Income Tax Appellate Tribunal - Delhi
Hi-Lex India Private Limited, Gurgaon vs Acit, Gurgaon on 3 March, 2017
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I-2 : NEW DELHI
BEFORE SHRI R.S. SYAL, ACCOUNTANT MEMBER
AND
SHRI KULDIP SINGH, JUDICIAL MEMBER
ITA No.2036/Del/2014
Assessment Year : 2005-06
Hi-Lex India Private Limited, Vs. ACIT,
Plot No.55, Sector-3, Gurgaon Circle,
IMT Manesar, Gurgaon.
Gurgaon.
PAN: AABCM9648Q
ITA No.1849/Del/2014
Assessment Year : 2005-06
ACIT, Vs. Hi-Lex India Private
Circle-2, Limited,
Gurgaon. Plot No.55, Sector-3,
IMT Manesar,
Gurgaon.
PAN: AABCM9648Q
(Appellant) (Respondent)
Assessee By : Shri Rajan Sachdev, CA &
Shri Varun Khanna, CA
Department By : Shri B. Ramanjaneyulu, Sr. DR
ITA Nos.2036 &1849/Del/2014
Date of Hearing : 01.03.2017
Date of Pronouncement : 03.03.2017
ORDER
PER R.S. SYAL, AM:
These two cross appeals - one by the assessee and the other by the Revenue - are directed against the order passed by the CIT(A) on 16.01.2014 in relation to the assessment year 2005-06.
2. The only issue raised by the assessee in its appeal is against non- granting of tolerance band of +/(-) 5% from the arm's length price (ALP) in accordance with the proviso to section 92C(2). The Revenue is aggrieved against the relief allowed in the first appeal.
3. Briefly stated, the facts of the case are that the assessee is a 100% Indian subsidiary of M/s Nippon Cable Systems Inc., Japan. It is engaged in manufacturing mechanical control cables for two-wheeler and four-wheeler makers. The assessee filed its return declaring Nil income. Certain international transactions were reported. The Assessing Officer (AO) referred the matter of determination of the arm's 2 ITA Nos.2036 &1849/Del/2014 length price (ALP) of the reported international transactions to the Transfer Pricing Officer (TPO). The TPO observed that the assessee declared an international transaction of `Purchase of raw material and components' with a transacted value of Rs.5,77,65,870/- apart from `Purchase of Machinery/Spare etc.' worth Rs.55,99,020/-. There were other two international transactions of Reimbursement of tax paid and other expenses, which were not disputed. The assessee applied Transactional Net Margin Method (TNMM) to demonstrate that its two international transactions of `Purchase of raw material and components' and `Purchase of machinery/spares etc.' were at ALP. The assessee selected certain comparable companies which were rejected by the TPO as functionally dissimilar. He, then, shortlisted two companies as comparable, viz., M/s Remsons Industries Ltd. and Suprajit Engineering Ltd., with average profit margin of 7.74%. The TPO determined the ALP of `Raw material purchased from AE' at Rs.4,65,32,510/- as against the declared value of Rs.5,77,67,870/-. This resulted into proposing transfer pricing adjustment amounting to Rs.1,12,33,360/-. The AO made the above addition in his order dated 27.11.2008. The 3 ITA Nos.2036 &1849/Del/2014 assessee went in appeal before the ld. CIT(A), who, vide the impugned order, reduced the transfer pricing adjustment from Rs.1.12 crore to Rs.23 lac. Both the sides are in appeal against the view taken by the ld. CIT(A) against their respective interest.
