9911796707
TMI Blog2022 (3) TMI 1522X X X X Extracts X X X X X X X X Extracts X X X X ..... nt, Trading Segment and Services Segment. 3. In the Manufacturing Segment, the assessee manufactures intermediate products that fall under the product classification automotive components/auto anciliary products like It operates in the following segments: -Instrument clusters; -Engine systems; -Immobilisers and transponders -Speed sensors, -Airbag controllers - Anti-lock braking systems(ABS) -Fuel supply modules; and -Temperature gauges, pressure gauges, etc. 4. In the manufacturing segment, the assessee is in charge of conceptualization and designs. It procures equipment for manufacture both fixed and capital equipments. It owns any intellectual Property rights (IPR) for the products developed by them. It receives technology and manufacturing know-how from its Associate Enterprise (AE) for its manufacturing process. It purchases raw materials and components from both third parties and AEs. The nature of raw materials purchased from the AEs and third parties are different. The raw materials procured from the AE are globally sourced by Continental group wherein prices are negotiated globally to get price advantage for bulk purchases. Manufacturing and assembly of p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arising from an international transaction hall also be determined having regard to the arm' s length price. * The term "international transaction' has been defined in section 92B(1) or the Act to mean a transaction between two or more "associated enterprises" either or both of whom are non-residents in the nature of inter alia purchase, sale or lease of intangible property or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. * Section 92A of the Act defines the term "associated enterprise" in relation to another enterprise, in a manner where the enterprise directly or indirectly participates in the Management, control or capital of the other enterprise. * The term "arm's length price" (ALP) has been defined in clause (ii) of section 92F of the Act, to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. Section 92C(1) of the Act provides that the arm's length price in relation to an international. By virtue of the provisions of section 92CA(1), the Assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we are concerned with two of the International Transactions carried out by the assessee during the previous year, in respect of which additions were made to the total income on account of determination of ALP, which has been challenged by the assessee before the Tribunal, viz., (i) Transfer pricing adjustment ("TP adjustment") of Rs.117,35,51,190/- made by the Transfer Pricing Officer ("TPO") in respect of the manufacturing segment of the Assessee pursuant to the DRP directions. (ii) TP adjustment of Rs.25,95,18,911/- made by the TPO in respect of the software development services ('SWD services' for short) rendered by the Assessee pursuant to the DRP directions. 11. In the course of assessment the Assessing Officer ("AO") made a reference to the TPO for examination of the arm's length price of the aforesaid transactions. On such reference, the TPO passed an order dated 30.10.2017 under Section 92CA of the Income-tax Act, 1961 ("the Act") determining the TP adjustment with respect to manufacturing segment and SWD services segment totaling to Rs.155,70,82,500/-. Initially, a draft assessment order dated 08.12.2017 came to be passed by the AO in which, inter alia, the aforesaid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eived from the AE. The Assessee chose Transactional Net Margin Method (TNMM) - as the Most Appropriate Method for comparing Assessee's profit margin with that of comparable companies. Under this method the comparison is made between the Assessee's the operating/ net margins with that of comparable companies to analyse if the related party transactions have been undertaken on an arm's length basis. Rule 10B(1)(e) of the Income Tax Rules, 1962 (Rules), explains transactional net margin method as a method by which,- (i) the net profit margin 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; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; Report this ad (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee as a comparable company in its TP study. Besides the above, the Assessee has also raised a contention that the provisions of Sec.92 of the Act have to be applied only to the proportionate value of international transaction i.e., transaction with the AE and transactions with non AEs should be not considered for the purpose of adjustment u/s.92 of the Act. 16. A comparison of the Assessee's TP study and the manner of determination of ALP by the TPO is given below: 1. Net mark-up on cost earned by the Assessee As per the TP study: Operating Income Rs. 5,17,71,00,000/- Operating Cost Rs.5,05,41,30,000/- Operating Profit (Op. Income - Op. Cost) Rs. 12,29,70,000/- Net mark-up (OP/OR) 2.38% As reflected in the TP Order: Operating Income Rs. 5,17,71,00,000/- Operating Cost Rs.6,04,57,20,000/- Operating loss (Op. Income - Op. Cost) Rs.-86,86,20,000/- Net mark-up (OP/OR) -16.78% 2. Comparison of the TP studies done by the Assessee and TPO: Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator (PLI) OP/OR OP/OR Database used PROWESS & CAPITALINE PLUS PROWESS &Ace-TP Comparables selected 6 11 3. Filters applied by As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. has taken the entire cost of Rs.604,57,20,000 incurred in the manufacturing segment and reduced the Arm's Length margin of 7.50% to arrive at the operating cost of Rs.478,88,17,500 that the Assessee ought to have incurred but since revenue that the Assessee's cost was Rs.604,57,20,000, the difference of Rs.125,69,02,500 (Rs.604,57,20,000 - Rs.478,88,17,500) was added as adjustment consequent to determination of ALP. 18. It is one of the contention of the Assessee before the TPO that the provisions of Sec.92 can be applied only to transactions with AE. In this regard the Assessee pointed out that in the manufacturing segment, the Assessee is in charge of conceptualization and designs. It procures equipment for manufacture both fixed and capital equipments. It owns any intellectual Property rights (IPR) for the products developed by them. It receives technology and manufacturing know-how from it's Associate Enterprise (AE) for its manufacturing process. It purchases raw materials and components from