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TMI Blog2014 (2) TMI 652X X X X Extracts X X X X X X X X Extracts X X X X ..... maintain its account on mercantile basis - Under such method of accounting, the expenses `incurred' are considered for deduction irrespective of the actual payment - Income is recognized when right to receive income is acquired notwithstanding the actual receipt of the amount - Such items of incurring of expenses or accrual of income have not been taken out of the amount of net profit to characterize the numerator as `Cash profit' - the profit so deduced by the assessee and claimed as `cash profit' is strictly speaking neither cash profit nor profit under mercantile system, but hybrid of both. Whether any adjustment towards higher depreciation is called for – Held that:- Sub-clause (iii) to rule 10B(1)(e) clearly provides that the normal gross profit mark-up of comparables is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions etc - To ask for adjustment, it is sine qua non that there should be some independent and substantial reason for claiming adjustment in profit rate of comparables - The singular effect of higher quantum of an item of expenditure de hors th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... abandoned – Revenue could not draw our attention towards any part of sections 35D or 37(1), which prohibits the allowability of expenses simply for the reason that it was incurred outside India – thus, the reasoning adopted by the CIT(A) cannot be upheld for sustaining this addition. Whether the expenditure should be allowed u/s 37(1) in entirety or should be allowed as preliminary expenditure u/s 35D – Held that:- The decision in CIT Vs Priya Village Roadshows Ltd. 2009 (8) TMI 765 - Delhi High Court ] followed - Where expenditure was incurred on feasibility study on new project development connected with the existing business with a common administration and common fund, and the new project was shelved with no new asset being created, the impugned expenditure was allowable as revenue expenditure - the assessee incurred such expenditure for the extension of the existing business on conducting market feasibility study for the same products in Mauritius – thus, the decision taken by the ld. CIT(A) cannot be upheld – Decided in favour of Assessee. - ITA No. 1816/Del/2011, CO No. 155/Del/2011 - - - Dated:- 11-2-2014 - Shri R. S. Syal And Shri I. C. Sudhir,JJ. For the Peti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here were no accumulated losses at the end of the year because the reduction in paid up capital took place during the said year. Since, the facts and circumstances for the current year are mutatis mutandis similar to those for the preceding year, in which the tribunal has allowed the assessee's claim, respectfully following the precedent, we hold that the benefit of brought forward loss cannot be denied for the purposes of computation of books profit u/s 115JB. However, the Assessing Officer is directed to verify the correctness of the figure so claimed. The impugned order on this issue is set aside and accordingly the matter is remitted to the AO for deciding it afresh in conformity with the mandate of the order of the Tribunal for the earlier year in the light of the facts prevailing for the year under review. 4.1. (i) Ground No. 2 of the Revenue's appeal is against the deletion of disallowance made on account of deduction u/s 80HHC for the purpose of computing the book profits u/s 115JB. (ii) Next ground of the Departmental appeal is against the deletion of disallowance of depreciation of vehicles which were pending for registration in the name of the assessee. (iii) Next ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cepted at Arm's Length Price which were benchmarked by the assessee by applying TNMM with PLI of OP/TC. 5.3. The entre dispute revolves around the determination of the ALP of the international transactions under the Tooling Division. To demonstrate that the international transactions under this Division were at ALP, the assessee here also applied TNMM. However, the PLI from the other two Divisions was departed from and chosen as `Cash profits to Sales' (CP/S) for this Division. The amount of `Cash profits' was computed by excluding two non-cash items viz., Depreciation and Tools written off from the Operating profit. In Notes to accounts, the assessee mentioned that Tools were written off over a period of two years from the date of purchase. On that basis, it was claimed that the mean of similar PLI of the comparables chosen by the assessee at 13% was well below its 20% under this Division. The TPO accepted the denominator of `Sales' as correct, but objected to the adoption of the numerator as 'Cash profits'. On being show caused, the assessee submitted that the profits of the Tooling Division were significantly impacted due to change in depreciation policy effected in this year. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... holding by the ld. CIT(A) of the substitution of cash profit with net operating profit, thereby reducing the amount of depreciation and tools written off (which is also a different nomenclature for depreciation). The ld. AR vehemently argued that primarily, the adoption of cash profit was appropriate and secondly, if the Bench was not with him, then suitable reduction be allowed towards higher depreciation charged by the assessee. I. IS IT CASH PROFIT OR NET OPERATING PROFIT UNDER TNMM ? i. The key question which falls for our adjudication is as to whether the adoption of Cash profits as the numerator under the TNMM is in accordance with law ? ii. Section 92C of the Act provides that the ALP shall be computed by any of the prescribed methods which is the most appropriate method. Five methods have been enshrined in specific and the last one is general. TNMM is the fourth method as provided u/s 92C. The mandate for determining the ALP under TNMM is given as per rule 10B(1). Clause (e) of this rule gives modus operandi for determination of ALP under TNMM as under:- (e) transactional net margin method, by which,-- (i) the net profit margin realised by the enterprise from an i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... operating profit margin') from international transactions is at arm's length. In common parlance, the term `Net profit' refers to the profit of the assessee after depreciation, interest and taxes. But in the context of TNMM, this term restricts itself to `Net operating profit', which means the profit from business activity after considering all direct and indirect costs and excluding non-operating incomes and expenses. To put it simply, it refers to the determination of profit by ignoring non-operating costs and revenues and also extraordinary and exceptional items which are non-recurring in nature. The logic in considering net operating profit margin is simple that the items of income/expense which are not concerned with the business operation of the assessee are taken out with a view to derive a fair picture about the profitability from operations. In this process, all the operating expenses and all the operating revenues are taken into consideration. However, the items of expenses or income which are not connected with the business operations of the assessee are excluded. This implies that all the operating expenses are required to be necessarily included while calculating the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o vitiate. v. Coming back to the facts of our case, we are unable to comprehend as to how depreciation can be excluded from operating expenses under TNMM, when the assessee is a manufacturing unit. As such, this contention advanced on behalf of the assessee is repelled. We hold that `net operating profit' is required to be considered and `cash profit' is not an appropriate numerator in this case. vi. Even otherwise the assessee's calculation of the so called 'Cash profit' by simply reducing the amount of depreciation from the amount of net profit does not stand anywhere. The assessee is a limited company. As such, it is required to maintain its account on mercantile basis. Under such method of accounting, the expenses `incurred' are considered for deduction irrespective of the actual payment. Similar is the position about the revenue. Income is recognized when right to receive income is acquired notwithstanding the actual receipt of the amount. When the assessee has maintained its account under the mercantile system of accounting, it automatically implies that the expenses having been incurred or income having been accrued but not actually paid or received have also impacted th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is no change in the rate of depreciation on Factory Equipments, Factory Equipment (For Export Ins. Machines), Dies and Moulds (both for Local production and Export production) and Computers. Although there is change in the rates of depreciation of generators and vehicles, yet the rate of depreciation on computer remains the same. Similarly, albeit the rate of depreciation on vehicles has changed, there is no change in other blocks of assets, such as, Building and Furniture and Fixture. An overview of such change in the rates of depreciation brings to light that the change in the rate of depreciation only on such assets has been effected which are not substantial. However, the rate of depreciation on Plant and Machinery (New and Old machines) has not been changed. Similarly, there is no change in the rate of depreciation on the blocks of Building and Furniture Fixture. The ld. AR was directed to place on record a chart showing the quantum of change in the overall amount of depreciation as a result of change in rate of depreciation of certain individual items of plant and machinery. No such information has been filed. As such, we infer that there is no substantial change in the ove ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related and consequential items, such as repair costs etc., the results are likely to be distorted. It shows that increase in one expense cannot be viewed in isolation. It is required to be examined with its corresponding effect on related items. Such increase or decrease in individual items of expenses may be due to a particular business model adopted by the assessee. To cite an example, an increased amount of Salaries may be due to the policy of the assessee in comparatively more outsourcing of items. In such a situation, though the expense under the head `Salary' will be less, but there will be more `Job work charges' etc. A company which outsources less and sticks to more own production regime, may need to have more assets, which may result in higher amount of depreciation. In such a case, claiming adjustment on account of higher depreciation will be absurd. Similarly, an entity may book entire salary expense under one head, while another may bifurcate it into different parts and include some part in Marketing expenses or Factory overheads etc. In such a case also, the comparison of `Salary' expense in separation will be meaningless. In the like manner, one company may use more ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year 2003-04 under consideration but also for the assessment years 2004-05 and 2005-06, which are also listed for adjudication before the bench along with the present appeals. To rebut the consistency rule, he relied on an order passed by the Delhi Benches of the Tribunal in ACIT Vs Mosaic India Pvt. Ltd. (ITA