AFTON CHEMICAL INDIA PRIVATE LIMITED ,HYDERABAD vs. INCOME TAX OFFICER, WARD-1(2), HYDERABAD

Hence, the assessee preferred this appeal before us on several grounds. Grounds No. 1 & 2 are general in nature, Ground No. 3 relates to the enhancement of adjustment value in respect of distribution segment of the assessee. This ground is not pressed by the assessee. Ground No. 4 relate to the challenge the inclusion of four entities, namely, KPL International Limited, Golden Chemicals Private Limited, Hitech Specialities Solutions Limited and Hindage Oilfield Services Limited. At the time of arguments, learned AR gave up the challenge in respect of Golden Chemicals Private Limited and confined to the other three entities only. Ground No. 5 is also not pressed but it relates to the addition of 5% mark up on recovery of expenses. Ground No. 6 relates to the outstanding receivables; whereas Grounds No. 7 & 8 are consequential in nature.

Coming to Ground No. 4, it could be seen from the record that the assessee determined the margins at 4.68% by adopting Transactional Net Margin Method (TNMM) as the most appropriate method and OP/OR as the profit level indicator. Assessee selected thirteen comparables and all such thirteen comparables were rejected by the learned TPO holding that such comparables failed one filter or the other. Learned TPO conducted fresh survey, selected seven comparables which include KPL International Limited, Golden Chemicals Private Limited, Hitech Specialities Solutions Limited and Hindage Oilfield Services Limited. Learned TPO calculated the margins of the comparables at 6.64% and on that, suggested an addition of Rs. 1,78,67,231/-, which was rectified by the learned TPO to enhance it to Rs. 2,51,71,958/- by order dated 08/11/2018.

Learned DRP considered the objections of the assessee challenging the inclusion of KPL International Limited, Hitech Specialities Solutions Limited and Hindage Oilfield Services Limited on the grounds of functional dissimilarity, non-availability of segmental information and erroneous margin computation, and rejected the same. Hence, the assessee is before us.

Insofar as KPL International Limited is concerned, before the learned TPO, the assessee objected this entity by stating that KPL specializes in the marketing of products in India, mainly in the field of chemicals, polymers, and paper chemicals, sourced from globally acclaimed manufacturers apart from establishing joint ventures, distribution and business development centres as a part of its expansion plan to cover engineering products. It is further objected that though the KPL trades in products which are not comparable to petroleum additives, no segmental information is available. Further objection taken in this respect is that KPL is owning significant intellectual property rights and focused on sustainable development and renewable energy. Lastly, it was submitted that if for any reason the KPL has to be considered as a comparable its correct margin is 6.51% as against 6.64% as computed by the learned TPO in the show cause notice.

According to the learned TPO, KPL is mainly engaged in trading of specialty chemicals and polymers, which is similar to the functions of the assessee. In respect of the segmental information, learned TPO, after referring to the relevant financials found in the annual report of the company, found that as seen from the annual report, the trading of goods constitutes 97.5% of the revenue of the company and since the company is predominantly involved in the business of trading of chemicals, merely because KPL involves in sale of tea, refrigerant gas and wind power only to the tune of 2.5% such objection cannot be countenanced. In respect of the ownership of intellectual property, learned TPO referred to the profit and loss account and found that the intellectual property/rights possessed by the KPL had no bearing on the profit margins.

Learned DRP also referred to schedule 17 at Page No. 32 of the annual report of KPL and found that the total revenue from the traded goods, namely, chemicals, polymers and others is Rs. 206,16,55,588/- whereas the total revenue of the company is Rs. 211,56,02,943/- which establishes that 97.2% of the total revenue of KPL is from trading in chemicals and, therefore, the contention of the assessee that the KPL is functionally dissimilar or that the non-availability of segmental information is fatal to the comparability. Learned DRP also further found that the ownership of IPRs by the KPL has no impact on the revenue generation or profit margin, and at the same time, the assessee also failed to explain how the IPRs have impacted the profits earned. Learned DRP, however, directed the learned TPO to verify the computation of margin in the light of the figures furnished by the assessee and to take a view.

