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Income Tax Appellate Tribunal, KOLKATA ‘C’ BENCH, KOLKATA
Before: Shri P.M. Jagtap & Shri Satbeer Singh Godara
Per Shri P.M. Jagtap, A.M.: These two appeals, one filed by the assessee being and the other filed by the Revenue being ITA No. 4114/KOL/2008, are cross appeals, which are directed against the order of ld. Commissioner of Income Tax (Appeals)-XXXII, Mumbai dated 18.02.2008, while the third appeal being ITA No.2722/MUM/2011 filed by the Revenue involves the consequential issue relating to imposition of penalty under section 271(1)(c).
The main issue involved in these cross appeals relates to the addition of Rs.7,42,23,000/- made by the Assessing Officer on account of transfer pricing adjustment, which is sustained by the ld. CIT(Appeals) to the extent of Rs.3,62,46,000/-.
The assessee in the present case is 100% subsidiary of Philips Medical Systems International BV (PMS Netherlands), which belongs to the Group of Royal Philips Electronics of Netherlands. The group has seven product divisions, out of which the Philips Medical Systems is one of the world leading suppliers of medical imaging modalities and patient monitoring systems. It is a global leader in the product segments of X-ray, ultrasound, nuclear medicine, patient monitoring, magnetic resonance, computed tomography, PET, radiation oncology systems etc. The assessee-company is a distributor and commission agent for medical I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 3 of 23 equipments in India. The products distributed by the assessee are high- end products and generally used in operations, scanning of patients, MRI, etc. The return of income for the year under consideration was filed by the assessee-company on 27.11.2003 declaring a loss of Rs.1,50,41,144/-. As declared in the said return, the assessee-company had entered into the following international transactions with its Associated Enterprises (AE) during the year under consideration:- Sr. Nature of international Amount (Rs. Method transaction In crores) No.
Import of equipment and 74.40 TNMM spares (after set off of credit note received of Rs.23.09 crores on account of transfer pricing adjustment) 2. Commission income earned 5.57 TNMM 3. IT charges-cost sharing 1.69 Accrual amount paid by assessee 4. Reimbursement paid to AE-: 716 Accrual received 3.28 Paid
In order to determine the Arm’s Length Price of the above International Transactions entered into by the assessee-company with its A.Es, a reference was made by the Assessing Officer to the Transfer Pricing Officer under section 92CA(1) of the Income Tax Act, 1961. In the Transfer Pricing Study report filed along with its return of income, the Transactional Net Margin Method (TNMM) was selected by the assessee- company as the most appropriate method to determine the Arm’s Length Price of its International Transaction with its AEs with operating profits to sales as the profit level indicator. On search in a public database, 12 entities were identified as comparables and since the arithmetic mean of the margins of the said comparables as worked out at 1.97% was less than the Operating Profit Margin on sales of the assessee-company as I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 4 of 23 worked out at 6.78%, the International Transactions entered into with its AEs were claimed by the assessee-company to be at Arm’s Length.
On verification of its own Operating Profit Margin on sales as worked out by the assessee-company at 6.78%, the Assessing Officer found certain mistakes. Firstly he found that a provision of Rs.4.13 crores made for bad and doubtful debts during the year under consideration was not considered by the assessee-company as a part of operating expenses and the same was liable to be added back to work out the operating profit margin on sales. In this regard, the explanation offered by the assessee that the said provision has been made in respect of bad debts relating to HSG business acquired by it during the year under consideration pursuant to the global acquisition of the HSG group by the parent company and thus represented an extra ordinary item was not found acceptable by the Assessing Officer. He held that a provision for bad and doubtful debts was a normal operating expense of any business and there was no reason for excluding the same for the purpose of determining the operating profits of a Company. Secondly, it was noted by the TPO that the assessee during the year under consideration had realized a sum of Rs.1.16 crores on account of exchange fluctuation and although the same was treated as part of its operating income for the purpose of determining the operating profit margins, a loss on account of exchange fluctuation was completely ignored for the purpose of determining the operating cost on the ground that it constituted an abnormal item. This inconsistent stand taken by the assessee-company was not accepted by the Assessing Officer and the loss on account of exchange fluctuation was treated by him as a part of the operating cost. Accordingly, the operating profit margin of the assessee- company on sales was recomputed by him at 3.75%.
