS of the assessee | 664,603,893 |
| Net Sales as per assessee | 438,918,760 |
| Gross profit as per assessee | -225,685,133 |
| Arm’s length profit *8.33% | 36,561,933 |
| Difference | 262,247,066 |
| International transaction related to import of finished goods excluding purchases in respect of high sea sales of Rs.165,086,041/- | 160,934,070 |
| % of transaction with AE excluding high sea sales | 24.22% |
| Proportionate Adjustment | 65,503,221 |
With regard to benchmarking of manufacturing segment, TPO observed that during FY 2013-14, assessee is engaged in the business of manufacturing of frozen French fries and other potato specialties for finished goods to its AEs and third party customers in India as well as outside India. For benchmarking, the assessee has used internal TNMM as MAM. After examining the present case, he issued a notice dated 11.09.2017 to the assessee to submit relevant information. The relevant notice was placed on pages 11 & 12 of the TPO order. In response to the above show-cause notice, assessee filed its reply dated 13.10.2017. After considering the same, the TPO considered the argument of the assessee related to use of current year data, use of turnover filter and use of persistent loss filter. After considering and discussing the above filters, the TPO determined the ALP for the manufacturing segment by adopting the following comparables and ALP adjustment as under :-
| Sr.No. | Company Name | OP/OR |
| 1 | DFM Foods Ltd. | 6.40% |
| 2 | Balaji Wafers Pvt. Ltd. | 13.95% |
| 3 | Capital Foods Ltd. | -0.91% |
| 4 | Flex Foods Ltd. | 20.55% |
| Average | 10.00% |
| Particulars | Amount |
| Operating Revenue (A) | 3,419,625,963 |
| OP/Sales of comparable (B) | 10.00% |
| Arm’s Length Margin C=A*B% | 341,962,596 |
| Arm’s Length Cost D=(A-C) | 3,077,663,367 |
| Cost shown by the assessee (E) | 3,625,309,712 |
| Difference F=(E-D) | 547,646,345 |
| Total transaction with AE under manufacturing segment | 166,894,305 |
| % of Transaction with AE under manufacturing segment | 4.88 |
| Proportionate Adjustment | 26,727,793 |
With regard to availing of support services (intra group services), the TPO observed that assessee has utilized intra group services from its AEs and paid management fees of Rs.13,77,85,900/- and IT support expenses of Rs.390,82,803/-. The assessee has adopted CUP method for management fees and other methods for other support services. A separate notice was issued to the assessee to collect various details. In response, assessee submitted its reply dated 04.10.2017. After considering the submissions of the assessee, TPO held that none of the benefits stated to have been received are tangible or real. He held that the payment of service fee for intra group services is only an arrangement to change tax base without any economic substance in the transactions. By relying on certain decisions, he rejected the submissions and method adopted by the assessee to benchmark the same, proceeded to benchmark at nil and proceeded to make the whole payment of intra group services as TP adjustment.
On receipt of the TPO order, the draft assessment order was forwarded to the assessee on 25.12.2017 and as per the record, assessee received the same on 21.01.2018. When the assessee was contacted, assessee submitted that it has opted to file appeal before ld. CIT (A), accordingly, the assessment order u/s 143(3) of the Act was completed and final assessment order was passed u/s 143(3)/144Cr.w.s. 92CA(3) of the Act.
Based on the TP adjustment and while finalizing the final assessment order, the AO observed during the proceedings that assessee has claimed an amount of Rs.10,90,814/- under the head ‘agronomy expenses’. When the assessee was asked to justify the above claim and why it should not be treated as capital expenditure like in earlier years. In response, assessee has submitted as under:-
“During the year the assessee has incurred expenses relating to agronomy activities amounting to Rs.l0,90,814/-. The assessee is in the business of manufacturing and trading in frozen food, for which potato is the main raw material. The assessee has maintained high quality / standard in respect of the raw material i.e. potato to be used in its products and for this purpose, it incur some expenditure on various agronomy activities in order to improve the quality of potatoes grown in India. These activities are carried out on leasehold agricultural land in India.
For the assessment year under consideration, the assessee had incurred agronomy expenses which inter alia included development of better quality seed products, potato variety trials to identify better processing varieties that are most suitable to the Indian growing conditions, indentifying growing practices which result in increased crop yield, lease rental of land on which such activities are carried on, expenses on fertilizers, pesticides irrigation, labour and tractor etc.
The aforesaid agronomy activities carried on by the assessee are critical to the success of its factory in Mehsana, Gujarat as the activities are aimed to improve the growers' yield quality and reduce the cost of processing potatoes. This ensures the assessee has sufficient raw material which is suitable to expand its Mehsana Factory's product, at a cost that reduces the dependency of the assessee on imported finished goods. Thus the above expenses are directly related to the business of the assessee and are incurred wholly and exclusively for the business purpose. Accordingly, the assessee had claimed such expenditure incurred as revenue expenditure under section 37(1) of the Income Tax Act, 1961
Such contention of the assessee and deduction of these agronomy expenses has been upheld by Commissioner of Income Tax {Appeals} ["CIT{A)'} New Delhi as well as the Honorable Income Tax Appellate Tribunal, New Delhi {ITAT}, for AY 2002-03 and 2006-07. Further, the CIT{A} has also allowed this deduction for A Y 2008-09 and AY 2009-10 as well. A copy of the CIT{A} order for AY 2008-09 and AY 2009-10 is herewith enclosed as Annexure 4a and 4b for your reference. The copies of ITAT Order for AY 2002-03 and AY 2006-07 are herewith enclosed as Annexure 4c & 4d for your reference.”
After considering the above submissions, the AO observed that assessee has incurred the abovesaid expenses for the development of improved potato seeds quality and finding better production methods for manufacturing of finished goods. He held that these expenses are clearly in the nature of capital expenditure. With the above observations, the AO further observed that the issue under consideration was decided by the ITAT in favour of the assessee and Revenue is in appeal before the Hon’ble Delhi High Court. With the above observation, he proceeded to disallow the above-said expenditure.
Aggrieved with the above order, assessee preferred an appeal before the ld. CIT (A)-44, New Delhi. After considering the detailed submissions of the assessee, ld. CIT (A) partly allowed the grounds raised by the assessee and TP adjustments as under :-
| Particulars | Adjustments as per TP order | CIT (A) findings |
| Adjustment on Management fees : (Ground 1 to 1.3 of appeal | 176,868,703 | 70% of the addition was sustained on an ad-hoc basis. |
| Trading Segment : Sale of manufactured goods (Ground 2 to 2.4 of appeal) | 63,503,221 | Upheld the Ld. TPO’s approach. |
| Manufacturing segment : Sale of manufactured goods (Ground 3 to 3.4 of appeal) | 26,727,793 | Partly allowed (inclusion/exclusion of comparables) |
Aggrieved with the above order, both assessee and Revenue are in appeal before us raising following grounds of appeal :-
Assessee’s Modified-cum-Additional Grounds of Appeal
MANAGEMENT AND ADMINISTRATIVE SERVICES
1.That the Ld. Commissioner of Income Tax (Appeals) ("Ld. CIT(A),,) erred in upholding the adhoc increase of the Appellant's income by 70% (INR 123,808,092) of the fees paid (INR 176,868,703) to an associated enterprise CAE") for management and administrative services, based on a misapplication of section 92CA(3) of the Income-tax Act, 1961 ("the Act"). In doing so the Ld. CIT(A) erred in:
1.1not adequately considering the significant amount of documentary evidence provided by the Appellant to evidence the services actually received and their considerable commercial and economic value;
1.2arbitrarily disallowing the deduction of 70% of such fees on an "estimate basis" without regard for the need to apply the most appropriate method prescribed under Rule 10B of the Income-tax Rules, 1962 (the "Rules") or the guidance in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the "OECD Guidelines"); and
1.3basing its conclusions on incorrect statements of fact, such as that" ... the Appellant has not furnished the details of how the costs were allocated to the Appellant and whether any amount was deducted by the AE for shareholding/stewardship activity" and " ... the services provided by the AE are largely generic and in the nature of shareholder activity."