4. We have heard the rival submissions and perused the relevant material on record. Firstly, we espouse the grievance of the Revenue. It can be seen that the TPO did not propose any transfer pricing adjustment for the international transaction of `Purchase of machinery/stores etc.'. He proposed transfer pricing adjustment only in respect of the international transaction of `Purchase of raw material and components' amounting to Rs.5,77,65,870, which is discernible from his calculation as under : -
Determination of Arm's Length Price:
Operating Income of the Assessee 325,720,182
Operating Profit shown @ 4.29% 1,39,77,382
Operating Profit @ 7.74% 2,52,10,742
Difference
Book value of raw material purchased from AE 5,77,65,870 ALP of raw material purchased from AE 4,65,32,510"4
ITA Nos.2036 &1849/Del/2014
5. It can be seen from the above working that the TPO started with the Operating income of the assessee at Rs.32.57 crore, which is the amount of Gross receipts as per the assessee's Profit & Loss Account, whose relevant part has been reproduced at page 6 of his order. Thereafter, Operating profit has been taken at Rs.1.39 crore in the working, which is again a figure picked up from page 6 of the his own order. These two figures are entity level results of `Revenue' and `Operating profit'. The TPO applied average profit rate of comparables of 7.74% to the amount of the Revenue at Rs.32.57 crore for determining the operating profit from all the transactions of the assessee at Rs.2.52 crore. Difference between the Operating profit of the assessee at Rs.1.39 crore at entity level and the arm's length profit of Rs.2.52 crore has been taken as the amount of adjustment. It is this adjustment through which the ALP of the `Raw material purchased' from AE has been computed at Rs.4.65 (Rs.5.77 crore minus Rs.1.12 crore). Thus, it is manifest that the TPO computed the transfer pricing adjustment at Rs.1.12 crore with reference to the entity level figures of the assessee, which include not only transactions of import of raw material from AEs, but also domestic 5 ITA Nos.2036 &1849/Del/2014 purchase/import from non-AEs. The ld. CIT(A), by means of his calculation tabulated below, restricted the amount of addition to the AE transactions, against which the Revenue is in appeal.
6. The moot question in the Revenue's appeal is if a transfer pricing adjustment can be made in respect of non-AEs transactions? Section 92 is a substantive provision in this regard. Sub-section (1) of sec. 92 provides that ; `Any income arising from an international transaction shall be computed having regard to the arm's length price.' The term "international transaction" has been defined u/s 92B to mean: "a transaction between two or more associated enterprises,.......". A conjoint reading of section 92 with section 92B clearly brings out that computation of income at ALP is permissible only in respect of international transaction, which, in turn, means a transaction between two or more associated enterprises. Similar position has been reiterated in the machinery provision contained in section 92C dealing with the manner of computation of ALP. Sub-section (1) of section 92C stipulates that :`The arm's length price in relation to an international 6 ITA Nos.2036 &1849/Del/2014 transaction shall be determined by any of the following methods.....'. The nitty-gritty of the above discussion is that addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. A fortiorari, no income arising from non- AE transactions can be computed having regard to its ALP. In fact, price/profit from comparable transactions of the assessee with non-AEs, is one of the subtle and most reliable modes for determining ALP of the international transactions. Thus, it boils down that the Act does not contemplate an addition by way of transfer pricing adjustment in respect of transactions with non-AEs. As the TPO ventured to make a composite addition and the ld. CIT(A) restricted it to the transactions with AEs, we uphold, in principle, the view point of the ld. CIT(A). Our view is fortified by the judgment rendered by the Hon'ble jurisdictional High Court in the case of CIT vs. Keihin Panalfa Ltd., (2016) 381 ITR 407 (Del).
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ITA Nos.2036 &1849/Del/2014
7. Now comes the manner of allowing relief by the ld. CIT(A) on merits. The ld. CIT(A) restricted the amount of transfer pricing addition to transactions with AEs in the following manner : -
Particulars Formula Value (in
INR Crs.)
