ORDER

Pramod Kumar, Accountant Member. - By way of this appeal, the Assessing Officer has challenged correctness of CIT(A)'s order, dated 29-3-2010, in the matter of assessment under section 143(3) of the Income-tax Act, 1961 for the assessment year 2004-05, mainly on the following ground :

On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 8,27,30,858 made by the Assessing Officer under section 92CA(3) by way of applying TNMM method with regard to the transactions with Associated Enterprises, without appreciating facts and circumstances of the case.

2. The assessee before us is engaged in the business of manufacturer and exporter of studded diamond and gold jewellery. During the relevant previous year, the assessee exported goods worth Rs. 29,92,83,448 to its associated enterprises abroad, out of a total turnover of Rs. 107,57,89,057. As its transactions with AEs were in excess of Rs. 5 crores, the Assessing Officer referred the ascertainment of arm's length price to the Transfer Pricing Officer. In the proceedings before the TPO, it was contended by the assessee that he has adopted cost plus method (CPM) of ascertaining the ALP so far as sale of finished goods is concerned. As per details given by the assessee, the assessee has earned a gross profit margin (i.e. gross profit/sales) of 18.65 per cent in transactions with unrelated parties, as against a margin of 21.75 per cent on transactions with AEs. The TPO, however, noted that the assessee has not given detailed calculations of the margins, that the cost plus method requires strict comparability and the nature of transactions with AEs are functionally different, on account of variations in terms and conditions and risk factors, and that the assessee has used sales/GP as the profit level indicator which is not correct indicator. He thus required the assessee to show cause as to why cost plus method not be rejected, but, in reply, the assessee merely submitted the gross profit rate computations. Accordingly, the TPO rejected the cost plus method for computing sales price of the finished goods. The TPO further noted that the assessee has purchased diamonds from its AEs and, for the purposes of benchmarking these transactions, said to have applied Comparable Uncontrolled Price (CUP) method. It was noted by the TPO that "the assessee has mentioned that the diamonds are purchased at the market price and are hence at arm's length" and added that "however, the assessee has not provided any data, such as third party invoices, as evidence of CUP method" A show cause notice was issued to the assessee was to why CUP method for ascertaining ALP of import of diamonds, on these facts, not be rejected, but as there was no compliance by the assessee and as the assessee did not provide "any further evidence to substantiate the use of CUP method", the TPO also rejected the stand of the assessee so far import of diamonds from AEs was concerned. It was also observed that the assessee has sold diamonds to AEs abroad. With respect to these transactions, the stand of the assessee was that it imports diamonds for making jewellery but as these diamonds are sometimes more than requirements of the assessee, these diamonds are returned to the AEs at the market price, and, as such, CUP method is applied to ascertainment of the ALP. However, once again, the assessee did not give any details about comparable prices or evidenced the export price being the same as comparable uncontrolled price. No documentation whatsoever was produced to justify ascertainment of price as per comparable uncontrolled price. It was in this backdrop that the TPO rejected assessee's claim for the ascertainment of arm's length price by CPM so far as exports are concerned and ascertainment of arm's length price by CUP so far as imports and exports of diamonds are concerned. The TPO required the assessee to show cause as to why, given the above position, the arm's length price of international transactions by the assessee not be adopted on the basis of transaction net margin method (TNMM), and confronted the assessee with comparable figures of profit level indicator as operational profit/total cost in eighteen cases which averaged to 7.25 per cent. As the assessee once again reiterated his arguments, without meeting the points raised by the TPO, the stand of the assessee was rejected. Accordingly, TPO proceeded to make an adjustment of Rs. 8,27,30,858 in the arm's length price of assessee's international transactions, and the sales to AEs was taken as the balancing figure. As the assessee's transaction value of sales to AEs was not within + 5 per cent margin of the ALP determined by the Assessing Officer, the adjustment of 5 per cent was also declined. When assessee was confronted by this determination of ALP, in the course of the assessment proceedings, the assessee, inter alia, submitted as follows:

