2025 (8) TMI 1676 - AT - Income Tax

Transfer pricing margins to be recomputed; export incentives and cash discounts treated as operating items; add comparables

M/s. ZF Rane Automotive India Private Limited Versus DCIT Non-Corporate Circle-8 (1) Chennai.

ITAT held the revenue's adjustments flawed and directed the AO/TPO to re-determine transfer-pricing margins in favour of the taxpayer. Export incentives ... TP Adjustment - Treatment of export incentives as operating income while computing the margin of Assessee - case of Revenue was that the same are non-operating income as some of the comparable companies do not have such income and hence, the same are to be excluded from operating margins of Assessee by applying the parity principle - HELD THAT:- In our view, the approach of the Revenue is fundamentally flawed. We believe the correct approach to determine whether an income is operating or non-operating would be heavily dependent upon the character of such income and its proximity to the normal business operation. Viewed from this angle, we feel that both the export incentives are intertwined with the core operation of manufacturing and export as the entitlement of such incentive is wholly on manufacturing and export. In fact, Section 28 of the Act, specifically states that these export incentives will chargeable to tax as “profits and gains of business or profession”, accordingly taking a cue from the corporate tax provisions it could be safely inferred that export incentives are operating in nature. Further, the Act does not provide any specific definition of the specific term “operating income”. Therefore we refer to other related Enactments/Rules to decipher the meaning of the aforesaid term. In this regard, the Safe Harbour Rules 10TA (1)(i) defines “operating revenue” in an inclusive manner to mean “the revenue earned by the assessee in the previous year in relation to the international transaction during the course of its normal operations but not including the following, namely (vii) other incomes not relating to normal operations of the assessee”. From this definition it is clear that an income to form part of operating income it should be derived from normal operations. Undoubtedly in the instant case, the export incentive is derived during the course of normal operations. We arrive at an emphatic conclusion that export incentives like Duty drawback and MEIS which have the effect of reducing the operating cost, ought to be considered as part of “operating revenue” while computing the margin of the Assessee and we direct so the TPO to re-determine the margin of the Assessee after including the same. Thus, this ground of appeal is decided in favour of the Assessee. Ground No.2.2 is allowed. Treatment of cash discount as non-operating income - whether the cash discount reflected as income in the Profit and Loss can be treated as operating revenue? - We agree in principal that cash discount ought to be treated as operating revenue and observation of the DRP by placing reliance on Rule 10TA of Safe Harbour Rules is not correct. In fact, even as per the definition of Safe harbour Rules, we are of the view that the said income is derived from the normal operation of business and therefore it ought to be treated as operating revenue. We also note that issue arising in the present appeal is squarely covered by the decision of this Tribunal in the case of M/s. Hyundai Motor India Limited [2021 (9) TMI 1013 - ITAT CHENNAI] wherein it has been held that discount income are to be considered as operating income for the purpose of computing operating margins. Following this decision, we direct so the TPO to re-determine the margin of the Assessee after including the same. Thus this ground of appeal is decided in favour of the Assessee. The grounds of appeal No.2.3 raised by Assessee is thus, allowed. Treatment of miscellaneous expenses as non-operating expense - Case of Revenue was that the Miscellaneous Expense is non-operating expense and it is excluded for comparable companies and similar expenses are excluded for Assessee as well by applying the parity principle. In our view, the approach of the Revenue is fundamentally flawed. We believe the correct approach to determine whether an expense is operating or non-operating would be heavily dependent upon the character of such expense and its proximity to the normal business operation. Viewed from this angle, we feel that Miscellaneous Expense is part of any normal business operation. In fact as per Section 37 of the Act, the same is allowed as business expenditure, accordingly taking a cue from the corporate tax provisions it could be safely inferred that Miscellaneous expense is operating in nature. Therefore Miscellaneous expense incurred by every company in its usual course of business cannot be said that they have no nexus with normal operation of business. We hold that Miscellaneous expense ought to be considered as part of “operating expense” of comparable companies (wherever applicable) irrespective of whether the assessee has incurred such Miscellaneous expense or not and we direct so the TPO to redetermine the margin of the comparable companies after including the same. Consideration of comparable segmental margins in the case of ZF Steering Gear Ltd as against entity level margins as considered by TPO - We find merit in the Assessee's above submission that since the audited financial statement of ZF Steering Gear Ltd provides segmental reports, the non-comparable segment