AO cannot make Transfer Pricing adjustment unless recommended by TPO

IN THE ITAT CHENNAI BENCH ‘A’

Assistant Commissioner of Income-tax

Versus

Handy Waterbase India (P.) Ltd.

IT APPEAL NO. 1429 (MDs.) OF 2012

C.O. NO. 147 (MDs.) OF 2012

[ASSESSMENT YEAR 2007-08]

SEPTEMBER 18, 2012

ORDER

Abraham P. George, Accountant Member – These are appeal and cross-objection of the Revenue and assessee respectively, against an order dated 15.3.2012 of Commissioner of Income Tax (Appeals)-XII, Chennai, for the impugned assessment year.

2. Appeal of the Revenue is taken up first for disposal.

3. Sole grievance raised by the Revenue is that CIT(Appeals) deleted an addition of Rs. 5.52 Crores made for difference in arm’s length price by the Assessing Officer. As per the Revenue, the Assessing Officer had not made such an addition based on Section 92(3) of Income-tax Act, 1961 (in short ‘the Act’) but had, on the other hand, applied Section 10B read with Section 80-IA(10) of the Act for such addition. Further, as per the Revenue, Assessing Officer had restricted the exemption claimed under Section 10B, by such amount and included it as income under the head “income from other sources” rightly.

4. Facts apropos are that assessee had filed its return of income for the impugned assessment year on 19.10.2007 declaring an income of Rs. 35,93,390/-. Assessee was engaged in sale and export of pasteurized crab meat. During the course of assessment proceedings, it was noted by the Assessing Officer that assessee had entered in international transactions with its Associate Enterprise for a sum exceeding Rs. 15 Crores. Assessing Officer referred it to Transfer Pricing Officer (TPO) for determination of the arm’s length price.

5. TPO vide his order dated 2.7.2010 fixed the arm’s length price of the sales effected by the assessee to its Associate Enterprise at Rs. 18,79,25,631/-. Sale price shown in the books by the assessee, for its sales to the Associate Enterprise was Rs. 24,32,24,499/-. In other words, the profit level indicated by the assessee was much higher than the one determined by the TPO based on comparables. Net margin indicated by the assessee was 44.08%, whereas, the one determined by the TPO was 21.66%. Assessing Officer was of the opinion that receipts of the assessee from its sales to the Associate Enterprise was in excess of the arm’s length price and such excess was nothing but income from other sources. The difference came to Rs. 5,52,98,818/- .

6. Though a draft assessment order in the above lines was given to the assessee, it exercised its option for filing an appeal against the assessment order and did not opt to move the Dispute Resolution Panel (DRP). Accordingly, assessment was completed on the lines of the draft assessment order. In such assessment order, Assessing Officer considered the sum of Rs. 5,52,98,818/- as income from other sources, as mentioned above. Further, for calculating the deduction under Section 10B of the Act, Assessing Officer applied the formula mentioned hereunder:-

Nevertheless, while taking the export turnover, Assessing Officer considered the turnover based on arm’s length price. In other words, he excluded the sum of Rs. 5,52,98,818/- from the sale price accounted by the assessee, taking it as excess price received it from its Associate Enterprise. However, similar exclusion was not made from the total turnover.

7. Assessee moved in appeal before CIT(Appeals) wherein its sole objection was on the addition of Rs. 5,52,98,818/- made under the head “income from other sources”. As per the assessee, actual sale price for the international transactions with its Associate Enterprise was much higher than the arm’s length price determined by the TPO and therefore, there was no requirement of any adjustment to be made in the value of the international transactions. Assessee further submitted that it was a 100% export oriented unit and its entire sales were made to its Associate Enterprise only. TPO had adopted Transaction Net Margin Method (TNMM) for determining ALP and such TNMM resulted in a lower value than what was actually received by the assessee. TPO had not proposed any adjustment in her order for variation based on the ALP. As per the assessee, when the ALP of the sales, determined by the TPO was lesser than the actual sale value, provisions of Section 92C(3) would apply and income computed on the basis of entries in the books alone could be considered.

