2023 (8) TMI 1638 - AT - Income Tax

TP Adjustment - disallowing the intra-group services claimed towards IT Services export services and management services paid - TPO treated the said services as part of the stewardship services and valued the ALP of the transactions at NIL - DRP has held that the assessee failed on the benefit test in respect of the intra-group services paid to its AE - what type of services have been provided by the AE to the assessee? - HELD THAT - TPO in the instant case determined the arm s length price of the international transaction at Nil without applying any of the methods prescribed under sub- sections (1) and (2) of section 92C. We find that the principle enunciated by the Hon ble High Court of Bombay in the aforesaid case is squarely applicable on the facts of the present case. Hence we find that the aforesaid action of the TPO (that is the determination of the ALP of the international transaction under consideration at nil) is without jurisdiction and it goes against the basic tenet of the Indian Transfer Pricing Regulation. In our opinion the facts brought to our notice by Assessee clearly show that the Assessee has a prima facie case. In respect of the payments made for various intra group services the evidence regarding benefit received by the Assessee have not been considered by the Ld. TPO / DRP. We therefore conclude that the Assessee has established the nature of services including quantum of services received from AE that services were provided in order to meet specific need of the assessee for such services the economic and commercial benefits derived by the Assessee from intra group services. TPO has not disputed any of the documentary evidences including the cost allocation. In view of our conclusion that the Ld. TPO and Hon ble DRP were in error in holding that the nature of services rendered by AE were in the nature of stewardship activity or shareholder activity we hold that the TPO s conclusion that no charges ought to have been paid by the Assessee is without any basis. After considering all the evidences submitted by the Assessee and various judicial precedents relied on the Ld. Counsel we conclude that the charges paid by the Assessee to AE are held to be at Arm s Length. Consequently the addition made by the revenue authorities in this regard are directed to be deleted and relevant grounds raised on this issue are allowed. TP adjustment made with respect to international transactions for export of ferrites for consumption by AEs - MAM selection - TPO and ld. DRP has rightly applied the transaction net margin method (TNMM) - HELD THAT - No merit in the submissions made by assessee because the only argument from its side is that its profit margin from the export sales to AEs is better than export sales to domestic as well as to third parties but this ground in itself is not sufficient to brush aside the finding of AO based on the proposed adjustment by the ld. TPO. Before us it has been accepted by the assessee that TDK Malaga manufactures the ferrite goods for its AEs only on the basis of confirmed orders and specifications. The quantity of goods sold through export sale and domestic sales has not been placed before us. Only mentioning the profit margin will in itself not solve the purpose unless and until the quantity of goods exported in the domestic market are almost at par to the export sales to the AEs and then only this contention of profit margin formula can be accepted. No such quantitative details have been filed at any stage. We restore this issue to the file of the Assessing Officer/TPO who shall call for the details from the assessee to examine the quantitative details of the export sales vis- vis domestic sales and only if both are reasonably at par (i.e. 10%) then only the internal TNMM method can be resorted to. For this reasonable opportunity to file the all necessary documents shall be provided to the assessee. And if it is found that the profit margin on export sales is better than the domestic sales then under such circumstances no adjustments will be called for. Disallowance of provision for slow-moving and non-moving inventory - AO disallowed the same treating the provision to be contingent in nature and not allowable - assessee submitted that the said adjustment of not allowing the provision for slow-moving and non-moving inventory is not justified because the assessee has made the adjustment based on Accounting Standard 2 issued by ICAI - HELD THAT - We note that the Assessee has created provision for the slow moving and non-moving inventory based on the guidance given under the Accounting standard 2 issued by the ICAI by adopting scientific approach to derive the value of the provision. In result we have considered the provision of slow moving and non moving as business loss and consider appropriate to direct the Ld. AO to delete the adjustment the additions made by the ld. AO are hereby directed to be deleted. Loss towards capital work in progress written off - HELD THAT - It is an admitted fact at the end of the assessee also that the Kalyani plant was just a venture by the assessee company and the plant never came into existence. It is also not proved that whether the regular business activity of the assessee company is similar to the one which was planned to be carried out at Kalyani plant i.e. manufacturing of new series of transformers. No evidence has been placed before us to prove that it is a part of business loss. If the said loss has been incurred in the regular course of business then the same should have been written off from the fixed assets block. Before us the claim of the assessee is that it is a revenue loss but to prove that the same as revenue loss no details has been filed before the lower authorities and even before us the assessee has been unable to justify the said claim. Prima facie the said claim seems to be a capital loss but since the details of such loss is not placed before the lower authorities we in the interest of justice restore this issue to ld. TPO who shall provide the assessee sufficient opportunity to place all relevant details on record and thereafter examine the nature of the loss and decide in accordance with law.

