Mr. Ramit Katyal, Advocates v. Commissioner Of Income Tax

* % + IN THE HIGH COURT OF DELHI AT NEW DELHI RESERVED ON: 08.07.2013 PRONOUNCED ON:16.12.2013 ITA 306/2012 LI AND FUNG INDIA PVT. LTD. ..... Appellant Through: Mr. Porus Kaka, Sr. Advocate with Mr. Neeraj Jain, Mr. Manish Kanth and Mr. Ramit Katyal, Advocates. Versus COMMISSIONER OF INCOME TAX ..... Respondent Through: Mr. N.P. Sahni, Sr. Standing Counsel and Mr. Ruchesh Sinha, Advocate. CORAM: HON'BLE MR. JUSTICE S. RAVINDRA BHAT HON'BLE MR. JUSTICE R.V. EASWAR MR. JUSTICE S.RAVINDRA BHAT 1.The present appeal under Section 260A of the Income Tax Act, 1961 (hereafter „the IT Act‟) impugns the order dated 30.09.2011 of the Income Tax Appellate Tribunal, Delhi Branch „D‟, New Delhi (hereafter „the Tribunal‟) in ITA No. 5156/Del/2010, for the assessment year 2006-07. The present appeal concerns the alleged apportioning of consideration between the Appellant (i.e. the assessee, M/s Li Fung (India) Pvt. Ltd, hereinafter „LFIL‟) and its Associated Enterprise (hereinafter „AE‟) in order to arrive at the arm‟s length price for the transactions between the two entities, using the Transactional Net Margin Method (TNMM). The following questions of law arise from the appeal: a.Whether the assessment of the Revenue of arm‟s length price applying the TNMM method was contrary to the transfer pricing provisions under the IT Act and Rules? applying the TNMM method was contrary to the transfer pricing provisions under the IT Act and Rules? b.Whether the Transfer Pricing Officer‟s(TPO‟s) apportionment by considering the cost plus mark up of 5% on FOB value of goods between third party enterprises, sourced through the appellant is in compliance with the law? considering the cost plus mark up of 5% on FOB value of goods between third party enterprises, sourced through the appellant is in compliance with the law? 2.The facts that give rise to these questions of law are as follows. LFIL is a wholly owned subsidiary of Li & Fung (South Asia) Ltd., a company incorporated in Mauritius as a captive offshore sourcing provider. Li & Fung (Trading)(the AE),is a group company incorporated in Hong Kong, which enters into contracts with customers viz. retail chains overseas, for rendering sourcing support services for the supply of high volume, time sensitive consumer goods. The appellant entered into an agreement dated 4.12.1997 with the AE, whereby the contract for rendering sourcing services is outsourced or subcontracted to LFIL, for which it is remunerated at cost plus a mark up of 5% for services rendered to the AE, and ultimately, the AE‟s customers. wholly owned subsidiary of Li & Fung (South Asia) Ltd., a company incorporated in Mauritius as a captive offshore sourcing provider. Li & Fung (Trading)(the AE),is a group company incorporated in Hong Kong, which enters into contracts with customers viz. retail chains overseas, for rendering sourcing support services for the supply of high volume, time sensitive consumer goods. The appellant entered into an agreement dated 4.12.1997 with the AE, whereby the contract for rendering sourcing services is outsourced or subcontracted to LFIL, for which it is remunerated at cost plus a mark up of 5% for services rendered to the AE, and ultimately, the AE‟s customers. 3.LFIL previously received buying support services fees amounting to Rs. 47, 69, 83, 904 from the AE, which ought to be considered as an international transaction of rendering buying support services to AE under the Transfer Pricing provisions under Sections 92 to 92F of the IT Act. To justify that the transaction was at arm‟s length, LFIL applied the Transactional Net Margin Method (TNMM) as the most appropriate, considering Operating Profit Margin divided by Total cost as the Profit level indicator. Since the operating profit margin at 5.17% exceeded the weighted average operating margin of 26 other comparable companies at 47, 69, 83, 904 from the AE, which ought to be considered as an international transaction of rendering buying support services to AE under the Transfer Pricing provisions under Sections 92 to 92F of the IT Act. To justify that the transaction was at arm‟s length, LFIL applied the Transactional Net Margin Method (TNMM) as the most appropriate, considering Operating Profit Margin divided by Total cost as the Profit level indicator. Since the operating profit margin at 5.17% exceeded the weighted average operating margin of 26 other comparable companies at 4.07%, LFIL contended that such a transaction of rendering of sourcing services was at arm‟s length on an application of the TNMM method. services was at arm‟s length on an application of the TNMM method. 4.During the course of the Transfer Pricing assessment, LFIL contended that it was a low risk captive sourcing service provider performing limited functions with minimal risk as an offshore provider and substantial functions relating to buying services was performed by the AE, which also assumed various enterprise risks. Thus, the compensation paid to the appellant at cost plus 5% as remuneration was to be considered at arm‟s length while applying the TNMM. Alternatively, the AE entered into contracts with unrelated third parties for rendering buying services @ 4% to 5% of the FOB value of exports. LFIL had in turn received service fee of Rs.47.69 crores which is equivalent to nearly 4% of the FOB value of the export (by the vendors) from the AE, which constituted 80% of the consideration received by the AE, which, in LFIL‟s opinion ought to have been considered at arm‟s length.it was a low risk captive sourcing service provider performing limited functions with minimal risk as an offshore provider and substantial functions relating to buying services was performed by the AE, which also assumed various enterprise risks. Thus, the compensation paid to the appellant at cost plus 5% as remuneration was to be considered at arm‟s length while applying the TNMM. Alternatively, the AE entered into contracts with unrelated third parties for rendering buying services @ 4% to 5% of the FOB value of exports. LFIL had in turn received service fee of Rs.47.69 crores which is equivalent to nearly 4% of the FOB value of the export (by the vendors) from the AE, which constituted 80% of the consideration received by the AE, which, in LFIL‟s opinion ought to have been considered at arm‟s length. 