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TMI Blog2015 (6) TMI 597X X X X Extracts X X X X X X X X Extracts X X X X ..... h the transfer pricing analysis in a right perspective. The assessee kept on harping on the adjustment to its profit on an unrealistic basis and the TPO ignored to examine, if the assessee was at all rightly entitled to any adjustment on account of its first year of operation. In our considered opinion, the proper transfer pricing analysis can be done only by first finding out suitable comparables with or without making adjustment in their profit margins in terms Rule 10B(1)(e)(iii). If, in any case, either the comparables are not available or the adjustment as discussed above is not feasible, then, the TNMM cannot be considered as the most appropriate method, which should be ignored and substituted with another suitable method for determining the ALP of the international transaction of `Export of finished goods.’. Removal of two comparables - Ahmedabad Steelcraft Ltd. - Held that:- This company is using its own wind mill against the assessee using generator sets of production. These two models of production have different implications on the operating costs. Apart from that, it is observed that the turnover of this company significantly reduced to ₹ 9.92 crore in the curr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... For the Responent: Shri Vikram Sahay, CIT, DR Ms Y.S. Kakkar, Sr. DR ORDER PER R.S. SYAL, AM: This appeal by the assessee emanates from the final order passed by the Assessing Officer (AO) on 20.10.2010 u/s 143(3) read with section 144C(13) of the Income-tax Act, 1961 (hereinafter also called the Act ) in relation to the assessment year 2006-07. 2. The first challenge in this appeal to the addition on account of transfer pricing adjustment amounting to ₹ 21,75,42,500/-. 3.i. Briefly stated, the facts of the case are that JCB, UK, is a major player in the global construction and agriculture sectors. JCB India Ltd., is a wholly owned subsidiary of JCB, UK. In turn, JCB Manufacturing Ltd. (i.e., the assessee) was set up by JCB India as its 100% subsidiary on 21.06.2004. The assessee commenced its business on 20.6.2005. It is a matter of record that the assessee company got merged with JCB India by virtue of the judgment of the Hon ble High Court dated 26.5.2010 w.e.f. 1.4.2009. Thus, in so far as the year under consideration is concerned, the assessee was a subsidiary of JCB India. The assessee manufactured components such as back blades, buckets, dip ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erating costs were high due to lower productivity on account of workmen being in learning phase; higher consumption of electricity on account of diesel gensets; and higher distribution cost and fixed overheads on account of lower volumes. The assessee invited the attention of the TPO towards Annexure H to the Transfer pricing study report, giving the working of the adjusted operating profit. The TPO observed that nothing was mentioned as to how the adjusted figures were arrived at and, further, the basis of such adjustment was unknown. He refused to allow this adjustment as, in his opinion, any adjustment can be made only to the profit margin of the comparables under Rule 10B(1)(e)(iii) and not to the profit margin of the assessee under Rule 10B(1)(e)(i). Discarding the adjusted positive profit margin declared by the assessee at 10.79% on a hypothetical basis, the TPO adopted unadjusted profit margin of the assessee at (-)45.23%. By considering the arithmetical mean of the operating profit margin of the comparables at 13.47%, the TPO applied benchmark of Operating profit/Total cost at 58.70% (45.23% +13.47%) on the international transaction of Export of finished goods. This resul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the figures for the assessment years 2009-10 and 2008-09. The question arises as to whether the course of action adopted by the assessee in substituting the actual costs incurred with some standard costs is permissible under law. To be more precise, whether any adjustment is permissible in the assessee s own profit margin? 6. In order to answer this question, we need to have a look at the provisions relating to computation of income from international transaction having regard to the arm s length price contained in Chapter- X of the Act. Sub-section (1) of section 92 provides that: Any income arising from an international transaction shall be computed having regard to the arm s length price. Computation of arm s length price has been enshrined in section 92C of the Act. Sub-section (1) of section 92C provides that: `The arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe . . Then ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions ; and conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 8. Rule 10B(3) stipulates that an uncontrolled transaction shall be comparable to an international transaction, if, (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market ; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 9. When we read sub-rules (2) and (3) in juxtaposition to Rule 10B(1)(e), it emerges that the arm s length price under TNMM can be determined by comparing the profitability of an inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... patent in providing for computing the profit margin of the assessee from its international transaction as such, we fail to appreciate as to how any adjustment can be made to the profit margin of the assessee under sub-clause (i) due to reasons, such as, the incurring of extraordinary and non-operating costs due to start up related reasons. If such an adjustment is made, the resultant figure will shed the character of the net profit margin realized, which