……..The Additional Commissioner of Income-tax (Transfer Pricing) is not justified in rejecting the basis of purchase of diamonds under CUP method without any basis and material to prove that CUP is not applicable. The assessee had proved beyond doubt that the diamonds were purchased at the market price and hence are at arm's length. The Additional Commissioner has merely, without giving any opportunity, rejected the CUP method without any evidence. He has merely stated that the assessee has not proved any further evidence to substantiate the use of CUP method and simply stated that in view of the same, the transaction is considered not to be at arm's length and the analysis undertaken by the assessee is being rejected.

In case of studded jewellery, the Additional Commissioner of Transfer Pricing-III is not justified in rejecting the calculations of sales price under cost plus method without any justification, basis and evidence to prove to the contrary………

3. The submissions so made by the assessee, being general in nature and not meeting the specific points raised by the TPO, were rejected by the Assessing Officer. Accordingly, the Assessing Officer proceeded to make an adjustment of Rs. 8,27,30,858 to "arm's length price of international transactions with associated enterprises". It appears that the adjustment so made was later subjected to rectification proceedings under section 154 and the matter travelled before a coordinate bench of this Tribunal which has partly remitted the matter back to the Assessing Officer so far quantification of adjustment is concerned. Be that as it may, in the meantime, the assessee carried the grievance, against the impugned ALP adjustment, before the learned CIT(A) and the precise grounds of appeal before the learned CIT(A) were as follows:

1. On the facts and in the circumstances of the case and in law, the ACIT erred in rejecting the CUP Method in regard to purchase and sale of diamonds with the Associated Enterprises used in the manufacturing and export of jewellery by the appellant.
2. The Assessing Officer ought to have accepted the CUP Method to determine the arm's length price with the Associated Enterprises for the purchase and sale of diamonds used in the jewellery manufactured and exported by the appellant as the cup method is the most appropriate method in the circumstances of the appellant's case and it is based on cogent evidence.
3. On the facts and in the circumstances of the case and in law, the Assessing Officer erred in rejecting the cost plus method to determine the arm's length price with the Associated Enterprises for the jewellery manufactured and exported by the appellant.
4. The Assessing Officer ought to have determined the arm's length price by applying the cost plus method as the same is the most appropriate method in the circumstances of the appellant's case and it is based on cogent evidence.
5. The Assessing Officer erred in applying the Transactional Net Margin Method to determine the arm's length price with the Associated Enterprises in respect of both purchase and sale of diamonds as well as sale of jewellery though the nature of the two transactions are entirely different.
6. The Assessing Officer failed to appreciate that the Transactional Net Margin Method is not the most appropriate method in the circumstances of the appellant's case and, therefore, the same ought not to have been applied.
7. The Assessing Officer erred in making adjustment of Rs. 8,27,30,858 by applying the Transactional net Margin Method to the total transactions of the appellant to determine the arm's length price with the Associated Enterprises.
8. The order of the Assessing Officer is bad in law and without jurisdiction inasmuch as neither the Transfer Pricing Officer nor the Assessing Officer gave any details of the Companies on whose data they relied on to apply the Transactional Net Margin Method in the case of the appellant.
9. The order of the Assessing Officer is bad in law and without jurisdiction inasmuch as neither the Transfer Pricing Officer nor the Assessing Officer gave sufficient opportunity of being heard to the assessee in view of the fact that the assessment was getting time barred on 31-12-2006.

