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Income Tax Appellate Tribunal, DELHI BENCH: ‘I-1’ NEW DELHI
Before: SHRI R. K. PANDA & MS SUCHITRA KAMBLE
PER SUCHITRA KAMBLE, JM This appeal is filed by the assessee against the order dated 30/08/2016 passed under Section 143(3) read with Section 144 C of the Income Tax Act, 1961 passed by ACIT, Circle-4(2), New Delhi for Assessment Year 2012-13.
The grounds of appeal are as under:-
“That the Ld. TPO and consequently DRP/AO has erred in law and on facts in the circumstances of the case in confirming the addition on account of arms’ length price under section 92CA(3) of the Income-tax Act amounting to Rs. 70,61,839/- on wholly illegal, erroneous and untenable grounds.
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The Ld. TPO as well as the DRP and consequently the AO have grossly erred in law and on fact of the assessee’s case in rejecting Resale Price Method (RPM) applied by the assessee as most appropriate method (MAM) for benchmarking the transaction of purchase of traded goods, on erroneous facts and reasons based on conjectures and surmises.
The Ld. TPO as well as the DRP and consequently the AO have grossly erred in law and on facts and in the circumstances of the case in erroneously: 3.1.1. Rejecting the scientifically run search process of the assessee without any reasons 3.1.2. Rejecting the assessee’s comparables for the trading segment of the assessee without giving any cogent reasons 3.1.3. Carrying out a fresh search process, and not giving the assessee such search process used against the assessee, which is against the principle of natural justice 3.1.4. Cherry Picking the comparables
The Ld. TPO as well as the DRP and consequently the AO have grossly erred in law and on the fact of the assessee’s case in considering Transaction Net Margin Method (TNMM) as the most appropriate (MAM) method for benchmarking international transaction of purchase of traded goods on an entity level.
The Ld. TPO as well as the DRP and consequently the AO have grossly erred in law and on facts in choosing new comparable companies which were different from the assessee both in the type of nature of activities and the functions performed, which is against the rules of comparability under Rule 10B(2) of the IT Rules.
Without prejudice to Ground 5, the Ld. AO/TPO and the Ld. DRP grossly erred in law in not appreciating that goodwill acquired &
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amortized via depreciation is an exceptional and non-operating item which required to be treated as such for making comparison of business segments.
The Ld. TPO as well as the DRP and consequently the AO have grossly erred in law and on facts in aggregating the trading and service segments for benchmarking transaction of purchase of traded goods which are functionally not similar and were separately benchmarked.
The order passed by the Ld AO/TPO/DRP based on conjectures and surmises is against the transfer pricing regulations & rules and is prayed to be quashed.
That the proposed addition of Rs. 70,61,839/- is bad in the law and is prayed to be deleted.
That the penalty proceedings initiated u/s Sec 271 (l)(c ) are on wholly illegal and untenable grounds since there was no concealment of any income nor submission of inaccurate particulars of income, nor any default according to law by the assessee.
That the interest charged u/s Sec 234B and 234C of the Act is on wholly illegal and untenable grounds and is prayed not to be upheld.
That each ground is independent of and without prejudice to the other grounds raised herein.
The appellant craves leave to add, amend, alter, change vary or substitute any of the aforesaid grounds or raise an additional ground.”
The assessee company was incorporated on 3/11/2011 and this is the first year of operation of the company. The assessee is a subsidiary of Bergen
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Engine, AS, Norway. The Company operates in India primarily in the business of supply of spare parts and other equipments used by engine based power plants and Oil & Gas Pumping System and also provides technical services in relation thereto. It also renders market support services and Project Management Services to its AEs. The assessee’s group companies include Rolls Royce Plc. and Rolls Royce Singapore Pte. Ltd. The assessee has entered into several international transactions with its AEs. The TPO has made an adjustment in the international transaction of purchase of traded goods. The assessee benchmarked this transaction using RPM as the Most Appropriate Method. The TPO rejected the use of RPM and adopted TNMM as the Most Appropriate Method. The TPO selected 7 comparables with an average OP/OI of 10.09% and made an adjustment of Rs. 70,61,839/- vide order dated 28.01.2016 only in respect of the transaction of purchase of the added goods. The other international transactions were held to have been conducted at ALP by the TPO and hence no corporate tax adjustment was in dispute. The assessee raised objections before the DRP and the DRP vide directions dated 12/8/2016 disposed of the same. The assessment order dated 30/08/2016 was passed thereby assessing loss of (-) Rs. 5,61,90,150/-.
Being aggrieved by the assessment order, the present appeal is filed by the assessee before us.
As regards Ground No. 2, relating to rejection of RPM for purchase of traded goods, the Ld. AR submitted that the assessee imported traded goods for subsequent sales to third parties in India without any value addition, RPM was considered as the most appropriate method (MAM). The RPM is considered as the most appropriate method in the transactions involving purchase made from an associated enterprise and resale to a non-associated enterprise, and there is very little or no value addition by the taxpayer which is the case of the assessee. The Ld. AR submitted that OECD in its Transfer Pricing guidelines state that, “It is generally accepted amongst most tax authorities that the RPM is
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applicable and preferable where the entity performs basic sales, marketing and distribution functions. (i.e. where there is little or no value added by reseller prior to the resale of the goods acquired from related parties). The Method is applicable even with differences in products, as long as the functions performed are similar.”
