Case Law Details
Toyota Kirloskar Motor (P) Ltd Vs ACIT (ITAT Bangalore)
The Appellant submits the in its own case for AY 2003-04, the Honourable Bangalore Tribunal has accepted that TP adjustment has to restricted to AE transactions. Further, in Appellants own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has upheld the action of CIT(A) in directing the TPO to restrict TP adjustment to AE transactions.
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 and the result mutatis mutandis shall apply to assessment year 2014-15.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
These appeals filed by the assessee are directed against separate Final Assessment order passed by the AO, Bangalore dated 22.11.2016 and 24.12. 2018 for the assessment year 2012-13 and 2014-15 respectively.
2. The assessee has raised following grounds of appeal:-
General grounds: (Assessment Year 2012-13)
1. The Orders passed by learned Assitant Commissioner of Income Tax, LTU Circle— 1, Bangalore (hereinafter referred to as “AO” for brevity), learned Additional Commissioner of Income Tax, Transfer Pricing-2(2), Bangalore (hereinafter referred to as “TPO” for brevity) and Honorable Dispute Resolution Panel-2 (hereinafter referred to as Honorable DRP) (“AO “TPO” and “DRP” collectively referred as “lower authorities” for brevity)-are bad in law and liable to be quashed.
GROUNDS RELATING TO TRANSFER PRICING — LEGAL ISSUES
2. The learned AO has erred in making a reference to TPO for determining arm’s length price without demonstrating as to why it was necessary and expedient to do so and without appreciating that being jurisdictional officer for all matters, he could not have referred the matter to the TPO. The DRP has erred in confirming the action of the Assessing officer.
3. The lower authorities have erred in:
a. Making transfer pricing adjustment of Rs. 773,93,55,214/-;
b. Passing the order without demonstrating that the Appellant had motive of tax evasion;
c. Not appreciating that there is no amendment to the definition of “income” and the charging or computation provision relating to income under the head “Profits & Gains of Business or Profession” do not refer to or include the amounts computed under Chapter X and therefore addition made under Chapter X is bad in law; and
d. Not appreciating that there being no disallowance under section 40A(2) for royalty payment, adjustment under Chapter X ought not to be made.
GROUNDS RELATING TO COMPUTATION OF ALP
4. The lower authorities have erred in :
a. Rejecting M/s Hindustan Motors Ltd as a comparable, on the ground that the comparable company is engaged in only manufacture of Car and it is a persistently loss making company;
b. Inappropriately computing operating margins of the Appellant by considering i)Interest received; ii) Claims received from insurance companies; iii) Liabilities/Provisions written back; iv) Miscellaneous income; and v) Interest paid as non-operating in nature. On parity of reasoning these should be considered as operating in nature even in case of comparables; and
c. Not providing the computation of revised TP adjustment pursuant to DRP Directions and not appropriately computing the operating margin of the Appellant and the comparables companies
5. The lower authorities have erred in :
a. Not making proper adjustment for enterprise level and transactional level differences between the Appellant and the comparable companies;
b. Ignoring the business, commercial and industry realities and economic circumstances applicable to the Appellant vis a vis the comparables;
c. Not providing Customs Duty adjustment, which was required to be made to put all comparables on a level playing fields;
d. Not providing adjustment for abnormal expenditure incurred due to Thai Floods; and Not providing working capital adjustment
e. Not providing working capital adjustment.
6. The lower income tax authorities have erred in:
a. Not considering Cash Profit Level Indicator (`PLI’) in the case of the Appellant and the Comparables for the purpose of TP analysis even though in the facts and circumstance Cash PLI was more appropriate; and
b. Without prejudice in case Cash PLI is not adopted, depreciation adjustment was required to be granted in the facts and circumstances of the case.
7. The lower authorities have erred in applying the modified PLI to all expense transaction including expenses incurred with non-associate enterprises and thereby making an adjustment in respect of transactions with non-associate enterprises also.
GROUNDS RELATING TO ROYALTY ADJUSTMENT
8. The leaned TPO has erred in performing alternate TP analysis of Royalty payments and directing AO to make alternate adjustment if main adjustment is deleted without appreciating that there is no legal sustainable basis for . such alt‘ ernate analysis and role of TPO is restricted to computing ALP.
9. Without prejudice to the above, the lower income tax authorities have erred in:
a. Not, appreciating that the Appellant had adopted the TNMM at the entity level, in which process, the royalty payment were considered as closely linked transaction and hence were subsumed into the expenditure and accordingly already considered;
b. Not substantiating how the royalty payment were singled out of the many transactions to be tested on the basis of the arm’s length principle;
c. Not appreciating that once the net profit margin is tested on the touchstone of arm’s length price, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm’s length; and
d. Comparing prices after completing the analysis of comparing margins. which process is unacceptable in law.
10. Assuming without admitting that the royalty is to be separately evaluated on the touchstone of arm’s length principle, the lower authorities have erred in adopting the CUP without justifying how the same` is the most appropriate method in the case of the Appellant.
11. The lower authorities have erred in:
a. Concluding that the Appellant has not received any economic benefit from know-how received from the AE’s;
b. Concluding, without basis, that there was no proof that the third parties are also charging identical royalty for similar technology and in similar circumstances;
c. Concluding that since the margin of the Appellant is lower than the comparable companies, it has not derived any economic benefit from the royalty payment; and
d. Not appreciating that a lower margin does not pre-suppose that no economic benefit has been derived;
12. The lower authorities have erred in not appreciating that:
a. Royalty represents a recurring payment for a one time transfer of technology; and
b. Technology for some models of Etios Tm was received during the year under consideration whereas technology for other existing vehicles had been received in the earlier years.
13. The lower authorities have erred in:
a .Rejecting external CUP transaction on unjustified grounds;
b. Ignoring the fact that the ratio of R&D expenses of TMC was much higher than the effective royalty rate of the Appellant;
c. Ignoring the fact that the Technical Assistance Agreements were approved by Government authorities and therefore royalty payment should be considered as at arm’s length; and
d. Ignoring the fact that, the learned CIT(A), DRP and ITAT in earlier years have accepted both factum as well as quantum of royalty as at arm’s length for the preceding assessment years;
14. Without prejudice to above, the lower authorities have erred in:
a. Adopting inconsistent denominator while calculating arm’s length price;
b. Adopting ratio of royalty and R&D expenditure to net sales in the case of comparables vis-à-vis that of royalty to Local Value Addition (LVA) instead of net sales in the case of the Appellant;
c. Not appreciating that the Appellant was using LVA as base for paying royalty and not net sales;
d. Adopting data of FY 11-12 only for analysis, without appreciating that the business, commercial, economic and technological factors require consideration of multi-year data; and
e. Not granting adjustment for superior quality of technology in case of Appellant vis-à-vis that of the comparables.
15. Assuming without admitting that the adjustment is to be made, the lower authorities have erred in not allowing the benefit of the +/-5% range prescribed in the proviso to section 92C(2).
GROUND RELATING TO CORPORATE TAX
16. The lower authorities have erred in:
a. Disallowing provision towards employee long term service benefit liability on the ground that such provision is contingent and not accrued;
b. Not appreciating that the provision for employee long terms service benefit is in accordance with provisions of Accounting Standard (AS) 15 Employee benefit and based on actuary valuation, and
c. Holding that employee long term service benefit liability has not crystallized nor has accrued.
17. The lower authorities have erred in:
a. Disallowing a sum of Rs. 60,26,382/-, as excess depreciation claimed on the basis of year end provision which were reversed in subsequent years;
b. Disregarding accounting methodology adopted by the Appellant and not appreciating that amount capitalized was based on fair estimates made for work c. already completed but. for which final bills were pending; and appreciating that the assets were acquired and put to use during the year under consideration.
d. Not appreciating the fact that reversal amount is reduced from opening WDV on gross basis thereby even reversing the depreciation.
18. The lower authorities have erred in:
a. Disallowing a sum of Rs. 57,53,23,147/- towards royalty pertaining to AY 11-12 claimed in accordance with the provisions of section 40(a)(i) on the ground that royalty is already disallowed in AY 201112 u/s 92CA as TP adjustment and also u/s 37;
b. Not appreciating that Rs.57,53,23,147 has been disallowed in AY 2011-12 u/s 40(a)(i) apart from TP adjustment of Rs. 107,98,91,825/-; and
c. Not appreciating that his action of not allowing deduction for Rs. 57,53,23147/- has led to double disallowance.
19. The lower authorities have erred in:
a. Disallowing a sum of Rs. 1,34,40,305/- towards price reduction of purchases which was offered to tax by the Appellant in subsequent year, when the income had actually accrued to it;
b. Disregarding the correct and regular accounting practices adopted by the Appellant and not appreciating that no liability accrued in favour of the Appellant during the year under consideration; and
c. Not appreciating that such a disallowance is revenue neutral and therefore addition is not called for:
GENERAL GROUNDS.
20. The lower authorities have erred in levying a sum of Rs 86,94,71,473/- as interest under section 234B. On the facts and in the circumstances of the case, nterest under section 234B is not applicable. Even otherwise, the interest u/s 234B is excessive.
3. Facts of the case are that the assessee company filed its original return of income for the Assessment Year 2012-13 on 28.11.2012 declaring loss of Rs.266,58,45,617/-. The case was selected for scrutiny and statutory notices were issued to the assessee. During the course of proceedings, it was observed that there was International transaction exceeding Rs. 15 crores, the case was referred to Transfer Pricing Officer (TPO) to determine the Arm’s length price. After receipt of reference with the prior approval of CIT(LTU), the ld. TPO started his proceedings and the assessee was asked to submit the documents mentioned in terms of sec.92D of the Act. The tax payer filed its TP documentation vide its letter dated 11.04.2014. A detailed notice dated 25/08/2014 was issued to the assessee proposing to make adjustments to the ALP in the manufacturing segments and specific queries with respect to manufacturing, marketing and trading intangibles also calling for details on payment of technical assistance fees, royalty and other intra group services. The tax payer filed its reply dated 28/09/2015 and other notices were also issued to the assessee.
3.1 The profile of the assessee company is as under:-
As per the TP study report of the taxpayer, the Taxpayer, Toyota Kirloskar Motor Private Limited (TKML), is a subsidiary of Toyota Motor corporation, Japan (TM C), manufactures and sells multi-utility vehicles. Presently it: manufactures MUV’s under the model name Innova “‘ and Fortuner. The passenger car under the model name Corolla TKML has obtained license to manufacture Innova TM, Corolla TM and Fortuner from the TMC, which owns these brands. Fortuner was launched during the year with the technology provided by the TMC. TKML also imports Camry TM and sports utility vehicle (SUV) Land Cruiser Prac.io, Prius and LC 200 Tm as Completely Built Units (CI3U) and sells the same in the Indian market. The CBUs are stored at a warehouse in Mumbai.
TKML commenced its manufacturing operations in November 1999. The manufacturing plant consists of Press shop, Weld Shop, Paint Shop and Assembly shop. TKML manufactures using world renowned Toyota Production System UPS), TKML imports various critical parts, components and FRW materials required for the manufacture of automobiles from the Group affiliates.”
3.2 The assessee had calculated PLI as under:-
3.3 Tax payers financials as per TP report is as under:-
3.4 Segmental result for trading and manufacturing segment is as under:-
3.5 The following international transactions were carried out by the assessee and the TNMM method was applied by the assessee for computation of PLI.
3.6 From the analysis done by the assessee there is a loss in the manufacturing segment of -0.86% and profit in the trading segment at 6.51%. The TPO observed that the company is engaged in 2 segments i.e manufacturing and sale of passenger cars and trading in auto components. In the TP documentation the segmental results were not given and combined segmental results were calculated by the assessee by adopting the TNMM method as most appropriate method. The TPO considered the segmental financial analysis from the audited financial statements. The TPO after discussing the Rule 10B(2) of the Income Tax Rules, 1962 for adopting the most appropriate method for calculating PLI and he observed that if the assessee is engaged in two separate segments viz., manufacturing of passenger cars and trading in auto components and the financial statements are available with the tax payer, these have to be analyzed separately by applying the most appropriate method in each case and he relied on the decision of the coordinate bench of ITAT Mumbai in the case of Star India Pvt. Ltd., Vs. ACIT (2008-TIOL-426-ITAT-MUM) and he also relied on the decision of LG Electronics India Pvt. Ltd., [TS-421-ITAT-2014(DEL)-TP]. We also observe from the order of the TPO that in the assessee’s own case for the assessment year 2003-04 the coordinate bench of the Tribunal directed the AO/TPO to compute the ALP at the NTT enterprises level by combining the trading and manufacturing segments and the decision is based upon the facts and circumstances of the case specifics and year specifics in particular case.
3.7 The TPO further observed in TP study report submitted by the assessee that he has made adjustment of custom duty. The assessee computed margin after excluding the custom duty paid. The assessee contended that its components of raw material is higher and, therefore, the corresponding custom duty expenses is also proportionately greater. This adds to the cost of import lowering the profit. The observation of the ld. TPO is as under:-
7. Determination of Arm’s Length Price by the taxpayer in its TP study:
7.1 The tax payer has reported international transactions and specified Domestic Transactions in respect of ‘Manufacturing segment.
7.2 The arm’s length price of the international transactions in Manufacturing segment provided to the associated enterprises (AE) has been determined by applying Transactional Net Margin Method (TNMM), stating to be the most appropriate method in the facts and circumstances of the case. The operating profit to operating cost ratio has been taken as the profit level indicator (PLI) in TNMM analysis.
8. Selection of comparables by the taxpayer in the TP study
8.1 It is seen that the taxpayer has selected 03 companies as comparables for Manufacturing segments respectively, on. the basis of search conducted in the public databases, namely Prowess,
8.2 The search criteria and the acceptance/rejection matrix applied by the company for screening the initially identified cases Jar arriving at a final comparable set are as under:
9. Analysis of TP document
9.1 In. the case of the taxpayer, the 7’110 is mainly concerned about whether the information or data used in the computation of the arm’s length price is reliable arid correct. It is clear from the provisions o Sec. 92C(3,)(c) read with Sec. 92GA that on the basis of material or information or documents in the possession of TPO, if he is of the opinion that the information or data used in computation of the arm’s length price is not reliable or correct, the ‘I’PO may proceed to determine the arm’s length. price in relation to the international transactions in accordance with Sec.. 92C(i) and 92C(2) on the basis of such material or information or document available with hits.
9.2 From the examination of the TP document, the following pertinent, defects have been found in the ‘Fr’ analysis carried on by the tax payer.
10. Search process applied by the TPO:-
10.1 Stage 1- Adoption of appropriate filters:
10.1.1 The purpose of applying a filter is to select desirable companies, which are capable of being identified as uncontrolled comparable, from undesirable companies. Undesirable companies are those companies which do not have potential of being selected as ‘uncontrolled comparables’. Therefore, filters, which work as a sieve must he such that they should not exclude capable companies from being considered as an uncontrolled comparable. If any filter may exclude such potential uncontrolled comparables then it is necessary, that the filter itself is rejected. As compared to such filter those filters arc preferable that allow inclusions of such companies that do not have the potential of being ‘uncontrolled comparable. The reason. for preference for such filters is that limited number of companies which pop up on. application of filter may be analyzed throughtly and decision may be taken about their inclusion, or exclusion as uncontrolled comparable. As against it, if a filter excludes potential uncontrolled comparables they are lost forever and there will be no second occasion to review the potential of excluded companies to be considered as uncontrolled comparables.
10.1.2. After careful study, it is found, that the .following filters or criteria may lead towards selecting proper comparables functionally similar to that of the tested party:
a) Use of current year data:
As per Rule 1013 ‘4), it is mandatory to use the contemporaneous data, Le,, the data fin- the F. Y. 2013-14. The proviso to Rule 1013 (4) says that data for earlier two years can, also be used if it is shown that such curlier year’s data had an influence in determining the current price. Further the use of earlier year data is in addition to the current year data, provided the conditions are satisfied.
Reason for non consideration of the earlier year data
TP study is a post event study. It is a study aimed at determining whether a transaction conducted sometime earlier was at arm’s length. At the time of conducting a transaction, it& price will be fixed according to the market conditions prevailing at that time, It is only when some extraordinary event influences (like fire, lockout, management’s decision to reduce the price to increase the turnover etc.,) pricing that support may be taken from earlier years’ data of’ the company, External factors will anyway influence pricing across board since all companies would be equally affected by external market conditions. The Indian statute provides for averaging the PUs of the finally selected comparables under the TNMM to eliminate any differences due to low or high margins earned by the companies. This also takes into account the differences in business models and other routine differences in the pricing and functioning of the companies. Thus, the arithmetic mean of the comparable will further even out any adverse influence and there is additionally, the benefit of +/- 3% as per the Act.
Thus in the absence of any cogent, relevant and reliable evidence to prove that the data for preceding two years revealed facts which could have an influence on the determination of’ the ALP, the taxpayer is not justified in. using the data pertaining to the two earlier years i.e. FY 2012-13 and 2011-12, Hence, the TPO used only the current year data to the exclusion of the earlier year data.
b. Companies having different financial year ending (I.e. not March 31, 2014) or data of the company which does not fall within 12-month period i.e. 0104-2013 to 31-03-2014, were rejected.
As the taxpayer’s financial year ends with. March considering companies whose ,financial year also ends with March, will be a more opportunities filter and may lead to proper comparability,
c. Companies who have more than 25% re lated party transactions of the sales were excluded
Companies having related party transactions of more than 25% ore proposed to be excluded. A threshold of 25% is being applied following the provisions of Section 92A(2u) which provides a limit of 26% of the equity capital carrying voting rights for treating an enterprise as Associated Enterprise. If the limit is reduced further it would only result in eliminating more and more companies on the other hand if the (limit is relaxed then companies with predominantly related party transactions would get included which would not represent uncontrolled transactions. Therefore, on a balancing note, 25% is a proper threshold limit for related party transactions. The companies having more than 25% related party transactions should therefore be rejected as comparables.
‘The Hon’ble ITA’I’ has upheld the application of this Jilter by the TPO in its order in the case of M/s. & Supportsoft India Put. Ltd for AY 2005.06 in IT(TP,)A 13721B/I I & 20/2012 dated 28.3.2013 following its own decision in the case of M/s. Actis Advertisers Put. Ltd vide] TA No.5277/Del/201 1 dated 12.10.2012
d Companies having negative PBIT were excluded from the list of comparable.
e. Companies which are functionally riot comparable to the taxpayer were excluded.
10.2 Applying the above filters on comparables chosen by the taxpayer :”
3.8 The ld. TPO did not accept the adjustment made by the assessee in regard to custom duty and rejected the arguments after relying above judgments.
3.9 In the TP study report the assessee had taken the following 4 companies as comparables, out of which the ld.TPO did not accept the Hindustan Motors Ltd., the accept/reject matrices is as under:-
3.10 The TPO observed that in the case of Hindustan Motors Co. Ltd., it is not functionally comparable because it is manufacturing only one car i.e Ambassador whereas the tax payer is manufacturing Innova, Fortuner Cororal , Cambry 90 – Etios Sedan and Liva cars. The company is also a persistently loss making company, therefore, the TPO rejected stating that it is not a comparable company. The TPO finally computed the average PLI and adjustment as under:=
3.11 Accordingly, the TPO made adjustment after applying TNMM at entity level for the determination of PLI of Rs.6,369,980,948/-.
3.12 Further the TPO bench marked the royalty payment and calculated the adjustment of Rs.1,545,432,070/- but he noted that no separate adjustment can be made because of the TNMM approach at entity level includes royalty payment also and passed his order on 29/01/2016.
3.13 After receipt of order from the TPO u/s 92CA, the AO passed draft assessment order after making the certain additions as under:-
3.14 Accordingly, he assessed income of Rs.446,32,51,992/- and passed his order on 21/03/2016.
3.15 Against the order of AO, the assessee filed objections before the DRP and he also raised some more new issues. The DRP gave some marginal relief to the assessee and passed order on 18/10/2016.
3.16 After receipt of the direction from the ld.DRP, the AO passed final assessment order on 22-11-2016 as under:-
3.17 After passing of the final assessment order, later on it was observed that there was a mistake on passing of the order u/s 92CA of the Act and the total adjustment was made of Rs.773,93,55,214/- instead of Rs.636,99,00,948/- and gave effect and passed the order u/s 154 of the Act on 29-12-2016, thereby there was an increase in the adjustment u/s 92CA of the Act of 136,94,54,266/-.
3.18 Again the above orders, [u/s 143(3) r.w.s 144C r.w.s 154] the assessee filed appeal before the Tribunal.
4. The assessee has filed written synopsis which is as under:-
Transfer Pricing Grounds :
Ground No.4a- Rejection of Hindustan Motors Ltd
2.1 The Appellant had selected Hindustan Motors Ltd as a comparable as it qualified all the filters applied by it the TP study (Pg No 269 of PB-1). However, the learned TPO rejected the same on the ground that it is persistent loss making company. The TPO also stated that the company is functionally different as it manufactures only one car “Ambassador”, whereas the Appellant manufactures various cars (Pg No.90 of Appeal Papers).
2.2 Before the DRP, the Appellant submitted that that the observation of the TPO that Hindustan Motors Ltd manufactures only ‘Ambassador’ is incorrect as it manufactures various other cars, which directly compete with the cars manufactured by the Appellant. Thus, the Appellant submitted that the company is functionally similar. The Appellant also submitted that a company should not be rejected merely on the ground that it is persistenty making losses. (Pg No.1023-1035 of PB-III). The DRP held that persistent losses on year on year basis itself shows existence of exceptional and extreme circumstances and therefore a good reason for exclusion of the company from comparable set. The DRP did not adjudicate on the ground of functionality. (Pg No.29 of Appeal Papers)
Submission before ITAT
2.3 In relation to functionality, the Appellant submits that Hindustan Motor Ltd launched sports utility vehicle (SUV) called Pajero Sport and a seven-seater upgraded version of the Mitsubishi Outlander during the financial year. The Appellant submits that that both Mitsubishi Pajero and Outlander vehicles are in direct competition to the Appellant’s vehicles namely Innova and Forunter. Further, Ambassador and Mitsubishi Cedia are in the passenger car segment. The Appellant, therefore submits that the TPO’s reason of rejection (Hindustan Motors Limited has only one car namely Ambassador) is factually incorrect. The products manufactured and sold by Hindustan Motors are similar to that of the Appellant and therefore Hindustan Motors is functionally comparable to the Appellant.
2.4 Further Hindustan Motors has been selected as a comparable consistently by the Appellant from AY 2002-03 onwards. The Tax Department has also been accepting Hindustan Motors as a comparables in certain years. Therefore, the Appellant submits that Hindustan Motors should be adopted as a comparable.
