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Income Tax Appellate Tribunal, AHMEDABAD ‘D’ BENCH, AHMEDABAD
Per Pramod Kumar, AM:
By way of this appeal, the assessee appellant has challenged correctness of the order dated 28th October, 2016, passed by the Ld. CIT(A), in the matter of assessment, under section 143(3) of the Income Tax Act 1961, for the assessment year 2012-13, on the following grounds:
“1. The Honorable CIT(A) erred both in law and on facts in confirming an addition of Rs.37,67,667/- towards upward adjustment made under section 92CA in respect of transaction of sales of finish goods. It be so held now and addition of Rs.37,67,667/- be deleted.
The Honorable CIT(A) erred in law and facts in holding that interest was required to be charged by the assessee company from the AES in view of delay in realization of sales invoices beyond the credit period. It be so held now and addition made by way of upward adjustment be deleted.
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 2 of 8 3. The Honorable CIT(A) failed to appreciate the fact that the appellant has applied Transitional Net Margin Method (TNMM) as Most Appropriate Method (MAM) which takes care of all such cost like involvement of working capital and interest cost for the recovery of sales proceeds from debtors. Once the AO/TPO have accepted the Transitional Net margin Method (TNMM) as Most Appropriate Method (MAM), no separate adjustment for notional interest on delayed payment is required to be adjusted.
Reliance is placed on decision of jurisdictional Ahmedabad ITAT in case of Microink Ltd. v ACIT ITA No.2873/AHD/2010.”
We will take up all these grounds of appeal together.
To adjudicate on this appeal, only a few material facts need to be taken note of. During the course of assessment proceedings, the Assessing Officer noted that there is a delay in realization of sale invoices to the associated enterprises (AEs) inasmuch as many invoices have been realized beyond the normal credit period of 120 days from the date of the bill of lading. He was thus of the view that not charging interest on such delays in realization of dues on AEs call for an arm’s length price adjustment in respect of period of delay in realization of dues. Accordingly, an ALP adjustment of Rs.49,35,629/- was made. Aggrieved, assessee carried the matter in appeal but without much success. Learned CIT(A) confirmed the action of the Assessing Officer in principle but reduced the quantum of adjustment to Rs.37,67,667/-. The assessee is not satisfied and is in further appeal before us.
We have heard the rival submissions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
As Learned Counsel for the assessee rightly points out, the issue in appeal is covered, in favour of the assessee, by a series of orders passed by the co-ordinate benches, including in the case of Micro Ink Ltd. vs. Addl. CIT [(2016) 157 ITD 132 (Ahd)] wherein the co-ordinate bench has, inter alia, observed as follows:
“4. The relevant material facts, as necessary for our adjudication, are like this. The assessee before us is a leading ink manufacturer in India. The assessee has a wholly owned subsidiary in Austria, by the name of Micro Inks GmbH which, in turn, owns Micro Ink Co USA. This step down subsidiary (Micro USA, in short) manufactures printing ink by using the base material supplied by the assessee. The inks meant for US markets thus are mixed, and given finishing touches, by Micro USA. The assessee company also has trading subsidiaries in China and Hong Kong. During the relevant previous year, the assessee sold goods worth Rs 215.51 crore to Micro USA. The Transfer Pricing Officer, in the course of proceedings before the TPO, it was noted that the assessee has sold goods
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 3 of 8 worth Rs 215.51 crore to Micro USA and allowed it an average credit period of 186 days as against average credit period of 130 days allowed to independent enterprises, i.e. non-AEs. It was also noted that out of total exports made by the assessee, 45% exports was to Micro USA. On these facts, and the TPO being of the view that "in a third party situation, such an allowance of use of money would have been possible only upon charge of a cost", the TPO required the assessee to show cause as to why ALP adjustment in respect of excess credit period of 56 days not be made, by computing time value of money @ 6.38% on LIBOR plus basis. In response to this show-cause notice, it was, inter alia, explained by the assessee that what is exported to Micro USA is semi-finished material which is required to be further processed and converted into saleable product. In effect thus, export to Micro USA cannot be compared with export of finished products as was done to the independent enterprises. The assessee had also pointed out that "average credit period of third parties is 120 days whereas credit period granted to Micro USA is 135 days" though "actual highest average debtor days to third parties is 161 days whereas for