TMI Blog2018 (10) TMI 49X X X X Extracts X X X X X X X X Extracts X X X X ..... from its AE is at arm’s length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only in respect of international transactions i.e., transactions with AE. Thus we hold that the transfer pricing adjustment should be restricted only to the AE related transactions of the assessee. Determining the operating expenses - Held that:- On the first aspect of allocation of foreign exchange gain on proportionate basis, we are of the view that the same has to be on actuals. With regard to considering bad debts as operating expense, we are of the view that it is only the bad debts in manufacturing segment that should be considered as expenses of manufacturing segment for working out the OP/OC. We hold and direct accordingly on the aforesaid additional grounds. Benefit of MAT credit u/s 115JAA - Held that:- Would be just and appropriate to direct the AO to verify the claim of assessee and allow the claim for MAT credit in accordance with the law. - IT (TP)A No.2192/Bang/2017 - - - Dated:- 17-9-2018 - SHRI N.V. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee to its AE. The dispute raised in this appeal which is one of the subject-matter of this appeal is with regard to this international transaction. For the purpose of establishing the ALP of its international transaction with its AE, the assessee filed a Transfer Pricing (TP) study. The assessee chose the Transactional Net Margin Method ( TNMM ) as the most appropriate method. In order to identify companies which are comparable to the assessee, search was conducted on Capitaline database (a database compiled and managed by Capital Market Publishers) for obtaining publicly available financial information of companies in India engaged in similar business activity as the assessee. The Profit Level Indicator (PLI) chosen for the purpose of comparison of assessee s profit margin with that of comparable companies was Operating Profit to Operating Cost (OP/OC). For the companies identified as comparables, operating margin was computed using the financial data pertaining to FY 2011-12 which was available to the assessee at the time of complying with the transfer pricing documentation requirements. The operating margin of the assessee was adjusted for under-utilization of capacity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... :- S. No. Particulars Margin (OP/OR) (%) Margin (OP/OR) (%) 1 Shree Pacetronix Limited 5.41% 5.72% 2 Continental Controls Limited 8.19% 8.92% 3 Hindustan Syringes Medical Devices Limited 12.37% 14.12% 4 Centenial Surgical Suture Limited 6.38% 6.81% 5 Allengers Medical Systems Limited 8.70% 9.53% Arithmetic Mean 8.21% 9.02% The TPO considered foreign exchange gain/losses as non-operating in nature while computing the operating margin of the comparable companies. However, he considered the foreign exchange gain/losses as operating in nature while computing the operating margin of the assessee. The TPO did not make suitable adjustments to account for differences in the working c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of foreign exchange fluctuation by considering the same as operating in nature for the Assessee and the comparable companies. In respect of the other grounds, the CIT(A) primarily agreed with the TPO's approach and did not appreciate the Assessee's submission. In addition to the above, the CIT(A) directed the TPO to recompute the ALP and TP adjustment on the entire manufacturing segment instead of restricting the adjustment to AE transaction. 10. Aggrieved against the order passed by learned CIT(A), the Assessee has preferred an appeal before the Tribunal on the following grounds of appeal. Grounds of general nature Ground 1: The order of the learned CIT(A) is based on incorrect interpretation of law and facts and therefore is bad in law; Grounds of appeal relating to transfer pricing matters Ground 2: The learned CIT(A) has erred in making an addition to the total income of the Appellant on account of adjustment in the arm's length price ( ALP ) relating to the manufacturing activity entered into by the Appellant with its Associated Enterprises ( AEs ) thereby holding that the international transactions do not satisfy the arm's l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1. Gansons Limited Functionally different Company is a manufacturer of process equipments like fluid bed processing equipment, high shear mixer granulator, etc. for various industries like pharmaceutical, foods, petrochemicals, etc. These equipments are similar to the equipments manufactured by the Appellant. Company is predominantly engaged in manufacturing activities and has earned 98.57% of its operating revenue from the sale of manufactured goods. 2. Span Diagnostics Ltd Functionally different According to the annual report, the company is engaged in the business of manufacturing, marketing and trading of diagnostics reagents, diagnostics instruments and allied products. The company operates in a single segment i.e. Diagnostic Products . Company is predominantly engaged in manufacturing activities and has earned 98.66% of its operating revenue from the sale of manufactured goods. 