TMI Blog2019 (4) TMI 1286X X X X Extracts X X X X X X X X Extracts X X X X ..... us. Shifting of ₹ 10 crores from trading segment to the manufacturing segment on ad-hoc basis - HELD THAT:- There is requirement for the Assessing Officer/CIT(A) to undertake the scrutiny of each of the expenditure accounts and analyze the nexus of the expenditure to the trading and manufacture segments on one side and the application of proper and appropriate basis to allocate the expenditure between the segments. AO should also pass a speaking order why the stated sales ratio is inappropriate on given facts. Therefore, we are of the opinion, this issue is required to be remanded to the file of the Assessing Officer/TPO with regard to the approved the applicability of the basis of sales ratio uniformly to all the accounts qua the trading and manufacturing account. With these directions, we remand this issue to the file of the Assessing Officer/TPO for fresh examination of the issue. The Assessing Officer shall grant a reasonable opportunity of being heard to the assessee in accordance with set principles of natural justice. Accordingly, relevant ground no.5 is allowed for statistical purposes. Computation of transfer pricing adjustment - additional ground - TP adju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it margins of BEML Limited for FY 2008-09. 5. Inappropriate non-consideration of the segmental financials providing split between trading and manufacturing operations of the Appellant and concluding that trading operations should at least break even. Erred on the facts and in circumstances of the case and in law by inappropriately rejecting segmental financials providing split between trading and manufacturing operations of the Appellant and concluding that trading operations of the Appellant should at least break even and thereby arbitrarily shifting expenses amounting to ₹ 10 crores from trading operations to manufacturing operations. 4. During the proceedings before us, assessee also filed an additional ground and the same reads as under :- Ground of appeal 7-Inappropriate computation of transferpricing from manufacturing torpaenrastaiocntsio onfs the Appellant instead of only to the value of international . The ld. AO erred in not following the directions of Hon ble CIT(A), in computing the proportionate transfer pricing adjustment i.e. adjustment if any, only in respect of value of international transactions instea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed that the filter of having 75% of total revenue from comparable activities is not satisfied in case of BEML. As per the assessee, (i) JCB India with 11.92% of OP/Income; and (ii) Telco Equipment with 8.32% of OP/Income are the only good comparables. During the TP proceedings u/s 92CA(3) of the Act, the TPO included BEML as a good comparable and rejected the objections of the assessee. Thus, the OP/Income of the 3 comparables rose to 16.41%. Aggrieved with the above inclusion of BEML, the assessee filed an appeal before the CIT(A) for exclusion of the said BEML from the list of good comparables. The CIT(A) considered the arguments of the assessee and confirmed the view taken by the Assessing Officer. The contents of paras 2.2.1 to 2.2.11 are relevant in this regard. 8. The CIT(A) extracted the written submissions of the assessee in para 2.2.2 of his order. As per the assessee, the BEML has various division such as (i) Mining and construction business; (ii) Defence business; (iii) Rail Metro business; (iv) Trading division; and, (v) Technology division. In the TP study, the assessee analyzed the details of the products of BEML and held the same are not comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... riteria to reject the same, inasmuch as ownership structure of a concern is normally not expected to have a bearing on its operating margins . 2.2.11 In view of the above discussion, I hold that learned TPO was correct in accepting mining and construction segment of the BEML as comparable with the Appellant. I confirm the action of the learned TPO in this regard. 10. Aggrieved with the above decision of the CIT(A), the assessee is in appeal before the Tribunal with the above extracted ground no.2. 11. Before us, referring to the first allegation on the functional test, ld. Counsel for the assessee relied on heavily on the written submissions made by the assessee before the CIT(A), which is extracted in para 2.2.2 of the order of the CIT(A). Referring to the functions of BEML, ld. Counsel submitted that the said company is engaged in manufacturing and selling of electric rope shovels, hydraulic excavators, bulldozers, wheel loaders, wheel dozers, dump trucks, motor graders, pipe layers, tyre handlers, water sprinklers, backhoe loaders, walking draglines for cost-effective operation in the opencast mines and underground mining pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ables, wherein the said three concerns were Public Sector Enterprises providing consultancy and end to end solutions to government and other companies. The said concerns i.e. WAPCOS is a Mini Ratna - I Public Sector Enterprise; Engineers India Ltd. was a Government of India Enterprise and became Public Listed Company in 1996 and KITCO was established in 1972 by IDBI, Government of Kerala, seven Public Sector Banks and other National and State level financial institutions, to provide technical assistance and consultancy. We find merit in the plea of the assessee that where the concerns were working on governmental policies and social obligations, the risk profile and functions of the said Public / Government Enterprises were completely distinct and dissimilar from a concern which was a captive service provider to its associated enterprises. The assessee was operating on Cost Plus Method which was distinct from the operations of the Public Sector / Government Enterprises. Further, even from the risk perspective, the assessee ITA Nos. 566 645/PUN/2013 and ITA No. 2637/PUN/2016 does not bear material risk including credit risk product liability, etc., whereas the said concerns bear t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the other arguments relating to the functional test of BEML and other arguments raised by the assessee s AR. Accordingly, ground no.2 is allowed without going into the merits of the function test. Thus, ground no.2 is allowed. 