Income Tax Appellate Tribunal - Pune
Vishay Components India Private ... vs Assessee on 19 March, 2012
THE INCOME TAX APPELLATE TRIBUNAL
PUNE BENCH "B", PUNE
BEFORE SHRI I C SUDHIR, JUDICIAL MEMBER
AND SHRI G.S. PANNU, ACCOUNTANT MEMBER
ITA No. 133/PN/11 : Asstt. Year: 2006-07
Vishay Components India P Ltd. ..
Loni-Kalbhor, Near Pune (C.Rly)
Pune 412 201
PAN AAACB 9652 L Appellant
Vs.
Dy. Commissioner of Income-tax, Respondent
Cir.7, Pune
Appellant by : S/Shri Farrokh V Irani, Rajesh
Parikh & R Ananda Krishnan
Respondent by : Shri Narendra Kumar, CIT
Date of hearing : 19.03.2012
Date of pronouncement : .05.2012
ORDER
PER G.S. PANNU, A.M.:
This appeal by the assessee is directed against the order dated 29.9.2010 passed by the Dispute Resolution Panel, Pune, Income-tax Department read with Draft assessment order of the Dy. Commissioner of Income-tax Cir. 7 passed under section 143(3) of the Income-tax Act, 1961 (in short "the Act"), pertaining to the assessment year 2006-07..
2. The appellant company is part of Vishay Group, which is a leading international manufacturer and supplier of electronic components. The assessee-company is involved in manufacture of resistors and capacitors used in various electronic applications/products. The manufacturing facilities 2 of the assessee-company include a Domestic Tariff Area unit (DTA unit) and an Export Oriented Unit (EOU), which exports to overseas group entities. For the assessment year under consideration, assessee filed a return of income wherein Book Profit u/s 115JB of the Act was shown at Rs. 4,01,98,256/-. The return was subject to a scrutiny assessment u/s 143(3) r.w.s. 144C(13) of the Act dated 25-11-2010 whereby the total income was determined at Rs. 15,38,24,330/- after making certain additions, which inter alia, included an amount of Rs. 10,98,07,842/-, representing adjustment on account of international transaction with the Associated Enterprises (AEs) pertaining to manufacturing activities, and such addition is the substantive dispute in the present appeal.
3. During the year under consideration, assessee has undertaken the following international transactions.
S. Nature of Transaction Amount (Rs) Method
No. Applied
1 Export of finished goods to 599,729,362 TNMM
overseas Group companies
2. Import of raw materials and 176,057,018 TNMM
components for manufacturing
finished goods
3. Import of finished goods for resale 3,160,161 TNMM
4. Receipt of commission 4,980,548 TNMM
5. Import of capital machinery 41,750,492 TNMM
6. Amount paid for software and data 10,498,643 At cost actual
communication expenses
7. Provision of IT services 25,156,277 TNMM
8. Reimbursement of hotel expenses, 940,143 Actual
equant charges and other
expenses
TOTAL 862,272,644
4. For the purpose of ascertaining the Arm's Length Price (ALP) of the international transactions, assessee aggregated the transactions itemized at Sr.No. 1-4 above and Transactional Net Margin Method (TNMM) was 3 considered the most appropriate method to benchmark the transactions. The PLI i.e. operating margin on operating cost in the case of assessee was worked out at 15.12% and the average operating margin of the external comparable chosen by the assessee was worked out at 20.35%. After considering the option allowed under the proviso to sec. 92C(2) of the Act of +5% , the assessee concluded that the international transactions with its AEs were at ALP as per the Indian transfer pricing perspective. In coming to such conclusion, the assessee adopted the following external comparables.
Sr. Name of the Average
PL1 Operating margin on
No. company operating
operating cost
margin on
___________________________
operating
2006 2005 2004
cost
1. CTR Manufacturing 30.03% 28.11% NC 29,.16%
Industries Ltd.
2. Gujrat Poly-Avx 48.73% 39.90% 29.96% 40.11%
Electronics Ltd.
3. Incap Ltd. 9.10% 13.29% 12.31% 11.59%
4. K. Dhandapani & 5.36% NC NC 5.36%
Co.Ltd.
5. Keltron Component NA NA 5.63% 5.63%
Complex Ltd.
6. Universal Cables 32.10% 32.10% 23.63% 30.26%
Ltd.
Arithmetic 20.35%
mean
5. The Assessing Officer, after considering the order of the Transfer Pricing Officer (TPO) dated 29-10-2009 and the direction of the Dispute Resolution Panel (DRP) dated 29-9-2010 has recomputed the operating profit margin over operating cost of @ 12.25% as against 15.12% done by assessee, and also computed the average operating margin of the external comparables @ 21.59%, the details of which are as under. 4
Particulars Operating Operating Operating
Profit Expenses Margin
CTR Manufacturing industries Ltd. 211.57% 849.40 24.91%
DEKI Electronics Ltd. 362.75 1963.40 18.48%
Gujrat Poly AVX electronics Ltd. 183.71 458.44 40.07%
Incap Limited 96.73 1115.41 8.67%
Tibrewala Electronics Ltd. 1198.73 4425.57 27.09%
Universal Cables Ltd. 311.47 1164.81 26.74%
21.59%
6. Based on the above, an addition of Rs. 10,98,07,842/- has been determined which has been challenged in appeal before us.
7. The first area of difference between the assessee and the Revenue is with regard to computing the operating profit margin in the assesee's case. The TPO/AO has computed the operating margin of the assessee as follows:
Sr. Head Description Amount (Rs)
No.
