Income Tax Appellate Tribunal - Mumbai
Hope Inida Polishing Works P. Ltd, ... vs Department Of Income Tax on 14 June, 2011
IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCHES " H ", MUMBAI
BEFORE SHRI N. V. VASUDEVAN, J.M. AND SHRI R.K. PANDA, A.M.
ITA No. : 2043/Mum/2010
Assessment Year : 2005-06
D.C.I.T., 8(2) M/s. Hope (India) Polishing
R.NO.-216-A, Aayakar Bhavan, Works P. Ltd.
M.K. Road, Mumbai-400 020 Off Chandivali Farm House,
Behind Ice Factory,
Vs. Chandivali Village,
Andheri (E), Mumbai-400 072
PAN NO: AAACH 7357 L
(Appellant) (Respondent)
&
ITA No. : 8187/Mum/2010
Assessment Year : 2006-07
M/s. Hope (India) Polishing D.C.I.T., 8(2)
Works P. Ltd. R.NO.-216-A, Aayakar Bhavan,
Off Chandivali Farm House, M.K. Road, Mumbai-400 020
Behind Ice Factory,
Chandivali Village, Vs.
Andheri (E), Mumbai-400 072
PAN NO: AAACH 7357 L
(Appellant) (Respondent)
Assessee by : Shri K. Gopal
Department by : Shri Goli Sriniwas Rao
Date of hearing : 14.06.2011
Date of Pronouncement : 09.09.2011
ORDER
PER R.K. PANDA, A.M.
ITA No. 2043/Mum/2010 filed by the Revenue is directed against
the order dated 14.12.2009 passed by the CIT(A)-15, Mumbai relating to 2 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
Assessment Year 2005-06. ITA No. 8187/Mum/2010 filed by the assessee is directed against the order dated 12.08.2010 of the Dispute Resolution Panel-I (DSP-I) relating to the Assessment Year 2006-07. Since common issues are involved in both the appeals, therefore, these were heard together and are being disposed of by this common order for the sake of convenience.
ITA No. : 2043/Mum/2010 Assessment Year : 2005-06
2. The only effective ground raised by the Revenue reads as under :-
"1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in deleting the addition made by the AO on account of adjustments made to the Arms Length Price of `.4,25,00,000/- u/s.92CA(3) in respect of international transactions entered into with Associate Enterprise without appreciating the facts of the case."
3. Facts of the case, in brief, are that a reference u/s. 92CA(1) in the case of the assessee was made by the AO to the TPO. The TPO noted that the assessee imports rough diamonds on free of cost basis from a group company and the cost of import is borne by the Supplier. The processing charges are fixed based on nature and quality of diamond processed and has no bearing on the cost of diamond. The assessee has charged for the processing at USD 10,20,35 AND USD 100 rates. After processing as per the design and specification, it exports the diamond back to the same group Company. Therefore, basically it is a job work for the assessee on captive industry basis. The assessee submitted that rate of processing 3 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
charge is same as in the earlier year. The TPO noted that the assessee has not shown that this rate for processing is the prevailing market rate. No other basis for fixing this market rate was given. The bifurcation submitted by the assessee is as under:-
Rate (USD) No. of Pieces Amount (USD) % of Total 100 147 14700 0.87 35 28592 1000720 59.08 20 29420 588400 34.74 10 9002 90020 5.31 Total 67161 1693840 100.00 3.1 The TPO noted that the assessee during the impugned Assessment Year has incurred net loss (PBT) of `.95,43,662/- compared to income of `.2,78,87,670/- in the preceeding year. On being asked by the TPO to justify the loss incurred in this year, the assessee submitted the following reasons (pg. no. 2 of the TPO's order) :-
(a) Change in Product Mix: In this year the diamonds processed has increased from 64239 pieces to 67161 pieces.
However due to shortage of rough stones, the large stones on which processing charge is more (USD 35) constitutes only 59.08% of the total stones processed compared to 84.15% in the preceeding year. The rate of processing on these stones is USD 35 equivalent to `.1600/- at average rate of `.45.70 per dollar while total cost to the assessee is `.945/- per piece giving a margin of `.655/- per stone.
4
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
This year the assessee has received more stones of USD 20 category. It constitutes 34.74% of total stones compared to 0.61% in the earlier year. The processing charge on such stones is USD 20 equivalent to `.914/- at average rate of `.45.70 per dollar while total cost to the assessee is `.505/- per piece giving a margin of `.409/- per stone. Therefore, it is stated that the loss due to shortage in rough diamonds and change in product mix has resulted in a loss of `.2.59 cr.
