DCIT, NEW DELHI vs. M/S. TIMEX WATCHES LTD., NEW DELHI

Per L.P. Sahu, Accountant Member:

This is an appeal filed by the Revenue against the order of ld.CIT(A)-

XX, New Delhi on the following ground :

“1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the addition of Rs.6,10,00,000/- made by the AO on account of difference in Arm’s Length Price as worked out by the TPO in his report u/s. 92CA(3), of the Income Tax Act, 1961.”

Timex Watches Ltd.) was incorporated on 04.10.1988 as a joint venture

between Timex Watches B.V., Netherlands (TWN) and Jayana Times

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Industries Ltd., an Indian Company. The company was originally setup to

manufacture components for quartz analog watches and was then called

Timex Jayana Ltd. In 1990, Jayana Timex Industries Ltd. withdrew from the

joint venture and was replaced by Titan Watches Ltd. and the name of

Company was then changed to Timex Watches Ltd. in 1991. During 1999-

2000, Titan also withdrew from the joint venture and sold its stake to TWN

and name of the Company was further changed to Timex Group India Ltd. The

assessee is engaged in the business of manufacturing, marketing and selling of

wristwatches and their spare parts and also provides after sales services of

those products. The assessee’s manufacturing plant was situated at Noida,

which is a prime Industrial area near New Delhi. During the Financial Year

the assessee was engaged in the following international transactions: S.No Particulars Amount (In INR Crores) 1 Purchase of raw material, components and spares 11.28 2 Sale of components 0.42 3 Purchase of finished watches 0.67 4 Sale of finished watches 1.30 5 Purchase of capital equipment 1.01 6 Reimbursement of expenses (Paid/payable) 0,34 7 Reimbursement of expenses (Received/receivable) 0.12 Total 15.14

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The assessee has used Transactional Net Margin Method (TNMM) as the most

appropriate method and Operating Profit (OP) upon Sales was chosen as the

Profit Level Indicator ('PLI) to corroborate the arm's length nature of all the

above mentioned international transactions. In the benchmarking analysis,

the appellant considered itself as the tested party and accordingly identified

comparable companies engaged in manufacturing wristwatches and their

spare parts. The assessee has adopted a detailed search process described in

para 6.4 of the Transfer Pricing Report and Indian database, viz., PROWESS of

centre for monitoring Indian Economy (CMIE) and a Foreign database, namely

Onesource.com have been used and a total of 11 companies have been

identified by the assessee as being comparable companies. By using the

PROWESS database, the assessee has selected following two Indian

companies:

(i). Indo Swiss Anti Shock Ltd. (ii). Jayana Mefa India Ltd.

Using the foreign database at onesource.com, the assessee has selected

following 9 foreign companies as being comparables to the assessee :

(i). Artifietd Group Ltd. (ii). Brain Technologies Industries CO. Ltd. (iii). China Everbright Technology Ltd. (iv). National Electronics Holdings Ltd. (v). Orient Co. Ltd. (vi). Shenzhen Fyta Holdings Ltd.

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(vii). CATIC Shenzhen Holdings Ltd. (viii). Eganagoldpfeil Holdings Ltd. (ix). Peace Mark

The assessee has calculated the weighted average NPM of three years i.e.

Financial Years 1999-2000, 2000-2001 and 2001-2002 and calculated the

mean NMP which comes to 3.88%. The details are as follows :-

S. No. Company name NPM(%) 1 Artifield Group Ltd. (0.14) 2 Brain Technologies Industries CO. Ltd. 2.05

3 China Everbrlght Technology Ltd. (7.95)

4 National Electronics Holdings Ltd. (0.04)

5 Orient Co. Ltd, (8.92)

6 Shenzhen Fiyta Holdings Ltd. (5.07)

7 CAT1C Shenzhen Holdings Ltd. 10.86

8 Eganagoldpfeil Holdings Ltd. 5.59

9 Peace Mark 5.02

10 Jayna Mefa India Ltd. 14.31

11 Indo Swiss Anti Shock Ltd, 26.92

Mean 3.88

Further, the assessee has computed its NPM and Arm’s Length Price at 6.73%.

The details of the calculation are as under :

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Particulars Amount (Rs. Million) Income Sales 614.52 Service income 12.91 Other income 8.33 Total Income (a) 635.76 Expenditure Material Cost Excise Duty 321.64 Personal cost 98.83 Other Expenses 194.57 105.00 Less: Deferred advertising Charge 28.8 Depreciation 165.77 Interest 87.31 Total Expenditure Less: Unabsorbed Overheads due to under 778.56 Utilization 100.00 Total Operating Expenditure (b) 678.56 Net Profit (a) – (b) (42.80) NPM (6.73)

Accordingly, the assessee has suffered a loss of Rs. 4.28 crores during the year

after adjusting for non-recurring items, excess capacity, deferred advertising

expenses. As per transfer pricing report of para 5, the assessee has stated that

this loss has been justified on the ground that it had to incur very high level of

operating expenses to make a fresh start in the market.