16. Ground no.5 relates to the shifting of ₹ 10 crores from trading segment to the manufacturing segment on ad-hoc basis. The relevant facts are discussed in the order of the TPO in para 9.1. 17. As stated in the preceding paragraphs, the assessee has two segments, (i) manufacturing segment and (ii) trading segment. After analyzing the segmental accounts and the allocation of expenditure between the segments, the Assessing Officer/TPO noted that the certificate issued by the Chartered Accountant relating to the allocation of expenses between the two segments of the assessee, is not credible. The relevant discussion given in para 9.1 of the order of the TPO and the same are extracted hereunder :- 9.1 Segments It has been argued that there are two segments in the case of assessee viz manufacturing and trading and that its segmental accounts should be accepted. There is no disagreem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A) analyzed the profitability statements of manufacturing and trading operations of the assessee in the said paragraph (para 2.5.4) before confirming the decision of the TPO/Assessing Officer. Otherwise, the assessee followed sales ratio in matters of adjudicating expenditure between the two segments. The relevant paras 2.5.5 to 2.5.10 of the order of the CIT(A) are extracted hereunder :- 2.5.5 I find that the Appellant has allocated majority of the expenses other than the cost of goods sold in the ratio of turnover between manufacturing and trading. It is fundamental accounting principle that if any expenditure is incurred for the particular segment, it would constitute direct expenditure for such segment. It is only common un-allocable expenses are allocated on the basis of the some allocation key. However, to allocate almost entire expenses below the line in proportion to turnover as the Appellant has done in this case, is unheard of and is against the accountancy principles and business reality. Therefore, such allocation is not possible to accept. 2.5.6 For example, the Appellant s allocation of employee cost is not transparent and giv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Appellant has not explained the reasons for incurring of losses by it in trading activity in para 5.5 of its transfer pricing study report. The Appellant has stated that it has suffered loss for business reasons however, no mention of it in its transfer pricing study report make the segmental accounts with loss in trading function unreliable. 2.5.10 In view of the above, it is not possible to accept split-financials prepared by the Appellant. I confirm the decision of the learned TPO to reject split-financials prepared by the Appellant. 19. Thus, the TPO/Assessing Officer shifted the expenditure of ₹ 10 crores to the manufacturing division from the trading segment on ad-hoc basis. 20. Aggrieved with the above decision of the CIT(A), the assessee raised the said ground no.5 before us. 21. Before us, ld. Counsel for the assessee submitted that the assessee is a start-up company, operated for few month in the year under consideration and the capacity utilization is only 4.5%. Further, the ld. Counsel for the assessee took objection to the adverse finding of the Assessing Officer/TPO, who questioned the certific ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e basis to allocate the expenditure between the segments. Assessing Officer should also pass a speaking order why the stated sales ratio is inappropriate on given facts. 24. Therefore, we are of the opinion, this issue is required to be remanded to the file of the Assessing Officer/TPO with regard to the approved the applicability of the basis of sales ratio uniformly to all the accounts qua the trading and manufacturing account. With these directions, we remand this issue to the file of the Assessing Officer/TPO for fresh examination of the issue. The Assessing Officer shall grant a reasonable opportunity of being heard to the assessee in accordance with set principles of natural justice. Accordingly, relevant ground no.5 is allowed for statistical purposes. 25. Additional Ground: Before us, the assessee raised an additional ground (extracted above) stating that the adjustments were made identity level instead of international transaction only. The CIT(A) decided the issue by observing as under :- 2.6.3 I have considered the arguments of the Appellant. I find that the learned TPO has changed the transfer pricing method to TNM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n similar view in the case of Demag Cranes Components (India) Pvt. Ltd. vs. DCIT vide ITA No.120/PN/2011 order dated 04.01.2012. The issue of manner of computation of adjustments restricting to the international transactions with AEs was discussed at length in paras 45 to 49 in the said order of the Tribunal (supra). For the sake of completeness, the said paras 45 to 49 are extracted as follows :- 45. Ground 10 refers to incorrect computation of TP adjustments to the manufacturing activity. In this regard, referring to the manufacturing segment and sale affected in this segment, Sri Lohia read out that the total sale of this segment is ₹ 23,32,42,565/- and the relatable cost of material is ₹ 1528.65 lakhs, (of course, the assessee submitted a different figure of ₹ 1557.39 lakhs in some other context). Thus, this cost of material (controlled and uncontrolled cost) of ₹ 1557.39 lakhs includes the ₹ 602.19 lakhs, relatable to the transactions with AEs ie controlled cost. As per the Counsel, revenue has erred in computing the TP adjustment on the entire manufacturing segment sales instead of computing the TP adjustment on those sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d international transactions worth ₹ 60,218,878/- on account of Import of raw materials, components and spares for assembly/manufacture of material handling products and to the related sales and not to the entire sales of the manufacturing segment of the assessee. The said relationship/ratio is the requirement in the present comparability analysis and not the entity level sales as wrongly considered by the TPO and relied upon by the DRP. In principle, such closure comparability analysis is needed in TNMM, when sales is used as a base for determining net profit margin. Thus, it is erroneous to bring relationship between the ₹ 60,218,878/- and ₹ 23,32,42,565/- ie the total sales. Assessee s failure to supply the data on relevant sales is no defense, when there are settled alternatives for adoption in such circumstances, well tested principle of proportionality in our opinion should help. Thus, the base of sales does not need to be total sales ; but the proportionate sales relatable to the impugned international transactions. It is a commonsensical approach. 