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Racold Thermo Limited Versus The Deputy Commissioner of Income Tax, Circle 10, Pune

2015 (10) TMI 1747 - ITAT PUNE

Transfer pricing adjustment - rejecting the methodology followed by the assessee for benchmarking of international transactions - TNMM v/s CUP method - Held that:- The associate enterprisesí segment also includes controlled transactions, wherein material imported had been used for manufacturing geysers / water heaters, which in turn, were sold both to associate enterprises and non-associate enterprises. All these above said explanations have been rejected by the TPO/DRP without any basis, wherei .....

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d we find no merit in the order of Assessing Officer in adopting CUP method to benchmark the international transactions with its associate enterprises. We hold that the TNMM method should be applied on aggregate basis for benchmarking international transactions of the assessee.

Benchmarking international transactions with its associate enterprises on aggregate basis, TNMM method should be applied and since the margins declared by the assessee are higher than the margins declared by th .....

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astogi, CIT ORDER PER SUSHMA CHOWLA, JM: This appeal filed by the assessee is against the order of Deputy CIT, Circle-10, Pune, dated 08.10.2010 relating to assessment year 2006-07 passed under section 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961. 2. The assessee has raised the following grounds of appeal:- 1. General: 1.1. The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in making an adjustment amounting to Rs.6, .....

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or benchmarking of international transactions while it has been accepted in the preceding assessment year as well as succeeding assessment year i.e. A Y 2005-06 and AY 2007 -08 respectively. 2. Rejection of benchmarking analysis performed by the Appellant: 2.1. The learned DCIT erred on the facts and in circumstances of the case pursuant to the directions of the learned DRP in rejecting the aggregation methodology followed for the manufacturing activity of the Appellant presented in its Transfer .....

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he learned DCIT erred on the facts and in circumstances of the case in rejecting the aggregation methodology followed by the Appellant while the learned DCIT himself followed aggregation methodology in benchmarking international transactions. 2.4. The learned DCIT erred on the facts and in circumstances of the case pursuant to the directions of the learned DRP in rejecting the Transactional Net Margin Method ("TNMM") as the "Most Appropriate Method" of the Appellant for bench .....

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s the "Most Appropriate Method" for benchmarking the international transaction of export of water heaters and spares. 3.2 The learned DCIT erred on the facts and in circumstances of the case in using internal comparables having controlled transactions for benchmarking the international transactions pertaining to manufacturing activity. 3.3 The learned DCIT erred on the facts and in circumstances of the case in making internal comparison without appreciating the significant and material .....

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"Direct and Indirect Cost of Production". 4.2 The learned DCIT erred in law and on facts and in circumstances of the case in arriving at Gross Profit by deducting the "Cost of Goods Sold" from "Sales Price" which amounts to circular referencing. 4.3 The learned DCIT erred in law and on facts and in circumstances of the case in comparing unadjusted "Gross Profit" to "Cost of Goods Sold". 4.4 The learned DCIT erred in stating that there could be di .....

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he Rules that specify that an adjustment should be made to account for differences between the transactions that may materially affect the price of such transactions. 5.2 The learned DCIT erred in law and facts and in circumstances of the case in not allowing adjustments for the significant and material differences in functions performed, assets employed and risk assumed by the Appellant while making internal comparison. 6. Benefit of the variation / reduction of 5 percent from the arithmetic me .....

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y proceedings section 271(1)(c) of the Act, without considering the fact that, adjustment to transfer price is just on account of difference of opinion as to application of selection criteria for comparable companies, etc and consequently on the computation of arm's length price as determined by the learned Transfer Pricing Officer vis-a-vis arm's length price determined by the Appellant. 8. Each one of the above grounds of appeal is without prejudice to the other. 9. The appellant reser .....

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of authorities below in rejecting the methodology followed by the assessee for benchmarking of international transactions while the same methodology had been accepted in the preceding as well as succeeding assessment years i.e. 2005-06, 2007-08, 2008-09 and 2010-11. 5. Briefly, in the facts of the present case, the assessee was engaged in the manufacturing of water heaters and instantaneous geysers. The assessee was an indirect subsidiary of Merloni ThermoSanitari Pte Ltd. (in short MTS ). The .....

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e, promotional and other expenses for exports. The assessee had benchmarked the international transactions by adopting TNMM method on aggregate basis. During the financial year, the assessee s operating profit margins were 6.57%, whereas the operating profit / sales of the comparable companies was 4.64%. Based on the said analysis, the assessee had concluded that its international transactions were at arm's length price. The TPO on the perusal of details and documents filed by the assessee w .....

