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Income Tax Appellate Tribunal, “C” BENCH : BANGALORE
Before: SHRI CHANDRA POOJARI & SHRI GEORGE GEORGE K.
Per Chandra Poojari, Accountant Member This appeal by the assessee is directed against the order of the Assessing Officer passed u/s. 143(3) r.w.s. 144C(13) r.w.s. 92CA of the Income-tax Act, 1961 [the Act] dated 30.9.2016 for the assessment year 2015-16.
The grounds raised are as follows:-
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Ground of Appeal Tax effect 1. The AO/TPO has grievously erred in making and the DRP in upholding the transfer pricing adjustment of Rs.4,09,89,945/-to prices charged by your appellant. 2. The TPO has erred in rejecting the Comparable Uncontrolled Price ("CUP") Method adopted by your appellant as the most appropriate method for the determination of the Arm's Length Price and wrongly adopting Transaction Net Margin Method. The DRP has erred in upholding this rejection of CUP method and disregarding prices quoted by London Metal There is no tax effect Exchange ("LME") which is a global bench in the current year mark for commodity pricing since the assessed income has been set 3. The TPO has erred in not considering the off against losses under utilization of manufacturing capacities brought forward of your appellant and the resulting idle costs from earlier years. which have been wrongly ignored while However, computing your appellant's margins. The considering the DRP has erred in upholding the action of the applicable tax rates TPO. for AY 2015-16, the 4. The TPO has erred in the application of functional similarity filter while selecting 5 tax impact is Rs. wrong comparable companies, whose 1,32,99,188. business and operations have nothing in common with that of your appellant. The DRP has erred in upholding the same. 5. The TPO has erred in failing to apply the imports filter and by selecting companies which have NIL or minimal imports as comparable to your appellant who had major imports during the year. 6. Without prejudice to Ground 7 below, the TPO has erred in not considering IT Support and Maintenance charges of Rs.72,44,263/- as non operating in nature while computing the net operating margins of your appellant.
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The AO and DRP has erred in considering There is no tax effect Rs.72,44,263/-incurred towards IT Support in the current year and Maintenance charges as prior period since the assessed expenses even though the liability to pay the income has been set expenses crystallised only during the year off against losses based on invoices received from the vendor brought forward in the current year. from earlier years. However, considering the applicable tax rates for AY 2015-16, the tax impact is Rs.23,50,401/-. 8. Your appellant craves leave to add, amend, alter, vary and/ or withdraw any or all of the NA above grounds of appeal. 9. For these and other grounds that may be adduced at the time of hearing, it may be directed that the order of the learned ITO as NA upheld by the Hon'ble DRP be modified to the extent appealed against. Total tax effect Rs.1,56,49,589/-
The assessee company is engaged in the business of commercial production of slitting of Copper Alloy Coils as per customer specifications w.e.f. September 2012. The company is also engaged in the marketing of products made of Copper alloys manufactured by the holding company and other group companies.
The assessee filed its return of income on 30.11.2015, declaring a loss of Rs.2,37,34,753/-. During scrutiny assessment, the case was also referred to the Transfer Pricing Officer (“TPO”) who passed an order u/s 92CA of the Income tax Act, 1961 (“the Act”) proposing a transfer pricing adjustment of Rs.4,09,89,945/-. Consequently, the AO passed a draft
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assessment order on 03.12.2018 after making a corporate tax adjustment of Rs.72,44,263/- in addition to the transfer pricing adjustment of Rs.4,09,89,945/- proposed by the TPO.
On appeal, DRP issued its directions u/s 144C(5) on 26-07-2019 confirming the additions proposed by the AO in the draft assessment order. Accordingly, the AO vide order u/s 143(3) r.w.s 144C(13) r.w.s 92CA of the Act dated 30.9.2016 issued the final assessment order. Aggrieved by the said final assessment order, the assessee is in appeal before this Tribunal.
Ground No.1 is general in nature requiring no adjudication.
Ground No.2 is regarding rejection of Comparable Uncontrolled Price (CUP) method adopted by the assessee Price and wrongly adopting Transaction Net Margin Method (TNMM) disregarding prices quoted by London Metal Exchange ("LME") which is a global benchmark for commodity pricing.
The ld. AR submitted that as per the Guidance note on Transfer Pricing issued by the Institute of Chartered Accountants of India, typical transactions where CUP method can be used are as follows:-
a. Transfer of goods b. Provision of services c. Intangibles d. Interest on loans
Typical transactions where TNMM may be adopted are:
a) Provision of services b) Distribution of finished products where resale price cannot be adequately applied
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c) Transfer of semi-finished goods
The major international transaction undertaken by the appellant with its AE is with respect to Transfer of goods. Hence, CUP is the MAM to be adopted since TNMM is not applicable in the case of transfer of goods. In case of commission for marketing services, the appellant had used TNMM as MAM.
The ld. AR submitted that the OECD in its Transfer Pricing Guidelines (2017) observes as under:
Para 2.14 “The CUP method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. If there is any difference between the two prices, this may indicate that the condition of the commercial and financial relations of the AEs are not at arm's length, and that the price in the uncontrolled transaction may need to be substituted for the price in the controlled transaction.” 12. Further, revised OECD Transfer Pricing Guidelines (2017) has additionally incorporated the application of quoted prices under the CUP methodology while establishing arm’s length nature of commodities’ transfer between AEs. The guidelines have broadened the applicability of the CUP method and have alleviated the arm’s length determination for commodity transactions. Para 2.19 of the guidelines asserts, “Under the CUP method, the arm’s length price for commodity transactions may be determined by reference to comparable uncontrolled transactions and by reference to comparable uncontrolled arrangements represented by the quoted price”.