5.The Transfer Pricing Officer by an order dated 28.10.09 under Section 92CA(3) of the IT Act did not dispute the selection of the comparable companies for application of TNMM by LFIL. However, he held that the cost plus compensation @ 5% of cost of incurred by LFIL was not at arm‟s length and applied a mark up of 5% on the FOB value of export of Rs. 1202.96 crores made by the Indian manufacturer to overseas third party customers. 92CA(3) of the IT Act did not dispute the selection of the comparable companies for application of TNMM by LFIL. However, he held that the cost plus compensation @ 5% of cost of incurred by LFIL was not at arm‟s length and applied a mark up of 5% on the FOB value of export of Rs. 1202.96 crores made by the Indian manufacturer to overseas third party customers. 5.The Transfer Pricing Officer by an order dated 28.10.09 under Section 92CA(3) of the IT Act did not dispute the selection of the comparable companies for application of TNMM by LFIL. However, he held that the cost plus compensation @ 5% of cost of incurred by LFIL was not at arm‟s length and applied a mark up of 5% on the FOB value of export of Rs. 1202.96 crores made by the Indian manufacturer to overseas third party customers. 92CA(3) of the IT Act did not dispute the selection of the comparable companies for application of TNMM by LFIL. However, he held that the cost plus compensation @ 5% of cost of incurred by LFIL was not at arm‟s length and applied a mark up of 5% on the FOB value of export of Rs. 1202.96 crores made by the Indian manufacturer to overseas third party customers. 6.The reasons given by the TPO were that: a) LFIL was performing all the critical functions, assumed significant risks and used both tangible and unique intangibles developed by it over a period of time; a) LFIL was performing all the critical functions, assumed significant risks and used both tangible and unique intangibles developed by it over a period of time; b) there was no evidence that the AE had either technical capacity or manpower to assist LFIL and that in the absence of any credible evidence, the involvement of the AE could not be accepted; c) LFIL had developed several unique intangibles which had given an advantage to the AE in the form of low cost of the product, quality of the product and enhanced the profitability of the AE, though the cost for development and use of intangibles was not taken for computation of routine mark up of 5% considered by LFIL; d) LFIL had crucially developed supply chain management which provided the link between the suppliers and customer to achieve strategic and pricing advantage; e) LFIL owned human capital intangible, developed at their own cost with all related risks in creation and maintenance of such intangible; f) the AE recognised that India offers both cost and operational advantage such as lower salaries for the employees, low cost material and low cost manufacture. LFIL had neither quantified this locational saving nor had the AE attributed any part of the additional profit on account of locational saving to LFIL. 7.The TPO did not, as stated earlier, dispute the analysis undertaken by LFIL, but for the above reasons applied the 5% mark up to FOB value of exports made by Indian manufacturer to overseas third party customers, amounting to Rs 1202.96 crores and accordingly computed an addition of Rs 57, 65, 61, 186/- to the appellant‟s income on account of the alleged difference in calculation of the arm‟s length price of the above transactions. Thus, the Assessing officer in the draft assessment order passed under section 144C(1) of the Act made an addition, inter alia, on account of transfer pricing adjustment of Rs. 57,65,61,186 on the basis of the order passed by the TPO. The reasoning of the TPO is as follows: LFIL, but for the above reasons applied the 5% mark up to FOB value of exports made by Indian manufacturer to overseas third party customers, amounting to Rs 1202.96 crores and accordingly computed an addition of Rs 57, 65, 61, 186/- to the appellant‟s income on account of the alleged difference in calculation of the arm‟s length price of the above transactions. Thus, the Assessing officer in the draft assessment order passed under section 144C(1) of the Act made an addition, inter alia, on account of transfer pricing adjustment of Rs. 57,65,61,186 on the basis of the order passed by the TPO. The reasoning of the TPO is as follows: “5.2.5 The compensation model of the assessee does not include the profit attributable to the assessee on account of location saving: “5.2.5 The compensation model of the assessee does not include the profit attributable to the assessee on account of location saving: Globalization and continuous search for lower cost has resulted in transfer of manufacturing and procurement activities from high cost economy like European Union, Japan, UK and United States, to lower cost economies like India to stay competitive and to increase profits. In this case, the AE has