Income Tax Appellate Tribunal - Delhi
Becton Dickinson India Pvt. Ltd., ... vs Dcit, New Delhi on 28 April, 2017
Fatal In the Income-Tax Appellate Tribunal, Delhi Bench 'I(1)', New Delhi Before : Shri I.C. Sudhir, Judicial Member And Shri L.P. Sahu, Accountant Member ITA No. 4548/Del./2011 Assessment Year: 2003-04 Becton Dickinson India Pvt. Ltd., 6th Floor, Signature Tower-B, Gurgaon. PAN- AAACB2656A (Appellant) vs.. D.C.I.T., Circle 2(1), New Delhi (Respondent) ITA No. 4337/Del./2011 Assessment Year: 2003-04 A.C.I.T., Circle 2(1), New Delhi (Appellant) vs.. Becton Dickinson India Pvt. Ltd., 6th Floor, Signature Tower-B, Gurgaon. (Respondent) Assessee by Sh. K.M. Gupta, Advocate Revenue by Sh. Neeraj Kumar, Sr. DR Date of Hearing 16.03.2017 Date of Pronouncement 28.04.2017 ORDER Per L.P. Sahu, A.M.:
These are two appeals filed by the assessee as well as revenue against the order of the CIT(A)-XX, New Delhi dated 29th of July 2011 for the assessment year 2003 -04 . The grounds taken by the both the parties in their appeals read as under :
Grounds raised by Revenue:
"1. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs.3,09,47,043/- made on account of provision for slow moving raw material.
2. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs.4,53,27,698/- made on account of provision for slow moving finished goods.
3. The Ld. CIT(A) has erred in directing the AO to allow depreciation of Rs.66,16,486/- in respect of the assets which were not put to use during the financial year relevant to the assessment year.
4. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs.4,42,963/- made u/s. 115JB of the I.T. Act on account of provision for warranty."
Grounds raised by assessee :
"1. That on the facts and in the circumstances of the case and in law, the orders passed by the Ld. Deputy Commissioner of Income-tax ('Ld. AO') and the Ld. Commissioner of Income Tax (Appeals) [CIT(A)], are bad in law and void ab-initio.
2. That the Ld. CIT(A) grossly erred on facts and in law in confirming an adjustment of Rs. 14,15,33,615 made by the Ld. Transfer Pricing Officer (TPO) to the arm's length price of components and finished goods declared by the appellant in respect of the international transactions entered into by it with overseas associated enterprises (AEs). The Ld. CIT(A) has grossly erred by confirming the action of the Ld. TPO of:
2.1 rejecting the 'TNMM' analysis undertaken by the appellant using multiple year data to substantiate that the international transactions pertaining to components and finished goods from its AEs are at arm's length.
2.2 not appreciating the fact that the appellant operated as a manufacturer as well as a distributor, thus necessitating a segregation of its business operations into manufacturing and distribution segments for analysing its transfer prices.
2.3 by aggregating the appellant's manufacturing and distribution activities and erroneously benchmarking its consolidated net operating margins against manufacturing entities.
2.4 not appreciating that the losses incurred by the appellant were on account of extraneous factors not attributable to the pricing of its international transactions.
3- That the Ld. CIT(A) grossly erred in law and on facts by confirming the action of the Ld. TPO/AO of denying the benefit of (+/-) 5% mentioned in the proviso to section 920(2) of the Act to the appellant."
The assessee has also raised an additional ground which reads as under :
"The ld. CIT(A) grossly erred in not restricting the transfer pricing adjustment to the value of international transaction as enunciated in the India TP Regulations, International guidelines and various judicial pronouncements."
For the sake of convenience, we are taking first the appeal of the Revenue.
2. The brief facts of the case are that the assessee company is engaged in the business of business of manufacture and trading of medical devices and diagnostic equipment. It manufactures and sells a range of supplies, devices and systems for use by healthcare professionals, medical research institutions and hospitals. The major products in medical Systems segment are hypodermic syringe used for injection, insulin syringe, infusion therapy devices, and surgical blades and SCAIPELS. The assessee filed its return of income on 25th of November 2005 declaring Nill income. The case was selected for scrutiny and statutory notices were issued to the assessee. During the course of his scrutiny proceedings questionnaires were issued to the assessee. In response to this questionnaire, the assessee filed written submissions before the assessing officer. The learned assessing officer also noted that the assessee has taken international transactions, therefore, the matter was also referred to transfer pricing officer for determining correct value of international transactions undertaken by the assessee. The learned assessing officer after considering the submissions of the assessee and transfer pricing officers directions, made various additions and enhanced the income of assessee as well as made adjustment on book profits also. Aggrieved by the order of the assessing officer the assessee carried the matter to the ld. First appellate authority, who deleted some of the additions because in the other assessment years the issues were directly covered by the decision of the ITAT in own cases for the assessment years 2001-02 to 2005-06 ( ITA No. 904/Dell 2010 ). However, the ld. CIT(A) sustained the addition made by AO on account of adjustment on transfer pricing issue. The Revenue was not satisfied with the deletion of additions and assessee was aggrieved with the sustenance of additions made by CIT (A), therefore, both the parties are in present appeals before the Tribunal.
3. The LD. Departmental representative relied on the order of the assessing officer and he submitted a written synopses which is as under :
"i. Ground No. 1, 2 and 4 of Revenue: AO has discussed in detail in his order for making additions on account of provision for slow moving raw material and finished goods. The AO has also discussed in detail for adding provision for warranty for computation of book profit u/s 115JB. ii. Ground No.3 of Revenue: Depreciation of Rs.66,16,486 claimed on assets held for sale: The Ld. CIT(A) allowed the claim of depreciation of Rs.66,16,486/- entirely on the ground that once the asset is put in a block of assets then its use needs to be decided only in the first year and even if it is not used in any subsequent year then also the claim of depreciation is allowable. The above reasoning is legally flawed as the asset is required to be put into use in the relevant financial year then only the claim of depreciation is allowable. It is evident from the provision of the section 32 of the Income Tax Act that depreciation is allowable only when it is put to use in that particular assessment year by the assessee. The plant, machinery and other depreciable assets have to be actually used for claim of depreciation. This has been held in several judgments. In Liquidators of Pursa Ltd. v. CIT (25 ITR 265), the Supreme Court while construing the meaning of the expression used for the purposes of the business held that it meant used for the purpose of enabling the owner to carry on the business and earn profits in the business. In CIT v Refrigeration and Allied Industries Ltd (247 ITR 12), the Delhi High Court held that the principal factors responsible for reduction in value of a capital asset and for depreciation are (a) ordinary wear and tear; (b) unusual damage; (c) inadequacy; (d) obsolescence. These factors include not only those relating to physical deterioration but also those relating to the suitability of the asset as an economically productive unit after a period of time. The two ingredients for depreciation allowance are (1) the depreciable asset should be owned by the assessee; and (2) it should be used for the purpose of the assessee's business or profession. The ld. CIT(A) has further held that AO has not conducted any inquiry and has made disallowance entirely on the basis of 'notes to accounts'. The Hon'ble jurisdictional High Court has held in case of [2015] 56 taxmann.com 286 (Delhi) Commissioner of Income-tax-II v. Jansampark Advertising &. Marketing (P) Ltd. that though it is obligation of Assessing Officer to conduct proper scrutiny of material, in event of Assessing Officer failing to discharge his functions properly, obligation to conduct proper inquiry shifts to Commissioner (Appeals) and Tribunal. The relevant extract is reproduced below:-
38. The provision of appeal, before the CIT (Appeals) and then before the ITAT is made more as a check on the abuse of power and authority by the AO. Whilst it is true that it is the obligation of the AO to conduct proper scrutiny of the material, given the fact that the two appellate authorities above are also forums for fact-finding, in the event of AO failing to discharge his functions properly, the obligation to conduct proper inquiry on facts would naturally shift to the door of the said appellate authority. For such purposes, we only need to point out one step in the procedure in appeal as prescribed in Section 250 of the Income Tax Act wherein, besides it being obligatory for the right of hearing to be afforded not only to the assessee but also the AO, the first appellate authority is given the liberty to make, or cause to be made, "further inquiry", in terms of sub-section (4) which reads as under:--
"The Commissioner (Appeals) may, before disposing of any appeal, make such further inquiry as he thinks fit, or may direct the Assessing Officer to make further inquiry and report the result of the same to the Commissioner (Appeals)."
