9911796707
TMI Blog2014 (2) TMI 36X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 international transactions of value exceeding the prescribed limit, Assessing Officer made a reference to Transfer Pricing Officer (TPO). 3. For the transactions in the nature of purchase of raw materials from its associate enterprise, assessee had adopted Transaction Net Margin Method (TNMM) for evaluating the pricing, whereas, for purchase of capital equipments, payment of royalty, reimbursement of travel and accommodation expenses and payment of guarantee fee, assessee had adopted Comparable Uncontrolled Price (CUP) method. TNMM was also followed for evaluating the technical services fee paid. The dispute before us, insofar it relates to transfer pricing is confined to determination of arm's length price of raw materials and material parts purchased from associate enterprise, for which TNMM was adopted. 4. Assessee had filed a TP study based on a set of comparables identified on a search conducted on 15.2.2007 in Prowess & Capital Line data bases. Since the search for the comparables itself was conducted during t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO. 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 certain other additions as well. These were for income arising out of an invoice raised subsequent to the end of relevant previous year, disallowance of amortization cost of lease hold land, disallowance of payment made for acquiring software licence and reimbursement of expenses for non-deduction of tax at source. 7. Assessee elected to move the DRP against proposed draft assessment. Objections of the assessee on the TP adjustment proposed could be summarized as under:- (i) TPO had conducted a fresh analysis and in the process, adopted a new set of comparables without cogent reasons and without rejecting the transfer price documentation of the assessee. (ii) TPO considered companies with controlled transactions also as comparables. (iii) TPO adopted data which were not contemporaneous. (iv) TPO did not make required adjustments under Rule 10B for difference in start-up expenses, depreciation, Customs Duty and capa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 no necessity to deduct tax at source. (v) A.O. erred in holding that assessee had excess depreciation on account of adjustment on notional gains on exchange fluctuation with the cost of the assets.' 9. The DRP, after considering the above objections of the assessee, held as under, with regard to transfer pricing adjustments proposed by the A.O.:- (i) TP study done by the assessee was correctly rejected by the TPO. TP study was done much before the end of the year and the data collated by the assessee was for period preceding to the relevant previous year. (ii) Multiple year data could not be considered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll 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 Systems Corporation, Korea and M/s Wipro Ltd. would show that what was acquired were customized softwares, specially designed for assessee. Hence, tax was required to be deducted at source. (iii) Disallowance of Rs. 3,26,500/- proposed on amortization of leasehold land was justified in the facts and circumstances of the case. (iv) Assessee's argument that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gainst 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 adjustment for the following: working capital, Customs duty and, One-time start-up expenses. (7) Erred ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l 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 assessee for starting its operations, before making a comparison. In any case, according to him, Assessing Offic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pital 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, requiring an adjustment, was never demonstrated by the assessee. Assessee had simply made 5% adjustment citing idle capaci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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 No. of companies passing the criterion Total universe of companies available in CapitalinePlus as of February 15, 2007 13,887 Identified additional companies with positive sales over the time period under consideration were selected i.e. companies for which data was not available in Prowess 762 Compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 was held that adjustment had to be granted for eliminating material effects, if any, arising out of difference in working capital between tested party and comparables. Nevertheless, we find from the said decision that the plea regarding adjustment for working capital was first raised before DRP and the DRP had decided the issue without realizing that this was never adjudicated by the TPO. As per the assessee, it was having negative working capital as against substantial posi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered 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 by the Customs authority on the import of raw material for the purpose of levy of Customs duty should be taken as a proper comparable, we do not find any merit. This is for the reason that, as pointed out by DRP, valuation by the Customs authority is as per Customs Rules, which are not relevant for the purpose of transfer pricing under income-tax rules. Further, the purpose of valuation by the Customs authority is to determine undervaluation and by its very nat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the total turnover. 33. Coming to the aspect of + 5% safe harbour limits, this is no more res integra, in view of the decision of Special Bench in the case of IHG IT Services (India) (P.) Ltd. v. ITO (I.T.A. No.5890/Del/2010 dated 30.4.2013). The Special Bench was constituted to consider whether prior to the insertion of the second proviso to Section 92C(2), the benefit of 5% tolerance margin as prescribed under provisio to Section 92C(2) for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eding 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, Assessing Officer was not impressed. According to him, Annual Report of the assessee clearly mentioned sales to M/s HML was Rs. 34.31 Crores. Assessee was following mercantile system of accounting and hence this income should have been accounted in the relevant previous year. He, therefore, proposed an addition of Rs. 5.34 Crores, which was confirmed by the D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... )(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 outright purchase of software and hence tax deduction under Section 194J was not required. This argument did not find any favour with DRP. 46. Now before us, learned A.R. submitted that Section 40(a)(i) and Section 40(a)(ia) both mandated deduction of tax at source on royalty payments. However, according to him, the term "royalty" mentioned in these Sections had ..... X X X X Extracts X X X X X X X X Extracts X X X X
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