2019 (4) TMI 2110 - AT - Income Tax

TP adjustment done to manufacturing segment - not considering export incentives as part of operating revenues of appellant and comparables or reducing from cost to determine operating profits - HELD THAT - As by respectfully following this judgment of Welspun Zucchi Textiles Ltd. 2017 (1) TMI 1037 - BOMBAY HIGH COURT we hold that the export incentives should be included in the operating profit of the assessee as well as the comparables. But it should be ensured that such export incentive is in respect of turnover of the present year only because if the export incentive is relatable to the turnover of an earlier year then the same cannot be included in the present year profit for TP analysis because in that situation, the profit will remain included in the numerator, but the corresponding turnover will not remain included in the denominator and this will give absurd result. Hence we direct the AO/TPO to decide the issue afresh - Ground no. 4 is allowed for statistical purposes. Non considering the under utilization of manufacturing capacities of your appellant and the resulting idle costs - HELD THAT - As relying on assessee own case for ay 2009-10 directed the A.O./TPO/A.O. to consider the claim of the assessee for the purpose of giving adjustment on account of low capacity utilization. We make it clear that the adjustment is only on account of cost attributable to idle capacity for the year under consideration. Accordingly, the assessee has to provide all the details of capacity utilization of assessee as well as comparable for computation of adjustment if any - we restore back this matter to the file of AO/TPO with similar directions. Ground no. 5 is also allowed for statistical purposes. Application of functional similarity filter while rejecting companies selected by appellant as comparables - HELD THAT - As as per clause (c) of Para 3.7, this is admitted position that this was the dispute raised before DRP that the TPO has committed errors in selection of comparable companies. TPO has wrongly selected 10 companies as comparables whose businesses and operations have nothing in common with that of the assessee. From the decision of DRP we find that this issue was decided by DRP that TNMM is the most appropriate method and there is no decision on any other aspect of the issue in dispute. In Para 3.9 of DRP directions as reproduced above, the decision is with regard to charging notional interest on the guarantee commission and in this Para also, there is no decision regarding selection of comparables. Hence we feel it proper to restore the matter back to the file of DRP for fresh decision. Ground no. 6 is also allowed for statistical purposes. Selection of Indfrag Limited as comparable - HELD THAT - For this company it is stated that rental income of Rs. 68 Lakhs has been considered as operating revenues. In the impugned order of DRP, there is no decision on this aspect that as to whether the same should be included in operating revenue or not and for this issue also, we restore the matter back to DRP for fresh decision. Ground no. 7 is also allowed for statistical purposes. Risk adjustment - HELD THAT - As decided in own case assessee is claiming the risk adjustment because of the majority of the sale to the AE in comparison to the comparables making sales to the third party. The Id. AR of the assessee has submitted that the assessee has furnished all the requisite details. Risk adjustment is one of the component to be taken into account for FAR analysis. Therefore the TPO/A.O./A.O is directed to consider the claim of risk adjustment on the basis of the details to be furnished by the assessee

Issues Involved:
1. Transfer Pricing adjustment to manufacturing segment
2. Rejection of Cost Plus Method and adoption of Transaction Net Margin Method
3. Computation of adjustments relating to AE transactions
4. Inclusion of export incentives in operating revenues
5. Underutilization of manufacturing capacities and idle costs
6. Application of functional similarity filter and selection of comparables
7. Margin computation errors for Indfrag Limited
8. Adjustments for differences in functions and risks
9. Commission on guarantee

Detailed Analysis:

1. Transfer Pricing Adjustment to Manufacturing Segment:
The AO and TPO made a transfer pricing adjustment of Rs. 12,90,24,688/- to the prices charged by the appellant. This adjustment was contested by the appellant on multiple grounds, including the rejection of the Cost Plus Method, incorrect computation of adjustments, exclusion of export incentives, and underutilization of manufacturing capacities.

2. Rejection of Cost Plus Method and Adoption of Transaction Net Margin Method:
The TPO rejected the Cost Plus Method (CPM) adopted by the appellant and instead used the Transaction Net Margin Method (TNMM) for determining the Arm's Length Price (ALP). The DRP upheld this rejection. It was argued that CPM was appropriate for the appellant's transactions involving semi-finished goods. However, the DRP justified the use of TNMM due to practical difficulties in identifying direct and indirect costs, and the absence of granular details for comparables.

3. Computation of Adjustments Relating to AE Transactions:
The appellant argued that the TPO erred in computing adjustments relating to AE transactions, as adjustments were also made to non-AE transactions. The DRP had previously directed that adjustments should be restricted to AE transactions only. The Tribunal restored this matter to the AO/TPO to ensure compliance with this directive.

4. Inclusion of Export Incentives in Operating Revenues:
The appellant contended that export incentives should be included in the operating revenues for computing operating margins. The Tribunal referred to the judgment of the Hon’ble Bombay High Court in CIT Vs. Welspun Zucchi Textiles Ltd., which held that DEPB benefits are operating revenue includable in arriving at operating profit. The Tribunal directed the AO/TPO to include export incentives in the operating profit of both the tested party and comparables, ensuring that incentives relate to the current year's turnover.

5. Underutilization of Manufacturing Capacities and Idle Costs:
The appellant claimed that the TPO ignored the underutilization of manufacturing capacities and the resulting idle costs while computing margins. The Tribunal referred to its previous order in the appellant's case for AY 2009-10, directing the AO/TPO to consider adjustments for idle capacity costs attributable to the year under consideration. This matter was restored to the AO/TPO for fresh consideration.

6. Application of Functional Similarity Filter and Selection of Comparables:
The appellant argued that the TPO erred in selecting comparables whose businesses and operations were not similar to the appellant's. The DRP did not address this issue in its decision. The Tribunal restored this matter to the DRP for fresh consideration, directing them to specifically address the selection of comparables.

7. Margin Computation Errors for Indfrag Limited:
The appellant pointed out that the TPO included rental income of Rs. 68 lakhs as part of the operating revenue for Indfrag Limited, which was incorrect. The DRP did not provide a decision on this issue. The Tribunal restored the matter to the DRP for fresh consideration and decision.

8. Adjustments for Differences in Functions and Risks:
The appellant claimed that the TPO did not make adjustments for differences in functions and risks undertaken by the appellant compared to the comparables. The Tribunal referred to its previous order for AY 2009-10, directing the AO/TPO to consider the claim for risk adjustment based on the details furnished by the appellant. This matter was restored to the AO/TPO for fresh consideration.

9. Commission on Guarantee:
The TPO added a notional commission on guarantees extended by the appellant to its AEs, which was contested by the appellant citing RBI guidelines prohibiting such charges. The Tribunal referred to its previous order for AY 2009-10, directing the AO/TPO to adopt an arm's length commission rate of 0.5% for corporate guarantees. The Tribunal upheld this directive for the current year as well.

Conclusion:
The appeal was partly allowed, with several issues being restored to the AO/TPO or DRP for fresh consideration and decision. The Tribunal provided specific directions for each issue, ensuring compliance with relevant legal precedents and principles.

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