Facts of the Case

The present matter involves three appeals filed by the Revenue against separate orders of the Income Tax Appellate Tribunal (ITAT) for Assessment Years 2007-08, 2008-09, and 2009-10.

The assessee, Itochu India Private Limited, is a wholly owned subsidiary of Itochu Corporation, Japan, engaged in providing support services such as facilitation and market support to its Associated Enterprises (AEs) for sourcing transactions. It operates as a “Sogo Shosha” company.

The dispute primarily concerns the determination of Arm’s Length Price (ALP) in respect of international transactions undertaken by the assessee with its AEs.

Issues Involved

  • Whether the Transfer Pricing Officer (TPO) was justified in enhancing the cost base by including the Free on Board (FOB) value of goods sourced by AEs while computing ALP.
  • Whether the application of the Transactional Net Margin Method (TNMM) was carried out in accordance with Rule 10B(1)(e) of the Income Tax Rules.
  • Whether recharacterization of the assessee’s business from a support service provider to a trader was legally sustainable.

Petitioner’s Arguments (Revenue)

  • The Revenue contended that the TPO was correct in adjusting the ALP by applying a mark-up on the FOB value of exports handled through AEs.
  • It was argued that such inclusion was necessary to correctly determine the profit margin arising from international transactions.
  • The Revenue challenged the ITAT’s reliance on earlier judicial precedents and sought reconsideration of the ALP computation methodology.

Respondent’s Arguments (Assessee)

  • The assessee argued that it was merely a support service provider and not a trader, and therefore its cost base should only include its own operating costs.
  • It contended that inclusion of FOB value of goods handled by AEs artificially inflated its cost base.
  • Reliance was placed on the Delhi High Court ruling in Li & Fung India Pvt. Ltd. v. CIT, which clarified that TNMM must be applied only with reference to the assessee’s own costs.
  • The assessee also highlighted that in subsequent assessment years (2011-12 to 2013-14), the ALP determination had been accepted by the Revenue.

Court’s Findings / Order

  • The Delhi High Court reaffirmed the legal position laid down in Li & Fung India Pvt. Ltd. v. Commissioner of Income Tax (2014) 361 ITR 85 (Del).
  • It held that under TNMM, the net profit margin must be computed with reference only to the costs incurred by the assessee, and not by including costs of third parties or AEs.
  • The Court observed that inclusion of FOB value of goods in the cost base is not permissible under Rule 10B(1)(e).
  • It upheld the ITAT’s finding that the TPO had artificially enhanced the cost base and wrongly recharacterized the assessee’s business model.
  • Following its earlier decision in Principal Commissioner of Income Tax v. Mitsui & Co. India Pvt. Ltd. (2016) 384 ITR 360 (Del), the Court dismissed the Revenue’s appeals.
  • The Court concluded that no substantial question of law arises, and accordingly, the appeals were dismissed.

Important Clarification

  • TNMM must be strictly applied based on the assessee’s own financials.
  • Inclusion of third-party costs or AE-related transaction values (such as FOB value) is impermissible.
  • Recharacterization of a support service provider as a trader without factual basis is legally unsustainable.
  • Pending appeal before the Supreme Court in Li & Fung India Pvt. Ltd. does not dilute its binding nature in absence of a stay.

Sections / Rules Involved

  • Section 92C of the Income Tax Act, 1961
  • Rule 10B(1)(e) of the Income Tax Rules, 1962 (Transactional Net Margin Method – TNMM)

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2019:DHC:7399-DB/SMD13052019ITA11112018_155021.pdf

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