2023 (2) TMI 1237 - AT - Income Tax

TP adjustment - treatment of duty drawback as non-operative in nature for computing the operating margin of the assessee - HELD THAT - The duty drawback is provided to the manufacturer and exporter for the purpose of compensating in the duty component which is already been included in the cost of raw material and the duty drawback received against the duty paid in our view is part of the operating profit of the assessee. As relying on Sami Labs. Ltd case 2019 (4) TMI 2110 - ITAT BANGALORE we remit the issue back to the TPO to verify that export incentive is in respect of turnover of the present year as per the ratio laid down in the above judgement. Needless to say that the assessee be given an opportunity of being heard. Comparable selection - UMW Industries Ltd - The major part of the revenue derived by the company is from sale of guidance wire. We also notice from the annual report (pg. 1493 of paper book) that one of the major suppliers for the company is Bharat Dynamics which is a Govt. of India Enterprise, which is a manufacturing base for guided weapon systems. Therefore we see merit in the submission of the ld AR that the company supplies the guided wire for defence activities and therefore not comparable with the assessee who supplies machinery to textile industry. TPO and the DRP have considered the profile of the company as manufacturer of other machinery for textiles, apparel and other industries whereas as per the annual return, the extract of which is reproduced above, the company is engaged in the manufacture of guidance wire and miniature control cable. In view of the discussion, we hold that the functional profile of UMW Industries Ltd. is different from that of the assessee and therefore not comparable. The AO/TPO is directed to exclude the company from list of comparables. Lohia Corporation Ltd. - assessee contended before the TPO and the DRP that the company incurs significant expenditure towards R D which is more than 3% on an average for the previous 3 years and assessee on the other hand is a licensed manufacturer and relies on the technical knowhow of which AE to manufacture the product - We notice from the above judicial pronouncements relied on by the assessee that application of R D filter with a threshold limit of 3% is a settled position now. We also notice that the Bangalore Bench of the Tribunal in the case of KBACE Technologies Pvt. Ltd. 2020 (2) TMI 78 - ITAT BANGALORE has also taken a similar view. In view of this we direct the TPO to exclude Lohia Corporation Ltd from the list of comparables. TP adjustment restricted to the value of only international transactions - We hold that the TP adjustment should be restricted only to AE related transaction and direct the TPO/AO to compute the TP adjustment accordingly. Benefit of adjustment for working capital denied - HELD THAT - As working capital adjustment is to be allowed as per actuals, after considering the decisions rendered in this order on the exclusion/inclusion of comparable companies out of/into the final set of comparables. The TPO/ AO are accordingly directed.

Issues Involved:
1. Validity of the assessment order.
2. Transfer Pricing (TP) adjustments.
3. Rejection of TP documentation.
4. Economic analysis undertaken by the appellant.
5. Filters and comparables selection.
6. Treatment of duty drawback.
7. Inclusion of specific comparable companies.
8. Computation of TP adjustment.
9. Working capital adjustment.
10. Capacity utilization adjustment.
11. Depreciation adjustment.
12. Deduction under section 37(1) for education cess and secondary & higher education cess.
13. Relief provided by the DRP.

Detailed Analysis:

1. Validity of the Assessment Order:
The appellant contested the validity of the assessment order passed by the AO, pursuant to the directions of the DRP and the TPO, claiming it was prejudicial. However, this issue was not separately adjudicated as it was deemed general.

2. Transfer Pricing (TP) Adjustments:
The AO made a TP adjustment of INR 32,04,00,000 to the appellant's international transactions. The appellant challenged this adjustment, asserting errors in the rejection of its TP documentation and economic analysis.

3. Rejection of TP Documentation:
The TPO rejected the TP documentation maintained by the appellant under Section 92D of the Act. The appellant argued that this rejection was arbitrary and that the economic analysis undertaken by them was in accordance with the Act and Income-tax Rules, 1962.

4. Economic Analysis Undertaken by the Appellant:
The appellant contended that the AO and DRP erred in rejecting the economic analysis it conducted and instead conducted a fresh analysis. This issue was not separately adjudicated as it was deemed general.

5. Filters and Comparables Selection:
The appellant argued that the AO/DRP erred in rejecting the filters applied by them and in selecting comparables that did not pass the test of comparability analysis. Specific companies contested included Lakshmi Machine Works Limited, Meera Industries Private Limited, UMW Industries Limited, and Lohia Corp Limited.

6. Treatment of Duty Drawback:
The appellant contended that duty drawback should be considered as part of the operating income. The Tribunal agreed, stating that duty drawback compensates for the duty component included in the cost of raw materials, thus forming part of the operating profit. The issue was remitted back to the TPO for verification.

7. Inclusion of Specific Comparable Companies:
UMW Industries Ltd.:
The Tribunal found UMW Industries Ltd. not comparable as its principal activity is manufacturing guidance wire for defense, unlike the appellant's textile machinery manufacturing.

Lohia Corporation Ltd.:
The Tribunal directed the exclusion of Lohia Corporation Ltd. due to its significant R&D expenditure, which differs from the appellant's reliance on AE's technical know-how.

8. Computation of TP Adjustment:
The appellant argued that the TP adjustment should be restricted to the value of international transactions. The Tribunal agreed, following the decision in IKA India Pvt. Ltd., and directed the TPO/AO to compute the adjustment accordingly.

9. Working Capital Adjustment:
The Tribunal held that working capital adjustment should be allowed as per actuals, following the decision in Huawei Technologies India P. Ltd. The issue was remitted to the AO/TPO for necessary examination and computation.

10. Capacity Utilization Adjustment:
The appellant did not press for this ground during the hearing.

11. Depreciation Adjustment:
The appellant did not press for this ground during the hearing.

12. Deduction under Section 37(1) for Education Cess and Secondary & Higher Education Cess:
The appellant did not press this ground during the hearing.

13. Relief Provided by the DRP:
The Tribunal noted that the AO did not consider the relief provided by the DRP regarding the weighted average operating margin of UMW Industries Limited. However, this became infructuous due to the exclusion of UMW Industries Ltd. from the comparables.

Additional Ground:
The Tribunal admitted an additional ground for the inclusion of GSL Textiles, which was initially rejected by the TPO. The issue was remitted back to the TPO for fresh consideration.

Conclusion:
The appeal was partly allowed, with directions for the AO/TPO to recompute adjustments and consider the inclusion/exclusion of comparables based on the Tribunal's observations.

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