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TMI Blog2019 (3) TMI 554X X X X Extracts X X X X X X X X Extracts X X X X ..... e have carefully perused all the grounds raised by the Revenue. Most of the grounds raised by the Revenue, are either academic in nature or contentious in nature. However, to meet the end of justice, we confine ourselves to the core of the controversy and main grievances of the Revenue. With this background, we summarize and concise the grounds raised by the Revenue as follows: Transfer Pricing Grounds (i).Ld.CIT (A) erred in deleting following additions made on account of Transfer Pricing adjustments by ignoring analysis done by Transfer Pricing Officer (TPO): (a).Arm`s Length Price adjustment for A.Y.200203 at Rs. 5,19,77,000/- (b).Arm`s Length Price adjustment for A.Y.200304 at Rs. 10,02,37,000/- Other Grounds (i).Ld CIT(A) erred in deleting provision for payment of gratuity under section 40A(7) of the Act and addition made on account of contribution to superannuation fund U/s 40A(9) of The Act. (a). Provision for gratuity u/s 40A(7), for A.Y.200203 Rs. 8,28,600/- (b). Provision for gratuity u/s 40A(7), for A.Y.200304 Rs. 20,71,870/- (c ).Contribution to Superannuation Fund U/s 40A (9), for A.Y. 200203 Rs. 14,75,778/- (d).Contribution to Superannuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ale of electronic component, namely, soft ferrites components. The soft ferrite components are widely used in entertainment electronics, telecommunication and industrial electronics industries.The assessee company filed its return of income for the assessment year 200304 on 28112003 declaring a loss to the tune of Rs. 15,35,09,431/. The determination of arm's length price of the international transactions was referred to the Ld. Transfer Pricing Officer (hereinafter referred to as the 'TPO') under section 92CA of the Act. The TPO directed following arm's length price (ALP) adjustments, under the Transactional Net Margin Method (TNMM') at the entity level, as under: (a).Arm`s Length Price adjustment for A.Y.200203 at Rs. 5,19,77,000/- (b).Arm`s Length Price adjustment for A.Y.200304 at Rs. 10,02,37,000/- 6. The assessee company entered into the following international transactions with its associated enterprises during the financial year ended 31st March, 2003: A.Import of raw materials, INR 5.65 Crores. B.Import of tools and capital equipment, INR 3.84 Crore. C.Payment, for service chargefor IT services, sales support, marketing and advertisement an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... OECD guidelines where it is possible to locate comparable uncontrolled transaction, CUP method is the most direct and reliable way to apply the arm's length principle. As a result,in such cases the CUP method is preferable over all other methods. Accordingly, the assessee applied the CUP method for determining the arm's length price of export of finished goods to its associated enterprises. However, the TPO rejected CUP as the most appropriate method to determine the arm's length price of export of finished goods to associated enterprises.The Ld.TPOalso rejected the RBI approval as benchmark to determine the ALP for payment of knowhew fees and considering TNMM as the most appropriate method for determining the ALP for technical knowhow fees/royalties. 7. Selection of comparable companies by assessee:The assessee carried outobjective search process in the Prowess database to identify independent comparablecompanies, whose functional profile was broadly comparable to that of the assesseecompany. The search wascarried out under the heading "electronics" in such database since the assesseeis engagedin manufacture of electronic components. This search gave an initial set o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n circumstances, not the effect of nonarm's length dealings. This approach of usingmultiple year data is consistent with the OECD guidelines on transfer price. According to the Para 3.44 of OECD guidelines, multiple year data should be considered in the TNMM for both the enterprise under examination and independent enterprises to the extent their net margin are being compared to take into account the effects on profits of products life cycles and shortterm economic condition.This also evident from the facts in the case of the assessee company. The Assesseecompanyincurred operating losses during the financial year ended 31 March 2003, due to change in economic and market conditions. There was a fall in the market of telecom business. As a result, the ferrite manufacturers shiftedtheir capacities from telecom sectors the electronic and lighting sectors.Assessee caters to the electronics and lighting sector. As a fall out, within a short period the activities for ferrites cores catering the lighting and electronic sector shot up significantly causing a price war, which adversely affected the profitability of assesseeduring the year under consideration. Therefore, the assessee was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red as appropriate benchmark for determination of arm's length price. However, the