TaxTMI 
TaxTMI 
2012 (1) TMI 60
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....nts i.e. (i) working capital, (ii) provision for Warranty and (iii) expenses relating to import of raw material - vide ground 4; 6. Incorrect computation of transfer pricing adjustment to the manufacturing activity - vide ground 10; 7. Use of multiple year data vide ground 5; 8. Use of contemporaneous data vide ground 6; 9. International transaction pertaining to export of components and spares - vide ground 8; 10. Transfer Pricing adjustment without giving benefit of +/-5% as available under erstwhile proviso to sec 92C(2) of the Act -vide ground 9; 11. Restricting the allowance in respect of the provision for warranty claim to Rs. 13,437,207 - vide ground 11; 12. Error in not reducing the appellant's sales by the amount of disallowance in respect of provision for warranty claims - vide ground 12; 13. Short grant of credit for TDS/SA - vide ground 13; 14. Levy of interest u/s 234B & 234C of the Act - vide ground 14 & 15; 3. Relevant facts of the case as culled out from the available records before us are that the assessee is engaged in manufacturing of material handling equipment ....
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....actions reported by the assessee. On the demand of the TPO, the assessee submitted segment-wise details of the alleged integrated business of the assessee. Manufacturing, trading and servicing are the relevant segments required for the proceedings under consideration. Further, the assessee also submitted the current year data of the comparables in place of the multiple year data mentioned in the provisions of Rule 10B(4) of IT Rules, 1962. Thus, there is no dispute between the parties about (i) the selection and the applicability of TNM Method and (ii) the selection of the six comparables from the Public data base source ie Prowell and Capitaline. 5. Thus, the assessee filed the current year and contemporaneous data i.e. FY 2006-07 relating to the entity level margins of the said comparables on the demands of the TPO. Further, the assessee supplied the segment-wise operating margins i.e. manufacture, trading and services and the net margin at the entity level i.e. manufacture segment as an entity, is 2.41%. TPO compared the same with that of the average of the six comparables at their entity level margin without entertaining any adjustments on any account. TPO is of the opinion,....
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....Dispute Resolution Panel - DRP, Pune as per the provisions of the Act and the assessee filed various objections opposing the abovesaid three adjustments, namely adjustments to manufacturing and trading segments and disallowance on account of warranty provisions. The assessee's written objections relating to adjustments to manufacturing and trading segments are briefly as under: ♦ Non-consideration of the compatibility analysis as documented in the TP report. ♦ Rejecting the aggregation of international transactions entered into by the assessee pertaining to manufacturing and trading activities. ♦ Incorrect determination of margin of manufacturing activity ♦ Non-grant of working capital adjustment ♦ Use of single year data pertaining only to F.Y. 2005-06 ♦ Use of financial information of the comparables pertaining to F Y. 2005-06 which was not available at the time of preparing the documentation report. ♦ Non-inclusion of high sea sales and services income for the purpose of computing appellants' margin for manufacturing activity ....
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....arized above in the language of the assessee. During the proceedings before us, the assessee was represented by Shri M.P. Lohia, Shri Anil B. Jain & Shri Rajendra Agiwal and the revenue is represented by Shri S.K. Singh CIT-DR & Shri Tejendra Singh CIT. The grounds are categorized into two categories (i) those which should be disposed as NOT PRESSED or ACADEMIC ones and (ii) the ones that requires adjudication. Firstly, we shall take up the ones categorized as (i) above. (i) GROUND TO BE DISMISSED AS NOT PRESSED OR ACADEMIC: 11. Shri M.P. Lohia took the lead and stated that the grounds raised in the appeal essentially revolve around the above three adjustments made by the revenue. The issues in the grounds relate to both academic as well as on merits of the additions. As per the assessee, the AO/PTO/DRP denied various claims, which are legally due to the assessee. Sri Lohia dutifully explained the need for adopting (i) the multiyear data as existed at the time of compliance to the guidelines; (ii) approach of aggregation of international transactions entered into by the assessee pertaining to both manufacturing and trading activities. He also questioned the order of the DRP i....
