TaxTMI 
TaxTMI 
2009 (6) TMI 125
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....g rear view mirror manufacturer for the Indian automobile industry. Its operations comprise of manufacturing of manual rear view mirrors which are supplied in the domestic market to car manufacturers such as Maruti, Ford, Toyota, Hyundai, etc. and cable assemblies which are exported to the group companies worldwide. 2.2 The Schefenacker Group companies have provided SML with technical information, know-how for the design and manufacturing of rear view mirror and related cable assemblies, and the required technologies and logistics support by way of technical engineering instructions, technical training, quality control, etc. 2.3 The taxpayer's associated concerns are responsible for complex product development, R&D, quality standards and processes, marketing and brand building and also for developing relationships with various OEMs and thus enjoys significant brand equity in the global markets. 2.4 A new plant was set up at Chennai in July, 2002 by taxpayer SML to manufacture/assemble door handles and T-Gate besides the existing product lines for catering to Hyundai India. 3. The taxpayer SML filed with return of income, a transfer pricing report (TP report) which revea....
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....of cash profit/sale of 9 comparable companies at 8.33 per cent using data for financial years 2001-02 and 2002-03. Taxpayer's cash profit/sale of the financial year 2002-03 was shown at 8.85 per cent. Since the margin of profit of the taxpayer was higher than the average arithmetic mean of nine comparable companies, the TP report claimed that the taxpayer had satisfied arm's length standard set under the Indian TP regulations relating to transactions of import of raw material, export of finished products and payment, of royalty. The TP report also stated that since cost recharges by the taxpayer to its associated companies represented actual cost incurred, supported by third party bills, the transactions independent of TP analysis satisfied arm's length standard. TPO's reasons for rejecting PLI of cash profit/sales 4. The Transfer Pricing Officer (TPO) to whom reference was made by AO raised objection on the selection of PLI by the taxpayer's auditor. He rejected TP analysis furnished by the taxpayer as not conforming to r. 10B of Indian IT Rules. Reasons for adapting above course are extracted below: "(a) In computing the PLI under TNMM, the taxpayer does not have any cho....
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....e comparability adjustments. " TPO's determination of ALP 4.2 The TPO also applied quantitative filter of ratio between depreciation and total cost to the nine selected comparables of the taxpayer and worked out percentage of depreciation to total cost as per table below reproduced from CIT(A)'s order: Table 3 in CIT(A)'s order -------------------------------------------------------------------- Sl. Name Depreciation Total cost % of No. (in Rs. (in Rs. depreciation crores) crores)&n....
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....2.64 -------------------------------------------------------------------- 10. Bhagwati Autocast Ltd. 0.47 20.02 2.34 -------------------------------------------------------------------- 5. In the light of provisions of r. 10C(2)(d) of the Rules, the TPO concluded that since no accurate adjustment could be made to account for different levels of capacity utilization, selection of comparables themselves have to be made on the basis of similar ratio of depreciation to total cost. Accordingly, the following 3 comparables (Table 4) which had somewhat similar ratios of depreciation to total cost as of the taxpayer, were selected as final comparables for finding mean operating margin of profit which was taken at 6.66 per cent as under: Table 4 from CIT(A)'s order ---------------------------------------------------------------- Sl. Name &n....
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....---------------------------------------------------------- Operating profit (cash profit of Rs. 1,74,54,970 minus depreciation of Rs. 1,60,13,886) = 14,41,084 ---------------------------------------------------------------- Operating profit at arm's length margin (6.66%) = 1,30,44,088 ---------------------------------------------------------------- Adjustment to the operating profit (Rs. 1,30,44,088 - Rs. 14,41,084) = 1,16,03,004 ---------------------------------------------------------------- 5% of international transaction = 28,91,857 ---------------------------------------------------------------- 5.2 The TPO has further observed that the taxpayer during the financial year 2002-03 made both transactions of sale and purchase with its AEs. Since PLI has been taken as the ratio between the net operating profit margin and the ....
