2016 (4) TMI 1306 - AT - Income Tax

Transfer pricing adjustment - treatment of extraordinary cost by the TPO as operating cost - Held that - The assessee bears all risks including environmental risk, which position is borne out from the assessee s Transfer pricing study report and has not been disputed by the ld. AR. This indicates that revenues of the assessee include compensation for environmental loss as well, which has not been treated as an item of non-operating revenue. Once there is such additional compensation also, which has been taken as an item of operating revenue, then the costs incurred in bearing such risks have to be naturally considered as operating costs of the assessee. In view of the above discussion, we are satisfied that the TPO was fully justified in not allowing reduction on account of extra-ordinary costs to the tune of ₹ 12.44 crore while calculating the assessee s operating profit margin. We, therefore, refuse to countenance the assessee s contention on this issue. TP adjustment in respect of capital expenses - MAM selection - Held that - Two items, namely, Purchase of capital goods at ₹ 124.82 crore and Fees for technical & consultancy services at ₹ 15.50 crore have been capitalized by the assessee and hence cannot be considered for making transfer pricing adjustment under the TNMM. Since operating profit is computed by considering the items of operating costs alone, the value of these two items which are capital in nature and have been capitalized in the balance sheet, cannot be included in the base amount for applying the operating profit margin rate of the comparables for computing the amount of transfer pricing adjustment. Direct to exclude them from the base amount of ₹ 148.78 crore for applying the mean profit margin rate of the comparables to determine the amount of transfer pricing adjustment under the TNMM. TPO has considered these two items under the overall TNMM, as was wrongly done by the assessee also and then he went on to consider the value of these two transactions of capital nature for making transfer pricing adjustment. This approach of benchmarking these items of balance sheet under the TNMM, as done by the assessee and then followed by the TPO, is not appropriate, thus, calling for correction. No doubt, the stand of the assessee seeking exclusion of these two transactions of capital nature from the base amount for calculating transfer pricing adjustment under the TNMM is justified, but, at the same time these transactions of capital nature are required to be benchmarked by considering CUP as the most appropriate method. The ld. AR during the course of hearing admitted this position. Since the TPO has not done benchmarking in a proper manner as discussed above, we set aside the impugned order and direct the TPO/AO to benchmark these transactions of capital nature under the CUP method independent of other transactions under the TNMM. Selection of comparables - Held that - Functional comparability has to be necessarily considered before including or excluding a company from the list of comparables. Nowhere has it been laid down in this case that a company with higher or lower turnover can be excluded merely for this reason. Therefore Bharat Glass Tube Ltd. is directed to be included in the final set of comparables. Triveni Glass Ltd. - no extraordinary reasons for incurring of loss of Triveni Glass Ltd. for the year and this company is not a consistent loss making company, we hold that the same cannot be excluded. Gujarat Guardian Ltd. - TPO has thoroughly dealt with all the objections raised by the assessee, such as, earning of dividend income by Gujarat Guardian, difference in power consumption and payment of royalty/fees for technical services, etc. AR has not brought any material on record to fortify his contention about difference in power consumption rates of the assessee vis- -vis this company. TPO was right in including this company in the list of comparables. Thus we aside the impugned order on the question of addition towards transfer pricing adjustment of Float glass division and remit the matter to the file of AO/TPO for recalculating the ALP and consequential addition. Addition u/s 14A - Held that - Hon ble jurisdictional High Court in Maxopp Investments Ltd. Vs. CIT (2011 (11) TMI 267 - Delhi High Court) has held that the provisions of Rule 8D are applicable only from the assessment year 2008-09. It has further been held that in the period anterior to that, the disallowance is required to be made on some reasonable basis. In view of the judgment above on the point, we cannot approve the view taken by the AO in computing the disallowance u/s 14A as per the mandate of Rule 8D of the Income-tax Rules. Accordingly matter is restored to the file of the AO for making disallowance u/s 14A on some reasonable basis

Summary

Issues Involved:
1. Addition of ?23.76 crore on account of transfer pricing adjustment.
2. Treatment of extraordinary cost by the TPO as operating cost.
3. Transfer pricing adjustment in respect of capital expenses.
4. Selection of comparables.
5. Addition of ?4,10,000/- made u/s 14A of the Income-tax Act.

Detailed Analysis:

I. Addition of ?23.76 crore on account of transfer pricing adjustment:
The primary issue in this appeal is the addition of ?23.76 crore due to transfer pricing adjustment. The assessee, an Indian company involved in manufacturing various types of glass, reported ten international transactions. The Transfer Pricing Officer (TPO) focused on transactions under the Float glass division, disputing four out of ten transactions. These transactions included fees for technical services, purchase of capital goods, and import of machinery spares and glass. The TPO recalculated the Operating Profit/Total Cost (OP/TC) of the Float glass division by including extraordinary costs due to rainfall, resulting in a transfer pricing adjustment of ?31.61 crore. The Dispute Resolution Panel (DRP) provided some relief, reducing the addition to ?23.76 crore.

II. Treatment of extraordinary cost by the TPO as operating cost:
The TPO included extraordinary costs of ?12.44 crore, incurred due to unrelenting rainfall, in the operating costs. The assessee argued that these costs should be excluded from operating costs as they were extraordinary. However, the tribunal held that adjustments due to differences between international transactions and comparables should be made in the profit margin of comparables, not the assessee’s profit margin. The tribunal cited Rule 10B(1)(e) and various precedents to support this view. The tribunal also noted that the assessee did not demonstrate that comparables did not incur similar extraordinary costs. Therefore, the tribunal upheld the TPO’s decision to include these costs in the operating costs.

III. Transfer pricing adjustment in respect of capital expenses:
The TPO included capital expenses in the base amount for applying the profit margin of comparables. The tribunal held that capital expenses, which were capitalized in the balance sheet, should not be included in the base amount for calculating transfer pricing adjustment under the Transactional Net Margin Method (TNMM). The tribunal directed the TPO/AO to exclude these capital expenses from the base amount and to benchmark these transactions separately under the Comparable Uncontrolled Price (CUP) method. This separate benchmarking would determine the arm’s length price for these transactions, affecting the depreciation allowance.

IV. Selection of comparables:
The TPO selected three comparables: Gujarat Guardian Ltd., Hindustan National Glass, and Saint Gobain Glass India, while excluding Bharat Glass Tube Ltd. and Triveni Glass Ltd. The tribunal directed the inclusion of Bharat Glass Tube Ltd., citing functional comparability and the principle that high/low turnover alone is not a ground for exclusion. Triveni Glass Ltd. was also included as it was not a consistent loss-making company and there were no extraordinary reasons for its loss. The tribunal upheld the inclusion of Gujarat Guardian Ltd., finding the assessee’s objections unconvincing.

V. Addition of ?4,10,000/- made u/s 14A of the Income-tax Act:
The AO disallowed ?4,10,000/- under section 14A, invoking Rule 8D, as the assessee earned exempt dividend income. The tribunal noted that Rule 8D applies only from the assessment year 2008-09, and for earlier years, disallowance should be made on a reasonable basis. The tribunal set aside the AO’s order on this issue and directed the AO to make a reasonable disallowance as per the jurisdictional High Court’s judgment in Maxopp Investments Ltd. Vs. CIT.

Conclusion:
The tribunal partly allowed the appeal for statistical purposes, directing recalculations and adjustments as per its detailed findings on each issue. The order was pronounced in the open court on 06.04.2016.