Addition on the on basis of allocation of indirect cost cannot be made to ALP if no actual expense been incurred

 ITAT PUNE BENCH ‘A’

Deputy Commissioner of Income-tax

versus

Bekaert Industries (P.) Ltd.

IT Appeal Nos. 1058 to 1060 and 1093 & 1094 (PN) OF 2011
[ASSESSMENT YEARS 2002-03 TO 2004-05]

JANUARY  31, 2013

ORDER

Per Bench

The first four cross appeals pertaining to A.Y. 2002-03 and 2003-04 and last appeal for A.Y. 2004-05, are filed by the assessee. The issues are almost common, so they are being disposed of by a common order for the sake of convenience.

2. First we take up ITA.No.1093/PN/2011 and 1098/PN/2011. These cross appeals are arising from the order of the CIT(A) for A.Y. 2002-03.

3. The Assessing Officer has added Rs. 50,32,752/- passed on the order of the TPO passed u/s.92CA(3) on 21.10.2004. The Assessing Officer in his assessment order dated 21.10.2004 has made addition of Rs. 50,32,752/- on the basis of order of TPO dated 25.10.2003. The TPO found that assessee M/s. Bekaert Industries Pvt. Ltd Pvt. Ltd., hereinafter called BIPL, was incorporated in 1996 as wholly owned subsidiary of N.V. Bekaert S.A. Belgium and was engaged in the manufacturing of Steel Tyre Cord and Hose Reinforcement Wire, used as a reinforcing material in radial tyres etc. The major purchasers in India are CEAT, J.K. Industries, MRF etc. These tyre manufacturing companies have been sourcing these materials from Bekaert group companies located outside India. In this background the parent company thought it prudent to establish a unit in India itself to meet the market requirement to the extent possible. The plant of the assessee was established at MIDC Ranjangaon Pune. Even though the commercial production started in February, 2001, the business of the assessee company practically took off from A.Y. 2004-05 onwards. The Bekaert Group head quartered at Belgium is the largest independent multi-national manufacturer of these products and have more than 55 manufacturing facilities worldwide. During the year under consideration, the assessee company was found to have numerous international transactions which were examined by the TPO for determining Arm’s Length Price (hereinafter called ALP). The TPO found most of the transactions at ALP requiring no adjustment except for

(a)          export of spools and

(b)          import of dies.

Out of the total adjustment of Rs. 50,32,752/- suggested by the TPO, Rs. 49,62,075/- was in respect of export of spools to various companies of this group worldwide and Rs. 70,676/- was for import of dies from China Bekaert Steel Cord Co. Both the above two adjustments being objected by the assessee which are being dealt in the following paras.

Adjustment in export price of spools:

4. The assessee claimed that spools are packaging material made of either steel or plastic on which the steel tyre cord is wound and packaged. These spools are reusable unless severely damaged. These are therefore, used for the supply of goods made by the assessee as well as other companies of this group engaged in manufacturing of similar products. It has been shown that the goods being manufactured by the assessee company are an import substitution and therefore, foreign group companies do supply similar products to the Indian consumers. During the year under consideration, supplies were made to Indian customers by N.V. Bekaert S.A. and China Bekaert Steel Cord Co. Ltd., China. As the spools are reusable and has no utility to the buyers, as a measure to increase the bottom line the local group companies, wherever possible, are involved in collection of empty spools for free from buyers for the packaging of their own products and its export in case the same are in excess of their requirement. It has been claimed that only cost of collection is required for these reusable spools. During the year, it was claimed that the assessee had exported spools to various group companies which were in excess of their own requirement. In doing so it has been claimed that the assessee company is charging cost plus 10% mark up. For determining the cost, only direct cost has been taken into account. The Assessing Officer/TPO observed that the major portion of the turnover in this year relates to export of spools (spools export turnover being nearly 50% of the total turnover) decided to also consider 25% of the indirect cost for determining ALP. The objections of the assessee that the method employed was incorrect because the spools were available to the assessee free of cost and only excess was exported with 10% mark up and the indirect expenses are not attributable to this incidental activity were not accepted by the Assessing Officer.

