2022 (3) TMI 1522 - AT - Income Tax

TP Adjustment - adjustment to operating cost on account of foreign exchange fluctuation - HELD THAT - TPO s and Assessee s comparable companies had an average import purchases to total purchases ratio of 10.33% and 3.65% respectively against the Assessee s ratio of 72.60%. As a result, the Assessee is more prone to the impact of foreign exchange fluctuation. Pre-agreed contracts with customers prevents passing the additional costs as a result of forex impact - Assessee had to oblige with the terms of contract and supply the products at the committed rate for the entire year even though there was significant increase in the cost of the products by virtue of higher cost of the components being imported vis- -vis comparable companies selected by the Assessee who had either no imports or less significant imports - also to be noted that the Assessee may not be able to pass on the entire impact of foreign exchange to customers as it operates in the competitive environment of the automobile industry. On an analysis carried out to determine the change in selling price per unit of the products to the customer across years, it was also observed that there was no significant increase in the selling price of the Assessee to its customers in majority of products. From the same it is evident that the Assessee is unable to negotiate for an increase in sale prices to account for the impact of forex fluctuations etc. Impact of forex fluctuations on the Assessee - Both the parties agreed that identical issue was decided by this Tribunal in Assessee s own case for AY 2012-13 2021 (11) TMI 1059 - ITAT BANGALORE as held it is normal that exchange rate is subject to fluctuation due to economic conditions. While determining the ALP, one has to consider these factors, accordingly, this issue is remitted to the file of the TPO for determining the ALP after considering the above three components i.e. customs duty adjustment, air freight adjustment and foreign exchange fluctuation adjustment. Grant of depreciation adjustment in computing operating cost of the Assessee - We are of the view that the adjustment on account of underutilization of capacity will sufficiently take care of the depreciation adjustment and no separate adjustment is required to be granted on account of difference in quantum of depreciation vis-a-vis difference in capacity utilization and cost of fixed assets. We hold and direct accordingly. Selection of comparables - Rajsriya Automotive Industries. Pvt Ltd. - In terms of Rule 10B(2)( a) of the rules specific characteristics of property transferred or services provided in either transaction is a relevant criteria. It may be true that broadly the Assessee and the comparable Rajsriya can be said to be in automotive component manufacturing. However, the specific characteristics of the property manufactured by the Assessee is electrical/electronics parts whereas the comparable company Rajsriya is manufacture of automotive components. Therefore there is a difference in the specific characterics of the property manufactured. So also in terms of Rule 10B(2)( b) of the Rules, presence of intangible as an Asset employed would be a relevant criteria to choose comparable. That being the case, we are of the view that if on a narrower search, if sufficient number of comparable companies are available in the automobile electrical/electronics component, then it would be just and proper to disregard companies who manufacture automotive components. We hold and direct accordingly. TVS Upasana Ltd. - We find that the reason that the Assessee was in electrical/electronic components manufacture and TVS is in manufacture of automotive/mechanical components in the automobile industry is a difference in the characteristics of the property which is a relevant criteria for choosing comparable companies. On this aspect whatever conclusions we drawn in respect of the comparable Rajsriya would be equally applicable to this comparable company also. In respect of the Related Party Transaction (RPT), the range of related party transaction would vary between 15% and 25% depending on the availability of comparable companies. If more companies are available for comparability then the percentage of RPT can be restricted to 15% and in cases where such comparable companies are not available then the range can go upto 25% to rope in more comparable companies. The fact that raw material consumption is more in the case of the Assessee does not seem to fit into any of the criteria for deciding comparability in terms of Rule 10B(2) of the Rules. Aspee Springs Ltd. - In so far as the contention regarding the dissimilarity in the characteristics of the property and presence of R D activities the conclusions while dealing with Rajsriya will apply to this company also. As far as the difference in own consumption of raw material and different business model, we are of the view that the conclusions while dealing with the comparable TVS will equally apply to this comparable also. Supreme Treon Pvt. Ltd. ( Supreme ) (formerly Supreme Treves Private Limited) - The conclusions while dealing with Rajsriya will apply to this company also. As far as the quantum of RPT is concerned, it would be appropriate to direct the TPO/AO to consider the plea of the Assessee that the RPT percentage is more than 25% for this comparable company. Borgwarner Morse TEC Murugappa Pvt Ltd. - Contention regarding the dissimilarity in the characteristics of the property the conclusions while dealing with Rajsriya will apply to this company also. As far as the difference in own consumption of raw material and different business model, we are of the view that the conclusions while dealing with the comparable TVS will equally apply to this comparable also. We hold and direct accordingly. As far as the quantum of RPT is concerned, it would be appropriate to direct the TPO/AO to consider the plea of the Assessee that the RPT percentage is more than 25% for this comparable company. Munjal Showa Ltd. - We find that the DRP has not gone into the comparability of this company but has proceeded under the mistaken belief that this company was not part of the search matrix before the TPO. This was a comparable chosen by the Assessee and rejected by the TPO and it was the plea of the Assessee that this company is comparable functionally. We