1. Operating income Manufacturing sale 108,7457,000
+ Sale of scrap +48,32,000
= 109,22,89,000
2. Operating cost Total expenses 109,65,60,000
including -cost for back office activities -2,18,75,000
depreciation -financial expenses -36,69,000
=107,10,16,000
3. Depreciation 9,79,82,000
4. PBDIT 1-2+3 11,92,55,000
5. Operating profit 4/(2-3_ 12.25%
margin
8. In this connection, the plea of the assessee is that costs of Rs. 2,13,78,691/- pertaining to RISFIC project and Rs. 50,00,000/- in the case of power capacitor project are extraordinary costs, which are abnormal and incurred only in the initial phase of production and therefore it should be excluded from the operating costs in order to arrive at the operating profit margin. The precise submission of the assessee in this regard are reproduced by the TPO in his order, the relevant portion is as under: 5
"Cost pertaining to RISFIC project In this regard, the assessee submits that during the year under consideration, production facilities of a Vishay Group entity in Portugal for manufacture of RFI capacitors were moved to Vishay India. The commercial production for these capacitors commenced during the second quarter of the calendar year 2005. Given the contemporary technology of the newly introduced products and lack of experience in India for absorption of such technology, there was an initial gestation period of two to three quarters for stabilization of production and achieving desired quality and levels of volumes of the production. During the initial phases of the newly set up project, Vishay India had to incur additional start-up costs on account of various reasons briefly described below:
Material cost Vishay India started manufacturing a new category of the products and as such, during the initial phase of the project there was excess use/wastage of raw materials.
Freight cost The production volume was insufficient to meet the minimum container load requirements. As such, Vishay India had to bear higher freight cost.
Labour cost Due to lower volumes of production, initial training activity, higher reworking etc. the labour cost was high as compared to the output generated.
Energy Energy costs were on higher side during the initial period.
Vishay India has compared ratio of the above costs to sales in respect of the new range of products for first three quarters of the financial year 2005-06 with the similar ratio for the last quarter of the financial year 2005-06 (during which production for new products had stabilized to some extent). Further, there is a significant increase in tools and repairs and maintenance cost during the initial period. Based on the comparison of costs incurred during the initial quarters with the last quarter, Vishay India has identified an amount of Rs. 21,378,691 as extraordinary cost incurred during the initial phase of production. This cost has been accordingly, excluded from the operating costs. The working of the extraordinary cost as referred above has been enclosed as Attachment 10.6
In view of the above, the assessee requests your Goodself to exclude the above cost from the operating costs as such costs being abnormal and non-operating in nature.
Cost pertaining to power capacitors project In connection with the project of power capacitors, it is further bought to your goodself's attention that the said project was in a nascent stage with negligible sales value during the year ended 31st March 2006. The sales for this project picked up in the later years. However, Vishay India incurred substantial costs for recruitment of marketing staff and their training and travel as well as participation in various exhibitions. Therefore, these costs have been excluded from the operating costs.
In view of the above, the assessee requests your Goodself to exclude the above cost from the operating costs as such costs being abnormal and non-operating in nature."
9. The Revenue has opposed the plea on the ground that both the costs are incurred during normal business operations and that the assessee has not demonstrated as to whether the Comparable Companies did not have to incur any such expenses.
10. Before us, learned Counsel for the appellant, has referred to Rule 10B(3) of the Income-tax Rules, 1962 (in short 'the Rules') to submit that adjustment be made in case of differences which could materially affect the amount of net profit margin in the open market. Reliance has been placed on the following decisions in support.
1) Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT Cir.
1(2) (ITA No. 120/PN/2011 for A.Y. 2006-07) dated 4-1-2012)
2. Skoda Auto India P. Ltd. 122 TTJ 699 (Pune)
3. Egain Communication Pvt. Ltd. Vs. ITO (118 ITD 243 (Pune ITAT)
11. On the other hand, the learned DR has opposed the plea based on the discussion contained in the orders of the authorities below. 7
12. We find that the issue pertaining to the adjustment on account of extraordinary expenses, which are likely to materially affect the price/profit in the open market, has been considered by our co-ordinate Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. (supra). The relevant discussion is as under:
"34. Ground 4 (b) has two limbs i.e. warranty claim and trade import cost of raw material and components and spares. Ld counsel mentioned that the adjustments with regard to the warranty claims are not pressed. Therefore, the limited issue for adjudication out of this said sub ground (b) relates to the adjustment on account of higher import cost. In this regard, Ld counsel submitted that the assessee provided the commercial reasons in relation to grant of adjustment on account of higher import cost of the assessee vis a vis the comparable companies before the TPO/DRP. The relevant write up by the assessee on this issue of import cost related adjustment read as under: The company has 35.71% higher imports as compared to its comparable companies. Further, the additional cost incurred by the Company as compared to comparable companies on basis custom duty, landing charges, clearing and forwarding charges and insurance & freight will be around 18% to 21%.
Summarized below are the key figures/details
Particulars
Operating profit/total sales 6.61%
(adjusted for higher import cost)
Arm's length operating Margin of 7.18%
Comparables (unadjusted)
Adjust after considering Rs.
adjustment for high 1,317,82
Import cost (Rs. 2
233,242,565*(7.18% - 6.61% =
0.57%)
The appellant places reliance on rule 10B(3) of the Rules and the OEC Guidelines, which lays emphasis on adjustment for difference between the transactions being compared which are likely to materially affect the profit arising from such transactions in the open market for which reasonably accurate adjustments are possible. Thus the differences on account of higher imports and warranty provision have resulted into lower profit as compared to the transactions in the open market for which reasonable adjustment is possible.8
In view of the above, the appellant submits that the margins of appellant be adjusted to take into consideration excess warranty claims and high import cost.
