Income Tax Appellate Tribunal - Mumbai
Chemtex Global Engineers P. Ltd, Mumbai vs Department Of Income Tax on 14 March, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL
"K" Bench, Mumbai
Before Shri D. Manmohan, Vice President
and Shri P.M. Jagtap, Accountant Member
ITA No. 3590/Mum/2010
(Assessment Year: 2004-05)
ACIT, Range 10(3) M/s. Chemtex Global Engineers P. Ltd.
Room No. 451, 4th Floor Vs. Chemtex House, Hiranandani Garden
Aayakar Bhavan, M.K. Road Main Street, Powai, Mumbai 400076
Mumbai 400020 PAN - AACCC4458P
Appellant Respondent
Appellant by: Shri Ajeet Kumar Jain
Respondent by: S/Shri Farrokh Irani
& Manoj Purohit
Date of Hearing: 14.03.2013
Date of Pronouncement: 12.06.2013
ORDER
Per D. Manmohan, V.P. This is an appeal filed at the instance of the Revenue and it pertains to A.Y. 2004-05.
2. Transfer pricing adjustment made by the AO, in the light of the order of the TPO, having been set aside by the learned CIT(A), Revenue is in appeal before us wherein it was contended that the learned CIT(A) was not justified in excluding "Rites Limited" as a comparable case and he erred in holding that there was no case for adjustment to arm's length price.
3. Facts necessary for disposal of the appeal are stated in brief. The assessee company i.e., Chemtex Global Engineers Pvt. Ltd. (hereinafter referred to as CGPL) is a 100% subsidiary of Chemtex Engineering of India Ltd. (CEIL) and it was specialising in carrying out basic and detailed engineering works, based on the process know-how provided by the licensors for large man made fiber, chemical and petrochemical plants. The CEIL, in turn, is owned by Chemtex International Inc., USA (CII) and American Investment Inc., USA. CII was agroup company of Mitsubushi Corporation, Tokyo.
2 ITA No. 3590/Mum/2010M/s. Chemtex Global Engineers P. Ltd.
4. During the financial year under consideration the assessee company provided engineering consultancy services to CII. The business operations of the assessee company were analysed by taking the assessee as "tested party", since, in the financial year relevant to A.Y. 2004-05, the assessee company provided engineering consultancy services to CII which is an Associate Enterprise (AE) of assessee company. According to the assessee the price charged was at arm's length.
5. In its Transfer Pricing Report it has analysed the transactions with the help of Transactional Net Margin Method (TNMM) as a primary method. During the course of assessment proceedings the assessee company has also compared the rates charged to AE vis-à-vis third party (non-AE) and benchmarked the price by applying CUP methodology in support of the international transactions. Vide letter dated 18th August, 2006 it was submitted that the assessee charged fees at hourly basis from the AE and also stated that the company had also entered into a contract with third party and the average hourly rate charged from the third party works out at `331/- which is lower compared to the fees charged from the AE i.e. `488/-. Again, vide letter dated 25th August, 2006 the assessee furnished figures to compare the fees charged from AE with that of the fees charged from non-AE company to highlight that even by applying the methodology of CUP there is no case for making any transfer pricing adjustment. Page 57 to 70 of the paper book highlights that the assessee benchmarked its international transactions by applying the methodology of TNMM and taking the berry ratio as profit level indicator (i.e. OR/OE). The company submitted that there is no case for making any adjustment, since it is within the safe harbour limit of plus or minus 5%. Pages 129 to 132 of the paper book highlights that the profit before tax in the case of the assessee company reflects a net operations margin of 4.65% (at page 132 - 4.80%), but in order to apply the correct procedure, one time extraordinary expenses, debited to the P & L Account, should be excluded since it results in compressing the profitability rate. If one excludes the one time expenditure the resultant net profit for the year would yield a net operating margin of 9.41% and in order to compare the profit margin of the assessee with the other comparable 3 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
companies' cases the non-recurring expenses and income has to be excluded. It can thus been seen that the assessee company benchmarked its international transactions by applying the TNMM methodology and also supported it by CUP methodology, by taking into consideration the rates charged from third party.