The Ld. AR relied upon the judicial pronouncement in case of Sanyo India Pvt. Ltd.(TS-368-ITAT-2014(Bang)-TP) wherein it is held that RPM is most appropriate method to benchmark pure trader activities with no value addition. Further, in case of L'Oreal India P. Ltd. [TS-376-HC-2014(BOM)-TP], it was held that RPM method is one of the standard method when the goods are purchased from AEs and there are sales effected to unrelated parties without any further processing. The Ld. AR submitted that the goods purchased from AE have been sold to third party without any value addition as evident from audited financials Note 19 wherein the revenue from operations has been shown from Sale of traded goods. Also there is no raw material cost incurred as evident from the Profit and loss account. This shows that no value addition has been done through further processing or manufacturing. The Ld. AR further submitted that the TPO basically accepts that assessee does not make any value addition to traded goods but somehow rejects RPM for other extraneous reasons without specifying how such reasons exist on the facts of the assessee. The Ld. AR further submitted that the TPO in the order accepts the nature of business of the assessee. The Ld. AR submitted that TPO rejected RPM by giving the reference of Rule 10B (1)(b) and stating that the assessee company had not adjusted all the functional differences and the differences in accounting practices between the international transaction and the comparables uncontrolled transactions, which may have materially affected the amount of gross profit. But the TPO has not given the specific reasons for the differentiation of functions between the tested party and the comparables chosen by the assessee, such that he has ignored the fact that the assessee company had already taken into account the functional as well as other
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differences between the tested party and the comparable companies while preparing the TP study which is reproduced here below:-
“Since, the above criteria were largely quantitative in nature, we applied qualitative criteria and manually checked each company on functions performed, assets employed and risk assumed analysis to be similar to that of the tested party.”
The Ld. AR submitted that the reasons given by the TPO for rejection of RPM as most appropriate method for benchmarking purchase of traded goods are very general in nature and are not relevant to the facts of the assessee’s case. The TPO has heavily relied on the OECD Guidelines 1995 which cannot be resorted to when the income tax law gives clear instruction on selection of most appropriate methods. The TPO has alleged the things which are not even claimed by the assessee. Some of the comments are mere repetition of what has been said earlier in the order. In effect, the whole order seems to be copy- paste of some other assessee without application of mind on the facts of the assessee’s case. Such as multiple year data, provision for doubtful debts etc. are not relevant in the case of the assessee. The TPO has mentioned all the possible situations of not applying RPM as Most Appropriate Method (MAM), however did not point out even single situation in case of the assessee as to why RPM should not be accepted as MAM. All the allegations of the TPO are general without any reference to the facts of the assessee’s case. The TPO did not dispute the fact that the assessee is a trader and admitted that assessee is engaged in the business of a distributor. The Ld. AR submitted that it is not open to the TPO to choose a different MAM for determining the ALP without assigning any cogent reasons. The Ld. AR relied upon the decision in case of Alumeco India Extrusion Ltd [TS-491-HC-2014-(TEL&AP)-TP] wherein it was held that where assesse had chosen most appropriate method, TPO must record reason for rejection of such method. The DRP issued directions that this ground of the TPO not considering the RPM method as the MAM was raised
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before DRP also in Ground 3. However, the DRP did not adjudicate on this objection specifically and rejected the objection of the assessee by generally discussing the activities of the assessee’s comparables and stating that RPM requires (sticker) comparability whereas TNMM is more tolerant of Functional differences. The DRP in para 4.2 of its order alleged that the assessee has not furnished complete detail of companies which have been excluded on the basis of different functional profit. This allegation of the DRP is not correct since the profile of the companies excluded is given in TP Study report. The detailed calculation of PLI is also given in the TP Study report only. The relevant extract of annual reports of these companies was also furnished before TPO/ DRP. The contention of DRP that TNMM is more tolerant to functional differences is not correct as per law. The Hon’ble Delhi HC in case of PCIT vs. Open Solutions Software Services P Ltd [2020] 315 CTR (Del) 497 (PB 316) by following Chryscapital decision held that while adopting TNMM, comparability of controlled international transaction with the uncontrolled transaction has to be seen in the light of the functions performed, taking into account the assets employed and risks assumed by the parties as per Rule 10B(2). These parameters cannot and should not be relaxed even while employing a method like TNMM, where the compared net margins of profit may be arguably unaffected by external factors surrounding the companies. It is a trite law that for the international transaction of purchase of traded goods from AE and re- selling to third party without any value addition, the most appropriate method shall be RPM. Various courts across the country have also appreciated this and upheld the same. Some of the rulings are as below: MATRIX CELLULAR INTERNATIONAL SERVICES PVT LTD [TS-1116-HC- 2017(DEL)-TP] Yamaha Motor India P Ltd [TS-546-HC-2016(DEL)-TP] Luxottica India Eyewear P Ltd [TS-532-HC-2015(DEL)-TP]- Topcon Sokkia India Pvt. Ltd [TS-340-ITAT-2020(DEL)-TP] Alcoa India Private Ltd [TS-1219-ITAT-2019(DEL)-TP]- Acer India Pvt. Ltd [TS-188-ITAT-2020(Bang)-TP]-
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Ecolab Food Safety & Hygiene Private Limited [TS-748-ITAT-2019(Mum)- TP]- Swarovski India Pvt. Ltd [TS-711-ITAT-2019(DEL)-TP]- A.O. Smith India Water Heating Pvt Ltd [TS-997-HC-2018(KAR)-TP]-
The Ld. AR submitted that the purchase of traded goods is a part of direct cost of the assessee thus should be benchmarked at gross profit level only. The Ld. AR relied upon the decision in case of Rosemount Tank Gauging India Pvt Ltd [TS-1136-ITAT-2019(PUN)-TP]. The Ld. AR submitted that the TPO in subsequent AY 2013-14 has accepted the Retail Price Method (RPM) adopted by the assessee for purchase of trade goods as evident from para 4 of TPO order and relevant extract of TP Study report. Therefore, following the stand adopted by the TPO in AY 2013-14, the rejection of assessee’s method in the year under assessment are erroneous and not in accordance with law. In the light of abovementioned facts and judicial precedents, it is requested that RPM be considered as the most appropriate method for benchmarking the international transaction of purchase of traded goods.
The Ld. DR relied upon the order of the TPO.
