2017 (12) TMI 1423 - AT - Income Tax

TPA - rejection of aggregation approach adopted by the assessee for benchmarking its international transactions in the manufacturing activities - Held that - Where various activities were so interlinked to the export of manufactured IC engines, then the said international transactions undertaken by the assessee for the year under consideration need to be aggregated for undertaking benchmarking analysis applying TNNM method. The Tribunal in this regard placed reliance on the principles laid down by the Hon ble High Court of Delhi in Sony Ericsson Mobile Communications India Pvt. Ltd. Vs. CIT (2015 (3) TMI 580 - DELHI HIGH COURT ). Following the same principle and where the assessee was engaged in similar activity of manufacturing, we hold that various activities need to be aggregated. Accordingly, we direct so. Applying the TNNM method - whether the margins earned by the assessee from exports to associated enterprises is to be compared with margins earned from sales in domestic market or the same have to be compared with external comparables? - Held that - Applying the said proposition laid down by the Hon ble High Court of Delhi in Sony Ericsson Mobile Communications India Pvt. Ltd. Vs. CIT (supra), we hold that accepting the aggregation approach of the assessee of its transactions under the manufacturing activity, we hold that while applying TNNM method, the margins of assessee company are to be compared with the margins of external comparables. However, since the TPO had not verified this factum of comparison with external comparables, we direct the Assessing Officer / TPO to consider the case of assessee and determine the arm s length price and re-compute adjustment, if any, in the hands of assessee on account of international transactions. It may be pointed herein itself that the adjustments were made in the hands of assessee in HHP division and no adjustment was made in LHP division. Approach adopted by the TPO in application of net profit to cost as PLI - Held that - We direct the Assessing Officer that while determining the PLI to adopt net profit to sales in order to benchmark the international transactions. Benefit of variation / reduction of 5% from the arithmetic mean is now decided against the assessee by the Special Bench of Delhi Tribunal in IHG IT Services (India) (P.) Ltd. Vs. ITO (2013 (5) TMI 309 - ITAT DELHI ), wherein it has been held that the benefit of 5% tolerance margin is available only when variation between arm s length price as determined under section 92C(1) of the Act and price at which international transactions has actually been undertaken does not exceed the said tolerance margin. Accordingly, we hold so. Re-working of deduction under section 80IB - Held that - As in assessee s own case authorities below in allocating head office expenses, directors salary, etc. to the Daman unit and thus, upheld the re-computation of deduction under section 80IB of the Act. Disallowance of expenses under section 14A - Held that - As the year of appeal being assessment year 2007-08 i.e. the year in which provisions of Rule 8D of the Income Tax Rules, 1962 were not applicable, we restrict the disallowance to ₹ 2 lakhs

Issues Involved:
1. Transfer Pricing Adjustment
2. International Transaction relating to export of IC Engines
3. Inappropriate comparison of profitability between "export to Associated Enterprises (AEs)" segment and "domestic sales" segment
4. Inappropriate approach adopted by TPO in application of "net profit to total cost" as Profit Level Indicator (PLI)
5. Benefit of the variation/reduction of 5 percent from the arithmetic mean
6. International Transaction relating to payment of Technical Know-how
7. International Transaction relating to Procurement Support Services
8. Disallowance of Deduction u/s. 80IB by the AO
9. Disallowance in respect of intangibles by the AO
10. Disallowance of expenses under section 14A
11. Initiation of Penalty Proceedings

Detailed Analysis:

1. Transfer Pricing Adjustment:
The assessee challenged the adjustment amounting to ? 55,23,59,930 to the value of international transactions with its Associated Enterprises (AEs) concerning export of IC engines, payment of technical know-how fees, and procurement support services. The Tribunal noted that the aggregation approach adopted by the assessee for benchmarking various international transactions was previously accepted in the assessee's own case for assessment years 2005-06 and 2006-07. The Tribunal directed that the aggregation approach should be accepted, and the transactions should be benchmarked using external comparables.

2. International Transaction relating to export of IC Engines:
The assessee contested the rejection of external comparable companies selected for benchmarking the manufacturing function. The Tribunal held that the TPO erred in comparing the profitability of exports to AEs with domestic sales, ignoring the differences in Functions, Assets, and Risks (FAR). The Tribunal directed that the margins of the assessee should be compared with external comparables.

3. Inappropriate comparison of profitability between "export to AEs" segment and "domestic sales" segment:
The Tribunal noted that comparing controlled transactions with other controlled transactions was not permissible under transfer pricing regulations. The Tribunal directed that the comparison should be made with external comparables only, following the principles laid down by the Hon'ble High Court of Delhi in Sony Ericsson Mobile Communications India Pvt. Ltd. Vs. CIT.

4. Inappropriate approach adopted by TPO in application of "net profit to total cost" as Profit Level Indicator (PLI):
The Tribunal found merit in the assessee's plea that the PLI should be "net profit to sales" instead of "net profit to total cost" and directed the Assessing Officer to adopt "net profit to sales" for benchmarking international transactions.

5. Benefit of the variation/reduction of 5 percent from the arithmetic mean:
The Tribunal held that the benefit of 5% tolerance margin was available only when the variation between arm's length price and the price at which the international transaction was undertaken did not exceed the said tolerance margin, following the Special Bench decision in IHG IT Services (India) (P.) Ltd. Vs. ITO.

6. International Transaction relating to payment of Technical Know-how:
The Tribunal directed that the payment of technical know-how fees should be aggregated along with other international transactions under the head 'manufacturing activity' and the arm's length price should be computed accordingly.

7. International Transaction relating to Procurement Support Services:
The Tribunal held that procurement support services should be aggregated with other international transactions under the head 'manufacturing activity' and directed the Assessing Officer to compute the arm's length price accordingly.

8. Disallowance of Deduction u/s. 80IB by the AO:
The Tribunal upheld the allocation of head office expenses, directors' salary, etc., to the Daman unit and the re-computation of deduction under section 80IB, following the decision in the assessee's own case for assessment year 2006-07.

9. Disallowance in respect of intangibles by the AO:
The ground of appeal concerning disallowance of depreciation on intangibles was not pressed by the assessee and hence dismissed.

10. Disallowance of expenses under section 14A:
The Tribunal restricted the disallowance to ? 2 lakhs, following the order in the assessee's own case for assessment year 2006-07, noting that Rule 8D of the Income Tax Rules, 1962, was not applicable for the year under appeal.

11. Initiation of Penalty Proceedings:
The Tribunal held that the initiation of penalty proceedings was premature and dismissed the ground of appeal.

Conclusion:
The appeal of the assessee was partly allowed, with specific directions provided for each issue raised. The Tribunal emphasized the need for consistent application of the aggregation approach and comparison with external comparables for benchmarking international transactions.

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