Micro USA it is 186 days". It was also explained that considering the time taken in shipping the semi finished goods to Micro US, its processing in US, maintenance of inventory at US and credit realization time in US, the total cycle was about 210 days, but even if bare minimum period to complete a sale cycle is taken into account, it cannot be less than 170 days. It was thus pointed out that the average credit period to Micro USA, which was 135 days, was reasonable. On the basis of these arguments, it was submitted that no ALP adjustment is warranted in respect of, what was termed as, 'excess credit period' allowed to the Micro Ink USA. None of these submissions were accepted by the TPO. He was of the view that, taking 130 days as permissible interest free credit period, interest @6.38% should have been charged on the excess credit period of 56 (i.e. 186-130) days. An amount of Rs 2,10,95,346, computed on this basis, was proposed to be added to the income of the assessee as an arm's length price adjustment. The assessee did raise a grievance, against this ALP adjustment, before the DRP but without any success. The Assessing Officer, therefore, proceeded to make the addition of Rs.2,10,95,346, aggrieved by which the assessee is in appeal before us. We find that this issue is covered, in favour of the assessee, by a decision 5. of the coordinate bench in assessee's own case for the assessment year 2002- 03 [reported as Micro Inks Ltd. v. Asstt. CIT [2013] 144 ITD 610/36 taxmann.com 50 (Ahd.), While deleting similar addition, the co-ordinate bench had observed as follows: "20. The only other ALP adjustment in appeal before us is with respect to, what the authorities below have treated as, excess credit period allowed to Micro USA. This adjustment must be deleted for the short reason that it was part of the arrangement that specified credit period was allowed and thus the cost of funds blocked in the credit period was inbuilt in the sale price. There is no dispute that similar products are not sold to any other concern, at same price or even any other price, and interest is levied on the similar credit period allowed to those independent parties but not to Micro USA. The question of excess credit period arises only when there is a standard credit period for the product sold at the same price and the credit period allowed to the associated enterprises is more than the credit period allowed to independent enterprises. That is not the case here. The credit period for finished goods cannot be compared with credit period for unfinished goods
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 4 of 8 and raw materials, and in any case, when products are not the same, there cannot be any question of prices being the same. Unless the prices of the product and the product are the same, and yet extra credit period is allowed, there cannot be any occasion for making ALP adjustment on the basis of the excess credit period. None of the authorities below have even disputed that the ingredients, raw materials and semi-finished goods sold to Micro USA are not sold to any other concern. The very foundation of impugned addition in arm's length price on account of excess credit period is thus devoid of any legally sustainable merits or factual basis. When all these factors were pointed out to the learned Departmental Representative, he did not have much to say except to place his bland but dutiful reliance on the orders of the authorities below. However, for the reasons set out above and in the absence of any comparative price and credit period figures on comparable product to support the case of the revenue, we uphold the grievance of the assessee and direct the Assessing Officer to delete this ALP adjustment. The assessee gets the relief accordingly." 6. Learned counsel for the assessee submits that the issue being squarely covered, in favour of the assessee and on admittedly similar set of facts, there is no occasion to reconsider the matter. We are urged to follow the said decision and delete the impugned adjustment. On the other hand, while learned Departmental Representative does not dispute that this issue is squarely covered by the aforesaid decision, he submits that the aforesaid decision is "severely flawed" as no matter what is the goods sold, "a credit period is a credit period". It is also submitted that "the credit period for sale of raw material to an independent manufacturer would be lower as the supplier does not have to factor the lead time for the sale of finished goods by the manufacturer" and that "the supplier is entitled to receipt of payment immediately on delivery irrespective of whether the finished goods is sold in the market, get spoiled in manufacturing or is damaged". He further submits that "it is by now acknowledged that granting of excess credit period is a service rendered to the AE and needs to be benchmarked". A reference is then made to Special Bench decision in the case of Aztec Software &Technology Services (P.) Ltd. v. Asstt. CIT [2007] 107 ITD 141/162 Taxman 119 (SB) (Bang.), in support of the proposition that merely by finding fault in the work done by the TPO, the adjustments cannot be deleted and that unless the ALP submitted by the taxpayer is specifically accepted, the appellate authorities, on the basis of material available on record have to determine ALP themselves. 