2.5 Minor product profile differences of the comparables need to be disregarded since TNMM is selected as the most appropriate method. In support of this, the Appellant relies on the decision of DCIT V Firmenich Aromatics (I) (P.) Ltd [2012] 24 taxmann.com 271 (Mum.) wherein the ITAT held that under TNMM minor difference in product is irrelevant.
2.6 On the ground of persistent losses, the Appellant submits that rejection of companies only on the ground that they are loss making is bad in law. The criteria for comparability are the economic parameters like functions performed, assets employed, risks assumed and not the financial results of these parameters. If at all there is a difference in the assets employed or risks assumed or functions performed an adjustment could have been made to the results of the comparable company.
2.7 The Appellant relies on the decision of the ITAT (SB) in the case of DCIT v M/s Quark Systems Pvt Ltd [2010] 38 SOT 307 (CHD.) (SB). The Honourable Tribunal held that merely because a comparable is making loss, it cannot be excluded from the list of comparables for the purposes of computation of arm’s length price. The honourable Tribunal further held that functional analysis is crucial for determining whether a company has to be selected or rejected as a comparable [Pg No. 1030 of PB-III]. The Honourable Bangalore Tribunal in the case of Acusis Software India Pvt Ltd v ITO IT(TP)A No. 442/Bang/2011 held on similar lines [Pg No.1996 of Case Law Compilation]
2.8 Therefore, the Appellant submits that the company should be accepted as a comparable.
Ground No.4b- Margin Computation of the Appellant
2.9 During the year under consideration, the Appellant had considered other income of Rs.1,37,04,40,000/- comprising of interest from banks, Claims received from insurance companies, Liabilities/provision written back and miscellaneous income as operating in nature. The Appellant also treated Finance cost of Rs.8,80,60,000/-as operating in nature. (Pg 147, 148 and 281 and of PB-I). Similar approach was also adopted while computing the margin of the comparable companies.
2.10 The learned TPO treated the other income and finance cost as non-operating nature without providing any reasons for the said treatment (Pg 70 of Appeal Papers). There is no discussion on these issues in the TP order.
2.11 With respect to treatment of above items, the Appellant submits as follow:
|
Sl. No. |
Submissions before DRP and decision | Submissions before ITAT |
| 1. | Interest received from Bank FD should be considered as operating income. The learned CIT(A) has upheld the action of the TPO in treating interest income as non-operating in nature (Pg 30 of Appeal Papers) | Interest received from Bank FD should be considered as operating income. The Bank FD have their origin in business funds due to efficient resource management strategy, Just-in-time approach and prudent business practice. (Pg 1039 and 1040 of PB-III)
In support of above, the Appellant relies on the decision of Snam Progetti S.P.A. v ACIT 132 ITR 70 [para 13 and 14 at Pg 1782 and 1783 of Case Law Compilation]. |
| 2. | Liabilities/Provisions written back of Rs.27,71,30,000/- should be considered as operating income. The learned DRP rejected the claim of the Appellant on the ground that it is dependent on number of factors in relation to business transaction and it cannot be considered as normal and direct operating expense. (Pg 30 of Appeal Papers) | Liabilities/Provisions written back should be considered as operating income. The Appellant submits that since in the year of creation, provision was treated as part of operating cost, the reversal of such provision should also be treated as operating in nature (Pg 1040 to 1044 of PB-III). The above contention of the Appellant is accepted by the Tribunal for AY 2013-14 at para 8.3 of the Order [ITA No.2016/Bang/2018, dated 18.08.2021 – Pg 2165-2166 of Case Law Compilation].
Further, reliance is placed on the decision in the case of Sony India (P.) Ltd. v DCIT [2008] 114 ITD 448 (DELHI) – para 106.1 and 106 at Pg No.1826 & of Case Law Compilation. |
| 3. | Claim received from insurance company is to be treated operating in nature. The learned DRP rejected the submission of the Appellant and held that it is a normal business income of the Appellant (Pg 30 of Appeal Papers) | Claims received from insurance companies should be considered as operating income. The claim relates to damage of insured assets. Further, premium is considered as part of operating cost. (Pg 1045 to 1046 of PB-III) In support of the same, the Appellant relies on the following decisions:
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| 4. | Miscellaneous income should be considered as operating in nature. The learned DRP rejected the submissions of the Appellant on the ground that same does not arise in normal course of business (Pg 30 of Appeal Papers) | Miscellaneous income should be considered as operating in nature. The breakup of miscellaneous income is given at Pg 1044 and 1045 of PB-III. These incomes relate to reimbursement/recovery of expenses, letting out of space to onsite suppliers, duty drawback income and other income. These should be taken as operating in nature for the following reasons:
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| 5 | Interest paid should be considered as operating expense. The learned DRP has not made any discussion on the same | Interest paid should be considered as operating expense both for the appellant and the comparables.
Automobile industry is capital intensive. An entity may be funded by debt or equity and interest paid reflects financial risk borne by the enterprise. (Pg 1046 and 1047 of PB-III) |
Ground No.5 and 6 – Adjustments
Custom Duty Adjustment
2.12 The Appellant in its TP study had made custom duty adjustment while computing the operating margins (Pg 268 of PB-I). The Appellant in its submissions before TPO requested to grant custom duty adjustment (Pg 893 to 904 of PB- II). The TPO denied custom duty adjustment by stating that it is the business decision of the Appellant and it does not impact the comparability (Pg 85 to 89 of Appeal Papers).
2.13 Before DRP, the Appellant made detailed submissions on why it should be granted custom duty adjustment (Pg 1048 to 1073 of PB-III). The learned DRP rejected the submission of the Appellant and upheld the action of TPO. (Pg 30 to 32 of Appeal Papers).
2.14 The Appellant submits that it has higher import component (53.22%) vis-à-vis the average import ratio of 10.88% of the comparables selected by the TPO (table at Pg 1049 of PB-III). Higher imports results in higher custom duty. Higher customs duty increases the cost of raw materials (table at Pg 1050 of PB-III). Since sale price is market driven, higher material cost impacts net margin. Comparables procure components from local manufacturers, who levy excise duty. However, input is available for excise duty. So, in order to eliminate the impact on margins due to duty differential, custom duty should be excluded from operating cost.
2.15 In support of the above arguments the Appellant relies on the following decision:
-
- Appellant’s own case for AY 03-04 – Page 1463-1465, findings at para 18.4. The ITAT remanded the matter back to TPO for fresh consideration.
- M/s Skoda Auto India Pvt Ltd v ACIT [2009] 30 SOT 319 (Pune) – [Pg 1054 of Case Law Compilation]
2.16 Therefore, based on above, the Appellant requests your honour to direct TPO to grant custom duty adjustment.
THAI Flood Adjustment
2.17 The Appellant in its TP study had excluded additional/extra-ordinary expenditure of Rs.42,74,80,053/- from operating expenditure as it was incurred as a result of Thai floods. (Pg 268 and 269 of PB- I). The Appellant in its submissions before TPO requested to grant Thai flood adjustment (Pg 904 to 908 of PB-II). The TPO denied thai flood adjustment without any discussion on this aspect in the TP order.
2.18 Before DRP, the Appellant made detailed submissions on why it should be granted Thai flood adjustment (Pg 1074 to 1079 of PB-III). The Appellant detailed supporting documents including working of extra cost and invoices. The learned DRP rejected the submission of the Appellant (Pg 32 to 34 of Appeal Papers).
2.19 The Appellant submits that its substantial imports are from Thailand. In comparison, the comparables have very minimal imports (Pg No. 1049 of PB-III). In July 2011, flood caused extensive devastation in Thailand. As plants in Thailand were shut, Toyota Group had to cut production in several parts of the world. (Please refer News reports at Pg No.948-956 and 1336 of PB-III].
2.20 The Appellant is highly dependent on Thailand for its imports (68% of imports in AY 1213, Thailand Import chart is at Pg No. 1364 of PB-III). The disaster resulted in major disruptions in supply chains of Appellant causing shortage of components for automobile manufacturing. During such period, the appellant had to procure these parts and components at higher price and incur substantial additional cost. Vehicle price list for before, during and after floods is at Pg No 1338 of PB-III. Price comparison of parts before, during and after floods at Pg No 1339 to 1363 of PB-III. The price was normalised post Thai floods.
2.21 The Appellant therefore submits that the additional cost incurred by it of ₹ 42.74 crores (calculation at Pg No 1332 of PB-III) should be considered as extra-ordinary in nature and excluded from the operating cost. The comparables did not incur similar costs as they do not have higher import component.
Working Capital Adjustment
2.22 The Appellant in its submissions before TPO provided working capital adjustment computation and requested the TPO to grant such adjustment (Pg 940 PB-II). The TPO did not grant working capital adjustment and has not made any discussion on this aspect in the order (Pg 96 to 98 of Appeal Papers).
2.23 Before DRP, the Appellant made detailed submissions on why it should be granted working capital adjustment (Pg 1079 to 1083 of PB-III). The learned DRP upheld the action of TPO and denied working capital adjustment on the ground that the Appellant did not demonstrate how workings capital levels has impacted the margins. (Pg 34 and 35 of Appeal Papers).
2.24 The Appellant submits that working capital adjustment is an accepted adjustment. In Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has upheld the action of CIT(A) in directing the TPO to grant the working capital adjustment [Para No.9.1 to 9.5 at Pg 2166-2167 of Case Law Compilation].
2.25 Based on above, the Appellant submits that it should be granted working capital adjustment.
Cash PLI/Depreciation Adjustment
2.26 The Appellant in its TP study had adopted Cash PLI (Pg 267 of PB-I). The Appellant in its submissions before TPO requested to adopt Cash PLI or in the alternative, grant depreciation adjustment (Pg 928 to 936 of PB-II). However, the learned TPO did not accept the contention. There is no discussion on this aspect in the order.
2.27 Before DRP, the Appellant made detailed submissions on why cash PLI should be adopted (Pg 1083 to 1092 of PB-III). The learned DRP rejected the submission of the Appellant (Pg 35 to 36 of Appeal Papers).
2.28 The Appellant submits that manufacturing activities require huge outlay on fixed assets. The Appellant undertook substantial expansion by setting up Plant II in FY 10-11 and FY 11-12. Comparable companies are comparatively old in the industry and operate with depreciated plant and machinery. This results in higher depreciation for Appellant at 3.84% vis-à-vis for comparables at 2.76%. Therefore, Cash PLI should be adopted and depreciation should be excluded from operating cost for the Appellant and the comparables. This will bring all entities at par. In the alternative and if Cash PLI is not accepted, depreciation adjustment should be given as given by the TPO in AY 03-04.
2.29 The Appellant relies on the following decision in support of its contention:
-
- PCIT v Novell Software Development India (P.) Ltd [2021] 126 com 29 (Karnataka) – [Para 7 & 8 at Pg 2120 of Case Law Compilation]. The Karnataka HC directed to exclude depreciation from operating cost.
- In AY 03-04, the ITAT in appellant’s own case cash PLI was rejected- [Para 19.4.1 to 19.4.3, Pg 1466 of Case Law Compilation]. However, the Tribunal observed that the TPO himself has given depreciation adjustment for difference in the level of depreciation cost with reference to sales.
2.30 Therefore, based on above, the Appellant requests your honour to direct TPO to adopt Cash PLI or to grant Depreciation adjustment.
Ground No.8 – TP Adjustment should be restricted to AE transactions
2.31 The Appellant submitted before the TPO to restrict the TP adjustment, if any only to the AE transactions. The Appellant submitted that out of total expenses it had entered into only 45.93% of the transaction with AE’s, whereas the balance expense transactions were undertaken with third parties (Pg 565 to 572 of PB-II). However, the learned TPO did not accept the contention. There is no discussion on this aspect in the order.
2.32 Before DRP, the Appellant submitted to restrict the TP adjustment, only to the AE transactions. The Appellant submitted that out of total expenses it had entered into only 42.72% of the transaction with AE’s whereas the balance expense transactions were undertaken with third parties (Pg 1094 to 1099 of PB-III). The DRP rejected the submission of the Appellant (Pg No.36 to 39 of Appeal Papers).
2.33 The Appellant submits the in its own case for AY 2003-04, the Honourable Bangalore Tribunal has accepted that TP adjustment has to restricted to AE transactions (Para 22 at Pg.1470 of Case Law Compilation). Further, in Appellants own case for AY 2013-14[ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has upheld the action of CIT(A) in directing the TPO to restrict TP adjustment to AE transactions (Para 10 at Pg 2167 of Case Law Compilation). Relevant extract of the same is as below:
2.34 Further, the Appellant relies on the following decisions to support its contention:
-
- CIT vs Keihin Panalfa Ltd (Del HC-TS-474-HC-2015) (Para 12); and
- CIT vs Tara Jewels Exports (P) Ltd [2017] 80 com 117 (Bombay).
Based on above the Appellant requests your honour to direct the TPO to restrict the TP adjustment to AE transactions.
Ground No.8 to 15- Royalty Benchmarking
2.35 The Appellant had adopted the TNMM at the entity level, in which process, the royalty payment is considered as closely linked transaction and part of operating cost (Pg 216 to 218 of PB-I). The Appellant filed detailed submission before TPO as to why royalty payment should not be benchmarked separately (Pg No.417 to 494 of PB-I). The learned TPO rejected the submission of the Appellant and benchmarked the royalty separately. The TPO rejected the above stand of the Appellant and proposed to benchmark the royalty transaction separately by comparing the royalty and R&D expenditure to net sales in case of comparable vis a vis that of royalty to Local Value Addition (LVA) in case of the Appellant. The TPO has computed TP adjustment of Rs.154,54,32,070/- in respect of royalty transaction. (Pg 117 of Appeal Papers).
2.36 However, the TPO has held that TNMM approach at entity level includes royalty also and therefore separate adjustment for royalty is not required. The TPO has stated that only in a case where adjustment at entity level does not hold good at appellate level, the learned AO may resort to adjustment on account of Royalty on standalone basis.
2.37 Before DRP, the Appellant reiterated it stand by filing detailed submissions against the analysis of TPO (Pg 1102 to 1221 of PB-III). The DRP rejected the submission of the Appellant and upheld the action of TPO (Pg.39 to 43 of Appeal Papers).
2.38 The Appellant submits that once the net profit margin is tested on the touchstone of arm’s length price, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm’s length.
2.39 The above view has been accepted by the Honourable Bangalore Tribunal in Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021] [Para 11.4 at Pg 2170 of Case Law Compilation]. Further, the Appellant relies on the decision rendered by the Honourable Bangalore Tribunal in its own case [IT (TP) A No.1315/Bang/2011 for AY 2007-08] wherein the Tribunal held that the royalty payments made by the Appellant are at arm’s length (Para 48 to 51 at Pg 1390 of Case Law Compilation). Reliance is also placed on, among others, para 101 of Delhi High Court decision in the case of Sony Ericsson Mobile Communications India v ACIT 55 Taxmann.com 240.
2.40 The Appellant also submits that the methodology adopted by TPO is not correct. The TPO compared the royalty and R&D expenditure to net sales in case of comparable vis a vis that of royalty to Local Value Addition (LVA) in case of the Appellant instead of net sales. In Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the ITAT has held that net sales should be adopted as denominator for the comparable and the Appellant [Para 11.5 at Pg 2173 of Case Law Compilation].
Corporate Tax Grounds
Ground No.16- Provision for Employee Long Term Service Benefit Liability
3.1 During the year under consideration, the Appellant had a program wherein all the employees who complete 10 years of service with the Appellant were awarded with mementos in the form of a 10-gram gold coin. As per the mandate of Accounting Standard-15 (AS-15), the Appellant made a provision of Rs1,01,88,674/- for the year under consideration in books of accounts towards future liability accruing to other employees, who are in service but have not yet completed the 10 years duration to be eligible for the memento and the same was claimed in the return of income. The provision was based on the Actuarial Valuation (Pg 1315 to 1317 of PB-III), which suggests only incremental amounts to be provided for in the books of accounts. In draft assessment order, the learned AO disallowed the provision on the ground that it is contingent in nature (Pg 120 of Appeal Papers).
3.2 Before the DRP, the Appellant made detailed submissions wherein it was submitted that the provision was created in line with the Accounting Standard. As per the mandate of Companies Act and Income Tax Act. As per section 145(2), the Appellant is under obligation to follow AS-1. AS-1 mandates observance of concept of prudence in preparation of accounts. Further, AS-29 provides that provision should be made if there is probability of outflow of resources embodying economic benefits. The Appellant further submits that AS-15 dealing with “Employee Benefits” provides for recognition as a liability of other long-term employee benefits (page 970 and 971 of Paper Book III). The Appellant submits that the liability is an existing liability and estimation is reliable as per Actuarial valuation. The learned DRP disallowed the claim of the Appellant by holding that the same is contingent in nature (Pg 38 of Appeal Papers).
3.3 The Appellant submits that it adopts mercantile system of accounting. The provision was made in compliance with the Accounting Standard-15 and as per actuarial valuation report. The Appellant submits that the liability is an existing liability and estimation is reliable.
3.4 The Appellant relies on the decision on the decision of Honourable Supreme Court in the case of Bharat Earth Movers vs CIT [2000] 245 ITR 428 (SC) wherein it was observed that merely because a liability is to be discharged at future date does not convert an accrued liability into a conditional one. Accordingly, the Supreme Court held that provision made for meeting leave encashment liability proportionate with the entitlement earned by the employees is an deductible expenditure.
3.5 Further, in Appellant’s own case for AY 2013-14, the Honourable Bangalore Tribunal has held that estimation of liability is reliable and provision is not towards contingent liability. The ITAT has remanded the matter back to the file of AO to verify the scientific basis of the provision [ITA No.2016/Bang/2018, dated 18.08.2021] [Para 3.4 to 3.4.3 at Pg 2149-2152_of Case Law Compilation].
3.6 Reliance is also placed on the decisions in the case of CIT v Eveready Industries India Ltd (2018) 98 taxmann.com 90 (Calcutta High Court) – para 11) wherein provision for medical benefit of its employees was allowed as deduction.
Ground No.17- Excess Depreciation
3.7 The Appellant had capitalized some assets based on provision at the year-end. The Assets were put to use during the year. Some of these provisions were reversed in subsequent years. When the provisions were reversed, the Appellant reversed the depreciation in the respective year and made adjustment to the WDV. The AO held that depreciation cannot be claimed on the basis of liability which has neither been quantified nor crystalized. In the draft assessment order, the learned AO disallowed a sum of Rs. 60,26,382/- as excess claim of depreciation referable to provisions. (Pg 121 of Appeal Papers)
3.8 Before, the DRP, the Appellant made detailed submissions wherein it was submitted that the provision was created in line with the Accounting Standard (Pg No.1254-1260 of PB-III). As per the mandate of Companies Act and Income Tax Act. The learned DRP rejected the claim of the Appellant and upheld the action of AO (Pg 44 of Appeal Papers).
3.9 The Appellant submits that in AY 2012-13, the Appellant invested Rs. 904.93 Crores towards additions to the fixed assets. Out of the above Rs. 683.10 Crores was invested towards additions to Plant & Machinery.
3.10 In some cases, the vendors supplied and installed the machineries before the close of the financial year and were unable to submit the bills before close of financial year because of pending price negotiation and finalization. In view of this, the Appellant made provision in the books for certain assets based on the purchase orders, as asset were put to use. Portion of provision (Rs.48.34 crores) was subsequently reversed. In the year of reversal, relevant WDV and depreciation were reversed completely. Therefore, instant disallowance by the AO is resulting in double disallowance.
3.11 The Appellant adopts mercantile system of accounting and the capitalisation is in accordance with AS-10. The liability is estimated on fair basis. When the assets were put to use, actual amounts were not available and therefore capitalisation was done on estimation basis [Extract of AS-10 is at Pg 1256-1257 of PB-III]. The Appellant submits that its claim is in accordance with the mercantile system of accounting and disallowance should be deleted.
Ground No.18- Double Disallowance of Royalty
3.12 In AY 2011-12, the Appellant had incurred Rs. 179.98 crores towards royalty. Out of this, Rs. 57.53 crores was provision made on 31.03.2011. With respect to provision of Rs. 57.53 crores, the Appellant had not remitted TDS within the stipulated time and same was disallowed in return of income for AY 2011-12 u/s 40(a)(i). The TDS was remitted subsequently and the Appellant made a claim of Rs.57.53 crores, while filing return of income for AY 2012-13 (TDS remittance details at Pg No 1262 of PB-III and challans at Pg No 1321-1322 of PB-III).
3.13 The learned AO in the draft Order, has disallowed the claim u/s 40(a)(i) of Rs.57,53,23,147/. On the ground that said amount pertains to Rs. 107,98,91,825/- which was disallowed under section 92CA in AY 2011-12. (Pg 122 of Appeal Papers).
3.14 Before, the DRP, the Appellant made detailed submissions (Pg No.1262-1270 of PB-III). The learned DRP disallowed the claim of the Appellant and upheld the action of AO (Pg 45 of Appeal Papers).
3.15 The Appellant submits that for AY 11-12, the learned TPO determined TP adjustment for royalty at Rs. 107,98,91,825/- out of total royalty expenditure of Rs. 179,98,19,708/-. Rs. 107.98 crores was added in the assessment order
3.16 In AY 2011-12, A sum of Rs. 57,53,23,147/- was suo motto disallowed by the Appellant u/s 40(a)(i). Total disallowance of royalty for AY 2011-12 was therefore Rs.165,52,14,972/-out of the total royalty of Rs.179,98,19,708/-. Given the fact that Rs. 107,98,91,825 and Rs. 57,53,23,147/- are separately disallowed, it is clear that Rs.57,53,23,147/- is out of Rs. 71,99,27,883/-, which was otherwise allowable being the arm’s length price determined by the TPO. In such circumstances, the Appellants claim of deduction of Rs.57,53,23,147 is in accordance with law.
3.17 The contention of the AO that the amount was disallowed in AY 11-12 u/s 37 is incorrect (Assessment order of AY 11-12 at Pg 1323-1327 of PB-III). The action of AO results in double disallowance. Therefore, disallowance of Rs. 57.53 crores should be deleted. In this regard, the Appellant relies on the decision in the case of Eaton Technologies Pvt Ltd v SCIT ITA No. 1621/PN/2011 wherein it is held that when the assessee itself disallowed the amount, the provisions of section 92 are not applicable – Para 14.3 (case law filed during the hearing).
