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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.: Out of these three appeals, two appeals being ITA No. 2723/MUM/2006 (Assessee’s appeal) and ITA No. 3183/MUM/2006 (Revenue’s appeal) are cross appeals for assessment year 2002-03, which are directed against the order of ld. Commissioner of Income Tax (Appeals)-VIII, Mumbai dated 01.03.2006, while the third appeal being ITA No.164/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.6,06,06,000/- made by the Assessing Officer/Transfer Pricing Officer on account of transfer pricing adjustment, which is sustained by the ld. CIT(Appeals) to the extent of Rs.2,60,32,000/-.
The assessee in the present case is a 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’s 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
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 3 of 25 resonance, computed tomography, nuclear medicine, PET, radiation oncology systems etc. The assessee-company is a distributor and commission agent for medical 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 30.10.2002 declaring a loss of Rs.3,68,51,112/-. 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:- 1. 47.87 crores TNMM & CUP Import of equipment and spares (after set off of a credit note received of Rs.11.87 crores on account of transfer pricing adjustment. 2. Commission income earned 3.73 crores TNMM 3. IT charges-cost sharing amount 1.07 crores Cost/CUP paid by assessee 4. Reimbursement paid to AE 0.47 crores Cost
In order to determine the Arm’s Length Price of the above International Transactions entered into by the assessee-company with these A.Es, a reference was made by the Assessing Officer to the Transfer Pricing Officer under section 92CA(3) of the Income Tax Act, 1961. Although in the Transfer Pricing Study report filed along with its return of income, the Transfer Pricing analysis in respect of the different typres of transactions entered into with its Associated Enterprises was made by the assessee as per the different methods, the assessee-company during the course of proceedings before the TPO made the transfer pricing analysis by applying the Transactional Net Margin Method (TNMM) at entity level by taking operating profit to sales as the profit level indicator. On search in the public database, 10 entities were identified as comparables and since the arithmetic mean of the operating margins of
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 4 of 25 the said comparables as worked out at 3.11% was less than the Operating Profit Margin on sales of the assessee-company as worked out at 5.07%, the International Transactions entered into with its AEs were claimed by the assessee-company to be at Arm’s Length.
As noted by the TPO, there was a mistake on the part of the assessee-company in working out its operating profit margin on sales at 5.07%, inasmuch as, the loss suffered on account of exchange fluctuation was completely ignored by the assessee-company for the purpose of determining the operating cost on the ground it constituted an abnormal item. The Assessing Officer did not accept this treatment given by the assessee-company and by treating the loss on account of exchange fluctuation as a part of operating cost, the operating profit margin of the assessee-company on sales was recomputed by him at 1.79%. As regards the 10 entities selected as comparables by the assessee-company, the Assessing Officer found that four of them had substantial related party transaction, while three entities were not functionally similar to the assessee-company. He also found that out of the remaining three entities selected by the assessee-company as comparables, two entities were having very high or very low turnover as compared to the assessee- company, while the third company was engaged in trading of computer- graphic equipments and not medical equipments or any other product closely comparable to the medical equipments distributed by the assessee. He, therefore, rejected all the entities selected by the assessee- company as comparables.
The TPO, on his own, selected four entities, which were engaged in dealing of medical equipments as comparables and proposed to consider the same for the purpose of determining the arm’s length price of the international transactions of the assessee with its AEs. He, accordingly obtained their annual reports by issuing notices under section 133(6) and
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 5 of 25 provided copies of the same to the assessee. The assessee-company raised a preliminary objection to the selection of the four 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 four entities selected by the TPO in support of its contention that the same were not comparable. After considering objections raised by the assessee, the TPO excluded one of the four entities selected by him as comparables and selected the remaining three entities as comparables for the following reasons given in paragraph no. 13 of his impugned order:- “(a) Schiller India Pvt. Ltd.: In view of the assessee’s contention that the said company is engaged in manufacturing activity, the same is not considered for the purpose of determining the arm’s length price.
