TaxTMI 
TaxTMI 
2018 (10) TMI 49
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.... November 2012, declaring a taxable income of Rs. 1,03,08,770. The following were the international transactions entered into by the assessee with its Associated Enterprise (AE) during the relevant previous year:- Nature of International Transaction Amount (Rs.) Import of raw materials and components 4,95,41,241 Export of finished goods 13,93,39,733 Purchase of traded goods 3,01,05,940 Receipt of marketing support service fee 53,12,346 Receipt of research and development fees 4,82,10,266 Payment of royalty 2,43,31,671 Payment of interest on loan 21,81,641 Payment of personnel support fees 1,66,79,236 Purchase of fixed assets / depreciation 50,71,189 4. In view of the provisions of section 92 of the Income-Tax Act, 1961 ["the Act"], income from an international transaction had to be determined having regard to the arm's length price (ALP). The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO accepted that all international transactions carried out by the assessee was at arm's length, except the international transaction of export of finished goods by the assessee to its AE. The di....
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....ons Limited 5.09% 5.37% Rejected 3 Span Diagnostic Limited 8.88% 9.74% Rejected Arithmetic Mean 6.59% 7.08% 7. As already stated, the TPO accepted the price paid or received by the assessee in all the international transactions as at arm's length, except the international transaction in relation to the manufacturing activity with its AE. The learned TPO did not accept the economic analysis undertaken by the assessee and conducted a fresh economic analysis. The TPO rejected 2 companies out of 3 companies selected as comparables by the assessee in the TP Study. The TPO on his search of the database chose 4 new companies and selected the following 5 companies as the final set of comparables with unadjusted margin of 8.21% on operating revenue:- S. No. Particulars Margin (OP/OR) (%) Margin (OP/OR) (%) 1 Shree Pacetronix Limited 5.41% 5.72% 2 Continental Controls Limited 8.19% 8.92% 3 Hindustan Syringes & Medical Devices Limited 12.37% 14.12% 4 Centenial Surgical Suture Limited 6.38% 6.81% 5 Allengers Medical Systems Limited 8.70% 9.53% A....
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....A) directed the TPO to re-compute the operating margins of the Assessee and the comparable companies. * The CIT(A) directed the AO/TPO to follow a consistent approach in treatment of foreign exchange fluctuation by considering the same as operating in nature for the Assessee and the comparable companies. * In respect of the other grounds, the CIT(A) primarily agreed with the TPO's approach and did not appreciate the Assessee's submission. * In addition to the above, the CIT(A) directed the TPO to recompute the ALP and TP adjustment on the entire manufacturing segment instead of restricting the adjustment to AE transaction. 10. Aggrieved against the order passed by learned CIT(A), the Assessee has preferred an appeal before the Tribunal on the following grounds of appeal. Grounds of general nature Ground 1: The order of the learned CIT(A) is based on incorrect interpretation of law and facts and therefore is bad in law; Grounds of appeal relating to transfer pricing matters Ground 2: The learned CIT(A) has erred in making an addition to the total income of the Appellant on account of adjustment in the arm's length price ("ALP") r....
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....unctionally comparable: a) Gansons Limited b) Span Diagnostics Limited S. No. Name of the comparable Reasons for rejection by TPO Appellant's contentions 1. Gansons Limited Functionally different Company is a manufacturer of process equipments like fluid bed processing equipment, high shear mixer granulator, etc. for various industries like pharmaceutical, foods, petrochemicals, etc. These equipments are similar to the equipments manufactured by the Appellant. Company is predominantly engaged in manufacturing activities and has earned 98.57% of its operating revenue from the sale of manufactured goods. 2. Span Diagnostics Ltd Functionally different According to the annual report, the company is engaged in the business of manufacturing, marketing and trading of diagnostics reagents, diagnostics instruments and allied products. The company operates in a single segment i.e. "Diagnostic Products". *Company is predominantly engaged in manufacturing activities and has earned 98.66% of its operating revenue from the sale of manufactured goods. 13. It was argued that Shree Pacetronix should be rejected o....
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.... product similarities. It may be acceptable to broaden the scope of the comparability analysis to include transactions involving products that are different, but functionally similar. The acceptance of such an approach depends on the effects of the product differences on the reliability of the comparison and on whether or not more reliable data are available. In other words, it cannot be said that product difference is a factor which needs to be either ignored or strictly followed. It depends on facts and circumstances of each case. 16. In the present case, the fact that the product manufactured by the tested party i.e. the Assessee viz., laboratory and processing equipment and the comparable company i.e., Shree Pacetronix viz., manufacture of pacemaker for implanting in heart, can be categorized as "manufacture of equipment". The relevancy of the end use of equipment whether by consumer or as component may be relevant while evaluating functional dissimilarity, Assets employed and risks assumed but not on the basis of characteristics of the property transferred under Rule 10B(2)(b) of the Rules. 17. For the reasons given above, we are of the view that Shree Pacetronix was rig....
