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Income Tax Appellate Tribunal, “J” BENCH, MUMBAI
Before: SHRI SAKTIJIT DEYAND SHRI RAJESH KUMAR
Date of Hearing – 01.03.2019 Date of Order – 24.05.2019
O R D E R PER SAKTIJIT DEY. J.M.
Aforesaid appeal has been filed by the assessee challenging the final assessment order dated 28thJanuary 2016, pertaining to the assessment year 2011–12, passed in pursuance to the directions of the Dispute Resolution Panel–2 (DRP), Mumbai.
In total, the assessee has raised 18 grounds.
2 Smith & Nephew Healthcare Pvt. Ltd.
Ground no.1, being general in nature and ground no.18 being premature at this stage, do not require adjudication, hence, dismissed.
Grounds no.2 to 12, are on the issue of addition made of ` 1,67,50,634, on account of adjustment made to the arm's length price of the import of capital assets.
In respect of the aforesaid grounds also, Shri M.P. Lohia, learned Counsel for the assessee submitted that grounds no.4, 7, 8 and 10, would require adjudication. In addition to the main ground, the assessee has also raised an additional ground, being ground no.19, the issue wherein is ancillary and incidental to grounds no.2 to 12. Therefore, the additional ground will be addressed at a later stage.
Brief facts relating to the issues raised in the aforesaid grounds no.2 to 12 are, the assessee an Indian company is a part of Smith and Nephew Group and is basically engaged in the business of marketing and distribution of advanced medical equipments and healthcare products, such as, all kinds of surgical dressing, bandages, wound closures/dressings, varieties of surgical instruments, all kinds of orthopedic implants, plates, screws, nails and all types of material and equipment for arthroscopic and minimally invasive surgery.
3 Smith & Nephew Healthcare Pvt. Ltd.
The assessee has broadly three business divisions viz., orthopedic, endoscopic and advanced wound management. For the assessment year under dispute, the assessee filed its return of income on 28th November 2011 declaring nil income under the normal provisions of the Act. Since, in the relevant previous year the assessee had entered into various international transactions with its overseas Associated Enterprises (AEs), the Assessing Officer made a reference to the Transfer Pricing Officer for determining the arm's length price of the international transactions. In the course of proceedings before him, the Transfer Pricing Officer, on perusing the transfer pricing study report filed by the assessee noticed that the assessee had imported certain capital assets from the AEs, such as, endoscopic tools and instrument which are used for the limited purpose of implanting medical devices sold/distributed by the assessee. The assessee benchmarked such transactions by applying Transactional Net Margin Method (TNMM) as the most appropriate method. To benchmark the arm's length price, the assessee selected four comparables with arithmetic mean of 2.27%. Since, as stated by the assessee, it had set–up its unit in financial year 2010–11 and it was in its second year of business, it was unable to fully utilize its capacity, which is not the case with the comparables. Therefore, the assessee made adjustment to depreciation by claiming depreciation as per the weighted average
4 Smith & Nephew Healthcare Pvt. Ltd. rate of depreciation charged by comparable companies in order to give a fair comparable analysis. After adjustment of depreciation, the operating margin shown by the assessee at 3.82% as against arithmetic mean of the comparable @ 2.27% was found to be at arm's length. The assessee also made an alternative benchmarking of the aforesaid transaction by using business projections. Since, the comparable companies were established and in more mature phase in the economic life cycles, the assessee used its business projection over the subsequent 4–5 years to benchmark the transaction and as per the said projection the assessee worked out its margin at 3.7% which was within the mean margin of the comparables. The Transfer Pricing Officer, however, did not accept the benchmarking done by the assessee in the transfer pricing study report. Relying upon the decision of the Tribunal, Delhi Bench, in DCIT v/s M/s. Sumi Motherson Innovative Engineering Ltd., ITA no.1816/Del./2011, dated 11th February 2014, he disallowed the depreciation adjustment undertaken by the assessee on the reasoning that depreciation is considered with reference to cost of asset and not sales effected. However, he observed that the assessee cannot be allowed to compare each and every item of borrowed cost with similar cost in case of comparables. As regards the capacity utilization, the Transfer Pricing Officer observed that in the absence of any evidence furnished by the 5 Smith & Nephew Healthcare Pvt. Ltd. assessee to substantiate its claim, adjustment on account of capacity utilization cannot be allowed. Further, he observed, since the level of capacity utilization in case of comparables is also not available i.e., whether they worked on single shift or triple shift, assessee’s claim cannot be accepted. Thus, on the basis of the aforesaid reasoning the Transfer Pricing Officer rejected assessee’s claim of adjustment to the operating margin on account of depreciation and capacity utilization. On the aforesaid premises, he computed the operating margin of the assessee at (–)4.4%, as against the arithmetic mean of the comparables @ 4.16%. As a result of such adjustment, the arm's length price of import of capital assets from the AE was determined at ` 18,70,74,832, as against the price paid by the assessee at ` 20,38,25,466. The resultant difference of ` 1,67,50,634, was treated as transfer pricing adjustment to the arm's length price. While doing so, the Transfer Pricing Officer also rejected the alternative benchmarking of the arm's length price through business projection method.