The steps involved in the application of this method are:
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i. Identify the price charged or paid in comparable uncontrolled transactions; ii. The above price should be adjusted for transaction level differences on the basis of functions performed, assets used and risks taken (FAR) analysis and enterprise level differences if any; iii. The adjusted price is the arm’s length price;
Reasonable and accurate adjustment can be made for differences in:
a. Type and quality of products b. Delivery terms c. Volume of sales and related discounts d. Product characteristics e. Contractual terms f. Risk incurred g. Geographical factors
TNMM method will be applicable to transactions that involve the provision of services or distribution of finished products where the resale price method cannot be adequately applied or in the instance of transfer of semi-finished goods. Hence, this method is not found appropriate for the international transactions presently under consideration. In view of the special circumstance of the case, net margin from the transaction will not be an appropriate method to determine whether the international transaction is at arms' length.
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Reason behind selecting London Metal Exchange [‘LME’] Prices as the Comparable Uncontrolled Price 16. According to the assessee, the LME is the world centre for the trading of industrial metals. The LME is the de facto price formation venue for industrial metals. The prices available on the LME platforms are used as the global reference and basis for physical trading as well as in valuation of portfolios. LME prices are trusted because the LME is the most liquid and the most traded industrial metals market in the world and its global network of warehouses ensures the price is truly effective of supply and demand.
The Company’s business is in products manufactured out of copper and copper alloy metals, which are commodities. The prices of copper which is the base metal for such products are determined based on market prices and the commodity stock exchange. Accordingly, the prices on the LME have been considered. The AE sources the raw material such as Copper Cathode from the metal traders and uses this for manufacturing the final product which consists of Melting, Casting, Hot Rolling, Milling, Annealing, Cold Rolling, Annealing, Pickling and final Cold Rolling. Some of these processes are performed multiple times to reach the desired Mechanical Properties and finish of the Strip, which is the final product. A presentation of the manufacturing process at Wieland Germany and Wieland India is filed in the paperbook.
Metal Price portion constitute substantial portion of the purchase consideration and all prices for transactions are fixed based on the metal price quoted on the LME. The fabrication cost, which is also a part of the purchase consideration, is not significant and accordingly, the same has been compared with the rates charged to unrelated parties. The metal price is fixed between the Company and the AE based on the LME prices for a particular metal/ alloy prevailing around 3 weeks prior to the scheduled despatch date. As LME prices are independent and are determined based
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on market factors, the same has been considered for the purpose of determining the arm’s length price of the transactions.
The AE charges non-associated enterprises also based on the LME rates. LME rates are accepted worldwide and all trades are initiated based on LME rates only. LME provides the most reliable price at which uncontrolled comparable transactions are entered into since it is an independent organisation. Thus, the external CUP, by way of LME prices, was chosen as the basis of determination of the transaction price in the instant case.
Computation of LME as considered in the TP documentation
The price available on the LME website is the price of the base metal. These prices are available for the four base metals viz., Copper (Cu), Zinc (Zn), Tin (Sn) and Nickel (Ni). Historical data of LME prices are available for a cost on the website of LME. However, this is available readily on the website of the AE of the appellant. (www.wieland.com/Metalinfo).
These prices are then used by the AE in arriving at the prices of 21. alloys which is manufactured and sent to the Indian company. There are several varieties of alloys, brass, special brass, bronze, etc. The prices charged by the AE is based on the LME prices of the respective metals used in a particular alloy. In this connection, certain sample copies of purchase invoices, along with the metal calculation sheets were filed with the TPO and DRP. This is available in Pages 275 to 294 of the Paperbook.
Prices charged by AE
It was submitted that Wieland India is engaged in commercial slitting of copper and copper alloy coils as per customer specifications. The
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Company also markets semi-finished metal products manufactured by its holding company and other group companies. The activities and functions of the AE includes sourcing of raw materials, i.e., the metal, manufacture of copper/ copper alloy coils, carrying out quality tests and finally exports the copper/ copper alloy strips to the appellant. It thereafter slits the copper alloy strips as per customer specifications and despatches it to the end customer.
As mentioned in the Transfer Pricing Documentation, the basis of pricing is given below:
• The price charged by the AE for the material imported by Wieland India consists of 2 elements, viz., ‘Metal Price’ and ‘Fabrication Price’. • Metal Price = Alloy metal value based on the prevailing LME rate + Premium + Melting loss of 2%. • ‘Premium’ is the addition in price over and above the cash seller settlement price published on a daily basis by the LME paid by metal fabricators to virgin metal suppliers. It is a part of the purchase price of the AE. • ‘Melting loss’ is the loss when an alloy is cast using virgin metal of the constituents of the alloy. • Fabrication Price = Cost of manufacturing/ processing + overheads + financial expenses + profit of the AE
The major component of cost is the metal alloy cost, which is considered based on the LME prices.
