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TMI Blog2016 (4) TMI 204X X X X Extracts X X X X X X X X Extracts X X X X ..... turing of Engines. It filed its return of income on 31-10-2005 declaring total income of Rs. 1,42,18,02,320/-. The AO made a reference u/s.92CA(1) of the I.T. Act to the TPO for computation of ALP in relation to the international transactions detailed in the audit report in Form 3CEB. The TPO accordingly issued notice to the assessee asking for details/explanations to support the ALP computed by it in the audit report. 4. From the various details furnished by the assessee the TPO noted that Cummins India Ltd. is a 51% owned subsidiary of Cummins Inc., USA. The balance equity is held by the Kirloskar group, the Indian public and various financial institutions. Cummins India was formerly known as Kirloskar Cummins Ltd.. The company is engaged inter alia in the manufacture and sale of IC Engines for power generation and industrial applications in the domestic market. It also manufactures and sells IC Engines and Components for exports. It also purchases spares by way of imports for reselling in domestic market. The details of international transactions carried out by the assessee are as under: Sr. No. International Activity Amount (Rs.) Method adopted Manufacturing Activ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 929/- made on account of procurement services and Rs. 78,72,507/- made on account of export of IC Engines of LHP Division. 8. Aggrieved with such part relief given by the CIT(A) the Revenue as well as the assessee are in appeal before us with the following grounds : Grounds of appeal by the Revenue : "1. The order of the learned Commissioner of Income-tax (Appeals) is contrary to law and to the facts and circumstances of the case. 2. The learned Commissioner of Income-tax (Appeals) grossly erred in allowing the assessee's appeal instead of confirming the Assessing Officer's order. 3. The learned Commissioner of Income-tax (Appeals) grossly erred in deleting the Transfer Pricing Adjustment on export of manufactured IC Engines of Rs. 8,23,19,580/- by rejecting the comparison of the gross Margins of the controlled AE transaction with the uncontrolled AE transactions and the uncontrolled Non AE transaction when TNMM with internal segmentation had been applied as the most appropriate method. 4. The learned Commissioner of Income-tax (Appeals) grossly erred in failing to apply the ratio of the decision of the jurisdictional Tribunal in the case of Amdocs Business Servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... spect of manufacturing activity of the HHP division. 2.4 The learned CIT(A) erred in law and on the facts and in circumstances of the case in not considering the use of external comparable companies selected by the Respondent for benchmarking the manufacturing activity of HHP division. 2.5 The learned CIT(A) erred in law and on the facts and in circumstances of the case in accepting the AO's stand of comparing segmental profitability of the Respondent's "exports to AEs" segment and "domestic sales" segment. 2.6 The learned CIT(A) erred in law and on the facts and in circumstances of the case in concluding without demonstrating that functions performed and risks assumed are greater in export market than in domestic market. 3. International Transaction relating to Procurement Support Services 3.1 The learned CIT(A) erred in law and On the facts and ill circumstances of the case in confirming an adjustment amounting to Rs. 12,84,929 to the value of international transactions in respect of provision of procurement support services. 3.2 The learned CIT(A) erred in law and on facts and in circumstances of the case in not accepting the Respondent's plea of granting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee, during the year under consideration, has grouped/aggregated international transaction at Sl.No.1 to 7 of the table at Para 4 of this order as manufacturing activity and has benchmarked using TNMM taking external comparables and by adopting PLI as operating margin to sales earned by third party comparables. The TPO observed that the assessee company manufactures variety of engines from 60 to 2000 horse powers operating either on Diesel or natural gas or dual fuel. The company does not have standard product available off the shelf. The company manufactures Engines of specific horse power according to customer's needs and extent of usage. He noted that the gross margin to sales in respect of third party sales of Engines stand at 18.83% as compared to gross margin over sales of 16.46% recorded by the company from export to AEs. Accordingly, the TPO proposed adjustment of equivalent to 2.3%, (i.e. 18.83% - 16.46%) on sales of Rs. 347.34 crores which resulted into an adjustment of Rs. 8,23,19,580/-. 