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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI GEORGE GEORGE K. & Ms. PADMAVATHY S
Date of hearing : 20.02.2023 Date of Pronouncement : 28.02.2023 O R D E R
Per Padmavathy S., Accountant Member
This appeal is against the final order of assessment passed by the ACIT, Circle 4(1)(2), Bangalore dated 21.9.2020 u/s. 143(3) r.w.s. 144C r.w.s. 254 of the Income-tax Act, 1961 [the Act] for the assessment year 2007-08.
The assessee is engaged in the manufacture of machine tools and components, trading in maintenance spares and also provides
IT(TP)A No.712/Bang/2020 Page 2 of 18 marketing support to Group companies, for their products in India. The assessee filed the return of income for AY 2007-08 on 30.10.2007 declaring a total income of Rs.8,41,39,074. The case was selected for scrutiny under CASS and notice u/s. 143(2) was duly served on the assessee. The reference was to TPO was made to determine the Arm’s Length Price (ALP) of the international transaction the assessee had with its AE. During the year, the assessee was engaged in Manufacturing segment (manufacture of machine tools), Trading segment (maintenance spares), Marketing support service and Provision of Engineering services. The assessee had maintained proper segmental details, which were submitted before the TPO. The TPO accepted the margins of the three segments as being at Arm’s Length and made adjustment only in the manufacturing segment for an amount of Rs.5,50,05,337. The AO passed the draft assessment order incorporating the TP adjustment and also by making a disallowance u/s. 10A amounting to Rs.26,23,392. The DRP confirmed the TP adjustment and the disallowance made by the AO.
Aggrieved, the assessee went in appeal before the Tribunal. The Tribunal vide its order dated 20.4.2018 has remitted back the TP issue to the TPO for fresh consideration. With regard to the issue of disallowance u/s. 10A, the Tribunal held that the issue is no longer res integra as the same is covered by the decision of the jurisdictional High Court in the case of CIT v. Tata Elxsi Ltd., 349 ITR 98 wherein it was held that the expenses excluded from export turnover should also be IT(TP)A No.712/Bang/2020 Page 3 of 18 excluded from the total turnover for consideration of deduction u/s. 10A. The relevant observations of the Tribunal is reproduced below- 8.2 As regards adjustment of deduction u/s 10A, the issue is no longer res integra as the same is covered by the decision of the jurisdictional High Court in the case of CIT v. Tata Elxsi [2012] 17 taxmann.com 100/204 Taxman 321/349 ITR 98 (Kar.) wherein it has been held that expenses excluded from the export turnover should also be excluded from the total turnover for computation of deduction u/s 10A of the Act.
We heard rival submissions and perused the material on record. We find from record that the assessee had not applied current year data in respect of comparables in deciding the comparability. Further, the TPO also made adjustment even in respect of non-AE transactions. In the circumstances we deem it fit and proper to send the matter back to the TPO for undertaking fresh exercise of TP analysis and also direct the assessee to furnish TP study report before the TPO by using current year data alone.
In the result, the appeal filed by the assessee is partly allowed for statistical purposes.
In the second round of proceedings before the TPO, the TP adjustment was computed at Rs.5,14,79,505 which is confirmed by the DRP. The assessee is in appeal before the Tribunal for the second time against the order in pursuance to the directions of the DRP. The assessee raised 12 grounds with regard to the TP adjustment. The assessee also raised additional ground Nos. 13 to 21 contending the TP adjustment on legal grounds and also for TPO not granting economic adjustments such as working capital adjustment, capacity utilisation adjustment etc.
IT(TP)A No.712/Bang/2020 Page 4 of 18
The ld AR during the course of hearing prayed for admission of these additional grounds. The additional grounds do not require fresh investigation into facts and therefore following the Hon’ble Supreme Court judgment in the case of M/s National Thermal Power Co. Ltd. Vs. CIT, 229 ITR 383 (SC), the additional grounds are admitted for adjudication.
Out of the 12 grounds with regard to TP adjustment, during the course of hearing the ld AR presented arguments with regard to ground No. 2 to 5 which read as under and submitted that if these grounds are adjudicated, the other ground would become academic and accordingly can be left open.
“2. The learned AO, learned TPO and the Hon'ble DRP grossly erred in not restricting the Transfer Pricing Adjustment to the extent of International Transactions alone under the Slim sub- segment.
3. The learned AO, learned TPO and the Hon'ble DRP grossly erred in not considering the submissions made by the Appellant relating to Manufacturing of slim machinery ("slim sub-segment") and manufacturing of spares ("Non-slim sub- segment").
