Income Tax Appellate Tribunal - Delhi
Mge Ups System India Pvt. Ltd., ... vs Assessee on 27 May, 2016
1 ITA No. 5773/Del/2011
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH: 'I-1' NEW DELHI
BEFORE SHRI S.V. MEHROTRA, ACCOUNTANT MEMBER
&
SHRI SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER
I.T.A .No.-5773/Del/2011
(ASSESSMENT YEAR-2007-08)
MGE UPS System India P. Ltd. vs DCIT
(Now known as American Power Circle 6(1)
Conversion (India) Pvt. Ltd.) New Delhi.
187/3 & 188/3, Jigani,
Bangalore.
AAECM6295N
Assessee by Sh. Himanshu Sinha, Adv.
Sh. M. Fahed Khalid, CA
Revenue by Sh. Amrendra Kumar, CIT DR
Date of Hearing 16.05.2016
Date of Pronouncement 27.05.2016
ORDER
PER S.V. MEHROTRA, ACCOUNTANT MEMBER:
This appeal filed by the assessee is directed against the order of AO, New Delhi, dated 19.10.2011 passed under section 143(3) r.w.s. 144C of the I.T. Act for A.Y. 2007-08.
2. Brief facts of the case are that the assessee is a subsidiary of MGE UPS Systems S.A., France which provides power protection solutions for business continuity for international customers. Its products provide uninterrupted power supplies 2 ITA No. 5773/Del/2011 systems for use by consumer electronics, PCs, printers, and home theater users. MGE France operates as a subsidiary of Schneider Electric S.A., France, which is the world's power and control specialist and caters to residential, building, industry and energy and infrastructure markets. The assessee was incorporated in 2005 and commenced its operations with distribution and marketing support services for UPS systems and accessories during the FY 2006-07. The assessment year under consideration is the first year of assessee's operation. The assessee imports finished goods (UPS systems and batteries) from its associated enterprises for resale in the domestic market. The products imported comprised of various categories/types of UPS systems. The asessee also performs certain marketing support services in connection with direct sales made by the associated enterprises to customers in India, for which it receives a commission income. The assessee had filed return of income declaring nil income. As the assessee had entered into various international transactions reference was made to transfer pricing officer for determination of arm's length price. The following are the details of international transactions with its associated enterprises as per Form 3CEB:
S.No. Description of transaction Value (In Rs.)
1. Sales Promotion Expenses 1,09,188
2. Purchase of finished goods from AE 12,38,16,952
3. Rendering of Services (Commission Recd.) 2,82,42,910
4. Freight Charges 7,03,091
5. Reimbursement of expenses paid 76,600
3. For determining the arm's length price of these international transactions, in the Transfer Pricing study, the 3 ITA No. 5773/Del/2011 assessee adopted resale price method as the most appropriate method with the profit level indicator (PLI) as gross profit upon sales. The assessee had selected eight comparables on the basis of search carried out by the assessee. As the gross profit of assessee was 28% as against mean GP of 12% of the comparables, the assessee's conclusion was that its international transactions were at arm's length price.
4. Ld. TPO rejected the use of RPM and applied transactional net marginal method (TNMM) as the most appropriate method. The ld. TPO also carried out a fresh search and on that basis found out following four comparables:
Name of the Company OP/Sales V-Guard Industries Ltd. 14.22% PAE Ltd. 0.66% Kuna Impex Ltd. 1.71% PL Enterprise 4.14% Arithmetic Mean 5.18%
The main reason for rejection of comparables selected by assessee was that those companies were not engaged in trading of UPS system and were dealing in dissimilar categories of products.
5. Ld. TPO determined the arm's length margin to be 5.18% viz-a-viz -31.81% of the assessee, PLI being operating profit/operating income. Ld. TPO computed the arm's length price and corresponding difference to be adjusted as under:
4 ITA No. 5773/Del/2011"Since the assessee has raised objections in the case of comparable (M/s PAE Ltd.) about the inclusion of commission income, therefore, the results shown by the assessee are recomputed as under:
1. Sales (Excluding other income) Rs. 14,01,54,678
2. Total Cost (excluding Finance Rs. 18,47,41,095 cost)
3. Operating profit Rs. (4,45,86,417)
4. OP/TC -24.13%
5. OP/Sales -31.81% The arm's length price of the international transaction relating to Purchase segment is calculated as below:
Total Sales : Rs. 14,01,54,678
OP at a margin of 5.59% : Rs. 72,60,012
OP shown : Rs. (4,45,86,417)
1. Purchase of finished goods from 12,38,16,952
AE
(Amt. paid by the assessee)
2. Arm's Length price of the 7,19,70,523
purchase of finished goods
Difference : Rs. 5,18,46,429
6. Ld. DRP upheld the application of TNMM over RPM but gave following two directions:
• For computing the operating income the commission income should be included both for the comparable companies as well as the assessee;
• For computing the operating expenses, pre-operating expenses should be excluded.
