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TMI Blog2012 (1) TMI 60X X X X Extracts X X X X X X X X Extracts X X X X ..... but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee's control. Therefore, the issue should be set aside to the files of the TPO with direction to examine the claim of the assessee relating to the import cost factor and eliminate the difference if any. Applicability of proviso to section 92C(2) – Held that:- Tribunal in case of Cummins India LTD vs CIT (2011 - TMI - 207660 - ITAT PUNE) has decided in favor of the assessee in support of grant of deduction of 5%, when multiple prices in establishing the arithmetic mean are involved. Thus the assessee's ground on this issue is allowed. Incorrect computation of TP adjustment on the entire manufacturing segment sales instead of computing it sales relatable to the import of the components and spares procured from the AEs only – principle of proportionality - Held that:- TP adjustments are to computed not considering the entity level sales. Rather it should be done ideally considering the relatable sales drawing the quantitative relationship to the imports from the AEs, i.e. controlled cost. Issues related to International transaction pertaining to expor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dard cranes, process cranes, jib cranes and KBK Cranes. In the process, the assessee serves industries like automotives, auto ancillaries, engineering and manufacturing cement, foundries, steel sector, power sector, agro and bio-tech, paper petro chemical and fertilizers, textiles, Parma industries etc. Assessee filed the return of income declaring the total income of Rs. 6.4 cr, rounded off. The assessee is a fully owned subsidiary of M/s Demag Cranes and Components Gmbh, Germany. Assessee reported dutifully of having international transactions with its associate enterprises (AE) abroad and also the details of methods i.e. Transactional Net Margin Method (TNMM) and CUP as the case may be, followed by the assessee for pricing of the same. In compliance of the provisions of section 92CA(3) of the Act, the case was referred to the TPO, Pune for determination of arm's length price (ALP). During the proceedings before the TPO, it was noticed that the assessee benchmarked all the transactions (i) on a combined or aggregate basis; (ii) using multiyear (FYs 2004-05 2005-06) data; (iii) comparing the entity level margins of the assessee with that of the comparables cases ignoring require ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee after use of the requisite filter, no further adjustments needs to be entertained. Thus, the TPO worked out the arithmetic mean at the entity level and profit level indicator (PLI) of the proposed set of comparables at 7.18% using the current year data and then, compared the same with that of the assessee's case 2.41% of the manufacturing segment of the assessee to work out the variance and in turn the ALP. The said variance works out to 4.77% (i.e. 7.18% - 2.41%) and the corresponding quantum of adjustment on this account is Rs. 1,11,25,670/- (i.e. 4.77*23,32,42,565/100). Undisputedly, Rs. 23,32,42,565/- is the total sales of the assessee for the year. To sum up, the TPO not only compared the PLI of the comparables at entity level with the segment level profit margin of the assessee to arrive at the ALP of the impugned international transactions but also denied both (i) adjustments on account of working capital, expenses etc. and (ii) the benefits of the provisions of the proviso to section 92C(2) of the Act. Therefore, the additions on account of the above exercise works out to Rs. 1,11,25,670/-. 6. Further, TPO picked up the international transactions appeared in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for lower margins of assessee in respect of manufacturing activity. Using Resale price method as the most appropriate method for analyzing the arm's length nature of the transaction of export of components and spares Computation of transfer pricing adjustment from the arithmetic mean of the arm's length price instead of lower 5% arithmetic mean of arm's length price. Incorrect computation of transfer pricing adjustment to the manufacturing activity. 9. At the end of the proceedings before the DRP, the adjustments to manufacturing segment were upheld. The other directions of the DRP, relating to (i) disallowance of warranty provision and (ii) adjustments to the international transactions of the trading segment, are given as under. (a) On the adjustment of Rs. 2,28,20,059/- on account of Provision of Warranty: Vide the paragraphs 3.3.2, DRP directed the AO to verify the actual expenditure on warranty expenses incurred during the year and allow the same on actual-basis and accordingly, the provisions as well as the reversals should not be allowed as a deduction or taxed respectively. (b) On the adjustment of Rs. 8,36,293/- relating to trading segment, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s on use of multiyear data and adoption of contemporaneous data i.e. as existed at the time of assessment; (iii) merits of adjustments made by the revenue on accounts of both manufacturing and trading activities; (iv) other issues in the ground number 15 raised in appeal. 