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Income Tax Appellate Tribunal, “J” BENCH, MUMBAI
Before: SHRI PRASHANT MAHARISHI, AM & SHRI SANDEEP SINGH KARHAIL, JM
ITA number 7476/M/2011 is filed by the assessee for assessment year 2004 – 05 against appellate order passed by The Commissioner Of Income Tax
Assessee is aggrieved with that and has preferred this appeal raising following grounds of appeal: –
“Ground No 1: Transfer Pricing adjustment of Rs. 2,30,24,555/-
1) On the facts and circumstances of the case, the learned Commissioner of Income-tax (Appeals) (CIT(A)) erred in upholding the action of the Assessing Officer (AO)/ Transfer Pricing Officer (TPO) of ascertaining the arm's length price of the international transactions at Rs. 5.13,30,548/- instead of Rs. 7,43,55,103/- as determined by the Appellant.
2) The learned CIT(A) further erred in: a. not accepting / appreciating the fact that the Appellant's loss was on account of its business strategy and not on account of its international transactions with the Associated Enterprises; b. not accepting / appreciating the economic adjustments carried out by the Appellant on account of annual maintenance contract income for future c. not granting the (+/-) 5% range benefit available under proviso to Section 92C(2) of the Income Tax Act, 1961.
3) The Appellant prays that it be held that the international transactions are at arm's length and accordingly the adjustment of Rs. 2,30,24,555/- be deleted.
Ground No 2: Short TDS credit of Rs. 14,16,080/-
1) The learned CIT(A) erred in not directing the AO to grant a TDS credit of Rs. 14,16,080/- (i.e. Rs.42,24,974/- as claimed by the Appellant in his return of income less Rs. 28,08,894/- granted by AO)
2) The Appellant prays that the AO be directed to grant credit for balance TDS of Rs. 14,16,080/-
The Appellant craves leave to add to, alter, amend or withdraw all or any of the Grounds of Appeal.”
Brief facts of the case shows that assessee is a private limited company established in India and started its operation in 1999. The assessee offers customers the latest models of lifts, technologically advanced to those currently available in Indian market at affordable prices. It provides installation, modernization and maintenance services for the
The assessee has entered into following international transactions: –.
Serial Particulars of Amount of Method benchmarking number transaction international adopted by transaction the assessee
Assessee 1 Purchase of 4,01,03,050 Transactional selected 5 stores and net margin comparable companies spares method whose Oprah rating profit margin was 2 Purchase of lifts 2,32,86,474 4.21% assessee has and escalators incurred losses at the gross profit level of 3 Professional fees 40,96,285 gross loss of 4.46%. Assessee adjusted the 4 Reimbursement 68,69,294 profit level indicator and of expenses after that computed adjusted operating margin ratio of 1.03%. Thus stated in transfer pricing study report that international transaction is at arm’s- length.
Serial particular amount amount number 1 Gross margin of the -2,44,33,998 assessee 2 Add discounted value of 1,704,98,667 gross margin of annual maintenance contract 3 Cost savings on differential 3,51,05,394 duties 4 Extraordinary replacement 2,01,13,028 cost total 2257,17,089 5 less Annual maintenance 93,04,221 contract margin for the year 6 And foreign exchange in 1,91,06,047 miscellaneous income 7 Less operating costs such 19,04,43,866 as salaries, other operating expenditure, depreciation and bank charges 8 Add cost of indigenization 21,98,011 9 Adjusted operating margin 56,49,062 10 sales 54,75,62,904 11 Adjusted operating margin 1.03%
Assessee has made following for adjustments to its margins.
