M/S CENTUM RAKON INDIA PVT LTD,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-2(1)(1), BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL BANGALORE BENCHES “A” BENCH: BANGALORE BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT BEENA PILLAI, JUDICIAL MEMBER ITA. No. 1964/Bang/2017 Assessment Year: 2009-10 M/s. Rakon India Pvt. The Deputy Ltd., Commissioner of #12, KHB Industrial Area, Income Tax, Yelahanka New Town, Circle 2(1)(1), Bangalore – 560 106. vs. Bangalore. PAN: AADCC2533L (Appellant) (Respondent) Appellant by : Shri Sandeep Chalapathy, CA Shri Kannan Narayanan, JCIT Respondent by : (DR) Date of Hearing : 17.08.2021 Date of Pronouncement : 01.11.2021 ORDER PER BEENA PILLAI, JUDICIAL MEMBER Present appeal is filed by assessee against order dated 14/07/2017 passed by the Ld.CIT(A), Bangalore-2 for assessment year 2009-10 on following grounds of appeal: “1. That the order of the learned Commissioner of Income Tax (Appeals) in so far it is prejudicial to the interests of the appellant is bad and erroneous in law and against the facts and circumstances of the case. 2. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in determining the ALP of international transaction at Rs. 32,77,99,833 /- 3. Comparables: 3.1. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in choosing M/s. Valiant Communication Ltd as a comparable entity ignoring the fact that M/s. Valiant Communication

Page 2 of 16 ITA No. 1964/Bang/2017 Ltd. is engaged in manufacture of full-fledged communication equipment whereas the appellant is manufacturing only components and the two entities are functionally different. 3.2. That the Commissioner of Income Tax (Appeals) erred in law and on facts in choosing Chemtrols Industries Ltd. as a comparable entity ignoring the fact that M/s. Chemtrols is engaged in manufacture of full-fledged communication equipment whereas the appellant is manufacturing only components and the two entities are functionally different. 3.3. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in choosing M/s. Ruttonsha International Rectifiers Ltd as a comparable entity ignoring the fact that there was an amalgamation during the year ended 31' March 2009 and the value of related party transaction is not determinable. 3.4. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in rejecting M/s. Kelton Components Complex Ltd on the ground that the related party transactions are high and such a finding is perverse as not being supported by any e -nces on record. 4. Determination of net margin : 4.1.That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in not treating foreign exchange gain / loss as a part if operating income / cost. 4.2. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in adopting the operating profit after depreciation even though the method of providing for depreciation is different and other circumstances exist to justify the adoption of profit before depreciation. 4.3.That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in not excluding the excise duty from the operating cost. 4.4. Without prejudice to ground no. 4.1 to 4.3 above, that the learned Commissioner of Income Tax (Appeals) ought to have taken the least net margin earned by a comparable entity as the ALP margin and not the average of net margin earned by the comparable entities. 5. Determination of ALP: 5.1. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in determining the operating cost for the appellant at Rs. 29,14,03,532/- 5.2. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in not determining the operating cost attributable to the international transaction of Rs.21,72,75,320/-

Page 3 of 16 ITA No. 1964/Bang/2017 5.3.That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in determining the operating cost at Rs. 29,14,03,532/- which included the operating cost attributable to non- international transactions. 5.4.That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in not adopting multiple year data. 5.5. That the learned Commissioner of Income Tax (Appeals) erred in law and on facts in adopting the data available at the time of Transfer Pricing proceedings even though such data was not available on or before the specified data. Each of the above grounds is without prejudice to one another and the appellant craves leave of the Income Tax Appellate Tribunal, Bangalore to add, delete, amend or otherwise modify one or more of the above grounds either before or at the time of hearing of this appeal.” Brief facts of the case are as under: 2. The assessee is a company and is engaged in manufacturing and supply of electronic components like Frequency Controlled Products (FCP) and resistor networks catering to the communications, military, aerospace and industrial electronic markets. The FCPs are primarily used in Telecom, Space and Defense segments. The crystal oscillator is one of the FCP. This crystal oscillator is the main product manufactured by the appellant and there are various kinds of oscillator. A crystal oscillator is an electronic oscillator circuit that uses the mechanical resonance of a vibrating crystal of piezoelectric material to create an electrical signal with a precise frequency. 3. During the year under consideration the assessee entered into following international transactions with Associated Enterprises. Export of FCPs Rs. 21,72,75,320 Import of Raw material Rs.11,45,85,225 Payment towards R & D service Rs.1,28,40,140