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.... Ld counsel mentioned that the difference in figures between the TNMM method and the resale price method is small and seeks direction of the Tribunal to the AO. On the other hand, the Ld. D.R. for the revenue also mentioned that the revenue will take necessary action to correct the mistake in this regard in an appropriate manner. We have heard the parties and perused the facts and the proceedings in the matter and find that the DRP has erred in not granting non-contradicting directions to the AO. As discussed above, the DRP has not approved the RPM as an appropriate method to the sale/trading activities involving the AEs or third parties for arriving at the arm's length margins. On the other hand, it recommended the net margins analysis of AEs and the third parties, which is essential ingredient of the TNMM method. If the TNMM with the due adjustments is applied, the addition is meager. Considering the promise of the Ld DR, we proceed to remit the issue to the AO for deciding the issue after applying the TNMM in its true spirit. Accordingly, ground no.8 is allowed. 16. Regarding the Grounds 13 to 15 relating to the issue of short grant of TDS/SA and charging of interest u/s 234B....
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.... decision of the Tribunal in the case of Mentor Graphics (Noida) (P) Ltd. 109 ITD 101, Ld Counsel mentioned that the "final set of comparables may need to eliminate differences by making adjustments for the following: (a) Working capital........" (para 27). Further, referring to the decision of Pune Bench in the case of E-gain Communication P. Ltd. reported in 118 ITD 243, Ld Counsel mentioned that when TNMM is applied to a case, 'the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect.' If these differences are not eliminated or removed, the comparison becomes unsound and unreliable. Further also, the decision of the Delhi Bench in the case of Sony India P. Ltd. (114 ITD 448) was cited for the proposition that deduction of 20% is allowable for various differences on account of intangibles, R&D, risk factors, working capital, etc. Referring to contents of the para 132 and 137 of the said decision, Sri Lohia stated that in that case the CIT(A) allowed adjustment to the extent....
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....d there is dispute on (i) if the 'working capital' constitutes a 'difference, if any between the international transactions and the comparable uncontrolled transactions of between the enterprises entering into such transactions,' as mentioned in sub-clause (iii) of clause (e) of Rule 10B(1) of the Income Tax Rules, 1962; and (ii) if the answer to first issue at (i) above is positive, next issue relates to if the said difference 'could materially affect' the amount of net profit margin of relevant transactions in the open market. We shall take up the first dispute mentioned above i.e. If the 'working capital' in instant case constitutes a 'difference, if any'. (i) If the 'working capital' (WC) constitutes a 'difference, if any: 22. For adjudication of the above, in our opinion, there is need for explaining the relevant provisions of Rule 10B of the Income-tax Rules, 1962, meaning and impact of the WC on the pricing or margin or profiting of the transactions, the decided cases on this issue of WC. We shall take up the meaning and relevance of Working Capital. (A) Meaning of WC: Working capital is a financial metric which represents operating liquidity available to a bu....
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....raphics (Noida) (P) Ltd (Supra) that the 'working capital' constitutes a subject matter for adjustments in the matters relating to ALP in Transfer Pricing. 23. Now we shall undertake to explain the provisions of Rule 10B of the Income Tax Rules, 1962 in the succeeding paragraphs. The said Rules read as under: Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price 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) to (d)** ** ** (e) transactional net margin method, by which, - (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is c....
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....nalyzing 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 no 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." 24. What does Rule 10B say in general: Thus, generally, as prescribed in rule 10B(1) of the Income Tax Rules, 1962, (i) the net profit margin (NPM) realized from international transaction is computed in relation to relevant base i.e. the (a) costs incurred or (b) sales effected or (c) assets employed or (d) any other relevant base; (ii) the said NPM realized from the comparable uncontrolled transaction is computed having regard to the same base; (iii) NPM realized from the comparable uncontrolled transaction mentioned in (ii) above is adjusted to taken into account the differences, if any; (iv) the differences, if any mentioned are of that type which affect the amount of NPM in the open market; (v) finally the NPM....
