DCIT, GURGAON vs. M/S. HI- LEX INDIA PVT. LTD., GURGAON

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCHES : I-2 : NEW DELHI BEFORE SHRI R.S. SYAL, ACCOUNTANT MEMBER AND SHRI KULDIP SINGH, JUDICIAL MEMBER

ITA No.2036/Del/2014 Assessment Year : 2005-06

Hi-Lex India Private Limited, Vs. ACIT, Plot No.55, Sector-3, Gurgaon Circle, IMT Manesar, Gurgaon. Gurgaon. PAN: AABCM9648Q ITA No.1849/Del/2014 Assessment Year : 2005-06 ACIT, Vs. Hi-Lex India Private Circle-2, Limited, Gurgaon. Plot No.55, Sector-3, IMT Manesar, Gurgaon. PAN: AABCM9648Q (Appellant) (Respondent)

Assessee By : Shri Rajan Sachdev, CA & Shri Varun Khanna, CA Department By : Shri B. Ramanjaneyulu, Sr. DR

ITA Nos.2036 &1849/Del/2014

Date of Hearing : 01.03.2017 Date of Pronouncement : 03.03.2017

ORDER PER R.S. SYAL, AM: These two cross appeals – one by the assessee and the other by the

Revenue – are directed against the order passed by the CIT(A) on

16.01.2014 in relation to the assessment year 2005-06.

granting of tolerance band of +/(-) 5% from the arm’s length price

(ALP) in accordance with the proviso to section 92C(2). The Revenue is

aggrieved against the relief allowed in the first appeal.

Indian subsidiary of M/s Nippon Cable Systems Inc., Japan. It is

engaged in manufacturing mechanical control cables for two-wheeler

and four-wheeler makers. The assessee filed its return declaring Nil

income. Certain international transactions were reported. The

Assessing Officer (AO) referred the matter of determination of the arm’s

ITA Nos.2036 &1849/Del/2014

length price (ALP) of the reported international transactions to the

Transfer Pricing Officer (TPO). The TPO observed that the assessee

declared an international transaction of `Purchase of raw material and

components’ with a transacted value of Rs.5,77,65,870/- apart from

`Purchase of Machinery/Spare etc.’ worth Rs.55,99,020/-. There were

other two international transactions of Reimbursement of tax paid and

other expenses, which were not disputed. The assessee applied

Transactional Net Margin Method (TNMM) to demonstrate that its two

international transactions of `Purchase of raw material and components’

and `Purchase of machinery/spares etc.’ were at ALP. The assessee

selected certain comparable companies which were rejected by the TPO

as functionally dissimilar. He, then, shortlisted two companies as

comparable, viz., M/s Remsons Industries Ltd. and Suprajit Engineering

Ltd., with average profit margin of 7.74%. The TPO determined the

ALP of `Raw material purchased from AE’ at Rs.4,65,32,510/- as

against the declared value of Rs.5,77,67,870/-. This resulted into

proposing transfer pricing adjustment amounting to Rs.1,12,33,360/-.

The AO made the above addition in his order dated 27.11.2008. The 3

ITA Nos.2036 &1849/Del/2014

assessee went in appeal before the ld. CIT(A), who, vide the impugned

order, reduced the transfer pricing adjustment from Rs.1.12 crore to

Rs.23 lac. Both the sides are in appeal against the view taken by the ld.

CIT(A) against their respective interest.

material on record. Firstly, we espouse the grievance of the Revenue. It

can be seen that the TPO did not propose any transfer pricing adjustment

for the international transaction of `Purchase of machinery/stores etc.’.

