2017 (9) TMI 112 - AT - Income Tax

Allocation of the expenses while determining the arm s length price - allocation of expenses under the head manufacturing and other expenses in the profit and loss account to the trading segment and the addition on account of difference in the arm s length price - Held that - In the present case, it is an admitted fact that the allocation of the expenses while determining the arm s length price also included some direct expenses e.g. depreciation, consumables and wages etc. which were related only to the manufacturing segment. So those expenses cannot be allocated to another segment i.e. trading segment. We, therefore, remand this issue back to the file of the TPO/AO for proper allocation and determining the arm s length price. Accordingly, the directions given by the ld. DRP are modified to this extent that expenses which are directly related to the manufacturing activity are to be excluded from the list of the total expenses to be allocated to the trading segment on the basis of turnover ratio.

Summary

Issues Involved:
1. Addition on account of transfer pricing matters.
2. Allocation of expenses to the trading segment.
3. Violation of the principle of natural justice.
4. Use of current year data for comparable companies.
5. Levy of interest under sections 234B and 234C.
6. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Addition on account of transfer pricing matters:
The assessee challenged the addition of INR 68,70,256 proposed by the Dispute Resolution Panel (DRP) under Section 144(C) of the Income Tax Act, 1961. The Assessing Officer (AO) assessed the income at INR 7,42,71,293 against the returned income of INR 6,54,78,631. The Transfer Pricing Officer (TPO) recomputed the margin of comparable companies by only considering the direct cost of production, leading to an adjustment of ?2,14,16,351. The DRP, however, directed the AO to make an adjustment of ?68,70,256.

2. Allocation of expenses to the trading segment:
The DRP allocated indirect expenses under the head 'manufacturing and other expenses' to the trading segment, which the assessee argued was erroneous. The assessee contended that no indirect expenses were allocated to the trading segment as the functions performed were minimal. The DRP, however, redrew the segmental accounts by allocating indirect expenses in the proportion of turnover from manufacturing and trading segments, respectively. The Tribunal found that certain direct expenses related to manufacturing should not have been allocated to the trading segment and remanded the issue to the TPO/AO for proper allocation.

3. Violation of the principle of natural justice:
The assessee argued that the DRP redrawing the segmental accounts without providing an opportunity to be heard violated the principle of natural justice. The Tribunal directed the TPO/AO to grant a due and reasonable opportunity of being heard to the assessee while deciding the allocation of expenses.

4. Use of current year data for comparable companies:
The assessee contended that the DRP erred by disregarding multiple year/prior years' data used in the transfer pricing documentation and using current year data for comparable companies. The Tribunal did not specifically address this issue in the detailed analysis but focused on the allocation of expenses and the arm's length price determination.

5. Levy of interest under sections 234B and 234C:
Both parties agreed that the levy of interest under sections 234B and 234C is consequential in nature. The Tribunal ordered accordingly.

6. Initiation of penalty proceedings under section 271(1)(c):
The Tribunal found that the initiation of penalty proceedings under section 271(1)(c) was premature and dismissed this ground.

Conclusion:
The Tribunal allowed the appeal for statistical purposes, remanding the issue of proper allocation of expenses to the TPO/AO and directing them to exclude expenses directly related to manufacturing from the trading segment allocation. The levy of interest was deemed consequential, and the initiation of penalty proceedings was dismissed as premature.