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Facts
The assessee filed its income tax return declaring 'nil' income for the assessment year 2020-21. The case was selected for scrutiny, and the Assessing Officer (AO) referred the matter to the Transfer Pricing Officer (TPO) concerning international transactions with associated enterprises. The TPO proposed significant upward adjustments to the assessee's income based on transfer pricing analysis.
Held
The Tribunal considered various grounds of appeal related to the aggregation of international transactions, selection of comparables, determination of arm's length price for corporate guarantees, and notional interest on outstanding receivables. The Tribunal remitted some issues back to the TPO for fresh consideration, allowed some grounds in favor of the assessee, and partly allowed others.
Key Issues
The main issues involved the validity of the aggregation of international transactions at the entity level, the appropriateness of the transfer pricing methods and comparables used, the determination of arm's length price for corporate guarantees and notional interest on receivables, and the allowability of set-off of brought forward losses.
Sections Cited
Sec 143(3), Sec 144C(13), Sec 144B, Sec 92B, Sec 92CA(1), Sec 10B(1)(e), Sec 234A, Sec 234B, Sec 270A, Sec 274, Sec 115JB
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Income Tax Appellate Tribunal, “J” BENCH, MUMBAI
Before: SMT. BEENA PILLAI & SHRI OMKARESHWAR CHIDARA
Per: Smt. Beena Pillai, J.M.: Present appeal filed by the assessee arises out of final assessment order dated 25/07/2024, passed under section 2 ITA 4840/Mum/2024 A.Y. 2020-21 143(3) read with section 144C(13) by the Assessment Unit, for assessment year 2020-21 on following grounds of appeal:
1. That the Assessing Officer (AO')/National Faceless Assessment Centre (NFAC) erred on facts and in law in completing assessment under section 143(3) read with section 144C(13)/144B of the Income-tax Act ( the Act") at an income of Rs. 40,96,76,986 as against the returned income of Rs. Nil.
2. That the DRP/NFAC/AO/TPO erred on facts and in law in making the upward transfer pricing adjustment of Rs. 35,76,46,432/- on account of international transaction of purchase and sale of goods and services entered into with AEs is not in accordance with law. 2.1.That the DRP/NFAC/AO/TPO erred on facts and in law in adopting an approach of determining the arm's length price of international transaction based on the operating revenue and operating cost amount of Consolidated Financial Statements of the assessee instead of Standalone Financial Statements, which is not in consonance with the transfer pricing provisions prescribed under the Act. 2.2.That the DRP/NFAC/AO/TPO erred on facts and in law in adopting an approach of determining the arm's length price of international transaction by aggregating associated enterprises ('AE') transactions and non-AE transactions which is not in accordance with the provisions of the Indian transfer pricing regulations. 2.3.That the DRP/NFAC/AO/TPO erred on facts and in law in benchmarking international transactions by comparing Assessee's entity level margin arrived at by aggregating AE transactions and non-AE transactions with the margin of companies not comparable with the Assessee company. 2.4.That the DRIP/NFAC/AO/TPO erred on facts and in law in adopting an approach of determining the arm's length price based on the companies identified by the DRP/NFAC/AO/TPO in the last year transfer pricing order, which is not in consonance with the transfer pricing provisions prescribed under the Act. 2.5.That the DRP/NFAC/AO/TPO erred on facts and in law in selecting companies as comparable even though they do not meet 3 ITA 4840/Mum/2024 A.Y. 2020-21 the criteria/filters applied by him and which are otherwise not comparable. 2.6.That the DRP/NFAC/AO/TPO erred on facts and in law in rejecting the Assessee's benchmarking analysis without providing any cogent reasons. 2.7.That the DRP/NFAC/AO/TPO erred on facts and in law in not appreciating that the benchmarking analysis done by the Assessee is in accordance with the provisions of the Act and in true spirit of transfer pricing principles and no adverse inference could be drawn on this account. 2.8.That the DRP/NFAC/AO/TPO erred on facts and in law in failing to appreciate that the segment account provided by the Assessee for benchmarking purpose need not be audited and the segmental account has been prepared by adopting proper and scientific allocation key.
3. That the DRP/NFAC/AO/TPO erred on facts and in law in making the upward transfer pricing adjustment of Rs. 1,89,75,199/- on account of guarantee commission on corporate guarantee provided to AE is not in accordance with law. 3.1.That the DRP/AO/NFAC/TPO erred on facts and in law in disregarding the rule of consistency and not appreciating that the approach adopted by the Appellant has been accepted by the DRP/TPO/AO in Appellant's own case in an earlier Assessment Year (i.e. 2018-19). 3.2.That the DRP/NFAC/AO/TPO erred on facts and in law in not appreciating that furnishing of corporate guarantee is not an international transaction even as per the amended section 92B of the Act 3.3.That the DRP/NFAC/AO/TPO erred on facts and in law in failing to appreciate that these guarantees were insued for the benefit of the Assessee and in discharge of its function as shareholder which do not warrant charge of any guarantee fees on arm's length basis. 3.4.That the DRP/NFAC/AO/TPO erred on facts and in law in disregarding the benchmarking analysis of arm's length guarantee fee which is more scientific and on the basis of approach widely accepted internationally to benchmark the transaction of provision of corporate guarantee 4 ITA 4840/Mum/2024 A.Y. 2020-21 3.5.That the DRP/NFAC/AO/TPO erred on facts and in law in not appreciating that the benchmarking analysis based on interest saving approach for determining arm's length rate of corporate guarantee fee has been accepted in earlier year in Assessee's own case 3.6.That the DRP/NFAC/AO/TPO erred on facts and in law in carrying out his arbitrary analysis of impugned guarantee fee without providing any reason for rejection of the Assessee's benchmarking analysis 3.7.That the DRP/NFAC/AO/TPO erred on facts and in law in computing the impugned guarantee commission on the upper cap of guaranteed amount (i.e. maximum value of guarantee) rather than on outstanding amount of underlying loan 4. That the DRP/NFAC/AO/TPO erred on facts and in law in making the upward transfer pricing on secondary adjustment of Rs. 16,95,145/- on account of corporate guarantee provided to AE is not in accordance with law.