13. It was argued that Shree Pacetronix should be rejected on account of the difference in products manufactured by Shree Pacetronix vis-a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... analysis to include transactions involving products that are different, but functionally similar. The acceptance of such an approach depends on the effects of the product differences on the reliability of the comparison and on whether or not more reliable data are available. In other words, it cannot be said that product difference is a factor which needs to be either ignored or strictly followed. It depends on facts and circumstances of each case. 16. In the present case, the fact that the product manufactured by the tested party i.e. the Assessee viz., laboratory and processing equipment and the comparable company i.e., Shree Pacetronix viz., manufacture of pacemaker for implanting in heart, can be categorized as manufacture of equipment . The relevancy of the end use of equipment whether by consumer or as component may be relevant while evaluating functional dissimilarity, Assets employed and risks assumed but not on the basis of characteristics of the property transferred under Rule 10B(2)(b) of the Rules. 17. For the reasons given above, we are of the view that Shree Pacetronix was rightly not excluded for the purpose of comparison on the ground of product difference. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO to apply the principle of treating foreign exchange fluctuation as operating in nature under both situations, when there is a loss as well as when there is a gain. The next prayer was to apply the same principle to determine the profit margins of the assessee and the comparable companies. The limited prayer so made is in accordance with the settled legal position in this regard and the TPO is directed to compute the profit margins of assessee and the comparable companies as prayed for by the ld. counsel for the assessee. Ground No.6 is decided accordingly. Ground No.7 : The learned CIT(A) has erred, in law and in facts, by upholding the action of the AO/TPO in rejecting capacity adjustment to account for differences in capacity utilization of the Appellant vis- -vis the comparable companies. 21. The assessee in its TP documentation as well as before the TPO and the CIT(A), highlighted the fact that there are significant differences in the capacity utilization between the assessee vis- -vis the comparables. It was also brought to the notice of the TPO and the CIT(A) that the assessee was incorporated in FY 2008-09 and FY 2011-12 (i.e., FY relevant to the impugned AY ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actors to be taken into account herein is the ability to make reliable and accurate adjustments. 26. The OECD Guidelines on this aspect is as follows:- Para 1.35 of the OECD Guidelines states as follows: Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm's length conditions Para 1.36 of the OECD Guidelines states as follows: . material differences between the compared transactions or enterprises should be taken into account. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm's length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm's length dealings. Attributes that may be important include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of transfer pricing regulations in harmony, the adjustments should be made on the tested party. In the following decisions it has been held that adjustment to the profit margins have to be made on account of underutilization of capacity: (i) In the case of M/s. Mando India Steering Systems Private Limited vs Assistant Commissioner of Income Tax, [I.T.A. No. 2092/Mds 12012], the Tribunal upheld the contention of the taxpayer for making a suitable adjustment on account of idle capacity for the purpose of margin computation. The relevant extract is reproduced as below: 10. . We are of the considered view that underutilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production. (ii) In the ruling of DCIT Vs Panasonic AVC Networks India Co Ltd (I.T.A. No.: 4620/De1/2011) , it was held that:- 5. .. Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ization of its infrastructure . The AO shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal of the assessee is disposed of. 30. The reliability and accuracy of adjustments would largely depend on availability of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not be available in public domain or may not be reliably determinable based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible). 31. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making reasonably accurate adjustments for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the values stated for the international transactions are at ALP i.e., whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don t restrict or provide that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in case of M/s Kiara Jewellery P.Ltd. (I.T.A.No.8109/Mum/2011), has directed the AO/ TPO to obtain the exact details of capacity utilization of comparable companies, if not available in public domain. The relevant extract of the aforesaid decision is as under:- 11. Keeping in view the decision of the Tribunal in the case of Petro Araldite (P) Ltd (supra) laying down the guidelines on the issue of capacity utilization, we consider it appropriate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same directly from the concerned parties and to decide this issue afresh after giving assessee an opportunity of being heard . (Emphasis Supplied) 35. Accordingly, we direct the TPO to exercise powers under section 133(6) of the Act to call for information on capacity utilization of the comparable companies such as - Installed Capacity, Actual Production in Units, Break-up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntion that a working capital adjustment is warranted:- (i) In the case of Demag Cranes Components (India) Pvt. Limited (ITA No.120/PN/2011) , the Pune Tribunal held as follows:- In our opinion, it is the duty of the TPO to apply the provisions of rule 10B(1)(e) to establish the ALP in relation to international transaction as per the TNMM, which is an undisputed method found applicable to the present case by both the parties . It is a settled accounting principle that the net margins can be influenced by some of the same factors which can influence price or gross margins. Further, it is the requirement of the rules / provisions that any difference which is likely to materially affect the NPM in open market has to be eliminated. TPO must know that the TNMM visualizes the undertaking of the thorough comparability analys and elimination of the differences through the requisite adjustments .. Therefore, we dismiss the revenue's contention that no further adjustment if any is entertained once the comparables are supplied by the assessee and when they are accepted by the TPO . Thus, working capital is a factor which influence the price in the open market and therefo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... jected the claim of the assessee for the reason the assessee has to demonstrate the impact on profit margins by reason of a particular level of working capital requirement in the case of the assessee and that of comparable companies. In coming to the above conclusion, the CIT(A) has placed reliance on decisions of Chennai ITAT in the case of Mobis India, ITA No.2112/Mds/2011 (AY 2007-08) and SAM Deutz Fahr India Pvt. Ltd., ITA No.2666/Mds/2016 AY 2006-07, order dated 22.2.2017 . In those cases, the Tribunal was dealing with cases where data was not provided. In the present case the assessee has given such working which is given as Annex. 4 to the written submissions filed before us. Such working was also given in pages 59 to 64 of submissions filed before the CIT(A). Therefore, the TPO/AO is directed to consider the claim of the assessee and allow adjustment to profit margins towards working capital adjustment in accordance with the law, after affording assessee the opportunity of being heard. Gr.No.8 is decided accordingly. Ground 9 : The learned CIT(A), has erred in law and in facts, by directing the AO/ TPO to make the transfer pricing adjustment on the entire manufactu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. The profit from comparable transactions of the assessee with non-AEs is one of the subtle and most reliable modes for determining ALP of the international transactions. The Act does not contemplate an addition by way of TP adjustment in respect of transaction with non-AEs. 48. The TPO determined addition to total income, consequent to determination of ALP only in relation to international transaction i.e., transactions with AE in the export of finished goods segment by considering the value of international transaction at ₹ 3,31,50,982 which is the value of export of finished goods by the assessee to its AE and not on the total sales in the finished goods segment of ₹ 39,19,74,355 (vide para 8.3 of the TPO s order). 49. The Hon'ble Bombay High Court in the case of Phoenix Mecano (India) Private Limited [ITA No. 1182 of 2014] , had to deal with the following question of law suggested by the revenue:- 6.1 Whether on the facts and in the circumstances of the case, the Hon'ble Tribunal was correct in directing the AO to restrict the deter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied) 51. The Hon'ble Mumbai Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 7032/Mum/2011] h eld that the ALP can only be determined on the value of international transaction alone and not on the entire turnover of the assessee at entity level. This decision was further upheld by the Hon'ble Bombay High Court in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 2201 of 2013], which held as below:- 2. .............. ( a) Whether on facts and the circumstances of the case and law, the Tribunal was justified in law in restricting the Transfer Pricing (TP) adjustment only to the transaction between the Associated Enterprises (AEs.)? 3. ........ ... . . ( e) We find that in terms of Chapter X of the Act, redetermination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent unrelated third parties. This is particularly so as there is no issue of avoidance of tax requiring adjustment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ell as to non AEs, for the manufacture of which, part purchases are from AEs and remaining from the non AEs. The TPO has considered OP/OR for purpose of computation of the ALP as the quantum of sales to AE are lesser than the purchase from AE and thus lesser controlled. When a product is sold, only overall profit margin is recorded without any data as to what would be the profit in relation to purchases from AE. So this cannot be presumed that the profit percentage earned in relation to costs related to AE transactions as well as non-AE transactions was same. Since costs are common to the products ultimately sold by the appellant, and the same includes AE transactions, so it is always possible that the margin of profit percentage vis-a-vis costs related to AE transaction is not the same as profit margin on costs related to non-AE transactions but ultimately overall certain profits are being shown. Further, the transactions with non-AEs can be presumed to be at arm's length as there is no reason to earn lesser profit. But in case of transactions with AEs, there is always a likelihood of earning lesser profits as transactions are controlled and decisions are influenced by AE. Thu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Appellant Without prejudice to the above, the learned CIT(A) has erred in law and in facts, not granting allowance of the prior period expenses in the previous year on account of being incurred wholly and exclusively for the purpose of business of the appellant. Without prejudice to the above, the learned CIT(A) ought to have set off the prior period income of ₹ 47,04,916 against the prior period expenditure of ₹ 65,48,1490 and thereby restricted the net disallowance of prior period expenditure to ₹ 18,43,233 . 58. It is not in dispute that in AY 2013-14, the Assessee has claimed the same expenses as deduction but the same was disallowed by the AO on the ground that it was expenditure relating to AY 2012-13 and therefore cannot be allowed as deduction in AY 2013-14 as it was prior period expenditure. The additional ground is admitted for adjudication as the claim could not be made by the Assessee in the assessment and appellate proceedings for AY 2012-13 as it was under the bonafide belief that the deduction would be allowed in AY 2013-14. 59. As far as the merits of the additional ground is concerned, we are of the view that the deduction unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment services and marketing and technical support services to Group companies. Accordingly, the assessee operates in four segments and the revenue from these segments for FY 2011-12 is as follows:- S. No. Business segment Revenue (INR) Ratio (%) 1 Manufacturing segment 39,19,74,335 80.21% 2 Trading segment 4,31,94,581 8.84% 3 Research and development 53,12,346 1.09% 4 Support services 4,82,10,266 9.87% Total 48,86,91,528 100% 65. Accordingly, the total foreign exchange gain of INR 53,89,273 of assessee should be allocated among all the four segments on a proportionate basis. Based on the above revenue ratio, the foreign exchange gain of INR 43,22,679 is attributable to the manufacturing segment of assessee. Hence, the foreign exchange ga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2,66,904 Add: Depreciation 59,30,947 59,30,947 Add: Other expenses (Detailed computation as per IKA India enclosed as Annexure 5) 13,53,16,993 12,90,13,451 Add: Bank charges 4,95,730 4,95,730 Less: Donations 13,03,400 13,03,400 Less: Loss on sale of asset 68,590 68,590 Operating cost (B) 40,17,64,099 39,54,60,557 Operating profit (C) (97,89,764) 8,36,457 Operating profit/ Operating revenues (C/A) (2.50%) 0.21% 68. Accordingly, the ld. AR has submitted that the revised operating margin of assessee for AY 2012-13 should be considered as 0.21%. 69. On the first aspect of allocation of foreign exchange gain on proportionate basis, we are of the view that the same has to be on actuals. With regard to considering bad debts as operating expense, we ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fit of MAT credit amounting to INR 5,59,895 as available under section 115JAA of the Act and holding that the same is consequential in nature. 73. It is the grievance of the assessee in ground No.13 that in the assessment order, while computing the tax liability of the assessee for AY 2012-13, the learned AO has not allowed the MAT credit of INR 5,59,895 as claimed by the assessee in its return of income as per section 115JAA of the Act. 74. We are of the view that it would be just and appropriate to direct the AO to verify the claim of assessee and allow the claim for MAT credit in accordance with the law. Ground 14: The learned CIT(A) has erred, in law and facts, by not providing direction to the AO to delete the interest under section 234A of the Act amounting to lNR 1,16,570 and holding that the same as consequential in nature. 75. It would be just and appropriate to direct the AO to verify the claim of the assessee that it had filed its return of income before the due date and therefore no interest is payable u/s. 234A of the Act. Ground 15: The learned CIT(A) has erred, in law and facts, in holding that the imposition of interest under section 234B and 234C of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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