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TMI Blog2018 (10) TMI 923X X X X Extracts X X X X X X X X Extracts X X X X ..... transactions entered into by the assessee with its Associated Enterprise (AE) during the relevant previous year:- Nature of International Transaction Amount (Rs.) Import of raw materials and components 8,53,90,600 Export of finished goods 14,40,84,509 Purchase of traded goods 2,62,99,700 Provision of marketing support services 2,59,94,545 Provision of research and development fees 6,29,16,160 Payment of royalty 2,06,19,173 Payment of interest on loan 16,65,636 Payment of personnel support fees 2,42,63,031 Purchase of fixed assets 18,84,045 Reimbursement of expenses to AE 68,71,417 4. In view of the provisions of section 92 of the Income-Tax Act, 1961 ["the Act"], income from an international transaction had to be determined having regard to the arm's length price (ALP). The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO accepted that all international transactions carried out by the assessee was at arm's length, except the international transaction of export of finished goods by the assessee to its AE. The dispute raised in this appeal which is one of the subject-matter of this appeal is with regard to this internat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 77% 4.80% 7. As already stated, the TPO accepted the price paid or received by the assessee in all the international transactions as at arm's length, except the international transaction in relation to the manufacturing activity with its AE. The learned TPO did not accept the economic analysis undertaken by the assessee and conducted a fresh economic analysis. The TPO rejected 2 companies out of 3 companies selected as comparables by the assessee in the TP Study. The TPO on his search of the database chose 12 new companies and selected the following 13 companies as the final set of comparables with unadjusted margin of 8.61% on operating revenue:- S.No. Particulars Margin (OP/OR) (%) Margin (OP/OC) (%) 1 Hindustan Syringes & Medical Devices 10.14 11.28 2. Artificial Limbs Mfg. Corporation of India 16.90 20.34 3. Allengers Medical Systems Ltd. 9.88 10.96 4. Elico Limited 12.99 14.93 5. Premier Medical Corporation Pvt. Ltd. 2.20 2.25 6. Centenial Surgical Suture Ltd. 6.72 7.20 7. Blue Neem Medical Devices Pvt. Ltd. 15.63 18.52 8. Iscon Surgicals Ltd. 8.83 9.68 9. Johari Digital Healthcare Ltd. 5.75 6.10 10. Hemanth Surgical Indu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vel indicator. 11. Aggrieved against the order passed by learned CIT(A), the Assessee has preferred an appeal before the Tribunal on the following grounds of appeal. Grounds of general nature Ground 1: The order of the learned CIT(A) is based on incorrect interpretation of law and facts and therefore is bad in law; Grounds of appeal relating to transfer pricing matters Ground 2: The learned CIT(A) has erred in making an addition to the total income of the Appellant on account of adjustment in the arm's length price ("ALP") relating to the manufacturing activity entered into by the Appellant with its Associated Enterprises ("AEs") thereby holding that the international transactions do not satisfy the arm's length principle envisaged under the Income Tax act, 1961 (the "Act"); Ground 3: The learned CIT(A) has erred in law and facts by upholding the action of AOTTPO in not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Income-tax Rules, 1962 ("Rules"), and conducting a fresh economic analysis for the determination of the arm's length price in connection with the impugned international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing companies are functionally comparable: a) Systronics India Limited b) Gansons Limited 15. Gr.No.5 & 6 are on the action of TPO in including 10 comparable companies and in excluding 2 comparable companies chosen by the Assessee in its Transfer Pricing Study. At the time of hearing it was agreed by the parties that on identical issue of inclusion of exclusion of comparable companies, this Tribunal in Assessee's own case in IT(TP)A.No.2192/Bang/2017 for AY 2012-13 order dated 17.9.2018 in Assessee's own case ruled regarding inclusion of the following comparable companies in favour of the Revenue with the following observations: "14. It was argued that Shree Pacetronix should be rejected on account of the difference in products manufactured by Shree Pacetronix vis-a-vis the assessee. It was argued that as per the annual report of the company for FY 2011-12, the company was engaged in manufacturing and marketing of Pacemakers. Since Shree Pacetronix was engaged in manufacturing life saving devices such as pacemaker which is used to support or enhance the functions of heart by implanting in the heart, this company cannot be considered as a comparable to the assessee engaged in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8. In the present case, the fact that the product manufactured by the tested party i.e. the Assessee viz., laboratory and processing equipment and the comparable company i.e., Shree Pacetronix viz., manufacture of pacemaker for implanting in heart, can be categorized as "manufacture of equipment". The relevancy of the end use of equipment whether by consumer or as component may be relevant while evaluating functional dissimilarity, Assets employed and risks assumed but not on the basis of characteristics of the property transferred under Rule 10B(2)(b) of the Rules. 