5. That the DRP/NFAC/AO/TPO erred on facts and in law in making the upward transfer pricing adjustment of Rs. 3,13,60,120/- on account of notional interest on outstanding receivables from AEs is not in accordance with law. 5.1.That the DRP/AO/NFAC/TPO erred on facts and in law in disregarding the rule of consistency and not appreciating that the approach adopted by the Appellant has been accepted by the DRP/TPO/AO in, Appellant/s own case in an earlier Assessment Year (i.e. 2018-19). 5.2.That the DRP/NFAC/AO/TPO erred on facts and in law in considering "continuing debit balance" with AE as a separate "international transaction within the meaning of international transaction as per section 928 of the Act independent of the international transaction of sale of goods and services to AEs. 5.3.That the DRP/NFAC/AO/TPO erred on facts and in law in making transfer pricing adjustment on account of outstanding receivables even though transfer pricing adjustment has already been made on the principal transactions of sale of goods and service and thus, such adjustment constitutes double additions. Without prejudice to the above:
5 ITA 4840/Mum/2024 A.Y. 2020-21 5.4.That the DRP/NFAC/AO/TPO erred on facts and in law in not appreciating that Assessee practices a uniform policy of not charging interest from non-AEs on delayed realization of outstanding receivables and hence, the practice of not charging interest to AEs for delayed payment is an arm's length practice applying the comparable uncontrolled price method, not warranting any such adjustment for notional interest. 5.5.That the DRP/NFAC/AO/TPO erred on facts and in law in going beyond his jurisdiction by questioning business decision and commercial prerogative of the Assessee on charging interest on delayed realization of outstanding receivables and failing to appreciate that commercial expediency ought to have been given a due regard while applying the arm's length principle. 5.6.That the DRP/NFAC/AO/TPO erred on facts and in law in not granting set off for notional interest on pre-mature payments made by AEs and for period of delays in payment by the Assessee to its AEs; 5.7.That the DRP/NFAC/AO/TPO erred on facts and in law in re- characterizing the outstanding receivables as interest free loans. 5.8.That the DRP/NFAC/AO/TPO erred on facts and in law in imputing interest on whole of the outstanding receivable balance without considering the actual period of delay in realization.
6. That the AO/NFAC erred on facts and in law in not allowing the set- off of brought forward loss/unabsorbed depreciation of Rs. 40,96,76,896 while computing the total income.
7. That the AO/NFAC erred in facts and in law in incorrectly levying interest under section 234A and 234B of the Act.
8. That the AO erred on facts and in law in initiating penalty proceedings under section 270A read with section 274 of the Act for the alleged under-reporting of income. The Appellant craves leave to add, amend, alter or vary, any of the aforesaid grounds of appeal before or at the time of hearing of the appeal and consider each of the grounds as without prejudice to the other grounds of appeal.” Brief facts of the case are as under:
6 ITA 4840/Mum/2024 A.Y. 2020-21 2. The assessee is a company, and filed its return of income for year under consideration on 22/01/2021, declaring total income at rupees nil. The income declared under section 115JB of the Act, was also at nil. Subsequently, the case was selected for scrutiny and notice under section 143(2) along with 142(1) of the act was issued. In response to statutory notices, the representative of assessee appeared before the Ld.AO and filed requisite details as called for. 2.1. The Ld.AO noted that, the assessee had international transaction with its associated enterprise. Accordingly reference was made to the transfer pricing officer(hereinafter referred to as the Ld.TPO) to compute the arms length price of such international transctions. On receipt of the reference u/s. 92CA(1), the Ld.TPO called upon the assessee to furnish details pertaining to international transaction in Form 3CEB. 2.2. The Ld.TPO noted that, the assessee is primarily engaged in the business of manufacturing soaps, fatty acids and fatty alcohol. The operations of the assessee is segmented into 2parts:
1. 1. Personal segment, wherein the assessee is contract manufacturer as well as manufacturing for own brand.
