TMI Blog2016 (9) TMI 1288X X X X Extracts X X X X X X X X Extracts X X X X ..... nies as well as tested party. So, this ground is also required to be restored to the TPO to make fresh adjustment regarding distribution segment by taking into account foreign currency fluctuation duly demonstrated by the assessee in view of the observations made herein before. Disallowance of 3/4th of the advertisement and sales promotion expenses and 4/5th of the recruitment expenditure - Held that:- Undisputedly, identical issue was dealt with by the coordinate Bench in assessee’s own case qua AY 2002-03 and AY 2003-04, orders of which are available at pages 64 to 81 of the paper book. Disallowance on account of advertisement and sales promotion expenses to the tune of ₹ 6,32,85,750/- and recruitment expenditure to the tune of ₹ 1,12,88,617/- made by the AO and confirmed by ld. DRP are allowable on the ground that these expenditure have not resulted into acquisition of any asset by the assessee company nor any enduring additions have been accrued to the assessee. So, by following the order passed by the coordinate Bench in assessee’s own case qua AY 2002-03 and AY 2003-04, grounds no.7 & 8 are determined in favour of the assessee as AO/DRP have erred in disallowin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essing Officer ('AO') pursuant to the directions of the Hon'ble Dispute Resolution Panel ('DRP') erred in making a transfer pricing adjustment of ₹ 101,88,29,361/- to the income of the appellant by holding that the international transaction pertaining to its manufacturing segment, distribution segment and research and development (R D)support services segment of the appellant does not satisfy the arm's length principle envisaged under the Income-tax Act, 1961 ('the Act'). Manufacturing Segment 2. The Ld AO/Transfer Pricing Officer ('TPO') erred in enhancing the income of the appellant by making a TP adjustment of ₹ 60,14,65,390 on account of the manufacturing segment while passing the rectification order u/s 154 of the Act and not allowing the adjustment claimed by the appellant in its TP study which is allowed in the order passed by the Ld TPO u/s section 92 CA(3) of the Act dated January 30, 2013. 3. The Ld. AO ID RP ITPO erred in enhancing the income of the appellant by making a TP adjustment \ of ₹ 60,14,65,390 on account of the manufacturing segment of the appellant by erroneously rejecting the appellant& ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nature of deferred revenue expenditure. 9. That on the facts of the case and in law, the Ld AO/Ld. DRP has erred in disallowing 3/4th of the Licenses and Permits expenditure amounting to ₹ 1,69,93,222 by erroneously holding that such expenditure is enduring in nature and thus, in the nature of deferred revenue expenditure. 10. That on the facts of the case and in law, the Ld. AO/Ld. DRP has erred in not allowing the appellant the eligible deduction under section 10A of the Act amounting to ₹ 3,53,38,348. 10.1 That on the facts of the case and in law, the Ld. AO/Ld.DRP has gravely erred in not excluding the income of section 10A unit amounting to ₹ 3,53,38,348 at source itself before arriving at the gross total income of the appellant. 11. Without prejudice to the above Ground No.7, 8 and 9, the Ld. AO ought to be directed to recompute the deduction under section 10A of the Act after considering the disallowance of expenses viz. Advertisement and sales promotion expenditure, Recruitment expenditure and Licences and permits expenditure and excluding any adjustment under section 92C(4) of the Act in view of the proviso to section 92C(4) of the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... MM 7. Receipts of repair maintenance services (paid/payable) 125,894 TNMM 8. Receipt of IT support services (paid/payable) 184,544,993 TNMM 9. Receipt of management support services (paid/payable) 150,688,232 TNMM 10. Payment of project support fees (paid/payable) 48,609,747 TNMM 11. Provision of e-conduct/ecatalogue Services (receives/receivable) 103,344,044 TNMM 12. Provision of business support services 107,554,362 TNMM 13. Provision of research development ( R D ) services (received/receivable) 682,422,512 TNMM 14. Reimbursement of expenses (paid/payable) 98,050,206 TNMM 15. Recovery of expenses (receiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee. 8. So far as the trading segment is concerned, TPO noticed from Annexure D-5 to the TP Report that the operating profit to the sales ratio in the case of assessee is minus 4.63% and assessee carried out the adjustment by claiming that it is importing 100% of the finished goods being sold by it as against the average 6.12% of import contents in the trading functions of the comparable selected by the assessee company and calculated the adjusted NPM at 13.97% but the assessee has failed to provide any basis as to how the adjustment has been made. After considering the reply filed by the assessee company, the ld. TPO came to the conclusion that the assessee has only made adjustment i.r.o. the AEs trading transaction and refused to entertain the contention of the assessee as to the proportionate adjustment and thereby computed an adjustment of ₹ 3758.66 lakhs in the trading segment. 