Walvoil Fluid Power India Pvt. Ltd. Vs DCIT (ITAT Bangalore)
On perusal of the list of the tools treated as capital in nature and we find that the value per item in the entire list is not significant. The ratio laid down by the Hon’ble SC in Sarvana Spinning Mills Pvt. Ltd., (Supra) is that these tools need to have independent functions and also they need to have a benefit of enduring nature. In the given case as submitted by the Ld AR these tools are spares used in the operations of the assessee to facilitate the manufacture of finished products that have short working life needing frequent replacement and do not have any independent function. The test of enduring benefit is not the only criteria for concluding an item to be revenue or capital in nature. The value of each of the items, resale value etc also warrants consideration. Based on the materials on record and the facts we are of the considered view that the tools are to be treated as revenue in nature and eligible to be claimed as expenditure in the profit and loss account.
FULL TEXT OF THE ORDER OF ITAT BANGALORE
This appeal of the assessee arises out of the final asst. order passed by the DCIT(A)-7(1)(2), Bengaluru u/s 143(3) r.w.s 144C of the Income-tax Act (the Act) dated 28/07/2017 passed in pursuant to the directions of the DRP dated 16/06/2017.
2. The assessee raised the following grounds:-
“1.That the order of the Ld. TPO and the order of the Honourable DRP in pursuance of whose directions, the said assessment order is passed insofar as it is prejudicial to the interests of the Appellant is opposed to law and facts of the case.
2. In respect of Transfer Pricing Adjustments:
a) That in the computation of ALP the Hon’ble DRP erred in not directing the Ld. TPO to include the interest paid in arriving at the operating profits of the Comparable entities.
b) That the Hon’ble DRP erred in sustaining the order of the Ld. TPO by including Triton Valves without appreciating the fact that the products manufactured by the said company is entirely different from that manufactured by the Appellant.
c) That in the Computation of the ALP, the Hon’ble DRP erred in not directing the Ld. TPO to consider the adjustments to the respective Working Capital position of the Appellant and the Comparable Entities.
3. In respect of Corporate Taxation matters:
a) That the Hon’ble DRP erred in holding that the tools and spares written off during the year were capital items when in reality they were merely consumable items used in normal manufacturing activity that have limited life due to the stringent quality requirements of the products manufactured by the Appellant.
4. The Appellant prays for leave to add, modify, delete or introduce additional Grounds of Appeal at any time before the Appeal is disposed off.”
3. The brief facts of the case are that the assessee is a subsidiary of Walvoil S.p.A Italy. The assessee is into the business of manufacture of hydraulic vales for automobiles and for industrial machineries. The assessee has manufacturing unit and assembling plant in Whitefield, Bangalore with necessary infrastructure. The following international transactions are made by the assessee with its Associated Enterprise (AE).
i) import of components and raw materials
ii) purchase of machineries
iii) Interest paid on acb
iv) repayment of loan
v) reimbursement of expenses
4. The assessee filed its return of income on 28/11/2013 declaring a loss of Rs.3,87,96,455/-. The case was selected for scrutiny u/s 143(2) of the Act. As the assessee had international transaction exceeding the prescribed limit, the AO referred the matter to the TPO for proper determination of arms length price (ALP) in relation to the international transactions. The TPO vide order dated 29/09/2016 made a revision of ALP for an amount of Rs.2,77,7,413/- u/s 92CA of the Act. While computing the ALP, the TPO included four comparables in addition to what assessee has included and excluded one comparable. The TPO, in the computation did not consider working capital adjustment and interest paid as an element of operating cost. The AO passed draft asst. order giving effect to the increased amount in the ALP. In addition, the AO also made an addition of Rs.1,68,36,376/- towards consumable tools claimed as revenue expenditure by the assessee.
6. Aggrieved by the order of the AO, the assessee raised objections before the DRP.
7. The DRP confirmed the ALP determined by the TPO. On the other additions made by the AO, towards consumable tools, the DRP called for a remand report from the AO. The AO after examining the facts and evidences held that tools worth Rs.1,50,23,75/- is revenue in nature and the balance Rs. 18,12,617 is capital in nature. Accordingly the DRP deleted the additions to the extent of what is revenue in nature and sustained the addition of Rs.18,12,617 being capital.