12. Summarizing the said grounds, Sri Lohia mentioned that the ground 1 is general and gets covered by the decision of the Tribunal on the other specific grounds of the appeal. Accordingly, the same may be dismissed as general in nature. We find the request of the AR is in order. Accordingly, ground 1 is dismissed as general. 13. Referring to the grounds at 2, 3, 5, 6 and 7, Ld Counsel for the assessee mentioned that these grounds either tweak into the legalities or academic aspects of the transfer pricing guidelines. Further, he mentioned that the same are not pressed if the assessee earns relief on additions made by the revenue. Ld Counsel also referred to a rectification application pending before the AO, who has not yet acted on the same. We have gone through the said grounds and find that they are academic in nature. Considering the assessee's concession, we dismiss the same as an academic exercise. 14. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of these issues, we direct the AO to grant necessary relief. Accordingly, ground nos.13 to 15 are remitted to the files of the AO for recomputation after hearing the assessee. (ii) GROUNDS FOR ADJUDICATION: 17. That leaves ground 4(a) relating to working capital related adjustments, ground 4(b) relating to import expenses related adjustments, ground 9 relating to applicability of proviso to section 92C(2) of the Act and ground 10 relating to incorrect computation of TP adjustments linking the adjustments to the gross manufacturing segment sales of Rs. 23.32 cr (rounded off) instead of the proportionate sales, which is 40 of the total sales, relatable only to the imports of raw materials, components and spares etc. Balance of the 60% of the sale relates to the indigenously acquired purchases. Issue-wise adjudication is given in the succeeding paragraphs of this order. Ground 4(a) - Working Capital Adjustment: 18. We will take up the issue relating to the 'working capital' raised in sub-ground 4(a) of the appeal. At the outset, Sri Lohia mentioned that in principle, the TP guidelines advocate in favour of making of adjustments to the unadjusted margins of the tested parties a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... working capital adjustments also have to be considered while arriving at the operating net margins. Written submissions of the DR 19. Per contra, Sri S K Singh, CIT DR and Shri Tejendra Singh CIT relied on the written submission sent by the present Sri Sajnay Singh Addl. DIT (TP)-1, Pune. Briefly, the revenue's contentions include (i) assessee did not make the claim for adjustment on account of 'working capital'; (ii) any adjustment has to be allowed in accordance with the provisions of Rule 10B(1)(e) relating to TNMM and relied on sub-clause (iii) for the proposition that the assessee failed to demonstrate that the impugned 'working capital' adjustment materially affect the price/cost/profit of relevant international transactions in the open market. (iv) as per the revenue, in the absence any definition, the 'net profit margin' normally mean the profit before tax (PBT); (v) there is elaboration on the expression 'difference' used in the said sub-clause (iii) and detailed the fact that the six comparable are filtered by the assessee himself on being satisfied about their fulfilment of the comparability on the functionality filter. Assessee never demonstrated the existence of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... working capital deficiency, also called a working capital deficit. Current assets and current liabilities include three accounts which are of special importance. They are: accounts receivable (current asset)/inventory (current assets), and/accounts payable (current liability). These accounts represent the areas of the business where managers have the most direct impact. (Source: www.wikipedia.com) (B) Effect of working capital on the Transactional pricing in turn on the Prices/ Net Profit Margin of the transactions: TNMM requires the comparing the operating profit relative to an appropriate base i.e. PLI of the tested party i.e. the controlled enterprise or transactions. Appropriate base/PLIs in controlled transaction in the TNMM are cost, sales and assets. PLI includes (i) rate of returns on capital employed i.e. operating profit to operating expenses (ii) financial ratios relationships between profit and costs/sales revenue (iii) other if they provide reliable measures of the income. Therefore, the question is if the Net working capital, i.e. current assets (accounts receivables + inventory) minus current liabilities (accounts payable), effects the pricing and therefore the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction. (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following namely :- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble accuracy to eliminate the said differences. 