TaxTMI 
TaxTMI 
2016 (4) TMI 204
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....d company dealing in the business of manufacturing of Engines. It filed its return of income on 31-10-2005 declaring total income of Rs. 1,42,18,02,320/-. The AO made a reference u/s.92CA(1) of the I.T. Act to the TPO for computation of ALP in relation to the international transactions detailed in the audit report in Form 3CEB. The TPO accordingly issued notice to the assessee asking for details/explanations to support the ALP computed by it in the audit report. 4. From the various details furnished by the assessee the TPO noted that Cummins India Ltd. is a 51% owned subsidiary of Cummins Inc., USA. The balance equity is held by the Kirloskar group, the Indian public and various financial institutions. Cummins India was formerly known as Kirloskar Cummins Ltd.. The company is engaged inter alia in the manufacture and sale of IC Engines for power generation and industrial applications in the domestic market. It also manufactures and sells IC Engines and Components for exports. It also purchases spares by way of imports for reselling in domestic market. The details of international transactions carried out by the assessee are as under: Sr. No. International Activity Amoun....
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.... on account of new engine performance inspection fee, deleted the disallowance of Rs. 40,36,560/- made u/s.14A and Rs. 2,55,41,000/- made on account of provision of warranty fee. He however sustained the addition of Rs. 12,84,929/- made on account of procurement services and Rs. 78,72,507/- made on account of export of IC Engines of LHP Division. 8. Aggrieved with such part relief given by the CIT(A) the Revenue as well as the assessee are in appeal before us with the following grounds : Grounds of appeal by the Revenue : "1. The order of the learned Commissioner of Income-tax (Appeals) is contrary to law and to the facts and circumstances of the case. 2. The learned Commissioner of Income-tax (Appeals) grossly erred in allowing the assessee's appeal instead of confirming the Assessing Officer's order. 3. The learned Commissioner of Income-tax (Appeals) grossly erred in deleting the Transfer Pricing Adjustment on export of manufactured IC Engines of Rs. 8,23,19,580/- by rejecting the comparison of the gross Margins of the controlled AE transaction with the uncontrolled AE transactions and the uncontrolled Non AE transaction when TNMM with in....
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....the price computed based on arithmetic mean as provided ill proviso to section 92C(2) of the Act. 2.3 The learned CIT(A) erred in law and on the facts and in circumstances of the case in not accepting the benchmarking analysis followed by the Respondent for benchmarking of international transactions in respect of manufacturing activity of the HHP division. 2.4 The learned CIT(A) erred in law and on the facts and in circumstances of the case in not considering the use of external comparable companies selected by the Respondent for benchmarking the manufacturing activity of HHP division. 2.5 The learned CIT(A) erred in law and on the facts and in circumstances of the case in accepting the AO's stand of comparing segmental profitability of the Respondent's "exports to AEs" segment and "domestic sales" segment. 2.6 The learned CIT(A) erred in law and on the facts and in circumstances of the case in concluding without demonstrating that functions performed and risks assumed are greater in export market than in domestic market. 3. International Transaction relating to Procurement Support Services 3.1 The learned CIT(A) erred i....
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....s of cross objection is without prejudice to the other. 7. The Respondent craves leave to add, to amend, to alter, to substitute, and to withdraw the above grounds of appeal." 10. In Grounds of appeal No.1 to 4 the revenue has challenged the order of the CIT(A) in deleting the TP adjustment of Rs. 8,23,19,850/- made by the AO. 11. Facts of the case in brief are that the TPO during the proceedings before him noted that the assessee, during the year under consideration, has grouped/aggregated international transaction at Sl.No.1 to 7 of the table at Para 4 of this order as manufacturing activity and has benchmarked using TNMM taking external comparables and by adopting PLI as operating margin to sales earned by third party comparables. The TPO observed that the assessee company manufactures variety of engines from 60 to 2000 horse powers operating either on Diesel or natural gas or dual fuel. The company does not have standard product available off the shelf. The company manufactures Engines of specific horse power according to customer's needs and extent of usage. He noted that the gross margin to sales in respect of third party sales of Engines stand at 18.83% as com....
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.... to the requirement of the customers and nature of application of the product for which the assessee levies additional mark up based on the basis of additional features available in the product. He accordingly rejected the above argument of the assessee. 15. As regards the contention of the assessee that it assumes more risk in the domestic sales such as product risk, market risk and credit risk whereas such risks are not there in export sales, which is evident from the higher warranty claim, the TPO noted that warranty claims will impact net margin of the assessee company and not the gross margin. Secondly, the assessee has not demonstrated with facts and figures that risk difference impacts the assessee's gross margins on sales made to third parties, vis-à-vis AEs. Rejecting the various explanations given by the assessee and relying on various decisions the TPO made an adjustment of Rs. 8,23,19,580/-. Subsequently, the AO made the above addition in the order passed u/s.143(3). 16. Before CIT(A) the assessee vehemently argued against adoption of gross margin as profit level indicator as against adoption of net margin as PLI. The assessee referred to para 3.17 of the O....
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....ormed and risks assumed are always greater in export market than in the domestic market. As a thumb rule, in an Indian situation, profit margins are always higher in the export sales than in the domestic sales. This is because, the enterprise assumes product liability risk (products are rejected if they do not meet required specifications). More importantly, in an Indian situation, parts of locational savings are also is available to the Indian manufacturing company. Therefore, unless the enterprise demonstrates with relevant facts as to why it earned lower profit while exporting to AEs as against the domestic market assessee's argument on this issue cannot be considered. The assessee has not advanced any arguments on this aspect. Therefore, I do not accept the contention of the assessee on this ground. 3.1.11 However, on the issue of PLI, I agree with the assessee that the transactional net margin method, refers to 'net margin' and not 'gross margin'. This aspect is clear in Rule 10B, which is as under : (e) Transaction net margin method by which : (i) The net profit realized by the enterprise from an international transaction entered into with an associ....