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....t is a simple principle of economics that the greater the risk, the greater the expected return (compensation). If there are material and significant differences in the risk involved, then the comparables identified are not correct as appropriate adjustments for differences in such cases are not possible. Therefore, while performing searches for potential comparable companies, not only turnover and operating profit but functions performed and risk profile are also to be considered. However, it can always be shown on the given facts of the case that comparables found are similar or almost similar to the controlled transaction and no adjustments are needed. It is useful to see the level of intangible assets in comparison to an appropriate base. Depending on facts of the case, final set of comparables may need to eliminate differences by making adjustments for the following: (a) Working capital; (b) Adjustment for risk and growth; (c) Adjustment of R&D expenses. The risk not only due to human resources, infrastructure and quality which are normally taken into account yet more significant risks like market risk, contract risk, credit and ....
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....ing decisions which has upheld working capital adjustment: Case law Mentor Graphics (Noida) Pvt. Ltd. (112 ITJ 408) (Delhi ITAT) Egain Communication (P) Ltd. v. ITO (118 ITD 243) Sony India (P) Ltd v. DCIT (114 ITD 448) UCB India P Ltd v. ACIT (ITA 428 & 429/Mum/07) (Mum) TNT India Ltd. v. ACIT (ITA No.1442 (BNG)/08) The appellant prays that in determining the arm's length price for the international transaction entered into by the appellant, the differences in working capital employed by the assessee vis-à-vis the comparables needs to be factored into. Also, after considering the benefit of the provisions of section 92C(2) of the Act providing for (+)(-) 5% adjustment, the appellant is at arm's length in relation to its manufacturing imports. Summarized below are the key figures/details calculating the adjustment after taking into consideration working capital adjustment: Particulars Relevant Operating Margin of Tested party -assessee 2.41% Arm's length Operating Margin of Comparables (unadjusted) 7.18% Arm's length Operatin....
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....le for any adjustments the moment the set of comparable are provided by him. In our opinion, this approach of the revenue is supported by the law or rules in existence. Rule 10B(3) provides for the guidelines as to eliminate the difference, if any and the legitimate way of benchmarking of the International transactions for ALP purpose involves such eliminations. It is the duty of the AO/TPO/DRP to minimize/eliminate the difference if any, which is likely to materially affect the price as discussed in Rule 10(3) of the Income-tax Rules, 1962. At the end of the assessment proceedings, the prayer of the assessee relating to the adjustments on account of working capital, was not attended either by the DRP by the AO. Yes, it is true that the assessee did not raise this issue before the TPO as evident from the order of the TPO but the same were raised before Ld DRP, who summarily relied on the order of the TPO as discussed in para 7.3.1 extracted above and without even examining if the request for working capital adjustment was raised at all before the TPO. 30. To sum up, the case of the assessee is that in TNMM, the working capital adjustments are required to be done to the margins o....
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....y us in the preceding paragraphs. The sub-clause (iii) specifies that the adjustments are to be made on account of differences, if any. Therefore, in this regard, the litmus test to be applied is if the 'difference, if any, is capable of affecting the NPM in open market? If any factor is capable of such affect, yes, TPO is under statutory obligation to consider and examine and eliminate such difference. AO/TPO/DRP cannot say that difference is likely exist in all accounts appearing in P&L account or Balance sheet, which are likely to materially affect the NPM in open market and therefore, the demands of the assessee should be ignored, is not the correct approach. Revenue's reasoning that the demanded adjustments should not be entertained by the TPO merely on the basis the comparables are supplied by the assessee is not the correct. In our opinion, it is the duty of the TPO to apply the provisions of rule 10B(1)(e) to establish the ALP in relation to international transaction as per the TNPM, which is an undisputed method found applicable to the present case by both the parties. It is a settled accounting principle that the net margins can be influenced by some of the same factors w....