2. Oleochemical segment The Ld.TPO noted that assessee purchased semi furnished / processed materials, being raw materials from its AE at Indonesia which was further processed in plants of the assessee for manufacturing Oleo-chemical, that are either used for manufacturing of personal care product or sold to the customers. Various international transaction entered into by assessee during
7 ITA 4840/Mum/2024 A.Y. 2020-21 the year under consideration as per the TP study report are as under:
Sr. Name of AE International Benchmarking Amount (Rs. No. Transactions Result in Million) A International Transaction on Purchase of Raw Materials 1 PT VVF Indonesia Purchase of TNMM-External - 1183.50 Glycerine & Fatty AE as Tested Acid Party 2 VVF Singapore Purchase of Soap CUP-Internal 5.67 Pte. Ltd Noodles 3 Green Planet LLC Purchase of Soap CUP - Internal 24.36 Noodles 4 Green Planet LLC Purchase of TNMM-Internal Yellow Colour Total (A) 1,213.60
B International Transaction on Sale of Finished Goods 1 VVF LLC Sale of TNMM-Internal 349.71 Oleochemicals 2 VVF Singapore Sale of TNMM-Internal 132.59 Pte Ltd Oleochemicals 3 VVF Illinois Sale of TNMM-Internal 4.11 Services LLC Oleochemicals 4 VVF Kansas Sale of TNMM-Internal 48.64 Services LLC Oleochemicals 5 VVF Kansas Sale of Soap TNMM-Internal 26.84 Services LLC 6 VitaLife FZCO Sale of Soap TNMM-Internal 5.61
7 Green Planet Sale of Soap TNMM-Internal 8.83 Industries LLC Noodles
8 Green Planet Sale of Fatty TNMM-Internal 0.17 Industries LLC Alcohols
8 ITA 4840/Mum/2024 A.Y. 2020-21 Total (B) 576.53 C International Transaction on Availing of Sales Support Services 1 VVF Singapore Payment of Sales CUP Internal 6.16 Pte Ltd Commission Total (C) 6.16 Grand Total (A+B+C) 1,796.30 2.3. The Ld.TPO noted that the assessee used transactional net margin method (herein after referred to as TNMM) as the most appropriate method by considering Indonesian AE as the tested party. Assessee used net cost plus marked up (herein after refer to as NCP) as profit level indicator (herein after refer to as PLI). It was noted that the assessee compared the NCP derived by Indonesian AE with arithmetic mean of 3year weighted average NCP earned by 7 broadly comparable independent companies, engaged in similar activities as that of the Indonesia AE. The assessee thus bench marked its transactions based on internal TNMM. 2.4. The Ld.TPO treated all the above transactions to be closely linked and was of the opinion that they cannot be bench marked separately. The Ld.TPO also rejected foreign AE to be the tested party. The Ld.TPO was of the opinion that the search process related to the economic and compatibility parameter adopted by the assessee was not correct. It was also observed by the Ld.TPO that, the filters applied for selecting comparables were arbitrary. The Ld.TPO thus applied profit level indicator of operating profit over operating cost at entity level to bench mark the transaction on aggregate basis. The Ld.TPO also shortlisted identified
9 ITA 4840/Mum/2024 A.Y. 2020-21 comparables to determine arm length price of the international transactions. The Ld.TPO thus proposed adjustment at 13.44% of the total operating income and computed adjustment at Rs.31,35,59,208/- was proposed to be made. 2.5. The next transaction considered by the Ld.TPO was on account of corporate guarantee on behalf of Indonesian AE. The Ld.TPO noted that, no guarantee commission was recognized in the books of the assessee, but voluntary adjustment was made in its return of income for the year under consideration at rate of 0.50 % p.a. based on interest savings approach analysis conducted with the help of an independent professional amounting to Rs.1,07,92,434/-. The Ld.TPO noted that, such arms length rate was bench marked by assessee by adopting Comparable uncontrolled Price (hereinafter referred to as CUP) method. The Ld.TPO rejected bench marking analysis by the assessee and determine the ALP of Corporate Guarantee at 1.30% based on rate obtained from various banks u/s. 133(6) of the Act. 2.6. The Ld.TPO also made secondary adjustment on account of corporate guarantee based on the period of the delay of payment of 1133 days by charging interest at the rate of 5.06% using 6 months LIBOR up to 30th September of the relevant financial year under consideration. 2.7. Ld.TPO further noted that, the assessee had outstanding receivables from various AE’s during the year under consideration. It was noted that assessee did not charge any interest on overdue receivables, including those from non-AE’s.
10 ITA 4840/Mum/2024 A.Y. 2020-21 The Ld.TPO thus proposed an adjustment of Rs.3,13,16,120/- on account of notional interest, by adopting the prime lending rate by SBI(hereinafter referred to as SBI PLR) applicable for year under consideration.
3. On receipt of the transfer pricing order the assessing officer passed draft assessment order on 20/07/2024 by making proposed additions in the hands of the assessee.
Aggrieved by the draft assessment order, the filed objections before DRP.
4. DRP upheld the action of aggregating international transactions by the Ld.TPO. The DRP also upheld comparables selected by the Ld.TPO, without analyzing the functional similarities. 4.1. The corporate guarantee commission attributed by the Ld.TPO, was also upheld by the DRP by relying on explanation to sub section (2) of 92B that defines what an international transaction is. Similarly, the secondary adjustment of corporate guarantees though the assessee various submissions, the adjustment were upheld by the DRP. 4.2. The DRP also upheld the rate of tax that applied to compute the notional interest on outstanding receivables by the Ld.TPO.
On receipt of the DRP direction, the Ld.AO passed the impugned order by making additions in hand of the assessee at Rs.40,96,76,896/-.
11 ITA 4840/Mum/2024 A.Y. 2020-21 Aggrieved by the order of the Ld.AO, the assessee is in appeal before this Tribunal.
The Ld.AR submitted that Ground No.1 is general in nature and therefore do not require any adjudication. 6.1. He also submitted that Ground No. 3.2 is not pressed at the instructions of the assessee. Accordingly Ground No.3.2 is dismissed as not pressed.
Ground no.2-2.8 is on the issue of aggregation of the international transaction by the Ld.TPO at entity level. The assessee has also challenged the rejection of segmental accounts as the same was not audited. The assessee also challenges the comparables selected without any comparability analysis. 7.1. The Ld.AR submitted that, the Oleo-Chemical segment consist of manufacture of fatty acids, fatty alcohol, and glycerin. It is submitted that, the assessee operates worldwide, and caters to both domestic and international market. The Ld.AR submitted that in the Personal care product segment, the assessee undertakes contract manufacturing of third party consumer products like soap bars, shampoos, conditioners, anti- persepirant, deodorant stick etc. It is submitted that international transactions undertaken by the assessee is mainly purchase of raw material from its AE, sale of finished goods to AE and also to non-AE’s independently. Further assessee sells the finished goods to Non AE’s through the AE located in said geographical region for which assessee pays sales commissions based on non-AE sales.
12 ITA 4840/Mum/2024 A.Y. 2020-21 7.2. The Ld.AR submitted that the Ld.TPO did not appreciate the international transactions entered into by assessee also includes AE and non-AE, and therefore aggregation of transactions at entity level is not permissible as per OECD Guidelines (2017). The Ld.AR also relied on OECD guidelines, and submitted that the net margin of the tax payer from controlled transactions should ideally be compared with net margin of comparable controlled transactions. The Ld.AR thus submitted that internal TNMM are available and they should be preferred over the external comparables as the financial analysis based on internal comparable are more reliable. He placed reliance on following decision in support the contention that bench marking analysis carried out by the TPO at entity level is not the correct way to determine the ALP of the transactions. “1. The Act or Rule does not explain or provide guidance with respect to what is 'closely linked transactions. However, paragraph 5.7 of the Guidance Note on Report u/s 92E of the Income Tax Act, 1961 (Transfer Pricing) (Ed 2022) issued by the ICAI, provides following explanation: 2. Hon'ble Chennai Bench of ITAT in case of ACIT v Coastal Energy (P) Ltd [2015] 64 taxmann.com 425.(Chennai - Trib.).