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....action is computed in relation to a particular factor such as costs incurred, sales, assets utilized etc. The net profit margin realized by an associated enterprise is compared with net profit margin of the uncontrolled transactions to arrive at the ALP. The TNMM is similar to RPM and CPM to the extent that it involves comparison of margin earned in a controlled situation with margins earned from comparable uncontrolled situation. The only difference is that, in the RPM and CPM methods, comparison is of margins of gross profits and whereas in TNMM the comparison is on margins of net profit". 3.1.15 Rule 10B(e) and the OECD Guidelines make it clear that this method seeks to compare net profit margins of the controlled and uncontrolled transactions. Comparing of gross margins is not envisaged under the Income Tax Rules. Conceptually also comparing of gross margins may provide unreliable reasons because of the factors mentioned above. In view of the above, I hold that the adjustment made by the TPO is not supported by the legal provisions and hence, it is deleted. The Appellant gets relief of Rs. 8,23,19,580/-. 3.1.16 Since the decision is taken in the assessee's fav....
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....as under : "Difference in products : Under this head it has been submitted that there is difference in the basic engines on account of parts and components which are selected depending upon the application of engines, that the engine configurations to satisfy requirements in the Indian market are different from the export markets, that the exported engines represent basic configurations while domestic engines include a great variety of additional features such as cooling systems, exhaust systems, Air filtration systems, fuel system, mounting system, instrumentation panel, electrical and charging system and auxiliary accessories and thus additional capabilities and therefore appropriate mark up forms part of the sales." He accordingly submitted that when it exports its products to the AE it is the AE who does all those things. Therefore, there is difference in the product. He further submitted that the assessee is not required to do marketing functions for the AEs since it is their job to do marketing. 23. Referring to page 14 of the order of the TPO he drew the attention of the Bench to para 3.27 of the OECD guidelines which read as under : "3.27 One strengt....
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....s for the two items together rather than individually. Such transactions should be evaluated, together using the most appropriate arm's length method or methods. A further example would be the routing of a transaction through another associated enterprise, it may be more appropriate to consider the transaction of which the routing is a part in its entirety, rather than consider the individual transactions on a separate basis." (emphasis supplied by the assessee before TPO). He submitted that OECD does not say to adopt gross margin in TNMM. 25. Referring to Rule 10B(1) he submitted that for the purpose of sub-section (2) of section 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: 1. CUP 2. Resell price 3. Cost Plus method 4. Profit split method 5. TNMM or 6. Any other method as provided in Rule 10AB 26. So far as TNMM is concerned he submitted that every where the starting point in TNMM is net profit. Referring to para 3.1.9 of the order of CIT(A) he submitted that the Ld.CIT(A) while deleting the ....
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....nd gross margin earned by the assessee from export of IC engines to AEs. We find in appeal the Ld.CIT(A) following provisions of Rule 10B(e) as well as para 3.26 of the OECD guidelines and various other decisions held that net profit margin of controlled transactions has to be compared with the net profit margin of uncontrolled transactions. He has further held that comparing of gross margin is not envisaged under the I.T. Rules. In view of the detailed reasoning given by him at para 3.1.8 to 3.1.16 of his order, which has already been reproduced in the preceding paragraphs, he deleted the addition made by the AO on account of adoption of difference in gross profit margin by the AO as against difference in net profit margin between sales to AE and sales in domestic market. We find no infirmity in the order of the CIT(A) who has decided the issue as per the provisions of Rule 10B(e) as well as para 3.26 of the OECD guidelines as well as various other decisions according to which net profit margin of controlled transactions has to be compared with net profit margin of uncontrolled transactions. The Ld. Departmental Representative could not controvert the legal and factual findings gi....
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....the AO and CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. We find the assessee during the impugned assessment year has earned interest and dividend income of Rs. 31,41,04,213/- which it claimed as exempt. We find the AO applying the provisions of Rule 8D disallowed an amount of Rs. 40,36,560/-. In appeal the Ld.CIT(A) following the decision of Hon'ble Bombay High Court in the case of Godrej and Boyce Mfg. Company Pvt. Ltd. (Supra) deleted the addition holding that provisions of Rule 8D are prospective in nature and therefore are applicable to A.Y. 2008-09 and on onwards. Since the assessment year involved in the impugned appeal is A.Y. 2005-06, therefore, no disallowance is called for under provisions of Rule 8D as the same is not applicable for the impugned assessment year. However, it cannot be said that no administrative expenses have been incurred by the assessee for earning the huge tax free dividend income. Considering the totality of the facts of the case, disallowance of an amount of Rs. 2 lakhs, in our opinion, will meet the ends of justice. We hold and direct accordingly. Accordingly, the grounds r....
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....t provided specific facts or figures as to how these conditions have reduced its profit margin on exports made to the AEs. According to him unless proved otherwise the profit margin in export sales should always be higher than any sales made in the domestic market in Indian situation. According to him it is for the assessee to explain as to how the export sales made to AEs is at Arm's length as relevant information is in its possession. Since the assessee has not done the same he held that the TPO was justified in making the adjustment. 42. Aggrieved with such order of the CIT(A) the assessee has taken this ground of appeal No.4 in the CO. 43. The Ld. Counsel for the assessee referred to page 463 of the paper book and drew the attention of the Bench to the following submission made before the TPO : "C. Your Honour has requested the Company to show cause as to why adjustment of an amount corresponding to the difference in the margins generated by the Company from export of IC Engines of LHP Division to AEs and as generated by the Company from sale of IC Engines of LHP Division to non AEs be not made towards the international transaction undertaken by the Company relat....