Case Law Details
Wrigley India Private Ltd Vs ACIT (ITAT Delhi)- Whether the Tax Officer has, inter alia, erred in disallowing the claim of brought forward losses and un absorbed depreciation of the Taxpayer post amalgamation?
The Tribunal agreed with the position taken by the Taxpayer by holding that:
– The conditions specified in Section 72A(2) of the IT Act are applicable only when amalgamating company has brought forward losses and un absorbed depreciation. However, in the Taxpayer‟s case, the amalgamating company does not have brought forward losses and un absorbed depreciation and hence, the provisions do not apply
– Post amalgamation, more than 51% shareholding remains in the same hands which fulfils the conditions laid down in Section 79 of the IT Act
– Provisions of Section 78 of the IT Act are also not applicable in the Taxpayer‟s case since it is not a firm and the amalgamating company does not have losses
– Since the scheme of amalgamation has been approved by the High Court, there is no reason to believe that the amalgamation was not for genuine business purposes and it was a colour-able tax device.
IN THE INCOME TAX APPELLATE TRIBUNAL
(DELHI BENCH ‘F’ : NEW DELHI)
SHRI R.P. TOLANI, JUDICIAL MEMBER
and
BEFORE SHRI B.C. MEENA, ACCOUNTANT MEMBER
ITA No. 5224/Del./2010
(ASSESSMENT YEAR :2006- 07)
M/s. Wrigley India Private Limited Vs Addl. CIT, Range 18,
O R D E RPER B.C. MEENA, ACCOUNTANT MEMBER :
The assessee has filed this appeal against the order of Additional CIT, Range 18, New Delhi passed u/s 143(3) read with section 144C of the Income-tax Act, 1961 for the assessment year 2006-07. The grounds raised in the appeal are as under :-
“1. That on the facts and in the circumstances of the case and in law, the order passed by the Ld. Assessing Officer (“Ld. AO”) under section 143(3) read with section 144(C) of the Act is bad in law and void ab-initio.
2. That on the facts and in circumstances of the case and in law, the Ld. AO erred in assessing the returned income of the appellant of Rs. Nil at Rs. 186,681,654.
4.1 That the Ld. AO, erred on facts & in law, in disallowing the benefit of section 80-IB of the Act to the Appellant stating that Forms No.10 CCB are in the name of Joyco India Private limited (amalgamating Company) and not in the name of Wrigley India Private limited (amalgamated Company).
4.2 That the Ld. AO, erred on facts & in law, in coming to the conclusion that Joyco India Private limited ceases to exist on the date of approval of scheme of amalgamation by Honourable High Court of Delhi on September 08, 2006.
4.3 That the Ld. AO, erred in not appreciating that the scheme of amalgamation between Joyco India Private limited and Wrigley India Private limited became effective only when certified copy of Honourable High Court order approving the scheme of amalgamation was filed with Registrar of Companies, NCT of Delhi and Haryana on October 13, 2006.
4.4 That the Ld. AO, erred on facts & in law, in concluding that after amalgamation of Joyco India Private limited (amalgamating company) with Wrigley India Private limited (amalgamated Company), the amalgamated company has been formed in the name of Wrigley India Private limited.
4.5 The Ld. AO, erred on facts & in law, in concluding that the Appellant is not honouring the order of Hon’ble High Court of Delhi approving the scheme of amalgamation by claiming deduction under section 80IB of the Act on the basis of Form 10CCB issued to Joyco India Private limited (amalgamating company) dated October 10, 2006, which was not in existence on that date as the Hon’ble High Court order approving the amalgamation was passed on September 8, 2006.
4.6 The Ld. AO, erred on facts & in law, in concluding that in case certificates of accountant in Form No 10CCB issued to Joyco India Private limited (amalgamating Company) has legal sanctity beyond October 12, 2006; then it implies that Joyco India Private limited (amalgamating Company) existed even after October 12, 2006 although amalgamation order between Joyco India Private limited (amalgamating company) with Wrigley India Private Limited (amalgamated Company) was filed with Registrar of Companies on October 13, 2006.
4.7 That the Ld. AO, erred on facts & in law, in holding that the Appellant has made a false claim of deduction under section 80-IB of the Act and had desperation to evade tax liabilities.
4.8 That the Ld. AO, erred in not appreciating that scheme of amalgamation approved by Honourable High Court of Delhi itself provided for rollover of benefits of section 80-IB of the Act from Joyco India Private limited to Wrigley India Private limited.
4.9 That the Ld. AO, grossly erred on facts in stating that half of the six manufacturing units of the Appellant are not eligible to deduction under section 80-IB of the Act for the assessment year under consideration.
4.10 That the Ld. AO, erred on facts and in law in invoking the provisions of clause (ii) of sub section (2) of section 80-IB of the Act holding that plant and machinery belonging to Joyco India Private limited have been transferred to new entity, Wrigley India Private limited by virtue of merger between the two entities.
4.11 That the Ld AO grossly erred on facts and in law in presuming that Forms No 10CCB were in the name of Joyco India Private Limited (amalgamating company) because auditors of Wrigley India Private limited may not have endorsed the idea of management to claim deduction under section 80IB of the Act when auditors of both Joyco India Private limited and Wrigley India Private Limited were the same.
4.12 That the Ld. AO, erred on facts and in law in ignoring the provisions of section 80-IB (12) of the Act.
4.13 That the Ld. AO, erred on facts in stating that Appellant was disallowed the benefit of section 80-1B of the Act in earlier years for Unit II of Plain toffees, Unit III of Lollipop, Unit IV for Gum base, Unit VI for Chewing Gum when the denial was only for Unit IV for Gum base.
4.14 That the Ld AO, erred on facts and in law in not following the order of Honourable Delhi Tribunal dated December 19, 2008 in the case of Appellant for the Assessment Year 2003-04 wherein the benefit of section 80-IB was conferred to the Appellant for Unit IV for Gum base and the only dispute was with respect to the determination of market value of the transferred goods.
4.15 That the Ld. DRP/AO, erred on facts and in law in not granting the benefit of section 80-IB of the Act to the Appellant even on the basis of Form 10CCB in the name of Wrigley India (amalgamated Company) submitted during the course of proceedings before it.
4.16 That the Ld DRP/AO erred on facts and in law in holding that deduction under section 80IB of the Act was denied in the draft order of AO on the ground that the Appellant is manufacturing articles and things mentioned in the eleventh schedule.
5. That the Ld. AO erred on facts and in law, in disallowing the claim of brought forward losses and un absorbed depreciation amounting to Rs. 10,21,45,290 adjusted against the taxable income of the Appellant for the captioned year and dis allowance of balance brought forward losses and un absorbed depreciation amounting to Rs. 66,19,39,751.
5.1 That the Ld. AO erred on facts and in law in concluding that provisions of section 72A of the Act are applicable to the amalgamation between Joyco India Private Limited (amalgamating Company) and Wrigley India Private limited (amalgamated Company) wherein Joyco India, a profit making entity is amalgamating with Wrigley India, a loss making entity.
5.2 That the Ld AO has erred on facts and in law by not appreciating that in case of amalgamation of a profit making company (amalgamating company) with the loss making company (amalgamated company), the losses of the amalgamated company prior to amalgamation are carried forward under section 72 of the Act and section 72A of the Act has no role to play in such a scenario.
5.3 That the Ld. AO erred on facts and in law in concluding that provisions of section 78(2) of the Act are applicable to the facts of the case under consideration.
5.4 That the Ld. AO has erred on facts and in law in concluding that the facts of the case clearly establish that amalgamation of Joyco India Private limited (amalgamating Company) and Wrigley India Private limited (amalgamated Company) is a case of organised tax evasion and is a colour able device to evade taxes.