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....p; TNMM 3,14,954 -------------------------------------------------------------- 4. Testing charges TNMM 91,743 -------------------------------------------------------------- 5. Recharges CUP 17,30,000 -------------------------------------------------------------- A similar TP report for asst. yr. 2004-05 6. The AO again made reference under s. 92CA(1) of the Act to the TPO for computation of ALP in respect of above international transactions. Vide order de 22nd Nov., 2006, the TPO proposed adjustment of Rs. 1,10,96,223 to international transactions of purchase. In its comparative analysis, taxpayer's auditor had focused on operative results of comparable companies fo....
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....hafts, axle beams, stub axles and steering arms and connection rods for 2, 3, 4 and 6 cylinder engines. 6.5 Minda HUF Ltd. was incorporated in 1986 and enjoyed market leadership in security systems for automotive industry. 6.6 Swaraj Automotives Ltd. was established in 1974 and was manufacturing air cleaners, head rests, seats and recliners. The TPO noted that profile of the assessee was quite different and 85 per cent of total sales related to rear view mirrors were made to top automobile companies and also exported. The TPO, accordingly, excluded above five companies. Computation of ALP by TPO 6.7 The TPO then proceeded to compute the ALP adopting ratio of operating profit to sales and by using data for the financial year 2003-04 for the remaining 10 selected comparables as detailed in Table 4 below: Table 4 -------------------------------------------------------------------- Sl. Company name Operating pr....
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....nbsp; 34.42 442.39 7.78 (Prowess Database) -------------------------------------------------------------------- 8. Rasandik Engineering 25.01 136.16 18.36 Inds. India Ltd. (Prowess Database) -------------------------------------------------------------------- 9. Simmonds Marshall Ltd. 1.16 13.34 8.69 (Prowess Database) -------------------------------------------------------------------- 10. Tata Auto Plastic Systems 13.59 140.79 9.65 Ltd. (Prowess Database) -------------------....
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....bsp; Table 5 ---------------------------------------------------------------- Computation of ALP of international transactions: ---------------------------------------------------------------- Total cost of the assessee company = 30,75,86,918 ---------------------------------------------------------------- Net operating profit = 2,30,45,224 ---------------------------------------------------------------- Operating profit at arm's length margin (net sales * 0.111) = 3,41,42,147 ---------------------------------------------------------------- Adjustment to the operating profit (3,41,42,147 - 2,30,45,224)* &n....
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....these technical objections in detail as learned counsel appearing for the taxpayer fairly conceded that the Benches of Tribunal have already decided these issues and impugned orders of CIT(A) were quite in line with the Tribunal's views. The learned counsel further did not challenge application of decision of jurisdictional Delhi High Court in the case of Sony India (P) Ltd. vs. CRDT (2006) 206 CTR (Del) 157 : (2007) 288 ITR 52 (Del) by the learned CIT(A) to the facts of the case. Adoption of cash profit as PLI reagitated. CIT(A) not convinced 7.3 Learned representative of the taxpayer further challenged the computation of ALP by the TPO and PLI adopted by him. The learned CIT(A) did not accept the contention of the taxpayer that PLI under the TNMM could be cash profit/sales. He also held that there was no justification to exclude depreciation while computing net margin of the taxpayers and the comparables. In the light of proviso to r. 10B(4) of IT Rules, the learned CIT(A) held that data for carrying TP analysis has to be of current financial year as there was nothing on record to show that data of preceding two years had any influence on the determination of the transfer p....
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....ten companies with following observations: "The appellant had chosen to aggregate all the international transactions of purchase, sale and royalty rather than going in for a transaction-wise analysis. The total cost includes payment of royalty to the AEs and payments for components that are used in the manufacturing process. Royalty is paid for the use of patented technology and the same technology is used in the enterprise level production process. The same is true for the components as well. Therefore, keeping in mind the relative importance of the sale transaction made to the AE and the fact that the cost involving international transactions have bearing on the overall sales of the entity, the base of total cost is held to be the correct denominator. Accordingly, I am inclined to agree with the TPO/AO that OP/TC is the correct PLI for the benchmarking analysis. 5.5 In the light of the discussion in the foregoing paras, the comparability analysis is to be carried out by using the current financial year data of 2002-03, using OP/TC as the PLI. During the appellate proceedings, the appellant furnished the following information relating to computation of PLI of the nine finall....