Hon'ble Chennai Bench of ITAT in case of ACIT v Coastal Energy (P) Ltd [2015] 64 taxmann.com 425.(Chennai - Trib.).
JCB India Ltd. vs. Deputy Commissioner of Income Tax [(2016) 46 CCH 0366 Del Trib),” 7.3. On the contrary, the Ld.DR submitted that the assessee did not provide the allocation between AE and non-AE in segments. He also submitted that, segmental account provided by the assessee was not audited and therefore deserves to be rejected. The Ld.DR submitted that, assesses was in the activity of purchase of raw material from AE and sale of manufactured or 13 ITA 4840/Mum/2024 A.Y. 2020-21 own products to AE, and hence there was no need to separately bench mark the transactions, as they were closely linked to each other. He thus supported the action of the Ld.DRP/TPO for the adjustment made by aggregating all the international transactions at entity level. We have perused the submissions advance by both sides in the light of records placed before us.
It is noted that the assessee entered into following transactions with its AE’s. It is submitted that, following table demonstrates factual summary of function, MAM and benchmarking methodology used by the assessee in respect of transactions aggregated by the Ld.TPO during assessment. Details of transaction MAM used by the Tested Party Remark Appellant Purchase of Raw Transactional Net PT VVF Appellant material (Glycerine & Margin method Indonesia purchased raw Fatty Acid) (AE) material from its AE. For this transaction, Appellant is characterised as entrepreneur manufacturer and the AE as captive manufacturer. CUP rejected as there was no identical product sold by the AE. Further, there is no identical product purchased by the 14 ITA 4840/Mum/2024 A.Y. 2020-21
appellant. RPM rejected being not appropriate for manufacturer. CPM rejected as the same requires high degree of comparability, PSM rejected as not appropriate. TNMM is used to benchmark the transaction as MAM. PLI of 7 set of comparable company is used to benchmark the transaction. Purchase of Raw Comparable AE Appellant material (Soap Uncontrolled Price purchased raw Noodles) Method material from its AE. For this transaction, Appellant is characterised as entrepreneur manufacturer and the AE as wholesale trader. The transaction was benchmarked using CUP, comparing the price per unit with transactions
15 ITA 4840/Mum/2024 A.Y. 2020-21 between independent third parties on or near the date of purchase. Purchase of Yellow Transactional Net Appellant Appellant has colour Margin method purchase yellow colour from AE. The said material used in Contract Manufacturing Business (CMB) of the Appellant. Value of purchase during the year was Rs. 70,961/- only. Transaction is benchmarked using TNMM based on PLI of Soap business of CMB division. Sale of Finished goods Transactional Net Appellant Appellant sold Margin method Oleochemicals, soap, and soap noodles to its AEs, characterized as an entrepreneur manufacturer. CUP, RPM, CPM, and PSM were rejected due to lack of strict comparability and differing economic circumstances
16 ITA 4840/Mum/2024 A.Y. 2020-21 between AE and non-AE transactions (e.g., long-term volume guarantees for AEs). TNMM was applied based on segmented results from audited accounts, as the resources employed in both for controlled and non- controlled transaction are comparable. Further, TNMM neutralizes differences in functions, assets, and risks by considering operating profit comparability. Payment of Sales Comparable Appellant For this Commission Uncontrolled Price transaction, RPM, Method CPM, PSM, TNMM, and OSM were not considered appropriate as the Most Appropriate Method (MAM) for benchmarking. Since the Appellant
17 ITA 4840/Mum/2024 A.Y. 2020-21 had also paid commission to independent third- party agents for similar services, the CUP method was determined to be the MAM. The transaction was benchmarked by comparing the commission rate paid to third-party agents.
8.1. It is noted that, the assessee purchases raw materials from its AE’s. It is noted that these transaction of purchase of raw materials are with different characteristics involving different AE’s. We find that the assessee entered into various transactions with its AEs during the year. The Assessee adopted the MAM applicable for each type of transaction separately, as listed hereinabove. The Ld.TPO rejected the ALP determined by the assessee and the MAM adopted by the assessee for each of the transaction and instead adopt aggregation method as under: In order to aggregate only Purchase of raw materials, there must be similarity in various factors. 8.2. Further it is noted that there are Non AE transaction undertaken by the assessee that is aggregated with the international transactions with AE’s, for determining arms length price of international transactions. The ratio of AE sales to total sates constitute 4.07% and ratio of AE purchases to total
18 ITA 4840/Mum/2024 A.Y. 2020-21 purchases constitute 12.45%(refer page 142 of PB Vol I). Then, to apply TNMM at entity level is against the basic canons of transfer pricing law the rules of transfer pricing assessment Rule [10A)(d) & Rule 10B] of Income tax Rules, 1961, read with OECD guidelines under chapter III. 8.3. It is relevant to note the provisions of Rule 10B(1)(e) of the Income-tax Rules, 1962 ('the Rules') which provides for the manner of determination of ALP of an international transaction while applying TNMM that reads as under: 10B. Determination of arm's length price under section 92C. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely: (a)……..….. (e) transactional net margin method, by which — (i) the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard of any other relevant base; 8.4. Clause (i) of Rule 10B(1)(e) of the Rules specifically provides that net profit margin realized by an enterprise from an international transaction is to be computed as the law mandates that whenever TNMM is applied or sought to be applied, as a 1st step the profit margin realized from the international transaction is to be computed. Accordingly, undertaking a companywide analysis of the profitability is not in compliance the provisions of the Income-tax Act, 1961 (the Act). More so when the revenue transactions with AE is less than 10% of total revenue.