It is also pertinent to mention that the assessee has reduced provision for sale of assets amounting to Rs.6.01 cr from its margin computation for the purpose of computation of ALP on the ground that these assets were never made operational. The above contention has been accepted by the TPO as well (refer para 7.2(d) of the TPO's order at pg no. 14 of the TPO's order). Thus, if the assessee is allowed relief on the ground of depreciation on these assets on the ground of 'put to use' then the above provision should also be included for computation of margin of the assessee while computing ALP purchase of raw material and traded goods.
iii. Ground No.2 of assessee : TP Adjustment of Rs. 14,15,33,615/- made by the TPO on account of purchase of traded and finished goods:
a. Multiple year data: The Hon'ble Delhi High Court has held in case of Chryscapital Investment Advisors (India) (P.) Ltd. v. Deputy Commissioner of Income-tax[2015] 56 taxmann.com 417 (Delhi) has held that multiple year data cannot be used as per the provision of Rule 10B(4). b. Aggregation of manufacturing and distribution by the TPO: The TPO has given detailed reasons for the aggregation of manufacturing and distribution segments. The TPO has held that all the segments are inextricably linked as the primary business of the assessee is sale of injection/syringes which are either manufactured or traded and even the service income is also in respect of the above business. Even the assessee has admitted in the TP Study Report that it failed to get comparables for the manufacturing segments and thus it has aggregated the manufacturing segment with distribution segment. c. Rejection of RPM (secondary analysis) for distribution segment: Detailed reasons have been given for rejection of RPM by the TPO and by the Ld. CIT(A). It is evident from the profile of the 4 comparables selected by the assessee in distribution segment is that all the comparables arc into manufacturing and thus they cannot be taken as comparables for trading segment. d. Benchmarking at entity level: Detailed reasons have been given by the TPO as well as by the Ld. CIT(A). e. Allocation of unallocated expenses: The TPO has allocated the unallocated expenses on a reasonable basis. In fact, the TPO has accepted the assessee's contention regarding reduction of provision for sale of assets amounting to Rs.6.01 cr from its margin computation for the purpose of computation of ALP on the ground that these assets were never made operational. However, the above expenditure is now required to allocated in view of the fact that the Ld. C1T(A) has allowed depreciation on these assets. f. Claim of proportionate adjustments: The above claim of the assessee is not correct as the PLI adopted by the assessee as well as the TPO is OP/OR. The judgments of the Hon'ble ITAT given in ease of II Jin Electronics India Pvt. Ltd. [2010 SOT 227] and of the Hon'ble Delhi High Court given in case of CIT v. Keihin panalfa [2016] 70 taxmann.com 328 (Delhi) are not applicable. In those cases Arm's Length OP were computed using TC instead of the costs pertaining to the International Transactions of the assessee. In this case the Arm's Length OP has been determined on the basis of OR and the assessee's international transactions are purchases not sales. Thus, the question of computation of Arm's Length using proportionate OR does not arise. Without prejudice to above, even in proportionate adjustment is allowed to the assessee then it should be in proportion of purchases from AEs, i.e. Rs.27.19 cr and total purchases i.e. Rs.42.38 cr (64%) as purchases from AEs cannot be compared with the total operating expenses. Hon'ble ITAT I1 Bench Delhi has held in case of Aithent Technologies (P.) Ltd. v. Deputy Commissioner of Income Tax, Circle-1(1) [2016] 74 taxmann.com 214 (Delhi - Trib.) that percentage has to be computed by either comparing RPT of purchases with total purchases or RPT of sales with total sales. The relevant extract of the above judgment is reproduced below:-
"13.2 Having heard the rival submissions and perused the relevant material on record, we find that the TPO has included sales as well as expenses in a combined manner as numerator with the denominator of operating revenue. This approach, in our considered opinion, is not correct. The percentage of numerator to denominator can be rightly calculated only when the contents of a part representing the RPT of a particular nature is seen with reference to the contents of whole of that nature. Both the numerator and denominator need to have the same nature of contents. This can be done by segregating transactions of one nature, like, comparing RPT of purchase with the total purchases or RPT of sales with the total amount of sales of the company. It is also possible to club small transactions of a distinct but related income producing activity with large transactions of major income producing activity as one unit, both in the numerator as well as in the denominator. For example, RPT of major sale transaction and minor job income can be combined to find out the percentage of RPTs with the total of sales and job income taken together. This entire exercise can be done by firstly calculating the percentage of RPT purchases with total purchases and then of RPT sales and service income as one unit with the total of sales and service income again as one unit. The decision as to whether a company should be included in the list of comparables by applying the filter of more than 25% RPTs, would depend on the outcome of two such percentages of RPTs. If either of the two breaches the 25% threshold, then the company will cease to be comparable. The impugned order, combining sales and expenses, for calculating the percentage of the RPTs is set aside to this extent and the TPO is, accordingly, directed to apply this filter in the manner discussed above."
In view of the above submission the appeal of the assessee is fit to be dismissed and appeal of the revenue is fit to be allowed."
4. On the other hand the learner A.R. relied on the order of the learner CIT (A) . He further submitted that the Ld. CIT(A) has done good order and it does not require any interference. The facts of the case of the assessee are identical to that of the earlier years and subsequent years also. The Hon'ble income tax appellate tribunal has decided this issue in favour of the assessee for the assessment year 2001 to 02, 2002 - 03, 2004 - 05 and 2005 - 06 in all these assessment years the issue has been decided in favour of the assessee and later on it has been decided by the jurisdictional High Court in favour of the assessee.
5. After hearing both the parties and perusing the materials available on records and case law as submitted by the assessee, we are of the considered opinion that ground No. 1 2 and 4 are covered by the order of the jurisdictional High Court in ITA No. 39, 40, 41, 42 and 43 of the 2012 and ITAT in assessee's own case for the preceding and subsequent assessment years, wherein the facts were identical. The finding of the ld. CIT(A) is as under :
"4. Ground No. 1a(i) and 1a(ii) is in respect of disallowance of provision for slow moving raw material of Rs.30,947,043 and provision for slow moving finished goods of Rs.45,327,698 under normal provisions of the Act. Findings of the AO is recorded in Page 5, para 5.2 of the AO order.
The Assessing Officer ("the AO") disallowed the above provisions holding that only the expenses that are actually incurred and pertain to the relevant previous year can be allowed against the income for that previous year. Past History The above ground has been decided in favour of the appellant in the appellant's own case by the Income Tax Appellate Tribunal in consolidated order for assessment years 2001-02 to 2005-06 (ITA No. 904/Del/2010). The relevant extract of the order (Pages 3-6, para 5) is reproduced as under:
"5. We have gone through the records including the details of slow moving stock as on 31.03.2001 and similar stocks in the other years and do not find any infirmity in the order of the C1T(A). The assesses has been consistently following the method, of accounting over a period of time. The assesses is in the business of pharmaceutical products where strict supervision of the quality has to be ensured and these products are mostly surgical needles and medical consumable and if such fast moving items are not sold for a considerably lengthy period. It can be safely said that they have lost their consumable acceptability over a period of time, may be due to advent of new products. After-all, as long as the assessee acted in a bona fide manner and has appreciated the business realities in which he is placed, the same should be accepted. The assessee has a foolproof method of identification of slow moving or dead stock and has put ihe realizable value for the purpose of valuing the same. In fact, the principle of valuation is the cost or the market value whichever is lower. The market value here means the value that is acceptable in the market. If an item has become slow obsolete or slow moving it naturally has a lower market value which the assessee has recognized. The assessee has properly identified such stock and has also followed in accordance with commercially accepted accounting principles of valuation. In our view, the CIT(A) was correct in law and on facts to have deleted the addition made by the AO which was based not taking into consideration the hard realities of assessee 's business. The addition in our view is properly deleted and we decline to interfere."