Summary

The core legal questions considered in this judgment pertain primarily to the determination of arm's length price (ALP) of various international transactions between the assessee and its associated enterprises (AEs) under the Income Tax Act, 1961, specifically under sections 92CA(3), 92C, and related provisions. The issues include the correctness of transfer pricing adjustments made by the Transfer Pricing Officer (TPO) and confirmed by the Dispute Resolution Panel (DRP) and Assessing Officer (AO), concerning:

• The nature and pricing of intra-group services (IT services, export support services, management support services) paid to the AE, including whether these services are stewardship activities and whether the ALP was correctly determined at nil.
• The characterization of the assessee as a contract manufacturer versus a manufacturer bearing normal business risks.
• The aggregation or separate consideration of transactions related to export of goods for resale and payment of sales margin.
• The application of the Comparable Uncontrolled Price (CUP) method and Transactional Net Margin Method (TNMM) for determining ALP of export of ferrites to AEs.
• The disallowance of provisions for slow-moving and non-moving inventory.
• The disallowance of capital work-in-progress (CWIP) written off relating to an abandoned project.
• The initiation of penalty proceedings under section 271(1)(c) of the Act.
• The application of the 3% variation/deduction under the proviso to section 92C(2) while determining ALP.

Several of these issues were not pressed by the assessee during hearing and thus dismissed as not pressed, specifically the issues relating to the contract manufacturing characterization and aggregation of export transactions.

Issue-wise detailed analysis:

1. Determination of ALP of intra-group services (IT, export support, management services) paid to AE:

Legal framework and precedents: The ALP determination must follow the provisions of sections 92C and 92CA of the Income Tax Act, which prescribe the use of prescribed transfer pricing methods to determine ALP of international transactions. The Supreme Court decision in DIT (International Tax) vs. Morgan Stanley and Co. Inc. was discussed, which defines stewardship activities and their treatment. The Bombay High Court decision in CIT vs. Lever India Exports Ltd. clarified that TPO's jurisdiction is limited to determining ALP by applying prescribed methods and cannot arbitrarily disallow expenses without proper application of transfer pricing methods. Tribunal decisions in Akzo Nobel India Ltd. and AT&S India Pvt. Ltd. were also relied upon.

Court's interpretation and reasoning: The TPO and DRP treated the intra-group services as stewardship activities and determined their ALP at nil without applying any of the six prescribed transfer pricing methods. The Tribunal noted that the TPO did not produce any benchmarking analysis or comparable uncontrolled transactions to justify the nil valuation. The assessee demonstrated the nature of services, the need for such services, and the benefits derived, supported by agreements, cost allocation statements certified by independent professionals, and consistent practice within the group. The Tribunal held that the TPO's approach was without jurisdiction and contrary to the basic tenets of Indian transfer pricing regulations.

Key evidence and findings: The assessee presented detailed submissions on the nature and necessity of IT support services (including centralized IT infrastructure management and third-party vendor coordination), export support services (market analysis, product strategy, customer relationship), and management support services (quality management, internal audit, R&D support). The cost allocation was transparent and certified. The services were also provided to other group companies on similar terms. The Tribunal found no adverse comments from the TPO on the cost allocation or the nature of services.

Application of law to facts: The Tribunal applied the principle that the TPO must determine ALP using prescribed methods and cannot reject the assessee's benchmarking without valid reasons or comparable data. The stewardship activity doctrine from Morgan Stanley was held inapplicable as the factual matrix differed and the issue was whether the services were stewardship activities, not whether such services created a permanent establishment. The Tribunal relied on binding precedents from its own Division Bench and High Court decisions to hold that the intra-group services were legitimate business expenses and the ALP adjustment at nil was unsustainable.

Treatment of competing arguments: The Revenue argued that the services were stewardship activities and thus not chargeable, relying on Morgan Stanley and the TPO's findings. The Tribunal rejected this, emphasizing the lack of application of transfer pricing methods and the evidence of benefit and necessity of services. The Tribunal also rejected the Revenue's failure to produce benchmarking data supporting the nil valuation.

Conclusion: The Tribunal deleted the transfer pricing adjustment relating to intra-group services, holding that the payments were at arm's length and allowable. This decision was applied mutatis mutandis to both AY 2014-15 and AY 2015-16.

2. Transfer pricing adjustment on export of ferrites for consumption by AEs:

Legal framework and precedents: The CUP method is an accepted method for determining ALP under the Act. The DRP had accepted the CUP method for subsequent years. The issue was whether the TPO's adjustment based on TNMM was justified.

Court's interpretation and reasoning: The assessee sold ferrites to AEs for consumption and resale, as well as to domestic third parties. The assessee claimed that the CUP method applied to sales for consumption showed prices were at or above third-party prices. The TPO applied TNMM and made adjustments on the entire ferrite segment. The Tribunal noted the lack of quantitative details comparing export sales and domestic sales, which is critical to validate the comparability of margins.

Key evidence and findings: The assessee submitted that operating margins on sales to AEs were better than to third parties. However, no data was provided to show that quantities sold domestically and to AEs were comparable.

Application of law to facts: The Tribunal held that without quantitative parity (+/-10%) between domestic and AE sales, the internal TNMM method could not be applied. The matter was remanded to the AO/TPO for detailed examination with opportunity to the assessee to produce relevant documents.

