TMI Blog2018 (10) TMI 923X X X X Extracts X X X X X X X X Extracts X X X X ..... ustments on uncontrolled transactions, however the same has to be read with Rule10B(3) of the Rules which clearly emphasizes the necessity and compulsion of undertaking adjustments. Hence in case appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations in harmony, the adjustments should be made on the tested party. - adjustment to the profit margins have to be made on account of underutilization of capacity. Disallowance of prior period expenses - non deduction of tds - Held that:- The Assessee had made disallowance of the disputed sum for the reason that tax was not deducted at source on the provision so made in the books and in view of the provisions of Sec.40(a)(ia) for non deduction of tax at source, the expenditure cannot be allowed as deduction. The limited prayer of the learned counsel for the Assessee was that as and when TDS is paid the deduction in question has to be allowed. We are of the view that the prayer for allowing deduction of expenses in the year in which TDS is paid to the Government is acceptable subject to the condition that the liability in question sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 [ the Act ], income from an international transaction had to be determined having regard to the arm s length price (ALP). The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO accepted that all international transactions carried out by the assessee was at arm s length, except the international transaction of export of finished goods by the 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 compar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed TPO did not accept the economic analysis undertaken by the assessee and conducted a fresh economic analysis. The TPO rejected 2 companies out of 3 companies selected as comparables by the assessee in the TP Study. The TPO on his search of the database chose 12 new companies and selected the following 13 companies as the final set of comparables with unadjusted margin of 8.61% on operating revenue:- S.No. Particulars Margin (OP/OR) (%) Margin (OP/OC) (%) 1 Hindustan Syringes Medical Devices 10.14 11.28 2. Artificial Limbs Mfg. Corporation of India 16.90 20.34 3. Allengers Medical Systems Ltd. 9.88 10.96 4. Elico Limited 12.99 14.93 5. Premier Medical Corporation Pvt. Ltd. 2.20 2.25 6. Centenial Surgical Suture Ltd. 6. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sment of the AO, the assessee preferred appeal before the learned CIT(A). 10. The CIT(A) did not provide any relief to the assessee on the transfer pricing matter. The approach of the CIT(A) while disposing assessment, in determining the ALP of the assessee in relation to the manufacturing activity with its AE can be summarised as below:- The CIT(A) directed the TPO to re-compute the operating margins of the Assessee and the comparable companies. The CIT(A) directed the AO/TPO to consider Analytical Instrument segment of Elico Ltd., for margin computation and comparability purpose. 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 operating margins of the comparable companies and the Assessee by considering operating profit on operating cost as profit level indicator. 11. 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owever, in the chart filed before us at the time of hearing, no specific arguments were advanced nor any oral submissions made on Gr.No.4 and hence, Gr.No.4 is dismissed. Ground 5: The learned CIT(A) has erred, in law and in facts, by considering the following companies as functionally similar to the Appellant and failed to appreciate the fact that the following companies are not functionally comparable: a) Hindustan Syringes and Medical Devices Limited b) Artificial Limb Manufacturing Corporation of India c) Allengers Medical Systems Limited d) Elico Limited e) Centenial Surgical Suture Limited f) Blue Neem Medical Devices Private Limited g) Iscon Surgicals Limited h) Hemant Surgicial Industries Limited i) Shree pacetronix Ltd. j) Continental Controls Ltd. Ground 6: The learned CIT(A) has erred, in law and in facts, by considering the following companies as functionally dissimilar to the Appellant and failed to appreciate the fact that the following companies are functionally comparable: a) Systronics India Limited b) Gansons Limited 15. Gr.No.5 6 are on the action of TPO in including 10 comparable companies and in excluding 2 comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid guideline also says that differences in the characteristics of property or services are also less sensitive in the case of the transactional profit methods than in the case of traditional transaction methods. Product difference to the extent they affect comparability on functions performed, assets used and/or risks assumed by the tested party, would be relevant. In practice, comparability analyses often put more emphasis on functional similarities than on product similarities. It may be acceptable to broaden the scope of the comparability 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. 18. 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 Pacetroni ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 15. Following the aforesaid ruling, we hold that the following companies were rightly included by the TPO as comparable companies. a) Shree Pacetronix Limited b) Continental Controls Limited c) Hindustan Syringes and Medical Devices Limited d) Centenial Surgical Suture Limited e) Allengers Medical Systems Limited It is not disputed before us that the above ruling will apply to comparable companies chosen by TPO, viz., Iscon Surgicals Ltd. and Hemant Surgical Industries Ltd. also and therefore the inclusion of these companies by the TPO in the list of comparable companies has to be upheld. Similarly, following the precedent in Assessee s own case, we hold that M/S.Gansons Ltd., and M/S.Systronics India Ltd., comparable chosen by the Assessee which was rejected by the TPO because of difference in products manufactured should be included as comparable company. 16. The remaining companies in the list of companies which was added by the TPO and whose inclusion is challenged by the Assessee in Gr.No.5 will now be taken up for consideration. 17. Artificial Limb Manufacturing Corporation of India, which is a comparable company chosen by the TPO was challenged as n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s concerned, the argument with regard to functional comparability is rejected following the decision in Assessee s own case in AY 2012-13. The learned counsel for the Assessee submitted that this company does both trading and manufacturing and the TPO has not considered the OP/OC of the manufacturing segment for the purpose of comparison. It was also highlighted that the revenue from manufacturing is not more than 75% of the total revenue and this was a filter for inclusion of companies chosen by the TPO. After hearing the rival submissions of the parties, we are of the view that it would be just and appropriate to direct the AO/TPO to call for the details with regard to segmental revenue of this company in exercise of the AO/TPO s powers u/s.133(6) of the Act from the said company and find out whether segmental information is possible and further examine if more than 75% of the revenue of this company is from manufacturing. The AO/TPO will confront the Assessee with the material that is gathered by them and after affording the Assessee opportunity of being heard, determine whether this company can be regarded as comparable. 