As given in the TP documentation (Pages 81-87 of the Paper book), the base metal price was bench marked against LME prices. As regards
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fabrication price, the appellant had furnished detailed workings of prices charged to unrelated parties in pages 40-45 of the TP documentation (Pages 88-93 of the Paper book). It contains information with respect to physical feature of the commodity sold. Since the data involved is very voluminous, the Appellant had not included all the other information in the TP documentation. This was only to establish that adequate margins were earned by the appellant on these transactions. The Company had also submitted a few sample invoices raised by Wieland Germany on other unrelated parties for sale of similar materials to them (Pages 295 to 304 of the Paper book). As can be seen from it, the prices charged to the Company and the other unrelated parties are on similar terms (Delivery at Terminal). The Appellant places reliance on judgements in the case of Hindalco Industries Ltd. Vs ACIT ([2015] 62 taxmann.com 181 (Mumbai – Trib), LME prices were considered as a benchmark and CUP was accepted as MAM for purchase of Copper concentrates. In this case also, treatment charges were charged by the AE. Similarly it was held in ACIT Vs MSS India Private Limited (ITA No. 393/PN/07). The relevant observations are as follows:-
“24. In our considered view, once it is not in dispute that the billing by the AE for raw materials supplied to the assessee is done on the basis of the London Metal Exchange prices plus certain mark up, there is no further need of the internal comparables since London Metal Exchange, being an independent organization entering into transparent and arm’s length transaction with a number of other organization, provides the most reliable prices at which uncontrolled comparable transactions are entered into. The comparable prices of uncontrolled transactions are available in the public domain and in fact these comparable prices are the prices which are the basis of prices at which the international transactions have been entered into with the associated enterprises. The only variation, which was between 2% to 6%, in these prices is the mark up factor and that mark up is attributed to the costs of ‘ significant service in
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procuring the raw material' and ‘freight and insurance which is paid by the associated enterprise'. There is no dispute about this position as evident from the observations made by the Transfer Pricing Officer himself. It is not even the case of the revenue authorities that the consideration paid by way of this mark up is excessive or unreasonable vis-à-vis, to use the words of the Transfer Pricing Officer, ‘significant services provided in procuring the raw material' and ‘freight and insurance costs'. One of the objection taken by the Transfer Pricing Officer is that the service charges charged by the AE from other uncontrolled transactions is not available but then it is nobody's case that the AE is engaged in providing similar services to unrelated enterprises. The external CUP, by way of London Metal Exchange prices, is the basis of determination of transaction prices and all that the Transfer Pricing Officer is to see is whether the variation in such prices vis-à-vis the prices at which the assessee has entered into transactions with the AE is reasonably explained. As a matter of fact, Rule 10B(1)(a)(ii) categorically provides that price charged for the property transferred in comparable uncontrolled transaction, which London Metal Exchange price inherently is, to be ‘adjusted on account of differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market”. What is translates into, on the facts of the present case, is that the adjustment on account of services rendered by the AE and the insurance and freight costs are required to be made to the LME prices. An adjustment of 2% to 6%, for such factors, cannot be said to be unjustified. ………………………
As long as the assessee has entered into raw material purchase transaction with the AE at an arms length price, it is of no consequence whether or not the assessee makes sufficient profits on manufacturing products from such raw material. There are a number of factors governing the profits that the assessee earns in its business and merely because the assessee's business results are not showing profits, or showing lesser profits than industry averages, such profits per se cannot lead to the conclusion that
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purchase of raw material is not at an arm’s length price. On the given facts, particularly when the comparable uncontrolled prices of the raw materials are readily available, it is not at all necessary to jump to TNMM method. The only factor which has prevailed on the Transfer Pricing Officer in rejecting the method adopted, or canvassed, by the assessee is the fact that the assessee has incurred loss in the relevant previous year, but, in our humble understanding, such a consideration is wholly irrelevant. The Transactional Net Margin Method, on a conceptual note, is described as one of the method of last resort and is put into service only when no standard or traditional method of ALP determination is appropriate for determination of arm’s length price. ……………………
As long as the prices at which international transactions are entered into are arm’s length prices, it is hardly relevant whether or not the AE has ensured that the assessee makes reasonable profits. As much as hypothetical independence of the transactions it does not permit artificially low profits by manipulating prices at which transactions are entered into by the associated enterprises, it does not also require that the transactions must also be entered into such a manner as to ensure that the assessee must make reasonable profits. The question of reasonableness or profits is relevant only when transaction profit methods are applied, but such a situation arises only when standard or traditional methods fail. That is not the situation before us. We are in sesisn (sic) of a situation in which traditional method is not properly faulted with and the parameters necessary for application of the same are available. The consideration about lower profits having been earned by the assessee, even if that be so, are not at all germane to the occasion.
It is also submitted that CUP (based on LME prices) was accepted as MAM in AY 2014-15 by the TPO. Considering that there are no changes in facts in the current year, the TPO ought to have accepted CUP as the
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MAM for AY 2015-16 also and the import transactions should have been treated as at arm’s length price based on the CUP Method.
On the other hand, the ld. DR submitted that the DRP held the CUP method requires stringent comparability of controlled transaction with third party transaction. Even though CUP is the most direct and reliable method for comparison, it requires transactions which are very closely similar and comparable. In the instant case, the purchase transactions of assessee with its AE for raw material (copper alloy coils) is the controlled transaction. The assessee proposed to compare the metal prices of LME. Hence at the outset, these two are not the same. The profit component can be different from company to company. Hence what is taken as comparable is pure metals indexed but what is being compared is totally different product. Hence, there are multiple variables like the type of metals mixed, ration of metal and fabrication process and the metal prices cannot be compared with alloy prices. In view of the above, it was submitted that the DRP rightly upheld the TPO's method of adopting Transactional Net Margin Method (TNMM) as the most appropriate method.
We have heard both the parties and perused the material on record. As per the documentation furnished for the assessment year under consideration, the assessee company has entered into the following international transactions with its Associated Enterprises (AEs):-
Particulars Method Amount (INR) 5028,12,442 CUP Purchase of materials - import (including goods in transit ) Income from sale of scrap 90,89,789 CUP Navision software implementation service 65,44,074 CUP Marketing services commission 126,89,937 TNMM 2,85,451 Compensation/ fee charged for Corporate Other guarantee method
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231,00,000 Investment in equity share capital (including Other securities premium) method IT Maintenance, Support & Services 85,90,787 Other method 1,45,210 Reimbursement of expenses incurred on Other behalf of the company method
The financials of the taxpayer for the FY 2014-15 as per P&L A/c are as under:-
Particulars Amount (INR) Revenue from operations (net) 6615,72,437 Other income 9,71,286 Total Revenue 6625,43,723 Expenses Cost of materials consumed 6232,97,320 Changes in inventories of metal alloy scrap 11,02,660 Employee Benefit Expenses 127,12,880 Finance costs 4,25,572 Depreciation and Amortization Expense 108,06,113 Other Expenses 333,40,777 Total Expenses 6816,85,322 Profit/ (Loss) before tax (191,41,599)
The financials of the taxpayer for the F.Y. 2014-15 as worked out by TPO are as under:-
Particulars Amount (INR) Revenue from operations 6615,72,437 Operating Income 6615,72,437 Total Expenses 6816,85,322 Less: Financial Cost 425572 Operating Expenses 6812,59,750 Operating Profit (196,87,313) OP/OR -2.98%
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Accordingly, the TPO made adjustment with regard to manufacturing segment as follows:-
Manufacturing Segment Particulars Formula Amount (INR) Taxpayer's operating revenue OR 66,15,72,437 Taxpayer's operating cost OC 68,12,59,750 Taxpayer's operating profit OP -1,96,87,313 Taxpayer's PLI PLI=OP/OR -2.98% A=[(100+PLI)*1.03]-100 (+)3% of the Taxpayer's margin -0.07% Mean Margin of comparable set B 3.22 Adjustment Required (if A< B) Yes Arm's Length Cost C = (100-B)*OR/100 64,02,69,805 Operating Cost OC 68,12,59,750 Excess cost being adjustment OC - N 4,09,89,945
It is also brought on record by the assessee that the functions performed by Wieland Metals India Private Limited and its associated enterprises with regard to the international transactions are detailed below:
Functions Performed
Purchase of materials — import (including goods in transit)
Wieland Metals India Private Limited has commenced commercial production of slitting of copper and copper alloy strip coil as per customer specifications w.e.f. September 2012. These copper and copper alloy strip coil are procured mainly from Wieland Werke AG and some from Wieland Metals Singapore (Pte) Ltd.
