R.P. Tolani, Judicial Member - This is assessee's appeal against the Addl. CIT's order dated 14-10-2009, passed u/s 92 CA(3) of the Income-tax Act, 1961, relating to A.Y. 2006-07.

1.1 Following grounds are raised:

"1. On the facts and in the circumstances of the case and in law, the Hon'ble Dispute Resolution Panel (DRP) erred in confirming order under section 92CA(3) the Income Tax Act, 1961 ("the Act") passed by the learned Transfer Pricing Officer ("TPO") and thereby confirming the draft order passed by learned Assessing Officer ("AO");

2. On the facts and in the circumstances of the case and in law, the Hon'ble DRP/TPO erred in confirming rejection of the transaction by transaction analysis carried out by the appellant and by applying Transactional Net Margin Method ("TNMM") on a company wide basis.

3. Without prejudice to the above ground, on the facts and in the circumstances of the case and in law, the Hon'ble Dispute Resolution Panel (DRP) erred in not directing to make suitable adjustment to the margins of the appellant to adjust for material differences between the appellant and comparable companies, while applying TNMM on a company wide basis.

4. Without prejudice to the above ground, on the facts and in the circumstances of the case and in law, the Hon'ble DRP/TPO erred in not selecting appropriate comparables for benchmarking the international transactions of the appellant.

4.1 The Hon'ble DRP/TPO erred in accepting Page Industries Limited and Microtex India Limited which earned significant revenues from non-comparable products as comparable companies.

4.2 The Hon'ble DRP/TPO erred in accepting Raymond Apparel Limited which has significant related party transactions, as comparable company.

4.3 The Hon'ble DRP/TPO erred in accepting Kewal Kiran Clothing Company and Koutons Retail India Limited which underwent major restructuring changes during the relevant year as comparable companies.

5. On the facts and in the circumstances of the case and in law, the Hon'ble DRP/TPO erred in confirming adjustment to the arm's length value of the international transactions involving import of garments and accessories, import of law material and payment of royalty which were at already established arm's length on the basis of Comparable Uncontrolled Price ("CUP") analysis submitted by the appellant in the absence of any adverse observations regarding the analysis of these transactions by DRP/TPO.

6. Without prejudice to the above, on the facts and in the circumstances of the case and in law, the Hon'ble DRP erred in not directing TPO to allow downward variation of 5 percent in determining the arm's length price as amended proviso to section 92C of the Act is not applicable to A.Y. 2006-07.

7. On the facts and in the circumstances of the case and in law, the learned AO erred in not meeting the preconditions for making reference to the TPO under section 92CA(1) of the Act and in not providing an opportunity of being heard before referring the transfer pricing issues to the learned TPO."

2. Brief facts are: The assessee is a wholly owned subsidiary of Benetton International NV, Netherlands, which in turn is a subsidiary of Benetton Group SPA, Italy, the ultimate holding company and is engaged in the manufacture and sale of wide range of readymade garments and accessories under the brand name of 'Benetton'. The assessee is also engaged in the business of providing buying services to the associated enterprise for sourcing of garments, handicrafts, leather products, etc. in India. The assessee during the relevant previous year entered into the international transactions and their method of evaluations with the associated enterprises, as under:

2.1 According to assessee, the ALP was determined on a "transaction by-transaction" basis for applying arm's length price on above method, using the most appropriate method having regard to functional analysis and availability of the comparable uncontrolled benchmark.

2.2 AO referred the report to ld. TPO for determination of ALP. Assessee submitted following justification for "transaction to transaction" basis and methods adopted for its TP report.

(a) Import of garments/ accessories/ raw material - CUP method:

For benchmarking the abovementioned international transactions, the assessee filed the invoices raised by the AE on the unrelated third parties as CUPs along with the standard price list at which such garments were sold to unrelated parties. On the basis of such comparison, it was concluded that the payment made to the AEs was at arm's length applying the CUP method.

(b) Purchase of fixed assets:

For the purpose of benchmarking, CUP method was applied and the third party invoices were furnished to the TPO as an evidence for purchase of fixed assets. There being no element of income, such transactions were to be regarded as being at arm's length.

(c) Payment of Royalty:

The assessee pays royalty @ 4.8% on domestic sales excluding sales to the associated enterprise. The transaction was benchmarked applying CUP method and the following documents were placed on record-

(i) The royalty rates of the following comparable companies were filed during the course of the assessment-

(ii) The copy of approval granted by the Central Government approving the rate of royalty.

