TMI Blog2016 (4) TMI 204X X X X Extracts X X X X X X X X Extracts X X X X ..... CIT(A) on the issue of net margin, the other arguments of the assessee are not considered being academic in nature. Grounds raised by the revenue are accordingly dismissed. Disallowance u/s 14A - Held that:- We find the assessee during the impugned assessment year has earned interest and dividend income of ₹ 31,41,04,213/- which it claimed as exempt. We find the AO applying the provisions of Rule 8D disallowed an amount of ₹ 40,36,560/-. In appeal the Ld.CIT(A) following the decision of Hon ble Bombay High Court in the case of Godrej and Boyce Mfg. Company Pvt. Ltd. (2010 (8) TMI 77 - BOMBAY HIGH COURT ) deleted the addition holding that provisions of Rule 8D are prospective in nature and therefore are applicable to A.Y. 2008-09 and on onwards. Since the assessment year involved in the impugned appeal is A.Y. 2005-06, therefore, no disallowance is called for under provisions of Rule 8D as the same is not applicable for the impugned assessment year. However, it cannot be said that no administrative expenses have been incurred by the assessee for earning the huge tax free dividend income. Considering the totality of the facts of the case, disallowance of an amount of & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f IC Engines for power generation and industrial applications in the domestic market. It also manufactures and sells IC Engines and Components for exports. It also purchases spares by way of imports for reselling in domestic market. The details of international transactions carried out by the assessee are as under: Sr. No. International Activity Amount (Rs.) Method adopted Manufacturing Activity 1 Import of Engine parts and components 205,47,91,880/- TNMM 2 Export of manufactured IC Engines 344,88,29,555/- TNMM 3 Payment of Royalty 15,64,19,584/- TNMM 4 Provision of Miscellaneous Services (Procurement Support Services) 1,67,74,530/- TNMM 5 Payment of fees for IT Support Services 4,06,99,976/- TNMM 6 Design ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dingly determined the income of the assessee at ₹ 155,20,83,790/- after deduction under Chapter VIA at ₹ 3,45,30,113/-. 7. In appeal the Ld.CIT(A) gave part relief to the assessee by deleting the addition of ₹ 8,23,19,580/- made on account of export of manufactured IC Engines, deleted the disallowance of ₹ 92,26,850/- made on account of new engine performance inspection fee, deleted the disallowance of ₹ 40,36,560/- made u/s.14A and ₹ 2,55,41,000/- made on account of provision of warranty fee. He however sustained the addition of ₹ 12,84,929/- made on account of procurement services and ₹ 78,72,507/- made on account of export of IC Engines of LHP Division. 8. Aggrieved with such part relief given by the CIT(A) the Revenue as well as the assessee are in appeal before us with the following grounds : Grounds of appeal by the Revenue : 1. The order of the learned Commissioner of Income-tax (Appeals) is contrary to law and to the facts and circumstances of the case. 2. The learned Commissioner of Income-tax (Appeals) grossly erred in allowing the assessee's appeal instead of confirming the Assessing Officer's o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... IT(A ) ] amounting to ₹ 8,23,19,580/-, with regard to the international transactions pertaining to export of IC engines by HHP division. 2.2 The learned C1T(A) erred in law and on facts and in circumstances of the ease in not accepting the Respondent's plea of granting benefit of +/-5 percent range from the price computed based on arithmetic mean as provided ill proviso to section 92C(2) of the Act. 2.3 The learned CIT(A) erred in law and on the facts and in circumstances of the case in not accepting the benchmarking analysis followed by the Respondent for benchmarking of international transactions in respect of manufacturing activity of the HHP division. 2.4 The learned CIT(A) erred in law and on the facts and in circumstances of the case in not considering the use of external comparable companies selected by the Respondent for benchmarking the manufacturing activity of HHP division. 2.5 The learned CIT(A) erred in law and on the facts and in circumstances of the case in accepting the AO's stand of comparing segmental profitability of the Respondent's exports to AEs segment and domestic sales segment. 2.6 The learned CIT(A) erred in law and on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5.1 The Learned AO erred in law and on the facts and in circumstances of the case in objecting to the deletion of disallowance u/s.14A by the learned CIT(A) amounting to ₹ 40,36,560/-. 6. Each one of the above grounds of cross objection is without prejudice to the other. 7. The Respondent craves leave to add, to amend, to alter, to substitute, and to withdraw the above grounds of appeal. 10. In Grounds of appeal No.1 to 4 the revenue has challenged the order of the CIT(A) in deleting the TP adjustment of ₹ 8,23,19,850/- made by the AO. 11. Facts of the case in brief are that the TPO during the proceedings before him noted that the assessee, during the year under consideration, has grouped/aggregated international transaction at Sl.No.1 to 7 of the table at Para 4 of this order as manufacturing activity and has benchmarked using TNMM taking external comparables and by adopting PLI as operating margin to sales earned by third party comparables. The TPO observed that the assessee company manufactures variety of engines from 60 to 2000 horse powers operating either on Diesel or natural gas or dual fuel. The company does not have standard product available ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ystem will not make products entirely different from each other. According to him, there cannot be product differentiation but for its capacities once end-use of the engines remains the same. Further, the company manufactures products according to the requirement of the customers and nature of application of the product for which the assessee levies additional mark up based on the basis of additional features available in the product. He accordingly rejected the above argument of the assessee. 