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ther, following TNMM method was not acceptable. The TPO further noted that the TP study report reveals that the company is specialized in manufacturing of electrical appliances i.e. water heaters, which were sold in the domestic market as well as were exported to the associate enterprises and also to non-associate enterprises. From the perusal of the details filed by the assessee on 22.09.2009, the TPO noted that the total third party sales of water heaters were ₹ 98.85 crores and the tota .....

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, he proposed to adopt Cost Plus Method (in short CPM ) for the purpose of benchmarking, as most appropriate method and gross profit as profit level indicator. The assessee was thus, show caused as to why an adjustment of an amount corresponding to the difference in the gross margins as indicated above be not made towards international transactions undertaken by the assessee in respect of export of water heaters to associate enterprises . In response, first issue raised by the assessee was that .....

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transactions pertaining to export of water heaters by using external comparables as enlisted at page 6 of the TPO s order and on verification of the functional profile of the said companies. The TPO observed that the assessee s product portfolio involves water heaters and geysers, but none of the comparables chosen by the assessee were into manufacturing of water heaters and / or geysers. Thus, the TNMM analysis involving the comparables so chosen by the assessee, as per the TPO, did not seem to .....

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ut the same were also used in respect of products sold to associate enterprises. Thus, eventually, the base remained the same, but even thereafter, the margins in respect of sales to associate enterprises were substantially thinner than the margins derived from sales to non-associate enterprises. The TPO further observed that where the margins from associate enterprises sales were compared with the margins from non-associate enterprises sales and even if the chances of controlled transactions af .....

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purpose of comparability than the external comparables, which would have far more differences based on the FAR analysis of the assessee s international transaction, relating to export of IC Engines to associate enterprises vis-à-vis FAR analysis of the individual external comparables. Thus, the contention of the assessee that there was difference in the products functions and risks between the export and domestic segment and it adopted TNMM method with external comparables, was not found .....

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year for transfer pricing analysis and results of the earlier years could not restrict or compel the TPO to follow the approach and adopt in the previous year. The Assessing Officer issued the draft assessment order. The assessee filed objections before the Dispute Resolution Panel (in short DRP ). The main objection raised by the assessee was against the application of CPM method by the TPO for benchmarking the transactions carried on by the assessee. The contention of the assessee before the .....

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adopted and TNMM method should be accepted as the most appropriate method for benchmarking the international transactions of the assessee pertaining to manufacturing activity. The DRP observed that the TPO had laid down number of reasons for rejection of TNMM method applied by the assessee. The DRP further observed that where the assessee had selected functionally non-comparable companies for TNMM analysis and benchmarked its international transactions on entity level, when internal comparables .....

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the most appropriate method to benchmark the international transactions. While dealing with the objections of the assessee as to why the CPM method adopted by the TPO cannot be held as the most appropriate method, the DRP held that However, if we see the broad picture, it seems that in terms of functions, assets and risks, the internal comparable in any case would be better and closer for the purposes of benchmarking than the external comparables having no functional similarity. Moreover, the ma .....

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er consequent thereto, passed an order under section 143(3) r.w.s. 144C(13) of the Act making an addition on account of a djustment as per transfer pricing order under section 92CA(3) of the Act at ₹ 6,82,60,528/-. 8. The assessee is in appeal against the aforesaid order of Assessing Officer. 9. The learned Authorized Representative for the assessee pointed out that the main issue arising in the present appeal is the application of principle of consistency and non-application of CPM method .....

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d Representative for the assessee before us was that there was no merit in not applying TNMM method on aggregate basis. The learned Authorized Representative for the assessee further pointed out that identical issue arose before the Tribunal in John Deere India (P.) Ltd. Vs. DCIT (2015) 56 taxmann.com 412 (Pune - Trib.) and in M/s. Drilbits International P. Ltd. Vs. DCIT in ITA No.1361/PN/2010, relating to assessment year 2006-07, order dated 23.08.2011, wherein, the facts of the case are simila .....

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nd the finished products were exported both to associate enterprises and non-associate enterprises. In addition, there were domestic sales of the products manufactured by the assessee. The learned Departmental Representative for the Revenue pointed out that the DRP had rejected the adoption of TNMM method as nature and scope of transactions were different and their separate margins could be worked out. The learned Departmental Representative for the Revenue further pointed out that the assessee .....

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efore us is the appropriate method to be applied for benchmarking the international transactions entered into by the assessee and whether the same has been applied on aggregation basis. The assessee during the year under consideration had entered into four different international transactions i.e. purchase of components and raw materials, sale of water heaters and spare parts, payment of management fees and reimbursement of payroll, travelling, telephone, promotional and other expenses for expor .....

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egard to other transactions, apparently the same has been accepted by the TPO and no adjustment is proposed in the aforesaid international transactions. The first objection of the TPO was with regard to the method to be employed for benchmarking international transactions entered into by the assessee. The assessee had applied TNMM method at the entity level, whereas the TPO was of the view that since internal comparables were available, then CPM should be adopted for benchmarking as the most app .....