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....------------------------- 8. Denison Hydraulics India Ltd. 3.72 11.78 31.58% ---------------------------------------------------------------- 9. Frontier Springs Ltd. 0.47 9.72 4.84% ---------------------------------------------------------------- Mean 9.17% ---------------------------------------------------------------- Schefenacker Motherson Ltd. 0.14 19.58 0.74% ---------------------------------------------------------------- Exclusion of comparable and determination of ALP 8.3 The learned CIT(A) th....
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....ve Gears Ltd. 0.09 4.64 1.94% ---------------------------------------------------------------- 6. Ring Plus Aqua Ltd. 7.38 32.81 22.47% ---------------------------------------------------------------- Mean 2.00 19.06 6.13% ---------------------------------------------------------------- Schefenacker Motherson Ltd. 0.11 19.58 0.74% ---------------------------------------------------------------- TP adjustments made by CIT(A) 8.4 Learned CIT(A) accordingly proposed TP assessment of Rs. 1,11,52,533 as per the following details: &....
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....orking of profit margin was at 11.10 per cent. He also reproduced in the impugned order the adjustment made by the AO based on the order of the TPO at Rs 1,10,96,223. He also took note of argument of the taxpayer that TPO wrongly applied PLI of operating profit/sales (OP/sales) instead of cash profit to sales suggested by the taxpayer. TPO's action in not considering material differences between the taxpayer company and the comparables was also challenged. It was argued that TPO wrongly excluded five companies out of comparables. The learned CIT(A) also noted reasons given by the TPO for rejecting taxpayer's claim which were quite similar to the reasons given for the asst. yr. 2003-04. These need not be repeated here. CIT(A)'s TP analysis 9.1 On facts and circumstances of the case, the learned CIT(A) rejected the use of multi years data as the same according to him was not permissible under r. 10B(4) of IT Rules. The learned CIT(A) also rejected argument of the taxpayer on under capacity utilisation for not considering depreciation. He held that the taxpayer has failed to give details of capacity utilisation of comparable cases. Taxpayer was also held to have failed to bring ....
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....------------------------ 6. Jay Ushin Ltd. 2.96 87.37 3.39% (Prowess Database) ---------------------------------------------------------------- 7. Lumax Industries Ltd. 13.23 258.47 5.12% (Prowess Database) ---------------------------------------------------------------- 8. Minda HUF Ltd. 5.96 105.74 5.64% (Capitaline Database) ---------------------------------------------------------------- 9. Phoenix Lamps Ltd. 18.55 147.41 12.58% (Prowess Database) ---------------------------------------------------------------- 10. Pricol Ltd. &nb....
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....----------------------------------------------------- 9.2 The learned CIT(A) then referred to requirement of r. 10B of IT Rules and factors which, according to him, are required to be considered in quantitative and qualitative filters. He then referred to various steps which are required to be taken into account while identifying comparable transactions. These are noted at p. 25 of the impugned order. The learned CIT(A) then considered the circumstances under which loss-making businesses (enterprises) can be taken into consideration. 9.3 The learned CIT(A), thereafter, re-examined 15 companies taken as comparables. Out of them, nine were finally selected for working out mean profit. Table 8 --------------------------------------------------------------------- Sl. Name Observations on qualitative Remarks No. aspects --------------------------------------------------------------------- 1. Amforge Industries Ltd. 1. As per the annual report, Accepted by the (Prowess this company supplies TPO. Held not to Database) crankshafts to leading be a correct brands of cars and also comparable. supplier of connecting rods to leading branded cars. 2. The company is nex....
