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Income Tax Appellate Tribunal, ‘D’ BENCH, CHENNAI
Before: SHRI MAHAVIR SINGHAND SHRI MANOJ KUMAR AGGARWAL
PER MAHAVIR SINGH, VICE PRESIDENT:
These cross appeals by the Revenue and assessee and cross objection by the assessee are arising out of order of the Commissioner of Income Tax (Appeals)-11, Chennai in dated 17.10.2018. The assessment was framed by the ACIT (OSD), Corporate Range-3, Chennai, for the assessment year 2014-15 u/s.143(3) r.w.s.92CA(3) of the Income Tax Act, 1961 (hereinafter the ‘Act’) vide order dated 26.12.2017.
The only issue in this appeal of Revenue is against the order of CIT(A) granting working capital adjustment despite the fact that the assessee had not established the need for working capital adjustment by showing that the credit period agreed between the assessee and its AE are more than the agreed period availed by the comparables. On this very issue, the Revenue has also raised that the CIT(A) failed to understand the issue that only difference in the days of credit between that of comparable and the agreed credit
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 period as per invoice / agreement with the AE should be taken into account and not the availed credit period. For this, the Revenue has raised various grounds 1 to 4, which are argumentative in nature and hence, need not be reproduced.
Brief facts are that the assessee was incorporated as private limited company under the Companies Act, during October 2007 as a wholly owned subsidiary of the Korean Holding company Woosu AMS Co. Ltd., South Korea. The company is having its manufacturing facility in Sriperumbudur. It is mainly engaged in the manufacture of transmission parts for automobile products such as Rail-sub Assembly, Fork-Shift, Rail shift, Complete Shaft Assemble, Brkt Assemble-Eng Supt, Gear Differential and Shaft Input. The company caters to OEM Hyundai Motors India and its ancillary units. The AO considering the issues involved, the matter was referred to Transfer Pricing Officer for determination of arms length price with reference to international transaction entered into by the assessee and as reported in Form No.3CEB for the relevant assessment year 2014-15 u/s.92CA(1) of the Act. The TPO noted in the show cause notice that the basis of working capital adjustment to increase assessee’s margin is not stated in its TP study and IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 working capital adjustment claimed in TP audit cycle was not found to be justified and therefore it was rejected. The TPO noted that in any case other than non-AE payables the credit period is 60 days and any interest on overdue payable should be with reference to the invoice in the case of tested party for the impeded interest to be proportionate to the credit period as per invoice only and he proposed the possible rate of interest would be as per LIBOR rate only because which is much lower than the rate of interest as per bank interest rates. According to TPO, the assessee has tried to make justification for working capital adjustment from the point of view of overdue payable to its AE without reference to the explicit period of credit mentioned in the invoice, the other factors of working capital adjustment are only academic. Hence, he rejected the working capital adjustment claimed by the assessee. The assessee moved to the CIT(A) and the CIT(A) relying on the assessment order for the assessment year 2013-14, wherein the AO himself allowed working capital adjustment, directed the AO / TPO to provide working capital adjustment accordingly by observing in para 11 as under:- 11. It is seen that the Assessing Officer had accepted the working capital adjustments sought by the assessee for AY 2013-14. The assessee has had a IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 deficit working capital of Rs.52.04 crores for AY 2014-15 as against a deficit working capital of Rs.25.78 crores for AY 2013-14. The average of two years working capital deficit works out to Rs.38.91 crores. Considering the turnover of Rs.228.80 crores for the year, the percentage average deficit of working capital is computed at 17.01 %. This has a substantive bearing on the profitability of the assessee company. The Assessing Officer could not have rejected the working capital margin without a proper appreciation of facts. The assumptions made by the TPO in the TP study are also not justified. In view of the same, the Assessing Officer/TPO are directed to provide the working capital adjustment as in AY 2013-14 in the case of the assessee.
Aggrieved, now Revenue is in appeal before the Tribunal.
We have heard rival contentions and gone through the facts and circumstances of the case. We noted that the TPO himself in the proceedings for assessment year 2013-14 considering the impact of negative working capital in profitability of assessee allowed working capital adjustment. Now the contention of the Revenue is to restrict the adjustment to the difference in agreed credit period between the AO and the assessee and that of comparables. But according to assessee, this is improbable as similar data is not available in the case of comparable companies. The ld.counsel for the assessee drew our attention to OECD guidelines which provides for considering the availed credit period rather than agreed credit period. The ld.counsel for the assessee
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 filed the OECD guidelines of July, 2010, wherein it is mentioned as under:- “A major issue in making working capital adjustments involves the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party.”