The assessee has submitted letter from the A.E. and other evidences in support of shortage of rough diamonds.
b) Due to difference in exchange rate the assessee has incurred loss of `.12.7 lacs.
c) The assessee has made additional investment of `.1.75 crores in this year during the end of Previous Financial Year. The bulk depreciation has therefore, charged in this year resulting in increase of depreciation to the tune of `.40.70 lacs.
d) It was further submitted that the processing charge is fixed on cost plus basis and the revenue loss cannot be passed on to the customers including the AE.
e) Further it is submitted that with the reduced figure of depreciation, change in product mix and increase in revenue and without making any change in the Processing Charges, HIPL has earned profit of `.25.21 lacs after charging depreciation of `.82.61 lacs in the subsequent year. 5
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
3.2 However, the TPO was not convinced with the reasons cited by the assessee. From analysis of the Profit & Loss account of the assessee, he noted that the rates for processing the diamonds as received from the A.E. have remained same in this year. On the other hand, the charges incurred by the assessee for processing the diamonds have increased substantially. According to him the assessee basically works as a captive unit depending solely on the work assigned by the A.E. Under this scenario there is no reason for incurring loss as such. The rates charged by the assessee should have been increased at least in the same proportion as the increase in rates paid by the assessee. However, this has not been done. According to the TPO the personnel cost (part of processing charges) paid by the assessee has increased from 3.98 crore in the preceeding year to 4.55 crore in this year. But processing income has decreased from 10.35 crore in the preceeding year to 7.58 crore in this year. Further, there is a sharp increase in the processing charges paid, while the processing income received per stone has remained stagnant. Thus, he considered that the arms length consideration has not been received. He accordingly issued a show cause notice as to why processing income should not be taken as (4.55 X 10.35)/3.98 = 11.83 crore instead of `.7.58 crore. In absence of any reply received, the TPO took `.11.83 crores as the ALP and made an adjustment of `.4.25 crores.
6
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
4. During the assessment proceedings the AO asked the assessee to explain as to why the TP adjustment proposed by the TPO should not be added back. The assessee company submitted without prejudice that it is eligible for deduction u/s. 10B of the I.T. Act and filed detailed submissions explaining that it is eligible for deduction u/s.10B. It was further submitted that due to negative income Form No.56 was not filed along with the return of income and hence no exemption u/s.10B has been claimed at the time of filing of the return. It is only due to the additions/disallowances made in the assessment, the income has become positive and therefore, the assessee has filed Form No.56 G. 4.1 The AO accepted the above contention of the assessee. After making addition of `.4.25 crores on account of T.P. adjustment, and certain other additions (which are not the issue before us), the AO arrived at the business income at `.3,95,02,697/-. After allowing exemption u/s.10B for the above amount, the AO determined the business income at NIL.
5. The assessee challenged the T.P. adjustment of `.4.25 crores before the Ld. CIT(A). Detailed submissions were made and arguments advanced. It was submitted that transfer pricing study was carried out by the assessee for the first time for the Assessment Year 2003-04. It was concluded in para 1.8 of the study that 'Given the nature of manufacturing operation performed by Hope India, availability of internal 7 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
comparables and based on other facts and circumstances of the case, the Transactional Net Margin Method is the most ideal method.' The operating profit margin was used as the profit level indicator and the operating profit margin earned by the assessee had been found to be comparable with the profit margin earned by other external comparables. 5.1 The Addl. Commissioner of Income Tax (TPO-II), Mumbai passed an order accepting the submissions of the assessee and confirming that the assessee's transactions were at Arms Length for Assessment Year 2003-
04. In the subsequent years, it was emphasized that the basis for fixing Processing Charges has not changed and the assessee have been consistently following the same basis.
5.2 In Assessment Year 2004-05, the assessee entered into similar transactions with related companies and the matter was again referred to the TPO for verification. In addition to the working filed for the earlier year, the assessee also filed a detailed working on the cost of processing one piece of diamond, the capacity utilisation etc. 5.3 It was submitted that a perusal of the workings clearly brings out certain relevant facts which are as under :-
8
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
(i) One category of diamonds for which the assessee charges US $ 35 per piece, accounts for 84.15% of the total revenues .
(ii) The assessee earns a mark up of 52.4% on sales and 110.09% on cost for this category of diamond.