Respectfully following this order of the Hon'ble ITAT, the AO is directed to delete the addition made under this ground.
(Relief given - provision for slow moving raw material of Rs. 30,947,043 and provision for slow moving Finished goods of Rs. 45,327, 698).
"6. Ground No. 1(a)(iv) is in respect of disallowance of Provision for warranty of Rs, 442,963 under normal provisions of the Act.
Findings of the AO is in Pages 12-13, para 12.1-12.2 of the AO order.
The AO disallowed the above provision created by the appellant holding that the expenses actually incurred were only allowable against income of that year and not the provisions.
The disallowance on account of provision for warranty in the earlier year has been deleted by the 1TAT in the consolidated order for assessment years 2003-02 to 2005-06 (1TA No, 904/Del/2010) after relying on the decision of the Supreme Court in the case of Rotork Controls India P. Ltd. vs. CIT (180 Taxman 422) (SC). The relevant extract of the order (Pages 8-10, para 7-30) is reproduced as under:
"... ... the Hon'ble Supreme Court in Rotork Controls India P. Ltd. vs. CIT 314 ITR 62 was concerned with an identical issue wherein identical provisions for warranty were made. The apex court after elaborately dealing with the issue has held that the assessee was entitled to deduction for provision of warranty claims... .... .."
In view of the judicial pronouncement, the issue is decided in favour of the appellant.
(Relief given - Provision for warranty of Rs,442,963).
6. In view of the above findings of the jurisdictional High Court as well as Hon'ble ITAT, we uphold the order of the ld. CIT(A) on grounds Nos. 1, 2 & 4.
7. Ground No. 03 is regarding disallowance of depreciation for Rs. 66,16,486/- on the assets which were not used by the assessee during the assessment year, as noted by the assessing officer from the notes of accounts. Further the ld. assessing officer noted that a note No. 3 of the tax audit report below annexure 3 in depreciation chart mentioned that "assets held for sale" would be deleted from the block upon disposal of these assets, which meant that depreciation was claimed on the same. He further noted that as per schedule 20 note No. 2 (d), certain part of block of assets were not used for the business purpose. These assets have been marked as "assets held for sale". The Ld. assessing officer has dealt this issue in his order in para No. 8.1 & 8.2 and disallowed the depreciation of Rs. 66,16,486/-. Aggrieved by the order of the assessing officer the assessee appealed before the CIT (A). The assessee submitted a detailed written submissions before the ld CIT (A) and he also relied some case laws. The ld. CIT (A) after considering the submissions of the assessee and findings recorded by the assessing officer, allowed the appeal of the assessee. Aggrieved by the order of the CIT (A) the revenue is in appeal before the ITAT.
8. The DR relied on the order of the assessing officer and he has submitted a written synopsis (supra) .
9. On the other hand the assessee relied on the order of the CIT (A). He further submitted that the Ld. CIT(A) has done good order and it does not require any interference. He also submitted that once the asset is put to use and incorporated under the block of assets, the assessee is entitled for depreciation unless the whole block is not exhausted. The assets remained within the factory premises and not sold during the year. The assets were parked under the current assets only for the better presentation of accounting. The case law relied by the Ld. DR. is not applicable because the assets were used during the year.
10. After hearing both the sides and perusing the materials available on record and order of authorities below, we noted that the assessee himself has submitted a description of assets which were not used for the manufacturing of products during the year. It has been incorporated by the ld. CIT(A) at page 10 of his order. It is clear from the submissions of the assessee that some assets were not used by the assessee during the year for the purpose of business. Notes to accounts were prepared by the company. In the paper book page No. 17 the company has provided schedule No. 20 (d) of the financial statements. The relevant part thereof is as under:
"The company is not using certain assets aggregating to Rs. 134392628. Out of these assets of the value of Rs. 105241764 were being carried over in the capital work in progress, and the balance represented few fixed assets of the net value of rupees to 29150804 (gross value whereof is Rs.65564143). The management is in discussions with certain group companies and few other buyers to explore the disposal of all these assets. As a result of these discussions/assessment, the Management assess loss of Rs.60101082 on the above noted assets. Also, alternative plans of use are currently been developed , to mitigate any losses in an unlikely event of management not being able to solicit a willing buyer. These assets are classified as "assets held for sale" under other current assets in schedule 8. To assess the realisable value for these assets :-
for assets aggregating to Rs. 4,69,75,894/-, losses of Rs. 72,29,273/- have been incurred on sale, subsequent to the year-end.
For assets aggregating to Rs. 49,42,944/- market quotes from willing buyers have been obtained.
For assets aggregating to Rs. 4,89,15,419/- the management expects to realise a value of Rs. 3,25,44,925/- based on understanding reached with potential buyers so far and:-
for balance assets aggregating to Rs. 3,35,58,371/- in absence of any willing/potential buyers has taken the realisable value of rupees nil.
Management believes that upon obtaining the formal quotes/purchase orders, there shall not be any significant change in its assessment of realisable value."
11. Thus it is clear from the above comments of the management and submissions made before the ld. CIT (A) that the said assets were not used for the purpose of business . For providing depreciation, the provisions of section 32 of the Income-tax Act 1961 are as under:-
32. (1) In respect of depreciation of--
(i) buildings, machinery, plant or furniture, being tangible assets;
(ii) know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998, owned, wholly or partly, by the assessee and used for the purposes of the business or profession, the following deductions shall be allowed--
(i) in the case of assets of an undertaking engaged in generation or generation and distribution of power, such percentage on the actual cost thereof to the assessee as may be prescribed27;
(ii) in the case of any block of assets, such percentage on the written down value thereof as may be prescribed28:
Provided that no deduction shall be allowed under this clause in respect of--
(a) any motor car manufactured outside India, where such motor car is acquired by the assessee after the 28th day of February, 1975 but before the 1st day of April, 2001, unless it is used--
(i) in a business of running it on hire for tourists; or
(ii) outside India in his business or profession in another country; and
(b) any machinery or plant if the actual cost thereof is allowed as a deduction in one or more years under an agreement entered into by the Central Government under section 42 :
Provided further that where an asset referred to in clause (i) or clause (ii) or clause (iia) 29[or the first proviso to clause (iia)], as the case may be, is acquired by the assessee during the previous year and is put to use for the purposes of business or profession for a period of less than one hundred and eighty days in that previous year, the deduction under this sub-section in respect of such asset shall be restricted to fifty per cent of the amount calculated at the percentage prescribed for an asset under clause (i) or clause (ii) or clause (iia), as the case may be :
29a[Provided also that where an asset referred to in clause (iia)or the first proviso to clause (iia), as the case may be, is acquired by the assessee during the previous year and is put to use for the purposes of business for a period of less than one hundred and eighty days in that previous year, and the deduction under this sub-section in respect of such asset is restricted to fifty per cent of the amount calculated at the percentage prescribed for an asset under clause (iia)for that previous year, then, the deduction for the balance fifty per cent of the amount calculated at the percentage prescribed for such asset under clause (iia)shall be allowed under this sub-section in the immediately succeeding previous year in respect of such asset:] Provided also that where an asset being commercial vehicle is acquired by the assessee on or after the 1st day of October, 1998 but before the 1st day of April, 1999 and is put to use before the 1st day of April, 1999 for the purposes of business or profession, the deduction in respect of such asset shall be allowed on such percentage on the written down value thereof as may be prescribed.
