Case Law Details
Brief of the Case
ITAT Ahmedabad held In the case of Micro Ink Limited. Vs. ACIT that such interest is includible in operating income and the operating income itself has been accepted as reasonable under method TNMM, there cannot be an occasion to make adjustment for notional interest on delayed realization of debtors. The very conceptual foundation, for separate adjustment for delayed realization of debtors and on the facts of this case, is thus devoid of legally sustainable merits. An adjustment for notional interest on excess credit allowed on sales to AEs will vitiate the picture, inasmuch as what has already been factored in the TNMM analysis, by taking operating profit figure which incorporate financial impact of the excess credit period allowed, will be adjusted again separately as well.
Facts of the Case
ALP Adjustment on account of excess credit period
The assessee is a leading ink manufacturer in India. The assessee has a wholly owned subsidiary in Austria, by the name of Micro Inks GmbH which, in turn, owns Micro Ink Co USA. This step down subsidiary manufactures printing ink by using the base material supplied by the assessee. The inks meant for US markets thus are mixed, and given finishing touches, by Micro USA. The assessee company also has trading subsidiaries in China and Hong Kong. During the relevant previous year, the assessee sold goods worth Rs 215.51 crores to Micro USA. The Transfer Pricing Officer, in the course of proceedings before the TPO, it was noted that the assessee has sold goods worth Rs 215.51 crore to Micro USA and allowed it an average credit period of 186 days as against average credit period of 130 days allowed to independent enterprises, i.e. non AEs.
It was also noted that out of total exports made by the assessee, 45% exports was to Micro USA. On these facts, and the TPO being of the view that “in a third party situation, such an allowance of use of money would have been possible only upon charge of a cost”, the TPO required the assessee to show cause as to why ALP adjustment in respect of excess credit period of 56 days not be made, by computing time value of money @ 6.38% on LIBOR plus basis. In response to this show cause notice, it was, inter alia, explained by the assessee that what is exported to Micro USA is semi finished material which is required to be further processed and converted into saleable product. In effect thus, export to Micro USA cannot be compared with export of finished products as was done to the independent enterprises. On the basis of these arguments, it was submitted that no ALP adjustment is warranted in respect of, what was termed as, ‘excess credit period’ allowed to the Micro Ink USA.
None of these submissions were accepted by the TPO. He was of the view that, taking 130 days as permissible interest free credit period, interest @6.38% should have been charged on the excess credit period of 56 (i.e. 186-130) days. An amount of Rs 2,10,95,346, computed on this basis, was proposed to be added to the income of the assessee as an arm’s length price adjustment. The assessee did raise a grievance, against this ALP adjustment, before the DRP but without any success. The Assessing Officer, therefore, proceeded to make the addition of Rs 2,10,95,346.
ALP adjustment on account of Corporate Guarantee
During the course of the proceedings before the Transfer Pricing Officer, it was noted that the assessee has issue various corporate guarantees on behalf of its associated enterprises, i.e. subsidiaries. It was also noted that guarantees were issued without charging the AEs any consideration for the same. The stand of the assessee was that these guarantees did not cost assessee anything nor any charges were recovered for the same, and that the “said guarantees were in the form of corporate guarantees/ quasi capital and not in the nature of any services”. The TPO, however, proceeded to compute arm’s length price for these guarantees @ 2%.
An ALP adjustment of Rs 2,23,62,603 was proposed on account of notional charges for corporate guarantees issued by the assessee. The assessee did raise an objection against this proposed adjustment by the TPO but without any success. While rejecting the grievance of the assessee, learned DRP referred to, and relied upon, ‘OECD Transfer Pricing Guidelines for Multinational Enterprise and Tax Administrations’, ‘OECD Report on Attribution of Profits to Permanent Establishments’ and decision of the Tax Court of Canada in the case of G E Capital Canada Vs Her Majesty the Queen [(2009) TCC 563]. The Assessing Officer thus proceeded to make the arm’s length price adjustment in respect of corporate guarantees at Rs 2,23,62,603.