19 ITA 4840/Mum/2024 A.Y. 2020-21 Further, the guidance from OECD Transfer Pricing Guidance on Multinational Enterprises and Tax Administrations (2017) "3.42 An analysis under the transactional net margin method should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise."
8.5. The OECD Guidelines emphasis that two or more transactions can be said to be linked with each other when such transaction emanate from a common source being an order or a contract or an agreement or an arrangement and the characteristic and terms of the transactions substantially flows from the said common source. As observed by coordinate bench of this Tribunal in case of Boskalis International Dredging International CV vs. DDIT reported in (2014) 47 taxmann.com 150, to examine whether number of transactions are closely linked in order to aggregate them, one has to verify whether, one transaction is a fall on of the earlier transactions and the subsequent transaction is carried out and depended wholly on the earlier transaction substantially. This Tribunal also held that aggregation of the various transactions is possible only with respect to the transactions which are carried out between the assessee and each associate enterprise.
20 ITA 4840/Mum/2024 A.Y. 2020-21 8.6. Hon'ble Bombay High Court in the case of CIT v. Thyssen Krupp Industries India (P.) Ltd. Reported in (2016) 70 taxmann.com 329, observed as under: "…… We find that in terms of Chapter X of the Act, re-determination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent unrelated third parties. This is particularly so as there is no issue of avoidance of tax requiring adjustment in the valuation in respect of transactions entered into with independent third parties. The adjustment as proposed by the Revenue if allowed would result in increasing the profit in respect of transactions entered into with non-AE. This adjustment is beyond the scope and ambit of Chapter X of the Act."
8.6. Similar view was expressed by: • Hon'ble Bombay High Court in the case of CIT v. Hindustan Unilever Ltd. Reported in (2016) 72 taxmann.com 325; • Hon'ble Hyderabad Tribunal, in the case of Alumeco India Extrusion Ltd. v. Asstt. CIT reported in (2013) 38 taxmann.com 371 • Decision of Hon'ble Delhi Tribunal, in the case of Cornell Overseas (P.) Ltd. v. Dy. CIT reported in (2017) 78 taxmann.com 76. • Decision of Hon'ble Bangalore Tribunal, in the case of Adecco India (P.) Ltd. vs. DCIT reported in (2023) 148 taxmann.com 374 8.7. In the present facts of the case, the international transaction entered by the assessee is, purchase of raw materials from AE’s and sale of finished goods to AE’s. These can only be aggregated, in the event the sale of finished goods cannot take place without purchase of raw material from AE. It is noted that, the assessee has purchased raw materials from different AE’s. The functions performed by the assessee under each segment has to be looked into carefully with the assistance of agreement entered into between assesees and the respective AE’s, before aggregating the transactions.
21 ITA 4840/Mum/2024 A.Y. 2020-21 8.9. It is not in dispute by the authorities that, the assessee also undertakes contract manufacturing of third party consumer products and sell such products under its own brand to domestic as well as international markets. These activities carried out by the assessee under the contract manufacturing business has to be considered independently. 8.9. From the paper book filed before this Tribunal, we note that, the assessee furnished allocation keys in the transfer pricing study report between AE’s and non–AE’s. It is also submitted that direct expenses are maintained for the soap Noodles segment. Further, the cost production is calculated by bifurcating AE and non-AE segment. It is also noted that, expenses like sales promotion etc., has was not allocated to AE’s sales, as assessee do not incur such expenses toward the sales made to AE. It was submitted that, based on a scientific allocation, the segmental reports were prepared and the Ld.TPO without pointing out any fault, rejected the same without assigning proper reasons. We therefore direct the Ld.AO/TPO to determine the ALP by aggregating the various transactions between the assessee and each associate enterprise separately, and not by clubbing the transactions with all associate enterprises. The Ld.AO/TPO is also directed not to consider the entity lever transaction that includes Non AE transaction also. The comparables are to be considered based on functional similarities by adopting the MAM in accordance with law. 8.10. It is noted that the Ld.TPO rejected the Foreign AE’s as the tested party to determine the ALP of international transaction pertaining to purchase of raw materials. On reading of the 22 ITA 4840/Mum/2024 A.Y. 2020-21 transfer pricing study report prepared by the assessee we do not find any material available with the assessee about the Singapore AE which was relied upon by the assessee whatsoever. 8.11. It is noted that the AE of the assessee is responsible for providing raw materials to other associated enterprises. It is assessee’s operation to procure raw material, engaging the labour, get the items manufactured and sell the same to the associated enterprises. The Ld.TPO rejected selection of the tested party because assessee selected the same without giving any substantial reasoning. Further, it is easier to gather the information regarding the assessee taxpayer company then the foreign AE. The assessee must ensure that the necessary relevant information about the AE and sufficient data on comparable is furnished to the tax administration to verify the selection and application of the transfer pricing method. 8.12. In this case no doubt the annual accounts of the associated enterprise were not available with the assessee. So far as the comparability analysis is concerned the assessee selected comparables from different database and TPO are selected three comparables from Prowess database. The assessee is into diverse business viz., manufacturing and selling consumer products, contract manufacturing business, Oleochemical business. Therefore, companies operating in similar products or manufacturing of similar products like assessee, undertaking similar functions would be appropriate comparables with assessee. 8.13. There is no doubt that, one can select a foreign entity as a tested party, if the arm's-length price
23 ITA 4840/Mum/2024 A.Y. 2020-21 of international transaction by selecting reliable method and reliable comparability analysis can be made. Therefore, the basic object of selecting a tested party is reliability of application of the method and comparability analysis for determining the arm's- length price of the international transaction. Both the parties have placed before us judicial precedent that foreign AE can be taken as a tested party, but all the decisions have held the tested party only could be the party on which the transfer pricing methods can be applied in the most reliable manner and for which most reliable comparables can be found. 8.14.There is nothing on record placed by the assessee to analyse whether the assessee or the foreign AE is least complex. Therefore, in view of above discussion, we restore the issue back to the file of the Ld.TPO, with a direction to the assessee to substantiate arm's-length price of the transaction of trading segment by showing sufficient data about the foreign AE as a tested party. The Ld.TPO may examine that the tested party selected by the assessee gives a reliable method and computation of arm's-length price or not. Thereafter, after giving assessee an opportunity of hearing, determine the arm's-length price of the international transaction of trading segment. In respect of selection of comparable by the Ld.TPO at entity level bench marking is flawed as the comparables selected are submitted to be not functional similar even under TNMM. It is submitted that the assessee has submitted before this authorities that 70% of its business is of Oleochemical and 25 to 30% of business pertains to finished goods. Whereas, the comparables selected by the Ld.TPO are either into manufacturing of raw
24 ITA 4840/Mum/2024 A.Y. 2020-21 materials or selling of finished goods whereas the assessee manufactures the final finished goods and sales it in the domestic as well as international market also to AE’s. For all the above reasons, we deem it proper to remit this issue to the Ld.TPO for de novo consideration. Assessee is also directed to furnish all requisite details and documents in support of its claim. The Ld.AO/TPO shall verify the details vis-a-vis the transactions undertaken by the assessee with its AE and then compute the ALP of the transactions in accordance with law. Accordingly ground 2-2.8 raised by the assessee stands partly allowed for statistical purposes.