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Raising of Purchase order
Wieland Metals India Private Limited's Sales department provides the stock requirement, on the basis of customer forecast, to the Purchase department. Based on this statement, the Purchase department determines the requirements of purchases and places Purchase orders on the associated enterprises. An order confirmation is given by Wieland Werke AG and other AEs after receipt of each purchase order.
Sourcing of materials
Wieland Metals India Private Limited imports majorly Master coils for slitting them into customer required widths which are packed in special packing material (using moisture inhibiting material and Euro Pallets) and supplied to customers. When customer requirement is very small and not regular, in this case strips as per customer required width is imported and sold from stock. Both are procured from Wieland Werke AG and other AEs. As far as Wieland Metals India Private Limited is concerned, these are semi-finished goods that can be sold to end customers after further processing i.e. slitting, in case of Master Coils. The final finished goods i.e. slit copper and copper alloy strip are sold to the end customers who are not associated enterprises and are located in India.
The entire process of sourcing and transportation of raw materials, needed for producing the strips, to AE's premises is carried out by Wieland Werke AG. Wieland Werke AG will manufacture the required materials based on customer requirements which will vary from customer to customer. Wieland Metals India Private Limited has no role in this function.
Manufacture of material strips and sale to Wieland Metals India Pvt. Ltd. Wieland Werke AG has invested in state of art production technology and quality testing systems in order to ensure high quality products. The entire
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process of manufacture and quality testing of the copper and copper alloy strips is undertaken by the Wieland Werke AG invoices and exports the copper and copper alloy strip Master coil to Wieland Metals India Private Limited on DAT Incoterms 2010, ICD Bangalore basis. The process of receipt of imported goods such as clearing and forwarding at the Customs in India is undertaken by Wieland Metals India Private Limited by engaging customs agent.
The copper and copper alloy strip master coils so purchased from Wieland Werke AG are subject to slitting process by Wieland Metals India Private Limited and then sold to end customers.
Activities relating to manufacture and export of goods mentioned in the purchase order
The Wieland group has manufacturing facilities in Germany, Austria, Great Britain, USA and Singapore. The activity of manufacture of product and export of products to the customers in accordance with their Purchase order is carried out by the Wieland group. These documents are sent to Wieland Metals India Private Limited. The products are then the property of the customer and hence no other functions are carried out by Wieland Metals India Private Limited when they reach the contractual territory. The research and development functions are carried out by Wieland Werke AG. Wieland Metals India Private Limited does not carry out any function relating to manufacture or research and development of these products.
Now the issue before us is with regard to TP adjustment by applying TNMM by the TPO instead of CUP method adopted by the assessee as most appropriate method in respect of determining of ALP of manufacturing segment. As seen from the details of international transactions, the assessee is importing raw material from its AE and also making exports of
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products to the customers in accordance with the Purchase Order which is carried out by Wieland group. Thus, import as well as export transactions are interlinked and closely linked. The price of export is not free from the impact of the import price. Therefore, the international transactions in respect of import of raw material has direct bearing on export of goods. The TPO has applied TNMM by taking entire turnover of the assessee and then proposed an adjustment being the difference between the net margin of assessee as well as comparable price. Since these international transactions are closely linked and rather inter-dependent having a bearing on each other, therefore, for the purpose of determining the ALP it is appropriate to take composite transaction and apply TNMM as the most appropriate method. CUP is no doubt a preferable method of determining ALP as it leaves no scope of any possible variations in the process of computing ALP. However, when transactions are relatable and inter- related, then if a particular transaction out of the composite transactions cannot be tested under CUP method, then it is not proper to apply separate methods for determining the ALP for each of the transaction, particularly when international transactions are closely linked and inter-depending having direct bearing on the price of each other. Therefore, we are of the considered opinion that in the given facts and circumstances of the case, the TNMM would be the most appropriate method for determining the ALP of international transactions entered into by the assessee with AE. We do not find any infirmity in the order of the DRP on this issue and the same is confirmed.
Ground No.3 is that the TPO has not considered the under- utilization of manufacturing capacities and the resulting idle costs while computing the assessee’s margins.
