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DCIT, Circle-1 (1) , Pune Versus Cummins India Ltd. and Vica-Versa

2016 (4) TMI 204 - ITAT PUNE

Transfer pricing adjustment - adjustment in respect of international transaction relating to export of manufactured IC engines by 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 - CIT(A) deleted the addition - Held that:- 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 t .....

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s upheld. Since we are dismissing the ground raised by the revenue by upholding the order of 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 provision .....

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ons 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 ₹ 2 lakhs, in our opinion, will meet the ends of justice

Adjustment on account of export of IC engines of LHP Division to AEs - Held that:- The lower authorities have not properly con .....

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: Shri S.K. Rastogi, CIT ORDER PER R.K. PANDA, AM : This appeal filed by the Revenue is directed against the order dated 08-10-2012 of the CIT(A)-IT/TP, Pune relating to Assessment Year 2005-06. The assessee has filed the cross objection against the appeal filed by the Revenue. For the sake of convenience, the appeal as well as the CO were heard together and are being disposed of by this common order. 2. There is delay of 87 days in filing of the appeal by the revenue for which a condonation pe .....

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reference u/s.92CA(1) of the I.T. Act to the TPO for computation of ALP in relation to the international transactions detailed in the audit report in Form 3CEB. The TPO accordingly issued notice to the assessee asking for details/explanations to support the ALP computed by it in the audit report. 4. From the various details furnished by the assessee the TPO noted that Cummins India Ltd. is a 51% owned subsidiary of Cummins Inc., USA. The balance equity is held by the Kirloskar group, the Indian .....

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onal 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 Services 2,15,64,258/- TNMM 7 Payment of global sourcing consideration 21,43,26,665/- TNMM Activity carried on by the .....

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rom time to time, the TPO vide order u/s.92CA(3) dated 25-07-2008 made following adjustments to the international transactions undertaken by the assessee : Amount (Rs.) Export of manufactured IC Engines 8,23,19,580 Procurement Support Services 12,84,929 Export of IC engines of LHP Division 78,72,507 Total 9,14,77,052/- 6. Subsequently, the AO passed the assessment order u/s.143(3) on 22-12-2008 incorporating the above mentioned TP adjustments. Apart from the above, the AO also made the following .....

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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 t .....

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ting the Transfer Pricing Adjustment on export of manufactured IC Engines of ₹ 8,23,19,580/- by rejecting the comparison of the gross Margins of the controlled AE transaction with the uncontrolled AE transactions and the uncontrolled Non AE transaction when TNMM with internal segmentation had been applied as the most appropriate method. 4. The learned Commissioner of Income-tax (Appeals) grossly erred in failing to apply the ratio of the decision of the jurisdictional Tribunal in the case .....

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Commissioner of Income-tax (Appeals) grossly erred in not applying the "reasonable basis" test and accordingly in not confirming the disallowance even while acknowledging that in the case of Godrej & Boyce Mfg. Co. Ltd. Vs. DCIT (2010), 328 ITR 81 (Bom), the Hon'ble Bombay High Court categorically held that prior to the A.Y. 2008-09, disallowance u/s.14A could be made on "reasonable basis". 7. For these and such other grounds as may be urged at the time of hearing, th .....

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and hence is void ab initio . 2. International Transaction relating to export of IC Engines by HHP Division 2.1 The learned AO has erred in law and on the facts and in circumstances of the case in objecting to the deletion of Transfer Pricing Adjustment by the leaned Commissioner of Income tax (Appeals)-IT/TP, Pune ["CIT(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) err .....

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ion. 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 .....

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ocurement support services. 3.2 The learned CIT(A) erred in law and on facts and in circumstances of the case in not accepting the Respondent's plea of granting benefit of +/-5 percent range from the price computed based on arithmetic mean as provided in proviso to section 92 C(2) of the Act. 3 .3 The learned CIT(A) erred on facts and circumstances on the case of the case in confirming rejection of three comparable companies considered for benchmarking the international transaction relating .....

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benefit of +/-5 percent range from the price computed based on arithmetic mean as provided in proviso to section 92C(2) of the Act. 4.3 The learned CIT(A) erred in law and on the facts and in circumstances of the case in confirming the rejection of the benchmarking analysis followed respect of manufacturing activity of the LHP division. 4.4 The learned CIT(A) erred in law and on facts and in circumstances of the case in confirming the rejection of the external comparable companies selected by t .....

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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 .....

