No TP adjustmentas for expenses disallowed by assessee sou-motu

ITAT PUNE BENCH ‘A’

Eaton Technologies (P.) Ltd

versus

Deputy Commissioner of Income-tax

IT Appeal No. 1621 (PN) of 2011
[ASSESSMENT YEAR 2007-08]

JANUARY 11, 2013

ORDER

R.K. Panda, Accountant Member

This appeal filed by the assessee is directed against the order passed u/s.143(3) r.w.s.144C of the Income Tax Act, 1961.

2. Grounds of appeal No 1 to 3 by the assessee reads as under :

“On the facts and circumstances of the case, and in law:

1. The Learned Assessing Officer (‘Ld. AO’), pursuant to the directions of the Learned Dispute Resolution Panel (‘Ld. DRP’), erred in making a double addition to income by disallowing the expenses relating to the reimbursement of expenses made to associated enterprises (‘AE’) i.e. Eaton UK amounting to Rs. 7,42,20,575 without appreciating that the assessee himself has voluntarily disallowed such expenses in its return of income for AY 2007-08 resulting in double taxation.

2. The Ld. DRP/AO erred in proceeding to compute the arm’s length price of the transaction relating to the reimbursement of expenses to Eaton UK without appreciating that the assessee has permanently disallowed these expenses as explained in Ground 1 above and thereby resulting in no erosion of tax base.

3. The Ld. DRP/AO erred in determining the arm’s length price of the transaction relating to reimbursement of expenses to Eaton UK as Nil.”

3. Facts of the case, in brief are that the assessee is engaged in providing customer support service activities including pricing analysis, technical support and application engineering services and business support services to Eaton Group of Companies outside India. The Global Support Service Centre (GSSC) owned by the assessee renders customer support services. This center is approved under the STPI Scheme and assessee has claimed deduction u/s.10A of the I.T. Act, 1961. The assessee filed e-return for A.Y. 2007-08 on 15-11-2007 declaring total income of NIL. The same was processed u/s.143(1) and the case was selected for scrutiny for which notice was issued on 17-09-2008. Subsequently the assessee filed a revised e-return on 16-01-2009 declaring total income of Rs. 6.94,378/-. The AO made a reference u/s.92CA(1) of the I.T. Act to the TPO for determination of Arms Length Price with reference to the transactions reported in Form No. 3CEB filed by the assessee company.

4. The TPO observed that Eaton Technologies Pvt. Ltd. (ETPL/assessee) is a subsidiary of Eaton Asia International Limited, which is in turn a Subsidiary of Eaton Corporation. The assessee is primarily engaged in providing customer support services and business support services to Eaton Corporation. Eaton Corporation, USA (“Eaton Corporation”) is a globally diversified industrial manufacturer of fluid power systems, electrical power products, electrical distribution and control products, automotive engine air management and fuel economy products, and intelligent truck systems for fuel economy and safety. During the period from April 2006 to July 2006, Eaton Industries Private Limited rendered the said business support services to Eaton Corporation. However, from August 2006, the said services have been rendered by ETPL to Eaton Corporation. The business support services rendered, which forms the non- STPI unit of ETPL, includes market research and analysis on the Group’s high-end markets, analysis of financial reports, analysis of competitive intelligence documents, financial analysis for decisions on mergers and acquisitions, creating acquisition proposals etc. The assessee is remunerated on the basis of cost plus a mark-up for the above mentioned services provided to Eaton Corporation.

4.1 The TPO further noted that the assessee, during the year under consideration, has undertaken the following International transactions :

5. During the TP assessment proceedings the TPO accepted the transaction relating to provision of Customer Support Services with Eaton Hydraulics In. USA amounting to Rs. 10.22 Crores. However, he noted that the bench marking done in the case of the transactions relating to business support services was not proper. So far as the amount of Rs. 7,42,20,575/- paid to Eaton Ltd. UK with regard to expenditure incurred for setting up of the Asia Pacific Shared Services Center (APSSC) is concerned the TPO noted that this being an international transaction should have been bench marked but the assessee has not done the same in spite of opportunity given. He noted from the details of expenses given in the various submissions filed by the assessee from time to time that the expenses are pre- operative in nature and the assessee was unable to show that any corresponding services have been received against such payments. He, therefore, confronted the same to the assessee. It was submitted that the assessee has made payment during the year amounting to Rs. 7,42,20,575/-to M/s. Eaton Ltd. UK on account of certain pre operative expenses in connection with setting up of a new business unit, the details of which are as under :

5.1 It was submitted that for the purpose of raising the invoices (except for traveling expenses), Eaton UK had maintained details pertaining to the time spent by its resources (on the work performed for ETPL). An hourly cost incurred by Eaton UK for rendering such services was computed and applied to the number of hours spent, to arrive at the total costs to be considered for mark up purpose. The aggregate of total costs plus the mark-up computed on such costs was the total amount charged to ETPL. The traveling expenses have been charged to ETPL on actual basis.

