ASSISTANT COMMISSIONER OF INCOME TAX,, PUNE vs. INA BEARINGS INDIA PRIVATE LIMITED,, PUNE

आदेश / ORDER

PER R.S.SYAL, VP : These two cross appeals – one by the assessee and other by

the Revenue - arise out of the order passed by the CIT(A)-13, Pune

on 15-11-2016 in relation to the Assessment year 2009-10.

of the companies of INA brand of Schaeffler group worldwide. It

is a wholly owned subsidiary of Schaeffler KG, Germany. The

assessee is engaged in the business of manufacturing,

development, marketing and distribution of roller bearing, linear

bearings system and engine components. The assessee filed its

original return declaring loss of Rs.8,89,36,198/-. This return was

revised to total loss of Rs.19,80,74,542/-. The assessee reported

certain international transactions entered into with its Associated

Enterprises (AEs). The Assessing Officer (AO) referred the matter

of determination of the arm’s length price (ALP) of the

international transactions to the Transfer Pricing Officer (TPO).

The TPO observed that though the assessee reported twelve

international transactions, but it categorized its business into two

segments viz., Distribution business and Production business. In

the Transfer Pricing study report, the assessee included certain

3 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

purchases and sale of goods along with other expenses under the

Distribution business segment. In the Production business segment,

the assessee recorded import of raw material, export of

manufactured goods and certain other expenses like Payment for

services/product development, technical and management support

and Payment of charges for SAP software and IT costs. Whereas

the assessee’s appeal is focused only on the Production Business or

Manufacturing segment, the Revenue’s appeal is based on

Distribution Business or Trading segment.

assessee employed the Transactional Net Marginal Method

(TNMM) as the most appropriate method for benchmarking the

international transactions under the Manufacturing segment. Profit

Level Indicator (PLI) of Profit before Depreciation, Interest and

Taxes (PBDIT)/sales was adopted. Four comparable companies

were chosen with their average operating profit margin of 5.38%.

That is how, it was shown that the international transactions under

this segment were at ALP. The assessee emphasized on the

adoption of PBDIT/Sales as PLI on the ground that it charged

depreciation at rates higher than those prescribed under the

4 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

Companies Act, 1956 and such higher rates of depreciation

resulted into excess depreciation to the tune of Rs.6,,77,83,377/-

and further that the depreciation cost on overall basis was

substantially higher than the comparables. The TPO did not

concur with the PLI adopted by the assessee. Instead, he held that

Profit before Interest and Taxes (PBIT)/Sales should be adopted.

Such a view point of the TPO was accorded imprimatur by the ld.

first appellate authority. The assessee has assailed this point of

view.

material on record. The assessee’s grievance in this regard is two-

fold, viz., first being the adoption of PBIT/Sales instead of

PBDIT/Sales, that is, the inclusion of amount of depreciation in

total operating costs for the purpose of determination of the

operating profit rate; and second, in the alternative, in not allowing

appropriate adjustment on account of excess amount of

depreciation in the case of the assessee vis-à-vis other

comparables.

ought to have been excluded from the ambit of total costs in

5 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

applying the TNMM. It is clarified that there is no dispute on the

application of TNMM as the most appropriate method. The

mechanism for determining the ALP under the TNM method has

been enshrined in clause (e) of rule 10B(1), which reads as under :

'(i) the net profit margin realised 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 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 and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, 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) ;

6 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

(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.'

profit margin realized by the assessee from an international

transaction. Sub-clause (ii) is the computation of net operating

profit margin realized by an unrelated enterprise from a

comparable uncontrolled transaction. Sub-clause (iii) of Rule

10B(1)(e) provides that the net profit margin realized by a

comparable company, determined as per sub-clause (ii) above, is

adjusted to take into account the differences, if any, between the

international transaction and the comparable uncontrolled

transactions, which could materially affect the amount of net profit

margin in the open market. It is this adjusted net profit margin of

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

which is used for the purpose of making comparison with the net

profit margin realized by the assessee from its international

transaction as per sub-clause (i). Thus, it is palpable that the net

profit margin realised by the enterprise as well as comparables is

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

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

7 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

margin is always the net profit margin and denominator varies,

which may be costs incurred or sales effected or assets employed

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

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

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

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

arising from the transaction on the basis of sales, costs, assets,

etc.’. Ergo, it is evident that the term “Net Profit” or the “Operating

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

Profit”. No specific definition of the term Operating Profit has

been given in the I.T. Rules, 1962. In common parlance, the

expression `operating profit’ means profit from business

operations, that is, operational revenue minus operating costs.