Page 4 of 16 ITA No. 1964/Bang/2017 Import of capital equipment Rs.13,86,63,257 Payment of interest Rs.20,80,931 Total Rs.48,54,44,873

Subsequently the Ld.TPO finalised the following 5 comparables with average margin at 12.49%. Comparable PLI (OP/OC) Gujarat Poly-Avx Electronics Ltd. 0.78% Incap Ltd. 6% Ruttonsha International Rectifier Limited 15.43% Valiant Communication Limited 33.93% Chemtrols Industries Limited 6.33% Average PLI (OP/OC) 12.49%

Page 5 of 16 ITA No. 1964/Bang/2017 The Ld.TPO thus determined the Arm’s Length Price (ALP) of the international transaction as under: Particulars Amount Operating Cost 29,14,03,532 Arm's Length Mean Margin /- Arm's Length Price (12.49% of 12.49% Operating Cost) 32,77,99,833/- Price Received 28,13,67,374/- Shortfall being adjustment 4,64,32,459/- u/s 92CA

Page 6 of 16 ITA No. 1964/Bang/2017 7. The Ld.DR though objects for admission of the additional grounds, could not controvert the submissions by the Ld.AR. We have perused the submissions advanced by both sides in light of records placed before us. 7.1 The Ld.AR submitted that assessee seeks for exclusion of 3 comparables and inclusion of one comparable in Grounds 3.1 to 3.4: For Exclusion: Valiant communications Ltd Chemcontrols Industries Ltd. Ruttonshah International Rectifier Ltd. For Inclusion: Keltron Component Complex Ltd 7.2 M/s. Valiant communications Ltd & M/s. Chemtrols Industries Ltd The Ld.AR submitted that, this company cannot be taken as comparable as they are manufacturing telecom transmission equipment whereas the appellant is manufacturing only the components. It is clearly stated therein that Valiant is manufacturing telecom transition equipment and cards, which are full-fledged equipment that cannot be compared with the component like FCP. Chemtrols Industries Ltd is functionally different as it is engaged in manufacturing of scader, process controlled analytical instruments. Whereas, the assessee is a manufacturer of frequency controlled product, which are just components and not a fully assembled equipment.

Page 7 of 16 ITA No. 1964/Bang/2017 7.2.1 He submitted that the Ld.CIT(A) held that no two companies can be 100% identical functionally, and thus held that M/s. Valiant Chemtrols can be treated as comparable. 7.2.2 The Ld.DR relied on observation of Ld.CIT(A). We have perused the submissions advanced by both sides in light of records placed before us. 7.2.3 We note that, this Tribunal in the subsequent assessment year while considering similar argument in case of comparability of Bharat electronics Ltd, MIC Electronics Ltd., and Bharat Heavy Electricals Ltd, observed that a full fledged manufacturing companies cannot be held comparable with companies that are involved in manufacturing only components. Respectfully following the same we direct these comparables to be excluded from the final list. 7.3 Ruttonsha International Rectifier Ltd The Ld.AR submitted that, comparable was selected as a comparable by the appellant in its TP study and the same was accepted by the Ld.TPO. Subsequently it came to the notice that there was an amalgamation of M/s. Ruttonsha and Orient Semi- Conductors Pvt Ltd during the year and the same was acknowledged by the CIT(A). The assessee submitted that due to the amalgamation, M/s. Ruttonsha's profits resulted high. The appellant also submitted the details of the profits of M/s. Ruttonsha from AY 2007-08 to 2011-12 to show that the profits after the amalgamation was substantially high compared to the earlier years.

Page 8 of 16 ITA No. 1964/Bang/2017 7.3.1 The learned CIT(A) held that the profits of M/s. Ruttonsha before and after its amalgamation are in the same range therefore, it cannot be excluded from comparable. 7.3.2 The Ld.DR relied on observation of Ld.CIT(A). 7.3.3 We have perused the submissions advanced by both sides in light of records placed before us. We note that the impact of amalgamation on the international transaction has not been verified by authorities below, keeping in mind that functional dissimilarities have not been questioned by both sides. Accordingly, we direct the Ld.AO/TPO to verify the same and consider the comparable in accordance with law. 7.4 M/s. Keltron Component Complex Ltd The Ld.AR submitted that M/s. Keltron Component Complex Ltd was rejected by the Ld,TPO on the ground that the related party transactions are significant. The assessee submitted that the related party transactions of M/s. Keltron Component Complex Ltd are only 1.68 % therefore, it satisfies RPT filter and to be accepted as a comparable. 7.4.1 The Ld.CIT(A) simply held that the conclusion of the TPO in selection of comparables is final therefore, Keltron cannot be included as comparable. 7.4.2 The Ld.DR relied on observation of Ld.CIT(A). 7.4.3 We have perused the submissions advanced by both sides in light of records placed before us. It is noted that this company satisfies the RPT filter, however the same needs verification by the Ld.AO/TPO.