i. The first adjustment made it to margins of the assessee is increase of the gross margin by a discounted value of gross margin of annual maintenance contracts amounting to Rs. 1,704,98,667/- . The annual maintenance contract income of the assessee for March 2004 is Rs. 93 lakhs. The contention of the assessee is that its annual maintenance contract income is less ii. The assessee has calculated the differential because of customs duties such as excise duty i. On annual maintenance contract income adjustment made by the assessee, the learned transfer-pricing officer was of the view that the assessment is for the period ended 31st of March 2004 and therefore the profitability of the assessee for that year only would be under consideration. Income of each year is separate and taxed separately. Therefore he did not agree with an economic adjustment to increase the income of 20 years and adjust it to the gross profits of the current year as it would unnecessarily inflate the profits of the current year as these profits would accrue to the assessee over 20 years.. He further noted that assessee is making this adjustment only for the iii. With respect to the extraordinary replacement cost, the learned TPO held that these costs are incurred in the course of the business and are intrinsic to the products imported by the assessee. Hence, they should not be considered as an adjustment as the assessee does not consider them extraordinary in its return of income and does not pay tax on it. He rejected this adjustment also. iv. With respect to indigenization cost, the learned transfer-pricing officer held that the business model of the assessee is to import the products from the associated enterprises, assemble it in India, and sell them. These costs are normal cost incurred in the course of the business as these cost would benefit the assessee in the form of better profits due to reduced imports in the period under consideration.
Accordingly, he computed the operating profit of the assessee at a loss of Rs. 212,961,817/–. He computed the profit margin of the assessee taking the margins of the comparable at 4.21% at Rs. 23,133,064/– and accordingly proposed an adjustment of Rs. 236,094,881/–. After that he is of the view that the total adjustment of Rs. 23.60
Based on the above adjustment an Assessment order under section 143 (3) of the act was passed on 29/12/2006 determining the total loss of the assessee of Rs. 169,176,070 against the returned loss of Rs. 192,200,620.
The assessee aggrieved with the above order preferred an appeal before the learned CIT – A who passed the appellate order on 23/8/2011. Assessee argued that the profit level indicator i.e. margin of the assessee is correctly computed which is not appreciated by the learned transfer pricing officer. The learned CIT – A referred to the provisions of rule 10 B (1) (e) with respect to the transactional net margin method and rejected the adjustment made by the assessee to margins of the assessee itself. Accordingly, appeal of the assessee was dismissed.
Aggrieved, assessee is in appeal before us. The learned authorized representative submitted that ii. He submitted that assessee has considered its relative position in the market being a new entrant in an established industry and facing tough competition from rivals and other economic conditions to compute the various economic adjustments calibrated. He submitted that the learned CIT appeal in his order has wrongly rejected the adjustment made by the assessee holding that these are the factors not affecting the net profit margin in the open market. He submitted that the assessee has claimed an adjustment for factors such as business strategies, market penetration schemes, competition in the market, difference in import content, replacement cost etc. Which materially affect the price, cost of profit of the transaction. Therefore, according to him the economic adjustment claimed by it is justified because it raises the material difference arising between the assessee and the comparable is due to its initial year of operation, marketing penetration scheme adopted and competition in the market. He further referred to the note submitted by him on assessee is India business strategy.
iv. With respect to the adjustment for market penetration strategy in the form of annual maintenance income for future years submitted that the elevator industry is highly competitive and price sensitive. While determining the sale price of a left, a company would definitely take into account the expected realization from annual maintenance contract in future years and accordingly arrive at the selling price. The annual maintenance cost revenue is measure business driver in the elevator industry and the v. Alternatively assessee also contended that the economic adjustment for the market penetration strategy can also be computed by adjusting operating margin by substituting the lower average sale price per unit by the rate equivalent to the sale price in the post-market penetration stage or by substituting the meager annual maintenance contract income by income at the rate equivalent to the AMC rate in the post-market penetration stage. Thus it was submitted that operating margin of the appellant as adjusted would be 9.07% which is much higher than the arm’s-length price at 4.21% of the comparable companies. He further relied on the decision of the coordinate bench in case of Syngenta India Ltd versus additional CIT wherein it has been held that the market penetration schemes, business strategies, increase in market share et cetera relevant factors affecting prices and profits of a transaction and thus reasonable adjustment should be allowed. vi. The adjustment for extraordinary replacement cost was also justified by the assessee stating
Accordingly, he submitted that the economic adjustment made in the operating margin of the appellant should be allowed to the assessee for comparability purposes in transfer pricing analysis.