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year 2010-11. The learned Authorized Representative for the assessee stressed that similar method has been applied by the TPO in the case of the assessee while benchmarking its international transactions in assessment years 2005-06, 2007-08, 2008-09 and 2010-11. The copies of the orders passed under section 92CA(3) of the Act relating to assessment year 2005-06, dated 09.09.2008, has been filed on record. The perusal of the said orders reflect that in the said year, the assessee had entered into .....

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Similarly, in assessment year 2007-08, order of the TPO under section 92CA(3) of the Act is dated 29.10.2010 and for assessment year 2008-09 is dated 31.10.2011 and the value of the international transactions with regard to the arm's length price has not been disturbed by the TPO. The perusal of the assessment order passed for assessment year 2010-11, dated 20.01.2015, the TPO has referred to the five international transactions as reported by the assessee in its TP study report i.e. import .....

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icable to the tax proceedings, but at the same time, where there is no change in the facts in respect of a particular transaction and / or issue or proceedings, then it is the requirement of law that consistency should be maintained and the methodology adopted by the assessee for benchmarking its international transactions should not be disturbed. Where the Revenue from year to year has accepted the method adopted by the assessee for benchmarking its international transactions with its associate .....

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The assessee has time and again explained the reasons why it had adopted the TNMM method and had also explained the difference between the exports made to the associate enterprises and nonassociate enterprises and also sales made in the domestic market. The assessee has also explained the functional risks which are different for both the segments and consequently, no comparison could be made on the gross profit level, as adopted by the TPO for benchmarking international transactions of the asse .....

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ater heaters, which in turn, were sold both to associate enterprises and non-associate enterprises. All these above said explanations have been rejected by the TPO/DRP without any basis, wherein similar explanation has been accepted by the TPO itself in all the other years. The conduct of the business and the products manufactured are identical in the year under consideration, when compared to the other years i.e. assessment year 2005-06, 2007-08, 2008-09 and 2010-11. In the entirety of the abov .....

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order of Tribunal in John Deere India (P.) Ltd. Vs. DCIT (supra), wherein the Tribunal vide order dated 20.02.2015 had decided the issue on both the aspects i.e. where a method has been consistently followed by the assessee why the same should not be applied to benchmark its international transactions and also the issue of application of TNMM method as compared to CUP method applied by the TPO. The Tribunal vide paras 16 to 21 has observed as under:- 16. We have heard the rival submissions of t .....

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Officer has accepted the method adopted by the assessee as well as determination of the ALP as per the T.P. study filed by the assessee. The contention of the assessee is that it had exported tractors to AEs for last several years and the assessee has adopted TNMM method as the most appropriated method for determining the ALP in respect of the transaction of export of tractors to the AEs from A.Y. 2004 -05. The said contention of the assessee has not been disputed before us by the Revenue. Admit .....

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h is placed at Page Nos. 353 - 354 of the P/B-2. Though the TPO/DRP has gone on discussing the provisions of law but have conveniently ignored to put of record how the facts of the current year are different from the fact in A.Ys. 2004-05 and 2005- 06 as in those years the TNMM was adopted by the assesse for determining the ALP which has been accepted as a most appropriate method by the TPO without any objection or reservation. The assessee has also filed the copy of the TPO order for the A.Y. 2 .....

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1 (SC). It is also certainly strange that in the A.Y. 2008 -09 the TPO has again accepted the TNMM method as an appropriate method which was adopted by the assessee and has not disturbed the result. We may refer here to the few decisions of the other Co-ordinate Benches in which it is held that when the facts involved are similar in various years and the Revenue has accepted the method adopted by the assessee in some years then there is no reason to take a different stand in the subsequent years .....

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jected the comparable entities selected by the assessee company. It is seen that in the A.Y. 2005 -06 out of the 8 comparable selected by the assessee, 7 comparable were common and the TPO has not disputed those in that year. In this year, the TPO expressed the reservation on the comparable selected by the assessee to support his working of the ALP. There cannot be two standards for the Assessing Officer one standard in one assessment year and different standard in the subsequent year without ex .....

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tractors segment is niche segment and there is no much difference in the turnover of the comparable entities selected by the assessee. 19. The TPO has expressed his reservation on the Escorts Ltd. and HMT Ltd. comparable selected by the assessee on the ground that those two companies have incurred losses. It is seen that in the A.Y. 2005 -06 those two companies has incurred the losses but in spite of the losses in that year, the TPO has not rejected those two companies as a comparable. We fail .....

