AT INDIA AUTO PARTS PRIVATE LIMITED,BANGALORE vs. ASSISTANT COMMISSIONER OF INCOME TAX, CIRCLE- 1(1)(1), BANGALORE

PER CHANDRA POOJARI, ACCOUNTANT MEMBER:

This appeal by assessee is directed against final assessment order passed by ACIT Circle-1(1)(1) Bengaluru for the assessment year 2018-19. The assessee has raised following grounds of appeal:-

General Ground, 1. On the facts and in the circumstances of the case and in law, final assessment order passed by Assistant Commissioner of Income-tax, Circle 1 (1 )(1), Bangalore ('learned AO')under section 143(3) r.w.s 144C(13) of the Act, in pursuance to the order of the Deputy Commissioner of Income Tax,1(1)(1)

Page 2 of 19 ('the learned Transfer Pricing Officer' or the learned TPO' or TPO'), and the directions of the Dispute Resolution Panel-1, Bangalore ('the learned DRP' or 'DRP'), to the extent prejudicial to the Appellant, is bad in law and is liable to be quashed

Grounds relating to Transfer Pricing ('TP') 2. On the facts and circumstances of the case and in law, the learned AO/DRP erred in confirming the action of the learned TPO of making an upward adjustment to the transfer price of the Appellant international transactions in respect of the Manufacturing segment of INR 43,47,27,911 to Associated Enterprises ('AEs'), holding that this international transaction does not satisfy the arm's length principle envisaged under the Act and in specific in doing so grossly erred in:

a) Rejecting the Transfer Pricing (TP') documentation maintained by the Appellant, in good faith, as required under section 92D of the Income-tax Act, 1961 ('the Act') read with rule 10D of the Income- tax Rules, 1962 ('the Rules') on the ground that the information or data used by the appellant in computing arm's length price ('ALP') is not reliable or correct. b) Rejecting transaction -by-transaction approach followed by the appellant and applying entity level Transaction net margin method (TNMM) by aggregating the various international transactions. c) Computing operating margin earned by the appellant after considering finance cost as an operating item and in doing so, not following the DRP directions dated 8th June 2022. d) Computing operating margin earned by considering foreign exchange fluctuation as operating in nature for computing operating margin of the appellant as well as comparable. e) Computing the operating margins of the following comparable companies by inconsistently considering certain line items as operating/non-operating in nature and disregarding the submissions filed by the Appellant with the correct computation of the operating margins along with the supporting documents: • Sundaram Fasteners Limited • Lumax Industries Limited

f) Including the following comparables that are not functionally comparable to the Appellant and which ought to have been excluded from the in the final list of comparables: • Sundaram Fasteners Limited • Mindarika Private Limited Page 3 of 19 • Jay Bharat Maruti Limited • Aditya Auto Products and Engineering India Private Limited 3. On the facts and circumstances of the case and in law, the learned AO erred in not allowing proportionate adjustment, thereby ignoring the fact that any TP adjustment should be restricted to the value of international transactions only.

Grounds relating to other than transfer pricing matters: 6. On the facts and in the circumstances of the case and in law, the learned AO erred in not granting the deduction of income-tax depreciation of INR 65,53,058 under section 32 of the Act, which was claimed by the assessee during the course of assessment proceedings despite the fact that the learned DRP had allowed the above claim.

On the facts and in the circumstances of the case and in law, the learned AO erred in initiating penalty proceedings under section 270A read with section 274 of the Act.

DETAILS OF THE APPELLANTS INTERNATIONAL TRANSACTIONS Particulars Amount in Rs. Most appropriate Outcome of the TP method selected Order by the Appellant Purchase of Rs. 49,318,343/- Other method- Adjustment of Rs. raw materials customs 43,47,27,911/- & document issued components by customs valuation officer. Purchase of Rs. 50,09,284/- Other method- Accepted to be at fixed assets customs arm’s length document issued by customs valuation officer.

