2015 (10) TMI 738 - AT - Income Tax

Working Capital Adjustment to the profit of the assessee - whether assessee is not eligible for the benefit of /- 5% as standard deduction in view of provisions of section 92C(2) - selection of comparables - Held that - On account of peculiar circumstances under which the assessee is carrying on its business i.e. providing services to its associate enterprises only with mark-up of 10% on the cost and where there is no adversity on account of working capital then such working capital adjustment is to be made in the hands of the companies which are picked up as comparables to bring the same to the level of the assessee while benchmarking the international transactions entered into by the assessee. Thus an endeavour is to be made to bring the results of comparables at par with the results of the tested party as if the same are working in the same environment. In the case of the assessee where it is benefited on account of its transactions entirely with its associate enterprises on the basis of an Agreement under which it is entitled to a mark-up of 10% on cost working capital adjustment on such account merits to be allowed to the assessee. The OECD has provided guidelines for such working capital adjustment and the said guidelines are one of the accepted modes of computing working capital adjustment. In view thereof we hold that the assessee is entitled to the working capital adjustment which in turn is to be computed as per the OECD guidelines. The assessee has filed the computation of working capital adjustment to the results of the comparables before us and the same were also filed before the Assessing Officer and some adjustment has been allowed on account of working capital adjustment by the Assessing Officer while giving effect to the order of CIT(A). However the errors pointed out by the assessee vide different communications to the Assessing Officer / TPO and the concerned Commissioner have not been carried out till date. Accordingly we direct the Assessing Officer to complete the exercise of working capital adjustment to be allowed to the assessee within a period of 45 days from the date of this order after affording reasonable opportunity of hearing to the assessee. Upholding the order of CIT(A) with regard to the allowability of working capital adjustment we dismiss the grounds of appeal raised by the Revenue. In view of the concession of the learned Authorized Representative for the assessee that in case the working capital adjustment is allowed to it then the margins shown by the assessee in respect of international transactions with its associate enterprises was within /- 5% of the margins shown by the list of comparables we do not adjudicate the issues raised in the appeal filed by the assessee.

Issues Involved:
1. Working Capital Adjustment
2. Rejection of Comparables
3. Adjustment of Administrative Expenses
4. Operating Margins and Non-Operating Expenses
5. Risk Adjustment
6. Tax Cost and Profit After Tax Consideration
7. Eligibility for Tax Holiday and Manipulation of International Transactions

Detailed Analysis:

1. Working Capital Adjustment:
The primary issue raised by the Revenue was the CIT(A)'s allowance of working capital adjustment without considering the correct practice of taking the average of opening and closing balances. The CIT(A) noted that the assessee, a wholly owned subsidiary of its parent AE company, worked only for the said company at a cost plus 10% margin, and thus, had minimal working capital requirements compared to other comparables. The CIT(A) directed the Assessing Officer to verify the calculation and allow working capital adjustment as per records, which would bring the margins within the acceptable range of +/- 5%. The Tribunal upheld the CIT(A)'s decision, directing the Assessing Officer to complete the exercise within 45 days.

2. Rejection of Comparables:
The assessee contended that the CIT(A) erred in confirming the rejection of certain companies considered as comparable due to functional differences and being loss-making. The CIT(A) followed the decision of the Special Bench of ITAT - Chandigarh Bench in DCIT v. Quark Systems (P) Ltd, which held that merely because a comparable is making a loss, it cannot be excluded. The Tribunal did not specifically adjudicate this issue due to the resolution of the working capital adjustment.

3. Adjustment of Administrative Expenses:
The assessee argued that the CIT(A) erred in not allowing adjustments for basic administrative expenses incurred to maintain corporate identity and support staff, which were not part of "Service Provider costs" as per the inter-company services agreement. The Tribunal did not specifically address this issue due to the resolution of the working capital adjustment.

4. Operating Margins and Non-Operating Expenses:
The assessee contended that the CIT(A) did not appreciate that the operating margins as per the inter-company services agreement were 10%, and non-operating expenses such as loss on sale of assets and donations should be added back while calculating operating margins. The Tribunal did not specifically address this issue due to the resolution of the working capital adjustment.

5. Risk Adjustment:
The assessee argued that the CIT(A) erred in not granting any adjustment towards the lower risk borne by the assessee compared to the comparables. The Tribunal noted that the TPO did not allow the risk adjustment due to lack of supporting evidence. The Tribunal did not specifically address this issue due to the resolution of the working capital adjustment.

6. Tax Cost and Profit After Tax Consideration:
The assessee contended that for benchmarking purposes, profit after tax should have been considered, and tax cost should be part of operating costs as the assessee was eligible for deduction u/s. 10A. The Tribunal did not specifically address this issue due to the resolution of the working capital adjustment.

7. Eligibility for Tax Holiday and Manipulation of International Transactions:
The assessee argued that it was eligible for a tax holiday u/s. 10A and had no reason to manipulate the value of its international transactions, as there was no benefit in shifting profits outside India. The Tribunal did not specifically address this issue due to the resolution of the working capital adjustment.

Conclusion:
The Tribunal upheld the CIT(A)'s decision to allow working capital adjustment, directing the Assessing Officer to complete the exercise within 45 days. Consequently, the appeals of both the Revenue and the assessee were dismissed. The Tribunal did not specifically address other issues raised by the assessee due to the resolution of the working capital adjustment.

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