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2019 (6) TMI 1716 - AT - Income TaxTP Adjustment - adoption of PBIT/Sales instead of PBDIT/Sales - inclusion of amount of depreciation in total operating costs for the purpose of determination of the operating profit rate - Depreciation ought to have been excluded from the ambit of total costs in applying the TNMM - It is clarified that there is no dispute on the application of TNMM as the most appropriate method. The mechanism for determining the ALP under the TNM method has been enshrined in clause (e) of rule 10B(1) - not allowing appropriate adjustment on account of excess amount of depreciation in the case of the assessee vis- -vis other comparables - HELD THAT - No adjustment on account of difference in the amount of depreciation of two companies is called for when the operating profits are determined because in the case of a company having purchased new asset, there will be higher depreciation and simultaneously lower repair cost and vice versa. The effect of all the individual items of operating expenses and incomes culminates into the overall operating profit margin. That is why, the legislature has provided for comparing the ratio of operating profit margin to a similar base of the assessee with that of its comparables, thereby dispensing with the need for making any adjustment on account of higher or lower amount of individual items of expenses or incomes. Merely because the amount of depreciation of one enterprise is more or less than the other, can never be a ground for seeking adjustment. Such higher amount of depreciation may be due to large scale of the company and host of other factors. By considering percentage of operating profit margin under the TNMM of the assessee as well as comparables, the higher or lower volume of two companies becomes immaterial and so is the quantum of depreciation. The nitty-gritty of the matter is that no adjustment can be allowed simply for the reason that one company has charged higher amount of depreciation vis-a-vis its comparable companies. Not only no adjustment on this score is permissible, the assessee cannot also seek an exclusion or inclusion of a company on the ground that the ratio of its depreciation to total expenses or sales etc. is more or less in comparison with comparables. It is so for the reason that such higher percentage of depreciation to total expenses is marginalized by the lower percentage of repairs and other incidental costs of the assets and vice versa. Thus the contention of the ld. AR in this regard, being devoid from any substance, is liable to be and is hereby jettisoned. The position may be different when there is a difference in the rates of depreciation charged by two companies on similar category of assets. One company may adopt the policy of charging depreciation on its assets in conformity with the rates prescribed in Schedule XIV of the Companies Act and other company may adopt a policy of charging depreciation at the higher rates than those prescribed under Schedule XIV. In such a situation, although both the companies use similar type of assets and everything else is also equal, but their respective operating profit percentages undergo change due to higher or lower rate of depreciation, thereby distorting their comparability. It is this difference in the amounts of depreciation due to different rates of depreciation and not due to different quantums of depreciation simplicitor, which calls for bringing both the companies at par. It is an agreed proposition on behalf of the assessee that the TPO himself allowed adjustment on account of excess rate of depreciation claimed by the assessee in its accounts. We, therefore, uphold the impugned order in sofaras the numerator of PBIT in the TNMM is concerned, that is, inclusion of depreciation in the operating costs; and also in not allowing any further adjustment on account of higher amount of depreciation (other than higher rates for which suitable adjustment was granted by the TPO). The grounds taken by the assessee in this regard, therefore, fail. Exclusion of Federal-Mogul Bearings India Ltd. (FMBIL) from the list of comparables drawn by the assessee - Separate profitability and benchmarking has been done for the Trading segment. The extant Manufacturing segment is exclusive of trading goods and has only the profit from the manufacture and sale of bearing products. Thus, in order to make a comparison of the Manufacturing segment with another company, it is sine qua non that such other company should also be engaged in manufacturing activity only of similar products or if it is engaged in both the manufacturing and trading, then segmental information qua the manufacturing segmental should be discernible from its Annual report. It is observed that FMBIL is engaged both into trading and manufacturing and further no segmental information of its manufacturing segment is available and the assessee has considered this company at entity level as comparable with its manufacturing segment. Once the position is such, we are unable to hold this company as comparable. In view of the foregoing discussion, we are of the considered view that this company was rightly excluded by the authorities below from the list of comparables on the ground of functional differences. In view of the functional dissimilarity at the threshold, there is no need to examine certain other factors taken note of by the TPO making it incomparable. We, therefore, uphold the exclusion of this company from the list of comparables. Grant of -5% margin in determining the ALP - Second proviso to section 92C(2) provides that if the variation between the ALP and the price at which the international transaction has actually been undertaken does not exceed the specified margin, which at the material time was 5%, then the price at which the international transaction has actually been undertaken shall be deemed to be the ALP. The effect of this proviso is that so long as the difference between the ALP as determined by applying one of the specified methods and the price at which the international transaction was undertaken is within the prescribed percentage, no transfer pricing adjustment can be made. This proviso was substituted by the Finance (No.2) Act, 2009 w.e.f. 01-10-2009. Explanation to sub-section (2) of section 92C has clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before the AO as on 1st October, 2009 . Thus, it is overt that even for the assessment year under consideration, namely, 2009-10, the benefit of the second proviso would be available by virtue of the Explanation given at the end of sub-section (2) of 92C. We, therefore, hold that the ld. CIT(A) was justified in extending the benefit of /-5% margin in determining the ALP of the international transactions. This ground of the Revenue fails. Comparability - inclusion of certain companies in the list of comparables, which as per the Revenue are not comparable - TPO tinkered with the list of comparables drawn by the assessee for this segment which led to the recommendation of the transfer pricing adjustment of Rs.4.69 crore. The AO made this addition, which was challenged by the assessee before the ld. CIT(A). The ld. first appellate authority directed the TPO to include certain companies in the list of comparables, which as per the Revenue are functionally incomparable. AR, at the very outset, submitted that even if all the companies directed to be included by the ld. first appellate authority, against which the Revenue has come up in appeal before the Tribunal, are excluded, its profit margin would be within the permissible range of /-5%. DR candidly accepted this proposition. In view of the rival but common submissions, though we technically accept the ground of the Revenue, but it would not lead to increase in the total income by reason of any transfer pricing addition under the Trading segment.
