Excise Duty Exemption Held Capital Receipt; Transfer Pricing Margins u/s 80-IC Recomputed Excluding Indirect Taxes

ITAT Delhi allowed the assessee's appeal. It held that, for transfer pricing and deduction u/s 80-IC, the operating profit margin of the eligible manufacturing unit in the backward area must be computed excluding excise duty, sales tax and income-tax, thereby directing the AO/TPO to recompute the margins accordingly. Further, on the additional ground, the Tribunal held that the excise duty exemption received by the unit, being an area-based incentive intended to promote industrial development and employment, constitutes a capital receipt and is not taxable under the normal provisions. Consequently, both the main ground and the additional ground were decided in favour of the assessee.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether, in determining the arm's length margin under the TNMM for the manufacturing segment located in a backward area, the operating profit margin should be computed after excluding the effect of excise duty and CST incentives specific to that backward area.

1.2 Whether the excise duty exemption availed under Central Excise Notification No. 49-50/2003-CE in respect of an industrial undertaking located in a specified backward area is a capital receipt, excludible from total income under the normal provisions as well as from computation under section 115JC.

1.3 How the transfer pricing issues relating to characterization of the assessee's activities, selection of comparables, applicability and scope of sections 80-IA(8), 80-IA(10) and 92BA, segment-wise benchmarking (manufacturing vs. trading), and the permissibility of entity-level TP adjustment are to be dealt with.

1.4 Effect of non-pressing of certain grounds of appeal by the assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Exclusion of excise duty and CST incentives while computing operating margin for TNMM

Interpretation and reasoning

2.1 The assessee's manufacturing unit is situated in a backward area of Himachal Pradesh and enjoys waiver of 12.5% excise duty (under Notification No. 50/2003-CE) and waiver of 2% CST under a State notification. The assessee contended that, for transfer pricing purposes under TNMM, its operating profit/operating revenue should be adjusted to neutralise these location-specific incentives so that its margin is properly comparable with margins of uncontrolled comparables that do not enjoy such benefits.

2.2 The Court noted that a co-ordinate Bench, in a case concerning a similar backward-area unit, had directed the AO/TPO to compute the operating profit margin "without considering the excise duty, sales tax and income-tax". The assessee placed reliance on this decision and on the fact that its claim was based on the same type of backward-area incentives.

2.3 On examination of the record, including financials, Form 10CCB and objections before the DRP, the Court found that the assessee had consistently claimed that its manufacturing profits were impacted by such backward-area benefits and that the lower authorities had not properly given effect to this location-specific aspect in the comparability analysis.

Conclusions

2.4 The Court directed that, for determining the operating profit margin under TNMM, excise duty and CST benefits specific to the backward-area unit are to be excluded. The ground relating to this adjustment was allowed.

Issue 2 - Nature of excise duty exemption: capital receipt and its treatment under normal provisions and section 115JC

Legal framework (as discussed)

2.5 The assessee's unit, located in a specified backward area, availed 100% excise duty exemption for ten years under Central Excise Notification No. 49-50/2003-CE, issued pursuant to an industrial policy for Himachal Pradesh/Uttaranchal. During the relevant year (the 10th year), the assessee availed excise duty exemption of Rs. 30,35,92,206 and claimed it as a capital receipt, not forming part of taxable income under normal provisions and also to be excluded for the purposes of section 115JC.

2.6 The assessee relied on the "purpose test" laid down by the Supreme Court in the decisions on subsidy characterisation, and on the High Court decision holding that excise duty refund/interest subsidy/insurance subsidy granted to promote industrialisation and employment in backward areas constituted capital receipts. The assessee also pointed to the Office Memorandum of the Ministry of Commerce & Industry and the scheme itself, evidencing that the objective was industrialisation of backward areas and generation of employment.

2.7 It was further urged that, even after insertion of section 2(24)(xviii), "exemption" from excise duty does not fall within its ambit, and that incentives under pre-existing schemes retain their character notwithstanding later legislative amendments.

Interpretation and reasoning

2.8 The Court observed that, as per the cited High Court judgment, excise duty subsidy and similar incentives granted for industrial development and employment generation in backward areas are capital receipts, applying the "purpose test". A co-ordinate Bench had already taken a similar view in an analogous matter involving excise incentives.

2.9 In light of the purpose of the excise exemption scheme for the backward area and the judicial precedents cited, the Court treated the exemption as a capital receipt in the hands of the assessee. It followed that, being a capital receipt with no profit element, it was not chargeable to tax under normal provisions and, correspondingly, not includible in the computation under the alternative minimum tax provisions.

Conclusions

2.10 The excise duty exemption of Rs. 30,35,92,206 availed under the backward-area notification was held to be a capital receipt, to be excluded from total income under the normal provisions and also to be excluded in computing income under section 115JC. The additional ground on this issue was allowed.

Issue 3 - Transfer pricing characterisation, benchmarking, comparables, and scope of adjustment (grounds 4-10)

Interpretation and reasoning

2.11 The assessee raised multiple objections to the TP analysis adopted by the TPO/DRP, inter alia:

(a) that the authorities had wrongly characterised the assessee as manufacturing "electronics including hardware" or "computers, its parts, UPS, inverters and all kinds of electric and electronics goods" contrary to the TP study which demonstrated that the assessee was engaged primarily in manufacturing UPS, inverters, stabilisers, wires and parts thereof, with about 82% of turnover from UPS, inverters and stabilisers;

(b) that manufacturing and trading activities, clearly distinguished in the financials, had been wrongly consolidated and not benchmarked separately;

(c) that TP provisions were applied to the trading segment merely because it appeared in Form 3CEB, without proper regard to the limited scope of specified domestic transactions;

(d) that the TPO/DRP presumed applicability of sections 80-IA(8) and 80-IA(10) only on the basis of the filing of Form 3CEB, without requisite findings about non-correspondence to market value or existence of any "arrangement";

(e) that comparables were selected randomly without ensuring functional similarity with the assessee's products, and without availability/consideration of financials and segmental data; and

(f) that the TP adjustment was wrongly made at the entity level, instead of being confined to the specific transactions falling within sections 80-IA(8) or 80-IA(10).

2.12 The Court noted that the TP study recorded manufacturing constituting about 82% of turnover; that the assessee's grievance was that these factual aspects and segmental distinctions had not been properly appreciated; and that there were allegations of inappropriate selection of comparables and of overbroad application of TP provisions.

2.13 It was observed that the assessee pointed out infirmities in the impugned TP order and sought a fresh, proper adjudication considering financials, segment-wise details and statutory preconditions for invoking sections 80-IA(8)/(10) and 92BA. The Revenue raised no objection to remand of the TP issues to the Assessing Officer.

Conclusions

2.14 All issues raised in grounds 4 to 10 concerning characterisation of the assessee's activities, the need for separate benchmarking of manufacturing and trading, the applicability and scope of sections 80-IA(8), 80-IA(10) and 92BA, the selection and comparability of alleged comparables, and the propriety of entity-level TP adjustment were remanded to the Assessing Officer for de novo adjudication in accordance with law, after affording due opportunity of hearing to the assessee.

Issue 4 - Non-pressed grounds

Conclusions

2.15 The assessee did not press grounds relating to: alleged invalidity of the DRP's order for want of DIN; alleged invalidity for not being passed through ITBA and without digital signatures; the contention that TP adjustments cannot be made at entity level; and the issue concerning retrospective operation of amendments to sections 43B and 36(1)(va) vis-à-vis employees' contribution to ESI/EPF. These grounds were dismissed as not pressed.

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