15. As regards the contention of the assessee that it assumes more risk in the domestic sales such as product risk, market risk and credit risk whereas such risks are not there in export sales, which is evident from the higher warranty claim, the TPO noted that warranty claims will impact net margin of the assessee company and not the gross margin. Secondly, the assessee has not demonstrated with facts and figures that risk difference impacts the assessee s gross margins on sales made to third parties, vis- -vis AEs. Rejecting the various explanations given by the assessee and relying on various decisions the TPO made an adjustment of ₹ 8,23,19,580/-. Subsequently, the AO made the ab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the assesse s argument on product differences. 3.1.10. The assessee has stated that it undertakes more functions and assumes more risks in the domestic market. I do not agree with the argument. In my view, functions performed and risks assumed are always greater in export market than in the domestic market. As a thumb rule, in an Indian situation, profit margins are always higher in the export sales than in the domestic sales. This is because, the enterprise assumes product liability risk (products are rejected if they do not meet required specifications). More importantly, in an Indian situation, parts of locational savings are also is available to the Indian manufacturing company. Therefore, unless the enterprise demonstrates with relevant facts as to why it earned lower profit while exporting to AEs as against the domestic market assessee s argument on this issue cannot be considered. The assessee has not advanced any arguments on this aspect. Therefore, I do not accept the contention of the assessee on this ground. 3.1.11 However, on the issue of PLI, I agree with the assessee that the transactional net margin method, refers to net margin and not gross margin . Thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 141 (Bang) (SB) the Honourable Bangalore Tribunal has held as under : Under this method, the net profit margin realized by an associated enterprise from an international transaction is computed in relation to a particular factor such as costs incurred, sales, assets utilized etc. The net profit margin realized by an associated enterprise is compared with net profit margin of the uncontrolled transactions to arrive at the ALP. The TNMM is similar to RPM and CPM to the extent that it involves comparison of margin earned in a controlled situation with margins earned from comparable uncontrolled situation. The only difference is that, in the RPM and CPM methods, comparison is of margins of gross profits and whereas in TNMM the comparison is on margins of net profit . 3.1.15 Rule 10B(e) and the OECD Guidelines make it clear that this method seeks to compare net profit margins of the controlled and uncontrolled transactions. Comparing of gross margins is not envisaged under the Income Tax Rules. Conceptually also comparing of gross margins may provide unreliable reasons because of the factors mentioned above. In view of the above, I hold that the adjustment made by the TPO is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the assessee drew the attention of the Bench to the submission of the assessee before the TPO which has been summarized by the TPO in his order and which reads as under : Difference in products : Under this head it has been submitted that there is difference in the basic engines on account of parts and components which are selected depending upon the application of engines, that the engine configurations to satisfy requirements in the Indian market are different from the export markets, that the exported engines represent basic configurations while domestic engines include a great variety of additional features such as cooling systems, exhaust systems, Air filtration systems, fuel system, mounting system, instrumentation panel, electrical and charging system and auxiliary accessories and thus additional capabilities and therefore appropriate mark up forms part of the sales. He accordingly submitted that when it exports its products to the AE it is the AE who does all those things. Therefore, there is difference in the product. He further submitted that the assessee is not required to do marketing functions for the AEs since it is their job to do marketing. 23. Refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacturing know-how and the supply of vital components to an associated manufacturer, it may be more reasonable to assess the arm s length terms for the two items together rather than individually. Such transactions should be evaluated, together using the most appropriate arm s length method or methods. A further example would be the routing of a transaction through another associated enterprise, it may be more appropriate to consider the transaction of which the routing is a part in its entirety, rather than consider the individual transactions on a separate basis. (emphasis supplied by the assessee before TPO). He submitted that OECD does not say to adopt gross margin in TNMM. 25. Referring to Rule 10B(1) he submitted that for the purpose of sub-section (2) of section 92C the ALP in relation to an international transaction shall be determined by any of the following methods being the most appropriate method in the following manner namely: 1. CUP 2. Resell price 3. Cost Plus method 4. Profit split method 5. TNMM or 6. Any other method as provided in Rule 10AB 26. So far as TNMM is concerned he submitted that every where the starting point in TNMM is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considering the difference in the gross margin earned by the assessee from sale of IC engines in the domestic market and gross margin earned by the assessee from export of IC engines to AEs. We find in appeal the Ld.CIT(A) following provisions of Rule 10B(e) as well as para 3.26 of the OECD guidelines and various other decisions held that net profit margin of controlled transactions has to be compared with the net profit margin of uncontrolled transactions. He has further held that comparing of gross margin is not envisaged under the I.T. Rules. In view of the detailed reasoning given by him at para 3.1.8 to 3.1.16 of his order, which has already been reproduced in the preceding paragraphs, he deleted the addition made by the AO on account of adoption of difference in gross profit margin by the AO as against difference in net profit margin between sales to AE and sales in domestic market. We find no infirmity in the order of the CIT(A) who has decided the issue as per the provisions of Rule 10B(e) as well as para 3.26 of the OECD guidelines as well as various other decisions according to which net profit margin of controlled transactions has to be compared with net profit margin o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the CIT(A) the revenue is in appeal before us. 35. We have considered the rival arguments made by both the sides, perused the orders of the AO and CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. We find the assessee during the impugned assessment year has earned interest and dividend income of ₹ 31,41,04,213/- which it claimed as exempt. We find the AO applying the provisions of Rule 8D disallowed an amount of ₹ 40,36,560/-. In appeal the Ld.CIT(A) following the decision of Hon ble Bombay High Court in the case of Godrej and Boyce Mfg. Company Pvt. Ltd. (Supra) deleted the addition holding that provisions of Rule 8D are prospective in nature and therefore are applicable to A.Y. 2008-09 and on onwards. Since the assessment year involved in the impugned appeal is A.Y. 2005-06, therefore, no disallowance is called for under provisions of Rule 8D as the same is not applicable for the impugned assessment year. However, it cannot be said that no administrative expenses have been incurred by the assessee for earning the huge tax free dividend income. Considering the totality of the facts of the case, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o was not convinced with the arguments advanced by the assessee. He noted that the TPO in his order has held that the assessee has offered only general arguments and has not provided specific facts or figures as to how these conditions have reduced its profit margin on exports made to the AEs. According to him unless proved otherwise the profit margin in export sales should always be higher than any sales made in the domestic market in Indian situation. According to him it is for the assessee to explain as to how the export sales made to AEs is at Arm s length as relevant information is in its possession. Since the assessee has not done the same he held that the TPO was justified in making the adjustment. 42. Aggrieved with such order of the CIT(A) the assessee has taken this ground of appeal No.4 in the CO. 43. The Ld. Counsel for the assessee referred to page 463 of the paper book and drew the attention of the Bench to the following submission made before the TPO : C. Your Honour has requested the Company to show cause as to why adjustment of an amount corresponding to the difference in the margins generated by the Company from export of IC Engines of LHP Division to AE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s such as specific characteristics of the properties transferred, functions performed with risks assumed and assets employed in the transactions, contractual terms and conditions prevailing in the markets. Considering the difference in the markets for sale of IC Engines in terms of size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition, the transactions of sale of IC Engines of ₹ 135.36 crores to non AEs are not comparable with the transaction of ₹ 17.69 crores in respect of sale of IC Engines to AEs. Considering the same, the Company is of the view that adjustment on account difference in margins to the extent of 4.45% is not required. 44. He submitted that comparison of export to export can be made but comparison of export to domestic sales cannot be made for arriving at the profit margin. He submitted that when the assessee has given all the details, therefore, the order of the CIT(A) stating that the assessee has not explained as to how the export sales to AEs is at Arm s length is incorrect. He accordingly submitted that the order of the CIT(A) be set aside ..... X X X X Extracts X X X X X X X X Extracts X X X X
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