The learned Authorised Representative submitted, though the Transfer Pricing Officer accepted the comparables selected by the assessee, however, he computed the margin of comparables on the basis of single year data which resulted in rejection of one comparable viz. Ashco Nuilab Industries Ltd. The learned Authorised
6 Smith & Nephew Healthcare Pvt. Ltd. Representative submitted, adjustment made by the assessee on account of depreciation is permissible, since, depreciation claimed by the assessee in its books of account is more than the depreciation prescribed under Schedule–XIV of the Companies Act, 1956. Drawing our attention to the annual report of the assessee, learned Authorised Representative submitted, while the assessee has claimed depreciation at higher rates, the comparable companies have claimed depreciation at a much lesser rate as per Schedule–XIV of the Companies Act, 1956. In this context, he drew our attention to the annual reports and financial statements of the comparables to emphasize that depreciation was charged at different rates by the assessee and the comparables. The learned Authorised Representative submitted, depreciation being a part of operating cost, adjustment on account of difference in depreciation claimed has to be allowed. In support of such contention, the learned Authorised Representative relied upon the decision of the Tribunal, Delhi Bench, in Honda Motorcycle & Scooters India Pvt. Ltd. v/s ACIT, [2015] 56 taxmann.com 237 (Del.). In addition to the aforesaid submissions, learned Authorised Representative submitted, while the comparables were having established business, the assessee comparatively was new as it was the second year of its business. Therefore, adjustment on account of depreciation and capacity utilization has to be allowed.
7 Smith & Nephew Healthcare Pvt. Ltd.
The learned Authorised Representative submitted, even otherwise also, the Transfer Pricing Officer has computed the margin of the comparables as well as the assessee incorrectly. He submitted, the Transfer Pricing Officer has computed the margin of the assessee at (–)4.4% by treating non–operating expenditure of ` 3,48,35,286, as operating in nature. He submitted, as per foreign exchange fluctuation loss and loss on sale of fixed asset cannot be considered as operating in nature. He submitted, this has also been recognized by the legislature by bringing in rule 10TA(j)(iv) and (vi) with effect from 18.09.2013. He submitted, the aforesaid provision being procedural in nature will apply retrospectively. He submitted, if the amount of ` 3,48,35,286, is excluded, the margin of the assessee would be 0.23% instead of (–)4.4%. Further, he submitted, the Assessing Officer has wrongly computed the margin of the comparables at 4.16% as against 2.99%. He submitted, though the assessee had filed a rectification application before the Transfer Pricing Officer in this regard and DRP had also directed the Assessing Officer / Transfer Pricing Officer to carry out the rectification after verification, however, the Transfer Pricing Officer disposed of the rectification application by stating that the issues raised therein are not mistakes apparent on the face of record. Further arguing on the additional ground, the learned Authorised Representative submitted, both Transfer Pricing Officer and 8 Smith & Nephew Healthcare Pvt. Ltd. the DRP have erred in computing adjustment on the transaction value of imported capital assets instead of computing the arm's length price with reference to the depreciation amount which is the relevant international transaction as per section 92B(1) of the Act, as it has bearing on profit and loss of the enterprise. In support of such contention, learned Authorised Representative relied upon the decision of the Tribunal, Delhi Bench, in case of Honda Motorcycle & Scooters India Pvt. Ltd. (supra).
The learned Departmental Representative, though, relied upon the observations of the Transfer Pricing Officer and the DRP, however, he submitted, in view of the new submissions made by the assessee, the issue may be restored back to the Assessing Officer for de novo adjudication.