Explanation.--For the purposes of this proviso,--
(a) the expression "commercial vehicle" means "heavy goods vehicle", "heavy passenger motor vehicle", "light motor vehicle", "medium goods vehicle" and "medium passenger motor vehicle" but does not include "maxi-cab", "motor-cab", "tractor" and "road-roller";
(b) the expressions "heavy goods vehicle", "heavy passenger motor vehicle", "light motor vehicle", "medium goods vehicle", "medium passenger motor vehicle", "maxi-cab", "motor-cab", "tractor" and "road roller" shall have the meanings respectively as assigned to them in section 2 of the Motor Vehicles Act, 1988 (59 of 1988):
Provided also that, in respect of the previous year relevant to the assessment year commencing on the 1st day of April, 1991, the deduction in relation to any block of assets under this clause shall, in the case of a company, be restricted to seventy-five per cent of the amount calculated at the percentage, on the written down value of such assets, prescribed under this Act immediately before the commencement of the Taxation Laws (Amendment) Act, 1991:
Provided also that the aggregate deduction, in respect of depreciation of buildings, machinery, plant or furniture, being tangible assets or know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets allowable to the predecessor and the successor in the case of succession referred to in clause (xiii), clause (xiiib) and clause (xiv)of section 47 or section 170 or to the amalgamating company and the amalgamated company in the case of amalgamation, or to the demerged company and the resulting company in the case of demerger, as the case may be, shall not exceed in any previous year the deduction calculated at the prescribed rates as if the succession or the amalgamation or the demerger, as the case may be, had not taken place, and such deduction shall be apportioned between the predecessor and the successor, or the amalgamating company and the amalgamated company, or the demerged company and the resulting company, as the case may be, in the ratio of the number of days for which the assets were used by them.
Explanation 1.--Where the business or profession of the assessee is carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing of any work in or in relation to, and by way of renovation or extension of, or improvement to, the building, then, the provisions of this clause shall apply as if the said structure or work is a building owned by the assessee.
Explanation 2.--For the purposes of this sub-section "written down value of the block of assets" shall have the same meaning as in clause* (c) of sub-section† (6) of section 43.
Explanation 3.--For the purposes of this sub-section, the expression "assets" shall mean--
(a) tangible assets, being buildings, machinery, plant or furniture;
(b) intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature.
Explanation 4.--For the purposes of this sub-section, the expression "know-how" means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil-well or other sources of mineral deposits (including searching for discovery or testing of deposits for the winning of access thereto).
Explanation 5.--For the removal of doubts, it is hereby declared that the provisions of this sub-section shall apply whether or not the assessee has claimed the deduction in respect of depreciation in computing his total income;
(iia) in the case of any new machinery or plant (other than ships and aircraft), which has been acquired and installed30 after the 31st day of March, 2005, by an assessee engaged in the business of manufacture30 or production of any article or thing 31[or in the business of generation, transmission or distribution] of power, a further sum equal to twenty per cent of the actual cost of such machinery or plant shall be allowed as deduction under clause (ii) :
32[Provided that where an assessee, sets up an undertaking or enterprise for manufacture or production of any article or thing, on or after the 1st day of April, 2015 in any backward area notified by the Central Government in this behalf, in the State of Andhra Pradesh or in the State of Bihar or in the State of Telangana or in the State of West Bengal, and acquires and installs any new machinery or plant (other than ships and aircraft) for the purposes of the said undertaking or enterprise during the period beginning on the 1st day of April, 2015 and ending before the 1st day of April, 2020 in the said backward area, then, the provisions of clause (iia)shall have effect, as if for the words "twenty per cent", the words "thirty-five per cent" had been substituted :] Provided 33[further] that no deduction shall be allowed in respect of--
(A) any machinery or plant which, before its installation by the assessee, was used either within or outside India by any other person; or (B) any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest-house; or (C) any office appliances or road transport vehicles; or (D) any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head "Profits and gains of business or profession" of any one previous year;
(iii) in the case of any building, machinery, plant or furniture in respect of which depreciation is claimed and allowed under clause (i) and which is sold, discarded, demolished or destroyed in the previous year (other than the previous year in which it is first brought into use), the amount by which the moneys payable in respect of such building, machinery, plant or furniture, together with the amount of scrap value, if any, fall short of the written down value thereof :
Provided that such deficiency is actually written off in the books of the assessee.
Explanation.--For the purposes of this clause,--
(1) "moneys payable" in respect of any building, machinery, plant or furniture includes--
(a) any insurance, salvage or compensation moneys payable in respect thereof;
(b) where the building, machinery, plant or furniture is sold, the price for which it is sold, so, however, that where the actual cost of a motor car is, in accordance with the proviso to clause (1) of section 43, taken to be twenty-five thousand rupees, the moneys payable in respect of such motor car shall be taken to be a sum which bears to the amount for which the motor car is sold or, as the case may be, the amount of any insurance, salvage or compensation moneys payable in respect thereof (including the amount of scrap value, if any) the same proportion as the amount of twenty-five thousand rupees bears to the actual cost of the motor car to the assessee as it would have been computed before applying the said proviso;
(2) "sold" includes a transfer by way of exchange or a compulsory acquisition under any law for the time being in force but does not include a transfer, in a scheme of amalgamation, of any asset by the amalgamating company to the amalgamated company where the amalgamated company is an Indian company or in a scheme of amalgamation of a banking company, as referred to in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949) with a banking institution as referred to in sub-section (15) of section 45 of the said Act, sanctioned and brought into force by the Central Government under sub-section (7) of section 45 of that Act, of any asset by the banking company to the banking institution.
(iv) [***]
(v) [***]
(vi) [***] (1A) [***] (2) Where, in the assessment of the assessee, full effect cannot be given to any allowance under sub-section (1) in any previous year, owing to there being no profits or gains chargeable for that previous year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of sub-section (2) of section 72 and sub-section (3) of section 73, the allowance or the part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there is no such allowance for that previous year, be deemed to be the allowance for that previous year, and so on for the succeeding previous years.
12. The assessee could not prove before the assessing officer whether the machine were used for the purpose of business but he has submitted before the CIT (A) that these assets were used during the financial year for the purpose of business. After careful reading of the notes to accounts of schedule 20 (d) the assessee has himself stated that the company was not using these assets . As per section 32 of the Income-tax Act, 1961, the assets should be "used" for the purpose of the business. The assessee could not produce any single credible evidence for the use of these assets during the year for the purpose of the business. As regards the usage factor of an asset, we rely on the decision of the Hon'ble Bombay High Court in the case of Dinesh Kumar Gulab Chand Agarwal V.CIT (2004) 267 ITR 168 (Bom), wherein it has been held that the term "used" in section 32 of the Act denotes the actual user of the asset and assets merely kept ready for use would not be sufficient for claim of depreciation. Furthermore, the special leave petition filed by the assessee against the said decision has been dismissed by Hon'ble Supreme Court ((2004) 266 ITR (st) 106). In fact, the Hon'ble Bombay High Court while passing the order in the case of Dinesh Kumar, Gulab Chand Agrawal (Supra) distinguished its earlier decisions. In the case of Whittle Anderson Ltd. V. CIT (1971) 79 ITR613 (Bom) by holding that the said decision was rendered in the context of the expression 'use or used' (active or passive user) and subsequent to that decision there has been an amendment in section 32 of the Act, which provides for the word 'used'(active user). Since the assessee could not prove to the satisfaction of the AO that the asset was put to use for the assessee business, the stand taken by the AO is found to be factually and legally tenable in disallowing depreciation. In view of the provisions of section 32 referred to above and the decision of Hon'ble Bombay High Court (supra), we, therefore, are of the opinion that the ld. CIT(A) was not justified in allowing the depreciation, disallowed by the ld. Assessing Officer. As a result, ground No. 3 of the Revenue's appeal deserves to be allowed. Accordingly, the appeal of the Revenue has to be partly allowed.