IMPORT OF FINISHED GOODS
2.The Ld. CIT(A) erred on facts and in law in confirming the additions made by the Ld. Assessing Office ("Ld. AO")/ Ld. Transfer Pricing Officer ("Ld. TPO") to increase the income of the Appellant by INR 63,503,221 relating to its purchase of finished goods from its AEs. In doing so, the Ld. CIT(A) erred in:
2.1determining that the resale price method is the most appropriate transfer pricing methodology without adequate consideration of its relative strengths and weaknesses (a position that is inconsistent with the Ld. CIT(A)'s use of the transactional net margin method ("TNMM") to test the Appellant's sale of finished goods to its AEs);
2.2providing no factual support for its conclusion that the Appellant is the appropriate tested party because its distribution activities are less complex than the manufacturing activities of its AEs (a position that is inconsistent with the Ld. CIT(A)'s treatment of the Appellant as the tested party when it manufactures finished goods for its AEs);
2.3rejecting the Appellant's application of the TNMM based on irrelevant considerations (e.g., that the Appellant did not provide the annual reports of the com parables), rather than the relative merits of the methodology; and
2.4without prejudice to the Appellant's other contentions, applying the resale price method without making appropriate adjustments to improve the comparability of the analysis, in contravention of the Indian TP Regulations', a Guidance Note issued by the ICAI as well as the OECD Guidelines :
SALE OF FINISHED GOODS
3.The Ld. CIT(A) erred on facts and in law in substantially confirming the additions made by the Ld. AO/ Ld. TPO to increase the income of the Appellant by INR 26,727,793 relating to its sale of finished goods to its AEs. In particular, the Ld. CIT(A) applied the TNMM in an unreliable manner that is inconsistent with the Rule 10B of the Rules and the OECD Guidelines including:
3.1applying the TNMM using financial data that includes the Appellant's transactions with both third parties and its AEs, rather than the certified segmented financial data submitted by the Appellant;
3.2choosing return on sales (i.e., operating profit/operating revenue) as the appropriate profit level indicator to benchmark the profitability of the Appellant's manufacturing activities;
3.3relying on functionally dissimilar third party comparables;
3.4relying on financial data for the comparable companies that was not contemporaneously available to the Appellant in AY 2014-15; and
3.5not making appropriate comparability adjustments to account for the Appellant's circumstances in AY 2014-15.
GENERAL GROUNDS
4.The reference made by the Ld. AO suffers from jurisdictional error as the Ld. AO has not recorded any reasons in the draft assessment order based on which he reached the conclusion that it was 'necessary or expedient' to refer the matter to the Ld. TPO for computation of the Arm's Length Price ("ALP"), as is required under section 92CA(1) of the Act.
Additional Ground
5.On the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in not accepting the additional evidence filed on October 15, 2018 wherein the Appellant has duly submitted the audited segmental financials for consideration in order to determine the arm’s length price of the international transactions entered into by the Appellant with its Associated Enterprise.
6.On the facts and in the circumstances of the case and in law, the Ld. TPO/ CIT(A) has erred in not accepting the segmental accounts for determination of ALP of the international transactions namely trading segment – import of traded goods and manufacturing segment - Sale of manufactured goods.”
Revenue’s Grounds of Appeal
l. In the facts and circumstances of the case, whether the order of Ld. CIT(A) is perverse in allowing 30% of the adjustment made by the TPO regarding the Payment of Management, relying on the assessee's superficial claims without any substantial fact to corroborate such claims, and without appreciating the facts brought on records by the TPO?
2.Whether the order of the Ld. CIT(A) is perverse on facts in rejecting the comparable i.e. DFM Foods on the ground that company owns certain intangibles in the form of trade mark when the TPO has established functional similarity and creation of brand value is not on account of marking but because of superior services. The order of Ld. CIT(A) is without giving due cognizance TPO order?
3.Whether the order of the Ld. CIT(A) is perverse on facts in rejecting the comparable Balaji Wafers Pvt. Ltd. on the ground that these comparable company is not functionally similar and also the fact that annual report is available in ACE TP data base. The order of Ld. CIT(A) is without giving due cognizance TPO order?
4.Whether, on the facts and circumstances of the case, the Ld CIT (A) is justified in deleting the addition of Rs.10,90,184/- on account of Agronomy activities ignoring the fact that the same is capital in nature, resulting in enduring benefit to the assessee in the form of agricultural produce?
The assessee has filed the aforesaid Additional Grounds No.5 & 6 on the direction of the Bench during the course of the hearing on November 9, 2023. After hearing both the sides, the same are admitted.
At the time of hearing, ld AR of the assessee submitted as under :-
“3.2 Management Fee :Payment of Management Fees and IT Support Fees
McCain India entered into an agreement with its AE, McCain Canada for receipt of certain services which can be broadly categorized into Integrated supply chain services, Scientific research services, Management support services, Marketing support services, Global information services, Financial and operational planning services, Pension and risk management services, Human resource services, Legal support services, and other miscellaneous services including internal audit assurance, taxation, and global coordination.
Approach of the Ld. TPO
The Ld. TPO disregarded the economic analysis furnished by the Appellant and the submission made during the course of assessment proceedings. Based on conjectures and surmises, the Ld. TPO concluded that the Arm’s Length Price (‘ALP’) of the said transaction as Nil on application of the CUP Method based on the assumption that no independent enterprise would have paid for services which did not tantamount to intra group services with demonstrable benefits.
Approach of the Hon’ble CIT(A)
The Hon’ble CIT(A), in its order, has accepted that the services have been rendered by the AE. However, the CIT(A) has mentioned that the Appellant has not furnished the details of how the cost were allocated to the Appellant and whether any amount was deducted by the AE for shareholding / stewardship activity. Further, the CIT(A) has mentioned that the documents filed by the Appellant shows that the services provided by the AE are largely generic and in the nature of shareholding activity. In doing so, the CIT(A) has referred to the judgement by the Hon’ble Delhi Tribunal in the case of Bombardier Transportation India Pvt. Ltd. (ITA No 1626/Bang/2015).Accordingly, the Hon’ble CIT(A) allowed 30% of the management fees on an adhoc basis.