Out of the 12 entities taken by the assessee as comparables, no data relating to the two companies had been provided by the assessee on the I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 5 of 23 basis of which any conclusion regarding there functional comparability could be established. The TPO, therefore, rejected the said two entities as comparables. Out of the remaining ten entities taken as comparables by the assessee, the TPO accepted only two and rejected eight entities after applying different criteria as under:- “(a) Advanced Micronic Devices Ltd.: On a reference to the balance sheet of this company it appears that the same is engaged in trading in healthcare devices and cardiac care equipment. It appears to be functionally comparable to the assessee and hence accepted as a comparable case.
(b) WH Brady & Co. Ltd. : This company has entered into significant relative party transactions. If the consolidated balance sheet is to be considered, then it is found that it is engaged in manufacturing activities also. Hence the same is rejected.
(c) Business Link Automation India Ltd.: There is very little information available about the operations of the company in the director’s report and the balance sheet. The company is dealing in computer hardware and is also engaged in providing software. It is not considered to be comparable to the assessee’s distribution activity
(d) Ashco Industries Ltd. : As per the management discussion and analysis provided in the balance sheet, this company is dealing in analytical 9instruments and providing analytical services to different industries such as agriculture, biochemistry, environmental studies, food, forensic, geochemistry, metallurgical, pharmaceuticals, petrochemicals, petroleum, plastics, paints and textile industry to strengthen the quality control. The company has set up three laboratories at Hyderabad, Mumbai and Noida, which cater to the requirements of the aforesaid industries, who do not possess the sophisticated analytical instruments. Hence ideally this company is not comparable to the assessee’s distribution business. However, due to the non-availability of many comparable cases, and as it has traded in analytical instruments and accessories which could be regarded as comparable to the assessee’s distribution activity, the same is included as a comparable case.
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 6 of 23 (e) Remi Sales and Engineering Ltd. : Very scanty information relating to the operations of the company is available from the balance-sheet. The company has been receiving income on account of dealing in shares, rent, interest, dividend and commission. All these clearly indicate that the company is into financial services activity. The various expenses incurred for the purpose of generating these income would be part of the company’s operating expenses. Hence, this company is not treated as a comparable case.
(f) George Oakes Ltd.: The company is essentially dealing in automobile s pares parts, tractors and agricultural implements. It has also entered into significant relative party transactions. The kind of goods dealt by the company cannot be regarded as comparable to the assessee’s distribution business in medical equipment. Hence, the same is rejected.
(g) Ador Fontech Ltd.: The primary business of this company is manufacturing activity. The company also deals in welding alloys, rods and wires. Having regard to the nature of products dealt by this company, the same cannot be regarded as comparable to the assessee.
(h) Lucas Indian Service Ltd.: This company essentially deals in automobile parts. It has significant dealings with related parties. Hence the same is rejected.
(i)Positive Electronics Ltd.: This company is a dealer in colour TV sets, and other household electronic items, such as audio and video players. In view of the nature of products dealt by it, it cannot be regarded as comparable to the assessee’s distribution activity.
(j) Redington India Ltd.: This company is dealing in computer, printers, spares and software. This company has a turnover of Rs.1500 crores in terms of volume of business it is too large to be compared with the assessee’s business activities. Further it has also entered into some related party transactions. Hence, the same is rejected”.
7. The TPO, on his own, selected three more entities, which were engaged in dealing of medical equipments as comparables and considered
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 7 of 23 the same for the purpose of determining the arm’s length price of the International Transactions of the assessee-company with its AEs. He accordingly obtained their annual reports by issuing notices under section 133(6) and provided copies of the same to the assessee. The assessee raised a preliminary objection to the selection of these three entities by the TPO as comparables on the ground that the data relating to the said entities was not available in the public domain. The assessee further raised specific objections in respect of each of the three entities selected by the TPO in support of its contention that the same were not comparable. This objection raised by the assessee was not found sustainable by the TPO and he overruled the same for the following reasons given in paragraph no. 17 of his order:- “(a) South India Surgical Company Ltd.: The assessee’s contention that the said company is engaged in manufacturing activity is entirely baseless. In this connection, it is observed that the directors report categorically makes a statement in this regard, it is clearly stated that the company is presently engaged only by trading activity. In view of the specific statement in the director’s report, this company is considered as comparable to the assessee. Further, as per the product description given in the annual report, the company deals in surgical items and surgical sterilizers. On a reference to all the heads of expenses, it is seen that they are all in the nature of expenses incurred by a trading company. It is further evident that the expenses are only for performing the functions of assembling, testing and polishing etc. This company is therefore clearly comparable to the assessee.