Operating costs are the costs which are incurred in relation to the

operations of a business. So, all the costs which facilitate the

operation of a business are operating costs. Like raw material and

labour costs, there can be no production of goods without the use

of machinery or other related assets. One cannot contemplate

manufacture of goods without use of assets for fetching sales

revenue, which is the starting point for calculating the amount of

operating profit. In fact, it is the user of the assets which results

8 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

into production and the resultant operating revenue. Depreciation

is an allowance for wear and tear of the assets used. Thus,

depreciation is an inseparable and an integral part of the operating

costs. The Hon’ble Bombay High Court in CIT Vs. Welspun Zucchi

Textiles Ltd. (2017) 292 CTR 1 (Bom.) had an occasion to deal

with the nature of depreciation. Question no. (ii) as urged before

the Hon’ble High Court reads : “(ii) Whether on the facts and in

the circumstances of the case and despite the prescription of

parameters of comparability by Rule 10 B (2) of the Income Tax

Rules, 1962, the Tribunal was correct in law, in directing the

inclusion of DEPB in turnover and depreciation in net profit for the

purpose of profit margin of comparables and assessee?” The

Tribunal in that case held that depreciation was includible in

arriving at the total operating costs. Affirming the view of the

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

is concerned, we find that the analysis done by the Tribunal to

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

determine operating profit, would be equally applicable in case of

depreciation for the purposes of holding it to be an operating

expenses to determine operating costs.’ From the foregoing

discussion, it is manifest that depreciation has to be necessarily

9 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

considered as part of operating costs not only of the assessee but

also of the comparables in the process of determining operating

profit under the TNMM. As such, there can be no question of

excluding depreciation from the ambit of operating costs for the

purpose of determining operating profit. The contention, therefore,

raised by the assessee that the numerator in the formula should be

PBIT/sales rather than PBDIT/sales as applied by the TPO, is

bereft of any force. We, therefore, countenance the view taken by

the authorities on this score.

urged for a suitable adjustment in the operating profits on account

of the assessee’s higher amount of depreciation. It is observed from

the factual matrix that the assessee contended before the TPO that

the depreciation charged by the assessee was at rates higher than

those prescribed under the Companies Rules and the comparables.

It was further contended that there was substantial under utilization

of capacity. The TPO concurred with the submissions advanced on

behalf of the assessee. He granted appropriate adjustment on

account of depreciation charged by the assessee at higher rates vis-

à-vis its comparables and also towards under utilization of

10 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

capacity. The ld. AR has conceded this position before the

Tribunal. His further argument was that de hors the excess rates on

which the depreciation was charged by the assessee for which

suitable adjustment was allowed by the TPO, the assessee should

be granted further adjustment on account of the excessive amount

of depreciation charged in comparison with its comparables. In

our considered opinion, this contention has no merit.

that sub-clause (iii) provides that the net profit margin realized by a

comparable company, determined as per sub-clause (ii) above, is

adjusted to take into account the differences, if any, between the

international transaction and the comparable uncontrolled

transactions, which could materially affect the amount of net profit

margin in the open market. It is this adjusted net profit margin of

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

which is used for the purpose of making comparison with the net

profit margin realized by the assessee from its international

transaction as per sub-clause (i).