(iii) After making adjustments for unutilized capacity, the assessee earned an overall net profit of 26.94%. The assessee submitted that this net profit is much higher than the average net profit of around 5% of the other 10 companies found to be comparable during the previous year.
(iv) The operation is highly labour intensive and the labour and the labour related costs, totally account for around approx 55% of the total cost (excluding depreciation).
(v) That the assesses unit worked at 53.46% capacity due to shortage of rough stones during the said period.
(vi) The assessee employs labour and makes heavy investment in training them to achieve the desired quality.
(vii) That the labour employed by the assessee is unionized and are governed by certain very rigid terms which makes the labour cost more like a fixed cost to the assesses.
5.4 The submissions made by the assessee were accepted by the TPO-IV and the transactions were considered to be at Arms Length for Assessment Year 2004-05 also. Hence no adjustment was made. 9
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
6. It was submitted that the TPO deviated from the T.P. orders of earlier years and made adjustment of `.4.25 crores in an arbitrary manner. It was submitted that the assessee continued its business in similar manner as in earlier years. Some of the factors which adversely affected the financial performances of the company, were highlighted which are as under :-
(i) Heavy shortage of high quality rough stone persisted through the year. As a result, the revenues fell to `.759.99 lacs as against `.1019.03 lacs. A fall of 25.42% for `.259.04 lacs.
(ii) Due to non-availability of high quality rough stone, the product mix changed drastically. The USD 35 category which accounted for 84.15% of the total revenues during the previous year fell to 59.08% during the year under appeal. The other low quality category of USD 20 rose and accounted for revenues of 34.74% during the year under appeal as against 0.61% during the previous year.
(iii) The overall expenses (excl. depreciation) have increased from `.680.84 lacs in the previous year to `.756.63 lacs.
The activity being highly labour intensive and the labour cost being in the nature of fixed cost has increased by about 10% based on the terms of the agreement with the union. Increase in labour cost accounts for a major portion of the increased in overall expenses.
(iv) The assessees anticipating an increase in business made heavy investments in sophisticated Plant & Machinery, towards the end of the previous year (i.e. Assessment Year 2004-05). This has resulted in increased depreciation of `.40.76 lacs during the year in appeal.
10
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
6.1 It was submitted that the assessee during the course of assessment proceedings filed workings similar to earlier year. The workings brought out the above facts as also the fact that due to shortage of quality stone, the assesses have worked at 40.08% much lower than 53.46% during the earlier year. The assessee earned a mark-up of 40.94% on sales and 69.32% on cost on USD 35 category. After making adjustments for unutilized capacity, the assessee earned an overall net profit of 37.50%. The assessee submitted that this net profit is much higher than the average net profit of around 5% of the other 10 companies found to be comparable during the previous year. In addition to this, the assessee also provided a separate working showing that total cartage processed during the year (22914.86 carats) and submitted that the assessee has charged average processing charges of `.33.09.70 per carat which is much higher than the normally accepted norm of `.500/- per carat charged by other comparable companies in the local market. The TPO-I(IV) has chosen to disregard all the submissions made by the assesses and has chosen to fix the Arms Length price of the transactions at `.11.83 crores on an adhoc basis, thus making an adjustment of `.4.25 crores. 6.2 It was submitted that the figure of Processing Charges (more particularly personnel costs) as shown in the profit and loss account, represents the amount spent by the assessee towards labour cost during 11 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
the year. In anticipation of future business every company hires labour in advance and trains them in order to prepare for the expected opportunity in future. Labour hired in anticipation of business is like a fixed cost. An increase of 10% in the cost of labour over a year is customary and acceptable in business parlance. Increase in total labour cost over a period cannot be compared with the sales prices charged. It was submitted that the TPO has strangely chosen to compare the increase in total labour cost with the processing charges charged per piece. If at all a comparison was necessary it was only appropriate that the cost of processing per piece be compared to the processing charges charged per piece. The detailed working submitted by the assessee at the time of proceedings clearly shows that the labour cost of processing one piece of diamond (USD 35 category) is `.329/- per piece as compared to `.326/- per piece in the earlier year.