9. So far as benchmarking of international transactions relating to contract R D is concerned, the assessee s unit is registered under the Software Technology Park of India (STPI) and assessee has benchmarked the aforesaid international transaction using Transactional Net Margin Method (TN ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e tune of ₹ 60,14,65,390/- qua manufacturing segment is that transaction by transaction approach needs to be followed for benchmarking the international transaction and to select its AEs as tested parties. 15. To decide the issue in controversy, we would like to examine the TP approach adopted by the ld. TPO qua the TP adjustment of the manufacturing segment, which is reproduced for ready perusal as under :- 3. BENCHMARKING OF MANUFACTURING BELATED TRANSACTIONS 3.1 The assessee has benchmarked the above stated international transactions using Transactional Net Margin Method. The tested party margin for this segment has been calculated as below :- Particulars Import of components, manufacturing and sales to Non AEs Manufacturing and export to AEs Sales net of excise 24,982.14 9,736.05 Total expenses 24,773.04 7.012.86 Operating profit 209.10 2,723.19 OP/OC 0.84% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... missions dated 08.10.2012, submitted the reply. However it is seen that: there are no cogent reasons for creating artificial segmentation for the purposes of transfer pricing. From the examination a/segmentation carried out for TP purposes it is noted that this inter-se segmentation artificially created by bifurcating the manufacturing function is not supported by audited financials. The segmentation for TP purposes is also not supported by audited AS-17 segmented financials. 3.7 In view of the above discussion, it is proposed to aggregate all the manufacturing segments. The results are computed as under: (Amount in Rs.Lacs) Particulars Import of components manufacturing and sales to Non AEs Manufacturing and export to AEs Manufacturing Local Total Sales net of excise 24,982.14 9,736.05 26639.77 61357.96 Total expenses 24,773.06 7,012.86 32569.61 64355.51 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Arm s length margin @ 7.88% 4835 Margin of the assessee -2997.55 Difference in the margin 7832.55 Adjustment proposed to be made 7832.55 As computed above, an adjustment of Rs: 7832.55 Lakhs is proposed to be made in the manufacturing segment 5.6 REPLY OF THE ASSESSEE The assessee in reply to show-cause notice issued, has furnished reply dated 24.01.2013, in which the assessee has taken the following arguments: The assessee has stated that 'Manufacturing Local segment' was created because this segment contains majority of domestic transactions and does not involve significant international transactions. The imported raw material components constitute only 15% of the total cost for manufacture of final products, whereas in the 'Manufacturing imported segment', these account for more than 80% of total cost. Assessee has relied upon Rule 10B(l)(e) wherein definition of TNMM has been given to state that the NPM margin pertaining to 'Manufacturing Local ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iven by the auditors except for reiterating what the assessee had itself carried out in its TP report. This post-facto certificate is not valid because of the following reasons: The segmentation carried out for TP purposes is not supported by audited AS-17 financials. The original auditors of the company, S R Batliboi Associates have carried out segmentation on the basis of Accounting Standard AS-l1 issued by Chartered Accountants of India. The segmental reporting is with respect to primary business segments, i.e. industrial, electrical and electronics items. The other segment is the segment relating to services segment which includes research and other services provided to group companies. The segment accounting policies have been specifically laid out in Note B of Schedule 19 to the accounts. No such sub segmenting has been carried out by the original auditors of the company. Certain expenses have been allocated on the basis of certain keys such as 'hours spent', 'net sales', 'fixed assets' and 'usage'. These allocation keys are not defined so as to arrive at accurate allocation. It may be mentioned that in the Audited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Margin of the assessee -2997.55 Difference in the margin 7832.55 Adjustment proposed to be made 7832.55 5.11 Since the price charged by the assessee varies by more than 5% from the value of international transactions, an adjustment of ₹ 78,32,55,000/- is to be made to the income of the assessee in the Contract R D Segment, being the difference between the arm's length price and the price charged by the assessee from its AEs for export of services. The Assessing Officer shall enhance the income of the assessee by an amount of ₹ 78,32,55,000/- while computing its total income. 