The ld.counsel stated that the CIT(A) has rightly allowed the claim. We uphold the order of CIT(A) and this issue of Revenue’s appeal is dismissed. Assessee’s Appeal in IT(TP)A No.27/CHNY/2019 5. The first issue in this appeal of assessee is as regards to reduction of economic adjustment on foreign exchange fluctuation loss, non-cenvatable custom duty adjustment, power relatable adjustment, risk adjustment and abnormal freight charges adjustment.
The assessee while computing ALP claimed working capital adjustment in relation to power related adjustment or freight adjustment and adjustment on account of foreign exchange fluctuation. The TPO rejected the air freight adjustment by observing as under:-
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 7.5 The rationale for rejecting Power cost adjustment applies with equal force to this claim also. With utmost reverence to the ITAT, whose decision was relied upon it is relevant to take note of the fact that whether a cost is normal or abnormal is a question of fact. If it is an abnormal cost which has a decisive edge in determining the profit margin of a particular year, the same would invariably find mention in the Financials by inviting attention to the factors responsible for the loss or the dip in profits occasioned. It is also relevant to take note that the assessee's voice can be heard as to the extra-ordinary factors accounting for its performance. But, the same cannot be true in the case of comparables who have no spokesperson other than the Financials. Both in the case of comparables and the assessee, the Financials do not make any mention of abnormal cost incurred accounting for a downslide in profits. Therefore, this adjustment cannot be entertained.
The TPO also rejected the risk adjustment by observing as under:- “The assessee failed to account for the rationale for deflating the margin of the solitary positive comparable by 50%. It failed to account for the returns for the other risks undertaken by it. Since there is no empirical evidence to attribute the incremental returns to each of the business risks undertaken by a risk-bearing entity, on account of the various risks assumed by it, in contrast to a risk-free entity or a risk-mitigated entity. Therefore, the claim is rejected.”
The TPO again rejected the claim of adjustment on various losses as non-operating in nature by observing as under:- “7.9 The assessee’s business primarily involves importing raw materials and components from its associated enterprises for the purpose of manufacturing transmission parts used in automobile industry for its sole customer namely, M/s.Hyundai Motors India Ltd. The assessee has chosen a decisive call in leaving its exposure to Forex fluctuations uncovered through hedging. This is strengthened by its FAR analysis as well. The assessee did not reduce its claim of loss filed in the Return of Income treating Forex loss arising on account of transactions and translations.
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 Taking into account the above set of factors, the adjustment sought for by the assessee is rejected.”
The TPO rejected the custom duty adjustment by observing as under:- “8.1 At the outset, it is pertinent to note that this adjustment is sought only in the response the show cause notice and not as part of the Transfer Pricing Study. The plethora of decisions relied upon by the assessee have been considered. Each business has its own unique features. In this case, if the pattern of imports of raw materials and components from AE is relied upon for the various years during which the assessee has been in existence, and unequivocal inference one would draw is that the assessee has an unique business model dictated by the parents of both the transacting parties, which in this case is the taxpayer, M/s. Hyundai Motors India Ltd. The Customs duty adjustment cannot be allowed as a matter of routine where the assessee has no other option but to rely upon its supplies from associated enterprises for reasons not specifically brought out on record. Therefore, the adjustment claimed is rejected.”
Aggrieved, assessee preferred appeal before CIT(A).
The CIT(A) also rejected the claim of custom duty adjustment by observing in para 14 as under:- “14. The submissions of the assessee company are verified. The customs duty paid / payable is a part of import cost of the assessee concern. The custom duty accepted by the assessee is a factor of the cost of local production. This cannot be claimed as an adjustment. Moreover, this adjustment had not been given to the assessee in the earlier assessment years also. I am in complete agreement with the logic given by the Assessing Officer in rejecting the customs duty adjustment sought for the year. Moreover, the customs duty paid is neither a one-off expenditure nor
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 any extraordinary expenditure incurred. This ground of the assessee concern seeking customs duty adjustment is rejected.”
The CIT(A) also rejected the claim of foreign exchange fluctuation by observing in para 17 as under:- “17. The submissions of the assessee are verified. The assessee company was expected to have fluctuations in the foreign currency exposure and guard itself against any fluctuations by hedging its exposure. This has deliberately not been done. The assessee company could have also avoided forex losses by timely payment or by possible equity infusion. This has also not been done. On account of the combined factors as above, it is held that the Assessing Officer has rightly rejected the forex fluctuation loss sought in working out the operating profit. The grounds with respect to the same are rejected.”
