Case Law Details
Huntsman International (India) Pvt Ltd Vs DCIT (ITAT Ahmedabad)
ITAT Ahmedabad held that transfer pricing adjustment should be restricted only in respect of turnover of assessee-company relating to international transactions. In nut-shell, transfer pricing addition should be restricted only qua international transaction and not entity level transactions.
Facts- The issue for consideration here is that whether the transfer pricing adjustment should be restricted to international transactions by the assessee with its associated enterprise or whether the adjustment is required to be computed at entity level.
Another issue involved here is disallowance of contribution of Rs. 11,04,588/- made by the assessee to “ Baroda Textile Effects Pvt. Ltd. Employees Gratuity Assurance Scheme” (Gratuity Scheme).
Conclusion- In the case of KHS Machinery (P.) Ltd. [2023] 151 taxmann.com 122, the Ahmedabad ITAT held that adjustment of PLI of comparables ought to be made at transaction level and not entity level. In the case of Kemrock Industries & Exports Ltd [2022] 141 taxmann.com 130 (Ahmedabad – Trib.), the Ahmedabad ITAT held that transfer pricing adjustment should be restricted only in respect of turnover of assessee-company relating to international transactions, sale of resins to its associated enterprises, and same should not be done in relation to all transactions. In the case of Bekaert Industries (P.) Ltd. [2022] 136 taxmann.com 355 (Pune – Trib.), the Pune ITAT held that Transfer pricing addition should be restricted only qua international transaction and not entity level transactions.
Held that where assessee had filed application to competent authority for approving gratuity scheme and it had duly complied with conditions laid down for approval under section 36(1 )(v), Assessing Officer ought not to have disallowed assessee’s claim for deduction under section 36(l)(v) merely because Commissioner had not granted approval to Gratuity Scheme.
FULL TEXT OF THE ORDER OF ITAT AHMEDABAD
This is an appeal filed by the assessee against the order of the ld. Dy. Commissioner of Income Tax, Circle-1(1)(1) Vadodara, in proceeding u/s. 143(3) r.w.s. 144C(13) vide order dated 23/02/2015 passed for the assessment year 2009-10.
2. The assessee has taken the following grounds of appeal:-
“Ground No. 1: Addition on account of Transfer Pricing
1.1. The learned AO/Transfer Pricing Officer (‘TPO’)/DRP erred in upholding the transfer pricing adjustment to the extent of Rs. 38,41,90,287 in determination of Arm’s Length Price (‘ALP’) by failing to consider the facts of the case, including the submissions made by the Appellant and the evidences produced with reference to the transactions reported in Form No. 3CEB filed by the Appellant.
GROUND NO. 2: Capacity utilization and extraordinary expenses adjustment
2.1. The learned AO/DRP erred in not appreciating the adjustment carried out by the Appellant for unutilized capacity of Appellant vis-a-vis comparable companies.
2.2. The learned AO/DRP erred in holding that the capacity utilization adjustment has to be carried out on the margin of the comparable companies instead of Appellant.
2.3. The AO/TPO/DRP erred in not allowing the extraordinary costs, in respect of repairs & maintenance, store and power & electricity expenses, incurred by the Appellant due to shutdown of the plant while computing the operating. Net Cost Plus (“NCP”) mark-up earned by the Appellant.
2.4 The AO/TPO/DRP erred in computing the correct operating NCP mark-up of the Appellant.
GROUND NO. 3: Direction of the DRP not followed by AO/TPO
3.1. The learned AO/TPO erred in not following the DRP direction in respect of allowing tolling expense amounting Rs. 32,66,607 (Total tolling expenses less allowed by the TPO) as an abnormal/ extraordinary expense in nature while computing the adjusted NCP mark-up earned by the Appellant.
3.2. The learned AO/TPO erred in not following the directions of the DRP while classifying the various expenses as fixed or variable in allowing the capacity utilization adjustment calculation of the comparable companies. Further, the learned AO/TPO erred in not following the consistent approach while classifying the various expenses into fixed or variable while computing the NCP mark-up earned by the comparable companies.
