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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & Ms. PADMAVATHY S
Assessee by : Shri. Sumeet Khuranna, CA Revenue by : Dr. Manjunath Karkihalli, CIT(DR)(ITAT), Bengaluru. Date of hearing : 04.04.2022 Date of Pronouncement : 21.04.2022 O R D E R Per N V Vasudevan, Vice President
This is an appeal by the assessee against the final Order of Assessment dated 25.03.2021 passed by the ACIT, Circle – 7(1)(1), Bengaluru, under section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (hereinafter called ‘the Act’), in relation to Assessment Year 20161-7.
The assessee is a company engaged in providing marketing and sales support services to its Associated Enterprise (AE) M/s. Tarkett SA, France. During the previous year relevant to Assessment Year 2016-17, the assessee
IT(TP)A No.201/Bang/2021 Page 2 of 14 provided marketing support services (MSS) to its AE for which it received a sum of Rs.4,98,38,366/-. Since the transaction of providing MSS to the AE was an international transaction, income arising from the said transaction had to be determined having regard to Arm’s Length Price (ALP) as laid down in section 92 of the Act. In support of the claim that the amount received from the AE was at arm’s length, the assesseee filed a transfer pricing analysis choosing Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determining ALP. The assessee also chose profit level indicator as OP/TC. The assessee’s OP/TC was 14.95% and this was compared with the comparables chosen by the assessee whose profit margins was in the range of 4.48 to 8.22%. The assessee claimed that the international transaction has been carried at ALP. In determining the ALP, the assessee also claimed working capital adjustment which was not granted by the TPO.
The TPO to whom the AO referred the question of determination of ALP under section 92CA of the Act, rejected the transfer pricing study of the assessee and he chose the following 4 comparable companies: Financial Year wise OP/OC (%) S.No. Company Name 2015-16 2014-15 2013-14 Average
Focus Suites Solutions & Services 1 Ltd. 21.04 4.12 12.58 2 Ugam Solutions Pvt. Ltd 5.75 11.53 14.48 29.08 3 Axience Consulting Pvt. Ltd 25.91 19.84 17.72 22.06 IT(TP)A No.201/Bang/2021 Page 3 of 14 4 Majestic Research Services & Solutions 35.17 18.49 26.83 Ltd., Average 18.98%
The TPO determined the ALP of the international transaction as follows: “19.3 Computation of Arm's Length Price: The median of the weighted average Profit Level indicators is taken as the s length margin. Please see Annexure A for details of computation of PLI of the comparables. Based on this, the arm's length price of the services rendered by the taxpayer to its AE(s) is computed as under:
SWD SEGMENT Particulars Formula Amount (in Rs.) 4,98,38,366 Taxpayers operating revenue OR Taxpayers operating cost OC 4,41,45,079
OP 56,93,287 Taxpayers operating profit Taxpayers PLI PLI=OP/OC 12.90%
18.98% Average Margin of comparable set Adjustment Required Yes Average Margin of comparable M 18.98% set Arms Length Price ALP=(1+M)*OC 5,25,23,815
IT(TP)A No.201/Bang/2021 Page 4 of 14 Price Received OR 4,98,38,366 Shortfall being adjustment ALP-OR 26,85,449
Aggrieved by the aforesaid addition made by the AO which was incorporated in the draft order of Assessment, the assessee filed objections before the DRP. The DRP gave certain directions which did not result in any relief to the assessee.
Aggrieved by the final order of Assessment passed by the AO as per the directions of the DRP, the assessee is in appeal before the Tribunal. The assessee raised the following grounds of appeal:
1. That the order of the National e-Assessment Centre, Delhi / Deputy Commissioner of Income-tax, Circle 7(1)(1), Bangalore (the 'Assessing Officer' or the 'learned AO') dated 25 March 2021, passed under Section 143(3) read with Sections 144C(13), 143(3A) and 143(3B) of the Income Tax Act 1961 ('the Act'), pursuant to the directions of the learned Dispute Resolution Panel-2, Bengaluru (the 'Learned Panel') to the extent prejudicial to the Appellant, is bad in law and liable to be quashed.
2. That the Assessment ought to be declared as null and void as the scope of assessment has been erroneously extended from limited scrutiny for (a) ascertaining correct disclosure of the 'value' of international transaction to (b) determination of 'arm's length price' of international transactions without seeking requisite approval from PCIT / CIT.
3. That on the facts and in the circumstances of the case, the learned AO and the Deputy Commissioner of Income-tax (Transfer Pricing) - 2(1)(2), Bangalore (the 'learned Transfer Pricing Officer' or the 'learned TPO') erred in making an adjustment to the transfer price of the Appellant and learned DRP erred in upholding the same..