recognized that India offers both cost and operational advantage such as tower salaries for the employees, low cost material and low cost manufacture. Accordingly, it has established a trading company in India for procurement of goods. Location savings generally emerge when companies transfer their operation site from high cost economy to economies with low cost. That is, they take advantage of price differences in the factors for production or procurement across the countries. In many cases, the location saving arise from differences of low labour cost, low raw material and finished goods cost, low logistic cost and lower quality control cost. The net location saving represent saving from moving to low cost economy. In this case, the assessee is operating in low cost economy has generated location saving due to huge difference in cost of procurement between high cost economy and low cost economy like India. From a trading pricing prospective the common question in this case is: “who is entitled to additional profits in form of locational saving?” or “which country should tax theprofits?” In this case, the assessee has established its sourcing subsidiary in India in order to earn or to have the advantage of the locational saving. However, the assessee has neither quantified locational saving nor has attributed any part of the additional profit on account of locational saving to the assessee, in India. It is pertinent to mention here that the assessee is the most critical part of global supply chain of the AE. It is responsible for identifying and qualifying the contracted manufacturer, for working with them and other designers to manufacture garments in the technical specifications, for selection of fabrics, for control over the manufacturer, for identifying appropriate sourcing of fabrics and accessories, for quality insurance, for transportation logistics and for coordinating logistics. The compensation model for the assessee which is based on reimbursement of the cost with the percentage mark up has not included locational saving attributable to the assessee. These facts prove that cost plus compensation @ 5% of cost of the assessee is not at arm‟s length because it does not include profit attributable to the assessee on account of locational saving. 5.3 Whether the assessed commission should be expressed as a percentage of the FOB price of goods sourced through the assessee? In this case the AB has allowed commission of 5% of cost incurred by the assessee for its sourcing activities in India and has not computed commission on FOB price of goods sourced through the buying office. I have examined the compensation model along with the facts of the case and reached a conclusion that in this case commission should be expressed as a percentage of FOB price of goods sourced through the assessee for the following reasons: (a) It is evident from the FAR analysis as discussed in Para 5.2.2 of this order that the assessee has played a major role in identifying suppliers, raw material, design, production control, manufacturing control, quality control, packing and export of merchandise and has been in constant touch with the buyer. It has assumed significant risks and has used both its tangibles and unique intangibles which resulted in enhancement and profitability of sourced goods as discussed in Para 5.2.4 and 5.2.5 of this order. These facts clearly prove that value addition activities of the assessee can only be expressed as a percentage of FOB of goods sourced through the assessee. (a) It is evident from the FAR analysis as discussed in Para 5.2.2 of this order that the assessee has played a major role in identifying suppliers, raw material, design, production control, manufacturing control, quality control, packing and export of merchandise and has been in constant touch with the buyer. It has assumed significant risks and has used both its tangibles and unique intangibles which resulted in enhancement and profitability of sourced goods as discussed in Para 5.2.4 and 5.2.5 of this order. These facts clearly prove that value addition activities of the assessee can only be expressed as a percentage of FOB of goods sourced through the assessee. (b) The assessee is operating in a low cost country like India and its operating cost is so low that it is a very poor proxy of the value it adds to the sourced goods. (c) The assessee has developed unique intangibles like supply chain management intangibles and Human Asset Intangible which has resulted in huge commercial and strategic advantage to the AE and these intangibles have enhanced the profit potential of the AE. However, these intangibles did not form part of the operating cost. Accordingly, the value addition made by the assessee using intangible, to the FOB value the goods sourced through it remained unremunerated and operating cost plus mark up model does not capture the compensation for value addition made through these intangibles. Accordingly commission should be computed on FOB value of goods. (d) The assessee has generated huge locational saving for the AE as discussion in Para 5.2.5 of this order. However, compensation model based on operating expense of the assessee does not include locational saving attributable to the assessee which could only be capture if commission is calculated on FOB value of goods sourced through the assessee. In view of the above findings, it is held that the correct compensation model at arm‟s length price, in this case, would be commission of FOB cost of goods sourced from India. 