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TMI Blog2014 (2) TMI 36X X X X Extracts X X X X X X X X Extracts X X X X ..... s actually undertaken does not exceed the specified percentage, then only the price at which the international transaction has actually been undertaken shall be deemed to be arm's length price - Thus, the benefit of tolerance margin would be available only if the variation is within the tolerance margin - Once the variation exceeded the tolerance margin, then there would be no benefit even up to tolerance margin - Then, the ALP as worked out under Section 92C(1) shall be taken as ALP without any benefit of tolerance margin. Adjustments carried out by the TPO were on purchases made from its associate enterprise –It could not be point out as to which were those companies which were excluded and what were the margin levels indicated by such companies - Assessee has indeed filed before the DRP, margins of comparables adjusted for difference in working capital, but at no point of time it had given any reason why such adjustments were required - What were the debtor adjustment and creditor adjustment and how these were relevant have not been demonstrated by the assessee - the assessee has not been able to justify the adjustments that were required to be made on account of negative wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted:- 14-8-2013 - ABRAHAM P. GEORGE AND S.S. GODARA , JJ. For the Appellant : K.R. Girish. For the Respondent : Guru Bashyam. ORDER:- PER : ABRAHAM P. GEORGE In this appeal filed by the assessee, it assails the directions given by the DRP and the pursuant adjustments carried out in its income by the Assessing Officer, based on the order of the Transfer Pricing Officer. Apart from this, assessee has also raised a few grounds on issues other than transfer pricing. 2. Facts apropos are that assessee, a company engaged in supply of assembly, front-end module, cockpit, rear chassis, front chassis, etc., is 100% subsidiary of one M/s Hyundai Mobis, Korea, also referred as 'Mobis Korea'. It was incorporated in India in July, 2005. As per the assessee, its commercial production started only on 27th January, 2007. Assessee had international transactions with M/s Mobis Korea on account of purchase of raw materials, purchase of capital equipment, payment of royalty, payment of technical services fee and payment of guarantee fee. Assessee had filed return for impugned assessment year on 31.10.2007 declaring a total income of Rs. 12,17,671/-. Since assessee had internat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment for its negative working capital, when compared to the substantial positive working capital of the comparables. But, the TPO was of the opinion that no data was provided by the assessee for arriving at the 5% adjustment sought by it. As per the TPO, just because assessee was in its first year of operation, did not mean that it was necessary to incur a loss. TPO also noted that assessee's expenditures were mostly on variable costs and hence, utilization of capacity did not have any material effect. She computed the arithmetic mean of PLI of comparable companies at 5.18% of sales. Adopting such PLI to the sales effected by the assessee, the TPO arrived at the ALP of the operating cost. Therefrom she deducted the actual non-AE cost of raw materials and arrived at ALP value of the AE purchases. Difference was determined at Rs. 9,58,60,522/- and recommendations to this effect was given to the Assessing Officer. 6. Assessing Officer proceeded to frame a draft assessment order based on the recommendations of the TPO. In such draft assessment order, Assessing Officer proposed an addition of Rs. 9,58,60,522/- for the arm's length price adjustment. In addition to this, there were cert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perating profit, to the proportionate AE transactions. (xiv) TPO did not recognize need for considering multiple year data for arriving at the profit level indicator." 8. On the additions proposed by the A.O. for items other than international transactions, objections of the assessee before DRP were as under: (i) A.O. included income of Rs. 5.34 Crores arising out of an invoice raised in subsequent year, ignoring that assessee had accounted such income in the subsequent assessment year. A.O. made the above addition though a right to claim such income came to be vested on the assessee only on issuing the invoice. (ii) TPO had wrongly presumed that assessee had amortized cost of lease hold land, and incurred an expenditure of Rs. 3,26,500/-. (iii) TPO failed to appreciate that assessee had not purchased any right in the software acquired from M/s Autoever Systems Corporation, Korea, and M/s Wipro India Ltd. but had only made purchase of "Shrink-Wrapped" software and thus there was no necessity for deduction of tax of the payments. (iv) A.O. erred in proposing disallowance of Rs. 6,50,000/-, which was reimbursement of expenses, on which there was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (xi) Safe harbour as claimed by the assessee at 5% under proviso to Section 92C(2) could not be given, since amendment introduced by the Finance (No.2) Act, 2009 had come into effect from 1.10.12009 and assessee's assessment was completed after the said date. As per the DRP, position was explained in Corrigendum to Circular No.5 of 2010 dated 30.9.2011 issued by CBDT. (xii) Assessee's claim that TPO had attributed the shortfall in profits entirely to its international transaction without taking the proportionate turnover relatable to raw material imported from associate enterprise, could not be accepted, since cost variation relating to non-AE transaction were passed on to unrelated parties." 