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Income Tax Appellate Tribunal, DELHI BENCH, ‘I-1’: NEW DELHI
Before: SHRI R.K. PANDA & SHRI KUL BHARAT
ORDER PER KUL BHARAT, JM This appeal filed by the assessee is directed against the order dated 16.09.2016 of the learned CIT(A)-44, New Delhi, relating to Assessment Year 2011-12. The assessee has raised following grounds of appeal:-
1. Ld Commissioner of Income Tax (A) ('Ld. CIT (A)") has erred in making an addition to the total income of the Appellant on account of adjustment in the Arm's Length Price ("ALP") of the following international transactions:
1A. Import of materials amounting to Rs. 35,766,157/- 1B. Receipt of engineering support services amounting to Rs. 35,835,172/- 1C. Receipt of administrative support services amounting to Rs. 69,526,849/- 2. In law and on facts and circumstances of the case, the Ld. CIT (A) has erred in considering the Appellant as the tested party by wrongly considering that: 2A. The Appellant is performing simpler functions and thus least complex entity. 2B. The Appellant is dependent on intangibles of its Associated Enterprises ("AEs") 3. In law and on facts and circumstances of the case, the Ld. CIT (A) has erred in rejecting foreign AE as the tested party and rejecting comparable companies as selected by the Appellant.
4. Without prejudice to the above, and in law and on facts and circumstances of the case, the Ld. CIT (A) has erred in selecting comparable companies by considering Appellant as the tested party.
5. Without prejudice to the above, and in law and on facts and circumstances of the case, the Ld. CIT (A) has erred in computing operating margin of the Appellant even if Appellant is considered as the tested party by considering foreign exchange gain as non-operating income.
6. Without prejudice to the above, and in law and on facts and circumstances of the case, the Ld. CIT (A) has erred in rejecting complete fresh search proposed by the Appellant even if Appellant is considered as the tested party due to the fact that Appellant has applied export turnover filter.
7. Without prejudice to the above, and in law and on facts and circumstances of the case, the Ld. CIT (A) has erred in appreciating the fact that the loss of the Appellant was due to its initial year years of operation and thus the Appellant was not able to fetch good market prices and was earning less margins at gross level as compared to comparable companies and the loss was not due to international transactions entered. Accordingly, the Ld. CIT(A) ought to have given adjustment for the fact that the Appellant was in initial year of operations and earning low Gross margin as compared to the comparable companies.
8. Without prejudice to the above and in law and on facts and circumstances of the case, the Ld. CIT (A) has erred on law by not granting the Appellant the option to chose a price that falls within +/- 5% range of the arithmetic mean of the comparables, as contemplated under the proviso to section 92C(2) of the Act.
9. In law and on facts and circumstances of the case the Appellant in the interest of justice, may be allowed to adduce additional evidence as may be necessary in support of the grounds raised
hereinabove after following due procedures laid down in the Income Tax (Appellate Tribunals) Rules, 1963”.
2. The facts giving rise to the present appeal are that the assessee company filed its return of income on 30.11.2011 declaring a loss of Rs.7,59,41,961/-. The assessee was incorporated on June 2009. It is currently engaged in the manufacturing of suspension of products (shock absorbers and strut modules). The current financial year (i.e. Financial Year 2010-11) is the first full year of operations and the company was still in the process of setting up its full fledged operations. The case was selected for scrutiny assessment.
The Assessing Officer during the course of assessment proceedings observed that as per Form No.3CEB filed along with Income Tax return, the assessee during the year had international transactions with its Associated Enterprises (“AEs”)/concerns. Hence, in order to determine the ALP in relation to international transactions, the case was referred to the Transfer Pricing Officer (“TPO”) after obtaining necessary prior approval of the Ld. CIT, Delhi-I. Thereafter, in pursuance to the reference, the TPO passed the order u/s 92CA(3) of the Act, thereby he recommended the upward adjustment of Rs.1,96,21,839/- in respect of determination of Arm’s Length Price (hereinafter ‘ALP’) of the international transactions. The Assessing Officer after having received the order of TPO issued a show cause notice dated 06.02.2015 calling upon as to why the adjustments as recommended by the TPO should not be made.
In response thereto, the assessee company filed its reply dated 13.03.2015, however, the same was not found acceptable by the Assessing Officer and the Assessing Officer on the basis of adjustment as suggested by the TPO made addition of Rs.1,96,21,839/-, hence assessed the income at loss of Rs.5,63,20,122/- against returned loss of Rs.7,59,41,961/-.
Aggrieved against this, the assessee preferred appeal before the Ld. CIT(A) who after considering the submissions of the assessee partly allowed the appeal.
Thereby, the Ld. CIT(A) sustained the finding of the Assessing Officer rejecting foreign AEs as the comparable instead opting NTN Japan as one of the comparables. Ld.CIT(A) further rejected the grounds regarding considering the appellant as a tested party and also computing mean operating margin of the assessee. However, the request of the assessee as made in Ground Nos.8 & 9, before Ld.CIT(A) was allowed. The TPO was directed to verify the proportionate adjustment and computation of the Arm's Length Price adjustment.
