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TMI Blog2022 (8) TMI 481X X X X Extracts X X X X X X X X Extracts X X X X ..... ing study at page-12 paragraph 4.5.5 has given reasons for choosing profit margin of Assessee at entity level for the purpose of comparison. It has been stated therein that the transactions of sale and purchase of extruders and parts and elements of extruders, commission on sales, purchase of fixed assets and services received were considered as closely linked transactions. Therefore, the Assessee evaluated the international transactions by adopting Combined Transaction approach at entity level. Admittedly as per TP Study the transaction of purchase of intangibles and interest received from China were benchmarked separately. The three international transactions are of purchase of extruders and parts from Steer China and payment of commission to Steer Japan and Steer America. The other international transaction is of purchase of fixed assets from Steer China. As to how these international transactions are interlinked and interdependent is not spelt out in the TP study. By it s very nature, these transactions appear to be independent. We also find that in the transfer pricing study the Assessee has given reasons as to why CUP method was not suitable in its case. It has been stated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lt in the rules. The idea is to get data for comparison. Assessee s transaction with AE has to be compared with that of an uncontrolled transaction. The net profit margin referred to in the uncontrolled transaction has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market. In such circumstances, the reasoning of the TPO in applying export turnover filter at 25% of the turnover is proper and calls for no interference. The two comparable companies which are admittedly comparable companies available for comparison, cannot be excluded on the basis of a filter which has no relevance to the factual scenario in the present case. We direct the TPO to determine the ALP in accordance with the directions contained in this order after affording the Assessee opportunity of being heard. Correctness of determination of ALP in respect of provision of Corporate Guarantee by the Assessee to its AE - HELD THAT:- The law is by now well settled that providing corpora ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Companies Act, 1956 with liability limited by shares. The Assessee manufactures Extruders and Parts and Elements for Extruders. M/s Steer Japan Corporation (hereinafter referred as Steer Japan for brevity) and M/s Steer America Inc (hereinafter referred as Steer America for brevity) are both 100% subsidiaries of the Assessee and act as distributors in Japan and America respectively for the products manufactured by the Assessee. Steer China Corporation (hereinafter referred as Steer China for brevity) manufactures full range of extrusion lines, twin screw compounding extruders and CNC Wire EDM machines. During the relevant previous year, Steer China operated as distributor for products manufactured by the Assessee. Steer China is a wholly-owned subsidiary of Chindia Company Limited, Hong Kong (hereinafter referred as Chindia for brevity) which is a wholly owned subsidiary of Steer Engineering Private Limited. Chindia is an investment company. 4. There is no dispute that (i) Steer Japan Corporation, Japan, (ii) Steer America Inc., USA and (iii) Steer China Corporation, China, were associated enterprise(AE) within the meaning of the term as defined in Sec.92A(1) of the Inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r of assessment against which, the Assessee has a right to file objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. Under section 144C(5), the Dispute Resolution Panel (DRP) shall issue the directions, as it thinks fit, for the guidance of the AO to enable him to complete the assessment after considering report of TPO. The AO passes a final assessment order on the basis of directions of the DRP. In case the Assessee chooses not to filed objections before the DRP to the draft assessment order within the time required u/s.144C of the Act, the AO passes a final assessment order. The Assessee has a right of appeal against the said order to the CIT(A), which course the Assessee has adopted in the present case. 5. During the previous year, the Assessee entered into the following international transactions with its AE: Sl. No Name of Associated Enterprises Nature of Transactions Value (INR) 1 Steer Japan Corporation Sale of Extruders / Parts and Elements of Extruders 124,631,529 2 Steer A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cts as that of the Assessee to unrelated parties. The net operating margins of the comparable companies so chosen by the Assessee in it s Transfer pricing analysis, for the financial year 2011-12 based on the above PLI along with the operating revenues, operating cost and operating profit is tabulated below: Sl. No. Name of the Company Operating Revenue Operating Cost Operating Profits Average Unadjue d Mar (%) 1 Kabra Extrusion Technik Ltd 1,902,883,000 1,814,029,000 88,854,000 4.90% 2 Rajoo Engineers Ltd 781,159,786 727,279,635 53,880,151 7.41% Arithmetic mean 6.16% On the basis of the above, the arithmetic mean of net operating margins on comparable companies was 6.16 per cent. 7. Computation of operating margin of Steer India: The net operating margin of the Steer India based on the financial statements for financ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable companies were taken at the entity level and that the two comparable companies also had transaction within the country (domestic sales) and outside the country i.e., international sales but they were to unrelated parties. As far as the Assessee is concerned it had sales within the country (domestic sales) with unrelated parties and sales outside the country of which part of it was with related parties and part was with foreign parties who were unrelated. The quantum of foreign sales of the Assessee with related parties out of the total foreign sales of Rs.43,54,22,715 was only Rs.29,57,59,913/-. The following chart would show the break up of domestic and international sales of the Assessee and the comparable companies. Sl. No. Particulars Domestic Sales and its % of total sales International Sales and its % of total sales Total Sales Annexure 1 Appellant 35, (45%) 43, 54,22,715 (55%) 78,74,83,935 1 2 RojooEngineers ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nover. In