2021 (3) TMI 270 - AT - Income Tax

Tribunal overturns order on international transaction pricing, orders fresh assessment by tax authorities.

The Tribunal set aside the impugned order on ALP determination of international transactions related to the Distribution activity, directing a fresh ... TP adjustment in Distribution activity, described as ESAS (Engine sale, Spares sale and After-sale service) - ALP determination - International transaction - commission income earned by the assessee on transactions of rendering marketing services for which the credit notes were issued by the AEs during the year under consideration, but invoices were raised in earlier year(s) - HELD THAT:- The scope of the international transaction of rendering marketing services broadly commences with the doing of background work for sale as a step one, followed by actual sale as a step two and ending with the realization of the invoice value by the AE from the Indian customers as a step three. It is only on the completion of the step three that the international transaction of rendering marketing support services comes to an end resulting into accrual of income therefrom and the consequential ALP determination. Thus all the operating costs/revenue pertaining to the above broad activities running into three steps leading to the international transaction of rendering marketing support services are to be considered for determining its ALP under rule 10B(1)(e). To put it differently, only the costs/revenue which are either anterior to the step one or exterior to the step three need to be ignored. As clear from the details of ₹ 5.65 crore given by the assessee that it carried out the above referred first two steps of rendering marketing support services in the earlier years, which is evidenced from the fact that the invoices were raised by the AEs in preceding years. A fortiori, all the operating costs incurred by the assessee in earlier years on such rendition of services are also required to be included in the operating cost base while determining the ALP of the transaction on its completion in the year under consideration. Necessary details in respect of the commission income of ₹ 3.02 crore as discussed in the earlier para and the amount of operating expenses incurred in preceding years towards the international transaction under consideration are wanting. We, therefore, set-aside the impugned order and direct the AO/TPO to decide the issue accordingly. Comparability - Cuprum Bagrodia Ltd., whose OP/OR was taken by the TPO at 18.33%. The assessee contended before the DRP that the calculation of the PLI was not correct inasmuch as this company was into two business segments, namely, Trading segment and Mining segment and only the Trading segment was to be considered as comparable. As against that, the TPO had computed the PLI by taking entity level figures. The DRP on page 13, directed the AO to consider the segmental data. While giving effect to the direction of the DRP, the TPO in his letter to the AO, took adjusted PLI of this company at 6.12%. The case of the assessee is that the PLI of this company is 0.50%. Under these circumstances, we direct the AO/TPO to verify the contention of the assessee and adopt the correct PLI of Cuprum Bagrodia Ltd. George Oakes Limited - TPO adopted the PLI of this company at 5.45%. The DRP observed that the TPO computed operating profit by also considering nonoperating revenue and costs. While giving effect to the direction of the DRP, the TPO determined PLI of this company at 4.77%. The case of the assessee is that the PLI of this company should be (-) 0.22%. The AO/TPO is directed to verify the assessee’s contention and adopt correct PLI while determining the ALP. Correct turnover filter - As seen that the TPO applied a particular turnover filter, which was modified by the DRP in para 11.2.3 of its direction. The AO, while giving effect to the direction of the DRP, inadvertently overlooked the same. The AO is directed to comply with the direction given by the DRP. TP adjustment should be restricted to the international transaction alone - ALP and the consequential transfer pricing adjustment are contemplated only in respect of the international transactions and not the entity level transactions. The TPO, in the instant case computed transfer pricing adjustment in respect of entity level transactions. We direct to restrict it to the AE transactions under consideration and not the entity level transactions. To sum up, we set aside the impugned order on ALP determination of the international transactions of the `Distribution activity’ and restore the matter to the file of the AO/TPO for a fresh determination of the ALP in accordance with our above observations/directions. Needless