19. For the reasons given above, we are of the view that Shree Pacetronix was rightly not excluded for the purpose of comparison on the ground of product difference. 20. The grounds on which Assessee seeks exclusion of (i) Continental Controls Limited; (ii) Hindustan Syringes and Medical Devices Limited; (iii) Centenial Surgical Suture Limited; (iv) Allengers Medical Systems Limited are identical to the ground on which the Assessee sought exclusion of Shree Pacetronix. For the reasons given above, we are of the view that the Revenue authorities were justified in retaining the aforesaid companies are comparable compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n Gr.No.5 will now be taken up for consideration. 17. Artificial Limb Manufacturing Corporation of India, which is a comparable company chosen by the TPO was challenged as not comparable company for the reason that it was a Government company. This argument is liable to be rejected in view of the decision of the Hon'ble Madras High Court in the case of CIT Vs. Same Deutz Fahr India Private Limited Tax case (Appeal) No.567 of 2017 order dated 5.12.2017 wherein it was held in para 17 & 18 that there is no reason why a government owned company cannot be treated as comparable. It was further submitted that the margin computation of this company is erroneous in as much as provision for bad and doubtful debt of Rs. 34,80,000 was considered as non-operating in nature. The TPO is directed to examine as to whether the provision in question is in relation to the business which is subject matter of comparison and if so consider the same as operating in nature. The argument with regard to functional comparability is rejected following the decision in Assessee's own case in AY 2012-13. No other arguments were advanced in the note filed at the time of hearing before us and the arguments advan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessee opportunity of being heard, determine whether this company can be regarded as comparable. 20. Ground Nos. 5 & 6 are decided accordingly. Ground 7: The learned CIT(A) has erred, in law and in facts, by treating foreign exchange fluctuation as operating in nature for the Appellant as well as the comparable companies. 21. At the time of hearing it was agreed by the parties that that on identical issue of inclusion of exclusion of comparable companies, this Tribunal in Assessee's own case in IT(TP)A.No.2192/Bang/2017 for AY 2012-13 order dated 17.9.2018 in Assessee's own case ruled on similar issue with the following observations: "20. On ground No.6, though the ld. counsel for the assessee submitted that the learned CIT(A) has erred, in law and in facts, by considering foreign exchange fluctuation as operating in nature while computing the operating margin of the Assessee and the comparable companies, the limited prayer made at the conclusion on this issue was restricted to a direction to the TPO to apply the principle of treating foreign exchange fluctuation as operating in nature under both situations, when there is a loss as well as when there is a gain. The next pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market" 23. Rule 10B(2) of the Rules provides comparability of an international transaction with an uncontrolled transaction needs to be judged with reference to certain specified factors. One such factor is 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. 22. Rule 10B(3) of the Rules provide 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." 23. As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red to as 'the US regulations') also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: "In order to be considered comparable to a controlled transaction, an uncontrolled transaction need not be identical to the controlled transaction, but must be sufficiently similar that it provides a reliable measure of an arm's length result. If there are material differences between the controlled and uncontrolled transactions, adjustments must be made if the effect of such differences on prices or profits can be ascertained with sufficient accuracy to improve the reliability of the results. For purposes of this section, a material difference is one that would materially affect the measure of an arm's length result under the method being applied." 26. The Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm's length price/ margin. While the Indian transfer pricing regulations refer to the adjustments on uncontrolled transactions, however the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity underutilisation can be granted .............. Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity underutilisation can be granted....." (iv) In the recent case of GE Intelligent Platform Private Limited (IT(TP)A No. 148/Bang/2015 and 164/Bang/2015) for AY 2010-11 was held as follows: "8 .......... now the law is quite settled to the extent that once there is unutilized capacity or men power, such underutilization impacts margin and therefore, the adjustment should be made while computing the ALP ............... If the underutilization is more than average underutilization of the industry then necessary adjustment is required to be made to the margin of computing ALP......" 27. Moreover, the above argument of the assessee for grant of capacity utilization adjustment is also supported by the following decision of Bangalore ITAT in the case of Genisys Integrating Systems (India) Pvt. Ltd (ITA No.1231/Bang/2010). Relevant extract of the decision is under:- "15.2 We agree with this contention of the counsel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment. 31. The assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible to an adjustment for the same. Therefore, such a benefit cannot be denied to the assessee only for the reason that the data about comparable companies is not available. Requiring the assessee to produce such a data which is not available in public domain would tantamount to requiring the Appellant to perform an impossible task. The only way to get the data in the current case, would be where the TPO collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. The relevant extracts of the section are as under:- "(6) require any person, including a banking company or any officer thereof, to furnish information in relation to such points or matters, or to furnish statements of accounts and affairs verified in the manner specified by the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), giving information in relation to such poi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9.2018 in Assessee's own case ruled on similar issue with the following observations: "37. The assessee used the TNMM in determining the ALP for the international transaction entered into during the FY 2011-12. The provisions of Rule 10B of the Rules prescribes the methods to be used and the manner in which it is to be used in determining the ALP relating to any international transaction. The Rules i.e., Rule 10B(1)(e)(iii), provide that a transaction can be considered as comparable, if reasonably accurate adjustments can be made to eliminate differences that are likely to materially affect the price or cost or profit between a controlled and an uncontrolled transaction. 38. According to the assessee, there were significant differences in working capital between the tested party, i.e. the assessee and the comparable companies, an appropriate adjustment may be required for such difference in determining the arm's length price in view of the-following:- * The extent to which companies extend and receive credit in the form of accounts payable and receivable affects their sales and cost of sales. Sellers extend credit to purchasers in the form of an accounts receivable balanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Capgemini India Private Limited Vs Asstt. Commissioner of Income Tax (ITA No.7861/Mum/2011), the Mumbai Tribunal held as follows:- "... In our view, working capital adjustments are required to be made because these do impact the profitability of the company. Rule 108(2)(d) also provides that the comparability has to be judged with respect to various factors including the market conditions, geographical conditions, cost of labour and capital in the market. Accounts receivable/payable effect the cost of working capital. A company which has a substantial amount blocked with the debtors for a long period cannot be fully comparable to the case which is able to recover debt promptly..." "... In our view, working capital adjustment will improve the comparability. We, therefore, direct the AO/TPO to make the working capital adjustment after necessary examination in the light of the observations made above and after allowing opportunity of hearing to the assessee." (emphasis supplied) (iii) In the case of Mentor Graphics Pvt. Ltd v DCIT [(2007) 109 ITD 101 (Delhi)], the Delhi ITAT held as follows:- "Depending on facts of the case, final set of comparables may need to eliminate d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eed by the parties that that on identical issue of inclusion of exclusion of comparable companies, this Tribunal in Assessee's own case in IT(TP)A.No.2192/Bang/2017 for AY 2012-13 order dated 17.9.2018 in Assessee's own case ruled on similar issue with the following observations: "42. The manufacturing segment of assessee sells products manufactured from both AEs and third parties. Similarly assessee purchases raw materials and components that are used for manufacture of finished goods from both AEs and third parties. has purchases from both AEs and third parties. 