4. In the course of proceedings before the Commissioner (Appeals), all the submissions of the assessee were sent back to Assessing Officer for his comments, and, to that extent, lack of effective opportunity to the assessee for presenting his case, even if any, was made good. On merits, learned Commissioner (Appeals) upheld the grievances of the assessee and, while doing so, reasoned as follows:

2.7 I have perused the assessment order/TPO's order and remand report, examined the submissions made by the appellant. I am of the opinion that appellant company was not given sufficient time for submitting the additional details asked by the TPO and the order was passed in haste. In this case, the appellant company has submitted detailed records of raw material cost of each item of jewellery exported on wholesale basis by it to the AEs as well as non AEs carrying on business in USA. The appellant company has furnished style wise and invoice wise cost sheets showing break up of raw material and consumables used in jewellery sold to AEs and non AEs. The method followed by the company is one of the prescribed methods. Even though jewellery items being sold generally vary in a variety of ways such as cartage, type of raw materials used, style/design and sizes, the margins to be applied on cost depends on company policies. The TPO has considered TNMM without using external comparables of 18 companies whose exact nature of business, details of manufacturing units, method and manner of receiving and executing the orders, product mix etc can differ substantially more so when it concerns diamond industry.

2.8 Taking into account the above facts, I am of the opinion that the cost plus method adopted by the appellant company using internal comparables is correct as the appellant company is maintaining total cost details of the AEs and non AEs. As per details submitted by the AR of the appellant company, the assessee company has earned average gross margin on its AE transactions, whereas the assessee company has earned average gross margin of 14.80 per cent on its non AE transactions. As the average margin earned from AE transactions is more than average margin earned from non AE transactions, no (ALP) adjustment is required to be made.

Ground Nos. 1 to 9 are allowed.