No. 4831/Del/2010 dated 18.12.2013) in which it has been held that the res judicata does not apply to income-tax proceedings. Apart from that, the ld. Departmental Representative contended that the acceptance of `Cash profit to sales' for the assessment year 2007-08 was tax neutral as could be seen from the letter dated 8.10.2010 written by the TPO to the Director of Income Tax, a copy of which was placed on record. It was shown from this letter that the TPO, in fact, worked out the OP/TC margin of the assessee for that year under the Tooling Division at 8.34% as compared to OP/TC margin of 10 comparables companies at 5.95%. Since, the OP/TC margin of the assessee was higher than the comparable companies, the TPO did not think it appropriate to categorically discuss the correctness of the PLI of `Cash profit of sales' in so many words as it did not call for any transfer prici ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der consideration but also for the subsequent two years, which we are disposing of by a separate order. We, therefore, find no force in this argument tendered by the ld. AR. iv. Reliance of the ld. AR on the order of Reuters India Pvt. Ltd. (supra) is misplaced in as much as the assessee in that case was engaged in I.T. Enabled Services. In such an industry, the major ingredient of the operating cost is remuneration to employee and the assets play minimal role in the process of rendering of such services. The depreciation component in such cases becomes quite insignificant. As such, this decision is of no help to the assessee, who is engaged in manufacturing industry. Moreover, the application of such PLI was accepted because in that case there was an isolated year in which such change in the numerator was objected to. For the subsequent years, the same was accepted. This position stands in contrast to our case in which the TPO has rejected such PLI consistently for three years in a row. Further, no material in that case was placed on record to show that the acceptance of cash profit to sales as the correct PLI worked to the prejudice of the Revenue in terms of the sacrifice of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esults of the Tooling Division is not explicable. ii. At this stage, it is also relevant to note that section 92C(1) provides that the ALP in relation to an international transaction shall be determined by any of the methods being the most appropriate method. Sub-section (2) of section 92C states that the most appropriate method shall be applied for determination of ALP. Similarly, rule 10B(1) also provides that the ALP in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method. Rule 10C which is of significance, provides through sub-rule (1) that; "the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of arm's length price in relation to the international transaction". An overview of the above discussed provisions makes it severely simple that the ALP is required to be determined by applying any one of the prescribed methods, which is most appropriate and the most appropriate method is one which is best suited to the facts and circumstances of each international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or role in the overall operating cost and as such cannot be excluded. If the amount of depreciation, which is otherwise an important item of the operating nature, is expelled from computation, then no meaningful analysis is possible under TNMM. We, therefore, reject this contention advanced on behalf of the assessee. v. Now, turning to the working done by the TPO under this method, it is noticed that he did not disturb the comparable cases as chosen by the assessee. He simply worked out the mean of ratio of OP/Sales of such companies at 6.17%. This exercise was done by the TPO, when the assessee failed to avail the opportunity granted by the TPO vide order sheet entry dated 12.12.2005 to work out the operating profit of such comparables. Though the assessee submitted its reply dated 13.1.2006, but did not give working of OP/sales of such comparables. It can also be seen from the assessee's submissions as recorded by the ld. CIT(A) that the correctness of such OP/sales of comparables was not disputed. The rightness of this calculation by the TPO has also not been controverted before us. As such, we hold that the determination of ALP by the TPO by considering OP/Sales at 6.17% of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll deductible because such expenses were incurred outside India. The ld. CIT(A) has adopted the third reason in rejecting the assessee's claim. On a specific query, the ld. DR could not draw our attention towards any part of sections 35D or 37(1), which prohibits the allowability of expenses simply for the reason that it was incurred outside India. This being the position, we are unable to uphold the reasoning adopted by the ld. CIT(A) for sustaining this addition. 6.3. Now comes the next question as to whether the expenditure should be allowed u/s 37(1) in entirety or should be allowed as preliminary expenditure u/s 35D. The Hon'ble Delhi High Court in CIT Vs Priya Village Roadshows Ltd. (2011) 332 ITR 594 (Del) has held that : `Where expenditure was incurred on feasibility study on new project development connected with the existing business with a common administration and common fund, and the new project was shelved with no new asset being created, the impugned expenditure was allowable as revenue expenditure.' Similar view has been reiterated by the Hon'ble Delhi High Court in Indo synthetic (I) Ltd. Vs CIT (2011) 333 ITR 18 (Del). The decisions of the Hon'ble non-jurisdicti ..... X X X X Extracts X X X X X X X X Extracts X X X X
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