ld TPO rejected the most appropriate method (MAM) adopted by the assessee and held as follows: (a) Application of comparable uncontrolled price method (CUP) in respect of export of soft ferrites to Associated enterprises (AE) is not acceptable in absence of any verifiable data. Even auditors of the assessee who prepared the transfer pricing report have not verified any data in this regard. Even during the proceedings, U/s 92CA (2) of the Act, the assessee did not provide evidence to support their claim that the goods sold by the assessee to its AE were then sold at the same price to the third party without any mark-up. Therefore, Ld TPO held that it is imperative to consider the transactions of export of soft ferrites under the last resort method of TNMM. (b) For payment of royalty, the ld TPO noted that mere approval of RBI is not an acceptable method therefore, TNMM method is suitable for determination of ALP of Royalty transaction. (c) For Inter-corporate loan, the TPO noted that mere approval of RBI is not an acceptable method therefore, TPO recommended CUP method. 9. The disputed is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." It is evident that for determination of Arm's Length Price u/s 92C, the data to be used in analysing the comparability of an uncontrolled transaction with the International transaction, in general, has to be the data relating to the FY in which the International transaction was entered Into. A distinction needs to be drawn between data to be used for computation of arm's length price (Section 92C/Rule 10B) and the data used for supporting documentation maintained by the assessee (Section 92D/Rule 10D). For the purpose of documentation, assessee can use data which is existing latest by the specified date referred to in Clause IV of Section 92F i.e. by due date of filing the return for that year i.e. by 31st October 2002. However, for the purpose of computing the arm's length price u/s 92C, as clearly laid down in Rule 10B (4), same year's data to be used. Under the law, there is a responsibility cast upon the assessee to maintain documentation as per section 92D/Rule 10D. This must be done before filing of return of Income. At the ti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... compared with the assessee company. (2) Karnataka Hybrid Devices Ltd This company manufactures electrical equipment and the assessee company manufactures raw material for the electronics Industry. The activities performed by both are completely different. Moreover, the turnover of this company at 7 crores is significantly less than the assessee company. It cannot be compared with the assessee company. (3) SPEL Semiconductors Ltd. This company is in the business of manufacture of computer and related hardware. This is once again a consumer of ferrite based electronic components whereas the assessee is a producer/manufacturer of ferrite components. It cannot be compared with the assessee company. (4) Fine Line Circuits This company manufactures printed circuit boards. The product mix is not comparable with the assessee company. (5) Pan Electronics (I) Ltd This company manufactures capacitors using mainly Polyester Film as raw material. The product mix is not comparable with the assessee company. Also, at about 5 crores of turnover it is a much smaller entity than the assessee company. (6) Ruttonsha International Rectifier Ltd. This c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2. The ld TPO noted that the size of an enterprise is an important factor in determining comparability. Size as reflected by turnover, determines 'relative competitive positions by buyers and sellers' and is thus a significant economic condition which could affect prices or profitability. Similarly, the TPO noted that the product comparability also play no less a significant part in determining whether an enterprise can be considered for comparison. The ld TPO, based on the above observations noted that the closest comparable Companies are M/s Continental Devices India Ltd. and M/s Cosmo Ferrite Ltd. Therefore, the results of these two companies only can be compared with the results of the assessee company. For the same period (Year Ended March 2002) results of these two companies are compared with the assessee company as below: Rs. in crores EPCOS Ferrite Ltd. (Assessee Co.) Continental Devics India Ltd Cosmo Ferrite Ltd Income Sales 53.13 97.12 26.90 Other Income 3.48 3.54 0.54 (A) Total Income 56.61 100.66 27.44 Expenditure Excise duty - 1.49 Material cost and change in inventory 16. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B 69,813 D Adjusted total income on credit side A+C 6,73,873 E Total income shown on credit side TP Report page 22 5,66,117 F Value of AE transactions (exports) 3CEB report 4,59,605 G Third party transactions on credit side E-F 1,06,512 1,06,512 H Adjusted value of AE transactions (exports) D-G 5,67,361 I 95% of Adjusted value of AE transactions (exports) H x 95% 5,38,993 J Total adjusted income after tolerance of 5% I + G 6,45,505 K OP/Sales 10.36% L Re-Adjusted Profits J x K 66,874 M Adjusted Costs J-L 5,78,631 N Costs shown on debit side TP Report page 29 6,04,060 O Value of AE transactions as claimed (Excluding capital costs and interest) 3CEB report 1,17,041 P Third party transactions on costs side N-O 4,87,019 4,87,019 Q Adjusted value of AE transaction on costs side M-P 91,612 R 105 % of Adjusted value of AE transaction on costs side Q x 105% 96,192 S Adjustment on account of exports to AE I-F 79,388 T Adjustment on account of costs incurred on transactions with AE O-R 20 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entiation has not been taken into account by the ld CIT(A). The ld DR also objected the profit level indicator (PLI) taken by the assessee based on net profit. Ld DR further pointed out that for determination of Arm's Length Price u/s 92C, the data to be used in analysing the comparability of an uncontrolled transaction with the International transaction, in general, has to be the data relating to the FY in which the International transaction was entered Into. A distinction needs to be drawn between data to be used for computation of arm's length price (Section 92C/Rule 10B) and the data used for supporting documentation maintained by the assessee (Section 92D/Rule 10D). For the purpose of documentation, assessee can use data which is existing latest by the specified date referred to in Clause IV of Section 92F i.e. by due date of filing the return for that year i.e. by 31st October 2002. However, for the purpose of computing the arm's length price u/s 92C, as clearly laid down in Rule 10B (4), same year's data to be used. The ld TPO rightly noted that the size of an enterprise is an important factor in determining comparability. Size as reflected by turnover, deter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cted the profitability of the assessee company. The turnover of the assessee company dropped by a sum of INR 16.80 crore over last two financial years. * It is pertinent to note that the assessee company was a price-taker in the international market in respect of sale of finished goods to its associated enterprises. The EPCOS group entities imported finished goods from the assessee company for further sale to unrelated customers in the international market at the same prices. Hence, the selling prices of finished goods were entirely governed by the demand and supply forces in the international market and the same were not within the control of the assessee company. During the course of hearing under section 92CA (3) of the of the Income-tax Act, 1961, the TPO had examined the TPSR and the functional profiles of the fourteen comparable companies selected by the assessee company. He retained only two comparable companies named Cosmo Ferrites Ltd and Continental Devices India Ltd. The TPO rejected the remaining twelve comparable companies primarily based on product comparability. As per the computation of the TPO, the net profit indicator (OP/sales) for the assessee company was (- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red the same product as that manufactured by the assessee company. However, the product mix of Continental Devices India Ltd was broadly comparable to that of the assessee company. In the assessee`s case, the comparable companies demonstrated in table No. (1) manufactured and sold electronic components and hence, the said companies were functionally comparable to the assessee company. Unlike the CUP Method, the TNMM does not require that the comparable company has to manufacture exactly the same product as that manufactured by the tested party. Hence, the TPO, while adopting the TNMM, erroneously rejected the aforesaid seven companies mentioned in table no. (1) based on product comparison between the assessee company (tested party) and the aforesaid independent companies. In this context, the ld Counsel relied on the decision of the Hon'ble Mumbai Tribunal in the matter of Dy. CIT v. Rolls Royce Marine India (P.) Ltd. [2016] 70 taxmann.com 245, wherein it is inter alia held that in the TNMM what is to be seen is functional comparability and not the product comparability. Therefore, ld counsel prayed the Bench to accept the aforesaid independent companies as comparable to the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... product as that manufactured by the assessee company. However, the product mix of Continental Devices India Ltd was broadly comparable to that of the assessee company. The comparable companies demonstrated in table No. (1) manufactured and sold electronic components and hence, the said companies were functionally comparable to the assessee company. Unlike the CUP Method, the TNMM does not require that the comparable company has to manufacture exactly the same product as that manufactured by the tested party. Hence, the TPO, while adopting the TNMM, erroneously rejected the aforesaid seven companies mentioned in table no. (1) based on product comparison between the assessee company (tested party) and the aforesaid independent companies. In the TNMM, what is to be seen is functional comparability and not the product comparability. The learned TPO ignored the