(b) Vascular Concepts Pvt. Ltd.: This company deals in various products such as valvuplaty balloons, catheters, stents, connectors etc. These are clearly medical equipments and hence comparable to the assessee. The total turnover of the company is Rs.2262 crores. From the details of the sundry debtors and creditors, it is seen that this company is dealing with hospitals. Hence, it is prima facie a comparable case. Regarding the doubt expressed by the assessee that the company is engaged in manufacturing activity It was confirmed by the company
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 8 of 23 itself that the various products dealt by them have all been im0orted from overseas parties. Considering the fact that the profit margin of the company was on the higher side and the fact that R&D expenses have been disclosed in the P/L account, this company was not considered for the purpose of determining the arms length price in the assessment of last year. Regarding the R&D expenses, it is quite evident that the company is not performing any research and development and the amount shown in the profit and loss account is only on account of write off of some earlier expenses, considering the fact that the assessee is entirely importing the products sold by it, the write-off of old expenses is not relevant. Hence, in terms of functions performed this company is closely comparable to the assessee company’s distribution activity. Once a company is established to be comparable, there is no discretion to reject the same, under the Indian regulations merely on the ground that the profit margins are very high or very low. Further the quantitative information provided in the schedule to accounts under the head ‘production’ refers only to the assembling of the products imported by this company. If the company had been engaged in manufacturing activity the same would have been disclosed in the form of some expenditure in the profit and loss account. Hence, the same is accepted as a comparable case.
(c) Biomed Importers Pvt. Ltd.: This case had been considered by the assessee to be comparable to it in the course of the transfer pricing assessment during the preceding year. It was also considered for the purpose of determining the arm’s length price last year. Hence, the same is treated as a comparable company”.
The TPO thus finally selected five comparables, two from the set of 12 comparables selected by the assessee and three considered by him as comparables and worked out there average operating profit margin at 8.99% as under:- Sl. No. Name of the company Operating Profit Margin 1. South India Surgical Co. Ltd. 14.09%
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 9 of 23 2. Biomed Importers Pvt. Ltd. 6.84% 3. Vascular Concepts Pvt. Ltd. 14.64% 4. Ashco Industries Ltd. 4.47% 5. Advanced Micronic Devices Ltd. 4.89% Arithmetic Mean 8.99% 9. Applying the said operating profit margin of 8.99% to the total turnover of the assessee-company, the Transfer Pricing Adjustment was worked out by the TPO at Rs.7,42,23,000/- and accordingly addition to that extent was made by the Assessing officer to the total income of the assessee on account of transfer pricing adjustment in the assessment completed under section 143(3) vide an order dated 27.03.2006.
Against the order passed by the Assessing Officer under section 143(3), an appeal was preferred by the assessee before the ld. CIT(Appeals) challenging the addition made by the Assessing Officer/TPO on account of transfer pricing adjustment by raising various issues. One of the issues raised by the assessee before the ld. CIT(Appeals) was related to the treatment given by the TPO to the provisions for bad and doubtful debts as part of operating cost. The ld. CIT(Appeals), however, did not find merit in the case of the assessee on this issue and rejected the stand of the assessee for the following reasons given in paragraph no. 8.5 of his impugned order:- “8.5. I have considered the submissions of the appellant. The provision for bad and doubtful debts during the year is about 3.15% on sales as against an average of 1% on total sales in earlier years as stated. The said increase is stated to be on account of HSG business acquired during the preceding year whose debts could not be recovered in that year. I agree with the argument of the TPO that bad debts arising from carrying out of a business are normal and regular feature of the business. Hence. they should be treated as normal business expense. The appellant cannot claim exclusion of the provision of bad and doubtful debts for justification of its arm's length price. This argument
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 10 of 23 is also strengthened on account of the fact that such a feature of excessive bad debts may also be present in the comparable cases selected by the appellant as well as TPO specially because mergers and takeovers are now regular features in the cases of big companies and multinational corporations. The business of HSG was acquired in earlier year when the debtors of that company merged with the debtors of the appellant company. Hence, these debtors and bad debts pertaining to them cannot be any more identified separately in successive years. Therefore, this item cannot be considered to be an abnormal item qualifying for exclusion in Transfer Pricing Analysis. Hence, I agree with the TPO that whenever any provision is created or there is write back of the provisions, whether in the case of the appellant or in the case of comparable cases, same is consistently treated as part of operating costs or operating revenues. The appellant's argument is, therefore, rejected”.