are therefore of the view that interest of justice would be met, if the TPO/AO is directed to consider comparability of this company afresh. Assessee as contended that the adjustment, if any should be restricted to the proportionate value of the international transactions of the Assessee - As relying on the case of IKA 2018 (10) TMI 923 - ITAT BANGALORE Adjustment on account of determination of ALP has to be restricted only to that part of the transaction with AE and not the entire value of the manufacturing segment as was done by the revenue authorities. Payment of Research and Development and licence fee (Royalty) to the AE as at nil - HELD THAT - DRP has held that as the adjustment in the manufacturing segment being made under TNMM incorporating the payment of license fee/royalty as a part of the operating cost, the adjustment comes to more than the amount of royalty and therefore, no separate adjustment is called for royalty. DRP held that in the event, the margin of the manufacturing segment is at arm s length or the adjustment under TNMM works out to be less than the payment for license fee/royalty, then the adjustment made towards royalty would be revived. As submitted that as no adjustment with respect to royalty has been made in view of the adjustment in the manufacturing segment being more than the amount of royalty, the said ground may not be adjudicated at this stage. However, the Assessee reserves liberty to urge this ground at a later stage in the event the adjustment made towards royalty is revived. We are of the view that the prayer so made is acceptable and the liberty prayed for is granted. Comparables for SWD services - We direct exclusion of (1) Infosys Ltd. (2) Larsen Toubro Infotech Ltd. (3) Persistent Systems Ltd. (4) Thirdware Solutions Ltd. from the list of comparable companies. Exclusion of Mintree Ltd - Assessee has limited its analysis only to functions but not to the assets, risks as well as prevailing market conditions in which both the buyer and seller of services located. Hence, the companies in which more than 75% of their export revenues come from onsite operations are to be excluded from the comparability study as they are not functioning in similar economic circumstances to that of the tax payer. Hence, it is held that this filter is appropriately applied by the TPO. We are of the view that it would be just and appropriate to remand the issue of comparability of Mindtree Ltd.,to the TPO/AO afresh in the light of the principles set out above and apply the onsite revenue filter. Functional dissimilarity - Companies functionally dissimilar with that of assessee need to be deselected from final list. Non grant of Working Capital adjustment - A working capital adjustment is one such adjustment which is to be applied in order to adjust for the differences between the working capital positions of the tested party and of the comparable. Reliance is placed by the Assessee on the decision of this Hon ble Tribunal in the cases of Bearing Point Business Consulting (P.) Ltd. 2014 (4) TMI 997 - ITAT BANGALORE Therefore, it is submitted that since it is now a settled proposition of law that necessary adjustments are to be made to the margins of comparables to give effect to the differences in the working capital positions of the tested party and of the comparables, the TPO ought to have given the Assessee the benefit of the same. We are of the view prayer in this regard deserve to be accepted. This tribunal has been consistently taking a view that working capital adjustment has to be allowed. Hence, we direct the TPO/AO to allow working capital adjustment, in accordance with law. Disallowance of provision for warranty - HELD THAT - The claim made by the Assessee that the method followed for creating provision for anticipated liability on account of warranty stands vindicated by the fact that the actual liability on account of warranty expenses is always on the higher side. The reasons given by the DRP for not accepting the claim of the Assessee is that the provision is created as a percentage of sale, ignoring the fact that past experience is also the basis for creation of provision for warranty. We are therefore of the view that the provision for warranty has to be allowed as a deduction, as the provision created satisfies the requirements for claiming provision as a liability, as laid down in the judicial precedents. We hold and order accordingly and allow the relevant ground of appeal of the Assessee. Disallowance of annual licence fee - AO disallowed the above for the reason that the reasons for mention licence fee as R D expenses were not submitted and except the Agreement, no supporting documents were furnished with regard to technical know-how provided by the group companies - HELD THAT - DRP disregarded the same by merely observing that submission of license agreements, raising of invoices, payments by cheques will not help the cause of the Assessee. Each and every one of the allegations of the AO has been countered by the Assessee and these have been given in the chart in the earlier paragraphs. As rightly submitted by the Assessee, the nomenclature of R D should not be the basis to conclude that the expenditure is capital expenditure in nature. We also find that similar disallowance in the earlier AYs has been set aside by the Tribunal to the AO for consideration afresh. The issue needs to be examined afresh in the light of the evidence filed before the Tribunal and the submissions made by Assessee as above. The AO will examine the issue afresh in the light of the observations made above and in the light of the evidence and additional evidence and submissions made as above, after affording the Assessee opportunity of being heard. Non-set off of brought forward losses - Assessee submitted that as per its return of income, an amount was brought forward under the head profits and gains from business or profession , which ought to be available for set off in terms of Section 72 - as prayed that the same be allowed to be set off against income under the head profits and gains from business or profession - HELD THAT - We are of the view that a direction to the AO to consider the claim of the Assessee after affording opportunity of being heard and after due verification, would be sufficient to dispose this ground of appeal. We hold and direct accordingly.

