TaxTMI 
TaxTMI 
2019 (4) TMI 1286
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....ation of operating profit margins of BEML Limited for FY 2008-09. Erred on the facts and in circumstances of the case by inappropriately considering an additional company, BEML Limited as comparable to the Appellant for FY 2008-09. Without prejudice to the above, erred by incorrectly computing operating profit margins of BEML Limited for FY 2008-09. 5. Inappropriate non-consideration of the segmental financials providing split between trading and manufacturing operations of the Appellant and concluding that trading operations should at least break even. Erred on the facts and in circumstances of the case and in law by inappropriately rejecting segmental financials providing split between trading and manufacturing operations of the Appellant and concluding that trading operations of the Appellant should at least break even and thereby arbitrarily shifting expenses amounting to Rs. 10 crores from trading operations to manufacturing operations." 4. During the proceedings before us, assessee also filed an additional ground and the same reads as under :- "Ground of appeal 7-Inappropriate computation of transferpricing from manufacturing torpaenrastaiocntsio onfs ....
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.... BEML are not comparable as the same is engaged in the manufacturing of wide range of products. Further, the data relating to the mining and construction business of BEML are not available. Further, the assessee submitted that the filter of having 75% of total revenue from comparable activities is not satisfied in case of BEML. As per the assessee, (i) JCB India with 11.92% of OP/Income; and (ii) Telco Equipment with 8.32% of OP/Income are the only good comparables. During the TP proceedings u/s 92CA(3) of the Act, the TPO included BEML as a good comparable and rejected the objections of the assessee. Thus, the OP/Income of the 3 comparables rose to 16.41%. Aggrieved with the above inclusion of BEML, the assessee filed an appeal before the CIT(A) for exclusion of the said BEML from the list of good comparables. The CIT(A) considered the arguments of the assessee and confirmed the view taken by the Assessing Officer. The contents of paras 2.2.1 to 2.2.11 are relevant in this regard. 8. The CIT(A) extracted the written submissions of the assessee in para 2.2.2 of his order. As per the assessee, the BEML has various division such as (i) Mining and construction business; (ii) Defenc....
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....e it is a government company. Para 24 the honourable ITAT held that 'in our considered opinion, mere fact that Comparable Company is owned by Government, it cannot be a criteria to reject the same, inasmuch as ownership structure of a concern is normally not expected to have a bearing on its operating margins'. 2.2.11 In view of the above discussion, I hold that learned TPO was correct in accepting 'mining and construction segment' of the BEML as comparable with the Appellant. I confirm the action of the learned TPO in this regard." 10. Aggrieved with the above decision of the CIT(A), the assessee is in appeal before the Tribunal with the above extracted ground no.2. 11. Before us, referring to the first allegation on the functional test, ld. Counsel for the assessee relied on heavily on the written submissions made by the assessee before the CIT(A), which is extracted in para 2.2.2 of the order of the CIT(A). Referring to the functions of BEML, ld. Counsel submitted that the said company is engaged in manufacturing and selling of electric rope shovels, hydraulic excavators, bulldozers, wheel loaders, wheel dozers, dump trucks, motor graders, pipe layers, tyre handle....
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..... The assessee is aggrieved by the inclusion of said three concerns in the final set of comparables, wherein the said three concerns were Public Sector Enterprises providing consultancy and end to end solutions to government and other companies. The said concerns i.e. WAPCOS is a Mini Ratna - I Public Sector Enterprise; Engineers India Ltd. was a Government of India Enterprise and became Public Listed Company in 1996 and KITCO was established in 1972 by IDBI, Government of Kerala, seven Public Sector Banks and other National and State level financial institutions, to provide technical assistance and consultancy. We find merit in the plea of the assessee that where the concerns were working on governmental policies and social obligations, the risk profile and functions of the said Public / Government Enterprises were completely distinct and dissimilar from a concern which was a captive service provider to its associated enterprises. The assessee was operating on Cost Plus Method which was distinct from the operations of the Public Sector / Government Enterprises. Further, even from the risk perspective, the assessee ITA Nos. 566 & 645/PUN/2013 and ITA No. 2637/PUN/2016 does not bear....