4. The learned AO, learned TPO and the Hon'ble DRP grossly erred in not appreciating the fact that the Non-slim sub- segment is already at arm's length and accordingly no adjustment is warranted to the international transactions entered with the AE in the Non-slim sub-segment.
5. The learned AO, learned TPO and the Hon'ble DRP grossly erred in not considering the internal comparability of the margins earned in AE and non-AE segment of the slim sub- segment .”
IT(TP)A No.712/Bang/2020 Page 5 of 18
As per the TP study, the assessee is engaged in following segments (1) Manufacturing of machine tools (2) Trading in maintenance spares (3) Provision of marketing support services (4) Provision of engineering services. In the manufacturing segment, as per the TP documentation, the assessee adopted TNMM as the most appropriate method and operating profit/operating revenue is considered as the profit level indicator. The assessee as per the TP report, arrived at a margin as below:-
SL Description Amount (Rs.) No 1 Operating Revenues 16,71,00,569 2 Operating Expenses 19,94,13,649 3 Operating Profit (-) 3,23,13,080 4 OP / Sales (-) 19.34% 5 OP / Cost (-) 16.20%
The assessee while arriving at the above margin has considered the sub-segments i.e. manufacture of slim machines which is a loss making sub-segment and the manufacture of non-slim machines which is a profit making sub-segment together. The assessee has provided the following as the reasons for the negative margin in the TP study –
i) The manufacture of slim machines was a new product business, whose actual sales started only in the month of September 2006 ii) The product being new and the components being imported were having higher landed cost put the finished product cost high while the IT(TP)A No.712/Bang/2020 Page 6 of 18 selling price could not be matched with in the market, due to which margins came under pressure iii) 88 slim machines were manufactured out of which only 37 were sold. As against this, 108 slim machines were sold in the subsequent years 9. Hence the contention of the assessee before the TPO was that the costs could not be recovered leading to losses in the manufacturing segment. Accordingly the assessee has considered 23 comparables in the TP study which were not accepted by the TPO.
10. The TPO did not accept the submissions of the assessee and held that the assessee did not submit details of start-up costs/ extraordinary costs. The TPO also did not accept the contention that the losses in the Manufacturing segment was due to non-recovery of costs in the Slim machine sub-segment (Para 6.2 of the earlier TP order) by observing that (i) The assessee did not elaborate the nature of extra-ordinary expenses (ii) At arm’s length, an entrepreneur would not be happy to incur losses in one segment and that the assessee did not show any extra ordinary expenses, which resulted in loss. 11. The TPO made a fresh search to select comparables whose average margin based on FY 2006-07 was worked out at 13.58%. Accordingly the TPO arrived at TP adjustment as below:-
Operating Revenues Rs. 16,71,00,569/- Operating Cost (a) Rs. 19,94,13,649/-
IT(TP)A No.712/Bang/2020 Page 7 of 18
Arm's Length Margin 13.58% of operating revenues Arms Length Cost (ALP) @ 86.42% of operating Rs. 14,44,08,312/- revenues (Including the cost involved in the international transactions) (b) Excess being adjustment u/s 92CA (a) - (b) Rs. 5,50,05,337/-
The assessee while raising its objections before the DRP during the first round, contended that –
i. The loss in the manufacturing activity was due to the slim machine sub-segment, which was introduced during the year ii. The TPO erred in making adjustment to the whole of the manufacturing segment instead of international transactions alone iii. The manufacturing activity constitutes two segments namely i) manufacture of slim machines and ii) manufacture of machine parts iv. Slim machines were sold in the domestic market as well as to its AEs. The assessee manufactured 88 slim machines out of which 37 were sold. Out of the sale of 37 machines, 11 were sold in the domestic market and the balance 26 were sold to AEs. v. The machine part manufacturing segment, which were sold only to AEs earned an operating margin of 15.73 % of sales. vi. The transfer pricing adjustment should be restricted to the sale of slim machines exported to AEs 13. The assessee vide submission dated 19.10.2011 made to the DRP, submitted the segmental details of Slim machines and Non-slim machines were furnished, the details of AE and non-AE segment of the slim machine sub-segment was also furnished. (Pages 90 – 91 of Paper
IT(TP)A No.712/Bang/2020 Page 8 of 18 book). The DRP after considering the contentions of the assessee, upheld the TP adjustment made. The DRP did not give any finding on the first issue that the loss in manufacturing segment was only due to the slim machine segment which commenced commercial production only during the year. As regards the second issue that the adjustments should be restricted only to the transactions related to the AEs, the DRP rejected the contention and upheld the adjustment made on the entire manufacturing activity.