Hence, since the average of royalty paid by the abovementioned companies was higher than the royalty paid by the assessee company, the international transaction of payment of royalty is to be regarded as being at arm's length applying CUP method.

(d) Reimbursement of expenses (paid and received):

CUP method was also found suitable for benchmarking international transactions of reimbursement made to and received from the associated enterprises in respect of expenses incurred as the same were merely reimbursement of expenses incurred by AEs for/on behalf of assessee. For benchmarking, such transactions were adequately supported by third party evidences. Since, such transactions do not have any element of income, hence it was considered to be at arm's length applying CUP method.

(e) Export of finished goods:

For benchmarking the transaction of exports, there was no internal comparable available to apply CUP method as the assessee and the AEs did not enter into similar transactions with unrelated parties. Hence, for determining the arm's length price of international transaction of export of finished goods, Transactional Net Margin Method (TNMM) was selected as the most appropriate method.

For the purpose of applying TNMM, operating profit to total sales was considered as the base or the profit level indicator. 46 companies in readymade garment business were identified based on selection criteria, which were considered functionally comparable to the business activity of the assessee. The result of TNMM analysis for transactions other than buying services is summarized as under:

Since the operating profit ratio of the assessee for exports made to related parties @17.41% is higher than the average of operating profit ratio of 8.73% of comparable companies, the international transaction of export of finished goods was therefore, considered being at arm's length using TNMM. Operating profit margin of the assessee company in respect of international transactions of export of manufactured goods at 17.41% was higher than the operating profit margin of comparable companies identified in the notice at 8.59% (determined by the assessee at 3.38%).

(f) Receipt of commission:

For determining the arm's length price of international transaction of receipt of commission, Transactional Net Margin Method (TNMM) was selected as the most appropriate method.

For the purpose of applying TNMM, operating profit to operating cost was considered as the base. After considering various criteria, comparable companies were identified.

The results of TNMM analysis for buying services are summarized as under:

Since the operating profit ratio of the assessee @ 23.96% was higher than the average of operating profit ratio of 9.68% of comparable companies, the aforesaid international transactions was considered having been entered at arm's length price, using TNMM.

(g) Payment of expatriates' cost:

For determining the arm's length price of international transaction of reimbursement of expatriates' costs, there was no mark up and the expat's cost was reimbursed on cost to cost basis. Accordingly, such payment was considered to be at arm's length.

All the international transactions entered into by the assessee with the associated enterprises have been satisfactorily evaluated separately by applying the most appropriate method for determining the arm's length price of the various international transactions.

2.3 In order to arrive at the most precise approximation of fair market value, the ALP should be determined on a transaction by-transaction basis and only in case when the separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis, that such transactions may be evaluated together.

2.4 Combining all transactions together, was not in conformity with the Income tax rules, OECD commentary and any internationally accepted benchmarking principles. All segments cannot be evaluated together as each activity will result in completely different functions and there is no basis for undertaking the benchmarking analysis combining all international transactions whereby a rate of operating profit margin is applied on the entire sales of the assessee company which is largely domestic sale not involving any international transaction.

2.5 The company in the relevant previous year had incurred substantial expenses to promote and establish its business in the domestic market.

2.6 The low profitability is entirely on account of the expenses incurred by the assessee company on establishing new show room, creating presence in the various parts of the country, large demonstration, marketing and selling expenses, etc. In other words, the low profitability of the assessee company is not on account of the international transactions as would be evident from the following:

(i) The gross profit margin of the assessee company is worked out at 44.53% as against 31.76% in the case of the comparable companies identified by the TPO. The profitability of the assessee is not impacted on account of the international transaction of imports, which is, in any case, only 2.54% of the total turnover.

(ii) The operating profit margin of the assessee company after excluding some of the expenses, such as, rent, advertisement, shop running and guarantee charges, etc., is worked out at 20.41% (OP/Sales %) as against 15.29% in case of the comparable companies identified the TPO.

2.7 In other words, low profitability of the assessee company could be largely attributed to the expenses incurred by the assessee to establish and promote itself in the domestic market and has nothing to do with the various international transactions undertaken by the associated enterprise.

3. The TPO in his order, however, held that arm's length should not be determined on a transaction by-transaction basis. The TPO argued that:

- segmental analysis done by the auditors in the notes to the financial statements is not appropriate

- the financials have been split artificially for the purpose of transfer pricing.

- the basis of allocation to compute net operating margin while separately benchmarking international transaction of export of finished goods and receipt of commission is not disclosed

3.1 The TPO in his order, for undertaking benchmarking analysis of the international transactions of import of garments & accessories, import of raw material, export of garments, payment of royalty and receipt of commission applying TNMM on entity level, rejected the benchmarking carried out by the assessee as aforesaid on transaction wise basis.

