2015 (7) TMI 568 - AT - Income Tax

Tribunal adjusts Cost Plus Method, allows inclusion of trading profits for deduction under Section 10B

The Deputy Commissioner of Income Tax, Circle 11 (3), Bangalore Versus M/s. GE BE Pvt. Ltd. and vice-versa

The Tribunal partly allowed the assessee's appeal, directing the TPO to make reliable and accurate adjustments for functional differences while applying ... Transfer pricing adjustment - determination of Arm’s Length Price (ALP) in respect of the international transaction of sale of manufactured goods by the Assessee to one its Associated Enterprise (AE) - claim of the Assessee that TNMM should be adopted as the MAM instead of CPM -selection of comparable - Held that:- In the instant case, the assessee has not made out any case or adduced any evidence to demonstrate that there has been any change in the facts, functionalities or availability of data. Nor is it the assessee's case that any of these have been taken wrongly in the TP Study that warrant a change of method has become necessary. The only reason for seeking change of method is that the comparables chosen by the TPO are different from that chosen by the assessee and that the functional profile of the comparables are different. While the aspect of functional difference has been discussed in the later part of the order, we can conclude here that the change of method sought by the assessee is not in tune with the Indian TP Rules, which finds support in the UN TP Manual. A careful perusal and analysis of the assessee's submissions before the CIT (Appeals) clearly places the assessee's stated position as one that accepts CPM as the MAM, provided certain adjustments are made for the differences in the marketing and selling functions, based on the actual expenses incurred by the companies. We, therefore, clearly find that it is before the Tribunal that the assessee has changed its stand, stating that TNMM is the MAM and that it would be absurd to consider CPM to be the MAM. TNMM was broached as an alternative approach only during the appellate proceedings. As we have already held, the concept of alternate approach or use of more than one method is not recognized in Indian TP Rules. The Indian TP Rules recognize use of only one method – the most appropriate method (MAM). Based on the discussions in the pre paragraph of this order, CPM is the MAM in this case. TPO has not given any weightage to the various aspects pointed out by the assessee which call for making appropriate adjustments to the margins of the comparable companies, as required under Rule 10B(1)( c )(iii), (ic) & (v) of the Rules. The computation of adjustment at 8% made by TPO is not backed by proper reasoning or rationale. The comparables selected by the TPO perform additional functions in the nature of selling & marketing thus evidencing functional differences with the appellant. This fact has been acknowledged by the TPO, but while giving adjustment, the TPO has computed the adjustment at an adhoc figure of 8%. In view of the difference in functions, the assessee is entitled to adjustments which are reliable and accurate, as stipulated in Rule 10C(2)(e) of the Rules. If such adjustments are provided on actual basis, the difference in the functional profile with the comparable companies gets quantified as provided in Rule 10B(1)( c ) (iii) as applicable to Cost Plus Method (CPM). In the absence of such adjustment, a mere application of CPM on comparables with different functional profile will not be intune with the TP Rules. Therefore, as CPM is adopted as the MAM, the assessee should be allowed adjustment on actual basis, which will reliable and accurate, as stipulated in Rule 10C(2). Needless to add, the TPO will afford opportunity of hearing to the assessee with leave to file detailed submissions in this regards, if necessary. - Decided in favour of assessee for statistical purposes. Profit derived from the business of the Export Oriented Unit (‘ECU’) by exporting spare parts, components etc. - whether was ineligible for deduction under section 10B of the Act and treating the export of spare parts, components as a “trading activity”? - Held that:- It is clear from the decision of the Special Bench in the case of Maral Overseas Ltd. [2012 (4) TMI 345 - ITAT INDORE ] that as far as deduction u/s. 10B is concerned, it is the profits of the business which have to be considered. Such profits will include even profits from trading activity. The Special Bench has clearly laid down that in section 80HHC, the legislature restricted the meaning of the words ‘profits of the business’ in Explanation (baa) to section 80HHC, but in section 10B, no such restriction or exclusion is laid down. The Special Bench thus opined that profits of the business would include all profits having nexus with the business of the assessee. In view of the decision of the Special Bench referred to above, we are of the view that the claim of the assessee should be accepted - Decided in favour of assessee. Excluding the turnover on account of spares and components from the export turnover without excluding the same from the total turnover while computing deduction u/s. 10B - Held that:- This issue is no longer res integra and has been settled by the decision of the Hon’ble High