ITAT Excludes Manufacturing Companies as Comparables as Assessee Was Predominantly a Trader

DCIT Vs 3M India Limited (ITAT Bangalore)

The Income Tax Appellate Tribunal Bangalore dismissed the Revenue’s appeals for Assessment Years 2008-09 and 2009-10 in a transfer pricing dispute involving exclusion of certain comparables and adjustment relating to IT support services.

The assessee company was engaged in manufacture, conversion, and trading of diversified products. The dispute primarily related to the healthcare segment, where the assessee reported an operating profit margin of 2.90% on sales. The assessee had selected five comparable companies with an arithmetic mean margin of 2.8% and claimed that its international transactions were at arm’s length.

The Transfer Pricing Officer (TPO) rejected the transfer pricing study and conducted a fresh search using Prowess and Capitaline databases. Six comparable companies were selected and an arithmetic mean margin of 14.55% on sales was determined. The TPO made an adjustment under Section 92CA after concluding that the arm’s length operating revenue was higher than the assessee’s reported figures.

The assessee argued before the TPO and subsequently before the Commissioner of Income Tax (Appeals) [CIT(A)] that it was predominantly engaged in trading activities, whereas some of the selected comparables were mainly manufacturing companies. The assessee pointed out that trading activities constituted 93.1% of its sales revenue while conversion activities accounted for only 6.7%.

The CIT(A) accepted the assessee’s contention and excluded Poly Medicure Ltd. and Opto Circuits (I) Ltd. from the list of comparables. The CIT(A) found that Poly Medicure Ltd. was an exclusively manufacturing-based company with only 1.39% trading revenue arising from sale of input materials. Similarly, Opto Circuits (I) Ltd. was found to derive 91% of its revenue from manufacturing activities. According to the CIT(A), the functional profile, assets employed, and risks assumed by manufacturing companies were substantially different from those of a predominantly trading entity.

The Revenue challenged this exclusion before the Tribunal, contending that the assessee itself was also engaged in manufacturing activities and had included Hicks Thermometer (I) Ltd., another manufacturing concern, in its transfer pricing study. However, the Tribunal observed that the assessee’s activities were predominantly trading in nature and that the TPO himself had accepted the manufacturing nature of the excluded companies. The Tribunal held that predominantly manufacturing entities could not be compared with a predominantly trading company for determining arm’s length price. It therefore upheld the exclusion of Poly Medicure Ltd. and Opto Circuits (I) Ltd. as comparables.

The second issue related to transfer pricing adjustment for IT support services. The TPO had determined the arm’s length price of administration and business support services at nil, treating the services as intra-group services and questioning their necessity. An adjustment was made on the ground that the assessee had local IT support arrangements, which according to the TPO indicated duplication of services.

The CIT(A) deleted the adjustment after noting that the IT infrastructure had originally been implemented through a regional data centre set up by 3M Singapore in financial year 2004-05 and that the major expenditure incurred during implementation had already been accepted in earlier proceedings. The payments in the relevant years related only to maintenance services such as software upgrades, patches, help desk support, disaster recovery, and business continuity backup.

The Tribunal observed that similar expenditure had been accepted by the Revenue in Assessment Year 2005-06 and no contrary material had been produced by the Department. Following judicial consistency, the Tribunal found no infirmity in the CIT(A)’s order deleting the adjustment relating to IT support services.

Since the issues for Assessment Year 2009-10 were identical, the Tribunal applied the same reasoning and dismissed both departmental appeals.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

1. ITA No. 1598/Bang/2013 for Assessment Year 2008-09 filed by the Deputy Commissioner of Income Tax LTU, Bengaluru against the Appellate Order passed by the Ld. Commissioner of Income Tax (Appeals), Large Taxpayers Unit, Bengaluru dated 23.08.2013 and ITA No. 307/Bang/2014 for Assessment Year 2009-10 filed against the order of the Commissioner of Income Tax(Appeals), Large Taxpayers Unit, Bengaluru dated 31.01.2014 is in case of M/s. 3M India Private Limited (the Assessee), involving the transfer pricing issues and therefore both are dealt with by this consolidated order.

