2017 (3) TMI 1626 - AT - Income Tax

Transfer pricing adjustment - international transaction entered into by the assessee with its associate enterprises - benchmark of international transaction - MAM selection - TPO made adjustment after rejecting the claim of aggregation and also while applying the TNNM method had compared the same with internal comparables i.e. domestic sales made by the assessee - Held that - Primary activity of assessee was to manufacture and sell IC engines and components both for domestic market and for exports then the activity of importing engine parts and components payment of royalty for getting know-how provision of miscellaneous service i.e. procurement support services to the associate enterprises to help the sourcing of components receipt of IT support services design services and payment of technical know- how fees etc. is closely linked to the export of manufactured IC engines. The principle of aggregation of closely linked transactions for undertaking benchmarking analysis applying TNNM method has been approved by the Hon ble High Court of Delhi in Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT 2015 (3) TMI 580 - DELHI HIGH COURT . Accordingly we hold that for benchmarking international transactions various activities undertaken by the assessee under the head manufacturing activities need to be aggregated. The Assessing Officer / TPO is directed so. Difference in gross profit margins by AO as against difference in net profit margins between sales to associate enterprises and sales in domestic market - Held that - The Tribunal in view of the detailed reasoning of CIT(A) observed that the addition made by the Assessing Officer on account of division of difference in gross profit margins by the Assessing Officer as against difference in net profit margins between sales to associate enterprises and sales in domestic market no addition is warranted. The Tribunal decided the issue as per provisions of Rule 10A(d) of the Rules and deleted addition. Applying the said principle we direct the Assessing Officer / TPO to re-compute the adjustment if any in the hands of assessee on account of international transactions. It may be pointed out herein itself that the adjustment was made in the hands of assessee in HHP Division only and no adjustment was made in LHP division. Perusal of details of administrative expenses reflects that certain expenses i.e. like depreciation rent rates repairs maintenance taxes and other expenses have not been allocated at all to the export division by the assessee. The assessee claims that depreciation and other expenses on plant machinery were already included in the cost of goods sold and the non- allocation if any does not affect cost. In the totality of the above said facts and circumstances we find no merit in re-allocation of administrative expenses and selling distribution expenses by the Assessing Officer / TPO. Methodology adopted by the TPO in application of net profit to cost as PLI - Held that - We find merit in the plea of assessee in this regard that where the assessee is engaged in the manufacture of components and the main aim of undertaking was to sell the said components then it is the sales which derive the profitability and not the cost of components. Accordingly while determining the PLI the TPO is directed to adopt net profit to sales in order to benchmark the international transactions. TPO ignoring interest received on extended credit while computing segmental profitability of exports to associate enterprises - Held that - Since the same is linked to exports to associate enterprises the same should be considered for ascertaining the segmental profitability of exports to associate enterprises. Benchmarking the receipt of commission from associate enterprises - Held that - There is no merit in the adjustment made by the Assessing Officer / TPO in respect of international transactions relating to receipt of commission from associate enterprises. Accordingly we direct the Assessing Officer to delete the same. See Tecnimont ICB (P.) Ltd. v. Asstt. CIT 2011 (2) TMI 107 - ITAT MUMBAI. Adjustment made under the head financing activity wherein the assessee was in receipt of interest for extended credit period facility - Held that - LIBOR rates have to be applied to the amounts due from associate enterprises for the extended period of credit and the extended period of credit. The Assessing Officer is directed to follow our directions in iGATE Computer Systems Ltd. (2015 (5) TMI 970 - ITAT PUNE) to adjudicate the issue after affording reasonable opportunity to the assessee. Disallowance of incremental provision for New Engine Performance Inspection Fee (in short NEPI Fee ) - Held that - the assessee was following a scientific basis for making the aforesaid provision which is not a contingent expenditure as the provision is made in relation to the IC Engines sold by the assessee. The assessee no doubt is making the provision and after the lapse of the period of inspection in case the expenditure has not been necessitated then the same is written back. In the totality of the above said facts and circumstances we find merit in the plea of the assessee and allow the claim of the provision made for any NEPI fee. It may also be pointed out that the inspection and servicing is different from warranty which is to be taken care of in case of failure of the Engine or its Components during the period of warranty. Accordingly we allow the claim of the assessee Disallowance of incremental warranty provision - Held that - We find no merit in the stand of the authorities below in this regard wherein the assessee is following a scientific basis in claiming the said expenditure and as in the case of NEPI fee the provision made by assessee is to be allowed as the amount is relatable to the IC Engines sold by the assessee. The warranty clause is part of the contractual obligations of the assessee and the same is an ascertained liability being determined on a scientific basis and hence the same is to be allowed as an expenditure in the hands of the assessee. Disallowance of expenses u/s.14A - Held that - no disallowance out of interest expenditure is to be made in the hands of assessee as the assessee has sufficient funds and even otherwise the provisions of Rule 8D are not applicable to the instant assessment year. Now coming to the administrative expenses following the precedent in assessee s own case we restrict the disallowance to 2 lakhs. Re-working of deduction under section 80IB - Held that - Even though the Daman unit was working independently but there is merit in the orders of the authorities below in allocating the directors expenses and part of administrative expenses to the eligible industrial undertaking and re-work the deduction under section 80IB of the Act.