Ground No.19- Price Reduction of Purchases
3.18 The Appellant follows annual price for various parts being supplied by different manufacturers and suppliers. Part prices are renegotiated on an annual basis. Initial price negotiation with Denso Kirloskar Industries Pvt Ltd was completed in Dec 2011. However, the supplier and the Appellant had multiple discussions to confirm the effective period of revision, the quantity and revised prices for the parts supplied. Based on mutual consensus, supplier issued credit note amounting to Rs.1,34,40,305/- for the difference in price due to price reduction ‘for various parts supplied during the period from April 2011 to Dec 2011. Though the credit note was dated 31.03.2012, it was communicated/issued by the supplier to the Appellant on 25.05.2012 (Copy of the credit note along with e-mail communication is at Pg No 371 & 372 of PB-I). Since the income accrued in FY 12-13 and also books of accounts of the Appellant were audited and financial statement for FY 2011-12 was approved by the Board on 07.05.2012, the Appellant accounted this credit note in the next year viz FY 2012-13 and offered to tax in AY 13-14.
3.19 In the draft assessment order, the AO has held that the price reduction from Denso Kirloskar Industries Pvt Ltd amounting to Rs. 1,38,79,923/- has to be accounted during AY 12-13 (Pg No 122 and 123 of Appeal Papers).
3.20 Before, the DRP, the Appellant made detailed submissions (Pg No.1270-1285 of PB-III). The learned DRP disallowed the claim of the Appellant and upheld the action of AO (Pg 45 of Appeal Papers). The Appellant also submitted that amount of credit note from Denso Kirloskar Industries Pvt Ltd towards price reduction is at Rs. 1,34,40,305/- and figure adopted by the AO is incorrect. The DRP upheld the action of the AO. However, the DRP directed to rectify the amount of addition. (Pg No 45 and 46 of Appeal Papers)
3.21 The Appellant submits that as per AS – 9, under accrual method, revenue recognition is to be postponed when there is inherent doubt on ultimate collection with reasonable certainty (AS 9 at page 1941-1953, para 10 at page 1947). The Appellant submits that in the instant case the income did not accrue till the communication of the credit note by the vendor. The Appellant had no debt due in its favour. The income is offered to tax in subsequent year and addition in the current year leads to double taxation.
3.22 The Appellant relies on the decision of the Supreme Court in case of CIT v Excel Industries Ltd. [2013] 38 taxmann.com 100 (SC), wherein the Honourable Supreme Court has discussed the principles of accrual and effect of timing difference in accounting of revenue [Para 20 and 32 at Page 1938 and 1940 of Case Law Compilation]
3.23 Therefore, based on above, the Appellant submits that as transaction is revenue neutral, the addition made during the current year should be deleted.
5. In addition to the above written synopsis, the AR of the assessee submitted as under:-
6. Ground No.4a. – Rejection of M/s. Hindustan Motors Ltd.; The ld.AR submitted that this company is functionally comparable and it qualified all the filters applied in the TP study. The ld.AR further submitted that the TPO has rejected on the basis that the company is persistent loss making company, he also submitted that the TPO has stated that it is not a functionally comparable and engaged in the production of only one segment of car i.e. “Ambassador Car” whereas the assessee is manufacturing Innova, Fortuner Cororal, Cambry 90 – Etios Sedan and Liva vehicles. The ld.AR contended that it is clear from the annual reports that Hindusthan Motors Ltd., is engaged in the manufacturing of various other cars, which directly compete with the cars manufactured by the assessee. He further submitted that from the annual report, it is clear that the Hindustan Motors ltd. is manufacturing other cars also which is clear from the report and it was submitted before the TPO at para No.4.1 to 4.20, placed at paper book page nos.915 to 926, which is as under.
“In March 2012, the Company launched a state-of-the art sports utility vehicle (SUV), called Pajero Sport and a seven seater upgraded version of the Mitsubishi Outlander both from its Chennai Car Plant under license from Mitsubishi Motors Corporation, Japan. Pajero Sport has been well received in the market. The Company also started production of CNG driven Winner from its Pithampur Plant during the year. These new products are expected to receive favourable response in the market.”
It is clear from the above, the company is functionally comparable. Further, he submitted that the persistent loss company can also be considered as a comparable if the comparable company’s function is similar with the assessee company.
6.1 He stated that the Hindustan Motors Ltd., was consistently considered by the assessee from the assessment year 2002-03 onwards as a comparable and the Department has accepted in certain years therefore, it should not be rejected. In regard to persistent losses, the criteria for comparability or the economic parameters like functions performed, assets employed, risks assumed and it should not be only on the financial results of the parameters. He also referred on the judgments as quoted in his written synopsis.
6.2 The ld .DR strongly supported the order of the TPO/DRP and submitted that the TPO has rightly rejected Hindustan Motors Ltd., on the basis that it is not functionally comparable and to which the ld.DRP also confirmed. He further submitted that where a company was persistent loss making company for continuously three years and net worth is continuously decreasing and the company is selling its other capital assets, which cannot be considered as comparable companies. The ld.DRP has relied on many judgments, which are squarely applicable in the present facts of the case. In support of this, he relied on the decision of Mumbai Tribunal in the case of GCO Technologies Centre Pvt. Ltd., Vs. ITO reported in [2021] 123 taxmann.com 222. The relevant part is as under:-
7. We shall now take up the claim of the assessee that the A.O had erred in making a TP adjustment of Rs. 8,10,171/- under Sec. 92C of the Act. As observed by us hereinabove, the genesis of the controversy primarily hinges around the aspect that the A.O while working out the ALP had excluded one of the comparable company viz. M/s Cather Consultancy Services Pvt. ltd. that was included by the assessee’s company in the list of the comparables in its TP study report for benchmarking the international transactions. It is the claim of the assessee, that the lower authorities had erroneously held the aforesaid comparable i.e M/s Cather Consultancy Services Pvt. ltd as a persistent loss making company and thus, excluded the same from the final list of the comparables. As observed by us hereinabove, it is the claim of the ld. A.R that though the aforesaid comparable company had suffered a loss of Rs. (-) 0.1 crore for financial year ending 31-32008 and a loss of Rs. (-)0.35 crores for the year ending 31-3-2010, however, it had made profit of (+) Rs. 0.01 crore for the year ending 31-3-2009. It is the claim of the assessee before us that the lower authorities had erred in stamping the aforesaid comparable company as a persistent loss making company for three years. It is in the backdrop of its aforesaid claim, that the ld. A.R had tried to impress upon us that the authorities below were in error in excluding the aforesaid comparable from the final list of comparable companies while benchmarking its international transactions. On the contrary, we find, that the A.O in the assessment order had observed that the difference in the working of the margins had arisen because the assessee had considered write off (bad debts) as a non-operating expense. It was observed by the A.O had that after treating the bad debts as an operational expense, the margin of the aforesaid company was negative for all the three years. At this stage, we may herein observe that the assessee had neither rebutted the said observation of the A.O before the lower authorities nor any contention to dislodge the same had been made before us by the ld. A.R.
8. We have deliberated at length on the aforesaid issue under consideration and are unable to persuade ourselves to subscribe to the projection of the aforesaid comparable company viz. M/s Cather Consultancy Services Pvt. Ltd by the assessee as a profit making company during the financial year 2009-10. As observed by us hereinabove, the assessee had tried to wriggle out of the fact that the aforesaid comparable company was a persistent loss making company by treating bad debts as a non-operational expenditure. In our considered view, the writing back of bad debts being a normal incident of a business operation which is carried everywhere in accounts to have a true picture of profits of the relevant party, thus, cannot be held to be a non-operational expenditure. Accordingly, we do not find any justification for exclusion of the bad debts written off by the aforesaid comparable company in its accounts, for the purpose of computing its margins for the aforesaid three years. To sum up, the margins of the aforesaid comparable viz. M/s Cather Consultancy Services Pvt. Ltd. after excluding the bad debts as a non-operating expenditure by the assessee cannot be accepted. Our aforesaid view is fortified by the order of the ITAT, Hyundai Motor India Engg. (P.) Ltd. v. Dy. CIT [2018] 100 taxmann.com 483 and Kenexa Technologies (P.) Ltd. v. Dy. CIT [2014] 51 taxmann.com 282/[2015] 67 SOT 195 (URO). In the backdrop of the aforesaid facts, we are of a strong conviction that as the aforesaid comparable company, viz. M/s Cather Consultancy Services Pvt. Ltd. can safely be held to be a persistent loss making company for three years, therefore, the A.O had rightly excluded it from the final list of comparables for the purpose of benchmarking the international transactions of the assesee for the year under consideration. Accordingly, finding no infirmity in the view taken by the A.O, we uphold his order to the said extent. The Ground of appeal No. 3 raised by the assessee is dismissed.
6.3 Accordingly, the ld.DR requested that this company be retained as good comparable company.
6.4 After hearing both the sides and perusing the entire materials available on records, we find that the revenue has excluded it on two counts; one is functionally dissimilar and this company is a persistent loss company. The ld.AR tried to distinguish both objections of the TPO/DRP. As narrated above, we also observe from the financial statements for the relevant assessment year at paper book page no.14, that the company has launched new vehicles in the month of March 2012 only. From its annual report we have observed as under:-
Sale of Company’s vehicles during the year was 5139 numbers compared to 10097 numbers in the previous financial year. The Company operates in niche segments only. The decline in number of vehicles sold was mainly due to the Company not having any BS-IV compatible diesel engine thus losing sale in major markets, decline in order from government customers, higher petrol prices, increased interest rates, delay in launch of Pajero Sport due to disruption in operation of Mitsubishi plant in Thailand caused by flood and shortage of working capital. The adverse fluctuation in foreign exchange severely affected the profitability of Chennai Car Plant despite reduction in kit prices by the collaborator Mitsubishi Motors Corporation, Japan in the second half of the year. The Company took measures like value engineering and cost reduction initiatives etc.
6.5 We noted that M/s. Hindustan Motors Ltd. was producing one Ambassador Car and in the month of March, 2016, the company has also started production of Pajero Sport vehicles. Therefore, it cannot be said that the company is engaged in only one segment for production of Ambassador car. We hold that it is engaged in more than one vehicle manufacturing activity. Therefore, M/s. Hindustan Motors Ltd. company is functionally similar with the assessee company. We reject the observation of the Ld. AO/TPO/DRP on this issue. Further, the lower authorities have observed that the company is persistent loss making company. We have gone through the financial statements and Director’s report. The Director’s report placed at paper book page no.2151 is as under:
From the above financial years, for 3 years, the company is continuously suffering loss.
6.6 We have also taken extract from the Director’s report to the share holder, which is placed at page No.2156, which is as under:-
“The revenue account shows a loss of Rs. 29.96 Crore after providing Rs. 21.79 Crores for depreciation & amortisation expense and taking credit of Rs. 3.44 Crores for deferred tax net of other taxes. There was a deficit of Rs. 47.76 Crores in the Statement of Profit and Loss in the last year. After considering the results of the year under review, there is a deficit of Rs. 77.72 Crores in the Statement of Profit and Loss as at the end of the year.
During the year, the Company sold 30,67,000 equity shares of T 10/- each of AVTEC Limited and its immovable properties at Kolkata and Halol, Gujarat and aggregate profit of Rs. 100.56 Crores thereon has been included in the Statement of Profit and Loss. Consequent to the sale of shares held by the Company in AVTEC Limited, its holding in AVTEC Limited (including the shareholding in AVTEC Limited through its subsidiary) reduced from 43.33 % to 31.06 %.
Sale of automobiles during the year under review is 5139 nos. compared to 10097 nos. during the previous financial year.
6.7 From the financial statements extracted above, it really shows that there is a steep decline in the business of the assessee company and from the above financial statements for three financial years, the operating loss is continuously increasing. The net worth of the company has also been decreased from Rs. 40.80 crores to Rs. 28.77 crores. During the financial year 2011-12 & 201011, the comparable company Hindustan Motors Ltd., has shown exceptional items at Note No.30 of Rs.10 56.06 and Rs. 9680.53 respectively, which is as under:-
| Exceptional items Surplus on Sale of non- | 2010-11 | 2011-12 |
| Current investments Surplus on sale of | 5260.16 | 3269.18 |
| Land and buildings | 4420.37 | 6786.88 |
| Total | 9680.53 | 10056.06 |
From the above Financial statement, it is clear that the company is selling its non – current investments and land and buildings. The net worth of the Hindustan Motors ltd. is also going down. The net worth in FY 2010-11 was Rs. 4080.32 Lakhs and in the FY 2011-12 it has come down to 2876.70 lakhs even after selling of non – current investments and land and buildings.
6.8 The company which is continuously incurring losses for three years cannot be considered as a comparable.
From the TP study the assessee has taken it as a comparable, whereas the AO/TPO/DRP have rejected this company as comparable on the noted points i.e (1) functionally not comparable and (2) the company is incurring persistent losses. The ld.DRP has also upheld the order of the TPO. The ld.DR relied on the decision of ITAT Bombay Tribunal in the case of CGO cited (supra). A similar case has been decided by the Hon’ble Delhi High Court in the case of Commissioner of Income-tax v. Future First Info Services (P.) Ltd. reported in [2022] 145 taxmann.com 35 (Delhi), which was a persistent loss company and the assessee had considered it as a comparable whereas the AO/TPO/DRP had not agreed for inclusion of the comparable company, the findings of the Hon’ble High Court are as under:-
15. Coming to the third company in issue i.e. Quintegra Solutions Ltd. TPO held that the said company was an abnormal company as on one hand, sales were declining, receivables and write-offs were also increasing. Further, the debtors of earlier years were affecting the working capital adjusted OP/TC of the company significantly. It was held that in a normal situation, there would be some debtors pertaining to earlier years, but they would be limited and would be counter balanced by creditors. In the said company same was not happening and there were significant debtors from previous year which though were not affecting the normal OP/TC of the company but were affecting working capital adjusted OP/TC so significantly that it was clear that said company did not have a sustainable business model. Further, it was found that as per the Annual Report there appeared to be different export percentages as per different portions of the annual report and the figures did not appear to be reliable. Said Company has thus not been taken as a comparable.
16. The ITAT found that the sales of said company were on falling trend. In the year ending 31.3.2008, it made sales of Rs.88.12 crore which in the next year stood reduced to Rs.77.2 crore and in the year under consideration to Rs.37.38 crore, with a further slide to Rs.17.69 crore in the next year. “Review of Operations and Outlook” given in the Director’s Report made it explicit that: “The company has not recovered from the burden of the heavy loss incurred by takeover of some companies as briefed in the last annual report.” The ITAT held that the company was regularly incurring losses, which fact was further borne out from its Profit & Loss Account indicating having incurred loss of Rs.15.77 crore in relevant year and Rs.21.30 crore in the preceding year. It held that persistent losses coupled with declining turnover over the period indicated abnormal functional circumstances, which rendered it non-comparable and justified the exclusion of such a company from the list of comparables.
17. Factually, it has been found that said company Quintegra Solutions Ltd. was an abnormal company; as on one hand, sales were declining, receivables and write-offs were increasing. Debtors of earlier years were affecting the working capital adjusted OP/TC of the company significantly. Said company was regularly incurring losses. Persistent losses coupled with declining turnover over the period indicated abnormal functional circumstances, which rendered it non- comparable and justified the exclusion of such a company from the list of comparables. Consequently, exclusion of Quintegra Solutions Ltd. was in order and cannot be interfered with.
18. In view of the above findings, this Court is of the opinion that no substantial question of law arises. The appeal is dismissed.
6.9 In the above judgment, the Hon’ble Delhi High Court has held that the persistent loss company cannot be considered as a good comparable. We further noted from the judgement relied by the Ld DR in which it has also been held that the persistent loss company cannot be considered as a comparable company with the assessee company. The facts of the case on hand are also similar and, therefore, the decisions quoted (supra) are squarely applicable. Respectfully following the above judgments, we dismiss the grounds taken by the assessee that M/s. Hindustan Motors Ltd. is not a good comparable company and accordingly we uphold the orders of the lower authorities. In the result the ground raised by the assessee is dismissed.
7. Ground NO.4b. The assessee has raised this ground in regard to inappropriate computation of margins by the AO/TPO/DRP by not considering the income and expenses which is as i) Interest received, ii) Claims received from Insurance Companies, iii) Liabilities/Provisions written back, iv)Miscellaneous income and v) Interest paid as non-operating in nature.
7.1 The ld. AR reiterated to the written synopsis quoted supra and in addition, he further submitted that the details were provided to the revenue authorities.
7.2 The ld.DR relied on the order of the lower authorities and submitted that the AO/TPO has rightly considered for computation of operating margin of the assessee to those transactions which have direct relation for determining the operating profit, in case of provision of return back and insurance claim received. He submitted that only the normal business transaction can be considered for calculating the operating profit. In case of interest income/expenditure, it cannot be considered as a normal business income expenditure of the assessee and in case of miscellaneous income, it has not arised in the course of normal business activity of the assessee and the assessee was unable to prove that these were closely linked with the international transactions undertaken by the assessee during the year.
7.3 After hearing both the sides and perusing the material available on record, we noted that the ld.AR of the assessee wanted to include/exclude the above 5 types of income/expenditure for calculating operating margin of the assessee. A similar issue has been decided by the coordinate bench of the Delhi Tribunal in the case of Bucher Hydraulics (P.) Ltd. v. ACIT, Circle-5(1), reported in [2021] 125 taxmann.com 92 (Delhi – Trib.), wherein it was held as under:-
19. Now, coming to the grounds raised by the assessee in respect of computation of PLI. First such ground of appeal no. 3, wherein, the assessee aggrieved by certain income side items not considered as operating income by Ld. AO/DRP/TPO, which are as under:—
? Commission received on direct sales made by AE in India-Rs.54,973/-:-
Compensation paid by the AEs to the assessee in consideration of direct sales affected in the assessee’s specified territory i.e. to any third party customer in India.
? Insurance claim recovered Rs. 7,774/-:- Recovery of insurance claim on lost laptops and testing devices.
20. Vide ground of appeal no. 4, the assessee is aggrieved as DRP directions were not followed by Ld. AO/TPO regarding treatment of certain expenses as non-operating expenses. We are of the view that both these issues raised vide ground of appeal nos. 3 and 4 needs to be looked into by the AO/TPO and decide the issue after affording reasonable opportunity to the assessee. Hence allowed.
7.4 Respectfully following the above decision, we also remit this issue to the AO for de-novo consideration and the assessee is directed to produce necessary documents for substantiating his case.
7.5 Ground 4(c) : The assessee has raised the ground that the revised TP adjustment has not been properly done as per the direction of the DRP. Considering to thearguments of the ld.AR, we also direct the AO/TPO for following the direction of the ld DRP for computing operating margin of the assessee and the comparable companies.
8. Ground No.5 a, b, c – Custom Duty Adjustment
At the outset of hearing, the ld.AR submitted that ground 5(a) and (b) are related to ground No.5(c), hence ground No.5(a) & (b) does not require separate adjudication. This ground relates to the custom duty adjustment as sought by the assessee. The assessee while calculating the operating margin, it was not considered as part of the expenditure. The TPO did not accept the contention of the assessee. Before the DRP, the detailed written submissions were also made, which is placed at paper book page nos.1048 to 1073 of paper book No.3 and DRP also rejected the contention of the assessee.
8.1 The ld.AR reiterated the submissions made before the lower authorities and on the written submissions quoted supra. He submitted that the import components contain 53.22%, which is a higher custom duty paid in comparison to the comparable companies and he also referred to page No.1050 of the paper book. He also stated that in assessee’s own case for the assessment year 2003-04, which is placed at paper book page No.1463 to 1465, the matter has been remanded back to the AO/TPO for fresh consideration. He also relied on the judgment of M/s Skoda Auto India Pvt. Ltd., Vs. ACIT [2009] 30 SOT 319 (Pune).
8.2 On the other hand the ld.DR supported the order of the lower authorities and he submitted that the authorities below has rightly analyzed the case of the assessee and Sony India Pvt. Ltd., Vs. DCIT, 114 ITD 448 and Skoda Auto India Pvt. Ltd., Vs. ACIT [2009] 30 SOT 319 (Pune). The ld.DR submitted that the decision whether to import or purchase locally is a commercial decision, as the method adopted is TNMM, which is tolerant of minor functional differences, adjustments cannot be made for each and every item of expenditures. The assessee is selling Toyota brand vehicles in India and has established its business knowing well that custom duty is required to be paid on import of vehicles to India in Semi Knocked Down [SKD] condition. He further submitted that the decision in the case of the Skoda Auto India Pvt. Ltd., is not applicable in the present facts of the case because it was first year of the case of the Skoda Auto India and the ITAT has given a clear finding that it is in assembling of cars, whereas the comparable companies were in manufacturing sector and it is a full pledged manufacturer with sufficient localization as evident from the documents. He submitted that higher import content does not warrant an adjustment, as it is a commercial decision. He further submitted that the case law relied by the ld. AR is not applicable in the present facts of the case of the assessee. Therefore, he requested the adjustment for custom duty should not be given to the assessee.
8.3 After going through the rival contentions, we observe that the assessee is a manufacturer as well as trader of Toyota motors of different products. During the impugned assessment year, the assessee has paid Rs.4187.32 million of custom duty for which he sought to be excluded for the computation of operating margin. In this regard, we want to reproduce the order of the TPO as well as the DRP, which is as under:-
Customs Duty adjustment
In its TP study, the Assessee had made adjustment for Custom Duty. The Assessee computed its margins after excluding the Custom Duty paid. The Assessee contended that its import component of raw material is higher and therefore the corresponding customs duty expense is also proportionately greater. This adds to the cost of imports lowering the profits.
In this regard, the Assessee was issued notice dated 07.01.2016 asking to make its submissions. With respect to Custom Duty adjustment, the submissions of the Assessee are summarized below:
-
- The Assessee was established through foreign collaborations and sells products under the brand name of Toyota. Certain quality parameters and customer satisfaction are attached to Toyota brand name. The Assessee is also under obligation to maintain those standards. Towards this, it requires quality engine, transmission etc. Since these are not available in Indian market, the Assessee was compelled to import these components from AE situated outside India.
- During the year under consideration, the Assessee had a considerable import component in its consumption as against comparables. The total value of imported raw materials as to total raw material consumed amounted to 53,22 %. In comparison, the comparable companies have negligible import content possibly due to the indigenization of materials required for production over a period of time.
- Import of goods attracts levy of customs duty. The inclusion of the customs duty skews the material cost upward and therefore the margins decline. In turn, this puts the Assessee at a disadvantage when compared with other comparable companies.
* To localize engines and/or transmissions with such huge investments, a large volume of units should be produced as a minimum so as to achieve economic viability of localizing manufacture of such parts. Assessee has clear intention to focus and achieve localization to bring down cost.
The customs duty is payment to government. It has no bearing on the price charged in the International Transactions, Gwen the fact that sale price is market driven, the profitability of the Assessee is influenced by such duties.