need not be considered as there could be some degree of influence of such non- comparable segment on the overall margins as in the present case. Our view is also supported by case of M/s. CMA CGM Shared Service Centre (India) (P.) Ltd [2019 (10) TMI 1598 - ITAT CHENNAI] wherein the Tribunal has considered only comparable segment results of the comparable company instead of entity level results. We deem it appropriate to direct the AO/TPO to consider only the Auto component segment of ZF Steering Gear Ltd while benchmarking the international transaction. Accordingly, Ground No.2.10 is allowed. Comparable Jay Ushin Limited - We find that the Assessee has chosen Talbros Automotive as comparable company and the said company has been accepted by the TPO. Since the Assessee, Talbros Automotive and Jay Ushin are all in the same line of manufacturing auto components we hold that Jay Ushin should also be included as a comparable company. Therefore, we direct the TPO to include Jay Ushin in the final list of comparables companies. Shivam Autotech Limited - Assessee has chosen Auto International as comparable company, and the said company has bene accepted by the TPO. Auto International is engaged in manufacture of suspension shock absorbers, radiators, silencers, exhaust pipes and it is on the same line that of Shivam Autotech which manufactures transmission shafts, spline shafts, plunger, brakes, gear boxes etc., Since, Auto International has been accepted as comparable company, TPO ought to have also included Shivam Autotech also as a comparable company. Therefore, we direct the TPO to include the same in the final set of comparable companies. Omax Autos Limited be included as manufactures steering shafts, axle shafts, piston, Gear Shifter Shaft Assembly etc., Since, Talbros Automotive has been accepted as comparable company. ISSUES PRESENTED AND CONSIDERED 1. Whether export incentives (Duty Drawback and MEIS) earned by the tested party are to be treated as operating revenue for computation of operating margin under TNMM. 2. Whether cash discount income arising from early payment rebates is to be treated as operating revenue for computation of operating margin under TNMM. 3. Whether miscellaneous expenses disclosed by comparable companies are to be treated as operating expenses for comparability analysis under TNMM. 4. Whether segmental margins of a comparable company (auto-component segment of a diversified entity) should be used in lieu of entity-level margins where audited financial statements provide segmental results. 5. Whether certain companies proposed by the tested party are functionally comparable and therefore ought to be included in the final comparable set (specific companies addressed). ISSUE-WISE DETAILED ANALYSIS - Export Incentives (Duty Drawback & MEIS) Legal framework: Section 28 (profits and gains of business or profession) and Safe Harbour Rule 10TA (definition of 'operating revenue'); Cost Accounting Standards definition of 'Revenue from operations'; statutory and scheme documents governing Duty Drawback and MEIS. Precedent treatment: Conflicting authorities exist; some tribunal/H.C. rulings treat export incentives as operating (examples considered by the Tribunal) while other decisions (relying on parity and anti-shifting concerns) have excluded such incentives. The Tribunal examined specific precedents relied on by both sides and found distinguishable facts in decisions excluding incentives. Interpretation and reasoning: The Tribunal applied a character-and-nexus test - whether the income is derived from or proximate to normal business operations. Duty Drawback refunds duties embedded in the cost of imported inputs used in exported manufacture; MEIS rewards are available only upon manufacture and export and reduce manufacturing/export cost. Cost Accounting Standards and Rule 10TA treat government export incentives as part of 'other operating revenue.' Section 28 characterizes such receipts as business income. The parity principle cannot convert an intrinsically operational item into non-operating merely because some comparables did not have identical receipts. Ratio vs. Obiter: Ratio - export incentives that reduce operating cost and are intrinsically linked to manufacture/export qualify as operating revenue for TNMM margin computation. Observational/distinguishing remarks on contrary authorities are obiter to the extent they are fact-specific. Conclusion: Duty Drawback and MEIS to be treated as operating revenue; TPO directed to include them while re-determining operating margin. Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Cash Discount Income Legal framework: General accounting treatment and Section 37 (allowability of business expenditure) and Safe Harbour Rule 10TA's inclusive definition of operating revenue. Precedent treatment: Tribunal precedent treating discount/commission/incentive receipts as operating (e.g., Hyundai Motor India decision) was followed. Interpretation and reasoning: Cash discounts are realized as income consequent to earlier recognition of operating purchases/expenses; they directly reduce net cost of inputs and are therefore proximate to the tested party's normal operations. Whether presented gross (expense and separate income) or net (reduced expense), the economic effect is operational. Reliance on Rule 10TA to exclude such income was held to be incorrect when the income arises from normal operations. Ratio vs. Obiter: Ratio - cash discount income earned from early payment rebates on procurement constitutes operating revenue for TNMM. Rejection of DRP's blanket reliance on Safe Harbour rules is part of ratio. Conclusion: Cash discount to be included as operating revenue; TPO directed to rework margins accordingly. Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Miscellaneous Expenses Legal framework: Section 37 (allowability of business expenditure); Safe Harbour Rule 10TA (operating expense definition by exclusion); Cost Accounting Standards guidance on 'other operating revenue/expenses.' Precedent treatment: Tribunal decision (ITO vs E Value serve.com) treating miscellaneous items (many small-value items) as operating expenses was relied upon. Interpretation and reasoning: Classification depends on character and nexus to business. Miscellaneous expenses, though aggregated and small, typically arise in the ordinary course of business and are allowable under Section 37; mere absence of detailed break-up or non-availability of similar disclosure in comparables does not automatically render them non-operating. Parity principle (excluding the same from both tested and comparables) cannot justify omission where the nature suggests operational nexus. Ratio vs. Obiter: Ratio - miscellaneous expenses having nexus to normal operations must be treated as operating expenses for comparability; generic exclusions under Rule 10TA without enquiry are inappropriate. Observations on disclosure practices and materiality are supplementary. Conclusion: Miscellaneous expenses to be treated as operating expenses for comparable companies (where applicable); TPO directed to include them and rework margins. Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Use of Segmental Margins (ZF Steering Gear Ltd) Legal framework: TNMM comparability requires functional similarity; when audited financials present reportable segment information, segmental results are relevant for functional comparability. Precedent treatment: Tribunal authorities have accepted segmental margins where a comparable is a diversified entity and segmental information is available and relevant (CMA CGM Shared Service Centre and analogous decisions cited). Interpretation and reasoning: Where audited accounts provide segmental bifurcation and the relevant segment corresponds functionally to the tested party's activity, entity-level results may be distorted by non-comparable segments. Even if non-comparable segment revenue is small, the presence of separate segmental reporting in audited statements justifies using segmental margins to ensure 'like-to-like' comparison. Prior acceptance in the tested party's own subsequent assessment advised consistent treatment. Ratio vs. Obiter: Ratio - where audited segmental accounts exist and a segment is functionally comparable, the segmental margin should be used for TNMM benchmarking rather than entity-level margin. Ancillary remarks on threshold of revenue split are illustrative. Conclusion: Auto-component segmental margins of the comparable are to be used; TPO directed to consider segmental results only. Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Inclusion of Specific Comparable Companies Legal framework: TNMM comparability analysis requires functional similarity across functions, assets and risks; acceptance of one comparable with similar activities supports inclusion of others with analogous activities unless specific dissimilarities are established. Precedent treatment: Principle of like-to-like comparison and inclusion where TPO accepted companies engaged in similar product lines/functions; reliance on record comparability and prior acceptance in the comparable list. Interpretation and reasoning: For each challenged company the Tribunal compared the functional profile and product lines with (i) accepted comparables and (ii) the tested party. Where an accepted comparable (e.g., Talbros Automotive or Auto International) operated in the same product/functional space as the disputed company, exclusion for 'functional dissimilarity' was unsustainable. The Tribunal applied consistent comparability logic: if A is accepted and B operates in a similar line, B should also be considered unless specific adverse functional distinctions are demonstrated with supporting material. Ratio vs. Obiter: Ratio - the TPO must include the specific companies identified (Jay Ushin Ltd., Shivam Autotech Ltd., Omax Autos Ltd.) as comparables because functional similarity to accepted comparables was established; methodological parity requires inclusion. Observations on reworking the margin and giving opportunity to be heard are procedural directions. Conclusion: Directed inclusion of the specified comparable companies in the final comparable set and remand to TPO/AO to rework ALP in accordance with directions given above. Ground(s) allowed. CONSOLIDATED DIRECTIONS The Tribunal directed the TPO/AO to re-determine the tested party's and comparables' operating margins: (a) include export incentives (Duty Drawback & MEIS) as operating revenue; (b) include cash discount income as operating revenue; (c) include miscellaneous expenses as operating expenses where applicable; (d) use segmental margins for comparable companies where audited segmental reporting exists and the relevant segment is functionally comparable; and (e) include the specified functionally similar companies in the comparable set. Adjustments to ALP and consequential computations to be undertaken after providing opportunity of hearing. Appeal disposed as partly allowed.