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....ng 9 companies, the learned CIT(A) worked out mean arm's length operating profit at 11.14 per cent against 5.97 per cent of the taxpayer. The adjustment to be made in the profit was worked out at Rs. 86,52,721 as per details below: Table 9 ---------------------------------------------------------------- Sl. Company name OP TC OP/TC No. ---------------------------------------------------------------- 1. Amforge Industries Ltd. 17.15 172.69 9.93% (Prowess Database) ---------------------------------------------------------------- 2. Bhagwati Autocast Ltd. 0.29 22.58 1.28% ....
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.... PLI for the appellant as 5.97% per information submitted to the TPO for the current financial year 2003-04, submitted vide letter dt. 10-10-2006. ---------------------------------------------------------------- Table 10 ---------------------------------------------------------------- Computation of ALP of international transactions: ---------------------------------------------------------------- Total cost of the assessee company 28,45,41,694 ---------------------------------------------------------------- Operating profit &nb....
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....aken into account by the learned CIT(A) for TP analysis were furnished by the taxpayer. Shri Mitra reiterated that while computing operating profit of the tested party and mean margin of comparables, cash profit was to be taken into account without depreciation. Shri Mitra, reiterated the contentions raised on behalf of the taxpayer before the Revenue authorities and noted above. Shri Mitra further showed his willingness to accept ratio of cash profit/total cost excluding depreciation be applied to the tested party as also to comparables taken by the learned CIT(A). He furnished calculations on above lines to show that no adjustments were required to be made. In the alternative Shri Mitra requested that the taxpayer be permitted to raise additional ground of appeal and additional evidence in these proceedings. A separate application was made for the above purpose. 12. Shri Ashok Mittal, learned senior Departmental Representative read out and relied upon orders of CIT(A). He submitted that in the impugned orders. the learned CIT(A) has elaborately discussed various issues and, therefore, it was not necessary for him to say anything or file any written submissions for which a spec....
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....e case of CIT vs. Bibhuti Bhusan Dutt (1963) 48 ITR 233 (Cal), the deduction of depreciation for working out divisible profits was held not necessary. The Court relied upon r. 4 of Company Law Rules which has been quoted in the decision as below: "Loss or depreciation of fixed capital does not affect the divisible profits or render it necessary to make good the same out of income." As per above view, depreciation cannot enter computation of profit. Depreciation only a privilege not an obligation (View of Supreme Court and several High Courts) 15. In the case of CIT vs. Mahendra Mills (2000) 159 CTR (SC) 381 : (2000) 243 ITR 56 (SC), Hon'ble Supreme Court held that taxpayer cannot be forced to claim depreciation in the computation of taxable income. It was held to be a privilege of the taxpayer and an option with him. A privilege cannot work to a disadvantage and an option cannot become an obligation. It was accordingly held that the AO cannot grant depreciation allowance when the same is not claimed by the taxpayer. The Hon'ble Supreme Court approved similar view taken by different High Courts in India in large number of cases. It specifically confirmed the following decis....
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.... Variation in allowance (depreciation) under income-tax and company law 16.2 It is further an accepted position that scheme of depreciation allowance under the Indian IT Act is quite different from scheme of depreciation under the Indian company law. Under the former statute, depreciation is computed at rates prescribed under rules varying between 5-100 per cent on the cost or on WDV, whereas under the Indian company law, depreciation is allowed as per schedule on straightline method or reducing balancing method which is claimed to accord to the actual depreciation suffered. Then, initial depreciation is allowed in the year of purchase of the asset besides the normal depreciation. There are further provisions for allowing 100 per cent of cost as depreciation on small assets of the specified value in the year of acquisition. By and large, cost of replacement is allowed as deduction in lieu of depreciation on certain assets for specified years. Under few provisions, depreciation is not deducted whereas generally it is deducted out of cost while working out "WDV" under tax laws. Obviously, such provisions under tax laws are made by way of incentives for setting new structures or....