35. Elaborating the above, Ld Counsel for the assessee has mentioned that assessee imported components and spares from AE to the tune of Rs 602.18 lakhs for manufacturing segment. It works out to nearly 40% of total imports i.e. Rs.1557.38 lakhs. Referring to the comparables, it is brought to our notice that the imports of the comparables works out to merely 3.68% and therefore, there are differences and they have to eliminated by way of adjustments to be a credible comparables to the tested party's data. As per the assessee, the revised PLI after adjustment for excess import duty work out to around 6.6%, which falls in the permitted range of +/-5%. Further, in support of the above, Ld Counsel relied on various decisions for the proposition that the adjustment on account of import cost constitutes permissible ones.
36. In response to the above, the Ld. D.R. for the revenue submitted that the assessee has not made this sort of adjustments during the proceedings before lower authorities. Further, the Ld. D.R. argued stating that these expenses do not fall under the category of extraordinary expenses which requires adjustments. Further, he also mentioned that adjustments, if any, in this regard should be made only on the comparable cases of uncontrolled transactions. In this regard, the CIT relied on the provisions of rule 10B(e) of I.T. Rules, 1962. Further, he is of the opinion that, if this is the way the adjustments are periodically claimed by the assessee, there is a need for analyzing every account of the comparables relied upon by the assessee. The CIT also mentioned that the comparables supplied to the A.O are those which are selected by the assessee himself. In these circumstances, the assessee should not be permitted to ask for adjustments to the already benchmarked ones.
37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analyzed the relevant provisions of Income Tax rules vis avis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the 'working capital'. In principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of 'import cost' works out to 0.57% (7.18%-6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decision relied upon by the assessee's counsel supports our finding relates to the decision of this bench of the Tribunal in the case of Skoda Auto India p Ltd 122 TTJ 9 699 (Pune) dated March 2009 wherein, it is held (in para 19 of the order) that,-
No doubt , a higher import content of raw material by itself does not warrant an adjustment in operating margins, as was held in Sony India (P) Ltd.'s case (supra), but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee's control. As was observed by a Co- ordinate Bench of this Tribunal in the case of E-Gain Communication (P) Ltd. (supra) "the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the open market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect". We do not agree with the AO that every time the assessee pays the higher import duty, it must be passed on to the customers or it must be adjusted for in negotiating the purchasing price. All these things could be relevant only when higher import content is a part of the business model which the assessee has consciously chosen but then if it is a business model to import the SKD kits of the cars, assemble it and sell it in the market, that is certainly not the business models of the comparables that the TPO has adopted in this case. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in public domain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that some approximations are to be made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee's operations and complete facilities ensuring reasonable indigenous raw material content was not in place. The assessee's claim is that it was in these circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car was computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is permissible merely because the higher costs are incurred for the inputs. That 10 argument has been rejected by a Co-ordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. This additional argument was not available before the authorities below and it will indeed be unfair for us to adjudicate on this factual aspect without allowing the TPO to examine all the related relevant facts. We, therefore, deem it fit and proper to remit this matter to the file of the TPO for fresh adjudication in the light of our above observations.
38. The perusal of the impugned orders shows that the above cited guidelines by way of decision of this bench of the Tribunal in the case of Skoda Auto India p Ltd (supra) were not available to the revenue authorities. Therefore, we are of the opinion, the issue should be set aside to the files of the TPO with direction to examine the claim of the assessee relating to the import cost factor and eliminate the difference if any. However, the TPO/AO/DRP shall see to it that the difference in question is 'likely to materially affect' the price/profit in the open market as envisaged in sub rule (3) of Rule 10B of the Income tax Rules, 1962. Accordingly, ground 4(b) is allowed pro tanto."
13. Furthermore, the appellant pointed out that the Comparable Companies, have not incurred any start-up activity cost as is amply clear from the Annual Reports.
14. In view of the aforesaid discussion, in our view, the assessee ought to succeed on this Ground and we accordingly direct the AO/TPO to examine the claim of the assessee in the light of the directions contained in the order of the Tribunal in the case of Demag Cranes& components (India) Pvt. Ltd (supra) dated 4-1-2012.
15. Another issue raised by the assessee relates to computing the adjustment without giving benefit of the option available to the assessee under proviso to section 92C(2) of the Act for the +5%. This aspect of the matter has been considered by the Pune Bench of the Tribunal in the case of Starent Networks (India) P. Ltd. vide ITA No. 1350/PN/2010 for A.Y. 2006-07 dated 3- 10-2011 in the following words.
11
20. We have carefully considered the rival submissions. In this case, a pertinent issue which has been vehemently agitated by the appellant is with regard to its claim of seeking benefit of the option available under the erstwhile proviso to section 92C(2) of the Act. The erstwhile proviso which was inserted by Finance Act, 2002 with effect from 1.4.2002 read as under:
"Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five percent of such arithmetical mean."
As per the said Proviso, an option is available to the assessee for adjustment of +/-5% variation for the purposes of computing ALP. As per the Proviso, where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices or at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean. The point made out by the assessee is based on the latter part of the Proviso whereby an option is given to the assessee to take an ALP which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean. Firstly, the claim of the Revenue is that such benefit is not available to the present assessee, because the price of international transaction disclosed by the assessee exceeds the margin provided in the Proviso. This aspect of the controversy, in our view, is no longer germane in view of the plethora of decisions of our co-ordinate Benches, namely, Sony India (P) Ltd. (supra); Electrobug Technologies Ltd. (supra), and Development Consultant P Ltd v DCIT 115 TTJ 577 (Kol.) wherein it has been observed that the benefit of the option contained in the latter part of the Proviso to section 92C(2) is available to all assessees, irrespective of the fact that price of the international transaction disclosed by them exceeds the margin prescribed in the Proviso.
21. So, however, the other argument set up by the Revenue and which has been more potently argued is to the effect that the benefit of such Proviso is not available to the assessee in the instant case, because the said Proviso has been amended by the Finance (No 2) Act, 2009 with effect from 1.10.2009 which reads as under:
"Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices:
Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at 12 which the international transaction has actually been undertaken shall be deemed to be the arm's length price."