(b) South India Surgical Co. 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 in trading activity. In view of the specific statement in the director’s report, this company is considered as comparable to the assessee. Further, this is a Public Limited Company.
(c) Vascular Concepts Pvt. Ltd.:- The assessee’s contention that this company is also engaged in manufacturing activity is ent4rely incorrect. In this connection, a ltter was addressed to the said company and it has been confirmed by them categorically that during the previous year they have only imported the various products dealt by them and sold the same in India. Hence, clearly they are engaged only in trading activity and not in any manufacturing or production activities. Hence this company can be considered as a comparable company.
(d) Biomed Importers Pvt. Ltd.:- In view of the fact that the assessee considers the same to be comparable to it, the same is treated as a comparable company.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 6 of 25 7. Out of the above three entities, TPO further excluded M/s. Vascular Concepts Pvt. Ltd. and the average operating profit margin of the two entities finally selected as comparables was worked out by the TPO at 8.12% as under:- Sl. Name of the company Profit Margin No. 1. South India Surgical Co. Ltd 10.44% 2. Biomed Imports Pvt. Ltd 5.80% Average profit margin: 8.12%
Applying the said average operating profit margin of 8.12% to the total turnover of the assessee-company, the transfer pricing adjustment was worked out by the TPO at Rs.6,06,06,000/- and accordingly the 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 30.03.2005.
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 relating to the treatment given by the TPO to the loss on account of fluctuation in foreign exchange 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 same for the following reasons given in paragraph nos. 26 & 27 of his impugned order:- “26. In so far as the issue at item (i) above is concerned, there is no merit in the claim considering that the appellant is dealing in trading of items purchased in convertible foreign exchange. The conversion rates of dollars of Euro, the currencies in which the purchase
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 7 of 25 price is paid vis-a-vis India Rupees in which the sale consideration is received are always liable for fluctuation. The additional liability, the appellant had incurred on this account is on account of the difference in the convertible rate of dollar on Euro on the date on which the invoice has been raised by the supplier and date on which remittance of the payment has been made by the appellant company.
The loss is, therefore, incidental and part and parcel of the business activity carried on by the appellant company. It is not on account of an additional liability on account of the appellant having raised loan in the convertible currency. Hence, it is not an extra ordinary liability that would have arisen on account of the appellant having taken the loan in convertible foreign exchange. Such loss or gain in trading is always to be anticipated. It has arisen as a normal incidence of the business and hence is an integral part of the profit arising to the appellant. Therefore, the claim in this respect is liable for rejection”.
The action of the TPO in rejecting all the ten 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 as well as the material available on record, the ld. CIT(Appeals) agreed with the TPO as regards the rejection of five entities selected by the assessee as comparables. He, however, did not agree with the TPO as regards the other five entities selected by the assessee as comparables.
As regards the two 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
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 8 of 25 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 fetters placed on the Assessing Officer or Transfer Pricing Officer, who could collect any information that they consider 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 two entities selected by the TPO as comparables and upheld the action of the TPO in considering the said two entities as comparables.
Accordingly five of the ten entities identified by the assessee and two entities identified by the TPO were finally selected by the ld. CIT(Appeals) as comparables and their average operating profit margin was worked out by him at 4.53% as under:-
Sr. No. Name of the Company NPM 2002 1. Ador Fontech Limited 6.11% 2. Business Link Automation (India) 3.26% Ltd. 3. Compunics Information Systems 0.39% 4. Digital Electronics Ltd. 4.08% 5. Redington India Ltd. 1.66% 6. South India Surgical Company 10.44% Limited 7. Biomed Importers Pvt. limited 5.80% Arithmetical mean 4.53%
Applying the average operating profit margin of 4.53% as against the average operating profit margin of 8.12% as applied by the TPO, the addition of Rs.6,06,06,000/- made by the Assessing Officer/TPO on account of transfer pricing adjustment was restricted by the ld.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 9 of 25 CIT(Appeals) to Rs.2,60,32,000/-. Aggrieved by the same, the assessee and revenue have raised the following grounds in their respective appeals:-
Assessee’s appeal
Ground No. 1 - Selection of comparable whose results are not available in the public domain.