2. First, we deal with the Appeal of the Ld. Assessing Officer for Assessment Year 2008-09. Brief facts of the case show that the Assessee is a company engaged in the business of manufacture, conversion and trading in diversified products. The Assessee filed its return of income on 30.09.2008 at a total income of Rs. 1,04,49,38,805/-. Return of income was picked up for scrutiny and necessary notices were issued u/s. 143(2) as well as u/s. 142(1) of the Act in time. The Assessment was made on 24.01.2012 u/s. 143(3) r.w.s. 144C of the Act wherein the total income of the Assessee was determined at Rs. 1,21,25,80,575/-. The major addition was with respect to the transfer pricing adjustment of Rs. 14,21,12,486/-. Further other disallowances were also made. But same are not required to be described here as same are not part of the dispute before us.

3. The transfer pricing adjustment was proposed by the Joint Commissioner of Income Tax (Transfer Pricing) – II, Bengaluru (the Ld. TPO) by passing an order u/s. 92CA of the Income Tax on 31.10.2011. The Ld. Transfer Pricing Officer was referred to determining the arm’s length price of the international transaction whereas the Assessee has entered into several transaction of import, purchase and sale of various products. The Assessee has applied transactional net margin method as the most appropriate method for determination of the arm’s length price. According to the financial statement of the Assessee, margins earned by the Assessee, being operating profit on operating cost was 18.68% and operating profit on revenue was 15.74%. The Assessee also maintains segmental data with respect to 6 segments by the Assessee namely industrial market segment, automotive and specialty material market segment, traffic and safety market, office equipment and construction market, healthcare market and consumer market. The operating profit on the cost with respect to these segments is 18.55%, 18.89%, 37.35%, 18.80%, 2.99% and 9.02%. Consequently, the operating profit on sales was also 15.64%,15.89%, 27.19%, 15.82%, 2.90% and 8.27%.

4. The only issue in dispute relates to the healthcare segment, in which the Assessee earned a margin of 2.90% on sales. The Assessee selected five comparable companies with an arithmetic mean margin of 2.8% and therefore claimed that the transaction was at arm’s length.

5. The Ld. Transfer Pricing Officer rejected the Assessee’s transfer pricing study report and undertook a fresh analysis. After searching the Prowess and Capitaline databases, he selected six comparable companies, arrived at an arithmetic mean margin of 14.55% on sales, and issued a show-cause notice.

6. The Assessee contended that it was primarily engaged in trading, whereas the comparables were engaged in manufacturing, and that some comparables did not have segmental financial statements. The Assessee also sought a working capital adjustment.

7. After considering the Assessee’s explanation, the Ld. Transfer Pricing Officer selected six comparables and determined the margins at 17.10% on OP/OC and 12.22% on OP/Sales. He computed the arm’s length operating revenue at Rs. 76,16,35,459/-, as against the actual operating cost of Rs. 84,24,94,000/-, and made an adjustment of Rs. 8,08,58,541/- under section 92CA.

8. The Assessee appealed to Ld. CIT(A), who, by order dated 23.08.2013, partly allowed the appeal. In paragraph 4 of the appellate order, the Assessee challenged several findings and adjustments made by the Ld. TPO. In paragraph 4.3, the Ld. CIT(A) accepted the Assessee’s contention that Poly Medicure Ltd. and Opto Circuits (I) Ltd. were manufacturing companies and should therefore be excluded.

9. Further, in relation to IT support services, the Transfer Pricing Officer made an adjustment of Rs. 6,12,53,945/-, determining the arm’s length price of administration and business support service fee paid by the assessee at Rs. Nil by applying the CUP method. The Ld. CIT(A), while dealing with ground no. 5 of the appeal in paragraph 6, deleted the adjustment on the basis that the Assessee had paid only maintenance charges for its information technology infrastructure. The Ld. CIT(A) also noted that the substantial expenditure of Rs. 3.89 crores incurred in financial year 2004-05 for project implementation had already been accepted, and therefore the maintenance-related expenditure for the current year also warranted acceptance. Accordingly, the adjustment was deleted.