Contentions of the Appellant
Not adequately considering the significant amount of documentary evidence provided by the Appellant (with reference to Ground 1.1):
As regards the benchmarking approach adopted by the Appellant in transfer pricing documentation, the Appellant would like to submit that, in the TP Documentation, the Appellant has used the CUP method/ Other Method. Since McCain Canada charged only cost for the services provided to McCain India without any mark-up, the transaction should be considered to meet the arm’s length standard as embodied in the Indian TP Regulations.
Further, as a secondary analysis, the Appellant aggregated the transaction of payment of management fee with other principal transactions under manufacturing segment using TNMM as the most appropriate method for benchmarking the manufacturing segment.
The Appellant has maintained appropriate documentation and evidence to support the payment of management charges and IT support charges. Further, the Appellant contends that it is not within the powers of the tax officer to question the commercial decisions of the Appellant as to whether the services are required to be availed.
Besides this, it may also be noted that the provision of services by related enterprises to each other to leverage on the expertise available within the related enterprises is a common practice amongst the Indian corporate groups as well. It may be noted that such Indian corporate groups pay for such services, while at the same time maintaining their own administrative set up. Hence, the payment for these services complies with the arm's length standard prescribed under the Indian Regulations.
A detailed break-down by type of service is depicted in the Table below:
Type of Service Amount (INR) Corporate Accounting 688,050 Global R&D and Innovation 27,199,650 Type of Service Amount (INR) McCain Business Solutions 4,229,700 Taxation 984,859 Pension 375,400 Risk Management 107,660 Internal Audit 1,197,440 Legal 1,637,073 Integrated Supply Chain 8,222,950 McDonald's Business Unit 1,076,730 Human Resource 7,825,200 BGMPA 5,673,100 APMEA Regional Support 33,273,804 GIS Support 40,444,836 Executive Management 9,011,668 Grand Total 141,948,154 As per Form 3CEB 137,785,900 Difference* 4,162,254 *The difference is on account of foreign exchange difference.
(Please refer page number 461 to 671of the paperbook for submission dated July 24, 2018 for detailed description services received and allocation methodology).
Appellant’s Rebuttal
Determination of arm’s length price as ‘30% of the international transaction’ on adhoc basis (with reference to Ground 1.2)
At the outset, the Appellant mentions that the Appellant has filed a compendium of documentary evidences before the Hon’ble CIT(A) included details of cost allocation (Refer page 814 to 1509 of the paperbook for documentary evidence and Page 639 to 641 for cost allocation details).
Further, the Appellant submits that its AE, McCain Canada also files return in India wherein the services rendered by employees of the AE in India is offered to tax. This also demonstrates the fact that services are indeed provided by the AE. In this regard, the Appellant submits the Assessment Order passed by the AO in case of MFL for AY 2014-15 as Annexure 1.
Without prejudice, the Appellant submits that:
No basis for adhoc 70% adjustment
The Appellant submits that the Hon’ble CIT(A) has not provided any basis for making adhoc adjustment of 70% of the management fee expense.
The Appellant submits that the Hon’ble CIT(A) has incorrectly applied the CUP Method to conclude that the arm’s length value of the disputed international transaction is ‘30%’, without identifying the third party comparable(s) relied on to make this conclusion. Doing so contravenes the provisions of Rule 10B of the Rules, Indian jurisprudence, and the OECD Guidelines.
Under the Indian TP regulations, the initial onus has been cast upon the Appellant to substantiate that its international transactions satisfy the arm’s length standard. Once satisfied, the burden shifts to revenue authorities, who must satisfy the conditions prescribed under law before proceeding to reject or disturb the Appellant’s arm’s length analysis carried out in its TP study. However, once the Appellant has discharged its obligations, the AO need not intervene unless conditions mentioned in clauses (a) to (d) of section 92C(3) of the Act are satisfied.
Without specifying the method and the comparable transaction(s), the proposed approach of considering the ALP as ‘30%’ would be tantamount to the disallowance of expenses rather than the determination of an ALP, which is not in accordance with the TP provisions.
Commercial expediency of the Appellant cannot be questioned
The Hon’ble CIT(A)/Ld. TPO in his order has questioned the commercial judgment of the Appellant in undertaking the transaction pertaining to payment of management fees. In this regard, we wish to submit to Your Honors that it is a long-settled principle in tax jurisprudence that the business model/transaction chosen by a taxpayer has to be respected and the revenue authorities shall not determine how the business should have been run/ managed by the Appellant.
Further, it is submitted that the Appellant has, in fact, received services and the services so received were purely intra-group services essential to carry out the Appellant’s day-to-day business operations. These services have been received from its overseas group companies with an objective to achieve economies of scale and avoiding duplication of activities apart from achieving cost savings.
The Appellant would like to submit that it is not within the powers of the Ld. TPO / AO to question the way an Appellant conducts its business as this is the prerogative of the Appellant itself. Accordingly, the need/decision of the Appellant for availing services cannot be rightly challenged by the Ld. TPO/AO.
No legal requirement to carry out a benefits test:
Without prejudice to the above submissions, while the Appellant has maintained and filed the need-benefit documentation, we wish to humbly submit that there is no legal requirement or mandate for any Appellant to necessarily undertake a cost-benefits analysis, and a mere absence of such analysis should not necessarily lead to a pre-conceived notion that no benefits have been received by the Appellant and should not form a basis to disallow the said payment.
The mere absence of any cost-benefit analysis cannot be presumed to imply that no benefit has accrued to the Appellant. Nowhere under the law or business conditions is it evident that a person can incur expenses only after doing a cost-benefits analysis.
Thus, the Appellant’s comparability analysis cannot be rejected merely by holding that a cost-benefit analysis is not available, as nowhere is such analysis mandated by law.
Benefits received and documentary evidence for the above services:
Without prejudice, the Appellant is, inter-alia engaged in the manufacturing and selling of French fries and potato specialties. Both, the raw material consumed as well as finished goods produced by the Appellant are perishable in nature. In order to minimize the loss of raw material and finished goods, the Appellant must be equipped with proper infrastructure for processing of good quality frozen food, cold storage facilities and transport facilities, etc. As mentioned earlier, McCain Canada is well equipped and has relevant expertise in all the areas of frozen food industry.
The guidance, advice and support obtained from the experienced and knowledgeable team of McCain Canada helped McCain India’s management of the operational and corporate activities reducing the level of staff required locally. Without these services, McCain India would have had to perform the services itself (and hire additional staff to do so), or outsource the services to a third party. The services provided by McCain Canada also facilitated increased sales by McCain India, as well as greater and more efficient use of the manufacturing assets of the receiving entities.
Please refer page number 461 to 671of the paperbook for submission dated July 24, 2018 for detailed description of the benefits received and page 814 to 1509 of the paperbook for documentary evidence for these services.
In addition, the Appellant submits that McCain Canada does not charge any mark-up on the costs allocated to various group companies for these central services.
As Your Honors would appreciate, provision of these services entails a cost to McCain Canada and in an independent scenario, any independent company would charge for provision of such services.