The ld. AR submitted that assessee’s request for adjustment of capacity utilization while computing operating margins under TNMM has
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not been considered by the revenue authorities. The TPO has ignored the fact that operations were started about 2 years ago and had not reached its full capacity utilization. During FY 2014-15, the company was operating at 33.62%. Thus, the idle capacity was 66.38%. This had to be adjusted to the fixed infrastructure related costs and semi-variable costs. Detailed computation in this regard was submitted to the TPO which was not considered (Page 209 of Paperbook). Since the company was operating only 33.62% of its installed capacity, the company was not in a position to absorb its entire fixed costs in terms of infrastructure related costs. According to the ld. AR, the summary of fixed costs that must be considered as non-operating costs for arriving at the Operating Expenses for computing OPM using TNMM is given below:-
Sl Nature of expenses Costs relating Computation of idle costs and no. to idle reference to Paper book capacity (Rs.) 1 Employee Benefit Expenses 50,98,793 Annexure 1 of submissions filed on 05-08-2018 to TPO (Page 225 of Paper book) 2 Depreciation – Plant & 52,63,138 33.62% of Rs.79,28,627 being Machinery depreciation on P&M (Page 17 of the Paper book) 3 Rent - Factory 35,41,339 Annexure 2 of submissions filed on 05-08-2018 to TPO (Page 226 4 Electricity charges – Factory 4,53,110 of Paper book) 5 Repairs – Factory Building 3,37,436 6 Repairs – Machinery 3,09,163 33.62% of Rs.4,65,741 (Page 21 of Paper book) 7 Insurance of assets 15,05,163 33.62% of Rs.22,67,462 (Page 21 of Paper book) 8 Transportation charges 10,01,688 33.62% of Rs.15,08,999 (Page 21 of Paper book) TOTAL 1,75,09,830
The ld. AR further submitted that in any business organisation, certain costs are fixed and others vary with output. Eg: Depreciation, rent and maintenance costs of factory premises, maintenance costs associated with Plant and Machinery, etc., continue to be incurred regardless of the
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volume or production at the factory. Thus, it is common knowledge that profit margins can be earned only if the business operates at an optimum level of activity. Since the company had under-utilised its capacity during the FY 2014-15 due to business reasons, adjustments should have been made while computing its Operating Profit Margins.
It was submitted that the TPO and the DRP have erred in rejecting this adjustment sought by the appellant on the contention that sufficient data pertaining to the capacity utilization of comparable companies should be available to see if any material differences exist between the assessee and comparable companies and that in the absence of such data, it is not possible to grant any adjustment. The TPO and the DRP ignored the very basic fact that impugned AY was only the second full year of the slitting operations of the company, whereas the comparable companies selected by the TPO were already established players in the industry. Hence, it was grossly incorrect to even assume that those companies would also require idle capacity adjustment as a 2 year old company like the appellant.
Further, The TPO and DRP erred in ignoring the fact that it is not possible for the appellant company to get details of the capacity utilization of the comparable companies selected by the TPO to make a comparison / adjustment possible, which are not available in public domain. In such a scenario, the TPO and DRP could have either sought information from such companies based on the powers vested in them or ought to have made certain reasonable approximations / assumptions to consider the adjustment sought by the appellant rather. Outright rejection of the adjustment is against the basic interest of justice.
The ld. AR submitted that several Benches of the Tribunal time and again looked at this issue and has directed the TPO/AO to allow
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adjustment for fixed costs on account of lower capacity utilization as follows:-
a) In the case of Ariston Thermo India Ltd ([2013] 36 taxmann.com 501 (Pune - Trib.), the Pune Bench of the Tribunal, while delivering the judgment, highlighted the actual objective of comparability analysis and adopting the Most Appropriate Method which was to determine ALP of the international transactions and to examine whether the price charged in relation to a controlled transaction is comparable to an uncontrolled transaction of similar nature. Further, it also stated that net profit margin of the tested party, as referred to in the Rules has not been defined as such to be such profit as is drawn from the financial accounts. It can be suitably adjusted by applying appropriate economic adjustments to facilitate its comparison with other uncontrolled entities / transactions before being considered as the net profit margin of the tested party as stated by the Rules as such. Thus, the Tribunal held that as long as the adjustment sought to be made in the profit margin of the tested party are based on cogent and sufficient reasons and seeks to make the comparability analysis with the comparable uncontrolled transactions more meaningful, a mere restriction or absence of a specific provision in the legislation does not operate as a bar in doing so. The ITAT held as under in Para 12 of this judgement:-
“Therefore, in our view, having regard to the precedents and the aforesaid discussion, in the present case assessee has to succeed in principle for adjustment on account of lower capacity utilization, and the loss suffered on account of unabsorbed fixed operating costs incurred in the initial year. The aforesaid factors, in our view, warrant an appropriate adjustment to the operating margins of the assessee to facilitate a meaningful comparison with the comparable uncontrolled transactions.”
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b) In the case of Global Turbine Services (ITA No, 3484/Del/2011 – Pages 754 to 757) the ITAT Delhi Bench held as follows:-
“10. We have heard the rival contentions and perused the material available on record. The suitable adjustment for non-utilisation of capacity is to be taken in to account after considering the ALP while working out TP adjustment, this proposition has been held by coordinate Bench in the case of the Amdocs Business Services Private Limited (Supra) and various other cases as cited here in above. 11. In the given facts and circumstances it was required on the part of the lower authorities to have given due effect to under capacity utilization of the assessee which has not been done TPO for adjustment for ALP determination. In view of the facts and circumstances we are inclined to set aside the matter ………………………………” (Emphasis supplied) c) In the case of Tasty Bites Eatables Limited [[2015] 59 taxmann.com 437 (Pune - Trib.), the ITAT, Pune Bench held as follows:-
“33. So far as the adjustment on account of capacity underutilisation is concerned, it is the submission of the Ld. Counsel for the assessee that capacity utilisation of the assessee works out to 15% whereas capacity utilisation of the comparable company was 53%. Therefore, the difference between the two is significant and material to impact the profit margin of the assessee and the comparable company’s ability to absorb the fixed overheads like depreciation, salary and wages, power, repair etc. is less where capacity utilisation is low and this would lead to increased cost and lower profit. 36.……. we are of the considered opinion that the assessee should be given the benefit of low capacity utilisation. ……” (Emphasis supplied)
d) In the case of Mando India Steering [2014] 45 taxmann.com 160 (Chennai - Trib.), the Chennai Tribunal held as under:-
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“We are of the considered view that under-utilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production. …….” e) Similar views have been taken by the various benches of the ITAT in the following cases: • Genisys Integrating Systems (India) Pvt. Ltd. Vs DCIT (15 (ITR-Trib) 475) – Bangalore Bench • ACIT vs. M/s Fiat India Pvt. Ltd., ITA No. 1848/Mum./2009 dated 30.04.2010; • Skoda Auto India (P.) Ltd. vs. ACIT, 122 TTJ 699 (Pune); • Egain Communication (P.) Ltd. vs. ITO 118 TTJ 354 (Pune); • Amdocs Business Services (P.) Ltd. vs. DCIT 26 taxmann.com 120 (Pune); and, • Schefenacker Motherson Ltd. vs. ITO 123 TTJ 509 (Delhi) 40. Hence, based on the facts of the case and judicial precedents submitted above, it was submitted that the idle capacity adjustment ought to have been allowed while arriving at the Operating Profit Method since the Company functioned only up to 33.62% of its capacity. Since under- utilisation of capacity during that year was significantly due to market forces, ignoring the same in arriving at the OPM which relates to actual operations only is grossly incorrect.