10.The Ld. Assessing Officer is aggrieved with the above Appellate Order has raised following two grounds of appeal: –

1. CIT(A) has erred in deleting two comparables namely Poly Medicure Ltd and Opto Circuits (I) Ltd on the ground that they are into predominantly manufacturing. However, the assessee is itself is into manufacturing segment along with trading. The assessee has taken Hicks thermometer (I) Ltd as a comparable which also predominantly into manufacturing segment.

2. The CIT(A) has erred in deleting Information Technology (IT) support service Rs. 21,39,572/- adjustment by the TPO in spite of lack of evidence furnished by the assessee. Therefore, further appeal is suggested on this issue. In earlier years also appeal has been filed on this issue.

11. The Ld. Departmental Representative Dr. Divya K., JCIT-DR vehemently submitted that the Assessee is also engaged in the manufacturing segment along with trading segment and Assessee itself has also taken the comparable companies. There is no infirmity in the order of the Ld. Transfer Pricing Officer. She submitted that the Ld. CIT(A) was incorrect in deleting the above addition. With respect to ground no. 2, she submitted that deletion of adjustment of Rs. 21,39,572/- by the Ld. CIT(A) is devoid of any merit as the Assessee has failed to show any evidence about the arm’s length price of such services being nil.

12. The Ld. Authorized Representative Shri Mukesh Bhutani, Advocate referred to para no. 4 of the order of Ld. CIT(A) to show that health care segment is predominantly as trading segment. Trading activity of the Assessee constitutes 93% and manufacturing activity constitutes only 6.7% of the total sales and therefore the Ld. CIT(A) has held Assessee to be predominantly into trading business. He further referred to para no. 4.4 of the order wherein the Ld. CIT(A) has analyzed the annual report of Poly Medicure Limited and found that company is primarily engaged in manufacture and sale of medical disposable. The Ld. CIT(A) further taken into cognizance the information available on website and annual report to held that Poly Medicure Limited is an exclusively manufacturing company having trading revenue of only 1.39%. Such 1.39% is also flown from sale of input material and not final products. He therefore submitted that the Ld. CIT(A) finding out the different functions performed by the Assessee of trading and functions performed by the Poly Medicure Limited of manufacturing has directed for its exclusion. He further referred to para no. 4.5 of the Appellate Order wherein the Ld. CIT(A) directed to exclude Opto Circuits (I) Limited. He submitted that company as per information available on website is engaged in manufacturing and marketing medical electronic devices and health care products. Further, the annual report of that company shows that it has produced 41,44,550 units of the product and thus 91% of the revenue has arisen from manufacturing activity.

13. He further submitted that the functions performed by a manufacturer i.e. comparables and functions performed by a trader i.e., Assessee are quite distinct and could not be compared and therefore Ld. CIT(A) is correct in excluding the same.

14. With respect to ground no. 2, he referred to para no. 6 of the order of the Ld. CIT(A). His main argument was that the services were rendered from Assessment Year 2005-06 and therefore rendition of services could not have been doubted. He further stated that Assessee has paid only for maintenance services and Assessee has some local IT support also. Because of these reasons, the Ld. Transfer Pricing Officer was of the view that there is a duplication of services. The Assessee has deleted the IT support expenditure from 2004-05 wherein the major expenditurehas been accepted by the Ld. CIT(A), and this year only the maintenance expenses are incurred.

15. We have carefully considered the rival contentions and perused the orders of the Ld. Lower Authorities. The transfer pricing adjustment covered by ground no. 1 of the Appeal relates to only 2 comparables directed to be excluded by the Ld. CIT(A) while computing the arm’s length price of the international transactions of health care segment by the Assessee. The margin earned by the Assessee, being operating profit on operating cost of health care market segment is 2.99% and margin of operating profit on sales of 2.90%. The Ld. Transfer Pricing Officer selected 6 comparable companies with arithmetical mean margin of 14.55% on sales, rejecting the transfer pricing study report made by the Assessee. The Assessee objected that Assessee did not have the functions of ‘manufacturing and trading’ but predominantly it is having a trading segment. The Ld. Transfer Pricing Officer was requested to exclude the companies which are having predominantly manufacturing activities. The Transfer Pricing Officer did not agree with the Assessee for the reason that Assessee is also partly dealing with manufacturing and trading activities and also has included Hicks Thermometer (I) Ltd. in its comparability analysis which is also into manufacturing. The Ld. Transfer Pricing Officer further referred to para no. 3.13 of the transfer pricing study report of the Assessee wherein the Assessee was characterized. It also states that Assessee undertakes conversion activities but stated to be not significant. According to that noting in transfer pricing study report the trading activities constitute 93.1% and conversion activities constitute 6.7% of the sales revenue. Thus, the Ld. Transfer Pricing Officer was of the view that Assessee is also a manufacturer and trader and therefore a manufacturer trader taken into comparability analysis by the Ld. Transfer Pricing Officer could not have been excluded.