In view of the above discussion, it is submitted as follows:
The Appellant has undertaken a detailed and methodical transfer pricing analysis to benchmark its transactions which has been outlined in the transfer pricing study report and the same should be accepted;
The Hon’ble CIT(A)/Ld. TPO cannot question the commercial expediency of the Appellant. Further, there is no legal requirement to carry out need benefit test Without prejudice, the Appellant has proved and discharged all its liability viz.
“need test”, “benefit test” and “evidence test” before Your Honors;
The Appellant was in actual receipt of services from its AE and if taken from an independent third party, could have been availed at a much higher cost.
Based on the above, Your Honors would appreciate that the Appellant has demonstrated actual need, benefit and evidence test for receipt of such services, no adjustment is required to be made to the international transactions entered into by the Appellant.
In this regard, reliance is also placed on the following judicial precedents:
M/s Dresser Rand India Private Limited —(ITA No. 8753/Mum/2010)
M/s EKL Aplanches Ltd. (ITA Nos.1068/2011 & ITA Nos.1070/2011)
M/s Hive Comunicación (P) Ltd (ITA No. 306/Del/2011)
M/s DSM Anti – Infectives India Limitad (ITA Nos. 1139/Chd/2011 & ITA No.
1290/Chd/2012)
M/s Atotech India Limitad (ITA No 104/Del/2012)
M/s Indo American Jewellery Ltd (ITA No. 6194/Mum/2008)
M/s Woco Motherson Advanced Rubber Technologies Limitad (ITA Nos.: 89 and 3208/Ahd/11, 2637/Ahd/12, 474/Ahd/14, 63 and 593/RJT/2015)
M/s ESPN Software India Ltd (ITA Nos. 2059/Del/2012 & ITA No.
3457/Del/2013)
M/s Dell International Cervices India Private Limitad (IT(TP)A No.130/Bang/2014 and IT(TP)A No.121/Bang/2014)
Trading Segment: Import of Traded Goods – Trading Segment
During the FY 2013-14, McCain India had purchased finished goods (constituting processed foods, french fries and potato specialties) from AEs (i.e McCain Canada, McCain USA)which were used by McCain India for distribution to wholesalers and customers in Indian territory. The AEs manufacture finished goods and sell to McCain India at a mark-up of 5% on total.
The impugned transaction of imported finished goods was benchmarked by the Appellant using the TNMM as the MAM with Operating Profit / Operating Cost (‘OP/TC’) as the Profit Level Indicator (“PLI”) and the AEs as the tested party. The McCain Group’s TP policy of charging a mark-up of 5% on the cost of finished products sold to the AEs was lower than the net margin earned in comparable uncontrolled transactions (5.89% in case of European region and 7.04% in case of US/Canada region), thereby demonstrating the arm’s length nature of McCain India’s subject international transaction.
However, the Ld. TPO/Hon’ble CIT(A) enhanced the income of the Appellant by INR 63,503,221 by holding that the Appellant’s international transaction pertaining to the trading segment do not satisfy the arm’s length principle envisaged under the Act.
Approach followed by the Ld. TPO/Hon’ble CIT(A)
The approach adopted by the Ld. TPO in the TP order is provided below:
o The Ld. TPO rejected the economic analysis undertaken by the Appellant in its TP documentation by disregarding the Appellant’s submissions on the analysis of functions performed, assets employed and risks assumed (‘FAR analysis’) of the Appellant and the AEs with respect to the trading segment.
o The Ld. TPO proceeded to apply the Resale Price Method (‘RPM’) by considering McCain India as the tested party. The Ld. TPO failed to appreciate that the AEs being the least complex entities in the intercompany transaction should be the tested parties and the TNMM should be considered as the MAM.
o Further, the Ld. TPO, while conducting the benchmarking analysis using RPM, also rejected the Appellant’s plea with respect to applying an adjustment for Custom Duty, Wharfages, THC Charges and Insurance charges (“import related charges”) to the Ld. TPO’s selected comparable company, ignoring the fact that such expenses are not in the nature of direct expenses and not undertaken by the comparable company while it has been incurred by the Appellant.
o In doing this, the Ld. TPO disregarded the Indian TP Regulations, Guidance Note issued by the ICAI as well as OECD Guidelines, which require adjustment to account for functional and other differences between the international transaction and the comparable uncontrolled transactions.
o Accordingly, the Ld. TPO determined the arm’s length gross margin of the said transaction as 8.33% and made a proportionate adjustment of INR 63,503,221 on the value of the finished goods imported from the AEs.
o The Hon’ble CIT(A) upheld the approach of the Ld. TPO.
Contentions of the Appellant
I. Contention against considering McCain India as the tested party instead of the AEs (with reference to Ground 2.1 to 2.3).
The Appellant submits the following table summarizes the functioned performed by the Appellant vis-à-vis McCain India's AEs in respect of transaction pertaining to import of finished goods:
Analysis of Appellant and AE in respect of transaction pertaining to import of goods:
| Particulars | AEs | McCain India |
|---|---|---|
| Functions performed | ||
| Procurement | | X |
| Manufacturing of finished products | | X |
| Quality verification and assurance | (limited) | |
| Marketing in India | X | |
| Selling and distribution in India | X | |
| Pricing | X | |
Risk analysis
The risk analysis for the said transaction is provided below:
| Particulars | AEs | McCain India |
| Market risk | X | |
| Product/ service liability risk | X | |
| Credit risk | X | |
| Inventory risk | X | |
| Foreign Exchange risk | X | Only to the extent of the difference between the respective foreign currency and the rupees conversion rates at the date of invoice payment |
Based on the above facts, it is clear that for the subject international transaction of import of finished goods by the Appellant, the Appellant operates as an entrepreneurial risk bearing entity, which bears all associated risks in relation to the operations. On the other hand, the AEs function as limited risk bearing manufacturing entities.
The TNMM was applied by the Appellant using its AEs as tested parties, given they perform relatively simple functions, own assets easily comparable to third party benchmarks, and bear proportionately fewer risks than McCain India.
The Ld. TPO/Hon’ble CIT(A) has considered the Appellant as the tested party while benchmarking the transactions relating to sale of manufactured goods considering the Appellant as the least complex entity. Similarly, in the case of the transactions relating to sale of traded goods, the AEs are the manufacturing entity and the least complex entity and should be considered as the tested party. By taking the Appellant as the tested party in both situations, i.e. where the Appellant is a manufacturer as well as where it is a trader, the Ld. TPO/Hon’ble CIT(A) has contradicted his own approach leading to gross mistake and injustice to the Appellant.
Thus, the AEs are the least complex entities and have thus been correctly chosen as the tested parties for the transaction pertaining to import of finished goods in the TP documentation with TNMM as the MAM and OP/TC as the relevant PLI.
The results of economic analysis for the subject transaction are reproduced below for Your Honors’s reference:
Tested Nature of Comparables Party’s International MAM PLI Tested Party Margin as Price/ Transaction per the Study Operating Margin
McCain
Canada, US/Canada
Region
McCain USA, 7.04% Import of TNMM OP/TC 5% finished goods
McCain
Europe, UK
Region5.89%
McCain
Australia As it is evident from the above table, the selection of Foreign AEs as tested party to benchmark the subject international transaction was the correct approach and based thereon, it can be reasonably concluded that the international transaction of the Appellant, pertaining to import of finished goods was in accordance with the arm's length standard required under the Indian TP Regulations.