Grounds no. 3-4 raised by the assessee is on the issue of the addition made on the account of corporate guarantee provide to AE being wholly owned subsidiary. The assessee also challenged secondary adjustment made so motto by imputing interest on the guarantee commission for the delay. 9.1. The Ld.AR submitted that, assessee provided guarantee to the bank for a loan taken by its AE being PT VVF, Indonesia a wholly owned subsidiary of assessee vide agreement order date 24/08/2014. It is submitted that the loan was secured by pledging the assets by the borrower as a standard practice and the lending bank insists on a guarantee from the parent entity of the borrower as an additional security. 9.2. The Ld.AR submitted that though no guarantee commission was recognize in the books of account for the year under consider assessee made voluntary adjustment in the income tax return filed, by computing arm length corporate guarantee fee at the 25 ITA 4840/Mum/2024 A.Y. 2020-21 rate of 0.5%. The said approach was rejected by the Ld. TPO was not accepted by the TPO. The Ld. TPO determine the arms length price to be 1.3% being the average bank rate reduced by 0.5% discount based on the data obtained from various banks u/s.133(6) of the Act. The Ld.AR submitted that assessee does not incurred any cost in provide guaranteed. He further submitted that corporate guarantee constituted merely a contingent liability that does not effects profits, income, losses Ld.AO or assets of the assessee either immediately or in the future he placed reliance on the provisions of section 92B and submitted that this characteristic essential for transactions to qualify international transaction. The Ld.AR also submitted that in A.Y 2018-19 the Ld.AO itself accepted corporate guarantee adjustment at 0.5% in assesses own case. 9.3. The Ld.AR submitted that in any event bank rated cannot be considered for bench marking corporate guarantee fee as held that Hon’ble Bombay High Court. “CIT v Everest Kento Cylinders Ltd [2015] 58 taxmann.com 254 and Glenmark Pharmaceuticals Ltd vs ACIT [2014] 43 taxmann.com 191”
9.4. On the contrary, the Ld.DR submitted that whether the corporate guarantee is invoked or not the assessee provides guarantee to its AE’s. It amounts to be international transaction and determination of arms length price is necessary. He placed reliance on amendment by way of insertion of sub clause (c) to sub section 1 of section 92B, that clearly defines what an international transaction is. He thus submitted that, providing corporate guarantee is a financial obligation to the AE by the assessee. The Ld.DR placed reliance on the decision of Special
26 ITA 4840/Mum/2024 A.Y. 2020-21 Bench of Hon’ble Kolkata in case of Instrumentarium Corporation Ltd. vs. ADIT, International Taxation-I, Kolkata, reported in (2016) 71 taxmann.com 193 in support of this contention. He thus supported the commission fee computed by the Ld.TPO at 1.3% We have perused the submission advance by the both sides in the light of records place before us.
9.5. We agree with the Ld.DR that extending corporate guarantee to its AE amount transactions that has to be bench marked as per the procedure laid down in the transfer pricing rules. However that has not been disputed by the assessee. It is noted that the Ld.TPO has adopted external CUP that to bank guarantee rates by providing discount. Such computation adopted by the Ld.TPO is not in accordance with the transfer pricing principles. In number of judgments, the rate ranging from 0.2% to 0.5% was found to be acceptable. Hon'ble Bombay High Court in case of Everest Kento Cylinders Ltd. (supra) observed that, issuance of a corporate guarantee are distinct and separate from that of bank guarantee and therefore, no TP adjustment can be made in respect of guarantee commission by making comparison between guarantees issued by commercial banks as against a corporate guarantee issued by holding company for benefits of its AE, a subsidiary company. Further, in the said case, the Hon'ble Court affirmed the guarantee adjustment of 0.5% upheld by this Tribunal. It is not discernible from the decisions relied by the assessee, if the assessee or the authorities below undertook the activity of analysing the financial transaction as per OECD commentary.