25. What does sub-clause (e) of Rule 10B(1) say, in particular: We have examined the provisions of 10B(1)(e)(iii) of the Income-tax Rules, 1962, which provides for the adjustments in the context of TNMM. From the above, it is explicitly clear that the for the arriving at the arm's length price (ALP) as per TNMM, the net profit margin arising out of the comparable uncontrolled transactions is adjusted to take into account differences, if any between the (i) international transactions and filtered comparables of uncontrolled transactions or enterprises entering into such transactions, which could materially affect the amount of the net profit margin in the open market. It is a fact the differences, if any mentioned in the said sub-clause (iii) are not specified in the Act. However, as evident from the above extract of the provisions, they provide for certain guidelines i.e. any differences, which could materially affect the amount of net profit margin fall in the scope of adjustments. Further, we may also take help of the available material in the form of the I T Rules, explanation-memoranda, commentaries, OECD guidelines, various jud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion P Ltd reported in 118 ITD 243, is relevant and when TNMM is applied to a case, 'the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect.' If these differences are not eliminated or removed, the comparison becomes unsound and unreliable. Further also, the decision of the Delhi Bench in the case of Sony India P Ltd (114 ITD 448) was cited for the proposition that deduction of 20% is allowable for various differences on account of intangibles, R D, risk factors, working capital, etc. referring to contents of the para 132 and 137 of the said decision, Sri Lohia stated that in that case the CIT(A) allowed adjustment to the extent of 10% against the 20% allowed by the TPO. Tribunal upheld the views of the TPO in the mater. Next one relates to an order of the Tribunal, Bangalore Bench, in the case of TNT India P Ltd supra, wherein it is mentioned that 'similarly, the working capital adjustments also have to be considered while arriving at the operating net margins'. 27. Now, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessee submitted before us that the issue of adjustments relating to Working Capital was raised before the revenue authorities and they passively allowed the issue to slip out of the active consideration. In this regard, Ld Counsel read out the contents of para 7.3.1 of the guidelines of the DRP and the same read as follows. 7.3.1 As regards the adjustment made to the manufacturing activity, as a result of which the income of the assessee has gone up by Rs. 1,11,25,670/-, it may be mentioned that after careful consideration of material on record, we are of the view that the ld TPO has given cogent reasons for coming to the conclusion that the benchmarking of assessee's international transactions falling under manufacturing activity is required to be done following the TNMM and taking comparables as has been adopted by the assessee in the Transfer Pricing study Report and considering their data for the AY 2005-06 . The TPO has already given detailed reasons for adopting PLI of proposed set of comparables at 7.18%. On the given facts, the same is found to be acceptable. Therefore, .the action of the TPO does not require any interference. 29. As seen from the above, the DRP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er subrules and in the context of the TNMM, we have analysed the need for the elimination of the difference, if any in the comparable uncontrolled transactions, which materially affect the profit margin in the open market. It is the requirement of the Rules. Who supplies the set of comparable is not the determining factor on this issue. Having noticed the difference, the revenue has to quantify the difference, if any and then revenue must decide if that difference constitutes 'materially affect' the price in open market. If the answer is affirmative, the said difference has to be removed and the margin has to be adjusted for arriving at the credible comparable PLI. Further, it is a settled proposition that the 'working capital' adjustment is one such adjustment that is required to be made in TNMM. The revenue's contention that the 'differences' specified should refer to only (i) the factor of demand and supply; (ii) existence of marketable intangibilities i.e. brand name etc; (iii) geographical location and the like, and such difference has to be in respect of the functions undertaken, assets employed and the risks assumed only. Further, the revenue's views that by making adjustmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... site adjustments. Yes, data availability is the limitation and both the parties need to ensure the procurement and use of the proper documentation. Therefore, we dismiss the revenue's contention that no further adjustment if any is entertained once the comparables are supplied by the assessee and when they are accepted by the TPO. Thus, working capital is a factor which influence the price in the open market and therefore the net profit margin of the business segment of the assessee which is targeted by the TPO/AO/DRP. Hence, in principle, we hold that the TPO/AO/DRP has failed to entertain the objections of the assessee on the 'working capital' adjustments issue. Therefore, we direct them to allow the requisite adjustment on account of the impugned 'working capital' while determining the Arm's Length operating Margin of the Comparables. Thus, relevant grounds of assessee's appeal are allowed. 