- The Assessee has relied on the case of M/s Skoda Auto India Put Ltd v AGJ’T 12009130 SOT 319 (Pune), Demag Granes & Components (India) (P.) Ltd. v DC’IT f2o13J 30 com 364 (Pune – Trib.) and Putzmeister concrete Machines P Ltd v DCIT TS-239-17AT-2014(PAN)-TP.
7.1 TPO’s Comments: Adjustment for difference on Custom Duty.
The TPO has studied the submission of the Taxpayer as submitted above in detail and discussed with the AR of the Taxpayer and Senior Officials of the company. The following conclusions are drawn as below:
1. Importing of parts, CBU, SKI) and other material from AE is a business decision of the Taxpayer for the commercial expediency and business requirements of Toyota Brand and to maintain the standards and high quality.
This reason cannot be accepted for low margins because it is the business model of the Taxpayer.
2. Import of goods attracts Custom Duty which is a part of the total cost of the goods imported. The price of goods imported are inclusive of Custom Duty. As any other Importer of goods a profit markup is decided with Customs valuations as a part of the cost. The sale price with markup is decided considering the Custom Duty along with the import price. Therefore, Custom Duty is an integral part of the value of the goods imported.
The Taxpayer’s claim of Custom Duty as a non-operating expenditure and same to be excluded from the cost base is not permissible for the reasons mentioned below: Refer to Rule 10B(i)(e) which mandates that adjustment can be made only to the comparables and not to the tested party. Rule is extracted below:
(e) transactional net margin method, by which, –
(i) the net profit margin realized by the enterprise from an international transaction 5-‘[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 to be employed by the enterprise of 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;
(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 the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv)the net profit margin realized by the enterprise and referred to in sub- clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);
v) the net profit margin thus established is then taken into account to arrive at an Ann’s Length Price in relation to the international transaction ss[or the specified domestic transaction Since, the adjustment has to be made on the comparables not on the tested party and the Taxpayer has failed to demonstrate similar expenses in the comparables, Taxpayer’s plea of excluding Custom Duty is rejected.
3. Hon’ble ITAT has ruled in the favour of Revenue and has held that adjustment cannot be made to the Tested party. Haworth India Pvt Ltd vs DCIT reported in [2011] 11 taxmann.com 76 (Del): [2011] 11 ITR (Trib) 757 (Del): [2011] 131 lTD 215 (Del): [2011] 140 TFJ (Del) 446.
AY 2006-07
Bench / Court: ITAT, New Delhi
Further in the case of DCIT V Petro Araldite P. Ltd (2013) 36 CCH 0330 Mum Trib: TS201-ITAT (Mum) – TP, the ITAT held that as per r ioB(i)(e)(i), adjustment cannot be made to the net profit margin of the Taxpayer. The ITAT held that adjustment is only possible to the comparables as per rule 10(B)(e)(iii).
4 The case laws relied upon by the-Taxpayer i.e ,M/Skôda7uito7ndia Put Ltd v ACIT [2009130 SOT 319 (Pune), 1)Demag Cranes & Components (India) (P.) Ltd. v DCIT [2013] 30 taxmann.corn 364 (Pune – Trib.) and Putzmeister Concrete Machines P Ltd v DIT TS-239-ITAT-2014PAN)-TP.
7.1.1 TPO’s comments on case laws relied upon by the Taxpayer: In the above mentioned case laws Hon’ble ITAT, Pune Bench in the case of M/s Skoda Auto India Put Ltd v AC’IT [2009] 30 SOT 319 (Pune) and Demag Cranes. & components (India) (P.) Ltd. v DCIT [2 01 3] 30 taxmann.com 364 (Pune – Tub.) has set aside the issue of Custom Duty adjustment back to the file of TPO for reconsidered and fresh adjudication. No relief has been granted by the Hon’ble Tribunal oil issue.
7.1.2.. Judicial Precedence in Taxpayer’s own case inAY2oo-o4.
Hon’ble ITAT in the AY 2003-04 in the Taxpayer’s own case has remanded back to the TPO whether Custom Duty adjustment is to be allowed or not. The TPO was directed to examine the contentions of the Assesse on custom duty adjustment in a holistic perspective also keeping in mind the observations made by us (supra) and in the light of the decisions of the ITAT, Pune in the case of Skoda Auto India Pvt Ltd Vs ACIT (2009-TIOL-214-ITAT-Pune) relied on by the Assesse and the case of Sony India Pvt Ltd Vs. DCIT 114 lTD 448 (Delhi) relied on by revenue.
7.1.3. The Taxpayer’s argument that it imports parts from foreign related parties and manufactures passenger car, whereas, comparable companies basically purchase parts within India and manufacture commercial cars. Therefore, there is a difference regarding the burden of customs duty and excise tax, which should be adjusted. The TPO should have excluded duty and customs in the comparability analysis.
The argument on this count is not tenable. Argument on account of Custom Duty is incorrect for the following reasons.
1. The customs duty is paid on the parts and components imported from its AlEs. So, it forms part of the cost of purchase of material. Even in the case of independent parties, the same would form part of cost. It is a commercial decision to import or to purchase locally. As the method adopted is TNMM which is tolerant to minor functional differences, adjustment cannot be made to each and every item of expenditure.
2. The Taxpayer argues that by paying customs duty, it is placed at a disadvantage position vis a vis other comparable companies. But, the Taxpayer is selling Toyota Brand vehicles in India and established its business in India knowing well before hand what are the customs duties to be paid imports. It is a commercial decision of the Taxpayer to import in semi-imports. It is a commercial decision of the Taxpayer to import semi knocked down and completely knocked and completely knocked down kits of vehicles for assembly in India and then sell them in local market. Similarly, in the case of comparable companies, there are various costs which also fluctuate so as to have disadvantageous positions vis a the Taxpayer. Further, these differences would not have material effect on net margins and that is why ‘I’NMM is adopted as the Most Appropriate Method.
3. These adjustments are not warranted as minor functional differences like that of sourcing of raw materials locally or imports would not affect net margins as the pricing of commercial or passenger vehicles would take all these into account by these companies.
4. This issue is also settled in favour of Revenue by the decision of ITAT Delhi in the case of Sony India Pvt. Ltd Vs. DCIT 114 lTD 448 which held that import duty forms part of the cost in comparability analysis relevant part of the Hon’ble ITAT’s ruling is reproduced below:
“136. As regards the Taxpayer’s claim for adjustment to the operating margins of the comparables on account of higher amount of Custom Duty paid on imported components viz. the comparables, it is noticed that the working of such adjustment sought by the Taxpayer is given oil no. 365 and 356 of the Taxpayer’s paper book. A perusal of the said working shows that it is mainly based on proportion of imported components and the duty paid oil imported components. In our opinion, this basis adopted by the Taxpayer for seeking the adjustment on account of excess Custom Duty before by it is not correct in as much as consideration of duty payment alone would not justify such adjustment and it would be necessary to take into account the cost of components imported along with the Custom Duty paid thereon for the purpose of comparison with the corresponding indigenous components consumed by the comparables. Moreover, the local levies such as sales tax etc. are also required to be taken into account for such comparison. It is also pertinent to note here that if the Taxpayer company has purchased the imported components after payment of custom Duty at a higher price than the indigenous components purchased by the comparables, this decision must have been taken by it consciously taking into account all the commercial consideration including the obvious benefits of better quality which is bound to reflect or translate into a higher selling price of the product. This leaves hardly any scope for adjustment to the profit margins of the comparables on this count”.
DRP
4.6 The assessee has made detailed submissions on this objection and the same has been, considered. In brief the objection of the assessee is that it has not been provided with custom duty adjustment, adjustment on account of flood in Thailand and working capital adjustment. The same are discussed as follows:
a) The assessee has argued for an adjustment on account of custom duty paid by it on the imports relating to its purchases of raw material. The assessee relied upon the decision of ITAT in the case of S/coda Auto India (‘P) Ltd v. AGIT (2009) 122 ?7’J 699. The submissions of the assessee have duly been considered. The issue has been discussed by the TPO in para 7 of his order. In case of M/s Mobis India Limited ITA. No. 21121W.0011 (AY? 2007-08), while discussing the order of ITAT Pune in Skoda Auto India (i) Ltd. v. ACIT (supra), the Chennai bench of ITAT observed as follows in relation to custom duty adjustment sought by the assessee:
“30 ………………. that higher import content of ran’ material itself did not warrant cm adjustment in operating margins. For getting the benefit of any such adjustment, assessee should be able to demonstrate that higher import content W(IS necessitated by (1fl extraordinary circumstance beyond us control.”
In the case under consideration too, the assessee has also not demonstrated as to how higher import content was necessitated by any extraordinary circumstance beyond its control. The assessee started manufacture of Innova and Corolla in FY 2007-08 and Fortuner in FY 2009-10, however there is hardly any effort towards localization of parts of these vehicles liii the year under consideration. In fact, the percentage of the value of local components in these vehicles shows decreasing trend from initial years and it further decreased in FY 2012-13. Importing various parts for manufacture of vehicles in India is a business model of the assessee and sale price has thus been decided accordingly. Thus, this is a commercial decision taken by the assessee. The reliance of the TPO on the decision of ITAT in the case of Sony India FyI Ltd is DCJT 114 lTD 448 is also well placed. Although the assessee has relied on the decision of ITAT in the case of Skoda Auto India (P) Ltd. v. ACJT (‘Supra) and tried to distinguish its own case from the case of Sony India Pvt. Ltd vs DCIT(Supra), however, both these decisions support the order of the TPO. In Skoda Auto India (F) Ltd. v. ACIT (Supra), the ITAT observed that it was assessee’s first full year of operation and the assessee had 98.55% of import content as compared to comparables which had import in the range of 26% to 56.83%, and that is why the case was different from that of the Sony
India FyI Ltd(‘Supra). The JTAT further observed that the case of Skoda”supra, was virtually that of an assembly job of imported knocked down- kits and its business model was fundamentally different from the comparables with import in range of 26% to 56.83%. The ITAT also observed that Sony India Pvt Ltd (Supra) needs to be applied if decision to have higher import content was a conscious decision taking into consideration all commercial facts including the benefits of a better quality, which is bound to reflect or translate into higher seller product. In the case of the assessee the import content is 53.22%, much lower than in the case of Skoda(‘Supra). The assessee has itself admitted that it cannot be considered as involved in assembly of SKD and CKD kits (para 5.79 page 100 of Form 35A). Thus its case cannot be compared with that of Skoda(supra. Thus the order of the TPO cannot be faulted with. Considering above, the objection of the assessee is not accepted.”
8.4 On perusal of the above orders, the ld.TPO has decided the issue as cited supra and he has also dealt the assessee’s own case for assessment year 2003-04 as cited by the ld.AR.
8.5 On going through the financial statement schedule no.34, we find that it has details of consumption and
| purchases. The schedule No.34b which contains details of value of import and indigenous materials consumed. The details are as under:- | ||
| Year | 2010-11 | 2011-12 |
| Raw materials | ||
| Imported | 53% | 56% |
| Indigenous | 47% | 44% |
| Stores and spare parts | ||
| Imported | 3% | 7% |
| Indigenous | 97% | 93% |
8.6 Further on perusal of the notes to the financial statements at schedule no.2 1 capital and other commitments.
The company has obtained various licenses to import Capital Goods under the Export Promotion Credit Guarantee (EPCG) Scheme from the Ministry of Commerce and Industry, Government of India, during the year. The Company is required to fulfill the export obligation as per Export-Import policy in force and has been approved to I port capital goods free of Customs Duty amounting to Rs.2,6,77.22. Based on the aforesaid approvals, the Company has imported capital goods the duty for which aggregates to Rs.2,206.61 (2011:Rs.2,011.27) and the corresponding export obligation required to be fulfilled by the Company within a period of sex years from the date of the licenses is Rs.13,271.14 (2011:Rs.12,099).
8.7 We further noted from the paper book 1049 of the paper book submitted by the assessee, the comparable
| companies have import components as under:- | |
| Ashok Leyland | 6.79% |
| Force Motors | 22.28% |
| Hindustan Motors | 56.53% |
| Swaraj Mazda | 3.57% |
8.8 During the impugned assessment year, the assessee sold 57,500 units of Innova vehicles and 11,500 units of Fortuner vehicles. Till the financial year 2009-10, the assessee was achieving sales volume of less than 1 lakhs units per annum. During the end of financial year 201011, the assessee commenced the second plant to manufacture of Etios, Cedan and Etios Liva version. In financial year 2012-13, the assessee increased its production capacity from 2,10,000 units to 3,10,000 units. We also observe from the financial statements that the turnover of the assessee has also been increased by 48% (114522.06 – 77241.26 = 37280.08 Rs.in million (net of excise duty compared to the previous assessment year. )
8.9 In the assessee’s own case for the assessment year 2007-08, 2008-09 and 2010-11 no such adjustment have been sought for, whereas the business model of the assessee is same. We noted that the assessee had paid custom duty for importing raw materials from its AEs, which is part and parcel of the total cost of the imported goods as well as for the part of the total production cost. Even if the materials are imported from independent parties, it is also a part of the total cost. It is a commercial decision whether the material/components have to be imported or to be purchased locally, the assessee has adopted TNMM method, therefore, the adjustment for each and every item cannot be made. Coming to the economic adjustments sought by the Appellant, we are of the view that the TPO/AO/DRP were correct in rejecting the same as the Appellant has failed to establish how the economic adjustments claimed by the Appellant could ‘materially affect the amount of gross profit margin in the open market as per the requirements of rule 10B(1)(b) of the Income-tax Rules, 1962. The facts apropos this issue are that the assessee submitted before the TPO that it had made 53.22% import of raw materials and components in comparison with comparables importing at 10.88%. It was urged that the increased cost of raw materials having the effect of Customs duty element, should be proportionately scaled down so as to bring the assessee at par with the comparables. The TPO rejected such a contention which however, met with concurrence in the first appeal. After considering the rival submissions and perusing the relevant material on record, it is observed that the claim of assessee for exclusion of Customs duty is based on the premise that it made more imports with the resultant increased cost of production because of higher incidence of Customs duty as against the comparables paying less amount of Customs duty. In our considered opinion, this argument is devoid of merits. The ld. AR could not brought any cogent material in regard to rate of custom duty. Whether the assessee has paid higher rate compared with comparable companies. It is just fundamental that if a person uses better quality raw materials, obviously, the corresponding sale price also goes up and vice-versa. Given the fact that the assessee imported more raw materials for manufacturing, it is but natural that the corresponding sale price would also have been on higher side, thereby nullifying the effect of higher payment of Customs duty, forming a part of the Operating cost based on the overall basis. The situation would have been different if the assessee had paid Customs duty at a rate higher than that paid by its comparables, which would have called for adjustment to have a level playing. Instantly, we are confronted with a case in which the assessee is claiming exclusion of extra custom duty onthe strength of its higher quantum and not the higher rate of Customs duty.
In case of comparable companies, there are various costs which also fluctuate so as to have disadvantageous position viz., to the taxpayer. These differences would not have material effect on net margins that’s why the TNMM method is adopted as a MAM.
8.11 Further during the course of hearing, the ld.AR could not substantiate that there is a variation in the rate of custom duty paid by the assessee in the imported goods for consumption of raw materials, the quantum of imported materials of the assessee company as well as the comparable companies are immaterial. Considering the facts and circumstances of the case, we direct the assessee for providing rates of custom duties paid by the assessee company as well as the comparable company to the AO/TPO and if the assessee could prove that the custom duty of assessee is higher than the comparable company’s custom duty rate for the import of goods, then the assessee would be eligible for claiming adjustment. Accordingly, this ground is remitted for fresh consideration by the AO/TPO for ascertaining the custom duty adjustment.
Ground No.5(d)
9. Not providing adjustment for abnormal expenditureincurred due to Thai floods.
9.1 The ld.AR submitted that during the Thai flood, the cost of imported raw material was increased high. The details were submitted before the lower authorities. The flood was on Oct, 2011 and the assessee company was depended on import of the 68% of the goods. Due to flood disaster, the supply chain of the assessee causing shortage of automobile manufacturing and during such period, the assessee has to procure the imported raw materials at higher price and incurred substantial additional cost, which comes to Rs.42.74 crores. The calculation is placed at page No133 of the paper book. He also submitted that the assessee had to pay additional cost for hand carry of parts due to temporary discontinuation of C segment. Therefore, he submitted that the additional cost of Rs.42.74 crores incurred by the assessee should be considered as extraordinary in nature and excluded from the operating cost. The comparables did not incur similar cost as they do not have hire import components. The ld.AR also requested that the matter may be remitted back to the AO for a fresh consideration and he has sufficient material to prove that there was a substantial increase in the price, therefore, the assessee has to incur extra cost of 42.74 crores.
9.2 The ld.DR relied on the order of the lower authorities and he submitted that the assessee should not be granted further adjustment towards Thai Floods. The assessee had made agreements with the suppliers of the components and without the mutual consent, the supplier cannot charge extra price from the purchasers. The assessee is unable to substantiate with any cogent material for any price revision between the assessee and the suppliers.
9.3 After considering the rival submissions and perusing the order of the authorities, we accept the prayer of the assessee for remitting this ground to the file of TPO for de-novo consideration. Considering the findings recorded by the ld. DRP. The assessee is directed to produce necessary documents for early disposal of the issue.
10. Ground No.5(e) Not providing working capital adjustment
10.1 During the course of TP proceedings, the assessee provided working capital adjustment and requested to the TPO for grant such adjustments but the ld.TPO did not grant working capital adjustment. The ld.DRP also upheld the action of the TPO and held that the assessee did not demonstrate how working capital levels have impacted the margins.
10.2 The ld.DR relied on the order of the lower authorities.
10.3 Considering the rival submissions the assessee has placed working capital adjustments. The working capital adjustment is an accepted adjustment and this issue has also been decided by various High Courts in favour of the assessee. A similar issue has been decided by the coordinate bench of the Tribunal in assessee’s own case in ITA No.2016/Bang/2018 order dated 18/08/2021 for the assessment year 2013-14, wherein it has been held as under:-
“9. The assessee had provided the working capital adjustment computation and requested the TPO to grant such adjustment. The TPO did not grant working capital adjustment. There is no discussion on this aspect in the TPO’s order.
9.1 Before the CIT(A), the assessee made detailed submissions why the working capital adjustment be granted. The CIT(A) requested for remand report from the TPO on this issue. In the remand report the TPO submitted that the working capital adjustment should not granted. The assessee filed a rejoinder and made detailed submissions. The CIT(A) accepted the submissions of the assessee and directed the AO / TPO to provide for both positive and negative working capital adjustment.
9.2 Aggrieved, the Revenue has raised this issue before theTribunal. The learned AR reiterated the submissions made before the Income Tax Authorities.
9.3 We have heard rival submissions and perused the material on record. The working capital adjustment is an accepted adjustment. In the following judicial pronouncements, it has been held that working capital adjustment has been provided for the purpose of better comparability. (a) Swiss Re Global Business Solutions India (P.) Ltd. v. DCIT [2020] 116 taxmann.com 716 (Bangalore – Tribunal) (b) Maxim India Integrated Circuit Design Pvt. Ltd. v. DCIT [IT(TP)A No.1573/Bang/2017 dated 02.11.2020.
9.4 In view of the above judicial pronouncements, we hold that the CIT(A) is justified in directing the AO to grant working capital adjustment. It is ordered accordingly.
9.5 Therefore, ground Nos. 5 and 6 are allowed.
10.4 Respectfully following the above decision, we allow this issue and the assessee is directed to provide requisite details for computation of working capital adjustments.
11. Ground No.6(a)(b) relates to the cash PLI and alternatively depreciation adjustment
11.1 The ld.AR submitted that the lower authorities had not given cash PLI, whereas in manufacturing activities required to use capital outlay on fixed assets. He further submitted that during the financial year, the assessee undertook substantial expansion by setting up of plant No.2 in financial year 2010-11 and 2011-12. The comparable companies selected by the TPO are old in the industry and operate with depreciated plant and machinery. This results in higher depreciation for the assessee at 3.84% vis-a-vis for comparables at 2.76%, therefore, the cash PLI should be granted to the assessee and depreciation should be excluded from the operating cost. He further submitted that if the cash PLI is not accepted, depreciation and adjustment should be given as given by the TPO in AY 2003-04 for the differential depreciation with comparable companies. He also relied on the judgments as cited in his written synopsis.
11.2 The ld.DR relied on the order of the lower authorities and submitted that they have rightly rejected the adjustments as sought by the assessee. The ld.DRP has discussed this issue in detail. He further submitted that the assessee company is working in India before the assessment year 2003-04 and it is also engaged in the manufacturing segments. Therefore, the plant and machinery used by the assessee has also become old. Therefore, the comparable companies are using old plant and machinery for their manufacturing which are not tenable. He further submitted that during the financial years 2010-11 and 2011-12, the assessee has enhanced his production capacity and the assessee started a second plant to manufacture and sell Etios versions of cars (Etios (sedan) and Liva (hatchback)). Further Etios sedan (diesel) with D, VD and VXD variants & Liva Hatchback (diesel) with GD & GD (SP) variants were launched in September 2011. During the year under consideration, in order to optimize the production capacity utilization, the assessee shifted manufacturing of Corolla vehicle from Plant 1 to Plant 2. Therefore, the assessee has no ideal capacity, and therefore, the cash PLI and depreciation adjustment should not be granted to the assessee.
11.3 Considering the rival submissions, we noted that the assessee has sought for cash PLI and depreciation adjustments and submitted that being involved in manufacturing segment, which require huge capital outlay for setting up of plant and machinery. We also noted that in the financial years 2010-11 and 2011-12, the assessee has enhanced its production capacity and new Plant No.2 was also utilized by the assessee. The assessee is also involved in manufacturing segment before the AY 2003-04. In assessment year 2003-04, the assessee had sought for adjustment of cash PLI which has been rejected by the coordinate bench of the Tribunal in the assessee’s own case in ITA No.828/Bang/2010 vide order dated 22/11/2012for the assessment year 200304. The relevant part is as under:-
“19.4.1 We have heard both parties and carefully perused and considered the material on record including the judicial decisions cited on both sides. There are varying opinions among experts whether depreciation should be taken into account for working out profits of an enterprise. One view is that it is not revenue deduction at all. As per that view, depreciation is only an annual loss in the cost / value of the capital assets due to factors like age of assets, their usage etc. and therefore allowance of depreciation, being capital in nature, should find no place in the computation of profits. The opposite view is that depreciation, though a capital loss, needs to be deducted, to replace the value of assets to the extent it has depreciated. Be that as it may, in the present case, ALP of the transactions to be determined by comparing the profits of the assessee with that of the comparable companies. There are no express statutory provisions which indicate that deduction for depreciation is a must. Depreciation, which can have varied basis and is allowed at different rates, is not an expenditure which must be deducted in all situations. It has no direct bearing or connection on price, cost or profit margin of international transactions. It can therefore be held that depreciation can be taken into account or disregarded in computing profit, depending on the context and purpose for which profit is to be computed.
