2018 (1) TMI 1613 - AT - Income Tax

TP Adjustment - assessee claims that Internal TNMM should have been considered as the most appropriate method - Comparable selection - HELD THAT - Rejection of internal TNMM analysis undertaken by the appellant during the course of transfer pricing assessment should not have been rejected. Appellant company has provided identical services to AE as well as non AEs and functions performed assets used and risks assumed in AE as well as non AE business were similar. Therefore even internal TNMM can be considered as most appropriate method. We find that the operating margin of the appellant from the AE segment was derived at 30.90% and the operating margins in the non AE segment was derived at Rs. 74.92%. TPO rejected the internal TNMM analysis on the basis that as the appellant has made operating loss in non AE business the transactions with non AEs are not at independent rates and they have been undertaken only to increase capacity utilization. The total turnover of Non AE segment of Rs. 5.67 lacs as against the turnover of Rs. 1909.60 lacs in the case of international transactions with AE. CIT(A) confirmed the rejection by holding that the turnover of the third party segment is very much less compared to that with AE. CIT(A) further held that the appellant has not proved the allocation of the common cost between AE and non AEs and whether they are scientific and at arm s length. We find that the TPO has nowhere disputed the common cost allocation made by the appellant. We also find that the ld. CIT(A) has also never raised any doubt on the allocation. The Comparable CG-Vak Sofware Exports Limited was rejected as the turnover of the company is less than 1 crore and hence does not qualify turnover filter. The turnover of the relevant segment of the company is 86.10 lacs but just because this company does not pass the turnover filter of 1 crore should not have been rejected as the business is exactly similar to that of the appellant company. If the aforementioned two companies are accepted as comparable as exhibited elsewhere the average of the 5 comparables comes to 15.17% whereas that of the appellant company comes to 30.90%. We further find that the appellant company has earned foreign exchange gain on revaluation of its outstanding revenue receivables which were not considered as part of operating profit by the TPO as well as CIT(A). We find that the foreign exchange gain earned by the appellant pertained towards revaluation of its debtors as on the balance sheet date which means that exchange fluctuation was towards revenue item. Further Safe Harbour Rules are only applicable to those assessee who have opted for Safe Harbour Rules and the same is made effective from A.Y. 2013-14 onwards. Foreign exchange fluctuation should be considered as operating in nature for the purposes of computing the operating profit of the appellant as well as comparable companies.Upward Adjustment is uncalled for and we direct the same to be deleted. Accentia Technologies Ltd. Acropetal Technologies Ltd. Coral Hub Limited - First Appellate Authority has held that these companies are incomparable to the business of the appellant and therefore the ld. CIT(A) has ruled in favour of the appellant.

Summary

Issues Involved:
1. Transfer Pricing Adjustment by TPO and CIT(A)
2. Applicability of Internal TNMM
3. Rejection of Internal CUP
4. Risk Profile Differences
5. Comparability of Companies
6. Foreign Exchange Gain Consideration

Detailed Analysis:

1. Transfer Pricing Adjustment by TPO and CIT(A):
The assessee challenged the Rs. 37,716,838/- Transfer Pricing Adjustment made by the TPO and confirmed by the CIT(A). The TPO applied the external TNMM using five comparables, rejecting both the internal CUP and internal TNMM methods proposed by the assessee. The CIT(A) upheld the TPO’s adjustments but excluded three of the five comparables selected by the TPO, maintaining the upward adjustment based on the remaining two comparables.

2. Applicability of Internal TNMM:
The assessee argued that the Internal Transaction Net Margin Method (TNMM) should be considered the most appropriate method. The TPO and CIT(A) rejected this, citing that the transactions with non-AEs were not at independent rates and were undertaken to increase capacity utilization. The Tribunal found that the appellant provided identical services to both AE and non-AE, with similar functions, assets, and risks, thus considering internal TNMM as appropriate. The Tribunal referenced the Delhi Bench in Lummus Technology Heat Transfer BV Vs. DCIT, which supported the use of internal TNMM despite differences in transaction volumes.

3. Rejection of Internal CUP:
The TPO and CIT(A) rejected the internal Comparable Uncontrolled Price (CUP) method, arguing that the pricing mechanisms for AE and non-AE were different. The Tribunal disagreed, stating that merely because pricing mechanisms differ, internal CUP should not have been rejected. The Tribunal emphasized that the average hourly rate from AE business was significantly higher than that from non-AE business, which should have validated the internal CUP method.

4. Risk Profile Differences:
The TPO noted that the risk profiles of AE and non-AE transactions were different. The Tribunal countered that reasonable accurate adjustments for such risk differences could not be made and that the internal CUP should have been accepted. The Tribunal cited the case of Lummus Technology Heat Transfer BV, which held that the size of the uncontrolled transaction does not render it incomparable.

5. Comparability of Companies:
The CIT(A) rejected Allsec Technologies Limited as a comparable due to its export turnover being less than 75% and considered the search during assessment proceedings as post facto analysis. The Tribunal found no merit in these observations, referencing the Delhi Bench in Mercer Consulting India Private Limited, which included Allsec Technologies as a comparable despite similar objections. The Tribunal also rejected the exclusion of CG-Vak Software & Exports Limited based on turnover, emphasizing functional similarity over turnover size.

6. Foreign Exchange Gain Consideration:
The TPO and CIT(A) did not consider foreign exchange gains on revaluation of outstanding revenue receivables as part of operating profit. The Tribunal disagreed, citing multiple precedents, including the Delhi High Court in Cashedge India Private Ltd., which treated such gains as operating items. The Tribunal concluded that foreign exchange fluctuations should be considered for computing operating profit.

Conclusion:
The Tribunal concluded that the upward adjustment of Rs. 37,716,838/- was uncalled for and directed its deletion. The appeal filed by the assessee was allowed, with the Tribunal emphasizing the appropriateness of internal TNMM and CUP methods, the comparability of certain companies, and the inclusion of foreign exchange gains in operating profit calculations. The Tribunal also noted that the revenue did not appeal against the exclusion of certain comparables by the CIT(A), thus no further adjudication was required on those companies.