5.2 It was submitted that the transaction does not assume the character of an international transaction. Further, it does not have any bearing on the income or profit of the assessee since the assessee itself has disallowed the expenditure while computing the taxable profit for the A.Y. 2007-08. The assessee has not taken any benefit, whatsoever, in subsequent years on account of the expenditure. Therefore, even if the said transaction is assumed to be an international transaction it does not impact the taxable income of the assessee.

6. However, the TPO was not satisfied with the explanation given by the assessee. Referring to the provisions of section 92B(1) he was of the opinion that the assessee and M/s. Eaton UK Ltd. UK are associated enterprises within the meaning of section 92A of the I.T. Act. Since the assessee has made payment of Rs. 7,42,70,575/- to M/s. Eaton Ltd. UK on account of certain pre- operative expenses in connection with setting up of a new business unit, the payments of which are not disputed by the assessee and since the payment has been made from the funds of the assessee and the same was debited to its profit and loss account, therefore, the transaction is a valid international transaction u/s.92B of the I.T. Act.

7. So far as the second contention of the assessee that it does not have any bearing on the income or profit of the assessee since the assessee in the computation statement has disallowed the same while computing the taxable income of the assessee the TPO noted that the expenses so disallowed has infact increased the profitability of the assessee and the assessee has claimed deduction u/s.10A of the I.T. Act during Assessment Year 2007-08. The profits and gains of the assessee during the year was Rs. -11,63,18,037/-. After disallowing the above expenses along with certain other expenses to the tune of Rs. 16,70,72,117/- the loss figure was transformed to profit. Hence the disallowance of the said expenses has not in any way made an adverse impact for the assessee. On the contrary, the assessee has taken undue advantage in this respect by claiming exemption u/s.10A and there is no need for the assessee to claim the said expenses in subsequent years. Since the assessee could not demonstrate by any evidence/document that it has received any corresponding services from its AE during the year and since the international transaction has not been bench marked the TPO was of the opinion that the cost incurred by the AE in rendering the said services is not known. He, therefore took the value of the international transaction amounting to Rs. 7,42,20,575/-entered into with the AE on account of the above said expenses as NIL and increased the income of the assessee by the above amount for this year.

8. On the basis of the report of the TPO, the Assessing Officer passed the draft assessment order which was challenged by the assessee before the DRP. However, the DRP also rejected the contention of the assessee and upheld the action of the TPO. The Assessing Officer thereafter passed the assessment order by making the above addition to the total income of the assessee. Aggrieved with such order of the Assessing Officer the assessee is in appeal before us.

9. The learned counsel for the assessee submitted that an amount of Rs. 7,42,20,575/- was paid to Eaton Ltd. UK with regard to expenditure incurred for setting up of the Asia Pacific Shared Services Center (APSSC) which is a separate business unit of the company under set-up stage as on 31-03-2007. Referring to Page 45 of the Paper Book he submitted that the assessee has not claimed the above amount of Rs. 7.42 Crores as an expenditure and infact added an amount of Rs. 16,70,72,117/- as “items debited to profit and loss account, not allowable under the act” which includes the above Rs. 7.42 Crores. Referring to Page 46 of the Paper Book he drew the attention of the Bench to the break up of Rs. 16,70,72,117/- which includes an amount of Rs. 11,46,04,774/- being “expenditure incurred prior to commencement of business”. Referring to Page 180 of the Paper Book he drew the attention of the Bench to the details of break up of Rs. 11,46,04,774/- which includes the amount of Rs. 7,42,20,575/-. He accordingly submitted that from the above details it is clear that the assessee has not claimed the amount of Rs. 7.42 Crores as an expenditure. Even the assessee has not capitalized it towards the cost of any asset. Again referring to Page 45 of the Paper Book he submitted that the assessee has claimed deduction of Rs. 4,69,00,153/- as deduction u/s.10A of the I.T. Act. Referring to Page 47 of the Paper Book he drew the attention of the Bench to the break up of Rs. 4,69,00,153/- and submitted that the deduction has been claimed under GSSP- STP unit. He submitted that since no expenditure has been claimed on account of payment of Rs. 7.42 Crores to the AE, therefore, the assessee has not made any TP study on this issue.