After these two directions the PLI of the assessee increased to - 31.03% (without including commission income) viz-a-viz the arm's length margin of 5.59% leading to an adjustment of arm's length price by Rs. 5,07,55,614/-.5 ITA No. 5773/Del/2011
7. The Assessing Officer, accordingly passed the assessment order u/s 143(3) read with section 144C on 19th October, 2011 determining the total income as under:
Total loss as per computation of income (91,62,665) Add:
(i) Addition on a/c of Transfer pricing adjustment 5,07,55,614
(ii) Claim of ROC expenses incurred in connection with increase in share capital 1,30,500
(iii) The expenses incurred in relation to start Of the business restricted to Rs. 10,90,815 10,90,815
(iv) Provision for warranty 16,99,465 5,36,76,394 Total income 4,45,13,729
8. Being aggrieved with the AO's order, the assessee is in appeal before us and has taken following grounds of appeal:
Transfer Pricing adjustment
1. "The ld. AO and the ld. TPO grossly erred in law and facts of the case in determining the arm's length price of the international transaction of the appellant as Rs.
7,30,61,338/- received on account of purchase of finished goods and thereby making an adjustment of Rs. 5,07,55,614/- with respect to the purchase of finished goods by the tax payer u/s 92CA of the Income Tax Act.
2. The ld. AO and the ld. TPO erred in rejecting the Transfer Pricing documentation without appreciating the contentions, and evidentiary data put forward by the appellant during the course of the proceedings before them, and in doing so have grossly erred:
2.1in accepting V-Guard Industries Ltd. as comparable since the functional, risk and product profile of V Guard are different from that of the appellant. 2.2 in rejecting Compuage Infocom Ltd. and Computer Point Ltd. by stating that they are not functionally comparable.
Further if the ld. TPO considers that "broadly" similar 6 ITA No. 5773/Del/2011 products may be considered as comparable, the companies selected, Compuage Infocom Ltd. and Computer Point Ltd. should be considered as comparables as they are engaged in trading of computer peripherals and related items.
3. The ld. AO and the ld. TPO ought to have appreciated that FY 2006-07 (relevant to AY 2007-08) is the first year of operations and losses incurred during the year are solely due to business or commercial reasons than on account of transfer pricing.
4. The ld. AO and the ld. TPO ought to have appreciated the fact that the appellant incurred expenditure, the benefit of which have resulted in the subsequent year.
5. The ld. AO erred in excluding commission income from the operating income of the appellant contrary to the directions of the Hon'ble DRP vide their order dated 14th September, 2011.
Non-Transfer Pricing adjustments
1. ROC expenses in connection with the issue of the share capital: Rs. 1,30,500 1.1 The ld. AO/DRP erred in confirming the gross disallowance of Rs. 130,500 incurred by the appellant towards filing fees with the Registrar of Companies in connection with the issue of the share capital of the Company.
1.2 Notwithstanding and without prejudice to above, should the said expenditure be treated as capital in nature, the ld. AO erred in not granting the deduction u/s 35D of the Act.
2. Expenses incurred before the commencement of operations: Rs. 1,090,815 2.1 The ld. AO/DRP erred in confirming the disallowance of expenses incurred before commencement of operations as capital in nature.
2.2 The ld. AO/DRP ought to have observed that said expenses were incurred wholly and exclusively for the purpose of business of the appellant and therefore, allowable u/s 37(1) of the Act.
7 ITA No. 5773/Del/20112.3 Notwithstanding and without prejudice to above, should the said expenditure be treated as capital in nature, the ld. AO erred in not granting the deduction u/s 35D of the Act.