11 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

‘Operating profit’ as envisaged under Rule 10B(1)(e) embraces

cumulative effect of all the items of income and expenses which

are of operating nature. Ordinarily, there can be no question of

considering each item of such operating expenses or income in

isolation de hors the other expenses/income to claim adjustment on

the ground of such expenditure or income of the assessee being on

the higher or lower side seen individually or as a percentage of

other operating expense/incomes in comparison with its

comparables. The reason is obvious that when we consider the

operating profit margin, the effect of all the individual higher or

lower items of expenses or incomes is subsumed in the overall

operating profit margin, ruling out the need for any adjustment on

comparison of one-to-one items resulting into the determination of

the operating profit margin.

its business, in which case, it will pay rent which will find place in

the operating costs. For the purpose of making comparison, one

cannot contend that the payment of rent by one enterprise in

comparison with a non-payment of rent by another, should be

12 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

neutralized by giving proper adjustment from the operating profit

of the comparable. The manifest reason is that the other enterprise

may have its own office premises and in that case, the amount of

depreciation on such premises will also form part of its operating

cost. When we consider the operating profit of the first enterprise

which is paying rent and then compare it with that of the second

enterprise which is not paying any rent but is claiming

depreciation on its own premises, the overall effect of rent in one

case gets counterbalanced with depreciation on premises of the

other.

assets charging higher amount of depreciation allowance in its

books of accounts vis-a-vis another comparable company using old

assets with lower amount of depreciation. No adjustment on

account of difference in the amount of depreciation of two

companies is called for when the operating profits are determined

because in the case of a company having purchased new asset,

there will be higher depreciation and simultaneously lower repair

cost and vice versa. The effect of all the individual items of

operating expenses and incomes culminates into the overall

13 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

operating profit margin. That is why, the legislature has provided

for comparing the ratio of ‘operating profit margin’ to a similar

base of the assessee with that of its comparables, thereby

dispensing with the need for making any adjustment on account of

higher or lower amount of individual items of expenses or

incomes. Merely because the amount of depreciation of one

enterprise is more or less than the other, can never be a ground for

seeking adjustment. Such higher amount of depreciation may be

due to large scale of the company and host of other factors. By

considering percentage of operating profit margin under the

TNMM of the assessee as well as comparables, the higher or lower

volume of two companies becomes immaterial and so is the

quantum of depreciation. The nitty-gritty of the matter is that no

adjustment can be allowed simply for the reason that one company

has charged higher amount of depreciation vis-a-vis its comparable

companies. Not only no adjustment on this score is permissible,

the assessee cannot also seek an exclusion or inclusion of a

company on the ground that the ratio of its depreciation to total

expenses or sales etc. is more or less in comparison with

comparables. It is so for the reason that such higher percentage of

depreciation to total expenses is marginalized by the lower

14 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

percentage of repairs and other incidental costs of the assets and

vice versa. Thus the contention of the ld. AR in this regard, being

devoid from any substance, is liable to be and is hereby jettisoned.

difference in the rates of depreciation charged by two companies

on similar category of assets. One company may adopt the policy

of charging depreciation on its assets in conformity with the rates

prescribed in Schedule XIV of the Companies Act and other

company may adopt a policy of charging depreciation at the higher

rates than those prescribed under Schedule XIV. In such a

situation, although both the companies use similar type of assets

and everything else is also equal, but their respective operating

profit percentages undergo change due to higher or lower rate of

depreciation, thereby distorting their comparability. It is this

difference in the amounts of depreciation due to different rates of

depreciation and not due to different quantums of depreciation

simplicitor, which calls for bringing both the companies at par. It

is an agreed proposition on behalf of the assessee that the TPO

himself allowed adjustment on account of excess rate of

depreciation claimed by the assessee in its accounts. We, therefore,

15 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

uphold the impugned order in sofaras the numerator of PBIT in the

TNMM is concerned, that is, inclusion of depreciation in the

operating costs; and also in not allowing any further adjustment on

account of higher amount of depreciation (other than higher rates

for which suitable adjustment was granted by the TPO). The

grounds taken by the assessee in this regard, therefore, fail.

the exclusion of Federal-Mogul Bearings India Ltd. (FMBIL) from

the list of comparables drawn by the assessee.

four companies as comparable including FMBIL. The TPO in his

final set of comparables considered three companies from the

assessee’s list except FMBIL. In addition, he added three new

companies. The average PLI of the six companies was computed

at 4.11%. This led to the recommendation of the transfer pricing

adjustment of Rs.12,45,49,000/- in the Manufacturing segment.