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....s raised for the first time before the Ld DRP and the DRP has passively relied on the order of the TPO without realizing that the said issue was never dealt with by the TPO. Therefore, the issue of granting of adjustment on account of 'working capital' for eliminating of the material effects and the issue of, if such adjustment @ 3.41% constitutes that difference, if any, which is likely to materially affect the price/profit margin, have not been examined. We find that there are written request of the assessee to the DRP to this extent and assessee furnished the relevant figures, which are enough to adjudicate the said request by the AO/DRR. It is not the case of the DRP that the above claims of the assessee are incorrect. Alternatively, it is not the request of the revenue's DR that these said issues should be remitted for another round of the proceedings before the revenue authorities. In our opinion, the existence of difference @ 3.41%, which is worth Rs. 31,72,099/-, attributable to the 'working capital' ought to amount to the 'material difference' considering the existing unadjusted operating margin of the comparables at 7.18%. In these circumstances, we are of the opinion tha....
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....ating the above, Ld Counsel for the assessee has mentioned that assessee imported components and spares from AE to the tune of Rs. 602.18 lakhs for manufacturing segment. It works out to nearly 40% of total imports i.e. Rs. 1557.38 lakhs. Referring to the comparables, it is brought to our notice that the imports of the comparables works out to merely 3.68% and therefore, there are differences and they have to eliminated by way of adjustments to be a credible comparables to the tested party's data. As per the assessee, the revised PLI after adjustment for excess import duty work out to around 6.6%, which falls in the permitted range of +/-5%. Further, in support of the above, Ld Counsel relied on various decisions for the proposition that the adjustment on account of import cost constitutes permissible ones. 36. In response to the above, the Ld. D.R. for the revenue submitted that the assessee has not made this sort of adjustments during the proceedings before lower authorities. Further, the Ld. D.R. argued stating that these expenses do not fall under the category of extraordinary expenses which requires adjustments. Further, he also mentioned that adjustments, if any, in this r....
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....nces having material effect". We do not agree with the AO that every time the assessee pays the higher import duty, it must be passed on to the customers or it must be adjusted for in negotiating the purchasing price. All these things could be relevant only when higher import content is a part of the business model which the assessee has consciously chosen but then if it is a business model to import the SKD kits of the cars, assemble it and sell it in the market, that is certainly not the business models of the comparables that the TPO has adopted in this case. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison po....
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....+/- 5% under erstwhile proviso to section 92C(2) of the Act: 39. Ground No.9 relates to applicability of the provisions of the proviso to section 92C(2) of the Act. We reproduce the relevant extract from the written submissions of the assessee as it is a self-contained one and it bring out briefly (i) the stand of the revenue and (ii) the rebuttal of the assessee. The submissions in this regard are as follows: "Transfer pricing adjustment without giving benefit of +/- 5% as available under erstwhile proviso to section 92C(2) of the Act ...... Hon'ble DRP and the learned AO/TPO have erred in facts and circumstances of the case by computing the arm's length price of the international transactions pertaining to manufacturing activity and export of components and spares without taking into account the +/- 5 per cent variation from the mean, which is permitted to and which has also been opted for by the appellant under the provisions of section 92C(2) of the Act. Hon'ble DRP and the learned AO/TPO has contended that the benefit of safe harbor of +5/-5% is not available to the appellant stating the following: "In the present case it is seen that the ALP of the internationa....
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....variation of the arithmetic mean thereof. There is no ambiguity in law in respect of the same. Thus, any adjustment to the income of the assessee should be computed after considering +/- 5% variation from the arithmetic mean. With respect to the amendment made by the Finance Act, 2009 and explanatory memorandum to the Finance Bill, 2009, the appellant wishes to state that the explanatory memorandum to the Finance Bill, 2009 states that "the amendment would apply to all cases where the proceedings are pending before the TPO on or after 1st Oct., 2009". However, it is submitted that wordings in the explanatory memorandum which are against the language of the law should not be resorted to unless the language of the section is not clear or unambiguous. Section 92 deals with the computation of income having regard to the arm's length price. Further, the amendment to section 92C refers to the "computation of the arm's length price". Thus, the amendment is to the substantive provisions dealing with the computation of income and not to the procedures dealing with the assessment of income. Thus, the proviso which is made effective with prospectively from 1st October, 2009 should not b....