comparability criterion laid down for application of TNMM. For that we rely on the judgment of the Hon`ble High court of Mumbai in the case of Pr. CIT v. Watson Pharma (P.) Ltd. [2018] 95 taxmann.com 281/257 Taxman 65 wherein it was held that TNMM requires only broad functional comparability between the tested party and comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted the impact on profitability of the differences in respect of technology, age of assets used in production, capacity utilization and depreciation expenses and its policies and interest expenses. We note that during the course of hearing, the Ld. counsel for the assessee submitted before the Bench that in the instant case, cash profit margin would be more appropriate financial indicator under the net profit margin. The assessee submitted the cash profit margin of itself and the comparable companies for the relevant financial year. The assessee demonstrated the reason for selecting cash profit margin as an appropriate financial indicator under the TNMM for the relevant financial year. It was explained that the assessee increased production capacity substantially from 2900 MT in FY 2001-02 to 3400 MT in FY 2002-03. Inspite of the increase in capacity, the sales of the assessee decreased from INR 550,440 thousands in FY 2001-02 to INR 5,31,300 thousands in FY 2002-03. On the other hand, the provision for depreciation increased from INR 70,693 thousand in the FY 2001-02 to INR 84,582 thousand in FY 2002-03. The assessee was not in possession of capacity related information regarding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... range of +/-5% based on OP/TC ratio (AY 2002-03) is concerned, the Ld. CIT(A), in paragraph no. 18, page no. 26 of his order for AY 2002-03, mentioned that he had accepted eleven comparable companies (selected by the assessee company in transfer pricing study report) as functionally comparable to the assessee company for the purpose of the arm's length analysis under the TNMM. Without prejudice to above, the Ld. CIT(A), confirmed that even if Cosmo Ferrites Ltd was selected as the sole comparable, the international transactions under consideration were at arm's length under the TNMM after application of +/-5% arm's length range. The aforesaid decision of the Ld. CIT(A) is based on the computation of arm's length range of +/-5% based on OP/Sales ratio. 21. We note that in subsequent years, the comparable companies selected by the assessee company were accepted by the ld TPO. We note that the assessee company functioned as a manufacturer and supplier of soft ferrite components (electronic components). For A.Y. 2004-05 and A.Y. 2005-06, the assessee company considered the associated enterprises as tested parties and selected comparable companies which were accepted by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reduced voltage motor starters etc. 4 Lakshmi Electricals Control Systems Ltd Control panels, engineering plastic components, wind power generation etc. 5 Sazler Electronics Ltd. CAM operated rotary switches, selector switches, wiring ducts, voltmeter switches, and allied products. 6 Kaycee Industries Ltd Rotary switches, rotary cam switches etc. 7 Reed Relays & Electronics India Ltd Reed switch, reed sensors, proximity sensors, thermal switch, float switch etc. 8 Bhartia Industries Ltd Electrical switchgear/control gear products, factory automation products. 9 Elpro International Ltd. High voltage Arresters and low voltage Metal Oxide Varistors (MOV). 10 Indo Asian Fusegear Ltd Electrical control & protection equipment, and lighting equipment. 11 K Dhandapani & Co Ltd. Electrical products Table No. 4 - Comparable companies considered by the assessee company from AY 2008-09 Sl. No. Comparable Companies Products manufactured 1 Controls & Switchgear Contractors Ltd Auxiliary relays, power contactors, thermal overload relays and motor starters. 2 Crompton Greaves Ltd Consumer electrical products 3 J S L Industries Ltd HT Indoor and outdoor in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the judgment of the Coordinate Bench of ITAT Bangalore in the case of Dy. CIT v. PMC - Sierra India (P.) Ltd. [2016] 74 taxmann.com 110 wherein it was held that since the turnover of the assessee was Rs. 45.85 crore, the permissible range of turnover of companies stood at Rs. 4.58 crores, that is, one-tenth of the assessee`s turnover to Rs. 458.50 crores (ten times of the assessee`s turnover). The ld CIT(A) rightly noted that turnover for the relevant financial year of the following comparable companies fall within the permissible range as aforesaid: Sl. No. Name of companies Turnover (FY 2002-03) Rs. in Crore) Tested party 53.13 Comparable Companies Akasaka Electronics Ltd Data not available Anand Electronics Ltd Data not available 1 CTR Manufacturing Inds Ltd 27.73 2 Continental Device India Ltd 97.12 3 Cosmo Ferrites Ltd 26.90 4 Deltron Ltd 19.63 5 Fine-line circuits Ltd 13.38 6 Incap Ltd 11.65 Karnataka Hybrid Micro devices Ltd Data not available Keltron components complex Ltd Data not available 7 Pan electronics (India) Ltd 8.05 8 Ruttonsha International Rectifier Ltd 6.41 9 SPEL Semi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, SPEL Semiconductor Ltd, Continental Device India Ltd and Cosmo Ferrites Ltd). are comparable with the FAR of the assessee company for the relevant financial year. Therefore, considering the entirety of facts and circumstances of the case and the material on record, and relying on the precedents cited above we uphold the nine comparable companies selected by the ld CIT(A) and use of cash profit margin ratio in TNMM, we uphold the order of ld. CIT(A) to delete the ALP adjustment of Rs. l0,02,37,000/- for A.Y. 2003-04 and ALP adjustment of Rs. 5,19,77,000/-for A.Y. 2002-03. 