43. The details of AE sales to total sales and AE purchases to total purchases in respect of manufacturing activity of the assessee is as provided below:- Ratio of AE sales to total sales Particulars Amount (INR) AE Sales (A) 13,93,39,733 Total Sales (B) 39,19,74,335 Ratio (C =A/B) 35.55% Ratio of AE purchases to total purchases Particulars Amount (INR) Raw material purchases from AE (D) 4,95,41,241 Total raw material purchases (E) 22,64,22,647 Ratio (F =D/E) 21.88% 44. Section 92(1) of the Act provides as under:- "Any income arising from an international transaction shall be computed having r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... termination of ALP by only restricting to transactions with AE." 50. The Hon'ble Bombay High Court on the above questions of law held as follows:- "5. With the assistance of the learned counsel for respective parties, we have considered the submissions and the judgment of the Tribunal. The Tribunal in para 7 of its order has observed as under:- "7. We have heard both the parties and their contention have carefully been considered. So far it relates to grievance of the assessee that the TP adjustment can only be applied to international transactions of the assessee with the AE and it cannot be applied at entity level, the issue is found to be covered by the aforementioned decision of the Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. (supra). Therefore, we hold that determination of arms length price should be restricted only to international transaction of the assessee with its AE. It was pointed out that the figures are available with the AO, details of which has also been filed before us at page 170 of the paperbook. Therefore, we direct the AO to take only the international transactions of the assessee with its AE for the purpose of determining arms length ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hus not entertained." 52. The ITAT Bangalore in the case of Kirloskar Toyota Textile Machinery Pvt. Ltd. v. ACIT [IT(TP)A No.1401/Bang/2010 held as under:- "Taking into consideration of these factors, we accept the first fold of submission made by the learned counsel for the assessee and direct the Assessing Officer to confine the adjustment, qua the purchases made by the assessee from the AE. To be more specific, the adjustment is to be made only to the purchases made from the AE ..... (emphasis supplied) 53. The CIT(A) in exercise of his powers of enhancement of income took the view that the ALP has to be determined on the basis of the entire sales in the finished goods segment including transactions with Non-AE also. The reasoning adopted by the CIT(A) for doing so was as follows:- "10.0 While examining the working of ALP in the case of appellant, it was observed that the TPO has reduced the adjustment proportionately by holding that only 8.46% of revenue of the appellant is from AE. She accordingly adopted 8.46% of the operating revenue and 8.46% of the Operating cost for purpose of the determination of ALP. However, this method is not the correct approach as the AL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... non-AE transactions. These decisions have already been extracted in the earlier paragraphs. The ld. DR relied on the order of the CIT(Appeals). 55. We have considered the rival submissions. The reasoning of the CIT(A) for considering the entire sales in manufactured finished goods segment for determination of ALP is that certain components and raw materials used in manufacture of finished goods are also sourced from AE and there is a possibility of the cost of such component having been bargained at a price which is not at arm's length. This presumption of the CIT(Appeals) is without any basis. He has not demonstrated with actual figures as to how there would be impact on profit margin on sale of finished products to AE because of purchases of some components from AE. He has given examples which are imaginary figures. Apart from this, the TPO has accepted that purchase of raw material and components by the assessee from its AE is at arm's length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dditional ground is concerned, we are of the view that the deduction under mercantile system of accounting has to be based on crystallization of liability. If the liability in question is established to have crystallized in AY 2012-13, then the Assessee should be allowed the deduction. We hold and direct accordingly." Ground No.14: Disallowance of provision for various expenses by treating as provision for contingent liability - INR 1,00,62,131 a) The learned CIT(A), has erred in facts and law, in not allowing deduction in respect of inadvertent and suo-moto disallowance made by the Appellant of the provision for expenses under Section 40(a)(ia) and Section 40(a)(i) on account of not withholding of taxes. b) The learned CIT(A) has erred in law and in facts, in disallowing the provision for various expenses under Section 37 of the Act by treating the same as unascertained/contingent liability in nature. c) The learned CIT(A) ought to have appreciated that the Appellant is following mercantile system of accounting and accordingly provisions are created in respect of the liabilities actually incurred/crystalized during the year but the invoices have not yet been received from ..... X X X X Extracts X X X X X X X X Extracts X X X X
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