8. The AO passed final order giving effect to the direction of the DRP. The assessee is now in appeal before us aggrieved by the final order of the AO passed in accordance with the directions of the DRP.
9. At the time of hearing, the ld.AR did not press ground No.2(a) pertaining to inclusion of interest paid in arriving at the operating profits of the comparable entities. Hence, this ground is dismissed.
10. In ground No.2(b), the assessee contended inclusion of Triton Valves Ltd., as comparable in the transfer pricing study which we will adjudicate first.
11. Before we undertake comparability analysis, it’s sine qua non to understand the FAR of assessee as per the TP document prepared by the assessee.
Functions: The assessee has a manufacturing and assembly plant in Whitefield, Bnagalore with the necessary infrastructure. The assessee has a service centre in Delhi and also a marketing department for developing new customers. The Managing Director (MD) of The assessee takes care of the overall management, R&D/Product development. The personnel from respective department support the MD to manage the day today functions when it comes to manufacturing, R&D, Product development, Marketing, Sales & Distribution, after sales services, Finance and administration.
Assets Owned: The assessee uses the brand name Walvoil in its product which is an intangible asset belonging to the parent company. The fundamental design and R&D work is done at the parent company level though the assessee carries out modifications and studies to suit Indian market. The assessee uses tangible assets such Plant & Machiner, Electrical Installation, Tools & Equiments, office equipment and Furniture & Fixtures etc. The assessee does not own any intangible assets and no separate payments are made for using brand name.
Risks assumed: The assessee bears the entire market risk consisting of loss of orders, bad debts, predatory pricing by competitors etc. The utilization risk is entirely in the hands of the assessee as although the parent compant bears this risk indirectly interms of dependency on the success of the Indian arm affects the global reputation of the brand. The foreign exchange due to fluctuations between foreign currency and Indian currency is born by the assessee as the assessee makes payments in foreign currency to the parent company. To the extent of third party transactions, the assessee would bear the credit and collection risk. The warranties, replacements and after sales services liability for Indian customers is partly owned by the assessee to the extent not shared by the AE’s share. The financial risk when it comes to dues to vendors, the significant portion is to the holding company and hence there is minimum risk.
Classification: The assessee is in the manufacture of hydraulic valves for automobiles and industrial machinery.
Method of determining Arm’s Length Price: As per the Trasfer Pricing (TP) Report, the most appropriate method chosen by the assessee is the Transaction Net Margin Method (TNMM).
12. The assessee in the TP Report included three entities for comparables. During the transfer pricing proceedings the TPO added four more comparables. Out of the inclusion, the assessee accepted all inclusions except Triton Valves Ltd (Triton Valve) against which the assessee raised objection stating that products and the industry serviced by Triton Valves is not comparable. The TPO rejected the submissions of the assessee and proceeded with the inclusion in the order passed u/s.92CA of the Act.
13. Before the DRP the assessee submitted that the products manufactured by Triton is entirely different from that of the assessee. The assessee also submitted that the valves, cores and accessories manufactured by Triton are used in tyre industry whereas the assessee manufactures hydraulic valves which are different and hence it is not a comparable industry. However the DRP did not accept the claim of the assessee and confirmed the decision of the TPO. The DRP in the order stated as under:-
“’The main argument of the assessee is that the valves, valve cores and accessories manufactured by Triton Valves are used in tyre industry where as the assessee manufactures hydraulic valves which are different. The submission of the has been considered. The TNMM requires establishing comparability at a broad functional level. A strict product comparison is not a necessity. Hence as both the asscssee as well as the comparable Triton Valves are manufacturing valves, both can be considered as functionally comparable under TNMM: Further, it is found that the comparables selected by the assessee, which are accepted by the TPO, also manufacture valves for use in different industries. While KAR Mobile Ltd. manufactures valves for internal combustion engines power generation, stationary and marine engine application, Rane Engine Valve Lid manufactures valves and valve train components, Dynamatic Technologies Ltd manufactures hydraulic gear pumps, control valves, hand pumps and other hydraulic elements, Schrader Duncan is a manufacturer of tyre tube valves and accessories and pneumatic products and hydraulic products which is same as done by Triton Valves, Thus, broad functional comparability being the criterion under TNMM, the argument of the assessee is considered to have no force. Consequently, the objection of the assessee cannot be accepted.
