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TMI Blog2012 (6) TMI 138X X X X Extracts X X X X X X X X Extracts X X X X ..... ofar as it relates to determination of ALP of the purchases made from AEs - matter remanded back On contention of assessee that adjustment ought have been allowed on the margins with reference to M/s Halonix Ltd., for a reason that it had different functionality it is held that ALP analysis is made under TNM method. TNM method is generally preferred where functions are not strictly comparable, but when the tested and comparables were in the same lines of business. - IT Appeal No. 1915 (Mds.) of 2011 - - - Dated:- 14-5-2012 - ABRAHAM P. GEORGE, VIKAS AWASTHY, JJ. ORDER Abraham P. George, Accountant Member In this appeal filed by the assessee, it assails the order of A.O., TPO and directions of the Dispute Resolution Panel (DRP) with reference to an addition of Rs. 13,22,36,997/- to its income. Out of this addition, Rs. 13.18 lakhs pertains to a Transfer Pricing (TP) issue, whereas, the balance is a disallowance under Section 14A of Income-tax Act, 1961 (in short 'the Act'). Both the additions have been strongly disputed by the assessee. 2. Issue regarding addition made under the Transfer Pricing Provision is taken up first. 3. Facts apropos are that assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee excluded those companies which were not having activities related to auto head lights. This eliminated another 23 companies. What was left were two companies, namely, one M/s Halonix Ltd. and one M/s Fiem Industries Ltd. Taking these two companies as comparables, assessee arrived at an arithmetical mean of 19.27% as operating profit of such companies. The operative margin of the assessee was 19.43%. Thus, as per the assessee, the purchase price paid for components stood justified. 5. For computation of ALP, Assessing Officer made a reference under Section 92CA of the Act, to the Transfer Pricing Officer (TPO). TPO issued a show cause notice wherein she pointed out that other income and prior period income including provisions were considered as a part of "operating income" and prior period expenses were considered as "operating cost". As per the TPO, only operating cost and operating income could be considered for arriving at operating margin and items of the type mentioned above were not part of such income or expenses. She, therefore, re-worked the PLI of the aforesaid two companies and for Fiem Industries Ltd., the PLI worked out by her was 8.12% and for Halonix Limit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s Sales Scrap Sales Income From Non-Financial Services Change in stock TOTAL (A) 264.33 1.21 - 0.29 265.83 289.31 0.68 0.44 (0.59) 289.84 193.32 0.24 1.14 4.10 198.80 Raw material expenses Packaging expenses Purchase of finished goods Power, fuel water charges Compensation to employees Indirect taxes Royalties, technical know-how fees, etc. Lease rent other rent Repairs maintenance Insurance premium paid Outsourced mfg. jobs (incl. job works, etc.) Outsourced professional jobs Selling distribution expenses Travel expenses Communication expenses Printing stationery expenses Miscellaneous expenses Depreciation Amortization TOTAL (B) 175.88 - - 5.13 8.53 36.86 3.12 0.08 5.36 0.19 4.67 1.58 1.03 1.16 0.20 0.15 0.04 5.89 1.18 251.04 155.70 14.61 0.36 5.99 24.81 12.60 - 0.67 7.24 1.15 - 2.14 11.78 5.19 0.58 0.42 0.41 10.75 - 254.40 108.83 3.21 0.82 8.02 15.76 27.02 0.42 0.14 2.17 0.18 2.46 0.26 3.29 2.06 0.27 2.22 0.50 5.12 - 182.75 OP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the DRP to include three more companies to the table of comparables, i.e. in addition to the two companies already taken by it. However, the DRP was not at all impressed by any of these submissions. As far as addition of new comparables were concerned, the DRP noted that assessee itself had chosen the two companies initially and that too after exhaustive search process. Insofar as objection of the assessee for adjustment being entirely made on international transactions, DRP was of the opinion that the likely impact of non-AE cost was taken care of in the pricing and therefore, no such attribution was necessary. Insofar as 5% safe harbour range was concerned, the DRP noted that assessee had considered revenue from operations for computing such 5% and this would not be accepted. Insofar as the objections against exclusion of provision for expenses while computing operating margin of comparables was concerned, DRP was of the opinion that such provisions were rightly excluded, since assessee had not included any provisions in its own computation of profit as per books. Thus, DRP confirmed the proposal made by the A.O. in draft assessment and the A.O. proceeded to complete the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd such determination