Before us, assessee submitted that inasmuch as the KPL is in the business of selling tea, refrigerant gas and wind power also, it is functionally not similar apart from the non-availability of segmental information makes it un-comparable. According to the assessee, a Co- ordinate Bench of this Tribunal in the case of Intoto Software India Pvt. Ltd., Vs. ACIT (2013) 35 taxmann.com 421 (Hyd. Trib) held that knowing fully well the difference between a product company and a software service provider, the learned Assessing Officer ought not to have taken the companies which are into both the product development and a software development service provider as comparable unless the segmental details are available, even if the companies pass the filter of more than 75% of revenue from the software service. He submitted that this view is upheld by the Hon'ble High Court of Andhra Pradesh in ITTA No. 233 of 2014. He further submitted that in the case of Intoto Software India Pvt. Ltd., (supra), three comparables, namely, Four Soft IT Solutions (India) Pvt. Ltd., Thirdware Solutions Limited and Flextronics Software Systems Limited, whose revenue from software development service and non-software development service was 81.07% & 18.93%, 78.31% & 21.69% and 85.13% & 14.87% respectively. On this ground, he submitted that this KPL has to be excluded.

Insofar as the findings of facts returned by the learned TPO and learned DRP are concerned, there is not much dispute. Both the authorities found that the assessee and the KPL are engaged in the business of sale of chemicals and polymers. Only difference is that apart from deriving revenues to a tune of 97.5% from the sale of speciality chemicals and polymers, KPL is also deriving revenue from the sale of products like tea, refrigerant gas and wind power to an extent of 2.5%. By no stretch of imagination can we say that the logic applicable to the entity engaged in both product and software development services is applicable to the entity engaged in sale of products. Assessee and KPL are engaged in sale of specified oils and apart from specified oils, the KPL is also selling some other product like tea and refrigerant gas etc., that too to the extent of a minuscule 2.5%. Even according to the learned DRP, it is 2.8%. There need not be any confusion between the dissimilarity of functions and dissimilarity of products. Function of both the assessee and the KPL is similar, namely, distribution of products. Even to the extent of 97.5% such products are also similar. Then, unless and until it is established by the assessee that a grave prejudice would be caused by comparing this company with the assessee or that the 2.5% revenue derived by KPL by the sale of other products, it is not fair for the assessee to seek the view taken in Intoto Software (supra), to be extended to the case of the assessee and KPL where both the companies are broadly in the sale of similar products and the additional product only secures 2.5% of the revenue. According to us, the view taken in Intoto Software (supra) has no application to the facts of this case. We accordingly uphold the findings of the learned Assessing Officer/ learned TPO and learned DRP in this regard and confirm the KPL as a comparable with the assessee.

Hitech Specialities Solutions Limited was objected by the assessee before learned TPO stating that this company is a trading business dealing in the distribution of speciality chemicals in India, with exclusive distribution rights for a number of leading global manufacturers, the company serves over 1,000 customers across several sectors, including Paint & Coating, Printing Ink, Lubricants, Leather Auxiliaries, Construction Chemicals & Adhesive, Personal Care, Food & Nutrition and other allied industries. Assessee’s case is that it is engaged in the distribution of petroleum additives which enhance the performance of automotive and industrial fuels, while Hitech Specialities supplies speciality chemicals which are used in paints and coatings industries and in agrochemicals as pesticides, fungicides, insecticides and herbicides, etc. Apart from this, assessee also complained against the computation of margin done by the learned TPO in the show cause notice at 10.65% instead of 9.31% which the assessee arrived at.