We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that the TPO did not dispute the fact that the assessee is a trader and admitted that assessee is engaged in the business of a distributor. RPM is one of the standard method when the goods are purchased from the AE’s and there are sales effected to unrelated parties without any further processing. In present assessee’s case, the goods are purchased from AE and are sold to third party without any value addition as evident from audited Financials Note 19 wherein the revenue from operations has been shown from sale of traded goods. There is no raw material cost incurred by the assessee which is evident from the Profit and loss account. Thus, there no value addition done through further processing or
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manufacturing. This factual aspect was not at all disputed by the TPO. The resale price method is to be adopted only when goods purchased from an AE are resold to unrelated parties and therefore, the present assessee must have taken RPM as most appropriate method (MAM). But Most appropriate method is ultimately selected for the purpose of determining ALP after benchmarking and correct selection of comparables. From the perusal of the order of the TPO and the observations of the DRP it can be seen that in present assessee’s case, in its search process the assessee selected engineering companies of various types and after excluding companies with insufficient financial information, the assessee was left with 97 companies. Thereafter, the assessee selected 37 companies with similar business activities/products. Thereafter, the assessee again excluded 24 companies on the basis of different functional profile. Finally, the assessee selected 3 comparables with an average gross profit margin of 29.89%. The assessee has not furnished complete details of the companies which have been excluded on the basis of a different functional profile. The assessee has selected 3 companies but these companies are engaged in a wide variety of activities even in their trading segment. For example, as per the information given in the assessee’s TP study, Batliboi Ltd. is engaged in trading in various types of machine tools. Similarly, Greaves Cotton is engaged in the business of various types of engines, gensets, agro equipment and construction equipment. Kirloskar Oil is also engaged in a wide variety of activities. The DRP was right in holding that the RPM requires stricter comparability whereas TNMM is more tolerant of functional differences. Merely, stating that the RPM is most appropriate method does not serve the purpose of selecting the comparability method. It should be more useful centric and should be meaningful while arriving at the appropriate ALP. Even if the assessee has applied qualitative criteria and manually checked each company on functions performed, still it lacks the actual functional similarities after going through the order of the TPO & DRP as well as the TP study report. As regards the case laws referred by the Ld. AR during the hearing, we have considered each case law cited before us separately and come to the conclusion
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that not a single decision is applicable in assessee’s case as facts of those cases are different and distinguishable. Thus, the contentions of the assessee failed to justify RPM as most appropriate method. Though the TPO in subsequent AY 2013-14 has accepted the Retail Price Method (RPM) adopted by the assessee for purchase of traded goods that cannot be treated as the threshold for allowing the correct appropriate method of benchmarking. In the present assessment year, there is no proper comparable available for allowing the RPM as the most appropriate method. In fact, the TNMM is proper in the present assessee’s case because the said method is tolerant of functional differences as well as it is adaptive in nature while benchmarking the other comparables. So the Transfer Pricing will be more appropriate by adopting TNMM. Therefore, the TPO as well as the DRP rightly rejected RPM as most appropriate method (MAM). Thus, Ground No. 2 is dismissed.
As regards to Ground No. 4 relating to objection for considering TNMM as most appropriate method over RPM, the Ld. AR submitted that the TPO has taken the TNMM as Most Appropriate method for benchmarking the purchase of traded goods by stating that “TNMM is the most, preferred‟ method in analyzing transactions (at the net level) as it is more tolerant to differences between the tested party and comparable uncontrolled transactions”.
The Ld. AR also relied upon the decision of the Hon’ble Delhi HC in case of PCIT vs. Open Solutions Software Services P Ltd [2020] 315 CTR (Del) 497. It was held by Hon’ble Delhi HC in case of Rampgreen Solutions Pvt. Ltd. 2015- TII-33-HC-Delhi-TP, that comparability under TNMM may be less sensitive to dissimilarities between tested party and comparables, however there cannot be the consideration for diluting the standards of comparable transactions/entity. Thus the TNMM though more tolerant to the minor differences between tested party and comparables, but it cannot take into account the functional differences between tested party and comparables arising due to operating in a different industry. In this respect, the Ld. AR submitted that the TPO has not
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considered that the Transactional Net Margin Method is mostly applied in the cases where, the tax payer enters into a transaction of purchase/sale of raw material, consumables or any other supplies with its associated enterprise where there is further processing or value addition before selling the final product, and not for the transactions relating to simple distribution of traded products involving no or little value addition and affecting only the gross profit margin of the selling company. In the present case, the assessee imported traded goods for subsequent sales to third parties in India without carrying out value addition, therefore, the RPM has been considered as the most appropriate method for the purpose of benchmarking the transaction of purchase of spares and accordingly the TNMM should not be applied. The Ld. AR relied upon the following judicial pronouncements of the various courts which held that RPM method overrules the TNMM method for benchmarking the transaction of purchase and resale of traded goods.
• Luxottica India Eyewear P Ltd [TS-532-HC-2015(DEL)-TP]- • St Jude Medical India Pvt Ltd [TS-67-ITAT-2016(HYD)-TP]-
The Ld. AR reiterated that the case laws quoted in Ground 2 above for RPM over TNMM should be taken into consideration. Therefore, the Ld. AR prayed that the Resale Price Method be accepted as Most Appropriate Method for benching the purchasing of traded goods and accordingly the TNMM applied on the same by the TPO be rejected.
The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. Since we have already answered the question as to which is the Most Appropriate Method (MAM) while dealing Ground No. 2 of the appeal and held that Resale Price Method taken by the assessee is not the Most Appropriate Method (MAM), the TNMM adopted by the TPO is correct. The contention of the assessee that there cannot be the consideration for diluting
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the standards of comparable transactions/entity, does not have practical approach as in the present case RPM fails the threshold of benchmarking while taking up the comparables which are not at all proper. Thus, the most appropriate method is TNMM as held by the TPO and the DRP. Hence, Ground No. 4 is dismissed.