GROUND NO. 4: Erroneous computation of NCP Plus mark-up of comparable companies by AO/TPO
4.1. The learned AO/TPO erred in not following the DRP direction in respect of considering the expenses as an operating & non-operating expenses while computing the NCP mark-up earned by the following comparable companies:
- Metropolitan Eximchem Limited;
- Sadhana Nitro Chemical Limited;
- Siddharth Colorchem Limited; and
- Sunshield Chemicals Limited
4.2. The learned AO/ TPO erred in calculating the margin erroneously in case of Sadhana Nitro Chemical Limited by reducing the decrease in stocks from the cost base instead of increasing the cost/ reducing the income. This has led to an erroneous increase in NCP mark-up of 18.07%. instead of negative NCP mark -up of 3.62%
4.3. The learned AO/TPO erred on the facts and circumstances of the case and in law, in considering miscellaneous sales & receipts as an operating income while computing the NCP mark-up earned by the comparable companies.
4.4. The AO/TPO erred by not considering the trading sales as fixed cost, without appreciating the facts that the capacity utilization is being done in relation to manufacturing activity only and trading sales do not have any impact on the capacity utilization, while computing the NCP mark-up earned by Metropolitan Eximchem Limited.
GROUND NO. 5: Restricting transfer pricing adjustment to international transaction
5.1. The learned AO/TPO and/or the DRP erred in not restricting the transfer pricing adjustment to the value of international transactions with associated enterprises.
GROUND NO. 6: Multiple year data vs. current year data
6.1. The AO/TPO/DRP failed to appreciate the contention of the Appellant with respect to the use of relevant year data as against use of multiple year data for benchmarking the international transaction of the Appellant.
GROUND NO. 7: Disallowance of contribution to gratuity fund
7.1. The learned AO erred by disallowing contribution of Rs. 11,04,588/- made by the appellant to “Baroda Textile Effects Private Limited Employees Gratuity Assurance Scheme”.
GROUND NO. 8: General
8.1. The learned AO erred in initiating Penalty Proceeding u/s 271(l)(c) read with Explanation 7 of the Act.
8.2 The Appellant craves leave to add, alter, amend and/or substitute all or any of the foregoing grounds of appeal at or before the hearing of the appeal.
8.3. The AO erred in not following the directions issued by the DRP u/s 144C(5) of the Act by making an adjustment of Rs. 38,41,90,287/-
8.4. Each one of the above grounds of appeal is without prejudice to the above.”
3. Ground No. 1 of assessee’s appeal is general in nature and does not require any specific adjudication.
4. Ground No. 2: Capacity utilization and extra-ordinary expenses adjustment
5. Ground Nos. 2.1 and 2.2 of assessee’s appeal are general and do not require any specific adjudication.
6. The counsel for the assessee has submitted that he shall not be pressing ground no. 2.4 of assessee’s appeal and accordingly, the same are dismissed as withdrawn.
7. Ground No. 2.3: the DRP erred in not allowing the extra-ordinary costs incurred by the assessee due to shut down of the plant while computing the operating net costs (NCP) mark up earned by the assessee.
8. The brief facts relating to this ground of appeal are that the assessee had incurred losses during the year under consideration, since during the year, the management of the company had changed and it look time for them to conduct the operations efficiently and therefore the plant was temporarily shut down. Therefore, the assessee did not carry out commercial operations and incurred start up cost and had low capacity utilization. One of the plants of the companies was not in operation during the year and consequently, the production capacity was utislized only to the extent of 58%. In view of the above, the assessee submitted that capacity utilization adjustment may given on account of lower capacity utilization and also adjustment may be granted on account of extra-ordinary expenses incurred by the assessee.
9. The Hon’ble DRP after appreciating the arguments of the assessee directed the TPO to allow capacity utilization in case of comparables on the ground that this was the first year of operations by the assessee company after change in the management and one of its plants remained nonoperational throughout the year and the assessee’s capacity utilization was as low as 58% only. Further, the DRP also directed the TPO to exclude the expenditure relating to toll manufacturing charges from operating cost for the propose of benchmarking. However, with respect to other adjustments on account of excess store consumption and excess electricity consumption, the DRP held that in view the fact that since it had already allowed capacity utilization adjustment, no further adjustment on account of extra-ordinary costs may be further allowed. While passing the order the Hon’ble DRP observed as under:-
“8. We have considered the fuels of the case. We fine! that the TPO ignored some of very relevant lads regarding the assessee such as this was the first year of operations by the assessee company after change in the management, one of its plant remained non operational throughout the year and (he assessee’s capacity utilization was as low as 58% only. We find it strange that the TPO has rejected many comparables for having a change in the management or in the production process during the year or for having a failed product. But similar facts in the assessee’s own case were not considered significant. Considering the various case laws cited by the assessee and as per the TP provisions capacity utilization is required in the assessee’s case, The TPO’s view that if an accurate .adjustment is not possible, the claim should be rejected in totality is not a reasonable interpretation of law. The TPO himself has mentioned that TP is not a science. Logically capacity adjustment being part of TP also cannot be science, The TPO should not have applied a liberal approach in proposing the overall adjustment but ask for a very strict compliance in allowing capacity utilization.