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cation for the TPO to reject those two comparable. The TPO has also objected to the inclusion of another entity i.e. Kerala Agro Machinery Corporation Ltd. (KAMCL) on the ground that the said company is manufacturing power tillers and power reapers and not engaged in the business of manufacturing tractors. According to the TPO the said company cannot be considered as a comparable for determining the ALP in the case of the assessee. The TPO has also stated that KAMCL is a PSU and hence, on the po .....

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and therefore the said company cannot be considered as a comparable entity. 20. The main objection of the assessee is on the approach of the TPO it is submitted that in the preceding year the TPO accept those companies as a comparable have determining the ALP when in that year also all the facts and figures were before him in the A.Y. 2006 -07 the TPO adopt the different approach. In respect of the reservation of the TPO to accept the Escorts as a comparable, the assessee s contention is that th .....

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four companies are comparable to the assessee company and in the same business as no specific objection is noted by the TPO, those companies should be considered as comparable. The assessee states that net operating margins (NOM) of the balance four companies is within plus or minus 5% of the net operating margin of the export segment and hence, the transactions are at ALP. The assessee has filed the working on the above contention which is as under: Sr. No. Name of the company Net operating mar .....

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e considered as a comparable in the A.Y. 200 6-07 as said company is not admittedly in the business of manufacturing tractors. But in respect of the remaining 7 companies as per the data placed before us, all those companies are in the line of same business i.e. tractor manufacturing. If we put the remaining 7 companies selected by the assessee, the picture is as under: Sr. No. Name of the company Operating Turnover Profit Margin 1 Escorts Ltd. 1320.32 -12.02% 2 Tractors & Farm Tractor Ltd. .....

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o its AEs is at ALP within the settle parameters. 15. The Tribunal further dealt with the second aspect of the issue i.e. the application of most appropriate method and observed as under:- 22. Let us deal with another objection of the TPO on the appropriate method whether the TNMM which is adopted by the assessee is a correct appropriate method or CUP which is applied by the TPO. This issue stands covered in favour of the assessee by the decision of the ITAT, Pune in the case of Drill bits Inter .....

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was not the most appropriate method for determining the ALP. The operating part of the discussion in the said decision is as under: 50. Considering the above submissions, vis-à-vis the method i.e. CPM (cost plus method) adopted by the learned TPO to determine the ALP, which has been relied upon by the learned Departmental Representative, we find that the learned TPO while adopting CPM has failed to appreciate several material aspects of the issue as discussed above. In our view, the learn .....

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he contractual statements also defer in the domestic segment vis-a-vis export segments. There are different characteristics and contractual terms in the two segments and further geographical and marked differences are also present. Thus, we are of the view that it is very difficult to make suitable adjustments for these differences, hence the CMA method is not appropriate method for determining the ALP. The learned TPO, in our view, has thus erred in adopting the CMA method as appropriate method .....

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on of ₹ 58,54,128 has been made. In this working, the learned TPO has failed to appreciate that during the year, the assessee has paid processing charges to the local contractors of ₹ 16,98,742 i.e. in respect of products sold in the domestic segment, hence the same should not have been allocated to the export segment. Besides, there is no reason to doubt the submission of the assessee that major time of the junior and serior staff is utilized for the domestic segment since while dea .....

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stified because major time of the employees is devoted towards the domestic segment. We also find substance in the submission of the learned Authorised Representative that assessee has also to incur selling and administrative expenses, freight expenses, bank interests etc., which cannot be ignored as ultimately the income-tax is levied on net profit and therefore, comparison of the net profit of the domestic export segment is more proper. The assessee at page No. 141 of the paper book has given .....

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argin computed for the domestic segment for the above risk. 52. Considering the above material facts in totality, we are of the view that the learned TPO was not justified in adopting the CPM as the most appropriate method. On the basis that the assessee had a joint facility arrangement or a long-term buy and supply arrangement with its AE, as we have discussed hereinabove, we find that there was no sufficient reasons with the learned TPO to reject CUP method or TNMM adopted by the assessee to d .....

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s. NGC Network (India) (P) Ltd. ITA No. 5307/Mum/2006, dt. 23rd Feb., 2011 (para 15) [reported at (2011) 56 DTR (Mumbai)(Trib) 1 -Ed.] on the rule of consistency and need for not taking the domestic comparables and need for taking up the external comparable in matters of the transfer pricing adjustments. It was held further that the uncontrolled transactions and the external comparables which was adopted by the officer in subsequent year holds relevant for current assessment year as well. We thu .....

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M but the said method was rejected by the TPO, and TPO substituted CPM in the place of TNMM. When the matter reached before the Tribunal it is held that CPM cannot be applied since there were various differences in the export segment and domestic segment such as market functions, geographic difference, volume difference, credit risk, related party transactions etc. In our opinion the said principles are clearly applicable in the present case. As we have already observed that the assessee has als .....

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