6.3 It was argued that making an adjustment by comparing the increase in total cost of labour over a period of one year with the processing charges charged is absolutely irrelevant. It was further contended that adjustment made to the current years revenues by taking the last years labour cost to revenue ratio, was improper, absurd, without any justification and liable to be set aside. Moreover, it was stated that the assessee company has not been formed with the intention of providing services to related companies 12 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
only. It was submitted that a perusal of the object clause of the Memorandum and Articles of Association clearly shows that the assessee company has not been formed with the intention of providing services to related companies only. In fact, to fill up the idle capacity the assessee have been trying to get business from other companies in the industry. However, it has failed to procure business at the rates being paid by the related companies. Assuming without admitting, that the assessee companies unit is a captive unit, expecting the AE to compensate for the losses on account of shortage of business cannot be justified. 6.4 Attention was also drawn to the TPO's statement that "The rates charged by the assessee should have been increased, at least in the same proportion as the increase in rates paid by the assessee". The working provided by the assessee shows that the labour cost per piece of processing has increased to `.329/- per piece as against `.326/- in the earlier year, an increase of 0.92%. Going by the statement made by the TPO the maximum adjustment to revenues should have been only to the extent of 0.92%.
6.5 Finally and most importantly it was submitted that while making a substantial adjustment to the assessee's arms length price (ALP) on the basis of labour cost to revenue ratio of the previous year, the TPO failed to 13 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
provide an independent comparable, where revenues increase based on such ratios. It was accordingly submitted that the adjustment of `.4.25 crores, made by the TPO are purely adhoc, without any justification against settled principles of law and liable to be set aside in full.
7. Based on the arguments advanced by the assessee, the Ld. CIT(A) deleted the T.P. adjustment of 4.25 crores by holding as under :
"I have perused the written submission of the appellant, TPO's order of the current year as well as those of earlier years also. Transfer pricing is a systematic, logical and step by step analysis commencing with screening of data for choice of comparable through statistical tool and application of most appropriate method deciphering Arms Length Range and culminating in the determination of the ALP.
In the present case, it is observed that though the TPO has proposed substantial adjustment on the basis of labour cost to revenue ratio of the previous year but has failed to provide any independent comparable where revenue increase was based on such ratio. This omission makes the whole exercise inherently flawed.
The TPO assumes that since the personnel (labour) cost has gone up, it should ipso facto lead to increased in processing income. Since that has not happened he has carried an adhoc adjustment in a whimsical manner.
The TPO also erred in comparing the increase in total labour cost with processing charges per piece. If at all the comparison was necessary it should be that the cost of processing per piece be compared to the processing charges levied per piece. This would have been a direct and straight comparison.14
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
From the working submitted by the appellant, it is evident that labour and cost of processing one piece of diamond (USD 35 category) is `.329/- per piece as compared to `.326/- per piece in the earlier year. Thus, the appellant has charged `.3/- more then that in the previous year. It is a fact that labour costs generally increase at least by 10% from the earlier year and it may or may not result in corresponding higher sales. This crucial aspect of business and commerce has been over looked by the TPO. If revenues were invariably to increase in direct proportion to labour costs then all businesses would make it a point to substantially increase their labour costs every year. But in reality trade, commerce and business do not run on such simple arithmetic or logic.
The appellant has furnished reasons which have contributed to fall in profits during the year and they are summarised as under :-
(a) Reduction of revenue amounting to `.259.04 lacs.
(b) Increase in overall expenses of `.7.79 lacs (Approx.10% of the previous year).
(c) Increase in depreciation of `.40.76 lacs on account of investment in plant and machinery.
These facts was neither rebutted or accepted by the TPO. It is an establishment fact that higher deprecation on new assets can distort profits especially if there is an excess unused capacity (Schefenacker Mother Son Delhi in ITAT) as has been observed this year in this case. Infact, its net profit after adjustment for unutilised capacity comes to 37.50% which is higher than earlier years figure on the same criteria at 26.94%. As stated earlier there was no adjustments in the earlier year in this case.
Despite these factors, it has earned a mark up of 40.94% on sales of 69.32% on the cost on USD 35 category which account for the bulk of its revenue. In fact its main driver of revenue was USD 35 per piece diamonds which had accounted for 84.5% in the last year but it fell to 59.08% during the year 15 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
whereas the lower quality category of USD 20 went up and accounted for revenue of 34.4% during the year in appeal as against 61% last year. This changed composition of turnover had a major role in depressing the profit. The appellant after making adjustment for unutilized capacity earned an overall profit of 37.50% and thus net profit was much higher than net profit of around 5% of another 10 companies which was found to be comparable in the previous year.
It is also relevant to add that its average processing charge of `.3309.70/- per carat is higher then normally accepted norm of 500 per carat charged by the other comparable companies in the local market.