The action of the TPO in rejecting ten of the twelve entities selected by it as comparables was also challenged by the assessee before the ld. CIT(Appeals) by making various submissions. After considering the submissions made by the assessee-company as well as the material available on record, the ld. CIT(Appeals) agreed with the TPO as regards the rejection of seven entities selected by the assessee as comparables. He, however, did not agree with the TPO as regards the rejection of the other three entities taken as comparables by the assessee and accepted the same as comparables for the following reasons given in his impugned order:- “(a)Business Link Automation Ltd. ; - This company is engaged in trading of systems and hardware and about 88% of receipts are from trading. The balance 12% receipts are from maintenance service contracts etc. which is a related activity. Thus, the product and functional profile of this company is quite similar to that of the appellant. Since TPO was not in possession of data (though submitted by the appellant as claimed) she could not take proper decision in this regard.
(b) Compunics Information Svstems Ltd. ;- This company also deals in products like computer systems, printers, mobile
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 11 of 23 phones and related consumables and hence, it is also comparable to the case of the appellant. In this case also, the TPO could not take proper decision due to non-availability of details though it is claimed by the appellant that such data was furnished to the TPO vide letter dtd.14.03 .2006.
(c) Remi Sales & Engineering Ltd. ;- This company is engaged in trading of scientific tools, electronic motors, fans and related consumables. The TPO's observation that it is engaged in financial service activity is not correct. The company has trading turnover of Rs.20.41 crores and other income of only Rs.67.34 lacs. In the preceding year, however, this company was not considered to be a comparable case by my predecessor; because from the trading activity, the exclusion of other income resulted in net loss. However, in the current year i.e. A. Y.2003-04, there is neither any share dealing nor any such resultant loss. Hence, this case is accepted to be a comparable case”.
As regards the three entities selected by the TPO as comparables, the assessee-company reiterated its objection before the ld. CIT(Appeals) that the said entities could not be taken as comparables as their data was not available in the public domain. Reliance in this regard was placed on behalf of the assessee on Rule 10D of the Income Tax Rules, 1962, which provided that the auditor had to restrict his analysis in regard to the international transactions only with reference to the records and documents available in public domain. The ld. CIT(Appeals), however, did not find merit in the same. According to him, the restriction as stipulated in Rule 10D was applicable only in case of an auditor and there was no such fetter placed on the Assessing Officer or Transfer Pricing Officer, who could collect any information that they considered as comparables and, therefore, necessary in the determination of the arm’s length price. He also did not find merit in the other submissions made on behalf of the assessee-company seeking exclusion of the said three entities selected by the TPO as comparables and upheld the action of the TPO in considering the said three entities as comparables for the following reasons given in paragraph nos. 8.23 to 8.25 of his impugned order:-
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 12 of 23 “8.23. In so far as the reservation of the Appellant in the selection of Biomed Importer Pvt. Ltd. as comparable case by the TPO it is to be said that the objection is basically on account of the fact that information relating to said company is not available in the public domain, However that basis has already been rejected after due discussion.
8.24. In so far as the Appellant's objection to the inclusion of the South India Surgical Co. Ltd (SISCO) as a comparable case is concerned, it is noticed that the main objection is on the ground that it is essentially in the business of manufacturing unlike the case of the Appellant which is either in the business of trading and indenting. I have carefully considered the submission of the Appellant and the various documents submitted on the background facts of SISCO. After considering the same, I am of the view that SISCO is a comparable case because it is not at all involved in any major manufacturing activity during the year. On 1st page of director's report in respect of particulars of conservation of energy, it is stated that the company being engaged primarily in trading activities, the consumption of power and fuel is negligible. The company deals in surgical items and surgical sterilizers etc. which are medical equipments similar to the case of the appellant. The TPO has also observed these facts which are incorporated in her order quoted above. In this regard, the appellant's observations as per para 8.12 above though applicable to SISCO in the past are not applicable for F.Y.2002-03 in which no manufacturing activity has been carried out. At the most, the company may also be involved in assembling of some of the traded medical equipments which would explain the narration of raw material in inventories. But the raw materials are nothing but surgical equipments which are assembled and then traded. There is vast difference in the terminology of assembling and manufacturing. Hence, I consider SISCO Ltd. to be a comparable case and hold accordingly.