5.5 That the Ld. AO erred on facts and in law in holding that amalgamation scheme of profit making entity with loss making entity is against the principles of commercial prudence.
5.6 That the Ld. AO erred on facts and in law in holding that Honourable Delhi Court has approved the scheme of amalgamation for the purpose of Companies Act, 1956 and not for the purpose of Income tax Act, 1961.
5.7 That the Ld. AO has erred on facts and in law in holding that many of the undertakings of Joyco India Private limited have completed more than 10 years, which is the statutory time limit for claiming deduction under section 80lB of the Act.
6. That on the facts and in circumstances of the case and in law, while undertaking the addition of Rs. 2,70,35,000/- the Ld. DRP 1 Ld. AO has grossly erred:
6.1 in determining the arm’s length adjustment to the Appellant’s international transactions from Associated Enterprises (AEs) and thereby enhancing the returned income of the Appellant by Rs. 2,70,35,000.
6.2 in rejecting the transfer pricing methodology adopted by the Appellant and by selecting CPM as the most appropriate method for determining arm’s length price of the international transactions undertaken by the Appellant based on subjective presumptions.
6.3 in not appreciating the fact that the there are material differences between the domestic and export segment of the Appellant, and accordingly, the gross margins of the export and domestic transactions are not comparable.
6.4 in not appreciating the approach followed by the Appellant of separately benchmarking the international transaction relating to the contract manufacturing activity using TNMM as the most appropriate method.
6.5 in not appreciating the Appellant’s notification submitted before the Ld. DRP of an error made in the computation of gross profit on cost for the purpose of segmental analysis, submitted to the TPO vide submission dated 23 October 2009.
6.6 by denying the benefit of (+/-) 5% mentioned in the proviso to section 92C(22) of the Act to the Appellant.
9. That the Ld. A.O. erred on facts and in law in initiating the prosecution proceedings against the Appellant under section 276C, 277A, 278B of the Act.”
“7.1 Deduction u/s 80IB of the Act
During the year M/s Jayco India Private Ltd. was amalgamated with M/s Wrigley India Pvt. Ltd. as per the order of Hon’ble Delhi High Court dated 08/09/2006. The assessee has furnished certificate of accountant in Form No. 10 CCB dated 10/10/2006 in the name of Jayco India Private Ltd. to claim deduction u/s 10IB. The AO has rejected the claim of the assessee as the corporate existence of Jayco India Private Ltd. ceased to exist on the date of High Court order. The assessee has submitted that the Jayco India Private Ltd. is wound up without dissolution w.e.f. the appointed date specified in the scheme of the high court order but from the effective date 13/10/2006 which is date of filing of the certified copy of the high court order with the ROC within five weeks of the order of the Hon’ble High Court as specified in the order of the Honourable High Court. Hence, the assessee submitted that the 10CCB certificate dated 10/10/2006 is perfectly valid and hence deduction u/s 80IB of the Act should be allowed. The assessee has also relied upon various judicial pronouncements.
We have gone through the submission made by the assessee, the assessment order. It is seen that the deduction u/s 80IB of the Act is denied by the AO on the other grounds also that it is manufacturing articles and things mentioned in the eleventh schedule specifically confectionery and chocolate. It is also seen that in the earlier assessment years the deduction was not allowed on this ground. The assessee has pointed out that the Honourable ITAT has granted the benefit u/s 80IB of the Act in the earlier years. However, since the issue is being litigated and has not attained the finality, we decline to interfere in the order of the AO.”
6. Learned AR submitted that all the allegations made by Assessing Officer and by the DRP are factually incorrect. He submitted that the amalgamation order was approved by the Honourable Delhi High Court in its order dated 8.9.2006 which became effective from 13.10.2006 on filing of the copy of order of Honourable Delhi High Court with Registrar of Companies, NCT of Delhi and Haryana. As per the claim of the amalgamation, all the assets, liabilities and reserves of JIPL were transferred to and vested with the amalgamated company ceased with effect from the appointed date, i.e. 1.4.2005 which is clearly mentioned in the order of the Honourable Delhi High Court, copy of which is placed in the paper book at page 86 to 127. He submitted that the filing of the copy of the order with the Registrar of Companies was a part of the scheme and mandatory requirement. The Honourable High Court directed the assessee to file the copies of the same with the Registrar of Companies within five weeks. The revised 10CCB certificate in the name of the appellant company was filed with the DRP as additional evidence. He pleaded that the copy of the same is placed at page 443 to 507 of the paper book. The deduction u/s 80IB is undertaking specific and deduction to be allowed to the amalgamating and amalgamated company in accordance with 80IB(12) of the Act. For this, he relied on the Board’s Instruction No.F.No.15/5/63-IT(AI) dated December 13, 1963. A copy of which was placed at page 508 of the paper book. He further pleaded that the only amalgamated company can claim deduction u/s 80IB of the Income-tax Act. He also pleaded that the dispute for deduction u/s 80IB is only in respect of Unit No.4, Gum base unit. The deduction u/s 80IB for the gum base unit was allowed in principle for assessment year 2003-04. For which, he placed the order at pages 532 to 570 of the paper book. He also pleaded that ITAT set aside the issue to the Assessing Officer only in view of the market value of the goods at the date of manufacture. For this, he placed relevant ITAT order at pages 571 to 580 of the paper book. He submitted that in pursuance of the ITAT order, the Assessing Officer allowed deduction for gum base unit. However, there was a reduction in the deduction u/s 80IB for that year for which the assessee preferred an appeal before the CIT (A) which is pending for decision. He also submitted that Assessing Officer has denied the claim u/s 80IB by heavily relying on the assessment order for assessment year 2005-06 which was passed on 31.12.2007 which is prior to the date of ITAT decision in assessment year 2003-04 which is dated 19.12.2008, therefore, the Assessing Officer cannot rely upon the assessment year 2005-06 when there is a contrary decision available from ITAT on the same issue. He also submitted that the denial of deduction on the ground that assessee is manufacturing article or things specified under Eleventh Schedule was also not justified in view of the provisions of section 80IB (4) wherein the unit set up in the backward states specified in the Eighth Schedule shall not attract the provisions of Eleventh Schedule. With regard to the Assessing Officer’s observations that half of the six manufacturing units are not eligible to claim of 80IB, learned AR submitted that this is factually incorrect. He pleaded that the units were allowed deduction in the preceding years and no such dispute arose. He submitted that the unit-wise claim of deduction attached with notes to computation filed with the return of income, the same is placed at page 228 of the paper book. He finally pleaded that the denial of deduction u/s 80IB to the assessee was based on incorrect appreciation of facts and legal position.