13. On the transfer pricing issue involved in assessee's appeal, ground No. 1 is general in nature and grounds Nos. 2.1 to 2.4 and ground No. 3 have not been pressed. Accordingly, these grounds are dismissed as such. In support of ground No. 2, the assessee has furnished a written synopsis which read as under:
The Appellant is engaged in the business of manufacturing, marketing, trading and support services of medical devices and diagnostic equipment. The major products in medical systems segment are hypodermic syringes and needles for injections, insulin syringes, infusion therapy devices and surgical blades and scalpels. (Refer page 1 of TPO order)
2. During financial year ('FY') 2002-03 (relevant to the captioned AY), the appellant had engaged in the following international transactions: (Refer page 2 of TPO order) S.No Particulars Most Appropriate Method Amount (In Rs.) i Purchase of raw material/components Transactional Net Margin Method ('TNMM') 6,19,01,013 2 Purchase of traded goods Aggregated in the TNMM analysis/Corroborative analysis using Resale Price Method ('RPM') 21,01,03,191 3 Purchase of capital goods Aggregated in the TNMM analysis 20,25,463 4 Commission earned Aggregated in the TNMM analysis 3,99,43,741 5 Interest paid Comparable Uncontrolled Price Method ('CUP') 1,66,179 6 Global cost sharing of ERP package 58,55,290 7 Purchase return 3,73,26,261 8 Chargeback of expenses by the appellant Cost to cost basis 66,08,560 9 Chargeback of expenses by associated enterprises OAEs') 14,06,851 Total 36,53,36,549
3.For the purpose of justifying the arm's length nature of international transactions, transaction no. 1 to 4 have been analysed by applying the TNMM using Operating Profit ('OP')/ Sales and for transaction no. 5 CUP method was applied in order to justify the arm's length nature of such transaction.
4.In case of purchase of trading goods, the Appellant undertook a corroborative analysis applying RPM using Gross Profit/Sales ('GP/Sales') as PLI.
For the purpose of the said benchmarking analysis, the Appellant considered itself as the tested party and accordingly identified comparable companies engaged in manufacturing, marketing and trading of medical devices and diagnostic equipment. A snapshot of the TNMM analysis conducted by the appellant in its TP documentation study using data of multiple years (i.e. FY 20OO-20O1, FY 2001-2002 and FY 2002-03) is provided below: (Refer page 3 of TPO order) Particulars No of comparables 6 Mean OP/Sales margin of comparables companies 8.74% Appellant's margin 9.64% Further, a snapshot of the corroborative analysis applying RPM analysis conducted by the appellant in its TP documentation study using data of multiple years (i.e. FY 2000-2001, FY 2001-2002 and FY 2002-03) is provided below:
(Refer page 3 of TPO order) Particulars No of comparables 4 Mean GP/Sales margin of comparables companies 33.32% Appellant's margin 39.01%
5.The corroborative analysis for trading segment was carried out by the Appellant by comparing the gross margins of 3 of the 6 companies which were initially selected by the Appellant for testing its overall margins and another company namely Span Diagnostics Ltd. These 4 companies were selected as these companies carried out comparable trading activities.
6.Proceedings before Ld TPO's approach During the assessment proceedings, the Appellant had submitted segmental accounts wherein it had bifurcated its audited financial into three sub-segments namely manufacturing, trading and services segment as provided below :
(Refer page 5 of the TPO order) Particulars As per P/L Manufacturing segment Trading Total Unallocated Service Income of the segment 96,28,22,148 43,32,19,962 47,98,19,623 98,38,821 3,99,43,741 Cost of goods sold 57,29,72,330 24,68,28,070 32,61,44,259
-
-
Gross profit/ operating expenses 38,98,49,818 18,63,91,892 15,36,75,364 3,99,43,741 Other expenses 59,08,13,103 14,19,66,634 11,69,34,851 29,63,10,326 3,56,01,292 Net Profit of the segment (20,09,63,285) 4,44,25,258 3,67,40,513
-
43,42,449 Operating Ratio
-20.87%
10.25% 7.66%
-
10.87% Note: in the above calculations by the Appellant miscellaneous income of Rs. 88,04,642 is included in manufacturing segment and miscellaneous income of Rs. 10,34,179 is included in service segment.
7.In the said segmented financial provided to the Ld. TPO, the Appellant had not allocated expenses of about Rs. 28 crores to any segment and treated them as abnormal expenses and had not considered while calculating operating margins. A break up of the said abnormal expenses is provided below:
(Refer page 11 of TPO order) SI.
No. Particular Amount (in Rs) i Depreciation on the basis of difference between US GAAP and also other wise as per companies act 3,24,85,887 5,64,93,658 2 Expired stock written off 3,17,65,396 3 Provision for slow moving raw material 3,09,47,043 4 Provision on slow moving finished goods 4,53,27,698 5 Provision for Bad Debts 1,08,95,359 6 Advances &Bad Debt written off 9,05,028 7 Provision for contingencies 1,80,41.851 8 Provision against Assets held for sale 6,01,01,082 9 Foreign exchange loss on ECB repayment finance cost 12,15,000 Total 28,81,78,002
8.Of the expenses mentioned above, the TPO agreed with the contention of the Appellant that expenses in nature of Depreciation on the basis of difference between US GAAP and also otherwise as per Companies Act and Provision against Assets held for sale were non-operating in nature. However, the Ld TPO did not agree with the contention of the Appellant in respect of the other expenses being non operating. The list of the expenses considered operating in nature by the Ld TPO is provided below:
SI No Particular Amount (in Rs) 1 Expired stock written off 3,i7,65>396 2 Provision for slow moving raw material 3,09,47,043 3 Provision on slow moving finished goods 4,53,27,698 4 Provision for Bad Debts 1,08,95,359 5 Advances &Bad Debt written off 9,05,028 6 Provision for contingencies 18,041,851 7 Foreign exchange loss on ECB repayment finance cost 12,15,000 Total 13,90,97,375
9. Furthermore, the Ld TPO concluded that if exact segmental accounts cannot be drawn, an entity wide benchmarking at transactional level would be most appropriate. Hence the Ld TPO rejected the segmented financial provided by the Appellant and thereafter aggregated the various sub-segments of the Appellant and arrived at its entity wide operating margin for benchmarking analysis. Thereafter, the Ld TPO calculated the entity wide OP/Sales of the Appellant to be -4.52%. The entity wide calculation of the OP/Sales margin of the Appellant by the Ld TPO is provided below for your Honours' ready reference.
(Refer page 15 of TPO order) Particulars Amount in INR Income as per P&L Account (A) 1,01,23,71,693 Less:
Interest Income (B) 1,31,608 Profit on sale of fixed asset (C) 1,40,541 Non-operating Income (D=B+C) 14,56,559 14,56,559 Operating Income (F.=A-D) 1,01,09,15,134 Total Expenditure as per P&L Account (F) 1,21,33,34,978 Less: Interest and Finance Charges (G) 81,04,555 Particulars Amount in INR Less: Claim of Excess Depreciation as per US GAPP (H) 3,20,58,533 Less: Claim of Excess Depreciation as per Companies Act 1956 CD 5,64,93,658 Less: Claim for Assets held for sale (J) 6,01,01,082 Total Abnormal Expense Claim allowed (K-G+H+I+J) 15,67,57,828 15,67,57,828 Operating Expense (L=F-K) 1,05,65,77,150 Operating Profit/ (Loss) (M=E-L) (45,662,016) Net Profit Margin over revenue (N=M/F)
-4-52%
10 In respect of the comparables, the Ld TPO selected most of the comparables adopted by the Appellant for benchmarking its manufacturing segment,. However, a comparable included by the Appellant namely Advance Micronic Devices Limited was rejected by the Ld TPO on account of non availability of segmental accounts.
11 Furthermore, the Ld TPO concluded that one of the comparables selected by the Appellant for benchmarking its trading segment - Span Diagnostic Limited, was not exclusively into trading as it also manufactured diagnostic reagents, elisa kits aggluratisers and considered it as a comparable in the final set.
12 Thus, the final set of comparables chosen by the Ld TPO is provided below: (Refer page 11 of TPO order) S.No Company Name OP/Sales (%) FY 2002-03 1 Centennial Surgical Suture Ltd.
8-77 2 Hicks Thermometer (India) Ltd.
5-21 3 Innovation Medi Equip Ltd.
6.92 4 Polv Medicurc Ltd.
15.61 5 Shree Pacetronix Ltd.
11.02 6 Span Diagnostics Ltd.