16. On Appeal before the Ld. CIT(A), the Assessee demonstrated that 93.1% of the activities are sales of the Assessee is resulting into the trading activities and 6.7% revenue is from the conversion activities. The Poly Medicure Limited was stated tobe by the Ld. CIT(A) in para no. 4.4 to be exclusively manufacturing based company and trading revenue of only 1.39% flown from sales of inputs. Thus, it is apparent that Poly Medicure Limited is a 100% manufacturing concern. The functional profile of a manufacturer like Poly Medicure Limited and a predominant trader like Assessee is substantially different. Further, the assets involved and used for manufacturing activities could not be compared with assets used for trading activities. Naturally, the risk of a manufacturer and the risk of a trader are also quite distinct and not comparable.

17. Further, Opto Circuits (I) Ltd is also engaged in manufacturing activity as 91% of its activity constitutes manufacturing. These facts have been recorded by the Ld. CIT(A) in para no. 4.5 of his Appellate Order.

18. Thus, the Ld. CIT(A) has categorically held that Assessee being a predominant trader could not have been compared with predominant manufacturer with comparison of margin cost of the difference in FAR and hence both the above comparables are correctly excluded.

19. The argument of the Ld. Departmental Representative that Hicks Thermometer (I) Ltd was admittedly engaged in manufacturing so included by the Ld. Transfer Pricing Officer. We find that there may be flaws in the transfer pricing study report of the Assessee which was rejected by the Ld. Transfer Pricing Officer and he carried out a fresh search. The Hicks Thermometer (I) Ltd was also a comparable selected by the Ld. Transfer Pricing Officer. We find that it is true that neither the Assessee nor theTransfer Pricing Officer applied the filter for selecting the trading companies. At that point itself, naturally the manufacturer would have been excluded straight away as they could not have satisfied that filter. With respect to Hicks Thermometer (I) Ltd we do not find any segmental data available and therefore we are unable to comment on the same. The Ld. CIT(A) vide para no. 4.3 also stated that segmental results for this diverse activity were not available. In any case, we are supposed to answer only the fact whether the exclusion of Poly Medicure Limited and Opto Circuits Ltd is proper or not as they are into predominantly manufacturing activities. None of party has questioned that the Hicks Thermometer (I) Ltd should also be excluded. We are only on the issue that whether the ld. CIT (A) has correctly characterized the assessee company as predominantly a trading company based on its turnover and activities and if the same is not disputed naturally to determine arm/’s length price of the international transaction can only be tested with the transaction entered in to by a comparable predominantly a trading company. Both the comparables were held by the CIT (A) as predominantly manufacturing unit, which is also accepted by the ld. TPO in his TP order. Accordingly ground no. 1 of the Appeal of the Ld. Assessing Officer is dismissed.

20. Coming to ground no. 2 where the Ld. Assessing Officer has challenged the deletion of adjustment of Rs. 21,39,572/- with respect to the information technology IT support services. In the present transfer pricing study report, the administration and business support services of Rs. 6,12,53,941/- paid by the Assessee was treated at Rs. Nil/- for the reason that the Ld. Transfer Pricing Officer held that same is intra group services. The Assessee has filed to show the rendition of the tests and therefore the arm’s length price of the same was determined at Rs. Nil/-. The Ld. CIT(A) was referred to by the Assessee that the arm’s length price determined at Rs. Nil/- by the Ld. Transfer Pricing Officer is not correct. The Ld. CIT(A) has partly allowed the Appeal wherein he rejected part of argument of the services and decided the claim of the expenditure for IT support services in favour of the Assessee holding that they have been rendered and being at arm’s length. Thus, the Ld. Assessing Officer is in appeal before us as per ground no. 2.