In this regard, reliance is also placed on the following judicial precedents: GE Money Financial Services Private Ltd. vs Pr Commissioner of Income Tax — ( ITA 662/2016, CM Nos. 31740-31741/2016) (Delhi High Court) Nivea India Prívate Ltd. Vs DCIT (ITA No.121/Mum/2013) (Delhi ITAT) IDS Infotech Ltd. Vs DCIT (I.T.A No. 130/ Chd/24316) Development Consultants Private Limited 12008-TH-o3-1TAT-KOL-TPJ Ranbaxy Laboratories Ltd vs ACIT (2016) 68 taxmann.com 322 (Delhi Trib.)
Landis + Gyr Limited vs DCIT (I.T.A No. 37/Koli2o12 and I.T.A No.
1623/K01/2012) Tata Motors European Technical Centre Plc ITA No 7630/Mum 2012 and ITA No 1698/Mum/2014 Global Vantedge (P.) Ltd vs DCIT (ITA NO's. 1432, 2321, 2763 AND 2764 /Del/2009
II. Contention with respect to adjustments relating to custom duty, wharfages, insurance, etc. (Without prejudice) (with reference to Ground 2.4).
At the outset, it is submitted that without prejudice to the Appellant’s contention that the AEs should be considered as the tested party with respect to import of trading goods, the Appellant submits that even if the Appellant was to be considered as tested party, adjustments to its margin must be made in order for it to be considered comparable with the companies selected by the Ld. TPO.
In this regards, the Appellant wishes to highlight that since its incorporation in 1996, it has been engaged in the trading of frozen French fries and potato specialties. It imports French fries and other products from its respective associated enterprises and sells the same to various institutional buyers including McDonald's, KFC, Pizza Hut, Oberoi Group, Taj Group, etc. throughout the country.
During the subject assessment year, the Appellant did not have sufficient manufacturing capacity to ensure supply of products to its primary customers throughout the year. Therefore, in order to not to lose its customer base to the competitors, the Appellant had to import finished goods from its AE to fulfill its customers' orders. In fact, the Appellant's only option to be able to supply McCain products to its customers was by importing finished goods from its AE. There are no third parties that can provide the Appellant with the same quality McCain finished products as the AEs.
Further, the Appellant could not have passed the import related charges to its customers because of stiff competition. As a result, the Appellant had to incur additional cost of importing the finished goods (custom duty, wharfages, insurance, etc). On the other hand, the comparable company selected by the Ld. TPO (Allanasons Ltd) was involved in the trade of frozen foods by purchasing finished goods primarily from domestic third-party suppliers and did not incur any substantial import related cost.
Therefore, in order to improve the comparability of an international transaction of import of goods by the Appellant with the uncontrolled transaction undertaken by the comparables, the Appellant submits that an adjustment to the cost of goods sold should be made by reducing the import cost mentioned above.
Adjustment to account for the functional and other differences is one of the basic transfer pricing principles and is allowed under the Indian TP Regulations
The Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm's length price/ margin. It is the cardinal principle of the transfer pricing regulations is to compare like with like and to eliminate differences, if any, by suitable adjustment.
In the subject international transaction of import of finished goods, the Appellant has incurred import related charges, which are not incurred by the comparable company. Since this would materially affect the measure of an arm's length result under the method being applied (RPM), a suitable adjustment is warranted to improve the reliability of the result and to determine the correct arm's length price.
Your Honors would appreciate that the import related charges have eventually been paid to the government/third parties, and not to the AE. Therefore, not making adjustment to account for such difference would tantamount to result in a conclusion that it is part of sale proceeds of the AE, which would be an incorrect inference.
To understand the methodology of application of the RPM, the ICAI Guidance note has illustrated the computation of the Arm's Length Price with a detailed analysis of adjustment required to be made to arrive at arm's length price while using RPM.
In the illustration, the tested party had incurred freight inward charges in the international transaction but the similar charges were not incurred in comparable uncontrolled transaction. Therefore, the adjustment was made in respect of such freight inward charges by adding it to the price arrived at after following the first three steps mentioned in Rule 10B(i)(b) of the Rules above in order to arrive at the arm's length purchase price.
It is pertinent to note that in this illustration, along with the freight inward charges, comparison was made between the custom duty paid by the tested party in the international transaction and in the comparable uncontrolled transaction. However, since the custom duty paid in both the scenario was same, no adjustment was made. This clearly shows that custom duty paid in the international transaction and comparable uncontrolled transaction needs to be compared and appropriate adjustment need to be made to the price in order to arrive at the arm's length price.
The Appellant wishes to submit that the issue of making adjustment to account for difference in functional profile and other difference has been analysed by the Hon'ble High Court/ Hon'ble Income Tax Appellate Tribunal ("ITAT,") which have ruled in support of the view that appropriate adjustment (including import duty adjustment) need to be made if the circumstance warrant in order to arrive correct arm's length price.
In this regard, we have relied on the following Judicial precedents: Motonic India Automotive (P.) Ltd. (IT APPEAL NO. 741 (MDS.) OF 2014 M/s. Federal Mogul Automotive Products (India) Pvt. Ltd. (ITA No.
5769/Del/at11) Skoda Auto India P Ltd 122 -TTJ 699 (Pune) dated March 2009 Demag Cranes &Components (India) Pvt. Limitad ITA No.12o/PN/2o11 Nord Drivesystems Private Limited (ITA No. 509/Pun/2015) Gates Unitta India company P Ltd [TS-360-ITAT-2017(CHNY)-TP] Doowon Automotive Systems India Pvt Ltd [TS-97-ITAT-2017(CHNY)-TP] (Chennai Tribunal)
Based on the above, even in the present case, given the fact that the import related cost was not incurred by the comparable company, an adjustment for the same would enable the Appellant to reliably measure its gross margin vis-a-vis the comparable company if the Appellant without prejudice to other contentions accepts your benchmarking approach of adopted RPM as the MAM.
III. Correction in computation of cost of goods sold (with reference to Ground 2.4)
Without prejudice to the Appellant’s contention that the AEs should be considered as the tested party with respect to import of trading goods, the Appellant submits that, even if the Appellant was to be considered as tested party, the Appellants correct margin with respect to the trading segment should be considered.
It is brought to Your Honor’ knowledge that the Ld. TPO/Hon’ble CIT(A) has considered the cost of goods sold from the audited financial statements for computing TP adjustment. However, the audited financial statements do not reflect the segment wise data and hence the Appellant has filed the audited segmental financial statements before the Hon’ble CIT(A), which provides the segment wise profit and loss account of McCain India (please refer page no. 19-25 of the paperbook).