Aggrieved against this, the assessee is in appeal before this Tribunal.
Ground No.1 is general in nature needs no separate adjudication.
Ground no. 9 is prayer for adducing additional evidence.
No such prayer was made during the course of hearing, hence dismissed.
Grounds No.2 to 8 are interconnected and related to the transfer pricing are being disposed of together.
The ld. counsel for the assessee has filed written submissions. The gist of the submissions of the assessee in brief are that for the purposes of computation of Arm's Length Price of the impugned international transaction, the assessee in its transfer pricing study relied upon Transactional Net Margin Method (“TNMM”) by considering AEs as tested party.
The appellant applied operating profit (OP) earned by the AE from the international transaction by net cost as the relevant Profit Level Indicator (“PLI”). On the basis of functional, assets and risk analysis of the transaction, AEs of the assessee was characterized as manufacturer of goods assuming less than normal risks associated with carrying out such a business.
Thus, it was selected as the tested party since they are the least complex of the controlled tax payers. To obtain a benchmark of comparable companies for the AEs of the appellant, Osiris Database, a search engine covering financial and business data for companies operating across the globe was used for the transactions of receipt of engineering support services and administrative support services. The arithmetic mean OP/OC was computed as per the computation of mean margin of the comparable companies was more than mark up charged by the AEs from the appellant. The impugned transactions were concluded to be at Arm's Length Price. The Ld. TPO vide its order had rejected AEs of the Appellant as the tested party and considered Appellant as the tested party.
Further, for benchmarking the transactions related to import of material and receipt of engineering and administrative support services, Ld. TPO had used TNMM as the most appropriate method. However, the Ld. TPO had used Rane (Madras) Ltd.; Sona Somic Lemforder Components Ltd.; and Gabriel India Ltd. as the comparables for the purpose of TNMM. The mean margin of these companies was 5.62%.
Since the margin earned by the assessee during the year, was less than the mean margin of the comparable companies. The TPO computed the transfer pricing adjustment and thereby, he proposed adjustment of Rs.1,96,21,839/-. The ld. counsel submitted that the Ld.TPO and Ld.CIT(A) grossly erred in considering the appellant as tested party. Thus, the impugned order has no ground to stand and was passed with pre- determination of mind. It was further submitted that it is an accepted rule that least complex entity should be considered as tested party and that in this case is AEs. The automobile industry/autoparts industry is an industry driven by innovation where companies compete with each other for developing more efficient and superior products every day.
Thus, in order to compete in the market, it was crucial for appellant to undertake continuous engineering R & D activities. The assessee company does not have any engineering design team of its own instead of it receives such engineering design support services from its AE-BWI Poland.
In consideration, the AE charged the appellant a mark-up of 5% on all costs incurred by it. Further, the appellant also receives support services in the nature of selling and marketing activities from its AE-BWI Inc.
Ld. Sr. DR opposed these submissions and supported the orders of the authorities below. He submitted that Ld.CIT(A) has rejected the grounds as the assessee failed to provide complete and reliable data in respect of AEs for benchmarking the international transaction which could be verified from the finances of the AE. Further, comparable data for AE as the tested party was also not verifiable with any statutory Courts.
In rejoinder, the Ld. counsel for the assessee submitted that for an entity selected as a tested party, reliable information regarding its comparable should be available in public domain. It was further submitted that the assessee had outsourced all the manufacturing process since the appellant performed very little functions for manufacturing process. The assessee was not able to identify that there existed similar third party arrangements due to limited data availability in public domain. Further, the comparables as proposed by Ld.TPO vide his order dated 29.12.2014 were completely functionally different to the appellant as those comparables are involved in full fledged in-house manufacturing which is evident from their annual reports as enclosed with the Paper Book. On the other hand, the assessee has outsourced its manufacturing function to Delphi India. He submitted that the authorities below failed to appreciate that there would be certainly impact on profit margin if the manufacturing is carried out by self and it is outsourced. Further, due to lack of reliable comparable data, the appellant could not be taken as a tested party for the benchmarking purpose. Accordingly, the AE which was involved in the provision of services and raw material for which the comparable data was readily available in public domain ought to have been accepted as tested party. It was further contended that the TPO had erred in rejecting the contention of the assessee on the ground that the AE own significant intangibles, however, the TPO failed to appreciate that in respect of transaction under dispute, the AE of the appellant did not own any non-routine tangibles and solely engaged in the provision of raw material and services. Thus, they may be considered least complex from the point of function performed risk borne and assets owned. Moreover, in T.P. report of the appellant has not attributed intangibles assets to any AE rather their ownership remained with BWI Group. Further, the order of the TPO suffers from various mistakes/misinterpretation which can be inferred from citing the example to explain the relationship between the assessee and its AE. Further, it was contended that Ld.CIT(A) erred in rejecting the contention of the assessee that complete and reliable data for benchmarking the international transaction was not provided. Ld.CIT(A) failed to appreciate the fact that the appellant had submitted the transfer pricing reports documentation of the foreign AE along with P&L A/c of the foreign comparables to the TPO.