7. On the other hand, the learned DR submitted that the assessee company submitted form No. 10CCB on 10th October, 2006 in the name of JIPL, which was stated to be the amalgamating company in view of the order of Hon’ble High Court passed on 8.9.2006. Since the assessee has admitted that JIPL was legally existed till 12.10.2006, thus form no. 10CCB was taken in the name of JIPL and claim was made by the amalgamated company and not by the company in whose name the form 10CCB was issued for the relevant assessment year. During the relevant year, JIPL was not entitled to claim u/s 80IB since it was the 11th year of the Bubble Gum unit. He also pleaded that certificate was made in the name of JIPL but falsely the claim was made by the assessee. He also pleaded that the decision of Honourable High Court was dated 8.9.2006 in which the Honourable High Court has stated that the transfer-or company shall place all documents to the ROC within five weeks. Since the AR of the assessee is arguing that 10CCB was taken in the name of JIPL and since it was legally existed till 12.10.2006, he submitted that rectified certificate u/s 10CCB filed before the DRP/Assessing Officer was in the name of the assessee company. He pleaded that on the one hand, JIPL was in existent till 12.10.2006 and alternatively it also wanted to get the benefit of 80IB through backdoor on account of amalgamation, since it was itself not entitled to this claim. He pleaded that AR has argued that there were specific provisions of section 80IB(12) of the Income-tax Act under which the claim made by the assessee was justified due to amalgamation of the two companies, but he pleaded that the provisions of section 80IB(2)(ii) clearly prohibit any claim u/s 80IB if any new business is started. He pleaded that assessee has admitted that it has started new business since the items being manufactured were different from the one prior to amalgamation. He also pleaded that assessee has submitted vide its letter dated 29.12.2009 that the business of the assessee company is totally different from the business of JIPL and he relied on the order of the Assessing Officer and pleaded that conditions of 80IB (2)(ii) are fundamental and basic, which if not fulfilled, would dis entitle the assessee from making the claim u/s 80IB at all. He pleaded that the provisions of section 80IB (12) are only supportive in nature and cannot override the provisions of section 80IB (2)(ii). Hence there is no case of the assessee for making the claim u/s 80IB. He summarised his stand on the following three legs :-
“(i) No valid form 10 CCB has been filed by the assessee to claim 80-IB deduction, since the form was filed in the name of M/s Jayco India Pvt. Ltd., which has been claimed to exist till 12.10.2006. As elaborately discuss by AO in his order this certificate was deliberately manipulated to claim the deduction through the assessee company as M/s Jayco India Pvt. Ltd. could not have claimed it on its own account. The assessee cannot take conflicting stand regarding legal existence stand of M/s Jayco India Pvt. Ltd. If M/s Jayco India Pvt. Ltd. existed up to 12.10.02006, regular return should have been filed and 80-IB should have been claimed by it accordingly. However, if M/s Jayco India could not exist, there was no possibility of submitting a legal report through form 10 CCB in its name. Accordingly the claim u/s 80IB made by the assessee is not justified. And the AD s order needs to be upheld.
(ii) It has been clearly pointed out by the Assessing officer that since the assessee has accepted commencement of new business, the condition u/s 80-IB(2)(ii) was not fulfilled. The assessee’s claim u/s 80-IB (12) cannot override provision u/s 80- IB (2)(ii).
(iii) The appointed date of amalgamation as per the High Court’s order (page 91 of Paper Book,), has been stated to be 1.4.2005 or such other date as the High Court may direct. The assessee has been taking conflicting stands with regard to the existence of M/s Jayco India Ltd. on that date, with the idea of making unjustified claim u/s 80-IB.”
8. After hearing both the sides on the issue, we decide as under ;-
8.1 During the year under consideration, one of the companies JIPL which was also wholly owned subsidiary of the parent company of the assessee engaged in the manufacturing and sale of confectionery products, like, bubble gums, chewing gums, lollipops and toffees amalgamated with the assessee company. This amalgamation was approved by the Honourable High Court on 8.9.2006 and also became effective from 13.10.2006 on filing the claim and the order of the High Court with the Registrar of Companies, Govt. of NCT of Delhi and Haryana. As per this amalgamation order the appointed date was 1.4.2005 which is clear from the order of the Hon’ble High Court which reads as under-
“THIS COURT DOTH HEREBY SACNTION THE SCHEME OF AMALGAMATION set forth in Schedule-I annexed hereto and DOTH HEREBY DECLARE the same to be binding on all the shareholders and creditors of the Transfer-or and Transferee Companies and all concerned and doth approve the said scheme of amalgamation with effect from the appointed dated i.e. 1.4.2005.”
8.2 The Hon’ble Supreme Court in the case of Marshall Sons and Co. (India) Ltd. vs. ITO reported in 223 ITR 809, the Hon’ble Supreme Court had held that the date of amalgamation shall be the date specified in the scheme of amalgamation if not specified any other date. The relevant extract reads as under :-
“Held accordingly, reversing the decision of the High Court, that since the company courts had not only sanctioned the scheme of amalgamation as presented to them, but had also not specified any other date as the date of transfer/ amalgamation, it followed that the date of amalgamation/ date of transfer was the date specified in the scheme as the transfer date. In such a situation, it would not be reasonable to say that the scheme of amalgamation took effect on and from the date of the order sanctioning the scheme. The business carried on by the subsidiary company should be deemed to have been carried on for and on behalf of the appellant-company. This was the necessary and the logical consequence of the court sanctioning the scheme of amalgamation as presented to it. The order of the court sanctioning the scheme, the filing of the certified copies of the orders of the court before the Registrar of Companies, the allotment of shares, etc., might have all taken place subsequent to the date of amalgamation/ transfer, yet the date of amalgamation in the circumstances of this case would be January 1, 1982. Therefore, the notices issued by the Income-tax Office were not warranted in law.”
In the assessee’s case, the Honourable High Court has clearly specified and mentioned the appointed date in the amalgamation order itself. The amalgamation took effect on and from the appointed date of order, i.e. 1.4.2005. The business carried on by the subsidiary company during the intervening period from 1.4.2005 till the order of Hon’ble High Court became effective, deemed to have been carried on for and on behalf of the appellant company and this is the necessary and logical consequence of the order of the gross sanctioning the scheme of amalgamation as presented to it. In view of this, the pleadings put forth by the learned DR are not sustainable that the JIPL was in existence till the effective date of the Honourable High Court order. Since claim of amalgamation was passed by Honourable High Court on 8.9.2006, therefore, a fresh 10CCB certificate was made in the name of assessee company and filed before the DRP. This 10CCB certificate deserves to be considered for a claim of deduction u/s 80IB of the Income-tax Act. The provisions of section 80IB(2)(ii) reads as under :-
“80IB
(1)…..
(2) This section applies to any industrial undertaking which fulfils all the following conditions, namely:-
(i) it is not formed by splitting up, or the reconstruction, of a business already in existence:
Provided that this condition shall not apply in respect of an industrial undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such industrial undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section;
(ii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose;
(iii)
Provided that the condition in this clause shall, in relation to a small scale industrial undertaking or an industrial undertaking referred to in sub-section (4) shall apply as if the words “not being any article or thing specified in the list in the Eleventh Schedule” had been omitted.
Explanation 1.-For the purposes of clause (ii), any machinery or plant which was used outside India by any person other than the assessee shall not be regarded as machinery or plant previously used for any purpose, if the following conditions are fulfilled, namely:-
(a) such machinery or plant was not, at any time previous to the date of the installation by the assessee, used in India;
(b) such machinery or plant is imported into India from any country outside India; and”
8.3 The benefit of this section is not available to the industrial undertaking which has been formed by the transferee to a new business of machinery or plant previously used for any purpose. Assessee relied on Board instruction No. F.No. 15/5/63-IT(AI) dated 13th December, 1963 to support its claim wherein provided as under:-
“New industrial undertaking taken over by another assessee before the expiry of five years – Whether benefit of s. 84 available to successor for the remaining years
The Board agree that the benefit of s. 84 of the IT Act, 1961, attaches to the undertaking and not to the owner thereof. The successor will be entitled to the benefit for the unexpired period of five years provided the undertaking is taken over as a running concern.”
