TaxTMI 
TaxTMI 
2014 (2) TMI 36
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....aterials, purchase of capital equipment, payment of royalty, payment of technical services fee and payment of guarantee fee. Assessee had filed return for impugned assessment year on 31.10.2007 declaring a total income of Rs. 12,17,671/-. Since assessee had international transactions of value exceeding the prescribed limit, Assessing Officer made a reference to Transfer Pricing Officer (TPO). 3. For the transactions in the nature of purchase of raw materials from its associate enterprise, assessee had adopted Transaction Net Margin Method (TNMM) for evaluating the pricing, whereas, for purchase of capital equipments, payment of royalty, reimbursement of travel and accommodation expenses and payment of guarantee fee, assessee had adopted Comparable Uncontrolled Price (CUP) method. TNMM was also followed for evaluating the technical services fee paid. The dispute before us, insofar it relates to transfer pricing is confined to determination of arm's length price of raw materials and material parts purchased from associate enterprise, for which TNMM was adopted. 4. Assessee had filed a TP study based on a set of comparables identified on a search conducted on 15.2.2007 in Pr....
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....icer. 6. Assessing Officer proceeded to frame a draft assessment order based on the recommendations of the TPO. In such draft assessment order, Assessing Officer proposed an addition of Rs. 9,58,60,522/- for the arm's length price adjustment. In addition to this, there were certain other additions as well. These were for income arising out of an invoice raised subsequent to the end of relevant previous year, disallowance of amortization cost of lease hold land, disallowance of payment made for acquiring software licence and reimbursement of expenses for non-deduction of tax at source. 7. Assessee elected to move the DRP against proposed draft assessment. Objections of the assessee on the TP adjustment proposed could be summarized as under:- (i) TPO had conducted a fresh analysis and in the process, adopted a new set of comparables without cogent reasons and without rejecting the transfer price documentation of the assessee. (ii) TPO considered companies with controlled transactions also as comparables. (iii) TPO adopted data which were not contemporaneous. (iv) TPO did not make required adjustments under Rule 10B for difference in start....
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....are acquired from M/s Autoever Systems Corporation, Korea, and M/s Wipro India Ltd. but had only made purchase of "Shrink-Wrapped" software and thus there was no necessity for deduction of tax of the payments. (iv) A.O. erred in proposing disallowance of Rs. 6,50,000/-, which was reimbursement of expenses, on which there was no necessity to deduct tax at source. (v) A.O. erred in holding that assessee had excess depreciation on account of adjustment on notional gains on exchange fluctuation with the cost of the assets.' 9. The DRP, after considering the above objections of the assessee, held as under, with regard to transfer pricing adjustments proposed by the A.O.:- (i) TP study done by the assessee was correctly rejected by the TPO. TP study was done much before the end of the year and the data collated by the assessee was for period preceding to the relevant previous year. (ii) Multiple year data could not be considered unless data for contemporaneous year was found to be unreliable for some valid reasons. (iii) Against eight companies considered as comparables by the assessee, TPO had considered 14 companies and assessee had n....
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....) Invoice raised in the subsequent year was only for difference between estimated price and final price, for sales already effected to M/s HMI. Under the matching principles of mercantile system of accounting, income stood accrued to the assessee. (ii) Though deduction of tax for royalty payment would not apply to off-the-shelf software, the agreement entered by the assessee with M/s Autoever Systems Corporation, Korea and M/s Wipro Ltd. would show that what was acquired were customized softwares, specially designed for assessee. Hence, tax was required to be deducted at source. (iii) Disallowance of Rs. 3,26,500/- proposed on amortization of leasehold land was justified in the facts and circumstances of the case. (iv) Assessee's argument that there was no excess claim of depreciation of assets, was to be accepted." Based on the above directions, a final assessment order was framed by the Assessing Officer. 11. Before us, assessee has taken eight grounds on transfer pricing adjustment. These grounds are reproduced hereunder:- (1) Erred on facts and in the circumstances of the case and in law by confirming the proposed addition of Rs. 14....