16. The ld. TPO declined to entertain the contentions raised by the assessee to adopt the transaction by transaction approach on the ground that assessee has artificially segregated its manufacturing segment function for TP purposes in order to determine inflated tested party margin to bring its transaction in arms length range. TPO also declined to entertain the reason given by the assessee for excluding manufacturing local segments being not convincing a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to 597 of Paper Book-1 have also neither been discussed nor replied with by the ld. DRP. 21. Identical issued was come up before the Tribunal in assessee s own case qua AY 2007-08 and AY 2008-09 wherein matter has been set aside to the AO for fresh adjudication, operative part of the order passed by the coordinate Bench of the Tribunal in assessee s own case for AY 2008-09 in ITA No.6281/Del/2012 is reproduced for ready perusal :- 5. We have heard both the sides on the issue. We have also gone through the written submissions made. The ITAT in assessee s own case Assessment Year 2007-08 in ITA No.5728/Del/2011 dated 22.11.2012 has restored the issue to the file of the Assessing Officer. The relevant portion of the order of ITAT is as under :- 5. Considering the above submissions we find that in the case Kyungshin Industrial Motherson Ltd. (Supra) the primary contentions of the assessee involved was regarding analysis of suppliers' profitability for imports and limiting the variation on account of transfer pricing only to the proportion of related party transactions. The authorities below did not address the issues for want of data. The Tribunal acceded to the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k for fresh adjudication by the AO qua AY 2007-08 and AY 2008-09, we deem it expedient to restore this issue as to the manufacturing segment to the file of AO who shall adjudicate after providing an opportunity of being heard to the assessee. Consequently, grounds no.3, 3.1 and 3.2 are determined in favour of the assessee. However, in the light of the findings returned by the Bench on grounds no.3, 3.1 and 3.2, ground no.2 has since become infructuous and needs no adjudication. GROUND NO.5 : 23. Assessee has benchmarked the international transaction relating to contract and R D and made a suo motu adjustment to the tune of ₹ 411 lakhs. However, the ld. TPO in order to benchmark international transaction to contract R D support services segment adopted the following filters :- i. Use of current year data : It has already been argued earlier that the transfer pricing provisions lay down that primarily current year data should be use. You have objected to the use of this filter. However, you have ignored the/act that the proviso to Rule 10D(4) allows the use of multiple year data only if the assessee is able to demonstrate through relevant data that certain factors ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions. There are Judicial pronouncements that support the case that exporters should not be compared with domestic companies. Hence, this filter is required to be applied with a threshold 75%. vi. Reject companies where related party transactions exceed 25% of sales: There is no doubt that companies with significant related party transactions need to be excluded from the benchmarking process. On the issue of threshold of related party transactions, it can be stated that when the RPT exceeds 25% of sales, it can be said to be the stage when it will start affecting the price paid/received. The rationale given for the use of the If in it of 25% is sound and this threshold limit has been approved explicitly an implicitly in quite a few judicial pronouncements. However, companies which are having consolidated sales not exceeding 125% of sales of standalone entity and not having large variation in the profit margins between the standalone entity and consolidated entity have been considered at the consolidate level irrespective of the related party transactions as the 'related party transactions cancel out at consolidated level and significant portion of the business ( 80%) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO rejected following comparables companies as selected by the assessee for benchmarking :- S.No. Name of the company Remark s of this office 1. Aditya Birla Minacs Technologies Ltd./Birla Technologies Ltd. Reject 2. Akshay Software Technolgies Ltd. Accept 3. Computech International Ltd. Reject 4. Halios Matheson Information Technology Ltd. Reject 5. L G S Global Ltd. Accept 6. Powersoft Global Solutions Ltd. Reject 7. R Systems International Ltd. Reject 8. Sasken Communication Accept 9. Sonata Software Ltd. Reject 10. Quintegra Solutions Ltd. Reject 25. Ld. TPO selected the following ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 26.86% Arm s length margin (Rs.) 174,636,325 Arm s length Price 824,808,792 Price charged by the assessee 723,615,888 105% of Price charged in international transaction 759,796,682 Difference for which adjustment is required to be made 101,192,904 Adjustment offered in the TP study 41,100,000 Adjustment now proposed to be made 60,092,904 19. Since the price charged by the assessee varies by more than 5% from the value of the international transactions, an adjustment of ₹ 60,092,904/- is to be made to the income of the assessee, being the difference between the arm s length price and the price charged by the assessee from its AEs for export of services. The Assessing Officer shall enhance the income of the assessee by an amount of ₹ 60,092,904/- while computing its total income. 27. Ld. AR for the assessee challenging the adjustment of ₹ 6,0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons of comparables selected by the assessee company. Assessee has computed adjusted Net Profit Margin (NPM) at 13.97%. 