2021 (7) TMI 44 - AT - Income Tax

TP Adjustment - improper working capital adjustment - HELD THAT - Advances to suppliers and advances from customers are integral part of working capital adjustment in the same way in which there are trade receivables and trade creditors. Such advances, ergo, cannot be excluded in computing the working capital adjustment. Reference to trade receivables and trade payables in the example given in Annexure to Chapter III of the OECD transfer pricing Guidelines, 2010 should be construed as including advances to suppliers and advances from customers. It is only for simplification purpose that the example refers to trade receivables and trade payables to the exclusion of advances to suppliers and advances from customers. We, therefore, amplify the direction of the ld. CIT(A) to the AO/TPO for adopting the method of working capital adjustment as provided in the example given in Chapter III of the OECD Guidelines by also considering Advances to suppliers and Advances from customers, in the same way as Trade receivables and Trade payables. The figures of Advances to suppliers and Advances from customers, as given by the assessee for the first time before the ld. CIT(A) pertaining to self and the comparables, have not been verified by any authority. These need to be examined and evaluated by observing that only advances to or from customers/suppliers should be included in the computation of working capital of the assessee as well as the qualifying comparables - no advance or outstanding other than relating to purchase or sale of goods should find its place in the computation of working capital. Filter of Manufacturing sales more than 75% of total sales - Exclusion of Fives Cail KCP Ltd. on improper application of one of the accepted filters - The filter under consideration - 'Manufacturing sales not less than 75% of the total sales' - applies at the first level of company selection so that only the companies engaged mainly in manufacturing activity get selected at the entry level. It has no application at the second level of transaction level comparison. If a company has passed the filter and entered the first level, it will have to pass the transaction level comparison also so as to get eligible for inclusion in the final list of comparables. In order to become comparable to an international transaction of Manufacturing, a company will get included only if it is either exclusively in Manufacturing or if it is not so exclusively in manufacturing (having 75% or more as manufacturing), but its segmental information of the Manufacturing is separately available. Adverting to the facts of the extant case, we find that Fives Cail KCP Ltd. passes the filter of Manufacturing sales not less than 75% of the total sales and ex consequenti the company level test is through, but it fails the transaction level test inasmuch as it is albeit largely a manufacturing company but also has service income of 17% of its total revenue and admittedly no segmental information for the Manufacturing activity is available. So, this company having manufacturing activity at 83% cannot be considered as comparable to the international transaction under consideration of 100% Manufacturing activity. We, therefore accord our imprimatur to the exclusion of this company from the list of comparable.

Summary

Issues Involved:
1. Working Capital Adjustment
2. Filter of Manufacturing Sales More Than 75% of Total Sales - Inclusion of Fives Cail KCP Ltd.

Issue-wise Detailed Analysis:

1. Working Capital Adjustment:

The assessee did not initially claim any working capital adjustment in its Transfer Pricing study report or before the Transfer Pricing Officer (TPO). The claim was first made before the Commissioner of Income Tax (Appeals) [CIT(A)], who directed the Assessing Officer (AO) to adopt the method of working capital adjustment as per the OECD Transfer Pricing Guidelines, 2010. The dispute centered on whether "Advances to suppliers" and "Advances from customers" should be included in the working capital adjustment.

The Tribunal noted that the OECD guidelines' example for working capital calculation does not explicitly include these advances. However, it reasoned that advances to suppliers and advances from customers impact profitability similarly to trade receivables and payables, thus should be included in the working capital adjustment. The Tribunal directed the AO/TPO to include these advances while computing the working capital adjustment, ensuring only advances related to the purchase or sale of goods are considered.

2. Filter of Manufacturing Sales More Than 75% of Total Sales - Inclusion of Fives Cail KCP Ltd.:

The assessee included Fives Cail KCP Ltd. as a comparable company, asserting it met the filter of having manufacturing sales comprising more than 75% of total sales. The TPO excluded this company due to its exceptionally low profit (loss), a reasoning overturned by the CIT(A). However, the CIT(A) excluded the company due to the lack of segmental information, as it also had significant revenue from services (17%).

The Tribunal upheld the CIT(A)'s exclusion of Fives Cail KCP Ltd. The Tribunal explained that the comparable selection process involves two levels: company level and transaction level. Even if a company passes the company level filter (manufacturing sales more than 75%), it must also pass the transaction level comparison. Since Fives Cail KCP Ltd. did not have separate segmental information for its manufacturing activity, it failed the transaction level test. Therefore, it could not be considered comparable to the assessee's 100% manufacturing activity.

Conclusion:

The Tribunal set aside the impugned order and remanded the matter back to the AO/TPO for redetermining the Arm's Length Price (ALP) in accordance with the directions provided. The appeal was partly allowed for statistical purposes, ensuring the assessee would be given a reasonable opportunity to be heard.