Page 9 of 16 ITA No. 1964/Bang/2017 Accordingly, we direct the Ld.AO/TPO to verify the same and consider the comparable in accordance with law. Accordingly Ground no. 3 stands allowed as indicated herein above. 8. Ground No. 4.1. Foreign exchange loss/gain: The Ld.AR submitted that while computing the net margins, the foreign exchange gains / loss should be taken as a part of operating income / expenses since it is related to the sales and purchases of FCPs and not related to any capital item. 8.1 The Ld.CIT(A) held that the appellant is unable to substantiate the above claim. Therefore, it was held that cannot be treated as part of operating cost/operating revenue. 8.2 The Ld.DR relied on observation of Ld.CIT(A). 8.3 We have perused the submissions advanced by both sides in light of records placed before us. The Ld.AR placed reliance on decision of Hon’ble Delhi ITAT in case of SSP India Pvt.Ltd vs. DCIT reported in (2015) 69 SOT 700 wherein the Tribunal observed and held as under:

“14 Having considered the rival submissions, we find that the issue is no longer res-integra and stands concluded by the decision of the Coordinate Bench in the case of Westfalia Separator India Pvt. Ltd. vs. ACIT ITA No. 4446/D/02 for Assessment year 2003-04 wherein it has been held as under: "We have heard the rival submissions and perused the relevant material on record. The forex gain or loss is the difference between the price at which an import or export transaction was recorded in the books of account on the basis of rate of foreign exchange then prevailing and the amount actually paid or received at the rate of foreign exchange prevailing at the time of actual payment or receipt. Since such forex loss or gain is a direct outcome of the purchase or sale transaction, it partakes of the same character as

Page 10 of 16 ITA No. 1964/Bang/2017 that of the transaction to which it relates. The Special Bench of the Tribunal in the case of ACIT vs. Prakash I. Shah (2008) 115 ITD 167 (Mum) (SB) has held that foreign exchange fluctuation gain is a part of export turnover. Though such decision was rendered in the context of section 80HHC, but the same logic applies generally as well. The essence of the matter is that any gain or loss arising out of change in foreign currency rate in respect of transaction for import or export of goods is nothing, but inherent part of the price of import or the value of export. The Hon'ble Supreme Court in Sutlej Cotton Mills Ltd. VS. CIT 116 ITR 1 (SC) has held that : 'where profit or loss arises to an asssessee on account of appreciation or depreciation ITA Nos.4446 & 4447/Del/2007 in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business'. When we read the ratio of the case of Sutlej Cotton (SC)(supra) in juxtaposition to that of the Special Bench in case of Prakash I Shah (supra), there remains no doubt that forex gain or loss from a trading transaction is not only an item of revenue nature, but is, in fact, a part of the price of import or value of export transaction, as the case may be. Operating expense is ordinarily an expense that a business incurs as a result of performing its normal business operations. As the business of 'Assembly' done by the assessee under this segment is not possible without purchases and forex gain is in relation to such purchase transactions, we have no hesitation in holding that it is an item of operating cost." 15 The learned DR during the course of arguments, supported the action of the authorities below only on the ground that DRP has rejected the contention of the appellant by observing as under: "The operating income/expenditure was never defined in any of the legislation so far. It was the conventional wisdom which went into the components of operating income/expenditure while calculating the operating profit. However, the position has changed since the notification of CBDT issued on 18.9.2013. This is the notification on 'Safe Harbour Rules'. Rule 10TA(j)(k) and (l) define the concept of "operating expense", "operating revenue" and "operating profit" respectively. According to this Rule, loss or income arising on account of foreign currency fluctuations are excluded from the calculation of "operating expense" and "operating income" respectively. Therefore the TPO was correct in excluding forex items from the calculation of operating profit. This objection of the assessee is rejected."