3.2 The TPO identified the following companies as comparable companies as per the selection criteria as stated in the 6.6 of the transfer pricing order and computed the operating profit margin as follows:

3.3 The average mean of the comparable at 10.57% being more than the operating profit margin of the entity @2.57%, the TPO proposed an adjustment in the arm's length price as per computation as follows:

3.4 TPO did not agree with assessee's T.P. report and proposed an adjustment of Rs. 1,51,62,998 on account that average margin of the comparable at 10.57% is more than the operating profit margin of the assessee company, computed by the TPO, at 2.57%.

4. The TPO's proposal was confirmed by AO who proposed this addition to assessee's income. Aggrieved, assessee approached DRP where following contentions were raised:

(1) The TPO has undertaken entity level benchmarking analysis applying TNMM combining all the international transactions as against transaction by transaction analysis as provided in the Transfer Pricing Regulations recommended by OECD guidelines (in paragraph 1.42). Reliance is also placed on the following decisions, wherein, determination of arm's length price of international transactions on transaction by transaction basis is upheld:

- Development Consultants (P.) Ltd. v. Dy. CIT [2008] 23 SOT 455 (Kol.)

- ACIT v. Star India Limited [IT Appeal Nos. 3585 & 3846 (M) of 2006]

- Aztec Software & Technology Services Ltd. v. Asstt. CIT [207] 107 ITD 141 (Bang.) (SB)

- UCB India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 95 (Mum.)

In the case of UCB India (P.) Ltd. (supra), relied upon by the TPO, too, the Hon'ble Mumbai Bench of the Tribunal upheld the determination of the arm's length price by considering segmental margin on a stand alone basis.

In view of the aforesaid, the various international transactions, other than international transaction of export of finished goods and receipt of buying service commission, which are separately established to be at arm's length and are not disputed by the TPO, should be accepted as being at arm's length.

Further, the TPO clearly erred in aggregating international transactions of export of finished goods and rendering of buying services which are functionally different international transactions undertaken with different associated enterprises.

In view of the aforesaid, the benchmarking analysis carried out by the assessee on transaction by transaction basis for manufacturing export activities and buying services activities cannot be disregarded.

(2) The following companies have been unjustifiably included in the list of comparable companies by the TPO:

a. Raymond Apparel Limited:

The company had substantial high related party transactions of 26.22%, which is beyond the limit of 10% to 15% as laid down by the Hon'ble Delhi Bench of the Tribunal in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448.

b. Kewal Kiran Clothing Limited

The company has undergone major restructuring during the relevant previous year by way of bringing forth an Initial Public Offer; acquisition of substantial assets of Kewal Kiran Enterprises, a partnership firm and the cessation Kewal Kiran Retail India Private Limited and Kornorstone Retail Limited to be its subsidiaries.

Since, the relevant previous year was abnormal; the operating result of the said company cannot be taken into account for the purpose of benchmarking analysis.

The TPO, however, rejected the contention of the assessee holding that the impact of business restructuring on profit margin of a company, always reduces profit margin of the restructured company in initial years.

The contention of the TPO is incorrect and not sustainable since year-wise comparative statement of profitability of M/s. Kewal Kiran Clothing Limited clearly demonstrates the substantial increase in the sales and income of the company on account of the business restructuring as aforesaid.

c. Microtex India Ltd

Microtex India Ltd. had turnover of 48.34 crores in the relevant year which was not within the filter of 50-210 crores as applied by the TPO. Accordingly, the company does not satisfy the selection criteria as considered by the TPO himself.

d. Koutons Retail India Limited:

The financial statements of Koutons Retail India Limited are not available on any public domain for financial year 2005-06. Secondly, the company has undergone major restructuring during the previous year 2005-06 as Koutons retail India Limited was incorporated by acquiring, Charlie creations, which was a partnership firm. Evidently, the profit of the company has considerably increased due to such restructuring and hence should not be considered as a comparable for the relevant assessment year.

4.1 Assessee contended that the following companies should be excluded from the set of comparable companies considered by TPO, applying TNMM:

4.2 The average operating profit margin (OP/OC%) of the remaining established companies, to be comparable, works out as under:

4.3 Since the operating profit margin of the assessee from the international transactions of exports @17.41% was higher than the average of operating profit ratio of 3.38% of comparable companies, the international transaction of export of goods, therefore, considered being at arm's length applying TNMM.