The ‘Purchase of frozen food products’ amounting to INR 616,906,463, considering by the Ld. TPO in the TP order contains the following costs which is incorrect. While the correct computation is shown in the segmental profit and loss account (please refer page no. 19-25 of the paperbook), the same is summarized below:
Therefore, the corrected cost of goods sold to be considered for computation of the relevant international transaction is:
| Particulars | Amount (INR) as per TP Order | Corrected as per the Appellant | Remarks |
|---|---|---|---|
| Purchase of finished Goods (other than high seas sales) | 160,934,070 | 160,934,070 | |
| Purchase of finished Goods for high sea sales | 165,086,041 | 165,086,041 | |
| Customs, Freight and other charges | 127,995,316 | - | Refer contentions in Ground 2.4 above. To be considered as non-operating |
| Particulars | Amount (INR) as per TP Order | Corrected as per the Appellant | Remarks |
| Loss due to Minimum Quantity Commitment | 29,858,668 | - | Non-operating in nature as it is written back in FY 2018-19 |
| Loss on Packaging & Sampling | 3,026,952 | - | Non-operating in nature as it is written back in FY 2018-19 |
| Cost of goods purchased from local vendors | 130,005,416 | - | Not related to international transactions and hence should not be considered. Further, it also relates to the manufacturing segment. The corresponding sales for these goods have been considered as part of the sale of manufactured goods in the audited financial statements of McCain India. |
| Total Purchase of goods | 616,906,463 | 326,020,111 | |
| Change in stock (only traded goods from financial statement) | 47,697,430 | 64,794,843 | The Ld. TPO has incorrectly considered changes in inventory of raw materials as well as traded goods. The Appellant correctly has considered changes in inventory of only traded goods. |
Accordingly, the gross profit earned by McCain India in the trading segment is as follows:
| Particulars | Amount (INR) |
|---|---|
| Sale of Traded Goods | 438,918,760 |
| Purchase of finished goods including (Refer table above) | 326,020,111 |
| Change in stock (only traded goods from financial statements) (Refer table above) | 64,794,843 |
| Total cost of goods sold | 390,814,954 |
| Gross Profit | 48,103,806 |
| Gross Profit/Sales | 10.96% |
The correct gross margins of McCain Indiaare10.96%. The gross margins earned by the comparable company as determined by the Ld. TPO is 8.33%. Since the gross margins earned by McCain India is more than the arm’s length price, the international transactions relating to the trading segment of McCain India are considered arm’s length. Therefore, the Appellant humbly requests Your Honors to accept the Appellant’s contentions and delete the transfer pricing adjustments.
3.4 Manufacturing Segment: Sale of manufactured goods
During the year 2013-14, McCain India was engaged in the business of manufacturing of frozen french fries and other potato specialties for sale of finished goods to its AEs and third-party customers in India as well as outside India.
The impugned transaction of the sale of finished goods to AEs was benchmarked by the Appellant using an internal TNMM as the Appellant sells finished goods to third parties and AEs. Further, a supplementary analysis was conducted by the Appellant using an external TNMM as the MAM with EBITDA/ Operating Cost as the PLI and the Appellant as tested party. The PLI earned by the Appellant in the international transaction (29.94%) was higher than the PLI earned in uncontrolled transaction (5.08%), thereby demonstrating the arm’s length nature of McCain India’s subject international transaction.
Approach followed by the Ld. TPO/Hon’ble CIT(A)
The approach adopted by the Ld. TPO in the TP order is provided below:
o Rejected internal transactional net margin analysis undertaken by the Appellant in the TP study.
o Rejected the supplementary economic analysis undertaken by the Appellant in the TP study using external TNMM as the MAM with EBITDA/ Operating Cost as the PLI and the Appellant as tested party;
o Undertook a modified economic analysis, after applying certain quantitative/ qualitative filters. In doing so, the Ld. TPO has arrived at a final set of four comparable companies (rejecting three comparable from the TP Study and proposing additional three comparable).
o Selected the PLI as “Operating Profit / Operating Revenue” to benchmark the transaction relating to the sale of finished goods without appreciating the fact in order to benchmark the sale of goods (Manufacturing activity), operating expenses, and not operating revenue, is the appropriate base in the PLI selected to test manufacturing activities.
o Further, the Ld. TPO also failed to appreciate the fact that during the subject assessment year, the Appellant had set up a new production line, adding a production output of 7.5 Tonne to the total manufacturing capacity, resulting in higher depreciation charges during the relevant year in comparison to that of the third-party comparable companies. Accordingly, since Cash Profits (EBIDTA)/ TC as the PLI eliminates the impact of such a material difference between the tested party and the third-party comparable companies, it should be used as the PLI and not Operating Profit/Operating Cost.
Accordingly, the Ld. TPO determined the ALP net margins of the said transaction as 10% and made a proportionate adjustment of INR 26,727,793 based on the value of the sale of finished goods to the AEs.
The Hon’ble CIT(A) partly accepted the Appellants contentions and excluded DFM Foods and Balaji Wafers from the set of comparable companies. Further, the CIT(A) directed the inclusion of Himalaya International Ltd. on passing all filters.
Contentions of the Appellant
I. Segmental Profit and loss account to be considered over entity level margin (with reference to ground 3.1)
At the outset the Appellant submits that even if the Ld. TPO approach is to be accepted, the certified segmental profit and loss submitted by the Appellant should be considered. It is brought to Your Honor’ knowledge that the Ld. TPO/Hon’ble CIT(A) has considered the operating margin of the Appellant at an entity level for computing TP adjustment. However, the audited financial statements do not reflect the segment wise data and hence the Appellant has filed the audited segmental financial statement before the Hon’ble CIT(A), which provides the segment wise profit and loss account of McCain India (please refer page no. 19-25 of the paperbook).
Further, the sales to AEs forms only 6.43% of the Appellant's total sales were made to AEs. The remaining 93.57% of sales were made to unrelated parties in India. Hence, the entity level margins are heavily influenced by functions, which are not performed by the Appellant with respect to sales to AEs. These functions include sales, marketing, and customer service functions, which are not required with respect to sales to AEs.
In this regard, the Appellant submits the summary of arm's length margin as per the Appellant and the Ld. TPO is provided below for your Honor's ready reference:
| Segment | Appellant’s OP/Sales margin (Entity Level) as considered by the Ld. TPO in the TP Order | Appellant’s OP/Sales margin as per segmental P/L (sale to AE) | Arm’s Length operating margin (OP/Sales) as determined by the Ld. TPO in TP Order | Arm’s Length operating margin (OP/Sales) as determined by Hon’ble CIT(A) |
|---|---|---|---|---|
| Manufacturing activity | -6.01% | 16.07% | 10.00% | 4.16% |
II. Contention with respect to exclusion of comparable selected by the Ld. TPO/Hon’ble CIT(A) (with reference to ground 3.3)
The Appellant contends that Flex Foods Ltd should also be excluded from the list of comparables. Our contention for rejecting the proposed comparable:
| S no. | Particulars | Contentions |
|---|---|---|
| 1 | Flex Foods Ltd. | Functionally not comparable as engaged in cultivation and processing of mushrooms Involved in product development of conventional herbs like Rucola, organic herbs like Coriander & Marjoram & vegetables like Chilly & Carrot. Fails advertisement & marketing filter (4.33%) |
The Company is involved in business of cultivation and processing of mushrooms, herbs fruits, herbs fruits Fruits & Vegetables in Freeze Dried, Air Dried and Individually Quick Frozen form as per its Annual Report. The relevant extracts are provided below:
(Refer Page 26 of the Annual Report for FY 2013-14)
In reference to the aforementioned, it is submitted before Your Honors that Flex Ltd involved in different business as compared to the Appellant. Also, as described above, the products manufactured by Flex Ltd are not comparable with McCain India’s products.
