ADDL. CIT, GHAZIABAD vs. M/S. PROGRESSIVE TOOLS & COMPONENTS PVT. LTD., GHAZIABAD

This appeal filed by the Revenue is directed against the order passed by the CIT(A) on 12.10.2010 in relation to the assessment year 2005-06.

The only issue raised in this appeal is against the deletion of transfer pricing addition amounting to Rs.74,70,729/- made by the Assessing Officer (AO).

Briefly stated, the facts of the case are that the assessee is a private limited company engaged in the business of manufacturing Auto parts and components. It is working from two different locations, that is, Unit- 1 at Sahibabad and Unit-2 at Bulandshahar road Industrial area, Ghaziabad. At Unit -1, the assessee is manufacturing dies, jigs, gauges, machinery parts etc. Unit-2 is for exclusive manufacturing of Automobile parts. The assessee filed return declaring Nil income. Three international transactions, viz., Purchase of material worth Rs.6,78,21,310; Royalty paid for providing technical know-how worth Rs.35,88,664; and Technical fee paid for providing technical assistance worth Rs. 10,96,337, were reported. The AO made reference to the Transfer Pricing Officer (TPO) for determining the arm’s length price (ALP) of these international transactions. The TPO disputed only the international transaction of ‘Purchase of material’ by the assessee from its Associated Enterprise (AE), F- Tech, Japan. The other two international transactions were impliedly accepted at arm’s length price (ALP). The assessee did not apply any prescribed method for demonstrating that the international transaction of `Purchase of materials’ was at ALP. As a matter of fact, no method was employed for any of the three international transactions, which is apparent from the remarks `None’ given under the column `Method employed’. To justify non-application of any method for benchmarking, the assessee stated that no comparables were available. The TPO, following his view for an earlier year, noticed that the AE of the assessee was supplying similar material to other parties in India also. He took upon himself the task of determining the ALP of this international transaction by applying Transactional Net Margin Method (TNMM) as the most appropriate method. Seven companies, which were chosen as comparable for the A.Y. 2003-04, were picked up by the TPO as comparable for this year as well. During the course of proceedings, the assessee also supplied data of three comparable companies. The TPO worked out the average net profit margin of the ten comparable companies as under :- 3

That is how, the average PLI of the comparables was determined at 9.87%. Thereafter, the TPO took the entity level figures of Sales and job work charges from the assessee’s Annual accounts totaling Rs.24,68,58,202/. The assessee’s net profit margin was determined at 4.25% as under:-

By applying average PLI of comparables at 9.87% to the assessee’s total Sale of automobile parts and Job work at Rs.24.68 crore, the TPO determined the assessee’s entity level profit at Rs.2,43,64,904/-. Out of the said margin, an amount already declared at Rs.40,57,981/-, was reduced and the remaining amount of Rs.2,03,06,923/- was treated as additional net margin on the entire manufacturing/trading activity. Then, the value of international transaction of purchase of raw material at Rs.6.78 crore was considered as against the total purchases made by the assessee at Rs.18,43,51,793/-.

We have heard the rival submissions and perused the relevant material on record. It is noticed that the only international transaction in dispute is `Purchase of material’ from F-Tech, Japan. The assessee did not apply any of the recognized methods for demonstrating that this international transaction was at ALP. In fact, no method at all was employed for finding out the ALP of the international transaction. This was on the premise that no functionally comparable company was available and, hence, the transfer pricing provisions could not apply.

At this juncture, it is pertinent to note that section 92D provides for maintenance and keeping of information and document by persons entering into an international transaction. Sub-section (1) of this section states that : `Every person who has entered into an international transaction shall keep and maintain such information and document in respect thereof, as may be prescribed’. The information and documents to be maintained have been prescribed under rule 10D with the caption :

When we advert to the contents of the so-called `Transfer pricing study report’ prepared by the assessee, it comes to the fore that the same is absolutely devoid of the relevant information as required to be mandatorily maintained. What to talk of maintaining `a record of uncontrolled transactions taken into account for analysing their comparability with the international transactions entered into’, the assessee has simply stated that no comparable is available. Then, as against the requirement of giving `a description of the methods considered for determining the arm’s length price in relation to each international transaction or class of transaction, the method selected as the most appropriate method along with explanations as to why such method was so selected, and how such method was applied in each case’, the assessee has merely said that no method is applicable. In view of the above position, the assessee cannot be said to have maintained `a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transaction’ or `a record of the actual working carried out for determining the arm’s length price, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any.’ Thus, it is unambiguous that the assessee did not undertake any transfer pricing analysis in the manner prescribed. In such circumstances, the TPO was fully justified in holding that the assessee did not maintain any worthwhile documentation or undertake any valid transfer pricing study.