In view of above, the assessee is entitled to deduction u/s 80IB if other conditions are satisfied. Further the ITAT has also decided the allowability of deduction u/s 80IA(8) in the case of amalgamating company while deciding the ITA No. 1562/Del/2007 on 19.12.2008 wherein the ITAT held as under :
“5.2 We have considered the facts of the case and rival submissions. It is clear that the provision contained in section 80IA(8) is applicable to the facts of this case. But as earlier pointed out, what is required to be found out is “the market value of transferred goods on the date of transfer” in the Indian market. This has not been done either at the stage of the A.O. or at the state of the ld. CIT(A). Therefore, as suggested by the ld. Counsel, this matter is restored to the file of the AO for fresh adjudication after hearing the assessee. The matter shall be decided in the light of directions contained in this order as aforesaid. Thus, these grounds are also treated as allowed for statistical purposes.”
With regard to revenue’s claim that assessee is producing articles or things specified in Eleventh Schedule, we hold that units set up in backward states specified in Eighth Schedule will not attract the applicability of Eleventh Schedule. The units have been allowed deduction u/s 80IB in the preceding years. In the result, we allow grounds of appeal related to claim of deduction u/s 80IB of Income-tax Act.
9.Grounds No.5 to 5.7 are for not allowing the benefit of carry forward of losses of amalgamated company for the period prior to the amalgamation.
10. The learned AR submitted that the Assessing Officer has held that provisions of section 72A are applicable, hence the benefit of brought forward losses or un absorbed depreciation cannot be allowed. The Assessing Officer also held that brought forward losses and un absorbed depreciation cannot be allowed as provisions of section 79 has triggered. The Assessing Officer also held that provisions of section 78 are applicable on the facts of the case. The Ld. DRP has appreciated the proposition of the Assessing Officer and held as under :-
“7.2 B/f of losses and unabsorbed depreciation
The AO has denied the benefit of b/f losses and unabsorbed depreciation resorting to sections 72A, section 78 and 79 of the I. T. Act. The assessee has submitted that
a) Section 72A triggers only when losses of amalgamating company are to be carried forward by amalgamated company. In this case there are no losses in amalgamating company. The losses are only of amalgamated company and, therefore, provisions of section 72A are not triggered as amalgamated company can carry forward its losses under section 72 of the act.
b) Section 79 is not triggered as more than 51% of the shareholding has remained the same.
c) Section 78 is triggered only when predecessor has losses. In this case amalgamating company does not have losses and hence section 78 is not triggered.
We have gone through the submissions made by the AR. It is seen that the AO has extensively discussed this issue on pages 25 to 34 of the order. The AO has stated that the intention of the legislature is not to give benefit to a reverse case of amalgamation when profit making companies amalgamate into a loss making company. Though we do not agree with the AO about the applicability section 79 of the Act as more than 51% of the shareholding has remained the same but it is pertinent to note that Jayco India Pvt. Ltd. has exhausted the claim u/s 80IB of the Act has many of its undertakings have completed more than 10 years which is the statutory limit for claiming the deduction and therefore, its profits are liable to taxed as discussed by the AO on page 31 of the order. We agree with the AO that the Honourable Delhi High Court has approved the scheme of amalgamation for the purpose of company Act, 1956 and not for the purpose of I. T. Act, 1961. The AO has also stated that the assessee company being the amalgamated company has not proved that the amalgamation is for a genuine business purposes and it is nothing but a colour able device to evade taxes. He has also relied upon the decision of Honourable Supreme Court in the case of McDowell Company Vs. CTO 154 ITR 148 and other judicial pronouncements. In view of the discussion above and the facts discussed in details in the assessment order we decline to interfere in the order of AO.”
11. The learned AR submitted that amalgamation took place between JIAL (amalgamating company) and Wrigley India Pvt. Ltd. (assessee company). He pleaded that the provisions of section 72A triggers only when the losses of the amalgamating company are to be carried forward by the amalgamated company. Therefore, section 72A is not applicable in the assessee’ s case. In this case, the losses were incurred by the amalgamated company and which have been carried forward and set off in the subsequent years. The learned AR also submitted that DRP has held that the provisions of section 79 are not applicable as more than 51% of the shareholding is in the same hands. He further submitted that DRP has accepted that provisions of section 79 are not applicable to the facts of the assessee’ s case. The provisions of section 78 are applicable only when predecessor has losses. In the assessee’s case, the amalgamating company does not have losses and hence section 78 is not applicable. He pleaded to delete the additions.
12. The learned DR pleaded that the provisions of section 72A are clearly applicable and also submitted written arguments as under :
“The important facts and observations are summarise as follow:
a) The provisions of section 72A are clear, and has also been confronted with the assessee wherein it has been highlighted the applicability of this provision to carry forward and set off accumulated loss and un absorbed depreciation, the same should pertain to “amalgamating company”.
It has been specifically highlighted by the AO on page 31 & 32 of the Asst. Order that the provision sub-section 72A are not applicable to the facts of the present case. The section allows such brought forward losses/un absorbed deprecation only in the case of “amalgamating company” and not in the case of “amalgamated company”. The underlying logic and intention of Income-tax Act was only to support weak loss making amalgamating companies to benefit from this provision. It is trite law that when a specific provision has been made, in this case, only to provide benefit to amalgamating company, the same cannot be extended to benefit any other situation which has not been mentioned in the Act itself.
(ii) In the present case from the facts it is clear that the assessee company has been making regular losses from 96-97 to 2005-06, whereas the amalgamating company, M/s Jayco India Pvt. ltd. has been making profits for various years and claiming deduction u/s 80-IB. The assessee has not been able to justify as to how the claim u/s 72A has been made in a reverse situation of the amalgamated company having sustained losses, while the amalgamating company has been having regular profit.
The DRP has also approved the observation and findings of the Assessing Officer and reiterated that the assessee had not amalgamated for a genuine purpose, but for evading taxes (page 35 & 36 of the assessment Order).
Accordingly, the assessee has no case for claiming the benefit u/s 72A of the Income-tax Act. The order of the Assessing officer/ DRP therefore deserves to be upheld, so far as the dis allowance under section 72A has been made.”
13. After hearing both the sides, we hold that the provisions of section 72A are applicable when the amalgamating company is engaged in the business and have accumulated loss or un absorbed depreciation. Certain conditions have been specified in section 72A(2) but these are applicable only when amalgamating company having carried forward loss and un absorbed depreciation. In assessee’ case, the amalgamating company is not having carried forward loss and un absorbed depreciation. In this case, the amalgamating company was a profit making company therefore, these provisions are not applicable. More than 51% shareholding remain in same hands which fulfils the condition laid out in section 79 of the Income-tax Act. The DRP has already held that the provisions of section 79 are not applicable to the assessee’ s case as more than 51% of the shares remained in the same name. Further the Honourable High Court has approved the scheme of amalgamation. Therefore, we are unable to agree with the observations of Assessing Officer that the amalgamation was not for genuine business purposes and it was a colour able tax device. Similarly, the provisions of section 78 of the Income-tax Act are also not applicable to the facts of the assessee’s case as assessee is a company. These provisions are only applicable when there is a change in the constitution of the firm or on succession. The provisions of section 78 read as under :-
“78. [(1) Where a change has occurred in the constitution of a firm, nothing in this Chapter shall entitle the firm to have carried forward and set off so much of the loss proportionate to the share of a retired or deceased partner as exceeds his share of profits, if any, in the firm in respect of the previous year.]
(2) Where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance, nothing in this Chapter shall entitle any person other than the person incurring the loss to have it carried forward and set off against his income.”
Thus, the provisions of section 78 are also not applicable in assessee’ s case as it is not a firm and amalgamating company was not having loss. Considering all these aspects, we set aside the orders of the authorities below on this issue and allow these grounds of assessee’ s appeal.