(3) The low profitability of the assessee was entirely on account of the expenses incurred on establishing new show rooms, creating presence in the various parts of the country, large demonstration, marketing and selling expenses, etc. They were not on account of the international transactions under taken by the assessee due to following factors:

(i) The gross profit margin of the assessee company is worked out at 44.53% as against 31.76% in the case of the comparable companies identified by the TPO.

(ii) The operating profit margin of the assessee company after excluding some of the expenses, such as, rent, advertisement, shop running and guarantee charges, etc., is worked out at 20.41% (OP/Sales %) as against operating profit margin of the comparable companies similarly computed at 15.29%.

(4) Even otherwise, considering that the operating profit margin of the assessee at entity level at 2.57% is within the range of ± 5% of the operating profit margin of the comparable companies at 4.77%., the adjustment is liable to dropped.

4.4 Learned DRP, however, upheld the order proposed by AO on the basis of TPO's order by following observations:

"TPO has done the comparison of operating profit margin OP/OC with operating margin of assessee's companies. Assessee has objection to entity level analysis against transaction by transaction. We don't find any invalidity in aggregating international Transactions of exports of finished goods and rendering of buying services which are functionally different International transactions undertaken with different associated enterprises.

Assessee has summed up his arguments in the table below in which the reasons for rejections are also given

Assessee has also tried to submit that low profitability in this years is entirely on account of the expenses incurred on establishing new show room, creating presence in the various parts of the country, large demonstration, marketing and selling expenses.

The exclusion of four companies on account of reinstructing related party transaction has been considered by us. Some objections raised by assessee has been answered by TPO in para 6.7, 6.8 and 6.9. Taking in view brand value of assessee company discussed, no directions are being issued regarding the arm's length price of international transactions determined by APO.

Aggrieved, assessee is before us.

5. Learned counsel for the assessee vehemently contends that:

(1) The benchmarking undertaken by the assessee on the following international transactions has not been disputed by the TPO

- Purchase of fixed assets

- Reimbursement of expenses (paid)

- Reimbursement of expenses (received)

- Payment of expatriates' cost

The assessee had undertaken the benchmarking of the following international transactions as follows:

(a) Import of garments/ accessories/ raw material - CUP method: For benchmarking the abovementioned international transactions, the assessee filed the invoices raised by the AE on the unrelated third parties as CUPs along with the standard price list at which such garments were sold to unrelated parties. On the basis of such comparison, it was concluded that the payment made to the AEs was at arm's length applying the CUP method.

(b) Payment of Royalty:

The assessee pays royalty @ 4.8% on domestic sales excluding sales to the associated enterprise. The transaction was benchmarked applying CUP method and the following documents were placed on record-

(i) The royalty rates of the following comparable companies were filed during the course of the assessment-

(ii) The copy of approval granted by the Central Government approving the rate of royalty.

Hence, since the average of royalty paid by the abovementioned companies was higher than the royalty paid by the assessee company, the international transaction of payment of royalty is to be regarded as being at arm's length applying CUP method.

(c) Export of finished goods:

For benchmarking the transaction of exports, there was no internal comparable available to apply CUP method as the assessee and the AEs did not enter into similar transactions with unrelated parties. Hence, for determining the arm's length price of international transaction of export of finished goods, Transactional Net Margin Method (TNMM) was selected as the most appropriate method.

For the purpose of applying TNMM, operating profit to total sales was considered as the base or the profit level indicator. 46 companies in readymade garment business were identified based on selection criteria, which were considered functionally comparable to the business activity of the assessee. The result of TNMM analysis for transactions other than buying services is summarized as under:

Since the operating profit ratio of the assessee for exports made to related parties @17.41% is higher than the average of operating profit ratio of 8.73% of comparable companies, the international transaction of export of finished goods was therefore, considered being at arm's length using TNMM. Operating profit margin of the assessee company in respect of international transactions of export of manufactured goods at 17.41% was higher than the operating profit margin of comparable companies identified in the notice at 8.59% (determined by the assessee at 3.38%).

(d) Receipt of commission:

For determining the arm's length price of international transaction of receipt of commission, Transactional Net Margin Method (TNMM) was selected as the most appropriate method.

For the purpose of applying TNMM, operating profit to operating cost was considered as the base. After considering various criteria, comparable companies were identified.

The results of TNMM analysis for buying services are summarized as under:

Since the operating profit ratio of the assessee @ 23.96% was higher than the average of operating profit ratio of 9.68% of comparable companies, the aforesaid international transactions was considered having been entered at arm's length price, using TNMM.