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....ind it relevant to not go into the other arguments relating to the functional test of BEML and other arguments raised by the assessee's AR. Accordingly, ground no.2 is allowed without going into the merits of the function test. Thus, ground no.2 is allowed. 16. Ground no.5 relates to the shifting of Rs. 10 crores from trading segment to the manufacturing segment on ad-hoc basis. The relevant facts are discussed in the order of the TPO in para 9.1. 17. As stated in the preceding paragraphs, the assessee has two segments, (i) manufacturing segment and (ii) trading segment. After analyzing the segmental accounts and the allocation of expenditure between the segments, the Assessing Officer/TPO noted that the certificate issued by the Chartered Accountant relating to the allocation of expenses between the two segments of the assessee, is not credible. The relevant discussion given in para 9.1 of the order of the TPO and the same are extracted hereunder :- "9.1 Segments It has been argued that there are two segments in the case of assessee viz manufacturing and trading and that its segmental accounts should be accepted. There is no disagreement with the propositio....
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....operations of the assessee in the said paragraph (para 2.5.4) before confirming the decision of the TPO/Assessing Officer. Otherwise, the assessee followed sales ratio in matters of adjudicating expenditure between the two segments. The relevant paras 2.5.5 to 2.5.10 of the order of the CIT(A) are extracted hereunder :- "2.5.5 I find that the Appellant has allocated majority of the expenses other than the cost of goods sold in the ratio of turnover between manufacturing and trading. It is fundamental accounting principle that if any expenditure is incurred for the particular segment, it would constitute direct expenditure for such segment. It is only common un-allocable expenses are allocated on the basis of the some allocation key. However, to allocate almost entire expenses below the line in proportion to turnover as the Appellant has done in this case, is unheard of and is against the accountancy principles and business reality. Therefore, such allocation is not possible to accept. 2.5.6 For example, the Appellant's allocation of employee cost is not transparent and gives impression that major part of total employee cost of Rs. 10 cr. Is allocated on the basis ....
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....tudy report. The Appellant has stated that it has suffered loss for business reasons however, no mention of it in its transfer pricing study report make the segmental accounts with loss in trading function unreliable. 2.5.10 In view of the above, it is not possible to accept split-financials prepared by the Appellant. I confirm the decision of the learned TPO to reject split-financials prepared by the Appellant." 19. Thus, the TPO/Assessing Officer shifted the expenditure of Rs. 10 crores to the manufacturing division from the trading segment on ad-hoc basis. 20. Aggrieved with the above decision of the CIT(A), the assessee raised the said ground no.5 before us. 21. Before us, ld. Counsel for the assessee submitted that the assessee is a start-up company, operated for few month in the year under consideration and the capacity utilization is only 4.5%. Further, the ld. Counsel for the assessee took objection to the adverse finding of the Assessing Officer/TPO, who questioned the certificate issued by Chartered Account in matter of expenditure allocation. Justifying the said certificate, ld. AR submitted that the assessee adopted sales-based allocation. Justifying t....
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.... issue is required to be remanded to the file of the Assessing Officer/TPO with regard to the approved the applicability of the basis of sales ratio uniformly to all the accounts qua the trading and manufacturing account. With these directions, we remand this issue to the file of the Assessing Officer/TPO for fresh examination of the issue. The Assessing Officer shall grant a reasonable opportunity of being heard to the assessee in accordance with set principles of natural justice. Accordingly, relevant ground no.5 is allowed for statistical purposes. 25. Additional Ground: Before us, the assessee raised an additional ground (extracted above) stating that the adjustments were made identity level instead of international transaction only. The CIT(A) decided the issue by observing as under :- "2.6.3 I have considered the arguments of the Appellant. I find that the learned TPO has changed the transfer pricing method to TNMM from what was used by the Appellant (TNMM and RPM) therefore; onus is on the learned TPO to make the adjustment on the value of the international transaction as required u/s 92 of the Income Tax Act. It is clear that the adjustment can be made only to t....
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....f the Tribunal (supra). For the sake of completeness, the said paras 45 to 49 are extracted as follows :- "45. Ground 10 refers to incorrect computation of TP adjustments to the manufacturing activity. In this regard, referring to the manufacturing segment and sale affected in this segment, Sri Lohia read 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 ie 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 ....