Page 5 of 19 Supply of Rs. 1,95,593/- CUP Accepted to be at finished goods arm’s length for testing Payment of Rs. 2,47,32,782/- CUP Accepted to be at royalty arm’s length Payment of Rs. 15,86,142/- TNMM Accepted to be at technical arm’s length assistance fees Payment of Rs. 35,72,106/- Other method- Accepted to be at interest due to SBI PLR arm’s length extension of credit period Payment of Rs. 3,71,35,094/- CUP Accepted to be at interest on arm’s length ECB Reimburseme Rs. 11,93,859/- Expenses Accepted to be at nt of expenses reimbursed at arm’s length paid actuals. Recovery of Rs. 60,58,304/- Expenses Accepted to be at expenses recovered at arm’s length actuals. Reimburseme Rs. 3,26,77,87/- Salary reimbursed Accepted to be at nt of salary at actuals. arm’s length paid to seconded employees Salary paid to Rs. 4,67,61,395/- Payment is in line Accepted to be at seconded with salary paid to arm’s length employees other employees Receipt of Rs. No income arises Accepted to be at ECB 64,76,00,000/- arm’s length Repayment of Rs. No income arises Accepted to be at ECB 30,00,00,000/- arm’s length

PURCHASE OF RAW MATERIALS & COMPONENTS A. ANALYSIS OF THE TP STUDY OF THE APPELLANT AND THE TPO: 2.1 Method adopted by the Assessee:

The assessee adopted 'other method’ and benchmarked the transaction by relying on the valuation of raw materials/consumables carried out by the customs officer, at the time of their import. The price at which the raw materials are Page 6 of 19 purchased is equal to the price determined by the customs officer and the consumables are purchased at a price lesser than the price determined by the Officer. Essentially what was applied by the assessee is ‘external CUP method’. The remaining international transactions were benchmarked by adopting the appropriate methods, as mentioned above. 2.2 Method adopted by the TPO The TPO rejected the assessee’s approach of benchmarking the purchase transaction by adopting other method, and instead proceeded to benchmark the said transaction by adopting TNM Method at the entity level. This was done without appreciating that at entity level, the assessee has transactions with third parties as well. 2.3 Net mark-up on cost earned by the Assessee as computed by the TPO: Operating Revenue Rs. 392,84,70,000/- Operating Cost Rs. 402,10,30,000/- Operating loss (Op. Revenue – Op. Cost) Rs. (-)9,25,60,000/- Operating/Net mark-up (OP/OR) -2.35%

2.4 Filters applied by the TPO:

Step Description 1. Companies whose data is not available for FY 2017-18 - excluded. 2. Companies having different financial year ending (i.e., not March 31, 2018) or data of the company does not fall within 12-month period i.e., 01-04-2017 to 31-03-2018 - excluded. 3. Companies whose income was less than Rs. 1 Crore - excluded. 4. Companies whose manufacturing income is less than 75% of its total operating revenue - excluded.

Page 7 of 19 5. Companies who have more than 25% related party transactions of the sales - excluded. 6. Companies having persistent loss - excluded.

2.5 Comparables selected by the TPO and their mean margin:

Sl. Name of the Company OP/OR No. 1. Sundaram Fasteners Ltd. 14.02% 2. Mindarika Pvt. Ltd. 7.33% 3. Jay Bharat Maruti Ltd. 5.55% 4. Lumax Industries Ltd. 4.61% 5. Aditya Auto Products and Engg. (India) Pvt. Ltd. 4.45%

Average Margin 7.19%

2.6 Computation of Arms’ Length Price made by the TPO and the adjustment made: Operating Revenue Rs. 392,84,70,000/- Operating Cost Rs. 402,10,30,000/- Operating Loss Rs. (-)9,25,60,000/- Arm’s Length OP/OR (Comparable Margin) 7.19% Arm’s length cost (Rs. 392,84,70,000*92.81%) Rs. 364,60,10,000/- Shortfall being adjustment u/s. 92CA Rs. 37,50,20,000/-

2.7 DIRECTIONS ISSUED BY THE DRP: The directions issued by the DRP in brief are as under: - The DRP rejected the following objections of the assessee: (i) that the international transaction of purchase of raw materials, consumables and spares cannot be Page 8 of 19 benchmarked at entity level, by aggregating all the international transactions, and by adopting TNM method; (ii) seeking grant of depreciation adjustment and adoption of gross profit margin; (iii) seeking restriction of adjustment to the value of international transactions; (iv) seeking treatment of forex loss as non-operating in nature. - The DRP, accepting the objections of the assessee, directed (i) the exclusion of Jay Bharat Maruti Ltd.; and (ii) interest expenses to be treated as non-operating.