1.1. The Commissioner of Income-tax (Appeals) - VlII, Mumbai [the CIT(A)] erred in holding that the restriction to use publicly available data as per the provisions of Rule 10D(4) of the Income-tax Rules, 1962 does not apply to the Assessing Officer.
1.2. The learned CIT(A) failed to appreciate, considering the submissions made, facts and circumstances of the case, the appellant's claim that the judicial principle of 'Impossibility of Performance' should be given due consideration while using secret comparables.
1.3. The learned CIT(A) failed to appreciate, considering the submissions made, facts and circumstances of the case, that the secret comparable considered by the learned TPO is bad in law and against the principle of natural justice.
1.4. The Appellant prays that the comparable whose results are not available in the public domain should be rejected for benchmarking its international transactions.
Ground No. 2 - Selection of South India Surgical Co. Limited (SISCO) as comparable
2.1. The learned CIT(A) overlooked the fact, considering the submissions made based on the facts and circumstances of the case, that SISCO is engaged in manufacturing activity.
2.2. The learned CIT(A) erred in holding, that SISCO is comparable on the alleged presumption that even though there are indications in the Annual Report of SISCO that it is getting its items manufactured, it is still comparable to Appellant's function while applying Transactional Net margin Method.
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2.3. The Appellant prays that SISCO should be rejected as comparable on account of the functional differences as that of the Appellant.
Ground No. 3- Rejection of comparables selected by the Appellant
3.1. The learned CIT(A) erred in holding, considering the submissions made, facts and circumstances of the case, that Remi Sales & Engineering Limited is not comparable to benchmark the Appellant's international transactions.
3.2. The learned CIT(A) erred in holding, considering the submissions made, facts and circumstances of the case, that other income disclosed in the financials of Remi Sales & Engineering Limited has no relationship to the business activity of the Company.
3.3. The learned CIT(A) erred in holding, considering the submissions made, facts and circumstances of the case, that comparables having transactions with Indian associated enterprises cannot be considered as comparables as per the provisions of Rule 10D(3)(ii) of the Income-tax Rules, 1962.
3.4. The Appellant prays that the Remi Sales & Engineering Limited and other comparables selected by the Appellant should be accepted as comparables for benchmarking the Appellants international transactions.
Ground No. 4 - Foreign exchange fluctuation loss
4.1. The learned CIT(A) failed to appreciate, considering the submissions made, facts and circumstances of the case, appellants' claim that foreign exchange loss incurred during the year was abnormal and should be ignored while computing the operating margin of the Appellant.
4.2. The learned CIT(A) has erred in holding on the alleged presumption that foreign exchange loss has arisen in the normal course of the business and hence is the integral part of the profit arising to the Appellant.
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4.3. The appellant prays that the foreign exchange loss should be considered as non operating expense for computing the operating profit margin of the Appellant.
Ground No. 5 - Use of multiple year data
5.1. The learned CIT(A) erred 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.
5.2. The learned CIT(A) erred in holding that for the relevant assessment year there was no error or omission on the part of the TPO to consider single year data only.
5.3. The learned CIT(A) failed to appreciate, considering the submissions made, facts and circumstances of the case that the operating margin of the comparable companies should be computed by using multiple year data.
5.4 The Appellant prays that multiple year data should be used for computing the operating profit margin of the comparables.
Ground No. 4 - Use of +/-5% range
6.1. The learned CIT(A) erred in rejecting the Appellant's claim that the benefit of +/-5% range while computing the arm's length price.
6.2. The Appellant prays that the benefit of plus 5% range be granted to the Appellant while computing the arm's length price and consequent adjustment to total income.
