P & H JOY MINING EQUIPMENT INDIA LIMITED,KOLKATA vs. ACIT, CIRCLE - 12, KOLKATA, KOLKATA

The Assessee now known as Joy Global (India) Limited (previously known as P&H Joy Mining Equipment India Ltd) (hereinafter referred to as Assessee or JMI) is a subsidiary of Joy Mining Machinery Ltd, UK (hereinafter referred to as JM UK). The Assessee is engaged in the business of selling spare parts for the mining equipment sold by JM UK. It also undertakes refurbishment jobs for Coal mining companies in India. In addition to the above it has also performed manufacturing functions, thereby manufacturing a few spares at its workshop. The manufacturing activities of the Assessee were not of substantial volume in the relevant financial year.

Section 92(1) of the Income Tax Act, 1961 ("Act") lays down that any income arising from an international transaction shall be computed having regard to the arm’s length price. Sec.92C (1) of the Act lays down that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of P&H Joy Mining Equipment India Ltd. A.Y.2004-05 transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed24 by the Board. Sec.92C(2) lays down that the most appropriate method referred to in sub-section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed. Rule 10B of the Income Tax Rules, 1962 ("Rules") lays down as to when and how the various methods have to be applied to determine ALP of an international transaction.

Joy Global Interest on 6,41,559 Inc., USA Loan

The Assessee filed a Transfer Pricing Documentation Report (TP Report) claiming that the price charged by it or received by it in respect of the international transactions with AE are at Arm’s Length as required by Sec.92 of the Act. In this appeal, we are concerned only with the dispute regarding determination of ALP in respect of the international transaction between the Assessee and its AE in respect of sale of traded spares between the Assessee and JM UK and Joy Partnership UK (JP UK). We will refer to this international transaction as the disputed international transaction.

In the TP Report, the Assessee adopted Cost Plus Method (CPM) as the Most Appropriate Method (MAM) to determine the ALP of the disputed international transaction. Rule 10B of the Rules lays down the manner of application of CPM to determine ALP of an international transaction and it reads thus: P&H Joy Mining Equipment India Ltd. A.Y.2004-05

As already stated, in the Transfer Pricing documentation, the Assessee used CPM as the most appropriate method to benchmark the disputed international transactions entered into by the Assessee. The Assesssee chose Profit Level Indicator (PLI) of gross profit to value added expenditure (GP/VAE) to compare its profits with the comparable companies selected. Profit indicators or profit level indicators (PLIs) are ratios that measure relationships between the profits earned by a tested party and the costs incurred or resources employed. Generally speaking, the choice of a PLI should be determined by the type of activity performed by the tested party and the economic circumstances of the related-party transaction, as well as the reliability of the available data for the third-party comparables. Generally PLI are chosen on the basis of return on capital employed (ROCE); return on sales (ROS); and return on operating costs. The Assessee selected (Gross Profit/ Value Added Expenses) as the PLI. The average margin earned by the comparable was 96% compared to 95% earned by the Assessee. The Second Proviso to Sec.92C (2) lays down as follows: “Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed 5% of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price.”

The comparable selected and the margin earned by the comparable companies so selected by the Assessee was as follows: P&H Joy Mining Equipment India Ltd. A.Y.2004-05

The TPO accepted the PLI chosen by the Assessee and the MAM for determination of ALP of the disputed international transaction viz., CPM and GP/VAE. The TPO rejected two comparable companies (Dee Graves Ltd. and Ricoh India Ltd.) selected by the Assessee in its TP report as according to the TPO loss making companies have to be excluded from the list of comparable companies for comparability of profit margins. After excluding the aforesaid two comparable companies, the TPO determined the GP/VAE of the remaining three comparable companies at 143% and proposed a transfer pricing adjustment amounting to Rs. 50,63,987/- . The final list of comparable selected by the TPO was as follows:

Based on the adjustment suggested by the TPO in his order, the Assessing Officer ("AO") passed the final AO order on December 29, 2006 adding a sum of Rs.50,63,987 to the total income of the Assessee.