The learned departmental representative vehemently supported the order of the lower authorities. He extensively relied on the order of the learned CIT – A and submitted that in the transaction net margin method above adjustment is not permitted. He further referred to the decision of the coordinate bench in case of ITA number 1727/M/2015 for assessment year 2010 – 11 in case of Alstom India Ltd wherein identical adjustment was denied by the coordinate bench holding that the expenses incurred by the assessee are normal expenditure incurred during the course of the business. With respect to the income accounted for by the assessee for
We have carefully considered the rival contention and perused the orders of the lower authorities. The learned CIT – A has dealt with this issue as under :-
"“a) From the plain reading of the aforesaid rule, it is crystal clear that profit level indicator (PLI) prescribed under TNMM is the net operating margins computed in relation to the prescribed base as mentioned in sub-section (i) above. The choice with the tax payer is regarding selection of base i.e. cost incurred or sale effected or assets employed or any other relevant base, but not in the selection of margins. b) Net profit margins have not been defined in the I.T. Act or rules made therein. When the statues have not provided the definition of a term used in it then general meaning of the term has to be taken into consideration. It has been held by the Kerala High Court in the case reported in 190 TTR 32(Ker)" While interpreting the meaning of a word, the court in the absence of the statutory definition will have to Thus, the net profit normally means profit before tax, computed in accordance with the accounting principles. However, any item of income or expenditure which has no bearing on the amount of the transactions under examination have to be excluded or included as the case may be. Some of these items may be as dividend income and interest income, which are not directly related to the transactions. c) Thus, under TNMM in the first step, net operating margin from international transaction is computed in relation to the appropriate base. In the second step, net operating margin of the uncontrolled transactions are identified. In the third step the net operating margin of uncontrolled transaction are adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entered into such transactions which could materially affect the amount of net profit margin computed in step 3 above is then taken to be net operating margin and the Arms Length Price of the transactions computed by that operating margin.
Appellant in its analysis has made an attempt to make adjustments to account for annual maintenance
The nature of the 'difference' which may warrant any adjustment should be such "which could materially affect the amount of net profit margin in the open market"". The appellant has made adjustment to i) Factor of demand and supply ii) Existence of marketable intangibilities i.e. brand name, etc. iii) Geographical location, and the like
For the purposes of the comparability analysis and benchmarking following TNMM, the comparables have been searched which are functionally similar. Further the search of comparables has also been done having regard to assets and risks of the appellant and the comparables. Thus the companies being comparable and fulfilling comparability criteria would have faced similar conditions in respect of demand and supply. The higher profitability in respect of the comparables is for the reason of either existence of marketing intangibles or geographical location is also not what is coming out of the facts of the case or the analysis carried out by the appellant. Thus even on this count the adjustment made by the appellant to its PLI is not acceptable.
In view of the facts of the case and discussion as above the contention of the appellant in respect of Appellant has further submitted in respect of genuineness of losses incurred and has mentioned that its losses are to the tune of Rs. 19,22,00,620/- whereas its international transactions is only Rs. 7,43,55,103/-. In this regard it is mentioned here that as per the transfer pricing study conducted by the appellant, which has been accepted by the TPO except acceptance of the so called economic adjustments carried out by the appellant, the adjustment required to arrive at the margins of the set of comparables (following TNMM) has been determined by the TPO at Rs. 23.80 crores. However subsequently considering the portion of the international transactions of the appellant, only proportionate adjustment has been considered and worked out at Rs. 2,30,24,555/-. Obviously this portion of adjustment is relatable to only the international transaction of the appellant. Accordingly the differential amount to the tune of Rs. 20 crores, which has been not considered by the TPO/AO towards the adjustment could only be considered towards the business losses of the appellant on account of the various non transfer pricing factors which have been mentioned by the appellant and have been discussed here in above.