21. The Ld. CIT(A) in para no. 6 has dealt with the above aspect as under: –

6. The IT support services, as per the appellant, relate to the IT infrastructure implemented in 2004-05 through the regional data centre set up by 3M Singapore for providing IT support services to 3M subsidiaries in the South and South-East Asian regions, including 3M India. During the years following FY 2004-05, the appellant has paid only maintenance services in respect of the IT infrastructure including servers, application softwares and network services along with help desk and disaster recovery and business continuity back up. Since the appellant had some local IT support also, primarily for its desk top management system using the outsourced services of Wipro Ltd., the TPO was of the opinion that there was duplication of the IT infrastructure and services which indicated that the services availed from 3M Singapore were not critically important for it and that it was not at Arm’s length. The appellant has protested against this assumption in Ground 14 in which the details of IT support expenses from FY 2004-05 onwards were provided and reliance was placed upon the order of the CIT (A) dt. 03.05.2011 for AY 2005-06 to show that she had accepted the appellant’s claim of expenditure in FY 2004-05 when the implementation of major application such as Customer Order Fulfilment System (COFS) and International Common Application Portfolio (ICAP) had taken place. In the impugned year, only the maintenance charges for upgradation of software, sending of patches etc has been covered in the payment. Considering that original substantial expenditure of Rs. 3.89 crore in FY 2004-05 for project implementation as well as IT service and support has been accepted by my predecessor for AY 2005-06, the maintenance related expenses in the present FY 2007-08, therefore, are also being accepted, following judicial consistency.

22. On careful analysis, we find that this issue was contested by the Assessee in Assessment Year 2005-06 wherein the claim of expenditure on identical facts and circumstances was accepted. We have not been shown anything contrary by the Ld. Departmental Representative and as it has been at arm’s length in the earlier year, we do not find any infirmity in the Appellate Order. Accordingly, ground no.2 of the Appeal is dismissed.

23. Accordingly, ITA No. 1598/Bang/2013 for Assessment Year 2008-09 filed by the Ld. Assessing Officer is dismissed.

24. ITA no. 307/Bang/2014 for Assessment Year 2009-10 is also on similar grounds as they were in ITA No. 1598/Bang/2013 for Assessment Year 2008­09 raising following grounds: –

1. The order of Ld. CIT(A) is opposed to law and facts of the case.

2. The Ld. CIT(A) has erred in directing the TPO to exclude the comparable companies, M/s. Poly Medicure Ltd & M/s. Opto Circuits (I) Ltd, as it is functionally different even when net margins are taken for comparison which even out minor functional differences.

3. The Ld. CIT(A) has erred in directing to accept the payment made towards IT support services amounting to Rs.61,33,738/- to its AR in absence of supporting evidences. Appeals have been filed on similar issues in earlier.

4. For these and such other grounds that may be urged at the time of hearing.

25. As ground no. 2 challenges the exclusion of Poly Medicure Limited and Opto Circuits (I) Ltd., on the identical grounds as were challenged by the Ld. Assessing Officer for Assessment Year 2008-09. There is no change shown to us in the facts and circumstances of the case or the characteristics of predominant manufacturing of the comparable companies, as we already upheld the order of the Ld. CIT(A) for Assessment Year 2008-09 in this year, for the same reasons we also held that they have been correctly directed to be excluded by the Ld. CIT(A). The ground no. 2 of the Appeal is dismissed.

26. The facts of ground no. 3 arewith respect to the IT support services of Rs. 61,33,738/- which is identical to ground no. 2 of the Appeal of the Ld. Assessing Officer for Assessment Year 2008-09. As for Assessment Year 2008-09, we have dismissed that ground of Appeal as in the earlier year the issue was accepted by the revenue about the rendition of services and consequent arm’s length price of the services, ground no. 2 of the Appeal is also dismissed.

27. Accordingly, Appeal of the Ld. Assessing Officer for Assessment Year 2009­10 is dismissed.

28. Thus, both the Appeals filed by the Ld. Assessing Officer are dismissed.

Order pronounced in the open court on 18^th May, 2026.