both third parties and AEs. The nature of raw materials purchased from the AEs and third parties are different. The raw materials procured from the AE are globally sourced by Contin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ef from original adjustment 90,96,29,854 The above plea was not accepted by the TPO. No specific discussion is there on this issue in the order of the TPO. 18B. Aggrieved by the aforesaid determination of ALP by the TPO in the draft order of Assessment by the AO, the Assessee filed objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. The DRP issued directions, whereby it upheld the contentions of the TPO, subject to the following directions: (i) Company Hindustan Hardy Spicer Limited to be included in the list of comparable companies. (ii)The TPO to examine the claim of the Assessee that Supreme Treon Private Limited and Borg Warner Morse TEC Murugappa Pvt Ltd fail the RPT filter. (iii) Re-computation of margins for Vijayashree Automotive Ltd (iv) The rectification petition filed by the Assessee to be considered on merits. 19. The AO passed the impugned final assessment order in line with the directions of the DRP in which the TP adjustment was reworked to Rs. 117,35,51,190/- in accordance with the order dated 22.11.2018 passed by the TPO. 20. The grounds that were pressed for adjudication regarding determination of ALP in the Manufacturing segment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he comparable companies and not the tested party and that the capacity utilisation of each of the comparable companies has not been considered. According to the AO in terms of Rule 10B(1)( e) clause (iii) the net profit margin arising in comparable uncontrolled transactions has only 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 and the Assessee's margin can never be adjusted. The TPO held that the data considered by the Assessee to compute the adjustment pertained only to 3 out of 7 companies and that the capacity utilisation for FY 2010 to 2014 alone were considered. It was also observed that under-utilization of capacity is not only for the Assessee but had affected the entire industry. Therefore, its comparable companies also have the same effect as the Assessee. Normally, utilization of capacity is significantly different between the Assessee and comparable companies in the initial stage of operation. However, the Assessee is not in the initi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies to the extent these adjustments are reasonably accurate. Such adjustment can be allowed only in a case where Assessee is able to furnish accurate and credible evidence in this regard. In the relevant case law, since Haworth India had not been able to furnish credible and accurate information with regard to capacity utilization, the adjustment was not allowed. However, in the Assessee's case, the Assessee has provided all information practically possible. Sufficient evidence has been provided in the form of capacity data of comparable companies as well as industry average from the Federation of Indian Chambers of Commerce & Industry ("FICCI") survey report. Hence principally capacity utilization adjustment should have been granted. 26. The Assessee has also relied on the following judicial precedents in this regard: * Global Vantedge P. Ltd. v. DCIT reported in [2010] 37 SOT 1 (DELHI) * ITO v. CRM Services India (P) Ltd reported in [2011] 14 taxmann.com 96 (Delhi) * CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay). * Transwitch (India) Pvt. Ltd. v. DCITreported in [2012] 21 taxmann.com 257 (Delhi - Trib.) * Capgemini India Private Lim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ublic domain, the AOITPO is directed to obtain the same directly from the comparable companies and decide theissue afresh, after affording opportunity of being heard to the assessee. Accordingly, this issue is remitted to the AO/TPO." 31. Following the aforesaid order, we remand the issue to the TPO/AO for consideration afresh on the lines indicated in the decision of the Tribunal for AY 2012-13, after affording the Assessee opportunity of being heard. 32. As far as Grd.No.10 raised by the Assessee is concerned, the same is in relation to adjustment to the cost base of the Assessee on account of custom duty. The Assessee has incurred significant customs duty charges which are proportionately much greater than that of the comparable companies leading to a lower profitability for the Assessee. The comparable companies have not incurred any significant custom duty expense as they primarily manufacture using materials available indigenously within India. It was submitted that the Assessee is still in the process of localizing its manufacturing process. To meet the quality standards and to overcome technological challenges, the Assessee imports raw materials from its AEs. Therefore, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remanded to issue to the TPO with the following observations: "30. This issue came up for consideration before the Chennai Tribunal in the case of Gates Unitta India Company (P.) Ltd. v. DCIT, 84 taxman.com 69 wherein it was held as follows:- "5. Before us, Id. A.R submitted that 90% of the raw materials of the assessee are' imported as such customs duty adjustments to be made and it includes Rs. 4.31 crores pertained to the customs duty in the manufacturing segment. In principle the customs duty adjustments is allowed in view of the Co-ordinate Bench decision in the case of Motonic India Automotive (P.) Ltd. v. Assn. CIT [20161 73 taxmanri.corn 235 (Chennai Trib.) wherein held that: '6.1 At this stage, it is pertinent to mention the finding of the Pune Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. v. DCIT (supra) dated 4.1.2012 in ITA No.120/PN/2011, which is as follows : "37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). it is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis a vis the scope of the adjustments in the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in public domain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that some approximations are to be made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee's operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee's claim is that it was in These circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car vas computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was submitted that the Assessee imports a considerable amount of raw material