19.4.2 In the case of Schefenacker Motherson Ltd (supra) of the ITAT, Delhi, the issue of whether depreciation can be excluded for comparison has been discussed at length and it was held in para 22 thereof that –
“… The basic issue involved was whether the cost paid or charged for international transactions was at arm’s length or not. The factors which go to influence price, cost or profits are / were relevant for computing profit and not depreciation having no direct connection with price or profit but responsible for wide differences. The case of revenue is not clear. If depreciation is not leading to any difference, its exclusion is immaterial. If it is leading to differences, then differences are required to be adjusted, as required by the IT regulations. There is no way to dislodge the claim of the tax payer. The context and purpose of legislation and facts of the case overwhelmingly approve adoption of cash profit only.” This case was relied upon by the assessee in support of its proposition that cash PLI or PBDIT is the appropriate PLI.
19.4.3 We find that the above finding of the Tribunal was given as the case of revenue was not clear and the TPO had rejected cash PLI without assigning any reasons. Subsequently, the Mumbai, ITAT, in the case of Fiat India Pvt Ltd (supra) held that in an asset intensive industry where assets are the key drivers, excluding depreciation would not lead to any meaningful outcome and PBIT and not PBDIT is to be taken for computing PLI. The assessee in the instant case is also similarly in the asset-intensive industry of automobile manufacturing like the assessee in the cited case (supra), where depreciation is a significant cost, which no prudent businessman would ignore while pricing a passenger car. In such an instance, when the price is determined by considering the depreciation cost, excluding depreciation from the profits for comparison under TNMM distorts the comparability analysis. We are therefore of the opinion that in view of the finding of the Mumbai ITAT in the case of Fiat India Pvt Ltd (supra) in which the assessee therein is in the asset intensive automobile industry, as is the assessee in the present case, that cash PLI or PBDIT to sales is not the appropriate PLI and also note that the TPO has given depreciation adjustment for differences in relative level of depreciation cost with reference to sales. We, therefore, dismiss this ground raised by the assessee.”
11.4 Respectfully following the above judgment, AO/TPO is directed to compute the adjustment in accordance with the above view taken by the coordinate bench in assessee’s own case.
11.5 Accordingly, this ground is allowed for statistical purposes.
12. Ground No.7 In this ground the assessee stated that the TP adjustment should be restricted only to AEs transactions only. The TPO rejected the request of the assessee as well as the ld. CIT (A) also. The ld. AR relied on his written submissions. The ld. DR relied on the order of the lower authorities. Considering the submissions from both sides, we observed that a similar issue has been decided by us in assessee’s own case for the assessment year 2013-14 in ITA No.2016/Bang/2018 dated 18.8.2021 at para No.10 to 10.6, which is reproduced as under:-
“Ground Nos. 7 and 8 – TP adjustment should be restricted to AEs transactions. 10. The assessee submitted before the AO / TPO that out of the total transactions which it had entered into, only 52.07% of the transactions are with its AEs, whereas, balance transactions are undertaken with third parties. The assessee requested the TPO to restrict the TP adjustment to only AEs transaction. The TPO, however, did not accept the contention (there is no discussion on this aspect in the order of the TPO).
10.1 Aggrieved, the assessee preferred an appeal to the first appellate authority. Before the CIT(A), the assessee filed detailed submissions why TP adjustment should be restricted to AEs transactions. The CIT(A) requested for a remand report from the TPO on this issue. The TPO submitted a remand report by stating ALP should be calculated on entity level. The assessee filed a rejoinder. The CIT(A) accepted the submissions of the assessee and directed the TPO to restrict the TP adjustment to the transaction it had entered with its AEs, alone.
10.2 Aggrieved, the Revenue has raised this issue before the Tribunal. The learned Departmental Representative relied on the order of the AO / TPO.
10.3 The learned AR, on the other hand, submitted that in assessee’s own case for assessment year 2003-2004, the Bangalore Bench of the Tribunal had accepted that the TP adjustment is to be restricted only to the transaction assessee had entered with its AE. Copy of the order of the Bangalore Bench of the Tribunal in assessee’s own case for assessment year 2003-2004 is placed on record.
10.4 We have heard rival submissions and perused the material on record. For assessment year 2003-2004 in assessee’s own case the Bangalore Bench of the Tribunal had accepted that TP adjustment has to be restricted to AEs transactions alone. Following judicial pronouncements has also held the TPO adjustment has to be restricted to the international transaction the assessee had entered with its AEs. (a) CIT v. Keihin Panalfa Ltd. (Del HC-TS-474-HC-2015 (b) CIT v. Tara Jewels Exports (P) Ltd. [2017] 80 taxmann.com 117 (Bombay).
10.5 In view of the above judicial pronouncements, we hold that the CIT(A) has correctly directed the AO / TPO to restrict the TP adjustment to the AEs transaction.
10.6 Accordingly, ground Nos.7 and 8 are rejected.”
12.1 Respectfully following the above judgment, we also direct AO/TPO to decide the issue on above terms.
13. Ground No.8 to 15 Relating to royalty adjustments:
In addition to the written synopsis the ld.AR submitted the assessee adopted TNMM at the entity level, in which process the royalty has been considered as a closely linked transaction as a part of operating cost. Therefore a separate adjustment for royalty is not required. The AR of the assessee relied on the judgments of assessee’s own case for the assessment year 2005-06 in ITA No.350/Bang/2014 vide order dated 21/02/2022, in para nos.5 to 13, wherein held as under:-
“Ground Nos. 10-12: 5. The Ld.AR submitted that assessee selected TNMM as the most appropriate method and operating margin at entity level after including royalty was compared with comparable companies. The operating margin of the assessee are at arm’s length as concluded by the Ld.TPO.
6. The assessee submits that once the operating margin at segment or entity level is at arm’s length, separate analysis of Royalty is not required. This is for the following reasons: Section 92C(1) provides that the arm’s length price shall be computed applying the most appropriate method out of the methods listed in section 92C(I). Rule 10C lays down the guidelines for selection of the most appropriate method. The most appropriate method is to be selected having regard to nature of transaction or class of transaction or class of associated persons, functions performed, assets employed and risks assumed etc.
7. The assessee selected TNMM as the “most appropriate method” is not disputed by the revenue. The Ld.AR submitted that the TNMM considers the net profit margin earned by an organization. Adjustments are made to the net profits to factor in the differences at the transaction level or the enterprise level. It is submitted that the adjustments are also made for difference in the accounting methodology. TNMM makes a comparison at the entity / global / segment level and not at the transactional level. He assailed that the merit of this method is that, it is resilient to minor functional differences. As a result of this characteristic, examination is not made at the individual component level of income or expenditure that has been reckoned in arriving at the net profit but at the entity level. The Ld.AR emphasized that when comparison is made at the macro (global) level, where multiple intertwined transactions exist, it is not possible to identify or pinpoint the contribution of each facet or transaction to the earning of net profit.
8. He submitted that in the process of adopting the TNMM, the assessee adopted the Net Profit as the starting point, and in arriving at its net profit, the assessee considered and factored the royalty payments. The Ld.AR submitted that, royalty is integral to and inseparable to its dealings in the business segments. It is submitted that being a relevant aspect of dealings, it would be impractical and also inappropriate to evaluate such payments on an individual and stand-alone basis, de hors the segment to which a benefit from such services accrues. He reiterated that the Ld. TPO in the TP Order held the profits so determined to be satisfying the arm’s length test. This aspect has not been disputed. He thus submitted that once the net profit margin is demonstrated to be at arm’s length, it pre-supposes that the various components of income and expenditure, including the international transactions that have been considered in the process of arriving at the Net Profit are also at arm’s length, and under such circumstances, it is impermissible to select another method to examine an individual transaction of a segment already considered and evaluated.
9. In support of this contention the Ld.AR relied on the judgment of the Hon’ble Delhi High Court in the case of Sony Ericsson Mobile Communications India (P.) Ltd. v CIT reported in [2015] 55 taxmann.com 240 (Delhi) which explains the terms “closely linked transaction” and under what circumstances a “bundled approach” can be adopted. The judgment also overrules ITAT Special Bench decision in the case of L.G. Electronics India Pvt. Ltd v. ACIT reported in [2013] 29 taxmann.com 300 (Delhi – Trib.) (SP) that rejected ‘bundled approach’.
10. The Ld.AR thus submitted that its manufacturing activity and payment of royalty are closely inter-linked, interdependent and flow from a common source. He at the cost of repetition reiterated that once the net profit margin is determined to be at arm’s length, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm’s length is to be upheld. On the contrary, the Ld.DR relied on the orders passed by the authorities below.
We have perused the submissions advanced by both sides in the light of records placed before us. It is the contention of the Ld.AR that assessee has paid royalty to TMC in accordance with the technical service agreement being an integral part of the manufacturing activity. Admittedly, the Ld.TPO upon segregating the manufacturing and trading activity found the margin determined under the separate segments to be at arm’s length. It has been submitted by Ld.AR that for:
A.Y. 2008-09 in IT(TP)A No. 1595/Bang/2012,
A.Y. 2010-11 in IT(TP)A No. 16/Bang/2015 and
A.Y. 2013-14 in ITA Nos. 2016 & 1972/Bang/2018
the Coordinate Bench of this Tribunal in assessee’s own case has analysed that the royalty payment has been made by assessee towards the license to manufacture items on exclusive basis. It is also been submitted that in the sister concern’s case being Toyota Kirloskar Auto Parts for A.Y. 2007-08 in IT(TP)A No. 1356/Bang/2011, this Tribunal has taken similar view. We note that for A.Y. 200708, this Tribunal in assessee’s own case for A.Y. 2007-08 reported in [2014] 48 taxmann.com 380 has considered the issue of separately bench marking the royalty as under.
“48. On the issue whether the TPO can come to a conclusion that the ALP of an international transaction is nil because no services were rendered or that the assessee did not derive any benefit from the AE for which payments were made, we have considered the submissions of the learned counsel for the assessee. This issue is purely academic because we have already held that the conclusions of the TPO/DRP that the trading and manufacturing segment of the Assessee are distinct and not inter related warranting combined transaction approach is not correct and that a IT(TP)A No.1315/Bang/2011 combined transaction approach has to be adopted and that on the basis of combined transaction approach the price paid for the international transaction is at Arm’s Length. We may also that legally the TPO should adopt the ALP as nil. On similar approach by TPO adopting ALP at Nil the ITAT, Bangalore Bench, in the case of M/s.Festo Controls Pvt. Ltd. vs. DCIT in ITA No.969/Bang/2011 (AY: 2007-08) dated 4-1-2013, the Tribunal examined the question as to whether the TPO can determine the ALP at nil on the ground that no services Page 15 of 23 IT(TP)A Nos. 350/Bang/2014 & 836/Bang/2014 were rendered. The Tribunal, on the above issue followed the decision of the Mumbai Bench of the ITAT in the case of Castrol India Ltd. v. ACIT in ITA No.3938/MUM/2010 dated 14.09.2012 wherein it was held that it was incumbent upon the TPO to work out the ALP of the relevant transactions by following some authorized method and the entire cost borne by the assessee cannot be disallowed by taking the ALP at Nil. The Tribunal also referred to the decision of the Hon’ble Delhi High Court in the case of CIT v. EKL Appliances Ltd., ITA No.1068/2011 dated 29.03.2012. In the aforesaid decision, the assessee entered into an agreement pursuant to which it paid brand fee/ royalty to an associated enterprise. The TPO disallowed the payment on the ground that as the assessee was regularly incurring huge losses, the knowhow/ brand had not benefited the assessee and so the payment was not justified. This was reversed by the CIT (A) & Tribunal on the ground that as the payment was genuine, the TPO could not question commercial expediency. On appeal by the department, the Hon’ble Delhi High Court held that the “transfer pricing guidelines” laid down by the OECD make it clear that barring exceptional cases, the tax administration cannot disregard the actual transaction or substitute other transactions for them and the examination of IT(TP)A No.1315/Bang/2011 a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. The guidelines discourage re-structuring of legitimate business transactions except where (i) the economic substance of a transaction differs from its form and (ii) the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. The OECD guidelines should be taken as a valid input in judging the action of the TPO because, in a different form, they have been recognized in India’s tax jurisprudence. The Hon’ble Court held that it is well settled that the revenue cannot dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur (Eastern Investment Ltd 20 ITR 1 (SC), Walchand & Co 65 ITR 381 (SC) followed). Even Rule 10B(1)(a) does not authorise disallowance of expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same. In light of the aforesaid decisions, we are of the view that the stand taken by the assessee in this regard deserves to be accepted. It is clear from the decisions referred to above that the TPO has to work out the ALP of the international transaction by applying the methods recognized under the Act. He is not competent to hold that the expenditure in question has not been incurred by the assessee or that the assessee has not derived any benefits for the payment made by the assessee and therefore he cannot consider the ALP as NIL. We hold accordingly.”
11. We note that post ITAT order, the department filed MP for Assessment Year 2007-08 before the Hon’ble Tribunal seeking clarification as to whether the TPO can compute ALP of the royalty payment. In M.P. No. 7/Bang/2015 [TS-70-ITAT2015(Bang)], the Tribunal further clarified that when margins at entity level were accepted, the matter of dwelling into ALP at transaction level was irrelevant.
“21. In this M.P., the Revenue after referring to paras 50, 51 and 48 has submitted as follows:-
“5. The above para reads to mean that the TPO is to recomputed the ALP in accordance with the methods laid down in the Act and also sates that the Assessee’s stand is accepted opening it to a reading that the appeal has been allowed in favour of the Assessee as well as that of it being set aside for the TPO to do it in accordance with the methods recognized under the Act. 6. The Tribunal was also pleased to set aside the matter to the file of the TPO for AY 2008-09 when read with para 51 leads to a belief that the TPO is to recomputed the ALP. 7. Therefore, it is requested that the Hon ‘ble ITAT may clarify and adjudicate the above issue.”
22. The ld DR reiterated the stand of Revenue as contained in the petition. We have considered the contentions in the petition and are of the view that the same are devoid of any merit. The addition by way of adjustments to the ALP has been deleted by the Tribunal in para 47 of its order. The observations in para 48 to 51 has been very clearly mentioned MP No.7/Bang/2015 to be purely academic. Therefore, the confusion as is sought to be brought out in the petition is without any basis and is rather mischievous. All that the AO has to do while giving effect to the order of Tribunal is to delete the addition on account of adjustment to ALP. We may also add that the miscellaneous petition is thoroughly misconceived and has been filed without a proper reading of the order of the Tribunal. We hope that such miscellaneous petitions will not be filed by the revenue in future, when the orders in question clearly set out its conclusions. The miscellaneous petition is therefore dismissed.”
12. It is also observed that the principle of aggregation has been upheld by various High Courts as well as decision of this Tribunal. Admittedly, the assessee has treated royalty to be closely interlinked with the transactions, which was rejected by the revenue authorities.
Reliance has been placed on following decisions in respect of above proposition.
a) DCIT vs. Air Liquide Engineering India P Ltd. reported in [2014] 43 com 299 (Hyderabad Tribunal)
b) Dell International Services India Pvt. Ltd. vs. JCIT in IT(TP)A No. 130/Bang/2014 & IT(TP)A No. 121/Bang/2014 dated 22.12.2021
c) McCann Erikson India Pvt Ltd vs. ACIT — ITA No.5871/Del/2011
d) M/s. Thyssen Krupp Industries India Pvt Ltd V ACIT — ITA No. 7032/Mum/2011
e) Lumax Industries Ltd v ACIT TS-152-ITAT-2013(DEL)-TP.
f) Hindustan Unilever Limited v Ad CIT ITA No. 7868/Mum/2010
g) DCIT v CMA CGM Global India (P) Ltd ITA No. 5979/Mum/2010
h) Yokogawa India Limited v ACIT ITA No. 1329/Bang/2011
13. We note that assessee’s margins have been computed including royalty payment which is higher than the margin of the comparables. It is also not disputed by the revenue that the comparables in case of the comparables, the royalty, margins are computed after including royalty and research and development expenses. The view taken by the Coordinate Bench of this Tribunal in assessee’s own case for A.Y. 200708 has been reproduced hereinabove wherein all these aspects have been considered. This Tribunal for A.Y. 2007-08 has deleted the adjustment made by the Ld.TPO in respect of royalty by separately bench marking the transactions. This has been fortified by the clarification given in a Miscellaneous Petition filed by the department which is also reproduced hereinabove. This view is also supported by various decisions of Coordinate Benches of this Tribunal as well as various High courts. Cojoint reading of these orders, we direct the Ld.AO/TPO to delete the adjustment proposed for royalty as a separate international transaction. Respectfully following the above view, we direct the Ld.AO/TPO to delete the adjustment proposed towards royalty as a separate international transaction. Accordingly, ground nos. 10 to 12 raised by assessee stands allowed. “
13.1 The ld.DR relied on the order of the lower authorities and he submitted that since the assessee has adopted TNMM and the TPO has also accepted the methods for calculation ALP, the TPO has not made separate adjustment in regard to payment of royalty, therefore, this issue should not be raised by the assessee.
13.2 After hearing both the sides, we observe from the order of the TPO, he has calculated the ALP in regard to royalty payment determined under TNMM of Rs.154.54 crores however, no separate adjustment of royalty has been proposed by the TPO since the TNMM was adopted at NTT level which includes royalty also. The ld. DRP also expressed his opinion that the TPO has not proposed any adjustment towards royalty payment. Considering the above observations and arguments, we uphold the order of the DRP and no separate adjustment is required for the payment of royalty if the TNMM approach has been adopted at entity level as decided by the coordinate bench of the Tribunal in the assessee’s own case noted supra, therefore ground Nos.8 to 15 become academic in nature, accordingly, we allow ground nos.8 to 15.
14. Ground No.16 (a,b,c) – Provision for Employees Long Term Benefit
In the revised return of income, the assessee made a claim of Rs.2,63,30,833/- as a provision for long term service liability. During the course of assessment proceedings, the assessee explained to the AO that the employees who have completed 10 years of service are presented with mementos in the form of gold. Therefore, the liability has been provided in the books of accounts. The AO noted that neither the liability was crystallized nor accrued accordingly, he disallowed. On objection before the DRP, he confirmed the objection no. (i) to (iii) and in case of objection no.4, the actual amount debited was Rs.1,01,88,674/-. In this regard the assessee has filed rectification application, accordingly, after verifying the records, the addition was reduced to Rs.1,01,88,674/-Accordingly, he partly allowed.
14.1 The ld.AR reiterated the submissions made before the lower authorities as well as the written synopsis quoted supra and submitted that the provision was made as per accounting standard 15 of Rs.1,01,88,674/-towards future liability accruing to other employees, who are in service for 10 years. The provision was based on the actuarial valuation and the assessee is adopting mercantile system of accounting and he further submitted that similar issue has been decided in assessee’s own case by the coordinate bench of the Tribunal in ITA No.1972/Bang/2018 for the assessment year 2013-14 and the matter has been remitted back to the AO.
14.2 The ld.DR relied on the order of the lower authorities and he submitted that the provisions cannot be made, which is not accrued during the year.
14.3 After hearing both the sides, we observe that the similar issue has been decided by the co-ordinate bench of the Tribunal as cited by the ld.AR. The observations are as under:-
“3.4 We have heard rival submissions and perused the material on record. It is an admitted fact that the assessee is following mercantile system of accounting. As per the mandate of Accounting Standard-15 (AS-15), the assessee is required to make the provision in the books of account towards future liability accruing to the employees who are in service but not yet completed 10 years duration to be eligible for memento. The assessee had engaged the services of actuary in order to determine the extent of provision to be made in accordance with AS-15. The actuary certified that as on 31.03.2013 (i.e. for the relevant assessment year under consideration), a sum of Rs.46,60,033 needs to be provided based on certain actuarial assumptions. A copy of the actuary valuation is placed at page 1221 of the paper book filed by the assessee. The AS-15 dealing with “employees benefits” defines the term “employees benefits” to include “other long term employee benefit”. The extract of the Accounting Standard reads as follow:-
“(c) other long-term employee benefits, including long-service leave or sabbatical leave, jubilee or other long-service benefits, long-term disability benefits and, if they are not payable wholly within twelve months after the end of the period, profit sharing bonuses and deferred compensation; and”
3.4.1 Therefore, if any company provides any long term service benefit to its employees, then the recognition, measurement and disclosure requirements laid out under AS15 is required to be adhered to. The liability in this case might arise on account of employees completing 10 years of service in future, is therefore, required to be quantified and recognized over a period of time in accordance with the Accounting Standards. “Accrual” is one of the fundamental accounting assumption. The term accrue is not defined in the Act. As per AS-1 (Disclosure of accounting policies), Accrual presupposes that the financial statements are prepared on mercantile system of accounting. Under this system, the effects of transaction and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in financial statements the period to which they relate.
3.4.2 The Hon’ble Supreme Court in the case of Bharat Earth Movers v. CIT [2000] 112 taxman 61 (SC) had held if business liability has definitely arisen in the accounting year, then the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied, it was held by the Hon’ble Supreme Court that the liability is not a contingent one and the liability is in praesenti though it will be discharged at a future date. It was further held by the Hon’ble Supreme Court that it does not make any difference if the future date on which the liability shall have to be discharged is not certain. The Hon’ble Supreme Court was considering a case where the assessee company had floated beneficial schemes for its employees for encashment of leave. The officers were entitled to earned leave calculated at the rate of 2.5 days per month, i.e., 30 days per year. The staff (other than officers) was entitled to vacation leave calculated at the rate of 1.5 days per month, i.e., 18 days in year. The earned leave / vacation leave could be accumulated up to 240/126 days maximum and the same could be encashed subject to the ceiling limit of 240/126 days. The taxpayer, in the case considered by Hon’ble Supreme Court, made provision for meeting the liability to the extent of entitlement of the officers and staff to accumulate earned vacation leave subject to ceiling limit of 240/126 days as might be applicable, and claimed that provision as deduction. The Tribunal held that the taxpayer was entitled to such deduction. The High Court, on the basis of the reasoning that the liability would arise only if an employee might not go on leave and instead would apply for encashment, held that the provision for accrued leave salary was a contingent liability and, therefore, was not a permissible deduction. The Hon’ble Supreme Court reserved the Hon’ble High Court’s conclusion by observing as above.