The ld. DR submitted that DRP held that as pointed out by the TPO sufficient data pertaining to the capacity utilization of comparable companies should be available to see if any material differences exist between the assessee and comparables. In the absence of such data it is not possible to grant any adjustment. Therefore, the directions of the DRP are to be upheld.
We have heard both the parties and perused the material on record. The assessee has not furnished sufficient data pertaining to capacity
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utilisation of comparable companies so as to determine the material difference existing between the assessee and comparable. Hence, we remit this issue to the file of TPO with a direction to the assessee to furnish necessary data pertaining to capacity utilisation of comparable companies and for fresh adjudication of the issue by the TPO.
Grounds 4 to 6 is with regard to selection of comparables by the TPO and application of filters.
Manufacturing activities filter / Functional similarity filter
It was submitted by the ld. AR that assessee company is a slitting centre which is not a full-fledged manufacturing process unlike the companies selected by the TPO which are full-fledged manufacturing companies. All the companies selected by the TPO are established players in the market. These companies have been operating in India since a long time (5 to 50+ years) unlike the assessee which set up its slitting centre in India only since Sept 2012. So it is only natural that these companies are earning much higher profits than the appellant who is still in the process of recovering the set up and infrastructure costs. The years of experience of the companies selected by the TPO is given below, based on information available in the public domain and their websites:-
Name of the Company Established Years of since experience in 2015 Gupta Metals Sheets Limited 1989 26 Rachna Metal Industries Pvt. Ltd 1978 37 Multimetals Limited 1962 53 Metals United Alloys & Fusion Product Ltd 2006 9 Madhav Copper Limited (Part of Madhav 2010 5 Group)
The other objections raised before TPO and DRP were as under:-
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Sl Name of the Remarks / Reason for rejection as comparable no. Company 1 Gupta Metal Sheets Functionally different • Dealing and manufacturing copper and copper alloy Ltd sheets, strips, foils and non-ferrous rolled semis • Involved in trading activities as per Financial statements – Refer Page 413 of the Paper book • Investment in Plant & Machinery is very limited thereby confirming that it is not a manufacturing company • Very large company with turnover of Rs.391 crores and therefore not comparable to the appellant company • No import of raw materials 2 Madhav Copper Ltd Functionally different Produces extensive range of enamelled, submergible wires, Copper Strips Profile suitable for any known application in Transformers, Motors, Alternators, Contactors, Relays, Auto electricals, Submersible Pump, Motor, also suitable for use in high speed coil winding machines The appellant does not cater to these industries and hence this company is not a comparable. • No import of raw materials • Their products and clad products of very high 3 Rachna Metal Industries Private thickness which are not used in Connector Limited manufacturing using high speed stamping • No import of raw materials other than capital goods and traded goods worth Rs.11.73 lakhs • Manufacturing company engaged in casting, annealing, 4 Metals United Alloys & Fusion Products drawing and finishing of copper base, Nickel base, tin Limited base and Zinc base alloys and not similar to the slitting operations carried out by the assessee company • Their products are enamelled wire and rods • No import of raw materials • Has a wide range of products including cast, extruded 5 Multimetals Limited and drawn tubes, pipes and wire • Imported raw materials is only about 29.85% of total purchases 46. The ld. AR submitted that thus, it is very clear that these companies are not comparable to the assessee who is in the business of slitting of
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Copper Alloy Coils as per customer specifications. However, the TPO and DRP has rejected all these contentions.
The ld. AR submitted that the adjusted OPM for AY 2015-16 will be as follows:-
Particulars Amount (Rs.) Amount (Rs.) (A) Revenue from Operations (“OR”) 66,15,72,437 Total Expenses 68,16,85,322 Less: Finance Costs (4,25,572) Less: Idle costs due to non-utilisation of (1,75,09,830) capacity Less: IT Maintenance, Support and Services (72,44,263) (discussed in detail in Grounds 7 and 8 below) Operating Costs (“OC”) (B) 65,65,05,657 Operating Profit Margins (“OP”) (A)- (B) 50,66,780 OP/OR 0.76%
Without prejudice to the contention that TNMM is not applicable in the case of the appellant company and CUP is the MAM, it was submitted that from the above, the OPM of the Company is 0.76% as against -2.89% computed by the TPO and upheld by the DRP. The average margin of the comparable companies selected by the TPO is 3.22%. The OPM of the company is well within the +/-3% range allowed by Sec 92C(2) of the Act and accordingly requires no adjustment.
We have heard both the parties and perused the material on record. We have gone through the following observations of the TPO:-
Gupta Metal Sheets The company is engaged in manufacturing and sale of copper and copper alloy sheets/strips.