2.8 LIST OF COMPARABLES POST DRP’S DIRECTIONS

Sl. Name of the Company Weighted No. Average 1. Aditya Auto Products and Engg. (India) Pvt. Ltd. 4.45% 2. Lumax Industries Ltd. 5.31% 3. Mindarika Pvt. Ltd. 7.33% 4. Sundaram Fasteners Ltd. 17.74%

Average Margin 8.71%

2.9 FINAL ASSESSMENT ORDER:

The Assessing Officer passed the final assessment order in which the TP adjustment stood enhanced to Rs. 43,47,27,911/-. Against this assessee is in appeal before us.

4.1 Facts of the case are that the assessee is challenging the action of the TPO in benchmarking the international transaction of purchase of raw materials, consumables and spares by aggregating the same with the other international transactions, and by adopting TNM method at entity level.

4.2 The assessee submitted that during the financial year 2017- 18, the assessee entered into various international transactions. The assessee had adopted transaction-by-transaction approach and had benchmarked each of the transactions separately, by adopting the most appropriate method for the transactions. The benchmarking approach adopted by the Appellant is as under:

Particulars Most appropriate method selected by the Appellant Purchase of raw materials & Other method- customs components document issued by customs valuation officer. Purchase of fixed assets Other method- customs document issued by customs valuation officer. Supply of finished goods for testing CUP Payment of royalty CUP Payment of technical assistance fees TNMM Payment of interest due to extension of Other method- SBI PLR credit period Payment of interest on ECB CUP Page 10 of 19 Reimbursement of expenses paid Expenses reimbursed at actuals. Recovery of expenses Expenses recovered at actuals. Reimbursement of salary paid to Salary reimbursed at seconded employees actuals. Salary paid to seconded employees Payment is in line with salary paid to other employees Receipt of ECB No income arises Repayment of ECB No income arises

4.3 In this regard, the ld. A.R. submitted that under Section 92 of the Act, any income arising from an “international transaction” shall be computed having regard to the ALP. Similarly, under Rule 10B of the Income-tax Rules, 1962 (“the Rules”), the ALP in relation to an “international transaction” shall be determined in the manner prescribed therein. Therefore, what is contemplated under the Act is benchmarking each international transaction on an independent basis. Reliance in this regard is placed on the decision of the Hon’ble High Court of Punjab and Haryana in the case of Knorr-Bremse India (P.) Ltd. v. ACIT ([2015] 63 taxmann.com 186 (Punjab & Haryana)); and the decision of the Delhi Bench of this Hon’ble Tribunal in the case of Gruner India (P.) Ltd. v. DCIT ([2016] 70 taxmann.com 240 (Delhi - Trib.)).

4.4 The ld. A.R. further submitted that in the present case, aggregated benchmarking is also not possible as the segmental financials (of the AE transactions) is incapable of being drawn up correctly. The assessee has purchased raw materials/consumables from AEs and from third party suppliers and segregation of costs and profits, and net operating assets of the Appellant that are solely attributable to the international transaction of purchase of raw materials is complex and unreliable. In the Page 11 of 19 absence of reliable segmental information, it is not appropriate to aggregate the transactions for benchmarking purposes,

4.5 Moreover, the ld. A.R. submitted that in the present case, the TPO has accepted the other international transactions to be at arm’s length and has only selected the international transaction of purchase of raw materials, consumables and spares for determining the ALP. Having accepted the other transactions to be at arm’s length, benchmarking the purchase transaction by aggregating all the international transactions is grossly erroneous and unsustainable. The DRP has proceeded on the wrong footing that the TPO has picked up all the transactions for benchmarking, when in fact, it was only the transaction of purchase of materials, consumables and spaces which was picked up for scrutiny. In view of the above, the DRP’s finding that aggregated benchmarking by applying TNM method is the most appropriate method to benchmark the transactions of purchase of raw material, purchase of fixed assets and sale of traded/finished goods, as they are interlinked to each other, is grossly erroneous.