5. The Assessing Officer is aggrieved of the relief so granted by the learned CIT(A), and is in appeal before us.

6. We have heard the rival contentions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position.

7. A plain look at the sequence of events shows that the first appellate authority completely missed the vital fundamental fact that TNMM was resorted to in this case not only because assessee's determination of ALP in respect of sales of finished goods to the AEs, which was stated to be on CPM basis, was rejected, but also because assessee's determination of ALP in respect of purchases of diamonds from the AEs and sales of diamonds to AEs, which was stated to be on CUP basis, was rejected. However, by giving finding on only the determination of ALP of sales to AEs - which, for the reasons we will set out in a short while, is incorrect anyway, the CIT(A) has rejected the impugned ALP adjustment, which was recommended by the TPO in respect of "all the transactions undertaken by the assessee" and adopted by the Assessing Officer "on account of adjustment made to the arm's length price of international transactions with the associated enterprises". The ALP adjustments were thus not only in respect of sales of finished goods to the AEs, but also in respect of imports of diamonds from the AEs and export of diamonds to the AEs. In a way, learned CIT(A) has been superficial in his approach in examining only one aspect of the matter, i.e. sales of finished goods to the AEs, and not even dealing with the issue regarding determination of ALP of diamonds imported and diamonds exported-which were specifically raised in ground nos. 1 and 2 of the assessee. Learned CIT(A) does not deal with these grounds, nor assessee makes any specific submissions on these issues - as indeed he did before us, and yet learned CIT(A) allows these grounds of appeal. In the CIT(A)'s impugned order, there is not even a whisper about the CIT(A)'s satisfaction of ALP determined by the assessee in respect of imports of diamonds from AEs and export of diamonds from AEs, and in this 379 page paper book filed before us by the assessee, there is not one piece of documentation in support of the comparable uncontrolled price (CUP) of the diamonds imported or exported. As a matter of fact, the assessee has not been able to produce any document whatsoever, at any stage of proceedings, in support of the ALP of diamonds imported or diamonds exported by the assessee. The assessee's claim is that these transactions have taken place at the prevailing market prices, but then there has to be something more than his words to substantiate this claim. Coming to the impact of these undisputed facts regarding assessee's inability to furnish any documentation in support of determination of ALP of diamond imports and diamond exports, it is only elementary that in a situation where international transactions with AEs have three significant areas of impact on the overall profitability (i.e. sales of finished goods to AEs, sales of raw materials to AEs and purchase of raw materials of AEs), and when ALP cannot be reasonably determined by CUP or any other direct method (i.e. cost plus method and resale price method) in respect of even one of these areas, the application of TNMM or other indirect method (i.e. profit split method) is inevitable and it cannot be rejected. Once it is clear that there is no documentation available for determination of ALP, under CUP or any other direct method, of diamond imports and diamond exports, and even if we assume that the sales is at an ALP, it is inevitable that TNMM has to be applied anyway, unless, of course, profit split method is found to be appropriate. On a conceptual note, when arm's length prices of the transactions with AEs cannot be reasonably ascertained, the profit earned by the assessee entering into these transactions is to be estimated, and that is precisely what TNMM does. When TNMM is applied in the context of sales of finished goods to AEs, it is this figure which is taken as variable figure and it bears the impact of higher margins, and when TNMM is applied in the context of purchases of raw materials from AEs, it is the figure of purchases of raw material from AEs which is taken as variable figure and it bears the impact of higher margins. Beyond that, the cause of invoking TNMM does not make much material difference. As we say so, we are alive to the fact that there is a school of thought, which appears to have been subscribed to by the coordinate benches, that the impact of TNMM has to be restricted on a proportionate basis to the transactions and not to the overall profits even when entity is engaged in the same business, we see no need to deal with this issue in any greater detail, as, in the present case, we are not required to adjudicate on that aspect of the matter. Suffice to say that, whatever be the approach adopted, merely because the sales to AEs have been held to be at ALP, and without vacating the findings of imports and exports of diamonds to the AEs not having been established to be at ALP, the application of TNMM on the facts of this case could not have been vacated. Learned CIT(A) did not vacate the findings of the TPO so far as rejection of CUP in the case of diamond imports and diamond exports was concerned, nor was assessee able to produce any material whatsoever to support his grievance against the stand of the TPO and the Assessing Officer on this issue, yet the CIT(A) deleted the adjustment made on the basis on application of TNMM in determination of ALP in respect of international transactions entered into by the assessee with AEs. The CIT (A) was thus clearly in error in deleting the impugned ALP adjustment in principle. Learned counsel, relying upon an observation made by a coordinate bench in the case of Commissioner Of Income-Tax v. Indo American Electricals Ltd. [2010] 41 SOT 1 (Mum.) , contends that since the assessee is enjoying tax benefits under section 10A, there cannot be any motives in shifting income to a jurisdiction which results in higher taxability, and, therefore, no ALP adjustments can be made. We see no merits in this approach. Firstly, the observations made by the coordinate bench is only an obiter dicta, which, as held by Hon'ble Bombay High Court in the case of Commissioner Of Income-Tax v. Thana Electricity Supply Ltd. [1994] 206 ITR 727 , does not have a binding force, though it "may have some persuasive efficacy". What is more important, however, is the fact that a five member bench of this Tribunal, in the case of Aztech Software & Technology Services Ltd. v Asstt. CIT [2007] 107 ITD 141 (Bang.) (SB) has held that it is not necessary to demonstrate tax avoidance motives before transfer pricing provisions can be enforced. The views so expressed by the larger bench bind us, and, respectfully following the same, we reject the technical objection raised by the learned counsel.

8. We now come to the question whether cost plus method, as claimed by the assessee and as applied by the assessee on the facts of this case, is sustainable in law. Let us begin by taking a look at the relevant statutory provision under Rule 10 B which provides as follows:

(c) cost plus method, by which,

(i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined;
(ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined;
(iii) the normal gross profit mark-up referred to in sub-clause ( ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market;
(iv) the costs referred to in sub-clause ( i) are increased by the adjusted profit mark-up arrived at under sub-clause ( iii);
(v) the sum so arrived at is taken to be an arms length price in relation to the supply of the property or provision of services by the enterprise.