As regards Ground No. 3.1.1 relating to objection to rejection of search process of the assessee, the Ld. AR submitted that out of 6 quantitative filters used by the TPO for the new search process, 5 filters are same as that of the assessee which has been used for obtaining the comparables in its TP study report, and in subsequent submission before TPO. The common filters are as under:
i) Use of current year data
ii) Reject companies having different financial year
iii) Reject companies where turnover is less than Rs. 1 crore
iv) Select companies where the ratio of service income to total income is at least 75%
v) Reject companies where related party transactions exceed 25% of sales
The filter which was not taken into account by the assessee company is relating to rejection of companies that are affected by some peculiar economic circumstances. It was not lawful for the TPO to reject the search process of the assessee without cogent objections with respect to the choice of filters and consequently the search process carried out by the assessee. A similar view has been upheld in M/s Frigoglass India Pvt. Ltd Vs DCIT [ITA No. 463/Del/2013] and ACIT vs. MSS India (P.) Ltd [ITAT-2009 -32 SOT 132- PUNE], establishing that the search process of the assessee cannot be rejected without cogent reasons.
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The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that out of 6 quantitative filters used by the TPO for the new search process, 5 filters are same as that of the assessee which has been used for obtaining the comparables in its TP study report. But while not taking into account one filter and rejecting the same, the TPO has not given any proper reasons as to why the said filter is not applicable. The TPO was not right in rejecting the said filter as the same is very much relevant for the search process of the assessee for arriving at the correct margin. Hence, Ground No. 3.1.1 is allowed.
As regards to Ground No. 3.1.2, relating to objection to rejection of assessee’s comparables, the Ld. AR submitted that the TPO rejected the assessee’s comparables stating functionally not similar. The assessee has chosen companies trading in tools and equipments for large industrial diesel engines that generate high/medium speed to be used in industrial applications, making them functionally similar to the assessee. Having rejected the assessee’s comparables on the basis of functionally not similar, the TPO subsequently stated in its order that the basis of rejecting the three comparables selected by the assessee namely Batliboi Ltd., Kirloskar Oil Engines Ltd. & Greaves Cotton is that these failed in the filter of total income from trading activity more than 75% revenue. Thus the reason of functional dissimilarity of these comparables does not hold good when read with TPO’s subsequent comments. However, without prejudice, the Ld. AR submitted that the TPO’s observation that the assessee’s comparables failed trading filter of 75% is erroneous, as the assessee has taken only the trading data of comparables for the benchmarking the transaction of purchase of traded goods which is also specified in the TP study and submissions of the assessee before TPO. The annual reports of assessee comparables showing that only trading data was used for benchmarking the transaction were before the TPO. The
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TPO overlooked the search criteria of the assessee and rejected such comparables in summary manner. The Ld. AR submitted that the 75% trading revenue filter is not required since the assessee considered only trading segment of these companies, thus 100% revenue is from trading activities. The Ld. AR relied upon the decision of Delhi ITAT in case of Vestergaard Asia Pvt. Ltd [TS-1020-ITAT- 2017(DEL)] where it was held that 75% service income filter not required since only service segment of comparable was considered. Thus, the assessee which is operating in trading of spares in engineering industry can only be compared with the companies operating in similar industry and not with the companies with automotive industry. The Ld. AR relied upon the decision of Toshiba India Pvt. Ltd (TS-123-ITAT-2009 (Del), wherein it was held that, the AO cannot make arbitrary addition without giving any reasonable ground for disregarding assessee’s transfer pricing analysis, such an arbitrary approach of the AO is not in accordance with law. Similar view was upheld in the decision of GE India Technology Centre Pvt. Ltd vs. DDIT (TS-768-ITAT- 2012 (Bang)-TP). The DRP in para 4.4 of its order alleged that the assessee has not furnished complete detail of companies which have been excluded on the basis of different functional profit. This allegation of the DRP is not correct since the profile of the companies excluded is given in TP Study report. The detailed calculation of PLI is also given in the TP Study report only. The relevant extract of annual reports of these companies was also furnished before TPO/ DRP. Thus, the Ld. AR prayed that the assessee’s 3 comparables be included in the final list of comparables.
The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that the detailed calculation of PLI is also given in the TP Study report only. The relevant extract of annual reports of these companies was also furnished before TPO/ DRP. The assessee has chosen companies trading in tools and equipments for large industrial diesel
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engines that generate high/medium speed to be used in industrial applications, making them functionally similar to the assessee. Having rejected the assessee’s comparables on the basis of functionally dissimilar, the TPO subsequently stated in its order that the basis of rejecting the three comparables selected by the assessee namely Batliboi Ltd., Kirloskar Oil Engines Ltd. & Greaves Cotton is that these failed in the filter of total income from trading activity more than 75% revenue. Thus the reason of functional dissimilarity of these comparables have been rightly justified by the TPO in the order. Thus, these comparables are not functionally similar in respect of the trading in tools and equipments for large industrial diesel engines to that of assessee company. Thus, Ground No. 3.1.2 is dismissed.
As regards Ground No. 3.1.3 relating to objection for not providing fresh search process to the assessee, the Ld. AR submitted that the TPO has erred in law and on facts for conducting a fresh search process without giving the assessee to the detailed search process to the assessee. Therefore, in that case the assessee is unable to submit its detailed objection to such search process applied, which is against the principles of natural justice. The Ld. AR relied upon the judgment of Exevo India Private Limited [TS-527-ITAT-2012(Del)] in which it held that, information unavailable to the assessee that is sought to be used for the assessee shall be shared with the assessee. A similar view has been upheld in the following judgments: • Colt Technology Services India Pvt. Ltd v Dy CIT • Sum Total Systems (India) Pvt. Ltd v ITO • Adobe Systems India Pvt. Ltd • Genisys Intergrating Systems India Limited • Ameriprise India Pvt. Limited v DCIT • First Advantage Offshore Services Pvt. Ltd. • Agilent Technologies Delhi
Considering the above facts and the case laws, the Ld. AR submitted that carrying out the fresh search process without giving the assessee the complete
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search process is bad in law and not warranted under chapter X of the Act hence, prayed to be rejected.