4.6 That apart, the ld. A.R. submitted that the aggregated benchmarking done by the TPO at entity level is wholly erroneous and unsustainable in as much as at the entity level, the transactions of the Appellant with third parties are also taken into consideration, which transactions can never be subjected to transfer pricing assessment. The international transaction of purchase of raw materials, spares and consumables (of Rs. 4,93,18,343/-) merely represent 1.25% of operating cost (of Rs. 394,16,00,000/-) and 1.8% of total purchases (Rs. 273,31,40,000/-). The international transaction being a miniscule portion of the total transactions, the benchmarking approach adopted by the TPO is wholly erroneous and results in absurd and Page 12 of 19 skewed result. This is manifest from the disproportionate adjustment determined by the TPO. While the value of the international transaction of purchase of raw materials, spares and consumables is only Rs. 4,93,18,343/-, the TPO has determined an adjustment of Rs. 37,50,20,000/-, enhanced to Rs. 43,47,27,911/- pursuant to the DRP’s direction, which is more than 8 times the value of the transaction. Clearly, the adjustment determined is disproportionate. - Method adopted by the Assessee to benchmark the purchase transaction is the most appropriate method: 4.7 The ld. A.R. submitted that the only ground on which the TPO rejected the TP documentation was that the “other method” applied by the assessee is not an appropriate method, which is wholly erroneous and misconceived. To benchmark the international transaction of purchase of raw material, consumables and spares, the assessee had relied on the valuation done by the customs officer at the time of import of raw materials/consumables. Since the materials are imported by the assessee from its AE, the import price ought to be valued in terms of Section 14 of the Customs Act, 1962 read with Rule 3 of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007. The method for determining the value of the goods under the Customs Act where the transaction is between related parties is similar to the method under the Income- tax Act. The value of the purchases were accepted by the Revenue authorities under the Customs Rules. Since the price of raw materials was equal to the price determined by the customs officer and the price of consumables was less than the price determined by the customs officer, the transaction ought to be accepted as being at arm’s length. Reliance in this regard is placed of the following decisions:

Page 13 of 19 - Coastal Energy Pvt. Ltd. v. ACIT ([2011] 12 taxmann.com 355 (Chennai) - ACIT v. Sarens Heavy Lift (I) P. Ltd. [2018] 93 taxmann.com 431 (Delhi - Trib.) - GKN Sinter Metals (P.) Ltd. v. ACIT ([2016] 71 taxmann.com 297 (Pune - Trib.)); and - ACIT v. GP Global Energy Pvt. Ltd. (Order dated 26.05.2022 passed by the Delhi Bench of this Hon’ble Tribunal in ITA No. 5695/Del/2018).

4.8 Moreover, in the present case, since the segmental financials cannot be reliably drawn up, and considering the business and economic circumstances of the assessee, TNM method cannot yield appropriate results, and would therefore render the TP assessment unreliable. Therefore, TNM method cannot be adopted in the present case. That apart, the assessee has consistently followed the same method for benchmarking and the department has accepted the same, without any demur.

6.1 Further in the case of Sarens Heavy Lift India Pvt. Ltd. the Delhi bench of Tribunal in ITA No.1027/Del/2015 dated 2.4.2018 reported in (2018) 93 taxmann.com 431 (Delhi-Trib), wherein held as under:

“Section 92C of the Income-tax Act, 1961 -Transfer pricing - Computation of arm's length price (Comparables and adjustments/Adjustment - Operating profit/cost) - Assessment year 2010-11 - Assessee-company was engaged in business of hiring and leasing heavy cranes - During relevant year assessee purchased nine used cranes from its AE -Assessee got such cranes valued from custom authorities and chartered engineers -Thereupon, assessee benchmarked said international transaction using TNMM - TPO rejected method adopted by assessee for purpose of benchmarking of international transactions related to purchase of cranes and applied CUP Method - He took written down value of cranes in books of AE as ALP - Accordingly, certain adjustment was made to assessee's ALP - DRP opined that written down value of cranes in books of AE could not be considered as ALP as it was not derived from transactions between enterprises other than associated enterprises - DRP further noticed that it was nobody's case that an old asset could not be sold at a price exceeding net book value - DRP thus directed TPO to accept valuation report of assessee company and delete addition made on account of ALP of cranes • Whether on facts, impugned order passed by DRP did not suffer from any legal infirmity and, Page 17 of 19 thus, same was to be confirmed - Held, yes [Paras 20 & 21] [In favour of assessee]”