12. The assessee objected to this adjustment. It was submitted that the adjustment so proposed is against the principles of transfer pricing provisions. It was argued that the e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sales, which is evident from the higher warranty claim, the TPO noted that warranty claims will impact net margin of the assessee company and not the gross margin. Secondly, the assessee has not demonstrated with facts and figures that risk difference impacts the assessee's gross margins on sales made to third parties, vis-à-vis AEs. Rejecting the various explanations given by the assessee and relying on various decisions the TPO made an adjustment of Rs. 8,23,19,580/-. Subsequently, the AO made the above addition in the order passed u/s.143(3). 16. Before CIT(A) the assessee vehemently argued against adoption of gross margin as profit level indicator as against adoption of net margin as PLI. The assessee referred to para 3.17 of the OECD transfer pricing guidelines and submitted that TNMM relates to net profit margin and not gross profit margin. The adjustment made by the AO by adopting gross margin as the basis is neither supported by the Indian Law nor by the OECD guidelines. Therefore, the entire adjustment is illegal and deserves to be deleted. It was argued that the operating margin on cost earned by the assessee for this activity is 4.8% whereas the margin earned by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y. Therefore, unless the enterprise demonstrates with relevant facts as to why it earned lower profit while exporting to AEs as against the domestic market assessee's argument on this issue cannot be considered. The assessee has not advanced any arguments on this aspect. Therefore, I do not accept the contention of the assessee on this ground. 3.1.11 However, on the issue of PLI, I agree with the assessee that the transactional net margin method, refers to 'net margin' and not 'gross margin'. This aspect is clear in Rule 10B, which is as under : (e) Transaction net margin method by which : (i) The net profit realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. 3.1.12 The above Rules provides for using PLI of cost incurred or sales affected or assets employed or any other relevant base, but it emphasizes that it is net profit margin of controlled transaction, which is to be compared with 'net profit margin' of uncontrolled transaction. 'Gross margin' is referred in CU ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profits and whereas in TNMM the comparison is on margins of net profit". 3.1.15 Rule 10B(e) and the OECD Guidelines make it clear that this method seeks to compare net profit margins of the controlled and uncontrolled transactions. Comparing of gross margins is not envisaged under the Income Tax Rules. Conceptually also comparing of gross margins may provide unreliable reasons because of the factors mentioned above. In view of the above, I hold that the adjustment made by the TPO is not supported by the legal provisions and hence, it is deleted. The Appellant gets relief of Rs. 8,23,19,580/-. 3.1.16 Since the decision is taken in the assessee's favour, it is not necessary to give findings on the other connected Grounds on this issue." 18. Aggrieved with such order of CIT(A) the revenue is in appeal before us. 19. The Ld. Departmental Representative strongly opposed the order of the CIT(A). He submitted that the powers of the CIT(A) are coterminous with that of the AO. He can do enquiries and do things which the AO has not done while passing the assessment order. Therefore, the matter may be restored to the file of the AO with a direction to verify whether external comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , instrumentation panel, electrical and charging system and auxiliary accessories and thus additional capabilities and therefore appropriate mark up forms part of the sales." He accordingly submitted that when it exports its products to the AE it is the AE who does all those things. Therefore, there is difference in the product. He further submitted that the assessee is not required to do marketing functions for the AEs since it is their job to do marketing. 23. Referring to page 14 of the order of the TPO he drew the attention of the Bench to para 3.27 of the OECD guidelines which read as under : "3.27 One strength of the transactional net margin method is that net margins (i.e. return on assets, operating income to sales and possibly other measures of net profit) are less affected by transactional differences than is the case with price as used in the CUP method. The net margins also may be more tolerant to some functional difference between the controlled and uncontrolled transactions than gross profit margins. Difference in the functions performed between enterprises are often reflected in variations in operating expenses. Consequently, enterprises may have wide range of gr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mitted