Revenue’s appeal 1. On the facts and in the circumstances of the case and in law, the CIT(Appeals) erred in not upholding the addition of Rs.6,06,06,000/- by invoking the provision of section 92C(1) of the Act. He erred in directing the AO to restrict the adjustment in terms of section 92CA(3) of the Act and to restrict consequential addition made in terms of section 92CA(4) to that extent, without appreciating the facts of the case.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 12 of 25 13. During the course of appellate proceedings before the Tribunal, the assessee has also raised the following two additional grounds which are related to the issue of transfer pricing adjustment:- “Ground No. 1- Transfer pricing adjustment to be restricted to international transactions
The Transfer Pricing Officer (the TPO) and Assessing Officer (the AO) and Commissioner of Income Tax (Appeals)-VIII, Mumbai (The CIT(A) have erred in law and on facts in attributing the entire alleged short fall in the profit margin of the appellant to the international transactions, in making the transfer pricing adjustment amounting to INR 26,032,000 instead of computing the transfer pricing adjustment only to the extent of the proportionate share of the value of the international transactions.
Ground No. 2 – The befit of +/-5% variation computed on Arm’s Length Price
On the facts and in the circumstances of the case, the TPO and the AO have erred in proposing and the CIT(A) has further erred in rejecting the benefit o +/-5% to appellant under second proviso to section 92C(2) of the Income Tax Act, 1961.
As regards the issue involved in Ground No. 1 relating to selection of comparables by the TPO whose results are not available in the public domain, the ld. Counsel for the assessee has not raised any specific contention in support of the assessee’s case on this issue. As rightly held by the ld. CIT(Appeals) in this regard, the restriction stipulated in Rule 10D is applicable only to the auditor and not to the TPO, who has an inherent power to make enquiry and collect and use the information and material, which is found to be relevant for the purpose of transfer pricing analysis in order to determine the arm’s length price of the relevant international transactions between the AEs. He has also discussed and relied upon various judicial pronouncements, which support this view.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 13 of 25 We, therefore, find no merit in Ground No. 1 of the assessee’s appeal and dismiss the same.
As regards the issue involved in Ground No. 2 of the assessee’s appeal challenging the selection of M/s. South India Surgical Co. Limited (SISCO) as comparable by the TPO, the ld. Counsel for the assessee explained the functional profile of the assessee-company. He submitted that the assessee-company is mainly a trading company, which deals in high-end medical equipment with market confined to India. He invited our attention to the profit & loss account of the assessee-company for the year under consideration placed at page 37 of the paper book to point out that the major source of income of the assessee-company was from sales and service and commission. He contended that the assessee-company thus was not engaged in manufacturing activity at all while the SISCO taken by the TPO as comparable was very much engaged in the manufacturing activity. In this regard, he invited our attention to the relevant portion of the annual report of the SISCO at page no. 2 of the annual report binder to show that the said entity had four factories at different locations. He also pointed out from page no. 23 of the annual report binder that the CIF value of raw materials imported was 10.72 crores and it was clearly mentioned that the quantitative particulars of raw materials in different trades and manufacturing could not be quantified in terms of any particular unit since SISCO was dealing in numerous varieties of products. He also pointed out from the details of cost of materials given at page no. 18 of the annual report of SISCO that substantial manufacturing expenses in the nature of wages, power, charges, consumables and assembly charges were incurred by the said entity.
The ld. Counsel for the assessee further invited our attention to the copy of catalogue placed at page no. 323 of the paper book and pointed
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 14 of 25 out from the functional profile of the said company given therein that SISCO was engaged in manufacturing of extensive range of surgical instruments. He contended that SISCO thus was also engaged in manufacturing activity and there was functional dissimilarity between the said entity and the assessee-company. He contended that no segmental details in respect of manufacturing and trading were available and in the absence of the same, SISCO cannot be taken as comparable. He submitted that this functional difference between the assessee-company and SISCO was accepted by the ld. CIT(Appeals) in paragraph no. 45 of his impugned order, but still he chose to ignore the same on the ground that it was a case of contract manufacturing rather than of own manufacturing. He contended that the ld. CIT(Appeals) as well as the TPO also erred in placing the entire reliance on the Director’s report indicating that SISCO was primarily engaged in trading activity ignoring completely the details reflected in the financial statements clearly showing the manufacturing activity carried out by SISCO. He contended that there was thus a fundamental difference in the functional profile of the assessee-company and SISCO, which cannot be ignored, even though the method followed is TNMM.