8.25. In so far as the objection to inclusion of Vascular Concepts (P) Ltd. as a comparable case is concerned, two fold arguments have been given by the appellant. Firstly, it is stated that this case was rejected by the TPO herself in earlier year due to functional difference: hence it should not have been selected. Secondly, it is stated that the company is mainly in design, development and manufacture of Endovascular medical devices and hence, it
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 13 of 23 is not a normal distributor/trader. I have perused the documents submitted by the appellant in respect of above company. It is seen that the company is engaged only in trading of medical equipments related to surgery including heart surgery. The trading turnover in F.Y.2002-03 was Rs.22.62 crores and other income was Rs.22.02 lacs. There is no major consumption of power and fuel and no manufacturing account was prepared. Also, from the accounts of the company it is seen that no revenue expenditure on R&D or decision, development activity has been booked. There is a minor amount of capital expenditure ofRs.43.13 lacs on R&D. It is seen that this company like SISCO Ltd. also assembles some of the medical equipments which are traded. Hence, none of the objections of the appellant are valid. Therefore, the case of Vascular Concepts (P) Ltd. is also very much comparable and I hold accordingly”.
The ld. CIT(Appeals) thus finally approved a list of eight comparables and worked out their average operating profit margin at 6.31% as under:- Sr. No. Name of Company NPM 2003 1. SISCO Ltd. 14.09% 2. Business Link Automation 3.30% (India) Ltd. 3. Compunics Information Systems 0.41% 4. 14.64% Vascular Concepts (P) Ltd. 5. Ashco Industries Ltd. 4.47% 6. Biomed Importers Pvt. Ltd. 6.84% 7. Advanced Micronic Devices Ltd. 4.89% 8. Remi Sales & Engineering Ltd. 1.85% 6.31% Arithmetical mean
Applying the above operating profit margin of 6.31% as against the average operating profit margin of 8.99% as applied by the TPO, the addition of Rs. 7,42,23,000/- made by the Assessing Officer/TPO on I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 14 of 23 account of Transfer Pricing Adjustment was restricted by the ld. CIT(Appeals) to Rs.3,62,46,000/-. Aggrieved by the same, the assessee and revenue have raised the following grounds in their respective appeals:- Assessee’s appeal “(1) Ground No. 1 - Assessment and Reference to TPO are bad in law 1.1. The orders passed by the Assessing Officer (AO) under section 143(3) of the Income Tax. Act, and the Commissioner of Income-tax (Appeals) - XXXII, Mumbai [the Ld CIT(A)] under section 250 of the Act, arc bad in law and on facts.
1.2. The Ld. CIT(A) erred in law in holding that AO was not required to inform reasons for disregarding the arms length price computed by appellant before referring the computation of the arm's length price to Transfer Pricing Officer (TPO).
1.3. The Ld CIT(A) erred in holding that opportunity of being heard is not required to be given to the appellant against the findings of the TPO.
1.4. The Ld CIT(A) erred in determining the arithmetic mean of arm's length net profit margin of 6.31% and a transfer pricing adjustment of Rs 36,246,000/-.
2. Ground No. 2 - Treatment of provision for bad and doubtful debts for determining operating margin The Ld CIT(A) erred in law and facts in holding that provision for doubtful debt related to HSG business taken over during the year was normal business expenses, hence should not be ignored while computing the operating margin of the appellant.
3. Ground No. 3 - Selection of comparable whose results are not available in the public database 3.1. The Ld CJT(A) failed to appreciate that 'secret comparables' which are not available in public database should not be considered as it is bad in law and against the principle of natural justice. 3.2. The Ld CJT(A) erred in law in holding that the restriction to use publicly available data as per the provisions of Rule I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 15 of 23 10D(4) of the Income-tax Rules, 1962 does not apply to the Assessing Officer.
4. Ground No. 4 - Arbitrary rejection/selection of comparables 4.1. The Ld CJT CA) has erred in selecting/rejecting comparables arbitrarily. Whereas the appellant has selected the comparables proper analysis of function performed, the assets employed and the risk assumed on data which is available in public domain. 4.2. Without prejudice to the ground no 4.1, the Ld CJT (A) has failed to appreciate that no search process had been undertaken by TPO to select these two new comparables.