Before us, the ld.counsel for the assessee argued that the assessee has made claim before TPO in regard to economic adjustment in respect of higher non-cenvatable customs duty paid on imports as compared to comparable companies for the reason as the assessee could not pass on the impact of entire higher import duty to its customer and as a consequence to the extent of such higher non-cenvatable duty, assessee’s PLI needs to be adjusted before comparing against the comparable companies. He also stated that the comparable companies have largely indigenized their operations with majority of the raw materials procured locally and the comparable companies do not bear the additional cost of the IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 customs duty in regard to their indigenized operation. According to counsel, the assessee has no choice but to import the raw material either from its AE or from other parties due to business reasons. The assessee has to pay higher import duties on account of stringent quality requirement. The assessee has tried to show the details of higher custom duty incurred but no comparable was cited but ld.counsel for the assessee stated that his mater can go back to the file of AO for verification whether the assessee is paying higher custom duty i.e., non-cenvatable custom duty and the comparables are either procuring indigenous raw material or buying lesser custom duty which could be set-off against cenvat. We noted that the authorities below have not adjudicated this issue by comparing the custom duty paid by the assessee and its comparable. Hence, this issue needs verification at the level of TPO/AO. Needless to say, the assessee will file all the details before the AO/TPO and accordingly, the matter is restored back to the file of the AO/TPO, who will examine the facts in detail and then decide this issue. Principally, the assessee is entitled to claim of non-cenvatable custom duty adjustment and it has to be decided based on facts. Accordingly, this issue is remitted back to the file of the AO.
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 8. As regards to foreign exchange fluctuation loss adjustment not provided by AO/TPO or CIT(A), the ld.counsel for the assessee stated that it imports all the main components from the overseas suppliers including its AE’s whereas comparable companies have largely indigenized purchase of raw material and on an average, the raw material imported by comparable companies is very minuscule or thin. The foreign exchange fluctuation loss has to be considered as non-operating while computing the margins of the assessee and the comparables for factoring the operational difference to improve the reliability of the comparisons. The ld.counsel for the assessee relied on various Tribunal decisions including the decision of co- ordinate bench of this Tribunal in the case of Infac India Pvt. Ltd., in IT(TP)A No.27/Chny/2018, wherein the Tribunal has considered this issue as under:- 8. We have considered the rival submissions on either side and perused the relevant material available on record. An identical issue was considered by the co-ordinate Bench of this Tribunal in Hanil Tube India Pvt. Ltd. (supra). This Tribunal after referring to safe Harbour Rules, found that the loss incurred by the assessee in foreign exchange fluctuation due to international transaction does not give any extra benefit to the Associated Enterprise who supplies the material. The loss arose due to exchange difference between the foreign currency and Indian currency. Therefore, the co- ordinate Bench of this Tribunal found that the foreign exchange loss or gain has to be excluded from operating income. In view of the decision of co-ordinate Bench of this Tribunal in Hanil Tube India
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 Pvt, Ltd. (supra), this Tribunal is of the considered opinion that the profit or loss due to foreign exchange fluctuation has to be excluded from the operating income for the purpose of PLI. Accordingly, the orders of the authorities below are set aside and the Assessing Officer is directed to exclude the loss or gain in foreign exchange fluctuation from the operating income for computing PLI.
8.1 We noted that in principle, the foreign exchange fluctuation loss adjustment has to be given being a non-operating expenses and the AO/TPO will recomputed the PLI after considering the details and facts of foreign exchange fluctuation loss claimed by assessee. In term of the above, this issue is also set aside to the file of the AO/TPO and allowed for statistical purposes.
As regards to the claim of power related adjustment, risk adjustment and abnormal or freight charges adjustment, none of these three issues is adjudicated by the CIT(A) and hence, these issues need to be reconsidered. In entirety of things, we feel that the above two issues are going back to the file of the AO/TPO, these issues also remitted back to the file of the AO/TPO, who will go into the details and then consider the issue of power related adjustment, risk adjustment and abnormal claim of air freight charges adjustment. Hence, these issues are also remitted back to the file of the AO/TPO and allowed for statistical purposes.
IT(TP)A No.27/Chny/2019 & CO No.17/Chny/2019 CO No.17/CHNY/2019 10. As regards to the cross objection of the assessee, the issues raised in assessee’s appeal are exactly identical and hence, the same has become academic and dismissed.
In the result, the appeal filed by the Revenue in CO No.17/CHNY/2019 are dismissed and the appeal filed by the assessee in IT(TP)A No.27/CHNY/2019 is partly-allowed for statistical purposes.
Order pronounced in the open court on 23rd August, 2023 at Chennai.