MITSUBA SICAL INDIA PVT. LIMITED,GUMMIDIPOONDI vs. DCIT, CHENNAI

आदेश / O R D E R PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER

1.‘’The order passed by the Deputy Commissioner of Income tax, corporate circle 4(1), Chennai (Assessing Officer or the AO) pursuant to the order of the Learned Joint Commissioner of Income-tax - 2 (Transfer pricing officer or TPO) and the directions issued by the Hon'ble Dispute Resolution Panel - 2, Bangalore (DRP) to the extent prejudicial to the Appellant, is erroneous, bad in law and contrary to the facts and circumstances of the case. 2.The Learned TPO/AO and Hon'ble DRP have erred in law and in facts by making an adjustment of INR 31,87,73,135 to the arm's length price of the Appellant's international transactions. 3.The Learned TPO/AO and Hon'ble DRP have erred, in law and in facts by rejecting the detailed transfer pricing documentation prepared by the Appellant in accordance with the provisions of the Income tax Act, 1961 (the Act) and proceeded to undertake a fresh search without providing cogent reasons for doing the same. 4.The Learned TPO/AO and Hon'ble DRP have erred, in law and in facts by not providing the complete details of the search process undertaken in order to arrive at the comparable companies to test the ALP of international transaction undertaken by the Appellant. 5.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts by disregarding the pricing policy adopted by AEs to export the raw material/ components to Appellant and the alternate approach adopted by the Appellant to benchmark the international transaction relating to "import of goods" considering AE as a tested party without providing any cogent reasons

Restriction of transfer pricing adjustment to value of international transactions 6.The Hon'ble DRP have erred in law and facts by directing the learned TPO/ AO to effect the transfer pricing adjustment to the total cost without restricting the same to the proportion of international transactions to the total cost.

ITA No. 400/2017 :- 3 -:

Economic adjustments 7.The learned TPO/ AO and Hon'ble DRP have erred, in law and in facts, in not appreciating the business/economic circumstances faced by the Appellant and consequently not allowing the economic adjustments relating to custom duty adjustment and revenue loss adjustment claimed by the Appellant. 8... The learned TPO/ AO and Hon'ble DRP have erred, in law and in facts in not taking cognizance of market penetration strategy adopted by the Appellant

Royalty expenses:-

9.The learned TPO/ AO and Hon'ble DRP have erred, in law and facts, by treating the royalty expense incurred by the Appellant to be operating in nature which has been subsequently waived off in succeeding year and also considering the same as part of cost base while computing value of international transaction for computing adjustment 10.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts in disregarding the CUP analysis undertaken by the Appellant to justify the arm's length nature of the international transaction relating to payment of royalty. Inclusion/ exclusion of comparables 11.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts by applying certain arbitrary quantitative and qualitative filters for the purposes of the comparability analysis 12.The learned TPO/ AO and Hon'ble DRP have erred, in law and in facts, by including functionally dissimilar companies to determine the arm's length price of the international transaction despite the fact that the Appellant had selected appropriate comparables in its transfer pricing documentation based on detailed economic analysis. 13.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts by including/ excluding companies based on unreasonable comparability criteria. Others 14.The learned TPO/ AO and Hon'ble DRP have erred in law and facts, while computing the ALP of an international transaction ought to have eliminated the expenses incurred by the Appellant in relation to customs duty, freight and insurance etc. from the value of international transaction of ITA No. 400/2017 :- 4 -: import of raw materials as these expenses are paid to the third parties and not to its AEs. Thus, the adjustment should be restricted to the value paid/payable by the Appellant to its AEs on the international transaction undertaken between them and not for the value paid/payable to third parties 15.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts, by rejecting the use of financial data of the prior two years i.e. FY 2010-11, FY 2009-10, which is permitted under proviso to Rule 10B(4) of the Income tax Rules,1962 without providing any cogent reasons for the same. 16.The learned TPO/ AO and Hon'ble DRP have erred in law and in facts, in computing the ALP without giving benefit of +/- 5 percent under the proviso to section 92C of the Act. Corporate tax matters 17.The learned AO has erred in law and facts by is regarding brought forward losses pertaining to earlier assessment years while computing the gross total income of the Appellant. In this regard, the learned AO has also failed to consider the rectification petition filed by the Appellant.

