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TMI Blog2015 (5) TMI 644X X X X Extracts X X X X X X X X Extracts X X X X ..... he Ld. DRP/AO thereby erroneously made a transfer pricing adjustment of Rs. 52,197,453 to the income of the appellant by holding that the international transactions of the appellant do not satisfy the arm's length principle envisaged under the Income-tax Act, 1961 ('the Act'). 2. The Ld. DRP/AO erred in determining the arm's length price of the international transactions pertaining to the manufacturing segment of the appellant, by comparing with external comparables when functionally similar internal comparables are available to determine the arm's length price under the internal Transactional Net Margin Method which is more reliable. 3. Without prejudice to Ground 2, the Ld. DRP/AO erred in selecting certain external comparables which were not functionally comparable and in rejecting certain comparables that were functionally comparable, and thereby choosing an incorrect set of comparables. 4. Without prejudice to Ground 2, the Ld. DRP/AO erred in not granting the benefit of +/- 5% range as envisaged by the proviso to Section 92C(2) of the Act. 5. Without prejudice to Ground 2, the Ld. DRP/AO erred in using data which was not available to the appellant at t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and is inter-alia engaged in the business of manufacturing and distribution of hydraulic components and packaged systems. It manufactures a wide range of 'Vickers' vane and pistons, pumps, power units, cylinders control valves and filters for mobile and industrial applications. The manufacturing facilities of the assessee are located at Pune and at Mumbai. Initially, the company was incorporated in the year 1965 as a joint venture between Mahindra & Mahindra Ltd. and Vickers Inc., but presently it is a wholly owned subsidiary of Eaton Corporation, a foreign based entity. 5. During the year under consideration, Assessing Officer noted that the assessee had entered into certain international transactions with its associated enterprises within the meaning of section 92B of the Act. As the income arising from 'international transactions' is required to be computed having regard to the arm's length price in terms of section 92(1) of the Act, the Assessing Officer referred the matter of computation of arm's length price of the international transactions to the Transfer Pricing Officer (in short 'the TPO') in terms of section 92CA(1) of the Act. The TPO a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the most appropriate method. The assessee considered Operating profit to Operating revenue as the PLI (i.e. Profit Level Indicator). The PLI of the assessee was worked out at 6.87% and as the average PLI of the external comparables was determined at 9.62%, assessee concluded that the stated value of the international transactions entered with the associated enterprises was at an arm's length price consistent with the requirements of the Indian Transfer Pricing Regulations. In carrying out the aforesaid benchmarking analysis, assessee adopted a set of 14 comparable concerns and the operating margins of such comparable concerns was taken on the basis of three year's financial data and accordingly, the arithmetic mean of the average operating margins was determined at 9.62%. At this point, it may be noticed that the TPO has differed with the assessee on this aspect and while ascertaining the operating margins of the comparable cases he has not considered the multiple year's data and has instead considered the data relating to the financial year in which international transactions have been entered into. The aforesaid point of difference has not been agitated by the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Roto Pumps Ltd. 11.42 6. Schrader Duncan Ltd. (Pneumatic products segment) 10.59 7. Sulzer Pumps India Ltd. 12.08 8. Yuken India Ltd. 10.61 9. Asco (India) Ltd. 38.36 10. Beacon Industries & Pumps Ltd. 11.34 11. Johnson Pump (India) Ltd. 14.17 Mean 14.57 9. The arithmetic mean of operating margin of the comparable cases arrived at 14.57% was compared with the operating margin of the assessee in respect of manufacturing segment which was 1.57%. Accordingly, an adjustment of Rs. 5,21,97,453/- was computed which was required to be made to the international transactions pertaining to Manufacturing segment of the assessee so as to bring it to the level of arm's length price. Pertinently, bifurcation of assessee's financial results into manufacturing and trading segment was done only in the course of proceedings before the TPO and so far as the segment of Trading activity is concerned the TPO accepted the position that it was at arm's length price and no addition has been proposed. The addition in question has been made only with regard to the Manufacturing segment. 10. By way of Ground of Appeal No. 2, assessee has assailed the approa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ransactions between the assessee and its associated enterprises. The case made out by the Ld. Departmental Representative is that the transactions with the associated enterprises are not purely identical with the transactions with third parties and in support reference has been made to a Tabulation in para 6.2.3 of the order of the TPO. As per the Ld. Departmental Representative, internal TNM Method canvassed by the assessee was in relation to benchmarking on the basis of sales made, but not that of purchases from associated enterprises, which was of a substantive value. The segmental statement between associated enterprises segment and third parties segment was based on sales, and in-fact the purchases are not evaluated separately. It was therefore contended that the approach of the TPO was quite justified. 