Now, we will examine and evaluate the reasons given by the ld. CIT(A) in deleting the transfer pricing addition

(A). The ld. CIT(A) recorded on page 12 of the impugned order that : `there are neither any unrecorded transactions nor any undisclosed facts reflecting the assessee’s intent to avoid tax’.

The above reasoning has absolutely no place in determining the ALP of an international transaction. Section 92(1) falls under Chapter X with the marginal note : `Special Provisions Relating to Avoidance of Tax.’ Sub-section (1) of section 92 provides that : ‘Any income arising from an international transaction shall be computed having regard to the arm’s length price.’ Thus each and every international transaction has to pass through the hammer of transfer pricing analysis and income shown by the assessee from an international transaction is required to be computed having regard to its ALP as determined by one the methods enshrined u/s 92C(1). This exercise cannot be dispensed with simply on the ground that there are no unrecorded transactions or undisclosed facts reflecting the assessee’s intent to avoid tax. The law does not provide that if there are no unrecorded transactions etc, then no benchmarking should be done of the international transaction. The process of determining the ALP has to be necessarily carried out even in the absence of any unrecorded transaction or intent to avoid tax. The view point of the ld. CIT(A) in this regard is, therefore, completely extraneous in so far as the determination of ALP of an international transaction is concerned.

(B) The ld. CIT(A) recorded in para 1.4 of the impugned order that: “It is nowhere prescribed to compare the net profit margin of the organization as a whole (which includes the net profit margin even of transactions which have no relation with the international transaction) with other organizations and to estimate the net profit of the assessee for the entire transactions including transactions other than the international transaction.”

We agree in principle that the transfer pricing provisions are applicable only qua the international transactions. If an assessee has transactions both with AE and non-AEs, the transfer pricing adjustment can be made only in respect of transactions with AEs and not non-AEs.

However, we find that the recording by the ld. CIT(A) that the TPO made transfer pricing adjustment on entity level, is factually incorrect. It can be seen that the TPO first computed the assessee’s net profit margin at 4.25%. He then determined the arm’s length margin of comparables at 9.87%, which was then applied to the entity level figure of Sale of automobile parts and Job work totaling Rs.24.68 crore. The amount of arm’s length margin so determined at Rs.2.43 crore, as being reduced by the assessee’s own profit margin at Rs.40.57 lac, was apportioned between the international transaction of purchase of material from AEs and total raw material purchased from AEs and non- AEs. Transfer pricing addition has been made only for a sum of Rs.74.70 lac in respect of that part of the excess profit which relates to the international transaction of purchase of raw material from the AEs.

(C) The ld. CIT(A) excluded five companies having turnover ranging between Rs.176 crore to Rs.598 crore out of ten companies chosen by the TPO. This was done on the premise that the assessee’s turnover at Rs.27.71 crore could not be compared with those five companies considered by the TPO having much higher turnover. The view adopted by the ld. CIT(A), in our considered opinion, cannot be countenanced because of the direct judgment of the Hon’ble jurisdictional High Court in the case of Chryscapital Investment Advisors (India) P. Ltd. vs. DCIT (2015) 376 ITR 183 (Del) in which it has been held that high or low turnover is not a criteria for excluding an otherwise comparable company. Logically also, when average PLI of comparables, consisting of companies having similar or high or low turnover, is considered for benchmarking, effect of different volumes of turnover is automatically ironed out. In view of the above discussion and respectfully following the precedent, we are satisfied that the ld.CIT(A) was not justified in excluding five companies and eventually bringing down average profit margin of comparables from 9.87% as computed by the TPO to 5.07% and thereby holding that the assessee’s profit margin was at ALP.

(D) The ld. CIT(A) noticed and rightly so that the assessee has two units. He, however, went astray by recording in paras 1.6 (d) and (f) that the net profit margin of Unit-2, which was only dealing with manufacture and sale of automobile components, at 5.34% was to be considered and not the margin from Job work receipts having no relation with the international transaction.

It is an admitted position that the assessee earned income from two units. Initially, the ld. AR also argued that the entire Job work was done under Unit-1 and the Manufacturing was done under Unit-2 and hence profit margin from Unit-2 alone ought to have been taken into consideration. On perusal of the Annual accounts of the assessee during the course of hearing itself, such a contention was found wanting. When confronted, the ld. AR admitted this position.