6. It may be noticed here that the assessee used prowess database to identify the comparables and in turn it has identified 18 companies as comparables. Nature of activity, turnover, qualitative analysis, etc. were taken for identifying the comparables. In short, Functions, Assets & Risks (FAR) analysis was done to identify and shortlist comparables. Rule 10B(4) of the IT Rules provides that two years data, prior to the relevant financial year, should ordinarily be taken into consideration. Assessee company provided two years data for most of the companies. However, the TPO opted to take only 10 comparables and in the place of balance eight comparables the TPO sought to take four fresh comparables and upon hearing the objections of the assessee he dropped three companies but sought to include Rites Ltd. as a comparable and, according to the TPO, by taking 11 comparables, including Rites Ltd., the assessee's case do not fall in the safe harbour limit and accordingly the arm's length price of the international transaction of the assessee has been computed at `15,41,49,544/- and an amount of `1,19,59,656/- was added to assessee's income and directed the AO accordingly. In the opinion of the TPO the average operating profit margin of the comparable case works out to 13.88% as against assessee's margin of about 5%.
7. Though several objections were raised before the AO challenging the methodology followed by the TPO, the AO proceeded to complete the assessment under section 143(3) of the Act by making an adjustment of `1,19,59,656/- to the income declared by the assessee. The main case of the assessee before the AO was that the learned TPO has not followed the principles of natural justice while rejecting the comparable companies listed out by the assessee company and he has also wrongly taken Rites Ltd. as a comparable case.
4 ITA No. 3590/Mum/2010M/s. Chemtex Global Engineers P. Ltd.
8. Aggrieved, assessee contended before the first appellate authority that the AO erred in making a reference to the TPO and also contended that the transactions entered into by the assessee are at arm's length and hence no adjustment is called for in the circumstances of the case. We are concerned herein with the adjustment made by the AO and hence the facts highlighted before the CIT(A) vis-à-vis the methodology followed by the assessee, to support that the international transactions are at arm's length, is highlighted herein.
9. The case of the assessee is that as per the Transfer Pricing Study Report the assessee furnished detailed analysis to highlight that the most appropriate method in the case of the assessee is TNMM and the most appropriate "profit level indicator" is the berry ratio. The berry ratio is defined as the ratio of operating revenue to operating expenses whereas the TPO has taken into consideration the operating profit and operating cost. It was also submitted that in addition to benchmarking its transactions under TNMM method the company supported its transactions by furnishing the "internal CUP" information and highlighted that even as per the CUP method the transactions with the AE are at arm's length. It was also highlighted that in the peculiar circumstances of the case the tax authorities ought not to have taken into consideration the one time extraordinary expenses as part of the profit.
10. A letter dated 28.11.2006 was referred to before the CIT(A) to submit that if one time expenditure is deducted the resultant net profit for the year gives a net operating margin of 9.41%. It was also submitted that the order passed under section 92CA of the Act does not contradict the claim of the assessee to the effect that the correct berry ratio is 1.09 rather than 1.05 shown earlier and if 1.09 is taken into consideration it is definitely a better result and hence no adjustment is called for. The methodology followed in computation of the berry ratio was also challenged by the assessee apart from claiming that the tax authorities have taken into consideration only 11 companies i.e., 10 companies out of the 18 comparables given by the assessee and Rites Ltd. and on such basis the profit margin is worked out at 13.8%; While not taking into consideration several comparables furnished 5 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
by the assessee no proper opportunity was given to the assessee and the AO has also not afforded an opportunity before rejecting the plea of the assessee about application of internal CUP method.
11. In the grounds of appeal filed before the CIT(A) it was highlighted that the assessee has given its FAR analysis to highlight as to why 18 comparables are chosen but the AO has not given any reason as to why the chosen comparables cannot be taken into consideration. It was also highlighted that as per the provisions of section 92C(2) of the I.T. Act, 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 a price which varies from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean. By adopting that formula the arithmetical mean of the berry ratio of the comparable cases given by the assessee works out to 1.06 whereas the berry ratio of the assessee worked to 1.05 before adjusting non-operational/extraordinary expenses and thus it is comparable with the average of the berry ratio of the independent comparable service companies. Therefore, the fees charged by the assessee has to be treated as reasonable and the price charged is in tune with the arm's length principle. It was also highlighted that selection of multiple year financial data for the comparables is in tune with Rule 10B(4) of the IT Rules.
