ASSISTANT COMMISSIONER OF INCOME-TAX, PUNE vs. NORD DRIVE SYSTEMS PVT. LTD., PUNE

PER R.S.SYAL, VP : The appeal by the Revenue and the Cross objection by the assessee arise out of the final assessment order dated 25-02-2016

2 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

passed by the Assessing Officer u/s.143(3) r.w.s. 144C(13) of the

Income-tax Act, 1961 (hereinafter called ‘the Act’) in relation to the

assessment year 2011-12.

grounds, which read as under :

“1. Whether the Hon’ble DRP was right in law and on facts in directing to allow cash PLI to the assessee and ignoring the fact that cash profit ratio is not a valid PLI as per the Indian Transfer Pricing Regulations.

company engaged in the business of manufacturing of components

for automation of industrial processes. The assessee mainly

manufactures geared motors and gear boxes. Return for the year

under consideration was filed declaring Nil income. Certain

international transactions were reported in Form No.3CEB. The

AO made a reference to the Transfer Pricing Officer (TPO) for

determining the Arm’s Length Price (ALP) of the international

3 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

transactions. The TPO benchmarked all the transactions in a

consolidated manner under the Transactional Net Marginal Method

(TNMM) by selecting certain companies as comparable with their

average adjusted Profit Level Indicator (PLI) at 10.78% as against

the assessee’s adjusted PLI at 1.88%, resulting into transfer pricing

adjustment of Rs.4,24,23,050/-. The AO in the draft order proposed

the above addition. The assessee assailed the correctness of the

draft order before the Dispute Resolution Panel (DRP) contending,

inter alia, that Cash profit PLI should have been taken instead of

the Operating profit PLI and further that the adjustment on account

of excess payment of custom duty should have been granted in the

hands of the assessee. The DRP called for the remand report from

the TPO, on the basis of which it accepted both the above

contentions of the assessee. These two points constitute the filament

of the above grounds raised by the Revenue before the Tribunal.

material on record. The first ground of the Department is that the

Cash profit margin should not have been accepted by the DRP in the

working of the TNMM, which has the effect of exclusion of the

depreciation cost.

4 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

unassailable. Rule 10B(1)(e) dealing with the determination of the

ALP under the TNMM clearly provides that it is the `Net Operating

Margin’ realized by the assessee as well as the comparables which

should be considered for benchmarking the international transaction

in relation to a common base, such as, costs incurred or sales

effected etc. So, the numerator in the formula for computation of

margin is always `net profit margin’ and denominator varies, which

may be either costs incurred or sales effected or assets employed

etc. Meaning of the term `net profit’ in the formula has been

considered by the Hon’ble Supreme Court in DIT (IT) Vs. Morgan

Stanley & Company (2007) 292 ITR 416 (SC), in which it has been

held that the : `TNMM apportions the total operating profit arising

from the transaction on the basis of sales, costs, assets, etc.’. Hence,

it is evident that the term “Net Profit” or the “Operating net Profit”

as used in Rule 10B(1)(e) is to be read as “Operating Profit”, which

means profit from business operations, that is, after adjustment of

all the items of operating costs, which predominantly include

Depreciation allowance on account of wear and tear of the assets

used. Thus, depreciation is an inseparable and an integral part of

5 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

the Operating costs. The Hon’ble Bombay High Court in CIT Vs.

Welspun Zucchi Textiles Ltd. (2017) 292 CTR 1 (Bom.) had an

occasion to deal with the nature of depreciation. Question no. (ii) as

urged before the Hon’ble High Court reads: “(ii) Whether on the

facts and in the circumstances of the case and despite the

prescription of parameters of comparability by Rule 10 B (2) of the

Income Tax Rules, 1962, the Tribunal was correct in law, in

directing the inclusion of DEPB in turnover and depreciation in net

profit for the purpose of profit margin of comparables and

assessee?” The Tribunal in that case held that depreciation was

includible in arriving at the total operating costs. Affirming the view

of the Tribunal, the Hon’ble High Court held that: `So far as

depreciation is concerned, we find that the analysis done by the

Tribunal to include DEPB benefit to hold it to be an operating

revenue to determine operating profit, would be equally applicable

in case of depreciation for the purposes of holding it to be an

operating expenses to determine operating costs.’ At this stage, it is

pertinent to note that as against Rule 10B(1)(e) specifically

providing for adoption of operating margin under the TNMM, rule

10B(1)(b) and 10B(1)(c) containing mechanism for determining the

6 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

ALP under the Resale Price method and the Cost Plus method

distinctively provides for adopting the `gross margin’. From the

foregoing discussion, it is manifest that depreciation has to be

necessarily considered as a part of the Operating costs in the process

of determining the operating profit under the TNMM. It is,

therefore, held that the statutory mandate for the numerator in the

formula as per rule 10B(1)(e) is to adopt operating profit rather than

Cash profit, as has been held by the DRP.