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el or natural gas or dual fuel. The company does not have standard product available off the shelf. The company manufactures Engines of specific horse power according to customer s needs and extent of usage. He noted that the gross margin to sales in respect of third party sales of Engines stand at 18.83% as compared to gross margin over sales of 16.46% recorded by the company from export to AEs. Accordingly, the TPO proposed adjustment of equivalent to 2.3%, (i.e. 18.83% - 16.46%) on sales of & .....

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n, assumes more risk, i.e. product liability while selling in domestic market as against selling in export market. Further, the volume of sales made to customers in domestic market is different as against made in the export market. 13. However, the TPO was not satisfied with the explanation given by the assessee. From an analysis of the nature of the clients dealt by the assessee company, the TPO noted that the assessee company deals with well established clients in the domestic market and with .....

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nt of the assessee that both the markets are not comparable because of substantial variation in volume of sales in both the market is without any basis. 14. As regards the argument of product difference is concerned the TPO noted that the assessee essentially has sold IC engines in domestic as well as in the export markets. The difference of certain features or specifications of engines such as cooling system, mounting system, instrumentation panel, electrical and charging system will not make p .....

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tention 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-à-v .....

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argin and not gross profit margin. The adjustment made by the AO by adopting gross margin as the basis is neither supported by the Indian Law nor by the OECD guidelines. Therefore, the entire adjustment is illegal and deserves to be deleted. It was argued that the operating margin on cost earned by the assessee for this activity is 4.8% whereas the margin earned by external comparable case was 6.34%. Accordingly, it was argued that no adjustment is called for. 17. Based on the arguments advanced .....

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ee has not furnished relevant costing and pricing statements for each product to substantiate its argument that the margin is impacted because of the differences in product. The assessee has not demonstrated that incorporating of a particular additional feature has made this specific difference to the margin of the product. It may be noted that, different features or specifications would not drastically impact margins of different products as the assessee company used same resources and undertak .....

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on in margin of each product type. Hence, I do not find any substance 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 sal .....

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ced 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 . This aspect is clear in Rule 10B, which is as under : (e) Transaction net margin method by which : (i) The net profit realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relati .....

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n is not to be considered in TNMM. The TPO has compared gross margins in trading by applying internal TNMM. The method used by the TPO neither can neither call under Rule 10B(b) on Re-sale Price method nor under 10B(c) on cost plus Method. As discussed above, it does not fall under TNMM also. 3.1.13 The TPO has relied on Para 3.26 of the OECD Guidelines in support of gross margin adopted by him under TNMM. However, in my opinion, the TPO has stretched the similarity between TNMM and CUP and Re-s .....

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argin method resembles, this, however, does not mean that a mere similarity of functions between two enterprises will necessarily lead to reliable comparisons. Assuming similar functions can be isolated from among the wide range of functions that enterprises may exercise, in order to apply the method, the net profit indicators related to such functions may still not be automatically comparable where, for instance, the enterprises concerned carry on those functions in different economic sectors o .....

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et 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 c .....

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favour, it is not necessary to give findings on the other connected Grounds on this issue. 18. Aggrieved with such order of CIT(A) the revenue is in appeal before us. 19. The Ld. Departmental Representative strongly opposed the order of the CIT(A). He submitted that the powers of the CIT(A) are coterminous with that of the AO. He can do enquiries and do things which the AO has not done while passing the assessment order. Therefore, the matter may be restored to the file of the AO with a directio .....

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the attention of the Bench to the international transactions carried on by the assessee during the year wherein the assessee has aggregated the manufacturing products which are closely interlinked and where the TNMM method has been adopted. Referring to page 4 para (i) of the order the Ld. Counsel for the assessee drew the attention of the Bench to the following observation of the TPO. From the TP Study Report it is seen that the company specializes in manufacturing of internal combustion engine .....

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and sold to the original equipment manufacturers who in turn sell their final equipment to the end user in the market. (emphasis supplied by the Ld. AR) 22. Referring to page 12 of the TPO s order the Ld. Counsel 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 .....

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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. Referring to page 14 of the order of the TPO he drew the attention of the Bench to para 3.27 of the OECD .....

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een enterprises are often reflected in variations in operating expenses. Consequently, enterprises may have wide range of gross profit margins but still earn broadly similar levels of net profits. 24. Referring to page 520 of the paper book the Ld. Counsel for the assessee drew the attention of the Bench to para 3.6 in the grounds of appeal before CIT(A) where the above OECD guidelines was brought to his notice according to which TNMM required net profit margin earned from controlled transaction .....

