TMI Blog2015 (7) TMI 492X X X X Extracts X X X X X X X X Extracts X X X X ..... gards the basis comparability adopted by the TPO i.e. the product comparability as against the functional comparability adopted by the assessee is concerned, it is stated by the learned counsel for the assessee that the very same issue had arisen in the case of related party to the assessee i.e. M/s.GE BE Pvt. Ltd. wherein issue is decided in favour of assessee. Depreciation on plant and machinery purchased from Elpro International Ltd. - Held that:- This issue had first arisen in the assessment year 1998-99 and had come up to the Tribunal for adjudication and the Tribunal had set aside the issue to the AO for verification of the claim of the assessee. It is submitted by the learned counsel for the assessee that the AO had made disallowance of depreciation in the orders passed u/s 143(3) r.w.s. 254 for the assessment years 1998-99 and 1999-2000 and the appeals against the same are pending before the CIT(A). He submitted that all the details were furnished before the CIT(A) for the assessment years 1998-99 and 1999- 2000 and therefore this issue is to be remanded back to the file of the CIT(A) to give effect to the orders of the CIT(A) for the assessment years 1998-99 and 1999-20 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot received during the relevant financial year; (ii) telecommunication expenses of ₹ 68,41,559/-; and (iii) income of ₹ 27,25,570/- from trading activity. (i) He observed that as regards the sum of ₹ 58,87,090/- the assessee s auditor has qualified Form 56F to the tune of ₹ 58,87,090/- stating that the approval is sought from the competent authority. The assessee was asked to produce proof in this regard to substantiate their claim but since assessee could not produce the said evidence, the AO did not consider the sum of ₹ 58,87,090/- as export turnover for the purpose of computation of deduction u/s 10A of the Act. (ii) Further, the AO observed that the expenses of ₹ 68,41,559/- incurred for telecommunication expenses are attributable to the delivery of the product or software outside India and therefore should be reduced from the export turnover. The assessee contended that if the same is excluded from the export turnover, then it should be excluded from the total turnover as well. The AO, however, did not agree with the assessee s contention and held that the telecommunication expenses of ₹ 68,41,559/- attributable to the delivery ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee to those employees on their retirement which does not quality for deduction u/s 32 and that the CIT(A) had confirmed the said disallowance. Therefore, following the orders of his predecessor, the AO disallowed the claim of depreciation for the relevant assessment year also. As regards the transfer pricing adjustment is concerned, he followed the order of the TPO and made the transfer pricing adjustment of ₹ 43,09,86,678/-. 5. Aggrieved by the order of the AO, assessee preferred an appeal before the CIT(A) who granted partial relief to the assessee. Against the relief given by the CIT(A), the revenue is in appeal before us, while assessee is in appeal against the confirmation of the addition made by the AO. 6. As regards the transfer pricing adjustment, brief facts are that the assessee, which is a contract manufacturer of medical equipments and components, is also rendering engineering services to the Group companies. During the relevant financial year, the assessee had entered into the following international transactions: Import of raw materials for contract manufacturing activity: ₹ 43,89,45,267/-. Purchase of fixed assets for contract manufact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of this, prices are hiked up increasing their margin vis- -vis tax-payer. The TPO, however, rejected the assessee s objection, holding that the assessee itself had adopted cost plus method as the most appropriate method and that no new fact or evidence is brought on record by the assessee to show that CPM ceased to be the most appropriate method or to justify switch over to a less direct method i.e. TNMM. He held that the CPM is the most direct method after CUP method to determine pricing when an enterprise manufactures and sells to affiliates. He held that arms length sales price is determined by adding the normal gross mark up on cost to the costs incurred. Thus it is affected only by the cost of production while TNMM is influenced by a lot of other factors such as operational efficiency. He, therefore, held that CPM is the most appropriate method. Thereafter, he examined the impact of advertising and marketing on the margins earned by the comparable companies and held that the average spending on advertisement, marking and distribution (functions not per formed by the assessee) by the comparable companies range between 7 to 8% and the spending by one of the comparables ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... son to interfere with the order of the CIT(A) on this issue and the revenue s ground of appeal on this issue is rejected. 