12. With regard to inclusion of Rites Ltd. as a comparable case the assessee company submitted that it is a multi-disciplinary consultancy organisation in the filed of transportation, infrastructure and related technologies. Since it provides an array of services under a single roof, and being a Government of India enterprise, it is not comparable with the services rendered by the assessee company. In fact foreign contracts executed by Rites Limited are with the governments of several countries such as Sudan, Myanmar, U.K. etc. and not with independent private parties. Therefore, the contracts of Rites Limited have government support and there is an implicit guarantee provided by the Government of India and it is not affected by the market forces/negotiations. Functional profile and risk profile is not similar to the assessee since it is a government enterprise 6 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
and it mostly executes contracts for government enterprises only, apart from the fact that the fixed asset base of the assessee company is very minimal as compared to Rites heavy investments and, looked at from any angle, it is not comparable. If Rites Limited is not taken into consideration the international transaction of the assessee company is at arm's length and hence no adjustment would be called for.
13. The learned CIT(A) observed that the assessee had entered into similar transactions/agreements with unrelated third parties namely, Garden Silk and Reliance Hazira project. The average hourly rate charged to the third party was about `331/- which was lower compared to the charges of `488/- collected from the AE. Therefore, the international transactions were held to be at arm's length due to availability of comparable uncontrolled price (by applying internal CUP method). Since this information was provided before the TPO as well as before the AO, according to the learned CIT(A) the same ought to have been considered during the course of assessment proceedings since the comparable average hourly rate charged by the assessee from its AE was more than the charges collected from the third party; it cannot be stated that it has under charged its AE, if the price is benchmarked under internal CUP method (comparing the fee charged from AE to the fee collected from the third party). It was also highlighted that in the earlier years also the assessee was subjected to transfer pricing scrutiny of same AE transactions but no adjustment was made.
14. The learned CIT(A) has also noticed that as per Rule 10B of the IT Rules the profit margin arising in comparable uncontrolled transactions can be adjusted to take into consideration the difference, if any, such as the specific characters of the transaction, functions performed and assets employed by the comparable companies. He also noticed that use of net margin can potentially introduce a greater element of volatility because the net margin can be influenced by some factors that may not have an effect on the gross margin and prices because of the potential for variation of operating expenses across enterprises. In this regard he observed that the extraordinary expenses highlighted by the assessee should not figure in the operating expenses and if such adjustment is made before determining the 7 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
ALP, the TNMM method employed by the assessee would offer a practical solution; further if the above mentioned material difference on account of "extraordinary expenses" is adjusted by removing them from operating expenses on PLI of the assessee then its berry ratio comes to 1.10 and the operating profit on operating cost comes to 10.40% which is higher than the berry ratio of 1.06 and operating profit to operating cost of 5.73% of the comparables. He thus concluded that the assessee's international transaction is at arm's length.
15. With regard to inclusion of Rites Limited as comparable, for bench marking, the learned CIT(A) was of the view that there is a difference in the activity of Rites Limited and hence it cannot be considered as comparable with the assessee company. In this regard he observed that it is a part of the government enterprise and was assured of obtaining contracts through Railways. This is a basic difference. In addition thereto Rites Limited was carrying on different functions in difference economic sections and markets and naturally has very high level of profitability and hence it cannot be taken as comparable. If Rites Limited is excluded from comparables the assessee's transaction would be at arm's length. He, therefore, deleted the addition.
16. Aggrieved, Revenue is in appeal before us. The learned D.R. submitted that the assessee having benchmarked its international transaction by applying the methodology prescribed under TNMM there is no need for the TPO or for the AO to apply another method to benchmark assessee's transactions. Adverting our attention to page 143 of the paper book the learned D.R. submitted that the assessee benchmarked its transaction by applying TNMM, with the help of berry ratio as profit level indicator i.e. operating income/operating expenses. He also referred to the Transfer Pricing Report filed by the assessee and, in particular, adverted our attention to pages 52, 53 and 57 of the paper book to submit that though the CBDT and OECD guidelines recognise five arm's length pricing methods i.e., CUP, RPM, CPM, TNMM and PSM, the assessee having made an analytical study of the suitable comparables it had categorically mentioned in its study report that in the absence of internal and external comparables, 8 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
CUP method cannot be regarded as the most appropriate method and in its ultimate analysis it benchmarked its transaction by applying TNMM since assessee company is engaged in rendering consultancy services overseas exclusively to CII. In this regard he also referred to page 34 and 50 of the paper book to submit that the assessee had taken into consideration the nature of services rendered by it to its AE while coming to the conclusion that TNMM is the most appropriate method. Therefore, the assessee cannot, at a later stage, request the AO/TPO to apply another method as the most appropriate method.