Ld. Counsel for the assessee, at the outset submitted that ground Nos.

1 to 5 could be considered as general in nature. Accordingly these grounds do not merit specific adjudication.

ITA No. 400/2017 :- 5 -: assessee had following international transactions during the relevant previous year:-

S. No Type of International Total value of transaction transaction (INR) 1 Import of raw material and 97,65,28,000 components 2 Purchase of traded goods 17,92,21,000 3 Sale of finished goods 21,93,000 4 Purchase of fixed assets 1,150,19,000 5 Royalty on sales 11,79,49,000 6 Training and technical 73,56,000 assistance fee 7 Other income 2,00,000 8 Reimbursement of expenses 2,93,11,000 Ld. Authorised Representative, referred to ld. TPO order working out the upward adjustment as under:-

Sl.No Particulars Amount in INR

1 Revised operating revenue 4,90,32,62,623 2 Arm’s length margin 2.64% 3 Arm’s length profit 12,95,31,843 4 Arm’s length cost 4,77,37,30,780 5 Adjustment restricted to proportion of international transaction (21.8%) 5,73,22,445 (international transactions/ operating cost)

Contention of the ld. Authorised Representative was that operating revenue of Rs.490,32,62,623/- in the above work out was taken from the profit and loss account of the assessee. According to him, the ld.

ITA No. 400/2017 :- 6 -:

TPO had restricted the recommended TP adjustment to the proportion of international transactions. International transactions, which comprised mainly expenditure, as per ld. Authorised Representative, came only to 21.8% of the total cost and accordingly, ld. TPO had restricted the adjustment to a sum of Rs.5,73,22,445/-. As

per the ld. Authorised Representative, in the draft assessment order the ld. Assessing Officer, had proposed an upward adjustment of �5,73,22,445/- for Arms Length Pricing.

ITA No. 400/2017 :- 7 -: out, it would result in upward revision of the cost relating to uncontrolled transactions also. Thus, according to the ld. Authorised Representative, ld. DRP fell in error in directing the ld. Assessing Officer to effect adjustment without restricting it to proportion of the international transactions to the total cost. Reliance was placed on the judgments of Hon’ble Delhi High Court in the case of CIT vs. Keihin Panalfa Ltd (2016) 381 ITR 407 and that of Hon’ble Bombay High Court in the case of CIT vs. Alstom Projects India Ltd (2016) 97 CCH 149 and a also decision of the Co-ordinate Bench in the case of M/s.

Mobis India Ltd. vs. DCIT, (2014) 61 SOT 40.

We have considered the rival contentions and perused the 6. orders of the authorities below. The method by which the ld. TPO had worked out the adjustment to be made on international transactions of the assessee with its Associated Enterprises has been reproduced by us at para 3 above. The ld. TPO had restricted the adjustment to the proportion to the international transactions. The proportion taken by the ld. TPO was value of the international transactions to operating cost. International transactions considered

ITA No. 400/2017 :- 8 -: by the ld. TPO for working out this proportion comprised of the following items:-

International transactions Amount (INR)

Purchase of raw materials 97,65,28,000 Royalty 11,79,49,000 Training and technical assistance 73,56,000 Total 1,10,18,33,000 A reading of the above clearly indicate that international transactions considered for adjustments were in the nature of expenses and not income. In our opinion ld. TPO was correct when he took the proportion of value of such international transactions to the total operating cost. The operating cost of the assessee was Rs.503,57,11,779/-. There is no case for the Revenue that the proportion of international transactions as worked out by the ld. TPO at 21.8% was incorrect. The direction of the ld.DRP not to restrict the upward adjustment to the value of the international transactions in our opinion went against the mandate of Section 92 read alongwith Section 92B(1) of the Act. Ld. DRP took a presumption that impact on the basis of calculation of Arms Length Pricing by applying most appropriate, would be proportionately reduced by deducting the cost of purchase from Non Associated Enterprises. Ld. DRP, also took

