2017 (8) TMI 282 - AT - Income Tax

Tribunal upholds TNMM for ALP, excludes depreciation in margins.

ACIT, Circle-12 (1) New Delhi Versus M/s. Gates India (P) Ltd.

The Tribunal upheld the CIT(A)'s decision to apply the Transactional Net Margin Method (TNMM) for determining Arm's Length Price (ALP), excluding ... TPA - application of TNMM as well as CUP as most appropriate method in respect of two transactions of import of goods and sale of finished products to the A.E. - Held that:- When the transactions are multiple and inter-related then if a particular transaction out of the composite transactions cannot be tested under CUP then it is not proper to apply separate methods for determining the ALP for each of the transaction, particularly, when the international transactions are closely linked and inter-depending having direct bearing on the price of each other. Therefore, we are of the considered opinion that in the given facts and circumstances of the case, the TNMM method would be the most appropriate method for determining the ALP of the international transactions entered into by the assessee. Hence, we do not find any error or illegality in the impugned order of the Ld. CIT(A) qua this issue. We, therefore, uphold the order of the Ld. CIT(A) on this issue. Exclusion of depreciation while computing the margins of the assessee as well as comparable companies to benchmark the international transactions - Held that:- Comparing only the depreciation cost of assessee and comparables will not serve the purpose as it will not gives the true and correct picture of the affairs. Hence, when high depreciation provided by assessee only on account of the new plant and machinery which is the state of art technology then the effect of reduction if any, in the cost of wages and salary has to be taken into consideration while comparing the depreciation cost of the comparable companies. Accordingly, on principle, we are of the view that if the assessee has brought on record a substantial difference in the cost of depreciation, then the depreciation has to be excluded to avoid the material difference. However, while undertaking this exercise of comparing the depreciation cost with the comparables, the other element and corresponding cost like wages and salary are also required to be taken into account. Accordingly, we set aside this issue to the record of the A.O./TPO for examining the same afresh Disallowance regarding testing fee by treating the same as capital in nature and further as FTS and by invoking the provisions of section 40(a)(ia) - Held that:- The testing of the product at the facility of the A.E. does not amount of rendering any technical services by the A.E. to the assessee but simply it is an activity of quality test of the product which is carried out outside India. In the absence of any material to show that assessee is using any technical knowledge or services rendered by the A.E. in the manufacturing process of its goods it cannot be treated as any technical services rendered by the A.E. Therefore, we do not find any material or facts either discovered by the A.O. or otherwise available on record to show that assessee has paid the testing fee for acquiring any technical knowledge or receiving any technical services from the A.E. Thus, the payments of testing fee to the A.E. is not fee for technical services. Since A.E. of the assessee is not giving any permanent establishment in India, therefore, the said receipt/income in the hands of the A.E. is not taxable in India and consequently, the assessee was under obligation to deduct TDS at source. As regards nature of expenditure being revenue or capital, we find that by incurring testing expenditure the assessee has not acquired any technology, advantage or enduring benefit but it is simply a quality test of its product. Therefore, it is part of the cost of the product and incurred only on the finished products of the assessee which has no connection with the manufacturing facility or plant of the assessee. Even otherwise, by incurring this expenditure, no new asset has come into existence and therefore, this expenditure cannot be categorised or classified as in capital field. Accordingly, we do not find any error or illegality in the order of the Ld. CIT(A) qua this issue. Disallowance made on account of computer software expenses treating as capital in nature - Held that:- Undisputedly, the assessee has incurred total expenditure of ₹ 6,27,988 under the head “Software Expenses”. The A.O. has made the addition of ₹ 4,39,592 on the ground that it is of capital in nature. At the outset, we note that the Ld. CIT(A) has decided this issue by following the decision of the Special Bench of the Tribunal in the case of Amway India Enterprise (2008 (2) TMI 454 - ITAT DELHI-C) as upheld by the Hon’ble Delhi High Court reported in (2011 (11) TMI 4 - DELHI HIGH COURT). Therefore, when the software package are only for smooth functioning of the business and has not brought into existence any new asset, then, having regard to the facts and circumstances of the case, we do not find any error or illegality in the order of the Ld. CIT(A). Appeal of the Revenue is partly allowed. Issues Involved:1. Deletion of addition on account of difference in Arm's Length Price (ALP).2. Non-affording of opportunity to the Transfer Pricing Officer (TPO) before computing margins.3. Deletion of addition on account of testing fees.4. Deletion of addition on account of computer software expenses treated as capital in nature.Detailed Analysis:1. Deletion of Addition on Account of Difference in Arm's Length Price (ALP):The assessee, a wholly-owned subsidiary of a US company, engaged in manufacturing and trading of hose pipes, reported multiple international transactions. The TPO applied the Transactional Net Margin Method (TNMM) and internal Comparable Uncontrolled Price (CUP) method for determining ALP, resulting in a proposed adjustment of Rs. 3,97,52,421. The CIT(A) accepted the assessee's contention that multiple TP adjustments using different methods were inappropriate and ruled that once TNMM was applied, separate ALP computation under CUP was unnecessary. The Revenue's appeal argued that depreciation is an essential part of operating costs and should not be excluded when computing margins under TNMM. The Tribunal upheld the CIT(A)'s order, agreeing that TNMM was the most appropriate method given the interrelated nature of the transactions.2. Non-affording of Opportunity to the TPO Before Computing Margins:The Revenue contended that the CIT(A) did not provide an opportunity to the TPO before computing margins. The Tribunal noted that the CIT(A) had accepted the assessee's claim for excluding depreciation from the total cost while computing margins. The Tribunal remanded the issue back to the AO/TPO to re-examine the exclusion of depreciation in light of the significant differences in depreciation costs between the assessee and comparable companies, considering the overall cost structure, including wages and salaries.3. Deletion of Addition on Account of Testing Fees:The AO disallowed Rs. 1,43,65,596 as testing fees, treating it as capital expenditure and fees for technical services (FTS), invoking Section 40(a)(ia) for non-deduction of TDS. The CIT(A) deleted the disallowance, accepting the assessee's explanation that the testing fees were for quality assurance and not for acquiring technical knowledge or services. The Tribunal upheld the CIT(A)'s decision, noting that the testing fees were not for technical services and did not result in any enduring benefit or asset creation, thus not capital in nature.4. Deletion of Addition on Account of Computer Software Expenses Treated as Capital in Nature:The AO disallowed Rs. 4,39,592 incurred on application software, treating it as capital expenditure. The CIT(A) deleted the disallowance, following the Special Bench decision in Amway India Enterprise vs. DCIT, which was upheld by the Delhi High Court. The Tribunal agreed with the CIT(A), noting that the software expenses were for the smooth functioning of the business and did not result in the creation of a new asset.Conclusion:The Tribunal upheld the CIT(A)'s order on the application of TNMM and exclusion of depreciation, remanding the issue for re-examination. It also upheld the deletion of disallowances on testing fees and software expenses, confirming that these were revenue expenditures. The Revenue's appeal was partly allowed.