2016 (7) TMI 811 - AT - Income Tax

TPA - selection of comparable - Exclusion of HMT Bearings Ltd - Held that - It is undisputed fact that this company is a public sector undertaking company. Its operations are based on policy requirements of the Government and it is a preferred company of the Govt. of India for entrusting of work and therefore, it totally operates in a controlled environment. Hence, this company cannot be compared with that of the assessee-company, which is a private company operating in uncontrolled business environment Exclusion of SLN Bearings Ltd., the assesseecompany is seeking exclusion of this company from the list of comparables on the ground that its export sales are less than 4%. We find from the Annual Report of the company, filed in paper book at page Nos.545 to 567, that the export sales were ₹ 62.03 lakhs as against total sales of ₹ 1239.17 lakhs which is less than 4% and whereas exports of assessee-company are 100% of total sales. Thus we hold that this company cannot be compared with the assessee-company whose export earnings are less than 4% as the assessee-company exports constitutes 100% of the sales. Gains made on account of foreign exchange earnings as part of operating income included. Exclusion of preliminary expenditure and preoperating expenditure from operating cost - Held that - As this expenditure have nothing to do with operations of the company. We hold that this should not be included as part of operating cost. Accordingly, we direct the AO to exclude this expenditure from operating expenditure. We make it clear that our directions relating to adjustment of operating profits/operating cost should be made applicable even in case of comparable companies finally chosen and accordingly, the issue is restored to the file of TPO/AO on the above lines.

Issues Involved:

1. Validity of reference to Transfer Pricing Officer (TPO).
2. Selection and rejection of comparables.
3. Inclusion of foreign exchange gains in operating income.
4. Exclusion of preliminary and pre-operating expenses from operating costs.
5. Adjustment to book profits under section 115JB.
6. Levy of interest under sections 234B and 234D.

Detailed Analysis:

1. Validity of Reference to TPO:
The assessee-company contended that the reference made by the Assessing Officer (AO) to the TPO was invalid as it did not establish the necessity or expediency of such a reference. The CIT(A) upheld the validity of the reference, justifying the AO's decision to involve the TPO for determining the arm’s length price (ALP) of international transactions.

2. Selection and Rejection of Comparables:
The TPO initially selected HMT Bearings Ltd. and SNL Bearings Ltd. as comparables but later excluded HMT Bearings Ltd. due to falling revenues and operational issues. The assessee argued that HMT Bearings Ltd. should not have been excluded as its functional comparability was not in dispute and the fall in profit was due to extraordinary expenses like VRS compensation. The tribunal upheld the exclusion of HMT Bearings Ltd., citing its operation in a controlled environment as a public sector undertaking, which is not comparable to the assessee-company operating in an uncontrolled business environment.

Regarding SNL Bearings Ltd., the assessee-company argued for its exclusion due to its predominantly domestic operations, with export sales constituting less than 4% of total revenue, unlike the assessee-company with 100% export sales. The tribunal agreed and excluded SNL Bearings Ltd. as a comparable, referencing the decision in Bechtel India Pvt. Ltd. vs. DCIT, which held that companies with significant domestic operations are not comparable to those with predominantly export operations.

3. Inclusion of Foreign Exchange Gains in Operating Income:
The assessee-company argued that foreign exchange gains should be included in operating revenue. The tribunal agreed, directing the TPO/AO to include foreign exchange gains as part of the operating income, referencing multiple decisions supporting this inclusion.

4. Exclusion of Preliminary and Pre-operating Expenses from Operating Costs:
The assessee-company contended that preliminary and pre-operating expenses should not be included in operating costs as they do not relate to the company’s operational activities. The tribunal upheld this view, directing the AO to exclude these expenses from operating costs and apply this adjustment to comparable companies as well.

5. Adjustment to Book Profits under Section 115JB:
The assessee-company argued that unabsorbed depreciation should not be added back to book profits. The tribunal did not provide a specific ruling on this issue, focusing instead on the transfer pricing adjustments.

6. Levy of Interest under Sections 234B and 234D:
The assessee-company contested the levy of interest under sections 234B and 234D. The tribunal did not specifically address this issue, as the primary focus was on transfer pricing adjustments.

Conclusion:
The tribunal partly allowed the appeal for statistical purposes, directing specific adjustments related to the exclusion of certain comparables, inclusion of foreign exchange gains in operating income, and exclusion of preliminary and pre-operating expenses from operating costs. Other grounds of appeal were dismissed as they were either not pressed or deemed unnecessary for adjudication.

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