3. Disallowance of provision for warranty: Rs. 1,699,465 3.1 The ld. AO/DRP erred in confirming the disallowance of provisions towards warranty made by the appellant as a percentage of sales made during the year based on technical estimate.
3.2 The ld. AO/DRP ought to have observed that the appellant follows scientific basis and a consistent policy while making provision for warranty. 3.3 The ld. AO/DRP ought to have observed that the expenses are incurred wholly and exclusively for the purpose of business of the appellant and is therefore, allowable u/s 37(1) of the Act.
3.4 The ld. AO/DRP erred in not following the judicial precedents in this regard:
Rotork Controls India (P) Limited vs. CIT (314 ITR
62) (SC) CIT vs. Indian Transformers Ltd. - 270 ITR 259 -
Kerala High Court Jay Bee Industries vs. DCIT 61 TTJ 403 (Asr) Bangalore ITAT in Wipro GE Medical Systems Ltd. vs. DCIT 80 TTJ 45
4. No credit for taxes deducted at source: Rs. 601,915 4.1 The ld. AO/DRP erred in granting no credit for taxes deducted at source amounting to Rs. 601,915/- 4.2 The ld. AO/DRP ought to have relied on Form 16A issued by the deductor while giving effect to the taxes deducted at source.
5. Calculation of Interest on resulting adjustment under section 234B of the Act: Rs. 8,240,827 5.1 The ld. AO erred in levying interest amounting to Rs.
8,240,827 under section 234B of the Act.
The appellant craves leave to add, alter and modify the above grounds during the course of appeal.
8 ITA No. 5773/Del/2011For the above and any other grounds which may be raised at the time of hearing, it is prayed that the order of the Assessing Officer be set aside."
9. Ld. Cousnel for the assessee submitted that first we should consider ground no. 3 & 4 because ld. TPO has not allowed the adjustment in regard to start up of phase. He submitted that assessee was in the first year of his operations and, therefore, losses were incurred. Under such circumstances, ld. TPO should have allowed adjustment because it is well settled commercial principle that break even could reach only after a sufficient period of operations by which time the income is sufficient to contribute towards fixed cost and also start earning profit. He submitted that assessee is not disputing the applicability of TNMM method but TNMM should be applied only after significant differences of operating cost between the comparables and assessee are adjusted. He submitted that first year business operations cannot be compared with old business.
9.1 Ld. Counsel pointed out that the comparables selected by the assessee were quite old which will be evident from the following table:
Name of the Company Year of Incorporation V-Guard Industries Limited 1996 PAE Limited 1950 Kuna Impex 1998 PL Enterprise 1992 9 ITA No. 5773/Del/2011
10. Ld. Counsel referred to page 136 & 137 of the paper book, wherein the objections raised before ld. DRP are contained in which it was, inter alia, stated as under:
"The assessee wishes to highlight to the Hon'ble DRP Panel that the ld. TPO has not appreciated the fact that FY 2006-07 was assessee's first year of business operations. The ld. TPO has not performed appropriate adjustments in this respect to the financials of the comparable companies (for e.g. V Guard is into 12th year of operations in FY 2006-07 and P.L. Enterprises is into 16th year of operations in FY 2006-07). The ld. TPO should have ideally examined and considered the results of first year of operations of the TPO selected comparables.
The assessee would like to humbly submit that the net loss incurred by the assessee during FY 2006-07 is not as a result of higher transfer price determined for the international transaction relating to purchase of goods, but is primarily due to the fact of certain extraordinary and fixed costs incurred during the first year of operations of business, which will be true even in case of the comparables. The detailed working in this regard would be produced by the assessee at the time of hearing before the Hon'ble DRP."
10.1 With reference to the abvoe objections raised before ld. DRP, ld. Counsel pointed out that though the assessee had not given any computation but raised specific point on this issue. He, inter alia, relied on the following case laws in support of his submission that adjustment for expenses incurred in start up phase has to be allowed:
S.No. List of case laws on Nature of ITA No. economic adjustments adjustment
1. Amdocs Business Services P. Adjustment for ITA No. 10 ITA No. 5773/Del/2011 Ltd. expenses incured 1412/PN/11 in start-up phase
2. Ariston Thermo India Ltd. Adjustment for ITA No. expenses incurred 1455/PN/2010 in start-up phase
3. Global Turbine Services Inc. Adjustment for ITA No. expenses incurred 3484/Del/2011 in start-up phase
11. Ld. Counsel referred to annexure 3 of Synopsis filed in course of the proceedings and submitted that the matter may be restored back to the file of ld. TPO to examine all the details and then make the adjustments to operating expenses.