Addition on account of software expense
During the course of assessment proceedings, the Assessing Officer noted that the assessee had debited Rs.11,86,371 towards professional fees for implementation of SAP software, user license (for SAP software) and user license for other software. When the Assessing Officer required the assessee to show cause as to why this expenditure not be treated as capital expenditure, the assessee submitted that the expenses incurred on implementing the SAP software is mainly increasing the efficiency of the assessee- company so far as the financial results are concerned. It was also submission that these expenses do not give enduring benefit and frequent updating of software required. The Assessing Officer, however, did not agree with any of the arguments and proceeded to treat the same as capital expenditure. The benefit of the additional depreciation was, nonetheless, allowed. The total deprecation thus allowed was Rs.67,41,569/-. In effect, a disallowance of Rs.51,22,143/- was made to the total income of the assessee. Aggrieved, the assessee did raise grievance before the DRP but without any success.
Contention of the Assessee
ALP Adjustment on account of excess credit period
The ld counsel of the assessee submits that the issue being squarely covered, in favour of the assessee by a decision of the coordinate bench in assessee’s own case for the assessment year 2002-03 [reported as Micro Inks Ltd Vs ACIT [(2013)144 ITD 610 (Ahd)] and on admittedly similar set of facts, there is no occasion to reconsider the mater.
ALP adjustment on account of Corporate Guarantee
The ld counsel of the assessee submitted that the transaction of issuance of a corporate guarantee, in favour of an AE, does not constitute an ‘international transaction’ within the meanings of Section 92 B of the Act. Our attention is invited to the transfer pricing report which categorically states that the “guarantees issued by the assessee are said to be in the form of corporate guarantees/ quasi capital and not in the nature of services” and that, accordingly, “these transactions are not considered as international transactions”.
He further relied on a decision of a coordinate bench of this Tribunal, in the case of Bharti Airtel Limited Vs ACIT [(2014}63 SOT 113 (Del)] which categorically holds that corporate guarantee issued for benefit of AE, not involving any costs to assessee and not having any bearing on profits, income, losses or assets of enterprise, are required to be kept outside ambit of ‘international transaction’. Learned counsel then takes us through a number of decisions of the coordinate benches following the same proposition, including the decisions in the cases of Redington India Limited Vs ACIT [(2014) 49 taxmann.com 146] (Chennai)],Redington India Ltd Vs JCIT [(2015) 61 taxmann.com 312 (Chennai)], Videocon Industries Ltd Vs ACIT [(2015) 55 taxmann.com 263 (Mum)].
He further submitted that any amendment in the transfer pricing law, which is more onerous in nature, cannot have retrospective effect. He relied on certain observations in Hon’ble Supreme Court’s judgment in the case of CIT Vs Vatika Townships Pvt Ltd [(2014) 367 ITR 466 (SC)] and relianced is placed on the same for presumption in favour of laws being prospective in nature.
Contention of the Revenue
ALP Adjustment on account of excess credit period
The ld counsel of the revenue submitted that the aforesaid decision is “severely flawed” as no matter what is the goods sold, “a credit period is a credit period”. It is also submitted that “the credit period for sale of raw material to an independent manufacturer would be lower as the supplier does not have to factor the lead time for the sale of finished goods by the manufacturer” and that “the supplier is entitled to receipt of payment immediately on delivery irrespective of whether the finished goods is sold in the market, get spoiled in manufacturing or is damaged”. He further submits that “it is by now acknowledged that granting of excess credit period is a service rendered to the AE and needs to be benchmarked”.
A reference is then made to Special Bench decision in the case of Aztec Software & Technology Services Pvt Ltd Vs ACIT [(2007) 107 ITD SB 141 (Bang)] in support of the proposition that merely by finding fault in the work done by the TPO, the adjustments cannot be deleted and that unless the ALP submitted by the taxpayer is specifically accepted, the appellate authorities, on the basis of material available on record have to determine ALP themselves.
ALP adjustment on account of Corporate Guarantee.