The ld. D.R., on the other hand, strongly relied on the relevant portion of the Director’s report of SISCO at page no. 6 of the annual report binder, wherein it was stated that the SISCO was engaged primarily in trading activities. He contended that the Director’s report is a reliable document and the statement made therein cannot be under- minded. He contended that there might be some manufacturing activity carried on by SISCO during the relevant year as pointed out by the ld. Counsel for the assessee from the annual report but it was a case of contract manufacturing only as evident from the relevant expenses claimed by SISCO and the quantum of such contract manufacturing was also very insignificant. He contended that such manufacturing activity
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 15 of 25 was only incidental to the main activity of trading and servicing carried on by the SISCO and the same was not relevant or material when the transfer pricing analysis was undertaken by adopting TNMM. He submitted that there was no mention at all in the annual report of SISCO regarding installed capacity, utilized capacity, etc., which again goes to show that there was hardly any manufacturing activity carried out by SISCO on its own and it was a case of contract manufacturing which was only incidental to the main activity of SISCO of trading and servicing.
As regards the addresses of four factories of SISCO given in the annual report as pointed out by the ld. Counsel for the assessee, the ld. D.R. submitted that two of the said units indicated as factories were named as sales office and service centre. He contended that all these four units mentioned as factories in the annual report of SISCO thus appear to be in the nature of service centres and not manufacturing units. As regards the reliance placed by the ld. Counsel for the assessee on the functional profile of SISCO given in the Brochure, the ld. D.R. contended that the same is general in nature, which is not conclusive to decide the functional profile of SISCO. He also contended that there is no difference in the product profile of SISCO and the assessee-company, inasmuch as, both are dealing with the products in the same medical field. He submitted that the assessee-company itself has taken one entity as comparable, which is not even dealing in medical equipments. He contended that the broad functional and product similarity is sufficient when TNMM is applied as the most appropriate method and the SISCO, therefore, is rightly included in the list of final comparables.
In the rejoinder, the ld. Counsel for the assessee clarified that even if two of four factories of SISCO are in the nature of sales & service centres going by the nomenclature used, there is nothing to show that there is no manufacturing activity in other two factories.
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We have considered the rival submissions and also perused the relevant material available on record. It is observed that the assessee is seeking exclusion of one of the entities selected by the TPO, namely SISCO from the list of final comparables on the ground that the same is not functionally similar. In this regard, the ld. Counsel for the assessee has contended that SISCO during the year under consideration was engaged in trading as well as manufacturing activity and the same, therefore, is not functionally similar to the assessee-company, which is engaged only in the trading activity. He has taken us through the annual report of the assessee-company in order to explain its functional profile and keeping in view the relevant details given in the said annual report including the financial statements, we find that the assessee-company during the year under consideration was engaged only in trading activity and rendering related services. Even the ld. D.R. has not disputed this position. As regards SISCO, the ld. Counsel for the assessee has invited our attention to the significant accounting policies followed by the said entity as given at page no. 22 of the annual report to point out that raw materials and stores and spares were being valued at cost by SISCO while finished goods were being valued at cost or market value, whichever is less. This shows that the inventory of SISCO was classified into raw materials and finished goods which indicates that SISCO was engaged in the activity of converting raw materials into finished goods, i.e. manufacturing.
As prescribed under Paragraph 3, 4(c) & 4(d) of Part-II of Schedule VI of the Companies Act, 1956, the Company is required to furnish the relevant quantitative particulars in its annual report. As pointed out by the ld. Counsel for the assessee from the relevant portion of the annual report of SISCO at page no. 23, it was mentioned that the relevant quantitative particulars of principal items traded and manufactured could not be given as it was not quantified in terms of any particular items
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 17 of 25 since the Company was dealing in numerous varieties of products. These details furnished by SISCO in its annual report further goes to show that it was engaged in the business of trading as well as manufacturing.