7. We find that, as evident from audit report on form 3CEB (pages 39 to 52 of the paper-book), the arm's length price of exports to the AEs, including Micro USA, has been determined on the basis of the Transactional Net Margin Method (TNMM). By way of a note at page 51, it is specifically stated that "further, the said amount of Rs 2428.26 millions has also been determined/ computed by the assessee having regard to the arm's length price on application of Transactional Net Margin Method (TNMM), on aggregation of transactions, as prescribed under section 92C of the Income-tax Act, 1961". In this backdrop, we can usefully refer to the decision of Hon'ble Delhi High Court, in the case of Sony Ericsson Mobile Corpn. (P.) Ltd. v. CIT [2015] 374 ITR 118/231 Taxman 113/55 taxmann.com 240 (Delhi), wherein Their Lordships had, inter alia, observed as follows: "Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 5 of 8 would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction," 8. By way of an example, this aspect of the matter was then explained by Hon'ble Delhi High Court as follows: "An example given below would make it clear: Particulars Case 1 Case 2
Sales 1000 1,000
Purchase Price 600 500
Gross Margin 400 (40%) 500
Marketing Sale promotion 50 150
Overhead expense 300 300
Net profit 50 (5%) 50 (5%)
The above illustrations draw a distinction between two distributors having different marketing functions. In case 2, a distributor having significant marketing functions incurs substantial expenditure on AMP, three times more than in case 1, but the purchase price being lower, the Indian AE gets adequately compensated and, therefore, no transfer pricing adjustment is required. In case we treat the AMP expenses in case 2 as Rs.501-, i.e. identical as case 1 and AMP of Rs. 100 as a separate transaction, the position in case 2 would be:
Particulars Case 2
Sales 1,000
Purchase Price 500
Gross Margin 500
(50%)
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 6 of 8
Overhead expenses 300
Marketing expenses 50
Net profit 150 (15%)
It is obvious that this would not be the correct way and method to compute the arm's length price. The purchase price adjustments/set off would be mandated to arrive at the arm's length price, if the AMP expenses are segregated as an independent international transaction....." 9. By the same logic, even making an adjustment for interest on excess credit allowed on sales to AEs will vitiate the picture, inasmuch as what has already been factored in the TNMM analysis, by taking operating profit figure which incorporate financial impact of the excess credit period allowed, will be adjusted again separately as well. Of course, in the example used by Hon'ble Delhi High Court, the AMP expenses are deductibles in computation of operating profit but that does not make any material difference because the interest levy for late realization of debtors, being inextricably connected with the sales, is also part of operating income. In the case of Nirma Industries Ltd. v. Dy. CIT [2006] 283 ITR 402/155 Taxman 330 (Guj.), Hon'ble High Court has dealing with the nature of interest on debtors, held it to be integral to business income. The same is the principle for the transfer pricing cases to that extent interest is to be taken as integral to sale proceeds, and, as such, includible in operating income. When such an interest is includible in operating income and the operating income itself has been accepted as reasonable under the TNMM, there cannot be an occasion to make adjustment for notional interest on delayed realization of debtors. One can understand separate adjustment for excess credit period when the arm's length price for exports has been benchmarked on the CUP basis but not in a case when the arm's length price of the exports has been benchmarked on the basis of TNMM. The very conceptual foundation, for separate adjustment for delayed realization of debtors and on the facts of this case, is thus devoid of legally sustainable merits. 10. The other aspect of the matter is that a separate adjustment for delayed realization of debtors can, even in a fit case, can only be made only to the extent the credit period allowed to the associated enterprises is more than the credit period allowed to independent enterprise in respect of the same or materially similar transactions. In the present case, it is an undisputed position that semi- finished goods, as sold to Micro USA, is not sold to any other independent enterprises. The assessee did have trading transactions in respect of the finished goods with trading subsidiaries in China and Hong Kong but it is not even the case of the TPO that excessive credit period was allowed to these AEs vis-à- vis the credit period allowed to independent enterprises, nor any ALP adjustment has been recommended in connection with the same. This fact, if anything, shows that the credit period allowed to the AEs is comparable with credit period of non-AEs in respect of similar goods. To compare credit period in respect of finished goods with the credit period in respect of semi-finished goods, is, therefore, somewhat fallacious in approach and untenable in law. In our considered view, merely because there is a delay in realization of debts cannot be reason enough to make an addition as long as such a delay is peculiar to the
