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JCB India Limited (formerly known as JCB Manufacturing Ltd.) Versus ACIT, Circle-9, Akurdi, Pune.

2015 (6) TMI 597 - ITAT DELHI

Transfer pricing adjustment - Non-adoption of adjusted PLI of the tested party - Held that:- Assessee vide its letter dated 7.9.2009 addressed to the TPO, submitted with prejudice to its earlier submissions that if the adjustment as computed by it was not acceptable, that is, the abnormal costs were not excluded, then the comparables so chosen by it would cease to be comparable. Similar contention was made by the assessee before the DRP vide its letter dated 20.7.2010. We find that the TPO/DRP h .....

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at both the assessee as well the TPO did not properly approach the transfer pricing analysis in a right perspective. The assessee kept on harping on the adjustment to its profit on an unrealistic basis and the TPO ignored to examine, if the assessee was at all rightly entitled to any adjustment on account of its first year of operation. In our considered opinion, the proper transfer pricing analysis can be done only by first finding out suitable comparables with or without making adjustment in t .....

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nd mill against the assessee using generator sets of production. These two models of production have different implications on the operating costs. Apart from that, it is observed that the turnover of this company significantly reduced to ₹ 9.92 crore in the current year from ₹ 36.68 crore in the preceding year due to change in the Government policies. It has been so recognized in the director’s report of this company. It has further been mentioned in such report that this company re .....

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, we find that this company has reported its revenues in three segments namely, Foundry, rolling and forging; Engineering & Fabrication; and Others. The assessee has chosen ‘Engineering and Fabrication’ segment of this company to be comparable. We are disinclined to accept the view point of the TPO/AO in excluding this company for the reason of the goods from Foundry, rolling and forging segment moving to Engineering and Fabrication segment. It is obvious that when the goods move from one segmen .....

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ng & Forwarding agent, viz., Haulage Corporation. Even the reimbursement of expenses have been made to such agent only. When the assessee furnished all the details about such expenses including sample supporting invoices and confirmation from Haulage Corporation, we cannot countenance the addition made on ad hoc basis without the AO specifically pointing out any lacuna in the details submitted by the assessee. We, therefore, order for the deletion of this addition. - Decided in favour of assesse .....

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he assessment year 2006-07. 2. The first challenge in this appeal to the addition on account of transfer pricing adjustment amounting to ₹ 21,75,42,500/-. 3.i. Briefly stated, the facts of the case are that JCB, UK, is a major player in the global construction and agriculture sectors. JCB India Ltd., is a wholly owned subsidiary of JCB, UK. In turn, JCB Manufacturing Ltd. (i.e., the assessee) was set up by JCB India as its 100% subsidiary on 21.06.2004. The assessee commenced its business .....

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e in Form No.3CEB for the year in question. First transaction is Export of finished goods amounting to ₹ 20,21,62,339/- and the second transaction is Import of raw materials to the tune of ₹ 73,73,270/-. The assessee benchmarked these two international transactions jointly by applying the Transactional Net Margin Method (TNMM). Apart from the above two, the assessee also entered into three more international transactions, namely, Import of machinery, jigs and fixtures , Reimbursement .....

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nsaction of Import of raw material and Operating profit/Total cost for the international transaction of Export of finished goods . The assessee aggregated these two international transactions of import of raw materials and export of finished goods and carried out entity level benchmarking. The TPO did not dispute the application of TNMM as the most appropriate method, nor did he disagree with the aggregation of these international transactions. The assessee used 10 companies as comparables, whic .....

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sted OP/TC at (-) 45.23%. On being called upon to explain as to how it could substitute its actual operating profit margin with some hypothetical adjusted figure, the assessee submitted that because of its first year of operation, the operating costs were high due to lower productivity on account of workmen being in learning phase; higher consumption of electricity on account of diesel gensets; and higher distribution cost and fixed overheads on account of lower volumes. The assessee invited the .....

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). Discarding the adjusted positive profit margin declared by the assessee at 10.79% on a hypothetical basis, the TPO adopted unadjusted profit margin of the assessee at (-)45.23%. By considering the arithmetical mean of the operating profit margin of the comparables at 13.47%, the TPO applied benchmark of Operating profit/Total cost at 58.70% (45.23% +13.47%) on the international transaction of Export of finished goods. This resulted into recommendation for a transfer pricing adjustment to the .....