The case set up by the Revenue is that the amended Proviso shall govern the determination of ALP in the present case, inasmuch as the amended provisions were on statute when the proceedings were carried on by the Transfer Pricing Officer (TPO). As per the Revenue, the amended Proviso would have a retrospective operation and in any case, would be applicable to the proceedings which are pending before the TPO on insertion of the amended Proviso, which has been inserted by the Finance (No. 2) Act, 2009 with effect from 1.10.2009 and, in this case, the TPO has passed his order on 30.10.2009. The learned Departmental Representative has also referred to the CBDT Circular No 5/2010 (supra) read with Corrigendum dated 30.9.2010 issued by the CBDT in this regard. Per contra, the stand of the assessee is that the amended Proviso would be applicable prospectively and would not apply in respect of the stated assessment year, which is prior to the insertion of the amended Proviso with effect from 1.10.2009.
22. We have carefully examined the rival stands on this aspect. The amended Proviso has been brought on the statute by the Finance (No. 2) Act, 2009 with effect from 1.10.2009. The Explanatory Notes to the provisions of Finance (No 2) Act, 2009 contained in circular No 5 of 2010 (supra) provides the objective behind the amendment of the Proviso. The Legislature noticed the conflicting interpretation of the erstwhile proviso by the assessee and the income-tax Department. The assessee's view was that the arithmetical mean should be adjusted by 5% to arrive at ALP, whereas the departmental view was that no such adjustment is required to be made if the variation between the transfer price and the arithmetical mean is more than 5% of the arithmetical mean. With a view to resolving this controversy, the Legislature sought to amend the proviso to section 92C(2), which has been reproduced by us in the earlier part of this order. In the said Circular, it has also been elaborated that the above amendment has been made applicable with effect from 1.4.2009 and will accordingly apply in respect of assessment year 2009- 10 and subsequent years. In any case, the Proviso contains a prescription to determine the ALP and quite clearly it is a substantive provision encompassing the eventual determination of an assessee's tax liability. Thus, it can be said that the Proviso is not a procedural piece of legislation and therefore, unless it is so clearly intended, the newly amended proviso cannot be understood to be retrospective in nature. In fact, it is a well- settled proposition that the statutory provisions as they stand on the first day of April of the assessment year must apply to the assessment of the year and the modification of the provisions during the pendency of assessment would not generally prejudice the rights of the assessee. Furthermore, we are fortified by the intention of the Legislature as found from circular No 5 of 2010 (supra) whereby in para 37.5, the applicability of the above amendment has been stated to be with effect from 13 1.4.2009 so as to apply in respect of assessment year 2009-10 and subsequent years. In this regard, we also find that the Delhi Bench of the Tribunal in the case of ACIT v UE Trade Corporation India (P) Ltd. vide ITA No 4405(Del)/2009 dt 24.12.2010 has observed that the proviso inserted by the Finance (No 2) Act, 2009 would not apply to an assessment year prior to its insertion. In this view of the matter, we therefore find no justification to deny the benefit of +/-5% to the assessee in terms of the erstwhile Proviso for the purposes of computing the ALP.
23. However, before parting we may also refer to a Corrigendum dated 30.9.2010 by the CBDT by way of which para 37.5 of the circular No 5/2010 (supra) has been sought to be modified. The Corrigendum reads as under:
" CORRIGENDUM In partial modification of Circular No. 5/2010 dated 03.6.2010,
(i) In para 37.5 of the said Circular, for the lines "the above amendment has been made applicable with effect from 1st April, 2009 and will accordingly apply in respect of assessment year 2009-10 and subsequent years."
the following lines shall be read;
"the above amendment has been made applicable with effect from 1st October, 2009 and shall accordingly apply in relation to all cases in which proceedings re pending before the Transfer Pricing Officer (TPO) on or after such date."
(ii) In para 38.3, for the date "1st October, 2009, the following date shall be read: "1st April, 2009".
In terms thereof, it is canvassed that the amended proviso has been made applicable with effect from 1.10.2009 and shall apply even to cases where proceedings were pending before the TPO on or after such date, irrespective of the assessment year involved and, therefore, in the instant case the benefit of the erstwhile proviso cannot be extended to the assessee. We have carefully pondered over the assertion made by the appellant that the Corrigendum is untenable in the eyes of law. Firstly, the said corrigendum does not bring out any preamble so as to throw light on the circumstances and the background in which the same has been issued. Secondly, it is well understood that the Explanatory Notes to the provisions of a Finance Act passed by the Parliament seeks to explain the substance of the provisions of the Act as intended by the Legislature. In fact, the Hon'ble Supreme Court in the case of K.P Varghese v ITO 131 ITR 597 14 (Ker) emphasized the sanctity of the statements contained in the Explanatory Notes of the provisions and stated that the interpretation placed in such documents is binding interpretation of law. The contents of the Corrigendum are quite inexplicable. Notwithstanding the aforesaid and without going into the validity of the Corrigendum dated 30.9.2010 (supra), we are of the view that the same would not operate to the detriment of the assessee since at the relevant point of time the contents of the Circular No 5/2010 (supra) were in operation. In other words, the withdrawal of the interpretation placed in circular No 5 /2010 (supra) on the applicability of the amended proviso is sought to be done away by the Corrigendum dated 30.9.2010 and, therefore, such withdrawal shall be effective only after 30.9.2010, even if such Corrigendum is accepted as valid. We may note here that the appellant has assailed the validity of the Corrigendum itself on which we have not made any determination. Therefore, the Corrigendum dated 30.9.2010, in our considered opinion, has no bearing so as to dis-entitle the assessee from its claim of the benefit of +/-5% in terms of the erstwhile proviso to section 92C(2) of the Act. In coming to the aforesaid, we have been guided by the parity of reasoning laid down in the judgments of the Hon'ble Bombay High Court in the cases of BASF (India) Ltd. v CIT 280 ITR 136 (Bom); Shakti Raj Films Distributors v CIT 213 ITR 20 (Bom); and, Unit Trust of India & Anrs. v ITO 249 ITR 612 (Bom). The Hon'ble High Court has opined in the case of BASF (India) Ltd. (supra) that the circulars which are in force during the relevant period are to be applied and the subsequent circulars either withdrawing or modifying the earlier circulars have no application. Moreover, the circulars in the nature of concession can be withdrawn prospectively only as held by the Hon'ble Supreme Court in the case of State Bank of Travancore v CIT 50 CTR 102 (SC). Considering all these aspects, we therefore find no justification in the action of the lower authorities in disentitling the assessee from its claim for the benefit of +/-5% to compute ALP in terms of the erstwhile proviso to section 92C(2) of the Act. We order accordingly."