8. CIT(Appeals) was appreciative of the contentions of the assessee. According to him, if the ALP as determined by the TPO, was taken as the sale value it would result in the income of the assessee getting reduced. Therefore, Section 92(3) of the Act squarely applied. According to him, TPO herself did not propose any adjustment. He. therefore, held that addition was not warranted and deleted the addition made by the A.O.

9. Before us, learned D.R. strongly assailing the order of CIT(Appeals), reiterated the grounds taken in the appeal filed by the Revenue. According to him, the addition was made relying on Section 10B(7) read along with Section 80-IA(8) and 80-IA(10) and this was nothing but a type of adjustment carried out to arm’s length price. Assessee had shown excessive receipt for the sales effected to its Associate Enterprise and thereby claimed excessive deduction under Section 10B of the Act. A.O. had rightly considered such excess amount as “income from other sources”.

10. Per contra, learned A.R. supported the order of CIT(Appeals).

11. We have perused the orders and heard the rival submissions. Assessing Officer had, during the course of assessment proceedings, made a reference to TPO for determination of arm’s length price for the international transactions entered by the assessee with its Associate Enterprise. TPO had issued a notice to the assessee and assessee had submitted details called for by the TPO. Based on the submissions of the assessee, TPO framed an order. Pertinent parts of the order of the TPO are reproduced hereunder:-

“3. Background of the company: Handy Water Base India Pvt. Ltd. (HWIPL) is equity joint venture project of M/s Towerebase Services Pvt. Ltd. and M/s Handy International In the case of. Handy Waterbase India Pvt. Ltd. was incorporated in 2003 as a Pvt. Ltd. Company under the Companies Act, 1956. This company is a 100% EOU and belongs to the seafood category. This company is engaged in the production and sale of pasteurized crab meat.

4. During the previous year 2006-07, the company has entered into the following International transactions with its AE.

5. Method Adopted :

The assessee has adopted Cost Plus method to derive the Arms Length Price of its international transactions. The assessee has given two comparable companies whose percentage of gross margin to sales is 10.44% and 32.87% with an arithmetic mean of 21.66% as against the gross margin on sales for the assessee company at 44.08%. On an independent search made in Prowess six comparable companies were identified and the gross margin to sales of the comparable companies ranges between 10.56% to 33.50% with an arithmetic mean of 22.23%. The PLI working by both assessee as well as by the TPO indicates that the assessee’s gross margin to sale is much higher than that of the arithmetic mean of PLI of comparables.

6. During the course of hearing the following anomalies are noticed. In form 3CEB the value of export of pasteurized crab meat is shown as received Rs. 20,47,34,304/- and receivable Rs. 8,28,29,236. Whereas in the TP document the value is shown at Rs. 24,32,24,499/-. On going through the copy of the ledger account of the Associate Enterprise and the statement showing the list of sales invoices raised on AE during the year and the amount shown as export sales in the P & L account (being 100% exports made to AE only) it is ascertained that the value shown in the Form 3CEB indicates the ledger balances and not the value of sales transaction entered with the AE during the year and that the value of export made to AE during the year is Rs. 24,32,25,499/-only.

7. Since the arithmetic mean of the PLI of the comparable companies as stated by the assessee company itself vide Appendix 10.5 of its TP document is 21.66% as against its own PLI of 44.08% the arm’s length price of the value of export of pasteurized crab meat to its AE is worked out at Rs. 18,79,25,631/- as per the calculations given below:-

 The ALP value of International transactions entered into by the assessee company with its AE is as follows:

8. It is hereby clarified that the findings and discussions made in this order are applicable only in respect of reference received for Assessment Year 2007-08 and not for any other Assessment Year.”