24. In the result, the appeals of the Revenue (in respect of transfer pricing grounds) are dismissed. 25. Now, we shall take other miscellaneous grounds raised by the Revenue. 26. (i) Ld CIT(A) erred in deleting provision for payment of gratuity under section 40A(7) of the Act and addition made on account of contribution to superannuation fund U/s 40A(9) of The Act. (a) Provision for gratuity u/s 40A(7), for A.Y. 2002-03 Rs. 8,28,600/- (b) Provision for gratuity u/s 40A(7), for A.Y. 2003-04 Rs. 20,71,870/- (c) Contribution to Superannuation Fund U/s 40A (9), for A.Y. 2002-03 Rs. 14,75,778/- (d) Contri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r, in the assessment order under section 143(3) of the Act the AO has also computed the total assessed income taking profit before tax amounting to Rs. 1,72,46,000/- as starting point. Therefore, the provision for tax amounting to Rs. 7,50,000/- was actually not claimed by the assessee company. We note that since the assessee had computed its total income chargeable to tax by taking net profit before tax amounting to Rs. 1,72,46,000/- and the Ld. AO has also computed the assessed income taking profit before tax amounting to Rs. 1,72,46,000/-as starting point. Therefore, the provision for tax amounting to Rs. 7,50,000/- was not claimed by the assessee and as such the ld CIT(A) has rightly deleted the disallowance made on this account. Therefore, we confirm the order passed by the ld CIT(A). 29. (iii) Ground Nos. 6, 7, 8, and 9 raised by the Revenue are interlinked and common. These grounds relate to computation of deduction under section 80HHC of the Act. The main grievance of the Revenue in these grounds are that CIT(A) was erred in directing the AO to consider foreign exchange gain as a part of export turnover, while such gains were not derived out of export activity and were no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e export incentive (i.e. DEPB credit), I direct the Ld. AO to exclude only the extent of 90% of DEPB credit as stated in the provision of clause (baa) of Explanation to section 80HHC for the purpose of computing deduction u/s 80HHC. 6. The assessee has further stated that the "AO has erroneously deducted 90% of earnings from cross currency swap transactions amounting to Rs. 51,69,000/- and miscellaneous income amounting to Rs. 16,48,000/- from the 'profit of the business respectively. 7. I have carefully considered the submission of the assessee and the provision stated in clause (baa) of Explanation to section 80HHC of Act wherein nothing has been mentioned in respect of exclusion of earning from cross currency swap transactions and miscellaneous income for the purpose of the calculation of "profits of the business". 8. In view of the same, I, direct the Ld. AO to include the earning from cross currency swap transactions and miscellaneous income for the purpose of the calculation of "profits of the business" for the purpose of computing deduction u/s 80HHC. 9. The assessee has also stated that the "AO has erroneously not deducted the sales tax amounting to Rs. 75,31,00 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... though the same could be restricted to 70% while computing deduction under normal provisions of the Act. 16. Since the assessee would be entitled to avail the benefit u/s 80HHC at 100% of export profit in computing Book Profit for the relevant year, in my view, the same cannot be restricted to 70% by applying the provisions of section 80HHC(IB) of the Act which is applicable under the normal provisions of the Act. Accordingly, I direct the ld. AO to allow deduction u/s 80HHC at 100% of export profit on finally assessed Book Profit. The aforesaid additional ground of the appeal is accordingly allowed." We note that Ld. counsel cited plethora of the case laws to bolster his claim which are not being repeated again since it has already been incorporated in the submissions of Ld. A.R. and have been duly considered to arrive at our conclusion. The Ld. DR could not bring to our notice any case laws to contradict the findings of the Ld. CIT (A), therefore, his order on these covered issues noted above are hereby upheld and grounds raised by the Revenue are dismissed. 31. (iv) Ground Nos. 3 and 4 raised by the Revenue for A.Y. 2003-04 relate to addition deleted by the ld CIT(A) under ..... X X X X Extracts X X X X X X X X Extracts X X X X
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