for undertaking the manufacturing operations in India. As a rule, import prices are significantly impacted by the foreign exchange rates, which is the case for the Assessee as well. Hence, foreign exchange fluctuation will be one of the significant factors impacting the import costs and in turn influencing the profitability. Accordingly, it made an adjustment to its operating costs by reducing an amount of Rs. 23.44 crores therefrom. The TPO disallowed such adjustment and the DRP upheld the same. The observations of the TPO/DRP and the Assessee's submission as regards the same was as under: TPO/DRP observations Assessees submissions * The Assessee has already included Foreign exchange gain/loss in its income statements and hence, it is not appropriate to adjust it for transfer pricing analysis. * The Assessee imports components and raw materials in Euro, US dollars and JPY but sells them in Indian Rupees and does bear the risk of foreign exchange transaction. The Assessee's loss is mainly due to higher import cost of raw materials * While the Assessee's submission talks about review and revisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble companies so that the difference which could materially affect the amount of net profit margin is removed. More so, in practical situations there may be absence of reliable data in the case of the comparable companies for which such material difference is to be analyzed or examined. In certain cases there may arise some difficulty when the reliable data for particular cost or profit may not be available, therefore, a reasonable accurate adjustment in the hands of the tested party may throw fruitful result. The Assessee's profitability is significantly impacted as a result of forex fluctuation where it had import content of around 73% unlike comparable companies with significantly lower portion of import of materials (4%). Hence such losses would not exist in the case of comparable companies. 38. The significant imports made by the Assessee are in Euro, USD and Yen. While accounting, the same is converted to INR based on the foreign exchange rates communicated by the Continental Group. During the relevant years, the INR depreciated considerably vis-à-vis most of the other major currencies and imports became costlier for the Assessee. The fluctuation in the value of Eur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee had to import from its group affiliates/foreign unrelated suppliers and therefore localisation of such high quality raw materials had not occurred during the assessment year in question due to several factors. In this connection, the Assessee's import consumption vis-à-vis the imports of comparable companies selected by the learned TPO and the Assessee are as below for the FY 2013-14: TPO's comparables Import/Total purchases Import/Sales Rajsriya Automotive Inds. Pvt. Ltd. 0.06% 0.03% TVS Upasana Ltd. 1.24% 0.48% Aspee Springs Ltd. 4.46% 2.23% Supreme Treon Pvt. Ltd 7.47% 3.84% JMT Auto Ltd 6.21% 3.26% Aditya Auto Products &Engg. (India) Pvt Ltd. 19.75% 10.25% Varroc Engineering Pvt Ltd. 7.56% 4.80% Leewon Precision Pvt. Ltd. 2.02% 1.05% Borgwarner Morse TEC Murugappa Pvt. Ltd. 0% 0% Maco Pvt. Ltd 64.88% 40.02% VijayshreeAutocom Ltd. 0% 0% Average Import Consumption 10.33% 6.00% Assessee's comparables Import/Total purchases Import/Sales Automotive Stampings & Assemblies Limited 0.93% 0.73% Bharat Gears Limited 0.85% 0.46% Hindustan Hardy Spicer Limited 0.52% 0.29% J M T Auto Limited 6.21% 3.26% Munja ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ign suppliers in majority of the components supplied as compared to the previous year. To demonstrate the fact that the increase in material costs are as a result of depreciation in currency and not because of price increase, the Assessee applied the following methodology: Step 1: Identify the total component wise invoice value in foreign currency for the parts imported by the Assessee in FY 2013-14; Step 2: Determine the corresponding quantity against such invoices imported; Step 3: Determine the per unit price in foreign currency (Step 1 divided by Step 2); Step 4: Carry out the same methodology for FY 2012-13 (previous year) and determine the per unit price in foreign currency; and Step 5: Compare the price (for the same components imported) so arrived at the Step 3 vis-à-vis Step 4 and identify the change in such price. 44. The above exercise was carried out for FY 2013-14 and it was observed that majority of the components imported by the Assessee did not result in higher per unit price when compared with the previous year. In fact, in majority of cases, the per unit price has only declined/stayed constant. This demonstrates that the foreign exchange rate flu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allowed. 47. The learned counsel for Assessee placed reliance on the judgment of this Hon'ble Tribunal (Delhi Bench) in Honda Trading Corpn. India Private Limited v. ACIT reported in[2013] 33 taxmann.com 21 (Delhi - Trib.), Gates Unitta India Company (P) Ltd reported in[2017] 84 taxmann.com 69 (Chennai - Trib.), Pangea 3 & Legal Database Systems Pvt Ltd v. Income-tax Officer reported in[2017] 79 taxmann.com 303 (Mumbai - Trib.) in support of its contentions. 48. The learned DR relied on the order of the DRP on this issue. 49. Both the parties agreed that identical issue was decided by this Tribunal in Assessee's own case for AY 2012-13 in IT (TP) A No.713/Bang/2017 and this Tribunal by it's order dated 24.11.2021 remanded to issue to the TPO with the following observations: "39. This issue was also considered by the Chennai Tribunal in the case of Gates Unitta India Company (P.) Ltd. (supra) and it was held as under:- "7. We have heard both the parties and perused the material on record. In our opinion, forex fluctuations loss in the operating cost of the assessee and also forex gains in the operating income of assessee, both to be excluded from the operating expenses as we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re observed not only for the Assessee but in the entire industry. It was further held that since the average of comparable margins are taken and a margin of 3% is also allowed, the same would take care of adjustments that cannot be carried out. 52. It was submitted that the DRP directed grant of depreciation adjustment vis-à-vis differences in depreciation cost in the Assessee's own case in AY 2012-13, consequent to which the transfer pricing adjustment