Aggrieved with the order of the AO, the appellant filed an appeal before the CIT(A). The main contention of the Assessee before the CIT(A) was that loss making companies cannot be excluded if they are otherwise comparable based on function, Assets employed and risks analysis. The CIT(A) passed an order dated February 17,2011 rejecting the Assessee’s claim by relying on a decision of the Delhi ITAT in the case of M/S.Adobe Systems India Pvt.Ltd., wherein it was held that companies whose results are extreme should be excluded. The CIT(A) P&H Joy Mining Equipment India Ltd. A.Y.2004-05 held that companies with extreme results should be excluded from the comparable set as they cannot be considered representative of the industry.

Aggrieved by the order of the CIT(A), the Assessee has preferred the present appeal before the Tribunal.

The learned counsel for the Assessee submitted that the action of the TPO and the CIT(A) in excluding loss making companies from the list of comparable companies cannot be sustained. It was argued that loss making companies should also be considered for computation of arm's length price. The learned counsel for the Assessee explained that it was a routine distributor who bears normal risks attached with it. The learned counsel for the Assessee explained the reasons for its low margins due to transition phase due to technological change in the industry of which Assessee was a part. It was submitted by him that the Indian mining companies in the past were using machinery based on 'Longwall technology'. In the earlier years of its operations i.e. 1997 onwards, the Assessee was in the position of a monopoly as regards the 'Longwall machinery spares'. But over the years the profits have been on a decline on the sale of spares of 'Longwall technology' because the Coal Companies have never revised their pricing basis at which they were placing orders with the Assessee. With increasing costs and overheads without any corresponding increase in selling prices, sale of longwall spares became less profitable over the years. Hence, for restructuring its business, the Assessee in the relevant previous year 2003-04 just commenced the sale of spares for 'Continous Miner Equipment' ,which is a part of the 'Room and Pillar technology'. The Assessee had borne all the risks during the restructuring of its business like any entrepreneurial concern engaged in trading activities would have borne. This resulted in decrease in profits for the Assessee during the relevant year. It was pointed out by him that even the CIT(A) acknowledged the fact that the Assessee was in a transition phase during the year under consideration. P&H Joy Mining Equipment India Ltd. A.Y.2004-05

The learned counsel for the Assessee placed reliance on the decision of the Special Bench ITAT, Chandigarh in the case of Quark Systems Pvt. Ltd (38 SOT 307) (CHD) (SB) wherein it was held that a company cannot be merely rejected on the premise that it had incurred losses in the year under consideration. The Special Bench analysed and compared the functions performed and risks undertaken by the company selected as a comparable which was adjudicated. The Special Bench based on the comparability factors rejected the company as it was not comparable to the taxpayer and not for the sole reason that it was merely a loss making company. It was submitted that comparability of companies with that of the tested party has to be done in accordance with Rule 10B(2) of the Rules and the rules do not provide exclusion of a comparable company only on the basis that it was a loss making company. Reliance was also placed on the following decisions, laying down identical proposition as was laid down by the Special bench in the case of Quark Systems Pvt.Ltd., (supra). • Willis Processing Services India Pvt. Ltd[TS-49-ITAT-2013(Mum)-TP], • Exxon Mobil Company India Pvt. Ltd [TS-754-ITAT-2012(Mum)-TP], • BP India Services Pvt. Ltd [TS-568-ITAT-2011(Mum)-TP], • TCL India Holdings Pvt. Ltd [TS-130-ITAT-2013(Mum)-TP] It was submitted that comparable selected by the Assessee were not earning loss at the Gross level on VAE. Each of the comparable company earned decent level of profit at this PLI level as per the chart given below:

The learned counsel for the Assessee submitted that the TPO has accepted the comparable companies selected by the Assessee as comparable functionally based on functions, assets employed and risks assumed. The TPO has not commented adversely on the functional comparability of the two companies that were excluded by him. The TPO has accepted that CPM is the MAM and that the PLI chosen by the P&H Joy Mining Equipment India Ltd. A.Y.2004-05 Assessee for comparability purposes viz., GP/VAE is appropriate PLI. The only reason for rejecting two comparable companies Dee Greaves Ltd and Ricoh India Ltd out of five was only on the ground of being loss making at the net level i.e. at the Operating Profit level. It was argued that the loss making companies should not be excluded while computing the Gross level mark-up on VAE earned by comparable companies selected to determine the arm's length price of the disputed international transactions entered by the Assessee with its associated enterprise. The learned counsel for the Assessee therefore prayed that the addition made by the revenue authorities by way of adjustment to the ALP should be deleted.