6. The risk profile of the assessee has been discussed in detail in Para 5.2.1 of this order. It has been discussed in detail in this order that the assessee functions like an independent entrepreneur. Hence, it takes matching risks. For sake of convenience, risks relevant in the business of the assessee and risks disclosed in T.P. studies are analyzed in the following table: It is evident from the risk analysis, as mentioned in the table above that the assessee is a risk bearing entity and it cannot be said that assessee- is a risk-free entity. It is an independent entrepreneur. Hence, there is no case for risk adjustment in the assessee‟s case. Without prejudice to the above finding that the assessee is a risk bearing entity and does not require any adjustment on account of risk, the claim of the assessee is not admissible on the following grounds: (a) The assessee has not conducted risk analysis either in case of tested party and comparables and has not demonstrated its risk matrix of comparables as different from tested party. (b) No computation of risk adjustment is filed. (c) The onus to support risk adjustment is on the assessee, who has not discharged that onus. ********** ************ 8.1 The assessee has adopted TNMM with a PLI of OP/OC. It may be pointed out that it is not the intention of this order to change the method adopted by the assessee. The method adopted by the assessee is accepted. The only change being made is on the cost base being applied while applying the PLI, chosen by the assessee. It has already been pointed that the costs do not include cost of sales made through the assessee. This being the case, the mark-up of 5% should obviously be calculated on the full FOB value of exports in on Rs.1202.96 Crores. Following the discussion in the preceding paras, the operating income shall be calculated as a mark-up the FOB value of exports that have been facilitated by the assessee. 9. Calculation of arm‟s length price ********** ************ 8.1 The assessee has adopted TNMM with a PLI of OP/OC. It may be pointed out that it is not the intention of this order to change the method adopted by the assessee. The method adopted by the assessee is accepted. The only change being made is on the cost base being applied while applying the PLI, chosen by the assessee. It has already been pointed that the costs do not include cost of sales made through the assessee. This being the case, the mark-up of 5% should obviously be calculated on the full FOB value of exports in on Rs.1202.96 Crores. Following the discussion in the preceding paras, the operating income shall be calculated as a mark-up the FOB value of exports that have been facilitated by the assessee. 9. Calculation of arm‟s length price The assessee has credited total receipt of Rs.476,983,904 on the basis of operating cost of the assessee plus a markup of 5% and at the net level the net operating margin of Rs.24,914,814 comes to 5.22%. This is in consonance with the assessee‟s claim it is operating on cost plus 5% markup basis. Following the discussion in the preceding paras, the receipt as claimed by the assessee, shall be substituted by the FOB value of exports being Rs.1202.96 crores. The markup of 5% that shall be applied to this and the same shall be credited to the Profit & Loss Account. After taking into account this gross income, the net operating income is computed at Rs.601,480,000. Thus, the arm‟s length price is calculated as below: Net Operating income (as calculated above) Rs.601,480,000 Operating income shown by assessee Rs.24,918,814 Difference Rs.576,561,186 Accordingly, the value of the international transaction of the assessee shall be adjusted upward by Rs.576,561,186 to bring it to arm‟s length. Since the difference computed as a percentage of the Arm‟s Length Price is more than 5% no benefits under the proviso to Section 92C(2) is available to the assessee. 10. The transfer pricing approach may be summarized as below. (i) The assessee has used TNMM as the method and OP/TC was claimed to be the PLI. (ii) It was noticed that the cost of goods sold through the assessee has not been included in the cost base while computing the margin. (iii) A show cause is this regard was issued to the assessee. The same is reproduced at Para 5.1. (iv)The assessee markup has been calculated on the FOB value of exports made through the assessee. The rationale for this has been given at para 5.3. exports made through the assessee. The rationale for this has been given at para 5.3. (v)An adjustment of Rs.576,561,186 was made to the value of international transaction. international transaction. (vi)The assessee was afforded reasonable opportunity of being heard (including personal hearing) as mentioned on page 1 of this order.”(including personal hearing) as mentioned on page 1 of this order.” 8.The Dispute Resolution Panel (DRP) by order dated 30.09.2010 passed under Section 144C (5) of the Act reduced the said mark up of 5% of FOB value of exports to 3%. The Assessing Officer accordingly in the final assessment order dated 8.10.2010 passed under section 143(3)/144C(3) of the IT Act computed LFIL‟s income at Rs 36, 67, 95, 634/- as against the returned income of Rs 3,08,26,448 after making the addition on account of transfer pricing adjustment. The material part of DRP‟s reasoning is as follows: “After going through the functions of the assessee, we find that it has assumed the role of a full risk bearing trader. Therefore, the plea of the assessee that the cost of goods should not be part of the cost base cannot be allowed. The assessee‟s plea that the Hon‟ble ITAT and the Delhi High Court, have held that it is eligible for deduction u/s 80-O of the Income Tax Act has no application in the instant case as the decisions were not rendered in the context of setting the