The assessee has accepted all the six companies as comparable. It

disputed only the exclusion of FMBIL before the ld. CIT(A), but

failed to convince the ld. first appellate authority to its line of

reasoning. This is how, the assessee is in appeal before the

16 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

Tribunal only against the exclusion of FMBIL from the final tally

of comparables.

material on record. The TPO excluded this company by, inter alia,

observing on pages 6 and 29 of his order that its manufacturing

turnover was less than 90% of total turnover and further that the

activities of this company also extended to Power Production and

Aluminum Tins other than the bearings. He further held that there

were significant Related Party Transactions (RPTs).

test in a comparability analysis is the functional similarity. If a

company fails on this count, then it loses the tag of comparability.

In such a situation, there is no need to examine other factors. Once

the functional similarity is established, only then it is further

examined if the comparability is not dislodged even on other

filters, such as, extraordinary events like acquisition and mergers

etc. or the extent of the related party transactions or the magnitude

of the operations.

17 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

bearings in this segment, the TPO noted that FMBIL was engaged

in manufacturing of Powder and Aluminum Tins apart from

Bearings. In this regard, it is relevant to note that this company

declared turnover of Rs.39.36 crore inclusive of `Other income’ of

Rs.3.11 crore. Bifurcation of `Other income’ has been given in

Schedule 13 of the Annual report of this company, a copy of which

has been placed on record by the ld. AR. `Other income’ include

Sale of scrap to the tune of Rs.2.05 crore and Interest, Insurance

claim and bad debts recovered etc. The ld. AR has drawn our

attention towards bifurcation of sales of this company given at

page 161 of the paper book. For the year under consideration, this

company made sales of Powder products at Rs.3.42 crore, Scrap at

Rs.2.05 crore, Aluminum Tins and large size Rs.0.55 crore in

addition to Bimetal Bearings at Rs.35.17 crore. All these items

total up to Rs.42.06 corre. This figure of Rs.42.06 crore is

inclusive of Trading sales and Manufacturing sales. Out of such

total sales of Rs.42.06 crore, this company made sales of Bearings

at Rs.35.17 crore, which are similar to the product manufactured

by the assessee. Sales of Powder and Aluminum Tins & large size

etc. made is peculiar to this company alone inasmuch as the

18 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

assessee is not into manufacturing of any Powder and Aluminum

Tins and large size. What we are contemplating to compare is the

profit rate of the assessee’s manufacturing of bearings. Per contra,

the profit figure of this company, apart from trading, also includes

profit from the sale of Powder and Aluminum and large size. What

is the impact of profit from the sale of Powder and Aluminum and

large size on the overall profitability of this company is not

ascertainable, which renders it incomparable. The contention of the

ld. AR that comparability can be compromised under the TNMM

is not tenable. The Hon’ble Delhi High Court in Rampgreen

Solutions Pvt. Ltd vs. CIT (2015) 377 ITR 533 (Del) has held that

selection of comparables does not differ with the method adopted.

It held that comparables should be selected on the basis of

similarity, even under the TNMM.

namely, Manufacturing segment and Trading segment. Separate

profitability and benchmarking has been done for the Trading

segment. In order words, the extant Manufacturing segment is

exclusive of trading goods and has only the profit from the

manufacture and sale of bearing products. Thus, in order to make

19 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

a comparison of the Manufacturing segment with another

company, it is sine qua non that such other company should also

be engaged in manufacturing activity only of similar products or if

it is engaged in both the manufacturing and trading, then segmental

information qua the manufacturing segmental should be

discernible from its Annual report. It is observed that FMBIL is

engaged both into trading and manufacturing and further no

segmental information of its manufacturing segment is available

and the assessee has considered this company at entity level as

comparable with its manufacturing segment. Once the position is

such, we are unable to hold this company as comparable.

view that this company was rightly excluded by the authorities

below from the list of comparables on the ground of functional

differences. In view of the functional dissimilarity at the threshold,

there is no need to examine certain other factors taken note of by

the TPO making it incomparable. We, therefore, uphold the

exclusion of this company from the list of comparables.