16. Following the precedent, the matter is restored back to the file of the Assessing Officer to decide accordingly as per law.
17. The assessee-company has raised an additional Ground of Appeal, which reads as under:-
"On the facts and in the circumstances of the case, the Hon'ble Dispute Resolution Panel ('the Hon'ble DRP') and consequentially the learned Dy. CIT Cir. 7, Pune (the learned 'AO')-
Should have appreciated that the Appellant is entitled for working capital adjustment on account of differences in the working capital employed by the Appellant and the companies considered as comparable".15
18. The learned Counsel submitted that, though the assessee did not raise the said issue before the lower authorities, the plea was justified and it was pointed out that in the assessee's own case for the assessment year 2007-08, the DRP has upheld the same in principle and directed the A.O/TPO to allow the appropriate relief. Apart therefrom reliance has been placed on the following decisions:
1) Egain Communication Pvt. Ltd Vs. ITO (118 ITD 243) (Pune ITAT);
2. Mentor Graphics (Noida) Pvt. Ltd. Vs. DCIT (112 TTJ 408 (Delhi ITAT)
3. Philips software Centre Pvt. Ltd. Vs. ACIT (2008) (119 TTJ 721) (Bang. ITAT)
4. Sony India Pvt. Ltd. Vs. DCIT (2008) (118 TTJ 865 (Delhi ITAT)
5. ACIT Vs. Vedaris Technologies Pvt. Ltd (2010) 131 TTJ 309 (Del)
6. Demag Cranes & Components (I) Pvt. Ltd (2011) (ITA No. 120/PN/2011) (Pune ITAT)
7. TNT India Pvt. Ltd. Vs. ACIT (2008) (ITA No. 1442/08) (Bang ITAT)
8. DCIT Vs. Vodafone India Services Pvt. Ltd. (TS 369-ITAT-2011 (Mum)
19. On the other hand, learned DR appearing for the Revenue opposed the plea primarily on the ground that no such plea was raised before the lower authorities.
20. In this connection, in our considered opinion, the non-raising of such an issue before the lower authorities does not preclude the assessee from raising it before the Tribunal, so long the issue is bonafide, relevant and is likely to affect the determination of tax liability of the assessee. In a somewhat similar situation, Pune Bench of the Tribunal in the case of Demag Cranes & 16 Components (I) Pvt. Ltd (supra) has dealt with the issue of allowing working capital adjustment in the following words:
"30. To sum up, the case of the assessee is that in TNMM, the working capital adjustments are required to be done to the margins of the comparable uncontrolled transactions to generate credible comparability data on transactional net margins. On the other hand, if appears that the case of the revenue is that the no such adjustments are called for to the set of comparable, which are supplied by the assessee.
31. We have so far analyzed Rule 10B(1)(e) on one side and other sub rules and in the context of the TNMM, we have analyzed the need for the elimination of the difference, if any in the comparable uncontrolled transactions, which materially affect the profit margin in the open market. It is the requirement of the Rules. Who supplies the set of comparable is not the determining factor on this issue. Having noticed the difference, the revenue has to quantify the difference, if any and then revenue must decide if that difference constitutes 'materially affect' the price in open market. If the answer is affirmative, the said difference has to be removed and the margin has to be adjusted for arriving at the credible comparable PLI. Further, it is a settled proposition that the 'working capital' adjustment is one such adjustment that is required to be made in TNMM. The revenue's contention that the 'differences' specified should refer to only (i) the factor of demand and supply; (ii) existence of marketable intangibilities i.e. brand name etc; (iii) geographical location and the like, and such difference has to be in respect of the functions undertaken, assets employed and the risks assumed only. Further, the revenue's views that by making adjustments, the net profits arrived are not of real type of profits and they are notional ones, which goes against the spirit of TNMM. All these objections of the revenue are not based only settled propositions. The provisions of 10B(1)(e) provides for the manner of adjustments vide its sub clauses (i) to (iv), which were already analyzed in the preceding paragraphs of this order. Briefly, (i) NPM realized from target transaction is computed in relation to cost incurred or sales effected or assets employed or to be employed or any other relevant base; (ii) NPM realized from a comparable uncontrolled transactions is computed having the same base; (iii) the NPM mentioned at (ii) is adjusted taking into account the differences, if any, which could materially affect the NPM in the open market. Thus, the scope of adjustments is defined, which is discussed by us in the preceding paragraphs. The sub clause (iii) specifies that the adjustments are to be made on account of differences, if any. Therefore, in this regard, the litmus test to be applied is if the 'difference, if any, is capable of affecting the NPM in open market? If any factor is capable of such affect, yes, TPO is under statutory obligation to consider and examine and eliminate such difference. AO/TPO/DRP cannot say that 17 difference is likely exist in all accounts appearing in P&L account or Balance sheet, which are likely to materially affect the NPM in open market and therefore, the demands of the assessee should be ignored, is not the correct approach. Revenue's reasoning that the demanded adjustments should not be entertained by the TPO merely on the basis the comparables are supplied by the assessee is not the correct. In our opinion, it is the duty of the TPO to apply the provisions of rule 10B(1)(e) to establish the ALP in relation to international transaction as per the TNPM, which is an undisputed method found applicable to the present case by both the parties. It is a settled accounting principle that the net margins can be influenced by some of the same factors which can influence price or gross margins. Further, it is the requirement of the rules / provisions that any difference which is likely to materially affect the NPM in open market has to be eliminated. TPO must know that the TNMM visualizes the undertaking of the thorough comparability analysis and elimination of the differences through the requisite adjustments. Yes, data availability is the limitation and both the parties need to ensure the procurement and use of the proper documentation. Therefore, we dismiss the revenue's contention that no further adjustment if any is entertained once the comparables are supplied by the assessee and when they are accepted by the TPO. Thus, working capital is a factor which influence the price in the open market and therefore the net profit margin of the business segment of the assessee which is targeted by the TPO/AO/DRP. Hence, in principle, we hold that the TPO/AO/DRP has failed to entertain the objections of the assessee on the 'working capital' adjustments issue. Therefore, we direct them to allow the requisite adjustment on account of the impugned 'working capital' while determining the Arm's Length operating Margin of the Comparables. Thus, relevant grounds of assessee's appeal are allowed.