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....ause in the case of financing, the interest income which accrues to the assessee will have the element of turnover and in such a case, receipts like interest, will not attract Expln. (baa). The point which we would like to make, therefore, is that in every matter the AO will have ,to ascertain whether receipt of interest, commission, labour charges, etc. were a part of operational income. We cannot lay down any standard test for deciding .what would constitute operational incomes". What constitutes "operational profit"; no standard test 17. The point emphasised by Hon'ble Bombay High Court is very relevant and has to be carefully noted for consideration in these appeals. There is no standard test for deciding what constitute operational income (or profit). What receipts or expenditure would constitute operational income would depend upon facts and circumstances of the case and nature of business involved. Therefore, Revenue's conclusion that operating profit or manufacturing cost must include "depreciation" irrespective of peculiar facts of case cannot prima facie be accepted as correct. If value of capital assets has got depleted then depleted value is to be taken into accou....
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.... (ii) 'arm's length price' means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises. in uncontrolled conditions." 18.2 Rule 10B of IT Rules makes provision of different methods of determining ALP including TNMM and for purposes of comparability of international transactions with uncontrolled transactions, the other principles provided are as under: "Rule 10B Determination of ALP under s. 92C.-(`) For the purposes of sub-s. (2) of s. 92C, the ALP in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely: (a) Comparable uncontrolled method/(details not relevant, not produced) (b) Resale price method -do- (c) Cash plus method -do- (d) Profit split method &....
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....ontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." Summarised TP principles (general) 18.3 Under provisions of s. 92(1) of the Act and r. 10B, income of international transaction between associated concern is to be computed having regard to ALP. ALP, in turn, is the price which w....
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....of the taxpayer (tested party) with mean net profit of comparables, Only receipts and expenditure, having connection with international transactions, were required to be taken into account. Any receipt or expenditure having no bearing on price or margin of profit could not be taken into consideration. It is evident from statutory provisions quoted above that it is nowhere provided that deduction of depreciation is a must. Depreciation can be taken into account or disregarded in computing profit depending upon the context and purpose for which profit is to be computed. There is no formula which would be applicable universally and in all circumstances. "Net profit" used in r. 10B can be taken to mean commercial profit as held by the TPO and confirmed on appeal by the learned CIT(A). But depreciation in such profit on commercial principles has to be the "actual" amount by which the assets of business got depleted between the two dates separated by a year. It cannot be depreciation under tax or companies rules or as per policy of the company. In the case in hand. Revenue authorities went wrong in disregarding the context and purpose for which the "net profit" was to be computed. Deprec....
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....o be taken into account for comparison and for computing profit. There is considerable support for the contention raised on behalf of the taxpayer in para 1.22 of the OECD Guidelines on Transfer Pricing which is reproduced below: "1.22 It may also be relevant and useful in identifying and comparing the functions performed to consider the assets that are employed or to be employed. This analysis should consider the type of assets used, such as plant and equipment, the use of valuable intangibles, etc., and the nature of the assets used, such as the age, market value, location, property right protections available, etc." Sufficient evidence to show material differences on account of depreciation 20.3 The claim of depreciation can lead to great difference in computing profits of comparables as depreciation is permitted depending upon nature of plant/machinery and year of use. In 5th or 6th year of commencement, depreciation can be 25 to 30 per cent of amount allowed in first year to an enterprise. In these appeals, the TPO had excluded certain comparables after noting differences in their year of start of operations. These were Bhagwati Autocast Ltd. (1982), Jay Ushin Ltd. (1....
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....--------------------------------------------------------- 5. Gujarat Automotive Gears 0.23 4.82 4.77 Ltd. -------------------------------------------------------------------- 6. Dennison Hydraulics India 0.36 10.6 3.39 Ltd. -------------------------------------------------------------------- 7. E.L. Forge Ltd. 1.3 41.95 3.09 -------------------------------------------------------------------- 8. Coventry Spring & Engg. 0.74 24.73 2.99 Co. Ltd. -------------------------------------------------------------------- 9. Frontier Springs Ltd. &n....
