2018 (9) TMI 1691 - AT - Income Tax

Assessee forced to use TNMM with external comparables; export incentives and scrap treated as operating income; s.14A limited, s.35(2AB) allowed

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

ITAT PUNE - AT held that the assessee's aggregation approach for benchmarking was rejected, but on parity with earlier orders the TNMM must be applied ... TPA - rejection of aggregation approach adopted by the assessee while benchmarking its manufacturing activity - comparable analysis - Held that:- We find that similar issue arose before the Tribunal in assessee’s own case in earlier years and the Tribunal in assessment year 2009-10 has decided the said issue in favour of assessee holding that various activities undertaken by the assessee are to be aggregated for determining arm's length price of international transactions. Most appropriate method to be applied - whether internal comparability was to be made i.e. profitability of export to associated enterprises was to be compared with domestic sales made by the assessee - Held that:- The said issue has been adjudicated by the Tribunal in earlier years and it has been held that TNMM method has to be applied and the margins of assessee are to be compared with average margins of external comparable companies. Treatment of export incentives while computing operating margins of assessee - AO/TPO held the same to be non-operating in nature, hence the same were excluded while computing operating margins of assessee - The case of Revenue was that the same are non-operating income and hence, the same are to be excluded from operating margins of assessee - held that:- We find that similar issue has been decided by the Hon’ble Bombay High Court in CIT Vs. Welspun Zucchi Textiles Ltd. [2017 (1) TMI 1037 - BOMBAY HIGH COURT] and it has been laid down that DEPB benefit arising to the assessee therein was operating revenue includable in arriving at operating profit. Export incentives and scrap sales are to be included as operating income. Accordingly, we hold that export incentives are to be considered as operating income of assessee, while benchmarking international transactions of assessee. Benefit of range of +/-5% is available if the variation does not exceed the said tolerance margin. Disallowance made under section 14A - formula adopted by the assessee of allocating the cost to earning of exempt income has been adopted for working out disallowance - Held that:- Disallowance under section 14A of the Act is to be restricted to ₹ 17,63,981/-. Hence, the ground of appeal partly allowed. Disallowance made under section 35(2AB) - Held that:- The assessee during the year under consideration has also claimed weighted deduction claim under section 35(2AB) of the Act and the issue raised stands squarely covered by the orders of Tribunal in earlier years in the hands of assessee. Applying the same parity of reasoning, we direct the Assessing Officer to allow weighed deduction under section 35(2AB) of the Act to the assessee. Issues Involved:1. Transfer Pricing Adjustment2. Rejection of Benchmarking3. Inappropriate Comparison of Profitability4. Exclusion of Export Incentive5. Application of Profit Level Indicator (PLI)6. Benefit of Variation/Reduction of 5%7. Disallowance of Expenses under Section 14A8. Disallowance of Deduction under Section 35(2AB)9. Initiation of Penalty ProceedingsDetailed Analysis:1. Transfer Pricing Adjustment:The assessee contested the adjustment of Rs. 31.28 crores made by the DCIT to the value of international transactions with its Associated Enterprises (AEs) concerning the export of IC engines and components. The adjustment was made disregarding the assessee's benchmarking approach of aggregating transactions using third-party comparables, while the DCIT used internal comparables. The Tribunal found that the issues raised were similar to those adjudicated in the assessee's favor in previous years (2005-06 to 2009-10), and thus, allowed the assessee's appeal on this ground.2. Rejection of Benchmarking:The DCIT rejected the third-party comparables selected by the assessee for benchmarking the manufacturing function. The Tribunal upheld the assessee's approach, referencing its earlier orders where it was held that the Transactional Net Margin Method (TNMM) should be applied, and the margins should be compared with external comparables. The Tribunal allowed the assessee's appeal on this issue.3. Inappropriate Comparison of Profitability:The DCIT compared the segmental profitability between 'export to AEs' and 'domestic sales,' ignoring differences in Functions, Assets, and Risks (FAR), and the nature of controlled transactions. The Tribunal reiterated its earlier stance that such comparisons should be made with external comparables, not internal segments, and allowed the assessee's appeal. The Tribunal also dismissed the related without-prejudice grounds as academic.4. Exclusion of Export Incentive:The DCIT excluded export incentives from the operating margin calculation. The Tribunal referenced the Bombay High Court's decision in CIT Vs. Welspun Zucchi Textiles Ltd. and its own previous rulings, holding that export incentives should be included as operating income. The appeal on this ground was allowed.5. Application of Profit Level Indicator (PLI):The DCIT used 'operating profit to total cost' as PLI instead of 'operating profit to sales' as selected by the assessee. The Tribunal found this issue covered by its earlier orders in favor of the assessee and allowed the appeal on this ground.6. Benefit of Variation/Reduction of 5%:The DCIT did not grant the benefit of +/- 5% from the arithmetic mean as per section 92C(2) of the Act. The Tribunal allowed the appeal, holding that the benefit is available if the variation does not exceed the tolerance margin.7. Disallowance of Expenses under Section 14A:The DCIT disallowed expenses related to exempt income. The Tribunal, following its earlier decisions, restricted the disallowance to Rs. 17,63,981/- based on the assessee's formula for allocating costs to earning exempt income.8. Disallowance of Deduction under Section 35(2AB):The DCIT disallowed the weighted deduction claimed under section 35(2AB) for R&D expenditure. The Tribunal, referencing its decision in the previous year, directed the DCIT to allow the weighted deduction, emphasizing that once the R&D facility is recognized, the expenditure should be allowed without curtailment.9. Initiation of Penalty Proceedings:The initiation of penalty proceedings under section 271(1)(c) was deemed premature by the Tribunal and thus dismissed.Revenue's Appeal:The Revenue's appeal contested the exclusion of certain comparables and the benchmarking of procurement support services. The Tribunal dismissed these grounds, stating that the issues become academic once the aggregation approach adopted by the assessee is accepted.Conclusion:The Tribunal partly allowed the assessee's appeals and dismissed the Revenue's appeals, applying the same reasoning and decisions from earlier assessment years. The order was pronounced on September 25, 2018.