12. Apropos ground no. 2 dealing with the issue relating to selection of comparables ld. Counsel pointed out that all the comparables chosen by the ld. TPO does not have commission income except PAE Ltd. He further pointed out that V-Guard Industries Ltd. is selling stabilizers and UPS is a very small segment of this company. He further pointed out that segmental details are not available. He, therefore, submitted that considering all these aspects fresh comparables having trading and commission income should be taken including PAE with adjustments as mandated by law.
13. Ld. DR submitted that the comparables selected by the TPO were primarily dealing in the same line in which the assessee was dealing. He submitted that it is the functional comparability which is relevant for selection of comparables. He relied on the following decision:
11 ITA No. 5773/Del/2011ION Trading India Pvt. Ltd. ITA No. 1035/Del/2015 dated 07/12/2015 (TS-643-ITAT-2015(Del)-TP AY 2010-11.
14. We have considered the submissions of both the parties and perused the record of the case.
14.1 We find considerable force in the submission of ld. Counsel for the assessee that for determining the arm's length price of international transactions between associated enterprises if the comparable selected are operating since long and the assessee is in the initial stages of operation then considerable adjustments has to be made to the operating expenses in order to give due leverage to the contribution of income to the fixed cost. Unless the fixed cost is fully recovered, the break even cannot be arrived at.
14.2 Under such circumstances, the losses incurred by the assessee cannot be the basis for finding out the arm's length price without making due adjustments to the operating expenses so as to bring it at the level playing field with the comparables. In the course of hearing the ld. Counsel pointed out that break even was arrived at in next year and ld. TPO has accepted the transactions being at arm's length price in next year. One of the contentions of the ld. CIT DR was that this plea was not taken before ld. TPO but, as reproduced earlier, before ld. DRP, specific objection to this effect had been taken. Therefore, merely on the ground that this plea was not taken, assessee's claim cannot be denied more particularly because not allowing for this adjustment would go 12 ITA No. 5773/Del/2011 against the very principle of comparability criteria contemplated under Rule 10B of the I.T. Rules. We further find that though ld. DRP had given direction for inclusion of commission income as part of the operating income but except PAE Ltd. all other comparables were not having any commission income.
14.3 Under such circumstances, as rightly suggested by the ld. Counsel for the assessee, the proper course would be to restore the matter to the file of ld. TPO to find out fresh comparables having trading and commission income both and include the same after making adjustments as mandated by the law. Ld. TPO will also examine the details as per annexure 3 and any further details as may be necessary to consider and will make adjustments to salary and rental income and other adjustments so as to bring the profitability of assessee inconformity with the profitability of the comparable after providing due opportunity of hearing to the assessee.
15. In the result, the grounds relating to transfer pricing adjustments are allowed for statistical purposes in terms of aforementioned observations.
Non Transfer Pricing Issues
16. Brief facts apropos ground no. 1 are that assessee had claimed ROC expenses aggregating to Rs. 1,30,500/- incurred in connection with increase in authorized share capital of assessee.
13 ITA No. 5773/Del/2011The AO disallowed these expenses observing that the same was of capital nature.
17. Before ld. DRP this issue was not raised. However, now assessee has taken fresh plea vide ground nos. 1 & 1.2 relying on the decision of the Hon'ble Rajasthan High Court in the case of CIT vs. Multi Metals Ltd., 188 ITR 151, wherein the alternative submission of the assessee in regard to allowability of the amount paid as fee for registration to ROC for amendment of the memorandum of association for raising the authorized capital being eligible for deduction u/s 35D was accepted. Ld. DR submitted that the issue is covered against the assessee by the decision of Hon'ble Supreme Court in 225 ITR 798 Brook Bond India Ltd. vs. CIT.