12. A reading of the above reproduced order of the TPO will clearly show that the prices at which assessee sold its products to its Associate Enterprise were much higher than the arm’s length price fixed by the TPO. Sales, as per the books, effected by the assessee to its Associate Enterprise came to Rs. 24,26,80,083/- , whereas, the arm’s length price was Rs. 18,79,25,631/- only. There is nothing whatsoever in the order of TPO which required or recommended any adjustment to the value of the international transactions. TPO did not deem it necessary to effect any revision of the sales price as shown by the assessee in its books. Such a recommendation was not made since substituting the sale price shown by the assessee with arm’s length price determined, would have resulted in the income getting reduced. By virtue of Section 92(3) of the Act, which is reproduced hereunder, such a reduction in income is not possible:-

“92(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into.”

13. A determination of arm’s length price if it has the effect of reducing the income chargeable to tax or increasing the loss as the case may be, has to be ignored on an application of Section 92(3). There being no recommendation by the TPO for any revision in the arm’s length price, we are of the opinion that A.O. was not at all required to make any adjustment in the arm’s length price. Coming to the aspect whether a part of the receipt on account of sales effected to Associate Enterprise could be considered under the head “Income from other sources”, we are afraid we cannot agree to this proposition of the learned D.R. If the price at which assessee sold its products to the Associate Enterprise was compared to the arm’s length price, no doubt, such sales had fetched the assessee a higher amount. Such excess received if it can be considered so, was Rs. 5,52,98,818/-. However, the receipt was admittedly against sales and in the course of the business of the assessee. As a natural corollary, it would be a part of business receipts and not income from other sources. The question whether Assessing Officer could deny the deduction claimed by the assessee under Section 10B of the Act, for the profits in excess of arm’s length price, by invoking provisions of Section 10B(7) read alongwith Section 80-I(8) and 80-I(10) of the Act, had come up before this Tribunal in the case of Tweezerman (India) (P.) Ltd. v. Addl. CIT [2010] 133 TTJ 308 (Chennai) where it was held as under:-

