Pramod Kumar, Member (A) -
(1.) OUT of these seven appeals, first six appeals are -cross appeals, filed by the assessee as also the AO, against a consolidated order dt. 11th Sept., 2012 passed by the CIT(A) in the matter of assessment under s. 143(3) of the IT Act, 1961 (hereinafter referred to as 'the Act), for the asst. yrs. 2003 -04, 2004 -05 and 2005 -06. The seventh appeal is assessee's appeal against order dt. 29th Oct., 2010 passed by the then AO under s. 143(3) r/w s. 144C of the Act, for the asst. yr. 2006 -07. All these appeals pertain to the same assessee, involve some common issues arising out of a common set of facts, and were heard together. As a matter of convenience, therefore, we are disposing of all these appeals together by this consolidated order. One common issue in all the assessment years is the challenge to the correctness of ALP adjustment made to the billing for contract manufacturing by the assessee, to its AEs based abroad. We will begin by taking up this common issue. The short question, as learned counsel for the assessee contends, that we have to adjudicate upon in this bunch of appeals is whether Cost Plus Method (CPM), with entrepreneurship profits derived from manufacturing and selling its products in India as the benchmark, would indeed be most appropriate method of determining the ALP of contract manufacturing of its same products for its AEs abroad. The background in which this question arises is as follows.
(2.) THE assessee company (Wrigley India, in short) was set up in India in October, 1993 as a wholly -owned subsidiary of the legendary William Wrigley Jr. Co. USA (Wrigley USA, in short) founded in 1891 and is thus part of a large network of business entities associated with Wrigley USA (collectively referred as Wrigley group) -world's largest manufacturer and marketers of chewing gum with its network in more than 180 countries. Wrigley India is engaged in the manufacture and sale of confectionery products like chewing gums, bubble gum, lollipops and toffees. The company is manufacturing and selling these products to the associated enterprises (AEs) as also to the independent enterprises (non -AEs).The fine line of distinction in respect of these transactions with AEs and non AEs, as canvassed before us, is that while the transactions with the AEs are in the capacity as limited risk contract manufacturer, its transactions with the domestic independent enterprises is a business transaction with regular entrepreneurship risks. The assessee, as we have noted above, started its operations in India in the end of the calendar year 1993. The assessee produced and marketed its products in India and since the assessee could not utilize its entire production capacity, the assessee also produced the same products for its AEs abroad. So far as the asst. yr. 2003 -04 is concerned, the transfer pricing study noted that the assessee's operating loss has come down from 76.21 per cent to 39.17 per cent due to reduced capacity under utilization, and that it was so done with the help of exports to AEs abroad. The transfer pricing study, inter alia, noted as follows :
"The losses were on account of lack of demand in the domestic market and substantial underutilization of existing capacity. However, the loss has decreased during the year due to improvement in the capacity utilization.
Wrigley India has produced 554 metric tonnes during the financial year ended on March, 2003 as against installed capacity of 1951 metric tonnes i.e. a capacity utilization rate of 28 per cent. The improvement in the capacity utilization as compared to 12 per cent is on account of increased demand in the export market.
Break even analysis portrays the relationship between the cost of production, volume of production and the sales value. The break even point is the level of sales at which the company would neither earn profit nor incur losses. Based on the information made available to us, we understand that the turnover achieved by Wrigley India for the current financial year is still below the break even point.
Other things being equal, Wrigley India will need to achieve minimum capacity utilization of about 60 per cent (of the present installed capacity) to achieve break even."
(3.) IN the course of dealing with determination of ALP in respect of these transactions, the transfer pricing study noted that CUP method cannot be applied to the facts of this case as "Wrigley India does not export such products to any unrelated party outside India" and "even though Wrigley India sells chewing gums to unrelated parties in India, the terms and risk profile for such transactions differ significantly" "from that of exports to Wrigley group companies". It was also noted that "there is no publicly available information on prices charged in independent transactions of similar or identical nature which reflect characteristics of the products exported to Wrigley group companies." The use of Resale Price Method (RPM) was ruled out on the ground that "the RPM is applicable in a resale situation where the property or service purchased from an AE is sold to unrelated enterprise." Even as it was recognized that, "the CPM is ordinarily used in cases involving manufacture, assembly or other production of goods that are sold to related parties or where the controlled transaction is a provision of services, "the transfer pricing study rejected the same inter alia on the ground that, "differences in cost accounting practices would materially affect the gross profit mark up and the ability to make reliable adjustments for such differences would affect the reliability of results." It was also added that the CPM method "has not been considered, in this case, as the most appropriate method, on account of inconsistency in cost accounting practices between the comparable uncontrolled transaction and controlled transaction." Ironically, even as the assessee was admittedly following CPM of billing to the AEs, the CPM was rejected for determination of the ALP. Be that as it may, as none of these direct methods were found to be most appropriate method for determining the ALP and as Profit Split Method (PSM) was also found unsuitable for the reason that neither it was a case of 'transfer of unique intangibles' nor a situation dealing with 'multiple inter -related transactions which cannot be separated', the assessee finally resorted to the Transactional Net Margin Method (TNMM), for want of applicability of all other methods of ascertaining the ALP, for benchmarking its sales transactions with the AEs. The assessee thus adopted TNMM with operative profit on operating cost (OP/OC) as the profit level indicator. The assessee selected eight comparables, namely, Britannia Industries Ltd., Cadbury India Ltd., Cremica Agro Foods Ltd., Parry's Confectionary Ltd., Priya Food Products Ltd., Sampre Nutritions Ltd., Ravalgaon Sugar Farm Ltd. and Veermani Biscuit Industries Ltd. The transfer pricing study further noted that since the information for the financial year 2002 -03 was not readily available and since the transfer pricing regulations permit use of data for upto two years prior to the relevant financial year, the financial information for the comparable companies was included for the financial years 2001 -02 and 2002 -03. The transfer pricing study then concluded as follows :
"Based on our analysis, the potentially comparable companies' operating margins (computed as defined above) lie between ( -) 1.37 per cent to 13.17 per cent. The arithmetic mean of the abovementioned range is 6.44 per cent...
Information provided by Wrigley India indicates that the net margin earmarked by Wrigley India on budgeted cost of exports was 10 per cent of costs (excluding SGA i.e. sales, general and administrative expenses). Hence, Wrigley India's budgeted net margin of the export transaction is within arm's range computed as defined above, and, therefore can be considered to be at arm's length.";