The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that since the search process given by the assessee is held as not correct by us in the abovesaid paras, hence, Ground No. 3.1.3 is dismissed.
As regards to Ground No. 3.1.4 & Ground 5 relating to objections to TPO’s comparables and cherry picking, the Ld. AR submitted that all the comparables taken by the TPO for benchmarking the transaction of purchase of traded goods is related to auto sector that is “provision of breaking part services” which is not at all related to the business of the assessee as assessee is admittedly engaged in the trading of spare parts used in engine based power plant which cannot be equated with the engine used in auto sector. Thus, all the comparables taken by the TPO are not at all comparables to the assessee company and shows that product criteria applied (if any) and the search process followed has not been on a scientific basis for obtaining companies comparable to the assessee’s trading segment and thus do not satisfy the criteria of Rule 10(B)(2) of the Income Tax Rules. The Hon’ble Delhi High Court in case of Li & Fung (India) Pvt. Ltd [2019-TII-169-HC-DEL-TP ] while following Rampgreen Solutions upheld the ITAT ruling in which it was held that a higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable arm's length price. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in profit level indicator must trigger further investigations/analysis. The Ld. AR submitted that the product criteria used by the assessee is correct which is evident from the fact that the TPO has asked the assessee to submit updated search process using the same products as used in TP Study report vide submission dated 21.09.2015 (PB 158-159). This
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shows that the TPO had no objections with the product criteria used by the assessee for obtaining comparables for trading segment. The specific objections in respect to each of the comparables of the TPO were already submitted before the TPO vide submission dated 20.01.2016 in response to SCN dated 14.01.2016. The Ld. AR submitted that none of the comparables chosen by the TPO satisfy the comparability criteria of Rule 10(B)(2) and accordingly prayed to be rejected.
Without prejudice, the companies selected by the TPO does not satisfy the 75% trading activity criteria of TPO itself as all the companies selected by the TPO are substantially or wholly manufacturing companies as objected by the assessee in its show cause reply dated 20.1.2016. The Ld. AR submitted that the DRP has not discussed the assessee’s specific objections of comparables and rejected the same by generally stating that RPM requires stricter comparability whereas TNMM is more tolerant of functional differences and referring the judgement of Hon’ble Delhi HC in case of Rampgreen Solutions Pvt. Ltd. 2015-TII-33-HC-Delhi-TP. The Ld. AR submitted that the Hon’ble Delhi HC in case of Rampgreen (supra) held that even KPO and BPO are not comparable due to functionally different even though broadly falls in services. Thus how can a manufacturing company be compared with the trading segment of the assessee in which there is extreme functional difference. The Ld. AR relied upon the judgment of Hon'ble jurisdictional Delhi High Court in the case of Chryscapital Investment Advisors (India) (P.) Ltd. Vs. DCIT reported in (2015) 376 ITR 183 (Delhi) wherein the Hon'ble High Court upheld the importance of functional comparability for determination of ALP. Similar view has been upheld by Hon’ble Delhi HC in case of PCIT vs. Open Solutions Software Services P Ltd. Thus, while under TNMM the sensitivity is reduced, the Ld. AR submitted placing reliance on Rampgreen Solutions Pvt. Ltd. (supra) that a trader of spare parts of engines used in the oil and gas industry cannot be compared with a manufacturer of engine parts which are used in an automobile. Thus, placing reliance on the decision of the Hon’ble Delhi HC and
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without prejudice to assessee’s our objections for TPO’s comparables which are primarily involved in manufacturing activity, the Ld. AR submitted that even if the gross profit ratio of these comparables is compared with the GP ratio of the assessee for benchmarking the transaction of purchase of traded goods, since RPM is the MAM then also the assessee would be at ALP. Thus even if comparables obtained by the TPO are retained but the RPM method is applied for benchmarking, then also the international transaction of purchase of traded goods shall be at ALP, as GP margin of comparable i.e. 36.93% is less than the GP margin of the assessee i.e. 43.21%.
The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. From the perusal of records it can be seen that the Ld. AR has contended that none of the comparables chosen by the TPO satisfy the comparability criteria of Rule 10(B)(2) and accordingly the contention of the Ld. AR that these comparables should be rejected appears to be genuine. But further, the Ld. AR contended that even if comparables obtained by the TPO are retained but the RPM method is applied for benchmarking, then also the international transaction of purchase of traded goods shall be at ALP, as GP margin of comparable i.e. 36.93% is less than the GP margin of the assessee i.e. 43.21%. Since we have already held that RPM is not the most appropriate method, we are not interfering with the comparables selected by the TPO. Ground No. 3.1.4 & Ground 5 are dismissed.
