2016 (6) TMI 590 - AT - Income Tax

Addition on account of transfer pricing adjustment - selection of comparable - Held that - We are covered under the first situation in which the TPO referred to seven new companies as comparable in his order but ignored them on the touchstone of parity in not considering any new company as comparable including those proposed by the assessee. Once, the assessee has assailed the non-inclusion of its company, namely, Kusalava International, which it is also lawfully entitled to and we accept such contention, then simultaneously the other seven companies originally selected by the TPO should also be taken up for consideration. We hold accordingly. In our opinion, considering the comparability of these seven companies does not amount to making out a new case by the AO/TPO because these seven companies were specifically taken note of by the TPO as comparable in his order. Turning to the merits of comparability, we find that there is not much discussion in the TPO s order about the functional profile of Kusalava International Ltd., on one hand and other seven companies viz., Varroc Engineering, Hi Tech Arai, Varroc Engineering, Asco India Ltd., Perfect Circle India Ltd., Rane Engine Valve Ltd., Auto Gallon Industries Ltd., on the other. Under such circumstances, we deem it befitting to set aside the impugned order and remit the matter to the file of TPO/AO for considering the comparability or otherwise of Kusalava International Ltd. and other seven companies afresh, after allowing a reasonable opportunity of being heard to the assessee. Apart from the inclusion of the Kusalava International Ltd., the ld. AR also pressed for the inclusion M/s Design Auto System in the list of comparables. It was fairly admitted that this company was not chosen by the assessee as comparable either before the TPO or before the DRP. Referring to the Annual report of this company, it was argued that the same was functionally similar. The ld. DR opposed the inclusion of this company in the list of comparables. As in an earlier para, we have restored for fresh consideration of Kusalava International Ltd. and seven other companies to the TPO after allowing due opportunity to the assessee. While carrying out this exercise, the TPO is also directed to consider the comparability or otherwise of Design Auto Systems and then deal with it accordingly. Non granting of working capital adjustment - Held that - If a company carries high trade receivables, it would mean that it is allowing its customers relatively longer period to pay their dues, which will result into higher interest cost and the resultant low net profit. Similarly, by carrying high trade payables, a company benefits from a relatively longer period available to it for paying back the dues to its suppliers, which reduces the interest cost and increases profits. In order to neutralize the differences on account of carrying high or low inventory, trade payables and trade receivables, as the case may be, it becomes eminent to allow working capital adjustment so as to bring the case of the assessee at par with the other functionally comparable entities. We, therefore, agree in principle with the grant of working capital adjustment. The view taken by the Dispute Resolution Panel for not allowing such an adjustment that the assessee did not furnish necessary details is not tenable since the assessee did furnish the necessary details, which have been adverted to during the course of proceedings before us. However, since such details qua the grant of such an adjustment have not been examined because of refusal to grant such adjustment at the threshold, we are of the considered opinion that it would be fit and proper to set aside the impugned order on this issue and send the matter back to the file of the AO/TPO for computing and allowing working capital adjustment, if any, available to the assessee Computation of transfer pricing adjustment in respect of transaction with Associated Enterprises (AEs) and non-AEs - Held that - Under the TNMM, the process is simple in initially finding out the operating profit margin of the assessee and then the average adjusted operating profit margin of comparable cases. Such adjusted profit margin of the comparables constitutes benchmark margin, which is then compared with the operating profit margin from the assessee s international transactions with its AE. It is not permissible to make transfer pricing adjustment, by applying the average operating profit margin of the comparables on the assessee s universal transactions entered into with both the AEs and non-AEs. As the entire exercise under Chapter-X is confined to computing total income of the assessee from international transactions having regard to the arm s length price, there is no scope for computing income from non-international transactions having regard to the ALP. As the TPO has computed the transfer pricing adjustment qua all the transactions carried out by the assessee with reference to the base of total sales , also inclusive of sales made to non-AEs, we vacate the impugned order on this issue and restore the matter to the file of the TPO/AO for recalculating the amount of addition of transfer pricing adjustment by taking into consideration the international transactions only to the exclusion of transactions with non-AEs. Assessee appeal is allowed for statistical purposes.

Summary

Issues Involved:
1. Comparables
2. Working Capital Adjustment
3. Transfer Pricing Adjustment for International Transactions

Detailed Analysis:

I. Comparables

The primary issue in this appeal is the addition due to transfer pricing adjustment amounting to ?2,74,69,498/-. The assessee, a wholly-owned subsidiary of Federal Mogul Pty. Ltd., Australia, engaged in manufacturing and marketing various auto components, used the Transactional Net Margin Method (TNMM) with a Profit Level Indicator (PLI) of Operating Profit/Sales. The assessee's Operating profit margin was 3.34%, while the average profit rate of five comparables was 1.77%. The Transfer Pricing Officer (TPO) did not dispute the TNMM method but altered the comparables, selecting three companies with an average OP/Sales of 8.82%. The assessee proposed including Kusalava International Ltd. as a comparable, which the TPO rejected due to its phase of losses.

The Tribunal noted that the TPO refused to consider Kusalava International Ltd. and other seven companies he identified, maintaining a stance of not considering any fresh comparables. The Tribunal emphasized the need to consider both Kusalava International Ltd. and the seven companies identified by the TPO for a fair assessment. The Tribunal remitted the matter to the TPO/AO to reassess the comparability of Kusalava International Ltd. and the seven companies, along with Design Auto Systems, which was newly proposed by the assessee.

II. Working Capital Adjustment

The second issue is the non-granting of working capital adjustment. The Tribunal disagreed with the authorities' view that the adjustment was not allowable due to the assessee's failure to demonstrate the impact of working capital differences on margins. The Tribunal highlighted that working capital adjustments are essential to neutralize differences in inventory, trade receivables, and trade payables, which affect net profit margins. The Tribunal remitted the issue back to the AO/TPO to compute and allow the working capital adjustment after examining the necessary details provided by the assessee.

III. Transfer Pricing Adjustment for International Transactions

The final issue is the computation of transfer pricing adjustment for transactions with both Associated Enterprises (AEs) and non-AEs. The TPO calculated the adjustment based on the entity-level figures, including unrelated transactions. The Tribunal clarified that transfer pricing adjustments should only apply to international transactions with AEs, not to transactions with non-AEs. The Tribunal vacated the impugned order and remitted the matter to the TPO/AO to recalculate the transfer pricing adjustment, considering only the international transactions. This view was supported by judgments from the Hon'ble jurisdictional High Court in CIT v. Keihin Panalfa Ltd. and CIT v. Thyssen Krupp Industries India (P.) Ltd.

Conclusion

The Tribunal set aside the impugned order on the issue of transfer pricing adjustment and remitted the matter to the AO/TPO for fresh determination of the Arm's Length Price (ALP) of the international transaction, ensuring due opportunity for the assessee to be heard. The appeal was allowed for statistical purposes, with the order pronounced in the open court on 11.05.2015.