Summary

Issues Involved:
1. Transfer pricing adjustment in the manufacturing segment.
2. Transfer pricing adjustment in the software development services (SWD) segment.
3. Disallowance of provision for warranty.
4. Disallowance of annual license fees.
5. Non-set off of brought forward losses.

Detailed Analysis:

1. Transfer Pricing Adjustment in the Manufacturing Segment:
The primary contention in this segment was the determination of the Arm's Length Price (ALP) for transactions between the assessee and its Associated Enterprises (AEs). The assessee used the Transactional Net Margin Method (TNMM) and adjusted its net profit margin to account for differences in capacity utilization, customs duty, and exchange rate fluctuations. The Transfer Pricing Officer (TPO) rejected these adjustments, leading to a significant dispute.

- Capacity Utilization Adjustment: The Tribunal remanded the issue to the TPO/AO for fresh consideration, directing them to obtain details of capacity utilization of comparable companies if not available in the public domain.
- Customs Duty Adjustment: The Tribunal followed its previous decision in the assessee’s case for AY 2012-13, remanding the issue to the TPO/AO for fresh consideration.
- Exchange Rate Fluctuation Adjustment: The Tribunal remanded the issue to the TPO/AO for fresh consideration, emphasizing the need to exclude forex gains/losses from operating costs.
- Depreciation Adjustment: The Tribunal held that the adjustment on account of underutilization of capacity would sufficiently address the depreciation adjustment.
- Comparable Companies: The Tribunal directed the TPO/AO to reconsider the inclusion/exclusion of specific companies as comparables based on functional similarities and other criteria.
- Proportionate Adjustment: The Tribunal held that the adjustment should be restricted to the proportionate value of international transactions with AEs, not the entire segment.

2. Transfer Pricing Adjustment in the Software Development Services (SWD) Segment:
The Tribunal addressed the inclusion/exclusion of several comparable companies used by the TPO and the assessee.

- Exclusion of Certain Comparables: The Tribunal directed the exclusion of Infosys Ltd., Larsen & Toubro Infotech Ltd., Persistent Systems Ltd., and Thirdware Solutions Ltd. based on previous Tribunal decisions.
- Inclusion of Certain Comparables: The Tribunal remanded the issue of inclusion of Akshay Software Technologies Ltd., Maveric Systems Ltd., and others to the TPO for fresh consideration.
- Working Capital Adjustment: The Tribunal directed the TPO/AO to allow working capital adjustments in accordance with the law.

3. Disallowance of Provision for Warranty:
The Tribunal allowed the provision for warranty as a deduction, holding that the provision was created based on past experience and historical trends, satisfying the requirements for claiming it as a liability.

4. Disallowance of Annual License Fees:
The Tribunal remanded the issue to the AO for fresh consideration, directing them to examine the evidence and submissions provided by the assessee regarding the nature of the expenses. The Tribunal also allowed the alternative claim of the assessee for depreciation if the expenses were treated as capital in nature.

5. Non-set off of Brought Forward Losses:
The Tribunal directed the AO to consider the claim of the assessee for set-off of brought forward losses after due verification and affording the assessee an opportunity of being heard.

Conclusion:
The Tribunal provided detailed directions for reconsideration and fresh adjudication of several issues by the TPO/AO, emphasizing the need for proper examination of evidence and adherence to legal principles in determining the ALP and other matters. The appeal was partly allowed, with specific remands and directions for each issue.