that for the purpose of sub-section (2) of section 92C the ALP in relation to an international transaction shall be determined by any of the following methods being the most appropriate method in the following manner namely: 1. CUP 2. Resell price 3. Cost Plus method 4. Profit split method 5. TNMM or 6. Any other method as provided in Rule 10AB 26. So far as TNMM is concerned he submitted that every where the starting point in TNMM is net profit. Referring to para 3.1.9 of the order of CIT(A) he submitted that the Ld.CIT(A) while deleting the addition has however made certain observations which is not at all correct. He has stated that all manufactured products of the assessee fall into the basket of IC engines, therefore, it is unlikely that there will be material variation in margin of each product type. He has accordingly rejected the argument of the assessee on account of product difference which according to Ld. Authorised Representative is not correct. 27. Referring to the submissions made before TPO on 21-05- 2008, a copy of which is placed at page 451 to 464 of the paper book the Ld. Counsel for the assessee drew the attention of the Bench to the page 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... option of difference in gross profit margin by the AO as against difference in net profit margin between sales to AE and sales in domestic market. We find no infirmity in the order of the CIT(A) who has decided the issue as per the provisions of Rule 10B(e) as well as para 3.26 of the OECD guidelines as well as various other decisions according to which net profit margin of controlled transactions has to be compared with net profit margin of uncontrolled transactions. The Ld. Departmental Representative could not controvert the legal and factual findings given by the CIT(A). In absence of any distinguishable features brought before us by the Ld. Departmental Representative we do not find any infirmity in the order of Ld.CIT(A) deleting the addition. Accordingly, the same is upheld. Since we are dismissing the ground raised by the revenue by upholding the order of CIT(A) on the issue of net margin, the other arguments of the assessee are not considered being academic in nature. Grounds raised by the revenue are accordingly dismissed. 30. In grounds of appeal No.5 the revenue has challenged the order of the CIT(A) in deleting the disallowance of Rs. 40,36,560/- made by the AO u/s.14 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ds. Since the assessment year involved in the impugned appeal is A.Y. 2005-06, therefore, no disallowance is called for under provisions of Rule 8D as the same is not applicable for the impugned assessment year. However, it cannot be said that no administrative expenses have been incurred by the assessee for earning the huge tax free dividend income. Considering the totality of the facts of the case, disallowance of an amount of Rs. 2 lakhs, in our opinion, will meet the ends of justice. We hold and direct accordingly. Accordingly, the grounds raised by the revenue on this issue are partly allowed. 36. Grounds of appeal No.7 and 8 being general in nature are dismissed. CO No.53/PN/2014 : 37. Ground of appeal No.1 in the CO refers to non admission of the appeal filed by the revenue due to delay in filing of the same. We have already condoned the delay while deciding the appeal filed by the Revenue. Therefore, this ground by the assessee is dismissed. 38. Grounds of appeal No. 2, 3 and 5 of the CO were not pressed by Ld. Authorised Representative. Grounds of appeal No.6 & 7 being general are dismissed. Thus, we are left with only Ground of appeal No.4 which relates the order of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Counsel for the assessee referred to page 463 of the paper book and drew the attention of the Bench to the following submission made before the TPO : "C. Your Honour has requested the Company to show cause as to why adjustment of an amount corresponding to the difference in the margins generated by the Company from export of IC Engines of LHP Division to AEs and as generated by the Company from sale of IC Engines of LHP Division to non AEs be not made towards the international transaction undertaken by the Company relating to export to IC Engines of LHP Division. C.1 The Company has submitted the following information in the letter dated 3rd April 2008 : Particulars Export sale to AE Export sale to Non-AE Domestic Sale to Non AE Total Sales to Non-AE A B C (B+C) Sales 17.69 6.23 129.13 135.36 Total income 17.69 6.23 129.13 135.36 Less : Material consumed 15.76 5.35 109.21 114.56 Manufacturing Expenses 0.52 0.32 2.98 3.3 Administrative Expenses 0.24 0.09 2.38 2.47 Selling & Distribution Expenses 0.58 0.22 4.09 4.31 Interest & Finance 0.03 0.01 0.21 0.22 Total Costs 17.12 5.99 118.88 124.86 Net Operating Margin 0.57 0.2 ..... 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