Payment of Arbitration Award cannot form part of Cost Base for Margin Calculation

Hyundai Rotem Company Vs. ACIT (ITAT Delhi)

Out of the international transactions, the taxpayer reported to have spent an amount of Rs. 96,71,69,164/- on account of payment of arbitral award on behalf of the AE and the same have been reimbursed by the AE to the taxpayer. This transaction has not been bench marked by the taxpayer on the ground that it is a cost to cost reimbursement. Major component of this transaction is reimbursement made by the AE to the tune of Rs. 95,50,32,150/- being the payment made by the taxpayer on behalf of its Associated Enterprises (AE) on account of arbitral award.

Undisputedly, the taxpayer paid an amount of Rs.95,50,32,150/- to DMRC out of remittance received from the Head Office and the balance amount of Rs.15,43,13,697/- has been adjusted by DMRC against offshore payment in compliance to the arbitration award dated 22.07.20 10. TPO taken the view that the AE has made reimbursement to the taxpayer as a support that Head Office would provide to its Project Office, but the payment arose in the course of business which the taxpayer carried out in India and as such, this transaction should form part of the margin calculation and would be added to the revenue and cost. Consequently, the TPO proposed to calculate the net margin as under :-

In the backdrop of the aforesaid undisputed facts and circumstances of this case, the sole question arises for determination in this case is :-

“as to whether the transaction of making payment of Rs. 95,50,31,150/- (on account of arbitral award) by the taxpayer to the DMRC made on behalf of its AE and consequently reimbursed forms part of the margin calculation to be added to revenue and cost for bench marking the international transaction?”

The ld. AR for the taxpayer drew our attention towards order passed by ld. DRP under Rule 13 of the Income-tax Rules, 2009, the operative part of which is reproduced as under for ready perusal:-

“Decision of the Panel

After considering the rectification request of the assessee the relevant paragraph is corrected and is replaced with the following paragraph :

The Panel has carefully examined the matter. The arbitration award was in respect of payment of customs and excise duty exemptions granted by the Government of India in relation to RS1 project. The perusal of the Audit Report in respect of RS1 project shows

Ia(a) the project office is regulate in depositing with appropriate authorities undisputed statutory due including provident fund, income tax, sales tax, wealth tax, service tax, custom duty, cess and other material statutory dues applicable to it.

From this it appears that the customs duty and service tax are liabilities of the project office. If so these should form part of the cost base of the assessee. The TPO/assessing officer is however directed to verify from record the facts as to whether the liabilities of payment of custom duty and service tax are of the assessee or the head office. In case the liabilities of payment of custom duty and service tax are of the project office, then the amount spent on payment of custom duties and service tax and thus also the expense on payment of Arbitration award, will be part of cost base of the assessee for purpose of mark-up, if not then it would not be so included. The Panel accordingly disposes the objection of the assessee.

In the light of above directions, the TPO should also examine whether the following expenses reimbursed by the AE as detailed in the TP Study report have been included in the cost base.

ROTEM Pos incurred miscellaneous operating expenses on behalf of ROTEM and charged back these expenses to ROTEM. The value of the charge back of these expenses is as follows :-

As the Citations mentioned against these expenses show that they relate to payment of service tax, custom duty, and other taxes and duties, therefore, the treatment to be meted out to these expense would be the same as to the arbitration award. If the assessee has already included these expenses in the cost base for purpose of margin calculation, it would clarify the treatment in regard to the payment on account of arbitration award, since, the nature of expenses in respect of the arbitration award and above reimbursements are the same. If not then following a consistent policy their treatment should be the same as in respect of Arbitration Award i.e. these should also form part of the cost base or otherwise depending on findings by the TPO as discussed above.

The TPO is directed to follow consistent policy in respect of treatment of these reimbursement and the reimbursement of the arbitration award.

The issue raised by the assessee in the application for rectification is rectified as above.”

Ld. DRP has taken the view that, “the nature of expenses in respect of arbitration award is the same with regard to the payment of service tax, customs duty and other taxes and dues but directed the TPO to follow consistent policy in respect of arbitration award i.e. these should also form part of the cost based or otherwise depending on the findings of the TPO as discussed above”. However, the ld. AR for the taxpayer contended that in AY 20 12-13, no such addition on account of this income has been made in the subsequent years (order available at paves 1119 to 1148 of the paper book Vol.3).

Ld. TPO while deciding the identical issue in AY 2012-13 called upon the taxpayer vide letter dated 12.01.2016 to explain the following information : –

(a) The nature of these transactions between you and your AE.

(b) The parties involved in these transactions for the payment of custom duties and other taxes.

(c) Why these should not be considered in your cost base for the calculation of margins as held by the TPO in the AY 2011-12 which was upheld by the Ld. DRP vide order dated 05.11.2015?

Sub-para (c) of preceding para 13 covers the controversy at hand. Perusal of the TP order passed by ld. TPO for AY 2012-13, available at paves 1119 to 1148 of the paper book, goes to prove that the only addition has been made on account of addition of TP adjustment by accepting the PLI of the taxpayer without including the expenses in the cost base for the purpose of margin calculation.

Even otherwise, perusal of the table drawn by ld. DRP in its order passed under Rule 13 of the Income-tax Rules, 2009 at page 970 of the paper book vol.2 shows that the DRP has taken the amount of Rs. 43,62,05,743/- as value of the charged pack of expenses which is not the actual fact because as per financial statement, available at page 418 of the paper book vol.1, total cost is Rs. 26,66,92,467/- which goes to prove that Rs. 43,62,05,743/- is not part of the cost base. This issue was required to be resolved by the ld. DRP by passing order under Rule 13 of the Rules by following the rule of consistency.

So, following the rule of consistency and in view of the facts and circumstances of the case, we are of the considered view that payment on account of arbitration award cannot form part of the cost base for purpose of margin calculation. Ld. TPO is to examine the issue on factual basis by following the rule of consistency in the light of its order passed in AY 2012-13. So, grounds no.3 & 12 are determined in favour of the taxpayer for statistical purposes.