He proposed transfer pricing adjustment only in respect of the

international transaction of `Purchase of raw material and components’

amounting to Rs.5,77,65,870, which is discernible from his calculation

as under : -

Determination of Arm’s Length Price: Operating Income of the Assessee 325,720,182 Operating Profit shown @ 4.29% 1,39,77,382 Operating Profit @ 7.74% 2,52,10,742 Difference Book value of raw material purchased from AE 5,77,65,870 ALP of raw material purchased from AE 4,65,32,510”

ITA Nos.2036 &1849/Del/2014

Operating income of the assessee at Rs.32.57 crore, which is the amount

of Gross receipts as per the assessee’s Profit & Loss Account, whose

relevant part has been reproduced at page 6 of his order. Thereafter,

Operating profit has been taken at Rs.1.39 crore in the working, which is

again a figure picked up from page 6 of the his own order. These two

figures are entity level results of `Revenue’ and `Operating profit’. The

TPO applied average profit rate of comparables of 7.74% to the amount

of the Revenue at Rs.32.57 crore for determining the operating profit

from all the transactions of the assessee at Rs.2.52 crore. Difference

between the Operating profit of the assessee at Rs.1.39 crore at entity

level and the arm’s length profit of Rs.2.52 crore has been taken as the

amount of adjustment. It is this adjustment through which the ALP of

the `Raw material purchased’ from AE has been computed at Rs.4.65

(Rs.5.77 crore minus Rs.1.12 crore). Thus, it is manifest that the TPO

computed the transfer pricing adjustment at Rs.1.12 crore with reference

to the entity level figures of the assessee, which include not only

transactions of import of raw material from AEs, but also domestic 5

ITA Nos.2036 &1849/Del/2014

purchase/import from non-AEs. The ld. CIT(A), by means of his

calculation tabulated below, restricted the amount of addition to the

AE transactions, against which the Revenue is in appeal.

adjustment can be made in respect of non-AEs transactions? Section 92

is a substantive provision in this regard. Sub-section (1) of sec. 92

provides that ; `Any income arising from an international transaction

shall be computed having regard to the arm’s length price.’ The term

“international transaction” has been defined u/s 92B to mean: “a

transaction between two or more associated enterprises,…….”. A

conjoint reading of section 92 with section 92B clearly brings out that

computation of income at ALP is permissible only in respect of

international transaction, which, in turn, means a transaction between

two or more associated enterprises. Similar position has been reiterated

in the machinery provision contained in section 92C dealing with the

manner of computation of ALP. Sub-section (1) of section 92C

stipulates that :`The arm’s length price in relation to an international

ITA Nos.2036 &1849/Del/2014

transaction shall be determined by any of the following methods…..’.

The nitty-gritty of the above discussion is that addition by way of

transfer pricing adjustment is mandated only in respect of transactions

between two or more AEs. A fortiorari, no income arising from non-

AE transactions can be computed having regard to its ALP. In fact,

price/profit from comparable transactions of the assessee with non-AEs,

is one of the subtle and most reliable modes for determining ALP of the

international transactions. Thus, it boils down that the Act does not

contemplate an addition by way of transfer pricing adjustment in respect

of transactions with non-AEs. As the TPO ventured to make a composite

addition and the ld. CIT(A) restricted it to the transactions with AEs, we

uphold, in principle, the view point of the ld. CIT(A). Our view is

fortified by the judgment rendered by the Hon’ble jurisdictional High

Court in the case of CIT vs. Keihin Panalfa Ltd., (2016) 381 ITR 407

(Del).

ITA Nos.2036 &1849/Del/2014

merits. The ld. CIT(A) restricted the amount of transfer pricing addition

to transactions with AEs in the following manner : -

Particulars Formula Value (in INR Crs.) Operating Income of the Appellant A 32.57 Cost of imported raw material & spares B 6.31 consumed Total Cost of Operation C 31.17 Cost of imported raw material & spares D 20.24% consumed as % to total cost of operation Arms length Operating Profit @ 7.74% (as E=7.74% 2.52 determined by TPO in his Order) of A Actual Operating Profit earned by the Appellant F 1.40 at the entity level Deficit in Operating Profit at the entity level G 1.12 Deficit Operating Profit attributable to the H=20.24% 0.23 Appellant’s International Transaction of G