respect of Business promotion and Marketing exhibition expenses the TPO allocated them on the basis of actual. The TPO thereafter drew segmental Profit Loss acc (i.e. domestic and international segment) as follows: Domestic segment International segment Entity level Allocation Sales (OR) 35,20,61,220 435422715 78,74,83,935 Actuals Cost of material Consumed 11,3084822 13,9861746 252946568 Ratio of sales Increase/decrease of Inventory and WIP 75,62,160 93,52,776 1,6914,936 Ratio of sales Employee benefit expenses 6,35,89,613 7,86,46,756 142236369 Ratio of sales Bank charges 24,19,436 29,92,324 54,11,760 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... u/s 92CA for manufacturing segment at Rs. 5,92,37,627/-. Following is the relevant extract of the TP Order: 4.1 The adjustment to international transactions is determined as under: Mean PLI of comparables A 6.16% Operating cost of tested party B 49,23,07,220 Arms length Operating Revenue C = (100+A)% of B 52,26,33,345 Operating Revenue of tested party D 43,54,22,715 Difference E = C-D 8,72,10,630 International transactions as part of Operating Revenue F 29,57,59,913 Ratio of international transaction in OR G = F/D 67.92% Adjustment to international transaction H = G% of E 5,92,37,627 4.2 Above adjustment of INR 5,92,37,627 is the adjustment to international transactions of taxpayer relating to sale to AEs. 13. Before the CIT(A), the Assessee c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Assessee as well statutory auditor are of the view that profit from reach geography cannot be computed with reasonable accuracy and they view them as single segment. In such circumstances arbitrary allocation of expenses by the TPO is bad in law and hence to be rejected. Relevant extract of the Annual Report is given below: It was further contended that the TPO has bifurcated expenses based on the ratio of turnover. However, the TPO has failed to appreciate that the basis for apportionment also included international transactions with AE s which itself is a tainted transaction. The TPO by allocating expenditure based on turnover, which has tainted transactions has therefore computed tainted segmental. The TP adjustment based on such tainted segmental is therefore bad in law. Therefore, the action of the TPO of drawing segmental based on turnover is incorrect and without basis. 14. Without prejudice to above submissions, it was contended that the segmental adopted by the TPO in the TP Order contains several errors. It was pointed out that the revenue for the international segment is considered at Rs.43,54,22,715/- without appreciation that the fact that Rs.43,54,22,715 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Assessee is consistently growing its market share in US using its made-in- India Technology and is penetrating into being the preferred supplier to the Top 25 Compounding Companies in the world. The Assessee tabulated below its sales trend and projection for sakes for US market: SALES TREND Financial Year Sales (INR Crs) 2011-12 16.70 2012-13 21.43 2013-14 33.32 2014-15 24.15 2015-16 50.03 PROJECTIONS FOR US MARKET INR Crores Sl. Particulars 2017-18 2018-19 2019-20 1 Sales 45.42 50.31 55.95 - Extruders 19.31 21.29 23.54 - Extruder Parts 26.11 29.02 32.41 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anufactured by the Assessee. During the year under consideration, Steer China has also operated as a distributor for products manufactured by the Assessee in China apart from the manufacturing activity for part of the year. During the year under consideration, the Assessee entered into following transactions with AE s: Sl. No. Nature of Transaction Amount 1 Sale of Parts and Elements of Extruders 29,57,59,913 2 Purchase of parts and elements of Extruders 61,48,295 3 Purchase of fixed assets 91,37,883 4 Purchase of intangibles 3,29,91,505 5 Payment of commission on sales 15,44,27,194 6 Reimbursement of sales promotion and other expenses 23,26,538 7 Interest received 8,11,791 21. The transactions of sale and purchase of extruders and parts and elem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... OECD Guidelines provide that a Combined Transaction Approach can be adopted in case the transactions are closely linked or continuous and they cannot be evaluated adequately on an individual basis. In such a situation, rather than assessing the arm's length terms of the transactions individually, these transactions could be evaluated together using the most appropriate method. The relevant observations of the OECD are as below: 3.9 Ideally, in order to arrive at the most precise approximation of arm s length conditions, the arm's length principle should be applied on a transaction-bytransaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include: a) some long-term contracts for the supply of commodities or services, b) rights to use intangible property, and c) pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing of manufacturing know-how and the supply of vital components to an associated man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions, then the same can be aggregated and construed as a single transaction for the purpose of determining the arm's length price. In case, there is close link exists between the different transactions, the same should be treated as composite transaction and appropriate method should be applied to work out the transfer pricing analysis. Where two or more transactions emanate from common source being an order or contract or an agreement or an arrangement, then such transactions could be said to be closely linked as the nature, characteristic and terms of such transaction substantially flow from the said common source. 24. It was submitted that the Assessee is a manufacturer of extruder and parts of extruder and the AE s act as distributor for such extruders and parts outside India. The products manufactured by the Assessee are being sold to AE, who in turn sell them to third parties. For remunerating the AEs for rendering distribution services, the Assessee has paid commission, which is part of business promotion expenses. In case of third party sales the Assessee performs similar functions. It manufacturers extruders and elements of extruders and sells directly to thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther the markets are wholesale or retail. 