10. On issues other than transfer pricing, the DRP held as under: (i) Invoice raised in the subsequent year was only for difference between estimated price and final price, for sales already effected to M/s HMI. Under the matching principles of mercantile system of accounting, income stood accrued to the assessee. (ii) Though deduction of tax for royalty payment would not apply to off-the-shelf software, the agreement entered by the assessee with M/s Autoever Sys ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w in selecting the comparable companies having controlled transactions. (5.3) Erred in law in upholding/confirming the action of the TPO in computing the arm's length price using single-year margin of the comparable companies as against three-year weighted average margin of the comparable companies as enumerated in Rule 10B(4) of the Rules. (6.1) Erred on facts and in the circumstances of the case and in law in ignoring the economic commercial circumstances prevailing in the appellant's business during the year in which the appellant's business was in operation only for two months and was in the nature of a start-up. Further, erred in adopting a biased premeditated approach to make a transfer pricing adjustment by completely ignoring the transfer pricing approach documented by the appellant. (6.2) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in not allowing suitable economic adjustment as provided under Rule 10B of the Rules, to account for the difference between international transactions and the comparable uncontrolled transactions selected by the learned A.O./TPO. Erred in not allowing adjustm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he raw material purchased. Assessee could not be compared with other companies, which were having substantial value addition on the material purchased. 16. In support of ground No.6, learned A.R. submitted that lower authorities ignored the date on which assessee had commenced its commercial operation. It was only on 26.1.2007 and therefore, assessee was a start-up concern. Assessee had operations for two months alone. Comparing the result of a two months old company with other well-entrenched companies, was not logical. Comparables chosen by the assessee were unjustly rejected. DRP itself had admitted that product-to-product comparability was not required in TNMM. In the companies selected by the TPO, atleast three were having related party transactions exceeding 20%. Further, according to learned A.R., adjustments were required to be made to the margin since assessee was having negative working capital. Substantial Customs duty was paid by the assessee. Imported raw material consumed by the assessee relatable to the AE itself came to 27% of its total cost. As per the learned A.R., adjustments were required to be carried out for off-setting excess expenditure incurred by the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore, the A.O. was justified in applying Rule 10B(4) and selecting a set of comparables by searching the Prowess and Capital Line data base. In any case, as per learned D.R., assessee had at no point of time objected to the comparables selected by the DRP. TPO had selected 14 comparables having similar manufacturing line and out of these, atleast three companies, namely, Automotive Stampings Assemblies Ltd., Axles India Ltd. and Subros Ltd. were common in the list considered by both the parties. Assessee selected eight companies under Prowess search and 'Nil' companies from Capital Line database. One of the filters adopted by the assessee, while arriving eight comparables, was exclusion of start-up companies. By this filter, assessee itself had excluded 61 companies. Having itself excluded the start-up companies from the list of possible comparables, assessee could not now turn back and say that it should be given adjustment for being a start-up. Further, as per learned D.R., assessee could never demonstrate that three companies out of fourteen selected by the TPO had related party transaction exceeding 26%. The impact of negative working capital on the profitability, if any, requ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtly owned by Government of Co-operative society were removed to concentrate on profit oriented companies 111 Companies having R D expenditure more than 3% of sales were rejected to eliminate full-fledged manufacturers 108 Companies having advertisement, marketing distribution expenses to sales more than 3% were eliminated to focus on companies not earning on account of performing such functions 60 Companies having Net fixed assets upon sales more than 50% were rejected to eliminate full-fledged manufacturers 54 Companies with a positive net worth were included to exclude companies whose net worth had eroded 52 Companies with sales turnover lesser than Rs. 1 Crore were selected to exclude startup companies 52 Companies whose value added expenditure as a percentage of total cost greater than 20% were rejected to exclude high value adding companies 19 Qualitative - companies that were functionally comparable and that did not have controlled transactions were selected 8 SUMMARY OF SEARCH PROCESS - CAPITALINEPLUS Criteria and reason for usage ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntemporaneous data had some deficiency rendering it not readily comparable. There was no such aspect pointed out. Just because the selected companies were old, would not by itself be a reason to reject the selection. Though assessee's counsel submitted that loss making companies were unjustly excluded by the TPO, he was unable to point out which were those companies which were excluded and what were the margin levels indicated by such companies. However, we find substantial strength in the grievance of the assessee that three of the companies selected by the TPO were having related party transaction in excess of 26%. This factor had not been addressed by any of the lower authorities. Comparisons have to be made with uncontrolled transactions and it is essential that entities having related party transactions are eliminated, in such comparison to the extent possible. If three out of the 14 companies, were having related party transactions in excess of 25%, as mentioned by the assessee, these had to be excluded. 