Summary

Issues Involved:
1. Transfer Pricing Adjustment
2. International Transaction relating to export of IC Engines
3. Inappropriate issue of two show cause notices
4. Inappropriate comparison of profitability of "export to Associated Enterprises (AEs)" and "domestic sales"
5. Inappropriate approach adopted by the TPO by ignoring interest received on extended credit while computing segmental profitability of export to AEs
6. Inappropriate allocation of administrative expenses and selling & distribution by the TPO
7. Inappropriate approach adopted by TPO in application of net profit to cost as Profit Level Indicator (PLI)
8. Benefit of the variation / reduction of 5 percent from the arithmetic mean
9. International Transaction relating to Payment of Royalty
10. International Transaction relating to payment of Technical Know-how
11. International Transaction relating to Procurement Support Services
12. International Transaction relating to receipt of Commission
13. International Transaction relating to interest received on extended credit offered to Associated Enterprises
14. Proposed disallowance of incremental provision for New Engine Performance Inspection Fee by the DCIT
15. Proposed disallowance of expenses u/s 14A of Income Tax Act,1961
16. Proposed disallowance of incremental warranty provision by the DCIT
17. Proposed disallowance out of Deduction u/s. 80IB by the DCIT
18. Proposed disallowance out of depreciation on intangible by the DCIT
19. Initiation of Penalty Proceedings

Detailed Analysis:

1. Transfer Pricing Adjustment:
The first issue raised was against a transfer pricing adjustment of ?40,64,87,070/- made by the Assessing Officer/DRP on account of various international transactions including export of IC engines, payment of royalty, technical know-how fees, procurement support services, receipt of commission, and interest received on extended credit period offered on exports. The Tribunal held that the aggregation of closely linked transactions for benchmarking was appropriate, and directed the Assessing Officer/TPO to re-compute the adjustment by aggregating the transactions.

2. International Transaction relating to export of IC Engines:
The Tribunal noted that the assessee had applied the TNMM method to benchmark its international transactions, while the TPO had rejected the aggregation approach and proposed an adjustment based on internal comparables. The Tribunal upheld the aggregation approach and directed the TPO to re-compute the adjustment using the TNMM method with external comparables.

3. Inappropriate issue of two show cause notices:
The assessee contended that the issuance of two show cause notices was inappropriate. The Tribunal dismissed this ground, stating that the issuance of multiple notices did not invalidate the proceedings.

4. Inappropriate comparison of profitability of "export to AEs" and "domestic sales":
The Tribunal found that the TPO's comparison of gross margins between domestic sales and exports to AEs was not appropriate. It held that the net profit margins of controlled transactions should be compared with those of uncontrolled transactions, and directed the TPO to re-compute the adjustment accordingly.

5. Inappropriate approach adopted by the TPO by ignoring interest received on extended credit while computing segmental profitability of export to AEs:
The Tribunal agreed with the assessee that interest received on extended credit should be considered while computing segmental profitability of exports to AEs and directed the TPO to include the interest received in the computation.

6. Inappropriate allocation of administrative expenses and selling & distribution by the TPO:
The Tribunal found that the TPO had re-allocated administrative and selling expenses without basis and directed that the allocation done by the assessee, based on generally accepted costing principles, should be accepted.

7. Inappropriate approach adopted by TPO in application of net profit to cost as Profit Level Indicator (PLI):
The Tribunal held that the PLI should be net profit to sales, not net profit to cost, as the selling price drives profitability. The TPO was directed to re-compute the PLI accordingly.

8. Benefit of the variation / reduction of 5 percent from the arithmetic mean:
This issue was deemed consequential based on the re-computation of the adjustments.

9. International Transaction relating to Payment of Royalty:
The Tribunal held that the payment of royalty should be aggregated with other manufacturing activities for benchmarking. The TPO was directed to re-compute the arm's length price after aggregation.

10. International Transaction relating to payment of Technical Know-how:
The Tribunal directed that the payment for technical know-how should also be aggregated with other manufacturing activities for benchmarking.

11. International Transaction relating to Procurement Support Services:
The Tribunal directed that the provision of procurement support services should be aggregated with other manufacturing activities for benchmarking.

12. International Transaction relating to receipt of Commission:
The Tribunal held that comparing controlled transactions with other controlled transactions was not appropriate and directed the TPO to delete the adjustment made for the receipt of commission from AEs.

13. International Transaction relating to interest received on extended credit offered to Associated Enterprises:
The Tribunal held that LIBOR + rates should be applied to the amounts due from AEs for the extended credit period and directed the TPO to re-compute the adjustment accordingly.

14. Proposed disallowance of incremental provision for New Engine Performance Inspection Fee by the DCIT:
The Tribunal allowed the provision for NEPI fees, noting that it was based on a scientific method and related to the IC engines sold by the assessee.

15. Proposed disallowance of expenses u/s 14A of Income Tax Act,1961:
The Tribunal held that Rule 8D was not applicable for the assessment year 2006-07 and restricted the disallowance of administrative expenses to ?2 lakhs.

16. Proposed disallowance of incremental warranty provision by the DCIT:
The Tribunal allowed the provision for warranty expenses, noting that it was based on a scientific method and related to the IC engines sold by the assessee.

17. Proposed disallowance out of Deduction u/s. 80IB by the DCIT:
The Tribunal upheld the allocation of directors' expenses and part of administrative expenses to the eligible industrial undertaking and re-worked the deduction under section 80IB accordingly.

18. Proposed disallowance out of depreciation on intangible by the DCIT:
The assessee did not press this ground, and it was dismissed as not pressed.

19. Initiation of Penalty Proceedings:
The Tribunal held that the initiation of penalty proceedings was premature and dismissed this ground.

Conclusion:
The Tribunal allowed the appeal of the assessee partly, directing re-computation of adjustments based on the principles laid down in the judgment.