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Income Tax Appellate Tribunal, BANGALORE BENCH “ C ”
Before: SHRI A.K. GARODIA & SHRI VIJAY PAL RAO
Per Shri Vijay Pal Rao, J.M. : These cross appeals are directed against the assessment order dt.23.10.2015 passed under Section 143(3) r.w.s. 144C(5) of the Income Tax Act, 1961 (in short 'the Act') in pursuant to the directions of the Dispute
2 IT(TP)A No.161 & 240/Bang/2016 Resolution Panel (in short ‘DRP’) dt.26.11.2015 for the Assessment Year 2011- 12.
2. First we take up the appeal of the assessee wherein the assessee has raised the following grounds :
3 IT(TP)A No.161 & 240/Bang/2016 On the above and such other grounds as may be urged at the time of hearing your appellant prays your Honour to consider the facts and circumstances of the case and render justice.”
3. Ground No.1 is general in nature and does not require any specific adjudication.
Ground Nos.2 & 3 are regarding rejection of Transfer Pricing documentation of the assessee by the Transfer Pricing Officer (‘TPO’) The assessee is engaged in the business of trading in cotton bales. The assessee purchased cotton bales from various factories in India and sold to its Associated Enterprises (AEs) as well as in domestic market. The international transactions as well as segment results have been reproduced by the TPO in paras 3 & 3.2 as under :
4 IT(TP)A No.161 & 240/Bang/2016 As it is clear from the above details the TPO has recomputed the results of the assessee after exclusion of foreign exchange gain treating the same as non- operative. The assessee adopted Transactional Net Margin Method (TNMM) as Most Appropriate Method (MAM) and selected 2 comparable companies to benchmark its international transactions. In its TP Study document the assessee computed the operating margin after excluding the difference of purchase price as per forward contract and actual purchase price. The TPO noted that the assessee has non-AE and AE segments engaged in the sale of 5 IT(TP)A No.161 & 240/Bang/2016 cotton bales. In the AE segment the assessee made an adjustment of Rs.88,59,92,134 under the head ‘Loss’ due to default of forward purchase contract. The TPO was of the view that the assessee is dealing in the purchase and sale of cotton bales to AE as well as non-AE segments. The purchase for both the segments are made from various vendors in India at prevailing market price. The TPO took the average sale price of cotton bale as furnished by the assessee for AE segment as well as non-AE segment @ Rs.13,141 per cotton bale and Rs.14,723 per cotton bale respectively as against the average purchase price of cotton bale of Rs.14,765 per cotton bale in AE segment and Rs.13,943 per cotton bale in non-AE segment. Thus the TPO found that the profit margin in non-AE segment was 4.32 % on cost and in AE segment was (-)
11.91 %. The TPO noted that the loss in the AE segment is due to high purchase price and low sale price when compared to non-AE segment. It was also noted that the assessee has losses only in AE segment and there are profits in non-AE segment although the purchases are made locally involving the same method.
In view of the above reason the TPO rejected the TP document as well as the external TNMM method adopted by the assessee. The TPO adopted the internal TNMM as the assessee is also selling the cotton bales to non-AE. The 6 IT(TP)A No.161 & 240/Bang/2016 TPO determined the Arm’s Length Price (‘ALP’)/mean margin of cost at 4.32% being the profit on non-AE segment and consequently proposed an adjustment under Section 92CA of Rs.10,79,60,685. The assessee challenged the action of the TPO/A.O. before the DRP but could not succeed.
Before us, the learned Authorised Representative of the assessee has contended that the assessee entered into forward purchase for purchase of cotton bale from the domestic market and sale of the same to the AE at a pre determined price as per the forward contract. Since the vendors have defaulted to forward contract and therefore the assessee had to purchase the cotton bales from the local market as per the prevailing market to supply to AE on the rates agreed between the parties as per the forward contract. Thus the learned Authorised Representative has submitted that the assessee has suffered a loss on account of default of forward purchase contract. He has referred to the arbitration proceedings in respect of default by the vendors of forward purchase contract. The learned Authorised Representative has also referred to the various forward contracts with the AE and submitted that the assessee has agreed to supply the cotton bales to the AE as per the rate agreed in the forward contract. Since the forward contract for purchase of the cotton
7 IT(TP)A No.161 & 240/Bang/2016 bales from the local market was not honoured by the seller therefore, the assessee suffered the loss being the difference of the prevailing price and the price at which the assessee agreed to purchase the cotton bales and sell to the AE as per the forward contract. The TPO has not appreciated that the loss was extraordinary in nature and beyond the control of the assessee due to adverse market environment and the default by the vendors. The TPO also did not consider the forward purchase contract primarily pertaining only to the AE segment and not to the non-AE segment on account of which the loss arising to the assessee from the default of forward contract. Thus the learned Authorised Representative has submitted that the TPO ignored all these facts on record.