31. However, the TPO rejected the adjustment made by the assessee on the ground that it has not disclosed the basis as to how the adjustment has been made nor the assessee has put any filter of a minimum level of imports of finished goods of its search for comparables. The calculation of the adjusted NPM at 13.97% made by the assessee is as under :- (Amount in Lacs) Particulars Actual Adusted Sales 42,084.56 42,141.20 Cost of Sale 35,763.61 27,943.75 Excise Stores Consumed Wages Industrial Cost Depreciation Industrial Specific Personnel Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sales net of excise 42,084.56 Arm s length margin @ 4.30% 1809.64 Margin of the assessee -1949.02 Difference in the margin 3758.66 35. Perusal of the order passed by the TPO as well as DRP goes to prove that both ld. TPO as well as ld. DRP have not taken into account the foreign currency loss suffered by the assessee company leading to the unhealthy margin. Ld. DRP rather toed the line of TPO to decide this issue. 36. Assessee categorically submitted before the ld. DRP that loss in distribution segment is due to adverse foreign exchange movement and has duly demonstrated the effect of loss of foreign currency at page 979 and 980 of the paper book. Relevant para are reproduced for ready perusal as under :- 50. The assessee would further emphasize that the loss in this segment was primarily on account of adverse foreign exchange movement. The assessee, in its distribution segment, imported 100% of finished goods from its AEs and hence the INR value purchases [invoiced in foreign currency by the AEs i.e. EURO C'EUR') ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rprise entering into international transactions for any differences between such international transactions and the transaction of comparables or between the enterprise entering into internationals transactions and comparable companies. The foreign exchange element also needs consideration. Rule 10B(3) of Income Tax Rules, 1962 provides that an appropriate adjustment is required to be made on account of the differences between the controlled and the uncontrolled transactions. This rule clearly stipulates that an uncontrolled transaction shall be comparable to an international transaction, if none of the differences between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market. This rule clearly stipulates that reasonably accurate adjustments can be made to eliminate the material effects of such differences. 39. By following the rule of consistency and the facts and circumstances of the case, foreign currency fluctuation needs to be taken into account for TP adjustment both for comparable companies as well a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see and disallow the expenses if the same are found to be not attributable to the year under assessment. GROUND NO.9 44. AO disallowed 3/4th of the licences and permits expenditure amounting to ₹ 1,69,93,222/- out of the licences and permits expenses of ₹ 2,26,57,629/- on the ground that the same lead to the enduring benefit to the assessee company as its benefits do not restrict to only one year and only allowed 1/4th of the expenditure amounting to ₹ 56,64,407/- and apportioned the balance amount of ₹ 1,69,63,222/- in the next five years and thereby made an addition of ₹ 1,69,93,222/-. Ld. DRP also affirmed the order passed by the AO. 45. Ld. AR for the assessee, relying upon the Special Bench decision of ITAT in case of Peerless Securities Limited vs. JCIT (2005) 94 ITRD 89 (Kol.)(SB) and decision rendered by Hon ble High Court of Madras in case of CIT vs. Southern Roadways Ltd. (2006) 155 Taxman 493 (Mad). 46. Operative part of the decision rendered by Special Bench of the Tribunal in case of Peerless Securities Limited (supra) is reproduced as under for kind perusal :- Section 37(1) of the Income-tax Act, 1961 - Business exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... conducting assessee's business as a share dealer and payment of Technology cost for imparting training to assessee's employees so as to make them qualified as per guidelines laid down by OTCEI was for purpose of carrying or running assessee's business of share trading in a profitable manner and was revenue expenditure - Held, yes - Whether expenditure towards nonadjustable deposit for admission as a trading member of wholesale debt market of National Stock Exchange of India (NSEI) so as to enable assessee to use and utilize network of NSEI for its trading operations at a nationwide level so as to facilitate it to carryon business smoothly, extensively, effectively and profitably was of revenue in nature - Held, yes - Whether deposit for Very Small Aperture Terminals (VSATs) on account of providing by NSEI online Screen Based Trading Facilities on Equal Access basis to all Trading Members, directly related to business operation and trading activities carried on by assessee and was, therefore, allowable as Revenue Expenditure - Held, yes. 47. Keeping in view the settled principle and the facts and circumstances of the case, expenditure of ₹ 2,26,57,629/- incur ..... X X X X Extracts X X X X X X X X Extracts X X X X
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