18. We have considered the submission of both the parties. Hon'ble SC in the case of Brook Bond India Ltd. (supra) had considered the expenditure in connection with additional issue of shares and had held that expenditure directly related to expansion of capital base and was therefore, capital in nature. This decision is subsequent to the decision relied upon by the ld. Counsel for the assessee in the case of Multi Metals Ltd. which is dated 27th October, 1990 and, therefore, we are not inclined to accept the additional plea raised by ld. Counsel for the assessee.
19. In the result, these grounds are dismissed.
14 ITA No. 5773/Del/201120. Brief facts apropos ground no. 2 are that during the assessment proceedings the AO noticed that assessee had incurred recruitment expenses of Rs. 20,58,421/-, training expenses of Rs. 14,25,845/- and entertainment expenses of Rs. 30,48,460/-. He pointed out that this was the first year of assessee's business and the assessee had incurred all these expenses to start its business. He noticed from the details of entertainment expenses that they had been incurred for the launch of the business of the assessee at various stations like Hyderabad, Pune, Kolkata, Mumbai, Delhi etc. After examining the details he concluded that all these three expenses aggregating to Rs. 65,32,726/- were capital in nature.
21. Ld. DRP relying on the decision in the case of EID Peri (India) Pvt. Ltd. vs. CIT, 257 ITR 253 (Mad.) held that these were pre-operative expenses incurred by assessee prior to the (commencement of the business dt. 11th May, 2006) and, therefore, directed to restrict the disallowance to Rs. 10,90,815/-.
22. Ld. Counsel submitted that ld. DRP has not considered the set up aspect of the business as has been clarified in the case of CIT vs. Saurashtra Cement Industries (91 ITR 170) & 26 ITR 151 (Mum.) (HC) Western India Vegetable Products Ltd. vs. CIT and, therefore, the matter may be restored back to the file of AO to find out the date of set up of the business. He pointed out that there is a clear distinction between the dates of commencement of the business and set up of the business and for the purposes of the 15 ITA No. 5773/Del/2011 Income tax Act the date of set up of the business and not the date of commencement of the business is to be considered.
23. Ld. CIT DR submitted that the ld. DRP has already considered the issue and has allowed considerable relief to the assessee.
24. We have considered the submissions of both the parties and have perused the record of the case. Both the decisions relied upon by the ld. Counsel of the assessee clearly hold that the relevant date for deciding whether an expenditure is pre operative or post operative is the date of setting up of business and not the date of commencement of business. Both the lower revenue authorities have not examined this aspect and, therefore, we restore this issue to the file of AO to examine the issue afresh with the light of aforementioned decisions.
25. In the result, this ground is allowed for statistical purposes.
26. Brief facts apropos ground no. 3 are that assessee had claimed provision for gratuity aggregating to Rs. 16,99,465/-. The assessee had made this provision as 6% of the sales. The AO disallowed the assessee's claim, inter alia, observing that estimation was not based on any statistical analysis or any historical data base. He further pointed out that this was the first 16 ITA No. 5773/Del/2011 year operation of the assessee and, therefore, assessee was not having any prior experience. Ld. DRP confirmed the AO's order.
27. Having heard both the parties, we do not find any reason to interfere with the order of AO because the estimation was not based on any scientific basis.
28. In the result, this ground is dismissed.
29. Apropos ground no. 4 is in regard to not granting credit for taxes deducted at source amounting to Rs. 6,01,950/-. The AO should examine the assessee's claim and pass the order in accordance with the law.
30. Ground no. 5 dealing with interest u/s 234B is consequential.
31. In the result, the assessee's appeal is partly allowed for statistical purposes.
Order is pronounced in the open court on 27.05.2016 Sd/- Sd/-
(SUDHANSHU SRIVASTAVA) (S.V. MEHROTRA)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: 27.05.2016
*Kavita Arora
17 ITA No. 5773/Del/2011
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(Appeals)
5. DR: ITAT
ASSISTANT REGISTRAR
ITAT NEW DELHI
Date
1. Draft dictated on 24.05.2016/26.05.16
2. Draft placed before author 25.05.2016/26.5.16
3. Draft proposed & placed before the second member
4. Draft discussed/approved by Second Member.
5. Approved Draft comes to 27.05.2016 the Sr.PS/PS
6. Kept for pronouncement on 27.05.2016
7. File sent to the Bench Clerk 27.05.2016
8. Date on which file goes to the AR
9. Date on which file goes to the Head Clerk.
10. Date of dispatch of Order.