IN THE ITAT MUMBAI BENCH ‘L’
Assistant Commissioner of Income-tax, 15(2)
IT APPEAL NO. 6399 (MUM.) OF 2007
[ASSESSMENT YEAR 2004-05]
AUGUST 3, 2012
I.P. Bansal, Judicial Member
This is an appeal filed by the revenue. It is directed against the order dated 1st Aug. 2007 of Ld. CIT(A)-XV, Mumbai for the assessment year 2004-05. The grounds of appeal raised by the revenue read as under:
1. “On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in deleting the addition of Rs. 2,58,00,000/- being the adjustments made to the purchase price of imports from Associated Enterprises.
2. On the facts and in the circumstances of the case and in law, the Ld CIT(A) erred in observing that the Comparable Uncontrolled Price Method can be used for determining the Arm’s Length Price in this case.
3. On the facts and in the circumstances o the case and in law, the Ld. CIT(A) erred in accepting the assessee’s plea that the benchmarked operating profit ratio should be applied to the sale turnover corresponding to the purchases made from Associated Enterprises and not to the total turnover.
4. On the facts and in the circumstances of the case and in law, the Id. CIT(A) erred in holding that the wording net profit margin for Rule 10B, necessarily means only the net profit determined after allowance of cost inclusive of interest cost and consequently holding that taking operating profit as base for benchmarking as considered by the Transfer Pricing Officer is not in tune of Rule 10B of Income tax Rules.
5. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in holding that the ‘capital base’ materially affect the operating profit, ignoring the findings of the Transfer pricing Officer that during the proceedings, the assessee could not demonstrate that the diamond industry is a capital intensive industry.
6. On the facts and in the circumstance of the case and in law, the Ld. CIT(A) erred in holding that seven comparable entities selected by the Transfer Pricing Officer do not appear to be comparable with the assessee.
7. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in accepting the working of Arm’s Length Price as done by the assessee which are based only on three entities or industry average based on four entities”
2. The assessee firm imports rough diamonds from M/s. Swetgems BVBA and other parties on principal to principal basis. It gets these diamonds cut and polished and then export such processed diamonds. The return of income was filed on 28/10/2004 on a total income of Rs. 26.26.217/-, which has been assessed vide order dated 26/12/2006 on an income of Rs. 2,84,26,217/- by making an addition of Rs. 2,58,00,000/- as per order dated 22/12/2006 passed by TPO under section 92CA(3) of the Income Tax Act, 1961 (the Act.). The international transactions entered into by the assessee with its Associated Enterprises (AE) is an aggregate sum of Rs. 16,19,73,522/- which represent import cost of rough diamonds. The assessee adopted TNMM method to bench mark the said transaction and during the course of hearing before TPO the assessee had additionally taken support of CUP method to bench mark the transaction. The TPO rejected the CUP method in view of the non availability of adequate documentary evidence regarding comparability of diamonds purchased from the AE and Non-AEs and took recourse to the remarks made in the transfer pricing report submitted vide letter dated 12/5/2006 in which it was stated as under:
“it is impossible and impracticable to compare the prices in one invoice with that in another though having same description i.e. Rough Diamonds. In fact, even a single invoice of rough diamonds contains different lots, all described as rough diamonds but priced differently and sometimes invoice gives details of only one lot though there are different qualities of goods included in parcel”.