Learned TPO considered the principal business activities of Hitech Specialities and found that the company is engaged in trading of speciality chemicals, which is similar to the functions of the assessee; that as could be seen from the annual report, the trading of specialty chemicals used in paints is the only segment of the company, and inasmuch as the Hitech Specialities is predominantly involved in the trading of chemicals, there is no dissimilarity of functions. Learned TPO further found that on further verification, the computation of margin was found to be correct.

Learned DRP on a consideration of the submissions made before them noted that the Hitech Specialities is trading in specialty chemicals and functionally similar to the assessee. Learned DRP, however, directed the learned TPO to verify the computation of margin in the light of the figures furnished by the assessee and to take a view.

Before us also the assessee submitted that as could be seen from the profit and loss account of Hitech Specialities, this company is deriving Rs. 6,16,43,940/- from services like management fee and commission against the total revenues of Rs. 63,08,57,190/-, namely, revenue from the service is about 10% of the total revenue and, therefore, it is not a good comparable. There is no dispute that both the assessee and Hitech Specialities are in the distribution business, assessee dealing with petroleum additives and the Hitech Specialities dealing in speciality chemicals.

Firstly, there is no material before us to show that the management fee and commission derived by the assessee is altogether from a different segment and have nothing to do with the function of distribution of petroleum additives. Even the information furnished by way of the paper book also does not reflect on the functional difference of various segments if any, of this entity. Though the revenue recognition at page No. 844 of the paper book shows that revenue from sale of goods is recognized on transfer of all significant risks and rewards of ownership to the buyer, revenue from services is recognized on rendering of services to the customers, brokerage income is recognized when the receipt of the brokerage from the insurance companies becomes certain, dividend income is recognized when the right to receive payment is established and interest income is recognized on the time proportion basis. In the annual report, there is no information as to the functions performed and risks involved, in detail.

In the profit and loss account of this entity as stated above, the revenue from management fee and commission is shown as Rs. 6.16 crores as against the total revenue of Rs. 63.34 crores. It is, therefore, clear that Hitech Specialities is deriving income not only from the sale of traded/finished goods but also derives about 10% of revenue from the services like management fee and commission. The segmental information at Note No. 35 to be found at page No. 807 of the annual report reads that the entire revenue is from only one segment, without any detailed figures as to the profitability of the sale of product and sale of service. In these circumstances, we are of the considered opinion that it is unsafe to consider this entity as a comparable to the assessee. We, therefore, direct the learned Assessing Officer/learned TPO to exclude this entity from the final list of comparables.

Now coming to Hindage Oilfield Services Limited, objection of the assessee before the learned TPO was that this company is functionally dissimilar to the business of the assessee because as per Note 31. Segmental Reporting of Hindage Oilfield Services Limited, this entity is in the business of automotive and related components. Further grievance was that Hindage Oilfield Services Limited operates into diversified business and segmental details were not available. The sales from the car care product is 23.39% of the total trading sales whereas from the distribution of lubricants and additives, this entity was deriving the rest of the revenue. Lastly, it was contended that there was erroneous margin computation in respect of this entity.

Learned TPO brushed aside the objection relating to the dissimilarity of function stating that Hindage Oilfield Services Limited is also engaged in trading of additives, lubricants and car care products, which is similar to the functions of the assessee. Apart from that, learned Assessing Officer found from the annual report that the trading of additives constitute 81% of the revenue of the company. Learned TPO justified the computation of margin.

Learned DRP having considered the contentions raised by the assessee held that 84% of the sales of the revenue of Hindage Oilfield Services Limited is from trading of additives and the balance is from the sale of car care products. On this premise, learned DRP rejected the contention of the assessee, but on the aspect of computation of margin, directed the learned TPO to re-visit the issue and to rectify the error if any.