As regards to Ground No. 6 relating to objection to treating goodwill written off as operating in nature for computing operating PLI as per TNMM is concerned, the Ld. AR submitted that pursuant to the resolution passed by board of directors in Feb 2012, the Diesel Power Business of Rolls Royce India Pvt. Ltd. was purchased for a lump-sum consideration of Rs. 103.5 crore as against net assets purchased of Rs. 43.72 crore. The excess consideration of Rs. 59.78 crore paid on account of business purchase has been recognized as
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goodwill in the books of the assessee, to be amortized over a period of 5 years. Thus amortization of such goodwill arising on business purchase is an extra- ordinary event that needs to be adjusted for computing the PLI of the assessee company from routine business operations. It is settled law that extra ordinary expenses are not a part of the routine operations of the company, and therefore, cannot, by very nature be expected to recur, such that they would be reflective of business cycles comparable to other companies chosen for benchmarking and accordingly must be adjusted. The Ld. AR further submitted that the amortization of business purchase goodwill arising on purchase of a business is an extra-ordinary event in the business life cycle of a company that needs to be adjusted for computing the PLI of the assessee company. Extra ordinary items are not a part of the routine operations of the company, and therefore, cannot, by their very nature be expected to recur, such that they would be reflective of business cycles comparable to other companies chosen for benchmarking. Comparisons under the Transfer Pricing regime are to be carried out based on the FAR analysis. The assets employed in FAR means, physical assets/intangibles employed for operations. The Ld. AR submitted that as per the FAR analysis carried out in the TP Study. Assets employed, Goodwill has not been included, since it has not been used for regular business operations of the assessee. Thus, the same is not used for carrying out the normal business operations of the assessee or for undertaking international transactions, and it is to be treated as non-operating in nature. The amortization of goodwill, which was the difference between the costs of actual physical/tangible assets purchased and the price paid for acquiring a running business represents an intangible asset purchased. Goodwill is an intangible rather invisible asset which cannot be brought into FAR analysis while comparing the financial results of the entities since the contribution of intangibles cannot be computed. The purpose of TP analysis is to compare the like with like.
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24.1 The Ld. AR submitted that any exceptional item which effects the comparisons in an open market are required to be ignored/ excluded in case of Federal Mogul Automotive Products India Pvt. Ltd [TS-110-ITAT-2015-DEL-TP], the Delhi ITAT upheld the exclusion of extraordinary provisions and non- operating items for computing the PLI. The Ld. AR further submitted that mergers, acquisitions, demergers, spin-off, business reorganizations etc. are extra ordinary events and effect the normal profitability of the company, thus need to be adjusted to reflect the true comparability. The Ld. AR relied upon the case of American Express India P Ltd [TS-517-ITAT-2015(DEL)-TP]. Thus, in the light of the above mentioned facts, the Ld. AR it submitted that the goodwill amortized of Rs. 1,99,27,211/- is an extra-ordinary item of expense which affects the operating profitability for the period in which it is amortized and should be adjusted for computing the PLI of the assessee company, to be reflective of the routine operating business cycle. The same issue came before the Delhi ITAT in case of ST Ericsson India Pvt. Ltd [ITA no.609/Del/2015]. It is the case of the assessee that goodwill is on account of acquisition of units through slump sale under Business Transfer Agreement and assessee treated the same as non-operating expense. The ITAT allowed the appeal by directing the TPO to allow the claim after verification as the issue is covered in his case by DRP.
24.2 The Ld. AR submitted that the goodwill in assessee’s case is also due to slump sale under business transfer agreement. Further, the TPO has treated the amortization of goodwill as operating expenses by stating that “Therefore, in view of discussion in preceding paragraphs, the assessee claim of considering amortization of goodwill as a non-operating expense is not acceptable. The expense related to amortization of goodwill has been considered as an operating expense of the taxpayer.” The TPO has discussed the treatment of foreign exchange gain/loss and states that the income and expenses related to the operations related to the relevant financial year which are considered for the computation of operating margin of the comparables, and while goodwill is
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discussed to be non operating, the same has been disregarded by him. However, finally TPO seems to be accepting that amortization of goodwill is non-operating in nature and nothing to do with the operations of the company are excluded from operating revenues. Thus, the Ld. AR submitted that the TPO has already accepted in its comments that amortization of goodwill is a non operating expense as per the discussion therefore, finally treating the same as operating is contrary stand of the TPO, one which is not in accordance with the law and prayed not to be upheld. The Ld. AR submitted that the DRP is wrongly relied upon Section 32 of the Act. The DRP rejected the assessee’s objection stating that since the deprecation on goodwill is claimed on year after year, therefore this expenditure is cease to be extra ordinary in nature. In this regard, the Ld. AR submitted that the allowability of depreciation u/s 32 in the computation of taxable income under Chapter IV for Profits and Gains of Business and Profession of the Act, is different from the computational mechanism for the determination of arm’s length price (including PLI) given in Chapter X – for Special Provisions in relation to avoidance of tax under the Act, these being special provisions. Thus, claiming of depreciation on Goodwill (intangibles) accounted for due to a Business purchase under Sec 32 of the Income Tax Act cannot change the extra ordinary nature of Goodwill amortized in the Audited Financials as per the Companies Act, which is used for the computation of ALP (including PLI) under Chapter-X of the Act, as these are mutually exclusive.