arms length price of the assessee‟s international transactions. “After going through the functions of the assessee, we find that it has assumed the role of a full risk bearing trader. Therefore, the plea of the assessee that the cost of goods should not be part of the cost base cannot be allowed. The assessee‟s plea that the Hon‟ble ITAT and the Delhi High Court, have held that it is eligible for deduction u/s 80-O of the Income Tax Act has no application in the instant case as the decisions were not rendered in the context of setting the arms length price of the assessee‟s international transactions. International transactions have to be judged at a different level as opposed to transactions covered by the domestic law. The OECD also recognizes the fact that related parties may fashion their transactions in such a manner that may call for looking at the substance of transactions over the form they are given. The relevant portions of the OECD guidelines issued on 22.07.2010 are as below:- “1.67 Associated enterprises are able to make a such greater variety of contracts and arrangements than can independent enterprises because the normal conflict of interest which would exist between independent parties is often absent. Associated enterprises may and frequently do conclude arrangements of a specific nature that are not or are very rarely encountered between independent parties. This may be done for various economic, legal, or fiscal reasons dependent on the circumstances in the particular case. Moreover, contracts within an MNE could be quite easily altered, suspended, extended, or terminated according to the overall strategies of the MNE as a whole, and such alterations may even be made retroactively. In such instances, tax administrations would have to determine what the underlying reality is behind a contractual arrangement in applying the arm‟s length principle.1.68 In addition, tax administrations may find it useful to refer to alternatively structured transactions between independent enterprises to determine whether the controlled transaction as structured satisfied the arm‟s length principle. Whether evidence from a particular alternative can be considered will depend on the facts and circumstances of the particular case, including the number and accuracy of the adjustments necessary to account for differences between the controlled transaction and the alternative and the quality of any other evidence that may be available.” Therefore, the assessee‟s claims that it does not bear the risks of a normal trader have to be tested in this light. Accordingly, we are inclined to accept the TPO‟s conclusion that the FOB value of goods should form part of the cost base for calculating the remuneration that should accrue to the assessee. That leads to the next question as to what should be the correct markup that should be applied. The TPO has applied the markup of 5% because the assessee is operating on a cost plus 5% model. However, when we are increasing the cost base manifold, the application of a markup of 5% will be excessive. We accordingly hold that given the facts and circumstances of the case a markup of 3% will be reasonable. This will adequately cover the valuable intangibles that have been developed and used by the assessee as also the location saving that the assessee is passing on to its AE. Directions under Section 144C(5) of the IT Act In view of the discussion on each of the grounds of objections above, the Assessing Officer is directed to complete the assessment as per the draft order forwarded by him to the assessee subject to modification as discussed in Para 3 above. The Assessing Officer may incorporate the reasons given by the Panel at appropriate places in respect of the various objections while passing the final order. He is also directed to append a copy of these directions to the assessment order. The objections of the assessee are disposed of as above.” Directions under Section 144C(5) of the IT Act In view of the discussion on each of the grounds of objections above, the Assessing Officer is directed to complete the assessment as per the draft order forwarded by him to the assessee subject to modification as discussed in Para 3 above. The Assessing Officer may incorporate the reasons given by the Panel at appropriate places in respect of the various objections while passing the final order. He is also directed to append a copy of these directions to the assessment order. The objections of the assessee are disposed of as above.” 9.LFIL preferred an appeal to the Tribunal against the assessment order, which by the impugned order dated 30.09.2011, even while accepting that the TNM Method was the appropriate method for calculation, rejected the LFIL‟s contention that under Rule 10B (1)(e) of the Income Tax Rules (“the Rules”) made no provision for considering the cost incurred by third parties or an unrelated enterprise to compute net profit margin. The Tribunal by its impugned order held that the appellant was performing all critical functions with the help of tangible and unique intangibles as well as supply chain developed, which helped the AE to enhance its business and resulted in location saving to the consumer, compensation for the services rendered by LFIL to the AE, equivalent to the cost plus 5% mark-up, was not at arm‟s length. Since LFIL was providing crucial sourcing services and the AE was remunerated by third parties based on such services, the Tribunal relied upon the mark up on FOB value of goods sourced through LFIL as the appropriate method to work out arm‟s length compensation. The tribunal accepted the TPO‟s reasoning for applying the 5% of the FOB value of