“We have considered the rival submissions. A perusal of the order of the TPO for the relevant assessment year shows that the TPO has verified the ALP and has confirmed that no adjustment on account of transfer pricing was required to be made. The provisions of transfer pricing relate to international transactions between two or more AEs. The intention of the provisions of transfer pricing is to see to it that when international transactions are done between two or more AEs, the affairs of the enterprises are not adjusted in such a manner as to deprive the country or the local AE of the correct revenue, which would result in the reduction of the taxable income of the local AE in the country. In the present case, undisputedly, the TPO has confirmed that the local AE being the assessee herein has received the revenue due to it and there is no adjustment made in the affairs of the AE so as to deprive the revenues of the assessee in the country. Reading of the provisions of s. 10B shows that the deduction of the profits and gains derived by the assessee from 100 per cent export-oriented undertaking is granted. The provisions of s. 10B(7) provide for the applicability of the provisions of s. 80-IA (10) and sub-s. (8) when computing the profits and gains of 100 per cent export oriented undertaking. The provisions of sub-s. (10) of s. 80-IA which have been invoked in the present case provide that if the AO is of the opinion that owing to the connection between the assessee carrying on the eligible business with another person the business between them is so arranged so that as a result of the business transacted between the eligible person and other person, the profit of the eligible person is inflated so as to claim the exemption provided, then the AO, while computing the profits and gains of the eligible business for the purpose of granting deduction can readjust the amount of profit as would reasonably be derived from such eligible business. Here, in the present case the TPO has categorically given a finding that the income of the assessee is at the arm’s length. One must keep in mind that the intention of transfer pricing is also on similar lines as s. 80-IA(10) insofar as under the provisions of transfer pricing it is to verify as to whether the local AE is getting its right share of revenue and as per s. 80-IA(10), it is to verify and adjust the profits of an eligible business so that under the garb of the eligible business the taxable income of an AE is not reduced by shifting its income to the eligible business. However, he has given a further fact in his order that the profit level indicator of the assessee is higher than the mean of the profit level indicator of the comparable cases. The assessee has been right from the beginning claiming that M/s Rahul Electricals & Electronics, which showed a low ratio of profit before tax to sales was not a comparable. This has not been refuted by either the TPO or the AO. In fact, with the comparable, which the assessee itself is pointing out being a sister-concern of the assessee showed the ratio of the PBT to sales at 90.1 per cent, if M/s Rahul Electricals & Electronics is being considered as comparable and had shown a PBT to sales at 7.3 per cent, has the TPO taken any action under transfer pricing against M/s Rahul Electricals & Electronics has also not been placed before us. This is because, afterall the assessee-company is showing a higher margin and complying with the intention of the transfer pricing policy in the country, whereas the comparable which has been taken by the TPO and the AO showed a far lower margin than even the mean of the profit level indicator of the so-called comparables. At the time of hearing, the learned Departmental Representative was vehemently of the view that the transfer pricing action by the TPO at the behest of the AO was a separate proceeding and the AO while completing the assessment by invoking the provisions of s. 10B(7) r/w s. 80-IA(10) was doing an independent action though using the evidence and documents which had been submitted before the TPO. Even if this submission of the learned Departmental Representative is accepted, then it becomes incumbent upon the AO to specify as to why he feels that the profits disclosed by the assessee are higher than the ordinary profits which might be expected to arise in the assessee’s business. The provisions of s. 80-IA(10) do not give an arbitrary power to the AO to fix the profits of the assessee. The AO has to specify as to why he feels that the profits of the assessee are being shown at a higher figure, which he has done by alleging the close proximity between the assessee and the USA company with whom the assessee is transacting. He has further to show as to how he has computed the ordinary profits which he deems to be the ordinary profits which the assessee might be expected to generate. Here, the AO failed insofar as he has blindly taken a calculation which the assessee has given before the TPO which the assessee himself has admitted to be erroneous and the errors have been corrected and the fresh calculation given. This calculation is also not a calculation for determining the ordinary profits which the assessee might be expected to generate. The AO would be expected to use a comparable case to determine the possible ordinary profit which the assessee could be expected to generate from his business. In the absence of any other substantial evidence available with him, when using a comparable, the assessee’s own past and future performance would obviously be the best comparable. Comparing the assessee’s modus operandi of conducting its business with another when the same are not of equal terms would be a travesty of justice insofar as the financial charges, the use of the plant and machinery, the depreciation thereon, the location which would affect the cost of transportation as also the cost of the labour, cost of power and fuel would have to be seen. These are but only some factors which would affect the comparability when comparing two different enterprises. M/s Rahul Electricals & Electronics which has a turnover of only Rs. 1.28 crores, obviously cannot be compared with the assessee which has the turnover of more than Rs. 15.06 crores. Further, from the order of the TPO, M/s Rahul Electricals & Electronics is also in the business of making tools, which include tweezers, whereas manufacture of tweezers is nearly 90 per cent of the total manufacturing of the assessee. The fact that the AO has also not shown any calculation on the basis of which he has determined Rs. 3.54 crores is the excess profit received by the assessee cannot stand in view of the fact that he has not shown as to what he feels is the actual ordinary profit which the assessee could have generated nor has he shown any particulars he has used for arriving at such a figure especially when the assessee himself has filed the calculation showing the error in the difference between the profits and the ALP as filed before the TPO. Under these circumstances, we are of the view that the reduction of the eligible profits of the assessee by an amount of Rs. 3.54 crores as done by the AO by invoking the provisions of s. 80-IA(10) r/w s. 10B(7) of the Act is unsustainable and consequently the same is deleted in toto.”

Thus even if we consider the addition made by the A.O., as to have been done under Section 10B(7) read along with Section 80-IA(8) and 80-I(10) of the Act, in view of the decision of this Tribunal in the case of Tweezerman (India) (P.) Ltd. (supra) reproduced above, the addition cannot be sustained. We, therefore, find no reason to interfere with the order of CIT(Appeals).

14. Assessee in its cross-objection assails the validity of the assessment itself. According to assessee, the assessment was barred by limitation of time. Since we have dismissed the appeal of the Revenue, the cross-objection of the assessee has become purely academic.

15. To summarize the result, both, appeal of the Revenue as well as cross-objection of the assessee are dismissed.