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TMI Blog2016 (5) TMI 714X X X X Extracts X X X X X X X X Extracts X X X X ..... EOU in Pune, set up for coating raw beads and the other in Delhi engaged in import and sale of crystal and crystal related products in India. The assessee filed its return reporting seven international transactions, out of which only three related to the Pune unit. One of such international transactions is 'Coating of raw beads' with transacted value of Rs. 316,84,850/-, which is under dispute. The assessee used Cost plus method (CPM) as the most appropriate method to demonstrate that this international transaction was at arm's length price (ALP). The Assessing Officer (AO) made reference to the Transfer Pricing Officer (TPO) for determining the ALP of the reported international transactions. The TPO took up the international transaction of 'Coating of raw beads' which was shown by the assessee at ALP by indicating its profit mark up over costs at around 30% against the gross mark-up of 19 comparable companies at 11%. The TPO observed that the assessee did job work of colouring raw beads at its Pune plant and was, hence, in the nature of a contract manufacturer. It was noticed that the assessee received raw beads from its associated enterprises (AEs) and after doing colour coating, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ), namely, application of TNMM by the TPO as the most appropriate method and determination of ALP of this international transaction. The ld. CIT(A) agreed with the TPO in applying TNMM as the most appropriate method. On second aspect also, the ld.CIT(A) echoed the assessment order in determining the cost base at Rs. 3.84 crore and the amount of transfer pricing adjustment at Rs. 84,06,916/-. The assessee is in appeal against the confirmation of this addition. 6. We have heard the rival submissions and perused the relevant material on record. There are basically two issues raised on behalf of the assessee in this regard, viz., selection of the most appropriate method and computation of ALP under such method. We will espouse these issues, one by one. I. Selection of most appropriate method 7.1. First issue before us is selection of the most appropriate method. The ld. AR submitted that the assessee correctly applied CPM as the most appropriate method to benchmark this international transaction but the TPO fell in error in resorting to the TNMM. In the opposition, the ld. DR submitted that the TPO, in fact, applied Cost plus method only as was evident from the fact that nowhere in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses appearing in the Profit & Loss account at Rs. 3.99 crore as reduced by certain non-operating costs. When we consider these two figures, namely, Total income (Operating revenue) and Total cost (Operating costs) as calculated for the assessee, and, then, view it in the setting of the Table depicting calculation of similar figures of the comparables, there remains no doubt that 4.4% is the average operating profit margin of the comparables. In other words, profit margin of 4.4% of comparables is OP/TC. The TPO applied this profit margin on costs incurred in providing job work services calculated by him at Rs. 3.84 crore to determine the ALP and the resultant transfer pricing adjustment. 7.3. This manifests that the TPO has applied TNMM and not the Cost plus method. The reason for our this conclusion is that the calculation of ALP under TNMM has been prescribed under Rule 10B(1)(e) in which the first step is to compute the net profit margin realised by the enterprise from an international transaction in relation to a particular base such as costs incurred or sales effected or assets employed or to be employed. Under sub-clause (ii), the net profit margin realized by the enterprise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... again we find that the term `net profit' in TNMM does not literally mean the amount of net profit at the end of the Profit and loss account, but `operating net profit', which is calculated by reducing operating costs from the gross revenue. Similarly, the term `gross profit' in CPM does not literally mean the amount of gross profit at the end of Trading account, but gross margin, which is calculated by reducing all the direct and indirect costs from the gross revenue. 7.4. When we view the calculation made by the TPO in determining the ALP of this international transaction, it clearly emerges that he has taken costs incurred at Rs. 3.84 crore, which are `Operating costs' as per his calculation and profit margin of 4.4% of comparables, which is ratio of operating profit to total operating costs. Thus, it is evident that the TPO has applied TNMM for determining ALP of this international transaction. This disapproves the contention of the ld. DR that the TPO applied CPM as the most appropriate method. 7.5. Now, we come to the question of the most appropriate method in the given facts and circumstances. It is found that the assessee is doing job work for and on behalf of its AEs. Nei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... occasion to examine the calculation given under the CPM. The assessee has made calculation of ALP under CPM in its Transfer pricing study report as per Annexure-B. When we peruse such Annexure in juxtaposition to the Profit & Loss Account of the Pune unit, it comes to the fore that in the Profit & Loss Account, there is a mention of first item of revenue as 'Sales (Including trading)' at Rs. 3,16,84,853. It is this figure of Rs. 3.16 crore, which has also been taken in Annexure-B as `Processing charges' to which amount of foreign exchange gain has been added for arriving at total amount of revenue of Rs. 3.24 crore. From this amount of gross revenue, certain direct and indirect costs have been reduced totaling Rs. 2.48 crore to compute gross profit at Rs. 76,47,114/-. We find that there is difference in some of the items of direct and indirect costs taken in Annexure-B vis-àvis the amounts appearing in the Profit & Loss Account. Though some of the figures, namely, Chemical and clearing charges of chemicals consumed, Packing material and sewing thread consumed and Purchase of consumables, etc. given in the Annexure are matching with the respective amounts given in the Profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amely, Trading, Transfers and Corporate. The ld. AR contended that the costs have been allocated to Trading, Transfers and Corporate heads as well because some of the activities of the Pune unit also related to these heads. When we peruse the Profit & Loss Account of the assessee, it discerns that there is an item of revenue characterized as 'Sales (including trading)' with the value of Rs. 3,16,84,843/-. We find that this is the exact amount of the revenue received by the assessee from its AE as job work charges. This is also fortified from the TPO's order in which the international transactions have been reproduced and the transaction at Sl. No.3 is 'Coating of raw beads' with value of Rs. 3,16,84,850/-. This indicates that the entire revenue of the Pune unit is from `Job work' and there is no transaction of revenue from Trading or Transfer, which position could not be controverted by the ld. AR as well. Thus it is palpable that the revenue in the Pune unit is only from the `Job work' and the mention of the words 'Including trading' in the Profit & Loss Account is superfluous. The ld. AR has also admitted that there is no amount of revenue from the Trading activity or any other a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s purchasing raw materials and then selling similar finished goods at their own assuming all the manufacturing risks as well. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings. 9.1. The next issue raised in this appeal is against the sustenance of addition amounting to Rs. 22,17,399/- in respect of amount written off under the head 'Fixed assets written off.' The assessee has also raised an additional ground, which reads as under:- "Without prejudice to the fourth ground of appeal, that on the facts and in law, the ld.AO may be directed to allow depreciation on total cost of the fixed assets acquired during the year and added to the WDV of the respective block of assets, including the amount of Rs. 22,17,399 written off under the head "fixed assets written off", under section 32 of the Income Tax Act, 1961." 9.2. No serious objection was taken by the ld. DR against the admission of the above additional ground. The same, being a legal ground, is hereby admitted for consideration. 9.3. Briefly stated, the facts of these grounds are that the assessee debited a sum of Rs. 22,17,399/- on account of write off in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l to see as to how such differential amount on account of fixed assets written off can be considered as revenue loss deductible in the computation of income. It is a clear cut case of capital loss resulting from the valuation of fixed assets. In support of the contention that it was business expediency of the assessee in purchasing these fixed assets from SPA Agencies and hence the loss written off be allowed as deduction, the ld. AR relied on the judgment of the Hon'ble Supreme Court in the case of Patnaik and Co. Ltd. vs. CIT (1986) AIR 1483 (SC). In that case, there was a business loss from sale of Government bonds or securities which had to be purchased by that assessee as a condition for having purchase orders from the Government and the loss was held to be revenue. In that case, the assessee was told that only if it subscribed for such Bonds that the preferential treatment would be given to him in placing orders for motor vehicles required by the various Government departments. This shows that the purchase of Government bonds was obviously a pre-condition for securing orders from the Government. It was under those circumstances that the Hon'ble Supreme Court held the loss to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... goods (CCD), Traded goods (CGD) and Finished goods. The AO observed that the assessee did not show such provision in the Profit & Loss Account and, further, there was no mention of such provision in the Notes to Accounts. On being show caused to justify the deductibility of such provision, the assessee contended that thousands of varieties of crystals are maintained by it, out of which several items go out of present trend, which are required to be written off. Amount of Rs. 99.95 lac was claimed as loss from such obsolescence. The assessee further stated that in some cases, the stocks written off were as old as 4-5 years while in other cases, the obsolescence was not full for which valuation was proportionately reduced. The AO observed that the assessee started its CCD and CGD business in November, 2000 only and there was no possibility of having any goods 4-5 years old. In response to that, the assessee stated that stocks purchased from SPA Agencies Pvt. Ltd. also included such obsolete stocks. The assessee explained that in some items of stock there was 100% obsolescence and the stock was accordingly written off in entirety, while in others, the obsolescence was less, for which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at Rs. 4,218/-. The facts of this ground are that the assessee claimed deduction of these three amounts. On inquiry by the AO, it transpired that the provision for doubtful debts amounting to Rs. 2,89,475/- pertained to old debts recoverable by SPA Agencies, which were taken over by the assessee along with other assets and accordingly written off as provision. Next amount of Rs. 5,10,254/- was on account of provision for doubtful advances, which represented the amount of 1% SVB (Special Valuation Branch) loading of customs duty which Customs Department charged due to import from associated companies. There was no explanation from the assessee for a sum of Rs. 4,218/-. This led to the making of an addition of Rs. 8,03,947/- (5,10,254+2,89,475+4,218). The ld. CIT(A) echoed the action of the AO in this regard. 11.2. Having heard the rival submissions and perused the relevant material on record, we find that the assessee claimed deduction for these three amounts u/s 36(1)(vii) as a provision for doubtful debts/doubtful advances. The claim of the assessee that the amounts be allowed as deduction in terms of section 36(1)(vii), in our considered opinion, is not acceptable in view of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee incurred a sum of Rs. 1,99,90,982/- on account of advertisement and publicity (net of reimbursement of Rs. 31.84 lac). The AO held that 10% of such expenditure was of capital nature because of the benefit from such advertisement also spilled over in the later years and a further 10% was disallowed by treating it as brand building of Swarovski owned by its AE abroad. In reaching the latter conclusion, the AO observed that as per Agreement dated 15.1.2002, Swarovski AG was competent to make direct sales to the customers in the territory of India on which the assessee was to be paid commission @ 15% of the net invoice value. The incurring of advertisement expenses, in the opinion of the AO, resulted in brand building of the AE, which was having a customer base in India. The ld. CIT(A) affirmed the assessment order on this point. 12.2. We have heard both the sides and perused the relevant material on record. The disallowance sustained by the ld. CIT(A) is in two parts. The first is 10% of total expenditure on advertisement and publicity treated as a capital expenditure to that extent. In this regard, we find that there is no dearth of decisions from various High Courts holding tha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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