To sum up, simply because the appellant has suffered a loss this year it has been subjected to adjustments in the Act. a holistic view has not been taken. It will be unfair only to see the outcome (profit or loss) in complete disregard of the material conditions & circumstances and other relevant parameters. In ACIT v/s. MSS India (P) Ltd. 32 SOT 132 Pune (2009), it has been held that the ultimate profit or loss of the tax payer is not a relevant factor for exercise. It is not out of place to mention here that the appellants transaction with AE for Assessment Year 2003-04 and 2004-05 after undergoing TPO's scrutiny were held to be Arms Length demonstrating confidence in Compliance System's and processes of the appellant. Further, the appellant being a 10 A unit has got no incentive for generating loss as even its profits are exempt from tax.
Taking all the facts and circumstances of the case, I hold that there is no ground for any adjustment and assessees price is held to be at Arms Length. Thus the addition of `.4,25,00,000/- is deleted."
8. Aggrieved with such order of the Ld. CIT(A), the Revenue is in appeal before us.
16
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
9. We have considered the rival submissions made by both the sides, perused the orders of the authorities below and the paper book filed on behalf of the assessee. There is no dispute to the fact that the assessee's T.P. study was accepted by the TPO in the Assessment Years 2003-04 and 2004-05 and the transactions with the AE's were held to be at arm's length. We find the assessee during the impugned assessment year has given detailed reasons as to how and why there was fall in revenue. The TPO or the AO has neither considered the same properly nor rejected the same. The action of the TPO in making substantial adjustment on the basis of labour cost to revenue ratio of the previous year without providing any independent comparable case where revenue increase was based on such ratio, in our opinion, is not proper and unjustified. Merely, because the personnel cost has gone up, the same in our opinion, cannot be the basis for assuming that the processing income also should go up. Therefore, ad hoc adjustment on this ground, in our opinion, is arbitrary. We also find force in the submission of the Ld. Counsel for the assessee that the fall in revenue is due to unutilised capacity, increase in depreciation and increase in overall expenses. The Ld. DR could not controvert the detailed findings given by the Ld. CIT(A). In this view of the matter, and in view of the detailed order passed by the Ld. CIT(A), we find no infirmity in the same. Accordingly, the same is upheld. The ground by the Revenue is accordingly dismissed.
17
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
ITA No. : 8187/Mum/2010 Assessment Year : 2006-07
10. Facts of the case, in brief, are that a reference was made to the TPO to ascertain the ALP of its international transactions with AE's since, the transactions with AE's had exceeded `.15 crores. From the various details furnished before the TPO summarised the international transactions of the assessee which are as under :
Sr. Nature of Transaction Amount
No.
1 Purchase of diamond industrial 3,05,739
powder
2 Processing charges for cutting & 7,89,50,462
polished diamonds
3 Purchase of machinery 1,05,05,462
4 Interest on loans 24,47,222
5 Reimbursement of expenses 19,70,262
11. The TPO noted that during the Assessment Year 2004-05, as against processing of 64239 pieces of rough diamonds, the assessee had earned total processing income of `.10.19 crores. The operating margin was around 28%. From the details given by the assessee, he noted that the assessee had operated at 54% of installed capacity during the Assessment Year 2004-05 and the total labour cost of `.3.99 crores was 39.16% of the processing receipts of `.10.19 crores. He noted that despite installing sophisticated machineries, increasing the capacity of processing and 18 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
increasing the labour component it had earned `.7.85 crores as processing charges for processing 60,289 diamonds. The labour cost constitutes 61% of the total revenue and the operating margin is around 6%. Further the assessee had not increased the rate of processing, although the labour expenses have gone up. He, therefore, asked the assessee to show cause as to why appropriate adjustments shall not be carried out. 11.1 The assessee vide its reply dated 23.10.2009 filed explanation, the details of which are as under :-
1. The labour costs is fixed in nature and due to the lower utilization of the capacity, the labour had to be kept idle which has resulted in a higher incident of labour in relation to the revenue. After considering a rebate for lower utilization of capacity the gross profit margin would come to around 43.54%.
2. The per unit rate charged by the assessee is around `.3700 per carat as against the market rate of around `.500 per carat and therefore, the pricing is at arm's length.
3. Due to poor market condition and lower supply of the diamonds by the AE, the assessee could not process the desired number of diamonds to achieve a good capacity utilization and take benefit of the new equipment installed for achieving higher operating profit.