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....he limited prayer made at the conclusion on this issue was restricted to a direction to the TPO to apply the principle of treating foreign exchange fluctuation as operating in nature under both situations, when there is a loss as well as when there is a gain. The next prayer was to apply the same principle to determine the profit margins of the assessee and the comparable companies. The limited prayer so made is in accordance with the settled legal position in this regard and the TPO is directed to compute the profit margins of assessee and the comparable companies as prayed for by the ld. counsel for the assessee. Ground No.6 is decided accordingly. Ground No.7: The learned CIT(A) has erred, in law and in facts, by upholding the action of the AO/TPO in rejecting capacity adjustment to account for differences in capacity utilization of the Appellant vis-à-vis the comparable companies. 21. The assessee in its TP documentation as well as before the TPO and the CIT(A), highlighted the fact that there are significant differences in the capacity utilization between the assessee vis-à-vis the comparables. It was also brought to the notice of the TPO and the CIT(....
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.... method would be one which inter alia provides the most reliable measure of ALP, and one of the important factors to be taken into account herein is the ability to make reliable and accurate adjustments. 26. The OECD Guidelines on this aspect is as follows:- Para 1.35 of the OECD Guidelines states as follows: "Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm's length conditions" Para 1.36 of the OECD Guidelines states as follows: ".... material differences between the compared transactions or enterprises should be taken into account. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm's length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm's length dealings. Attributes that may be important include the characteristics of the prop....
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....appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations in harmony, the adjustments should be made on the tested party. In the following decisions it has been held that adjustment to the profit margins have to be made on account of underutilization of capacity: (i) In the case of M/s. Mando India Steering Systems Private Limited vs Assistant Commissioner of Income Tax, [I.T.A. No. 2092/Mds 12012], the Tribunal upheld the contention of the taxpayer for making a suitable adjustment on account of idle capacity for the purpose of margin computation. The relevant extract is reproduced as below: "10. .......... We are of the considered view that underutilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production." (ii) In the ruling of DCIT Vs Panasonic AVC Networks India Co Ltd (I.T.A. No.: 4620/De1/2011), it was held that:- "5. ..... Capacity under....
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....lar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The AO shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal of the assessee is disposed of." 30. The reliability and accuracy of adjustments would largely depend on availability of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not be available in public domain or may not be reliably determinable based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible). 31. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making "reasonably accurate adjustments" for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the v....
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....ssessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), will be useful for, or relevant to, any enquiry or proceeding under this Act :" 34. In this regard, we find that the Mumbai ITAT in case of M/s Kiara Jewellery P.Ltd. (I.T.A.No.8109/Mum/2011), has directed the AO/ TPO to obtain the exact details of capacity utilization of comparable companies, if not available in public domain. The relevant extract of the aforesaid decision is as under:- "11. Keeping in view the decision of the Tribunal in the case of Petro Araldite (P) Ltd (supra) laying down the guidelines on the issue of capacity utilization, we consider it appropriate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same directly from the concerned parties and to decide this issue afresh after giving assessee an opportunity of being heard." (Emphasis Supplied) 35....
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.... of goods/service sold/rendered reflects not only the purchase price of goods but also the time value for the loan from their suppliers. Difference in the terms of sale and purchase can affect comparisons. 39. The assessee placed reliance on the following decisions in support of its contention that a working capital adjustment is warranted:- (i) In the case of Demag Cranes & Components (India) Pvt. Limited (ITA No.120/PN/2011), the Pune Tribunal held as follows:- "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 TNMM, 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 which can influence price or gross margins. Further, it is the requirement of the rules / provisions that any difference which is likely to materially affect the NPM in open market has to be eliminated. TPO must know that the TNMM visualizes the undertaking of the thorough comparability analys and elimination of the differences through the requisite adj....
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....ce between the companies are so material that adjustment is not possible, then comparables are required to be rejected." (Emphasis supplied) 40. In light of the principles embodied in the above judgement, the assessee prayed that the benefit of a working capital adjustment should be accorded to the assessee in the instant case. 41. The CIT(A) rejected the claim of the assessee for the reason the assessee has to demonstrate the impact on profit margins by reason of a particular level of working capital requirement in the case of the assessee and that of comparable companies. In coming to the above conclusion, the CIT(A) has placed reliance on decisions of Chennai ITAT in the case of Mobis India, ITA No.2112/Mds/2011 (AY 2007-08) and SAM Deutz Fahr India Pvt. Ltd., ITA No.2666/Mds/2016 AY 2006-07, order dated 22.2.2017. In those cases, the Tribunal was dealing with cases where data was not provided. In the present case the assessee has given such working which is given as Annex. 4 to the written submissions filed before us. Such working was also given in pages 59 to 64 of submissions filed before the CIT(A). Therefore, the TPO/AO is directed to consider the claim of th....