27 ITA 4840/Mum/2024 A.Y. 2020-21 9.6. It is noted that on 11/02/2020, the Organization for Economic Co- St operation and Development (hereinafter referred to as OECD) released its final report with transfer pricing guidance on financial transactions (hereinafter referred to as "the Report"). The Report covers the accurate delineation of financial transactions, in particular with respect to multinational enterprises' (MNEs) capital structures. The Report also addresses specific issues related to the pricing of financial transactions such as treasury functions, intra-group loans, cash pooling, hedging, guarantees, and captive insurance. It also provides guidance on the determination of risk-free rates of return and risk-adjusted rates of return, where an associated enterprise is entitled to such return. 9.7. The guideline as per the report now forms part of Chapter 1 and Chapter VI of the OECD TPG(accurate delineation of the transaction) from 2022, which stipulates that, accurate delineation of financial transactions requires an analysis of the factors affecting the performance of businesses in the industry sector in which the MNE group operates. It further stipulates that commercial or financial relations between the parties and the conditions and economically relevant circumstances attaching to those relations should be identified. Similar to the analysis of any controlled transaction, this includes an examination of the contractual terms of the transaction, the functions performed, assets used, and risks assumed, the characteristics of the financial instruments, the economic circumstances of the parties and of the market, and the business strategies pursued by the parties.
28 ITA 4840/Mum/2024 A.Y. 2020-21 9.8. In our view, the above analysis needs to be carried out by the authorities in order to determine the rate attributable to the corporate guarantee provided by the assessee to its subsidiary AE. We accordingly remit the issue back to the Ld.AO/TPO for fresh adjudication based on the above observation and the guidelines provided by OECD that forms part of Chapter X.
Accordingly ground 3-3.7 raised by the assessee stands partly allowed for statistical purposes.
In respect of secondary adjustment by the Ld.AO on the corporate guarantee we note that as per rule 10CB computation of interest commences from the due date of filing the return of income. It is noted that for the year under consideration due date was 15/02/2021. Since the specific mechanism for computation of said rule in the computation, any secondary adjustment cannot be levied in the primary adjustment to accordingly we do not find any basis for making the secondary adjustment for the year under consideration. Accordingly ground 4 raised by the assessee stands allowed.
The Ground no. 5 raised by the assessee is computation of notional interest on outstanding receivables. The Ld.AR submitted that assessee export sales and service transactions with the AE as well as non-AE’s on credit terms with the standard paying period of 30 days from goods and 60days for services. He submitted that, assessee do not charge interest for any delay from the AE as well as non AE and therefore no interest is attributable in the present facts. He submitted that,
29 ITA 4840/Mum/2024 A.Y. 2020-21 for the year under consideration the average delay in realization for AE’s is 302 days as compared to non-AE transaction 319 days. 11.1. The Ld.AR submitted that the Ld.TPO made an upward adjustment of notional interest by following cup method at rate of 13.4% by using SBI PLR rate The Ld.AR submitted that said action upheld by the DRP. Objecting to the said adjustment before Tribunal, Ld.AR relied on the decision of coordinate bench of this Tribunal in case of Livin Stones vs. DCIT reported in (2014) 41 taxmann.com 419, wherein Hon’ble Court observed as under 12. We have carefully considered the rival submissions and also perused the relevant finding of the TPO as well as the CIT(A) and also the material on record. It is an undisputed fact that the assessee has not charged any interest from the third party in respect of delayed payments even when the time period of realization has exceeded more than 300 to 400 days. From the perusal of the details as submitted by the learned counsel in the paperbook, it is seen that there are many instances in which more than 200 days have been exceeded in realization of payments in case of third parties. Once on such delayed payments with third party no interest has been charged, then to work out the notional interest in case of delayed payment by the AE is also not called for. The comparison in such a case has to be made with controlled and uncontrolled transactions and once there is no such factor present in the uncontrolled transaction then the same cannot be taken as a bench mark for the controlled transaction. Moreover, we agree with the contention of learned counsel that in the case of AE the volume of sale is very huge as compared to volume of sale in case of third party and such delay in realization of payment should not be adversely viewed on the basis of average working of days. The average days of delay in payment as worked out by the TPO is also inappropriate as number of sale transactions with AE is far more than the non AE and will result in improper working of average days. On these facts of the case, we do not find any reason for making any kind of upward adjustment on account of differences in period for realization of payments in respect of sales made to AE as well as non AEs. Such a notional interest cannot be charged for the purpose of making adjustment in arm's length price. Thus the order of CIT(A) deleting the adjustment of Rs, 4,65,23,007/- on this score is upheld and the ground raised by the department stands dismissed.
30 ITA 4840/Mum/2024 A.Y. 2020-21 11.2. The Ld.AR submitted that said decision upheld by Hon’ble Bombay High Court in (2018) 94 taxmann.com 504. He also placed reliance on the decision of in case of CIT vs. Indo American jewelry reported in (2014) 44 taxmann.com 310. The Ld.AR thus vehemently submitted that where there is complete uniformity in not charging AE’s and non-AE’s for delay in realization of export proceeds, the assessing officer was not justified in making addition of notional interest in respect of the transaction with AE’s. 11.3. Without prejudice to the above submission the Ld.AR submitted that in the event notional same is to be computed the rate shall be as per LIBOR. He also prayed for netting off of the payable against the receivable with each AE, while calculating the outstanding receivable before the LIBOR rate is applied. The Ld.AR submitted that grace period of 90 days may be granted in respect of the balance outstanding for computing the notional interest. 11.4. On the contrary Ld.DR submitted that interest on receivables is an international transaction and Ld.TPO rightly determined its ALP. Ld.DR submitted that expression 'debt arising during the course of business' refers to trading debt arising from sale of goods or services rendered in course of carrying on business. Once any debt arising during course of business is an international transaction, he submitted that any delay in realization of same needs to be considered within transfer pricing adjustment, on account of interest income short charged or uncharged. It was argued that insertion of 31 ITA 4840/Mum/2024 A.Y. 2020-21 Explanation with retrospective effect covers Assessment Year under consideration and hence under/non-payment of interest by AEs on debt arising during course of business becomes international transactions, calling for computing its ALP. 11.5. He submitted that the decision of Hon’ble Bombay High Court in case of CIT v. Patni Computer Systems Ltd. Reported in (2013) 215 Taxman 108 considered an identical situation. He pointed out that while answering the above question, Hon'ble Bombay High Court noticed that amendment to section 92B has been carried out by Finance Act, 2012 with retrospective effect from 1.4.2002. Setting aside view taken by Tribunal, Hon'ble Bombay High Court restored the issue to file of Tribunal for fresh decision in light of legislative amendment. It was thus argued that non/under-charging of interest on excess period of credit allowed to AEs for realization of invoices, amounts to an international transaction and ALP of such international transaction has to be determined by Ld.TPO. 11.6. The Ld.DR referring to the decision relied by Ld.AR referred to in preceding paras, submitted that the above decision of Hon’ble Bombay High Court was not brought to the notice of the coordinate bench of this Tribunal as well as Hon’ble High Court.