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....ment by completely ignoring the transfer pricing approach documented by the appellant. (6.2) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in not allowing suitable economic adjustment as provided under Rule 10B of the Rules, to account for the difference between international transactions and the comparable uncontrolled transactions selected by the learned A.O./TPO. Erred in not allowing adjustment for the following: working capital, Customs duty and, One-time start-up expenses. (7) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in making adjustment on the shortfall in the margin of the appellant on total transactions (i.e. controlled as well as uncontrolled) instead of applying the shortfall in the margin only to controlled transactions. (8) Erred on facts and in the circumstances of the case and in law in initiating penalty proceedings under Section 271AA on pretext of non-compliance of Section 92D(1) read with Rule 10D." 12. Learned A.R. admitted that first two grounds raised by the assessee were....
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....the TPO, atleast three were having related party transactions exceeding 20%. Further, according to learned A.R., adjustments were required to be made to the margin since assessee was having negative working capital. Substantial Customs duty was paid by the assessee. Imported raw material consumed by the assessee relatable to the AE itself came to 27% of its total cost. As per the learned A.R., adjustments were required to be carried out for off-setting excess expenditure incurred by the assessee for starting its operations, before making a comparison. In any case, according to him, Assessing Officer having made an income addition of Rs. 5.34 Crores for an invoice raised in subsequent year, it ought have been considered while working out the profit margin, before attempting a comparison. 17. In support of ground No.7, learned A.R. submitted that the difference on account of PLI should not have been applied directly to the total transactions of the assessee. The shortfall in margin, if any, ought have been restricted to the controlled transactions. According to him, the arm's length prices of the AE purchases were worked out by the TPO by applying the PLI on the total sale, fo....
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....was exclusion of start-up companies. By this filter, assessee itself had excluded 61 companies. Having itself excluded the start-up companies from the list of possible comparables, assessee could not now turn back and say that it should be given adjustment for being a start-up. Further, as per learned D.R., assessee could never demonstrate that three companies out of fourteen selected by the TPO had related party transaction exceeding 26%. The impact of negative working capital on the profitability, if any, requiring an adjustment, was never demonstrated by the assessee. Assessee had simply made 5% adjustment citing idle capacity, negative working capital and start-up difficulties. Of this, DRP had given considerable relief for idle capacity, and assessee could not be aggrieved any further. 24. Vis-à-vis the Customs duty adjustment, learned D.R. submitted that assessee could not demonstrate that comparables were not having similar imports. Even otherwise, if the purchases were made within India, assessee would have had to pay excise and other taxes. 25. As for the claim of the assessee that addition of Rs. 534 lakhs made on its revenue for invoicing done in succeeding ....
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....ted to exclude startup companies 52 Companies whose value added expenditure as a percentage of total cost greater than 20% were rejected to exclude high value adding companies 19 Qualitative - companies that were functionally comparable and that did not have controlled transactions were selected 8 SUMMARY OF SEARCH PROCESS - CAPITALINEPLUS Criteria and reason for usage No. of companies passing the criterion Total universe of companies available in CapitalinePlus as of February 15, 2007 13,887 Identified additional companies with positive sales over the time period under consideration were selected i.e. companies for which data was not available in Prowess 762 Companies having the ratio of sales manufacturing to sales more than 90% were selected to primarily filter for manufacturing companies 258 Selected companies classified in the Transport Equipment industry. 12 Companies which are not wholly or partly owned by Government or Co-operative society were selected to concentrate on profit oriented companies 11 Companies having R&D expenditure less than 3% of sales were selected to eliminate full-fledged manufacturers 11 Co....
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....ng related party transactions in excess of 25%, as mentioned by the assessee, these had to be excluded. 29. Coming to the aspect of adjustment pleaded by the assessee for negative working capital, no doubt, in the case of Demag Cranes & Components (India) (P) Ltd. (supra), it was held that adjustment had to be granted for eliminating material effects, if any, arising out of difference in working capital between tested party and comparables. Nevertheless, we find from the said decision that the plea regarding adjustment for working capital was first raised before DRP and the DRP had decided the issue without realizing that this was never adjudicated by the TPO. As per the assessee, it was having negative working capital as against substantial positive working capital enjoyed by the comparables. If the assessee is able to demonstrate that negative working capital had effected its margins, adjustment should have been made. Assessee has indeed filed before the DRP, margins of comparables adjusted for difference in working capital, but at no point of time it had given any reason why such adjustments were required. Assessee had made adjustment on inventories, debtors and creditors, wh....