The TPO incorrectly proceeded to anlayse the sales and purchase price per cotton bale for the AE segment and non-AE segment without appreciating the fact that the lower sale price in the AE segment was on account of the sale price agreed as per forward contract. Thus the assessee supplied the cotton bales to the AE on account of forward contract and has suffered losses which is extraordinary in nature. Thus the learned Authorised Representative has reiterated the assessee's stand as taken before the authorities below and submitted that the loss suffered by the assessee due to default of purchase
8 IT(TP)A No.161 & 240/Bang/2016 forward contract of the vendor shall be treated as extra-ordinary in nature for the purpose of determining the ALP.
On the other hand, the learned Departmental Representative has relied upon the orders of the authorities below and submitted that in the case of the assessee the economic and financial scenario of AE and non-AE are similar and comparable. Therefore when an internal comparable is available which is direct and close relationship to the transaction then as per the OECD Guidelines the internal comparable should be preferred than the external comparable. He has further submitted that once the internal comparable is available then there is no need to go for the external comparables.
We have considered the rival submissions as well as the relevant material on record. The international transactions of the assessee are export of cotton bales to the AE. Therefore there is no value addition by the assessee in the process of purchase and sale of cotton bales to the AE. It is purely a trading activity. The assessee is also selling the same goods to the non-AE clients and therefore it is an undisputed fact that an internal uncontrolled comparable price is available in the case of the assessee. Further the assessee is exporting the same goods/articles to AE and non-AE. Therefore the internal price is 9 IT(TP)A No.161 & 240/Bang/2016 more reliable and comparable and therefore preferable in comparison to the external uncontrolled price. The assessee chose to select external comparables to bench mark its international transactions and while doing this exercise the assessee has excluded the difference of purchase price of the cotton bales which were exported to the AE from the price as per the forward purchase contracts. It is pertinent to note that the TPO found that even the sales price to the AE and non-AE are not equal but the assessee has charged more price from the non-AE and less price from AE. Similarly the purchase price of cotton bales has been shown by the assessee more in the case of AE segment than non-AE segment. The comparative analysis has been done by the TPO in para 6.1 as under :
10 IT(TP)A No.161 & 240/Bang/2016 The main contention of the assessee is that the assessee has entered into forward contract for sale to AE as well as purchase of cotton bales from local market. It is contended that the local market vendor has defaulted the forward contract obligation and therefore the assessee had to purchase cotton bales from the market at the prevailing price and supply the same to the AE at a lesser rate as per the forward contract. It is pertinent to note that the concept of forward contract is to hedge the fluctuation of the price in future and is adopted when the parties are dealing independently without any mutual interest. Therefore to avoid the risk due to the fluctuation of the price in future the parties enter into forward contract for purchase or sale of the goods at a pre-agreed price. In the case on hand, the assessee has entered into a forward contract with the AE. Since both the parties of the contract are related parties therefore, the agreement between the related party does not serve the very purpose of entering the forward contract because a loss to either of the party will not be the gain to the other party. The forward contract serves its purpose only between independent parties and therefore in the case of fluctuation in the price in future if protects the interest of the parties
11 IT(TP)A No.161 & 240/Bang/2016 independently in any of the situation whether it is high or low price of the particular goods/commodity on the date of supply. Thus the gain of one party will be the loss of the other party but this principle does not work when the transaction is between the related parties. Even otherwise when the assessee purchased cotton bales from market at a higher price then the sale price to the AE at a lower rate and that too lower than the sale price to the non-AE clearly manifest the internal arrangements of the related party to supply the cotton bales to the AE at a price which is lower than the purchase price of the assessee.
Further the forward contract with the AE is not material and relevant for the purpose of computing the Arm’s Length Price (‘ALP’) as it is a contract between the related parties and therefore the price charged by the assessee to the AE has to be decided by comparing the same with the comparable independent and unrelated price. Thus the export price has to be compared with the price between the two independent and unrelated parties. The assessee has undisputedly exported to the non-AE clients and therefore the export price to non-AE is an internal comparable price. Hence we do not find
12 IT(TP)A No.161 & 240/Bang/2016 any error or illegality in the order of the TPO to apply the internal TNMM which is most appropriate in comparison to the external TNMM.