entity level made by the TPO at Rs.1.12 crore appears at ‘G’ in the

above table. The ld. CIT(A) restricted it Rs.23 lac under ‘H’ by

applying percentage of 20.24% to the amount of total transfer pricing

addition at the entity level. This 20.24% has been computed by dividing

Rs.6.31 crore with Rs.31.17 crore multiplied by 100 i.e., 6.31/31.17 x

ITA Nos.2036 &1849/Del/2014

Purchase of raw material and component and also Purchase of

Machinery/spares etc. Rs.31.17 crore is the Total cost of operation as

per ‘C’ in the table. In our considered opinion, the ld. CIT(A) went

wrong in adopting these two figures. He undertook this calculation for

segregating profit from the AE transaction of Purchase of raw material

and components from the overall operating profit of the assessee. We

have noted above that the TPO proposed transfer pricing adjustment

only w.r.t. the international transaction of `Purchase of raw material and

components’ and not the other international transaction of `Purchase of

machinery/spares etc.’. No bifurcation is available of the transaction of

purchase of machinery and spares etc. Obviously, purchase of machinery

cannot directly affect the operating profit except through the amount of

depreciation on ALP of purchase price of the machinery, which has not

been determined by the TPO or the ld. CIT(A). The other component of

this international transaction, being the purchase of spares etc., has been

taken by the TPO at ALP. This shows that we need to work out the

profit from the international transaction of `Purchase of raw material and

components’ alone. This can be done by apportioning the total operating 9

ITA Nos.2036 &1849/Del/2014

profit in the ratio of `utilized raw material purchased from the AEs’ (i.e.

Opening stock of raw material purchased from the AEs + Purchases of

raw material from the AEs – Closing stock of raw material out of the

above transactions with AEs) and `utilized raw material purchased from

non-AEs’ (i.e. Opening stock of raw material purchased from non-AEs +

Purchases of raw material from non-AEs – Closing stock of raw material

out of the above transactions with non-AEs). Or alternatively, the share

of operating profit from the `utilized raw material purchased from the

AEs’ can be deduced from the total amount of operating profit by

dividing the amount of `utilized raw material purchased from the AEs’

with the overall amount of `utilized raw material purchased from the

AEs and non-AEs’.

that he has taken Rs.6.31 crore as numerator, which is the value of both

the international transactions of `Purchase transaction of raw material

and components’ and `Purchase of machinery/spares etc.’ The

denominator in the ld. CIT(A)’s formula is Rs.31.17 crore, which is

ITA Nos.2036 &1849/Del/2014

‘Total cost of operations’ being item ‘C’ in his table. On a pertinent

query, it was stated that Rs.31.17 crore is the total cost of goods sold,

which not includes the cost of raw material but also other direct costs,

such as, wages and power etc. In our considered opinion, there is no

logic in considering all the other operating costs in denominator alone,

when the numerator is exclusive of such other operating costs. Either the

other operating costs relating to raw materials purchased from AEs

should also have been included in the numerator or these should have

been eliminated from the denominator as well. Taking other operating

costs only in denominator alone has distorted the apportionment of profit

between the international transactions and non-international transactions.

More appropriate course, in our considered opinion, is to apportion the

total operating profit of the assessee to the international transaction by

dividing the amount of `utilized raw material purchased from the AEs’

with the overall amount of `utilized raw material purchased from the

AEs and non-AEs’, as has been discussed supra. We order accordingly.

As the necessary figures of numerator and denominator in the manner

discussed above, are not readily available with the ld. AR, we, therefore, 11

ITA Nos.2036 &1849/Del/2014

set aside the impugned order and remit the matter to the file of AO/TPO

for doing the needful in above terms. Needless to say, the assessee will

be given an adequate opportunity of hearing in doing the above exercise.

of +/- 5% adjustment which the ld. CIT(A) did not allow without

assigning any reason.