5. Ground No. 5 - Selection of South India Surgical Co. Limited (SISCO) and Vascular Concepts (P) Ltd. as comparable 5.1. The Ld CIT(A) erred in fact in confirming the selection of South India Surgical Co. Ltd and Vascular Concepts (P) Ltd. as comparables. 5.2. The Ld CIT(A) erred in facts in not appreciating that these new companies are functionally not comparable with the appellant.
5.3.The Ld CIT(A) ignored the fact that in immediate previous assessment year ( AY 2002- 03), the TPO herself rejected Vascular Concepts (P) Ltd Due to functional difference.
6. Ground No. 6- Rejection of comparables selected by the Appellant The Ld CIT(A) erred in facts in confirming the rejection of WH Brady & Company, Redington (India) Ltd. and Ador Fontech Limited as comparables, without proving that these comparable companies were deficient or insufficient.
7. Ground No. 7 - Use of multiple year data The Ld CIT(A) erred law and facts in holding that there is no useful purpose is served in taking into consideration the material data available in respect of the earlier accounting years where said provisions were not applicable.
8. Ground No. 8 - Use of +/-5% range The CIT(A) erred in law in not granting the benefit of +/- 5 per cent variance as per proviso to section 92C(2) of the Act.
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 16 of 23 Revenue’s appeal “1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in determining the operating profit of the assessee company at 6.31% being average profit margin of the comparable cases worked out in the appellate order as against the operating profit at 8.99% determined by the TPO in the order under section 92AC(3) resulting into adjustment of Rs.7,42,23,000/- to the income shown by the assessee”.
Ground No. 1 raised in the appeal of the assessee is general in nature and as submitted by the ld. Counsel for the assessee, the same does not call for any specific adjudication.
Ground No. 2 of the assessee’s appeal involves the issue relating to the treatment to be given to the provision for bad and doubtful debts for determining the operating margin.
The ld. Counsel for the assessee submitted that the provision of Rs.4.13 crores made by the assessee-companay for bad and doubtful debts has been treated by the TPO as well as by the ld. CIT(Appeals) as part of operating expenses without considering the relevant facts and circumstances of the case. He contended that the said provision was made for the debts related to HSG business, which had become bad and irrecoverable. He submitted that the HSG business was acquired by the assessee-company during the financial year 2001-02 and in the course of the said acquisition, debtors of HSG were also taken over by the assessee- company. He submitted that the assessee-company, however, could not recover part of the debtors so taken over and accordingly a provision was made in its books for the year under consideration for doubtful debts. He invited our attention to the details of such debts given at pages no. 291 to 300 of his paper book and pointed out that the amount of Rs.4.13 crores in question was entirely provided for the debts related to HSG business,
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 17 of 23 which was taken over by the assesee-company in the earlier years. He contended that the said provision thus was not with respect to sales of the year under consideration and it, therefore, cannot be treated as part of operating expenses of the year under consideration in order to determine the operating margin. In support of this contention, he relied on the decision of the Bangalore Bench of this Tribunal in the case of M/s. Marble India Pvt. Limited –vs.- ACIT rendered vide its order dated 06.04.2018 in ITA No.2173/Bang./2017.
The ld. D.R., on the other hand, contended that the provision for bad debts is a part of operating expenses as already held by the Tribunal in certain cases. He contended that the case of M/s. Marble India Pvt. Limited (supra) decided by the Bangalore Bench of the ITAT and cited by the ld. Counsel for the assessee involved different facts and circumstances and the decision rendered by the Tribunal therein is not applicable in the present case.
We have considered the rival submissions and also perused the relevant material available on record. It is observed that the amount in question provided for bad and doubtful debts was entirely related to HSG business, which had been acquired by the assessee during the financial year 2001-02 and this position clearly evident from the relevant details furnished by the assessee at pages no. 291 to 300 is not disputed even by the ld. D.R. As submitted by the ld. Counsel for the assessee, the debtors of HSG were taken over by the assessee-company as a part of the said acquisition and the amount of such debts to the extent could not be recovered was provided for as bad and doubtful debts. It is thus clear that the provision in question made for bad and doubtful debts was not with respect to sales made by the assessee-company during the year under consideration but the same was with respect to sales made during the earlier year and that too by HSG.