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....his +/-5% is not a standard deduction and this option is available only when the assessee computes the ALP and not when the AO/TPO/DRP does the same. The note also says that the said view was upheld by the Hyderabad Bench of the ITAT in the case of Deloitte Consulting India P Ltd for the AY 2004-05 vide their order dated 22/7/2011. 41. During the rebuttal time, Sri Lohia Ld Counsel for the assessee filed a chart showing a detailed working to demonstrate that the variance is not beyond +/-5% in case the adjustments on accounts of (i) working capital; (ii) expenses; (iii) correct quantification of margins realized vis-a-vis relatable sales as relevant base etc. are allowed. Relevant working read as under: Particulars Operating Revenue as PLI Tested Party Total Cost 227,613,571 Tested Party Total Sales 233,242,565 Tested Party Profits 5,628,994 Operating Profit/total sales 2.41% ALOM* of Comparable after Working Capital adjustments 3.77% Difference in Margins (3.77- 2.41) 1.36% *Arm's Length Operating Margin 42. Without prejudice to the above, as given in the note, Ld Counsel mentioned, that there are various decis....
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....ad out that the total sale of this segment is Rs. 23,32,42,565/- and the relatable cost of material is Rs. 1528.65 lakhs, (of course, the assessee submitted a different figure of Rs. 1557.39 lakhs in some other context). Thus, this cost of material (controlled and uncontrolled cost) of Rs. 1557.39 lakhs includes the Rs. 602.19 lakhs, relatable to the transactions with AEs i.e. controlled cost. As per the Counsel, revenue has erred in computing the TP adjustment on the entire manufacturing segment sales instead of computing the TP adjustment on those sales relatable to the import of the components and spares procured from the AEs only. While establishing the ALP on this segment, the AO worked out the said variance @ 4.77% (i.e. 7.18% - 2.41%) and worked out the corresponding quantum of adjustment at Rs. 1,11,25,670/- (i.e. 4.77*23,32,42,565/100). In this regard, the Ld counsel for the assessee mentioned that if total international transactions under consideration for adjustment on account of 'Import of raw materials, components and spares for assembly/manufacture of material handling products' worth Rs. 60,218,878/- works out to only 40% of the total cost, the same proportion of the....
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....s failure to supply the data on relevant sales is no defense, when there are settled alternatives for adoption in such circumstances, well tested 'principle of proportionality' in our opinion should help. Thus, the base of sales does not need to be 'total sales'; but the proportionate sales relatable to the impugned international transactions. It is a commonsensical approach. 48. In this regard, we have perused the existing decisions relied upon by the assessee and the following extracts from some of the decisions are relevant and the same read as follows. A. Emersons Process Management India P Ltd - ITA NO. 8118/M/2010 AY-2006-07 -Pg 452 of Paper Book " 19. Fifthly, as has been consistently held by the coordinate benches, the transfer pricing adjustment is to be made with respect to international transaction and not the entries sales............. We, therefore, direct the Assessing Officer to compute the transfer pricing adjustment in the light of this legal position. " B. T Two International P Ltd and Tara Jewels Eports P Ltd and Tara Ultimo P Ltd ITA NO. 5644, 5645 & 5646/M/2008 Ay 2004-05 - para 13 @ page 460 of Paper Book " 13. We have considered the rival submi....
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....Book "13. As in this case, TPO has not applied TNMM, as contemplated in the Act, we have no other alternative but to set aside her order........... We also agree with the arguments of learned counsel for the assessee that adjustments, if any, arising due to computation of ALP should be restricted only to the international transactions and not to the entire turnover of the assessee company. No addition can be made to local transactions under Chapter X of the Act. Such things are done only when the AO invokes s. 144. We direct the AO to restrict the adjustments, if any only to international transactions, which are found by him to have taken place at price other than ALP." E. Abhishek Auto Industries Ltd v. DCIT 136 TTJ 530 Del- para 8.2 at Page 494 of the Paper book: "8.2 It has not been disputed that provisions X, s. 92C deals with international transactions only and not with transactions which have no international cross-border element at all. Therefore, the basis of making the adjustments on the enterprise level by taking Rs. 68.76 crores as the base is not correct. What should have been taken is the sale to domestic parties using Takata technoloty and Takata raw material....