5.1 Ld. counsel contends that the TPO proceeded to apply TNMM on entity wide basis disregarding the aforesaid benchmarking undertaken by the assessee. The adjustment proposed by the TPO is arbitrary and unjustified due to following:

(I) The TPO proposed to benchmark the international transactions of export of garments and receipt of buying services applying Transactional Net Margin Method (TNMM) after combining the two transactions on an entity basis as against separate benchmarking the net profit margin from these transactions undertaken by the assessee.

(II) The TPO has applied TNMM, in the case of the assessee, on entity basis, combining the international transactions of export of garments and receipt of buying service commission allegedly on the following basis-

(a) The various costs have been allocated artificially for computing margin in different business segments for Transfer Pricing purposes.

(b) Separate transactions closely interlinked and cannot be evaluated adequately on a separate basis

(c) separate segmental accounts not maintained

(III) For the purpose of determining the arm's length price in relation to international transactions, in terms of sub-section (2) of section 92C of the Act, Rule 10B of the Rules provides the manner of application of the various prescribed methods. Clause (e) of sub-rule (1) of Rule 10B of the Rules provides for application of Transactional Net Margin Method as under:

"(e) Transactional Net Margin Method, by which,-

(i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;

(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;

(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;

(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);

(v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction."

(IV) For application of TNMM the net profit margin (over an appropriate base) realised by the enterprise from an international transaction entered into with the associated enterprise is to be compared with that from comparable uncontrolled transaction by an unrelated enterprise. The net profit margin arising in comparable uncontrolled transactions is adjusted to take into account the difference, if any, between the international transaction(s) and the comparable uncontrolled transaction(s) or between the enterprise entering into such transaction which would materially affect the amount of net margin profit.

The OECD guidelines provide that in order to arrive at the most precise approximation of fair market value, the arm's length principle should, ideally be applied on a transaction-by-transaction basis. Your Honour's attention is invited to paragraph 1.42 of the OECD guidelines which provide that "Ideally, in order to arrive at the most precise approximation of fair market value, the arm's length principle should be applied on a transaction-by-transaction basis …"

(V) The Calcutta Bench of the Tribunal in the case of Development Consultants (P.) Ltd. (supra) reiterated the principle in this regard and provided to the following effect:

"The assessee had entered into the following types of transactions (a) Engineering drawing and design services, (b) Deputation of employees, (c) Reimbursement of traveling costs and (d) Rendering data entry services through its group entity Datacore India. Therefore, the ALP of each of the international transactions should be determined separately as the nature of transactions entered by the assessee with its AEs was different. Hence, the ALP would be determined based on the nature of services provided by the assessee for each class of transaction taking into consideration the functions performed, assets employed and the risks assumed, by the respective parties to the transactions."

(VI) Similar convtroversy came up before Mumbai Bench of the ITAT in the case of Star India Ltd. ( supra). In this case TPO has ignored the detailed analysis of the various international transactions individually entered into by the assessee in respect of its two principal business activities namely the export business and buying services business. The TPO treated all the activities as one and determined the arms length price at an entity level ignoring that one cannot compare a distributor with a principal and an agent at the same time, as each activity will result in completely different functions and reasons analysis.

The ITAT upholding the contention of the assessee, held as under in this behalf:

"63. We have carefully examined all the activities of the assessee and we find that the assessee is in fact involved in three independent activities, i.e. (a) distribution activity for which assessee has to pay the license fee for the right to distribute the Star channels to Asian Broadcasting Corporation Ltd also based in Dubai and Indian Region Broad Casting Ltd., a company based in Hong Kong. This distribution right cannot be linked up with other activities of the assessee, i.e. with commission for collecting the advertisement sales or with the export of TV programmes. The other activity that results in receipt of commission is also independent activity and the assessee acts as a marketing and collecting agent for Star Ltd. and NGC Asia in relation to advertisement sales to the satellite television channels broadcast by them in India. The contract for advertisement is directly entered into between the advertisers, advertising agencies and Star Ltd and NGC Asia, as the case may be. These entities directly raise the invoice on the advertisers and the advertisement agencies and for the services rendered by the assessee, it receives commission at 10% of the advertisement revenue collected by it from Star Ltd in respect Star channels. In the case of NGC Asia, the assessee recovers 15% commission in respect of advertisement sales revenue of NGC. The assessee collects the dues from the advertisement agencies on behalf of Star Ltd. or NGC Asia as the case may be, but out of the advertisement commission at a maximum of 15% of the gross billing and applicable income-tax withholding. The assessee is entitled to the agreed commission on the net billed amount, and deduct its own commission at the time of realisation and the rest of the amount is paid to the principal. In the light of these facts, commission on advertisement sales arises out of an independent activity, which cannot he linked up with the other activities of the assessee, i.e. distribution activity or activity of exporting television programmes. Likewise, the third activity of export of television programmes or supply of content of television channels to its group entities is also an independent activity, in which assessee provides content procurement service and also acts as a creator/procurer of various types of content for sale to its group entities viz. Star Ltd. and SGL. The various types of content procured by the assessee fall under the category of programs, films, format shows, in house productions and promotions. The assessee procures content in any one of the ways, such as acquiring content from external producers, in house production, joint production with external producers. Assessee also produces the content on the basis of formal specified by the overseas entities and film procurement. In these activities, assessee's assets were utilized and the risks were assumed. This activity is also an independent activity and could not be linked up with the other two remaining activities. Since all the three activities of the assessee are not inter related or interlinked, the Arms Length Price for all the activities should have been determined independently, in the light of comparable case. But. the TPO has consolidated and treated all the three activities as one activity and has determined a common Arms Length Price, having adopted Arithmetic Mean of operating cost margins of six comparable cases., which are not involved in all the activities as involved by the assessee.