exports to third parties by Indian manufacturers. The relevant part of the reasoning in the impugned order is reproduced below: which by the impugned order dated 30.09.2011, even while accepting that the TNM Method was the appropriate method for calculation, rejected the LFIL‟s contention that under Rule 10B (1)(e) of the Income Tax Rules (“the Rules”) made no provision for considering the cost incurred by third parties or an unrelated enterprise to compute net profit margin. The Tribunal by its impugned order held that the appellant was performing all critical functions with the help of tangible and unique intangibles as well as supply chain developed, which helped the AE to enhance its business and resulted in location saving to the consumer, compensation for the services rendered by LFIL to the AE, equivalent to the cost plus 5% mark-up, was not at arm‟s length. Since LFIL was providing crucial sourcing services and the AE was remunerated by third parties based on such services, the Tribunal relied upon the mark up on FOB value of goods sourced through LFIL as the appropriate method to work out arm‟s length compensation. The tribunal accepted the TPO‟s reasoning for applying the 5% of the FOB value of exports to third parties by Indian manufacturers. The relevant part of the reasoning in the impugned order is reproduced below: “The TPO did not consider the cost plus compensation @ 5% at arms length by holding that assessee is performing all critical “The TPO did not consider the cost plus compensation @ 5% at arms length by holding that assessee is performing all critical functions, assuming significant risks and used both tangibles and unique intangibles developed by it over a period of time. The associated enterprise is not having technical capacity and manpower to assist the assessee in this regard. The assessee has developed several unique intangibles which has been given advantage in the form of low cost of product, quality of the product and enhanced the profitability of AE. These intangibles have developed profit potential of AE. The assessee has developed the supply chain management which gives customer a strategic and pricing advantage. The assessee has also developed its own human capital intangible at its own cost. The cost for the same is born by assessee. The AE has recognized that India offers both cost and operational advantage on account of lower salaries for the employees, low cost material and low cost manufacture. The associated enterprise is charging from the purchasers on the basis of FOB value of exports up to 5%. The total exports effected by the assessee during the year were Rs.1202.96 crores. Assessee has been paid in respect of the international transaction effected in the form of exports on the basis of cost plus 5%. The Learned AR‟s plea that no adjustment has been made in the earlier years. For this, he has submitted assessment order for AY 2002-03 to 2005-06 wherein the transaction net marginal method with operating profit over total cost (OP/TC) as a profit level indicator has been accepted. This TNMM method has been accepted in these years. Reliance is also placed on the decision of Hon'ble Supreme Court in the case of Radhasoami Satsang Vs. CIT, cited supra and CIT vs. New Poly Pack (P) Ltd., 245 ITR 492, other case laws. In this regard, we hold that the principle of res judicata is not applicable in the income-tax proceedings. Each assessment year is a separate unit and what is decided in one year shall not ipso facto apply in the subsequent years. We have gone through the orders passed in the earlier years which has been placed in the paper book at pages 293 to 305 and for all these assessment years starting from 2002-03 to 2004-05, we find that while accepting profit level indicator nothing has been said about the basis on which the compensation has been received by the associated enterprise on the goods exported from India through assessee. As we have already stated earlier, the associated enterprise was receiving the compensation as a percentage of the FOB value of the goods exported through the assessee and as per the guidelines of the OECD which recognizes that the related party may fasten their transaction in such a manner that may call for looking at the substance of transactions over the form they are given. In this case, the associated enterprise was receiving the compensation on the basis of FOB value while the Indian associate (assessee) was compensated only by cost plus 5% mark up. When the associated enterprise are receiving the compensation at FOB value and the assessee which is providing critical functions with the help of tangible and unique intangibles developed over the years and with the help of supply chain management which are important to achieve the strategic and pricing advantage. All these help the associated enterprise to enhance and retain the business and also contributes towards the locational savings on account of low cost salary, low cost material and low cost manufacture in India. Therefore, in our considered view, the cost plus 5% mark up is definitely not on the arms length while working out the compensation for the services rendered by the assessee to the associated enterprise. In such a situation, mark up on the FOB value of the goods sourced through the assessee shall be the most appropriate method to work out the correct compensation at arms length price. Therefore, the rules of consistency cannot be applied forever when such facts have not been considered/discussed at all in the earlier years. It is also pleaded that the assessee has received 80-O deduction in the earlier years in respect of providing these professional and