The company has reported following major international transactions in form 3CEB –
|
S.No. |
International Transaction |
Method used By Assessee |
Value in |
|
Import of material |
TNMM |
23,258,028 |
|
Export of manufactured products |
TNMM |
102,101,495 |
|
Intra group services received |
TNMM |
16,174,976 |
|
Export of machinery |
CUP |
774,668 |
|
Interest on loan |
CUP |
472,508 |
|
Cost reimbursement received |
On actual Exp |
2,781,258 |
|
7. |
Cost reimbursement paid |
On actual Exp |
109,556,521 |
| Total |
255,119,454 |
4. Transfer Pricing approach adopted by the assessee in A Y 2005-06:
As a primary analysis assessee had taken 7.5% as the markup on the budgeted cost for export (after excluding selling, general and administrative expenses). The assessee selected 07 broadly comparable companies, whose weighted average operating margin was 8%. As a secondary analysis, assessee has used TNMM as the most appropriate method with OP/TC as the PLI. Assessee had made capacity utilisation adjustment to the financials of the com parables. As a result or the capacity utilisation adjustment, the assessee showed lesser loss than that of the com parables. This was on the similar line of justification used by the assessee in the earlier years.
4.1 Transfer Pricing approach adopted by the assessee in A Y 2006-07:
For the year under consideration the assessee has adopted a transfer pricing approach based on the profitability earned by it on an entity wide level. Herein, Transactional Net Margin method has been used by the assessee to determine the arm’s length price of the international transactions undertaken by it. Based on the bench marking study conducted by the assessee on the public-ally available databases, the margin (operating profit/Total Cost) of the comparable companies was determined to be 8.07% while that earned by the assessee was 3%. No adjustment for capacity utilisation by the assessee has been done in this year.
”a) Applicability of Cost plus method :
Herein, we would like to bring to the notice of your good self that even as per OECD guidelines a cost plus method is more suitable where semi-finished goods are sold between related parties. However, in the instant case, your good self would appreciate the fact that most goods exported by the assessee are in completely finished form which are resold by the AE in their domestic market hence, use of cost plus method in case of assessee would not be appropriate.
b) Significant Related Party Transactions:
Herein, it may also be noted that as per the segmented financial used by the Ld. TPO during the previous year, most of the purchases even in the case of domestic segment were from associated enterprises. Thus, the gross margins earned in the domestic segment can not be deemed to be earned from uncontrolled transactions as they were influenced by related party transaction.
a) Significantly Different Market-
Your good self would appreciate the fact that the comparison of margins earned in domestic and export segment would not be a like to like comparison as export sales were made to the diverse geographical areas which include Middle East, Israel, Spain, and Kenya etc. Hence, the markets would have economic differentials like geographic location; the size of markets; the extent of competition in the markets and the relative competitive positions of the buyers and sellers and hence, these can not be used to make a comparison with domestic sales on gross margin basis.
b) Different Function and Risk Profile –
Your good self would appreciate the fact that for the sales of goods in the domestic segment the assessee also carries on additional functions on account of maintaining distribution network and also, on marketing and advertising its product. Thus, the assessee performs additional function for making sales in the domestic segment.
Further, even the risk profile in both the segments was completely different. Mentioned below are the key risk which were borne by the assessee in the domestic segment, however, were very minimal in the export segment.
Market’ Risk: The assessee incurs huge expenditure towards marketing and advertising its product in domestic market and thus, bears risk to the extent. As far as export segment is concerned most of the products are sold to associated enterprises which does not necessitates any marketing or advertisement expenditure.
Credit Risk: The dues of the assessee from its export segments are assured as most of the sales are made to associate enterprises however, in case of domestic segment the assessee is subject to credit risk.
Thus the assessee operates in a relative risk free environment in its export segment as compared to domestic segment.
We would like to bring to the notice of your good self that the cost structure of domestic and export segment of the assessee are completely different. In case of domestic segment the assessee incurs huge expenditure on advertising and marketing expenditure which are reflected in the operating expenses (below the gross margin line) of the company. Considering the fact that in case of export segment, most of the sales are made to the associated enterprise; the assessee need not incur any amount on marketing the products.
The above discussion clearly depicts that the functional profile of the assessee under its domestic and export segment are completely different. The assessee performs additional functions and assumes additional risk under its domestic segment and is bound to have different pricing basis under the two markets. Thus, domestic and export segment of the assessee are incomparable.”
7. The submissions of the assessee are careful1v examined and not found acceptable as per discussion below :-
The assessee’s argument that OECD guidelines provide that CPM should be applied in the case of semi-finished goods only is neither acceptable nor binding. The IT Rules clearly provide that if gross profit margins between closely identifiable transactions can be determined then CPM is the most appropriate method. The relevant provision is produced below :-
“Cost plus method is one by which –
(i) “The direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined;
(ii) The amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a member of such transaction, is determined.
As may be seen from above, the IT Rules only refer to transaction involving transfer or property or services. There is no mention of semi-finished goods as referred to by the assessee. In the case of Wrigley the same product using raw material from the same source is being manufactured in the same factory for the domestic and export markets. No closer comparison can be there for determining the gross profit margins of the two transactions than this.
Regarding the assessee’ s argument that related party transaction has a bearing on the assessee’s margin in the case of the domestic segment and is therefore not an uncontrolled transaction for the purpose of comparison, it can very well be argued that the effect is nullified since RPT has a bearing on the export segment also. The assessee has made purchase of raw material from its AE’s and the same raw material has been used for manufacturing the product for both the export and domestic segments. Accordingly, the cost being incurred by the assessee in purchase of raw materials is the same for both the segments and the impact of RPT is on both the segments equally and can therefore be ignored. Moreover the assessee has not been able to quantify the quantum of the transaction and it is not known whether related party transactions are more than 15% of the sales, the benchmark normally applied for evaluating the impact of a controlled transaction.
Regarding the assesses contention that products were sold in different geographical markets which may have different purchasing power, tastes and economy which may have a bearing on the price the same are found to be without substance, The assessee has made sales to AE’s in the Middle East, Israel, Spain, Kenya and South Africa. All these economies are much more advanced than India and so is the purchasing power of the people living in these countries. The assessees argument fails to justify the wide variation in the margins between the sales in the domestic market and the export based on the differences in the market.
Regarding the assesses argument that its return in the domestic market is better than the export market because it bears market risk which involves incurring huge expenditure towards marketing and advertising its product in domestic market does not make much business sense. Normally, incurring of expenditure on marketing and advertising would have the impact of reducing the profitability of an enterprise rather than the opposite. Secondly we are comparing the gross profit margins of both the segments which does not take into account expenses on marketing and advertising. Such expenses would have an impact on the net profit margins. In calculating the gross profit the same expenses are taken into account for manufacturing the product. The assessee has not been able to justify why there is a huge difference in the GP rate in the export and domestic segment. The low GP rate in the export segment clearly shows that the transactions is not at arm’s length.
Lastly it is a specious argument by the assessee that it uses un-utilised capacity only for export purposes. The principle of marginal pricing does not distinguish between domestic market sales or export sales. Since FOB prices are taken for the export sales, the statement that the assessee operates in two different markets will not hold water.
It is also a fact that two clearly comparable segment are available within the financial results of the company which is the tested party, i.e. the assessee. Therefore, a more proximate and direct comparable is available internally. In view of the above reasons, the contention of the assessee is rejected and internal Cost Plus method is used taking GP/Direct Cost of Production as the PLI.
8. The PLI and ALP of the international transaction of the assessee is worked out based on the segmental results submitted by the assessee (vide submissions dated 23.10.2009.)
