2015 (4) TMI 722 - AT - Income Tax

Transfer pricing adjustment - Income on account of determination of arm's length price of the international transactions entered by the assessee with its associated enterprises - CIT(A) deleted the addition - working capital adjustment working - Held that - In-principle, we are in agreement with the stand of the assessee that while carrying out comparability analysis in the TNM Method, appropriate adjustment deserves to be allowed with respect to the working capital differences between the tested party and the potentially comparable concerns. In the present case, the assessee has not incurred any interest expenditure and therefore the stand of the Revenue is that no adjustment is to be allowed with respect to the working capital differences vis- -vis the comparable concerns. In our considered opinion, the aforesaid objection of the Revenue is not in a correct perspective as it does not take into consideration other factors which have a bearing on the working capital requirements. No doubt, incurrence of interest expenditure for the funds used in business impact the operating margins. So however, the period of credit allowed to the customers also is a factor which would impact the working capital requirements and consequential sale realizations. In the present case, assessee has worked out the working capital difference for the time lag in recovery of the sale proceeds. In assessee s case the said time lag is quite short inasmuch as it was also pointed out that in some cases assessee has received monies in advance. Nevertheless, assessee has placed a working regarding the difference in time lag in sale recoveries in the case of the assessee and that of the three comparables concerns selected by the TPO. The difference in such time lag is applied to the Prime Lending Rate (PLR) to compute the working capital adjustment. On this basis, an adjustment of 5.90% was determined, which was required to be applied to the operating margins of the three comparable concerns. The CIT(A), in our view, made no mistake in accepting the plea of the assessee for allowing of such working capital adjustment. The said action of the CIT(A), in our view, is liable to be affirmed. As before the CIT(A), assessee pointed out that while it calculated its own PLI i.e. operating cost/operating profit without including any interest expenditure as it was Nil , but advertently in respect of the comparable concerns, who had incurred interest costs, assessee did not remove such interest costs while working out their PLIs. In this manner, the assessee furnished a revised working of the PLIs of the three comparables concerns selected by the TPO. Accordingly, as against the average margin of 20.91% computed by the TPO, the revised average margin of the three comparable concerns was computed at 23.70%. The CIT(A) accepted the aforesaid position and thereafter he has accepted assessee s plea for an adjustment of working capital differences between assessee and the three comparable concerns. The CIT(A) held that the denial of working capital adjustment by the TPO was not correct and that though the computation of the working capital adjustment was before him, it was not examined by the TPO. Therefore, for the limited purpose of verification of such working he has remanded the matter back to the file of the Assessing Officer. Thus no addition on account of the arm's length price of the international transaction to be made - Decided in favour of assessee.

Summary

Issues Involved:
1. Deletion of addition made to the returned income on account of determination of arm's length price of international transactions.
2. Entitlement to working capital adjustment in the comparability analysis.
3. Acceptance of comparable entities and adjustments in determining the arm's length price.

Issue-Wise Detailed Analysis:

1. Deletion of Addition on Account of Arm's Length Price Determination:
The Revenue's primary grievance was against the order of the Commissioner of Income Tax (Appeals) [CIT(A)] deleting the addition of Rs. 1,52,21,969/- made to the returned income due to the determination of the arm's length price of international transactions entered by the assessee with its associated enterprises. The Assessing Officer, based on the Transfer Pricing Officer's (TPO) report, had determined the arm's length price higher than the stated value, leading to the addition. The CIT(A) deleted this addition, prompting the Revenue's appeal.

2. Entitlement to Working Capital Adjustment:
The CIT(A) granted the assessee a working capital adjustment while carrying out the comparability analysis vis-`a-vis the comparables selected by the TPO. The CIT(A) noted that the working capital requirements of the assessee were different from those of the comparables, justifying the adjustment. The CIT(A) directed the Assessing Officer to verify the calculation and if the adjusted margins fell within the acceptable range of +/- 5% of the assessee's margin, no adjustment would be required. This decision was challenged by the Revenue but upheld by the ITAT, affirming the CIT(A)'s stance on allowing the working capital adjustment.

3. Acceptance of Comparable Entities and Adjustments:
The assessee's Cross-objection raised issues regarding the acceptance of 13 comparable entities, the inclusion of Compucon Software Ltd. as a comparable, and the allowance of various adjustments for determining the arm's length price. However, since the appeal of the Revenue was dismissed, rendering the addition on account of the arm's length price moot, these cross-grounds were considered academic and not adjudicated.

Conclusion:
The ITAT upheld the CIT(A)'s decision to delete the addition made to the returned income based on the arm's length price determination, affirming the entitlement to working capital adjustment. The Revenue's appeal was dismissed, and the assessee's cross-objection was rendered infructuous. The judgment emphasized the importance of considering working capital differences in comparability analysis and validated the CIT(A)'s approach in granting the necessary adjustments.