29. Coming to the aspect of adjustment pleaded by the assessee for negative working capital, no doubt, in the case of Demag Cranes Components (India) (P) Ltd. (supra), it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its objection before the DRP that total raw material imported from the associate concern constituted only 27% of its total cost. As per the assessee, cost of components consumed by AE was 27% of the total cost of Rs. 370633638/- incurred, whereas, the remaining cost related to unrelated domestic suppliers. No doubt, in the case of Skoda Auto India (P) Ltd. (supra), it was held by Pune Bench that higher import content of raw material was a factor to be considered while doing the ALP analysis. Nevertheless, it is also mentioned therein that higher import content of raw material itself did not warrant an adjustment in operating margins. For getting the benefit of any such adjustment, assessee should be able to demonstrate that higher import content was necessitated by any extraordinary circumstance beyond its control. Assessee had endeavoured to make a 5% adjustment to its total cost for off-setting the leverage derived on account of negative working capital and for taking care of under utilization of capacity. Nevertheless, there was no empirical data ever provided by the assessee to support the figure of 5% arrived by it. 31. As to the claim of the assessee that valuations made b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as calculated the operating profit on the entire sales of the assessee, which in our considered opinion, is not justified, when it is admitted position that only 45.51 per cent of raw material has been acquired by the assessee from its associate concerns for the purpose of manufacturing items. The assessee has stated that the operating profit if applied to 45.51 per cent of the turnover would come to Rs. 35,52,573 as against operating profit of Rs. 24,35,175 booked by the assessee, and the difference thereof would only be called for to be made as addition to the profit shown by the assessee. We, therefore, direct the Assessing Officer to modify the assessment and make the adjustment only to the extent of difference in the arm's length operating profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the assessee. Therefore, to this extent, the addition made by the Assessing Officer and further confirmed by the CIT(A) is reduced. We order accordingly." Thus, if assessee's purchase of raw material from associate enterprise is 27% of the total raw material purchase, then the adjustment for ALP has to be restricted to 27% of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd No.8 is dismissed as not pressed." 35. Accordingly, Assessing Officer shall re-work the adjustment required to the pricing of the international transactions by restricting such adjustment to the turnover proportionate to purchase of raw materials from associate enterprise, after excluding the three comparables having related party transactions exceeding 25%. 36. Now we take up the assessee's grounds which are not related to transfer pricing. 37. Vide ground No.9, grievance raised by the assessee is that a sum of Rs. 5,34,00,000/- added to its income despite the invoice having been raised in the succeeding year. 38. Facts apropos are that related party transactions reported by the assessee showed that it had made sales of Rs. 34.31 Crores to M/s Hundai Motor India Limited (HML). However, the Profit Loss account reported a figure of Rs. 28.97 Crores only. Assessee was required to explain why such sum should not be added to its income both for computing total income and book profit income. Reply of the assessee was that supplementary invoice of Rs. 5.34 Crores was not raised on HML during the relevant previous year and hence could not be considered as income. However, Ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price of the raw materials purchased by the assessee from its associate enterprise. 42. Ground No.9 of the assessee stands allowed. 43. When ground No.10 was taken up, learned A.R. submitted that he was not pressing the same. Hence, this ground is dismissed as not pressed. 44. Vide ground No.11, assessee is aggrieved on disallowance made under Section 40(a)(i) and 40(a)(ia) of the Act for non-deduction of tax at source on payments made for acquiring certain software. 45. Facts apropos are that Assessing Officer had found that assessee had acquired a software license from M/s Autoever Systems Corporation, Korea for Rs. 80,71,622/- and another software license for Rs. 13,34,327/- from M/s Wipro Ltd., India. Assessee had not deducted tax at source on both the above payments. Assessing Officer was of the opinion that former was covered under Section 40(a)(i) and the latter was covered under Section 40(a)(ia) of the Act. Disallowance was proposed for both these amounts. Though assessee submitted before the DRP that these were "Shrink-Wrapped" or copyrighted packaged software. According to it, while purchasing such software, there were no royalty whatsoever involved. These were o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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