Tribunal Adjusts Transfer Pricing, Allows Appeal with Functional Comparability Guidelines

The tribunal partly allowed the appeal, reducing the addition on account of transfer pricing adjustment to Rs. 23.76 crore from Rs. 31.61 crore. It upheld the inclusion of extraordinary costs as operating costs and directed the exclusion of capital expenses from the base amount for transfer pricing adjustment. The tribunal instructed the selection of comparables based on functional comparability, including Bharat Glass Tube Ltd. and Triveni Glass Ltd. It set aside the disallowance made under section 14A of the Income-tax Act, directing a reasonable disallowance as per relevant case law.

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Issues Involved:
1. Addition of Rs. 23.76 crore on account of transfer pricing adjustment.
2. Treatment of extraordinary cost by the TPO as operating cost.
3. Transfer pricing adjustment in respect of capital expenses.
4. Selection of comparables.
5. Addition of Rs. 4,10,000/- made u/s 14A of the Income-tax Act.

Detailed Analysis:

I. Addition of Rs. 23.76 crore on account of transfer pricing adjustment:
The primary issue in this appeal is the addition of Rs. 23.76 crore due to transfer pricing adjustment. The assessee, an Indian company involved in manufacturing various types of glass, reported ten international transactions. The Transfer Pricing Officer (TPO) focused on transactions under the Float glass division, disputing four out of ten transactions. These transactions included fees for technical services, purchase of capital goods, and import of machinery spares and glass. The TPO recalculated the Operating Profit/Total Cost (OP/TC) of the Float glass division by including extraordinary costs due to rainfall, resulting in a transfer pricing adjustment of Rs. 31.61 crore. The Dispute Resolution Panel (DRP) provided some relief, reducing the addition to Rs. 23.76 crore.

II. Treatment of extraordinary cost by the TPO as operating cost:
The TPO included extraordinary costs of Rs. 12.44 crore, incurred due to unrelenting rainfall, in the operating costs. The assessee argued that these costs should be excluded from operating costs as they were extraordinary. However, the tribunal held that adjustments due to differences between international transactions and comparables should be made in the profit margin of comparables, not the assessee’s profit margin. The tribunal cited Rule 10B(1)(e) and various precedents to support this view. The tribunal also noted that the assessee did not demonstrate that comparables did not incur similar extraordinary costs. Therefore, the tribunal upheld the TPO’s decision to include these costs in the operating costs.

III. Transfer pricing adjustment in respect of capital expenses:
The TPO included capital expenses in the base amount for applying the profit margin of comparables. The tribunal held that capital expenses, which were capitalized in the balance sheet, should not be included in the base amount for calculating transfer pricing adjustment under the Transactional Net Margin Method (TNMM). The tribunal directed the TPO/AO to exclude these capital expenses from the base amount and to benchmark these transactions separately under the Comparable Uncontrolled Price (CUP) method. This separate benchmarking would determine the arm’s length price for these transactions, affecting the depreciation allowance.

IV. Selection of comparables:
The TPO selected three comparables: Gujarat Guardian Ltd., Hindustan National Glass, and Saint Gobain Glass India, while excluding Bharat Glass Tube Ltd. and Triveni Glass Ltd. The tribunal directed the inclusion of Bharat Glass Tube Ltd., citing functional comparability and the principle that high/low turnover alone is not a ground for exclusion. Triveni Glass Ltd. was also included as it was not a consistent loss-making company and there were no extraordinary reasons for its loss. The tribunal upheld the inclusion of Gujarat Guardian Ltd., finding the assessee’s objections unconvincing.

V. Addition of Rs. 4,10,000/- made u/s 14A of the Income-tax Act:
The AO disallowed Rs. 4,10,000/- under section 14A, invoking Rule 8D, as the assessee earned exempt dividend income. The tribunal noted that Rule 8D applies only from the assessment year 2008-09, and for earlier years, disallowance should be made on a reasonable basis. The tribunal set aside the AO’s order on this issue and directed the AO to make a reasonable disallowance as per the jurisdictional High Court’s judgment in Maxopp Investments Ltd. Vs. CIT.

Conclusion:
The tribunal partly allowed the appeal for statistical purposes, directing recalculations and adjustments as per its detailed findings on each issue. The order was pronounced in the open court on 06.04.2016.

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