8 3.4.3 Therefore, taking into account the judicial pronouncements and the AS-15, we hold that if the liability is an known liability and the estimation of liability is reliable, the provision made for the relevant assessment year cannot be stated to be a contingent liability. In this case, the actuary valuation for claiming provision of Rs.46,60,033 for the relevant assessment year is placed on record at page 1221 to page 1233 of the paper book filed by the assessee. On perusal of the same, it is not clear as regards the basis of arriving of the above stated provision. In simple terms, if the assessee had made a provision on proportionate basis, i.e., taking into account 10% on an year to year basis for gifting the memento on completion of 10 years of service, we could have understood the valuation report is based on some reasonable basis. Further, when the employee leaves the assessee company prior to completion of ten years, how the provision is reduced on year to year basis, is also not explained. Before us, no explanation was offered as regards how the provision of Rs.46,60,033 is arrived at. Therefore, in the facts of the given case, the assessee has to prove before the A.O. the scientific basis for creating a provision for Rs.46,60,033. For this purpose, the issue raised in ground No.11 is restored to the files of the A.O. with the above directions. It is ordered accordingly.”
15. Ground No.17 – Excess claim of depreciation
The assessee had capitalized some capital assets on provisions basis, the assets were acquired. Subsequently, in the next financial year it was reversed. Before the AO vide letter dated 25/02/2016, the assessee submitted that it was only because of the price negotiations with the vendors was not finalized, therefore the assessee claimed depreciation on the basis of liability, which has neither been quantified nor crystallized. On the same letter the assessee admitted that there was excess claim of depreciation of Rs.60,26,382/- has been claimed on provisions created and it was reversed subsequently. The explanations were not accepted by the AO and he added it into the total income of the assessee. On objections raised before the DRP, the assessee submitted detailed submissions. The ld.DRP observed that the assessee has not adopted any scientific approach for claiming depreciation on provisions and the provisions has been reversed in the financial year 2012-13 and 2013-14 and they confirmed the order of the AO.
15.1 He reiterated the submissions made by the lower authorities and relied on the written synopsis cited supra. The assessee submitted that the assessee is maintaining his books of accounts on mercantile system of accounting and financial statements have been prepared following the accounting standard applicable to the company. During the financial year, the assessee invested for capital asset of Rs.904.93 crores out of which, Rs.683.10 crores were invested in addition to plant and machinery. During the financial year, the suppliers have supplied the machineries before the close of the year and bills were not submitted in some cases because of the pending price negotiations and finalizations. Therefore, as per AS 10, the assessee was bound to make provision for the outstanding liabilities and he also submitted that the assets were put to use during the year, therefore, the assessee is eligible for depreciation.
15.2 The ld .DR relied on the order of the lower authorities and submitted that the depreciation cannot be claimed on provisional basis and there is no scientific method adopted by the assessee for creating provisions. Accordingly, he submitted that the order of the lower authorities should be upheld.
15.3 After hearing both sides, we observe from the submission made by the AR of the assessee in the paper book page no.1254 to 1260 that the assessee made provisions of Rs.48,34,50,207/- as under:-
| Buildings | 23,88,52,782/- |
| Plant and Machinery | 22,29,86,906/- |
| Computers | 02,02,05,240/- |
15.4 Out of the above provisions, the assessee has reversed in the following subsequent financial year as under:-
| 2012-13 | 2013-14 | |
| Buildings | 23,88,52,782 | 4,33,67,034 |
| Plant and Machinery | 22,29,86,906 | 15,19,545 |
| Computers | 2,02,05,240 | ——— |
| Total | 48,34,50,207 | 4,48,86,579 |
15.5 Since this is a company and it has to prepare its financial statements following the accounting standards, the accounting standard AS 10 para no.9.1 is as under:-
“9.1 The cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price. Examples of directly attributable costs are:
( i) site preparation;(
(ii) initial delivery and handling costs;
(iii) cost, such as special foundations for plant; and
(iv)installation professional fees, for example fees of architects and engineers.
The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar factors.”
15.6 As per the above accounting standard the fixed assets are to be capitalized if it is ready for use, the cost components includes all relevant costs which are directly attributable cost of bringing the assets to its working conditions for its intended use. The assessee submitted that the assets were put to use during the impugned assessment year to which the revenue authorities have not disputed merely the ld.DRP did not accept the claim of the assessee that the assessee has not adopted any scientific approach. Now the sec.32 for claiming depreciation on the following two conditions must be satisfied.
(i) It should be owned, wholly or partially by the assessee and
(ii) it should be used for the purpose of business or profession
15.7 During the impugned assessment year, the assessee has submitted that the assets were put to use by the assessee but from the documents available it is not clear whether the ownership of the assets were transferred to the assessee because there was no price fixed by the suppliers as stated by AR of the assessee. The assessee has not satisfied both the conditions, therefore, the assessee is not eligible for claiming depreciation on provisional basis. We also notice that from
the above table the provision was made in the books of accounts for Rs.48.35 crores and even after expiry of 2 years the price was finalized only of Rs.6.44 crores and the assessee has reversed the provisions only. We also noted it from the order of the AO vide his letter dated 25/02/2016. Accordingly, we uphold the order of the lower authorities. The assessee admitted that there was excess claim of depreciation of Rs.60,26,382/- on the provisions created, which has been reversed subsequently. Considering the totality of the facts and circumstances of the case, we uphold the order of the revenue authorities. Accordingly, this ground is dismissed.
Ground No.18 – Claim u/s 40(a)
16.The AR reiterated the submissions made before the lower authorities and also the written synopsis filed by it.
16.1 During the assessment year 2011-12, the assessee has debited an expenditure of Rs.179.98 crores towards payment of royalty. Out of which, the assessee did not comply the provisions of sec.40(a) and it was added back while computing its total income. Accordingly, the effective claim of royalty was Rs.122.45 crores. The ld.TPO determined the ALP of royalty at Rs.77.99 crores, thereby the adjustment was of Rs.107.99 crores. Accordingly, it was assumed that Rs.50.46 crores was subjected to TDS and rest of the amount of Rs.57.53 crores on which no TDS was made and the same amount was also disallowed by the assessee. The revenue authorities noted that the disallowance of an amount of Rs.57.53 crores was adjustment u/s 92CA of the Act towards the royalty payment. Accordingly it was disallowed.
16.2 On objections filed before the DPP, the DRP held as under:-
“6.5 The submissions of the assessee in relation to above objections have duly been considered. In brief, during the AY 2011-12, the assessee had debited an expenditure of Rs 119,98,19,708/- to its P&L account as expenditure relating to royalty. However, in relation to above amount, the assessee had not complied with the provisions of section 40(a) in respect of an amount of Rs .57,53,23,147/-. So, as per assessee, this amount was disallowed in the computation of income. So effectively an amount. of Rs 122,44,96,561/- was claimed as expenditure on account of royalty by the assessee for AY 201142. The TPO determined the ALP of royalty at .Rs 71,99,21,883 and accordingly recommended adjustment of Rs 1.07,98,91,825/- to the assessing officer. This adjustment constituted of two parts:
|
The amount on which tax at source Deducted: |
Rs 50,45,68,678/- |
| The amount on which tax at source not deducted : | Rs 57,53,23,147/- |
| Total adjustment: | Rs107,98,91,825L |
6.6 Thus, the adjustment re.comrne1ed by the TPO and that made by the AO included the amount on which tax at source was not deductc1 by the assessee. Even if the assessee had deducted tax at source on this amount of Rs 5045,68,678/-, the amount would not have been allowed as expenditure in the AY 2011-12 due to above adjustment. So, deduction of tax at source on this amount subsequently will not alter the situation, as the amount itself is, not allowable as expenditure due to adjustment done by the TPO in the amount of royalty. Considering this, the assessee cannot claim this amount is allowable expenditure by claiming that the tax at source has been deducted on it during the y6ar under consideration. As such there is no double disallowance in the year under consideration and the objection is not accepted.”
16.3 The ld.AR submitted that the royalty adjustment made by the authorities as per sec.92CA has been decided by the Tribunal in favour of the assessee, therefore, the addition made by the AO by stating that it is an amount of adjustment made u/s 92CA does not survive. The ld.AR also submitted that while filing the income-tax return for the assessment year 2011-12, the assessee perse made disallowance u/s 40(a) and subsequently the TDS was made on the same amount in the following assessment year. Therefore, the assessee is eligible for claim of deduction in the following assessment year as per sec.40(a) of the Income-tax Act. He relied on the order of ITAT Pune Bench in the case of Eaton Technologies Pvt. Ltd., in ITA No.1621/PN/2011 vide order dated 11-01-2013, wherein at para 14.3 it was held as under:-
“14.3 From the above, it is clear that the allowance of any expenditure arising from an international transaction shall also be determined having regard to the ALP. However, in the instant case the assessee has not claimed the expenditure of Rs.7,42,20,575/-during the impugned assessment year and has itself disallowed the same while computing its taxable income. Therefore, we agree with the submission of the learned counsel for the assessee that the provisions of section 92 are not applicable. We also find force in the submission of the learned counsel for the assessee that there cannot be double disallowance/addition of the same amount. We, therefore, are of the opinion that although the transaction between the assessee and its AE falls within the meaning of an international transaction still no adjustment on account of ALP can be made since the assessee has suo-moto added the amount while computing its taxable income for the impugned assessment year and no benefit of the same has been taken either by capitalising it and claiming depreciation on it or taken benefit in subsequent years. In this view of the matter, the order of the Assessing Officer on this issue is set-aside and the grounds raised by the assessee are allowed.”
16.4 The ld .DR relied on the orders of the lower authorities.
16.5 Considering the submissions from both the sides, the amount of Rs.57.53 crores was disallowed by the assessee in the assessment year 2011-12 while computing taxable income and the assessee submitted before us that the TDS has been made in the following assessment year and the details are placed in the paper book. The ld. DRP observed that the disallowance of Rs.57.53, which was a part of the disallowance made u/s 92CA in the previous assessment year, therefore, it cannot be allowed/disallowed as per sec.40(a)/37(1) of the Act. The addition made u/s 92CA cannot be correlated with the disallowance u/s 40(a)/37(1) of the Act. Therefore, we do not find substance on the submissions of the ld. AR. The case law relied by the ld. AR is not applicable on the present facts of the case. The ld. AR submitted that the ITAT has decided this issue in favour of the assessee for the AY 2011-12 wherein it has been held that if the assessee has applied TNMM at entity level then no separate adjustment can be made for Royalty payments u/s 92CA, but no copy of the order was produced before us for the AY 2011-12 on this issue. Therefore, the assessee is directed to produce the order of the ITAT for the AY 2011-12 on this issue and if there is no separate adjustment for royalty u/s 92CA, no addition can be made during the year because the assessee has complied the provisions of section 40(a). Considering the facts of the case we are remitting this issue to the AO for verification. This ground is allowed for statistical purposes.
16.6 Ground No.19 relates for price reduction of purchase of Rs.1,34,40,305/- which was offered to tax in subsequent AY. During the impugned assessment year, the assessee received credit note for the year ending 31/03/2012, it was communicated/issued by Denso Kirloskar Pvt. Ltd. The annual accounts were adopted by the board of management of the company on 7th May, 2012, which is prior to information received from the supplier company. Accordingly, the assessee did not offer any income for the assessment year 2012-13. In draft assessment order, the AO did not accept the explanations of the assessee and on filing objections before the DRP, the ld.DRP also confirmed the action of the AO. The AO passed the final assessment order by holding as under: –
“During the course of assessment in the case of Dcnso kirloskar who is one of the suppliers to the assessec , it was found that the supplier has reduced the prices of various items sold to the assessee and the total price reduction amounted to Rs.1,41,95,451/- In this regard the assessee was asked to furnish details of such price reduction offered by the various suppliers and the how same has been accounted for. It was conceded by the assessee that there was price reduction due to re negotiation with the suppliers. Though the assessee was allowed sufficient time the assessee has sent mail seeking 10 more days time to furnish details. The assessee was informed that the detail should be furnished by 16/3/2016 failing which 5% of the purchases will be disallowed towards price reduction and renegotiation. The assessee by its letter dated 16/3/2016 submitted that an amount of Rs. 10, 87, 63,369/ – was accounted for as price reduction during the FY20 1112. This has been confirmed by the assessee by its mail that this amount has been reduced from the purchases . As regards price reduction by M/s Denso Kirloskar, only a sum of Rs.3,15,528 /- is included in the above as the assessee claims that the balance was accounted for in FY.2012-13. Hence, the balance amount of Rs. 1,38,79,923/- is to be reduced from the purchases during this year to reflect the correct taxable income. This amount is accordingly added to the total income. It is to be noted e credit note for this amount was received by the assessee on 25/5/2012 much before the filing of Return of Income. However, this has been admitted by the assessee only upon persistent enquiry by the undersigned.”
16.7 Aggrieved from the above addition, the assessee filed appeal.
16.8 The ld.AR reiterated the submissions made before the lower authorities as well as he relied on the written submissions cited supra.
16.9 The ld.DR relied on the order of the lower authorities and he submitted that the lower authorities have rightly passed the order on this issue. The income was accrued to the assessee in the impugned assessment year. For the purpose of computation of income, the assessee should have taken it as income for the year because the credit note was received well before the date of filing of return of income on 28/11/2012. The AO assessed it as income for the impugned assessment year on the basis of real income theory. The case law relied by the ld.AR is not applicable in the present facts of the case.
16.10 After hearing both the sides, we have considered the rival submissions and observed that the assessee received credit note on 25/05/2012 for the year ending 31/03/2012. The books of accounts were adopted by the board of management on 07/05/2012. The assessee filed return of income on 28/11/2012. The assessee could have offered it as income for the impugned assessment year because there was a certainty to receive the income. While computing taxable income for the relevant assessment year, the real income theory is applied for the income-tax purpose. No doubt the books of accounts of the assessee were closed on the date of filing of the return of income but to receive the income was certain. It is well-settled that the Act levies charge of income-tax on the total income as per section 4. Section 5 of the Act defines the scope of total income. The provisions of section 145 (1) define that income chargeable under the head ‘Profits and gains of business or profession’ or ‘income from other sources’ shall, subject to the provisions of section 145 (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. From the reading of section 145, in conjunction with the charging provisions contained in section 4, the scope of total income as defined in section 5 and other relevant provisions, it is clear that the provisions of section 145 cannot override provisions of section 5. If income has neither actually accrued nor is received within the meaning of section 5, whatever section 145 may say, such income cannot be charged to tax, even though a book keeping entry may have been made recognizing such hypothetical income, which, in law, and, in fact, did not really accrue or arise or was received in the previous year. Section 145 determines the method of computing the taxable income; it does not affect the range of taxable income or the ambit of taxation. The computational provisions cannot enlarge or restrict the contents of taxable income. Accordingly, the range of taxable income or ambit of taxation is to be determined in accordance with the charging provisions. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax; that accrual is a matter to be decided on commercial belief, having regard to the nature of business of the assessee and character of the transaction. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to the business character of the transaction. No doubt, the Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of income or its receipts but the substance of the matter is the income. If the income does not result at all, there cannot be a tax, even though the book keeping entry is made about hypothetical income which does not materialize. In the case on hand, the right to receive income was certain and merely the assessee had adopted its books of accounts in the annual general meeting which is prior to the receipt of information from Denso Kirloskar Industries Pvt. Ltd. Therefore, the facts of the case law relied by the ld.AR are different from the assessee’s case. Accordingly, the judgment relied on by the ld.AR is not acceptable in the present facts of the case. Accordingly we uphold the order of the AO and dismissed the ground raised by the assessee. The AO is also directed to give benefit for the subsequent assessment year. The AO has to keep in mind that while giving tax effect that it should not be taxed twice and necessary effect should be given to the assessee.
17. In the result, the ground No. 19 raised by the assessee is dismissed.
18. In the result, the appeal filed by the assessee is partly allowedfor statistical purposes.
ITA No.320/BANG/2019 – Assessment Year: AY 2014-15
19. The assessee has raised following grounds of appeal:-
“GENERAL GROUND
1. The Order of the learned Commissioner of Income Tax (Appeals)-1 (hereinafter referred to as CIT-(A)) to the extent prejudicial to the Appellant is bad in law.
2. The learned CIT(A) has erred in confirming the action of the AO and TPO in:
a. Making a reference for the determination of the Arm’s Length Price of the international and specified domestic transactions to the TPO without demonstrating as to why it was necessary and expedient to do so.
b. Not appreciating that there is no amendment to the definition of “income” and the charging or computation provision relating to income under the head Profits & Gains of Business or Profession” do not refer to or include the amounts computed under Chapter X and therefore addition made under Chapter X is bad in law;
c. Not appreciating that the provisions of section 40A(2) override the provisions of Chapter X and there being no action under section 40A(2) for royalty expenses, no adjustment under Chapter X can be made.
d. Passing the order without demonstrating that the Appellant had any motive of tax evasion.
GROUND RELATING TO TNMM ANALYSIS
3. The learned CIT(A) has erred in confirming the action of the AO and TPO in selecting i) Tata Motors Ltd. ii) Mahindra and Mahindra Ltd and iii) Maruti Suzuki India Ltd as comparables under TNMM analysis, without appreciating that they fail related party transaction filter of 25% on sales and not comparable in terms of functional analysis.
4. The learned CIT(A) has erred in:
a. Unilaterally directing the AO/TPO to compute RPT of the comparables by adopting ratio of ‘total RPT divided by total sales plus total expenditure’ without appreciating that both the Appellant and the TPO had adopted the ratio of “total RPT by total sales “; and
b. Drawing incorrect inference from the Order of CIT(A) for AY 2013-14 and accordingly modifying the RPT ratio to be adopted for applying the filter.
5. The learned CIT(A) has erred in confirming the action of the AO and TPO in:
Ca Inappropriately computing the operating profit margin of the comparables.
b. Inappropriately computing operating margins of the Appellant by considering i) Interest received; ii) Liabilities/Provisions written backs iii) Miscellaneous income; and iv) Interest Paid, as non-operating in nature. On parity of reasoning these should be considered as operating in nature even in case of comparables;
c. Inappropriately computing operating margins of the Appellant by considering Provision for PF of International Workers as operating in nature without appreciating that these expenses should be treated as non-operating in nature.
6. The learned CIT(A) has erred in confirming the action of the AU and TPO in:
a. Not making proper adjustment for enterprise level and transactional level differences between the Appellant and the comparable companies;
b. Ignoring the business, commercial and industry realities and economic circumstances applicable to the Appellant vis a vis the comparables;
c. Not providing Customs Duty adjustment, which was required to be made to put all comparables on a level playing field;
d. Not providing working capital adjustment; and
e. Not providing capacity underutilization adjustment;
7. The learned CIT(A) has erred in confirming the action of the AO and TPO in:
a. Not considering Cash Profit Level Indicator (‘PL’) in the case of the Appellant and the Comparables for the purpose of TP analysis even though in the facts and circumstance Cash PLI was more appropriate;
b. Without prejudice, in case Cash PLI is not adopted, depreciation adjustment was required to be granted in the facts and circumstances of the case.
8. The learned CIT(A) has erred in confirming the action of the AU and TPO in applying the modified PLI to all expense transaction including expenses incurred with non-associate enterprises and Specified domestic transaction and thereby making an adjustment in respect of transactions with non-associate enterprises and SDT also.
9. The learned CIT(A) has erred in confirming the action of the AO and TPO in not appreciating that section 92BA(i) of the Act is omitted without any saving clause by Finance Act 2017, which has retrospective effect as if the clause was never in existence and therefore TP addition made with respect to these transactions are bad in law. GROUNDS RELATING TO ROYALTY ADJUSTMENT
10. The learned CIT(A) has erred in confirming the action of the AO and TPO in:
a. Not appreciating that the Appellant had adopted TNMM at the entity level, in which process, the royalty payment were considered as closely linked transaction and hence was subsumed into the expenditure;
b. Not substantiating how the royalty payment were singled out of the many transactions to be tested on the basis of the ALP; and
c. Not appreciating that once the margin is tested on the touchstone of ALP, it presupposes that the various components of income and expenditure considered in the process of arriving at the margin are also at ALP;
11. Assuming without admitting that the royalty is to be separately evaluated on the touchstone of arm’s length principle, the CIT(A) has erred in confirming action of the AO and TPO in adopting the TNMM for royalty payment without following the prescribed methodology as per Rule lOB.
12. The learned CIT(A) has erred in confirming the action of the AO and TPO in not appreciating that:
a. Royalty represents a recurring payment for a one-time transfer of technology; and
b. Technology for some models was received during the year whereas technology for other existing vehicles had been received in earlier years.
13. The learned CIT(A) has erred in ignoring the submissions made by the Appellant and confirming the action of the AO and/DO with respect to:
a. Not considering external CUP transaction for computing ALP;
b. Ignoring the fact that the ratio of R&D expenses of TMC was much higher than the effective royalty rate of the Appellant;
c. Ignoring the fact that the Technical Assistance Agreements were approved by Government authorities and therefore royalty payment should be considered as at arm’s length; and
d. Ignoring the fact that, the CIT(A), DRP and ITAT in earlier years have accepted both factum as well as quantum of royalty as at arm’s length for the preceding assessment years.
14. Without prejudice to above, the learned CIT(A) has erred in confirming the action of the AO and TPO in:
a. Relying on TP analysis of AY 2012-13 & AY 2013-14 for making TP’ adjustment, without considering the facts and circumstances applicable to the year under consideration;
b. Making TP adjustment by taking blanket Royalty Rate at 6% without appreciating that Royalty Rate varied with the products manufactured and sold;
c. Adopting inconsistent denominator by applying ratio of royalty and R&D expenditure to net sales in the case of comparables vis-à-vis that of royalty to LVA instead of net sales in the case of the Appellant;
d. Adopting single year data for analysis, without appreciating that the business, commercial and technological factors mandate adoption of multi-year data.
e. Not granting adjustment for superior quality of technology in case of Appellant. GROUND RELATING TO CORPORATE TAX (LONG TERM BENEFIT):
15. The learned CIT(A) has erred in confirming the action of the AO in:
a. Disallowing provision of Rs. 28,42,112/- towards employee long term service benefit liability on the ground that such provision is contingent and not accrued;
b. Not appreciating that the provision for employee long terms service benefit is in accordance with provisions of Accounting Standard (AS) 15 – Employee benefit and based on actuary valuation; and
c. Holding that employee long term service benefit liability has not crystallized nor has accrued.
GROUND RELATING TO CORPORATE TAX (MISCELLANEOUS EXPENSE)
17. The learned CIT(A) has erred in confirming the action of the AO in disallowing a sum of Rs. 17,21,675/- incurred towards construction of basic civil structure for water purification Plant and supply of water purifier cum cooler, without appreciating the fact that these expenses are incurred wholly and exclusively for the purpose of business of the Appellant and are therefore allowable;
The learned CIT(A) has erred in disallowing 50% ofRs.l0,519/- incurred towards promotion of Japanese language, without appreciating the fact that it is incurred wholly and exclusively for the purpose of business of the Appellant and are therefore allowable.