On page no. 23 of the annual report, SISCO had also given the information that the CIF value of raw material imported by it during the year under consideration was 10.72 crores. Relying on this information given by the SISCO as well as the direct expenses claimed by the said entity under the head “cost of materials” in the form of wages amounting to Rs.10,19,953/-, power charges amounting to Rs.7,64,958/-, consumables amounting to Rs.7,21,075/- and assembly charges amounting to Rs.4,10,672/-, the ld. Counsel for the assessee has contended that SISCO was engaged in manufacturing, which was a significant activity. Neither the authorities below in their respective orders nor the ld. D.R. at the time of hearing before us has disputed these facts and figures highlighted on behalf of the assessee. They, however, have taken a view that the activity of SISCO was in the nature of contract manufacturing and the same was only incidental to the main activity of trading and rendering related services. We are unable to concur with this view in the absence of any material or information to support and substantiate the same. When the CIF value of raw materials imported by the assessee-company during the year under consideration was Rs.10.72 crores, vis-a-vis the total sales of Rs.20.86 crores and the expenses incurred by it, which were in the nature of direct manufacturing expenses amounting to above Rs.30 lakhs, it is difficult to say that the manufacturing activity of SISCO was insignificant and the same was only incidental to its trading activity.
In support of the revenue’s case for inclusion of SISCO in the list of final comparables, heavy reliance is placed by the authorities below as well as by the ld. D.R. on the Director’s report of SISCO, wherein it was
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 18 of 25 stated that the Company is engaged primarily in trading activities. In this regard, it is observed that the SISCO was required to furnish particulars of conservation of energy, technology and foreign earnings/outcome under section 217(1(i)(e) of the Companies Act, 1956 and in this context, it was stated in the Director’s report that the company being engaged primarily in trading activities, the consumption of power and fuel is negligible. In our opinion, this general statement made in the Director’s report in an altogether different context cannot be relied upon to conclude that SISCO was engaged only in trading activities and there was no manufacturing activities, especially when the relevant details reflected in the financial statements were clearly showing that manufacturing activity was carried out by SISCO in the year under consideration besides trading. The ld. Counsel for the assessee has placed on record a copy of catalogue of SISCO at pages 323 to 326 of the paper book, wherein it is mentioned that SISCO manufactures extensive range of surgical instruments from General Surgery, Cardio-Vascular, Neuro, Urology, Plastic, Obstetrics and Gynaecology, Tungsten Carbide, Minimal Invasive Instruments. It is also mentioned that SISCO had 4-5 years ago started its full-fledged production of Disposables Syringes and Foley Catheter and had proved its significance notably. The copy of this catalogue was filed by the assessee before the ld. CIT(Appeals) under letter dated 24.12.2005 and although the ld. D.R. has contended that this general catalogue cannot conclusively establish the manufacturing activity of SISCO, we are of the view that the same coupled with the other relevant details reflected in the financial statements and annual report of SISCO are sufficient to establish that the SISCO was engaged in manufacturing also as a significant activity and in the absence of segmental details, the same cannot be taken as comparable to the assessee-company, which is mainly engaged in trading activity. We accordingly direct the TPO to exclude SISCO from the list of final comparables and allow Ground No. 2 of the assessee’s appeal.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 19 of 25
At the time of hearing before us, the ld. Counsel for the assessee has submitted that if SISCO is excluded from the list of final comparables and the arm’s length price of the international transactions of the assessee- company with its AEs is determined by applying the average operating profit margin of the remaining comparables, 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. 1. We accordingly direct the Assessing Officer/TPO to re-compute the arm’s length price of the international transactions of the assessee-company with its AE by excluding SISCO from the list of final comparables and if the same is found to be within the tolerance limit of 5%, the Assessing Officer/TPO is directed to delete the addition made on account of transfer pricing adjustment. Additional Ground No. 2 of the assessee’s appeal is accordingly allowed.