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.... 2002-03 -------------------------------------------------------------------- Schefenacker Motherson Rear view mirrors, 2.78 crores Ltd. door handles, T-Gates and cable assembly -------------------------------------------------------------------- Ring Plus Aqua Ltd. Shaft bearings, starter 43.33 crores Gears, pulleys and rollers -------------------------------------------------------------------- ....
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....nces, if any, are to be noted and discussed during the course of proceedings before the TPO and not in TP report. The approach adopted in this case was wrong would be more than clear from provisions of sub-s. (2) of s. 92CA reproduced below: "(2) Where a reference is made under sub-s. (1), the TPO shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may rely in support of the computation made by him of the ALP in relation to the international transaction referred to in sub-s. (1)." 21.1 It is quite clear from above that supporting evidence is to be produced before the TPO and this was done. TPO has not raised any objection on this score. The learned CIT(A) was not right in drawing adverse inference against the taxpayer." Depreciation leading to material differences has not been challenged at all 22. The learned CIT(A) has observed "fresh investment was being made in automobile ancillary industry which was in expansion phase and, therefore, there is no requirement to exclude depreciation in computing PLI". What expansion, when made, the date and year of expansion, its c....
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....nt years showed before the Revenue authorities that profit shown by the taxpayer satisfies arm's length requirement on ratio of cash profit to sales if uniformly applied. As the deduction of depreciation is leading to wide differences, the same should be excluded. The only reason given for rejecting taxpayer's analysis and for making adjustment in the two years is that use of ratio of cash profit without depreciation is not permitted under the law. This view in the light of above discussion cannot be accepted as correct and is disapproved. AO directed to examine/verify taxpayer's claim 24. The learned CIT(A) determined ALP by taking ratio of profit/total cost (OP/TC) and thus made adjustment in the two assessment years. The learned representative of the taxpayer had furnished detailed working to the Revenue authorities, taking the base of cash profit/sale (excluding depreciation). No comments of Revenue authorities are available on this claim. The taxpayer has also furnished similar working taking cash profit/TC (excluding depreciation) and has claimed that if benefit of proviso to s. 92(2) is allowed, there is no case for making any adjustments in the two years is as under: ....
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....nbsp; 36.05 3.85 --------------------------------------------------------------------- Frontier Springs Ltd. Page 737 10.19 9.72 0.47 --------------------------------------------------------------------- Gujarat Automotive Gears Ltd. Page 771 4.73 4.64 0.09 --------------------------------------------------------------------- Average (CIT comparables) --------------------------------------------------------------------- Company Page 814 19.73 19.59 0.14 --------------------------------------------------------------------- Table continues... --------------------------------------------------------------------- March, March, March, March, March, March, &n....
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....; 1.01 4.86 12.18% 10.68% 35.04 13.87% --------------------------------------------------------------------- 0.09 0.24 0.8 7.85% 4.84% 9.39 8.52% --------------------------------------------------------------------- 0.07 0.23 0.39 8.25% 1.94% 4.34 8.99% --------------------------------------------------------------------- 0.17 2.64 10.19 25.34% 22.47% 30.03 33.93% --------------------------------------------------------------------- &....
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....bsp; Sales Total Operating Cost profit (TC) (OP) --------------------------------------------------------------------- Amforge Industries Ltd. Page 536 189.84 172.69 17.15 --------------------------------------------------------------------- Bhagwati Autocast Ltd. Page 576 22.87 22.58 0.29 ----------------....
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.... March, March, March, 2003 2003 2003 2003 2003 2003 2003 --------------------------------------------------------------------- Amortis- Deprec- Cash CP/Sales OP/TC Total cost CP/Adj TC ation iation profit excluding (CP) depreciation ....
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....nbsp; 3.41% 56.95 7.43% --------------------------------------------------------------------- 0.01 0.35 1.4 10.49% 8.46% 11.94 11.73% --------------------------------------------------------------------- 0.36 6.7 18.89 13.42% 9.17% 121.9 15.50% --------------------------------------------------------------------- 13.87% 11.14% 16.85% --------------------------------------------------------------------- 1.83 &n....