10. As regards the basis comparability adopted by the TPO i.e. the product comparability as against the functional comparability adopted by the assessee is concerned, it is stated by the learned counsel for the assessee that the very same issue had arisen in the case of related party to the assessee i.e. M/s.GE BE Pvt. Ltd., in ITA No.850/Bang/2010 dated 06/12/2013. The learned Departmental Representative, however, supported the orders of the AO/TPO. 11. On perusal of the order of the Tribunal in the case of M/s.GE BE Pvt. Ltd. (cited supra) we find that M/s.GE BE Pvt. Ltd., is a contract manufacturer of medical equipment and that it also entered into similar international transactions with its AEs which are reproduced at para.4 of the order of the Tribunal. In the said case also, the assessee therein, had adopted CPM as the most appropriate method for determining the ALP and had adopted comparables involved in manufacture of automobile parts on contract basis. The TPO therein was of the view that since the assessee was a manufacture of medical equipment, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s mark-up on cost was 16.24% and therefore it was claimed that the price received from the AE by the Assessee in respect of the international transaction was at Arm s length. 33. The TPO accepted the methodology adopted by the Assessee viz., CPM as the MAM. The profit level Indicator (PLI) chosen by the Assessee viz., Gross profit on cost was also accepted by the TPO. The TPO was of the view that the comparable chosen by the Assessee were not from the Medical equipment industry segment and in terms of Rule 10B(2) (a) the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the specific characteristics of the property transferred or services provided in either transaction. The TPO therefore was of the view that product comparability is very important. The TPO referred to para 2.18 of the OECD guidelines on Transfer Pricing wherein it is provided that although broader product differences can be allowed in the resale price method, the property transferred in the controlled transaction must still be compared to that being transferred in the uncontrolled transaction. The guidelines also lay down that closer comparability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acetronix Ltd. was rejected as per the taxpayer s request since it had related party transactions. The final list of comparable companies was as follows: Sl. No. Name of the comparable % of GP over costs 1. Contential Surgical Suture Ltd 74.167 2. Polymedicure Ltd. 27.646 3. South India Surgical Co. Ltd. 37.833 Avg. 46.55% The adjustment and consequent addition to the ALP was made by the AO. 37. The CIT(A) confirmed the reasoning of the TPO on all the above objections of the Assessee. On the question of product comparability being important the CIT(A) agreed with the view of the TPO. However with regard to the objection of the Assessee that the comparable companies chosen by the TPO do not have export sales, the CIT(A) found merit in the argument advanced by the Assessee. He found that 2 out of the three companies chosen by the TPO viz., Centenial Surgical Suture ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y took was not sustainable in law and seeks to take a different stand either in the course of proceedings before the Assessing Officer or Appellate authorities, the claim of the Assessee has to be tested on the basis of the applicable provisions of law. It cannot be rejected solely on the basis that it was contrary to the stand which the assessee had taken originally. At the same time, it does also mean that the assessee could be allowed free license to vary the functional analysis and the method adopted at any time during the appellate proceedings. The above proposition finds support in the decision of the ITAT, Pune, in the case of ACIT Vs MSS India (supra) reported in 009-TII-67-ITAT-Pune-TECHNICAL SERVICES dated 29.5.2009 is relevant. In this case, the ITAT had observed that a method chosen cannot be discarded unless there are compelling reasons for the same. While this ruling has been given in the context of the TPO changing the method during the TP audit, it would, in all fairness and equity, be equally applicable to the assessee as well. The ruling of the Pune, ITAT in the case of MSS India Pvt. Ltd. (supra) at para 22 of the order is as under : The consid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t always available and that is the reason that despite better results produced by these methods, these methods are not as much put to use. However, whenever necessary inputs for applying one of these methods are available and there is no dispute about comparability of those inputs, there is no good reason to resort to transactional profit methods. It would thus follow that in a situation in which the assessee has followed one of the standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods, unless the revenue authorities are able to demonstrate the fallacies in application of standard methods. In any event, any preference of one method over the other method must be justified by the Transfer Pricing Officer on the basis of cogent material and sound reasoning. (Para 22). 