5. Matter was carried before the First Appellate Authority wherein detailed submissions were made from time to time. It was explained as to how different expenses constituting indirect cost expenses considered by TPO for calculating ALP should not have been considered. It has been claimed that the TPO has erred in allocating the expense on the basis of turnover as in the initial years the assessee was in the process of establishing and stabilizing its business. The majority of the expenses were towards this activity which got reflected in higher turnover in subsequent years. It was further submitted that the spools were mainly collected for its own use and only the excess was exported, that too with 10% mark up. In the initial years the export of spools was more than its own use as the production and business had not stabilized and gradually the consumption increased. The TPO, as per the assessee, had failed to consider the benefit accruing to the assessee on the free use of spools which otherwise would have costed Euro 5.32 per spool on import. According to the assessee no incremental overhead cost (other than direct cost charge) were incurred for the export activity considering the overall cost of the whole plant. As per assessee the spools collected do not undergo any process and therefore, all costs which are incurred are recovered from the customer with 10% margin. The overall activity of the company employed for this work is claimed to be minimal and negligible. The assessee subsequently also made their submission vide their letter dated 04.06.2010 wherein without prejudice to their claim of no adjustment, agreed to adoption of principle applied by the TPO in A.Y. 2004-05, claiming the same to be more judicious. In the said method the TPO had taken into consideration the entire economic activity for allocation of indirect expenses.

6. The assessee has given computation on the basis of principle adopted by the TPO in A.Y. 2004-05 without prejudice to their claim raised in the grounds. The said computation given in Annexure-3 of their letter dated 04.06.2010 and same is quoted below:

Working of upward adjustment in respect of export of spool on the basis of A.Y. 2004-05 addition.

7. Having considered the above referred grounds which lead to addition of Rs.49,62,075/- made by the Assessing Officer on the basis of the order of the TPO passed u/s.92CA(3) for export of spools, alongwith the rival submissions as are apparent from record, the CIT(A) found it correct that spools are reusable and have a considerable value and therefore the arrangement by which the assessee company gets the same free by only making expenses relating to cost of collection, is beneficial to the business of the assessee. The collection of spools, therefore is incidental but for the purpose of the business. The assessee is not involved in the process in an activity which is separate from the regular activity and the nature also is such for which it is difficult to accept that huge activities involving cost would be involved. The CIT(A) also observed that in initial years the assessee had lesser requirement of these spools as the business was in the process of being established and stabilized. It was also observed that the system of collecting these spools also had to be put in place and stabilized to ensure its supply on a sustained basis. In such a view of matter, the export of spools made in the initial years cannot be completely seen in isolation as an independent business activity demanding allocation of indirect expenses in the ratio of turnover. In view of the above as well as in consideration of the facts and circumstances of the case, the CIT(A) found that the system adopted by the TPO to allocate indirect expenses on the basis of turnover in initial assessment years was not correct. As against that, the claim of the assessee that no indirect expenses can be considered for determining the ALP of export of spools also looks incorrect because no activity can be carried out without any involvement of cost which are generally clubbed and classified as indirect expenses. Therefore, the CIT(A) observed that a method has to be found out which can lead to proper computation of ALP. In this context, the proposition of the assessee to adopt the system used by the TPO in A.Y. 2004-05 were found appropriate. In the said method, every economic activity was captured for allocating the expense and in view of the same, this method will give the most appropriate method for determining ALP, especially in years when the business has not stabilized. The computation given by the assessee is already quoted above and as per this the addition comes to Rs. 5,07,651/-. Accordingly, the addition to that extent be sustained by the CIT(A). However, the Assessing Officer was directed to check the computation while giving the appeal effect and ensure that the computation is made properly as per the principle laid by the TPO in A.Y. 2004-05. Accordingly, the addition to that extent was sustained. Same has been opposed by the Revenue vis-a-vis relief granted to the assessee and assessee has come in appeal vis-a-vis sustenance of the addition to the extent of Rs.5,07,651/-.