32. Meaning of 'Likely to materially affect '- Quantification: Now we shall take if the quantity of the said 'working capital' adjustments is that much which is likely to materially affect the price/margin of the international transactions involved. As per the assessee, unadjusted Arm's len ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ground 4 (b) has two limbs i.e. warranty claim and trade import cost of raw material and components and spares. Ld counsel mentioned that the adjustments with regard to the warranty claims are not pressed. Therefore, the limited issue for adjudication out of this said sub-ground (b) relates to the adjustment on account of higher import cost. In this regard, Ld counsel submitted that the assessee provided the commercial reasons in relation to grant of adjustment on account of higher import cost of the assessee vis-a-vis the comparable companies before the TPO/DRP. The relevant write up by the assessee on this issue of import cost related adjustment read as under: The company has 35.71% higher imports as compared to its comparable companies. Further, the additional cost incurred by the Company as compared to comparable companies on basis custom duty, landing charges, clearing and forwarding charges and insurance freight will be around 18% to 21%. Summarized below are the key figures/details Particulars Operating profit/total sales (adjusted for higher import cost) 6.61% Arm's length Operating Margin of Comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparables relied upon by the assessee. The CIT also mentioned that the comparables supplied to the A.O are those which are selected by the assessee himself. In these circumstances, the assessee should not be permitted to ask for adjustments to the already benchmarked ones. 37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analysed the relevant provisions of Income Tax Rules vis-a-vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the 'working capital'. In principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of 'import cost' works out to 0.57% (7.18%-6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decision relied upon by the assessee's coun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The argument before us was that it was first year of assessee's operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee's claim is that it was in these circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car was computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is permissible merely because the higher costs are incurred for the inputs. That argument has been rejected by a Co-ordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. This additional argument was not available before the authorities below and it will indeed be unfair for us to adjudicate on this factual aspect without allowing the TPO to examine all the related relevant facts. We, therefore, deem it fi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -5% is not available to the assessee." The appellant is contesting the above conclusion of the Hon'ble DRP and with respect to its contention that the transfer pricing adjustment, if any, should be made after giving the benefit of +/-5%, the appellant places its reliance on the following cases: Case law Cummins India Limited [ITA No.277 1412/PN/07] (Pune ITAT) DCIT v. Sony India TS-19-ITAT-2008 (DEL)(Delhi ITAT) ACIT v. UE Trade Cortn (India) Pvt. Ltd [2010] [ITA No.4405 (Del)/2009 Starent Networks (India) P Ltd v. DCIT [ITA No.1350/PN/2010] (Pune ITAT) M/s. SAP Labs India Pvt. Ltd. v ACIT (ITA No.398/Bang/2008) Bang ITAT Tecnimount ICB Private Limited [ITA No.7098/Mum/2919] (Mumbai ITAT) Huntsman Advanced Materials India Pvt. Limited ITA No.8237/Mum/2010 ITO v. Hartland Info Consultancy Services Ltd. ITA No.5175(Del) ITAT) Further the appellant submits that as per the proviso to section 92C(2) of the Act, an assessee has the option of charging a price to its AEs, which may vary from the arm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at prescribing a range for determining arm's length price would help accommodate for wide differences between the functions performed, risks undertaken, business circumstances and other similar circumstances pertaining to the 'tested party' vis-a-vis the comparables. A similar view is endorsed by OECD guidelines. "It also is important to take into account a range of results when using the transactional net in the business characteristics of associated enterprises and any independent enterprises engaged in comparable uncontrolled transactions, because the range would permit results that would occur under a variety of commercial and financial conditions." Thus, drawing reference from the position as per the provisions of the Act, also supported by