The assessee’s overall Profit & Loss Account is available at page 11 of the paper book, which has the figure of Sales (net of excise duty) at Rs.23.71 crore. The next figure is Job work amounting to Rs.97.49 lac. Page 27 of the paper book is Profit & Loss Account of the assessee for Unit-2 alone which shows the figure of Sales (net of excise duty) at Rs.22.25 crore and that of Job work at Rs.82.91 lac. Thus, it is manifest that as against the total Job work receipts of Rs.97.49 lac, the Job work receipts pertaining to Unit-2 stand at Rs.82.91 lac. This implies that the remaining Job work receipts of Rs.14.58 lac (Rs.97.49 lac minus Rs.82.91) are in relation to Unit-1. Ergo, it is apparent that the recording by the ld. CIT(A), as also initially argued by the ld. AR, that Unit-2 deals only with Manufacturing and sale of automobile components, is factually incorrect as it also has Job work receipts.

It can be seen that the ld. CIT(A) has proceeded on the premise that all the imports from AE were utilized only in the manufacturing of Unit-2. That is why, he focused on PLI from Unit-2 at 5.34%. As against this, the TPO has proceeded with the assumption that the international transaction of material purchased from the AE was used in both the units. That is the reason for his firstly computing profit from both the units and then proportionately reducing it with the amount of purchases from AE vis-a-vis total purchases. The presumption drawn by the ld. CIT(A) that all the imports from AE were utilized only in the manufacturing of Unit-2, is unsubstantiated and not borne out from his order or record. On a pertinent query, the ld. AR could not point out the description of material purchased from AE amounting to Rs.6.78 crore from which it could be ascertained if such material was consumed only for manufacturing in Unit-2 or Unit-1 as well.

(E) The next point which weighed with the ld. CIT(A) in deleting the addition is his recording in para 1.7 of the impugned order that he personally made an effort to peruse the financial statistics of the assessee’s AE i.e., F-Tech Inc., Japan, which is engaged in the manufacturing of the same parts as being manufactured by the assessee.

(F). The next point taken note of by the ld. CIT(A) is that depreciation on ED plant capitalized during the year (exclusively required for earning revenue from job work), should not be considered.

This finding is again not sustainable. Firstly, there is no discussion to fortify his view that ED plant was ‘exclusively required for earning revenue from job work’. Secondly, it is not clear if purchase of material was also used for job work. In such circumstances, the exclusion of depreciation on ED plant from the operating costs for determining the operating profit margin, and that too, by restricting the computation only to the Unit-2, cannot be justified.

The ld. CIT(A) deleted the addition by summing up his point of view in para 1.8 of the impugned order as under:-

In view of the discussion made in preceding paras, it is obvious that all the points taken note of by the ld. CIT(A) in deleting the transfer pricing addition lack valid reasoning and suffer from certain inconsistencies. We, therefore, hold that the impugned order deleing the transfer pricing addition made by the AO, cannot be sustained.

Having set aside the impugned order, let us see if the addition made by the AO on the recommendation of the TPO can be upheld. We have noticed supra that the assessee did not apply any method or for that matter, did not at all determine the ALP of the international transaction.

Rule 10B(1)(e) contains the mechanism for applying the transactional net margin method. Sub-clauses (i) and (ii) of this rule read as under :-

Sub-clause (i) deals with the computation of the net operating profit margin realised by the enterprise from an international transaction in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base.

It is further noticed that the TPO considered seven companies as comparables on the basis of his decision taken for the A.Y. 2003-04. The ld. AR contended that the view taken by the TPO in his order for the A.Y. 2003-04 has been set aside by the tribunal and the matter has been restored for a de novo adjudication. A copy of such order has been placed on record. It is patent from the extant TPO’s order itself that he chose seven companies as comparable on the basis of his order for the A.Y. 2003-04. We find from the Tribunal order that the computation of ALP has been simply set aside and there is no separate discussion about the comparability or otherwise of the seven companies. The ld. AR disputed the comparability of these companies as well.

In view of the foregoing discussion and considering the totality of facts and circumstances of the instant case, we are of the considered opinion that it will be in fitness of the things if the impugned order is set aside and the matter is remitted to the file of AO/TPO for a fresh determination of the ALP of the international transaction. We order accordingly. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.

In the result, the appeal is allowed for statistical purposes.