Aggrieved the assessee filed the appeal before the Tribunal raising the same contentions raised before the DRP with regard to the sub-segments of manufacturing segment viz., slim and non-slim segments and also that with regard to the adjustment in the slim segment the adjustment should be restricted to only AE transactions. The Tribunal vide order dated 20.4.2018 has remitted back the TP issue to the TPO for fresh consideration with the following directions
(i) The assessee to furnish TP report by using current year alone (ii) Adjustment to be made only in respect of AE transactions 15. In the remanded proceedings, the assessee submitted the revised TP study with respect to manufacturing segment as per the directions of the Tribunal. The assessee submitted before the TPO that the sub- segments of manufacturing segment in terms of slim machine segment and non-slim machine segment is to be considered separately for the purpose of determining the ALP. In this regard the assessee submitted
IT(TP)A No.712/Bang/2020 Page 9 of 18 the sub-segment wise financials (earlier submitted before the DRP in the first round) as given below:-
Particulars Slim segment Non-slim segment (Rs.) (Rs.) Total operating income 97,452,772 69,647,797 Total operating expenses 138,425,375 59,500,731 Operating profit (-)40,972,603 10,147,066 OP/OC (-) 42,04% 14.57%
With regard to slim machine segment, the assessee submitted that it is having transactions with both AEs and non-AEs and therefore internal TNMM is used to determine the ALP. Accordingly, the assessee presented the following working:-
Total Particulars AE Sales Non AE Sales 66.595,27 Manufacturing Sales 97,452,772 30,857,500 Material Cost 89,825,677 Less: Customs Duty 9,980,631 Net Material Cost 79,845,046 Material Costs from AEs 15,969,009 10,912,573 5,056,436 (20 % of total purchases) Third Party Purchases 63,876,037 43,650,293 20,225,744 (80% of total purchases) Other Costs 13,040,932 8,911,644 4,129,288 35,558,-66 Fixed Costs 24,987,241 10,571,525 Operating Margin/(Losses) (30,991,972) (21,866,479) (9,125,493) Operating Margin -31.80% -32.83% -29.57%
With regard to non-slim segment, the assessee submitted that the margin computed as per the comparables chosen by the assessee is less than the margin of the non-slim segment and therefore the assessee concluded that the same is within arm’s length. With regard to slim segment the assessee re-iterated that the adjustment if any should be IT(TP)A No.712/Bang/2020 Page 10 of 18 restricted only to the AE transactions the breakup of which is furnished as above.
The TPO after considering the revised TP analysis did not accept the break-up of slim and non-slim transactions for the reason that as per directions of the Hon’ble ITAT, the segmental information with regard to AE & non-AE transactions only to be considered. The TPO also held that both slim and non-slim segments have AE and non-AE transactions and that the assessee has not shared the said details. The TPO further held that the basis for allocation and documentary evidences to substantiate the break-up between slim and non-slim transactions is not provided by the assessee. Therefore the TPO chose final list of comparables in the remanded proceedings as given below:-
Company Name Sl OP to No Sales 1 Flat Products Equipments (India) Ltd 6.60% 2 Kebra Extrusiontechnik Ltd: 6.34% 3 Solitaire Machine Tools Ltd. 21.78% 4 United Drilling Tools Ltd. 10.83% 5 Miven Machine Tools Ltd. 7.10% 6 I T L Industries Ltd. 9.78% 7 Guindy Machine Tools Ltd. 21.89% 8 Lakshmi Precision Tools Ltd. 13.99% 9 Dagger-Forst Tools Ltd. 13.24% 10 Premier Ltd. 0.31% 11 Kulkarni Power Tools Ltd. 14.36% AVERAGE 11.47%
IT(TP)A No.712/Bang/2020 Page 11 of 18
Accordingly the TPO arrived at the TP adjustment as per below working :-
Operating Revenues Rs.16,71,00,569 Operating Cost (a) Rs.19,94,13,649 Arm’s Length Margin 11.47% of operating revenues Arms Length Cost (ALP) @ 88.53% of operating revenues (Including the cost Rs.14,79,34,134 involved in the international transactions) (b) Excess being adjustment u/s. 92CA (a)-(b) Rs.5,14,79,515
The DRP upheld the TP adjustment by holding that –
“7.2.2 The assessee has not furnished any information as to how these transactions are captured in the various segmental break-up made by the assessee. From the information in the TP Study Report, it is evident that these transactions are related to the manufacturing segment. However, even during the course of hearing before us the assessee could not clarify as to how these transactions are captured in the segmental information of the manufacturing segment submitted by the assessee. 7.2.3 Before us, it was contended that Transfer Pricing adjustment should be restricted to the value of international transactions with associated enterprises under the Slim sub- segment only. However, we cannot agree with the assessee that Transfer Pricing adjustment should be restricted to the value of international transactions with associated enterprise under the Slim sub-segment only because admittedly thee are international transactions with the AEs under Non-Slim segment also. The assessee has not given any justification or documentation as to why the adjustment should be restricted to the transactions in the Slim Sub-segment only when there are international transactions in the other segments Including the Non-AE segment . Moreover, the assessee only submitted a chart supposedly showing the AE and Non-AE segment with regard to the manufacturing segment.