Segment data not available
As provided above, Flex Ltd is involved into the manufacturing of diversified product ranges and segmented results are not available so as to compare the segment which is similar to the Appellant's business.
Fails Advertisement & Marketing Filter:
Flex ltd fails the A&M expense filter applied by the Appellant. The A&M expense of Flex Ltd is 4.33% of sales. Hence, the company has undertaken significant amount of advertising expenditure in relevant FY 2013-14. Such investment may result in development of non-routine marketing intangibles. Therefore, a return for such intangibles will also be factored into the overall return achieved by it. This is in complete contrast with the Appellant.
Sales and marketing expenses
Based on page 35 of the annual report of Flex Ltd for FY 2013-14, it incurs commission on sale and sample testing charges amounting to 4.33% of its total sales. The relevant extract from the annual report is shown below.
During FY 2013-14, Flex Ltd has an A&M/ sales ratio in excess of 3 percent (a threshold limit applied by the Appellant for screening companies in the TP study analysis) which clearly indicates that it also enjoys a return on account of marketing intangibles on the other hand McCain India is engaged in contract manufacturing of potato products while making sales to its AEs is has not incurred any advertising and marketing relating expenditure and hence, is not comparable to the Appellant.
As per the website of the company, it is engaged in production of natural food ingredients. It is engaged in production of various diversifies products like herbs, fruits, vegetables, mushroom, pickle etc.
(Please refer https://www.flexfoodsltd.com/index.php#about)
(Please refer https://www.flexfoodsltd.com/index.php#about)
III. Contention with respect to considering cash profits as the PLI (with reference to 3.2 and 3.5)
The Appellant wishes to reiterate the fact that McCain India had set up a new production line in FY 2013-14, adding a production output of 7.5 Tonne to the total manufacturing capacity of McCain India, hence, there is higher depreciation charge in Profit and Loss Statement during the relevant year in comparison to the comparable entities. Further, the new production line for the manufacturing facility set by McCain India is state of the art and much better and expensive than the facilities typically set up Indian processed food manufacturers. On account of this expansion, the depreciation expense for the year is higher by Rs. 66,454,075 which is not the case for comparable entities.
As the above has impacted the profitability of the tested party and not the comparables, use of Cash Profits (EBIDTA)/ TC as the PLI would eliminate the impact of difference in accounting policy between the tested party and comparables. Accordingly, EBIDTA/ TC has been used as PLI for the purpose of analysis in the TP documentation.
The summary of arm's length analysis by the Appellant and the Ld. TPO is summarized below:
Segment Appellant’s EBITDA/TC margin at segment level (sale to AE) EBITDA/TC of comparable companies as per the CIT(A) Order Manufacturing Activities 29.52% 7.69% Your Honors would appreciate that the EBIDTA/TC of the Appellant's sale to the AE segment is 29.52% as compared to the EBITDA/TC of comparable companies determined by the Ld. CIT(A) which is 7.69%.
In this regard. reliance is also placed on the ruling of Hon'ble Delhi bench of ITAT in the case of Schefenacker Motherson Ltd vs ITO [TS-15-ITAT-2009(DEL)-TP].
In light of the above contentions, the Appellant humbly prays that Your Honors accept the contentions of the Appellant and accept EBIDTA/Total cost as an appropriate PLI for benchmarking the transaction.”
On the other hand, ld. DR of the Revenue brought to our notice detailed findings of TPO and ld. CIT (A). With regard to appeal preferred by the assessee, he heavily relied on the detailed findings of the ld. CIT (A). With regard to Department’s appeal, he brought to our notice paras 7.6 to 7.8 of the first appellate order and submitted that ld. CIT (A) has given relief to the assessee on the basis of submissions of the assessee, he gave relief merely on the basis of observation that services have largely been rendered in order to maintain same standards among all group of AEs and he objected to give relief on the basis of estimate by merely relying on the findings of erstwhile ld. CIT (A) in AYs 2010-11 and 2011-12. In this regard, he brought to our notice page 624 of the paper book which is the management agreement between the assessee and its AEs , he further submitted that various clauses contain general terms which do not give clear picture on the aspect of need test, he heavily relied on the detailed findings of the TPO and he pointed out that TPO held clearly that there is no specific item of services pointed out by the assessee which were absolutely and urgently needed by it, which was provided on time to immensely benefit in it business and not supported by proper documentation.
With regard to ground no.4 raised by the Revenue, he fairly accepted that the issue under consideration is in favour of the assessee.
Considered the rival submissions and material available on record. We shall deal with the issues raised by both the parties. First, with regard to management fee and IT support fees paid by the assessee to its AE, we observed that the AE provides various services like Integrated supply chain services, Scientific research services, Management support services, Marketing support services, Global information services, Financial and operational planning services, Pension and risk management services, Human resource services, Legal support services, and other miscellaneous services including internal audit assurance, taxation, and global coordination. However, TPO rejected the same with the observation that the services rendered are not tangible and unreal, it is only an arrangement to shift tax base without any economic substance. However, Ld CIT(A) held that the services were rendered by the AE with the rider that the assessee had not furnished the details of how the cost were allocated and they are falling under shareholding/ stewardship activities. With the above observations, he gave part relief to the assessee by restricting the benefit to the extent of 30%. Hence, both parties are in appeal before us. On careful consideration, we noticed that the assessee is part of the group entity, which is controlled by the group philosophy and standards, as per the arrangement, the assessee had received various services, the relevant documents were submitted before the lower authorities, the same is enclosed in the paper book, for brevity, the index is reproduced below to indicate that various services were received by the assessee from it AE : From the above, it is clear that various services were provided within the group standards, accordingly, the assessee was invoiced. What is missing was that the assessee was charged various charges by the AE through the debit notes, it is also claimed that it is only reimbursement without there any profit element. Therefore, in our considered view, as submitted, the AE also declared the relevant service charges in their return of income in India and offered to tax. Since, the services provided by the AE as common to all AEs under their control. In our view, the assessee should have submitted / maintained the various debit notes along with the basis of charges allocated by the AE including the allocation key to support the claim. In absence of the same, it is difficult for all the parties to appreciate the services provided and utilized by the assessee, in our view, the CIT(A) had agreed that there are services provided by the AE but on the similar observation made by us, he proceed to presume that the assessee is eligible to get the benefit only 30%, which is not proper. In our view, the assessee had obtained the services from the AE and merely because the proper documents were not maintained or submitted, the whole claim cannot be rejected. It is factual issue and various case law relied by both the parties are distinguishable. Therefore, we are inclined to remit this issue to the file of AO/TPO with the direction to the assessee to file the relevant debit notes and relevant calculations before the AO/TPO, at the same time we direct the AO/TPO to appreciate the documents which will be submitted by the assessee in due course as directed above. In the result, grounds raised by both the parties are allowed for statistical purpose.