The ld counsel of the revenue submitted that in the case of Everest Kanto Cylinders Limited Vs DCIT [(2012) 34taxman.com 19 (Mum)], has observed that, “So far as the learned Senior Counsel’s contention that guarantee commission is not an international transaction and there could not be any method for evaluating the ALP for the guarantee commission, we do not find any merit in the said contention in view of the amendment brought by the Finance Act, 2012 with retrospective effect from 1-42002 by way of Explanation added in Section 92B. Payment of guarantee fee is included in the expression ‘international transaction’ in view of the Explanation i(c) of Section 92B”. It is then submitted that this decision of the Tribunal has been approved by Hon’ble Bombay High Court in the judgment reported as CIT Vs Everest Kanto Cylinders Limited [(2015) 119 DTR 394 (Bom)].
He further submitted that “Hon’ble Delhi ITAT was not requested by the contesting parties to decide the issue as to whether the provision of guarantee was a service or not” and added that “various Tribunal decisions have already held that provision for bank guarantee is a service and as such it needs to be benchmarked” and that “whether the service has caused any extra cost to the assessee should not be the deciding factor to determine whether it is an international transaction”. He then gave an example of brand royalty to illustrate the above proposition. On the basis of this reasoning, learned Departmental Representative urged us to confirm the action of the Assessing Officer and decline to interfere in the matter.
Held by ITAT
ALP Adjustment on account of excess credit period
We find that this issue is covered, in favour of the assessee, by a decision of the coordinate bench in assessee’s own case for the assessment year 2002-03 [reported as Micro Inks Ltd Vs ACIT [(2013)144 ITD 610 (Ahd)]. In this case it was held that the credit period for finished goods cannot be compared with credit period for unfinished goods and raw materials, and in any case, when products are not the same, there cannot be any question of prices being the same. Unless the prices of the product and the product are the same, and yet extra credit period is allowed, there cannot be any occasion for making ALP adjustment on the basis of the excess credit period. None of the authorities below have even disputed that the ingredients, raw materials and semi finished goods sold to Micro USA are not sold to any other concern. The very foundation of impugned addition in arm’s length price on account of excess credit period is thus devoid of any legally sustainable merits or factual basis.
We find that, as evident from audit report on form 3CEB the arm’s length price of exports to the AEs, including Micro USA, has been determined on the basis of the transactional net margin method (TNMM).
By way of a note, it is specifically stated that “further, the said amount of Rs 2428.26 millions has also been determined/ computed by the assessee having regard to the arm’s length price on application of Transactional Net Margin Method (TNMM), on aggregation of transactions, as prescribed under section 92C. In this backdrop, we can usefully refer to the decision of Hon’ble Delhi High Court, in the case of Sony Ericsson Mobile Corporation Pvt Ltd Vs ACIT [(2015) 374 ITR 118(Del)] held that “Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction,”
By the same logic, even making an adjustment for interest on excess credit allowed on sales to AEs will vitiate the picture, inasmuch as what has already been factored in the TNMM analysis, by taking operating profit figure which incorporate financial impact of the excess credit period allowed, will be adjusted again separately as well. In the case of Nirma Industries Limited Vs DCIT [(2006) 283 ITR 402 (Guj)], Hon’ble High Court has dealing with the nature of interest on debtors, held it to be integral to business income. The same is the principle for the transfer pricing cases to that extent interest is to be taken as integral to sale proceeds, and, as such, includible in operating income. When such an interest is includible in operating income and the operating income itself has been accepted as reasonable under the TNMM, there cannot be an occasion to make adjustment for notional interest on delayed realization of debtors. One can understand separate adjustment for excess credit period when the arm’s length price for exports has been benchmarked on the CUP basis but not in a case when the arm’s length price of the exports has been benchmarked on the basis of TNMM. The very conceptual foundation, for separate adjustment for delayed realization of debtors and on the facts of this case, is thus devoid of legally sustainable merits.
In the present case, it is an undisputed position that semi finished goods, as sold to Micro USA, is not sold to any other independent enterprises. The assessee did have trading transactions in respect of the finished goods with trading subsidiaries in China and Hong Kong but it is not even the case of the TPO that excessive credit period was allowed to these AEs vis-à-vis the credit period allowed to independent enterprises, nor any ALP adjustment has been recommended in connection with the same. This fact, if anything, shows that the credit period allowed to the AEs is comparable with credit period of non AEs in respect of similar goods. To compare credit period in respect of finished goods with the credit period in respect of semi-finished goods, is, therefore, somewhat fallacious in approach and untenable in law.