IT(TP)A No.712/Bang/2020 Page 12 of 18
The assessee has neither produced nor submitted the basis for allocation of the costs or any documentation to support. On an adhoc basis the assessee has allocated 20 % of the cost of material towards AE purchases without any documentation. As per information in the annual report about 67% of materials consumed pertaining TO manufacturing activity were imported, and the imports were only from the AEs as per information submitted. This clearly shows that the allocation given by the assessee is prima facie unreliable and incorrect. In view of the discrepancies, and more so, when the international transactions are interlaced and intertwined both on the cost and revenue side in the entire manufacturing activity, we are unable to accept the assessee's plea to restrict the adjustment to the value of international transactions. On the other hand, the adjustment made by the TPO is on the basis of the information available in the audited financial results of the company for the year. We, therefore, are inclined to accept the adjustment proposed by the TPO. 7.2.4 On the plea for internal comparability of AE & Non-AE segment in the slim sub-segment. We do not find merit in the said plea, as already noted by us, the international transactions are embedded either by way of cost of revenue in both segments, and hence the adoption of external TNMM is justified. 7.2.5 On the plea that the sale price of machines sold to AE and Non-AE to be taken for comparison, we note that the sales to non-AE are not entirely uncontrolled transaction, as the cost includes imports from AEs. Besides, taking differential price would not be appropriate as it does not fall into any of the prescribed methods. CUP analysis is also not feasible as the non- AE revenue is not totally untainted. Therefore, these pleas are rejected. 7.2.6 With regard to adjustment on account of start-up phase, the assessee could not furnish the details of the nature of extra- ordinary expenses, if any, for the F.Y. 2006-07. No details of any expenses debited to profit and loss account pertaining to the product pre-launching expenses were submitted before the TPO as well as before this Panel. The assessee did not show any extra ordinary expenses incurred which resulted in loss. Therefore, we are unable to consider adjustment on account of start-up phase
IT(TP)A No.712/Bang/2020 Page 13 of 18 without any details and documentation to show that extra ordinary expenses beyond the control of the assessee were expended during the year.”
The ld. AR submitted that the statement of the TPO that the segmental details have not been furnished is factually incorrect since the details have been filed. The ld AR in this regard drew our attention to the rectification petition filed u/s 154 dated 19.10.2011pointing the mistake of not considering the details furnished regarding the segmental details furnished by the assessee before the DRP during the first round of proceedings and the DRP has not acted on the same (page 79 of paper book). The ld AR submitted that the same details furnished before the TPO in the remand proceedings and therefore the contention that no details are furnished is not correct.
The next contention of the ld AR is that TPO himself in the initial TP proceedings did not accept the margins calculated by the assessee where the assessee has considered the slim and the non-slim segments together under manufacturing segment for the reason that the assessee has consolidated the slim and the non-slim business which is not correct since slim business is making losses cannot be set off against the profits of the non-slim business. The ld AR further submitted that the spares manufacturing segment is unrelated to the slim machine segment and that the relevant submissions along with the workings were filed before the TPO. Further, the TPO himself has admitted that the Spares manufacturing segment is unrelated to the slim machines segment. The ld AR drew our attention to the relevant
IT(TP)A No.712/Bang/2020 Page 14 of 18 paragraph of the TP order dated 11 June 2019 which is extracted below:
The ld. AR also submitted that when the TPO himself did not accept the consolidation and when the assessee is presenting the segmental financial with regard to slim and non-slim segment, the TPO is once again rejecting the same, which is contrary to his own view. The ld. AR submitted that in the manufacturing segment the assessee is having 2 segments i.e., Slim and Non-slim segment and in slim segment, the assessee is having transactions with AEs as well as non- AEs. It is submitted that this sub-segment break up has not been understood properly by the lower authorities. The ld AR contended that when all the details with regard to the sub-segments are submitted before the TPO and the DRP, it is not factually correct to hold that the details are not being furnished. The ld AR also submitting a detailed written submission in which each of the contentions of the TPO and the DRP is rebutted and the same is taken on record for the purpose of adjudication. Accordingly, the ld AR prayed that the direction to be issued to consider the sub-segment-wise profitability for the purpose of determining the ALP and to consider only the AE transactions for determining the ALP in the slim segment.