The learned DR reiterated the stand of the revenue as reflected in the orders of the revenue authorities. According to him, the fact that the two comparable companies that were excluded by the TPO were making profit at the gross level is not relevant. Since those companies were loss making companies, even though they were otherwise functionally comparable, have to be excluded from the list of comparable companies.

We have given a careful consideration to the rival submissions. The TPO has accepted the comparable companies selected by the Assessee as comparable functionally based on functions, assets employed and risks assumed. The TPO has not commented adversely on the functional comparability of the two companies that were excluded by him. The TPO has accepted that CPM is the MAM and that the PLI chosen by the Assessee for comparability purposes viz., GP/VAE is appropriate PLI. The only reason for rejecting two comparable companies Dee Greaves Ltd and Ricoh India Ltd out of five was only on the ground of being loss making at the net level i.e. at the Operating Profit level. The fact the two companies that were excluded from the final list of comparable companies were making profits at the gross level is not in dispute. The chart given at paragraph 14 of this order clearly shows that the two companies that were excluded for the purpose of comparability were making profits at the gross level. P&H Joy Mining Equipment India Ltd. A.Y.2004-05

Where the arm’s length price of the international by the assessee is to be determined by applying CPM as MAM then, ALP must be determined with reference to the functions performed, taking into account the assets employed or to be employed and the comparability the risks assumed by the respective parties to the transaction as per rule 10B(2)(b). Rule 10B(3) mandates that a given or select uncontrolled transaction selected in terms of Rule 10B(2) “shall be comparable to an international transaction” if none of the differences, if any, between the compared transactions, or between enterprises entering into such transactions “are likely to materially affect the price or cost charged or paid or the profit arising from such transaction in the open market or reasonably accurate adjustment can be made to eliminate the effects of such difference. Therefore if a comparable company or it’s international transaction broadly confirm to the assessee’s functioning, it has to be regarded as comparable. The other exercise which the TPO has to necessarily perform is that if there are some differences, an attempt to “adjust” them to “eliminate the material effects” should be made. Once there is functional comparability keeping into consideration the assets employed and risks, then exclusion of some companies whose functions are broadly similar on the ground that it was loss making, cannot be sustained. We are therefore of the view that the two companies excluded by the TPO from the list of comparable companies on the ground that they were making loss that too at the net level, cannot be sustained. The CIT(A) in our view erred in confirming the action of the TPO. The special bench ITAT Chandigarh in the quark systems (P) Ltd., has taken a view that merely because a comparable is making loss, it cannot be excluded from the list of comparable companies for the purpose of computation of arm’s length price. The other decision cited by the Assessee before the CIT(A) also supports the same view. We direct the TPO to include the aforesaid two loss making companies also in the list of final comparable companies. If the two companies are included then the price of the disputed international transaction carried out by the Assessee is within the (+) (-) 5% range difference permitted by the 2nd proviso to Sec.92CA(2) of the Act. Therefore addition on account of adjustment to ALP should be deleted. We hold and direct accordingly. P&H Joy Mining Equipment India Ltd. A.Y.2004-05 19.Gr.No. 1 raised by the Assessee was not pressed. Gr.No.5 raised by the Assesssee does not need any adjudication as it is an alternative plea if the challenge to the addition on account of ALP raised in Gr.No.2 to 4 is for any reason not accepted. Since Gr.No.2 to 4 are allowed as indicated in this order, Gr.No.5 does not require any adjudication.

In the result, appeal of the Assessee is partly allowed.