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 18 of 23
In the case of Marble India Pvt. Limited (supra) cited by the ld. Counsel for the assessee, actual sales were accounted for in the earlier years and the corresponding debts were also created in the earlier years on the basis of such sales. The provision for bad and doubtful debts, however, was made in the subsequent year when it was seen that the recovery of such debts had become doubtful. In these facts and circumstances as involved in the case of Marble India Pvt. Limited (supra), the Bangalore Bench of this Tribunal held that such provision for doubtful debts cannot be reduced for determining the operating profit for the purpose of transfer pricing analysis either in the case of tested party or comparables. The Tribunal took a note of the whole purpose of transfer pricing analysis as well as the method followed for determining the arm’s length price including TNMM and held that if the provision for doubtful debts made with respect to the sale of the earlier year is reduced from the profit of the subsequent year, the numerator is reduced but the denominator is not reduced because corresponding sale stood considered in earlier year, which could not be considered in the subsequent year. It was held that such provision for bad and doubtful debts thus has to be ignored and added back to the operating profit of the tested party or of the comparables as the case may be for determining the operating margin while making the transfer pricing analysis. While arriving at this conclusion, the Bangalore Bench of ITAT also took into consideration certain decisions of the Tribunal rendered earlier on this issue on which reliance is placed by the ld. D.R. in support of the revenue’s case.
As already noted, the relevant bad debts for which the amount in question was provided for by the assessee-company in the year under consideration were not only in respect of sales made in the earlier years but the same were related to HSG business, which was acquired by the I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 19 of 23 assessee-company in the financial year 2001-02. Keeping in view this undisputed factual position and the decision of the Bangalore Bench of ITAT in the case of Marble India Pvt. Limited (supra), we are inclined to agree with the contention of the ld. Counsel for the assessee that the provision for bad and doubtful debts amounting to Rs.4.13 crores cannot be treated as a part of operating cost for the purpose of computing operating profit of the assessee-company for the year under consideration. We accordingly direct the Assessing Officer/Transfer Pricing Officer to re-compute the operating margin of the assessee- company by reducing the said amount and allow Ground No. 2 of the assessee’s appeal.
At the time of hearing before us, the ld. Counsel for the assessee has submitted that if the provision for bad and doubtful debts amounting to Rs.4.13 crores is reduced from the operating cost for the purpose of computing the operating margin of the assessee-company and arm’s length price of the international transactions of the assessee-company with its Associated Enterprises is determined by applying the average operating profit margin of the comparables as selected by the TPO, the same would fall within the tolerance limit of 5% as compared to the price actually charged by the assessee-company to its AEs for the said international transactions, the benefit of which is being claimed in additional Ground No. 2. We accordingly direct the Assessing Officer/TPO to re-compute the difference between the arm’s length price of the international transactions of the assessee company with its AEs as determined by them and the price charged by the assessee-company by taking its operating margin after excluding the provision for bad and doubtful debts and if the same is found within the tolerance limit of 5%, the Assessing Officer/TPO is directed to delete the addition made on account of transfer pricing adjustment. The additional Ground No. 2 of the assessee’s appeal is accordingly allowed.
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 20 of 23
As a result of our decision rendered above while deciding the issue involved in Ground No. 2 and additional Ground No. 2 of the assessee’s appeal, the other issues raised in Grounds No. 3 to 8 and additional Ground No. 1 of the assessee’s appeal and Ground No. 1 of the Revenue’s appeal relating to the addition made on account of transfer pricing adjustment have become infructuous or rendered academic only. We, therefore, do not consider it necessary or expedient to decide the same.
As regards the remaining issues raised in Ground No. 9 of the assessee’s appeal and Ground No. 2 of the Revenue’s appeal relating to the disallowance on account of employer’s contribution to P.F. and Pension Fund and employees contribution to P.F. and Pension Fund respectively, it is observed that the same are squarely covered in favour of the assessee by the decision of the Hon’ble Supreme Court in the case of CIT –vs.- Alom’s Extrusions Limited [185 Taxman 416] and CIT –vs.- Vinay Cement Limited [213 CTR 268], wherein it was held that the employer’s/employees contribution towards Provident Fund and Pension Fund paid before the due date of filing of the return of income for the relevant year cannot be disallowed under section 43B, even if it has been paid after the due date as per relevant Acts. Respectfully following the said decision of the Hon’ble Apex Court, we decide this issue in favour of the assessee. Ground No. 9 of the assessee’s appeal is accordingly allowed, while Ground No. 2 of the Revenue’s appeal is dismissed.