6.2 Further, in the case of GKN Sinter Metals (P) Ltd. the Pune Bench of Tribunal in ITA No.91/PN/2013 dated 6.5.2016 reported in (2016) 71 taxmann.com 297 (Pune-Trib.), wherein held as under:

• “If the TPO was not satisfied with the valuation certificate given by an independent Chartered Engineer at UK, the TPO should have referred the matter to DVO who is an expert to determine the value of such capital assets. The TPO has erred in extrapolating the average arithmetic mean of operating profit of companies manufacturing similar machines in India. [Para 7]

• The said adjustment has been made by TPO without making reference to the DVO and rejecting the valuation report from an independent Chartered Engineer furnished by the assessee. Undisputedly the valuation report was' accepted by the Customs Authorities for the purpose of levy of import duty. The action of TPO for making such adjustment could not be concurred with. The Act provides for reference to Valuation Officer for valuation of capital assets in case of any doubt. The TPO has erred in extrapolating average operating margin of Indian manufacturers and applying CUP method to mark-up import price and determine ALP.

• Insofar as objection of TPO with respect to variation in the book value of capital asset and the price at which assessee has purchased the capital asset is concerned, it is not necessary that book value and market value of the capital asset are at par. [Para 11]

• The DRP while dealing with the objections of the assessee in respect of valuation of capital asset has not properly appreciated the facts and circumstances. The DRP has merely examined one aspect of the transaction relating to pricing of capital asset i.e. the price paid by assessee to acquire old machine viz-a-viz price of new model of same machine. The DRP has failed to take holistic view of the transaction. [Para 11]

• Thus, in view of the facts of the case and various decisions the findings of the authorities below on this issue were set aside. [Para 12]” 6.3 In the case of GP Global Energy Pvt. Ltd. the Delhi Bench of Tribunal in ITA No.5695/Del/2018 dated 26.5.2022 held as under:

Page 18 of 19 “7. In so far as bench marking the international transactions using customs data is concerned we sustain the order of the Ld: CIT(Appeals) as the Ld. CIT(A) observed that the Chennai Bench of the Tribunal in the case of Coastal Energy Pvt. Ltd. Vs. ACIT (supra) held that the valuation was made by custom authorities by assigning values to import goods on the basis of scientifically formulated methods as they were responsible for making fair assessment value of the imported goods according to internationally accepted protocols. Therefore, we see no infirmity in the order of the Ld. CIT(A) on this issue. Ground no. 1 of the Revenue is rejected.”

6.4 In view of the above precedents, we direct the AO to benchmark the international transactions of purchase of raw materials, consumables and spares by adopting the valuation made by custom authorities in respect of these goods and to determine the ALP. Accordingly, the issue in dispute is remitted to the file of AO for denovo consideration.

6.5 In view of the above, we remit the issues in ground Nos.2(a) & 2(b) remitted to the file of AO/TPO for reconsideration and allowed for statistical purposes.

“6. On the facts and in the circumstances of the case and in law, the learned AO erred in not granting the deduction of income-tax depreciation of INR 65,53,058 under section 32 of the Act, which was claimed by the assessee during the course of assessment proceedings despite the fact that the learned DRP had allowed the above claim.

Page 19 of 19 8.1 In these grounds, the grounds of assessee are that final assessment order was not passed by AO in compliance with the direction of the ld. DRP.

8.2 We direct the AO/TPO to pass fresh assessment order in conformity with the direction of ld. DRP. Ordered accordingly.

Order pronounced in the open court on 15th Feb, 2023.

Sd/- Sd/- (N.V. Vasudevan) (Chandra Poojari) Vice President Accountant Member

Bangalore, Dated 15th Feb, 2023. VG/SPS Copy to: 1. The Applicant 2. The Respondent 3. The CIT 4. The CIT(A) 5. The DR, ITAT, Bangalore. 6. Guard file By order

Asst. Registrar, ITAT, Bangalore.