9. The application of Cost Plus Method thus provides for (i) ascertaining the direct and indirect costs of property transferred, or services rendered, to the associated enterprises; (ii) ascertaining the normal mark up of profit over aggregate of direct costs and indirect costs in respect of same or similar property or services, or a series of transactions of same or similar property or services, to the unrelated enterprises; (iii) adjusting the normal mark up, or gross profit, for differences, if any, in the material factors (to give simple examples of such variations, these variations could be risk profile, credit period, market differences, nature of goods of services etc.,); (iv) applying the mark up or gross profit so arrived at on the aggregate of direct and indirect costs. The way this rule works, the benchmark gross profit is to be applied on each transaction with the AEs , while, for computing the benchmark, one could take into account a series of same or similar transactions. In other words, while setting the benchmark, one can take into account several transactions with unrelated enterprise on what can be termed as 'global basis', essentially in respect of same or similar property or services though, the benchmark so arrived at cannot be applied on the global basis i.e. the average of gross profit earned from same or similar transactions with AEs. The application of CPM has to be on transaction basis rather than on global basis, and this fundamental scheme of cost plus method is also evident from the plain wordings of Rule 10 B as well. Any other view of the matter will result in incongruities. For example, if our average mark up to unrelated enterprises is 20 per cent. and we charge a mark-up of 2 per cent in one transaction with AE and 38 per cent in another transaction with the AE, both these transactions, by applying the mark up on global basis, will meet the test of ALP whereas in the first case, the mark up charged is certainly not a mark-up resulting in an ALP. In this particular case, for example, the normal mark up in transactions with has been computed at 16.31 per cent. and the average of mark up on sales to AEs having been taken at 17.08 per cent. entire sales to AEs has been taken at ALP, but, the mark up in the many cases is clearly less than benchmark. To give one example, at page 221 of the paper-book, margin of 14.15 per cent (4 invoices), 13.95 per cent. 13.81 per cent. 14 per cent (4 invoices), 14.14 per cent (2 invoices), and 14.16 per cent is given by assessee's own computation, and, on the same page, on one invoice, the assessee has shown a margin as high as 27 per cent. The cost plus method, therefore, has not been correctly applied. In any case, one of the most important input, i.e. diamond, has been imported at a price for which no ALP documentation is available and the price of imports have been taken into account in computation of costs as well. The costs of inputs have not been verified either. No efforts are made to show that the terms of sale to the AEs and all other relevant factors are materially similar vis-a-vis the transactions with independent enterprises. The CPM is applied by comparing gross profit on sales, whereas the method requires comparison of mark up on costs on transactions with AEs vis-a-vis mark up on costs on transactions with non AEs. In view of these discussions, the CIT(A) was in error in upholding assessee's computation of ALP by cost plus method.

10. We have also noted that the assessee was duly confronted with comparable cases for application of transaction net margin method, but the assessee did not have anything to say beyond his rather vague and generalized objections to the application of TNMM and insistence that the CUP and CPM method adopted by him should not be disturbed. Even in proceedings before us, no specific submissions have been made in this regard, nor any document, in support of his stand on comparable cases being incorrect, have been filed before us in the paper-book. There is no discussion whatsoever about precise comparability of the cases selected for TNMM, nor is there any application of suitable filters, even if any. Given these facts, what weighed heavily with us was the option of confirming the stand of the Assessing Officer in principle and proceeding to deal with corollaries thereto, but, realizing that proceedings at the first appellate stage have been conducted in a manner which leaves a lot to be desired, we deem it fit and proper to remit the matter to the file of the CIT(A) for adjudication de novo in the light of our above observations and in the light of whatever additional material the assessee is able to produce in support of his grievances, in accordance with the law, by way of a speaking order and after giving a reasonable opportunity of hearing to the assessee. We, therefore, vacate the impugned relief granted by the CIT(A) but remit the matter to him for fresh adjudication in the light of our above observations.

11. In the result, the appeal is allowed for statistical purposes in the terms indicated above.