Treatment of competing arguments: The Revenue supported the TPO's TNMM approach. The Tribunal found merit in the assessee's argument on CUP method but required further factual verification.

Conclusion: The adjustment was set aside for statistical purposes and remanded for further inquiry.

3. Disallowance of provision for slow-moving and non-moving inventory:

Legal framework and precedents: Accounting Standard 2 (AS-2) issued by ICAI governs valuation of inventories and provisions for obsolescence. Provisions made on scientific basis for diminution in value of inventory are allowable business expenses.

Court's interpretation and reasoning: The AO treated the provision as contingent and disallowed it. The DRP directed the AO to examine the details and consider the correct figure. The Tribunal noted that the assessee followed AS-2 and maintained provisions based on a scientific approach.

Key evidence and findings: The assessee provided details of inventory and justification for the provision. The AO had no specific adverse findings against the scientific basis of the provision.

Application of law to facts: The Tribunal held that the provision was a legitimate business loss and allowable as revenue expenditure.

Treatment of competing arguments: The Revenue relied on case law to argue that mere provision without basis is not deductible. The Tribunal found the assessee's approach justified and supported by accounting standards.

Conclusion: The disallowance was deleted and the provision allowed as deduction.

4. Disallowance of capital work-in-progress (CWIP) written off relating to abandoned project:

Legal framework and precedents: The deductibility of written-off CWIP depends on whether the expenditure is capital or revenue in nature. Jurisprudence including Binani Cement Ltd. vs. CIT and other High Court and Tribunal decisions hold that such write-offs may be allowed as business losses if linked to business operations.

Court's interpretation and reasoning: The AO and DRP disallowed the claim for lack of details and treated it as capital expenditure. The assessee claimed the write-off was due to obsolescence and linked to business operations.

Key evidence and findings: The assessee failed to produce sufficient documentary evidence before the lower authorities to establish the nature of the loss as revenue.

Application of law to facts: The Tribunal noted the lack of evidence and restored the matter to the AO/TPO for examination after providing opportunity to the assessee to submit relevant details.

Treatment of competing arguments: The Revenue argued capital nature and lack of details. The Tribunal took a neutral view pending further evidence.

Conclusion: The issue was restored for fresh adjudication.

5. Penalty proceedings under section 271(1)(c): The assessee challenged the initiation of penalty proceedings. The Tribunal allowed the grounds relating to penalty, consistent with the deletion of transfer pricing adjustments.

6. Application of 3% variation/deduction under proviso to section 92C(2): This ground was raised but not specifically adjudicated in detail, presumably subsumed in other findings.

Significant holdings and core principles established:

"The jurisdiction of the TPO is specific and limited, i.e., to determine the arm's length price of an international transaction by applying any of the methods prescribed under sub-sections (1) and (2) of section 92C of the I.T. Act, being the most appropriate method. However, the TPO, in the instant case, determined the arm's length price of the international transaction at Nil without applying any of the methods prescribed under sub- sections (1) and (2) of section 92C of the I.T. Act. We find that the principle enunciated by the Hon'ble High Court of Bombay in the aforesaid case is squarely applicable on the facts of the present case. Hence, we find that the aforesaid action of the TPO (that is, the determination of the ALP of the international transaction under consideration at nil value) is without jurisdiction and it goes against the basic tenet of the Indian Transfer Pricing Regulation."

"The term 'stewardship activity' has not been defined by the I.T. Act. The Hon'ble Supreme Court has defined the term 'stewardship activity' in the matter of DIT (International Tax) vs. Morgan Stanley and Co. Inc. However, the ruling in the aforesaid decision, in our view, has no application to the facts of the present case. In the case of DIT (International Tax) vs. Morgan Stanley (supra), firstly, the observations were rendered in the context of an admitted factual position by the applicant before the Authority for Advance Ruling (AAR) that certain services were in the nature of stewardship services. Secondly, the observations were made by the Hon'ble Supreme Court as to whether stewardship activity rendered by the holding company for the Indian subsidiary in India would constitute a Permanent Establishment (PE) within the meaning of Article 5(2)(1) of the DTAA between India and USA. However, in the present case, the factual dispute is as to whether the IT services received by the assessee under the aforesaid agreement was in the nature of stewardship services or not. To this extent, we conclude that the aforesaid decision of the Hon'ble Supreme Court (supra) is not relevant to the present case."

"The essence is that a businessman himself is the best judge in determining the reasonableness / usefulness / benefit of an expenditure which is wholly and exclusively laid out for the purpose of business. The Revenue has no role to play in determining the reasonableness / usefulness / benefit of a business expenditure."

Final determinations on each issue include:

• Deletion of transfer pricing adjustments relating to intra-group services payments for AY 2014-15 and AY 2015-16, holding such payments at arm's length.
• Remand of the transfer pricing adjustment relating to export of ferrites for consumption for AY 2014-15 for further factual inquiry.
• Allowance of deduction for provision for slow-moving and non-moving inventory for AY 2014-15.
• Remand of the claim for deduction of CWIP written off for AY 2014-15 for further examination.
• Penalty proceedings challenged and allowed in favor of the assessee.