We have considered rival submissions and perused material on record. The dispute is with regard to the adjustment made to the arm's length price of the imported capital assets. As could be seen from the materials on record, the assessee while benchmarking the international taxation relating to import of capital assets under TNMM has made adjustment to the margin on account of depreciation. Before the Transfer Pricing Officer and learned DRP, it was the contention of the assessee that since the comparables were established companies,
9 Smith & Nephew Healthcare Pvt. Ltd. whereas, the assessee was in the second year of its business, it was unable to utilise its capacity fully. Therefore, some adjustment on account of depreciation and capacity utilization is permissible. However, before us, learned Counsel for the assessee has advanced a completely fresh argument by submitting that while in the books of account the assessee has provided depreciation at a higher rate, whereas, the comparables have claimed depreciation at the rate prescribed under Schedule–XIV of the Companies Act, 1956. The Tribunal, Delhi Bench, in Honda Motorcycle & Scooters India Pvt. Ltd. (supra) has held that the difference in the amount of depreciation due to different rates of depreciation requires to be brought at par. However, in the aforesaid decision, the issue was restored back to the Assessing Officer / Transfer Pricing Officer since the assessee took such argument for the first time before the Tribunal. The facts are identical in the present appeal also. The assessee had never raised the issue of difference in the rate of depreciation between itself and the comparables either before the Transfer Pricing Officer or before learned DRP. Though, we find substantial force in the submissions made on behalf of the assessee, however, since the aforesaid contention was raised for the first time before us, we are inclined to restore the issue to the Assessing Officer for considering assessee’s claim of depreciation adjustment after verifying the rate at which the 10 Smith & Nephew Healthcare Pvt. Ltd. assessee and the comparables have claimed depreciation and keeping in view the ratio laid down in the decision of the Tribunal, Delhi Bench, in Honda Motorcycle & Scooters India Pvt. Ltd. (supra).
As regards assessee’s claim of incorrect computation of its margin by treating certain non–operating expenses as operating in nature as well as assessee’s contention that margin of the comparables have been computed wrongly, we are of the view that the Transfer Pricing Officer was not justified in rejecting assessee’s application filed under section 154 of the Act on the ground that they are not in the nature of mistake apparent on the face of record. In our view, aforesaid decision of the Transfer Pricing Officer is unacceptable. Moreover, the issue relating to the incorrect computation of margin of the comparables constitutes a mistake apparent on the face of record. Therefore, we direct the Transfer Pricing Officer to dispose of the application filed by the assessee under section 154 of the Act on merits by correctly computing the margin of the assessee and the comparables.
As regards the issue raised in the additional grounds, undisputedly, this issue was not raised either before the Transfer Pricing Officer or before learned DRP. It has been raised for the first time before us. Since, the issue raised in the additional ground does
11 Smith & Nephew Healthcare Pvt. Ltd. not require investigation into fresh facts and is a legal issue, we admit the addition ground. However, as the issue has been raised for the first time before us, to give a fair opportunity to the department, we restore the issue to the Assessing Officer / Transfer Pricing Officer for considering assessee’s claim keeping in view the provisions contained under section 92B(1) of the Act as well as the ratio laid down by the Tribunal, Delhi Bench, in Honda Motorcycle & Scooters India Pvt. Ltd. (supra). Needless to mention, the Assessing Officer / Transfer Pricing Officer must afford reasonable opportunity of being heard to the assessee. Grounds raised are allowed for statistical purposes.
In grounds no.13 to 15, the assessee has challenged the addition made of ` 40,50,275, on account of adjustment to the arm's length price of management service charges.
In the course of proceedings before him, the Transfer Pricing Officer noticed that the assessee had paid an amount of ` 40,50,275, to its AE towards allocation of management service charges. After calling for necessary details, the Transfer Pricing Officer noticed that such service charges were paid to the AE on account of service provided towards finance and accounting, internal audit, human resources, treasury, taxation, information technology, corporate regulation / secretarial, public relation / communication and group
12 Smith & Nephew Healthcare Pvt. Ltd. executive. After perusing the agreement with the AE for availing management support service and invoices raised in this regard, the Transfer Pricing Officer found that assessee had debited auditor’s remuneration, communication expenses and legal and professional fees under the head operating and other expenses. Thus, he was of the view that there was duplication of payment in terms of expenditure covered under the management service charges. He further observed that invoices raised do not mention for which services the details were raised. He also observed that the assessee was unable to demonstrate that he has received any service from its AE and the benefit derived to justify the payment. Thus, ultimately, he determined the arm's length price of management service charges at nil thereby making an adjustment of ` 40,50,275.
Before learned DRP, the assessee furnished additional evidences to prove that services were rendered by the arm's length and the assessee has availed such services. After calling for a remand report, learned DRP, however, ultimately sustained the adjustment made on the ground that the assessee has failed to demonstrate that it has derived benefit from services rendered by the AE. Accordingly, the adjustment was incorporated in the final assessment order.
