2024 (10) TMI 1147 - AT - Income Tax

ITAT excludes multiple companies from transfer pricing comparables due to functional differences and high export sales

ITAT Delhi directed exclusion of multiple companies from transfer pricing comparables for an auto components manufacturer. Brakes India Pvt. Ltd., Clutch ... TP Adjustment - determination of Arm’s Length Price (‘AMP’) of international transactions entered - comparable selection - HELD THAT:- Elofic Industries Ltd. AND WABCO TVS (India) Ltd. Brakes India Pvt. Ltd. be excluded as functionally dissimilar with that of assessee, an Indian manufacturing for Auto components System and breaking system products. Brakes India Pvt. Ltd. is having diversified operations and diversified market, the Brakes India Ltd. cannot be proper comparable. Accordingly, we order to exclude Brakes India Pvt. Ltd. from the list of comparables. Clutch Auto Ltd. cannot be a valid comparable vis-à-vis a taxpayer having export sales of more than 10% . Accordingly, we direct the TPO to exclude it from the list of comparables. ANG Industries Ltd. excluded from comparables as total sales are not even near to the taxpayer which is having a meager export sale of 0.17% and since the comparable companies are operating in entirely different geographical market, the same cannot be a valid comparable vis-à-vis the taxpayer. Faiveley Transport Rail Technologies India Ltd. has revenue from comparable segment 26% and it has AMP expense ratio of 4% which is higher than filter of 2% which has been considered appropriate by the CIT(A) to direct the TPO to exclude from the comparable in the absence of any contrary materials on record, we find no error or infirmity in the finding and the conclusion of the CIT(A). XLO India Ltd. excluded having negative net worth - As per the financials of the XLO India Ltd., it had profit of Rs. 6,150/- thousand in AY 2010-11 and it had negative net worth in the same year. The net worth of the said company has been improved from previous three years and it is not the case of diminishing returns, to substantiate the above claim, the Assessee produced the working at Annexure A-1 to the submission filed on 13/06/2024 - thus as relying on the ratio laid down in the case of Gillette Diversified and Operation Pvt. Ltd.[2017 (5) TMI 1828 - DELHI HIGH COURT] and Welspun Zucchi Textiles Ltd. [2014 (2) TMI 1287 - ITAT MUMBAI] we direct the T.P.O. to consider XLO India as comparable company. Rane Brake Lining Ltd be excluded as the same is having AMP expense ratio of 4% which is higher than filter of 2% as considered appropriate by CIT(A) and it is also supplying goods in aftermarket segment. Sundram Brake Linings Ltd. sales are not even near to the taxpayer which is having a meager export sale of 0.17% and since the comparable companies are operating in entirely different geographical market, the same cannot be a valid comparable vis-à-vis the taxpayer. Determination of operating revenue - not considering the foreign exchange gain as operating income - Assessee contended that foreign exchange fluctuation is directly related to business transaction, therefore it is an operative item, therefore, the foreign exchange fluctuation should be considered as operating revenue - HELD THAT:- By relying on the order of the Co-ordinate Bench in Assessee’s own case for A.Y 2010-11 [2018 (7) TMI 2351 - ITAT DELHI] we direct to compute the operating margin of the tax payer, foreign exchange gain is to be considering the same as part of operating income for computing the operating margin as well as comparable companies. Accordingly, the Ground No. 4 of the Assessee is allowed. Not considering cash profit/operating income as profit level indicator on account of high depreciation component - It is the case of the assesses that the average depreciation/sales of the Assessee is 10.57%, therefore, sought adjustment on account of depreciation - TPO has not allowed the adjustment in PLI of the Assessee on the ground that for the tested party, no adjustment should be allowed in the net profit - HELD THAT:- As relying in Assessee’s own case for Assessment Year 2010-11 [2018 (7) TMI 2351 - ITAT DELHI] we direct the TPO to decide the issue afresh in the light of decision rendered in the case of ACIT Vs. Gates India Pvt. Ltd. [[2017 (8) TMI 282 - ITAT DELHI] and Schefenacker Motherson Ltd. [2009 (6) TMI 125 - ITAT DELHI] accordingly the Ground of the Assessee is partly allowed for statistical purpose. Issues Involved:1. Adjustment in Arm's Length Price (ALP) of international transactions.2. Selection of comparable companies.3. Consideration of foreign exchange gain as operating income.4. Adjustment on account of high depreciation.5. Use of cash profit/operating income as a profit level indicator.Detailed Analysis:1. Adjustment in Arm's Length Price (ALP) of International Transactions:The Assessee and Revenue both contested the adjustments made to the ALP of international transactions for the assessment years 2011-12 and 2012-13. The Assessee argued that the adjustments were erroneous due to incorrect selection of comparables and exclusion of certain income elements. The Revenue challenged the deletion of disallowances made by the CIT(A).For AY 2011-12, the TPO had computed an adjustment of Rs. 1,66,03,544 based on a set of comparables with an average PLI of 7.84%. The Assessee's PLI was computed at 1.33%. The Tribunal partly allowed the Assessee's appeal for statistical purposes, directing the TPO to reconsider the adjustments in light of the Tribunal's findings.2. Selection of Comparable Companies:The selection of comparables was a significant issue, with the Assessee contesting the inclusion of companies like Elofic Industries Ltd., WABCO TVS (India) Ltd., and Brakes India Pvt. Ltd. The Tribunal, following its earlier decisions, excluded these companies due to factors like high export turnover and functional dissimilarity.For AY 2012-13, the Tribunal directed the exclusion of Brakes India Pvt. Ltd. and Clutch Auto Ltd. from the list of comparables, citing similar reasons. The Tribunal emphasized the need for comparables to have similar geographical markets and functional profiles.3. Consideration of Foreign Exchange Gain as Operating Income:The Assessee argued that foreign exchange gains should be considered as operating income, which was initially rejected by the CIT(A) based on Safe Harbour Rules. However, the Tribunal, referencing its decision for AY 2010-11, directed that foreign exchange gains be treated as part of operating income for computing operating margins.4. Adjustment on Account of High Depreciation:The Assessee sought adjustments for high depreciation costs, arguing that it affected profitability comparisons. The CIT(A) had rejected this on the basis that depreciation adjustments are not typically allowed. The Tribunal, however, remanded the issue back to the TPO for reconsideration, citing similar cases where cash profits were used to account for excessive depreciation.5. Use of Cash Profit/Operating Income as Profit Level Indicator:The Assessee contended that cash profit should be used as a profit level indicator due to high depreciation. The Tribunal, following its previous decisions, remanded the issue to the TPO for fresh consideration, allowing the Assessee to demonstrate the impact of depreciation on profitability.Conclusion:The Tribunal's judgment involved a detailed examination of the selection of comparables, treatment of foreign exchange gains, and adjustments for depreciation. The appeals were partly allowed for statistical purposes, with directions for the TPO to reconsider certain issues in light of the Tribunal's findings and previous decisions. The judgment underscores the importance of accurate comparability analysis and the treatment of income elements in transfer pricing assessments.