in the manufacturing segment for the AY 12-13 was reduced by INR 24.23 crores. Since there has been no change in facts from AY 12-13, the Assessee prays that the same be granted in the AY 14-15 as well. 53. Without prejudice to the arguments below on the comparability of companies chosen by the TPO, if depreciation adjustment is granted, the arithmetic mean of the margin of comparable companies adopted by the learned TPO would be -0.14%. The learned counsel for Assessee relied on the following judicial precedents: - CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay) - Schefenacker Motherson Ltd vs. ITO reported in[2009] 123 TTJ 509 (Delhi) - CIT vs. Rakhra Technologies Private Limited report ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Assessee's case, the AE is responsible for the product design and development. The Assessee does not own any intangibles. Hence, the same company ought to be excluded from the final list of comparables. The learned DR relied on the order of the DRP which held that broad comparability as part of automotible components was good enough and the conclusion that presence of intangibles by itself is not sufficient to disregard comparability when otherwise there is functional similarity. 57. Rule 10B(2) of the Rules provides the criteria for considering an international transaction undertaken by an Assessee as comparable with an uncontrolled transaction and it lays down as follows: "Rule 10B(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss of manufacturing spokes and nipples for all the major OEM's in India. These automotive components are less complex and are mechanical in nature as compared to the electric components manufactured by the Assessee. The Assessee is into the manufacture of electrical components like instrument clusters, engine systems, speed sensors, airbag controllers, anti-lock braking system etc for the automobile industry. It is the further plea of the Assessee that TVS is also engaged in manufacture of various products and operates in different segments. Moreover, raw material consumption ratio on sales of TVS and the Assessee are widely variant. The proportion of raw materials consumed by the Assessee (76%) exceeds 2 times that of TVS. Particulars TV Upasana Ltd Amt (in Rs) Assessee Amt (in Rs) Raw material cost 33,50,12,898 394,68,84,336 Sales 91,47,45,212 517,71,01,220 Raw material cost/Sales 37% 76% It was also pleaded that TVS fails the RPT filter of 15% consistently applied by the Tribunal. Therefore, the said company cannot be considered as a comparable and ought to be excluded from the final list of comparables. 60. The learned DR relied on the order of the DRP and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s consumed by the Assessee (76%) exceeds 1.5 times that of the comparable company. The relevant details as extracted from the annual reports are provided below. Particulars Amt (Rs.) Raw material cost 14,55,03,466 Sales 30,61,07,713 Raw material cost/Sales 48% From the above, it is evident that Aspee operates on a different business model from that of the Assessee and hence is functionally non-comparable. Therefore, the said company ought to be excluded from the final list of comparables. 63. The learned DR relied on the order of the DRP. 64. In so far as the contention regarding the dissimilarity in the characteristics of the property and presence of R & D activities the conclusions while dealing with Rajsriya will apply to this company also. As far as the difference in own consumption of raw material and different business model, we are of the view that the conclusions while dealing with the comparable TVS will equally apply to this comparable also. We hold and direct accordingly. d) Supreme Treon Pvt. Ltd. ('Supreme') (formerly Supreme- Treves Private Limited) 65. As far as the objection of the Assessee for exclusion of this company is concerned, it has been reite ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny fails the RPT filter of 25% applied by the TPO. The RPT workings as extracted from the annual report are provided below: Particulars Amt (Rs.) Related party transactions 33,14,12,001 Sales 129,10,14,168 RPT/Sales 25.67% It was submitted that while the DRP directed the RPT filter to be reapplied by the TPO, the same was inappropriately applied by the latter and the company was included in the final list of comparable companies. The Assesseealso submits that the raw material consumption ratio on sales of Borgwarner and the Assessee are widely variant. The relevant details as extracted from the annual reports are provided below. Particulars Amt (Rs.) Raw material cost 47,46,47,085 Sales 99,66,28,898 Raw material cost/Sales 48% The proportion of raw materials consumed by the Assessee (76%) exceeds 1.5 times that of the comparable company. From the above, it is evident that Borgwarner operates on a different business model from that of the Assessee and hence is functionally non-comparable. The learned DR relied on the order of the DRP. 68. In so far as the contention regarding the dissimilarity in the characteristics of the property the conclusions while dealing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isions of the Act. Reliance was placed on the following decisions in support of the above contention of the Assessee: * IL Jin Electronics (I) (P.) Ltd v. ACIT reported in[2010] 36 SOT 227 (DELHI) * M/s Tupperware India Private Limited (ITA No. 2140/Del/2011 and 1323/Del/2012) * IKA India Private Limited v. ACIT reported in [2019] 101 taxmann.com 276 (Bangalore). * CIT v. Alstom Projects India Limited reported in [2017] 88 taxmann.com 465 (Bombay) * Alstom Projects India Limited v. CIT reported in [2013] 36 taxmann.com 130 (Mumbai - Trib.) * CIT v. Thyssen Krupp Industries (P) Limited reported in [2016] 70 taxmann.com 329 (Bombay) * Claas India Pvt. Ltd., - ITA No.3883/Del/2010 * CIT v. Petro Araldite Pvt. Ltd reported in [2018] 93 taxmann.com 438 (Bombay) * Kyungshin Industrial Motherson Limited v. DCIT reported in [2015] 57 taxmann.com 166 (Delhi - Trib.) * Emersons Process Management India (P) Ltd v. ACIT reported in [2011] 13 taxmann.com 149 (Mumbai) * DCIT Vs Starlite reported in 133 TTJ 425(Mum) * Gillete India Ltd v. ACIT reported in [2014] 44 taxmann.com 133 (Jaipur - Trib.) * Phoenix Mecano (India) Private Limited v. ITO reported in [2014] 42 taxm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of ALP. Sub-section (1) of section 92C stipulates that:- "The arm's length price in relation to an international transaction shall be determined by any of the following methods.....". 