9 We think that an adjustment can be worked out in the assessee’s case by adjusting the margin of each of the comparable selected by the TPO. This can be done by simply assuming that for example if Aksharchem makes a profit of 161.79 cr at capacity utilization of 104.86% what would be its profit if capacity ulizalion was only 58% i.e. equivalent to the assessee. Costs such as repairs and maintenance, depreciation etc should be considered as fixed cost. Even employee cost – wages etc should be considered as fixed cost because in India we do not follow hire and lire policy. Wherever full details are not available to treat a particular cost as fixed or variable in the case of comparables, that item of cost may be given the same treatment in comparables as is given in the case of the assessee. What is fixed cost in the ease of the assessee should be held as fixed cost in the case of the comparable and vice versa. The TPO can work out capacity ulilizaiion on these lines; the assessee will provide necessary details. We direct the TPO accordingly to allow a capacity utilization adjustment in the case of comparables.
10 As regard the toll manufacturing charges we agree with the assessee that the charges were being paid as extra ordinary cost. None of the comparable had such an overriding agreement to its disadvantage. We direct the TPO to exclude this expenditure from operating cost for the purpose of benchmarking.
11. As we have directed to allow capacity utilization adjustment, no other adjustment on account of excess stores consumption, excess electricity consumption is to be allowed.”
10. The assessee is in appeal before us against the aforesaid order passed by DRP and submitted that DRP erred in not allowing extra-ordinary costs in respect of repairs and maintenance and store and power and electricity expenses incurred by the assessee due to shut down of the plant while computing the NCP mark up earned by the assessee. The counsel for the assessee submitted that the capacity utilization adjustment granted by the DRP has nothing to do with the extra-ordinary expenses incurred by the assessee, for which a separate adjustment needs to be granted. The counsel for the assessee drew our attention to page 302 and pages 673-675 and 738 of the paper book and requested that adjustment on account of the above expenses may kindly be granted to the assessee.
11. In response, the ld. Departmental Representative relied on the observations made by the DRP in its order.
12. We have heard the rival contentions and perused the material on record. The primary argument of the counsel for the assessee is that when the plant was shut down due to change in management, even though the assessee did not have to bear variable expenses, it was under obligation to incur fixed cost to maintain these plants. These costs included repair and maintenance expenses since pursuant to acquisition of BTE by Huntsman Group, the assessee had to undertake huge repairs and maintenance expenses for rendering the plants functional. Further, the assessee had to bear power and electricity expenses to maintain the plants so that they would be in working conditions once the same would be operative. We observe that the Hon’ble DRP has been reasonable in its approach while allowing the capacity utilization adjustment to the assessee on account of one of the plant being non-operational and the assessee was operating at only 58% of its full capacity. Further, the DRP also allowed the assessee to make adjustment with respect to toll manufacturing charges on the ground that these charges were paid as extra-ordinary costs. Further, regarding excess power and electricity expenses, the TPO observed that the assessee in its calculation has not provided a bifurcation of power expenses into fixed and variable costs for the earlier year as well as year under consideration. Accordingly, looking into the instant facts of the case, we are of the considered view that DRP has not erred in facts and in law in not granting adjustment towards repairs and maintenance and excess power, electricity and store expenses.
13. In the result, ground no. 2.3 of assessee’s appeal is dismissed.
14. Ground No. 3 : Direction of DRP not followed by the A.O/TPO
15. Ground No. 3.1 : the ld. A.O./TPO erred in not following the DRP direction for allowing tolling expenses amounting to Rs. 32,66,607/-while computing adjusted NCP mark up earned by the assessee
16. The brief facts in relation to this ground of appeal are that the ld. TPO gave only part credit of total tolling expenses amounting to Rs. 1.4 crores and allowed adjustment for an amount of Rs. 99,83,333/- as extra-ordinary expenses for the purpose of calculation of PLI in the case of the assessee. However, the TPO did not give credit amounting to Rs. 36 lakhs incurred towards tolling expenses by the assessee. In appeal, the Hon’ble DRP directed that full credit of tolling expenses may be granted to the assessee, however, the TPO in remand proceedings did not allow full credit to the assessee. The counsel for the assessee submitted that the assessee filed rectification application dated 25th May, 2015 in which adjustment towards the aforesaid tolling was sought by the assessee. However, till date, the aforesaid rectification application remains undisposed of by the Department.