8. The Ld. Departmental Representative submitted that the CIT(A) erred in restricting the addition on account of upward adjustment to Arm’s Length Price u/s.92CA(3) in respect of export of spools from Rs. 50,32,752/- to Rs. 5,07,651/-. The CIT(A) grossly erred in adopting the calculation of Arm’s Length Price u/s.92CA(3) on the basis of principle adopted by the TPO for A.Y. 2004-05 without appreciating the facts that the business activities for A.Y. 2002-03 and A.Y. 2004-05 were not comparable. Accordingly he requested to sustain the order of the Assessing Officer.

9. On the other hand, Ld. Authorised Representative submitted that the spools in question are reusable unless severely damaged. These are used for supply of goods made by the assessee as well as other companies of this group engaged in manufacturing of similar products. This item is an import substitution. During the year under consideration, supplies were made to Indian customers by NV Bekaert SA and others. As spools are reusable and has no utility to the buyer as a measure to increase the bottom line economy of the local group companies, wherever possible assessee involved in collection of empty spools free from buyers for packaging their own product and its export in case same were in excess of their requirement. It has been claimed that only cost of collection is required for these reusable spools. Assessee has claimed to have exported spools to various group companies which were in excess of their own requirement. In doing so, it has claimed that assessee is charging cost plus 10% mark up. For determining the cost only indirect cost has been taken into account. According to the assessee, the method employed by the TPO was incorrect because spools were available to assessee free of cost and only excess was exported with 10% mark up and indirect expenses are not attributable to this incidental activity. Accordingly no adjustment is called for.

10. After going through the above material and submissions, we find that addition of Rs. 49,62,075/- made by the Assessing Officer on the basis of order of the TPO passed u/s.92CA(3) for export of spools. The assessee was incorporated in 1996 as wholly owned subsidiary of N.V. Bekaert S.A. Belgium and was engaged in the manufacturing of Steel Tyre Cord and Hose Reinforcement Wire, used as a reinforcing material in radial tyres etc. The major purchasers in India are CEAT, J.K. Industries, MRF etc. These tyre manufacturing companies had been sourcing these materials from Bekaert group companies located outside India. In this background, the assessee company thought it prudent to establish a unit in India itself to meet the market requirement to the extent possible. Accordingly, plant was established at MIDC Ranjangaon Pune. Spools are packaging material made of either steel or plastic on which the steel tyre cord is wound and packaged. These spools are reusable. These were used for the supply of goods made by the assessee as well as other companies of this group engaged in manufacturing of similar products. The goods being manufactured by the assessee company are an import substitution and therefore, foreign group companies do supply similar products to the Indian consumers. As the spools are reusable and has no utility to the buyers, as a measure to benefit local group companies, wherever possible, are involved in collection of empty spools for free from buyers for the packaging of their own products and its export in case the same are in excess of their requirement. The Assessing Officer made the addition on the basis of the order of the TPO u/s.92CA(3) of the Act on export of spools. Spools are reusable and have a considerable value and therefore the arrangement by which the assessee company gets the same free by only making expenses relating to cost of collection, is beneficial to the business of the assessee. The collection of spools, therefore is incidental but for the purpose of the business. The assessee has not involved in the process in an activity which is separate from the regular activity. There is nothing on record to suggest that huge activities involving cost would be involved. In the initial years the assessee had lesser requirement of these spools as the business was in the process of being established and stabilized. The system of collecting these spools also had to be put in place and stabilized to ensure its supply on a sustained basis. The system adopted by the TPO to allocate indirect expenses on the basis of turnover in initial assessment years was not justified. There is nothing on record to suggest any indirect expenses for determining the ALP of export of spools. However, no such adjustments were made by the TPO in A.Y. 2004-05. Accordingly, the CIT(A) was not justified in restricting the addition to Rs. 5,07,651/- as there was no element of indirect cost involved.