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, 4, 5, & 6 and additional Ground No. 1 of the assessee’s appeal as well as in 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.
The issue raised in the remaining ground of the assessee’s appeal, i.e. Ground No. 7 relates to the disallowance of Rs.42,75,122/- made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of assessee’s claim for bad debts written off.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 20 of 25 27. The deduction claimed by the assessee on account of bad debts written off was disallowed by the Assessing Officer on the ground that there was a failure on the part of the assessee to establish that the relevant debts had actually become bad and irrecoverable during the year under consideration. Before the ld. CIT(Appeals), it was contended on behalf of the assessee that after the amendment made to section 36(1)(vii) read with section 36(2) w.e.f. 1st April, 1989, it was no longer necessary for the assessee to establish that the relevant debts had actually become bad during the relevant year in order to claim deduction on account of bad debts written off and the only requirement was that the said debts representing trading debts were written off in the books of account as irrecoverable. Reliance in support of the contention was placed by the assessee on the CBDT Circular No. 551 dated 23.01.1990. The ld. CIT(Appeals) did not find merit in this contention raised on behalf of the assessee. According to him, it was necessary for the assessee to establish that the relevant debts had actually become bad during the relevant year in order to claim deduction under section 36(1)(vii) read with section 36(2) and this position had remained unchanged even after the amendment made in the said provision w.e.f. 1.4.1989. He accordingly confirmed the disallowance made by the Assessing Officer on account of bad debts written off.
At the time of hearing before us, the ld. Representatives of both the sides have agreed that this issue involved in Ground No. 7 of the assessee’s appeal now stands squarely covered in favour of the assessee by the decision of the Hon’ble Supreme Court in the case of TRF Limited, wherein it was held that the legal position relating to the allowability of bad debts written off has changed after the amendment made by the Direct Taxes laws (Amendment) Act, 1987 in section 36(1)(vii) with effect from 01.04.1989 and it is no more necessary for the assessee to establish that the debt, in fact, has become irrecoverable. As further held
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 21 of 25 by the Hon’ble Supreme Court, it is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. Respectfully following the said decision of the Hon’ble Apex Court, we delete the disallowance made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of assessee’s claim for deduction on account of bad debts written off and allow Ground No. 7 of the assessee’s appeal.
As regards the Revenue’s appeal, the only other issue involved therein besides the addition made on account of Transfer Pricing Adjustment as raised in Ground No. 2 relates to the deletion by the ld. CIT(Appeals) of the disallowance of Rs.11,32,532/- made by the Assessing Officer on account of interest paid on capital borrowings.
During the course of assessment proceedings, it was noticed by the Assessing Officer that the assessee has utilized the borrowed funds for acquiring a new business. According to him, interest attributable to the borrowed funds to the extent utilized for acquiring the new business was an expenditure of capital nature and the same was liable to be disallowed. He accordingly worked out such interest at Rs.11,32,520/- and made a disallowance to that extent. On appeal, the ld. CIT(Appeals) deleted the said disallowance made by the Assessing Officer on the ground that the only requirement for allowing deduction on account of interest as per the provision of section 36(1)(iii) applicable to the year under consideration i.e. A.Y. 2002-03 (prior to amendment made w.e.f. 1st April, 2004) was that the interest was paid in respect of capital borrowed for the purpose of assessee’s business or profession. He noted that the assessee-company had acquired Healthcare Solution Group of Agilent Technologies India Pvt. Limited as a going concern and even the profit from the said business earned during the year under consideration was offered to tax by the assessee. He held that the borrowed funds thus were utilized by the
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 22 of 25 assessee-company for the purpose of its business and interest paid thereon was allowable as deduction under section 36(1)(iii) of the Act.