Operating Income of the Appellant A 32.57
Cost of imported raw material & spares B 6.31
consumed
Total Cost of Operation C 31.17
Cost of imported raw material & spares D 20.24%
consumed as % to total cost of operation
Arms length Operating Profit @ 7.74% (as E=7.74% 2.52
determined by TPO in his Order) of A
Actual Operating Profit earned by the Appellant F 1.40
at the entity level
Deficit in Operating Profit at the entity level G 1.12
Deficit Operating Profit attributable to the H=20.24% 0.23
Appellant's International Transaction of G
8. It can be seen that the amount of transfer pricing adjustment at entity level made by the TPO at Rs.1.12 crore appears at 'G' in the above table. The ld. CIT(A) restricted it Rs.23 lac under 'H' by applying percentage of 20.24% to the amount of total transfer pricing addition at the entity level. This 20.24% has been computed by dividing Rs.6.31 crore with Rs.31.17 crore multiplied by 100 i.e., 6.31/31.17 x
100. Rs.6.31 crore is the value of the international transaction of 8 ITA Nos.2036 &1849/Del/2014 Purchase of raw material and component and also Purchase of Machinery/spares etc. Rs.31.17 crore is the Total cost of operation as per 'C' in the table. In our considered opinion, the ld. CIT(A) went wrong in adopting these two figures. He undertook this calculation for segregating profit from the AE transaction of Purchase of raw material and components from the overall operating profit of the assessee. We have noted above that the TPO proposed transfer pricing adjustment only w.r.t. the international transaction of `Purchase of raw material and components' and not the other international transaction of `Purchase of machinery/spares etc.'. No bifurcation is available of the transaction of purchase of machinery and spares etc. Obviously, purchase of machinery cannot directly affect the operating profit except through the amount of depreciation on ALP of purchase price of the machinery, which has not been determined by the TPO or the ld. CIT(A). The other component of this international transaction, being the purchase of spares etc., has been taken by the TPO at ALP. This shows that we need to work out the profit from the international transaction of `Purchase of raw material and components' alone. This can be done by apportioning the total operating 9 ITA Nos.2036 &1849/Del/2014 profit in the ratio of `utilized raw material purchased from the AEs' (i.e. Opening stock of raw material purchased from the AEs + Purchases of raw material from the AEs - Closing stock of raw material out of the above transactions with AEs) and `utilized raw material purchased from non-AEs' (i.e. Opening stock of raw material purchased from non-AEs + Purchases of raw material from non-AEs - Closing stock of raw material out of the above transactions with non-AEs). Or alternatively, the share of operating profit from the `utilized raw material purchased from the AEs' can be deduced from the total amount of operating profit by dividing the amount of `utilized raw material purchased from the AEs' with the overall amount of `utilized raw material purchased from the AEs and non-AEs'.
9. When we advert to the calculation of the ld. CIT(A), it can be seen that he has taken Rs.6.31 crore as numerator, which is the value of both the international transactions of `Purchase transaction of raw material and components' and `Purchase of machinery/spares etc.' The denominator in the ld. CIT(A)'s formula is Rs.31.17 crore, which is 10 ITA Nos.2036 &1849/Del/2014 'Total cost of operations' being item 'C' in his table. On a pertinent query, it was stated that Rs.31.17 crore is the total cost of goods sold, which not includes the cost of raw material but also other direct costs, such as, wages and power etc. In our considered opinion, there is no logic in considering all the other operating costs in denominator alone, when the numerator is exclusive of such other operating costs. Either the other operating costs relating to raw materials purchased from AEs should also have been included in the numerator or these should have been eliminated from the denominator as well. Taking other operating costs only in denominator alone has distorted the apportionment of profit between the international transactions and non-international transactions. More appropriate course, in our considered opinion, is to apportion the total operating profit of the assessee to the international transaction by dividing the amount of `utilized raw material purchased from the AEs' with the overall amount of `utilized raw material purchased from the AEs and non-AEs', as has been discussed supra. We order accordingly. As the necessary figures of numerator and denominator in the manner discussed above, are not readily available with the ld. AR, we, therefore, 11 ITA Nos.2036 &1849/Del/2014 set aside the impugned order and remit the matter to the file of AO/TPO for doing the needful in above terms. Needless to say, the assessee will be given an adequate opportunity of hearing in doing the above exercise.
10. This brings us to the assessee's grievance about the non-granting of +/- 5% adjustment which the ld. CIT(A) did not allow without assigning any reason.