After rejection of CUP method claimed by the assessee the TPO had proceeded to use TNMM method. The TPO selected certain comparables out of 65 diamond manufacturing cases which had different categories of sale turnover. As the assessee’s turnover is Rs. 57.27 crores the TPO selected the comparables having sales between Rs. 50 to Rs. 100 crores and the operating profit margin on sales of those comparables was worked out at 5.13%. A list is stated to be enclosed as Annexure -A with the order of the TPO, however, the said annexure has not been filed by the revenue alongwith order of the TPO. It is observed by the TPO that since assessee’s margin did not fall within safe harbour of +/- 5% the assessee was required to explain as to why TP adjustment should not be made. The assessee inter- alia submitted that the working capital was only Rs. 36.92 lacs as against the total capital of some of the entities sought to be compared of Rs. 102.72 crores; outstanding creditors constitute 134 days to the purchases as against only 103 days for some of the comparables; outstanding debtors constitute only 46 days of the sales as against 110 days of the comparables; sale of the assessee to capital ratio i.e. capital turnover ratio is about 158 times as against just 1.83 times of some of the comparables etc. Ld. TPO rejected all the these submissions of the assessee stating inter-alia that diamond is not a capital intensive industry; the assessee did not incur interest cost while comparables have incurred and the margin of the comparables have been worked out after excluding the interest cost; the assessee did not furnish any price comparison data on an invoice to invoice basis etc. The TPO calculated an addition of Rs. 2.58 crores vide para 12 of his order as under:
“12. In the light of the above, the arguments provided by the assessee are rejected. Thus an adjustment is made to the purchase price of import from AEs as under:
|Particulars||Actual (Rs. In Cr.)||Arm’s length (Rs. In Cr.)|
105% of 13.61 = 14.29 which is, not within +/- 5% also. Hence, an adjustment of Rs. 2.58 cores is made to the income of the assessee by reducing the cost of purchase from the AE by Rs. 2.58 cores.”
3. Aggrieved, the assessee filed an appeal before Ld. CIT(A) raising as many as 13 grounds. The first issue raised by the assessee was regarding application of Comparable Uncontrolled Prices method to determine the ALP. The foremost contention of the assessee to support such ground was that necessary details were filed with the TPO vide letter dated 12/05/2006, where one to one comparison were given with respect to the transactions made with AE and Non-AE. According to assessee for working ALP under CUP method sufficient data and analysis was furnished and, therefore, TPO was wrong in laying unnecessary emphasis on the general comment given in the TP report. Copies of import invoices and bills of entries duly attested by Custom Authorities were also furnished to TPO and TPO has rejected the same. Ld. CIT(A) has given a chart at page 4 of the impugned order, wherein the assessee has compared transactions of the AE and Non-AEs to show that what rate was charged by its AE was also charged by the unrelated parties and looking into the said details Ld. CIT(A) has accepted the contention of the assessee and has recorded a finding that with the application of CUP method the ALP of AE falls within the range of +/- 5%. Ld. CIT(A) has also upheld the contention of the assessee on TNMM method vide which after giving adjustment sought by the assessee in the comparable margin, Ld. CIT(A) has held that the ALP worked out will be within the safe harbour of 5%, therefore, no adjustment is required. It is against these finding of Ld. CIT(A) the revenue has raised the aforementioned grounds.
4. Before us both parties have argued the issues raised in the present appeal at length. It was found that on the basis of following chart which is given in page 10 of the Ld. CIT(A) it has been held that the assessee’s transaction is at Arm’s Length as it is within safe harbour of +/-5%.
|M/S Super Diamonds|
|Operating profit to sales as per TPO||5.13%|
|Sale price of purchase from AE||163,176,492|
|Less: Operating profit @5.13%||8,370,954|
|Operating cost i.e. purchase price at ALP||154,805,538|
|105% of ALP||162,545,815|
|As actual price is less than ALP as adjusted by 5%, No adjustment is required.|
From the aforementioned chart it was noticed that the operating cost shown by the assessee with its AE did not include operational cost, while treating the sale operational profit was taken into consideration. The Ld. AR of the assessee admitted that there is a mismatch and to rectify the same Ld. A.R sought one day time and the matter was adjourned to 31/7/2012. On 31/7/2012. The Ld. A.R has furnished the following chart.
