TMI Blog2013 (11) TMI 930X X X X Extracts X X X X X X X X Extracts X X X X ..... trary to the very definition of 'international transactions' and the mandate of rule 10B(l)(e). Approving the course of action adopted by the assessee for calculating profit margin in respect of AE and Non-AE segments would require rewriting of the relevant provisions as discussed supra. By considering some transactions with Non-AEs also as a part of the AE segment, the computation of the operating profit margin in respect of AE transactions at 6.54% has completely lost its significance. Once the figure of OP/OC margin at 6.54% is itself incorrect, there can be no question of comparing it with that of Non-AE segment at 4.20%, which again stands distorted because of the exclusion of certain purchases and sales from/to Non-AEs from this segment eventually finding their way into the AE segment. Related party transactions in this case are admittedly a little more than 20% but less than 25%. On page 11 of the order passed by the TPO, it can be seen that he adopted filter of related party transactions at 25%. - a case can be taken as uncontrolled if its related parties transactions do not exceed 25% of the total revenue. - the assessee suo motu included this case in the list o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... RBI dated 26.03.2008 is available on page 240 of the paper book. Through this letter, the Central Bank of India forwarded relevant documents along with a copy of the agreement. The RBI vide its letter dated 21.04.2008 requested Central Bank of India to consider the assessee's case in accordance with its AP(DIR Series) No.76 dated 24.02.2007. It is in pursuance to the deemed approval by RBI under the automatic approval scheme that the assessee made payment of royalty and technical fee to its AE. It is relevant to note that such payment has been approved or deemed to have been approved by the RBI. When a payment is made after obtaining due approval from the RBI, how its ALP can be computed at Rs. Nil, is anybody's guess. The fact of approval of the payment by the RBI has been succinctly recorded by the TPO in his order as well. He still chose to propose adjustment in respect of full payment. In our considered opinion, when the rate of royalty payment and fee for drawings etc. has been approved or deemed to have been approved by the RBI, then such payment has to be considered at ALP - Decided in favour of assessee. - ITA No.6460/Mum/2012 - - - Dated:- 27-2-2013 - R.S.Syal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l handling equipment, steam generators etc. While executing turnkey projects, the equipments required for installing the plant were either manufactured by the assessee or sourced from various vendors including its AEs. During the year in question the assessee imported spares and equipments from its AEs amounting to Rs. 23.48 crore and also exported certain equipments and components etc. to its AEs amounting to Rs. 82.23 crore. The assessee benchmarked these international transactions by using Transactional Net Margin Method (TNMM) as the most appropriate method by considering Profit Level Indicator (PLI) as Net Operating Margin to Sales (OP/Sales). The assessee submitted that it earned margin of 4.63% from its transaction with AEs as under:- Particulars Total (Rs.in million) Sales/Operating Income 14184.18 Less : Operating Expenses 13527.88 Operating Profit 656.29 Operating profit/sales 4.63% 4. The assessee stated that the international transactions formed a small portion of less than 10% of its total turnover. During the course of hearing before TPO, the assessee submitted segmental data for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ernational transactions, recording the AE sales alone in the segmental accounts at Rs. 322 crore and the total of international transactions at Rs. 137 crore in the report in Form No. 3CEB, the TPO came to hold that the figures of AE and Non-AE segments as produced during the course of proceedings before him, were not mutually exclusive. On further examination, he noticed that the ratio of the material consumed to sales in case of AE segment worked out at 73% whereas that of Non-AE segment was at 86%. This led to the difference of 13% (86% - 73%) in absolute terms and 17.8% in relative terms. In the backdrop of the foregoing factors, the TPO rejected the audited segmental account and entity level results, which were produced by the assessee in support of its contention that the internal TNMM should be applied to benchmark its profit from international transactions with its AEs. 6. As far as external TNMM is concerned, the assessee had originally selected six comparable cases in its Transfer Pricing study with the arithmetical mean of operating profit margin to sales at 4.36% as under:- Sr. No. Name of the company Average Operating Profit margin 1. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cases to six by also including three cases left from the assessee's list of comparables. One case of TRF Limited, which was originally included by the assessee in its TP study but later on dropped, was also included. Two new cases, namely, Engineers India Limited and Sriram EPC were also included in the final list of six comparable cases as under:- Sr. No. Company OP/TC% OP/Sales % 1. Tata Projects 4.98 4.74 2. Walchandnagar Inds. 11.74 10.5 3. Mcnally Bharat 11.92 10.65 4. Engineers India Ltd. 14.17 12.42 5. TRF Limited 20.85 17.25 6. Sriram EPC 12.69 11.26 Average 12.725 11.13 9. As the assessee's PLI of OP/TC in respect of international transactions was found much below the average PLI of 12.72% of these six comparable cases, the TPO worked out an adjustment of Rs. 6.72 crore, which, pursuant to the direction given by the DRP, was subsequently reduced to Rs. 5.10 crore. It is this final adjustment of Rs. 5.10 crore, which the assessee is contesting in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shed by the assessee during the course of proceedings before the TPO for contending that the internal TNMM should be applied. Admittedly no such segment-wise accounts were maintained by the assessee. Such figures of AE and Non-AE transactions were segregated by the assessee from the common pool of figures. While making such classification and to demonstrate that its so-called profit rate under the TNMM from internal comparables was favourable to such profit rate from Non-AE transactions, the assessee also included in the sales of AEs, the amount of sales to Non-AEs for which the material was purchased from AEs and also included in the purchases of the AEs, the amount of purchases from Non-AEs for which the material was sold to the AEs. 11.3 Chapter X of the Act contemplates computation of income from international transaction having regard to arm's length price. Sub-section (1) of section 92 provides that : 'Any income arising from an international transaction shall be computed having regard to the arm's length price.' Thus it is patent that the ALP is required to be computed in respect of an international transaction. The expression 'International transaction' has been defined i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... length price in relation to the international transaction. 11.4 It is relevant to note that sub-clause (i) of rule 10B(l)(e), which is first step in the computation of ALP under TNMM, talks of ascertaining the profit margin realised by the enterprise from an international transaction entered into with an associated enterprise. We have noticed the definition of 'International transaction' above as a transaction between two or more associated enterprises. A bare perusal of this provision divulges that this step contemplates the determination of actual profit realized on transaction between two AEs. It is this profit margin which is scrutinized for determining as to whether or not it is at arm's length. The margin with which such margin earned by the assessee is compared with for determining the ALP, can be internally available from comparable transaction(s) or from externally available cases. If the enterprise has entered into similar transactions with third parties as are under consideration with the AE, then the profit realized from such transactions with third parties is a good measure to benchmark the margin from international transaction. Thus, on one hand we need to have pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , which again stands distorted because of the exclusion of certain purchases and sales from/to Non-AEs from this segment eventually finding their way into the AE segment. We, therefore, uphold the view taken by the authorities below on this count. 11.6 The next objection taken by the TPO in disregarding the figures furnished by the assessee as of AEs and Non-AEs is the difference in the ratio of material consumed to sales. The TPO worked out such percentage at 73% in respect of AE segment and 86% in respect of Non-AE segment in his original order. The DRP reduced such percentage in respect of Non-AE segment to 7%. It is this final figure of 77% which has been taken into account by the A.O. while making adjustment in his order u/s 143(3) read with section 144C(13) of the Act. In that view of the matter, there is no need on the part of the assessee to embark upon the ratio of material consumed to sales in Non-AE segment at 86%, which does not constitute the foundation for the ultimate transfer pricing adjustment. Restricting ourselves to the ratio of material consumed to sales in case of AE segment at 73% and in case of Non-AE segment at 77%, we find that still there is a differenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h has been considered as non-operating and not the actual incurring of bad debts. Obviously a provision for doubtful debts cannot be considered as operating cost. We, therefore, uphold the calculation of OP/TC at 4.13% in respect of Tata Projects Limited. 12.3 Next is Walchandnagar Industries Limited. The TPO originally calculated OP/TC ratio at 11.74%. However, in the subsequent proceedings, such rate of OP/TC was reduced to 9.63%. Here also the assessee is assailing the exclusion of Depreciation transferred from revaluation reserve, Provision for doubtful debts and Expenditure capitalized from total operating expenses. In our considered opinion these three items have been rightly excluded as these have no relation with the operating cost. Depreciation transferred from revaluation reserve cannot be considered as operating cost. Similarly expenditure capitalized can in no sense be considered as operating cost. Provision for doubtful debts has been discussed above and held to be not an item of operating cost. We, therefore, approve the ratio of OP/TC at 9.63% as computed by the TPO in the second round. 