various judicial precedents and OECD Guidelines, the appellant submits that benefit of +/- 5per cent variation in determining the arm's length price needs to be given in the instant case in case the Hon'ble ITAT proposes to continue with the transfer pricing adjustment in the case of the appellant. The appellant prays that the adjustment (if any) be made after allowing the benefit of +/- 5% variation from the arithmetic mean arm's length ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Networks (I) P Ltd ITA NO 1350/PN/2010. In this regard, Ld Counsel cited a paragraph from the order of the Tribunal in the case of cited case from the Hyderabad Bench of the ITAT in the case of Deloitte Consulting India P Ltd, supra stating that the order of the Co-ordinate Bench of the Tribunal will normally to be followed in case where there are contrary decisions of two Benches of the Tribunal. 43. We have perused the cited decisions of various benches in general and the decisions of the Pune Bench in particular and find that Pune Bench of the tribunal has decided in favour of the assessee in support of grant of deduction of 5%, when multiple prices in establishing the arithmetic mean are involved. It is a settled law vide Hyderabad Bench of the ITAT in the case of Deloitte Consulting India P Ltd, supra, that the order of the Co-ordinate Bench of the Tribunal will normally to be followed in case where there are contrary decisions of two Benches of the Tribunal. It is also a settled law that the judgment favourable to the assessee to be followed when there are two contrary decisions on the issue. Therefore, we find no reason to not to follow our own Co-ordinate Bench decisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ). In this regard, Ld Counsel relied on the provisions of the Rule 10B(1)(e) and also various judicial pronouncements on the subject i.e. (i) Emerson Process Management India P Ltd ITA NO. 8118/M/2010; (II) T Two International P Ltd and others; IL Jin Electronics I P Ltd 36 SOT 227 Del; Starlite case 2010-TII-28-ITAT-DEL-TP; Abhishek Auto Industries Ltd 2010-TII-54-ITAT-DEL-TP etc. 46. We have heard the parties and perused the relevant provisions of the said rule. Sub-clause (i) and (ii) of the Rule 10B(1)(e) referred to the expressions 'in relation to' and the 'relevant base'. They read as follows: (i) The net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) The net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; 47. From the above, it is vivid that in TNMM, the net profit margin realized by the test ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to arrive at the amount of adjustment. In simple terms if the sales to Associated Enterprises is taken at Rs. 25 crores and straight way 7.25% margin is applied then approximately total margin would be Rs. 1.81 crores, whereas adjustment has been made at Rs. 2,57,26,138/-..." C. IL Jin Electronics I P. Ltd. v ACIT 36 SOT 227 Page 470 of the Paper Book: " 15. The assessee has also taken one alternative ground out of the total raw materials consumed by the assessee for manufacturing printing circuit boards, only 45.51 per cent of the total raw materials were imported through assessee's associated concerns, and, therefore, any adjustment, if any called for, can only be made to the 45.51 per cent of the total turnover, and not to the total turnover of the assessee. After considering the facts of the case, we do not find any difficulty in accepting this contention of the assessee that at best only 45.51 per cent of the operating profit can be attributed to imported raw material acquired from assessee's associate concerns. In the present case, the AO has calculated the operating profit on the entire sales of the assessee, which in our considered opinion, is not justified, when it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the domestic sales segment it is only 2.88 per cent. .. We, therefore, accept this second proposition also that only international transaction is to be taken into account while calculating the ALP". 49. All these cited decision in general and the decision in the case of IL Jin Electronics I P Ltd, supra, in particular are uniform in asserting that the TP adjustments are to computed not considering the entity level sales. Rather it should be done ideally considering the relatable sales drawing the quantitative relationship to the imports from the AEs, i.e. controlled cost. The principle of proportionality is relevant here and it is a settled law in this regard. In the situation like the one in the instant case of the assessee, there is data relating to controlled and uncontrolled cost particulars. This undisputed data is suffice to arrive the proportionate sales relatable to the international transaction with the AEs i.e. controlled cost. Accordingly, the grounds 10 relating to Incorrect computation of transfer pricing adjustment to the manufacturing activity is allowed pro tanto. 50. Therefore, in principle, we accept the argument of Ld Counsel for the assessee and allo ..... X X X X Extracts X X X X X X X X Extracts X X X X
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