12. However, the TPO was not satisfied with the above explanation. He noted that the assessee has operated at 54% capacity during Assessment 19 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
Year 2004-05 and during the current year the capacity utilization is almost 50 to 51%. This shows that there has not been any significant change in the capacity utilization. However, the percentage of labour charges to processing income has gone up from 39.16% to 55.14%. 12.1 Secondly, the assessee has claimed that it is undertaking specialized cutting and polishing operation involving specialized machines and technology. Keeping in view the same, the rate charged by the assessee cannot be compared with the prevailing market price for cutting which is pre-dominantly carried out in traditional manners with common prevalent designs.
12.2 Finally, the assessee is a captive unit of the AE. It is the AE which has undertaken a massive expansion on the capacities and insisted on the assessee to install sophisticated machines for carrying out its works. In such a scenario from a transfer pricing prospective the AE should have compensated the assessee at an arm's length price. 12.3 The TPO further noted that during the Assessment Year 2004-05, the assessee had carried out a detailed transfer pricing analysis giving the comparable rates of third party processors. During the current year no such exercise has been carried out by the assessee nor has it been able to justify the lower margins earned by it. The fact that the assessee has not 20 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
increased its processing rates margins during the past three years inspite of an increase in labour cost to processing income ratio from 39.16% to 55.41%, itself shows that the processing charges are not at an arm's length. No prudent businessman will continue to charge the same rate of processing from a third party inspite of an increase in its operating cost. 12.4 Since the assessee has not been able to substantiate the fact that the price charged by him is at an arm's length, the TPO relied on the decision of the Tribunal in the case of M/s. Aztec Software & Technology Services Ltd. reported in 294 ITR (AT) 32 proceded to make the adjustment of ALP. According to the TPO, labour is a major component of the total costs. The assessee has not been able to substantiate that the labour is of a fixed nature only. Even otherwise the AE should have compensated the assessee for excess labour, due to its inability to give substantiate work to its AE keeping the base year 2004-05 when a proper bench marking had been carried out. The assessee should have at least recovered enough processing charge to recover the excess labour. According to the TPO, the incidence of labour in Assessment Year 2004-05 was 39.16% on the total income of `.10.19 crores. As against the same labour cost is `.4.35 crores on total receipts of `.7.85 crores in the current year i.e. 55.41%. Applying the benchmark rate of Assessment Year 2004- 05, the processing charges received during the year according to him 21 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
should have been `.11,11,34,937 {(7,85,42,576/39.16) x 55.41} against the actual amount received of `.7,85,42,576/-. He accordingly made an adjustment of `.3,25,92,361/-. He further noted that the assessee shall not be entitled to any exemption under Section 10A of the Income Tax Act, in respect of the above adjustment in view of the specific provisions of Section 92C(4) read with first proviso thereto.
13. During the course of assessment proceedings the AO confronted the TPO's report to the assessee. Rejecting the various explanations he made addition of `.3,25,92,361/- in the draft assessment order which was upheld by the Dispute Resolution Panel. The AO accordingly made addition of `.3,25,92,361/-. In the said order, the AO had treated the interest on FD's as income from other sources, thereby denying benefit of deduction u/s.10A of the I.T. Act.
14. Aggrieved with the order of the DRP which upheld the AO's action in making addition of `.3,25,92,361/-, the assessee is in appeal before us with the following grounds :
"1. The learned AO/TPO/Dispute Resolution Panel (DRP-I) grossly erred in making adjustments to the Arm's Length Price charged by the appellants for international transactions, totally amounting to `.3,25,92,361/-
1.1 The learned AO/TPO/DRP-I erred in completely ignoring the fact that on reference made to the Transfer Pricing Officer, during the previous year 2003-04 i.e. Assessment Year 2004- 22 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
05, the price charged by the appellants had been accepted to be the Arm's Length Price. The appellants submit that there is no change in the price charged by the appellants during the year under appeal and the same ought to have been accepted to be the 'Arm's Length Price'.
1.2 The learned AO/TPO/DRP-I, completely disregarded the fact that, adjustments made on similar facts for the assessment for AY 2005-06 have been set aside in appeal by the learned CIT(A).
1.2 The learned AO/TPO/DRP-I grossly erred in making the adjustment to the appellants sales figure, in proportion to the wages paid by the appellants. The appellants respectfully submit that wages paid are of no relevance and cannot form the basis for deciding the revenues of the appellant.
1.3 The Appellants respectfully submit that the adjustments made to the 'Arms Length Price' is unwarranted, without proper justification, against settled principles of law and is liable to be set aside."