24.3 The Ld. AR submitted that the assessee had also objected the treatment of goodwill as operating before the ITAT in AY 2013-14 wherein the Tribunal did not adjudicate this ground since the assessee had got the entire relief of TP adjustment without adjudicating this. Without prejudice to these submission the Ld. AR in respect of other grounds the assessee has given the calculation of PLI wherein it was pointed out that after treating the amortization of goodwill as non-operating as well as operating in nature by the assessee. As against the average PLI of the comparables of 10.09%, assessee PLI of the assessee is
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9.08% which is within +/-5% range as per the proviso to Sec 92C of the Act. Thus in the light of above mentioned provisions and judicial precedents, the Ld. AR submitted that the goodwill written off of Rs.1,99,27,211/- is an extraordinary expense which affects the normal profitability for the period in which it is amortized and should be adjusted for computing the PLI of the assessee company. Without prejudice to above, the Ld. AR submitted that the TPO has erred in law and on the fact of the assessee’s case by not allowing the depreciation adjustment it being a reasonable accurate adjustment admissible under Rule 10B(3) of IT Rules. In this regard, the Ld. AR submitted that the operating assets that generate revenue and are intrinsic to the day to day working / functioning of a company and are used for the carrying out of the operating business are the ones relevant for establishing comparability under Rule 10B(2) of the IT Rules, i.e. F A R analysis rule. If as per the FAR analysis the assets used by the tested party and the comparables are similar i.e. that comparability is established, then the effect of the consequential depreciation allowance on their PLIs respectively will also be similar. The TPO was requested that if he wishes to treat depreciation on goodwill as an operating item, then applicable adjustment as per rule 10B(3) should be allowed on account of depreciation because depreciation represents ‘assets employed’. In assessee’s FAR analysis, assessee has not depicted ‘goodwill’ in assets employed because ‘goodwill’ may result in increase in sales over the years but it certainly does not affect the operations which are required to be examined for the purposes of determining PLI of tested party for comparisons for TP analysis. The Ld. AR submitted that depreciation as percentage of cost or sales of assessee as compared with comparables clearly warrants adjustments and conveys that the ‘assets employed’ by assessee are highly disproportionate to the comparables. However, this has also not been accepted by TPO by referring to the provision of (i) safe harbour rules (ii) provisions of section 32 of the Income Tax Act. In this regard, it is to be noted that, Rule 10B(3)(ii) of the Rules mandates adjustment for material differences. In the present case, since reliable internal financial data for carrying out the comparability adjustments is available and
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the materiality and purpose of such adjustment are discussed at length above, the aforesaid adjustments are warranted as per Rule 10B(3) to establish the reliability of the results. A comparison of the percentage of depreciation expense incurred by the comparables as compared to their total expense (Depreciation/Total OC) vis-a-vis that of the tested party is done. The comparison shows that in case of trading and ancillary service companies, the asset base is very low, since manpower is the largest operating expense component. Thus, the high % in the tested party, is abnormal and on investigation based on FAR reveals a non-operating asset, the consequent effect of which in the PLI must be adjusted for a meaningful comparison.
24.4 Without Prejudice, to the assessee’s objections to the comparables selected in the final list of comparables by the TPO, a difference in the asset base under Rule 10B(2) should be adjusted as per Rule 10B(3), and if a reasonable adjustment cannot be made in the comparables, then in the alternate, it is necessary that, the effect of such expense be neutralized in both the tested party and the comparables. A comparative chart showing the difference in depreciation levels was submitted by the Ld. AR during the hearing of the appeal. The Ld. AR relied upon the decision of Schefenacker Motherson Ltd [TS-15-ITAT-2009(DEL)-TP] in which case, the Delhi ITAT held that depreciation resulting in significant differences in margin calculation could be excluded which conducting TP analysis and relying on ICAI Guidelines. The Ld. AR also relied upon the following decisions:
• M/s Qual Core Logic Limited vs Deputy CIT [2012] 52 SOT 574/22 taxmann.com 4 (Hyd.) • Sabic Research and Technology Pvt. Ltd. [TS-327-ITAT-2017(Ahd)] • Siemens Healthcare Diagnostics Ltd v. ACIT [(Year) 152 ITD 155] by the Ahd. ITAT • Siemens Healthcare Diagnostics Ltd v. ACIT (152 ITD 155) –Ahd. ITAT
The Ld. DR relied upon the order of the TPO and the order of the DRP
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We have heard both the parties and perused all the relevant material available on record. It is pertinent to note that the TPO has treated goodwill written off as operating in nature for computing operating PLI as per TNMM. The assessee while claiming of depreciation on Goodwill (intangibles) accounted the same for due to a Business purchase under Sec 32 of the Income Tax Act and submitted that the same cannot change the extra ordinary nature of Goodwill amortized in the Audited Financials as per the Companies Act, which is used for the computation of ALP (including PLI) under Chapter-X of the Act, as these are mutually exclusive. The Ld. AR submitted that the assessee had also objected the treatment of goodwill as operating before the ITAT in AY 2013-14 wherein the Tribunal did not adjudicate this ground since the assessee had got the entire relief of TP adjustment without adjudicating this. But the TPO has rightly pointed out that in assessee’s FAR analysis, assessee has not depicted ‘goodwill’ in assets employed. The reason given by the Ld. AR that because ‘goodwill’ may result in increase in sales over the years but it certainly does not affect the operations which are required to be examined for the purposes of determining PLI of tested party for comparisons for TP analysis does not have any bearing to support the case of the assessee. Therefore, this contention of the assessee fails. As regards to without prejudice argument of the Ld. AR has submitted the calculation of PLI of the assessee after treating the amortization of goodwill as non-operating as well as operating in nature. As against the average PLI of the comparables of 10.09%, assessee PLI of the assessee is 9.08% which is within +/-5% range as per the proviso to Sec 92C of the Act. Thus these submissions of the Ld. AR are more practical in nature and are accepted and it appears that the goodwill written off of Rs.1,99,27,211/- is an extraordinary expense which affects the normal profitability for the period in which it is amortized and should be adjusted for computing the PLI of the assessee company after taking into account whether the assessee claimed for depreciation or not on the goodwill. Therefore, we remand back this issue to the file of the TPO/AO for proper verification in light of the above findings. Needless to say, the assessee be given opportunity of hearing by following
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principles of natural justice. Thus, Ground No. 6 is partly allowed for statistical purpose.
As regards Ground No. 7 relating to objection for aggregating the trading and service segments for benchmarking the transaction of purchase of traded goods, without prejudice to above contentions, the Ld. AR submitted that the TPO has benchmarked the transaction of purchase of traded goods and correspondingly proposed an adjustment by aggregating the trading and service segment without appreciating the fact that purchase of traded goods is part of the trading segment, therefore the adjustment should be proposed by considering only the trading segment. The Ld. AR has given the working of TP adjustment by considering only the trading segment. The said working represent that if the TPO would have proposed the adjustment on the transaction of purchase of traded goods by considering only trading segment then the adjustment should be restricted to Rs. 64,14,301/- only instead of Rs. 70,61,839/- as originally proposed by TPO. Thus, without prejudice to the submission above, the Ld. AR prayed to restrict the TP adjustment to Rs. 64,14,301/- only and correspondingly deleted the excess adjustment of Rs. 6,47,538 (i.e. Rs. 70,61,839/- minus 64,14,301/-).