40. Of course the facts of the case in MSS Ltd. are little different from that of the facts in the instant case. In the case of MSS India, internal comparability analysis was available whereas it is absent in the case of the assessee. Further, in that case, the TPO had noted that CPM cannot be applied as the relevant data for applying the method was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of data necessary for application of the method; (d) the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method. 42. In this regard, it is seen that in the TP Study submitted, the assessee has itself adopted. The Cost Plus Method ( CPM ) as the Most Appropriate Method ( MAM ). While doing so, the appellant has observed in the TP Study, at page 22, as under : Cost Plus Method The cost plus method ( CPLM ) evaluates the arm s length character of a controlled transaction by referencing the gross profit mark up realized in comparable uncontrolled transactions. The arm s length price for the controlled transfer is the controlled taxpayer s cost of producing the property involved in the transaction, pl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for developing countries, 2012 in para 5.3.6 lays down the following criteria for choosing MAM. 5.3.6. Selection of Transfer Pricing Method 5.3.6.1. The most appropriate transfer pricing method will be selected taking into account the strengths and weaknesses of the method, the appropriateness of the method in the light of the nature of the controlled transaction (based upon a functional analysis), the availability of reliable information (especially on uncontrolled comparables) and the degree of comparability between the controlled and the uncontrolled transactions(including reliability of comparability adjustments needed). 5.3.6.2.Once the taxpayer has identified the transfer pricing methods that are potentially applicable to the controlled transaction, application of the most appropriate method rule involves a careful balance in which the following factors may be taken into account to assess the relative accuracy of the identified methods: i. The extent to which the comparability factors (characteristics of the property or services, functional analysis, contractual terms, economic circumstances and business strategies) of uncontrolled transactions or entit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ountries, 2012 in para 6.1.3.3 lays down as follows: 6.1.3.3. Once a method is chosen and applied taxpayers are generally expected to apply the method in a consistent fashion. Assuming that an appropriate transfer pricing method is being applied, a change in method is typically required only if there are any changes in the facts, functionalities or availability of data. The above guidelines presupposes an appropriate transfer pricing method being applied. The above guidelines emphasize on consistency being followed in applying the method. It also provides that the method can be changed, only if there are any changes in the facts, functionalities or availability of data. Assuming that there could be situations where on assessee may be required to change its chosen MAM for the same year between the time of his TP Study and the assessment / appellate proceedings, such a change can happen only if there are any changes in facts, functionalities or availability of data. 46. In the instant case, the assessee has not made out any case or adduced any evidence to demonstrate that there has been any change in the facts, functionalities or availability of data. Nor is it th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod to use in transactions involving a fully-fledged manufacturer which owns valuable product intangibles as it will be very difficult to locate independent manufacturers owning comparable product intangibles. That is, it will be hard to establish a profit mark-up that is required to remunerate the fully-fledged manufacturer for owning the product intangibles. In a typical transaction structure involving a fullyfledged manufacturer and related sales companies (e.g. commissionaires), the sales companies will normally be the least complex entities involved in the controlled transactions and will therefore be the tested party in the analysis. The resale price method is typically more easily applied in such cases. 