We have heard the rival submissions, perused the material on record and gone through the submissions of the assessee. The grievances of the assessee are in three fold, one that the appellant ought not to be considered as tested party, two the comparables selected by the TPO who are functionally different from the assessee having different business module and three not granting the appellant the option to choose a price that falls within the ±5% range of arithmetic mean of comparables as contemplated under proviso of section 92C(2) of the Act. The Ld. CIT(A) has decided the issues against the assessee by observing as under:-
“I have considered the Transfer Pricing Order, written submission and oral arguments of the Ld. AR carefully. It is undisputed position that the tested party should be selected on the basis of simpler roles. The party which performs complex functions should be avoided from choosing the tested party. Further in respect of the tested party as well as the comparables reliable and verifiable data should not be present. The Ld AR is arguing that the appellant is performing simpler task.
In subsequent grounds of appeal the Ld AR has taken the stand that the appellant is in nascent stage therefore, conducting manufacturing process as 3rd party contract manufacturers therefore, during this stage the appellant is completely dependant on its AE for technology trade norms and technology guidelines for its operation. Appellant only does not take selling and marketing support and technology support from its AE but also imports vital raw materials from the AE. BWI Group is old establishment in automobile- sector therefore, the function performed by these AEs for manufacturing of parts used by the appellant as raw materials cannot be said as simpler task just because those intermediate products are used by appellant as raw materials. The expenditure of the appellant is on the use of trade mark and technology expertise of the AE therefore, I am not convinced that the appellant is performing simpler function compare to its AE. Further, Ld AR has not provided complete and reliable data in respect of its AE for bench marking the international transactions which can be verified from the financials of the AE. Further, comparables data for AE as the tested party is also not verifiable with any statutory records. In the case of indigenous comparables the data of the comparables companies can be verified from authentic and statutory source such as data from MCA sites and BSE/NSE sites. Considering the entire facts and significance of the case I confirm the decision of the TPO to reject AE and select the appellant as the tested party.”
13. Further, the Ld. CIT(A) also rejected the arguments of the assessee in respect of comparables selected by the TPO by observing as under:-
“I have considered order of the TPO and arguments of the Ld. AR.
The appellant has used facility of Delphi India Ltd. for manufacturing of auto components through contract manufacturing service agreement date 1st day of November 2009 between the appellant and Delphi auto motive system Ltd. This agreement is only for the use of manufacturing facility of Delphi India. There if no mention of marketing division for the sale of the products of the appellant. The facts remains that the raw materials is being provided by the appellant the production is carried out in accordance with and guidance of the appellant through the use of its AE’s engineering consultancy marketing is done in the name of BWI Group therefore even though the appellant is using manufacturing facilities of other during the year, the facts remain that the appellant is m the manufacturing and sales of automobile parts three comparables namely Rane (Madras), Sona Somic Lemforder Components Ltd., and Gabriel India Ltd. Are in the business of manufacturing of auto component therefore, in my view slight variation of either engaging manpower and use of factory of its own or to a contract manufacturing will not alter the profitability much. In fact appellant has taken alternative TP study treating itself as tested party where also the comparables are taken of manufacturing of auto mobile components and not on the basis of contract manufacturers. As far as export turnover of the comparable namely Rane (Madras) Ltd. and Gabriel India Ltd is concerned export turnover compared to its total turnover-is less than 20% in the case of Rane Madras Ltd. and in the case of Gabriel India Ltd. it is 13%. Therefore, export turnover in both the comparables is less than 20% of the turnover. Therefore in my view small portion of export turnover, will not effect the change in the functionality which warrants exclusion of Jiese comparables. As a result I approve all the three comparables in the final list. Accordingly, this grounds of appeal is dismissed.”
14. We find merit into the contention of the learned counsel for the assessee that comparables selected by the TPO are functionally different on account of the fact that the assessee did not have its own manufacturing facility, the business model of the assessee is quite different coupled with fact that the appellant is operating only in domestic market whereas the comparables namely Rane (Madras) Limited and Gabriel India Ltd. had sufficient export turnover. We are conscious of the fact that two companies cannot be compared with accurate arithmetic precision; however, the factors that would influence the profit margin substantially should be kept in mind while rejecting the comparables. In the present case, this is first year of operation; the appellant does not have its own manufacturing facilities and is purely operating in domestic market. In our considered view, these factors certainly would have substantially impact on the profit margin of the assessee. Therefore, findings of the authorities below cannot be sustained under the facts and circumstances of the present case. The impugned order is therefore hereby set- aside and the issue of computation of Arm’s Length Price is restored to the file of the Assessing Officer. The Assessing Officer would refer the matter to the TPO for making search for fresh set of comparables, who accordingly, recommend the computation of Arm's Length Price afresh. The grounds raised by the assessee are allowed in terms indicated hereinabove for statistical purpose only.
In the result, the appeal of the assessee is partly allowed for statistical purpose.
`Order was pronounced in the open court on 13th October.
2021.