17. We observe that the Hon’ble DRP has agreed with the contention of the assessee that toll manufacturing charges were paid as extra-ordinary cost and had given a categorical direction to the TPO to exclude this expenditure from operating cost for the purpose of benchmarking. However, despite the same, no relief has been granted to the assessee in the final assessment order. It would be pertinent to reproduce relevant extracts of the directions given by the Hon’ble DRP for reference.
“10 As regard the toll manufacturing charges we agree with the assessee that the charges were being paid as extra ordinary cost. None of the comparable had such an overriding agreement to its disadvantage. We direct the TPO to exclude this expenditure from operating cost for the purpose of benchmarking.”
18. In view of the categorical directions made by the Hon’ble DRP, we direct that toll manufacturing charges be excluded from operating costs for the purpose of benchmarking, as per directions of Hon’ble DRP
19. In the result, ground no. 3.1 of assessee’s appeal is allowed.
20. Ground Nos. 3.2 and 4 of assessee’s appeal
21. Before us, the counsel for the assessee submitted that ground no. 3.2 of the assessee’s appeal (the ld. A.O./TPO erred in not following direction of DRP while classifying various expenses as fixed or comparable in allowing the capacity utilization adjustment calculation of the comparable companies) and ground no. 4.1, 4.2 and 4.4 are similar and the ld. A.O./TPO has erred in facts and in law in not giving effect to DRP order holding that the assessee is entitled to capacity utilization adjustment. The counsel for the assessee drew our attention to paras 8-9 of the order passed by Hon’ble DRP, wherein a specific direction was given by Hon’ble DRP to give adjustment towards lesser capacity utilization. The counsel for the assessee drew our attention to page 1 of paper book dated 22-04-2021 and submitted that while following the directions of DRP, the DCIT has made errors in items 5 to 9 of the table at page 2 of the order passed by DCIT dated 19-02-2015. The counsel for the assessee submitted that ground no. 4.1 of assessee’s appeal deals with four parties and submitted that the ld. A.O. committed arithmetical errors while giving effect to capacity utilization adjustment/not following direction of DRP in respect of parties mentioned at serial no. 5 to 8 at page 2 of the aforesaid paper book. Further, the counsel for the assessee submitted that the assessee filed rectification application pointing out discrepancies in respect of the aforesaid parties, which till date has not been disposed of.
22. Looking into the instant facts of the case, directions given by the Hon’ble DRP and the factual inaccuracies pointed out by the counsel for the assessee at the time of giving effect to the directions given by the DRP, in the interest of justice, ground no. 3.2 and ground no. 4 of assessee’s appeal are being restored to the file of TPO to re-compute the relief granted to the assessee taking into consideration the directions given by Hon’ble DRP. The assessee may also file written submissions/documentary evidences in support of the contentions put forth by the assessee. In the result, ground no. 3.2 and 4 are being restored to the file of ld. TPO with the aforesaid directions
23. In the result, ground no. 3.2 and 4 of the assessee’s appeal are allowed for statistical purposes.
24. Ground No. 5 : restricting transfer pricing adjustment to international transaction
25. The issue for consideration with respect to this ground of appeal is that whether the transfer pricing adjustment should be restricted to international transactions by the assessee with its associated enterprise or whether the adjustment is required to be computed at entity level. In the case of Tara Jewels Exports (P.) Ltd. [2017] 80 com 117 (Bombay) , the Bombay High Court held that adjustment to be done to arrive at arm’s length price is only in respect of transaction with its associated enterprises. In the case of KHS Machinery (P.) Ltd. [2023] 151 taxmann.com 122 (Ahmedabad – Trib.), the Ahmedabad ITAT held that adjustment of PLI of comparables ought to be made at transaction level and not entity level. In the case of Kemrock Industries & Exports Ltd [2022] 141 taxmann.com 130 (Ahmedabad – Trib.), the Ahmedabad ITAT held that transfer pricing adjustment should be restricted only in respect of turnover of assessee-company relating to international transactions, sale of resins to its associated enterprises, and same should not be done in relation to all transactions. In the case of Bekaert Industries (P.) Ltd. [2022] 136 taxmann.com 355 (Pune – Trib.), the Pune ITAT held that Transfer pricing addition should be restricted only qua international transaction and not entity level transactions.
26. In view of the judicial precedents highlighted above, ground no. 5 of assessee’s appeal is allowed.
27. The counsel for the assessee submitted that we shall not be pressing ground no. 6 of assessee’s appeal and accordingly, ground no. 6 of assessee’s appeal is dismissed as not pressed.