ITA No. 400/2017 :- 9 -: a presumption that reduction in margins of the assessee on account of inflated purchases from Associated Enterprises would get considered when Transactional Net Margin Method (hereinafter referred to as ‘’TNMM’’). Both these presumptions, in our opinion, had no factual or legal basis. In our opinion the directions of the ld. DRP to calculate the upward adjustment considering all the transactions of the assessee without restricting it to the transactions undertaken by the assessee with its Associated Enterprises is not in accordance with law. Hon’ble Bombay High Court in the case of Alstom Projects India Ltd (supra) had held as under at paragraphs 11 and 12 of its judgment:-

11We also note that the Delhi High Court in Commissioner of Income Tax Vs. Keihin Panalfa Ltd. (ITA No.11 of 2015) decided on 9th September, 2015 has while dealing with transfer pricing adjustment in the absence of segmental accounts held that adjustments have to be restricted only to transactions with Associated Enterprises. It further held that where separate accounts are not available, then proportionate adjustments to be made only in respect of the international transactions with Associated Enterprises.

12 We are in respectful agreement with the view of the Delhi High Court in Keihin Panalfa Ltd. (Supra). One must not loose sight of the fact that the transfer pricing adjustment is done under Chapter X of the Act. The mandate therein is only to redetermine the consideration received or given to arrive at income arising from for International Transactions with Associated Enterprises. This is particularly so as in respect of transaction with non Associated Enterprises, Chapter X of the Act is not triggered to make adjustment to considerations received or paid unless they are Specified Domestic Transactions. The transaction with non Associated Enterprises are presumed to be at arms length as there is no relationship which is likely to influence the price. If the contention of the Revenue is ITA No. 400/2017 :- 10 -: accepted, it would lead to artificial increase in the profits of transactions entered into with non Associated Enterprises by applying the margin at entity level which is not the object of Chapter X of the Act. Absence of segmental accounting is not an insurmountable issue, as proportionate basis could be adopted as done by the Delhi High Court in Keihin Panalfa Ltd. (supra).

Hon’ble Delhi High Court had also considered a similar issue in the case of Keihin Panalfa Ltd (supra). What was held by their lordships at para 12 of its judgment is reproduced hereunder:-

‘’12. The contention that the adjustment on account of expenses as determined by the Transfer Pricing Officer must be attributed entirely to the international transaction is bereft of any merits. During the financial year 2003-04 relating to the assessment year 2004-05, the assessee had reported an operating income of Rs. 72,24,22,000. The total expenses for the said period amounted to Rs. 68,00,88,000. Admittedly, the international transactions in question amounted to Rs. 15,90,66,935 which were only 23.38 per cent. in value of the total expenses. The Transfer Pricing Officer had determined the profit level indicator (operating profit over total cost) of comparable cases at 8.29 per cent. against 6.22 per cent. as declared by the assessee. Applying the profit level indicator of comparable cases, the adjusted total expenses were computed at Rs. 66,71,17,924, thus, indicating an adjustment of Rs. 1,29,70,076. As is apparent from the above, the said adjustment related to the entire expenses and not just the international transactions alone. Since the international transactions only constituted 23.38 per cent., a transfer pricing adjustment proportionate to that extent could be made in respect of such international transactions. Thus, only an adjustment of Rs. 30,33,593 could be attributed to the international transactions in question. The same was accepted by the ITA No. 400/2017 :- 11 -:

Commissioner of Income-tax (Appeals) as well as the Tribunal. We do not find any infirmity with their decision’’.