As regards the revenue’s appeal being which is directed against the order of ld. Commissioner of Income Tax (Appeals)-15, Kolkata dated 07.01.2011, whereby he cancelled the penalty of Rs.1,39,56,548/- imposed by the Assessing Officer under section 271(1)(c) of the Act, it is observed that the penalty imposed by the Assessing Officer under section 271(1)(c) of the Act in respect of I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 21 of 23 addition made to the total income of the assessee on account of transfer pricing adjustment as sustained in the first appeal to the extent of Rs.3,62,46,000/- as well as in respect of other addition for disallowance on account of belated payment of employees contribution towards Provident Fund, etc. was deleted by the ld. CIT(Appeals) vide paragraphs no. 4 to 9 of his impugned order, which read as under:-
“4. I have perused the assessment order, penalty order as well as the case laws cited by the appellant. Penalty proceedings are separate from quantum proceedings (assessment proceedings) and simply because an addition has been made in the assessment order which even has been confirmed at the appellant level will not ipso facto lead to levy of penalty u/s. 271(1)(c). This is because the considerations which prevail in penalty proceedings are different from those which obtain at the assessment proceedings.
5. This aspect assumes greater significance as penalty relating to adjustments made under the special provisions of the I.T. Act (Transfer Pricing) contained in Chapter X are governed by Explanation 7 to section 271(1)(c).
6. Explanation 7 basically revolves around two core issues "good faith’ and "due diligence". It has to be seen in objective manner whether the appellant has acted in "good faith' and "due diligence" or not, before the penalty can be levied. Both these additions have to be satisfied cumulatively.
The appellant carried out transfer pricing study and adopted TNMM as MAM. While carrying out TNMM, it undertook its search in public database and identified 2 companies as comparables to its distribution activities in India. The TPO has not found fault in the search process for selection of comparable companies submitted by the appellant. On the other hand, the TPO by invoking powers u/s 133(6), picked up 3 companies to arrive at the margin of 8.99%. The information collected by the TPO by invoking
I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 22 of 23 section 133(6) of the I.T. Act in respect of these companies, was not available in public domain.
8. It will be unfair to penalize the appellant in respect of data/ information gathered by invoking the provisions of Section 133(6) of the I.T. Act, which the appellant cannot exercise. The Ld. CIT(A) partly agreed with the contention of the tax payer and included its 3 comparable companies out of final set of comparables and arrived at the operating margin of 6.31% as against 8.99% determined by the appellant. It is clear that the whole exercise is a subjective one based on selection and rejection of comparables and so levying a concealment penalty on this exercise would be unfair in the light of the decision of the Mumbai ITAT in the case of Firmenich Aeromatics (India) Pvt. Ltd. 2010-TII-17-ITAT-MUM-TP.
Based on the above facts and circumstances, it cannot be said that the appellant either acted in bad faith or negligently so as to satisfy the conditions for levy of penalty under Explanation 7 of the Income Tax Act. The explanation offered by the appellant is held to be bonafide and hence the penalty so levied, is cancelled”.
While we agree with the reasons given by the ld. CIT(Appeals) for cancelling the penalty imposed by the Assessing Officer under section 271(1)(c), it is pertinent to note that even the addition made on account of transfer pricing adjustment and disallowance of employees contribution towards Provident Fund, etc. as sustained by the ld. CIT(Appeals) are found to be not sustainable by us while disposing of the quantum appeals as held in the foregoing portion of this order. Consequently the penalty imposed under section 271(1)(c) in respect of the said addition is not sustainable and the impugned order of the ld. CIT(Appeals) cancelling the penalty imposed by the Assessing Officer is liable to be upheld on this ground also. We accordingly uphold the I.T.A. No 3412/MUM/2008 Assessment year: 2003-2004 & Assessment year: 2003-2004 & ITA-2722/MUM/2011 Assessment Year: 2003-2004 Page 23 of 23 impugned order of the ld. CIT(Appeals) and dismiss this appeal of the Revenue.
In the result, the appeal of the assessee is allowed, while the Revenue’s appeals are dismissed. Order pronounced in the open Court on September26, 2018.