to say, the assessee will be allowed a reasonable opportunity of hearing. Addition u/s 40(a)(ii) - Education cess on income tax and secondary and higher education cess on income tax - HELD THAT:- We find that this issue is no more res integra in view of the judgment of Sesa Goa Lt. Vs. JCIT [2020 (3) TMI 347 - BOMBAY HIGH COURT] in which it has been held that Education Cess is not disallowable expenditure u/s.40(a)(ii) of the Act. Similar view has earlier been taken in Chambal Fertilisers and Chemicals Ltd. and Another [2018 (10) TMI 589 - RAJASTHAN HIGH COURT]. We direct to allow deduction for such an amount after verification. Issues Involved:1. Transfer pricing adjustment related to the Distribution activity.2. Inclusion of prior period commission income in operating revenue.3. Determination of Profit Level Indicator (PLI) for comparables.4. Application of correct turnover filter.5. Restriction of transfer pricing adjustment to international transactions.6. Deduction of education cess and secondary and higher education cess on income tax.Issue-wise Detailed Analysis:1. Transfer Pricing Adjustment Related to the Distribution Activity:The assessee contested the transfer pricing adjustment of Rs. 4,28,63,019/- made by the AO in the Distribution activity. The AO referred the international transactions to the TPO, who segregated the Engineering services segment from the Distribution segment for benchmarking. The TPO computed the assessee’s PLI at (-) 2.95%, leading to a transfer pricing adjustment of Rs. 4,80,08,677/-. The DRP gave certain directions, but no relief was provided regarding the exclusion of prior period commission income of Rs. 5.65 crore. The TPO, in his letter to the AO, worked out the adjustment at Rs. 4.28 crore with seven comparables and their fresh mean adjusted profit margin at 6.96%.2. Inclusion of Prior Period Commission Income in Operating Revenue:The assessee argued that the prior period commission income of Rs. 5.65 crore should be included in the operating revenue for determining the ALP. The Tribunal noted that the commission income was recognized when the AE issued credit notes, which was the final step in the marketing support services. Therefore, the commission income of Rs. 5.65 crore should be included in the operating revenue base for determining the ALP. However, the Tribunal directed the AO/TPO to verify if the non-issuance of credit notes for Rs. 3.02 crore was due to incomplete transactions or a delay by the AE.3. Determination of Profit Level Indicator (PLI) for Comparables:The assessee objected to the PLI determination for two comparables, Cuprum Bagrodia Ltd. and George Oakes Limited. For Cuprum Bagrodia Ltd., the TPO computed the PLI at 18.33%, but the DRP directed the AO to consider segmental data, resulting in an adjusted PLI of 6.12%. The assessee contended that the correct PLI was 0.50%. For George Oakes Limited, the TPO computed the PLI at 5.45%, but the DRP directed the TPO to exclude non-operating revenue and costs, resulting in a PLI of 4.77%. The assessee argued that the correct PLI was (-) 0.22%. The Tribunal directed the AO/TPO to verify and adopt the correct PLI for both comparables.4. Application of Correct Turnover Filter:The TPO applied a turnover filter, which was modified by the DRP. However, the AO overlooked this modification while giving effect to the DRP's directions. The Tribunal directed the AO to comply with the DRP's direction regarding the turnover filter.5. Restriction of Transfer Pricing Adjustment to International Transactions:The assessee raised an additional ground that the transfer pricing adjustment should be restricted to international transactions alone. Section 92 of the Act mandates that the ALP and the consequential transfer pricing adjustment should be in respect of international transactions only. The Tribunal directed the AO/TPO to restrict the adjustment to AE transactions and not entity-level transactions.6. Deduction of Education Cess and Secondary and Higher Education Cess on Income Tax:The assessee argued for the deduction of education cess and secondary and higher education cess on income tax. The Tribunal referred to the judgment of the Hon’ble jurisdictional High Court in Sesa Goa Ltd. Vs. JCIT (2020) 423 ITR 426 (Bom.), which held that education cess is not disallowable u/s.40(a)(ii) of the Act. The Tribunal directed to allow the deduction for such an amount after verification.Conclusion:The Tribunal set aside the impugned order on ALP determination of the international transactions of the Distribution activity and restored the matter to the AO/TPO for fresh determination in accordance with the Tribunal's observations and directions. The appeal was partly allowed for statistical purposes.