47. It is the plea of the assessee that addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. The profit from comparable transactions of the assessee with non-AEs is one of the subtle and most reliable modes for determining ALP of the international transactions. The Act does not contemplate an addition by way of TP adjustment in respect of transaction with non-AEs. 48. The TPO determined addition to total income, consequent to determination of ALP only in relation to international transaction i.e., transactions with AE in the export of finished goods segment by considering the value of international transaction at Rs.3,31,50,982 which is the value of export of finished goods by the assessee to its AE and not on the total sales in the finished goods segment of Rs.39,19,74,355 (vide para 8.3 of the TPO's order). 49. The Hon'ble Bombay High Court in the case of Phoenix Mecano (India) Private Limited [ITA No. 1182 of 201 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ures of international transaction are available, so also the order referred above. No substantial question of law arises for consideration. As such the appeal is dismissed with no costs." (Emphasis supplied) 51. The Hon'ble Mumbai Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 7032/Mum/2011] held that the ALP can only be determined on the value of international transaction alone and not on the entire turnover of the assessee at entity level. This decision was further upheld by the Hon'ble Bombay High Court in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 2201 of 2013], which held as below:- "2. .............. (a) Whether on facts and the circumstances of the case and law, the Tribunal was justified in law in restricting the Transfer Pricing (TP) adjustment only to the transaction between the Associated Enterprises (AEs.)? 3. ........... ........... (e) We find that in terms of Chapter X of the Act, redetermination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave duly been considered and the issue is being decided as follows: 10.1 In the case under consideration, the appellant is selling its product to AE as well as to non AEs, for the manufacture of which, part purchases are from AEs and remaining from the non AEs. The TPO has considered OP/OR for purpose of computation of the ALP as the quantum of sales to AE are lesser than the purchase from AE and thus lesser controlled. When a product is sold, only overall profit margin is recorded without any data as to what would be the profit in relation to purchases from AE. So this cannot be presumed that the profit percentage earned in relation to costs related to AE transactions as well as non-AE transactions was same. Since costs are common to the products ultimately sold by the appellant, and the same includes AE transactions, so it is always possible that the margin of profit percentage vis-a-vis costs related to AE transaction is not the same as profit margin on costs related to non-AE transactions but ultimately overall certain profits are being shown. Further, the transactions with non-AEs can be presumed to be at arm's length as there is no reason to earn lesser profit. But in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decision rendered in the case of IKA (supra) squarely applies to the present case. Therefore, the adjustment on account of determination of ALP has to be restricted only to that part of the transaction with AE and not the entire value of the manufacturing segment as was done by the revenue authorities. 75. As far as Grd.No.17 is concerned, the Assessee in this ground has challenged the order of the TPO whereby he treated the payment of Research and Development and licence fee (Royalty) to the AE as at nil. In this regard it was submitted that the TPO erred in making an adjustment treating the ALP as 'Nil' with respect to royalty fee payment on the ground that the Assessee had failed to prove that the services were actually rendered by the AE. It was submitted that though the DRP has upheld the order of the TPO, the DRP has held that as the adjustment in the manufacturing segment being made under TNMM incorporating the payment of license fee/royalty as a part of the operating cost, the adjustment comes to more than the amount of royalty and therefore, no separate adjustment is called for royalty. Further, the DRP held that in the event, the margin of the manufacturing segment is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns Pvt Ltd
13.36
8.
Hepatica Technologies Pvt Ltd
-1.43
9.
Hinode Technologies Pvt Ltd
-3.60
Arithmetical Mean
5.71%
The TPO selected 3 comparables from the TP study of the Assessee and rejected 6 comparables selected by the Assessee in its TP study.
Filters applied by the TPO:
Step
Description
1.
Companies whose data is not available for FY 2013-14- excluded.
2.
Companies which are functionally comparable - selected
3.
Companies having different financial year ending (i.e. not March 31, 2014) or data of the company does not fall within 12 month period i.e., 01-04-2013 to 31-03-2014- rejected.
4.
Companies whose service income X X X X Extracts X X X X X X X X Extracts X X X X ..... DRP erred in upholding the inclusion of Infosys Ltd., Persistent Systems Ltd., Mindtree Ltd, Larsen and Toubro Infotech Ltd. and Thirdware Solutions Ltd. (Ground No. 23).
(ii) That the DRP erred in not directing inclusion of Akshay Software Technologies Ltd., KALS Information Systems Ltd, Sasken Communication Technologies Ltd., Hepatica Technologies Pvt Ltd., Maveric Systems Ltd., Daffodil Software Ltd., and I2T2 India Ltd. (Ground No. 24).
(iii) That the DRP erred in not granting WC Adjustment (Ground No. 25).
82. As far as Ground No.23 raised by the Assessee is concerned, in this ground, the Assessee is seeking the exclusion of Infosys Ltd., Persistent Systems Ltd., Larsen and Toubro Infotech Ltd. and Thirdware Solutions Ltd and Mindtree Ltd. from the list of comparables.
83. As far as the challenge by the assessee on exclusion of aforesaid 5 companies in ground No.23, the ld. counsel for the assessee has brought to our notice a decision of Bangalore Bench of ITAT for the very same Assessment Year 2014-15 in the case of LG Soft India Pvt. Ltd. in IT(TP)A No.3122/Bang/2018 for AY 2014-15, order dated 28.5.2019. In this order rendered in a case of assessee rendering SWD serv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .
84. As far as exclusion of Larsen & Toubro Infotech Ltd., is concerned, the Tribunal in the very same case of M/s. LG Soft Pvt. Ltd. (supra) in another order dated 27.9.2019 in MP No.95/Bang/2019 held that exclusion of Larsen & Toubro Infotech Ltd., was omitted to be adjudicated in the original order dated 28.5.2019 passed by the Tribunal referred in the earlier paragraph and held that Larsen & Toubro Infotech Ltd., is also not a comparable company because there were extraordinary events that occurred in the relevant previous year and that it possessed brand and intangibles and there was no segmental information of subcontracting expenses.
85. Respectfully following the aforesaid decision, we direct exclusion of (1) Infosys Ltd. (2) Larsen & Toubro Infotech Ltd. (3) Persistent Systems Ltd. & (4) Thirdware Solutions Ltd. from the list of comparable companies.
86. As far as exclusion of Mintree Ltd., is concerned, it was submitted that Mindtree ought to be excluded from the final list of comparables inter alia for the reasons that it is not functionally comparable to the Assessee. Mindtree is engaged in the business of Manufacturing, Banking, Financial Services and Insurance, H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f intangibles/patents. Assessee failed to justify the significant expenditure in foreign currency affects comparability and in any event Assessee cannot be aggrieved by a company which undertakes onsite development activity in which the profit earned is low.
88. We are of the view that if the onsite revenue of the comparable is more than 25% of its total revenue, then the company cannot be regarded as comparable. In this regard, we find that this tribunal has been taking a consistent stand by following the decision in the case of Triology E-Business Software ITA No.1054/Bang/11 order dated 23.11.2012 wherein it was held that companies who generate more than 75% of the export revenues from onsite operations outside India are effectively companies working outside India having their own geographical markets, cost of labour etc., and also return commensurate with the economic conditions in those countries. Thus assets and risk profile, pricing as well as prevailing market conditions are different in predominantly onsite companies from predominantly offshore companies like the taxpayer. Since, the entire operations of the tax payer are taking place offshore i.e. in India; it is but nat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the case cited by the ld. counsel for the assessee. Following were the relevant observations of the Tribunal:-
"(i) Akshay Software Ltd. which has a margin of 8.13%. The income from commission on sale of software license constitute meager 0.5% of total revenue and TPO has not applied transfer development filter. The said company was rejected by the TPO for the reason that the company is engaged in providing provisional services, procurement installation, employment support of ERP products. The DRP has rejected the comparable without applying the filter and there is no difference in the business model adopted by the company and the assessee. We on perusal of the Annual Report at Page 1373 of Paper Book, found that major revenues are from operations as per Note 19 being income from software services and commission received on sale of software licenses. The earnings as per Note 28 as per the financial statements, the company has earning from export of software and in the F.Y. 2013-14 which constitute more than 95% of income. Therefore we found these facts are not considered by the TPO or DRP and accordingly we restore this issue to the file of TPO for examination and verification ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iness of both software products and software services. It was submitted that KALS was engaged only in software development services during the FY 2013-14. KALS has not earned any revenue from software product during the current financial year and does not have any inventory of software products. KALS was engaged both in provision of software product and services till the year ending March 2012. Thereafter, the company has been only engaged in provision of the software development activities and had not owned any software products during the year ended March 2014. Therefore, it was submitted that the company ought to be included in the final list of comparables. We are of the view that this aspect was not examined either by the TPO or DRP and therefore deem it fit and appropriate to remit the issue and direct the TPO/AO to consider the claim in this regard.
97. As far as exclusion of Sasken Communication Technologies Ltd. ("Sasken") We find that this company was selected by the Assessee and came to be rejected by the TPO for the reason that the company is functionally not comparable to the Assessee. The exclusion of the company came to be upheld by the DRP on the grounds that (i) t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be fit and appropriate to remit the issue and direct the TPO/AO to consider the claim in this regard.
99. As far as exclusion of Daffodil Software Limited is concerned, we find that this company proposed by the Assessee during the course of TP proceedings came to be rejected by the TPO for the reason that the company has earned revenue from sale of software services as well as from products and segment data for the same in unavailable. It was contended that the DRP has erred in rejecting the company on the ground that the company employs intangible assets developed by itself amounting to INR 2,80,59,023/. It is submitted that the said amount of is intangible under development, i.e. work-inprogress which the company has not yet employed in its operations. Therefore, this company ought to be included in the final list of comparables. We have considered the submission and are of the view that once the company is found to be a product company also and no segmental details are available and if that finding is not in challenge, then that ground would be sufficient to disregard this company as a comparable company and therefore the presence of intangibles would not make any difference. H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provision for warranty contending the same to be contingent liability/ created on estimate basis. The DRP upheld the disallowance proposed by the learned AO and rejected the Assessee's objections in this regard. The AO passed the final order disallowing the aforesaid expense pursuant to DRP directions.
103. It was submitted by the learned counsel for the Assessee that it supplies dashboard sensors and other allied auto components to various automotive manufactures like TVS, Hyundai, Tata, etc. The Assessee provides warranty of 12 months on its products to the customers. The Assessee creates two kinds of provision for warranty, they are:
a. General Provision for warranty - The Assessee creates general provision for warranty on a scientific basis towards the expected liability that could arise during such warranty period. The Assessee creates provision for warranty on the percentage of sale for each product. The quality department based on past experience and historical trend of the performance of each product arrives at a percentage based on which provision for warranty is created.
b. Additional provision for warranty - Bearing in mind the nature of industry of that of automob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch provision amount is arrived at. Further, utilization amount represents expense incurred on actual claims received by the Assessee.