WRIGLEY India
GROSS PROFIT & CONTRIBUTION WORKSHEET – YEAR 2005- 06
| Total |
Domestic |
Export |
Basis of |
|
| Company |
Allocation |
|||
| Production Volume in MT |
12,446 |
11,931 |
515 |
Actual |
| Sales Volume in MT |
12,512 |
11,914 |
598 |
Actual |
|
In Rs (000) |
||||
| Sales |
1,913,623 |
1,808,666 |
104,956 |
Actual |
| Less : Excise Duty |
(182,574) |
(182,574) |
Actual |
|
| Export Incentives |
664 |
– |
664 |
Actual |
| Variable Costs | ||||
| – Purchase of Traded Goods |
– |
– |
– |
– |
| – Ingredients |
449,707 |
474,949 |
24,758 |
Actual |
| – Wrapping Materials |
243,060 |
217,848 |
25,211 |
Actual |
| – Labor & Benefits |
14,157 |
13,472 |
685 |
Actual |
| – Direct Manufacturing Exp. |
12,506 |
10,777 |
1,729 |
Actual |
| – Stores & Spares- Distribution & Freight | 10,021 45,577 | 9,163 45,577 |
858 – |
Actual Actual |
| Sub Total |
925,028 |
771,787 |
53,241 |
|
| Contribution |
906,685 |
854,306 |
52,379 |
|
| Contribution % |
52.4% |
52.5% |
49.6% |
|
| Fixed Costs |
42,472 |
40,416 |
2,055 |
Actual Actual Actual Actual Actual Actual |
| – Lab-or & Benefits- Direct Manufacturing Exp.
– Factory Overheads (Stores & Spares) – Research & Development – Depreciation – (Accr) Decr: FG & WIP – Increase in FG |
||||
| Sub – Total |
246,378 |
218,806 |
2l7,572 |
|
| Total Variable & Fixed Costs |
1,071,407 |
990,593 |
80,814 |
|
| Gross Profit |
660,306 |
635,500 |
24,807 |
|
| Gross Profit % on sales |
38.10% |
39.10% |
23.50% |
|
| Gross Profit % on cost |
64.15% |
30.70% |
||
| Working of the ALP | ||
| GP/Cost in un controlled Transaction |
64.15% |
|
| Cost of Export Segment |
80,814 |
|
| ALP GP |
51,842 |
|
| GP Shown by the assessee in export segment |
24,807 |
|
| Adjustment to the Sales to bring it to Arm’s Length |
27,305 |
Therefore adjustment to the international transactions of Rs. 2,70,35,000/- to bring it to the arm’s length price. Assessing Officer may make an addition of Rs. 2,70,35,000/- to the total income of the assessee. No adverse inference is drawn in respect of the other international transactions involved in this case.”
16. The DRP has dealt the issue as under :-
“4. Transfer pricing issues
The various objections raised and the submission made by the assessee’s AR can be summarised as under :
The assessee has adopted TNMM as the most appropriate method (MAM) adopting profitability earned by it on the entity wide level. OP/ TC was used as the PLI. The assessee has objected for selecting internal CPM as the MAM by the TPO. The AR has submitted, the TPO entirely relied on the approach used by predecessor TPO while passing the TPO order for AY. 2005-06. The TPO has not considered the detailed submissions made with respect to the fact that there were significant differences in export and domestic transactions and hence they are not comparable. The assessee has further pointed out that the TPO while selecting the CPM and comparing the gross margins achieved form the export segment with that of the domestic segment failed to appreciate that the export sales are made with the difference strategy. The AR has further pointed out that besides economic difference and difference in geographical market, the gross margin from domestic/ exports sales cannot be similar as the functional and risk profile of the assessee under these two segments are significantly different. The assessee has also submitted that the TPO has arbitrary rejected the economic adjustment for excess advertisement cost incurred by the assessee to bring it at par with the com parables companies.
We have carefully considered the submissions made, the TPO’s order and the relevant records. The TPO while justifying the adoption of CPM has stated that the entire export is to the related parties and the products are manufactured in the same factory. Hence, using the direct cost of the production, GP margin can be easily worked out. Cost base of the assessee is by and large with the unrelated parties. Compare to the export to the unrelated parties the import of raw material from the related party is less than 15%. It is seen that this method has been consistently used by the TPO in the last two assessment years. The TPO asked the assessee vide order sheet noting dated 13/01/2009 to show cause why the same method should not be used in this assessment year also. We have noticed that similar submissions were made before the TPO which are discussed by him in detail in para 6 and 7 of the order. We agree with the view of the TPO that two clearly comparable segment are available within the financial results of the assessee company which is the tested party. Hence a more direct and proximate comparable is available internally. Thus, internal Cost Plus Method used by the TPO taking GP/Direct Cost of production as the PLI is justified. Hence, the assessee’s objections ate rejected.”
17. The Assessing Officer has finally decided on this issue as under :-
“ During the year under consideration, the case has been referred to TPO and TPO order dated 27-10-2009 has been received on 30-10-2009. The TPO has held that an adjustment of the international transaction of Rs. 2,70,35,000/- to bring into the ALP. On receipt of TPO’s order assessee company has been asked to submit an explanation. However, assessee’s explanation is not accepted.
The Dispute Resolution Panel-II, New Delhi in its order dated 29-09-2010 communicated vide F.No.DRPII/Del/13212010-11/167 dated 29/30-09-2010 justified the adjustment made by the TPO. The relevant portion of the directions of the Dispute Resolution panel in this connection is reproduced here under:
“4. Transfer pricing issues
The various objections raised and the submissions made by the assessee’s AR can be summarized as under. .
The assessee has adopted TNMM as the most appropriate method (MAM) adopting profitability earned by it on the entity wide level. OP/TC was used as the PLI. The assessee has objected for selecting internal CPM as the MAM by the TPO. The AR has submitted, the TPO entirely relied on the approach used by predecessor TPO order for A.Y. 2005-06. The TPO has not considered the detailed submissions made with respect to the fact that there were significant differences in export and domestic transactions and hence they are not comparable. The assessee has further pointed out that the TPO while selecting the CPM and comparing the gross margins achieved from the export segment with that of the domestic segment failed to appreciate that the export sales are made with the difference strategy. The AR has further pointed out that besides economic difference and difference in geographical market, the gross margin from domestic/exports sales cannot be similar as the functional and risk profile of the assessee under these two segments are significantly different The assessee has also submitted that the TPO has arbitrary rejected the economic adjustment for excess advertisement cost incurred by the assessee to bring it at par with the com parables companies.
We have carefully considered the submissions made, the TPO’s order and the relevant records. The TPO while justifying the adoption of CPM has stated that the entire export is to the related parties and products are manufactured in, the same factory. Hence, using the direct cost of the production, GP margin can be easily worked out. Cost base of the assessee is by and large with the unrelated parties. Compare to the export to the unrelated parties the import of raw material from the related party is less than 15%. It is seen that this method has been consistently used by the TPO in the last two assessment years. The TPO asked the assessee vide order sheet noting dated 13/0112009 to show cause why the same method should not be used in this assessment year also. We have noticed that similar submissions were made before the TPO which are discussed by him in details in para 6 and 7 of the order. We agree with the view of the TPO that two clearly comparable segment are available within financial results of the assessee company which is the tested party. Hence a more direct and proximate comparable is available internally. Thus, internal Cost Plus Method used by the TPO taking GP/Direct Cost of production as the PLI is justified. Hence, the assessee’s objections are rejected.