technical services. In this regard, we hold that every assessment year is a separate assessment year for income-tax purposes and the principle of res judicata is not applicable. Further during this year, the assessee has not claimed or entitled for 80-O deduction. Therefore, it cannot be a plea to justify the transaction at the arm‟s length. Assessee claims that there is no provision in the Rule 10B(1)(e) to include the cost incurred by third parties or unrelated enterprise to compute the net profit margin of the assessee. For this proposition, we do not agree in view of the fact that assessee is providing all critical functions and the majority of work related to these exports is performed by assessee itself. Associate enterprise had no capacity to execute the work. The associated enterprise is charging from the third party on the basis of FOB value of the exports made possible by assessee. Assessee is providing sourcing services through its tangible and intangible capacity to these third party clients in the form of low cost product resulting into profitability and pricing advantage. The assessee‟s reliance on Assessee claims that there is no provision in the Rule 10B(1)(e) to include the cost incurred by third parties or unrelated enterprise to compute the net profit margin of the assessee. For this proposition, we do not agree in view of the fact that assessee is providing all critical functions and the majority of work related to these exports is performed by assessee itself. Associate enterprise had no capacity to execute the work. The associated enterprise is charging from the third party on the basis of FOB value of the exports made possible by assessee. Assessee is providing sourcing services through its tangible and intangible capacity to these third party clients in the form of low cost product resulting into profitability and pricing advantage. The assessee‟s reliance on DCIT vs. Cheil Communication India Pvt. Ltd., cited supra, is not of much help as in that case, the facts were different. In that case, the assessee was providing to their party/media agency for and on behalf of the principal. In that case, the advertising space has been let out to the third party vendor in the name of ultimate customer and the beneficiary of advertisement. The assessee in that case was simply acting as intermediary between ultimate customer and the third party vendor in order to placement of advertisement. In assessee‟s case, the associated enterprise has been receiving the mark up as 5% of the FOB value of exports effected by assessee by applying its tangible and intangible capacity. The critical and all crucial work is done by assessee. The AE is paying back to the assessee only on the basis of cost plus 5% mark up. Such an arrangement cannot be said at arms length. In our considered view, such method will go against the basic normal business sense, as inefficient and high cost services provided by assessee shall fetch more revenue to the assessee. Such an arrangement on the face of it cannot be said to be at arm‟s length. The AE is getting remuneration on FOB value of export for which critical and main functions are performed by assessee. We also uphold that the assessee has developed a technical capacity and owns manpower which had developed human intangibles to perform all the critical functions. These tangible and unique intangible have been developed over the years. In view of these facts, we hold that to arrive at arm‟s length of these transactions, the mark up must be on the basis of FOB (free on board) value of the exports. Since the AE is receiving 5% of FOB value then the total receipt by AE must be Rs.60.148 crores. Thus, the attribution between assessee and AE must be from this amount. AO made addition of Rs.33.60 crores. If it is added to the actual receipts of assessee then it is much more than the total amount received by associated enterprise regard to these exports. Thus, the way in which this adjustment has been made gives abnormal / absurd results which cannot be sustained. The assessee was performing critical functions with the help of tangible and unique intangibles developed over the period of time and with the help of supply chain management which the assessee had developed, the majority of compensation based on the FOB value of the exports materialized through the assessee must come to the assessee. So the correct compensation at the arms length price based on the FOB cost of the goods sourced from India needs to be decided. The total export during the year was Rs.1202.96 crores. AE received in total of Rs.60.148 crores. India needs to be decided. The total export during the year was Rs.1202.96 crores. AE received in total of Rs.60.148 crores. The assessee‟s claim that no agreement was entered by the assessee with the ventures to whom the goods are sourced shall not justify the cost plus mark up. The associate enterprise entered into the agreements for sourcing the goods and the compensation is based on the FOB value of the goods sourced from the India and the assessee performing all crucial and critical function to fulfill the conditions to execute the agreements. Therefore, we find no merits in this plea. The other claim of the assessee that location savings attributable to the end purchaser is also not justified as the assessee has developed many unique intangibles and also human capital intangibles which gives the locational advantage to procure low cost goods which helps the associated enterprise to obtain/retain the business and also benefits the end purchaser. These tangibles and unique intangibles developed over the period of time and the developed supply chains of the