+-5% margin in determining the ALP.

20 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

material on record. Second proviso to section 92C(2) provides that

if the variation between the ALP and the price at which the

international transaction has actually been undertaken does not

exceed the specified margin, which at the material time was 5%,

then the price at which the international transaction has actually

been undertaken shall be deemed to be the ALP. The effect of this

proviso is that so long as the difference between the ALP as

determined by applying one of the specified methods and the price

at which the international transaction was undertaken is within the

prescribed percentage, no transfer pricing adjustment can be made.

This proviso was substituted by the Finance (No.2) Act, 2009

w.e.f. 01-10-2009. Explanation to sub-section (2) of section 92C

has clarified : “that the provisions of the second proviso shall also

be applicable to all assessment or reassessment proceedings pending before the Assessing Officer as on 1st October, 2009”.

Thus, it is overt that even for the assessment year under

consideration, namely, 2009-10, the benefit of the second proviso

would be available by virtue of the Explanation given at the end of

sub-section (2) of 92C. We, therefore, hold that the ld. CIT(A)

was justified in extending the benefit of +/-5% margin in

21 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

determining the ALP of the international transactions. This ground

of the Revenue fails.

CIT(A) for inclusion of certain companies in the list of

comparables, which as per the Revenue are not comparable. Here,

it is relevant to mention that the ground is relevant only for the

Trading segment of the assessee company.

determine the ALP of the international transactions recorded by the

assessee under the Trading segment. The TPO tinkered with the

list of comparables drawn by the assessee for this segment which

led to the recommendation of the transfer pricing adjustment of

Rs.4.69 crore. The AO made this addition, which was challenged

by the assessee before the ld. CIT(A). The ld. first appellate

authority directed the TPO to include certain companies in the list

of comparables, which as per the Revenue are functionally

incomparable.

companies directed to be included by the ld. first appellate

authority, against which the Revenue has come up in appeal

22 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

before the Tribunal, are excluded, its profit margin would be

within the permissible range of +/-5%. The ld. DR candidly

accepted this proposition. In view of the rival but common

submissions, though we technically accept the ground of the

Revenue, but it would not lead to increase in the total income by

reason of any transfer pricing addition under the Trading segment.

of the Revenue is partly dismissed on merits and partly having

become academic.

Order pronounced in the Open Court on 07th June, 2019.

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

पुणे Pune; �दनांक Dated : 07th June, 2019 सतीश

23 ITA Nos.148 and 281/PUN/2017 INA Bearings India Pvt. Ltd.

आदेश आदेश क� आदेश आदेश क� क� �ितिलिप क� �ितिलिप �ितिलिप अ�ेिषत �ितिलिप अ�ेिषत अ�ेिषत/Copy of the Order is forwarded to: अ�ेिषत

अपीलाथ� / The Appellant; 1. ��यथ� / The Respondent; 2. 3. The CIT(A)-13, Pune 4. The Pr.CIT-1, Pune िवभागीय �ितिनिध, आयकर अपीलीय अिधकरण, पुणे 5. “C” / DR ‘C’, ITAT, Pune; गाड� फाईल / Guard file. / True copy // 6.

आदेशानुसार आदेशानुसार/ BY ORDER, आदेशानुसार आदेशानुसार

// True Copy // Senior Private Secretary आयकर अपीलीय अिधकरण ,पुणे / ITAT, Pune

Date 1. Draft dictated on 04-06-2019 Sr.PS 2. Draft placed before author 04-06-2019 Sr.PS 3. Draft proposed & placed JM before the second member 4. Draft discussed/approved JM by Second Member. 5. Approved Draft comes to Sr.PS the Sr.PS/PS 6. Kept for pronouncement on Sr.PS 7. Date of uploading order Sr.PS 8. File sent to the Bench Clerk Sr.PS 9. Date on which file goes to the Head Clerk 10. Date on which file goes to the A.R. 11. Date of dispatch of Order.

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