26. Rule 10B(2) of the Income Tax Rules provide that for application of Transfer Pricing methods, it is important to ensure that comparability exists between comparable companies selected and international transactions undertaken by the taxpayer. Rules has also spelt out that Geographical locations are one of the important comparability criteria s. If the comparability criteria s do not tally, then such uncontrolled comparable companies cannot be compared to the taxpayer. It was pointed out that the TPO has completely disregarded the above aspects. The TPO has stated that Tested Party should be selected first and comparables have to be searched later. The TPO has not appreciated that both the Assessee and TPO has selected the same tested party i.e. the Assessee. The Assessee has benchmarked the international transactions considering entity wide margins for the following reasons: Only two comparables i.e. Kabra Extrusion Technik Ltd and Rajoo Engineers Ltd. are available in public database whose functions, risks and assets are similar to the Appellant [This is also accepted by the TPO in para 3.7 of the TP Order] Both the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ments and computed ALP under TNMM adopting combined transaction approach. The taxpayer contended that even the comparables have trading of spare activity and level of its trading activity and that of comparable is same. The ITAT observed that while it is true that function, assets and risks of the trading and manufacturing segments generally differ; however, circumstances may warrant combining both of them. It is only in the specific facts of the case that the combining of both segments is advisable. In the instant case, the sale of spare parts is triggered as a result of the manufacturing activities, including warranty commitments. Therefore, it would not be in the fitness of things for the sale of spare parts and components to be considered in isolation from the sale of manufactured vehicles. The ITAT held that on an overall consideration, it can be concluded that trading in spare parts is closely inter-linked with the manufacturing segment of the taxpayer. The ITAT held that no meaningful purpose would be served in segregating the trading and manufacturing segments particularly when the taxpayer and the comparable companies are at par with regard to the nature and scale of combi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eliance was placed on the following decisions wherein in identical circumstances, entity level profits were taken for comparison purposes viz., Toyota Kirloskar Motors 28 taxmann.com 293 (Bang.) and DCIT Vs. JDSU Indian Pvt.Ltd. (2018) 93 taxmann.com (Delhi-ITAT). It was submitted that entity level TNMM comparison was accepted in the earlier years by the revenue i.e., for AY 2009-10 to 11-12 and therefore applying the rule of consistency, it should be accepted this year also. If international segment of the Assessee is to be compared, then comparables should pass 75% export turnover filter. It was submitted that turnover cannot be adopted for allocating all costs. Export and domestic markets have different product mix, different packing and documentation requirements and different cost of Goods sold. Alternatively it was submitted that the export sales to AE was only Rs.29.57 crores and the segmentation and operating profit margin of only export sales should be taken for the purpose of comparison both in the case of the Assessee as well as the comparables. It was submitted that in any event foreign exchange fluctuation gain has to be treated as part of the operating profit. The lea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in subclause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction]; Rule 10A(d) defines transaction to include a number of closely linked transactions . In terms of Rule 10B(1)(e) (i) of the Rules, the net profit realized by an enterprise from an international transaction has to be ascertained first. The Assessee in it s Transfer Pricing study at page-12 paragraph 4.5.5 has given reasons for choosing profit margin of Assessee at entity level for the purpose of comparison. It has been stated therein that the transactions of sale and purchase of extruders and parts and elements of extruders, commission on sales, purchase of fixed asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... suitable in its case. It has been stated therein that the extruders parts and elements are manufactured based on specific order. The products are unique and not comparable to others. The terms and conditions and the economic circumstances under which the Assessee sells extruders parts and elements to AE are materially different from the comparable uncontrolled transactions. We are therefore of the view that the question of adopting the profit margins at the entity level based on the submissions made by the Assessee before the CIT(A) cannot be accepted. 34. The next part of the first issue is as to whether the profit margin of export sale including sale to AE and non AE or only export sale to AE ought to have been considered by the TPO. On this aspect we find that the revenue for the international segment is considered at Rs.43,54,22,715/- without appreciating the fact that Rs.43,54,22,715/- contains both sales made to AE and non-AEs. Perusal of Form 3CEB shows that sales made for the relevant previous year to AE was only Rs. 29,57,59,913/-. The AE ultimately sold these products to third parties. Therefore, considering whole of international segment for comparison is without bas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompared with that of an uncontrolled transaction. The net profit margin referred to in the uncontrolled transaction has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market. In such circumstances, the reasoning of the TPO in applying export turnover filter at 25% of the turnover is proper and calls for no interference. The two comparable companies which are admittedly comparable companies available for comparison, cannot be excluded on the basis of a filter which has no relevance to the factual scenario in the present case. 38. We direct the TPO to determine the ALP in accordance with the directions contained in this order after affording the Assessee opportunity of being heard. 39. The next issue that needs to be adjudicated in this appeal is with regard to correctness of determination of ALP in respect of provision of Corporate Guarantee by the Assessee to its AE. The law is by now well settled that providing corporate guarantee to AE is an inte ..... X X X X Extracts X X X X X X X X Extracts X X X X
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