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 7 of 8 transactions with AEs. The adjustment before us is an adjustment to arrive at an arm's length price and unless there is something, more than sweeping generalizations as implicit in the arguments before us, to at least indicate that such a delay in realization of debts in similar transactions is absent in arm's length transactions, these adjustments cannot be made even when sales are benchmarked on CUP basis. The delay in realization of debts, resulting in a continuing debit balance, is not a stand-alone international transaction per se, but is a result of the international transaction as it only reflects that the related payment has not been made by the debtor. As for the learned Departmental Representative's stand that "the supplier is entitled to receipt of payment immediately on delivery irrespective of whether the finished goods is sold in the market, get spoiled in manufacturing or is damaged" would probably be valid in the perfect market conditions which are more of a myth than reality. The only other merit of this approach is its simplicity, or, to put it more appropriately, naivety. The real life trade and commerce is seldom so simple. It is not at all necessary that a payment is to be made as soon as goods or services are delivered. A call is to be taken by the vendor, in consultation with its client and based on the business exigencies, as to what should be the terms on which payments for the supplies is to be made. It is a harsh commercial reality that immediate payments are more of exceptions rather than rule, and more so in a complex case in which the assessee is sole vendor and the very existence of the buyer is to process the semi-finished goods and sell it to the end buyers. Many factors, such normal business practices and the commercial exigencies, influence the fact of payment in respect of a commercial transaction. Whether a payment is made immediately by the AE or is made after six months cannot, therefore, be seen in isolation with what is the position is with respect to similar payments due from non-AEs. The whole exercise of ALP adjustments is to neutralize the impact of inter se relationships between the AEs and it is, therefore, not the delay simplictor in payment but delay in payment vis-à- vis similar situations with non-AEs (i.e. independent enterprises) which is of crucial consideration. Such a comparison cannot be based on the hypothesis as to what would have, in the wisdom of the TPO, happened if assessee was to have similar transactions with non-AEs. The comparison has to be based on real transactions of similar nature, if at all such transactions have taken place. When no such transactions have taken place, as is the case before us, there is obviously no occasion of any comparison. The stand taken by the learned Departmental Representative, therefore, is not only quite detached from commercial reality but also wholly untenable in law. In any case, what can be examined on the touchstone of arm's length principles is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into. In this view of the matter, learned Departmental Representative's reliance on Aztec decision (supra) is of no assistance to the case of the revenue. The international transaction is exports of goods which has been benchmarked on TNMM basis and which is duly accepted by the TPO. In view of these discussions, and respectfully following the decision of the coordinate bench in assessee's own case for the earlier years, we uphold the grievance of the assessee and direct the Assessing Officer to delete the impugned ALP adjustment of Rs.2,10,95,346.”
ITA No.3543/Ahd/2016 Assessment Year: 2012-13 Page 8 of 8 6. We see no reasons to take any other view of the matter than the view so taken by the co-ordinate bench. Respectfully following the same, we uphold the plea of the assessee and delete the impugned ALP adjustment of Rs.37,67,667/-. That was the only issue agitated before us.
In the result, appeal is allowed in the terms indicated above. Pronounced in the open court on this 16th day of May, 2018.
Sd/- Sd/- Madhumita Roy Pramod Kumar Judicial Member) (Accountant Member) Dated: 16th May, 2018.
PBN/*
Copies to: (1) The appellant (2) The respondent (3) CIT (4) CIT(A) (5) DR (6) Guard File
By order
Assistant Registrar Income Tax Appellate Tribunal Ahmedabad benches, Ahmedabad