We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. As rightly held by the ld. CIT(Appeals), the only requirement for allowing deduction on account of interest under section 36(1)(iii) for the year under consideration was that such interest was paid in respect of capital borrowed for the purpose of assessee’s business or profession and the proviso to section 36(1)(iii) putting a bar on the allowability of interest paid in respect of capital borrowed for acquisition of assets has been inserted in the Statute only w.e.f. 1.4.2004 applicable to A.Y. 2004-05 and onwards. In the present case, the borrowed funds having been utilized by the assessee-company for acquiring a going oncern and the profits from the business of the said concern having been offered to tax in the year under consideration, we find ourselves in agreement with the ld. CIT(Appeals) that the borrowed funds were utilized by the assessee- company for the purpose of its business and interest paid thereon was eligible for deduction under section 36(1)(iii) as applicable to the year under consideration. We accordingly uphold the impugned order of the ld. CIT(Appeals) on this issue and dismiss Ground No. 2 of the Revenue’s appeal.
As regards the Revenue’s appeal being ITA No. 164/MUM/2011, which is directed against the order of the ld. CIT(Appeals)-15, Kolkata dated 20.10.2010, whereby he cancelled the penalty of Rs.92,93,424/- 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 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.2,60,32,000/- was deleted by the ld.
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 23 of 25 CIT(Appeals) vide paragraphs no. 4 to 10 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.
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).
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.
Applied to the facts of the present case the appellant carried out transfer pricing study. It first benchmarked its transactions under CUP as the most appropriate method. In doing so, it compared the price of similar equipments sold by its related overseas party to a non-related party in India. Wherever CUP was not available, TNMM method was considered as the most appropriate method. The very fact that the appellant had tried to benchmark its transaction on the CUP, demonstrates its willingness and confidence to determine its Arm's Length Price by the most direct and reliable method.
Even while carrying out TNMM, it undertook its search in public database and identified 10 Companies as comparables to its distribution activities in India. The TPO
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 24 of 25 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 2 companies to arrive at the margine of 8.12%. The information collected by the TPO by invoking section 133(6) of the I.T. Act in respect of these companies, was not available in public domain.
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 5 comparable companies, which were rejected by the TPO and arrived at the operating margin of 4.43% as against 8.12% 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) in respect of addition made on account of transfer pricing adjustment, it is pertinent to note that even the addition made on account of transfer pricing adjustment to the extent of Rs.2,60,32,000/- as sustained by the ld. CIT(Appeals) is 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
I.T.A. No 2723/MUM/2006 Assessment year: 2002-2003 & I.T.A. No. 164/MUM/2011 Assessment year: 2002-2003 & ITA-3183/MUM/2006 Assessment Year: 2002-2003 Page 25 of 25 of the ld. CIT(Appeals) cancelling the penalty imposed by the Assessing Officer deserves to be upheld on this ground also. We accordingly uphold the impugned order of the ld. CIT(Appeals) and dismiss this appeal of the Revenue.
In the result, the appeal of the assessee is partly allowed, while the Revenue’s appeals are dismissed. Order pronounced in the open Court on September 26, 2018.
Sd/- Sd/- (Satbeer Singh Godara) (P.M. Jagtap) Judicial Member Accountant Member Kolkata, the 26th day of September, 2018
Copies to : (1) M/s. Philips Electronics India Limited, 7, Justice Chandra Madhab Road, Kolkata-700 020
(2) M/s. Philips Medical Systems Private Limited, (now merged with Philips Electronics India Limited) Corporate Fiscal, Building No. 9B, DLF Cyber City, DLF Phase-3, 8t h Floor, Gurgaon, Haryana-122 002, India
(2) ITO/DCIT, Ward-8(2)(4), Mumbai, Room NO. 216A, Aayakar Bhawan, M.K. Road, Mumbai-400 020
(3) Commissioner of Income Tax (Appeals)-XXXII, Mumbai, (4) Commissioner of Income Tax- , (5) The Departmental Representative (6) Guard File
By order
Senior Private Secretary, Head of Office/D.D.O. Income Tax Appellate Tribunal, Kolkata Benches, Kolkata Laha/Sr. P.S.