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The company's manufacturing plant is located in Rewari (Haryana) with an installed capacity of 14,500 tonnes per annum as on March 31, 2015. The company manufactures strips and sheets in various sizes starting from 0.1 mm to 14 mm to its customer base. The company has shown Plant & Equipment worth Rs. 27 Crores in its financial statements and an addition of 1.87 Cr made during the F.Y. 2014-15. The import filter objection has been dealt with in detail. Hence, the taxpayer's objections are rejected and the company is retained as a comparable. Madhav Copper Ltd. The company manufactures copper enamelled, submergible wires, copper strips and rods etc. It is not necessary for the comparable company and the taxpayer to cater to the same industries in order to be functionally comparable. The import filter objection has been dealt with in detail. In view of the above discussion, the objections of the taxpayer are rejected, and the company is retained as a comparable. Rachana Metal Industries Pvt. Ltd. The company is involved in copper alloy products such as rods, tubes, bus bars, strips, plates, wires, pipes, sheets & circles. As discussed earlier, TNMM does not require strict product comparability such as the difference in thickness of the copper and copper alloy products produced. The import filter objection has been dealt with in detail. In view of the above discussion, the objections of the taxpayer are rejected, and the company is retained as a comparable.
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Metals United Alloys & Fusion Products Ltd. The company is a copper-based alloy wire manufacturing company. The company is engaged in manufacture of wires of various copper-based alloys both in round and flat profiles. It is reiterated that TNMM does not require strict product comparability such as the difference in thickness of the copper and copper alloy products produced. The import filter objection has been dealt with in detail. In view of the above discussion, the objections of the taxpayer are rejected, and the company is retained as a comparable.
Multimetals Ltd. The company is a manufacturer of seamless extruded copper, copper alloy products in the form of hollows, sections, profiles and rods as per customers' requirements, high performance copper alloy wires, etc. The company's manufacture of a wide range of copper alloy products does not make it functionally incomparable to the taxpayer. As discussed above, TNMM does not require strict product comparability such as the difference in thickness of the copper and copper alloy products produced. The import filter objection has been dealt with in detail. In view of the above discussion, the objections of the taxpayer are rejected, and the company is retained as a comparable. 50. We do not find any infirmity in the findings of the DRP and the same is confirmed.
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Application of Foreign currency expenditure filter / Imports filter
The ld. AR submitted that the TPO had selected 5 companies as comparables to the assessee, even though they had nothing in common to the company or its functioning. While doing so, the TPO had applied wrong filters in selecting the comparable companies. None of the companies selected by the TPO are comparable since none of them are fully dependent on imported materials for their manufacturing activities. In 4 cases, there were no imports at all and in one case, the imports are only 29.85%. Thus, there is wide disparity in the functioning of the assessee vis- à-vis the functioning of these companies.
Without prejudice to the contention that TNMM is not the MAM, it is submitted that certain basic filters are to be applied while selecting comparable companies. In this case, transactions / companies cannot be compared if there are geographical differences. Thus, purchases of raw materials procured from outside India cannot be compared with indigenous purchases due to variations in quality, price, exchange rate differences, etc. Location savings arising out of geographic markets for raw materials have to be considered while determining comparability.
The DRP has rejected this ground by stating in Page 15 as follows:-
“If the raw materials were much cheaper in India, the prudent assessee must have procured them locally instead of importing them. Hence, it goes to show that the cost of raw materials was not a differentiating factor whether one industry imports or not. Hence imports filter is not very relevant or critical to apply.” 54. It is submitted that the DRP grossly erred in overlooking the business model of the assessee which is significantly different from that of the companies selected by the TPO as comparables. No bench-marking exercise in transfer pricing analysis is complete without making certain
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adjustments that are required for functional differences between the tested party and the comparable.
The DRP also erred in overlooking a fundamental principle of business that cost is not the only determining factor for any business decision. A prudent businessman, inf act, prioritizes quality over costs. The DRP has traversed beyond its powers by stepping into the shoes of a businessman by deciding that the prudent assessee should have instead procured the material locally to keep its costs lower. It was submitted that if it is to be accepted that the business models of the assessee and comparable companies were the same, it is very clear that it was on account of initial stages of business that the unusually high costs were incurred by the assessee company vis-a-vis its actual operations. The following case laws were relied on in support of the assessee’s contentions:-
(i) In the case of ACIT Vs Genesys International Corp Limited (26 taxmann.com 102 (Mum.), the Mumbai ITAT held that it was necessary to find possible differences with reference to geographical location of the parties chosen for comparison. In the case of companies engaged in export of goods or services to its AEs outside India, the Income tax department has always applied the export turnover filter of 75%. i.e. only companies having export business of 75% of its total turnover were accepted as comparable companies. This rationale is to be applied in the case of import transactions. Since the appellant company’s purchases are 100% from outside India, a foreign currency expenditure / imports filter of 75% should be applied while selecting the comparable companies. Hence, none of the companies selected by the TPO and approved by the DRP are comparable to the appellant on account of this filter.
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ii) In the case of Gates Unitta India Company (P) Limited Vs Dy. CIT (2017- 84 taxmann.com 69), the Chennai Bench of ITAT had held that the business model of an automotive belt manufacturer, having 99 percent import content in raw material, normally could not be same as that of comparable companies which were having import content of 29%.
iii) In the case of Skoda Auto India (P) Limited Vs Asst CIT (2009- 30 SOT 319), the Pune Bench of ITAT noted that year in question was first full year of assessee’s operation in which import content of raw materials was as high at 98.55% whereas import content of raw material in cases of comparables selected by revenue authorities ranged from 26% to 56.83%. The Bench held that aforesaid variation was particularly important because business model of a car maker having 98.5% import content in raw material normally could not be same as of a car maker having import content of 26% to 56.84% and thus no comparisons were possible between them, unless impact of import contents was eliminated.
The ld. DR relied on the directions of the DRP.