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....verage derived on account of negative working capital and for taking care of under utilization of capacity. Nevertheless, there was no empirical data ever provided by the assessee to support the figure of 5% arrived by it. 31. As to the claim of the assessee that valuations made by the Customs authority on the import of raw material for the purpose of levy of Customs duty should be taken as a proper comparable, we do not find any merit. This is for the reason that, as pointed out by DRP, valuation by the Customs authority is as per Customs Rules, which are not relevant for the purpose of transfer pricing under income-tax rules. Further, the purpose of valuation by the Customs authority is to determine undervaluation and by its very nature, this would not fit with the scheme of transfer pricing analysis under the Income-tax Act. Decision of Hon'ble jurisdictional High Court in the case of P.R.P. Granites (supra) strongly relied on by the learned A.R., was in relation to a claim for exemption under Section 10B, based on an approval granted by Ministry of Commerce under Section 14 of the Industries (Development and Regulation) Act, 1951, to which CBDT was a party. On the other ....
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.... this extent, the addition made by the Assessing Officer and further confirmed by the CIT(A) is reduced. We order accordingly." Thus, if assessee's purchase of raw material from associate enterprise is 27% of the total raw material purchase, then the adjustment for ALP has to be restricted to 27% of the total turnover. 33. Coming to the aspect of + 5% safe harbour limits, this is no more res integra, in view of the decision of Special Bench in the case of IHG IT Services (India) (P.) Ltd. v. ITO (I.T.A. No.5890/Del/2010 dated 30.4.2013). The Special Bench was constituted to consider whether prior to the insertion of the second proviso to Section 92C(2), the benefit of 5% tolerance margin as prescribed under provisio to Section 92C(2) for the purposes of determining the arm's length price of an international transaction is allowable as a standard deduction in all cases, or is allowable only if the difference is less than 5%. In the meanwhile, the second proviso to Section 92C(2) was amended by the Finance Act, 2012 with retrospective effect from 1.4.2002. The assessee claimed, relying on Piagio Vehicle (P.) Ltd. v. Dy. CIT that even after the retrospective amendment by....
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....28.97 Crores only. Assessee was required to explain why such sum should not be added to its income both for computing total income and book profit income. Reply of the assessee was that supplementary invoice of Rs. 5.34 Crores was not raised on HML during the relevant previous year and hence could not be considered as income. However, Assessing Officer was not impressed. According to him, Annual Report of the assessee clearly mentioned sales to M/s HML was Rs. 34.31 Crores. Assessee was following mercantile system of accounting and hence this income should have been accounted in the relevant previous year. He, therefore, proposed an addition of Rs. 5.34 Crores, which was confirmed by the DRP. 39. Now before us, learned A.R. submitted that the annual report gave only an analysis of corporate margins. According to him, supplementary invoice was raised on 30th June, 2007. It was duly accounted in financial year 2007-08 also. Unless and until the invoice was issued, the party would not have paid. Related party transactions given in the audited final accounts at Schedule 18, did not show such amount as income of the relevant previous year. 40. Per contra, learned D.R. supported th....
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....overed under Section 40(a)(i) and the latter was covered under Section 40(a)(ia) of the Act. Disallowance was proposed for both these amounts. Though assessee submitted before the DRP that these were "Shrink-Wrapped" or copyrighted packaged software. According to it, while purchasing such software, there were no royalty whatsoever involved. These were outright purchase of software and hence tax deduction under Section 194J was not required. This argument did not find any favour with DRP. 46. Now before us, learned A.R. submitted that Section 40(a)(i) and Section 40(a)(ia) both mandated deduction of tax at source on royalty payments. However, according to him, the term "royalty" mentioned in these Sections had to be given the same meaning in Explanation 2 to clause (vi) of sub-section (1) of Section 9 of the Act. Relying on the said Explanation, learned A.R. submitted that the payments made by the assessee did not fall within the said Explanation. According to him, Explanation 4 inserted by Finance Act, 2012 with retrospective effect from 1.6.76 had no effect whatsoever for construing the meaning of the term "royalty" mentioned in Explanation 2. In support of this, learned A.R. r....