11. The next issue is with regard to the addition of Rs. 70,676/- made by the Assessing Officer on the basis of the report of the TPO for import of dies from AE. In addition to the export of spools, TPO also, in his order passed u/s.92CA(3), asked for downward revision of import cost on the basis of principle of ALP. It was found by the TPO that the assessee imported dies of Rs. 6,59,634/- from Bekaert China and of Rs.1,00,614/- from Bekaert Belgium. After considering the details relating to the said transaction, the TPO came to the conclusion that the margin of 12% applied on the cost of die was in contravention to the stated policy of the Chinese company and considering the same the TPO held that the ALP of the imported Chinese die would be of Rs. 5,88,958/- and, therefore, an addition of Rs.76,676/- was made, which was objected on behalf of the assessee stating that the Chinese company had imported the dies from group company and the pricing pattern for dies covers direct cost and margins for overhead expenses and for this 12% margin has been charged. The CIT(A) having considered the facts and circumstances involved, did not find merit in the submission of the assessee and the finding of the TPO was found to be in accordance with the established Transfer Pricing principles. In view of above, the addition was sustained by the CIT(A). This reasoned finding need no interference from our side. We uphold the same.

12. As a result, appeal of Revenue is dismissed and that of the assessee is partly allowed.

13. In ITA.No.1094/PN/2011 and 1059/PN/2011 for A.Y. 2003-04, similar issue of addition on account upward adjustment to ALP u/s.92CA(3) of the Act in respect of export of spools has been raised. The Assessing Officer made addition of Rs. 62,83,591/- which was restricted to Rs. 5,20,372/- by the CIT(A). We have discussed and decided similar issue in A.Y. 2002-03 vide para 10 of this order. Facts being similar, so following same reasoning, we uphold that the CIT(A) was not justified in restricting the addition to Rs. 5,20,372/- from Rs. 62,83,591/-. The Assessing Officer is directed accordingly.

14. As a result, appeal of the Revenue is dismissed and that of the assessee is allowed.

15. In ITA.No.1060/PN/2011, the appeal has been filed by the assessee against the order of the CIT(A). In the year under consideration also additions were made to the tune of Rs.1,04,55,037/- which was restricted by the CIT(A) to Rs. 5,67,248/-. Revenue has not filed any appeal against relief granted to the assessee. However, Ld. Authorised Representative has filed an appeal against restricting of transfer pricing addition of Rs. 5,67,248/- in respect of international transaction of export of spools out of total addition of Rs. 1,04,55,037/- made by the Assessing Officer. The Ld. Authorised Representative again submitted that the CIT(A) was not justified in holding that some element of indirect expenses incurred by the assessee was attributable to activity of export of spools to Associate Enterprises. Hence, as a consequence, he erred in holding that mark up of 10% should have been levied by considering certain portion of indirect cost incurred by the assessee company. It was further submitted that the CIT(A) erred in not appreciating the various indirect expenses like water charges, communication, rent, sale commission, travelling, office expenses, conveyance, printing, stationery, bank charges and other expenses. It was also submitted that export of spools is secondary and ancillary activity of the assessee company. Assessee company is not owner of spools exported. Associate Enterprises have allowed assessee company to use the spools collected from Associate Enterprise customers for packaging assessee’s company’s own manufactured product for which no charges were levied by the Associate Enterprises. Hence, when assessee company had charged a mark up of 10% on direct cost incurred by it for collection of spools idnciate that assessee’s transaction of export of spools was at ALP. Only the excess spools collected which was not used by assessee were exported in fact price charged by the assessee company for collecting and exporting spools plus 10% mark up is justified. On the other hand, Ld. Departmental Representative supported the order of the CIT(A).

16. After going through the above submissions and material on record, we find undisputed that Associate Enterprises has allowed assessee company to use spools collected from Associate Enterprise customers for packaging assessee’s company’s own manufacturing product for which no charge was levied by Associate Enterprise. Export of spools is secondary and ancillary activity of the assessee company. Assessee company is not the owner of the spools exported. In facts and circumstances, assessee company was justified in exporting spools with 10% mark up. Accordingly, sustaining addition made in respect of export of spools of Rs.5,67,248/- u/s.92CA(3) of the Act is not justified. Same is directed to be deleted. As a result, appeal filed by the assessee is allowed.

17. In the result, Revenue’s appeals in A.Y. 2002-03 and 2003-04 are dismissed, whereas assessee’s appeal for A.Y. 2002-03 is partly allowed, whereas assessee’s appeal for A.Y. 2003-04 and 2004-05 are allowed as indicated.

NF