We have perused the submissions advanced by both sides in light of records placed before us.
We agree with the arguments advanced by the Ld.DR on this issue that, once any debt arising during the course of business is an international transaction. Any delay in the realization of such debt is liable to be visited with the transfer pricing adjustment on 32 ITA 4840/Mum/2024 A.Y. 2020-21 account of interest income short charged or uncharged. Hon'ble Bombay High Court in the case of CIT v. Patni Computer Systems Ltd. (supra) dealt with following question of law: (c) 'Whether on the facts and circumstances of the case and in law, the Tribunal did not err in holding that the loss suffered by the assessee by allowing excess period of credit to the associated enterprises without charging an interest during such credit period would not amount to international transaction whereas section 92B(1) of the Income-tax Act, 1961 refers to any other transaction having a bearing on the profits, income, losses or assets of such enterprises?' 12.1. Hon'ble Bombay High Court noticed that amendment to section 92B by Finance Act, 2012 is with retrospective effect from 1/04/2002. Setting aside view taken by Tribunal, Hon'ble Bombay High Court restored the issue to file of Tribunal for fresh decision in light of legislative amendment. The assessee in present facts has not pressed the ground pertaining to the nature of transaction to be falling under section 92B, then it is inevitable that transaction has to bench marked in as per transfer pricing rules. 12.2. We refer to the decision of Hon’ble Delhi Tribunal in case of Ameriprise India (P.) Ltd. v. Asstt.CIT reported in (2015) 62 taxmann.com 237, in which, this issue has been thoroughly discussed and interest on trade receivables has been held to be an international transaction by observing as under: 28. We do not approve the reasoning given by the DRP about the subsuming of such interest in the working capital adjustment. It is axiomatic that the working capital adjustment is in respect of international transaction of rendering services to the AE. Interest for the credit period allowed as per the agreement is factored in the price charged for the rendering of services. Au contraire, the non-realization of invoice value beyond the stipulated period is a separate international transaction, whose ALP is required to be determined. Granting of working capital adjustment is confined to the international transaction of rendering of services, whose ALP is separately determinable. On the 33 ITA 4840/Mum/2024 A.Y. 2020-21 other hand, the international transaction of interest receivable from its AEs for late realization of invoices beyond such stipulated period is a separate international transaction. Allowing working capital adjustment in the international transaction of rendering services can have no impact on the determination of ALP of the international transaction of interest on receivables from AEs beyond the stipulated period allowed as per the agreement. The amendment made by the Finance Act, 2012 in terms of insertion of Explanation to section 92B with retrospective effect from 1-4-2002 by considering 'any other debt arising during the course of business' as a separate international transaction, impliedly disapproves the view canvassed by the DRP in obliterating the determination of the ALP of the separate international transaction of interest on allowing the working capital adjustment in the international transaction of rendering of services. Both the transactions are separate and distinct from each other. Whereas the international transaction of rendering services contemplates comparison of the price charged for rendering services by impliedly including the interest for the period allowed for realization of invoices as per the terms of the agreement, the international transaction of charging interest on late recovery of trade receivable covers the period which starts with the termination of the period of credit allowed under the agreement, which is subject matter of the international transaction of rendering of services. There is one more fallacy in the reasoning given by the DRP about the subsuming of interest income in the working capital adjustment. It is simple that working capital adjustment is ordinarily computed by considering the average of the opening and closing values of inventories, receivables and payables. The TP adjustment on account of interest on delayed realization of invoice value has nothing to do with the closing of opening values. It depends on the period of realization on transaction-to- transaction basis. To put it differently, suppose an invoice is raised on 1st May; period allowed for realization is two months; and the invoice is actually realized on 31st December. Notwithstanding the fact that interest on such late realization would become chargeable for a period of 6 months (from 1st July to 31st December), but the amount of invoice will not be receivable as at the end of the financial year on 31st March. As such, this receivable would not have an impact on the working capital adjustment in any manner, but would call for addition on account of the late realization of invoice value for a period of six months. Therefore, the reasoning given by the DRP in deleting the addition is rejected. However, in view of the fact that all the invoices were realized within the maximum period of 60 days allowed as per the agreement, the charging of interest on receivables is not sustainable on the extant facts.
Accordingly, ground no.5 - 5.8 raised by the assessee stand partly allowed for statistical purposes.
34 ITA 4840/Mum/2024 A.Y. 2020-21 13. Ground no. 6 is in respect of not allowing the set off of brought forward losses of unabsorbed depreciation. The Ld.AR submitted that DRP in its direction had allowed the claim of brought forward and set off of losses which has not been followed by parting the final assessment order. He prayed for directions to the Ld.AO to compute as per the DRP directions. 13.1. On perusal of the objection raised before the DRP as well as we note that no such objections were raised by the assessee. However, in the interest of justice it is necessary to consider the set off of brought forward unabsorbed depreciation in order to compute correct income in the hands of the assessee. We therefore direct the Ld.AO to considered the claim of assessee accordance with law. Accordingly ground no 6 raised by the assessee stands allowed for the statistical purpose Ground no. 7 & 8 are consequential in nature and do not require adjudication. In the result appeal filed by the assessee stands partly allowed for statistical purposes. Order pronounced in the open court on 14/02/2025