14. Aggrieved by the order of the DRP, the assessee is in appeal before the Tribunal.
15. The ld.AR submitted that the assessee manufactures hydraulic valves that are used in heavy-duty machinery and vehicle such as construction of earth moving machines, material handling equipment, and industrial vehicles. The products of the assessee are applied in operating of boom/buckets of earth moving equipment, pavers or harvesting equipments. Triton valves on the other hand are engaged in the manufacture of tyre-tube valves, industrial and home air conditioner valves, special vales for electric vehicles, valves for allowing inlet and outlet of air and monitoring the tyre pressure. The valves manufactured by Triton Valves are used in industrial and home air conditioner, tyre pressure monitoring systems in petrol pumps. The ld.AR therefore contended that the products manufactured by the assessee is completely different fr0m that of Triton Valves Ltd., and prayed for the exclusion of the same.
17. The ld.DR relied and supported the decision of lower authorities.
18. We have heard the rival submissions and perused the materials on record. The assessee has used the TNMM method as the most appropriate method for computing the ALP. While choosing the comparables the assessee applied the filters to identify companies which are potentially comparable the assessee and conduct transactions similar to that of the assessee. The assessee eliminated companies based on turnover, un-comparable products, companies having more than 20% of related party transactions. The final list of comparables chosen by the assessee are (1) Dynamic Technologies Ltd., (2) Kar Mobiles Ltd., (3) Rane Engine Value Ltd. The TPO included four more comparables (1) Oswal Industries Ltd., (2) Schrder Duncan Ltd., (3) Sundram Bleistahl Ltd., (4) Triton Valves Ltd. The assessee is objecting to the inclusion of Triton Valves Ltd., on the ground that the products manufactured are not comparable and the industries to which Triton Valves serves are also not comparable.
19. Before going into the merits of this case, we will first look into the legal position with regard to the TNMM used for determining the ALP between the AEs. The Transfer Pricing Regulations (i.e. Section 92C of the Act, read with Rule 10B of the Income-tax Rules) as well as the OECD Transfer Pricing Guidelines provide the 5 common transfer pricing methods for evaluating the related party transactions undertaken between entities. Of these TNMM is the most common method that is used for determining the arm’s length nature of transactions. It compares the operating/ net margins of companies to analyse if the related party transactions have been undertaken on an arm’s length basis. Rule 10B (1) (d) states as under
10B . (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :—
******
(e) transactional net margin method, by which,—
(i) the net profit margin realised by the enterprise from an international transaction [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 having regard to any other relevant base;
(ii) the net profit margin realised 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 realised 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 arm’s length price in relation to the international transaction [or the specified domestic transaction];
20. Under TNMM, the net profit of a controlled transaction of an associated enterprise (tested party) is determined and this net profit is then compared to the net profit realized by comparable uncontrolled transactions of independent enterprises. As opposed to other transfer pricing methods, the TNMM requires transactions to be “broadly similar” to qualify as comparable. “Broadly similar” in this context means that the compared transactions don’t have to be exactly like the controlled transaction. This increases the amount of situations where the TNMM can be used and thus TNMM is the most commonly used methodology applied and accepted for determining the ALP. When TNMM is used for determining the ALP, it is not necessary for the comparable company and the taxpayer to cater to the same industries in order to be functionally comparable. Further TNMM does not require strict product comparability. Therefore we are of the considered view that that the contention of the assessee that the products of Trion Valves and the industry to which Triton Valves serve are not comparable with assessee is not tenable as the most appropriated method as chosen by the assessee for determination of ALP is TNMM.