4. That on the facts and in the circumstances of the case, the Learned Panel and the learned AO erred in upholding the learned TPO's approach of determining the arm's length price for the provision of marketing support services ('MSS') of the Appellant by:
IT(TP)A No.201/Bang/2021 Page 5 of 14 4.1 Conducting a fresh comparability analysis by rejecting certain filters applied by Appellant in the TP documentation and applying additional / modified filters. 4.2 Including the company Axience Solutions Private Limited even though this company is functionally different (i.e., engaged in consulting and other diversified activities) from the Appellant (engaged in ground level work): 4.3 Excluding the following companies even though the same are functionally comparable to the Appellant: Cheers Interactive India Private Limited Empire Industries Limited - Trading & Indenting segment Showhouse Event Management Private Limited MCI Management India Private Limited Competent Automobiles Co. Limited - Services & Spares segment MIG Media Neurons Limited 4.4 Not providing working capital adjustment for determining the arm's length price while relying on the judicial precedents based on a fact pattern, which is not applicable to the Appellant. 4.5 Not treating the foreign exchange loss as operating item while computation of operating cost mark-up of the Appellant for determining the arm's length price while relying on the judicial precedents.
5. That on the facts and in the circumstances of the case, the learned AO erred in not granting consequential relief in the computation of interest under section 234B of the Act while computing the tax payable.
At the time of hearing, learned Counsel for the assessee pressed for adjudication of only ground No.4.4 with regard to not providing working capital adjustment. In this regard, we find that the reasons given by the DRP and the TPO for not providing working capital adjustment has been that because of the inputs in determining the working capital adjustments being variables, it is not possible to reasonably give accurate adjustments. On identical reasons, working capital adjustments was denied to the assessee in the case of Huawai Technologies India Pvt. Ltd., Vs. JCIT
IT(TP)A No.201/Bang/2021 Page 6 of 14 IT(TP)A No.1939/Bang2017 order dated 31.10.2018, the Tribunal on a consideration of the very same reasons held as follows:
“10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT(A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows: Determination of arm's length price under section 92C . 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (a) to (d) .... (e)transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic 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 to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions,
IT(TP)A No.201/Bang/2021 Page 7 of 14 which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction];
(f)…… (2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
IT(TP)A No.201/Bang/2021 Page 8 of 14 9. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be 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.
Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.
In Paragraph 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows: "13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include IT(TP)A No.201/Bang/2021 Page 9 of 14 an element to reflect these payment terms and compensate for the timing effect.
14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect.
A company with high levels of inventory would similarly need to either borrow to fund the purchase, or reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers — (less) the period granted to pay debts to suppliers."
Examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these IT(TP)A No.201/Bang/2021 Page 10 of 14 figures. (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables.
15. In the present case the TPO allowed working capital adjustment accepting the calculation given, by the Assessee. The CIT(A) in exercise of his powers of enhancement held .that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons: (i) The daily working capital levels of the tested party and the comparables was the only reliable basis of determining adjustment to be made on account of working capital because that would be on the basis of working capital deployed throughout the year. (ii) Segmental working capital is not disclosed in the annual reports of companies engaged in different segments and therefore proper comparison cannot be made. (iii) Disclose in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results.
The CIT(A) also placed reliance on a decision of Chennai ITAT in the case of Mobis India (2013) 38 taxmann.com. That decision was based on the factual aspect that the Assessee was not able to demonstrate how working capital adjustment was arrived at by the Assessee. Therefore nothing turns
IT(TP)A No.201/Bang/2021 Page 11 of 14 on the decision relied upon by the CIT(A) in the impugned order. In the matter of determination of Arm's Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm's Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working capital adjustment, the Delhi Bench of ITAT in the case of ITO Vs. E Value Serve.com (2016) 75 taxmann.com 195(Del-Trib) has held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opeing and closing working capital deployed. The Bench has also observed that that in Transfer Pricing Analysis there is always an element of estimation because it is not an excact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore there is little merit in CIT(A)'s objection on working adjustment based on unavailable daily working capital requirements data. There is also no merit in the objection of the CIT(A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. Therefore this objection of the CIT(A) is also not sustainable.
IT(TP)A No.201/Bang/2021 Page 12 of 14 17. In the light of the above discussion we are of the view that the CIT(A) was not justified in denying adjustment on account of working capital adjustment. Since, the CIT(A) has not found any error in the TPO's working of working capital adjustment, the working capital adjustment as worked out by the TPO has to be allowed. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at page 173 & 192 of the Assessee's paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of Rule 10B(1)( e) (iii) of the Rules, the net profit margin arising in comparable uncontrolled transactions should be 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 not the case of the CIT(A) that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by CIT(A) working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules, which provides as follows:
(3) An uncontrolled transaction shall be comparable to an international transaction if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged to paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.
In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would therefore fail. Therefore in keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison.
IT(TP)A No.201/Bang/2021 Page 13 of 14 Therefore the working capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly.”
In the present case, the assesse has given the computation of the working capital adjustment and the same is given an Annexure to this order. Similar computation has been given for Assessment Years 2014-15, 2015- 16 and the same are given in the assessee’s Paper Book. We are of the view that in the light of the decision referred to above, the assesse is entitled to working capital adjustment. The TPO is accordingly directed to allow the same as per law.
In the result, the appeal is partly allowed.
Pronounced in the open court on the date mentioned on the caption page.