32. Meaning of 'Likely to materially affect '- Quantification:
Now we shall take if the quantity of the said 'working capital' adjustments is that much which is likely to materially affect the price/margin of the international transactions involved. As per the assessee, unadjusted Arm's length Operating Margin of the Comparables is 7.18% and Arm's length Operating Margin after making adjustments on account of 'working capital', works out to only 3.77%. It shows the drop in margins to the extent of 3.41% in the Arm's length Operating Margin of the Comparables. We have already discussed these figures in the preceding paragraphs and on translation to real figures, the said percentage of 3.41 works out to Rs 31,72,099/-. In our opinion, in the given case, such a difference constitutes the said 'difference, if any' which is likely to materially affect the ALP/ Arm's length Operating Margin of the Comparables as mentioned in Rule 10B(3) of the Income tax rules, 1962. The same needs to be eliminated as per the said sub-rule (3).18
33. We have already discussed in the preceding paragraphs, this issue of adjustment on account of WC was raised for the first time before the Ld DRP and the DRP has passively relied on the order of the TPO without realizing that the said issue was never dealt with by the TPO. Therefore, the issue of granting of adjustment on account of 'working capital' for eliminating of the material effects and the issue of, if such adjustment @ 3.41% constitutes that difference, if any, which is likely to materially affect the price/profit margin, have not been examined. We find that there are written request of the assessee to the DRP to this extent and assessee furnished the relevant figures, which are enough to adjudicate the said request by the AO/DRR. It is not the case of the DRP that the above claims of the assessee are incorrect. Alternatively, it is not the request of the revenue's DR that these said issues should be remitted for another round of the proceedings before the revenue authorities.
In our opinion, the existence of difference @ 3.41%, which is worth Rs 31,72,099/-, attributable to the 'working capital' ought to amount to the 'material difference' considering the existing unadjusted operating margin of the comparables at 7.18%. In these circumstances, we are of the opinion that the said working capital differences constitutes quantitatively likely to materially affect the ALP / AL Operating Margin of the comparable. Therefore, the claims of the assessee are allowed. Accordingly, the grounds 4(a) is covered by the cited decisions and is allowed pro tanto. "
21. In the light of the aforesaid, the plea of the assessee has to be upheld in principle. So, however, as the issue has not been examined by the lower authorities, we therefore, deem it fit and proper to restore the issue back to the file of the AO/TPO with direction to examine the claim of the assessee relating to working capital adjustment and eliminate such difference, if any, as are likely to materially affect the profit margins, following the parity of reasoning in the case of Demag Cranes & Components (India) Pvt. Ltd (supra) and as per law. Thus, on this Ground assessee succeeds for statistical purposes.
22. Another aspect which has been vehemently argued is to the effect that the TPO adopted an incoherent approach for selection/rejection criteria of Comparable Companies. In particular, it has been pointed out that the TPO was not justified in rejecting the three Comparable Companies viz. Keltron Component Complex Ltd., Keltron Resistors Ltd., and Keltron Electro 19 Ceramics Ltd. The aforesaid Comparable Companies have been rejected for the reason that the same are Government companies and on account of that there lies a difference in operations, objectives and motives of a Government undertaking as against those companies which are net profit sectors. Keltron Components Complex Ltd., has been rejected for the reason that it has a negative networth and being a sick company which has been referred to the BIFR in 2005. Keltron Electro Ceramics Ltd. has been rejected for the reason that it was a persistent loss making company. Keltron Resistors Ltd., has been rejected as it was a persistently loss making and has negative net worth. Apart from assailing rejection of such Comparable Companies, the assessee pointed out before us that if the criteria referred to by the TPO to reject all loss making companies, is accepted then, another Comparable Company, viz., Gujarat Poly Avx Electronics Ltd. selected by him also needs to be rejected as it has been making loses in the past years; has a negative net worth and has reported abnormally high net profit only for the period under consideration.