21. Even on merits, the other comparables included and accepted assessee during the TP proceedings are having different products and serves different industries. Oswal Industries Ltd., for example serves mainly to oil companies and the valves manufactured by this company is different from the valves of the assessee. It is also noted that one of comparables chosen by the assessee in the TP Study, namely KAR mobiles is into Manufacture and Exporters of Engine Valves for Applications in Segments such as Agricultural / Indusrial /Stationary, Automotive – Passenger Cars / Light Commercial Vehicle / Heavy Commercial Vehicles, Battle Tanks, Farm Trackors, High Performance Cars, Locomotives and Marine. If the contention of the assessee is to be accepted then the inclusion of these companies as comparable as by assessee needs to be questioned. We are therefore in agreement with the decision of the TPO and CIT(A) that under TNMM method the comparison is done at a broader level and narrow comparison is not applied. In the light of the above, we uphold the order of the AO including the Triton Valves as a comparable and dismiss the appeal of the assessee.
22. The next ground raised by the assessee is relating to exclusion of working capital adjustment while computing ALP.
23. The assessee in the transfer pricing analysis made adjustment towards working capital. The assessee submitted that the assessee enjoys large credit period from its AE in respect of purchases made which have a substantial bearing on the liquidity position and consequently on profitability. The assessee therefore considered iit appropriate to make working capital adjustment that would enable a meaningful comparison to the margins of the comparables entities. The TPO did not allow the working capital adjustment on the basis that the assessee manufactures niche products using hydraulic technologies and there is no free flow of tech information. The TPO also contended that the nature of business in which the assessee is operating is not purely competitive market and comparable adjustment are not warranted in their case. In the objections raised before the DRP the assessee’s plea for inclusion of working capital adjustment was rejected on the ground that the assessee has not been able to demonstrate that the working capital differences had impact on its profit. The DRP further relied on the decision of ITAT Chennai bench in the case of M/s Mobis India Ltd., in ITA No.2112/MDS/2011.
24. The Ld AR submitted that in a competitive environment money has a time value, and hence the price should include an element to reflect the timing effect of payment terms (receivable / payable). The Ld AR also submitted that making a working capital adjustment is an attempt to adjust for the difference in time value of money between the tested party and potential comparables with an assumption that the difference should be reflected in profits. The Ld AR further relied on the following decisions
(i) Demag Cranes and components India Private Limited (144 TTJ 320) – ITAT Pune
(ii) TNT India Private Limited (61 DTR 81) – ITAT Bangalore
25. The Ld DR supported the decision of the lower authorities. We have considered the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal has been consistently adjudicating that the working capital adjustment is permissible. In the following judicial pronouncements the Tribunal has held that working capital adjustment has been provided for the purpose of better comparable.
1) Swiss Re Global Business Solutions India (P) Ltd., Vs. DCIT [2020] 116 com 716 (Bangalore – Trib.)
2) Maxim India Integrated Circuit Design Pvt. Ltd. Vs. DCIT [IT(TP)A No.1573/Bang/2017 dated 2/11/2020.
3) Nagravision India Pvt. Ltd., Vs. ACIT (TP 1536/Bang/2017 dated 3/7/2020
26. In the case of Nagravision India Pvt. Ltd., (Supra), the Tribunal held that the working capital adjustment should be allowed. For holding so, the Tribunal has followed the decision rendered by another Bench in the case of Huawei Technologies (India) Pvt. Ltd., Vs. DCIT (2019) (101 taxmann.com 313). The decision rendered in the case of Huawei Technologies (India) Pvt Ltd (supra) are extracted below:-
“10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows:
Determination of arm’s length price under section 92C.
10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely ;—
(a) to (b)** ** **
(e) transactional net margin method, by which,—
(i) the net profit margin realised by the enterprise from an international transaction [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 having regard to any other relevant base;
(ii) the net profit margin realised 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 realised 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 arm’s length price in relation to the international transaction [or the specified domestic transaction);
(f) ** ** **
(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:-—
(a) the specific characteristics of the property transferred or services provided in either transaction;
(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;
(d) 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.
(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic 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.
11. A reading of Rule 10B(l)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market.
12. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:
