M/S. FLINT GROUP INDIA PRIVATE LIMITED,GUJARAT vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE 3(1)(1), BENGALURU

This is an appeal by the assessee against the final Order of the Assessment dated 27.10.2017 passed by the DCIT, Circle 3(1)(1), Bengaluru, u/s.143(3) read with Sec.144C (13) of the Income Tax Act, 1961 (Act).

Ground No.1 was not pressed for adjudication as it is general in nature. Ground No.2 was also not pressed being general in nature. Ground No.3 raised by the assessee is with regard to the grievances of the assessee in the action of the Dispute Resolution Panel (DRP) in upholding the stand of the AO in not providing unabsorbed cost adjustment to the assessee on account of untilized capacity.

In terms of Sec.92(1) of the Act which provides that any income arising from an international transaction shall be computed having regard to the arm’s length price the Assessee filed Transfer pricing analysis justifying the payments made to the Associated Enterprises (AE) adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) for determination of Arm’s Length Price (ALP) of the international transaction in terms of Sec.92 of the Act. The transactions relating to purchase of raw material, purchase of traded goods, purchase of capital assets, reimbursement of expenses paid and management services were treated as inextricably linked the to activity of licensed manufacturing activity and hence closely linked and considered to be included in the IT(TP)A No.2750/Bang/2017 Page 3 of 16 manufacturing activity by adopting a combined transaction approach. The approach of the Assessee was accepted by the Transfer Pricing Officer (TPO) to whom the question of determination of ALP was referred to by the Assessing Officer (AO) u/s.92CA of the Act.

The Profit Level Indicator (PLI) chosen for the purpose of comparison of Assessee’s profit margin with that of the comparable companies was Operating profit on Operating Revenue i.e., OP/OR The OP/OR as per the TP study was as follows: Operating Income Rs. 2,05,65,88,838/- Operating Cost Rs.1,93,84,70,013/- Operating Profit (Op. Income – Op. Cost) Rs. 1,18,118,825/- Net mark-up (OP/Sales) 5.74% The TPO computed OP/OR as follows: Operating Income (OR) Rs. 2,05,65,88,838/- Operating Cost(OC) Rs.2,08,92,67,136/- Operating loss (OC-OR) Rs.-3,26,78,298/- Net mark-up (OP/OR) -1.59%

The difference in profit margins as arrived at by the TPO and the assessee is due to the assessee adopting operating cost of Rs.193,84,70,013/- (second row of the first table). whereas the TPO adopted the Operating Cost of Rs.208,92,67,136/- (Second row of the second table). One of the reason for the difference between the operating costs as adopted by the assessee and as adopted by the TPO due to the assessee considering the following items as not part of operating expenses:

The TPO rejected the contention of the assessee on the adjustment to assessee’s margin for underutilization of capacity by reducing certain expenses and depreciation which were unabsorbed, from the operating costs and he recomputed the operating cost by disallowing the adjustment made towards underutilized capacity. According to the TPO, the assessee did not furnish any evidence in support of its contentions. The TPO also considered the loss arising from fluctuation of foreign currency as being operating in nature and included the same in the operating cost base and this is subject matter of Gr.no.4 in this appeal, which will be dealt with in the later part of this order.

Against the draft order of assessment, the assessee filed objections before the Dispute Resolution Panel (DR) which rejected the same on the basis that Appellant had not furnished any evidence in support of its contentions. It also rejected the contention of the assessee that gains/losses arising from fluctuation of foreign currency ought to be considered as non-operating in nature. Pursuant to the directions of the DRP, the AO passed the final assessment order dated 27.10.2017 against which the assessee is in appeal before the Tribunal.

As far as Gr.No.3 raised by the assessee is concerned, the learned counsel for the assessee submitted that the assessee shifted its manufacturing facility from Bangalore (Hosur) to Vadodara in the financial year 2012-13 relevant to the assessment year in question. It was the contention of the assessee that Vadodara was a new market for the assessee and it was in the process of gaining market in the new place. Moreover, as result of this relocation, the assessee was not able to operate at its optimum capacity and could not recoup its fixed costs from out of the production during the year under consideration. This resulted in significant underutilization of the production capacity in the factory, resulting in low utilization of the available capacity to manufacture the products, which in turn resulted in non-absorption of various costs. It was submitted that during the year, the manufacturing facility of the Appellant had a production capacity of 20,700 units. As against the same, during the year under consideration, the assessee was able to manufacture only 11,769 units. A summary of the production capacity vis-à-vis the actual production was given as under:

The learned DR while placing reliance on the directions of the DRP submitted that an adjustment for underutilization of capacity is to be made to the margins of the comparable companies and not the tested party and that the assessee had not furnished details with regard to the capacity utilization of the comparable companies and that comparable companies were working at 100% capacity

We have considered the rival submissions and we notice that this Tribunal has in assessee’s own case for AY 2014-15 (order dated 31.10.2019 in IT(TP)A No. 3285/Bang/2018) set aside the issue to the TPO for consideration afresh and directed the TPO to grant an adjustment on account of capacity utilisation by calling for relevant information on capacity utilisation in the case of comparable company by exercising his power under Section 133(6) of the Act to collate the information on capacity details of the comparable companies such as actual capacity in units, installed capacity, break up of fixed and variable cost, product wise segmental profitability (if any) and provide the assessee an opportunity by sharing the details so obtained on the comparable companies, and accordingly grant the adjustment for capacity under-utilized. The Tribunal also held that if challenges on the lack of information / data are accepted than the adjustment should be made to the tested party. Facts and circumstances of the case being identical to AY 2014-15, we respectfully follow the decision of the Tribunal for AY 2013-14 and set the order of the AO on this issue remand the same to the AO/TPO for consideration afresh

As far as Ground No. 4 raised by the assessee is concerned, the same relates to Loss/gains arising from fluctuation and restatement of foreign currency ought to be treated as non-operating in nature. On this issue, the learned counsel for the assessee submitted that during the year under consideration, the TPO has considered forex fluctuation as being operating in nature while computing the margin of the assessee as well as the comparable companies. In this regard, it was submitted that the assessee bears the risk arising from forex fluctuations. The assessee would not be insulated or compensated by its AEs for the forex loss incurred during a given period. Further, it was submitted that at the time of determination of arm’s length price, it is not possible for the assessee to anticipate the variation in the forex fluctuations. In such situations, forex variation can never be taken into account by the assessee while determining the arm’s length price. Therefore, the loss or gains arising from forex fluctuations is not in the control of the assessee or the comparable companies.

It was submitted that the assessee is not a captive service provider but a licensed manufacturer, i.e., revenue is earned from third parties and majority of its transactions are with third parties. Therefore, in such a scenario, it is even more imperative to not consider the foreign exchange fluctuations as operating in nature. On the above argument, the learned counsel admitted that the assessee is not in a position to bifurcate transactions with AE and third parties and quantify the loss/gain in foreign currency fluctuation/restatement. The learned counsel placed reliance on the decision of the Hon’ble Tribunal in the case DHL Express (India) Private Limited v. ACIT (order dated 27.04.2011 in wherein the Tribunal agreed with the assessee that IT(TP)A No.2750/Bang/2017 Page 9 of 16 interest income, rent receipts, dividend receipts, penalty collected, rent deposits returned back, foreign exchange fluctuations and profit on sale of assets do not form part of the operational income because these items have nothing to do with the main operations of the assesse. This decision is distinguishable as the finding is that the foreign exchange fluctuation did not arise out of the international transaction of the assessee for which ALP was being determined.

Reliance was placed on Rule 10TA(j) of the Safe Harbour Rules as notified by the Central Board of Direct Taxes (“CBDT”) which defines ‘operating expenses’ which excludes loss arising on account of foreign currency fluctuations:

The learned DR reiterated the stand of the revenue that the net loss/gain on account of fluctuation/restatement foreign exchange currency has to be treated as part of the operating expenses/gain respectively.

We have carefully considered the rival submissions. In the context of transfer pricing, the Bangalore Bench of the Tribunal in SAP Labs India Pvt. Ltd. Vs ACIT (2011) 44 SOT 156 (Bangalore) has held that foreign exchange fluctuation gain is part of operating profit of the company and should be included in the operating revenue. In the light of above

The AO/TPO will compute the ALP of the international transaction in question in accordance with the directions given above after affording assessee opportunity of being heard.

In Ground No. 5 the assessee has projected its grievance in the action of the revenue authorities disallowing deduction of a sum of Rs.12,40,195/-. We have already seen that during the previous year, the assessee had shifted its operations from Bangalore to Vadodara. In the process of relocation, some of the original invoices depicting the amount of duties paid, for which credit was yet to be claimed, were lost. Since for the purpose of claiming countervailing and excise duty, original invoices/bills are required and as the same were lost in the process of relocation, the credit of the same could not be claimed by the assessee and therefore, was written off in the books of accounts. The AO disallowed the amount written off by holding that the same can be claimed only on payment basis as per the provisions of Section 43B of the Act and since the duty was not paid in AY 2013-14, the same would not be allowable. Further, the AO held that it was only the government department which could disallow the credit and that the assessee cannot suo moto write off the claim. The DRP accepted the contention of the assessee that duty credits are in the nature of receivables and hence the provisions of Section 43B would not be attracted. The DRP however held that duty credits were not in the nature