64. We have thoroughly examined the order of the Special Bench in the case of Aztec Software and Technologies Ltd. (supra) and we find that the Tribunal has examined the Chapter-X of the Income-tax Act, relating special provisions relating to avoidance of tax in detail and the Tribunal has held that ideally in order to arrive at the most precise approximation of fair market value arms length principle should be applied on transaction to transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be adequately dealt with on a separate basis. The Tribunal has also held that the burden of proving and establishing Arms Length Price and to furnish the relevant information lies initially on the assessee…………………."

(VII) Ld. counsel contends that the manufacturing export segment is functionally different and distinct from the buying service segment as:

(i) In manufacturing export segment, the international transactions related to export of finished goods, viz., garments manufactured by the assessee, buying service segment involves undertaking source related services, such as, identifying of the vendors, merchandize, undertakings, design, quality control, handling, co-ordination and logistics, etc. These two activities are entirely different.

(ii) Manufacturing export activities and buying service activities are independent of each other and are not interconnected or inter-related.

(iii) Manufacturing export segment and buying services segment involve the following different functions, assets and risk:

(iv) The two business activities require performing different functions, utilization of assets and risks are entirely separate and different activities.

(v) There is a separate team of people for the two business segments.

Reliance is placed on the judgment of ITAT in the case of UCB India (P.) Ltd. (supra) where ITAT while examining the applicability of TNMM of entity level or on a transaction by transaction basis held that under TNMM, an international transaction or class of transaction should be evaluated on a standalone basis by computing the segmental margins -

(VIII) The TPO has adopted a combined analysis of manufacturing transactions and buying services, undertaken by the assessee, and considered comparable companies engaged in manufacturing of garments on entity level basis. The comparison of manufacturing enterprises for bench marking of the buying services by the assessee. Therefore, it would be erroneous and inconsistent with fundamental test of comparability as provided in the Transfer Pricing regulations. Having regard to the functional analysis of the transactions, it would be inappropriate and in consistence with the accepted transfer pricing convention and practices to evaluate manufacturing exports and buying service segment together on an entity level for determining the arm's length price.

Therefore, benchmarking analysis carried out by the assessee separately considering manufacturing export activities and buying services activities provide an ideal benchmark for the respective international transaction and cannot be disregarded.

(IX) The TPO for the purpose of undertaking the benchmarking of the international transactions of export of finished goods and rendering of buying services applied Transactional Net Margin Method ("TNMM"). The TPO for the purpose of applying TNMM identified the following 9 comparable companies having average operating profit margin (OP/OC) at 10.57%:

In this exercise the following companies have been unjustifiably included in the list of comparable companies by the TPO:

(i) Raymond Apparel Limited:

The company had substantially high related party transactions of 26.22% during the previous year 2005-06.

Delhi ITAT in the case of Sony India Ltd. (supra) held that:

"We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-a-vis sales and not profit since profit of an enterprise is influenced by large number of other factors"

The TPO, however, disregarded the contention of the assessee that the above company having related party transaction should not be considered as part of the comparable companies. TPO erroneously held that since the filter of substantial related party transactions was not applied by the assessee in the Transfer Pricing documentation, the said contention could not be raised by the assessee at this stage.