9.1 In the light of the above facts the learned counsel for the assessee made two fold arguments. He submitted that when an expenditure has never been claimed, no addition can be made. Referring to CBDT Circular explaining the new legislation to curb tax avoidance by abuse of transfer pricing, (Page 193 of the Paper Book) the learned counsel for the assessee drew the attention of the Bench to the following:

“55.5A The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country’s tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the arm’s length price determined under the regulations would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction”.

9.2 Referring to the decision of Honorable Delhi High Court in the case of Sony India (P) Ltd. v. CBDT [2007] 288 ITR 52 he submitted that the circular issued by the CBDT is valid. He reiterated that the assessee has neither claimed the amount as an expenditure nor even capitalized the same and has not claimed depreciation on it and it is a dead capital loss to the assessee.

10. Referring to provisions of section 92(1) he submitted that as per the said provisions any income arising from an international transaction shall be computed having regard to the ALP. Since there is no income arising from this international transactions, therefore, the provisions are not applicable. Referring to provisions of section 92B(1) he submitted that as per the said section the transaction must have a bearing on the profit. Since the assessee has not claimed any deduction on account of this expenditure, therefore, the same is not applicable.

11. In his alternate contention the learned counsel for the assessee submitted that the TPO was not justified in determining the value of international transaction at NIL. Referring to provisions of section 92C(3) the learned counsel for the assessee submitted that as per the said provisions the TPO has to determine the ALP in relation to the international transaction in accordance with the sub section (1) and sub section (2) of section 92C. The burden is on the TPO and the TPO cannot take it at NIL. Since the AO/TPO in the instant case has determined such arm’s length price at NIL, therefore, the same is not proper and liable to be quashed. He also relied on a number of decisions.

12. The learned Departmental Representative on the other hand heavily relied on the order of the Assessing Officer. He submitted that since the amount paid by the assessee to the AE has a bearing on the assets of the enterprise, therefore, it is a valid international transaction. Further since the assessee did not give any break up or details of the amounts paid to the AE, therefore, the TPO was justified in determining such value at NIL. He accordingly submitted that the order of the Assessing Officer should be upheld.

13. The learned counsel for the assessee in his rejoinder submitted that the submission of the learned Departmental Representative that because of bearing on the assets of such enterprise it is an international transaction is not correct in view of provisions of section 92(1). Further, there cannot be double addition of the same amount.

14. We have considered the rival arguments made by both the sides, perused the orders of the revenue authorities and the Paper Book on behalf of the assessee. We have also considered the various decisions cited before us. There is no dispute to the fact that the assessee has made payment of Rs. 7,42,20,575/- to Eaton Ltd. UK with regard to expenditure incurred on set-up of the Asia Pacific Shared Services Centre. According to the revenue the above transaction between the assessee and Eaton Ltd. UK, an associated enterprise, falls within the definition of international transaction and since the assessee could not demonstrate with evidence to the satisfaction of the AO/TPO regarding the nature of services rendered by Eaton Ltd. UK and in absence of any bench marking done by the assessee the value of such international transaction has to be taken at NIL. It is the argument of the learned counsel for the assessee that the assessee has made suo-moto dis allowance of the above expenditure in the computation statement during the impugned assessment year and no benefit whatsoever has been taken by the assessee either by capitalizing the same and claiming depreciation on it nor has taken benefit in subsequent years, therefore, the provisions of section 92(1) and 92C are not applicable. According to the learned counsel for the assessee there cannot be double dis allowance/addition of the same amount. It is also the submission of the learned counsel for the assessee that the benefit of deduction u/s.10A was claimed on account of profit of the GSSC-STP unit and no benefit of deduction u/s.10A has been taken on account of dis allowance of the expenditure of Rs. 7,42,20,575/-

14.1 We find from the details furnished by the assessee in the Paper Book Pages 45, 46 & 180 that the assessee has disallowed the expenditure of Rs. 7,42,20,575/- in the computation statement. The break up of Rs. 7,42,20,575/- has already been given at Para 2 of this order, the details of which are as under :

We find the assessee while claiming deduction of Rs. 4,69,00,153/- u/s.10A has computed such deduction, the details of which are as under (Page 47 and 48 of the Paper Book) :

EATON TECHNOLOGIES PVT. LTD. (GSSC-STP UNIT)

COMPUTATION OF TAX HOLIDAY UNDER SECTION 10A OF THE ACT

From the above, it is clear that the assessee has not claimed any benefit of deduction u/s.10A on account of dis allowance of any of the expenditure disallowed forming part of Rs. 7,42,20,575/-.