12.4 Third comparable case is Mcnally Bharat Limited. Originally the TPO comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case are admittedly a little more than 20% but less than 25%. On page 11 of the order passed by the TPO, it can be seen that he adopted filter of related party transactions at 25%. In the case of ACTIS Advisers Pvt. Ltd v. Dy. CIT[2011] 10 taxmann.com 24 (Delhi), the Delhi Bench of the Tribunal has held that a case can be taken as uncontrolled if its related parties transactions do not exceed 25% of the total revenue. In reaching this conclusion, the Tribunal took assistance from various provisions of the Act. Thus, it is discernible that the limit of 25%, though, not expressly, set out in the statute, cannot at the same time be branded as ad hoc. The Delhi Bench of the tribunal has taken assistance from certain other provisions of the Act for the adoption of such limit Respectfully following the precedent, we approve the filter of 25% related transactions as adopted by the TPO in preference to 10% as applied by the assessee on ad hoc basis. Going by this filter, we find that since the related party transactions in the case of TRF Limited are less than 25%, the TPO was justified in admitting this case in the list of comparable cases. At this juncture, it is pertinent to mention th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re only two segments of TRF Limited, viz., Product services and Project services. It has been rightly pointed out by the ld. DR that the total revenue of Rs. 11551.07 lakh of "Product services" segment includes a substantial part comprising of Inter-segment revenue of Rs. 5049.19 lakh. It is evident that the amount of Rs. 5049.19 lakh is 'Inter-segment revenue', which obviously refers to the goods or services supplied by the Product services segment to the Project Services. When the goods or services under Product segment are supplied at market rate, the separate profit of the Project segment will not get affected. It can be understood by a simple example of Product segment producing some goods at cost of say Rs. 90 and selling it to outside customers at Rs. 100, thereby earning profit of Rs. 10. When the same goods are sold to the Project division again at the same market rate of Rs. 100, the profit emerging from the sale of such goods at Rs. 10 stands included in the Product division under the head 'Inter-segment revenue'. In so far as the Project division is concerned, it has purchased the goods at Rs. 100 from its Product division. Because of the transaction of purcha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Engineering Division". The same page contains information about the further break-up of the Engineering Division as comprising of manufacture and sale of "Steel Structurals, Pipes and equipments and Designing, Supplying, erectioning and Commissioning of projects on turnkey basis". From the above extract of the information given by the said company under the Engineering Division, it is vivid that it is also engaged in the business of projects on turnkey basis. It can further be noticed that the total revenue of this concern from Engineering Division is at Rs. 74.17 crore. The TPO has excluded this case by mentioning that the said company is primarily engaged in man-made cotton fibre yarn and also saleable tea. We fail to appreciate this reason for the exclusion of this case on segment level because the revenue from the Engineering segment is Rs. 74.17 crore, which is much more than the assessee's uncontroverted filter of Rs. 25 crore minimum turnover. The revenue from the Engineering Division may be less in percentage terms on the entity level, but is substantial on the segment level. In our considered opinion, segmental results of Engineering Division of Gillanders Arbuthnot Comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ght in including this case in the list of final comparables. 12.10 We, therefore, sum up our conclusion on inclusion or exclusion of cases in the final list drawn by the TPO. The cases of Tata Projects Limited, Walchandnagar Industries Limited, Mcnally Bharat Engg. Co. Limited and Sriram EPC Limited are held to have been rightly included. The case of TRF Limited is held to have been rightly included, but it should be considered on segment level instead of entity level as adopted by the TPO. The case of Engineers India Limited is directed to be excluded. The case of Gillanders Arbuthnot Company Ltd. (on segment level) is directed to be included. In view of change in the list of comparable cases and also the composition in some cases, the AO/TPO are directed to re-compute the ALP in the light of our above discussion. 13.1 The next issue is against denying plus minus 5% benefit available under the proviso to section 92C(2) of the Act despite the direction issued by DRP to allow the same. The facts apropos this issue are that the TPO did not allow plus minus 5% benefit. The assessee challenged this aspect before the DRP contending that standard deduction of 5% ought to have been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... between the price charged/paid in respect of international transaction and ALP determined by taking the results of comparable cases does not exceed 5%. In case such variation is more than 5%, then no such benefit of 5% can be allowed on standard basis. As the matter of computation of ALP and the resultant addition, if any, has been restored by us to the AO/TPO in earlier paras, we direct that this point may be considered in accordance with our above observations. 14.1 The next issue is against the adjustment of Rs. 4,29,03,966 pertaining to payment of royalty. The facts concerning this issue as recorded in the order of the TPO are that the assessee obtained know-how and project-engineering drawings from its Associated Enterprise vide collaboration agreement dated 23.07.1996. As per this agreement, the assessee availed technical and engineering support for cement plant equipment and machinery. For availing the said manufacturing drawings and project engineering services, the assessee paid 2% of contract value to its AE and for know-how. It also paid royalty at 5% of the selling price to its AE. Royalty agreement between the assessee and Krupp Polysius AG was approved by Reserve Ba ..... 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