The assessee has also raised the additional grounds as under :
“ 1. Without prejudice to the appropriateness of the transfer pricing documentation maintained by the appellant, the ld. TPO and the Hon'ble DRP erred in not providing working capital adjustment on the operating profit margin computed with respect to the AE-segment vis- à-vis the chosen comparable segment/transactions.
2. Without prejudice to the appropriateness of the transfer pricing documentation maintained by the appellant, the ld. TPO and the Hon'ble DRP erred in not considering that the forward market price of cotton as prevailing on the date of the forward contract as comparable to the forward contract prices agreed with the AE.
3. Without prejudice to the appropriateness of the transfer pricing documentation maintained by the appellant, and assuming butnot admitting that the domestic unrelated party sales segment is comparable to the export AE-segment, the margin of the AE segment should be compared only with the margin of the segment where the appellant sold goods to domestic customers under forward contracts. We pray to the Hon. Bench to admit the above additional grounds of appeal. ”
10. We have considered the rival submissions as well as the relevant material on record. The additional ground No.1 is regarding working capital adjustment.
We find that the assessee did not claim working capital adjustment either before the TPO or before the DRP nor the assessee has given any working in 13 IT(TP)A No.161 & 240/Bang/2016 the TP study regarding working capital adjustment. The learned Authorised Representative of the assessee has submitted that the assessee raised advance from the AE and therefore an appropriate working capital adjustment has to be granted. We find that this claim of the assessee is not supported by the agreement as there is no clause for giving any advance against the purchase price payable by the assessee. Therefore if the assessee received loan or other advance which is not an advance against the export then the claim of the assessee cannot be accepted. Accordingly in the facts and circumstances of the case when the assessee has not claimed working capital adjustment before the authorities below and this claim of the assessee before us is also not substantiated by any material or evidence, we do not find any merit in this additional ground, hence the Additional Ground No.1 is rejected.
Additional Ground Nos.2 & 3 are regarding the forward market price to be considered as ALP.
The learned Authorised Representative of the assessee has submitted that the price was fixed as per the forward contract therefore the forward market price to be considered as ALP for the purpose of bench marking the international transactions of export of cotton bales to AE.
14 IT(TP)A No.161 & 240/Bang/2016 13. On the other hand, the learned Departmental Representative has submitted that the forward market price cannot be taken into consideration when the contract was between the related parties and only price charged by the assessee to the AE has to be compared with the price to unrelated party.
Having considered the rival submissions as well as the relevant material on record, we find that the assessee has raised this plea that the forward market price as on the date of contract between the assessee and AE has to be taken as ALP. It is pertinent to note that in support of this claim the assessee has not furnished any evidence to show the forward market price on that date.
Therefore in the absence of relevant details as well as relevant record this issue cannot be entertained at this stage. Further we have already decided the issue of determination of ALP and taken a view and actual price to the non-AE during the year are relevant. The international transactions involving export to the AE and a comparable price being export to non-AE are taken into consideration.
Therefore for the purpose of determining the ALP and in view of our finding on the issue above, we do not find any substance in these additional grounds of the assessee.
15 IT(TP)A No.161 & 240/Bang/2016 Revenue’s Appeal (IT(TP)A No.240/Bang/16)
The revenue has raised the following grounds :
“ 1. Whether the Hon'ble DRP is correct in holding that foreign exchange loss/gain is to be treated as operating in nature without appreciating the fact that such adjustment has been made to make the export sales to AE comparable to the internal unit making domestic sales.
Whether the Hon'ble DRP is correct in law & fact in following the decisions of the ITAT rendered is the context of external comparables wherein both the tested party and the comparable were engaged in exports.
Whether the Hon'ble DRP is correct in law & facts to allow the belated remittance of PF/ESI.”
The only issue raised in this appeal is regarding foreign gain or loss as directed by the DRP as operating in nature.
We have heard the learned Authorised Representative as well as learned Departmental Representative and considered the relevant material on record.
There is no quarrel on the issue that if the foreign exchange fluctuation gain or loss is arising from the sales realization then it will be operating in nature.
However, it would be considered as part of the operating revenue or cost only when such gain or loss is arising from the realization of the sale made during the year. Accordingly, the TPO/A.O. is directed to verify the relevant details
16 IT(TP)A No.161 & 240/Bang/2016 and then treat the foreign exchange gain/loss as operating in nature and recompute operating profit/cost of the assessee for the purpose of determining the ALP.
In the result, the assessee's appeal is dismissed and the revenue’s appeal is partly allowed for statistical purpose.
Order pronounced in the open court on 8th March, 2017.