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....considered by the TPO and relied upon by the DRP. In principle, such closure comparability analysis is needed in TNMM, when sales is used as a base for determining net profit margin. Thus, it is erroneous to bring relationship between the Rs. 60,218,878/- and Rs. 23,32,42,565/- ie the total sales. Assessee'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 td - 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, the....
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....ting profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the assessee. Therefore, to this extent, the addition made by the AO and further confirmed by the CIT(A) is reduced. We order accordingly." D. DCIT vs Starlite 133 TTJ 425 Mum AY 2002-03 Page Para 13 at 478 of the Paper 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 vs DCIT 136 TTJ 530 Del- para 8.2 at Page 494 of the Paper book: "8.2 It has not been disputed that prov....
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....ts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to make capacity adjustment by recommending a method without justifying the reliability of the method? 2. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to make adjustment to cost of assessee when income-tax rule 10B(e)(iii) prescribed that adjustment is to be made to comparable only? 3. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to compute the TP adjustment international transactions proportionate to entered by the assessee. The law does not provide for a pro-rata adjustment when TNMM is applied at segment level. 4. Whether on the facts and circumstances of the case, the Ld. CIT(A) was justified in giving relief out of total adjustment made by the TPO, without appreciating the non-availability of authentic bifurcation of the transactions between the AE and Non-AE? 5. The appellant craves leave to add, amend or alter any of the above ground of appeal." 31. The ground nos.1 and 2 relates to the capacity adjustment to the cost. Further, ground nos.3 and 4 relate to the TP adjus....
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....osts for two comparables. The 3 data points is of sales and total costs for AY 2009-10 and two preceding years i.e. AY 2008-09 and 2007-08. This has been used by attempting to fit an equation y = a + bx. This mathematical model has been used to determine the average fixed costs across 3 years: The method adopted is not found acceptable for the following reasons. Firstly, this involves data for 3 years which is not sanctioned by the IT Rules which require contemporaneous data to be used. No case has been set up justifying the use of data of prior 2 years. Secondly, this assumes a mathematical model that relationship between sales and total costs is linear. There is no evidence or basis to support this hypothesis. In fact it is generally not the case that fixed costs will remain the same across years. In theory of finance and accounting too, no such theory is found. Thirdly, the statistical indicator of goodness of fit to validate the accuracy of model is not submitted despite specifically calling for the same. Fourthly, a visual inspection of the scatter diagram shows that there are three data points through which a straight line is drawn which does not fit well. In the case of JCB,....
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....ch of the Tribunal in the case of CIT vs. M/s Petro Araldite Pvt. Ltd. (35 taxmann.com 590) which is relevant for the proposition of making the adjustments on this account to the "profit margins of the comparables". He read out the contents of paras 23 to 25 of the said order of the Tribunal (supra). For the sake of completeness, the same are extracted hereunder :- "23. The question that now arises is what is the proper method of making adjustment for difference in capacity utilization within the frame work given in Rule 10B. As already discussed by us, the difference in capacity utilization affects the profitability mainly because of the difference in rates at which the fixed overheads are absorbed or allocated depending on the level of capacity utilization. The example given by us clearly depicts this position. The said example shows that the allocation of fixed overheads at the capacity utilization of 50%, 60% & 80% is 40%, 33.33% & 25% respectively resulting in the profit margin of 10%, 16.67% and 25%. In our opinion, if the fixed overheads allocation or absorption of comparable is brought at the level of the assessee , it would nullify the effect of difference in capa....
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....ating cost instead of sales would be more appropriate as the same will eliminate the effect of difference in profit margin or difference in level of stock of finished goods, if any of the tested party and comparables. 35. Therefore, rejecting the assessee's method for quantifying the "capacity utilization adjustment" to the tested party, we direct the Assessing Officer to follow the judgement of the Jurisdictional High Court in the case of Petro Araldite (P.) Ltd. (supra). The said judgement is relevant for following proposition :- "(v) In the above view, taking into account the capacity utilization of the comparable, in the present facts, as it materially affects the profit margin, the invocation of Rule 10-B(1)(e)(iii) of the Rules, cannot be found fault with This is self evident position from the reading of the aforesaid provision that all aspects/difference between the international transactions and the comparable uncontrolled transactions which materially affects the net profit margin had to be taken into account so as to have the fair comparison while determining the ALP of the tested party's transaction." 36. Considering the above, we find this issue should be....