correct legal position as discussed supra, the direction of the DRP to

adopt Cash profit margin as numerator in the TNMM is not its own

independent conclusion but the acceptance of the argument by the

TPO in the remand proceedings, which started at the instance of the

DRP, when it sent the assessee’s submissions and calculation to the

TPO for comments. The TPO sent a remand report dated

01.12.2015, whose copy has been placed at pages 90 onwards of the

paper book. This issue has been discussed by the TPO at the internal

page no. 12 of his report under the caption `Cash PLI ground of

objection no. 3.5 of the DRP objections’. Firstly the TPO has

reproduced the assessee’s contention for adoption of Cash PLI and

7 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

thereafter a table containing: `Summary of the unadjusted and

adjusted margin (using cash PLI) of comparable companies

(considered in the TP order dated 23 Jan 2015)’. Then the TPO gave

his comments, which are reproduced verbatim:-

“I have analysed the comparability using cash PLI. The difference (depreciation, in the present case) between the controlled and the comparable controlled transaction has a likely effect of affecting the price, or cost charged/paid or profit arising therefrom. I agree with the contention of the assessee. However, the decision may be taken on merit.”

with the assessee on adoption of Cash profit margin during the

course of the transfer pricing proceedings but when the assessee

raised the issue of espousing cash profit margin issue before the

DRP, he agreed with the contention of the assessee.

(2A) of section 253 of the Act, which, prior to its omission w.e.f.

1.6.2016, was inserted by the Finance Act, 2012 w.e.f. 1.7.2012

and later on amended by the Finance (No.2) Act, 2014 w.r.e.f.

1.6.2013 providing that: `The Principal Commissioner or

Commissioner may, if he objects to any direction issued by the

Dispute Resolution Panel under sub-section (5) of section 144C in

8 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

respect of any objection filed on or after the 1st day of July, 2012,

by the assessee under sub-section (2) of section 144C in pursuance

of which the Assessing Officer has passed an order completing the

assessment or reassessment, direct the Assessing Officer to appeal

to the Appellate Tribunal against the order.’ This provision, thus

enabled the Revenue to file appeal before the Tribunal against the

order of the AO containing any direction issued by the Dispute

Resolution Panel, which is otherwise binding on the AO. The

essence of the provision is that the Revenue ought to have some

recourse against any adverse direction of the DRP. What is hereby

referred to is the suo motu direction given by the DRP not favoring

the Revenue. Such a direction cannot envelope any concession

given by the AO/TPO during the remand proceedings. If the

AO/TPO get satisfied with the version given by the assessee in the

remand proceedings, it is but natural that the same, when

incorporated in the direction of the DRP, cannot be assailed by the

Revenue in terms of section 253(2A) of the Act. The situation

contemplated in this sub-section is only the adverse directions qua

the Revenue which is suo motu given by the DRP on appreciation of

the material and not the one which flows from the concession of the

9 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

AO/TPO during the remand proceedings. As any other adverse

order qua the Revenue passed by the AO cannot be challenged by

the Department in any appeal, for which, of course, there are other

statutory remedies, such as revision, rectification or reassessment, in

the like manner any adverse direction given by the DRP qua the

Revenue which is based on the concession given by the AO/TPO,

cannot be equally legally challenged by the Department in appeal

before the Tribunal. On the facts of the instant case, we hold that

albeit the TPO was not legally correct in accepting the Cash profit

margin in place of the Operating profit under the TNMM in the

remand proceedings, but this issue cannot be raked up in appeal

before the Tribunal as the consequential direction of the DRP is

based only on the concession of the TPO and not de hors the same.

In our considered opinion, there is no qualitative difference between

the two situations, viz., one, in which a legally wrong course of

action adopted by the assessee goes unnoticed by the AO/TPO and

the order is passed as such, and the two, in which a legally wrong

course of action adopted by the assessee comes to the notice of the

AO/TPO but the same gets concurrence as correct. In both the

circumstances, the Department cannot challenge the action of the

10 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

AO/TPO directly before the appellate forums. Extantly, we are

confronted with the second situation, in which though the

acceptance of Cash margin in the determination of the PLI is legally

incorrect, but its acceptance by the TPO in the remand proceedings

has denuded the Revenue from challenging the same before the

Tribunal. This ground, being not maintainable, is dismissed.

