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TMI Blog2023 (1) TMI 117X X X X Extracts X X X X X X X X Extracts X X X X ..... he raw material consumption is unique to each business and depends on many factors including internal and external factors like location, environment, etc. and needs to be examined factually based on evidences and supporting. In view of the above discussion we remit this issue back to TPO/AO to examine the issue afresh and pass a speaking order after giving a reasonable opportunity of being heard to the assessee. The assessee is directed to submit all the relevant details and evidences as may be called for in this regard and cooperate with the proceedings. It is ordered accordingly. This ground is allowed in favour of the assessee for statistical purposes. Exclusion of certain comparables - Exclusion of Mazda Ltd. - The overview of business of Mazda Ltd. shows that it a manufacturing and engineering company mainly into space and energy saving ejector vaccum systems. The product catalogue of the company includes vaccum systems, condenser, heater vaccum pump, hotshot pump, etc. One of the products manufactured is the value and the company in its annual report has given the financials of the valve product separately. We notice that the TPO has for the purpose of comparability con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al is against the final order of the AO passed u/s. 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961 [the Act] dated 28.6.2019 for the assessment year 2007-08 on the following grounds:- 1. That the order of the Ld. TPO and the order of the Honourable DRP in pursuance of whose directions, the said assessment order is passed insofar as it is prejudicial to the interests of the Appellant are opposed to law and facts of the case. 2. That in the calculation of Operating Margin of the Assessee, the Hon'ble DRP erred in not directing the Ld TPO to exclude the abnormal cost incurred on raw materials by the Assessee during the relevant assessment year, which is the first active year of operation. 3. That the Hon'ble DRP erred in sustaining the order of the Ld.TPO by including M/s Mazda Ltd as a comparable without appreciating the fact that the products manufactured by the said company is entirely different form that manufactured by the Appellant. 4. That in computation of ALP, the Hon'ble DRP erred in not directing the Ld TPO to include M/s Leader Valves as a comparable even though the company is in the same industry as that of the Assessee. 5. That the Hon' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment made by TPO. Meanwhile, the assessee filed rectification application before TPO on 05.11.2018 and consequently the TPO has passed the order u/s 154 dated 22.01.2019 reducing the TP adjustment from Rs. 2,19,73,114/- to Rs. 1,40,13,901/-. The DRP vide its order dated 23.05.2019 rejected the grounds of the assessee relating to Transfer Pricing issues. The assessee is now in appeal before the Tribunal against the final order of the AO passed as per the directions of the DRP in the second round. We will adjudicate the issues raised in the grounds by the assessee in the following paragraphs. Exclusion of abnormal raw material consumption 4. The assessee made an adjustment of 18% towards abnormal raw material consumption during the AY 2007-08 as it is the first full year of operation of the company. The TPO while considering the issue during the remand proceedings did not allow the adjustment for the purpose of computation of ALP. The DRP was of the view that this claim was not made by the assessee in the first round and the assessee cannot raise this plea in the second stage of proceedings, as the TPO cannot travel beyond the scope of boundaries in the set aside proceeding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 007 - 08 2008 - 09 2009 - 10 2010 - 11 Sales other related income 15,32,28,023 42,79,34,852 44,61,99,700 44,78,88,654 Material consumption 13,47,44,093 30,56,52,601 30,49,51,994 33,77,07,924 Percentage % 88% 71% 68% 71% Average of AY 2008-09, 2009-10 2010-11 70% Percentage of raw materials allowance claimed by the appellant 18% (iii) From the above, it was submitted, it can be seen that average material consumption to sales declined by about 18% from the second year onwards. Based on the above, it is prayed to direct the AO to consider an allowance of 18% to the margins of the assessee in arriving at the ALP. 6. The ld. DR submitted that this is a fresh adjustment made by the assessee during the remand proceedings and the TPO/DRP were right in rejecting the adjustment as this issue was no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r material cost is the wastage of raw material in the initial years of operation. We notice that the raw material consumption is not reducing in a linear manner as claimed by the assessee warranting an adjustment for the purpose of ALP. Further, this adjustment is done by the assessee during the remand proceeding as a new adjustment to the ALP and from the order u/s.92CA passed by the TPO it is not coming out clearly whether this adjustment is examined in detail during the remand proceedings by the TPO. One of the reasons quoted by the DRP for rejection of this adjustment is that the assessee has not submitted the annual reports of the subsequent years to substantiate the raw material consumption details. The raw material consumption is unique to each business and depends on many factors including internal and external factors like location, environment, etc. and needs to be examined factually based on evidences and supporting. In view of the above discussion we remit this issue back to TPO/AO to examine the issue afresh and pass a speaking order after giving a reasonable opportunity of being heard to the assessee. The assessee is directed to submit all the relevant details and evi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreement with the filters applied by the assessee and that in the revised TP study the assessee came up with only one comparable as the assessee prayed for exclusion of the original comparables chosen. The DRP concluded with the following observations on the inclusion / exclusion of the comparables:- The TPO's study resulted in two comparables one being M/s. Mazda Ltd. The comparable is into manufacture of engineering goods like vacuum products and valve products (as per para 6 of annual report). The assessee is into manufacture of Hydraulic components and fluid power products. He noted that the product range of both are broadly similar being engineering products involving vaccum fluid and valve products. The assessee argued that only one range of products i.e., control