Page 11 of 16 ITA No. 1964/Bang/2017 16 We find that the aforesaid basis that foreign exchange gain/loss should be treated as non-operating item is based on the notification of CBDT issued on 18.9.2018 on safe harbour. However, such a contention has been rejected in the aforesaid order of the coordinate bench wherein it was held as under: "4.8. The ld. AR relied on Rule 10T(j) to contend that loss arising on account of foreign currency fluctuations cannot be included in the operating expense. We are not persuaded to give any mileage to the ld. AR on this count for the simple reason that Rule 10T is a part of Safe harbor rules notified on 18.09.2013 which are not applicable to the assessment year under consideration." 17 Moreover, we find that the Assessing Officer while computing the margin of the tax payer, has adopted the foreign exchange loss of Rs. 13,01,702/- as part of the operating cost; whereas while computing the margin of the comparables, he has treated foreign exchange gain/loss as non operating item which to our mind, is apparently contradictory and otherwise not in conformity with the aforesaid decision of the Tribunal. In light of the above, we direct the AO/TPO to treat the foreign exchange gain/loss as an operating item. As such, the ground raised by the appellant is allowed.” Respectfully following the above view, we direct the Ld.AO/TPO to treat the foreign exchange gain/loss to be operating income. Accordingly this ground raised by assessee stands allowed. 9. Ground No.4.2 Cash profits as PLI: The Ld.AR submitted that the net margin should be computed before depreciation in view of difference in accounting policy for depreciation and also in view of the fact that a large investments have been made during the FY 2008-09 in plant and machinery by the appellant. 9.1 The Ld.CIT(A) held that the said computation made by the TPO is as per law and is upheld. 9.2 The Ld.DR relied on observation of Ld.CIT(A). 9.3 We have perused the submissions advanced by both sides in light of records placed before us.

Page 12 of 16 ITA No. 1964/Bang/2017 The Ld.AR placed reliance on decision of coordinate bench of this Tribunal in assessee’s own case in ITA No. 472/Bang/2016 for assessment year 2011-12 by order dated 20/07/2018, wherein the Tribunal observed and held as under: “12. The next grievance of the revenue is that while determining the PLI, depreciation should be regarded as part of operating cost. We have heard the rival submissions of the parties in this regard. At page- 355 of the paper book filed by the Assessee, a chart showing the difference in the method of charge of depreciation by the Assessee and the comparable companies chosen by the TPO is given. Perusal of the same shows that there is substantial variation in the manner of charging depreciation by the Assessee and the comparable companies. The question therefore is as to whether the profits to be compared should be ignoring the depreciation charge/expenditure. An identical issue was considered by this Tribunal in the case of Honeywell Technology Solutions Lab v. DCIT, 61 SOT 61 GIRO) (Bang) wherein this Tribunal took the view following decision in the case of 24/7 Customer.com (P.) Ltd. v. Dy. CIT 12013] 140 ITD 344/[2012] taxmann.com 258 (Bang.), held that if there are differences in the method of charging depreciation between the Tested party and the comparable companies, then there would be impact on the operating profits and in such circumstances it is safe to consider PLI without considering depreciation as part of the operating cost. The Tribunal in the case of BA Continuum India Pvt Limited v. ACIT [2013] 28 ITR (Trib.) 445 (Hyd) took the view that depreciation had an impact on the profit margin of the assessee. The Assessing Officer was directed to use the profit level indicator as profit before depreciation, interest and taxes to recompute the arm's length price. 13. We are of the view that it would be just and appropriate to set aside the order of DRP and the final order of assessment and direct the AO/TPO to consider the determination of PLI by considering the ratio of the decisions referred to above.”

Respectfully following the same we direct the Ld.AO/TPO to consider determination of PLI by considering the ratio of decision referred herein above. Accordingly this ground raised by assessee stands allowed for statistical purposes. 10. Ground No.4.3. Exclusion of excise duty:

Page 13 of 16 ITA No. 1964/Bang/2017 The Ld.AR submitted that the excise duty paid on finished products should not be taken as a part of operating cost as it is reduced from the sale value in accordance with the Accounting Standard 11 issued by the Central Government and the Institute of Chartered Accountants of India. 10.1 The Ld.CIT(A) held that the issue is not elaborated therefore, the order of the Ld.AO is justified. 10.2 We note that this issue has not been considered and looked into by the authorities below. Both sides submitted that the issue may be remanded for verification by the Ld.AO/TPO. 10.3 We direct the Ld.AO/TPO to carry out necessary verification and to consider the claim in accordance with law. Accordingly this ground raised by assessee stands allowed for statistical purposes. 11. Ground No.4.4. Single most favourable comparable: The Ld.AR submitted that the ALP should be determined on the basis of a single comparable which is most beneficial to the appellant. Even a cursory glance at the Rule 10B(1)(e) would show that the comparison can be with reference to a single comparable uncontrolled transaction. There is no mandate that it is compulsory for an assessee to choose a number of transactions. The Ld.CIT(A) held that the computation made by the Ld.TPO is as per law and is upheld. We have perused the records based on the submissions advanced by both sides. We note that assessee benchmarked the transaction using TNMM as most appropriate method. In our view, in indirect method like TNMM, a reasonable number of comparable is an important

