2018 (10) TMI 49 - AT - Income Tax

TPA - comparables selection criteria - Held that - In the present case, the fact that the product manufactured by the tested party i.e. the Assessee viz., laboratory and processing equipment thus companies functionally dissimilar with that of assessee need to be deselected from final list. Benefit of a working capital adjustment - TPO/AO is directed to consider the claim of the assessee and allow adjustment to profit margins towards working capital adjustment in accordance with the law, after affording assessee the opportunity of being heard. TPA - CIT(A) for considering the entire sales in manufactured finished goods segment for determination of ALP - Held that - Presumption of the CIT(Appeals) is without any basis. He has not demonstrated with actual figures as to how there would be impact on profit margin on sale of finished products to AE because of purchases of some components from AE. He has given examples which are imaginary figures. Apart from this, the TPO has accepted that purchase of raw material and components by the assessee from its AE is at arm s length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only in respect of international transactions i.e., transactions with AE. Thus we hold that the transfer pricing adjustment should be restricted only to the AE related transactions of the assessee. Determining the operating expenses - Held that - On the first aspect of allocation of foreign exchange gain on proportionate basis, we are of the view that the same has to be on actuals. With regard to considering bad debts as operating expense, we are of the view that it is only the bad debts in manufacturing segment that should be considered as expenses of manufacturing segment for working out the OP/OC. We hold and direct accordingly on the aforesaid additional grounds. Benefit of MAT credit u/s 115JAA - Held that - Would be just and appropriate to direct the AO to verify the claim of assessee and allow the claim for MAT credit in accordance with the law.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for international transactions.
2. Selection of comparable companies.
3. Treatment of foreign exchange fluctuations.
4. Adjustment for capacity utilization.
5. Adjustment for working capital differences.
6. Scope of transfer pricing adjustments.
7. Deduction of prior period expenses.
8. Computation of operating margin.
9. Deduction of sales commission to non-resident agents.
10. Allowance of MAT credit.
11. Imposition of interest under sections 234A, 234B, and 234C.
12. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for international transactions:
The assessee used the Transactional Net Margin Method (TNMM) to establish the ALP for its international transactions. The Transfer Pricing Officer (TPO) rejected the economic analysis and comparables chosen by the assessee, conducting a fresh analysis and selecting different comparables. The Tribunal upheld the TPO's rejection of the assessee's TP study, stating the reasons given in the TPO's order were sufficient to reject the study.

2. Selection of comparable companies:
The TPO rejected two of the three comparables selected by the assessee and included four new companies. The Tribunal upheld the inclusion of the TPO's selected comparables, stating that differences in the products did not significantly affect the comparability based on functions performed, assets employed, and risks assumed. However, the Tribunal directed the inclusion of Gansons Limited and Span Diagnostics Limited, which were initially rejected by the TPO, as they were functionally comparable to the assessee.

3. Treatment of foreign exchange fluctuations:
The Tribunal directed the TPO to treat foreign exchange fluctuations consistently as operating in nature for both the assessee and the comparable companies. This direction was in line with the settled legal position.

4. Adjustment for capacity utilization:
The Tribunal emphasized the necessity of making adjustments for capacity utilization differences between the assessee and the comparables. It directed the TPO to obtain capacity utilization data from the comparable companies using powers under section 133(6) of the Act and make necessary adjustments to account for the under-utilization of capacity by the assessee.

5. Adjustment for working capital differences:
The Tribunal acknowledged the impact of working capital differences on profit margins and directed the TPO to allow adjustments for working capital differences between the assessee and the comparables, following the principles laid down in various judicial precedents.

6. Scope of transfer pricing adjustments:
The Tribunal held that transfer pricing adjustments should be restricted to transactions with Associated Enterprises (AEs) only and not the entire segment. This conclusion was based on the provisions of section 92 of the Act and supported by judicial precedents, including decisions from the Bombay High Court and ITAT Bangalore.

7. Deduction of prior period expenses:
The Tribunal admitted the additional ground regarding the deduction of prior period expenses and directed that the deduction should be allowed if the liability crystallized in the relevant assessment year (AY 2012-13).

8. Computation of operating margin:
The Tribunal directed the TPO to rectify the computation of the operating margin by considering the correct amount of foreign exchange gains and bad debts attributable to the manufacturing segment. The revised operating margin of the assessee was to be computed accordingly.

9. Deduction of sales commission to non-resident agents:
The Tribunal did not entertain the issue of deduction of sales commission to non-resident agents in the current appeal, as it was not raised before the AO or CIT(A). The assessee was advised to agitate this issue in AY 2013-14.

10. Allowance of MAT credit:
The Tribunal directed the AO to verify and allow the MAT credit of ?5,59,895 as claimed by the assessee, in accordance with the law.

11. Imposition of interest under sections 234A, 234B, and 234C:
The Tribunal directed the AO to verify the claim of the assessee regarding the filing of the return before the due date and accordingly delete the interest under section 234A. For interest under sections 234B and 234C, the AO was directed to give consequential relief.

12. Initiation of penalty proceedings under section 271(1)(c):
The Tribunal dismissed the ground regarding the initiation of penalty proceedings under section 271(1)(c), stating that no appeal lies against the initiation of penalty.

Conclusion:
The appeal by the assessee was partly allowed, with specific directions to the TPO and AO on various grounds, ensuring adjustments and computations were made in accordance with the law and judicial precedents. The Tribunal's detailed analysis provided clarity on the treatment of comparables, adjustments for capacity utilization and working capital, and the scope of transfer pricing adjustments.

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