15. The Ld. Counsel for the assessee submitted that the assessee is a 100% subsidiary of a Japanese Company and the business of the assessee is that of polishing diamonds. He submitted that the assessee is subjected to transfer pricing study since Assessment Year 2003-04 onwards. Referring to pg. no. 64 of the paper book, he drew the attention of the bench to the order passed u/s.92CA(3) of the Act for determination of the ALP for the Assessment Year 2006-07. The Ld. Counsel for the assessee submitted that the assessee has given the method of pricing. However, the method has not been questioned by the TPO. Referring to pg. no. 10 of the paper book, he drew the attention of the bench to the details of purchase of consumer goods from the AE. Referring to pg. no. 11 and 12 of the 23 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
paper book, he drew the attention of the bench to the income from processing, where the method used for determining the ALP has been mentioned as (Cost +). Similarly referring to pg. no. 13 of the paper book, he drew the attention of the bench to the purchase of laser machine and measuring equipment from the AE and the TNMM method used for determining the ALP. Referring to pg. no. 14 of the paper book, he drew the attention of the bench to the interest paid on external commercial borrowing from the AE and the CUP method used for determining the ALP. Referring to pg. no. 15 and 16 of the paper book, he drew the attention of the bench to the recovery of freight expenses incurred from the AE, where the method used for determining the ALP has been mentioned as 'CUP' Method. Referring to pg. no. 52 of the paper book, he drew the attention of the bench to the letter dated 22nd September, 2009 addressed to the TPO giving the information required under Rule 10(1) of the I.T. Rules. Referring to the said letter, he drew the attention of the bench where it has been mentioned that there is no change in the above information as compared to earlier years. Referring to pg. no. 53 and 54 of the paper book, he submitted that the assessee in response to the question on captive use of the facility created by the assessee company by the associated companies, he submitted that the assessee company has not been established with the intention of catering to the needs of the group companies only. The assessee has been trying to obtain business from 24 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
independent customers but has not been able to accept proposals due to low prices being offered by the independent customers. Referring to pg. no. 55 of the paper book, he drew the attention of the bench to the letter addressed to the TPO on 20th October, 2009 where it was clearly mentioned that HIPL has received rough diamonds from 'Associated Enterprises' on 'Loan Basis' for Processing. He submitted that the property belongs to others. If any thing goes wrong while doing the processing, the assessee will loose only the processing charges. The assessee is not the owner of the diamonds at any point of time. Referring to pg. no. 33 of the paper book, the Ld. Counsel for the assessee drew the attention of the bench to the analysis of Processing Charges for the Assessment Year 2006-07. Referring to pg. no. 34 of the paper book, he drew the attention of the bench to the Computation of Gross Profit - For USD 35 and the percentage of net profit on sales shown at 44.42%. Referring to pg. no. 35 of the paper book, he drew the attention of the bench to the Total (Direct + Indirect) Cost and basis of its allocation. He submitted that the TPO without going through the various details furnished by the assessee has made the adjustments. Referring to Circular No.12 of 2001 dated 23rd August, 2001 issued by CBDT, the Ld. Counsel for the assessee drew the attention of the bench to clause (iii) of the said circular which reads as under :-
25
ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
"(iii) It should be made clear to the concerned Assessing Officers that where an international transaction has been put to a scrutiny, the Assessing Officer can have recourse to sub-section (3) of section 92C only under the circumstances enumerated in clauses (a) to (d) of that sub-section and in the event of material information or document in his possession on the basis of which an opinion can be formed that any such circumstance exists. In all other cases, the value of the international transaction should be accepted without further scrutiny."
15.1 He submitted that the TPO had no material information or document to contradict the various submissions made by the assessee. The adjustment was purely whimsical and based on presumptions and submissions. He accordingly, submitted that the adjustment made by the TPO should be deleted and the return of the assessee should be accepted.
16. The Ld. DR on the other hand, referring to pg. no. 58 of the paper book submitted that as against operating profit of 44.40% in Assessment Year 2003-04 and 26.90% in Assessment Year 2004-05, the operating profit has declined to 6.01% for the Assessment Year 2006-07. The problem started because of down fall in the operating profit. Referring to the decision of Bangalore Special Bench of the Tribunal in the case of Aztec Software & Technology Services Ltd. vs. ACIT reported in 107 ITD 141, he submitted that selection of most appropriate method is based on nature of transaction, the availability of relevant data and the possibility of making appropriate adjustments. The burden to establish that an international transaction was carried at ALP is on the taxpayer. He has 26 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
also to furnish comparable transactions, apply appropriate method for determination of ALP and justify the same by producing relevant material and documents. In the instant case, the assessee has not discharged the burden transferred to it, therefore, the TPO was justify in determining the ALP.