management owned by assessee benefits the ultimate purchaser and also provide locational savings to the all including the associated enterprise. As we have already said that the amount of adjustment computed by the TPO cannot exceed the amount which could have been received by the associated enterprise. There is nothing on the record from where we could gather that the compensation @ 5% on FOB value received by AE is depressed or on lower side. In view of these facts, we are of the view that the amount of adjustment so computed should not exceed the amount received by the associated enterprise. In our considered view, the AO as well as the DRP has proceeded on a wrong footing which have given absurd results of adjustments. In view of the fact that majority and crucial services rendered by assessee, the distribution of compensation received by AE @ 5% of the FOB value of the exports between the assessee and the associated enterprise should be in the ratio of 80 : 20. The assessee must get 80% of the total receipt by AE from the ultimate purchasers. AO is directed to compute the arm‟s length price in the above manner.” 10.LFIL‟s counsel argued that the addition of Rs. 33, 59, 69, 186/- made on account of difference in the arm‟s length price of international transactions of buying/sourcing services is not sustainable for the reason that the TPO account of difference in the arm‟s length price of international transactions of buying/sourcing services is not sustainable for the reason that the TPO applied the TNMM method contrary to the Transfer Pricing Regulations. Section 92 of the Act stipulates that any income arising from an international transaction shall be computed having regard to the arm‟s length price. Further, Section 92F(ii) defines arm‟s length price as a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. For the purpose of determining the arm‟s length price in relation to an international transaction, various methods are prescribed under section 92C(2) of the Act and Rule 10B of the Rules provide the manner in which such methods should be applied by the assessee, assessing officer, Transfer Pricing Officer, etc. applied the TNMM method contrary to the Transfer Pricing Regulations. Section 92 of the Act stipulates that any income arising from an international transaction shall be computed having regard to the arm‟s length price. Further, Section 92F(ii) defines arm‟s length price as a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. For the purpose of determining the arm‟s length price in relation to an international transaction, various methods are prescribed under section 92C(2) of the Act and Rule 10B of the Rules provide the manner in which such methods should be applied by the assessee, assessing officer, Transfer Pricing Officer, etc. 11.Mr. Porus Kaka, learned senior counsel, while stating that the TNMM was chosen by LFIL as the appropriate method to calculate the arm‟s length, provided the court with an interpretation of the provision. He argued that for applying TNMM, it would be noted that the net profit margin realized from the international transactions by the appellant is to be computed only with reference to the cost incurred by LFIL itself. The provision does not consider or impute cost incurred by the third parties or unrelated enterprises, to compute net profit margin of the appellant enterprise. chosen by LFIL as the appropriate method to calculate the arm‟s length, provided the court with an interpretation of the provision. He argued that for applying TNMM, it would be noted that the net profit margin realized from the international transactions by the appellant is to be computed only with reference to the cost incurred by LFIL itself. The provision does not consider or impute cost incurred by the third parties or unrelated enterprises, to compute net profit margin of the appellant enterprise. 12.The learned counsel stated that the TPO, in the impugned order, enhanced the cost base of the appellant enterprise artificially by considering the cost of manufacture and export of finished goods by third party vendors which is clearly inconsistent with the manner of application of TNMM as provided in Rule 10B(1)(e). He argued that the TPO‟s enhancement of LFIL‟s cost base, by artificially considering the cost of manufacture and export of finished goods, clearly amounts to imputing notional adjustment/income in LFIL‟s hands on the basis of a fixed percentage of the FOB value of export made by unrelated party vendors. Thus, the value the cost base of the appellant enterprise artificially by considering the cost of manufacture and export of finished goods by third party vendors which is clearly inconsistent with the manner of application of TNMM as provided in Rule 10B(1)(e). He argued that the TPO‟s enhancement of LFIL‟s cost base, by artificially considering the cost of manufacture and export of finished goods, clearly amounts to imputing notional adjustment/income in LFIL‟s hands on the basis of a fixed percentage of the FOB value of export made by unrelated party vendors. Thus, the value of exports by third party vendors or customers does not provide any benchmark for determining arm‟s length price. 13.The learned counsel for LFIL submitted that, while applying the TNMM method, payment made by an assessee to third party vendors for and on behalf of the principal (which was reimbursed by the AE), cannot to be included in the total cost for determining the profit margin and the mark up is to be applied to the cost incurred by the appellant company. The value of export by third party vendors to third party customers does not provide any substantial basis for determining the arm‟s