The appellant has also contended to consider the set of comparable which it gave during the course of the proceedings before the TPO. It may be mentioned
In view of the facts and discussion hereinabove, the contention raised by the appellant in respect of Ground no. 2 is not found to be acceptable and accordingly the ground so raised is dismissed.”
Now we look at The Income tax Rules 1963 whether in TNMM application such an adjustments are permitted or not.
Provision of Rule 10 B (1) ( e ) is as under :-
(i) the net profit margin realized by the enterprise from an international transaction 94[or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction 94[or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub- clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction 94[or the specified domestic transaction];
On Plain reading of the Rule, what is to be compared is profit Realized by the Enterprises with profit Realized by unrelated enterprises. Therefore, without looking in to further merit of claim of assessee, that discounted cash flow earnings of probable annual maintenance contract income to be generated for 20 years is to be included in to the margins of the assessee, we find that such income is not at all realized, therefore, such an economic adjustment, if at all permitted, cannot be carried out in application of TNMM method. Hence, we are not inclined to consider the claim of the assessee that a
There is an another aspect to this claim, Assessee has computed what it would earn in a period 20 years subsequent to this year on account of annual maintenance contract income . We find that such a working is based on many assumptions that cannot be verified or tested in this year. Further, to the future income there is no functions performed by the assessee during the year, no risks assumed and no assets employed for earning in future of such an annual maintenance income of the assessee.
None of the decisions cited before us deal with an issue of inclusion of future income to compute margin of current year.
On the issue of higher custom duty component, it was submitted that assessee has 28 % of import content compared to 11 % in case of comparable. The Import duty as sated is 57 % where as the excise duty is only 16 % therefore, assessee should get an adjustment in margin of the Assessee.
It is to be noted that the claim of assessee for exclusion of differential Customs duty is based on the premise that it made more imports with the
With respect to extraordinary replacement cost, we find that product failure and customization are the normal business expenditure in case of machinery manufacturers and traders. The product failure is part of warranty cost and provisioning which is a normal provisioning and expenditure in such business, therefore we do not find any fault with the Action of LD TPO in not granting adjustment of
Ground no 2 is with respect to short tax credit, we direct the ld AO to grant tax credit of TDS to the assessee after verification. Ground no 2 is allowed.
Accordingly, appeal of assessee for AY 2004-05 is partly allowed.
Now we come to the appeal for assessment year 2005 – 06 where both the parties is challenged the order of the learned CIT – A dated 18/8/2011.
The brief facts shows that assessee filed its return of income on 31 October 2005 declaring a total loss of ₹ 137,071,800/–. As assessee has entered into international transaction identical to assessment year 2004 – 05, the learned transfer pricing officer by passing an order under section 92CA (three) has determine the arm's-length price of such transaction proposing and adjustment of Rs. 1,81,09,090/–. Subsequently that the total income of the assessee was computed at rupees loss of 11,89,62,705 by passing an assessment order under section 143 (3) of the act on 10/12/2008. The assessee preferred appeal before the learned CIT – A challenging the transfer pricing adjustment. The learned CIT – A disposed of the appeal of the assessee by passing an
With respect to the appeal of the assessee, identical issue is decided by us also in appeal of assessee for assessment year 2004 – 05, for the similar reasons we dismiss the appeal of the assessee.
With respect to the appeal of the learned AO we find that the learned CIT – A has granted the benefit of proviso to section 90 2C (2) of the act following the decisions of the coordinate benches holding that proviso to section 92C (two) has been amended subsequently and as per circular of the civility number 5/2010 dated 3/6/2010 amended provision is applicable with effect from 1/4/2009 i.e. for assessment year 2009 – 10 and subsequent
In the Result, appeal of the assessee for assessment year 2004 – 05 and 2005 – 06 are dismissed and appeal of the learned assessing officer for assessment year 2005 – 06 is also dismissed.
Order pronounced in the open court on 03/04/2023