13 Smith & Nephew Healthcare Pvt. Ltd.
The learned Authorised Representative submitted, duty of the Transfer Pricing Officer is to determine the arm's length price of the international transaction. He submitted, the Transfer Pricing Officer cannot step into the shoes of the Assessing Officer to look into the business expediency of expenditure. He submitted, while determining the arm's length price of management service charges at nil, the Transfer Pricing Officer has not followed any one of the prescribed methods. He submitted, before DRP assessee had furnished various additional evidences to demonstrate that not only it has received various services from the AE but it has also derived benefit there from. In this regard, he drew our attention to the agreement with the AE and the additional evidences filed before the DRP, as placed in the paper book. The learned Authorised Representative submitted, since the Transfer Pricing Officer has not determined the arm's length price by applying any one of the prescribed methods, the determination of arm's length price at nil should be struck down and the payment made by the assessee be accepted as the arm's length price. Further, he submitted, though, the assessee had made similar payment in assessment year 2010–11, no adjustment was made by the Transfer Pricing Officer. Thus, he submitted, the addition made should be deleted. In support of such contention, the learned Authorised Representative relied upon the following decisions:–
14 Smith & Nephew Healthcare Pvt. Ltd. i) CIT v/s EKL Appliances Ltd., [2012] 345 ITR 241 (Del.); ii) CIT v/s Lever India Exports, [2017] 78 taxmann.com 88 (Bom.); iii) Merck Ltd. v/s DCIT, [2016] 179 TTJ 121 (Mum.); iv) TNS India Pvt. Ltd. v/s ACIT, ITA no.944/Hyd./2007, etc., dated 22.01.2014; and v) CIT v/s CA Computer Associates India Pvt. Ltd., 351 ITR 069 (Bom.).
However, he submitted that the issue may be restored back to the Assessing Officer for enabling the assessee to demonstrate that it has not only received services from the AE but has derived benefit there from and further to establish its benchmarking made in the transfer pricing study report.
Learned Departmental Representative submitted, issue may be restored back to the Assessing Officer/Transfer Pricing Officer for examining the issue afresh.
We have considered rival submissions and perused material on record. It is apparent, the Transfer Pricing Officer while determining the arm's length price of the management service charges at nil has not benchmarked it by applying any one of the prescribed methods. Further, he has done so by making certain general observations that the assessee failed to demonstrate that services were actually rendered by the AE and the assessee derived any benefit there from.
15 Smith & Nephew Healthcare Pvt. Ltd. In our view, the arm's length price of an international taxation has to be determined not only with reference to the stated income and expenditure but also by applying any one of the methods prescribed under section 92C of the Act. The Transfer Pricing Officer has not stated, by adopting which method he has determined the arm's length price of management service charges at nil. Further, though the assessee had furnished a number of evidences before learned DRP by way of additional evidences, learned DRP has neither examined them at their level nor the Transfer Pricing Officer has examined them properly in the course of remand. In any case of the matter, as per the statutory mandate the duty of the Transfer Pricing Officer is to determine the arm's length price of the international transaction by applying any one of the prescribed methods as per section 92C of the Act. The Transfer Pricing Officer has failed to do so in the present case. Therefore, we are inclined to restore the issue to Assessing Officer/Transfer Pricing Officer to properly examine the benchmarking of the assessee and all other documentary evidences furnished by the assessee and if they are not satisfied with assessee’s benchmarking, they may determine the arm's length price by applying any of the prescribed methods. Needless to mention, the Assessing Officer must afford reasonable opportunity of being heard to the assessee. These grounds are allowed for statistical purposes.
16 Smith & Nephew Healthcare Pvt. Ltd.
In grounds no.16 and 17, the assessee has challenged the issue of not allowing assessee’s claim of set–off of brought forward business loss amounting to ` 15,61,451.
Brief facts are, while computing income for the assessment year 2009–10 in assessee’s case, the Assessing Officer determined the loss of ` 1,78,26,692, a part of this loss was set–off against the income computed for the assessment year 2010–11 and an amount of ` 15,61,451, was carried forward to the subsequent assessment year. In the draft assessment order passed for the impugned assessment year, the Assessing Officer computed total income at nil after setting–off brought forward loss of ` 15,61,451, and unabsorbed depreciation of ` 1,92,39,458. However, in the final assessment order in pursuance to the directions of the DRP, the Assessing Officer only allowed set–off of unabsorbed depreciation without allowing set–off of brought forward business loss.
We have considered rival submissions and perused material on record. As cold be seen, the Assessing Officer in the draft assessment order has allowed set–off of brought forward loss amounting to ` 15,61,451 along with unabsorbed depreciation of ` 1,92,39,458. However, in the final assessment order, the Assessing Officer has omitted to allow set–off of brought forward business loss without any 17 Smith & Nephew Healthcare Pvt. Ltd. valid reason. In view of the aforesaid, we direct the Assessing Officer to allow assessee’s claim of brought forward business loss and after set–off of such brought forward business loss may set–off the unabsorbed depreciation of prior years. Grounds are allowed.
In the result, appeal is partly allowed. Order pronounced in the open Court on 24.05.2019