2
Provision is made on estimate basis/ adhoc basis
The Assessee had submitted following details to the AO:
* Ledger extract for actual warranty expenses incurred by the Assessee along with the supporting documents on sample basis
* Summary of provision created for warranty
Please refer paper book - Volume-3 filed on 11 March 2019 Page No.1385 to 1509 Page No.1511
The above evidences the methodology of creating such provision and substantiates that the warranty policy adopted by the Assessee is on scientific basis and not adhoc basis.
3
Actual warranty claims debited to profit and loss account/ No separate ledger
The AO failed to appreciate that the Assessee adjusts actual warranty claims against provision in the provision account, a separate ledger is maintained for the said purpose. Further, certain direct actual warranty expense not in the nature of provision was directly debited to profit and loss account.
It was reiterated that the Assessee follows the specific methodology of creating provis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... centage. The claim made by the Assessee that the method followed for creating provision for anticipated liability on account of warranty stands vindicated by the fact that the actual liability on account of warranty expenses is always on the higher side. The reasons given by the DRP for not accepting the claim of the Assessee is that the provision is created as a percentage of sale, ignoring the fact that past experience is also the basis for creation of provision for warranty. We are therefore of the view that the provision for warranty has to be allowed as a deduction, as the provision created satisfies the requirements for claiming provision as a liability, as laid down in the judicial precedents referred to above. We hold and order accordingly and allow the relevant ground of appeal of the Assessee.
108. Ground Nos. 36 to 46 are in respect of Disallowance of annual licence fee of Rs. 28,00,21,116/-. The facts with reference to these grounds are that during the year under consideration the Assessee debited expenses amounting to Rs. 28,00,21,116 to profit and loss account under the head "R&D". The break-up of the total R&D expenses is as under:
Sl. No.
Nature of expenses
Amo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he technical information, to the Assessee for development, manufacturing and sale of automotive products.
* Compensation for the aforementioned license has been agreed to be paid by the Assessee as an annual royalty of 3% of net sales on account of use of intellectual property generated from basic R&D and 2% on net sales (which shall decrease by 0.25% during every calendar year after 2009) on account of use of intellectual property generated from old application R&D. [Basic R&D is Product related research and development for the general benefit of the company in manufacturing of the automotive products and Application R&D is Customer specific product related research and development].
Agreement B (page refer page no. 1541 to page no. 1551 of the paper book - volume 3 filed on 11 March 2019): The Assessee has entered into a License and Technical Assistance Agreement dated 1 January 2009 with Continental Teves AG & Co. OHG, Germany ("CT AG"). Under this agreement, CT AG grants license to use technical information for development, manufacture and sale of sensors and supply information relating to commercial manufacture, sale and distribution. Compensation for the aforementioned lic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 ITR 849 (Bombay HC)
* Alembic Chemical Works Co. Ltd. v. CIT [1989] 43 Taxman 312 (SC)
* J.K. Synthetics Ltd. v. CIT[2009] 176 Taxman 355 (Delhi High Court)
* DCIT v. Honda SIEL Power Products Ltd I.T.A .No. 1579/DEL/2017 (A.Y 2012-13) & S. A No. 217/Del/2017 in ITA No. 1579/Del/2017
114. Based on above judicial decisions, the factors to be considered and conditions to be satisfied were summarized as below:
Factors to be considered
Conditions to be satisfied
License period and termination
The license is granted for a limited period and not exclusive. The parties have a right to terminate the license
Restriction on creation of further rights/ assignment
The licensee has restricted rights to create further rights/ assign the license in favor of third parties
Confidentiality
The arrangement prohibits parting with confidential information
Degree of transfer
The license does not transfer all the 'fruits of research' of the licensor, "once for all"
Nature of royalty
Royalty paid as a percentage of sales is linked to sales achieved by the assessee and hence, is considered as cost in earning the same
115. It was submitted that the agreements under which the annual li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the group benefits out of such knowledge sharing and technical guidance and support.
c) Some of the key benefits out of the above support to the Assessee includes timely business planning, optimum resource utilization, and meeting customer's requirements where the expectation is always to deliver as per global standards, gaining competitive advantage, and running the business smoothly and efficiently.
d) Corporate Project Management Manuals and Standards - CPMMs and CPMS provided by Continental global aid in project management. Further, the Assessee refers to the standard document provided by Continental global in planning introduction of a new product, which provides basic guideline for innovation introduction. Continental group provides the latest updates relating to development of key manufacturing technologies. This helps the Assessee to upgrade its business including the manufacturing process to the latest available technology.
117. Relevant Snapshots of the manuals, emails and standard documents demonstrating the rendering of these services are produced before this Hon'ble Tribunal under cover of an application for additional evidence. The additional evidence sought to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t would not be in a position to produce high quality automobile products as per global standards.
- Access to various tools/platforms
a) There are numerous tools/ software platforms that are made available by Continental global to the Assessee for the purpose of its business. These tools are developed in-house by Continental global or developed by third party and customized for use by Continental group. These tools/software platforms are primarily online tools/platforms and shared drives which facilitate various technical support including:
- Sharing of best practices/ standard procedures (discussed above).