12. We have carefully considered the rival submissions. The dispute on this aspect relates to a plea put-forth by the assessee during the course of the proceedings before the TPO whereby assessee canvassed that the international transactions in the Manufacturing segment be benchmarked by using internal TNM Method. No doubt, in the Transfer Pricing Study carried out by the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt were functionally comparable in every aspect. Therefore, it was canvassed that based on the aforesaid internal TNM analysis, the international transactions of the assessee in the Manufacturing segment were at an arm's length price. 13. In-fact, the internal comparables do have a more direct and closer relationship to the tested transactions rather than the external comparables. In other words, the profitability of an assessee from the controlled transactions can be benchmarked more meaningfully with reference to the assessee's profitability from similar transactions carried out in uncontrolled conditions, i.e. with third parties. In the present case, assessee pointed out that the associated enterprises segment and the third parties segment were functionally comparable and therefore the third parties segment was a good uncontrolled comparable available to benchmark the international transactions entered with the associated enterprises. 14. Pertinently, assessee also undertook similar analysis with regard to its Trading segment before the TPO. In the Trading segment also, assessee tabulated the associated enterprises segment and the third parties segment and pointed out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal operating expenses, as explained above were allocated considering net sales of each segment as the reasonable allocation key. Your good self would appreciate that Transactional Net Margin Method ('TNMM') requires a functional similarity rather than product similarity. Thus, under both the aforesaid segments, there is a functional similarity viz. manufacturing function though the product may not be identical. In view of the above, the internal comparability of profit from sale of manufactured products under AE and Non-AE segment would be the most appropriate method to benchmark the international transactions pertaining to manufacturing segment." 15. The aforesaid shows that the segmentation of Manufacturing segment into associated enterprises segment and Third parties segment was done by the assessee on product basis, i.e. the associated enterprises segment reflect profitability on products which require consumption of raw material and components from associated enterprises whereas the Third parties segment reflects profitability from products which do not entail purchases of raw materials and components from associated enterprises. The TPO has pointed out that the sal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . * The operating margin derived from the international transaction pertaining to purchase of raw material and components purchased from AEs (forming a part of in the AE segment) would be benchmarked against the comparable operating margin derived from the third party transactions (covered in the AE segment). * The operating margin derived from the international transaction pertaining to sale of finished products to AEs (forming a part of in the AE segment) would be benchmarked against the comparable operating margin derived from the third party transactions (covered in the AE segment)." 17. On the basis of the aforesaid fact analysis, which has not been controverted by the TPO, we find that in the present case internal comparison of the operating margins using internal TNM Method is liable to be upheld in order to compute arm's length for the international transactions of purchase of raw material and components from associated enterprises as well as sales of finished goods effected to the associated enterprises. On the basis of the aforesaid benchmarking, the profitability of international transactions under the associated enterprises segment computed at 3.25% is higher tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o depreciation was claimed, and it claimed deduction for the principal portion of the lease rentals. In the assessment year 2003-04, Assessing Officer observed that since the assets were registered in the name of the assessee thereby giving it ownership, the expenditure towards re-payment of principal values of the assets was to be treated as a capital expenditure and the amount was disallowed. Following the aforesaid, in the present year also the Assessing officer disallowed the claim of the assessee towards re-payment of principal value of lease rentals amounting to Rs. 12,14,618/- and Rs. 5,30,371/- on account of vehicles and computers respectively. 21. In this background, the learned counsel for the assessee pointed out that the dispute for the assessment year 2003-04 was still not final and therefore the matter may be set-aside to the file of the Assessing Officer with the directions to decide the issue in the light of the ultimate decision with regard to such dispute in the assessment year 2003-04. The learned Departmental Representative appearing for the Revenue has not contested the aforesaid factual matrix and has also not opposed the plea of the assessee for remanding th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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