is contrary to the express language of the provision. It is obvious that in the computation of operating profit margin from an international transaction, all nonoperating costs do not form part of the cost base which are thus excluded at the very outset. In so far as the operating costs are concerned, these find their place in the computation irrespective of the fact whether they are higher or lower due to any reason whatsoever. The rationale behind the entire transfer pricing regime is to compare the costs/profits incurred/earned by the assessee from an international transaction as it is with an uncontrolled transaction and compute income from such international transaction having regard to its ALP determined on the basis of a com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uncontrolled transaction. The crux of the matter is that the adjustment due to differences between the international transaction and comparable uncontrolled transaction is always adjusted in the profit margin of the comparables as per sub-clause (iii) and not in the profit margin of the assessee as per sub-clause (i) of rule 10B(1)(e). 11. Having held that adjustment is warranted in the operating margin of the comparables for neutralizing the material effects of the differences between the international transaction and uncontrolled transactions, we want to accentuate that the simple fact of the assessee incurring a particular operating cost higher than its comparables, cannot call for any adjustment. It can be noticed that the TNMM contemplates comparison of the percentage of the operating profit margin earned by the assessee from its international transaction with such a percentage of the operating profit margin earned by comparables in uncontrolled transactions. Firstly, when we take into consideration the percentage of the operating profit margins, the effect of quantitative differences between the two sets of transactions is automatically wiped out. Secondly, when we consid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perating expenses for the year in question at ₹ 3706.55 lac. However, for the purposes of the Transfer pricing analysis, the assessee reduced such operating expenses to ₹ 1831.98 lac and computed its profit margin with such reduced operating expenses. This exercise was done by the alleged standardization of the actual operating costs on the basis of such costs incurred by it during the periods relevant to the assessment years 2008-09 and 2009-10. The methodology adopted by the assessee for carrying out transfer pricing analysis is simply devoid of any statutory sanction, totally unacceptable and a glaring example of travesty of the transfer pricing provisions. As against this, the TP analysis should have started with the actual operating costs of ₹ 3706.55 lac and then the assessee specifically showing how some of the first year of operation specific expenses were absent in the case of comparables, requiring adjustment in the profit margin of the comparables. Nothing of this sort has been done by the assessee. 13. We notice that the assessee vide its letter dated 7.9.2009 addressed to the TPO, a copy of which is available on page 1004 of the paper book, submitt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... proceed to examine the comparability or otherwise of these two companies, one by one. (i) Ahmedabad Steelcraft Ltd . 15. The assessee chose this company as comparable with OP/TC at (-)16.71%. The TPO removed it from the final set of comparables by noticing that the same apart from being functionally different, also suffered losses because of change in the Government policy and on account of retrenchment of employees and other extraordinary factors. The assessee is aggrieved against the exclusion of this company. 16. After considering the rival submissions and perusing the Annual report of this company, which is available on pages 553 onwards of the paper book, it can be seen that this company is using its own wind mill against the assessee using generator sets of production. These two models of production have different implications on the operating costs. Apart from that, it is observed that the turnover of this company significantly reduced to ₹ 9.92 crore in the current year from ₹ 36.68 crore in the preceding year due to change in the Government policies. It has been so recognized in the director s report of this company. It has further been mentioned in s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eing heard in such fresh proceedings. 20. The only other ground which survives in this appeal is against the ad hoc disallowance of expenses to the tune of ₹ 2 lac. The facts apropos this ground are that the assessee appointed a Clearing Forwarding agent, viz., Haulage Corporation. On being called upon to produce details of such expenses, the assessee submitted all the necessary details along with sample supporting invoices and corresponding confirmation from Haulage Corporation. The AO observed that these expenses were in the nature of transportation charges, custom clearing and reimbursement of expenses. He disallowed a sum of ₹ 2 lac on ad hoc basis by mentioning that the assessee failed to furnish invoices in support of reimbursement of expenses, which were to the tune of ₹ 34.81 lac. The assessee has assailed this addition. 21. After considering the rival submissions, it is observed that these expenses have been incurred by the assessee by way of payment to Clearing Forwarding agent, viz., Haulage Corporation. Even the reimbursement of expenses have been made to such agent only. When the assessee furnished all the details about such expenses includi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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