11. Section 92(1) provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Section 92B(1) defines "international transaction" to mean ".....a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.......". Section 92C dealing with the computation of arm's length price provides through sub-section (1) that : "The arm's length price in relation to an international transaction shall be determined by any of the following 12 ITA Nos.2036 &1849/Del/2014 methods, being the most appropriate method, having regard to the nature of transactions or class of transaction or class of associated persons.......". When we read the above discussed three provisions, it clearly emerges that firstly, there should be an international transaction; secondly, there should be income arising from such international transaction; and thirdly, such income should be computed having regard to the arm's length price. What we compute is income and the base from which such income is computed, is an international transaction, which can be in the nature of purchase or sale or provision of services etc. With this background in mind, let us have a look at proviso to section 92C(2) at the material time, 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, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean."
12. The ALP is nothing but a benchmark or a standard price meant for comparison with the price charged or paid by the assessee in the international transaction with its associated enterprise. Since this 13 ITA Nos.2036 &1849/Del/2014 standard price constitutes the basis for making addition in the hands of the asssessee on account of its international transactions with the associated enterprises, the legislature, in order to iron out the differences between the actual transacted price and such standard price, inserted proviso to section 92C(2). The role of this proviso is to make such standard price or ALP flexible and not rigid. It has been provided that if the price actually charged or paid by the assessee falls within plus minus 5% range of such ALP or standard price, then no addition should be made.
13. From the language of the above proviso, it can be noticed that where more than one price is determined by the most appropriate methods, the arm's length price shall be taken to be the arithmetical mean of such prices. A further option has been given to the assessee by which variation up to plus minus 5% of `such arithmetical mean' can be ignored. The former part of the proviso talks of the ALP as arithmetical mean of such prices and the later part of the proviso refers to five percent of such arithmetical mean. The word `such' arithmetical mean 14 ITA Nos.2036 &1849/Del/2014 brings the focus back to the price. Thus the prescription of this proviso makes it clear that the plus minus five percent is on the price and not on the profit embedded in such price.
14. The conclusion that plus minus 5% should be applied to the price of purchase or sale or services etc. instead of income component in such price is fortified from the mandate of the methods for determination of arm's length price. Section 92C(1) gives five specific methods for computing arm's length price. Rule 10B deals with the determination of arm's length price under such methods. First is Comparable uncontrolled price (CUP) method, under which the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction is first identified. After making certain adjustments to make it compatible with the international transaction, the adjusted price is taken as arm's length price in respect of property transferred or services provided in the international transaction. Thus it can be noticed that what is determined under this method is the price. When we refer to plus minus 5% of the value determined under this method as per proviso to section 92C(2), it inevitably refers to the figure 15 ITA Nos.2036 &1849/Del/2014 determined under this method, which is price and not profit embedded in the price. For example, if an assessee has sold goods to its AE worth Rs.100 and the ALP in respect of such goods sold under CUP method is say Rs.103 or Rs.98, then no adjustment is required because it is within 5% of Rs.100, being the price at which goods were sold to associated enterprises in the international transaction. Irrespective of the fact whether the profit component in the sale value of Rs.100 is Rs.4 or Rs.8 or Rs.10, it is, in fact, the comparison of the price charged or paid for property transferred which is the subject matter of proviso to section 92C(2). Thus it can be seen that the plus minus 5% is required on the value of international transaction, being the purchase price in the instant case and not on the profit element in such transactions. We, therefore, direct that +-5% should be given effect in the calculation of the transfer pricing adjustment from the international transaction, if any. It is however, clarified, that this +-5% is not a standard deduction. This benefit is to be given only if the ALP falls within +-5% range of the price and not otherwise.
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ITA Nos.2036 &1849/Del/2014
15. In the result, both the appeals are allowed for statistical purposes.
The order pronounced in the open court on 03.03.2017.
Sd/- Sd/-
[KULDIP SINGH] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 03rd March, 2017.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.
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