The assessee did not undertake benchmarking analysis in the Transfer Pricing documentation applying TNMM. The assessing officer for the first time in the show cause notice has applied TNMM to determine the arm's length price of the international transaction and identified the aforesaid companies as comparable companies. Consequently, there was no occasion for the assessee to apply the substantial related party filter in the Transfer Pricing documentation.

Therefore, Raymond Apparel Ltd. having substantial related party transactions calls for being excluded from the list of comparables.

(ii) Kewal Kiran Clothing Limited

The company has undergone major restructuring during the relevant previous year. As given in its annual report, the company brought an IPO of 31,00,037 Equity shares of Rs. 10/- and became a public limited company w.e.f. from 02.11.05. The sales and operating income increased from Rs. 261.19 mn to Rs. 859.64 mn during the year. The net profit before tax also increased to Rs. 181.99 mn as against Rs. 48.79 mn because of the major restructuring in the company in the relevant previous year.

Besides, the company during the year acquired substantial assets of Kewal Kiran Enterprises, a partnership firm and two of its subsidiaries, viz. Kewal Kiran Retail India Private Limited and Kornorstone Retail Limited ceased to be subsidiaries of the company w.e.f. August 6, 2005. These facts are evident from annual report of the company.

The relevant extract from the annual report are as follows:

a. "Results of the company include effect of the above for part of the year and hence previous year figures are not strictly comparable.

b. "Your Company had during the year acquired substantial assets of Kewal Kiran Enterprises, a partnership firm and therefore the data for the current year would not be strictly comparable with that of the previous year for the corresponding period.

c. "As a result of restructuring of the group entities during the year, the entire apparel manufacturing and marketing business now rests with the company.

Due to above major restructuring in the business of Kewal Kiran Clothing Limited, the relevant previous year was abnormal year and the operating result of the said company cannot be taken into account for the purpose of benchmarking analysis.

iv. The TPO in his order sought to identify comparable companies considering turnover filter of 50-210 crores. In other words, only companies having turnover in the range of 50-210 crores were identified as comparable by the TPO. The TPO, however, inadvertently considered Microtex India Ltd. having turnover of 48.34 crores also as part of the comparable companies. The said company, it would be appreciated, does not satisfy the selection criteria as considered by the TPO himself. The said company for that reason is to be excluded from the set of comparable companies.

v. The financial statements of Koutons Retail India Limited are not available on any public domain for financial year 2005-06.

Besides, as per various news reports on the internet, in public domain, the company has undergone major restructuring during the previous year 2005-06. On 07.02.06, Koutons retail India Limited was incorporated by acquiring, Charlie creations, which was a partnership firm.

As a result of the restructuring, as reported, the total income of Koutons Retail India Limited has increased to Rs. 21,270.78 lakhs in financial year 2005-06 as against 986.6 lakhs in financial year 2004-05 (Source: Capitaline).

(X) It has been consistent stand of the Revenue that the companies with major restructuring should not have been accepted as a comparable, Koutons Retail India Limited should not be included as a comparable company. The TPO without basis has observed that the business restructuring reduces the profit margin of the company in the initial years. The comparative statement of profitability of the Koutons is as under:

Thus, the profit of the company increased due to restructuring. Hence, company should not be considered as a comparable for the relevant assessment year.

(XI) If these companies are excluded, the average operating profit margin (OP/OC%) of the remaining comparable companies, works out as under:

Since the operating profit ratio of the assessee for exports made to related parties @17.41% is higher than the average of operating profit ratio of comparable companies, the international transaction of export of goods, therefore, considered being at arm's length using TNMM.

(XII) The TPO has applied the operating profit margin of the aforesaid comparable companies to the value of all the international transactions as follows:

5.2 The adjustment on account of the difference in the arm's length price computed by the TPO in the impugned order passed under section 92CA(3) of the Act being within the range of ± 5%, is thus liable to be excluded. The provision reads as under:

"92C. Computation of arm's length price.

(2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed:

Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean." (emphasis supplied)

5.3 Reliance is placed on the decision of Calcutta Bench of the ITAT in the case of Development Consultants (P.) Ltd. (supra), wherein the aforesaid contention of the assessee has been upheld by the Hon'ble Tribunal.

5.4 The benefit of +/(-) 5% as per proviso to section 92C(2) of the Act has been held to be admissible as standard deduction while computing the arm's length price of the international transactions in the following decisions:

- Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 /(Bang.)