9-33 Mean 9-47
13. Thereafter, the Ld TPO concluded that the Appellant for the year under consideration in order to earn net profit margin over total revenue @ 9.47% should earn a profit of 95,871,599/-(being 9.47% of 10,123,716,93/-). However, as the Appellant has earned a loss of 45,662,0167-therefore, the total difference i.e. Rs. 141,533,615/- was attributable to difference in arm's length price ('ALP') of the international transaction entered into by the Appellant with its AE during the year under reference. Thereafter, all the international transactions except the following international transactions were taken to be at arm's length for the purpose of computing the transfer pricing adjustment.
S.No International Transaction Book Value ALP being 47.97% of the book value Difference 1 Purchase of raw material/ components 6,19,01,013 2,96,91,679 3,22,09,334 2 Purchase of traded goods 21,01,03,191 10,07,78,909 10,93,24,281 Total 27,20,04,204 14,15.33,615 Proceeding before Ld CIT (A) The Ld CIT (A) also rejected the various contentions placed by the Appellant and followed the approach adopted by the Ld TPO and confirmed the transfer pricing adjustment undertaken by the Ld TPO.
Contentions of the Appellant Distribution Segment 14 During the assessment proceedings, Ld. TPO rejected the contention of the Appellant of using RPM as the most appropriate method for benchmarking the transactions related to distribution segment i.e. purchase of finished goods from AEs. At this juncture, the Appellant would highlight that it is involved in trading and distribution of finished goods, which are imported from its overseas AEs and earns around 47% of its total revenue from such activities. This is also evident from the extract of TP order January 31, 2006- (Refer page 2 of TP Order) 2.1 During financial year under reference, assessee company posted a loss of Rs.20.09 crores on total turnover of Rs. 101.23 crores. Broadly assessee company-has 47% of manufacturing, 47% of trading 6% of commission and other income if figures of Profit & Loss account are analysed.
15 In this regard, the Appellant submits that RPM evaluates the arm's length nature of a controlled transaction by reference to the gross profit margin realised in a comparable uncontrolled transaction. RPM measures the value of functions performed and is appropriate in cases involving the purchase and resale of tangible goods/services in which the buyer/ reseller does not add value to the goods by physically altering them.
16 The selection of RPM for international transactions pertaining to distribution operations is in accordance with the selection of RPM as provided in Rule 10B(i)(b) as follows:
i. the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; ii. such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; iii. the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services; iv. the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; the adjusted price arrived at under sub-clause is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise;"
(Emphasis Supplied)
17 In light of above, it can be seen that RPM begins with the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. This price (the resale price] is then reduced by an appropriate gross margin (the "resale price margin") representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. Therefore, a reseller's gross profit provides both compensation for the performance of the distribution and functions and a return on the capital invested and risks assumed by the distributor. Thus, under the RPM comparability is primarily dependent upon the similarity of functions performed and the risks assumed by the controlled and uncontrolled entities, and are less dependent on the similarity of tangible goods bought and resold.
18 Although broader product differences can be allowed in the RPM, the property transferred in the controlled transaction must still be compared to that being transferred in the uncontrolled transaction. While less product comparability may be required in using the RPM, it remains the case that closer comparability of products will produce a better result.
19 Accordingly, considering that RPM measures the value of functions performed and is appropriate in cases involving the purchase and resale of tangible goods/ services in which the buyer/ reseller does not add value to the goods by physically altering them (like in the instant case), RPM should be selected as the Most Appropriate Method for the distribution function.
20 The Appellant would like to draw your Honours' attention to the fact that in the case of a distributor such as the Appellant, not just Rule 10C(1) read with Rule 10B(1)(b)(i), but also the OECD Guidelines, and paragraphs 6.10 and 6.11 of the Guidance Note Report on International Transactions under Section 92E of the Act issued by the Institute of Chartered Accountants of India ('ICAI') ('Guidance Note'), all highlight and emphasize the appropriateness of using RPM rather than TNMM.
21 The Guidance issued by the ICAI states that RPM should be adopted as the most appropriate method in case of distributors. The relevant text of paragraphs 6.10 to and 6.11 are reproduced below:
"6.10 Typical transactions where the resale price method may be adopted are distribution of finished products or other goods involving no or little value addition. 6.11 The OECD in its Transfer Pricing Guidelines has observed as under:
"An appropriate resale price margin is easiest to determine where the reseller does not add substantially to the value of the product. In contrast, it may be more difficult to use the resale price method to arrive at an arm's length price where, before resale, the goods are further processed or incorporated into a more complicated product so that their identity is lost or transformed (e.g. where components are joined together in finished or semi-finished goods). Another example where the resale price margin requires particular care is where the reseller contributes substantially to the creation or maintenance of intangible property associated with the product (e.g. trademarks or trade names) which are owned by an associated enterprise. In such cases, the contribution of the goods originally transferred to the value of the final product cannot be easily evaluated.
A resale price margin is more accurate where it is realised within a short time of the reseller's purchase of the goods. The more time that elapses between the original purchase and resale the more likely it is that other factors - changes in the market, in rates of exchange, in costs, etc. - will need to be taken into account in any comparison."
It is generally accepted amongst most tax authorities that the Resale Price method is applicable and preferable where the entity performs basic sales, marketing and distribution functions (i.e. where there is little or no value added by the reseller prior to the resale of the goods acquired from related parties). The method is applicable even with differences in products, as long as the functions performed arc similar. It is less useful where goods are further processed or incorporated into other products."
(Emphasis Supplied) 22 Furthermore, OECD Guidelines provide a clear preference of use of RPM over TNMM Para 2.49 of the OECD Guidelines states that:
"Traditional transaction methods are the most direct means of establishing whether conditions in the commercial and financial relations between associated enterprises are arm's length. As a result, traditional transaction methods are preferable to other methods."
Para 3.49 of the OECD Guidelines states that:
"Traditional transaction methods are to be preferred over transactional profit methods as a means of establishing whether a transfer price is at arm's length, i.e. whether there is a special condition affecting the level of profits between associated enterprises."
Also, OECD Guidelines in Paras 3.50 and 3.54 indicate that use of transactional profit methods like TNMM should be in cases of last resort.
Further to the above, various weaknesses of TNMM have also been highlighted by the OECD Guidelines in Paras 3.29, 3.34, 3-35, 3-36, 3-37 and 3.39.
23 The Appellant would reiterate that in its distribution segment, it procures finished products from its AEs, performs functions associated with the distribution activity viz. sales planning, storing, preserving, maintaining its nature & identity, clearing from bonded warehouse, trading, selling and distribution, undertaking marketing, advertising and promotion activities, arranging for a distribution channel, raising of invoices, paying duties/ taxes/ cess/ levy, observance of local laws, obtaining licenses and permissions from concerned authorities, pricing and after-sales services, etc. It employs normal assets like office space, warehouse, workforce etc. and undertakes all the risks associated with a distributor like inventory risk, credit risk, market risk, price risk etc. 24 Hence, from the observation of OECD Guidelines and Guidelines issued by ICAI, it can be concluded that the Appellant suffices all the requirements mentioned below for choosing RPM as the most appropriate method for its transaction related to its distribution segment:
i. BD India does not own any valuable intangible properties;
ii. BD India's AEs are full-fledged manufacturers owning intangible assets; and iii. BD India is a distributor which does not add any substantial value to the product.
25 Furthermore, in connection with the selection of most appropriate method in case of an entity engaged in distribution function, the Appellant would place reliance on the rulings pronounced by Hon'ble Income Tax Appellate Tribunal in the case of Mattel Toys India P Ltd [ITA No.2476-Mumbai-2008] wherein it has been observed as under:
"...Thus, in our opinion, under the RPM, products similarity is not a vital aspect for carrying out comparability analysis but operational comparability is to be seen. Since the gross profit margin is the main criteria while evaluating the transactions in the RPM wherein price is identified at which property or services are resold and normal gross profit margin is derived at by the enterprise which is deducted from the resale price of such property or service in comparable uncontrolled transactions. The gross profit margin earned by the independent enterprise in comparable uncontrolled transactions is served as a guidance factor. This is also what happens in the case of a distributor wherein the property and service are purchased from the A.E. and are resold to other independent entities, without any value additions. The gross profit margin earned in such transactions becomes the determination factor to see the gross compensation after the cost of sales. In the instant case, the Assessee is a distributor of Mattel toys and gets the finished goods from its A.E. and resells the same to independent parties without any value addition. In such a situation, RPM can be the best method to evaluate the transactions whether they are at ALP."