23. In this background, we find that factually speaking, there is an ostensible inconsistency on the part of the TPO in formulating selection/rejection criteria of Comparable Companies. As has been opined by the Special Bench of the Tribunal in the case of Dy. CIT Vs. Quart Systems Pvt. Ltd. (2009) 4 ATR 606 a Comparable company cannot be rejected merely because it is a loss making concern so long as it satisfies the functional tests of similarity. In this context, the learned DR appearing for the Revenue emphasized that a Government undertaking has altogether different objectives than a private entity and that it would not facilitate meaningful comparison if the Keltron group concerns are adopted as comparables. 20
24. In our considered opinion, mere fact that Comparable Company is owned by Government, it cannot be a criteria to reject the same, inasmuch as ownership structure of a concern is normally not expected to have a bearing on its operating margins. Nevertheless, even if we were to go along with that thought process of the TPO on this count to reject such Comparable Companies, but after having accepted their comparability on account of functionality, the onus was on the TPO to establish that it had certain peculiar features which actually impacted the profit margins. In this context, in para 1.9.2.3 of the written submissions addressed to DRP, a copy of which is placed in the Paper Book at pages 15.1 to 15.11, the assessee has tabulated the employee cost percentage to sales ratio of the Comparable vis-à-vis the assessee. In terms of the same, the cost of compensation of employees on sales of Comparable Companies, including, Keltron group of companies works out to 14.68% which is quite comparable with the employee's cost to sales of the assessee-company which stands at 4.68%. Therefore, in our view, having regard to the orders of the authorities below, we finds that Keltron group concerns have been rejected by the TPO on the basis of perceptions which are not borne out of the record and do not stand established on the basis of material brought out by the TPO. Therefore, we hold that exclusion of the above concerns was not appropriate for the purposes of benchmarking the international transactions of the assessee. We therefore, hold that the Assessing Officer shall re-examine the matter in the above light. Since we have upheld the plea of the assessee against exclusion of the Keltron group companies, the plea regarding Gujarat Poly Avx is rendered infructuous. Thus, the assessee succeeds on this aspect.
25. An alternative plea has been raised by the assessee to the effect that if at all any transfer pricing adjustment has to be made, the same be computed 21 with reference to the value of international transactions with its AEs alone and not on the total turnover of the assessee. In this context, we find that the objective of the transfer pricing mechanism is only to examine the ALP of the international transactions as contained in sec. 92B(1) of the Act. Therefore, it is meant to arrive at income of international transaction alone in terms of section 92 of the Act and therefore, the plea of the assessee that the transfer pricing adjustment, if any, be made to the total income of the assessee should only be with reference to international transaction of the assessee with AEs and not with reference to the total turnover has to be upheld. The said plea is hereby upheld which is also in line with the decision of the Tribunal in the case of Dy. CIT Mumbai Vs. M/s. Starlite (2010) (133 TTJ 425 (Bom), and T Two International Pvt. Ltd., Tara Jewels Exports Pvt. Ltd. Tara Ultimo Pvt. Ltd. Vs. ACIT (2008) (122 TTJ 957) (Mum). Therefore, on this aspect, the assessee succeeds.
26. In this background, we therefore, set aside the issue relating to determination of ALP of the international transaction back to the file of the Assessing Officer who shall re-work the same in the light of our aforesaid discussion. The assessee partly succeeds.
27. The next Grounds No. (10) and (11) relate to the manner of computation of deduction under section 10B of the Act. In brief, the facts relevant are that the assessee availed deduction under section 10B of the Act at Rs 38,39,493/- and the Assessing Officer has re-worked the deduction under section 10B of the Act at Rs 38,03,558/-. The first grievance of the assessee is that the deduction has been wrongly reduced by reducing the expenses incurred towards insurance and communication expenses amounting to Rs 38,333,859/- and Rs 10,94,937/- respectively from the figure 22 of export turnover by wrongly appreciating Explanation 2(iii) to section 10B of the Act. According to the appellant, no such adjustment was required and notwithstanding the aforesaid, it is further submitted that if at all insurance and commission expenses were to be reduced from the figure of export turnover, same be also reduced from the figure of total turnover in order to compute deduction under section 10B of the Act.
28. Before us, the learned Counsel for the assessee submitted that in terms of Explanation 2(iii) to section 10B of the Act only freight, telecommunication charges or insurance attributable to the delivery of the article or thing or computer software outside India are liable to be reduced from the export turnover and in so far as the amount of freight is concerned, assessee had suo motu reduced the same. With regard to the telecommunication charges of Rs 10,94,937/-, it is submitted that its break-up is as under:
"Particulars Amount (Rs)
Telephone expenses 441,066
Postage expenses 10,134
Courier expenses 9,204
Stationary 634,533
Total 1,094.937"
and this would show that only Rs 4,41,066/- is incurred towards telephone charges and the balance is in relation to postage, courier and stationery and, therefore, cannot be considered as communication expenses so as to be excludible as per Explanation 2(iii) to section 10B of the Act from the figure of export turnover.
29. Even with regard to the details of insurance expenses of Rs 38,33,859/-
which are as under:,
"Insurance - Fire insurance for plant, premises etc. 3,432,708
Insurance - others 76,124
Transit risk insurance 325,027
Total 3,833,859"
23
30. it was explained that only Rs 3,25,027/- pertains to transit risk insurance and the balance is towards other insurances. It was submitted that if at all any amount is to be reduced from the export turnover/total turnover, it would only be out of the amount of Rs 3,25,027/- pertaining to transit risk insurance. Notwithstanding the aforesaid, it has also been contended that none of the expenses have been incurred in foreign currency and, therefore, same are not excludible from the figure of export turnover in terms of Explanation 2(iii) to section 10B of the Act.
31. In the alternate ground, it has been submitted that whatever amounts are excluded from the figure of export turnover, the same would also be liable to be excluded from the figure of total turnover so as to maintain parity and in this regard, reliance has been placed on the judgment of the Special Bench of the Tribunal in the case of ITO v. Sak Soft Ltd 121TTJ 865 (SB)(Chennai). Apart therefrom, reliance has also been placed on the judgment of the Hon'ble Bombay High Court in the case of CIT v Gem Plus Jewellery India Ltd 330 ITR 175 (Bom).