• Reference to TPO
The objection raised by the assessee is unfounded because the reference to the TPO was made by the AO with the prior approval of the CIT. As held by the special bench of the Bangalore ITAT in the case of Aztec Software and Technology Services Pvt. Ltd. 107 ITD 141 (Bangalore) (SB), it is not a condition precedent for the AO to either record his opinion or reasons or to provide the assessee an opportunity of hearing for referring the matter to TPO. As the AO has made the reference with the of CIT, the assessee objection is rejected.
• Proviso to Section 92C(2) of the Act
The next objection of the assessee is that the TPO has erred in not allowing benefit of +/- 5% while determining the ALP. This Legal objection of the assessee is not maintainable. Amendment to the proviso to section 92C (2) only stipulates that if the difference in the arms length price arrived at by the TPO/Assessing Officer and the transfer price shown by the assessee is less than 5% of arms length price shown by the assessee then for the purpose of making assessment variation in the income will not be made on this account. Since in this case the difference between the arms length price shown by the assessee, exceeds 5% of the arm’s length price i.e. the margin shown by the assessee no benefit is allowable to the assessee on this ground.”
In view of the detailed discussion made by the TPO in her order dated 27-10-2009 and keeping in view the directions of the DRP, rejecting the assessee’ s objections an addition of Rs. 2,70,35,000/- is made in the hands of the assessee.”
18. We have heard both the sides in details and we have also perused the material available on record and also considered the case laws relied upon by both the sides. After perusing all the relevant record submitted before us, we find that the following facts are undisputed :-
The total turnover of the assessee was Rs. 191.3 crores out of which Rs. 10.4 crores were out of exports. The raw material plus packing material consumed was of Rs.74.2 crores and out of which the imported was of Rs. 10.7 crores which comes to 14% of the raw material consumed. The domestic sales of the assessee were to the unrelated parties. The exported goods were completely in finished form. The export of goods were made to following as under :-
|
Sr No. |
Particulars |
Amount (Rs.) |
|
1 |
Wrigley Dubai (U.A.E.) | Rs. 7,02,43,130/- |
|
2 |
Wrigley Spain | Rs. 1,54,35,954/- |
|
3 |
And others | Rs. 1,80,69,092/- |
Thus, majority of exports around 82% were to U.A.E. and Spain. The goods sold in domestic market to unrelated parties and the export made to related parties have been manufactured by the same raw material in the same factory. The assessee adopted the TNMM (Transactional Net Margin Method) method to determine the arms length price. The transfer pricing authority has adopted the cost plus method to work out the arms length price.
19. We have considered the pleadings of the assessee with regard to method adopted and had also gone through the order of ITAT, L Bench, Mumbai in ITA No.3557/Mum/2006 in the case of M/s. Chiron Behring Vaccines Pvt. Ltd. vs. ACIT, 201 1-TII-30-ITAT-MUM-TP. In this case, the ITAT has observed as under :-
“4.10 The assessee has adopted ALP by comparing the export operating profits of the assessee company with the valuation of operating profits of the other companies which are taken as comparable companies selected by it. We further note that the other comparable are not manufacturing vaccines and the operating profits of the comparable are taken at enterprises level instead of export / international transactions level. The assessee has not taken the same class of transactions for comparing the profit with the com parables. When the comparables are not licencee manufacturers of the similar commodity then it would not satisfy the requirement of the law as well as the Rules prescribed under the Statute. The provisions of law requires the comparison between the net margin realized from the operation of the uncontrolled parties transactions and the net margin derived by the Associate Enterprises on similar transactions/operation. The AO has also not followed the correctmethod and procedure while making the adjustments in the Arm’s Length Price. The AO has applied the adjustment made by the TPO who has taken the comparison between the assessee’s international transaction with its domestic transactions which is also against statutory requirement. Thus, it is clear that the provisions of Act and Rules have not been followed either by the assessee or by the AO. In the cases cited by the learned DR(supra), this Tribunal has consistently held that (TNMM) requires the comparison of net margin realized by the enterprises from international transactions or aggregate of international Transactions and not comparison of operating the margin of the enterprise with the operating margin of the com parables of enterprise level. Therefore, the comparison of net profits margin realised by the assessee from the international transactions should be compared with the net profit margin of the uncontrolled parties transactions realised by enterprise which is unrelated and from the comparable uncontrolled transactions.
4.11 In view of the above discussions, as well as, the decisions of this Tribunal as relied upon by the learned DR, we hold that the transfer pricing adjustment suggested by the TPO are not as per the provisions of law. At the same time, the assessee has also not adopted the correct method of determination of TNMM. Therefore, the issue is set aside to the file of the AO for fresh adjudication in accordance with law.”
Thus, Assessing Officer had applied the adjustment made by the TPO by comparing between the assessee’ s international transaction with its domestic transaction and the same is held against statutory requirement and on this basis, the matter was remanded to Assessing Officer for fresh adjudication. We have gone through the decision and from the decision, we find that the assessee has made a plea in the submissions that the comparison of the domestic margin on the domestic sales with the margin of export sales while passing the order u/s 92CA(3) is against the law and statute. In this case, the method adopted by both TPO and asses see to compute the arm’s length price (ALP) was TNMM. Assessee had not demonstrated how this method was against the law and statute and it has also not been elaborated. The ITAT Bench has also not elaborated, how the comparison between international transactions with related parties and unrelated domestic transactions are not as per statutory requirement. Moreover, in this case, the method is different than the method adopted by TPO in assessee’ s case. The provisions in Chapter X are special provisions relating to the avoidance of the tax in which the computation of income from international transactions have to be determined having regard to the arms length price and the arms length price in relation to an international transaction shall be determined by the most appropriate methods as provided in section 92C having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe. Section 92C prescribes six methods, namely,
(a) comparable uncontrolled price method;
(b) the sale price method;
(c) cost plus method;
(d) profit split method;
(e) transactional net margin method; and
(f) such other method as prescribed by the Board.
The most appropriate method shall be applied for determination of arms length price as provided in the Rules. The Rule 10B provides about the manner in which the most appropriate method for determination of arms length price in relation to an international taxation has to be determined. In this Rule, nowhere it is provided that comparable uncontrolled transaction shall be only an international transaction. The Rules provide for adjustment for differences. The “uncontrolled transaction” in comparison of the arms length price has been defined in Rule 10A for the purpose of Rule 10B to 10E as under :-
“ “Uncontrolled transaction” means a transaction between enterprises other than associated enterprises, whether resident or non-resident.”
Thus Rules provide that uncontrolled transaction may also be with resident which could be taken for comparison. The cost plus method adopted by the TPO to work out the arms length price provides as under :-
“(c) cost plus method, by which,—
(i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined;
(ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined;
(iii)the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit markup in the open market;
(iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii);
(v) the sum so arrived at is taken to be an arm’s length price in relation to the supply of the property or provision of services by the enterprise”
In this method, the direct and indirect costs of production incurred by the enterprises in respect of property transferred or services provided to an associated enterprise are determined and the amount of normal gross profit mark-up to such costs arising from the transfer or provision of the same or similar property or services by the enterprises or by an unrelated enterprise in a comparable uncontrolled transaction. In the assessee’ s case, the products which have been sold in the domestic market to the unrelated parties and exported to the related parties are produced in the same factory with same raw material. The cost base of the asset is also by and large with the unrelated parties. As it is clear that the raw material purchased from the associated enterprises was only 14%. Hence, direct and proximate comparable is available internally. Therefore, internal cost plus method taking GP/Direct cost of production as PLI is justified. In view of this, we uphold that the method adopted by the authorities below to determine the arms length price.