Page 14 of 16 ITA No. 1964/Bang/2017 factor to ensure that the results are truly representative of the segment to which the listed party belongs. In the present facts, there are multiple comparables already available to compute arms length. 12. Grounds 5.1-5.3 Determination of ALP: It is submitted that the Ld.AO determined the operating cost of the appellant at Rs. 29,14,03,532/-. The Ld.AR submitted that perusal of the profit and loss account would show that this is the total cost incurred by the appellant during the previous year ended 31" March 2009. It was submitted that out of the turnover of Rs. 27.95 crore, sum of Rs.21.72 crore is the value international transactions. The balance turnover is not in respect of international transactions. 12.1 The Ld.AR thus submitted that, any adjustment should be only with reference to that portion of the operating cost which is attributable/relatable to the international transactions. The appellant submitted a statement apportioning the operating cost to the international transactions and the apportionment has been made on the basis of the ratio of the turnover of the international and non-international transaction. 12.2 At the outset, the Ld.AR submitted that though the sale value involved in the international transaction was only Rs.21,72,75,320/-, the Ld.AO/TPO applied ALP margin on the total operating cost incurred with respect to entire sale of Rs.28,13,67,374/-. It is submitted that in assessee’s reply to the TPO notice, a specific objection was raised as far as selection of comparables and computation of net margins are concerned. made by the TPO is as per law and is upheld.

Page 15 of 16 ITA No. 1964/Bang/2017 12.3 The Ld.DR relied on observation of Ld.CIT(A). 12.4 We have perused the submissions advanced by both sides in light of records placed before us. The Ld.AR placed reliance on decision of coordinate bench of this Tribunal in IKA India Pvt.Ltd vs. ACIT reported in (2019) 101 taxman.com 276, wherein the Tribunal observed and held as under: “54. We have heard the rival submissions. The ld. counsel for the assessee reiterated submissions made before the CIT(A) that transaction with non-AE cannot be subject matter of determination of ALP because section 92 clearly speaks of determination of ALP only in respect of transactions with AE. He also referred to certain decisions of the Tribunal for the proposition that section 92 of the Act is not applicable to non-AE transactions. These decisions have already been extracted in the earlier paragraphs. The ld. DR relied on the order of the CIT(Appeals). 55. We have considered the rival submissions. The reasoning of the CIT(A) for considering the entire sales in manufactured finished goods segment for determination of ALP is that certain components and raw materials used in manufacture of finished goods are also sourced from AE and there is a possibility of the cost of such component having been bargained at a price which is not at arm's length. This presumption of the CIT(Appeals) is without any basis. He has not demonstrated with actual figures as to how there would be impact on profit margin on sale of finished products to AE because of purchases of some components from AE. He has given examples which are imaginary figures. Apart from this, the TPO has accepted that purchase of raw material and components by the assessee from its AE is at arm's length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only in respect of international transactions i.e., transactions with AE.”

Respectfully following the same we direct the Ld.AO/TPO to compute the ALP by considering the ratio of decision referred herein above. Accordingly this ground raised by assessee stands allowed.

Page 16 of 16 ITA No. 1964/Bang/2017 13. The additional Ground raised by assessee is in respect of considering the coorect margines of the comparable companies that are finally retained. 13.1 We direct assessee to provide the correct margines, which shall be considered by theLd.AO/TPO in accordance with law for determining the ALP of the international Transaction. Accordingly this ground raised by assessee stands allowed for statistical purposes. In the result, the appeal filed by the assessee stands allowed. Order pronounced in open court on 01st November, 2021.

Sd/- Sd/- (CHANDRA POOJARI) (BEENA PILLAI) ACCOUNTANT MEMBER JUDICIAL MEMBER Dated: 01st November, 2021. /MS/

Copy to 1. The Appellant 2. The Respondent 3. CIT(A) 4. Pr. CIT 5. DR, ITAT, Bangalore. 6. Guard File By order

Assistant Registrar Income-tax Appellate Tribunal Bangalore