The Ld. DR relied upon the order of the TPO and the order of the DRP.
We have heard both the parties and perused all the relevant material available on record. From the perusal of the record, it can be seen that the TPO has benchmarked the transaction of purchase of traded goods and correspondingly proposed an adjustment by aggregating the trading and service segment without appreciating the fact that purchase of traded goods is part of the trading segment, therefore the adjustment should be proposed by considering only the trading segment. The Ld. AR has given the working of TP adjustment by considering only the trading segment. The said working represent that if the TPO would have proposed the adjustment on the transaction of purchase of traded goods by considering only trading segment
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then the adjustment should be restricted to Rs. 64,14,301/- only instead of Rs. 70,61,839/- as originally proposed by TPO. Thus, the contentions of the Ld. AR appears to be genuine but the same needs verification. Therefore, we direct the TPO to verify the same and if it is proper then to restrict the TP adjustment to Rs. 64,14,301/- only and correspondingly delete the excess adjustment of Rs. 6,47,538 (i.e. Rs. 70,61,839/- minus 64,14,301/-) as per due process of law and facts. Thus, Ground No. 7 is partly allowed.
As regards to Ground No. 8 relating to quashing of order passed by the AO/TPO/DRP, the Ld. AR submitted that the order is based on conjunctures and surmises and is against transfer pricing regulations and rules and same may be quashed. The Ld. AR submitted that the TPO observed in the order that the assessee has given certain arguments in support of retaining persistent loss companies. But the Ld. AR submitted that this issue was never dicussed in the assessment nor assessee filed any submissions for objecting use of this filter. Rather no comparable of the assessee was persistent loss making, thus, the TPO’s allegations are baseless. The Ld. AR further submitted that the TPO while supporting the use of current/single year data filter alleged that taxpayer has used multiple year data, which is totally wrong fact as the assessee himself used the current year data filter. The TPO reproduced the submission in support of multiple year data alleging that the same has been filed by the assessee, which is grossly incorrect. The assessee never filed such submission and no query in this regard was asked. This act of the TPO further strengthens the fact that TPO has done copy paste of some other assessee order without appreciating whether such issue was involved in assessee case or not. Such a casual approach by TPO is not warranted. At Page 17 onwards the TPO gave 5 page arguments for treating Forex gain/ loss as non-operating, and ended up concluding on pg.22 that Goodwill amortization is non-operating expense. This clearly shown non-application of mind while preparing the order. Moreover the TPO itself treated Forex loss as non-operating expense and the assessee did not object to the same. On Pg.39 the TPO accepts that the taxpayer is primarily in
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the business of trading of spare parts and other equipment used by engines based power plant and oil & gas pumping systems. However in the same para alleged that assessee and the comparable are in auto sector. How can the oil and gas extracting industry be equated to auto sector? The TPO at Pg. No. 8 of the order putting some market trends graph without specifying that how it is relatable to the assessee’s case. The TPO discussing the appropriate level indicator at Pg. No. 17-22 of the order without specifying that how it is relatable to the assessee case and the same has been pasted again at Pg. No. 32-37 of TPOs order. Most parts of the TPO order are repetition as evident from Pg.29 which is repetition of Pg.27. The above observations in the TP order demonstrate that the TPO passed his order without applying his mind as to the facts and circumstances of the assessee’s case. The objections was also filed before DRP, but DRP has not addressed the same in its order. Therefore, in view of above discussions it is evident that the TPO order has been made by non-application of mind, the Ld. AR prayed that the TP order, being bad in law, non-est and void-ab-intio, be quashed. In support of above prayer of quashed the order, the Ld. AR relied upon the judgment of Hon’ble Mumbai High Court in the case of CIT v. M/s. Maersk Global Service Centre (I) Pvt. Ltd. [ITA No. 692 & 693 of 2012] wherein the Ld. DR alleged that Transfer pricing order has in a short and cryptic order as he did not identify the parties / instances as comparable. The Ld. AR also stated that Transfer Pricing Officer blindly and boldly refused to carry out the exercise and thereafter passed an order in terms of section 92CA sub-section (3) thus the matter ought to go back to the Transfer Pricing Officer. However, the Hon’ble High Court dismissed this ground and does not allow the 2nd chance of inning to TPO and upheld the ITAT order. The Mumbai ITAT in the case of Supermax Personal Care Private Limited v. ACIT [I.T.A. No. 1840/Mum/2017] follows the above view of Hon’ble Mumbai High Court in the case of CIT v. M/s. Maersk Global Service Centre (I) Pvt. Ltd. [ITA No. 692 & 693 of 2012].
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The Ld. DR relied on the order of the AO/TPO and submitted that its valid order.
We have heard both the parties and perused the material available on record. The TPO while deciding the filters has given his own reasons and the same does not make an order bad in law or non-est & void-ab-initio in totality. The case laws cited before us are not applicable in the present case as the assessee’s factual aspect has been rightly pointed out by the TPO in the order which are not denied in toto by the Ld. AR and also not brought on record any contrary facts to that effect. Thus, the contention of the Ld. AR appears to be not correct. Hence, Ground No. 8 is dismissed.
As regards to Ground No. 1, 9, 12 & 13 are general in nature, hence, the same are not adjudicated.
As regards to Ground No. 10 & 11, the same are consequential in nature, hence not adjudicated.
In result, appeal of the assessee is partly allowed for statistical purpose.
Order pronounced in the Open Court on this 05th Day of February, 2021.
Sd/- Sd/- (R. K. PANDA) (SUCHITRA KAMBLE) ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated: 05/02/2021 R. Naheed
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