Issues Involved:
1. Adoption of PBIT/Sales instead of PBDIT/Sales for benchmarking international transactions under the Manufacturing segment. 2. Adjustment on account of higher depreciation rates and under-utilization of capacity. 3. Exclusion of Federal-Mogul Bearings India Ltd. (FMBIL) from the list of comparables. 4. Grant of +/-5% margin in determining the Arm’s Length Price (ALP). 5. Inclusion of certain companies in the list of comparables for the Trading segment. Issue-wise Detailed Analysis: 1. Adoption of PBIT/Sales instead of PBDIT/Sales for Benchmarking International Transactions: The assessee employed the Transactional Net Marginal Method (TNMM) with PBDIT/Sales as the Profit Level Indicator (PLI) to benchmark its international transactions under the Manufacturing segment. The TPO substituted PBDIT/Sales with PBIT/Sales, including depreciation in the total operating costs. The Tribunal upheld this substitution, reasoning that depreciation is an integral part of operating costs. The Tribunal emphasized that "depreciation is an inseparable and an integral part of the operating costs," aligning with the Hon’ble Bombay High Court’s decision in CIT Vs. Welspun Zucchi Textiles Ltd. 2. Adjustment on Account of Higher Depreciation Rates and Under-utilization of Capacity: The assessee argued for adjustments due to higher depreciation rates and under-utilization of capacity. The TPO allowed adjustments for higher depreciation rates and under-utilization of capacity but denied further adjustments for excessive depreciation compared to comparables. The Tribunal agreed, stating that no further adjustment is permissible as the overall operating profit margin encompasses the cumulative effect of all operating expenses and incomes. 3. Exclusion of Federal-Mogul Bearings India Ltd. (FMBIL) from the List of Comparables: The TPO excluded FMBIL from the comparables due to its diversified activities, including manufacturing of Powder and Aluminum Tins, and significant Related Party Transactions (RPTs). The Tribunal upheld this exclusion, highlighting the importance of functional similarity in comparability analysis. It noted that FMBIL’s diversified activities and lack of segmental information made it incomparable to the assessee, which is solely engaged in manufacturing bearings. 4. Grant of +/-5% Margin in Determining the ALP: The Revenue contested the grant of a +/-5% margin in determining the ALP. The Tribunal referred to the second proviso to section 92C(2), which allows for such a margin if the variation between the ALP and the transaction price does not exceed the specified margin. The Tribunal upheld the CIT(A)’s decision to grant this margin, noting its applicability to the assessment year 2009-10 as clarified by the Finance (No.2) Act, 2009. 5. Inclusion of Certain Companies in the List of Comparables for the Trading Segment: The Revenue challenged the inclusion of certain companies in the list of comparables for the Trading segment. The Tribunal noted that even if the contested companies were excluded, the assessee’s profit margin would still fall within the permissible +/-5% range. Consequently, while technically accepting the Revenue’s ground, the Tribunal concluded that it would not lead to any transfer pricing addition under the Trading segment. Conclusion: The Tribunal dismissed the assessee’s appeal and partly dismissed the Revenue’s appeal on merits, with part of it becoming academic. The Tribunal upheld the TPO’s approach to including depreciation in operating costs, denied further adjustments for higher depreciation, and supported the exclusion of FMBIL from comparables. The decision to grant a +/-5% margin in determining the ALP was also upheld.
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