In our considered view, merely because there is a delay in realization of debts cannot be reason enough to make an addition as long as such a delay is peculiar to the transactions with AEs. The adjustment before us is an adjustment to arrive at an arm’s length price and unless there is something, more than sweeping generalizations as implicit in the arguments before us, to at least indicate that such a delay in realization of debts in similar transactions is absent in arm’s length transactions, these adjustments cannot be made even when sales are benchmarked on CUP basis. The delay in realization of debts, resulting in a continuing debit balance, is not a standalone international transaction per se, but is a result of the international transaction as it only reflects that the related payment has not been made by the debtor.
The international transaction is exports of goods which been benchmarked on TNMM basis and which is duly accepted by the TPO. In view of these discussions, and respectfully following the decision of the coordinate bench in assessee’s own case for the earlier years, we uphold the grievance of the assessee and direct the Assessing Officer to delete the impugned ALP adjustment of Rs 2,10,95,346.
ALP adjustment on account of Corporate Guarantee
It is only elementary that the determination of arm’s length price, under the scheme of the international transfer pricing set out in the Income Tax Act, 1961, can only be done in respect of an ‘international transaction’. Section 92(1) provides that, “(a)ny income arising from an international transaction shall be computed having regard to the arm’s length price”. In order to attract the arm’s length price adjustment, therefore, a transaction has to be an ‘international transaction’ first. The expression ‘international transaction’ is a defined expression.
In the present case, we have held that the issuance of corporate guarantees were in the nature of shareholder activities- as was the uncontroverted claim of the assessee, and, as such, could not be included in the ‘provision for services’ under the definition of ‘international transaction’ under section 92 B of the Act. We have also held, taking note of the insertion of Explanation to Section 92B of the Act, that the issuance of corporate guarantees is covered by the residuary clause of the definition under section 92 B of the Act but since such issuance of corporate guarantees, on the facts of the present case, did not have “bearing on profits, income, losses or assets”, it did not constitute an international transaction, under section 92B, in respect of which an arm’s length price adjustment can be made. In this view of the matter, and for both these independent reasons, we have to delete the impugned ALP adjustment.
Suggested way forward to deal such kind of cases
We must add that, in our considered view, the way forward, to avoid such issues being litigated and to ensure satisfactorily resolution of these disputes, must include a clear and unambiguous legislative guidance on the transfer pricing implications of the corporate guarantees as also on the methodology of determining its ALP, if necessary. Of course, no matter how good is the legislative framework, the importance of a very comprehensive analysis, in the transfer pricing study, of the nature of corporate guarantees issued by the assesses, can never be overemphasized. The sweeping generalizations, vague statements and evasive approach in the transfer pricing study reports, which are quite common in most of the transfer pricing reports, cannot do good to a reasonable cause. When judicial calls on the complex transfer pricing issues are to be taken, utmost clarity in the legislative framework and a comprehensive analysis of relevant facts, in the transfer pricing documentation, are basic inputs. Unfortunately, both of these things leave a lot to be desired. We can only hope, and we do hope, that things will change for better.
Addition on account of software expense
Having heard the rival contentions and having perused the material on record, we see no reasons to interfere in the matter. The reason is this. Learned counsel for the assessee has primarily relied upon the decision of Hon’ble jurisdictional High Court in the case of CIT Vs NJ India Invest Pvt Ltd [(2013) 32 taxmann.com 367 (Guj)] but then that is hardly of any assistance because that was a case in which the expenditure was incurred in the “nature of maintenance, back up and support service to the existing hardware and software already installed by the company for the purpose of its business” and not on the new software per se. The situation before us is materially different. This is a case when ERP has been introduced for the first time and the expenditure is not in the support or maintenance of the existing software. We, therefore, approve the stand of the authorities below on this point and decline to interfere in the matter.
Accordingly, appeal of the assessee partly allowed.