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ompanies from the list of comparables. Apart from the above, all other aspects of the TP analysis carried out by the TPO, have been accepted by the assessee. We will deal with the above referred two issues one by one. I. Non-adoption of adjusted PLI of the tested party. 5. It is an undisputed position that the assessee s unadjusted PLI (OP/TC) stood at loss of (-)45.23%. The assessee, however, adjusted such PLI to 10.79%. This was done by adopting the amount of operating expenses for transfer pr .....

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was further submitted that it had incurred costs which were extraordinary and non-operating in nature due to the start-up related reasons. It was further submitted through its letter dated 15.6.2009 that the costs for the current year were considered on the basis of the costs incurred for the financial year 2008-09 as a first point of reference and also the audited accounts for financial year 2007- 08, where the figures for financial year 2008-09 were not available. This has been mentioned in p .....

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curred with some standard costs is permissible under law. To be more precise, whether any adjustment is permissible in the assessee s own profit margin? 6. In order to answer this question, we need to have a look at the provisions relating to computation of income from international transaction having regard to the arm s length price contained in Chapter- X of the Act. Sub-section (1) of section 92 provides that: Any income arising from an international transaction shall be computed having regar .....

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rescribe…. . Then five specific methods have been set out in this provision and the sixth one is: Such other method as may be prescribed by the Board. Rule 10B deals with the determination of arm s length price u/s 92C with the methods as prescribed under the Act. Adverting to the facts of the instant case, it is found that the assessee applied the TNMM as the most appropriate method, which has been concurred with by the TPO. The modus operandi for the computation of ALP under this method .....

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transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (iv) the net prof .....

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actors given in this provision, such as, the specific characteristics of the property transferred or services provided in either transaction ; the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions ; the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between t .....

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ction, if, (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market ; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 9. When we read sub-rules (2) and (3) in juxtaposition to Rule 10B(1)(e), it emerges that the arm s length p .....

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ends and the comparables are determined and the ALP can be worked out. The other situation may be when there are differences between the international transaction and uncontrolled transaction, which materially affect the price or profit from such transactions. In such a situation, the law contemplates of making a reasonably accurate adjustment to the uncontrolled transaction for eliminating the material effects of such differences. Coming back to the modus operandi given in Rule 10B(1)(e) for t .....

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under sub-clause (i), namely, costs incurred or sales effected or assets employed, etc. Under sub-clause (iii), which is the third step, the profit margin of the uncontrolled transaction realized in sub-clause (ii) is adjusted to take into account the differences between the international transaction and the comparable uncontrolled transaction. It is this adjusted profit margin of comparables which is considered for benchmarking the profit margin realized by the assessee from international trans .....

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ting the profit margin of the assessee from its international transaction as such, we fail to appreciate as to how any adjustment can be made to the profit margin of the assessee under sub-clause (i) due to reasons, such as, the incurring of extraordinary and non-operating costs due to start up related reasons. If such an adjustment is made, the resultant figure will shed the character of the net profit margin realized, which is contrary to the express language of the provision. It is obvious th .....

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onal transaction as it is with an uncontrolled transaction and compute income from such international transaction having regard to its ALP determined on the basis of a comparable uncontrolled transaction. If the operating costs incurred by the assessee from the international transaction are adjusted at the very threshold, then how the transfer pricing provisions would apply to determine the ALP of an international transaction, is beyond our comprehension. The mandate of the provision is crystal .....

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g profit margin earned by the assessee from an international transaction without any adjustment, it has to be the operating profit margin as per the books of account strictly in conformity with the business conditions as they exist without any plus or minus. 10. The above discussed is not the end of the road. We want to make it clear that it is not as if the difference between the international transaction and comparable uncontrolled transaction, not reckoned in the operating profit margin of th .....

