2022 (8) TMI 118 - AT - Income Tax

Tribunal Partially Upholds Appeal on Transfer Pricing, Allows Working Capital Adjustment

The Tribunal partly allowed the appeal, upholding the inclusion of Triton Valves Ltd. as a comparable under TNMM for transfer pricing but directing the AO ... TP Adjustment - Method of determining Arm’s Length Price - TNMM used for determining the ALP between the AEs - assessee is in the manufacture of hydraulic valves for automobiles and industrial machinery - HELD THAT:- Under TNMM, the net profit of a controlled transaction of an associated enterprise (tested party) is determined and this net profit is then compared to the net profit realized by comparable uncontrolled transactions of independent enterprises. As opposed to other transfer pricing methods, the TNMM requires transactions to be “broadly similar” to qualify as comparable. “Broadly similar” in this context means that the compared transactions don’t have to be exactly like the controlled transaction. This increases the amount of situations where the TNMM can be used and thus TNMM is the most commonly used methodology applied and accepted for determining the ALP. When TNMM is used for determining the ALP, it is not necessary for the comparable company and the taxpayer to cater to the same industries in order to be functionally comparable. Further TNMM does not require strict product comparability. Therefore we are of the considered view that that the contention of the assessee that the products of Trion Valves and the industry to which Triton Valves serve are not comparable with assessee is not tenable as the most appropriated method as chosen by the assessee for determination of ALP is TNMM. Comparable selection - Oswal Industries Ltd., for example serves mainly to oil companies and the valves manufactured by this company is different from the valves of the assessee. It is also noted that one of comparables chosen by the assessee in the TP Study, namely KAR mobiles is into Manufacture and Exporters of Engine Valves for Applications in Segments such as Agricultural / Indusrial /Stationary, Automotive - Passenger Cars / Light Commercial Vehicle / Heavy Commercial Vehicles, Battle Tanks, Farm Trackors, High Performance Cars, Locomotives and Marine. If the contention of the assessee is to be accepted then the inclusion of these companies as comparable as by assessee needs to be questioned. We are therefore in agreement with the decision of the TPO and CIT(A) that under TNMM method the comparison is done at a broader level and narrow comparison is not applied. In the light of the above, we uphold the order of the AO including the Triton Valves as a comparable and dismiss the appeal of the assessee. Working capital adjustment while computing ALP - AO is not justified in denying the working capital adjustment to the assessee. We accordingly direct the AO to allow the working capital adjustment. The assessee appeal on this ground is allowed. Nature of expenditure - purchase of tools and spares - revenue or capital expenditure - HELD THAT:- On perusal of the list of the tools treated as capital in nature and we find that the value per item in the entire list is not significant. The ratio laid down in SARAVANA SPINNING MILLS P. LTD. [2007 (8) TMI 16 - SUPREME COURT] is that these tools need to have independent functions and also they need to have a benefit of enduring nature. In the given case as submitted by the Ld AR these tools are spares used in the operations of the assessee to facilitate the manufacture of finished products that have short working life needing frequent replacement and do not have any independent function. The test of enduring benefit is not the only criteria for concluding an item to be revenue or capital in nature. The value of each of the items, resale value etc also warrants consideration - tools are to be treated as revenue in nature and eligible to be claimed as expenditure in the profit and loss account. Hence, we allow the ground in favour of the assessee. Issues Involved:1. Transfer Pricing Adjustments2. Corporate Taxation MattersDetailed Analysis:1. Transfer Pricing Adjustments:a) Inclusion of Triton Valves Ltd. as Comparable:The assessee contended the inclusion of Triton Valves Ltd. as a comparable entity in the transfer pricing study. The assessee argued that Triton Valves manufactures products entirely different from those manufactured by the assessee, thus making it an unsuitable comparable. The Tribunal analyzed the Functional, Asset, and Risk (FAR) profile of the assessee and noted that the Transactional Net Margin Method (TNMM) was used to determine the Arm's Length Price (ALP). The Tribunal held that under TNMM, strict product comparability is not required, and broad functional comparability suffices. The Tribunal found that other comparables accepted by the assessee also manufactured different products for various industries. Therefore, the Tribunal upheld the inclusion of Triton Valves Ltd. as a comparable and dismissed the appeal on this ground.b) Exclusion of Working Capital Adjustment:The assessee argued for the inclusion of working capital adjustments while computing the ALP, stating that the large credit period from its Associated Enterprise (AE) significantly impacted its liquidity and profitability. The Tribunal observed that working capital adjustments are permissible and cited several judicial pronouncements supporting this view. The Tribunal directed the Assessing Officer (AO) to allow the working capital adjustment, thereby allowing the assessee's appeal on this ground.2. Corporate Taxation Matters:a) Disallowance of Tools and Spares as Revenue Expenditure:The AO had added back Rs.1,68,36,376/- debited to the profit and loss account towards the purchase of consumable tools, treating it as capital expenditure. The DRP, after calling for a remand report, allowed Rs.1,50,23,759/- as revenue expenditure and sustained the addition of Rs.18,12,617/- as capital expenditure. The assessee appealed against the addition of Rs.18,12,617/-. The Tribunal examined the list of tools and found that the value per item was not significant and that these tools were used in operations with a short working life, needing frequent replacement, and did not have any independent function. The Tribunal concluded that these tools should be treated as revenue in nature and allowed the assessee's appeal on this ground.Conclusion:The appeal was partly allowed. The Tribunal upheld the inclusion of Triton Valves Ltd. as a comparable under TNMM but directed the AO to allow the working capital adjustment. Additionally, the Tribunal allowed the assessee's claim for treating the tools and spares as revenue expenditure.