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of the Bench to para 1.42 of the OECD guidelines which advocate aggregation of transactions and which reads as under : 1.42 Ideally, in order to arrive at the most precise approximation of fair market value, the arm s length principle should be applied on a transaction-by-transaction basis. However; there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. Some long-term contra .....

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sactions 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 Ru .....

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the order of CIT(A) he submitted that the Ld.CIT(A) while deleting the addition has however made certain observations which is not at all correct. He has stated that all manufactured products of the assessee fall into the basket of IC engines, therefore, it is unlikely that there will be material variation in margin of each product type. He has accordingly rejected the argument of the assessee on account of product difference which according to Ld. Authorised Representative is not correct. 27. .....

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cation of the engine, the electrical system with which it is to be integrated etc. It was also submitted that the engine configurations to satisfy requirements in the Indian market are different from the export market. Therefore, the observation of the CIT(A) in the last 4 lines of para 3.1.9 are baseless and unsustainable. 28. Referring to various case decisions he submitted that the CIT(A) has correctly held that the adjustment made by the TPO amounting to ₹ 8,23,19,580/- is not supporte .....

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vity and has benchmarked using TNMM taking external comparables and adopted the PLI as operating margin to sales earned by third party comparables. We find the TPO rejected various arguments advanced by the assessee and made an adjustment of ₹ 8,23,19,580/- in respect of international transaction relating to export of manufactured IC engines by 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 .....

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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 tran .....

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sue of net margin, the other arguments of the assessee are not considered being academic in nature. Grounds raised by the revenue are accordingly dismissed. 30. In grounds of appeal No.5 the revenue has challenged the order of the CIT(A) in deleting the disallowance of ₹ 40,36,560/- made by the AO u/s.14A of the I.T. Act. 31. Facts of the case, in brief, are that the AO during the course of assessment proceedings noted that assessee has received interest and dividend of ₹ 31,41,04,21 .....

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₹ 19 lakhs only. It had no secured loans. Therefore, no disallowance is called for u/s.14A as the investments were made from the own funds of the company. 32. However, the AO was not satisfied with the explanation given by the assessee. According to him, it is not possible to conceive that no expenses can be attributed to earning of exempted income as investment decisions are complex decisions and assessee is bound to have incurred certain expenses for earning dividend income. Applying Rul .....

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idered 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 o .....

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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 ₹ 2 lakhs, in our opinion, will meet the ends of justice. We hold and direct accordingly. Accordingly, the grounds raised by the revenue on this issue are partly allowed. 36. Grounds of appeal No.7 and 8 being general in nature are dismissed. CO No.53/PN/2014 : 37. Ground of appeal No.1 in the CO refers to non admission of the ap .....

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he value of international transactions in respect of export of IC engines by the LHP Division. 39. Facts of the case, in brief, are that the TPO during the course of TP assessment proceedings noted that the assessee company manufactures IC engines of capacity lower than 125 KVA, i.e. 164 horse power in its LHP Division. He noted that total export sales to AEs from LHP Division is ₹ 17.69 crores on which the company earned operating margin to sales at 3.22%. However, the company has earned .....

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s of the property transferred, functions performed with risks assumed and assets employed in the transactions and contractual terms and conditions prevailing in the market. It was submitted that at best, comparison can be made between exports to AEs and exports to non AEs in the same overseas market provided functions involved, contractual terms and conditions prevailing in the overseas market are same. It was submitted that the TPO wrongly made adjustment of ₹ 78,72,507/-. 41. However, th .....

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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. You .....

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008 : Particulars Export sale to AE Export sale to Non-AE Domestic Sale to Non AE Total Sales to Non-AE A B C (B+C) Sales 17.69 6.23 129.13 135.36 Total income 17.69 6.23 129.13 135.36 Less : Material consumed 15.76 5.35 109.21 114.56 Manufacturing Expenses 0.52 0.32 2.98 3.3 Administrative Expenses 0.24 0.09 2.38 2.47 Selling & Distribution Expenses 0.58 0.22 4.09 4.31 Interest & Finance 0.03 0.01 0.21 0.22 Total Costs 17.12 5.99 118.88 124.86 Net Operating Margin 0.57 0.24 10.26 10.5 % .....

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ome Tax Rules, 1962 prescribe that the comparability of the transactions depend on various factors 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 econom .....

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