14.2 We find the provisions of section 92 read as under :

“92. (1) Any income arising from an international transaction shall be computed having regard to the arm’s length price.

Explanation.-For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price.

(2) Where in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm’s length price of such benefit, service or facility, as the case may be.

The following sub-section (2A) shall be inserted after sub-section (2) of section 92 by the Finance Act, 2012, w.e.f.01-04-2013 :

(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm’s length price.

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

14.3 From the above, it is clear that the allowance of any expenditure arising from an international transaction shall also be determined having regard to the ALP. However, in the instant case the assessee has not claimed the expenditure of Rs. 7,42,20,575/- during the impugned assessment year and has itself disallowed the same while computing its taxable income. Therefore, we agree with the submission of the learned counsel for the assessee that the provisions of section 92 are not applicable. We also find force in the submission of the learned counsel for the assessee that there cannot be double dis allowance/addition of the same amount. We, therefore, are of the opinion that although the transaction between the assessee and its AE falls within the meaning of an international transaction still no adjustment on account of ALP can be made since the assessee has suo-moto added the amount while computing its taxable income for the impugned assessment year and no benefit of the same has been taken either by capitalizing it and claiming depreciation on it or taken benefit in subsequent years. In this view of the matter, the order of the Assessing Officer on this issue is set-aside and the grounds raised by the assessee are allowed.

15. Grounds of appeal No. 4 to 7 by the assessee are as under :

“4. The Ld. DRP/AO erred in proposing a transfer pricing adjustment of Rs. 6,51,967 for international transactions pertaining to provision of business support services.

5. The Ld. DRP AO erred in not recognizing the differences in the risk profile of the appellant and the com parables and thereby erred in not making reliably accurate adjustments for such differences as required under the law for comparability analysis.

6. The Ld. DRP/AO erred in not granting the benefit of plus / minus 5 percent range as envisaged by the proviso to Section 92C(2) of the Act.

7. The Ld. DRP/ TPO erred in using data which was not available to the appellant at the time of conducting the transfer pricing analysis for computing the transfer pricing adjustment, not unfairly penalizing the appellant for an act that was impossible to perform on the part of the appellant.”

15.1 Facts of the case, in brief, are that the TPO during the course of TP assessment proceedings noted that the assessee company has undertaken international transaction valued at Rs. 36,98,134/- with Eaton Corporation on account of business support services. He noted that for the purpose of bench marking the international transaction relating to business support services the assessee company has adopted TNMM as the most appropriate method. He observed that for the purpose of analysis of the international transactions segmental operating profit over total cost (OP/TC) has been taken as profit level indicator (PLI). The assessee has taken a set of 4 external com parables and has taken average operating margin as PLI for the set of com parables. The PLI in the case of the assessee company was computed at 8% (OP/TC). For computing the PLI of the com parables data pertaining to three years including assessment year 2007-08 was considered and the weighted average was arrived at 10.98% by the assessee. The TPO therefore asked the assessee to provide the single year profitability ratio of the selected companies. The assessee filed the details in response to said query raised by the TPO which are as under :

The TPO noted from the above that the mean PLI of the comparable companies is coming to 27.04% considering the data for the F.Y. 2006-07. However, the margin of the assessee company for the concerned year is coming to 8% only. According to the TPO applying the TNMM for determining the arm’s length price would require that the two are in the same range. However, in the case of the assessee it was taken 8% as against 27.04%. The TPO therefore proposed adjustment of Rs. 6,51,967/-.

16. The assessee submitted that while attempting to determine an arm’s length outcome for international transactions between the AEs, the results of any one year may be distorted by differences in economic or market conditions. Further, enterprises may not be uniformly affected by business and product cycles and therefore differences between dealings may reflect differences in circumstances. Therefore, it was submitted that multiple year data will improve the reliability of transfer pricing analysis. Further, the same is useful in providing information about the relevant business and product life cycles of the com parables. It was further submitted that multiple year data will help to overcome the differences in accounting standards and practices adopted by the enterprise as such differences, if any, will annul over a period of time when the period under examination is long enough. The assessee also submitted that the OP/TC margin for one of the com parables, i.e. ICRA Online Ltd. using only F.Y. 2006-07 data is 64.42% as against the corresponding margin of 16.72% as mentioned in the TP report. It was further argued that irrespective of the use of single year data, on account of the difference between the risk profile of the assessee and its com parables the risk adjustment should be granted.