IT(TP)A No.712/Bang/2020 Page 15 of 18
The ld. DR, on the other hand, relied on the order of the DRP as extracted in the earlier part of this order.
We heard the rival submissions and perused the materials on record. Based on the various submissions of the ld AR it can be summarised that the issue before us for adjudication is that the margins of slim segment and non slim segment whether can be considered separately for the purpose determining the ALP and that ALP adjustment if any should be done only in the slim segment taking into account only the transactions with AE in that sub-segment.
We notice that as per the initial TP study, the assessee has considered the slim and non-slim sub-segments as one under manufacturing segment and proceeded to benchmark the same for determining the ALP. We further notice that during the first round of proceedings itself, while raising the objections before the DRP the assessee had made submission to consider the margins at sub-segment level and the relevant details in this regard as reproduced in the earlier part of this order have also been furnished before the lower authorities. We also notice that the assessee had submitted before the DRP that non-slim segment is having a healthy margin of 17.05% which is more than the margins of the comparables as computed by the TPO and that the ALP adjustment if any is to be made only with respect to slim segment where only the transactions with AEs alone need to be considered. These submissions of the assessee in our view have not been considered properly by the lower authorities even during the IT(TP)A No.712/Bang/2020 Page 16 of 18 remanded proceedings. This view of ours is strengthened when we peruse the various grounds on which the lower authorities have rejected the submissions of the assessee.
It is brought to our notice that in the first round of TP proceedings, the TPO himself has rejected the TP study of the assessee in the manufacturing segment for the reason that the assessee has considered the segment at a consolidated level taking slim and non- slim segment together (refer TPO observations reproduced above) and that when the assessee is requesting for these two sub-segments to be considered separately, the same is rejected by the lower authorities.
In the remand proceedings, the TPO did not accept the segmental financials i.e. slim & non-slim and AE and non-AE submitted by the assessee for the reason that the same is properly not substantiated by evidences. However we notice that no further details in this regard have been called for by the TPO. The DRP also has rejected the plea of the assessee on similar ground. From this, it is clear that the lower authorities have not understood the assessee’s request to consider these two segments separately for the purpose of ALP adjustment and also that details submitted in this regard have also not been considered. Further the Hon’ble Tribunal in the first round has sent the matter back to the TPO for undertaking fresh exercise of TP analysis and that the TPO has in the remanded proceedings has just repeated the same exercise as in the first round. In view of this, we find
IT(TP)A No.712/Bang/2020 Page 17 of 18 it appropriate to remit the issue back to the TPO/AO with a direction to consider the following prayers of the assessee afresh:- i. The sub-segmental financials at slim segment and non-slim level to be considered for the purpose of ALP. ii. No adjustment is required in the non-slim segment where the margins taking into account the transactions with AE and non- AE are more than the margins of the comparables. iii. In slim segment, the internal TNMM to be applied by taking transactions with AEs and non-AEs into consideration. iv. In slim segment ALP adjustment if any is warranted the same should be done taking into account only the AE transactions.
The TPO is further to call for any further details that may be required for proper adjudication of the above issues. The assessee is directed to provide all the relevant details before the TPO and cooperate with the proceedings. It is ordered accordingly.
Since we have remitted the issue of TP adjustment back to the TPO with the above directions, the legal contentions raised by the assessee through additional ground does not warrant separate adjudication and left open. With regard to the additional grounds raised in connection with regard to the various economic adjustments sought, we direct the TPO to consider the adjustments in accordance with law while recomputing the ALP as per the directions given in this order.
Ground No.1 & 12 are general and grounds 10 & 11 are consequential.
IT(TP)A No.712/Bang/2020 Page 18 of 18
In the result, the appeal is allowed for statistical purposes.
Pronounced in the open court on this 28th day of February, 2023.