(Emphasis supplied) 26 Furthermore, the Appellant would also like to place reliance on the following judgments:
• M/s Aztec Software & Technology Service Ltd. [107 ITD 141] • Star Diamond Group, vs The Dy. Director of Income Tax [ITA No. 3923/Mum/2Oo8] • Nokia India (P) Ltd. [ITA No. 242/Del/2010] • M/s. Yamaha Motor India Pvt. Ltd. [ITA No. 5748/Del./2011] • M/s Sanyo India Pvt. Ltd. [IT(TP)A No. 1O22(B)/2O12] • Luxottica India Eyewear P. Ltd. [ITA No. 1115/Del./2O14] 27 The above rulings places the burden to select the most appropriate method on the Appellant and says that the selection of the most appropriate method by the Appellant is to be done objectively, after considering all the facts and circumstances of the case, availability of reliable data and degree of comparability. Further, once the Appellant has selected a particular method as the most appropriate method, the burden of proof shifts to the TPO/AO to provide cogent reasons for rejecting the method followed by the Appellant before substituting and prescribing a new method.
28 In light of the facts presented, the Appellant vehemently contends that RPM is the most appropriate method in respect of its trading segment and a comparison of the gross margins is representative of the measure of remuneration for the distribution function performed.
29 Furthermore, in the TP Order dated January 31, 2006 Ld. TPO has rejected the RPM method on the sole ad-hoc basis that the comparables selected by the Appellant are majorly involved in manufacturing activities. In this regard, the Appellant would like to submit that the calculation of GP/Sales of 3 out of 4 comparables with respect to the trading operations conducted by the comparables is available and duly substantiated by their annual reports. A summary of the arm's length results is provided below for the ready reference of Hon'ble Bench:
S.No Company Name GP/Sales (%) Trading Operations FY 2002-03 (Refer Annexure 1) i Hicks Thermometer (India) Ltd.
46.27% 2 Poly Medicure Ltd.
12.00% 3 Span Diagnostics Ltd.
23.80% Mean [Arm's length margin] 27.50% GP/Sales of Appellant in trading segment 39-01%
30 Thus, from the above analysis it is evident that the international transactions of purchase of finished goods by the Appellant from its AEs pertaining to its trading segment would adhere to the arm's length principle as envisaged in the TP Regulations. Hence, the Appellant strongly contends that no adjustment is warranted in respect of the said transaction. Hence, the Appellant strongly contends that no adjustment is warranted in respect of the said transaction.
Manufacturing Segment Aggregated approach adopted by Ld. TPO 31 As provided above, during the year the Appellant was involved in manufacturing, marketing, trading and support services of medical devices and diagnostic equipment. The Ld. TPO in his order dated January 31, 2006 has also recorded the fact that the Appellant is involved in variety of functions and operations. The relevant extract of the same is also provided below for Hon'ble Tribunal's ready reference:
(Refer page 2 of TP Order) 2.1. During financial year under rerference, assesses -company posted a loss of Rs, 20.09 crores on total turnover of Rs.101.23 crores. Broadly assessee company has 47% of manufacturing, 47% of trading and about 6% of commission and other income if figures of Profit & loss account are analysed.
32 However, during the course of assessment proceedings, Ld. TPO proceeded to adopt overall TNMM for benchmarking the aforesaid international transactions of the Appellant.
The Appellant takes the opportunity to highlight that the adoption of overall TNMM for benchmarking all the international transactions of the Appellant on aggregate basis is in contravention of the fundamental tenets of transfer pricing.
33 The Indian TP Regulations and various decisions pronounced by Hon'ble ITAT recommend that the international transactions ought to be analysed separately or aggregated with other related party transactions to determine their arm's length nature. This has also been enshrined in the OECD Guidelines, TP regulations and judgements.
34 furthermore, this has been squarely covered in the ruling of the Special Bench of Delhi ITAT in case of LG Electronics India Pvt. Ltd. [(2013) 29 taxmann.com (Delhi) SB] wherein the Hon'ble Bench has stated that all international transactions should be benchmarked on a transaction by transaction basis.
35 Also, Para 3.9 of the OECD Guidelines states:
"Ideally, in order to arrive at the most precise approximation of arm's length conditions, the arm's length principle should be applied on a transaction-by -transaction basis..."
(Emphasis Supplied) 36 In accordance with the OECD Guidelines above, the international transaction of the Appellant should be analysed on a transaction-by-transaction basis. This view is also reflected in the Indian TP Regulations as given below:
92. (l) of the Act states:
"Any income arising from an international transaction shall be computed having regard to the arm's length price.
Explanation.--For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm's length price.
(2) Where in an international transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be.
(Emphasis Supplied) 37 The intention of the Indian TP Regulations is to ensure that the price of an international transaction is similar/equal to the price for a similar service/product between comparable independent entities.
38 Furthermore, there are umpteen numbers of judgments by various benches of the ITAT wherein the transaction by transaction approach was upheld:
• UCB India Pvt. Ltd. vs. ACIT [2009-TIOL-184-ITAT-Mum] • Star India Private Ltd. vs. ACIT [2008-TII-07-ITAT-MUM-TP] • Abhishek Auto Industries Ltd. [2010-TII-54-ITAT-Del-TP] • Global Vantedge Pvt. Ltd. [2010-TII-TIOL-24-ITAT-Del] • Golawla Diamonds [2010-TII-53-ITAT-Mum-TP] • Star Diamond Group [2011-TII-20-ITAT-Mum-TP] • Symantec Software Solutions Pvt. Ltd. [2011-TII-60-ITAT-Mum-TP] • Twinkle Diamond [2OO9-TII-O2-ITAT-Mum-TP] • Wockhardt Ltd. [2010-TII-46-ITAT-Mum-TP] • Bayer Material Science P Ltd. [2012] 134 ITD 582 (MUM.)]
39 Thus, the Appellant vehemently contest that it was absolutely correct in bifurcating its audited financial into three sub-segments as the Appellant was clearly operating in three different segment namely manufacturing, trading and services which was also recorded by the Ld TPO in its TPO order (supra).
40 Thus, the Appellant would pray that redrawn segmental anlaysis of the profit and loss account of the Appellant for the financial year ended on March 31, 2003 (Refer Annexure 2) submitted to corroborate the international transactions on a transaction by transaction analysis should be accepted.
Proportionate adjustment 41 Further, without prejudice to the above contentions, the Appellant submits that the Appellant would like to submit that the TP adjustment should be made only in proportion of international transactions of the Appellant i.e. excluding domestic and non AEs transactions. Such argument of the appellant derives support from the judicial precedents in India. The said principle was laid down by the ITAT in the case of IL Jin Electronics (I) Pvt. Ltd. ('IL Jin') [2010 36 SOT 227]. Reliance may be placed on the following extract from the said Ruling:
"15. The appellant has also taken one alternative ground out of the total raw materials consumed by the appellant for manufacturing print circuit boards, only 45.51% of the total raw materials were imported through appellant's associate concerns, and, therefore, any adjustment, if any called for, can only be made to the 45.51% of the total turnover, and not to the total turnover of the appellant. After considering the facts of the case, we do not find any difficulty in accepting this contention of the appellant that at best only 45.51% of the operating profit can be attributed to imported raw material acquired from appellants associate concerns. In the present case., the AO has calculated the operating profit on the entire sales of the appellant., which in our considered opinion., is not justified, when it is admit ted position that only 45.57% of raw material has been acquired by the appellant from its associate concerns for the purpose of manufacturing items..... We, therefore, direct the AO to modify the assessment and make the adjustment only to the extent of difference in the arm's length operating profit with adjusted profit with reference to the 45.51% of the turnover, and not to the total turnover of the appellant."