17. However, the TPO was not satisfied with the explanation given by the assessee. According to him the net profit margin arising in comparable uncontrolled transaction may be adjusted to take into account the differences between the international transactions and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. Thus, under TNMM, in the first step, net operating margin, from international transaction is computed in relation to the appropriate base. In the second step, net operating margin of the uncontrolled transactions are identified. In the third step the net operating margin of uncontrolled transaction are adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entered into such transactions which could materially affect the amount of net profit margin computed in step 3 above is taken to be net operating margin and the Arm’s Length Price of the transactions computed by that operating margin. Therefore, it is the margins of comparable companies which are to be adjusted and not the margin of the tested party. No such adjustments have been made by assessee/claimed during any time of the assessment proceedings. Hence, there is no question of such adjustment being made at this juncture. The risk adjustment, thus claimed in the case of the assessee is beyond the purview of law and thus, not allowable. He, therefore, considered the unadjusted PLI (OP/TC) of the assessee for the marginal analysis. Since the PLI of the assessee is at 8% whereas the mean PLI of the com parables taking the data for the relevant financial year i.e. 2006-07, is 27.04%, therefore, he adjusted the difference in the profit margin of 19.04% to the PLI of the assessee and following TNMM made adjustment of Rs. 6,51,967/-.

18. The Assessing Officer confronted the report of the TPO during draft assessment proceedings. The assessee challenged the same before the DRP who upheld the action of the TPO. In assessment, the Assessing Officer made addition of Rs. 6,61,967/- in the international transactions pertaining to the provision of business support service for which the assessee is in appeal before us.

19. The learned counsel for the assessee referring to Page 8 of the Paper Book drew the attention of the Bench to the following which was submitted before the Assessing Officer/TPO :

“ETPL is engaged in providing support services to Eaton Corporation, which includes market research and analysis on the Groups high-end markets, analyze financial reports, analysis of competitive intelligence documents, financial analysis for decisions on mergers and acquisitions, creating acquisition proposals etc in India. ETPL is remunerated on the basis of a mark-up of 8% on cost for the business support services provided to Eaton Corporation. During the year under review, ETPL has also provided customer support services to Eaton Corporation. These have been analyzed in a separate report.”

19.1 Referring to Page 13 of the Paper Book the learned counsel for the assessee drew the attention of the Bench to the functions performed by ETPL, the details of which are enumerated at Para 4.3.6 and 4.3.7. Referring to Page 32 of the Paper Book the learned counsel for the assessee drew the attention of the Bench regarding the determination of Arm’s Length results on the basis of 4 comparable companies, the details of which are as under :

19.2 Referring to Page 30 of the Paper Book the learned counsel for the assessee drew the attention of the Bench to Para 5.12.1 which reads as under :

“If there are material differences between the controlled enterprises being examined, adjustments may need to be made to them to improve the reliability of the results if the effect of such differences on prices or profits can be ascertained with sufficient accuracy. The following comparability adjustments need to be made to this analysis to take into account material difference between ETPL and the selected uncontrolled com parables.”

19.3 Referring to the letter addressed by assessee to the TPO placed at Paper Book Page Nos. 58 to 59 the learned counsel for the assessee drew the attention of the Bench to Page No.65 and submitted that the assessee has made a claim regarding the adjustment for differential risk, therefore, the TPO is wrong in stating that assessee has not made any claim on account of risk. He accordingly submitted that the TP analysis done by the assessee being reasonable and proper should be accepted and the adjustment made by the TPO/AO should be deleted.

20. The learned Departmental Representative on the other hand heavily relied on the order of the Assessing Officer.

21. We have considered the rival arguments made by both the sides, perused the orders of the Assessing Officer and the Paper Book filed on behalf of the assessee. We find from the details furnished by the assessee that the same has not been properly appreciated by the Assessing Officer/TPO. We find the assessee vide letter dated 03-09-2010 addressed to the TPO at Page No.8 of the same has categorically requested for adjustment for differential risk. He has also cited certain decisions. In fact at Page No.10 of the said letter the assessee has computed such risk adjustment. However, we find the TPO at Para No.12 of his order has observed that no such adjustments have been made by the assessee nor claimed during any time of the assessment proceedings. We, therefore, deem it proper to restore the issue to the file of the Assessing Officer with a direction to decide the issue afresh and in accordance with law after giving due opportunity of being heard to the assessee. We hold and direct accordingly. The above grounds are accordingly allowed for statistical purposed.

22. Ground of appeal No.8 was not pressed by the learned counsel for the assessee for which learned Departmental Representative has no objection. Accordingly, the same is dismissed.

23. In the result, the appeal of the assessee is partly-allowed for statistical purposes.