On a perusal of the Note 14 to the profit and loss account incorporated in the annual report of Hindage Oilfield Services Limited, we find that the total revenue of operations is from sale of traded goods and the details of the traded goods describe the products as additives, lubricants and car care products. The traded goods relate to the consumables of the automobile sector and absolutely there is no material before us to show that sale of car care products constitute a distinct segment for the purpose of separately mentioning the segmental information. As stated above, the distinction between the similarity of functions and similarity of products has to be kept in mind and an entity which is predominantly in the sale of the products that are sold by the assessee also, merely because they are selling some other type of the consumable of the same field, it cannot be said that such an entity is dealing with diversified functions and is expected to maintain segmentals for each and every product separately. TNMM subsumes into its fold all such minor variations, lest, Comparable Uncontrolled Price (CUP) would have been resorted to. It is not always possible to see that the comparable company is also so exactly similar to the compared company in its products, territorial operation, exact quantity so on and so forth.

Further, the view taken in Intoto Software (supra), cannot be made applicable to the comparison between the assessee and Hindage Oilfield Services Limited because there is no functional dissimilarity. Both the entities are engaged in the sale of traded products. There is slight variation in the description of the products. TNMM will take care of the variations. For this reason, we decline to interfere with the findings of both the authorities in respect of inclusion of Hindage Oilfield Services Limited as a comparable.

Now coming to Ground No. 6 in respect of the adjustment towards interest on receivables, on a perusal of the annual report of the assessee for the financial year 2014-15, the learned Assessing Officer found that there are trade receivables to the tune of Rs. 3,54,51,597/- and proposed to charge notional interest, for the purpose of tax at an average SBI PLR of 14.75% per annum. Contention of the assessee before the learned TPO and the learned DRP has been pleaded that the delay in receivables or deferred receivables would not constitute international transaction; that the receivables are not in the nature of ‘capital financing’ and would not constitute international transaction; that when the primary transactions are found to be at arm’s length, no adjustment could be made on account of deferred receivables; and that the receivables are closely linked with the principal transaction and not an independent international transaction.

Learned TPO placed reliance on the decision of the Delhi Bench of the Tribunal in the case of Bechtel India Pvt. Ltd., (in dated 16/05/2017) which in turn referred to the decision of the Hon'ble Bombay High Court in the case of CIT Vs. Patni Computer Systems (2013) 215 Taxmann 108 (Bom), wherein the amendment to Section 92B of the Act by Finance Act, 2012 with retrospective effect from 01/04/2002 was considered. Basing on the view taken in a number of decisions of the Tribunal of various Benches, learned TPO held that it is incumbent upon the taxpayer to separately benchmark the arm’s length price of the international transaction relating to interest on overdue receivables from the AE by way of analysis of functions, assets and risks. While following the view taken by the Tribunal in the case of M/s. Logix Microsystems Ltd. Vs. ACIT in I.T.A No.423/Bang/2009, dated 07/10/2010, learned TPO thought it proper to consider the SBI short term deposit rate as appropriate CUP to determine the ALP of the interest on outstanding receivables.

Learned DRP relied upon the same case law referred to by the learned TPO and also the decision of the Hon'ble High Court of Bombay in the case of PCIT Vs. Tecnimont (P) Ltd., (2018) 96 taxmann.com 223 and concluded that extending credit period beyond normal period of sixty days is in substance granting of loan to an AE so as to enjoy the funds, which the AE would otherwise have to repay within the period of sixty days and, therefore, extending credit period beyond the normal credit or agreed credit period would constitute a separate international transaction. Learned DRP, however, granted relief to the assessee to the extent of directing the learned TPO to compute the interest liability on payables on similar basis and adjust the same against the interest receivables.