We have heard the rival submissions. It is noted that the consumption of raw materials is there in all of the comparable companies. The TPO has narrowed down to industries engaged in copper and its alloys. If copper and alloys are available in foreign markets much cheaper than the local markets, the comparables must have imported the raw materials from abroad. If the raw materials were much cheaper in India, the prudent assessee must have procured them locally instead of importing them. Hence, it goes to show that the cost of raw materials was not a differentiating factors whether one industry imports or not. Functional
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issues of each comparable are important here. The DRP compared each of the five companies with details and finally concurred with the findings of the TPO. Being so, we find no infirmity in the same and accordingly uphold the order of DRP.
Ground 7 and 8 are regarding disallowance of IT Support and Maintenance charges as prior period expenses. The ld. AR submitted that the revenue authorities erred in considering Rs.72,44,263/- incurred towards IT Support and Maintenance charges as prior period expenses even though the liability to pay the expenses crystallised only during the year based on invoices received from the vendor in the current year.
During the year, the Company had incurred a cost of Rs.91,31,333/- towards IT Maintenance, Support and Services. This includes Rs.72,44,263/- being expenses relating to services provided in earlier years now accounted after detailed negotiation process of such costs with the holding company. Since the liability to pay the expenses to the party was crystallised during the year, the expenses accrued in the books of the Company during FY 2014-15. Thus, the same cannot be treated as a prior period expenses since it arose during the year.
In this connection, the detailed ledger extract of the expenses, the 60. copy of the invoices for these expenses were filed with the TPO vide submissions dated 16-11-2018 (Pages 670-710 of Paper book) and before the DRP. It was submitted that a perusal of the same shows that all the invoices were raised during FY 2014-15 (relevant to AY 2015-16) after the costs were negotiated and finalized. Reliance was placed on the following judicial precedents:-
(i) In the case of SMCC Construction India Limited (38 taxmann.com 146), the Delhi High Court held that the prior period expenses are eligible for
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deduction during the current year provided the liability was determined and crystallized during the relevant year. It was held as under:-
“The expenditure of Rs. 31,55,228 has not been crystallized during the year 2001-02 relevant to the assessment year 2002-03, such prior period expenses should have been disallowed is not based on any material that had come to the knowledge of the Assessing Officer. The Assessing Officers has placed reliance on the notes to the accounts that were available at the time of the scrutiny assessment. But the notes also states that the prior period expenses had crystallized/settled in the year.” 61. According to the ld. AR, the facts of this case are squarely applicable to the instant case also since the liability had crystallized during the year and the invoices were received by the asse during the year from the vendor. In other words, a liability for an expenditure cannot be disallowed merely on the contention that the same pertains to transactions of an earlier year. Any expenditure incurred to meet a liability accruing and crystalizing in that year ought to be allowed. In the instant case, the assessee had no means of knowing or quantifying the expenditure that will be charged by the vendor until the invoice was received from them. The amounts were quantified, and the invoice was raised by the vendor and received by the appellant in AY 2015 16. Accordingly, the liability also crystalized in AY 2015-16. In this regard, the ld. AR also placed reliance on the following judicial precedents:-
i. PCIT vs. Rajasthan State Seed Corporation Ltd. [2017] 88 taxmann.com 445 (Rajasthan) ii. CIT vs. Indian Petrochemicals Corporation Ltd. [2016] 74 taxmann.com 163 (Gujarat) iii. DIT vs. Apparel Export Promotion Council [2010] 1 taxmann.com 222 (Delhi) iv. DCIT vs. Enercon India Ltd [2017] 82 taxmann.com 334 (Mumbai)
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The ld. AR submitted that it may also be noted that prior to introduction of the Income Computation and Disclosure Standards, the ‘Tax Accounting Standard’ II defined ‘Prior Period Items’ as “material charges or credits which arise in the previous year as a result of errors or omissions in the preparation of the financial statements of one or more previous years”. Thus, prior period items are those that occur due to any errors or omissions in the preparation of financial statements of earlier years. In the instant case, there was no such error or omission as the liability to record the IT service / maintenance expenses as an expenditure crystallised only in AY 2015-16 upon receipt of the invoices from the vendor and the same could not have been provided for on an estimate basis in the earlier years.
Without prejudice to the above submissions, it was brought to our attention that these expenses were considered as that relating to the current year by the TPO while computing the net operating margins of the assessee. Consequently, the Transfer pricing adjustment proposed in the order u/s 92CA is also higher to this extent. Hence, these expenses should not be treated as prior period expenses.
The ld. DR relied on the orders of lower authorities.
We have heard both the parties and considered the rival submissions. The AO disallowed the claim of expenditure to the tune of Rs. 72.44,263 relating to the earlier years. There is no dispute with regard to the fact that these expenses pertain to the earlier years. The assessee contends that these expenses are accounted for in this year as there were protracted negotiations with regard to the costs and after the crystallization of the same the invoices were raised and these expenses are accounted in this year. The assessee also relied on various court decisions including Delhi High court decision in the case of SMCC Construction India Ltd (38 Taxmann.com 146) wherein the Court held that the prior period expenses
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can be allowed if the liability is determined and crystallized in the current year. From the details furnished by the assessee, it is observed that all these expenses are from the related group concerns and assessee has not produced any evidence to show that these expenses actually crystallized during the current year, except invoices from its AE. No evidence for negotiations or finalization of terms is produced. We don't find any such negotiations are required for the sharing of expenditure as much of the expenses are in the nature of Information Technology services made available to the assessee in India. Apparently, no TDS was effected. There is no dispute that these expenses are related to earlier period and there is no substantiation that these are crystallised during the current AY except for the raising of invoices by the AE which is within the ambit of the assessee. Accordingly, the expenditure is not relatable to this year, as the same is crystallized this year. Hence we confirm the directions of the DRP.
In the result, the appeal by the assessee is partly allowed for statistical purposes.
Pronounced in the open court on this 22nd day of September, 2021.
Sd/- Sd/- ( GEORGE GEORGE K. ) ( CHANDRA POOJARI ) JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore, Dated, the 22nd September, 2021.
/Desai S Murthy /
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Copy to:
Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.
By order
Assistant Registrar ITAT, Bangalore.