2015 (12) TMI 1275 - AT - Income Tax

Transfer pricing adjustment - selection of comparables - Held that - We are inclined to accept the contention of the ld. CIT DR because there is no straitjacket formula given in either section 92A(2)(b) or in Rule 92A(2)(b) or in Rule 10B of the Rules for applying filter to the related party transactions, however, it is a well-settled proposition that if any company is functionally comparable with the taxpayer but at the same time it is more than a specific percentage of RTP, then the same should be ignored by treating it as a controlled transaction and hence, the view taken by the ITAT Delhi in the case of Nokia India Pvt. Ltd. (2014 (11) TMI 101 - ITAT DELHI ) is a balanced view supported by various orders of the Tribunal on the issue. Therefore, we are inclined to accept the contention of the ld. CIT DR that a company should be considered as non-comparable only if its RPT exceeds 25%. It cannot be ignored that the NTPCES is also enjoying settlement of all employees from the holding company NTPCS at cost and the benefits received from the holding company and related party transactions (RPT) are not monetised in the annual report and in absence of specific data in this regard, NTPCES cannot be held as comparable with the assessee company. Therefore, AO/TPO was not justified in including NTPCES in the final set of comparables for benchmarking impugned international transaction of the assessee company and they are directed to delete the same. The functional dissimilarity as well as distinction in the geographical market in the light of foreign exchange fluctuation risk of the assessee company coupled with below 25% RPT undertaken by the CIEL, we, therefore, decline to agree with the conclusion of the AO/DRP/TPO that the CIEL is a suitable comparable for the purpose of proposed TP adjustment made by the authorities below. Functional dissimilarity and other aspects cannot be ignored and these factors clearly demonstrate that CIEL should not have been included in the final set of comparables for making transfer pricing adjustment pertaining to the impugned international transactions of the assessee company and we order to exclude the same from the final set of comparables. Mark to market losses on foreign exchange forward contracts disallowed - Held that - Undisputedly, the facts and circumstances of the present case are more or less similar to the present AY 2009-10 and the assessee booked mart to market loss of ₹ 21.80 crore as on 31.3.09 being difference in the INR value of the USD as on 31.3.09 and the value of which the hedging contract was agreed to be settled. We further note that the assessee is following mercantile system of account for recognition of this loss in its financial statements. When we see the order of the DRP para 3.7.1, then it is amply clear that the ld. DRP has alleged that the forward contracts are not fully supported by the underlying support invoice both in terms of the amount as well as the tenure. DRP has drawn the table in this appeal and thereafter noted that out of 9 forward contracts, the assessee has only used 4 forward contract fully and the assessee has not used these forward contracts immediately but started using them against the sale invoice after the lapse of time of few months. Ld. DRP further noticed that contract no. 1461 was used for the first time on 31.10.08 for a nominal sum of USD 632 and thereafter in November for USD 144247 and balance in December 2008 for USD 2755121. Thus, it shows that there was no underlying asset for this contract from 6.8.2008 till 31.10.08. The entire forward contract could be utilised only by 31.12.08. There is no observation of the ld. DRP in para 3.7.1 which support the contention of the assessee that all forward contracts were duly honoured by delivery of contracts under USD. In this situation, in principle, we agree that in view of the ratio laid down by Hon ble Supreme Court in the case of Woodward Governer (2009 (4) TMI 4 - SUPREME COURT) while the assessee is following mercantile system of accounting, the loss suffered by the assessee by fluctuation in the foreign exchange as on the date of balance sheet is an item of expenditure u/s 37(1) of the Act. Under this proposition and dicta of Hon ble apex court, and facts emerging from the DRP order, we find it appropriate that the issue requires detailed examination and verification and calculation on scientific basis at the end of the AO/DRP in the light of relevant proposition and provisions of the Act. Therefore, relying on the said propositions and following the judgement of Hon ble apex court in the case of Woodward Governor (supra), we restore this issue to the file of AO/DRP for a fresh adjudication after factual analysis and examination of the impugned transactions after affording due opportunity of hearing for the assessee and without being prejudiced by the earlier orders.

Summary

Issues Involved:

1. Addition to the returned income by recomputing the arm's length price (ALP) of international transactions.
2. Disallowance of Mark to Market (MTM) losses on foreign exchange forward contracts.
3. Charging of interest under sections 234B, 234C, and 244A.
4. Initiation of penalty proceedings under section 271(1)(c).

Issue-Wise Analysis:

1. Addition to the Returned Income by Recomputation of ALP:

The core issue revolved around the addition of Rs. 57,46,70,024 to the returned income of the appellant by recomputing the ALP of international transactions under section 92 of the Income Tax Act. The appellant contested the rejection of its set of comparable companies by the Transfer Pricing Officer (TPO) based on additional/modified quantitative filters without valid reasoning. The appellant also argued against the inclusion of companies with high/supernormal margins and government-held enterprises in the final comparable set. The Tribunal noted that the appellant is a captive service provider offering engineering design and related services to its Associated Enterprises (AEs). The Tribunal found merit in the appellant's contention that Certification Engineers International Ltd. (CEIL) and NTPC Electrical Supply Company Ltd. (NTPCES) were not suitable comparables due to their functional dissimilarity, geographical market differences, and related party transactions (RPT). The Tribunal directed the deletion of these companies from the final set of comparables, thereby nullifying the need for any transfer pricing adjustment to the returned income of the appellant.

2. Disallowance of Mark to Market (MTM) Losses:

The appellant claimed a loss of Rs. 21,80,46,325 on re-measuring the foreign exchange forward contract as on the balance sheet date. The Assessing Officer (AO) disallowed this loss, terming it notional and contingent. The appellant argued that the AO erred in relying on Instruction No. 3/2010 issued by the Central Board of Direct Taxes (CBDT), which was applicable to assessees trading in forex derivatives and issued after the relevant financial year. The Tribunal noted that the appellant consistently followed a method of accounting for forward contracts based on a scientific method in the ordinary course of business. The Tribunal observed that the issue was covered in favor of the appellant by the Tribunal's order for AY 2008-09, where similar losses were allowed. However, the Tribunal restored the issue to the file of the AO/Dispute Resolution Panel (DRP) for fresh adjudication after factual analysis and examination of the transactions, following the Supreme Court's judgment in the case of Woodward Governor (312 ITR 254).

3. Charging of Interest Under Sections 234B, 234C, and 244A:

The Tribunal did not provide a detailed analysis of this issue, as it was consequential to the primary issues discussed. The Tribunal dismissed this ground as it was consequential in nature.

4. Initiation of Penalty Proceedings Under Section 271(1)(c):

The Tribunal found this ground premature and dismissed it without detailed discussion.

Conclusion:

The Tribunal partly allowed the appeal on transfer pricing issues by directing the deletion of certain comparables and partly allowed the appeal for statistical purposes on the issue of MTM losses by restoring it to the AO/DRP for fresh adjudication. The grounds related to interest and penalty proceedings were dismissed.