GROUND RELATED TO ADDITIONAL CLAIM
18. The learned CIT(A) has erred in remanding the matter back to the file of the AO in relation to the Additional Claim of the Appellant relating to disallowance of deprecation on assets capitalized on provisional basis and reversed subsequently, and reversal of mark to market losses on derivative hedge contracts, without giving specific direction on non-taxability of such amounts.
GROUND RELATING TO INTEREST
19. The learned CIT(A) has erred in confirming the action of the AO in levying a sum of Rs 56,75,09,089/- and Rs.46,99,520/- as interest under section 234B and 234D respectively. On the facts and in the circumstances of the case, interest charged under section 234B and 234D is excessive and Appellant denies its liability to pay the same.
The Appellant submits that each of the above grounds/ sub-grounds are independent and without prejudice to one another.
The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before or at, the time of hearing, of the appeal, so as to enable the Income-tax Appellate Tribunal to decide the appeal according to law.
20. The assessee filed its return of income for the assessment year 2014-15 on 27/11/2014 declaring a loss of Rs.99,54,32,619/- under the normal provisions of the Act and admitted loss under book profit u/s 115JB of Rs.1,85,94,46,575/-. Subsequently, the assessee revised his return of income on 28/11/2014 declaring loss of Rs.102.87 crores and admitting loss under book profit u/s 115JB of Rs.185.94 crores. The case was selected for scrutiny and statutory notices were issued to the assessee. From the documents submitted by the assessee, it was noticed that the assessee has entered into several international transactions with its AEs, accordingly after obtaining approval from the competent authority, the matter was referred to the TPO. The TPO stated that the assessee for computing ALP of its international transaction, he adopted the TNMM as a most appropriate method, the financial/international extracted from the TPO’s order are as under:-
21. A detailed show cause notice dated 07/09/2017 was issued to the tax payer, the tax payer furnished his response to the show cause notice vide letter dated 28/09/2017. The TPO observed that the assessee had selected 3 companies as comparable for the manufacturing segments, out of which the Force Motors Ltd., and Ashok Ltd., was accepted by the TPO and ESML Isuzu Ltd., was rejected by observing that this company does not pass RPT Filter. The TPO had selected the five companies viz., Maruti Suzuki India Ltd., Ashok Leyland Ltd., Tata Motors Ltd., Force Motors Ltd. and Mahindra & Mahindra Co. Ltd. The assessee filed objections for selecting the comparables in respect of three companies viz., Martui Suzuki India Ltd., Tata Motors Ltd. and Mahindra & Mahindra, which were rejected by the TPO. Accordingly based on the search process adopted by the TPO and after discussing objections raised by the assessee, in the final set of comparables, the following companies were selected by the TPO and computed average margin as under:-
21.1 After selecting of the above five comparable companeis, the arithmetic margin of the profit level indicator (PLI) was taken as arms length price and computed the following adjustmetns:-
21.2 Accordingly as per above table, the adjustment u/s 92CA was calculated by the TPO of Rs.496,06,27,952/-.
21.3 Further, the TPO calculated adjustment based on account of excess Royalty payment of Rs.199,8322,791/- on the basis of observation in the assessment year 2012-13 and 2013-14 @2%.
The royalty was paid by the assessee @6%, therefore, the adjustment u/s 92CA for excess payment of royalty calculated as above. However, the TPO observed that no separate adjustment of Royalty needs to be done because TNMM approach at entity level includes Royalty also. Accordingly, he passed an order on 25/10/2017.
22. The AO passed draft assessment order on 14/02/2018. The draft assessment order was forwarded to the assessee but the assessee did not file objections before the DRP vide his consent dated 30/01/2018. Accordingly, the AO passed final assessment order on 14/02/2018 and the AO computed assessed income as under:-
| Loss income as declared by the assessee | Rs.(102,87,25,711) |
| Add: TP Adjustment | Rs.4960627952 |
| Add: Disallowance on Misc. Expenditure | Rs.1732194 |
| Add: Provisions for long Service | Rs.2842112 |
| Total Assessed Income | Rs.3936476547 |
23. Aggrieved from the above assessment order, the assessee filed appeal before the CIT(A) and the CIT(A) partly allowed the appeal of the assessee.
24. Aggrieved from the order of the CIT(A), the assessee filed appeal before the Tribunal.
25. The ld.AR of the assessee reiterated the submissions made before the lower authorities and he also reiterated the arguments advanced for the assessment year 2012-13 as noted supra, whichever is applicable. In addition to the above, the assessee has filed written synopsis, which is as under:-
Ground No.3 and 4- Rejection of Companies based on RPT Filter
2.41 The Appellant applied 25% RPT filter wherein companies having related party transactions (income transactions plus expenses transactions) in excess of 25% of sales were rejected as comparables (Pg 210 of Paper Book I). The Appellant rejected Tata Motors Limited, Maruti Suzuki India Ltd and Mahindra and Mahindra Ltd as comparables based on said RPT filter (Pg No.232 & 233 of Paper Book I).
2.42 However, the learned TPO selected Tata Motors Limited, Maruti Suzuki India Ltd and Mahindra and Mahindra Ltd by holding that these companies qualify RPT filter (Pg 99 and 100 of Appeal Papers). The Appellant submits that the TPO has applied 25% filter but there is no discussion in the Order under section 92CA whether the said filter has been applied by aggregating both income and expense transactions or has been applied separately for both income and expense transactions (Pg 85 of Appeal Papers). The Appellant also requested the TPO to provide RPT computation of the aforesaid comparables vide letter dated 02.11.2017 and 05.03.2018 (Pg 704 to 708 of Paper Book II) but till date details are not provided.
2.43 Before the CIT(A), the Appellant submitted that Tata Motors Ltd, Maruti Suzuki India Ltd and Mahindra and Mahindra Ltd should be rejected as comparables as they fail 25% RPT filter (Pg 739-747 of Paper Book III). The details of ratios are tabulated below:
| Sl No | Name of the Company | RPT Ratio on Sales | Pg No for calculation |
| 1 | Maruti Suzuki India Limited | 31.80% | 742 |
| 2 | Tata Motors Limited | 32.78% | 743 and 744 |
| 3 | Mahindra & Mahindra Ltd | 31.33% | 745 |
2.44 The learned CIT(A) drew incorrect inference from the Order of CIT(A) for AY 2013-14 and unilaterally directed the TPO to adopt RPT ratio of ‘total RPT divided by total sales plus total expenditure’ for selecting the above comparables. (Pg No. 17 of Appeal Papers).
Submission before ITAT
2.45 The Appellant submits that RPT ratio has to be calculated on aggregate basis taking ratio of RPT incomes plus RPT expenses by sales. The said position has been accepted by the Honourable Bangalore Tribunal in its own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021] [Para 7.4 at Pg No 1122 of Case Law Compilation]. The Tribunal held that RPT ratio has to be calculated on an aggregate basis by taking the ratio of RPT income plus RPT expense on sales. The relevant extract of the ITAT order is as below:
2.46 Therefore, based on above the Appellant submits that the RPT ratio should be applied on an aggregate basis to ensure that only uncontrolled transactions are compared as per mandate of Section 92F(ii). The Appellant submits that Tata Motors Ltd, Maruti Suzuki India Ltd and Mahindra and Mahindra Ltd should be rejected as a comparable on ground that they fail RPT filter.
Ground No.5 – Margin Computation of the Appellant
2.47 During the year under consideration, the Appellant had considered other income of Rs.1,71,74,90,000/- comprising of interest income, provision written back and miscellaneous income (lease rent, scrap sales etc) as operating in nature. The Appellant also treated Finance cost of Rs.58,04,60,000/-as operating in nature. Further Provision for PF of international workers was treated as non-operating in nature as it is only an anticipated liability and major part of the provision pertained to earlier years (Pg 236 of Paper Book I). Similar approach was also adopted while computing the margin of the comparable companies.
2.48 The learned TPO treated the other income and finance cost as non-operating nature and Provision for PF as operating in nature without providing any reasons for the said treatment (Pg 75 of Appeal Papers). There is no discussion on these issues in the TP order.
2.49 The Appellant submits as follow:
| Sl. No. |
Submissions before CIT(A) and decision | Contentions |
| 1. | Interest received from Bank FD should be considered as operating income. The learned CIT(A) has upheld the action of the TPO in treating interest income as non-operating in nature (Pg 17 and 18 of Appeal Papers) | Interest received from Bank FD should be considered as operating income. The Bank FD have origin in business funds due to efficient resource management strategy, Just-in-time approach and prudent business practice. (Pg 749 and 750 of Paper Book III) In support of above, the Appellant relied on the decision of Snam Progetti S.P.A. v ACIT 132 ITR 70 [para 13 and 14 at Pg 1300 and 1301 of Case Law Compilation]. |
| 2. | Liabilities/Provisions written back of Rs.73,70,70,000/- should be considered as operating income. The learned CIT(A) rejected the claim of the Appellant on the ground that the Appellant did not furnish any details in support of its claim. (Pg 19 and 20 of Appeal Papers) | Liabilities/Provisions written back of Rs.73,70,70,000/- should be considered as operating income. The Appellant submits that since in the year of creation, provision was treated as part of operating cost, the reversal of such provision should also be treated as operating in nature (Pg 750 and 754 of Paper Book III). The above contention of the Appellant is accepted by the Tribunal for AY 2013-14 at para 8.3 of the Rrder [ITA No.2016/Bang/2018, dated 18.08.2021 – Pg 1124 of Case Law Compilation]. Further, reliance is placed on the decision in the case of Sony India (P.) Ltd. v DCIT [2008] 114 ITD 448 (DELHI) – para 106.1 and 106. |
| 3 | Provision for PF of international workers is to be treated as non-operating in nature. The learned CIT(A) rejected the submission of the Appellant and held that it is operating in nature as it is a normal and regular expenditure and has direct relation for determining the profit of the Appellant. (Pg 19 and 20 of Appeal Papers) |
Provision for PF of international workers (Pg 757 to 761 of Paper Book III) is to be treated as non-operating in nature as it is only an anticipated liability. Further, out of total provision of Rs.116.72 crores, Rs.101.50 crores pertains to earlier years. Further entire provision has been disallowed while computing the total income of the Appellant [Pg 136 of Paper Book I].The Appellant relies on the following decisions wherein it is held that expenses disallowed should be excluded from operation cost:
|
| 4 | Miscellaneous income should be considered as operating in nature. The learned CIT(A) rejected the submissions of the Appellant on the ground that similar breakup of miscellaneous income is not available in case of comparables. (Pg 18 and 19 of Appeal Papers) | Miscellaneous income should be considered as operating in nature. The breakup of miscellaneous income is given at Pg 754 and 755 of Paper Book III. These incomes relate to reimbursement/recovery of expenses, letting out of space to onsite suppliers, duty drawback income and other income. These should be taken as operating in nature for the following reasons:
• The above incomes have direct link or nexus with business activity of the Appellant • Expenses incurred in relation to above incomes are debited to P&L account and are considered as part of operating cost. • If these incomes are considered as non-operating, then even the expenses attributable to these incomes will have to be excluded from the operating cost. |
| 5. | Interest paid should be considered as operating expense. The learned CIT(A) has upheld the action of the TPO in treating interest expenses as non-operating in nature (Pg 17 and 18 of Appeal Papers) | Interest paid should be considered as operating expense both for the appellant and the comparables. Automobile industry is capital intensive. An entity may be funded by debt or equity and interest paid reflects financial risk by the enterprise. (Pg 756 of Paper Book III) |
2.50 Based on above the Appellant submits that Interest income/Provisions written back/miscellaneous income/finance cost should be treated as operating in nature and PF Provision for international workers as non-operating in nature.
Ground No.6 and 7 – Adjustments
Working Capital Adjustment
2.51 The Appellant in its submissions before TPO provided working capital adjustment computation and requested the TPO to grant such adjustment (Pg 701 to 703 of Paper Book II). The TPO did not grant working capital adjustment (Pg 96 to 98 of Appeal Papers).
2.52 Before CIT(A), the Appellant made detailed submissions on why it should be granted working capital adjustment (Pg 807 to 832 of Paper Book III). The learned CIT(A) upheld the action of TPO and denied working capital adjustment on the ground that the Appellant did not demonstrate how workings capital levels has impacted the margins. (Pg 22 to 24 of Appeal Papers).
2.53 The Appellant submits that working capital adjustment is an accepted adjustment. In Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has upheld the action of CIT(A) in directing the TPO to grant the working capital adjustment [Para No.9.4 at Pg 1125 of Case Law Compilation].
2.54 Based on above, the Appellant submits that it should be granted working capital adjustment.
Custom Duty Adjustment
2.55 The Appellant in its TP study had made custom duty adjustment while computing the operating margins (Pg 215 of Paper Book I). The Appellant in its submissions before TPO requested to grant custom duty adjustment (Pg 522 to 547 of Paper Book II). The TPO denied custom duty adjustment by stating that it is the business decision of the Appellant and it does not impact the comparability (Pg 90 to 95 of Appeal Papers).
2.56 Before CIT(A), the Appellant made detailed submissions on why it should be granted custom duty adjustment (Pg 764 to 798 of Paper Book III). The learned CIT(A) rejected the submission of the Appellant and upheld the action of TPO. (Pg 21 to 22 of Appeal Papers).
2.56 The Appellant submits that it has higher import component (46.72%) vis-à-vis the comparables average rate of 8.96% (table at Pg 765 of Paper Book III). Higher imports results in higher custom duty. Higher customs duty increases the cost of raw materials (table at Pg 766 of Paper Book III). Since sale price is market driven, higher material cost impacts net margin. Comparables procure components from local manufacturers, who levy excise duty. However, input is available for excise duty. So, in order to eliminate the impact on margins due to duty differential, custom duty should be excluded from operating cost.
2.58 In support of the above arguments the Appellant relies on the following decision:
-
- Appellant’s own case for AY 03-04 – Page 1189-1190, findings at para 18.4. The ITAT remanded the matter back to TPO for fresh consideration.
- M/s Skoda Auto India Pvt Ltd v ACIT [2009] 30 SOT 319 (Pune) – [Pg 1238 and 1239 of Case Law Compilation]
2.59 Therefore, based on above, the Appellant requests your honour to direct TPO to grant custom duty adjustment.
Capacity Under Utilization Adjustment
2.60 The Appellant in its TP study had claimed capacity underutilization adjustment while computing the operating margins (Pg 216 of Paper Book I). In AY 2013-14, the Appellant increased the production capacity from 2,10,000 units to 3,10,000 units per annum. Due to adverse market & economic factors the Appellant produced only 1,54,627 units and thereby resulting in underutilization of 50.44%. The industry underutilization stood at 42.80% (Pg 217 of Paper Book I). Before TPO, the Appellant submitted that capacity utilization adjustment should be granted (Pg 547 to 551 of Paper Book II). The TPO denied capacity utilization adjustment by stating that law allows to make adjustment to the profit of the comparables and not of the tested party. So, the adjustment made by the Appellant is incorrect (Pg 95 to 96 of Appeal Papers). However, the TPO does not deny the fact that the Appellant has underutilization of capacity.
2.61 Before CIT(A), the Appellant made detailed submissions on why it should be granted capacity utilization adjustment (Pg.798 to 807 of Paper Book III). The learned CIT(A) rejected the submission of the Appellant. (Pg 24 to 28 of Appeal Papers).
2.62 The Appellant submits that manufacturing activities require huge outlay on fixed assets. The Appellant undertook substantial expansion by setting up Plant II in FY 10-11 and FY 11-12 and capacity expansion in FY 2012-13. Due to this there was significant increase in fixed costs. Fixed costs are sunk costs and are incurred irrespective of the level of the output. Costs like depreciation on fixed assets, wages, rent, electricity, security, etc. are fixed and are not dependent on the vehicles manufactured.
2.63 During FY 2013-14, the market conditions were very grim. To add to the problems, there were strikes due to dispute in wage negotiation between the Appellant and labour union. The Appellant also declared lockout due to labour unrest. This resulted in slow production levels and even there was complete halt of production.
2.64 For the aforesaid reasons there was underutilization of capacity when compared to the comparables. So, an idle cost adjustment is to be given for the unutilized capacity in excess of industry unutilized capacity i.e. 7.64% (50.44% – 42.80%) capacity.
2.65 The Appellant relies on the decision of Honourable Bangalore Tribunal in the case of IKA India Pvt Ltd vs DCIT [TS-1049-ITAT-2018Bang-TP] wherein it is held that capacity utilization adjustment has to be given and it is also held that in case appropriate adjustments cannot be made to the uncontrolled transaction due to lack of data then to read the provision of transfer pricing regulations in harmony, adjustments should be made on the tested party [Para 28 at Pg 1270 and 1271 of Case Law Compilation].
2.66 Therefore, based on above, the Appellant requests your honour to direct TPO to grant capacity adjustment.
Cash PLI/Depreciation Adjustment
2.67 The Appellant in its TP study had adopted Cash PLI (Pg 215 of Paper Book I). The Appellant in its submissions before TPO requested to adopt Cash PLI or to grant depreciation adjustment (Pg 551 to 560 of Paper Book II). However, the learned TPO did not accept the contention. There is no discussion on this aspect in the order.
2.68 Before CIT(A), the Appellant made detailed submissions on why cash PLI should be adopted (Pg 832 to 848 of Paper Book III). The learned CIT(A) rejected the submission of the Appellant and upheld the action of TPO (Pg 28 to 29 of Appeal Papers).
2.69 The Appellant submits that manufacturing activities require huge outlay on fixed assets. The Appellant undertook substantial expansion by setting up Plant II in FY 10-11 and FY 11-12. Comparable companies are comparatively old in the industry and operate with depreciated plant and machinery. This results in higher depreciation for Appellant at 4.14% vis-à-vis for comparables at 3.15%. Therefore, Cash PLI should be adopted and depreciation should be excluded from operating cost for the Appellant and the comparables. This will bring all entities at par. In the alternative and if Cash PLI is not accepted, depreciation adjustment should be given as given by the TPO in AY 03-04.
2.70 The Appellant relies on the following decision in support of its contention:
-
- PCIT v Novell Software Development India (P.) Ltd [2021] 126 com 29 (Karnataka) – [Para 7 & 8 at Pg 1242 and 1243 of Case Law Compilation]. The Karnataka HC directed to exclude depreciation from operating cost.
- In AY 03-04, the ITAT in appellant’s own case cash PLI was rejected- [Para 19.4.1 to 19.4.3, Pg 1191 to 1192 of Case Law Compilation]. However, the Tribunal observed that the TPO himself has given depreciation adjustment for difference in the level of depreciation cost with reference to sales.
2.71 Therefore, based on above, the Appellant requests your honour to direct TPO to adopt Cash PLI or to grant Depreciation adjustment.
Ground No.8 – TP Adjustment should be restricted to AE transactions
2.72 The Appellant submitted before the TPO to restrict the TP adjustment, if any only to the AE transactions. The Appellant submitted that out of total expenses it had entered into only 45.93% of the transaction with AE’s whereas the balance expense transactions were undertaken with third parties (Pg 565 to 572 of Paper Book II). However, the learned TPO did not accept the contention. There is no discussion on this aspect in the order.
2.73 Before CIT(A), the Appellant detailed submission on why TP adjustment should be restricted to AE transactions (Pg 844 to 854 of Paper Book III). The CIT(A) rejected the submission of the Appellant and upheld the action of TPO (Pg No.29 to 33 of Appeal Papers).
2.74 The Appellant submits the in its own case for AY 2003-04, the Honourable Bangalore Tribunal has accepted that TP adjustment has to restricted to AE transactions (Para 22 at Pg.1194 to 1195 of Case Law Compilation). Further, in Appellants own case for AY 2013-14[ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has upheld the action of CIT(A) in directing the TPO to restrict TP adjustment to AE transactions (Para 10.5 at Pg 1127 of Case Law Compilation). Relevant extract of the same is produced below:
2.75 Further, the Appellant relies on the following decisions:
-
- CIT vs Keihin Panalfa Ltd (Del HC-TS-474-HC-2015) (Para 12); and
- CIT vs Tara Jewels Exports (P) Ltd [2017] 80 com 117 (Bombay).
2.76 Based on above the Appellant requests your honour to direct the TPO to restrict the TP adjustment to AE transactions.
Ground No.10 to 14- Royalty Benchmarking
2.77 The Appellant had adopted the TNMM at the entity level, in which process, the royalty payment is considered as closely linked transaction and part of operating cost (Pg 150 to 153 of Paper Book I). The TPO rejected the above stand of the Appellant and proposed to benchmark the royalty transaction separately as per the methodology adopted in AY 201213 and AY 2013-14. The Appellant filed detailed submission before TPO on why royalty payment should not be benchmarked separately. The learned TPO rejected the submission of the Appellant and benchmarked the royalty separately by the following approach of AY 2012-13 and AY 2013-14 (Pg 101 to 103 of Appeal Papers).
2.78 The learned TPO has made TP adjustment for shortfall in margins as well as Royalty. The Royalty adjustment has been made despite royalty being part of operating cost, although the royalty adjustment is held by the TPO as subsumed within the margin adjustment.
2.79 Before CIT(A), the Appellant reiterated it stand by filing detailed submissions against the analysis of TPO (Pg 855 to 954 of Paper Book III). The CIT(A) rejected the submission of the Appellant and upheld the action of TPO (Pg.33 to 35 of Appeal Papers).
2.80 The Appellant submits that once the net profit margin is tested on the touchstone of arm’s length price, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm’s length.
2.81 The above view has been accepted by the Honourable Bangalore Tribunal in Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021] [Para 11.4 at Pg 1128 of Case Law Compilation]. Further, the Appellant relies on the decision rendered by the Honourable Bangalore Tribunal in its own case [IT (TP) A No.1315/Bang/2011 for AY 2007-08] wherein the tribunal held that the royalty payments made by the Appellant are at arm’s length (Para 48 to 51 at Pg 1148 to 1150 of Case Law Compilation). Reliance is also placed on, among others, para 101 of Delhi High Court decision in the case of Sony Ericsson Mobile Communications India v ACIT 55 Taxmann.com 240.
2.82 The Appellant also submits that the methodology adopted in AY 2012-13 and AY 2013-14 was not correct. In AY 2012-13 and AY 2013-14, the TPO compared the royalty and R&D expenditure to net sales in case of comparable vis a vis that of royalty to Local Value Addition (LVA) in case of the Appellant instead of net sales (Pg 577 to 602 of Paper Book II). In Appellant’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the ITAT has held that net sales should be adopted as denominator for the comparable and the Appellant [Para 11.5 at Pg 1131 of Case Law Compilation].