20. The assessee’ s plea that the cost plus method is more suitable to the situation where the semi-finished goods are sold to the associated enterprises is also not a justified stand taken by the assessee. The Rules prescribed for determination of arms length price with the method of cost plus method does not provide any such thing. The assessee is exporting completely finished products produced in the same manufacturing unit with the same raw material with mostly unrelated cost base, therefore, we hold that the cost plus method is a most appropriate method to determine the arms length price. As provided in the Rules, the comparability of an international transaction with the uncontrolled transaction is to be judged with reference to the specific characteristics of the property transferred in either transaction. In assessee’ s case, the characteristics of the property transferred to the associated enterprises and to the unrelated parties were not having any significant different or any specific different characteristics. There is no substantial product differentiation. Only manufacture of brands to make product differentiation shall not effect the cost base for working out normal gross profit mark-up. The function performed and the asset deployed were of the similar magnitude. The risk assumed regarding the expenditure incurred towards the marketing and advertising of the product in the domestic market also does not justify any significant difference which could materially affect the profit mark-up as direct cost. India is a developing country. The expenditure on marketing and advertising of product will rather reduce the market risk by making a stable market in the domestic segment. Since the marketing and advertising expenditure has to be also incurred by the associated enterprises to market the product in their respective territories, therefore, we have considered this aspect for making some adjustments as provided in Rule 10B(1)(c)(iii). The credit risk in transaction with unrelated parties in the domestic market and the transactions to the related associated enterprises are not having any very significant difference which may materially affect the determination of the gross profit mark-up on the cost. Credit sales are also made to associate enterprises for 30 days. However, a small adjustment to profit mark-up as provided in the Rules is being made for this aspect. As regarding the claim in respect of the locations of the different related associated enterprises and different geographical market, we would like to state that the majority of the exports were made to the Middle East UAE and Spain (around 82%) where the per capita income is much higher than the India. The goods produced by the assessee are the goods which are not the necessity of life but these are the goods which are normally consumed by the middle or upper strata of the society. The per capita income of countries where these associated enterprises are located are better than India. In our considered view, the geographical location of these markets and type and size of the markets must have made rather positive impact on determination of the gross mark-up on the cost rather than a negative impact in comparison to the domestic segment. The most of economies of countries in which the associated enterprises located are more advanced economies in terms of per capita income than Indian economy. The purchasing power of people in UAE and Spain is more than India. Therefore, the impact on the gross profit margin must be a positive impact in comparison to the domestic segment. Assessee’ s claim regarding huge expenditure of marketing and advertising for the domestic segment shall reduce the net profitability for domestic market rather than increasing it. However, the gross profit margins are being compared which are not taking into account the expenses of marketing and advertising on both the segments as these expenses are finally having impact on the net profit margins only. Considering all the relevant factors which are relevant for applying the cost plus method including the geographical location of the markets, size of the market, extent of the production in the market, relative purchasing power of the consumers in both the markets, the risk profile like market risk and credit risk, we are of the considered view that the domestic margins earned by the assessee are the best and direct comparable to determine the arms length price in relation to the international transaction.
21. The assessee has also raised the issue regarding denying the benefit of +/- 5% provided in Proviso to Section 92C(2) of Income-tax Act. On this issue, after hearing both the sides, we hold that this objection of the assessee is also not maintainable. The amended Proviso to Section 92C(2) only stipulates that the taxpayer has the option to choose transfer price which may not vary +/- 5% from the mean arm’s length price determined under the most appropriate method. In such cases, the TPO will not make any adjustment if the transfer price adopted by the tax payer in its books of account differs by not more than +/- 5% from the arm’s length price determined by the most appropriate method. But these provisions do not say anything in respect of the difference between the arm’s length price determined by most appropriate method and the transfer price adopted by the taxpayer is more than +/- 5% from the mean of arm’s length price. In our considered view, this +/- 5% safe harbor was available to the taxpayer only if the value of international transaction is within +/- 5% from the arithmetical mean. If the value of the international transaction is beyond +/- 5% from arithmetical mean, the transfer pricing adjustment has to be made from the arithmetical mean of prices as determined by the most appropriate method. When the variation exceeds 5% of the arm’s length price the assessee shall not get benefit. The ITAT, Visakhapatnam Bench in the case of ACIT, Circle 3 (1) Vs. Essar Steel Limited, 131 ITD 22 (Visakh.) had considered the issue in the light of Board Circular and amendments by Finance Act, 2002 and held as under :-
“It can be seen that the Finance Act, 2001 has inserted new sections 92 and 92A to 92F in the place of old section 92. The above said circular has been issued in order to explain the amendment from the assessment year 2002-03 onwards.
Under the proviso to section 92C(2) as inserted by the Finance Act, 2001, only arithmetical mean of the prices has to be taken and the statute did not provide for any concession. Hence, considering the practical difficulties, it appears that the CBDT has issued Circular No. 12, dated 23- 8-2001, which was relied upon by the asses see, in order to give concession of +/-5 per cent. Though the CBDT has explained the amendments brought out by the Finance Act, 2001 in a subsequent Circular No. 14, dated 12-12-2001, yet it did not prefer to refer there in, its previous Circular No. 12, dated 23-8-2001.
However, it is pertinent to note that the Finance Act, 2002 has amended the above said proviso section 92C(2) with effect from 1-4-2002, i.e., the amendment so made shall also be applicable from the assessment year 2002-03 on wards.
It is interesting to note that the Finance Act, 2001 has originally inserted section 92C along with the impugned proviso with effect from 1-4-2002, i.e., the assessment year 2002-03 on wards. However, the Finance Act, 2002 amended the proviso so inserted by the Finance Act, 2001 and the amended proviso was also made applicable from 1- 4-2002, i.e., the assessment year 2002-03 on wards, meaning thereby, the proviso, which was inserted by the Finance Act, 2001, never came into operation. It can be noticed that the Circular No. 12 of 2001 was issued only to explain the amendments made by the Finance Act, 2001, which never came into operation.
Now the question that arose was whether an assessee could place his reliance on a circular issued for explaining certain provisions, which never came into operation. The CBDT derives its power to issue the circulars from section 119.
The CBDT is empowered under section 119 to issue such orders, instructions and direction to other Income-tax authorities, as it may deem fit for proper administration of Act. In the instant case, the proviso, for which the Circular No. 12 (supra) was issued, had never come into operation and, hence, the question of the administration of the said proviso to section 92C(2) did not arise at all In view of the subsequent amendment brought in by the Finance Act, 2002, the said circular had become otiose. In view of the above, assessee could not place reliance on the Circular No. 12 and for the year under consideration, only the proviso to section 92C(2), as amended by the Finance Act, 2002 was applicable. In that case, the said proviso shall apply only if the ‘most appropriate method’ results in more than one price, in which case the arithmetical mean of such prices shall be taken as the ALP. However, the assessee shall have an option to adopt a price which may very from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.
In the instant case, only one price had been determined under ‘most appropriate method’. Hence, the question of application of the proviso did not arise. Accordingly, the assessee was entitled to the concession, as prescribed in the proviso to section 92C(2). Accordingly, the order of the Commissioner (Appeals) was to be revised and the order of the Assessing Officer was to be restored.”
In view of these facts, we hold that the assessee’ s plea has no merits.
22. Taking all material into consideration and giving due weightage to the relevant factors as stated above including small market and credit risk, we direct to adopt 60% as profit margin mark-up on the direct cost. In view of these, grounds of the assessee are partly allowed.
25. In the result, the appeal of the assessee is partly allowed.
Order pronounced in open court on this 5th day of August, 2011.