valves with turnover of Rs.I.07 crore is similar. However, from para 6 of the Annual report the DRP found that valve segment turnover is Rs.8.16 crores out of Rs.52 crores. Even otherwise apart from valves, other products (vacuum products) are also very similar. According to the DRP, under the TNMM method, there is no requirement of product identity for comparability and broad product range comparability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dingly, it is prayed that this company may be excluded. Leader Valves Ltd . - It was submitted that the ITAT had set aside the entire issue to the TPO. Accordingly, the assessee made a fresh search for comparables by applying the filters in search matrix and two final comparables were taken. During the proceedings before the TPO, the Assessee had accepted that one of the companies was too small and had substantial trading activity also and agreed for its exclusion. Accordingly, only one company namely Leader Valves Ltd was contended to be included. This company is engaged in the manufacture of fluidic piping systems and valves and forged steel gate valves and similar products. 13. The ld AR further submitted that in the assessee s own case for AY 2013-14, the ITAT has held that as opposed to other transfer pricing methods, the TNMM requires transactions to be broadly similar to qualify as comparable. Broadly similar in this context means that the compared transactions don't have to be exactly like the controlled transaction. This increases the amount of situations where the TNMM can be used and thus TNMM is the most commonly used methodology applied and accepted for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 common transfer pricing methods for evaluating the related party transactions undertaken between entities. Of these TNMM is the most common method that is used for determining the arm's length nature of transactions. It compares the operating/ net margins of companies to analyse if the related party transactions have been undertaken on an arm's length basis. Rule 10B (1) (d) states as under: 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- ** ** ** (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic 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; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce and energy saving ejector vaccum systems. The product catalogue of the company includes vaccum systems, condenser, heater vaccum pump, hotshot pump, etc. One of the products manufactured is the value and the company in its annual report has given the financials of the valve product separately. We notice that the TPO has for the purpose of comparability considered the revenue and cost attributable to value products only. The level of comparability under TNMM is at a broad level of product comparability and high level functional comparability. Therefore, in view of this discussion and following the decision of this Tribunal in assessee s own case ( supra) , we hold that Mazda Ltd. cannot be excluded and the orders of the lower authorities are upheld. Exclusion of Yuken India Ltd. 19. This company is included by the assessee in its TP study and it was not contended in the first round of proceedings. However, during the remand proceedings, the assessee has sought for its exclusion before the TPO on the basis that the list of items manufactured by the company includes products that are not similar to that of that of the assessee and the segmental profit with respect to valu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee s own case ( supra) , has decided this issue in favour of the assessee with the following observations:- 26. In the case of Nagravision India (P.) Ltd., (supra), the Tribunal held that the working capital adjustment should be allowed. For holding so, the Tribunal has followed the decision rendered by another Bench in the case of Huawei Technologies (India) (P.) Ltd. v. Jt. CIT [2019] 101 taxmann.com 313 (Bang. - Trib.). The decision rendered in the case of Huawei Technologies (India) (P.) Ltd. (supra) are extracted below:- '10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows: Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] sha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, 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. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic 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. 11. A reading of Rule 10B(l)(e)(iii) of the Rules read with Sec. 92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. 12. Chapters I and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers - (less) the period granted to pay debts to suppliers. 14. Examples of how to work out adjustment on account of working capital adjustment is also given in the sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cision relied upon by the CIT (A) in the impugned order. In the matter of determination of Arm's Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm's Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the open market. It is not the case of the CIT (A) that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by CIT (A) working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of rule 10B(3) of the Rules, which provides as follows: (3) 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 to 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. 18. In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Pvt Ltd [ITA No 282 of 2013] . 25. The ld. DR, on the other hand submitted that the DRP stated that the TPO computed arm's length interest under CUP method. Under CUP the interest that is charged between unrelated parties under similar circumstances would be taken as arm's length interest. The issue that is examined was the interest rate at which tax payer would have got the loan from unrelated third parties. It is verified by the TPO that no security is provided by the assessee against the loans received. In the circumstances, the DRP upheld the method adopted by the TPO to arrive at the arm's length interest. Accordingly, it is held that RBI rates do not apply to the transactions under consideration. He submitted that the order of the DRP may be upheld. 26. We have considered the rival submissions and perused the material on record. During the course of hearing, the ld. AR drew our attention to the Master Circular of RBI, RBI/2005-06/87, A.P.(DIR Series) Circular No.5 dated 1.8.2005 which is at pages 99 to 103 of PB, wherein sub-clause (IV) of clause (A) of the Annexure to the Circular provides as follows:- The all-in-cost ceilings for ECB are indicated fr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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