CORPORATE TAX GROUNDS
Ground No.15- Provision for Employee Long Term Service Benefit Liability
3.24 During the year under consideration, the Appellant had a program wherein all the employees who complete 10 years of service with the Appellant were awarded with mementos in the form of a 10-gram gold coin. As per the mandate of Accounting Standard-15 (AS-15), the Appellant made a provision of Rs.28,42,212/- in books of accounts towards future liability accruing to other employees, who are in service but have not yet completed the 10 years duration to be eligible for the memento and the same was claimed in the return of income. The provision was based on the Actuarial Valuation (Pg 1069 to 1081 of Paper Book III), which suggests only incremental amounts to be provided for in the books of accounts. The learned AO disallowed the provision on the ground that it is contingent in nature (Para 6 at Pg 60 and 61 of Appeal Papers).
3.25 Before the CIT(A), the Appellant made detailed submissions wherein it was submitted that the provision was created in line with the Accounting Standard. As per the mandate of Companies Act and Income Tax Act. As per section 145(2), the Appellant is under obligation to follow AS-1. AS-1 mandates observance of concept of prudence in preparation of accounts (page 953 of Paper Book III). Further, AS-29 provides that provision should be made if there is probability of outflow of resources embodying economic benefits (page 954 & 9555 of Paper Book III). The Appellant further submits that AS-15 dealing with “Employee Benefits” provides for recognition as a liability of other long-term employee benefits (page 970 and 971 of Paper Book III). The Appellant submitted that the liability is an existing liability and estimation is reliable as per Actuarial valuation (Pg 1069 to 1081 of Paper Book III). The learned CIT(A) disallowed the claim of the Appellant by holding that the same is contingent in nature (Pg 38 of Appeal Papers).
3.26 The Appellant submits that it adopts mercantile system of accounting. The provision was made in compliance with the Accounting Standard-15 and as per actuarial valuation report. The Appellant submits that the liability is an existing liability and estimation is reliable.
3.27 The Appellant relies on the decision on the decision of Honourable Supreme Court in the case of Bharat Earth Movers vs CIT [2000] 245 ITR 428 (SC) wherein it was observed that merely because a liability is to be discharged at future date does not convert an accrued liability into a conditional one. Accordingly, the Supreme Court held that provision made for meeting leave encashment liability proportionate with the entitlement earned by the employees is an deductible expenditure.
3.28 Further, in Appellants own case for AY 2013-14, the Honourable Bangalore Tribunal has held that estimation of liability is reliable and provision is not towards contingent liability. The ITAT has remanded the matter back to the file of AO to verify the scientific basis of the provision [ITA No.2016/Bang/2018, dated 18.08.2021] [Para 3.4.3 at Pg 1110 of Case Law Compilation].
3.29 Reliance is also placed on the decisions in the case of CIT v Eveready Industries India Ltd (2018) 98 taxmann.com 90 (Calcutta High Court) – para 11) wherein provision for medical benefit of its employees was allowed as deduction.
Ground No.16 & 17- Miscellaneous Expenses
3.30 During the year under consideration, the Appellant incurred a sum of Rs.17,32,194/-towards construction of basic civil structure for water purification Plant, Promotion of Japanese Language and supply of water purifier cum cooler. The said expenditure is forming part of Miscellaneous expenditure reported under Note 30 ‘Other Expenses’ of Financial Statements (Pg 123 of Paper Book I). The learned AO rejected the submission of the Appellant and disallowed the same by alleging that the same has not been incurred for the purpose of business (Pg 60 of Appeal Papers). The learned CIT(A) held that the above expenditure is not incurred for the purpose of business and on adhoc basis allowed 50% of the expenditure incurred for promotion of Japanese language only. (Pg 38 to 39 of Appeal Papers).
3.31 The Appellant has its manufacturing plant at Bidadi Industrial Area which is in Ramanagar Taluk. Close to 20% of the Appellant’s permanent/contract production team members hail from the Manchanayakanahalli and nearby villages. The Appellant constructed civil structure for water purification plant at Bidadi and Manchanayakanahalli Village located around 2.5 Km away from the Appellant’s manufacturing plant and also supplied water purifiers cum coolers for benefit of its employees and their families. Good health of its employees and their family would ensure more efficiency at work.
3.32 The Appellant’s employees who are selected for Inter Company Transfers, have to learn Japanese Language. Therefore, there was a requirement to develop Japanese Language Learning Centre in Bangalore. So, to promote Japanese language and also to benefit the employees who have enrolled for this course, the Appellant made payment amounting to Rs. 10,519/- to Bangalore University.
3.33 The Appellant would like to submit that above expenses are incurred wholly and exclusively for the purpose of its business and enhancing its brand image. The Appellant relies on the following case laws:
-
- CIT vs Infosys Technologies Ltd [2014] 43 com 251 (Karnataka High Court) [Pg 1252 and 1253 of Case Law Compilation] – expenditure on traffic signal is allowable.
- PCIT vs Gujarat Narmada Valley Fertilizer and Chemicals Ltd [2020] 121 com 82 (Gujarat) [Para 10] – CSR expenses allowed as deduction.
- CIT vs Shree Rajasthan Syntex Ltd [2009] 221 CTR 410 (RAJ)– purchase of bus for welfare of employee children.
3.34 Therefore, the Appellant submits that the above referred expenditure has been incurred for the purpose of business and allowable as deduction u/s 37 of the Act.
3.35 The Appellant submits that in its own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021], the Honourable Bangalore Tribunal has allowed 30% of the Miscellaneous expenses taking a overall view and to put a quietus to the issue. [Para 4.7 at Pg 1114 of Case Law Compilation].
26. The Ld. DR reiterated the arguments advanced by him for the AY 2012-13 wheresoever applicable and supported the order of the lower authorities which are related from the ground taken by the assessee.
27. Ground No.1 to 2 is general in nature, hence does not require adjudication.
28. Ground No.3 & 4 is related to RPT Filter as contested by the AR of the assessee as per his written synopsis. A similar issue has been decided by the coordinate bench of the Tribunal in assessee’s own case in ITA No.2016/Bang/2018 vide order dated 18/08/2021 for assessment year 2013-14 by holding as under:-
“7.4 We have heard rival submissions and perused the material on record. There is nothing on record to suggest how RPT ratio has been calculated for all the comparable companies. The learned AR has argued that the TPO in order to retain Tata Motors Ltd. and Maruti Suzuki India Limited has deviated and adopted a new mechanism for computing RPT ratio. On a query from the Bench how RPT ratio has been calculated for other comparables, the learned AR has unable to point out the same. The RPT ratio has to be consistently calculated on an aggregate basis taking the ratio of RPT income plus RPT expenses by sales. The said position was adopted by the Revenue in the past years. In this regard, the TPOs order in assessee’s own case for assessment year 2007- 2008 has been placed on record. A perusal of the same it is clear that RPT ratio has been calculated taking both RPT income transactions plus RPT expenses transactions on aggregate basis. On the facts of this case, it is not clear how RPT ratio has been calculated for Tata Motors Limited vis-à-vis other comparable companies. Therefore, this issue is restored to the files of the A.O. The A.O. is directed to calculate RPT ratio on an aggregate basis taking the ratio of RPT income plus RPT expenses by sales across the board for all the comparable companies (including Tata Motors Ltd. and Maruti Suzuki India Limited.”
28.1 On perusal of the order of the CIT (A), he has followed the order of the co-ordinate bench of the Tribunal in assessee’s own case for the AY 2013-14 and directed the AO for fresh consideration as per his direction. Respectfully following the above judgment, we also direct the AO/TPO to calculate RPT ratio in above terms as per assessee’s own case in the assessment year 013-14 cited supra considering the direction of the CIT (A), accordingly, this issue is allowed for statistical purposes.
29. Ground No.5(a), (b) & (c) :
A similar issue in respect of interest received from bank FD, interest paid, liabilities provisions/written back and Miscellaneous expenses has been decided by us in assessee’s own case for the assessment year 2012-13 at para Nos.7 to 7.4 and the result mutatis and mutandis shall apply to assessment year 2014-15. The Provision for PF of international workers is to be seen in the light of the AY 2012-13 too.
30. Ground No.6(a)(b) is general in nature and does not require any adjudication.
31. Ground No.6(c) : Custom Duty Adjustment :
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para Nos.8 to 8.13 and the result mutatis mutandis shall apply to assessment year 201415.
32. Ground No.6(d): Not providing Working Capital Adjustment :
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para Nos.10 to 10.4 and the result mutatis mutandis shall apply to assessment year 2014-15.
33. Ground No.6(e) : Not Providing Capacity Underutilization Adjustment –
The assessee has raised this issue by holding that the assessee has enhanced its capacity during the year and the Plant 2 could not achieve its installed capacity and some Fixed Expenses are required to be incurred irrespective of production of finished goods for unutilized capacity. The variable costs are depending upon the level of productions. The appellant increased its production capacity from 2,10,000 units to 3,12,000 units and produced only 1,54,627 units, therefore, the appellant raised this issue for adjustment of under capacity utilization . The ld. AR relied on his written synopsis and ld. Dr relied on the order of the lower authorities. Considering the arguments from both sides, we observed that this issue was also raised before the lower authorities and they have not granted under utilization capacity adjustment.
32.2 From the paper books filed by the assessee for the AY 2012-13 at page No. 893 to 897, the relevant part is as under
(A) para No. 2.2 as under:
The assessee submits that it was setup in India to manufacture and sell Multi Utility Vehicle ( hereinafter referred as “MUV”for sort), Sports Utility Vehicle ( hereinafter referred as “SUV” under the model name Innova TM and SUV under the model name FOrtuner TM and passenger Car under the model name CorollaTM. During financial year 2010-11 the assessee started a second plant to manu8facture and sell Etios versions of cars (Etios (Sedan) and Liva ( hatchback)). Further Etios sedan (diesel) with D,VD and VXD variants & Liva Hatchback (diesel) with GD & GD (SP) variants were launched in September 2011. During the year under consideration, in order to optimize the production capacity utilization, the assessee shifted manufacturing of Corolla TM vehicle from Plant 1 to Plant 2.
2.9 Till FY 2009-10 the assessee was achieving a sales volume of less than 1,00,000 units per annum, During end of the FY 2010-11, the assessee commenced the second plant to manufacture Etios Sedan & Etios Liva versions. The assessee further invested for enhancement of production capacity anticipating market demand. In FY 2012-13, the assessee increased its total production capacity from 2,10,000 units to 3,10,000 units. Considering potential growth in automobile sector, in line with the increase in capacity, the assessee also initiated to localize petrol engine required for Etios model. The assessee through manufacturer localized manufacturing of petrol engine from October 2012. Also, the assessee through its local supplier localized manufacturing of transmission for Etios petrol version of vehicles from January 2013. With these localizations, the assessee could achieve more than 90% localization of parts in case of Etios Petrol vehicles.
2.10 However, due to adverse fuel price position ( the price of petrol was significantly higher than the price of diesel), the efforts of the assessee did not bear required fruits. The exorbitant price difference resulted to high demand for diesel version of vehicles and pushed down the demand for petrol vehicles. As explained above, the assessee has been localizing various parts of all the models manufactured and focusing on improving the local contents of parts. However, this can be achived only when the company will be able to sustain the volume in line with the capacity created and achieve improving trend of volume annually.
32.3 The assessee has produced the documents which were also produced before the CIT (A)/TPO/AO, the same has been reproduced as above in the CIT (A)/TPO orders as produced above, which is clear from the paper book page No. 799 & 800, in which the assessee has himself accepted that there was no available capacity utilization level of comparables. He has further stated in his written submissions for the AY 2012-13, which has been extracted hereinabove that “With these localizations, the assessee could achieve more than 90% localization of parts in case of Etios Petrol vehicles”. The assessee has further stated that “During the year under consideration, in order to optimize the production capacity utilization, the assessee shifted manufacturing of Corolla TM vehicle from Plant 1 to Plant 2. The appellant claims that the average industry utilization is 52.20% during the year whereas its own capacity utilization is 49.56%. However, in absence of data of capacity utilization in respect of comparables the revenue authorities have not granted capacity utilization adjustment. A similar case has been decided by the coordinate bench of Tribunal in the case of IKEA India Pvt. Ltd. vs DCIT in IT(TP) A No. 2192/Bang/2017 order dated 17.09.2018 relied by the ld. AR placed at paper book page No. 1256 to 1294 , the relevant part of the order is as under:-
22. We have heard the submissions of the assessee and the ld. DR on the issue raised by the assessee in ground No.7. We shall first see the statutory provisions relevant to the issue. Rule 10B(1)(e) of the Rules states that adjustments should be made to account for:
“…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”
23. Rule 10B(2) of the Rules provides comparability of an international transaction with an uncontrolled transaction needs to be judged with reference to certain specified factors. One such factor is conditions prevailing in the markets in which the respective parties to the transactions operate, 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.
24. Rule 10B(3) of the Rules provide that:
“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 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.”
25. As per Section 92C of the Act, ALP is required to be computed using any of the given six methods and in the manner as is prescribed in Rule 10B of the Rules. Rule 10B in turn states that the most appropriate method would be one which inter alia provides the most reliable measure of ALP, and one of the important factors to be taken into account herein is the ability to make reliable and accurate adjustments.
26. The OECD Guidelines on this aspect is as follows:-
Para 1.35 of the OECD Guidelines states as follows:
“Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm’s length conditions”
Para 1.36 of the OECD Guidelines states as follows: “…. material differences between the compared transactions or enterprises should be taken into account. In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm’s length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm’s length dealings. Attributes that may be important include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the circumstances of the parties, and the business strategies pursued by the parties.”
Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows:
“….. Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method’ (Emphasis supplied)
27. US transfer pricing Regulations on this aspect is as follows:-
In addition, the US transfer pricing regulations, u/s 482 of the Internal Revenue Code (hereinafter referred to as ‘the US regulations’) also support the above. Regulation 1.482-1(d)(2) of the US regulation states as follows: “In order to be considered comparable to a controlled transaction, an uncontrolled transaction need not be identical to the controlled transaction, but must be sufficiently similar that it provides a reliable measure of an arm’s length result. If there are material differences between the controlled and uncontrolled transactions, adjustments must be made if the effect of such differences on prices or profits can be ascertained with sufficient accuracy to improve the reliability of the results. For purposes of this section, a material difference is one that would materially affect the measure of an arm’s length result under the method being applied.”
28. The Indian transfer pricing regulations, OECD Guidelines and the US transfer pricing regulations call for an adjustment to be made in case of material differences in the transactions or the enterprises being compared so as to arrive at a more reliable arm’s length price/ margin. While the Indian transfer pricing regulations refer to the adjustments on uncontrolled transactions, however the same has to be read with Rule10B(3) of the Rules which clearly emphasizes the necessity and compulsion of undertaking adjustments. Hence in case appropriate adjustments cannot be made to the uncontrolled transaction, due to lack of data, then in order to read the provisions of transfer pricing regulations in harmony, the adjustments should be made on the tested party. In the following decisions it has been held that adjustment to the profit margins have to be made on account of underutilization of capacity:
(i) In the case of M/s. Mando India Steering Systems Private Limited vs Assistant Commissioner of Income Tax, [I.T.A. No. 2092/Mds 12012], the Tribunal upheld the contention of the taxpayer for making a suitable adjustment on account of idle capacity for the purpose of margin computation. The relevant extract is reproduced as below:
“10. …………………. We are of the considered view that underutilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production.”
(ii) In the ruling of DCIT Vs Panasonic AVC Networks India Co Ltd (I.T.A. No.: 4620/De1/2011), it was held that:-
“5. ….. Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment.”
(iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 & 493/Bang/2015) for AY 2010-11, the Tribunal held as follows:
“10.4.1. We have heard the rival contentions and perused and carefully considered the submissions made and material on record; including the judicial pronouncements cited. The issue for consideration is whether adjustment for under-utilisation of capacity is allowable in the case on hand and if so, the manner of computation thereof and the quantum of adjustment
10.4.5 In the above cited case of the Mumbai Tribunal i.e. Petro Araldite P. Ltd. (supra), the Tribunal has upheld the principle that adjustment for capacity underutilisation can be granted…………… Following the decision of the ITAT, Mumbai in the case of Petro Araldite P. Ltd. (supra), we hold that any adjustment for capacity underutilisation can be granted “
(iv) In the recent case of GE Intelligent Platform Private Limited (IT(TP)A No. 148/Bang/2015 and 164/Bang/2015) for AY 2010-11 was held as follows:
“8 ………………. now the law is quite settled to the extent that once there is unutilized capacity or men power, such underutilization impacts margin and therefore, the adjustment should be made while computing the ALP
…………….. If the underutilization is more than average underutilization of the industry then necessary adjustment is required to be made to the margin of computing ALP…. “
29. Moreover, the above argument of the assessee for grant of capacity utilization adjustment is also supported by the following decision of Bangalore ITAT in the case of Genisys Integrating Systems (India) Pvt. Ltd (ITA No.1231/Bang/2010). Relevant extract of the decision is under:-
“15.2 We agree with this contention of the counsel for the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The AO shall consider this fact also while determining the ALP and make the TP adjustments. With these directions, the appeal of the assessee is disposed of.”
30. The reliability and accuracy of adjustments would largely depend on availability of reliable and accurate data. For certain types of adjustments, relevant data for comparables may either not be available in public domain or may not be reliably determinable based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible).
31. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making “reasonably accurate adjustments” for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the values stated for the international transactions are at ALP i.e., whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don’t restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per sub-clause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the adjustment of the profit margin of tested party. The above view has also been upheld in the following decisions:-
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- Capegemini India Pvt. Ltd. (ITA No.7861/Mum/2011)
- Demang Cranes & Components (India) Pvt Ltd. [49 SOT 610 (Pune)]
32. As far as data of comparable companies on capacity utilization being not available in public domain is concerned, it is practically not possible to obtain data on capacity utilization of comparable companies and consequently compute adjustment on the comparable companies, the operating cost of the tested party is adjusted for capacity utilization adjustment.
33. The assessee has under-utilized capacity during the subject AY and is accordingly factually and legally eligible to an adjustment for the same. Therefore, such a benefit cannot be denied to the assessee only for the reason that the data about comparable companies is not available. Requiring the assessee to produce such a data which is not available in public domain would tantamount to requiring the Appellant to perform an impossible task. The only way to get the data in the current case, would be where the TPO collates the same from the comparable companies by exercising his powers under section 133(6) of the Act. The relevant extracts of the section are as under:-
“(6) require any person, including a banking company or any officer thereof, to furnish information in relation to such points or matters, or to furnish statements of accounts and affairs verified in the manner specified by the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), giving information in relation to such points or matters as, in the opinion of the Assessing Officer, the Deputy Commissioner (Appeals), the Joint Commissioner or the Commissioner (Appeals), will be useful for, or relevant to, any enquiry or proceeding under this Act :“
34. In this regard, we find that the Mumbai ITAT in case of M/s Kiara Jewellery P.Ltd. (I.T.A.No.8109/Mum/2011), has directed the AO/ TPO to obtain the exact details of capacity utilization of comparable companies, if not available in public domain. The relevant extract of the aforesaid decision is as under:-
“11. Keeping in view the decision of the Tribunal in the case of Petro Araldite (P) Ltd (supra) laying down the guidelines on the issue of capacity utilization, we consider it appropriate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same directly from the concerned parties and to decide this issue afresh after giving assessee an opportunity of being heard.” (Emphasis Supplied)
35. Accordingly, we direct the TPO to exercise powers under section 133(6) of the Act to call for information on capacity utilization of the comparable companies such as —
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- Installed Capacity,
- Actual Production in Units,
- Break-up of Fixed Cost and Variable Cost;
- Segmental/ product wise information, if any.
36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly.
Respectfully following the above judgement, we also remit this issue to the lower authorities in above terms. Ground No. 6 (e) is allowed for statistical purposes.
34. Ground No.7 (a) & (b) – Not Providing Cash PLI/Depreciation Adjustment :
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para No.11 to 11.5 and the result mutatis mutandis shall apply to assessment year 2014-15.
35. Ground No.8 – TP Adjustment should be restricted to AEs Transactions :
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para No.12 and the result mutatis mutandis shall apply to assessment year 2014-15.
36. Ground No.9 is general in nature and does not require any adjudication.
37. Ground No.10 to 14 – Royalty Adjustment :
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para No.13 to 13.2 and the result mutatis mutandis shall apply to assessment year 2014-15.
38. Ground No.15 – Provision for Employee’s Long Term Benefit
A similar issue has been decided by us in assessee’s own case for the assessment year 2012-13 at para No.14 to 14.3 and the result mutatis mutandis shall apply to assessment year 2014-15.
39. Ground No.16 to 17- Miscellaneous Expenses
A similar issue has been decided by us in assessee’s own case for the assessment year 2013-14 at para No.4.7, which is reproduced as under:-
“4.7 We have heard rival submissions and perused the material on record. Majority of the expenses incurred by the assessee amounting to Rs.73,91,476 is incurred in villages very near to assessee’s manufacturing plant. It is the claim of the assessee that the workers and their family has benefitted from the above expenditure. This fact has also accepted by the CIT(A) by allowing as deduction 10% of the total expenditure. The amount of Rs.8,13,782, expended for promotion of Japanese language will also ultimately benefit the employees of the assessee. Taking the overall view and to put a quietus to the issue, we hold that 30% of the total expenditure would have benefitted the employees of the assessee-company. Accordingly, we allow a sum of Rs.22,17,441 out of the total expenditure of Rs.73,91,476. It is ordered accordingly.”
Respectfully following the above judgment, we also allow 30% of the total expenditure Rs.17,32,194/- (Rs.10519 + Rs.17,21,675/-) incurred by the assessee, which comes to Rs.5,19,658/-. Accordingly, this ground is partly allowed
40. Ground No.18 is not argued by the assessee, hence dismissed as not pressed.
41. Ground No.19 is consequential in nature.
42. In ground No. 6 (e) the assessee has sought for capacity utilization adjustment and Ground No. 7 (a) & (b) for providing Cash PLI/Depreciation adjustment , we note that while calculating these two adjustments the depreciation expenses has major role, therefore we direct to the lower authorities while calculating these adjustments (if granted to both) the assessee should not get double benefit of depreciation expenses adjustment.
43. In the result, the appeal of the assessee is partly allowed for statistical purposes.
44. In the combined results, both the appeals filed by the assessee are partly allowed for statistical purposes. A common order passed, be placed in respective case files.
Order pronounced in the open court on 2nd December, 2022.