17. He also adverted our attention to page 70 and 71 of the paper book to submit that while selecting the profit level indicator the assessee adopted berry ratio as the most appropriate PLI which is defined as the ratio of operating revenue to operating expenses whereas Rule 10B(c))i) provided that profit level indicator should be with reference to the cost or sales of assets. On the contrary, in berry ratio, profit is not taken into consideration since only operating revenue and operating expenses are taken into account. Therefore, the PLI adopted by the assessee is not in accordance with the rules prescribed under the IT Rules.
18. He also adverted our attention to pages 127 and 129 of the paper book to submit that as per berry ratio it works out to 1.05 and operating profit and operating cost also comes to 11.17% only on account of the fact that extraordinary expenses claimed by the assessee were reduced from the cost, as otherwise it will be 5.04%. He also adverted our attention to pages 130 and 195 of the paper book to submit that exclusion of extraordinary expenses was the main basis upon which the learned CIT(A) arrived at a conclusion that the profit margin declared by the assessee is within the safe harbour limit. However, the learned CIT(A) has not given any clear cut finding as to why this expenditure has to be excluded. He thus submitted that the CIT(A) erred in accepting the plea of the assessee with regard to exclusion of extraordinary expenses from the cost.
19. With regard to the new comparable adopted by the TPO i.e., including Rites Limited in the list of comparable companies, the learned D.R. 9 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
submitted that the TPO has highlighted the nature of activities of Rites Limited to bring home the point that main component of the business of Rites Limited was service contract and even the Rites Limited was having independent business; therefore, there was no reason to exclude Rites Limited from the list of comparables.
20. He further contended that the assessee has not benchmarked its international transaction under CUP method at the time of filing the Transfer Pricing Study Report and hence it is not entitled to make a fresh claim at a later stage. The case of the learned D.R. is that in the study report the assessee company stated that it had no internal or external comparables so as to adopt CUP method but at a later point of time the company sought to furnish data with regard to internal comparables and hence the TPO as well as the AO were justified in rejecting the fresh contention of the assessee. Under these circumstances the learned CIT(A) ought not have accepted the new plea i.e. application of CUP data for benchmarking its international transaction. He thus strongly relied upon the order passed by the AO.
21. On the other hand, the learned counsel for the assessee submitted that though in the Transfer Pricing Study Report the assessee benchmarked its international transaction under TNMM method, the company referred to internal comparables to support that even under CUP method the transaction is at arm's length. In this regard the learned counsel for the assessee adverted our attention to page 124 and 125 of the paper book to submit that all the details with regard to the transaction with the non-AE company were furnished before the TPO and hence no fresh facts were furnished before the learned CIT(A). It also adverted our attention to several letters addressed to the TPO to highlight that all the details were available before the TPO and hence it is incumbent upon the TPO as well as the AO to take into consideration the CUP data to examine as to whether the international transactions of the assessee are at arm's length. He adverted our attention to the order passed by the learned CIT(A) to submit that based on the fees charged from non-AE companies the international transactions 10 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
with the AE are at arm's length and hence it was held to be not a fit case for making any adjustment.
22. With regard to exclusion of extraordinary expenses from the cost/operating expenses the learned counsel submitted that this issue was specifically raised before the TPO (page 130 of the paper book) but the TPO did not question as to how these are not extraordinary expenses. The TPO had proceeded to adopt the ratio of operating profit to operating expenses as PLI but the most important factor that needed to be kept in mind was that the "cost that needs to be taken for computing the profit must be identical both in assessee's case as well as in the comparable cases". The extraordinary expenses are one time expenditure which are not commonly found in other comparable cases; where a specific issue was raised before the TPO as well as before the AO, in the absence of any material to reject the plea of the assessee, the TPO ought to have accepted the contention of the assessee instead of merely rejecting the same that too without calling upon the assessee to furnish further information in that regard if he is not satisfied with the claim of the assessee. It was also highlighted that the assessee gave due explanation (page 194 of the paper book) as to why such extraordinary expenses should be excluded from the cost and the learned CIT(A), having appreciated the contention of the assessee, accepted the plea and reworked out the ratio by excluding the extraordinary expenses from the cost. He, therefore, contended that if the extraordinary expenses are excluded then the transaction of the assessee would be at arms length in comparison to the comparable cases.