Court of Karnataka in the case of Tata Elxsi Ltd. (2011 (8) TMI 782 - KARNATAKA HIGH COURT), wherein held that whatever is excluded from the export turnover should also be correspondingly reduced from the total turnover while computing deduction u/s. 10B of the Act. Following the decision of the Hon’ble High Court of Karnataka, we direct the AO to exclude the turnover from export of spares & components both from the total turnover as well as the export turnover. Income from scrap sales - whether would form part of the profits of the undertaking eligible for deduction u/s. 10B? - Held that:- It is not in dispute before us that in assessee’s own case, this Tribunal has taken a view that income from sale of scrap should form part of profits of the undertaking eligible for deduction u/s. 10B of the Act.In the circumstances, following the decision of the Tribunal in assessee’s own case, we uphold the order of the ld. CIT(Appeals) - Decided against revenue. Selection of comparables - Held that:- We are of the view that 25% export earning is an appropriate filter and the fact that by applying that filter only one company is left as a comparable, will not be a ground not to apply the aforesaid filter. We are therefore of the view that the ld. CIT(A) was correct in applying 25% export earnings filter.- Decided against revenue. Issues Involved:1. Determination of Arm's Length Price (ALP) for international transactions.2. Applicability of Cost Plus Method (CPM) versus Transactional Net Margin Method (TNMM) for determining ALP.3. Eligibility of trading profits for deduction under Section 10B of the Income Tax Act.4. Inclusion of scrap sales in the profits eligible for deduction under Section 10B.5. Application of the 25% export earnings filter for comparables in Transfer Pricing.Issue-wise Detailed Analysis:1. Determination of Arm's Length Price (ALP) for international transactions:The assessee, a joint venture, engaged in manufacturing and international transactions with its Associated Enterprises (AE), claimed that the price received for its manufactured goods was at arm's length. The Transfer Pricing Officer (TPO) rejected the comparables selected by the assessee, which were from the automobile parts industry, and instead chose comparables from the medical equipment industry. The TPO determined the ALP based on the Cost Plus Method (CPM) and added an adjustment to the assessee's income. The assessee argued for the adoption of the Transactional Net Margin Method (TNMM) as an alternative, which was rejected by the TPO and the CIT(A).2. Applicability of Cost Plus Method (CPM) versus Transactional Net Margin Method (TNMM) for determining ALP:The Tribunal analyzed the appropriateness of CPM versus TNMM. The assessee initially adopted CPM but later argued for TNMM, citing differences in functional profiles of the comparables. The Tribunal held that there is no estoppel in taxation matters, and the most appropriate method should be determined based on the facts and circumstances. The Tribunal concluded that CPM is generally the most appropriate method for contract manufacturers like the assessee, provided reliable and accurate adjustments are made for functional differences. The Tribunal directed the TPO to allow adjustments on an actual basis to account for these differences.3. Eligibility of trading profits for deduction under Section 10B of the Income Tax Act:The assessee exported spare parts and components, earning a profit, which it claimed as eligible for deduction under Section 10B. The AO and CIT(A) excluded this profit, considering it as trading income. The Tribunal referred to the Special Bench decision in Maral Overseas Ltd. v. ACIT, which held that the entire profits of the business, including trading profits, should be considered for deduction under Section 10B. The Tribunal allowed the assessee's claim, stating that profits of the business include all profits having a nexus with the business.4. Inclusion of scrap sales in the profits eligible for deduction under Section 10B:The revenue contended that income from scrap sales should not be included in the profits eligible for deduction under Section 10B, arguing a lack of nexus with manufacturing activity. The Tribunal, following its earlier decision in the assessee's own case, held that income from scrap sales forms part of the profits of the undertaking and is eligible for deduction under Section 10B.5. Application of the 25% export earnings filter for comparables in Transfer Pricing:The CIT(A) directed the TPO to apply a 25% export earnings filter for selecting comparables, which the revenue challenged. The Tribunal upheld the CIT(A)'s decision, stating that the filter is appropriate and the fact that only one comparable remains after applying the filter does not invalidate its application. The Tribunal dismissed the revenue's grounds on this issue.Conclusion:The Tribunal partly allowed the assessee's appeal, directing the TPO to make reliable and accurate adjustments for functional differences while applying CPM. The Tribunal also allowed the inclusion of trading profits and scrap sales in the profits eligible for deduction under Section 10B. The revenue's appeal was dismissed, affirming the application of the 25% export earnings filter for comparables.