No doubt, Hon’ble Apex Court has admitted an appeal filed by Revenue in the case of CIT vs. Firestone International P. Ltd (2016) 96 CCH 271 against a judgment of Hon’ble Bombay High Court in (2015) 378 ITR 558 affirming the view taken by the Tribunal that adjustments on arms length transactions had to be restricted to the value of international transactions with Associated Enterprises. However no stay was granted by Hon’ble Apex Court. Hence as on date the judgment of Hon’ble Bombay High Court, is operative. We are therefore of the opinion that ld. DRP fell in error in giving a direction to do an upward adjustment on aggregate of international transactions of the assessee without restricting it to the proportion of such transactions with its Associated Enterprises. Such directions of the ld. DRP are set aside. Ground No.6 of the assessee stands allowed.

Vide its ground 7 & 8, assessee is aggrieved that economic 7. adjustments relating to custom duty and revenue loss were not allowed to it.

account of revenue loss. As per the ld. Authorised Representative, ld. TPO had denied any adjustment for customs duty taking a view that assessee could not show breakup of the consumption of imported raw materials to the total raw materials. However, as per the ld. Authorised Representative, assessee had produced a certificate which proved the proportion of the imported raw materials to the total raw materials consumed. Contention of the ld. Authorised Representative was that assessee was dependent on imported raw materials. Such imported raw materials, as per the ld. Authorised Representative formed 49.61% of the total raw materials consumed. Further, as per the ld. Authorised Representative in the case of comparables selected by the ld. TPO the imported raw materials comprised only 7.41% of total material cost. Thus, according to him, an adjustment was required to the given for higher proportion of imported raw materials consumed by the assessee viz-a-viz that of the comparables and resultant higher customs duty outgo. As per the ld. Authorised Representative, though this was brought to notice of the ld. DRP they had rejected such contention relying on a decision of the Co-ordinate Bench in the case of Mobis India Ltd. (supra). Contention of the ld. Authorised Representative, was that in Mobis India Ltd. (supra) proportion of raw materials on which custom duty was paid to the total raw materials cost was much lower, than that of the assessee.

ITA No. 400/2017 :- 13 -:

Hence, as per the ld. Authorised Representative, the said decision was erroneously relied on by the ld. DRP. Reliance was also placed on the decision of Pune Bench of the Tribunal in the case of Skoda Auto India (P) Ltd vs. ACIT, (2009) 30 SOT 319.

Per contra, ld. Departmental Representative strongly 9.

supported the orders of the lower authorities.

We have considered the rival contentions and perused the 10. orders of the authorities below. No doubt in the case of Skoda Auto India (P) Ltd (supra) it was held by the Pune Bench that higher import content in raw material was a factor to be considered while arriving at the Profit Level Indicator (PLI). However, it is also mentioned in the said case that higher import raw materials by itself did not warrant an adjustment for operating margins. For making such adjustment, assessee should be able to demonstrate that higher import content was necessitated by some extraordinary circumstances which was beyond its control. Just because there is a difference in proportion of imports between comparables and the assessee would not by itself, in our opinion, warrant any adjustment on profits unless assessee is able to show some extraordinary circumstances which necessitated higher imports when compared to the selected comparables. Assessee in the case before us, has been unable to demonstrate that raw materials

ITA No. 400/2017 :- 14 -: purchased after payment of custom duty was of a similar nature as purchased by the comparable entities and there was a substantial difference in custom duties and excise duties on such material. Thus, in our opinion, assessee was rightly denied the adjustment sought by it for custom duty on raw materials. Grounds 7 and 8 of the assessee stand dismissed.

No arguments were addressed by the ld. Authorised 11.

Representative on any other grounds except for ground no.17, which is a corporate tax issue. Therefore grounds 9 to 16 are dismissed as not argued.

We are of the opinion that this issue can be looked into by 13. the ld. Assessing Officer. If the assessee had claimed set off of any brought forward loss from earlier years, which were determined in the regular assessment for such assessment years, then set off could be allowed. We direct the ld. Assessing Officer to look into this issue and provide, if required, appropriate relief to the assessee. Ground No.17 is allowed for statistical purpose.

ITA No. 400/2017 :- 15 -:

Order pronounced on Thursday, the 3rd day of May, 2018, at Chennai.