48. In this regard, we have perused the existing decisions relied upon by the assessee a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ate concerns for the purpose of manufacturing items.The assessee has stated that the operating profit if applied to 45.51 per cent of the turnover would come to ₹ 35,52,573 as against operating profit of ₹ 24,35,175 booked by the assessee, and the difference thereof would only be called for to be made as addition to the profit shown by the assessee. We, therefore, direct the AO to modify the assessment and make the adjustment only to the extent of difference in the arm s length operating profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the assessee. Therefore, to this extent, the addition made by the AO and further confirmed by the CIT(A) is reduced. We order accordingly. D. DCIT vs Starlite 133 TTJ 425 Mum AY 2002-03 Page Para 13 at 478 of the Paper Book 13. As in this case, TPO has not applied TNMM, as contemplated in the Act, we have no other alternative but to set aside her order .. We also agree with the arguments of learned counsel for the assessee that adjustments, if any, arising due to computation of ALP should be restricted only to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e issue, we are of the opinion that the said issue raised in the additional ground has to be decided in favour of the assessee. Consequently, we direct the Assessing Officer to restrict the adjustments, if any only to the international transaction with AEs. Accordingly, additional ground is adjudicated in favour of the assessee. Accordingly, the additional ground is allowed. 29. In the result, the appeal of the assessee is allowed. ITA No.1670/PUN/2015 (By Revenue) 30. The Revenue has raised the following grounds of appeal :- 1. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to make capacity adjustment by recommending a method without justifying the reliability of the method? 2. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to make adjustment to cost of assessee when income-tax rule 10B(e)(iii) prescribed that adjustment is to be made to comparable only? 3. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in directing the AO to compute the TP adjustment in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utilization affects the price of the transactions. Assessee has merely stated that capacity utilization is different. Second, as regard the reported capacity utilization which is more than 100% in the case of comparable, leading to doubts on the reliability of installed capacity figure and the corresponding capacity utilization, the assessee in its reply has merely reiterated that the figures should be accepted as reliable and that this is the only information in public domain. The assessee in its TP report has claimed capacity utilization adjustments. The methodology adopted by the assessee comprises of fitting a straight line through 3 data points on a two dimensional axis graph plotting Sales vs Total Costs for two comparables. The 3 data points is of sales and total costs for AY 2009-10 and two preceding years i.e. AY 2008-09 and 2007-08. This has been used by attempting to fit an equation y = a + bx. This mathematical model has been used to determine the average fixed costs across 3 years: The method adopted is not found acceptable for the following reasons. Firstly, this involves data for 3 years which is not sanctioned by the IT Rules which require contemporaneous data to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the assessee made various submissions in this regard and the same are extracted in para 2.3.2 of the order of the CIT(A). In the said submission, the assessee sought a direction from the CIT(A) to the Assessing Officer to accept the method used by the assessee to carry out capacity utilization adjustment to the operating margins of the comparable companies identified by the assessee. The CIT(A) considering the same and directed the Assessing Officer to grant the capacity utilization adjustment by computing the formula specified in page 113 in the Book published by the Chamber of Tax Consultant, Mumbai in Practical Guide to Indian Transfer Pricing . 34. Before us, ld. DR for the Revenue relied on the decision of the Mumbai Bench of the Tribunal in the case of CIT vs. M/s Petro Araldite Pvt. Ltd. (35 taxmann.com 590) which is relevant for the proposition of making the adjustments on this account to the profit margins of the comparables . He read out the contents of paras 23 to 25 of the said order of the Tribunal (supra). For the sake of completeness, the same are extracted hereunder :- 23. The question that now arises is what is the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed party, the profit of the comparable would be reduced by ₹ 1.20 crores thereby giving a net profit of ₹ 0.80 crores which would bring the profitability to 10%, i.e. at par with the tested party. Similarly, if the adjustment is made in the profit margin of a comparable having 60% capacity utilization by allocating more fixed overheads at 6.67% of sales to bring the rate of allocation of fixed overheads at par with that of the tested party, the profit of the said comparable would be reduced by ₹ 0.40 crores thereby giving a net profit of ₹ 0.60 crores which would bring the profitability to 10% i.e. at part with the tested party. 25. Having held that the adjustment on account capacity utilization is required to be made of difference in and having explained with illustration that the same can appropriately be made by absorbing or aaltl otchaeti nsga mfixee rda otvee arhse tahdast s oufc hth aes tdeespteredc ipaatiortny on sales of the comparable , we are of the view that such absorption or allocations of fixed overheads on operating cost instead of sales would be more appropriate as the same will eliminate the effect of difference in profit m ..... X X X X Extracts X X X X X X X X Extracts X X X X
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