6.2.21 Case Examples of Cost Plus Method: 6.2.21.1. Example 1 (i) LCO, a domestic manufacturer of computer components, sells its products to FS, its foreign distributor. UT1, UT2, and UT3 are domestic computer component manufacturers that sell to uncontrolled foreign purchasers; (ii) Relatively complete data is available regarding the functions performed and risks borne by UT1, UT2, and UT3, and the contractual terms in the uncontrolled transactions. In ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the uncontrolled producers. In addition, data is sufficiently detailed to permit adjustments for differences in accounting practices. However, sufficient data is not available to determine whether it is likely that all material differences in contractual terms have been identified. For example, it is not possible to determine which parties in the uncontrolled transactions bear currency risks. As the differences in these contractual terms could materially affect price or profits, the inability to determine whether differences exist between the controlled and uncontrolled transactions will diminish the reliability of these results. Therefore, the reliability of the results of the uncontrolled transactions must be enhanced. As a general rule it can be said that the above guidelines advocate use of CPM in the case of Contract manufacturers. However, the provisions of Sec.92C(2) of the Act read with Rule 10C(1) (2) make it clear that MAM has to be determined on the basis of parameters laid down therein. One can therefore conclude this discussion by holding that as a general rule CPM would be the MAM in the case of Contract Manufacturers but that would be subject to the satisf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eting advertisement) is negligible and insignificant, much the same as is the case with the appellant. Therefore, the profit margins of these companies are primarily reflective of the return on the manufacturing function. However, it would be worthy to note that the ld. TPO has given weightage to product similarity over the functional similarity thereby contradicting the basic premise of application of CPM. Based on this, the ld. TPO has chosen the set of comparables which fall under the broad category of Medical Equipments as classified in the Prowess database. The comparables chosen by the ld. TPO are engaged in the manufacture of medical consumables viz. Disposable syringes, Disposable sutures, Disposable needles, etc. On the other hand, the appellant is a contract manufacturer engaged in manufacturing Tubes, Inserts, Detectors, Tanks and other parts and accessories for medical diagnostic imaging equipment. Such components are incorporated by the Affiliates into equipment which are in the nature of capital goods. Hence, on the analysis of product comparability, the comparables chosen by the ld. TPO are not comparable with the products of GE BE as the comparison is pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is more so necessary because the level of these expenses as a proportion of sales for each of the ld. TPO comparable varies. In this regard, the appellant would like to mention that Centenial Surgical (a comparable selected by the ld. TPO) is a case in point, for the reason that its marketing expenses as a proportion of sales is 30% and the adjustment of 8% Tribunal sales granted by the ld. TPO would be grossly inadequate to eliminate the effect of the marketing, distribution and advertisement function on the gross profits. Therefore the appellant submits that the financial analysis by the ld. TPO to arrive at the appropriate gross margin is erroneous, and the adjustment for the differences in the marketing and selling functions ought to be recomputed based on the actual expenses incurred by the companies. Further, in the same written submissions, at page 117 of the paper book, it is submitted as under : Analysis considering alternative approach using TNMM Further, without prejudice to our submissions above, the appellant submits that if one were to argue that : - the adjustments mentioned above are not to be considered; or - that the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 50. One of the pleas raised by the Assessee was that functional similarity is to be first seen before choosing an appropriate method and that the TPO in choosing CPM has given weightage to product similarity rather than functional similarity. The Assessee had further pointed out that the comparable chosen by the TPO were manufacturing medical consumables viz., disposal syringes, disposable sutures, disposable needles etc., and that the same cannot be compared with contract manufacturing of tubes, inserts, detectors, tanks and other parts and accessories for medical diagnostic imaging equipment which the Assessee manufactures and which are incorporated by the AE into equipment which are capital goods. On the above submission, the learned DR has submitted that it cannot be said that product similarity has no relevance. Product similarity is also important. If there is no product similarity then even though there may be functional similarity then CPM may not be the right method. The conclusions of the CIT(A) in this regard are found to be correct in the present case. The TPO in the present case has given due weightage to functional similarity also. The argument on behalf of the Asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PM, on the facts and circumstances of the present case, is the MAM. 12. Subsequent thereto, as regards the assessee s contention that the appropriate adjustments to the margins of the comparable companies as regards advertisement and marketing expenses should be made, the Tribunal, at para.54, has held as under: 54. It is however seen that the TPO has not given any weightage to the various aspects pointed out by the assessee which call for making appropriate adjustments to the margins of the comparable companies, as required under Rule 10B(1)( c )(iii), (ic) (v) of the Rules. The computation of adjustment at 8% made by TPO is not backed by proper reasoning or rationale. The comparables selected by the TPO perform additional functions in the nature of selling marketing thus evidencing functional differences with the appellant. This fact has been acknowledged by the TPO, but while giving adjustment, the TPO has computed the adjustment at an adhoc figure of 8%. In view of the difference in functions, the assessee is entitled to adjustments which are reliable and accurate, as stipulated in Rule 10C(2)(e) of the Rules. If such adjustments are provided on actual basis, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The learned Departmental Representative has not been able to produce any evidence to rebut this finding of the CIT(A). On the other hand, the learned counsel for the assessee has placed reliance upon the judgment of the Hon ble Karnataka High Court in the case of CIT vs. Tyco Electronics Corpn.India (P) Ltd., (2012) 22 Taxman.com 267(Kar.) wherein the Hon ble High Court at para 9 of its order has held as under: 9. A reading of the aforesaid provision makes it clear that the assessee to be entitled to the benefit of section 10A, the sale proceeds would have to be brought into the country within a period of six months from the end of the previous year. However, the legislature has consciously in express words has vested the power to extend the timelimit for the said benefit, if the competent authority chooses to allow the said benefit. Therefore, the six months period prescribed is not mandatory. A discretion is vested with the competent authority to extend the said benefit of the section even in cases where the sale proceeds are received beyond the period of time prescribed under the said provision. The only condition is that the sale proceeds would have to be received. If th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ourt, we do not see any reason to interfere with the same. This ground of appeal is accordingly rejected. (iii) As regards exclusion of profit from sale of spare parts and components of ₹ 27,25,570/-, we find that the CIT(A) confirmed the disallowance by following the decision of the ITAT in the case of GEBE Pvt. Ltd., i.e. a group company of the assessee on identical facts. The learned counsel for the assessee submitted that the CIT(A) has followed the decision of the Tribunal in the case of Group of companies for the assessment year 2003-04 whereas the Tribunal, in the case of GE BE Pvt. Ltd., in ITA No.815/Bang/2010 dated 06/12/2013 for the assessment year has considered the issue by following the decision of the Special Bench of the Tribunal, Indore in the case of Maral Overseas Ltd. vs. ACIT (136 ITD 177)(SB)(Indore) to hold that the claim of the assessee that profits from trading activity of the spare parts is also to be considered for the purpose of deduction u/s 10B of the Act should be accepted. The learned Departmental Representative, on the other hand, relied upon the judgment of the Hon ble Supreme Court in the case of Liberty India Ltd. reported in (2009) 317 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he basis of the aforesaid distinction, sub-section (4) of section 10A/10B of the Act is a complete code providing the mechanism for computing the profits of the business eligible for deduction u/s 10B of the Act. Once an income forms part of the business of the income of the eligible undertaking of the assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction u/s 10B of the Act. As per the computation made by the Assessing Officer himself, there is no dispute that both these incomes have been treated by the Assessing Officer as business income. The CBDT Circular No. 564 dated 5th July, 1990 reported in 184 ITR (St.) 137 explained the scope and ambit of section 80HHC and the mode of determination of profits derived by an assessee from the export of goods. I.T.A.T., Special Bench in the case of International Research Park Laboratories v. ACIT, 212 ITR (AT) 1, after following the aforesaid Circular, held that straight jacket formula given in sub-section (3) has to be followed to determine the eligible deduction. The Hon'ble Supreme Court in the case of P.R. Prabhakar; 284 ITR 584 had approved the principle laid down in the Special Ben ..... X X X X Extracts X X X X X X X X Extracts X X X X
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