(Emphasis supplied) 42 Reliance is also placed on the ruling of:
• M/s Demag Cranes & Components (India) Pvt. Ltd. [2012-TII-07-ITAT-PUNE-TP] • M/s. Phoenix Mecano (India) Limited [(2012) 49 SOT 515 (MUM)] • M/s Genisys Integrating Systems (India) Pvt. Ltd [64 DTR 225 (Bang)] • M/s Starlite [2O10(133)-TTJ-O425-TBOM] • Ratilal Becharlal & Sons [TS-719-ITAT-2O12(Mum)-TP] • Firestone International (P) Ltd. [TS-712-ITAT-2O12(Mum)-TP]
43 The ITAT has unequivocally stated in the above Rulings that if at all adjustment is made by the tax authorities, the same should be made only to the international transactions of the appellant. Accordingly, the appellant on without prejudice basis submits that if at all adjustment is sustained by your Honours'; the same should be directed to be made only to the international transactions of the appellant and not to the domestic transactions and export made to a third party.
44 In light of the above precedents and without prejudice to its contention regarding the arm's length pricing of its international transactions, the Appellant has determined the maximum TP adjustment which may be made.
45 The computation of the related party transaction as a proportion of the total operating cost is provided below:
Total related party transactions in the manufacturing and trading segment Particulars Amount in INR l. Details of TP adjustment as made by the Ld TPO on total turnover:
Operating Revenue (A) 1,010, 915,134 Operating cost (B) 1,056,577,150 Operating profit (C)=A-B
-45,662,016 Arm's length margin (OP/Sales as per Ld TPO order) (D) 9-47% Arm's length operating profit (E)=A*D 95,733,66;-5 Particulars Amount in INR Difference in margin (F)-E-C (representing the TP adjustment) 141,395,679
2. Computation of TP adjustment based on arm's length margin computed by taking consistent comparables and HSL Arm's length margins (G) 9.47% Arm's length operating profit on total turnover (H)=A*G 95,733,663 Difference in margin (I)=H-C 141,395,679 Total of operating expenses (J)- A+B 1,056,577,150 Purchase of raw material (K) 61,901,013 Purchase of traded goods (L) 210,103,191 Total RPT (expenses) as a percentage of total operating expenses (M)=(K+L)/J 25.74% Proportionate amount of adjustment (N) - (I*M) 36,400,767
46 Hence, the Appellant on without prejudice to above contentions of the Appellant, contends that the related party transaction accounts for only 25.74% of the total operating expenses and thus adjustment in its manufacturing segment should be attributed only to this extent.
Computation of gross margins of comparables from trading operations
1. Hicks Thermometer (India) Ltd.
Trading Operations Particulars Amount in INR (Page 27 of Annual Reports Compendium) Sales 24,438,530 Purchases 10,261,859 Change in stock 2,868,512 Gross Profit 11,308,159 GP/Sales 46.27%
2. Span Diagnostics Limited Trading Operations Particulars Amount in INR lakhs (Page 136 of Annual Reports Compendium) Sales 911.74 Purchases 686.9 Change in stock 7.82 Gross Profit 217.02 GP/Sales 23.80%
3.Poly Medicure Ltd.
Trading Operations Particulars Amount in INR thousands (Page 94 of Annual Reports Compendium) Sales 17601 Purchases 13813 Change in stock 1415 Gross Profit 2373 GP/Sales 13.48%
14. The learned DR, on the other hand, relied on the orders of the authorities below and laid emphasis on the written synopsis, reproduced hereinabove.
15. We have carefully considered the rival contentions as well as the orders of the Ld. Transfer Pricing Officer, Ld. assessing officer and Ld. CIT (A). According to the claim of the assessee, it has been submitted that the segmental accounts in the course of transfer pricing proceedings and gist of the segmental results were shown. According to those results, it was found that the assessee has not allocated expenses of about Rs. 28.81 crores to any of the segment on the argument that the expenses are abnormal in nature and therefore while arriving at the profit margins should not be considered. Before the Ld. assessing officer assessee was given an opportunity where the assessee submitted that these expenses should not be considered. However, the Ld. assessing officer rejected the contention of the assessee for the reason that that the argument of the assessee during the year under consideration. There is an abnormal expenses on account of the expired stock written off, provision for slow-moving robot rails and provision for slow-moving finished goods. We have seen that assessee has given details of these expenditure starting from the assessment year 2001 - 02 to 2005 - 06, which are tabulated by the Ld. Transfer Pricing Officer as under:
Particulars Year ending March 01 to March 05 2001 2002 2003 2004 2005 Expired stock written off 14791543 36926250 31,765,396 8,570,535 10,046,275 Provision for slow moving raw material 0 0 30,947,043 5,415,824
-11,781,684 Provision for slow moving finished goods 27422000 2600000 45,327,698
-6,530,447
-22,254,346
16. On looking at the above table it is seen that in case of expired stock return of the assessee is claiming expenditure from that particular year till the assessment year 2005 2006. However, in respect of provision for slow-moving raw material, assessee claimed expenditure starting from assessment year 2003 - 04 to assessment year 2004 - 05. In assessment year 2005 - 06, the provision for slow-moving raw material was reversed by Rs. 1.17 crores. With respect to the provision for slow-moving finished goods the claim of the assessee is from assessment year 2001 - 02 to the assessment year 2005 - 06. In assessment year 2004 2005 and 2005 2006, the assessee has shown reversal of those provisions which is apparent from the above table. The only issue arising before us with respect to this claim is that whether the amount of expired stock written off, provision for slow-moving raw material and provision for slow-moving finished goods should be considered as in a normal expenditure and should not be included in the working out of the profit margin of the assessee or should be included. As it is imperative that in some of the years the assessee has also shown reversal of such provisioning which is apparent that for assessment year 2005 - 06, the assessee has shown reversal of provision for slow-moving raw materials and for assessment year 2004- 05 and 2005 - 06, the assessee has shown reversal with respect to the provisions for slow-moving finished goods. If in the subsequent year, i.e., in assessment year 2004- 05 and 2005- 06, those reversal have been shown by the assessee in its transfer pricing study report including the above reversal as income then the assessee does not have a case to say that these kind of expenditure incurred in earlier years should not be included. Conversely, if such items have been excluded by the assessee in the subsequent years, the expenditure should not be included in working out the PLI for these years. As before us, neither the assessee nor the revenue could place the working of PLI for assessment year 2004 - 05 and 2005 - 06 with respect to those years where the reversals have occurred, it is not possible to ascertain their treatment given in subsequent years. Therefore, in the interest of Justice and to give a fair treatment accepted by both the parties in subsequent years to these expenditure in the current year, we set aside this issue to the file of the Ld. transfer pricing officer to consider appropriately if reversal of those expenditure are also considered in working out profit margin for those years. Then these expenditures are required to be considered as operating expenditure of the assessee for working out profit level indicator of the assessee for the current year. If they have not been included in assessment year 2004-05 and 2005-06 for working out the PLI of the assessee then for this year, these expenditure debited is required to be removed for working out the PLI. Needless to say that Ld. transfer pricing officer shall give a proper opportunity of hearing of the assessee to substantiate its case on merits. Accordingly, the appeal of the assessee deserves to be allowed for statistical purposes.
17. In the result, the appeal of the Revenue is partly allowed and that of the assessee is allowed for statistical purposes.
Order pronounced in the open court on 28.04.2017
--Sd-- --Sd--
(I.C. Sudhir) (L.P. Sahu)
Judicial member Accountant Member
Dated: 28.04.2017
*aks*
Copy forwarded to:
1. Appellant 2. Respondent
3. CIT 4. CIT(Appeals)
5. DR, ITAT 5. Guard File Assistant Registrar
Date
1.
Draft dictated (DNS)
24.04.17
PS
2.
Draft placed before author
28.04.17
PS
3.
Draft proposed & placed before the second member
JM/AM
4.
Draft discussed/approved by Second Member.
JM/AM
5.
Approved Draft comes to the Sr.PS/PS
PS/PS
6.
Kept for pronouncement on
PS
7.
File sent to the Bench Clerk
PS
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.
44
ITA Nos. 4548 & 4337/Del./2011