2016 (10) TMI 1386 - AT - Income Tax

TP Adjustment - Normal Gross Profit Mark-Up over Cost computation - inclusion of abnormal loss in the cost of consumption of Raw Material for the purposes of calculation - whether abnormal loss is purely during the course of normal manufacturing operations and does not constitute/is not attributable to any international transaction between assessee co. and its AE - HELD THAT - As apparent that the assessee has incurred certain costs which are extraordinary in nature. However, the claim of the assessee is half-hearted as assessee has not furnished the details of the cancellation of order and what are the materials, which were procured by the assessee against which order of the buyer who got bankrupt. Further, there are no details available that what the realisable value of those materials is and how the valuation loss were determined. Agreeing with the contention of the assessee that extraordinary cost/ abnormal cost cannot be included in the cost for working PLI of the assessee, but assessee has prove first about the actual loss incurred leading concrete evidences. We set aside this issue to the file TPO/AO to examine with respect to quantity, price and quality or specification of the material revalued with respect to the material which was purchased or designed by the assessee specifically for that buyer who cancelled the orders and gone bankrupt. The appellant is also directed to furnish all this information to justify its claim and also to show the nature and extent of extraordinary loss incurred by the assessee with evidences. Directions given by the Ld. Dispute resolution panel with respect to the selection of certain companies which were incurring persistent losses - grievance of the assessee was only with respect to the only one comparable that is Scott industries Ltd. - TPO has refused to give effect to the direction of the LD. DRP on the ground that the annual report of the company is not available in public domain. It was submitted by the Ld. authorized representative that assessee has submitted the copy of the profit and loss account of the party for 3 years from prowess database, which has not been considered by the Transfer pricing officer. DR also submitted that same may be considered if the proper information is provided by the appellant to the Ld. assessing officer. We set aside ground of the appeal of the appellant to the file of TPO to consider the letter submitted for exclusion of the above comparable, as directed by the Ld. DRP, if he is satisfied about the correctness of the information, which should be reliable and authentic. Applicability of the transfer pricing adjustment only to transactions with related parties - No hesitation in holding that the transfer pricing adjustment should be restricted to the international transactions only and it cannot be applied to uncontrolled transactions. Recently in CIT V Hindustan Unilever Limited 2016 (7) TMI 1245 - BOMBAY HIGH COURT has held that While determining ALP of international transactions, benchmarking has to be done only on AE transactions and not for entire turnover. Therefore respectfully following that decision we direct ld TPO/AO to restrict the adjustment on account of ALP to the extent of the transaction with AE only.

Issues Involved:
1. Inclusion of abnormal loss in the cost of raw material consumption for calculating Normal Gross Profit Mark-Up.
2. Exclusion of loss-making companies from comparables and selection methodology of comparables.
3. Non-compliance with Dispute Resolution Panel (DRP) directions regarding comparables.
4. Rectification of factual inaccuracies in the computation of average gross margin.
5. Charging of consequential interest and initiation of penalty proceedings.
6. Applicability of transfer pricing adjustment only to related party transactions.

Detailed Analysis:

1. Inclusion of Abnormal Loss in Cost of Raw Material Consumption:
The appellant argued that the abnormal loss of Rs. 2,40,79,629 should not be included in the cost of raw material for calculating Normal Gross Profit Mark-Up, as it is not attributable to any international transaction. The Tribunal noted that the Cost Plus Method (CPM) requires exclusion of extraordinary costs unrelated to the sale of goods. The appellant claimed the loss was due to revaluation of inventory following the bankruptcy of a major buyer. However, the Tribunal found the appellant failed to provide concrete evidence of the specific loss incurred. The issue was remanded to the Transfer Pricing Officer (TPO) to verify the details and evidences of the claimed loss.

2. Exclusion of Loss-Making Companies from Comparables:
The appellant contended that the TPO erred in eliminating loss-making companies from the comparables, leading to an unscientific methodology in determining the arm's length margin. The Tribunal did not provide a separate detailed judgment on this issue but implied that the selection of comparables should follow a scientific methodology.

3. Non-Compliance with DRP Directions:
The appellant argued that the Assessing Officer (AO) did not follow DRP directions regarding the selection of certain companies. Specifically, the dispute was about the inclusion of Scott Industries Ltd., which was allegedly incurring persistent losses. The Tribunal directed the TPO to reconsider the appellant's submission and verify the correctness of the information provided regarding Scott Industries Ltd.

4. Rectification of Factual Inaccuracies:
The appellant claimed factual inaccuracies in the computation of average gross margin. The Tribunal did not separately address this issue in detail, but it is implied that rectification should follow proper verification of facts and adherence to DRP directions.

5. Charging of Consequential Interest and Initiation of Penalty Proceedings:
The appellant contested the charging of consequential interest and initiation of penalty proceedings. The Tribunal did not provide a separate detailed judgment on this issue, indicating that it might be consequential to the main issues being resolved.

6. Applicability of Transfer Pricing Adjustment Only to Related Party Transactions:
The appellant argued that the transfer pricing adjustment should be restricted to transactions with associated enterprises (AEs) only and not applied to uncontrolled transactions. The Tribunal agreed, citing the Bombay High Court's decision in CIT v. Hindustan Unilever Limited, and directed the TPO/AO to restrict the adjustment to the extent of transactions with AEs only.

Conclusion:
The appeal was partly allowed. The Tribunal remanded the issue of abnormal loss inclusion back to the TPO for further verification and directed the TPO to reconsider the inclusion of Scott Industries Ltd. as a comparable. The Tribunal also upheld that transfer pricing adjustments should be restricted to transactions with AEs only. Other issues were either implicitly addressed or deemed consequential to the main issues resolved.

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