Knorr-Bremse India Pvt. Ltd vs. ACIT (P&H High Court)

Rule 10A(d): Law on when multiple transactions can be regarded as a single composite transaction for determining arm’s length price explained. Fact that a transaction results in a profit or a loss has no bearing on whether it is at arm’s length price  (Nov 23, 2015)

(i) The answer to the issue whether a transaction is at an arm’s length price or not is not dependent on whether the transaction results in an increase in the assessee’s profit. This would be contrary to the established manner in which business is conducted by people and by enterprises. Business decisions are at times good and profitable and at times bad and unprofitable. Business decisions may and, in fact, often do result in a loss. The question whether the decision was commercially sound or not is not relevant. The only question is whether the transaction was entered into bona fide or not or whether it was sham and only for the purpose of diverting the profits.

(ii) It would make no difference even if the profit is entirely on account of the international transaction. In fact, even if it is established that on account of an international transaction an assessee’s venture has profited, it does not necessarily establish that the transaction was entered into at an arm’s length price. Mere profitability does not indicate that the transaction which was responsible for the enhancement of the profits was at an arm’s length price. That an international transaction has enabled an assessee to earn profit is one thing and the price paid for the same is another thing altogether. Profit is a motive and the aim of a venture.

(iii) A view to the contrary would cause considerable confusion and lead to arbitrary, if not illogical, results. A view to the contrary would then raise a question as to the extent of profitability necessary for an assessee to establish that the transaction was at an arm’s length price. A further question that may arise is whether the arm’s length price is to be determined in proportion to the extent of profit. Thus, while profit may reflect upon the genuineness of an assessee’s claim, it is not determinative of the same. (CIT vs EKL Appliances Ltd., [2012] 345 ITR 241(Delhi) & Commissioner of Income-Tax vs. Cushman and Wakefield (India) Pvt. Ltd., [2014] 367 ITR 730 (Delhi) referred).

(iv) The AO or TPO is required to determine the arm’s length price in relation to “an international transaction”. The acquisition of various items/components in the assessee’s venture could indeed be telescoped into and form a single transaction. For instance, in the case of a package deal where each item of the package is not separately valued but all the components thereof are given a composite price, the transactions form but one composite transaction. An assessee may enter into one composite transaction with its AE involving the provision of various services or the sale of various goods. A party may opt for a single window facility where all the services and/or goods are provided under a composite agreement. Each of the components may even be priced differently. If it is established that each transaction was so inextricably linked to the other that the one could not survive without the other, it could be said that it formed a part of a transaction and that it was an international transaction. Take, for instance, a case where an AE offers to provide a bouquet of services and goods to the assessee each priced differently but on the understanding that the pricing was dependent upon the assessee accepting all the services and/or all the goods. In that event, it would not be open to the assessee to accept only some of the goods or the services at the prices indicated. It either takes all or none. This would normally constitute one transaction.

(v) The assessee would have to prove that although each sale and each provision of service is priced separately, they were all provided under one composite agreement which constitutes an international transaction.

(vi) The contention that as the services and goods are utilized by the assessee for the manufacture of the final product they must be aggregated and considered to be a single transaction and the value thereof ought to be computed by the TNMM is not acceptable. Merely because the purchase of each item and the acceptance of each service is a component leading to the manufacture/production of the final product sold or service provided by the assessee, it does not follow that they are not independent transactions for the sale of goods or provision of services. The end product requires several inputs. The inputs may be acquired as part of a single composite transaction or by way of several independent transactions. In the latter case, the sale of certain goods and/or the provision of certain services from out of the total goods purchased or services availed of by an assessee together can form part of a separate independent international transaction. In such an event, the AO/TPO must value this group of sale or purchase of goods and/or provision of services as separate transactions.

(vii) The TNM Method may establish the aggregate price paid for the goods and services received under independent transactions to be an arm’s length price. This, however, would give a skewed picture. One of these independent transactions may be at a bargain and the pricing, therefore, is not objected to by the department. This bargain may be for a variety of reasons and in a variety of circumstances unconnected however to the other transactions. The value of the other transactions, on the other hand, may be overestimated and would not be at the arm’s length price. In that event, for the purpose of the Act, the price of the second transaction cannot possibly be taken to be the arm’s length price for it was not the arm’s length price. It does not become the arm’s length price merely because the bargain struck with respect to the first transaction balanced the inflated price of the second although the two transactions were independent of each other. The two transactions are different and, therefore, the arm’s length price of each of them must be determined separately. The question, therefore, in each case must first be whether the sale of goods or the provision of services was a separate independent agreement or whether they formed part of an international transaction i.e. a composite transaction.


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