32. On the other hand, the learned Departmental Representative, appearing for the Revenue, has relied upon the orders of the Income-tax authorities in support of the case of the Revenue. As per the learned Departmental Representative, there was no specific clause permitting for exclusion of insurance and communication expenses from the figure of total turnover and, therefore, the Income-tax authorities were justified in not doing so. In so far as the plea of the assessee that no expenditure is incurred on foreign currency for exclusion in terms of Explanation 2(iii) to section 10B of the Act, the learned Departmental Representative submitted that incurrence of expenditure in foreign currency is a condition attached to the second limb of 24 the expenses mentioned in Explanation 2(iii) to section 10B of the Act, which is providing of technical services outside India. Therefore, on this aspect the argument of the appellant has been opposed.
32. We have carefully considered the rival submission on these aspects. Explanation 2(iii) to section 10B of the Act provides the meaning of expression 'export turnover' for the purposes of section 10B of the Act. Section 10B makes a special provision in respect of newly established 100% EOUs. Sub- section (1) of section 10B provides that a deduction of such profits and gains as are derived by a 100% EOU from the export of articles and things or computer software for a specified period beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce articles or things or computer software as the case may be, shall be allowed from the total income of the assessee. Sub-section (4) provides the manner in which profits derived from the export of article of things or computer software shall be computed. It is provided therein that such profits shall be the amount which bears to the profits of the business of the undertaking, same proportion as the export turnover in respect of which articles or things or computer software bears to the total turnover of the business carried on by the undertaking. Explanation 2 to section 10B provides the meaning of some of the expressions contained in the section and for our purpose, clause (iii) of the Explanation explaining the meaning of expression 'export turnover' is relevant. It is provided that the expression 'export turnover' means the consideration in respect of the export by the undertaking of article or things or computer software received in or brought into India in convertible foreign exchange, but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing technical 25 services outside India. In terms thereof, in the present case, the Assessing Officer computed the deduction under section 10B of the Act by excluding from the figure of export turnover amounts of insurance and communication expenses amounting to Rs 38,33,859/- and Rs 10,94,937/- respectively. Factually, it is sought to be brought out by the assessee that it is only a sum of Rs 4,41,066/- which can be considered as communication expenses out of the total of Rs 10,94,937/- and even such amount is not fully excludible since it is only the portion of the expenses which is attributable to the delivery of the article or thing or computer software exported outside India, which is excludible. We find that the break-up of such expenditure was furnished by the assessee before the learned DRP also and there has been no rebuttal from the side of the Revenue on this aspect even before us. Therefore, in our view, it is only the amount of Rs 4,41,066/- representing telephone expenses, that is liable for consideration in terms of Explanation 2(iii) to section 10B of the Act. Similarly, with regard to the insurance expenditure also, the amount of Rs 3,25,027/- alone is relevant to be considered in terms of Explanation 2(iii) to section 10B of the Act. On these aspects, we therefore uphold the contention of the assessee, in principle. So however, on this point it would be necessary to examine as to the appropriate amount that is required to be considered as attributable to delivery of exports so as to be excludible in terms of Explanation 2(iii) to section 10B of the Act from the figure of export turnover. In this connection, we may make reference to the following observations of the Special Bench:
"27. At this juncture, it is necessary to refer to one aspect of the matter. It may be an easy task to exclude the freight, telecom charges or insurance attributable to the delivery of computer software outside India or expenses, if any, incurred in foreign exchange in providing the technical services outside India from the export turnover and the total turnover if they are separately mentioned in the invoice raised by the assessee. In the course of 26 the arguments addressed on behalf of M/s Sak Soft Ltd. a question arose as to what would happen if these items are not separately show in the invoice and are included in the total amount raised by the invoice. It was conceded on behalf of the assessee by is learned representative that in such a case, the AO will have the power to go behind the invoice and find out how much of the invoice amount pertains to the recovery of the aforesaid items. We are also of the view that in an appropriate case it would be open to the AO to exercise such power in order to apply the formula in a meaningful manner."
34. Therefore, following the aforesaid parity of reasoning, it would be appropriate to cull out as to what is the appropriate amount that is required to be excludible from the figure of export turnover within the meaning of Explanation 2(iii) to section 10B of the Act out of communication and insurance expenses. Even with regard to the claim of the assessee that such like amount is also liable to be excluded from the figure of total turnover in order to compute deduction under section 10B, the same is justified in view of the decision of the Hon'ble jurisdictional High Court in the case of Gem Plus Jewellery India Ltd. (supra) as also of the Special Bench of the Tribunal in the case of Sak Soft Ltd. (supra).
35. In this view of the matter, while upholding the pleas of the assessee, in principle, we set-aside the matter back to the file of the Assessing Officer to ascertain the appropriate amount of communication and insurance expenses that are attributable to export outside India so as to be excludible from the figure of 'export turnover' as well as total turnover, and thereafter rework the deduction under section 10B of the Act. Needless to say, the Assessing 27 Officer shall allow a reasonable opportunity of being heard to the assessee and thereafter decide as per law. On this Ground, the assessee succeeds for statistical purposes.
In the result, the appeal of the assessee is partly allowed. Decision pronounced in the open Court on 25 th day of May, 2012 Sd/- sd/-
(I C SUDHIR) (G.S. PANNU)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Pune, Dated 25 th May, 2012
B
Copy to:-
1) Assessee
2) DCIT Cir. 7, Pune
3) DRP, Pune
4) CIT/DIT (International Taxation), Pune
5) DR, "A" Bench, I.T.A.T., Pune.
6) Guard File
True copy By Order
Sr. PS, ITAT Pune