- Real-time production control and monitoring.
- Planning/ forecasting the material and labor requirements.
- Survey the customer's demands/ requirements.
- Tracking and overall management of the project on real-time basis.
- Integration of costing software and accounting software (SAP).
b) Various tools like tech.net, prod.net, log.net, camlineetc are provided to the Assessee and some of the key tools in use by the Assessee are discussed below:
Sl. No.
Tool Name
Tool/ platform description
Benefit to 'Continental India'
1
Tech.Net
It is a platform w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... global strategic sourcing approach i.e., strategy for obtaining raw material/ resources across the world in a standardized manner, which can achieve economic advantages in terms of obtaining significant discounts.
Continental global locates suppliers, seeks samples from them and tests their products. Upon satisfaction about the quality of the product, Continental global provides such information of suppliers located across the globe, to the group. It also negotiates for bulk discounts and set quality standards for the suppliers. This in turn helps the Assessee in procuring quality raw materials at best price without any efforts. Sample email communications demonstrating procurement of raw materials by Continental Global, instructions/solutions on raw material shortage and quality issues are produced before this Hon'ble Tribunal under cover of an application for additional evidence.
- Provision of designs, procedures and layouts
Every product that the Assessee manufactures is unique and complex. Continental global develops and shares its designs, layouts and drawings relating to products, manufacturing process, etc. with the Assessee. The requirement of the customers varies f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to mitigate the issues at every plant location across the world. If the issues are highly vulnerable and needs personal monitoring by the experts, the global team send experts to that particular location to address the specific and routine issues and bring down the occurrence of quality incidents.
- Other assistance:
a) Continental globalenters into centralized agreements for procuring certain techniques, technical services. This helps the Assessee to improve the product quality. The aforesaid assistance received from Continental group helps in improving the technological performance of the Assessee's operations in terms of quality and cost and also helps in optimum utilization of resources in an efficient manner. It also creates synergy among the group entities including the Assessee and ensures access to latest technical information.
120. Based on the above, it was submitted as the present case satisfies the conditions of section 37 of the Act, the license fee paid should be allowed as revenue expenditure.
SUBMISSIONS WITH REGARD TO PROJECT RESEARCH AND DEVELOPMENT EXPENSES OF RS.6,59,74,419:
121. The Assessee has entered into an Agreement for application research and dev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s.
Expense capitalized since the same was commercialized
4,10,56,133
Expense charged to the customers in the subsequent year (recorded as unbilled revenue in the captioned AY)
4,07,27,558
Expense charged off in the profit and loss account as it could neither be commercialized nor chargeable to the customers
6,59,74,419
Total
14,89,99,314
It was pointed out that party-wise Invoice details of technical knowhow availed from group companies amounting to Rs. 14,89,99,314 and sample invoice copies thereof were submitted before the Hon'ble DRP.
123. It was submitted that as can be seen from the above, an amount of Rs. 6,59,74,419 has been charged to profit and loss account related to specific projects. This expense relates to the technical knowhow availed from the group companies which was utilized by the Assessee towards the manufacturing and sales activities which is in the ordinary course of its business. However, since the same did not lead to any fructuous result (as it could neither be commercialized nor chargeable to the customers), it was charged off to the profit and loss account. In this regard, list of projects for which amount was charged off during the year was p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s group entities since the Assessee was carrying on the business even prior to entering aforesaid agreements
The Assessee submits that merely because an agreement is entered into, no businessman would change the business. It is for the purpose of the business that a businessman enters into an agreement.
Assessee had taken a business decision to avail the services from group entities to facilitate and further its business objects.
It is also submitted that having provided the factual and legal basis of the expense, the learned AO cannot question commercial expediency of a transaction.
Further, entering into agreements for use of intellectual property of the group companies has benefited the Assessee.
Reliance in this regard is placed on below judicial decisions, where it has been observed that "AO cannot take managerial decision and conclude what expense needs to be incurred by the business and what not".
* DCIT vs. International Institute of Planning &Management (P.) Ltd. [2015] 41 ITR(T) 733 (Delhi - Trib.)
* CIT vs. Dalmia Cement (P.) Ltd. [2002] 254 ITR 377 (Delhi) - this was affirmed by the Hon'ble Supreme Court [2007] 288 ITR 1 (SC)
5
Sundry creditors are increasing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P has erred in holding that the annual license expense does not fall under the definition of intangible assets under section 32 of the Act, without appreciating that the same falls under the limb of aforesaid definition, namely, "any other business or commercial rights of similar nature". Notwithstanding and without prejudice to the above, even if the said expenses are to be disallowed, the AO failed to appreciate that out of the total amount of Rs. 28,00,21,116, an amount of Rs. 27,63,35,693 has already been included in the adjustment made under section 92CA of the Act thereby leading to double disallowance of the same amount.In this regard, reliance is placed on the decision of DCIT v. Honda SIEL Power Products Ltd. (supra) wherein the Delhi Bench of Hon'ble Tribunal accepted the contention of the assessee in the said case that royalty has been already considered while arriving at the TP adjustment and hence, disallowance under section 37 of the Act has led to double disallowance .Further, the DRP in Assessee's own case for AY 2012-13, had directed the AO to remove the disallowance of R&D expense made under section 37 of the Income-tax Act, 1961.In view of the above, the learned ..... X X X X Extracts X X X X X X X X Extracts X X X X
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