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.... by any of the following methods.....". 47. It is the plea of the assessee that addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. The profit from comparable transactions of the assessee with non-AEs is one of the subtle and most reliable modes for determining ALP of the international transactions. The Act does not contemplate an addition by way of TP adjustment in respect of transaction with non-AEs. 48. The TPO determined addition to total income, consequent to determination of ALP only in relation to international transaction i.e., transactions with AE in the export of finished goods segment by considering the value of international transaction at Rs. 3,31,50,982 which is the value of export of finished goods by the assessee to its AE and not on the total sales in the finished goods segment of Rs. 39,19,74,355 (vide para 8.3 of the TPO's order). 49. The Hon'ble Bombay High Court in the case of Phoenix Mecano (India) Private Limited [ITA No. 1182 of 2014], had to deal with the following question of law suggested by the revenue:- 6.1 Whether on the facts and in the circumstances of the case, the....
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....law arises for consideration. As such the appeal is dismissed with no costs." (Emphasis supplied) 51. The Hon'ble Mumbai Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 7032/Mum/2011] held that the ALP can only be determined on the value of international transaction alone and not on the entire turnover of the assessee at entity level. This decision was further upheld by the Hon'ble Bombay High Court in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 2201 of 2013], which held as below:- "2. .............. (a) Whether on facts and the circumstances of the case and law, the Tribunal was justified in law in restricting the Transfer Pricing (TP) adjustment only to the transaction between the Associated Enterprises (AEs.)? 3. ........ ... .......... . (e) We find that in terms of Chapter X of the Act, redetermination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent u....
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....ing decided as follows: 10.1 In the case under consideration, the appellant is selling its product to AE as well as to non AEs, for the manufacture of which, part purchases are from AEs and remaining from the non AEs. The TPO has considered OP/OR for purpose of computation of the ALP as the quantum of sales to AE are lesser than the purchase from AE and thus lesser controlled. When a product is sold, only overall profit margin is recorded without any data as to what would be the profit in relation to purchases from AE. So this cannot be presumed that the profit percentage earned in relation to costs related to AE transactions as well as non-AE transactions was same. Since costs are common to the products ultimately sold by the appellant, and the same includes AE transactions, so it is always possible that the margin of profit percentage vis-a-vis costs related to AE transaction is not the same as profit margin on costs related to non-AE transactions but ultimately overall certain profits are being shown. Further, the transactions with non-AEs can be presumed to be at arm's length as there is no reason to earn lesser profit. But in case of transactions with AEs, there i....
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....rged to the profit and loss account in the year under consideration and incurred for the purpose of business of the Appellant Without prejudice to the above, the learned CIT(A) has erred in law and in facts, not granting allowance of the prior period expenses in the previous year on account of being incurred wholly and exclusively for the purpose of business of the appellant. Without prejudice to the above, the learned CIT(A) ought to have set off the prior period income of Rs. 47,04,916 against the prior period expenditure of Rs. 65,48,1490 and thereby restricted the net disallowance of prior period expenditure to Rs. 18,43,233". 58. It is not in dispute that in AY 2013-14, the Assessee has claimed the same expenses as deduction but the same was disallowed by the AO on the ground that it was expenditure relating to AY 2012-13 and therefore cannot be allowed as deduction in AY 2013-14 as it was prior period expenditure. The additional ground is admitted for adjudication as the claim could not be made by the Assessee in the assessment and appellate proceedings for AY 2012-13 as it was under the bonafide belief that the deduction would be allowed in AY 2013-14. ....
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.... engaged in business of manufacture and trading of laboratory and processing equipment and also provides research and development services and marketing and technical support services to Group companies. Accordingly, the assessee operates in four segments and the revenue from these segments for FY 2011-12 is as follows:- S. No. Business segment Revenue (INR) Ratio (%) 1 Manufacturing segment 39,19,74,335 80.21% 2 Trading segment 4,31,94,581 8.84% 3 Research and development 53,12,346 1.09% 4 Support services 4,82,10,266 9.87% Total 48,86,91,528 100% 65. Accordingly, the total foreign exchange gain of INR 53,89,273 of assessee should be allocated among all the four segments on a proportionate basis. Based on the above revenue ratio, the foreign exchange gain of INR 43,22,679 is attributable to the manufacturing segment of assessee. Hence, the foreign exchange gain of INR 43,22,679 should be considered as operating in nature and included in the computation of operating revenue. Accordingly, the revised operating revenue of assessee for the manufacturing segment would be INR 39,62,97,014 (i.e. INR 39,19,7....
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....as operating expense, we are of the view that it is only the bad debts in manufacturing segment that should be considered as expenses of manufacturing segment for working out the OP/OC. We hold and direct accordingly on the aforesaid additional grounds. Ground 10: The learned CIT(A), has erred in facts and law, in not allowing deduction in respect of inadvertent and suo-moto disallowance of sales commission payable to non-resident agents amounting to Rs. 7,45,316 under section 40(a)(i) of the Act. Ground 11: The learned CIT(A) ought to have appreciated that the sales commission payable to non-residents who have no business presence in India and entirely rendered services from outside India, would not be subject to withholding of taxes in India and hence the same shall not fall under section 40(a)(i) of the Act. Ground 12: The learned CIT(A) ought to have appreciated that the sales commission expense incurred by the Appellant, is a genuine business expenditure and should be allowed as a deduction from the business profits of the Appellant. 70. During the FY 2011-12, the assessee had paid sales commission expenses of INR 7,45,316 to non-resident agents towards....