“M/s. Super Diamonds
|Working of Operating Profit vis-a-vis Purchase From AE & Non AE AY||2004-04|
|1. Total operating cost||578,084,572|
|2. Operating Profit||4,293,419|
|4. Operating Profit/Sale (3/1%)||0.74|
|5. Total Operating cost include cost of goods sold||557,562,928|
|Other operating cost including L/C||20,521,644|
Allocation Between AE/Non AE
|Allocation of cost of goods sold Actual purchase||161,973,522||395,589,406||557,562,928|
|Op. Cost out of other operating expenses like labour charges, etc. Apportion on the basis of actual cost.||5,961,592||14,560,052||20,521,644|
|Total operating cost as in 1 above||167,935,114||410,149,458||578,084,572|
|Actual operating revenue apportioned on the Basis of Op. Cost as in 1 Above.||169,182,361||413,195,620||582,377,981|
|Operating profit earned on transmission with AE/Non AE As in 3 above||1,247,247||3,046,162||4,293,409|
|Operating profit attributable to Purchase from AE||0.74||0.74||0.74|
|Operating profit to sale per TPO||5.13|
|Operating revenue of goods purchased from AE||169,182,361|
|Op. Profit @ 5.13%||8,679,055|
|Operating cost per TPO||160,503,306|
|Operating cost as attributable to AE as determined by TPO + 5%||168,528,471|
|Actual cost With Labour Charges||167,935,114|
|Actual purchase price||161,973,522|
As actual cost/purchase price falls within ± 5% of ALP no adjustment is called for.”
5. On the above facts, Ld. D.R submitted that the CIT(A) was wrong in accepting the CUP method for determination of ALP and taking recourse to the grounds of appeal, which has been reproduced above, it is the case of the Ld. D.R that Ld. CIT(A) has wrongly deleted the addition. So far as it relates to calculations in the aforementioned chart, it was pleaded by Ld. D.R that to verify the calculation the matter may be restored back to the file of A.O.
6. As against that referring to the aforementioned chart it is the case of the Ld. AR that without prejudice to the other submissions of the assessee, if margin taken by TPO is applied, even then the assessee’s case will fall within the safe harbour of +/- 5%. He, therefore, submitted that the TPO has wrongly taken into consideration the entire sale of the assessee, whereas according to the provision ALP can be applied only to international transactions of the assessee with its AE and if this fact is accepted then according to aforementioned chart, there being safe harbour of +/- 5% available to the assessee, no adjustment is required to be made and on this ground the order of the Ld. CIT(A) be upheld.
7. We have carefully considered the rival submissions in the light of the material placed before us. So far as it relates to application of CUP method, it is the case of Ld. CIT(A) that assessee had furnished proper details to show comparable transactions of Non-AE parties which match with the transaction of the assessee with its AE. During the course of hearing we have perused that chart which is reproduced at page -4 of the order of Ld. CIT(A), it was observed that the rate of diamonds per carat varies between Rs. 38,561/- to Rs. 98,499/-. The Ld. A.R was required to submit the details regarding particular quantity of the diamonds stated therein. It was the submission of Ld. A.R that the transaction compared being in the immediate vicinity of the transaction entered into by the assessee with its AE is sufficient to prove that the price charged by its AE was comparable with price charged by Non-AEs. However, he could not produce details about the quality of the diamond mentioned with reference to invoices. Therefore, we are of the opinion that Ld. CIT(A) has wrongly accepted the CUP method and TPO was right in observing insuffciant details were furnished to prove the justification of applicability of CUP method.
8. Now coming to the TNMM method which even was considered by the assessee in its TP report, it can be mentioned that it is the main case of the assessee that according to the calculations submitted in the chart furnished before us the margin of the assessee being 0.74% and the margin applied by the TPO being 5.13%, the case of assessee will fall within safe harbour of +/-5%. It is also the contention of the assessee that determination of ALP can only be in respect of international transactions entered into by the assessee with its AE and it cannot be extended to Non-AE transactions. This issue is well established that determination of ALP can be made only with regard to international transactions of the assessee with its AE and it cannot be extended to international transaction of the assessee with its Non-AEs. Therefore, we hold that the ALP can be worked out only with respect to international transaction of the assessee with its AE. If it is so, we consider it just and proper to restore this issue to the file of AO with a direction to verify the aforementioned calculations submitted by the assessee after giving the assessee reasonable opportunity of hearing and if the aforementioned calculations are correct then the difference being within the safe harbour of +/- 5%, no addition with regard to ALP should be made. It may be mentioned here that on this ground alone the matter can be decided, therefore, we do not consider it necessary to adjudicate other grounds on which the assessee is assailing the TP adjustment as those will become academic only.
9. In view of the above discussions, the appeal of the revenue is considered to be allowed for statistical purposes in the manner aforesaid.