16.1 Referring to the decision of the Tribunal in the case of DCIT vs. Starlite reported in 133 TTJ 425, he submitted that the TNMM does not permit the assessee or the AO to compare enterprise level profits and make adjustments. Referring to the said decision, he submitted that complete reading of the relevant provisions of the Act as well as the Rules shows that it is mandatory for the assessee to follow one of the prescribed methods and demonstrate that the international transaction entered into by it with AE is at ALP. By simply saying that none of the method can be applied and citing excuses for the same does not absolve the assessee of its statutory duty in determining the ALP as per the law. He accordingly, submitted that the TPO was justified in making the adjustments.
17. The Ld. Counsel for the assessee in his rejoinder submitted that both the decisions cited by the Ld. DR are not applicable to the facts of the present case. The assessee in the instant case has discharged the burden cast on it by explaining the most appropriate method based on the nature of the transaction and justify the same by producing the relevant material 27 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
and documents. It was also submitted that the comparable cases of earlier years are equally applicable to this year. However, no other comparable case has been cited by the TPO.
18. We have considered the rival submissions made by both the sides, perused the orders of the AO and the Ld. CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. From the order of the TPO, we find the main reason for adjustment of the ALP is that although there is no significant change in the capacity utilization during the impugned assessment year as compared to A.Y. 2004-05, the percentage of labour charges to processing income has gone up from 39.16% to 55.41%. According to the TPO, the assessee has not been able to substantiate that the labour is of a fixed nature only. Further, according to the TPO, the AE should have compensated the assessee for excess labour due to its inability to give substantial work to it. However, we do not find any sound reason for adjustment of ALP on this account. We find force in the submission of the ld. Counsel for the assessee that the increase in labour cost during the year is hardly 10 to 12% as compared to the preceding year which is due to annual increment of salary etc. When regular employees are working with an assessee, he cannot terminate their services because of lesser capacity utilization during the year. The utilization of capacity during the year depends on 28 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
various factors, the main factor being receiving orders from overseas and other clients. Further, the orders also should be acceptable to the assessee considering the profitability. Similarly getting work order from others, especially in diamond industry, also depends on various factors such as demand in market due to customer's choice etc. We also do not find any sound reason on the logic of the TPO that the AE should have compensated to the assessee for the excess labour charge incurred by it. 18.1 We find under identical circumstances, the adjustment made by TPO in the A.Y. 2005-06 was deleted by the CIT(A) and on further appeal by the Revenue we have dismissed the appeal of the Revenue at para 9 of the impugned order. Since the facts for the impugned assessment year are identical to the facts of the preceding A.Y., therefore, in view our detailed discussion at para 9 of the impugned order, we hold that the adjustment of ` 3,25,92,361/- is uncalled for and accordingly directed to be deleted. The order of the DRP is accordingly set aside and the grounds raised by the assessee are allowed.
19. So far as the grounds of appeal No. 2 to 2.2 are concerned challenging the order of the A.O. in treating the interest income as income from other sources and thereby denying the benefit of exemption u/s 10A, we find these grounds do not emanate from the order of the DRP against 29 ITA No : 2043/Mum/2010 & 8187/Mum/2010 M/s. Hope (India) Polishing Works P. Ltd.
which the assessee has filed this appeal. At the time of hearing also the ld. Counsel for the assessee did not seriously press for these grounds. Under these circumstances grounds of appeal No. 2 to 2.2 are dismissed.
20. Grounds of appeal No. 3 being general in nature is dismissed.
21. In the result, appeal in ITA No. 2043/M/10 for A.Y. 2005-06filed by the Revenue is dismissed and appeal in ITA No. 8187/M/10 for 2006-07 filed by the assessee is partly allowed.
Order pronounced on this 9th day of September, 2011.
Sd/- Sd/-
( N. V. VASUDEVAN ) ( R. K. PANDA )
JUDICIAL MEMBER ACCOUNTANT MEMBER
MUMBAI, Dt: 09.09.2011
Copy forwarded to :
1. The Appellant,
2. The Respondent,
3. The C.I.T.
4. CIT (A)
5. The DR, H - Bench, ITAT, Mumbai
//True Copy//
BY ORDER
ASSISTANT REGISTRAR
ITAT, Mumbai Benches, Mumbai