With regard to trading segment, we observed that the assessee is importing finished goods from its AE from the inception and marketed the same to various wholesalers and other vendors in India. After commencement of manufacturing facility in India, it has started to sell manufactured goods to local vendors and to the intercompany. During the year under consideration, the assessee had benchmarked the transaction using TNMM as the MAM with OP/TC as the PLI and selected the AE as the tested party. The assessee submitted that the AE charges 5% margin on the finished goods and sells the same to the assessee, the AE had earned 5.89% and 7.04% from the European and US/Canada regions respectively, as the mark up of 5% charged by the AE is less than the mark up earned in the uncontrolled transaction by the AE. Considering the submissions, we are of the view that mere selection of the tested party, presuming that they have earned or declared margin in the uncontrolled transactions are within the range, in our view, without there being any comparative data or market data of the comparable companies, which were not available to the revenue cannot be accepted. Therefore, we are inclined to reject the same. It is relevant to note that in the previous year, the assessee had followed the RPM as MAM and assessee itself as the tested party, it has not been able to substantiate why the same cannot be followed for the present assessment year. The submissions made before us were considered and found not acceptable. It is fact on record that the assessee sells the finished goods imported from its AE and mere least complex party alone without there being any comparable data of other comparable companies and complete financial data of the tested party, which was to be submitted before the tax authorities or the authorities cannot acquire, makes the above selection of tested party more cumbersome. Further, the assessee had proposed to follow the TNMM and keep the AEs from Canada, USA, Europe and Australia as tested party and proposes to compare the results of same AEs for bench marking, in our view, it is not practical. The case law relied by the assessee in the written submissions, which were never argued nor filed any copies filed before us. However, the same are distinguishable to the facts in the present case. Therefore, we are inclined to reject the above submissions.
Coming to the method adopted by the lower authorities, it followed the RPM and proceeded to determine adjustment on the basis of average margin determined at 8.33% from the comparables selected on the above basis. It is submitted before us that the assessee regularly imports from the AEs from the inception and sells the same to the various prime customers in India. At the same time, the assessee, itself, submitted before us that it did not have sufficient manufacturing capacity to ensure supply of products to its primary customers throughout the year. Therefore, in order not to lose its customer base to the competitors, the Assessee had to import finished goods from its AE to fulfill its customers' orders. It was submitted before us that in fact, the Assessee's only option to be able to supply McCain products to its customers was by importing finished goods from its AE. There are no third parties that can provide the Assessee with the same quality McCain finished products as the AEs. It is clear from the above submission that primarily it was supplying finished goods by import and after having its own manufacturing facility, it does not depend on its AEs. Just because there was no manufacturing capacity, it cannot supply the same. It is fact on record that the assessee would not have supplied its primary customers when there was no manufacturing capacity, without incurring import and related costs, it is part of procurement cost. That being the case, on top of the cost of purchase (includes the accepted margin of its AE’s of 5%) and procurement cost, it would have added its own margin on top of the above total cost. From the profit and loss statement, we observed that the assessee had declared huge loss due to supply to its primary customers by procuring the finished goods from its AEs. In our view, it is not adding up, the assessee procures the raw material within India and manufactures the goods to supply to its prime customers. The pricing of imported goods and their own selling price from manufactured product are not compatible. We noticed that the assessee had taken the conscience decision to procure the finished goods from its AEs and supplied them to its prime customers and resulted in huge losses. We observed that the assessee had frozen the prices with the prime customers and in order to meet the demands, procured the material from its AEs to cater to the demand, that being the case, the loss declared in the trading segment is extraordinary and it has absorbed the price difference due to additional import cost in the trading segment, whereas it should be part of manufacturing segment, hence, not declared the actual results. This needs to be verified on the basis of pricing method adopted by the assessee when the assessee was wholly dependent on the supply from its AEs before the commencement of manufacturing facility. The assessee cannot declare loss in the trading segment; there are absolutely no sensible reasons for that. The issue is the comparability of prices of imported goods verses manufactured goods. In the present case, since the selling prices are already frozen after the assessee had started the commercial production, the nature of the business of the assessee had changed dramatically, the focus is only on the basis of manufacturing facility and its capacity utilization. In assessee’s own admission, the assessee had procured the finished goods from its AEs to meet the demands of the primary customers.
Coming to the manufacturing segment, we observed that the assessee had benchmarked the manufacturing segment by applying internal TNMM on the basis that it sells finished goods to its AEs and third parties. Further, the assessee also benchmarked the segment using external TNMM as the MAM with EBITA/OC as the PLI and keeping the assessee as tested party. For the same, the assessee has allocated the various cost on the basis of various allocation keys between the international transaction (supply to its AEs) and supply to third parties, it submitted the results as, it has earned profit of 19.14% (OP/OC) in international transaction and profit of -4.25% (OP/OC) in uncontrolled transactions. After going through the chart submitted by the assessee, we noticed that the assessee had allocated cost such a way that most of the indirect costs were distributed on the basis of volume and the direct costs on actuals and volume but for the manufacturing of the same goods, how the same are so much variance, there may some special ingredients to supply to its AEs, it can never have such different result, almost 550% variance. This is not acceptable and explanation is not acceptable. It indirectly suggests that it charges premium to its own AEs. There is no material brought on record to suggest such pricing. Therefore, we are inclined to reject the submissions made by the assessee in this regard.
Further, we observed that the TPO had proceeded to bench mark the transaction adopting TNMM as MAM for this segment and proceeded to select various comparables, accordingly bench marked the manufacturing segment on the basis of filters and selected comparables. However, the Ld CIT(A) made certain adjustments in the selection of comparables.
After consideration were the nature of the business, the assessee in the earlier years, the business was heavily dependent upon the supply from the AEs and it only supplies the finished goods to its primary customers and manufacturing risks was always with the AEs and the assessee was making profits on top of the margin of its AEs which was predetermined at 5%. In the above scenario, the method of bench marking on the basis of RPM was justified. However, in the change circumstances, the primer goal of the assessee is to manufacture and only when the capacity issues arises, it cater to the requirement by taking supplies from its AEs. In our considered view, the bench marking on the basis of RPM or on the basis of TNMM in segment wise is not justified, both the business are interlinked and the purpose of the assessee is only to cater to the existing and primary customers, who are predominantly of the global customers, who are also getting supply from the AEs, in the past. Therefore, Bench marking separately will not serve or give appropriate results. In our view, the business of the assessee is to sell the finished goods to its primary customers and the goods were either manufactured or procured from its AEs, also the prices are already frozen, the assessee will earn profit on the basis of cost of manufacture or cost of procurement, the bottom line is fixed. Hence, we direct the AO/TPO to bench mark the international transaction on entity level by adopting appropriate methods as per law. At the same time, we direct the assessee also to submit the relevant documents and information to bench mark the international transactions as per above directions. Accordingly, the issues under consideration are remitted back to the file of AO/TPO. In the result, appeals filed by the assessee as well as revenue are allowed for statistical purposes.
The issue raised by the revenue in ground no 4 is squarely covered in favour of the assessee, therefore, after considering the submissions of both parties, the above ground raised by the revenue is dismissed.
In the result, appeal filed by the revenue is partly allowed for statistical purposes and appeal filed by the assessee is allowed for statistical purposes.