had to be with reference to international transactions only. Further, according to him, in the case of M/s Halonix Ltd., it was not an original equipment manufacturer but was supplying to retail distributors also. As against this, assessee was supplying only to original equipment manufacturers (OEMs) and was contractually debarred from supplying to any retail distributors. Assessee was functionally not in the same kind of business and therefore, if at all a comparison ought have been made, then in accordance with clause (d) of sub-Rule (2) of Rule 10B, adjustments were required to be carried out. Learned A.R. submitted that even if a small adjustment was made for difference in the functionalities, the margin will fall within +5% range and any variation in ALP would not be required. In any case, according to him, assessee had submitted before DRP three more comparable companies and these were rejected without giving any justifiable reasons. A query was put by the Bench as to whether M/s Halonix Ltd. was also involved in the same business line as that of the assessee. For this, learned A.R. replied that assessee was manufacturing light assemblies for cars exclud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sofar as non-adjustment for functional differences between comparable companies and tested assessee, learned A.R. submitted that it was a statutory requirement under the Rules and even if assessee had not made any such adjustment, Assessing Officer was bound to carry out such adjustments. 11. We have perused the orders and heard the rival submissions. At the outset we deal with the issue regarding addition of three new comparables by the assessee before the DRP. According to us, this was rightly rejected by the DRP. Assessee itself had selected two comparable companies originally and such a selection was done based on a detailed analysis, which has been given by the assessee in its Transfer Pricing Report (paper-book page 111). It is clearly mentioned that PROWESS database was utilized for selecting the two comparable companies. Exclusions were done based on availability of financial results of comparables, turnover and proportionate percentage of fixed asset and sales. Exclusions were also done on type of economic activity. Thus from 439, assessee itself eliminated 437 companies and selected two companies, namely, M/s Halonix Ltd. and Fiem Industries Ltd. TPO had not done any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts comparables after excluding those items which did not fall within operating expenses or operating income. Such exclusions were confirmed by the DRP and assessee is also not agitated by such exclusion before us. While computing the arithmetic mean of the PLIs of the two comparables, no doubt, the operating margin of M/s Halonix Ltd. has been taken as 12.93%. The operating margin even going by the figures given by the Assessing Officer was only 12.23% and not 12.73%. This is a sheer arithmetic mistake. When 12.23% is considered, the arithmetic mean of PLI comes to 10.17%. This error no doubt has to be rectified. For better understanding, the determination of ALP done by the TPO, we are re-formatting his work-out without substituting the corrected PLI, upto the level of arriving at the operating costs hereunder:- Operating income of assessee-company 265.83 Crores Operating cost of assessee-company 251.04 Crores Operating profit of assessee-company 14.79 Crores Operating profit as a percentage operating income of assessee-company 5.56% Operating ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not logical. He deducted from the operating cost, only the material cost relatable to purchases from AEs and not the operating cost attributable to such material cost. The resultant figure will not give ALP of the purchases made from AEs. If along with the material cost paid to AEs, operational cost attributable to such cost was also considered, then the sum of Rs. 2.57 Crores considered by the TPO as ALP of AE purchases, would have gone up significantly. In our opinion, therefore, the work out of ALP of the purchases from non-AEs has been erroneously done. The difference of Rs. 13.18 Crores arrived at is hypothetical. If at all raw material was deducted, other costs excluding the total raw material cost also had to be pro rata divided and deducted. No doubt, this will result in a higher ALP for the purchases made from AEs. Whether the cost when so determined falls within the +5% safe margin limits can be verified, only after a correct computation of ALP is made. We are, therefore, of the opinion that the matter requires a re-visit by the Assessing Officer insofar as it relates to determination of ALP of the purchases made from AEs. The question of application of margins on absolut ..... 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