23. With regard to application of berry ratio the learned counsel submitted that even the learned D.R. has not raised any serious objection with regard to application of such methodology and hence detailed arguments are not necessary in that regard. At any rate the learned CIT(A) having excluded the extraordinary expenditure from the cost and the data of Rites Limited from comparable cases, the transaction of the assessee with the AE is at arm's length and hence the order of the learned CIT(A) is in accordance with law. He also explained that the nature of activities of Rites Limited is different and hence the same cannot be taken into consideration in the list of 11 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
comparable cases. The learned counsel also relied upon the order of the ITAT "K" Bench Mumbai in the case of M/s. Thyssen Krupp Industries India P. Ltd. (page 24 of ITA No. 6460/Mum/2012 dated 27.02.2013) to submit that profit motive is not relevant consideration in the case of government undertakings and that is one of the factors to be taken into consideration while considering as to whether it can be considered as a comparable case or not. He thus relied upon the order passed by the learned CIT(A).
24. We have carefully considered the rival submissions and perused the record. In our considered opinion the order passed by the learned CIT(A) does not call for any interference for the following reasons. According to the TPO operating margin on operating cost in the case of comparable companies works out to 13.88% as against 5% in the case of the assessee company whereas, in order to arrive at the cost, the one time extraordinary expenses, which are not standard expenses for earning income, ought not have been taken into consideration and, therefore, the learned CIT(A) was justified in reducing the extraordinary expenses for the purpose of arriving at the cost and by adopting such cost as the basis, the rate of profit declared by the assessee would be at arm's length and hence there is no need for making any adjustment.
25. Even with regard to the comparable companies which are taken into consideration by the AO/TPO the learned CIT(A) has correctly held that Rites Limited is a Government of India enterprise and considering the nature of the contracts and the implicit guarantee provided by the Government of India, etc. Rites Limited cannot be taken as a comparable case and hence the learned CIT(A) was justified in excluding the same.
26. Further, the Act does not provide that an assessee has to choose a particular method for benchmarking its transactions. Even if a particular method is chosen at the time of furnishing it study report the company can always support its transactions with another method. In the instant case all the details were furnished before the TPO and the AO to highlight that the average hourly rate charged to the third parties were lower compared to the AE and hence the international transactions were at arm's length. Even at 12 ITA No. 3590/Mum/2010 M/s. Chemtex Global Engineers P. Ltd.
this stage the learned D.R. could not place any material on record to justify that the assessee is precluded from taking support from any other method for benchmarking its transactions. In other words, the Income Tax Act does not preclude the assessee from benchmarking its transactions with the help of any other method other than the one which is taken for consideration in its study report.
27. For the purpose of sub-section (1) of section 92C of the Act the most appropriate method has to be selected by the AO. Rule 10C also provides that most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction. In other words, the AO/TPO has to exercise their judicial discretion in considering as to whether the method/methods adopted by the assessee is suitable to the facts of the case and if, in their opinion, the method followed by the assessee is not suitable, the AO/TPO has to give show cause notice to the assessee before adopting an appropriate method. Ordinarily, in service contracts, CUP method is more suitable, where an assessee enters into agreement with unrelated third parties on similar lines as that of AE. When such facts are available, the AO/TPO has to give their reasons before rejection of the data furnished by the assessee.
28. With regard to the berry ratio taken as the PLI the learned D.R. has not raised any serious objection with regard to the assessee's plea and hence it is not necessary for us to delve on this issue. In fact if the extraordinary expenses are adjusted, by reducing extraordinary expenses from operating expenses, its berry ratio comes to 1.10 and the operating profit on operating cost comes to 10.40% which is higher than the berry ratio and operating profit of the comparables. Thus even from that angle the assessee's transactions are at arm's length.
29. Under these circumstances we are of the firm view that the order passed by the learned CIT(A) does not call for any interference. We, therefore, uphold the order of the CIT(A) and dismiss the appeal filed by the Revenue.
13 ITA No. 3590/Mum/2010M/s. Chemtex Global Engineers P. Ltd.
30. In the result, appeal filed by the Revenue is dismissed.
Order pronounced in the open court on 12th June, 2013.
Sd/- Sd/-
(P.M. Jagtap) (D. Manmohan)
Accountant Member Vice President
Mumbai, Dated: 12th June, 2013
Copy to:
1. The Appellant
2. The Respondent
3. The CIT(A) - 15, Mumbai
4. The CIT- 10, Mumbai City
5. The DR, "K" Bench, ITAT, Mumbai
By Order
//True Copy//
Assistant Registrar
ITAT, Mumbai Benches, Mumbai
n.p.