20. Ground Nos. 5 6 are decided accordingly. Grou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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) was just the third year of commercial operation of the assessee during which the installed capacity was under-utlized to a significant extent. The assessee pleaded before the TPO and CIT(A) to provide an adjustment for idle capacity. However, the TPO/CIT(A) did not allow any adjustment to account for the differences in the capacity utilization by the assessee vis- -vis the comparables while computing profit margin of assessee as well as the comparable companies. 22. We have heard the submissions of the assessee and the ld. DR on the issue raised by the assessee in ground No.7. We shall first see the statutory provisions relevant to the issue. Rule 10B(1)(e) of the Rules states that adjustments should be made to account for: ...the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market 23. Rule 10B(2) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tant include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties. Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows: .. Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method' (Emphasis supplied) 25. US transfer pricing Regulations on this aspect is as follows:- In addition, the US transfer pricing regulations, u/s 482 of the Internal Revenue Code (hereinafter referred to as 'the US regulations') also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment . (iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 493/Bang/2015) for AY 2010-11, the Tribunal held as follows: 10.4.1. We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under-utilisation of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment...... 10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity underutilisation can be granted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don t restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per subclause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been upheld in the following decisions:- Capegemini India Pvt. Ltd. (ITA No.7861/Mum/2011) Demang Cranes Components (India) Pvt Ltd. [49 SOT 610 (Pune)] 30. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... information on capacity utilization of the comparable companies such as - Installed Capacity, Actual Production in Units, Break-up of Fixed Cost and Variable Cost; Segmental/ product wise information, if any. 34. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly. 24. The TPO is directed to follow the directions as given above in the order for AY 2012-13 in the present AY also. Ground 10: The learned CIT(A) has erred, in law and in facts, by upholding the action of the AO/TPO in not allowing suitable adjustment to account for the differences in the working capital position of the Appellant vis- -vis the comparable companies. 25. At the time of hearing it was agreed by the parties that that on identical issue of inclusion of exclusion of comparable companies, this Tribunal in Assessee s own case in IT(TP)A.No.2192/Bang/2017 for AY 2012-13 order dated 17.9.2018 in Assessee s own case ruled on similar issue with the following observations: 37. The assessee used the TNMM in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 analysis 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 therefore the net profit margin of the business segment of the assessee which is targeted by the TPO/AO/DRP. Hence, in principle, we hold that the TPO/AO/DRP has failed to entertain the objections of the assessee on the 'working capital' adjustments issue. Therefore, we direct them to allow the requisite adjustment on account of the impugned 'working capital' while determining the Arm's Length operating Margin of the Comparables. (emphasis supplied) (ii) In the case of Capgemini India Private Limited Vs Asstt. Commissioner of Income Tax (ITA No.7861/Mum/2011), the Mumbai Tribun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 26. The TPO is directed to follow the directions as given above in the order for AY 2012-13 in the present AY also. Ground 11: 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 manufacturing segment of the Appellant rather than restricting the same to the value of international transactions undertaken with Associated Enterprises only. Without prejudice, in case the adjustments made to international transactions are held to be valid, then the same deserves to be restricted in proportion to international transactions in the interest of justice. 27. At the time of hearing it was agreed by the parties that that on identical issue of inclusion of exclusion of compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 determination of the ALP to transactions with the AE rather than on the entire turnover of the Company. 6.2 Whether on the facts and in the circumstances of the case and in law, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ernational 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 in the valuation in respect of transactions entered into with independent third parties. The adjustment as proposed by the Revenue if allowed would result in increasing the profit in respect of tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 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. Thus the overall profits on account of transactions with AE as well as non-AE gets suppressed. 54. We have heard the rival submissions. The ld. counsel for the assessee reiterated submissions made before the CIT(A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. c) 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 . 29. At the time of hearing it was agreed by the parties that that on identical issue of inclusion of exclusion of comparable companies, this Tribunal in Assessee s own case in IT(TP)A.No.2192/Bang/2017 for AY 2012-13 order dated 17.9.2018 in Assessee s own case ruled that the expenses should be allowed on the basis of crystilization. The AO is directed to follow the aforesaid direction contained in paragraph 58 59 of the aforesaid order on this issue, which reads as follows: 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wance of the disputed sum for the reason that tax was not deducted at source on the provision so made in the books and in view of the provisions of Sec.40(a)(ia) of the Act for non deduction of tax at source, the expenditure cannot be allowed as deduction. The limited prayer of the learned counsel for the Assessee was that as and when TDS is paid the deduction in question has to be allowed. We are of the view that the prayer for allowing deduction of expenses in the year in which TDS is paid to the Government is acceptable subject to the condition that the liability in question should be crystalized/ascertained. It is made clear that crystallization even if it is in earlier period should not result in disallowance u/s.40(a)(ia) of the Act and on payment of TDS the deduction should be allowed subject to such expenses being otherwise allowable. Gr.No.14 is decided accordingly. 31. Ground No.15 is regarding levy of interest u/s.234B of the Act, which is mandatory but the AO should give consequential relief based on the ultimate determination of total income. Gr.No.16 is regarding action of the AO in initiation of penalty proceedings under section 271(1)(c) of the Act. No appe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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