international transaction shall be computed having regard to the arm’s

length price. Section 92B(1) defines “international transaction” to mean

“…..a transaction between two or more associated enterprises, either or

both of whom are non-residents, in the nature of purchase, sale or lease

of tangible or intangible property, or provision of services, or lending or

borrowing money or any other transaction having a bearing on the

profits, income, losses or assets of such enterprises…….”. Section 92C

dealing with the computation of arm’s length price provides through

sub-section (1) that : “The arm’s length price in relation to an

international transaction shall be determined by any of the following

ITA Nos.2036 &1849/Del/2014

methods, being the most appropriate method, having regard to the

nature of transactions or class of transaction or class of associated

persons…….”. When we read the above discussed three provisions, it

clearly emerges that firstly, there should be an international transaction;

secondly, there should be income arising from such international

transaction; and thirdly, such income should be computed having regard

to the arm’s length price. What we compute is income and the base from

which such income is computed, is an international transaction, which

can be in the nature of purchase or sale or provision of services etc.

With this background in mind, let us have a look at proviso to section

92C(2) at the material time, which reads as under:-

“Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.”

for comparison with the price charged or paid by the assessee in the

international transaction with its associated enterprise. Since this

ITA Nos.2036 &1849/Del/2014

standard price constitutes the basis for making addition in the hands of

the asssessee on account of its international transactions with the

associated enterprises, the legislature, in order to iron out the differences

between the actual transacted price and such standard price, inserted

proviso to section 92C(2). The role of this proviso is to make such

standard price or ALP flexible and not rigid. It has been provided that if

the price actually charged or paid by the assessee falls within plus minus

5% range of such ALP or standard price, then no addition should be

made.

where more than one price is determined by the most appropriate

methods, the arm’s length price shall be taken to be the arithmetical

mean of such prices. A further option has been given to the assessee by

which variation up to plus minus 5% of `such arithmetical mean’ can be

ignored. The former part of the proviso talks of the ALP as arithmetical

mean of such prices and the later part of the proviso refers to five

percent of such arithmetical mean. The word `such’ arithmetical mean

ITA Nos.2036 &1849/Del/2014

brings the focus back to the price. Thus the prescription of this proviso

makes it clear that the plus minus five percent is on the price and not on

the profit embedded in such price.

of purchase or sale or services etc. instead of income component in such

price is fortified from the mandate of the methods for determination of

arm’s length price. Section 92C(1) gives five specific methods for

computing arm’s length price. Rule 10B deals with the determination of

arm’s length price under such methods. First is Comparable

uncontrolled price (CUP) method, under which the price charged or paid

for property transferred or services provided in a comparable

uncontrolled transaction is first identified. After making certain

adjustments to make it compatible with the international transaction, the

adjusted price is taken as arm’s length price in respect of property

transferred or services provided in the international transaction. Thus it

can be noticed that what is determined under this method is the price.

When we refer to plus minus 5% of the value determined under this

method as per proviso to section 92C(2), it inevitably refers to the figure 15

ITA Nos.2036 &1849/Del/2014

determined under this method, which is price and not profit embedded in

the price. For example, if an assessee has sold goods to its AE worth

Rs.100 and the ALP in respect of such goods sold under CUP method is

say Rs.103 or Rs.98, then no adjustment is required because it is within

5% of Rs.100, being the price at which goods were sold to associated

enterprises in the international transaction. Irrespective of the fact

whether the profit component in the sale value of Rs.100 is Rs.4 or Rs.8

or Rs.10, it is, in fact, the comparison of the price charged or paid for

property transferred which is the subject matter of proviso to section

92C(2). Thus it can be seen that the plus minus 5% is required on the

value of international transaction, being the purchase price in the instant

case and not on the profit element in such transactions. We, therefore,

direct that +-5% should be given effect in the calculation of the transfer

pricing adjustment from the international transaction, if any. It is

however, clarified, that this +-5% is not a standard deduction. This

benefit is to be given only if the ALP falls within +-5% range of the

price and not otherwise.

ITA Nos.2036 &1849/Del/2014

The order pronounced in the open court on 03.03.2017.

Sd/- Sd/-

[KULDIP SINGH] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated, 03rd March, 2017. dk Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT (A) 5. DR, ITAT

AR, ITAT, NEW DELHI.