- Sony India Ltd.'s case (supra)

- Skoda Auto India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 319 (Pune)

- Development Consultants (P.) Ltd.'s case (supra)

5.5 Assuming even if assessee's other arguments are not accepted, in view of the clear provisions of proviso to section 92C (2) of the Act No adjustment is called for as assessee ALP is not less than 95% of the average operating profit margin of the comparable uncontrolled enterprises determined applying TNMM method.

5.6 In any case the assessee company during the relevant previous year has incurred substantial expenses to promote and establish its business in the domestic market. Low profitability of the assessee is mainly on account of the expenses incurred for establishing new show rooms creating presence in the various parts of the country, large demonstration, marketing and selling expenses, etc. Low profitability of the assessee company is not on account of the international transactions, which is clear from the facts that:

(i) The gross profit margin of the assessee company is worked out at 44.53% as against 31.76% in the case of the comparable companies. It would be appreciated that the profitability of the assessee is not impacted on account of the international transaction of imports, which is, in any case, only 2.54% of the total turnover.

(ii) The operating profit margin of the assessee company after excluding some of the expenses, such as, rent, advertisement, shop running and guarantee charges, etc., is worked out at 20.41% (OP/Sales %) as against 15.29% in case of the comparable companies.

5.7 The low profitability of the assessee company being largely attributable to the expenses incurred by the assessee to establish and promote itself in the domestic market, has nothing to do with the various international transactions undertaken with associated enterprise.

6. Learned DR supports the TPO's reports and orders passed by AO and DRP and contends that T.P. analysis requires consideration of various bench marks, comparable & FAR analysis. The TPO has given detailed reasons in support of analysis which should be upheld.

7. We have heard rival contentions, perused the material available on record. The first and foremost question in this case is to determine whether the action of TPO in undertaking entity level benchmarking by TNM method combining of the international transactions is justifiable or the TP analysis provided by assessee, based on "transaction to transaction" basis in respect of different segments should be adopted.

7.1 From the facts mentioned above, it is clear that assessee's manufacturing export activities; buying/sourcing and commission earning activities are independent of each other. Each activity has different factors in respect of source, identification of vendors, merchandise, designs quality control, handling etc. The FAR analysis in each of the activity will have distinct and separate considerations.

7.2 We, find merit in the argument of the learned counsel that the TPO should have accepted the method of assessee's benchmarking analysis on the basis of transaction to transaction basis in respect of different segments of assessee's international transactions with associated enterprises. In our view, assessee's functions, risk and assets FAR considerations, which are given in the above table, deserves to be merited. TPO did not appreciate the assessee's transactions correctly and applied entity level benchmarking on TNMM method by combining assessee's all international transactions with associated enterprise without justification.

7.3 Our view is supported by ITAT judgments - Mumbai Bench in the cases of UCB India (P.) Ltd. (supra); and Star India Ltd. ( supra); and Kolkata Bench in the case of Development Consultants (P.) Ltd. (supra). All these cases clearly lay down that ALP would be determined based on the nature of service provided by assessee for each class of transaction based on various factors and analysis. In the case of Star India Ltd. (supra), also the TPO treated all the activities of the assessee as one and determined the ALP at entity level without appreciating that one cannot compare the FAR of a principal and agent on same footing.

7.4 In our view, in the assessee's case there are different segmental activities, which are independent of each other. They are required to be analyzed on transaction to transaction basis and not by combining all activities. Consequently, we uphold the assessee's method of ALP.

7.5 In respect of working of the assessee's ALP, we see no infirmity in the FAR analysis given by assessee, which is detailed above. Therefore, we uphold the assessee's method and working of ALP. In combine benchmarking also, TPO has not considered the fact that the cases of Raymond, Kewal Kiran Clothing Ltd., Microtex India Ltd., Koutons Retail India Ltd. cannot be taken as comparables due to their substantially high related party transactions, restructuring etc. Consequently, these comparables are to be excluded. On exclusion thereof, what remains out of the comparables i.e. Oswal Knit India, Lux Hosiery Industries Ltd., Page Industries Ltd. with average OP/sales of 4.77%. In contrast the assessee's operating profit ratio of export to related parties at 17.41% is higher than the average operating profit.

7.6 Coming to the assessee's alternate contention based on plus -minus 5% acceptance of variation, as prescribed by Sec. 92CA(3), we find merit in the argument of learned counsel that even if all the factors are assumed against assessee; the operating profit margin of the assessee entity level comes to 2.47%, which is within the end of plus - minus 5% margin. In this eventuality also assessee deserves to succeed.

7.7 In view of the foregoings, we have no hesitation to uphold the assessee's working of ALP for international transactions with associated enterprises, the additions made are deleted.

8. In the result, assessee's appeal is allowed.