We have gone through the findings of the authorities in the light of the submissions made on either side. In view of the view taken by the Hon'ble Bombay High Court in Patni Computer Systems (supra), on the amendment to Section 92B of the Act by way of Finance Act, 2012 with retrospective effect from 01/04/2002, it is not open for the assessee to agitate the question as to whether or not the interest on outstanding receivables is an international transaction requiring separate benchmarking. Only issue remains to be considered is in respect of the rate of interest, while placing reliance on the decisions reported in Tecnimont ICB House Vs. DCIT [2015] 60 taxmann.com 143 (Mumbai - Trib.), Hon'ble Bombay High Court in PCIT Vs. Tecnimont (P) Ltd., (supra) and CIT Vs. CottonNaturals (I) (P.) Ltd. [2015] 55 taxmann.com 523 (Delhi). Assessee prayed that LIBOR+200 basis points may be adopted. This aspect is no longer res integra and dealt with by the Mumbai Bench of the Tribunal in the case of Tecnimont ICB House (supra) and confirmed by the Hon'ble Bombay High Court. CottonNaturals (I) (P.) Ltd. (supra) is also on the same aspect.

Insofar as the interest on receivable is concerned, Munbai Bench of the Tribunal, vs. DCIT [2015] 60 taxmann.com 143 (Mumbai - Trib.) considered the view taken in Everst Kanto Cylinder Ltd. v. Asstt. CIT (LTU) [2014] 52 taxmann.com 395 (Mum.); PMP Auto Components (P.) Ltd. v. [IT Appeal No. 1484 (Mum.) of 2014, dated 22-8-2014]; Hinduja Global Solutions Ltd. v. Addl. CIT [2013] 145 ITD 361/35 taxmann.com 348 (Mum.); Tata Autocomp Systems Ltd. v. Asstt. CIT [2012] 52 SOT 48/21 taxmann.com 6 (Mum.); CIT v. Tata Autocomp Systems Ltd. [2015] 56 taxmann.com 206 (Bom.); Four Soft Ltd. v. Dy. CIT [2011] 142 TTJ 358 (Hyd.); and Everst Kanto Cylinder Ltd. v. Asstt. CIT (LTU) [2015] 56 taxmann.com 361 (Mum.) wherein the Hon'ble Tribunals has upheld use of LIBOR for the purpose of benchmarking loan/advance given to foreign AE's, and held that the notional interest has to be worked out for so called amount receivable from AE, by applying LIBOR interest rate for the purpose of computation of transfer pricing adjustment, if any. This view is affirmed by the Hon'ble Bombay High Court [2018] 96 taxmann.com 223 (Bombay) observing that in cases where any business enterprise is required to pay interest on delayed payment, it would examine the cost of interest and if the same is higher then the amount of interest payable on funds obtained locally, it would take a loan from local sources and pay the amounts payable for exports and expenses within time. Therefore, extending of credit beyond the normal period of sixty days is in substance a granting of loan to an AE so as to enjoy the funds, which the AE would otherwise have to repay within the period of sixty days. On this premise the Hon'ble High Court upheld the Tribunal computing interest at LIBOR rates as the rate prevailing in country where the loan is received/consumed by the AE by observing that the same cannot be faulted.

In the case of CIT Vs. CottonNaturals (I) (P.) Ltd. [2015] 55 taxmann.com 523 (Delhi) the Hon'ble Delhi High Court considered the question - whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, observed that such a question must be answered by adopting and applying a commonsensical and pragmatic reasoning and held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid; that the interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. It is further observed that the interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters; that the interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable; that the currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest. While referring to the Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115, the Hon'ble High Court held that the PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate and the PLR rates are not applicable to loans to be re-paid in foreign currency. Hon'ble Court accordingly held that whatever the principle that is applicable to the case of outbound loans, would be equally applicable to inbound loans given to Indian subsidiaries of foreign AEs, that the parameters cannot be different for outbound and inbound loans, and a similar reasoning applies to both inbound and outbound loans.

Respectfully following the judicial opinion stated supra, we are of the considered opinion that the ends of justice would be met by accepting the interest rate on similar foreign currency receivables/advances as LIBOR+200 points. We direct the learned Assessing Officer / learned TPO to adopt the same. Ground No. 6 is partly allowed accordingly.

In the result, appeal of the assessee is partly allowed for statistical purposes.