We have heard the rival submissions. It is not in dispute that the assessee wrote off the countervailing and excise duty by debiting its profit and loss account to the extent it was ineligible to claim the duty credit and consequently claimed the same as a deduction under Section 37(1) of the Act. Since the credit cannot be claimed by the assessee and the said amount was written off, the same ought to be allowable as business expenditure under Section 37(1) of the Act more so, when the conditions specified for claim for expenditure under Section 37 of the Act are satisfied. In terms of Rule 9 of the Cenvat Credit Rules 2004, the assessee would not be able to claim credit on the basis of photocopies of invoices. The Chandigarh Bench of ITAT in the case of Mohan Spinning Mill v. ACIT (order dated 25.04.2012 in allowed CENVAT credit written off by the assessee as a business expenditure under the provision of Section 37 of the Act. The DRP held that cases cited by the learned counsel for the assessee were cases where either the registration certificate was surrendered or the business itself was closed. The DRP directed the AO to examine whether the credits were actually written off and if so allow the claim as bad debt. In our view, the sum in question can be regarded as loss incidental to business. It is no doubt true that in the event of loss, the year in which the loss crystallized is important. The assessee’s claim that the original invoices were lost and hence the IT(TP)A No.2750/Bang/2017 Page 13 of 16 assessee could not claim credit for duty paid is not disputed. In such circumstances, to allow the claim as loss incidental to the business in year of write off ought to have been accepted. We therefore direct that the claim of the assessee should be allowed as deduction.

In Ground No. 6, the assessee has challenged the order of the revenue authorities in disallowing a sum of Rs.20,000 being admission fees paid to employee of the assessee for securing admission for the employees child in a school. A sum of Rs. 20,000/- was paid to an employee as reimbursement which was incurred due to the transfer of his employment from Bangalore to Vadodara. The AO has held the expenses to be personal in nature and at best can be considered as perquisite in the hands of the employee and taxed in the hands of the employee. Since the evidence to show that the amount was treated as perquisite in the hand of the employee was not filed, the AO disallowed the same. The DRP upheld the order of the citing that the business expediency of the same was not demonstrated.

The learned counsel for the assessee submitted that the expenditure in question ought to be considered as having been incurred owing to business expediency. It was submitted that the expenditure was incurred as a necessity for the furtherance of business interest of the assessee company for the purpose of employee welfare to ensure continue employment in the new place of business and thus not an expense of personal nature. Had the expense not been incurred, the assessee would have had to incur expenses on hiring and training fresh employees for newly set up office at Vadodara, which would have resulted in same, or maybe more cost. Also, the hindrance of the business operations would have taken place which cannot be quantified in monetary terms for the purpose of the present cost benefit analysis. It was submitted that the expenditure incurred by the IT(TP)A No.2750/Bang/2017 Page 14 of 16 assessee was (i) wise (ii) prudent, (iii) pragmatic, (iv) ethical, man of the world of business would conscientiously incur with an eye on promoting his business prospects subject to the expenditure being genuine and with reasonable limits. It was submitted that the purpose of the expenditure supersedes the nomenclature given to it, while determining its deductibility. It was argued that the expenses have been incurred in the interest of the business and should be allowed as a deduction under Section 37 of the Act. The learned DR relied on the order of the DRP.

We have carefully considered the rival submissions and are of the view that the sum in question is personal expenditure of the employee. The employer having met those expenses, the employer should regard is as a perquisite in the hands of the employee. Admittedly, the sum in question has not been regarded as perquisite in the hands of the employee and therefore the sum in question was rightly disallowed by the AO. We find no grounds to interfere with the order of the DRP. Reliance placed by the learned counsel for the assessee on the decision of the ITAT Kolkata Bench in the case of Gopalpur Tea Company Limited v. ITO reported in 12 ITD 259 (Calcutta) is on payment of bonus over and above the statutory limit and that ratio cannot be applied to the facts of the present case. Hence, we dismiss Gr.No. 6 raised by the assessee.

In Ground No. 7, the assessee has challenged the action of the DRP in upholding disallowance of irrecoverable insurance claim. As a policy, the assessee accounts for transit damage losses in the account “Claim Recoverable – Insurance” and inventory is adjusted accordingly. Thereafter, claims are filed with the insurance company. Based on the approval letters received from the insurance company, any amount of claim rejected is charged off to “Insurance irrecoverable” account. According to the assessee a sum of Rs.1,77,872/- which was irrecoverable insurance

At the time of hearing it was brought to our notice that in AY 2014-15, this Tribunal in assessee’s own case for AY 2014-15 (order dated 31.10.2019 in IT(TP)A No. 3285/Bang/2018) remanded the issue to the AO with direction to the assessee to furnish the required details to show that claim made for recovery from the insurance company was rejected to the extent of sum claimed as deduction by the assessee and directed the AO to examine the claim of the assessee in the light of the details that may be filed. We are of the view identical order would meet the ends of justice in the present AY also. We hold and direct accordingly.

In the result, appeal by the Assessee is partly allowed for statistical purpose.