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e uncontrolled transactions…. which could materially affect the amount of net profit margin.. . Thus, it is vivid from the prescription of the provision that if there are differences in terms of Rule 10B(2) between the international transaction and uncontrolled transaction and such differences have bearing on the amount of net profit margin, then such differences should be adjusted in the net profit margin of the comparables as per sub-clause (iii) of Rule 10B(1)(e), so that the internati .....

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r neutralizing the material effects of the differences between the international transaction and uncontrolled transactions, we want to accentuate that the simple fact of the assessee incurring a particular operating cost higher than its comparables, cannot call for any adjustment. It can be noticed that the TNMM contemplates comparison of the percentage of the operating profit margin earned by the assessee from its international transaction with such a percentage of the operating profit margin e .....

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y comparing the higher amount of depreciation charged by the assessee vis-à-vis its comparables. It is so for the reason that when during the initial years, the amount of depreciation is higher, the repair costs is on the lower side. In later years of operation, when the amount of depreciation goes southwards, the repair cost goes northwards. When we take up operating profit for comparison under the TNMM, such figure of operating profit counterbalances the effect of all such higher and lo .....

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t claim any adjustment in the first year of its operation without specifically pointing out the differences with comparables indicating the incurring of abnormal costs. As a matter of fact, any year of operation can be an extraordinary depending upon the facts and circumstances of each case and there can be no thumb rule that the first year of operation is always extraordinary. Before claiming any adjustment in the first year of operation, it is incumbent upon the assessee to specifically delin .....

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first year of operation, without any substantiation, cannot be allowed. 12. Reverting to the facts of the instant case, it is noticed that the assessee actually incurred operating expenses for the year in question at ₹ 3706.55 lac. However, for the purposes of the Transfer pricing analysis, the assessee reduced such operating expenses to ₹ 1831.98 lac and computed its profit margin with such reduced operating expenses. This exercise was done by the alleged standardization of the act .....

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ing how some of the first year of operation specific expenses were absent in the case of comparables, requiring adjustment in the profit margin of the comparables. Nothing of this sort has been done by the assessee. 13. We notice that the assessee vide its letter dated 7.9.2009 addressed to the TPO, a copy of which is available on page 1004 of the paper book, submitted with prejudice to its earlier submissions that if the adjustment as computed by it was not acceptable, that is, the abnormal cos .....

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e to its first year of operation. If, in fact, such abnormal costs were incurred, then it was mandatory on the part of the authorities to adjust the profit margin of comparables to that extent. It appears that both the assessee as well the TPO did not properly approach the transfer pricing analysis in a right perspective. The assessee kept on harping on the adjustment to its profit on an unrealistic basis and the TPO ignored to examine, if the assessee was at all rightly entitled to any adjustme .....

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ethod for determining the ALP of the international transaction of Export of finished goods. . II. Removal of two comparables 14. The assessee has, by means of specific grounds, objected to the removal by the TPO of Ahmedabad Steelcraft Ltd. and Shiv Agrico Implements Ltd. (Seg.) from the list of comparables. Here it is pertinent to mention that the assessee chose some companies as comparable under the TNMM and the TPO, accepting the applicability of this method, excluded these two companies. As .....

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les by noticing that the same apart from being functionally different, also suffered losses because of change in the Government policy and on account of retrenchment of employees and other extraordinary factors. The assessee is aggrieved against the exclusion of this company. 16. After considering the rival submissions and perusing the Annual report of this company, which is available on pages 553 onwards of the paper book, it can be seen that this company is using its own wind mill against the .....

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es and compensation aggregating to ₹ 42.39 lac was paid during the year. In our considered opinion, the above cited extraordinary and abnormal differences make this company incomparable with the assessee. We, therefore, hold that the TPO was right in excluding this company from the list of comparables. (ii) Shiv Agrico Implements Ltd. (Seg.) 17. The assessee included this company on segment level in the list of comparables with OP/TC at (-)50.79%. The TPO held this company to be non-compar .....

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his company on segment level. 18. Having heard the rival submissions and perused the relevant material on record including the Annual report of this company for the year in question, we find that this company has reported its revenues in three segments as discussed above. The assessee has chosen Engineering and Fabrication segment of this company to be comparable. We are disinclined to accept the view point of the TPO/AO in excluding this company for the reason of the goods from Foundry, rolling .....

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