28. Ground No. 7 : disallowance of contribution to gratuity fund.
29. The brief facts relating to this ground of appeal are that the Assessing Officer disallowed contribution of Rs. 11,04,588/- made by the assessee to “ Baroda Textile Effects Pvt. Ltd. Employees Gratuity Assurance Scheme” (Gratuity Scheme). In appeal, the DRP upheld the disallowance on the ground that the aforesaid fund was not granted approval during the year under consideration and the approval to the fund was granted in the subsequent year. Accordingly, the DRP held that the payment made towards gratuity fund which was not an approved fund created by the assessee for the exclusive benefit of the employees was not allowable in terms of section 36(1)(v) of the Act.
30. The assessee is in appeal before us against the aforesaid disallowance upheld by Hon’ble DRP. The counsel for the assessee drew our attention to the decision of Hon’ble Supreme Court in the case of CIT vs. Textool Company Ltd. 263 CTR 257 (SC) at para 8 and submitted that in the aforesaid decision, the Hon’ble Supreme Court has observed that while allowing the deduction u/s. 36(1)(v), it is manifest that the real intention behind the provision is that the employer should not have any control over the funds of the irrevocable trust created exclusively for the benefit of the employees. Accordingly, the counsel for the assessee submitted that in the instant facts, once the contribution is made, the assessee has no control over the funds deposited in the aforesaid gratuity fund. Further, it is also not disputed that all the contributions made by the assessee in the aforesaid gratuity fund was for the benefit of the employees of the assessee company. Further, admittedly aforesaid fund got approval by the concerned authority in the succeeding assessment year as well. Accordingly, looking into the facts of the case and the intention underlying the provision of section 36(1)(va) of the Act as highlighted by the Hon’ble Supreme Court in the case of Textool Company Ltd. supra, it was submitted that deduction u/s. 36(1)(va) of the Act may be allowed to the assessee.
31. We have heard the rival contentions and perused the material on record. In the case of Textool supra, the Hon’ble Supreme Court of India has made the following observations:
“From a bare reading of Section 36(1)(v) of the Act, it is manifest that the real intention behind the provision is that the employer should not have any control over the funds of the irrevocable trust created exclusively for the benefit of the employees. In the instant case, it is evident from the findings recorded by the Commissioner and affirmed by the Tribunal that the assessee had absolutely no control over the fund created by the LIC for the benefit of the employees of the assessee and further all the contribution made by the assessee in the said fund ultimately came back to the Textool Employees Gratuity Fund, approved by the Commissioner with effect from the following previous year. Thus, the conditions stipulated in Section 36(1)(v) of the Act were satisfied. Having regard to the facts found by the Commissioner and affirmed by the Tribunal, no fault can be found with the opinion expressed by the High Court, warranting our interference.”
In the case of Gujarat State Co-op. Marketing Federation Ltd. [2021] 129 taxmann.com 53 (Ahmedabad – Trib.), the Ahmedabad ITAT held that where AO disallowed deduction under section 36(1)(v) to assessee company on account of payment of premium made directly to LIC towards employees gratuity fund created by it with LIC on ground that such gratuity fund was not approved, since undisputedly approval under section 2(5) was granted to gratuity fund subsequently by Commissioner, deduction was to be allowed. In the case of Prakash Software Solution (P.) Ltd. [2018] 89 taxmann.com 130 (Ahmedabad – Trib.), the Ahmedabad ITAT held that payment to a gratuity fund on a date prior to date of approval of a gratuity fund does not come in way of deduction u/s 36(1)(v) being allowed. In the case of Jaipur Thar Gramin Bank [2017] 81 taxmann.com 126 (Rajasthan), the Rajasthan High Court held that where assessee had filed application to competent authority for approving gratuity scheme and it had duly complied with conditions laid down for approval under section 36(1 )(v), Assessing Officer ought not to have disallowed assessee’s claim for deduction under section 36(l)(v) merely because Commissioner had not granted approval to Gratuity Scheme.
32. In view of the above decisions and the facts highlighted before us, we are of the considered view that the assessee is eligible for claiming deduction amounting to Rs. 11,04,588/- u/s. 36(1)(v) of the Act.
33. Ground No. 5 of assessee’s appeal is general and does not require any specific adjudication.
33. In the result, the appeal of the assessee is partly allowed for statistical purposes.
Order pronounced in the open court on 30-06-2023
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