about the granting of custom duty adjustment in the computation of

the assessee’s PLI rather than that of the comparables. This issue

arose for the first time before the DRP. The assessee contended that

because of higher volume of imports, it paid additional import duty

vis-à-vis the comparables paying only the basic custom duty. The

assessee furnished calculation of such excess custom duty before

the DRP and requested that such excess should be adjusted in the

computation of its own PLI. The DRP sent such calculation to the

TPO for verification and comments. After considering the remand

report, the DRP directed to make such adjustment in the assessee’s

PLI.

clause (i) of rule 10B(1)(e) eloquently provides for computing the

11 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

net profit margin as realized by the enterprise from the international

transaction. Sub-clause (ii) deals with the computation of net

operating profit margin from a comparable uncontrolled transaction,

may be internal or external. Sub-clause (iii) provides that the net

profit margin realized by a comparable company, determined as per

sub-clause (ii) above, ‘is adjusted to take into account the

differences, if any, between the international transaction and the

comparable uncontrolled transactions, ..... which could materially

affect the amount of net profit margin in the open market.’ It is this

adjusted net profit margin of the unrelated transactions or of the

comparable companies, as determined under sub-clause (iii), which

is used for the purposes of making comparison with the net profit

margin realized by the assessee from its international transaction as

per sub-clause (i). Thus the law explicitly provides for adjusting the

profit margin of comparables on account of the material differences

between the international transaction of the assessee and

comparable uncontrolled transactions. It is not the other way around

to adjust the profit margin of the assessee. In other words, the net

operating profit margin realized by the assessee from its

international transaction is to be computed as such, without

12 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

adjusting it on account of differences with the comparable

uncontrolled transactions. The adjustment, if any, is required to be

made only in the profit margins of the comparables.

that the assessee made a claim before the DRP furnishing necessary

details and seeking adjustment in its own profit margin due to

Additional custom duty paid because of the excessive imports. The

DRP called for a remand report from the TPO on this count. The

TPO in his remand report firstly noted the contention of the assessee

with the relevant calculations and then offered his Comments as

under:

“I have analysed the computation of the custom duty adjustment for comparable companies by comparing the ratio of imported goods/total goods of comparable companies. I agree with the contention of the assessee. However, the decision may be taken on merit.”

himself that the DRP directed to give adjustment on account of

additional custom duty paid in the PLI computation of the assessee.

Position here is again mutatis mutandis similar to the first issue

discussed supra inasmuch as though the direction of the DRP is not

13 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

legally sound, but the same is based on the concession given by the

TPO in the remand proceedings, which has the effect of proscribing

the Revenue from agitating this issue in appeal before the Tribunal.

This ground of the appeal is also dismissed as not maintainable.

pressing the Cross objection, if the Departmental appeal is not

allowed. In view of our decision in dismissing the Departmental

appeal, the cross objection of the assessee is also dismissed as ‘not

pressed’.

dismissed.

Order pronounced in the Open Court on 28th November,

2019.

Sd/- Sd/- (PARTHA SARATHI CHAUDHURY) (R.S.SYAL) JUDICIAL MEMBER VICE PRESIDENT

पुणे Pune; �दनांक Dated : 28th November, 2019 सतीश

14 ITA No.825/PUN/2016 & Co. No.12/PUN/2018 Nord Drive Systems Pvt. Ltd.,

आदेश क� क� क� �ितिलिप क� �ितिलिप �ितिलिप अ�ेिषत �ितिलिप अ�ेिषत अ�ेिषत/Copy of the Order is forwarded to: अ�ेिषत आदेश आदेश आदेश अपीलाथ� / The Appellant; 1. ��यथ� / The Respondent; 2. 3. The CIT(A)-13, Pune 4. The Pr.CIT-V, Pune िवभागीय �ितिनिध, आयकर अपीलीय अिधकरण, पुणे 5. “सी” / DR ‘C’, ITAT, Pune; 6. गाड� फाईल / Guard file. आदेशानुसार आदेशानुसार/ BY ORDER, आदेशानुसार आदेशानुसार // True Copy // Senior Private Secretary आयकर अपीलीय अिधकरण ,पुणे / ITAT, Pune

Date 1. Draft dictated on 27-11-2019 Sr.PS 2. Draft placed before author 28-11-2019 Sr.PS 3. Draft proposed & placed JM before the second member 4. Draft discussed/approved JM by Second Member. 5. Approved Draft comes to Sr.PS the Sr.PS/PS 6. Kept for pronouncement on Sr.PS 7. Date of uploading order Sr.PS 8. File sent to the Bench Clerk Sr.PS 9. Date on which file goes to the Head Clerk 10. Date on which file goes to the A.R. 11. Date of dispatch of Order. *