2017 (3) TMI 1626 - AT - Income Tax

Tribunal revises transfer pricing adjustments, upholds aggregation approach for benchmarking, guides TPO on corrections

Cummins India Limited Versus The Dy. Commissioner of Income Tax, Circle – 1 (1), Pune

Cummins India Limited Versus The Dy. Commissioner of Income Tax, Circle – 1 (1), Pune - TMI Issues Involved:1. Transfer Pricing Adjustment2. International Transaction relating to export of IC Engines3. Inappropriate issue of two show cause notices4. Inappropriate comparison of profitability of 'export to Associated Enterprises (AEs)' and 'domestic sales'5. Inappropriate approach adopted by the TPO by ignoring interest received on extended credit while computing segmental profitability of export to AEs6. Inappropriate allocation of administrative expenses and selling & distribution by the TPO7. Inappropriate approach adopted by TPO in application of net profit to cost as Profit Level Indicator (PLI)8. Benefit of the variation / reduction of 5 percent from the arithmetic mean9. International Transaction relating to Payment of Royalty10. International Transaction relating to payment of Technical Know-how11. International Transaction relating to Procurement Support Services12. International Transaction relating to receipt of Commission13. International Transaction relating to interest received on extended credit offered to Associated Enterprises14. Proposed disallowance of incremental provision for New Engine Performance Inspection Fee by the DCIT15. Proposed disallowance of expenses u/s 14A of Income Tax Act,196116. Proposed disallowance of incremental warranty provision by the DCIT17. Proposed disallowance out of Deduction u/s. 80IB by the DCIT18. Proposed disallowance out of depreciation on intangible by the DCIT19. Initiation of Penalty ProceedingsDetailed Analysis:1. Transfer Pricing Adjustment:The first issue raised was against a transfer pricing adjustment of Rs. 40,64,87,070/- made by the Assessing Officer/DRP on account of various international transactions including export of IC engines, payment of royalty, technical know-how fees, procurement support services, receipt of commission, and interest received on extended credit period offered on exports. The Tribunal held that the aggregation of closely linked transactions for benchmarking was appropriate, and directed the Assessing Officer/TPO to re-compute the adjustment by aggregating the transactions.2. International Transaction relating to export of IC Engines:The Tribunal noted that the assessee had applied the TNMM method to benchmark its international transactions, while the TPO had rejected the aggregation approach and proposed an adjustment based on internal comparables. The Tribunal upheld the aggregation approach and directed the TPO to re-compute the adjustment using the TNMM method with external comparables.3. Inappropriate issue of two show cause notices:The assessee contended that the issuance of two show cause notices was inappropriate. The Tribunal dismissed this ground, stating that the issuance of multiple notices did not invalidate the proceedings.4. Inappropriate comparison of profitability of 'export to AEs' and 'domestic sales':The Tribunal found that the TPO's comparison of gross margins between domestic sales and exports to AEs was not appropriate. It held that the net profit margins of controlled transactions should be compared with those of uncontrolled transactions, and directed the TPO to re-compute the adjustment accordingly.5. Inappropriate approach adopted by the TPO by ignoring interest received on extended credit while computing segmental profitability of export to AEs:The Tribunal agreed with the assessee that interest received on extended credit should be considered while computing segmental profitability of exports to AEs and directed the TPO to include the interest received in the computation.6. Inappropriate allocation of administrative expenses and selling & distribution by the TPO:The Tribunal found that the TPO had re-allocated administrative and selling expenses without basis and directed that the allocation done by the assessee, based on generally accepted costing principles, should be accepted.7. Inappropriate approach adopted by TPO in application of net profit to cost as Profit Level Indicator (PLI):The Tribunal held that the PLI should be net profit to sales, not net profit to cost, as the selling price drives profitability. The TPO was directed to re-compute the PLI accordingly.8. Benefit of the variation / reduction of 5 percent from the arithmetic mean:This issue was deemed consequential based on the re-computation of the adjustments.9. International Transaction relating to Payment of Royalty:The Tribunal held that the payment of royalty should be aggregated with other manufacturing activities for benchmarking. The TPO was directed to re-compute the arm's length price after aggregation.10. International Transaction relating to payment of Technical Know-how:The Tribunal directed that the payment for technical know-how should also be aggregated with other manufacturing activities for benchmarking.11. International Transaction relating to Procurement Support Services:The Tribunal directed that the provision of procurement support services should be aggregated with other manufacturing activities for benchmarking.12. International Transaction relating to receipt of Commission:The Tribunal held that comparing controlled transactions with other controlled transactions was not appropriate and directed the TPO to delete the adjustment made for the receipt of commission from AEs.13. International Transaction relating to interest received on extended credit offered to Associated Enterprises:The Tribunal held that LIBOR + rates should be applied to the amounts due from AEs for the extended credit period and directed the TPO to re-compute the adjustment accordingly.14. Proposed disallowance of incremental provision for New Engine Performance Inspection Fee by the DCIT:The Tribunal allowed the provision for NEPI fees, noting that it was based on a scientific method and related to the IC engines sold by the assessee.15. Proposed disallowance of expenses u/s 14A of Income Tax Act,1961:The Tribunal held that Rule 8D was not applicable for the assessment year 2006-07 and restricted the disallowance of administrative expenses to Rs. 2 lakhs.16. Proposed disallowance of incremental warranty provision by the DCIT:The Tribunal allowed the provision for warranty expenses, noting that it was based on a scientific method and related to the IC engines sold by the assessee.17. Proposed disallowance out of Deduction u/s. 80IB by the DCIT:The Tribunal upheld the allocation of directors' expenses and part of administrative expenses to the eligible industrial undertaking and re-worked the deduction under section 80IB accordingly.18. Proposed disallowance out of depreciation on intangible by the DCIT:The assessee did not press this ground, and it was dismissed as not pressed.19. Initiation of Penalty Proceedings:The Tribunal held that the initiation of penalty proceedings was premature and dismissed this ground.Conclusion:The Tribunal allowed the appeal of the assessee partly, directing re-computation of adjustments based on the principles laid down in the judgment.