Rs.21,46,07,142/-. The return was processed u/s. 143(1) and selected for

scrutiny. The case was referred for special audit u/s. 142(2)(a) of the Act and

the assessee furnished the audit report on 25.05.2005 in pursuance to the

directions u/s. 142(2)(a). The case referred to the TPO and the TPO made

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order u/s. 92CA(3) on 25.08.2005. The ld. TPO rejected the comparables by

saying that they are operating in different geographical locations. The TPO

referred to Rule 10B(2) and Rule 10C(2). The TPO also rejected two Indian

Companies which were in the list of comparables because the current year’s

data were not available. The TPO made fresh search in the Indian Database

namely PROWESS and Capital line of business as the assessee is carrying on.

The names of the companies are as under :

(a). Titan Industries Ltd. (b). Kamla Dials & Divices Ltd. (c). IST Ltd.

companies should not be considered as comparable companies. In reply, the

assessee objected in respect of IST Ltd. that this company is not

predominantly in the watch making industry and is mainly engaged in the

manufacturing of components for supply to defense stores and this objection

is accepted by the TPO. Therefore, he excluded IST Ltd. from the comparable

companies’ list. For the remaining two companies, the assessee contended

that these companies have related party transactions and therefore, are not

appropriate comparables. The related party transactions in the case of Kamla

Dials and devices Ltd. was 10% and in case of Titan Industries Ltd. related

7 ITA No.4374/Del./2011

part transaction was 37%. The assessee objected for the inclusion of Titan

Industries Ltd. because the size and scale of operation of this company is

really not comparable to the size and scale of operation of the assessee

company. The ld. TPO calculated the NPM by applying the average arithmetic

mean of 9.82% as against 0.22% of the assessee. The calculation made by the

TPO is as under :

Calculation of NPM Titan Kamla

Operating Revenue ( excluding non 734.44 35.84 recurring income, interest and dividend income)

Operating Expenditure ( excluding non 668.13 32.03 recurring exp., interest etc.)

Operating Net Profit 66.31 3.81

NPM / Sales 9.02% 10.63%

Hence, the average of the above works out to 9.82% used for the purpose of

determining the Arm’s Length Price of the international transactions. The

NPM calculated by the assessee is as under :

Particulars Amt.(Rs. Crore) Total Operating Revenue 63.57

Total Operating Expenses (as per Appendix 5 of 80.73 TP Report)

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Less Unabsorbed overheads due to under 10.00 utilisation Less Unabsorbed advertising charge 2.88 Less Claim on account of inefficiencies 5.98 Add Foreign Exchange fluctuation 1.56 Revised Operating Expenses for this purpose 63.43 Revised Net Operating Profit 0.14 NPM (Percent) 0.22%

The learned TPO after considering the submissions, objections and inclusion

of two more new companies, concluded as under :

“14.11 Thus, 0.22% is considered as the NPM of the assessee for the purpose of comparability analysis. As against this, the comparable companies’ mean NPM is 9.82%. It is observed that the assessee has not shown to have earned comparable margin even though all the required adjustments as requested by the assessee have been considered fully. Thus, after making adjustment for under-capacity utilization, unabsorbed advertising charges, inefficiencies etc. and fully accepting the amounts of such adjustments claimed in TP Report and also during the course of these proceedings, the assessee should have shown similar margins as the comparable companies. However, there is a vast difference in the margins, which is not covered by proviso to Section 92(2) of the Act. Therefore, a re-computation of arm's length price is warranted in this case. 15. Computation of the arm's length price of imports from AEs • In order to arrive at the arm's length NPM of 9.82%, the Net Profit of the assessee should be; 9.82 % of Sales [Rs 63.57 Crore) = Rs 6.24 Crore • The arm's length expenses for arriving at the above Net Profit should be Sales - Net Profit (i.e. 63.57 - 6.24) = Rs. 57.33 Crore • The current expenses incurred by the assesses amount to Rs. 63.43 Crore

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• The additional expenses incurred by the assessee is ; Actual expense - Arm's Length Expense (i.e. 63.43 - 57.33] = Rs. 6.10 Crore.

On the basis of above calculation, the ld. TPO directed the AO to compute the

ALP by making an addition of Rs.6.10 crores. The ld. Assessing Officer passed

the order on 31.08.2005 as per directions received from the TPO and the ld.

Assessing Officer also made various other additions. Aggrieved by the order of

the Assessing Officer, the assessee appealed before the first appellate

authority and the first appellate authority after considering the submissions

of the assessee and the material on record deleted the additions of Rs.6.10

crores made by the Assessing Officer as per directions of the TPO for

determining the ALP of the International transactions.

nine companies taken by the assessee as comparable, are foreign companies

and therefore, the same have rightly been excluded from the final set of

comparables by the AO/TPO on the basis of Geographical locations, size of the

market, prevailing laws and government orders, cot of labour and capital in

that market, overall development of the respective country etc. If the assessee

has chosen the foreign companies as comparables, the onus of providing these

details was on the assessee to enable the TPO to judge the test of

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comparability of the foreign companies but the assessee failed to make such

details available. He referred Rule 10C(2), 10B(2)(d), 10B(4). He also

objected that the ld. CIT(A) has not used capital line database. It was

submitted that each year is separate unit and the comparables of foreign

companies used by the TPO in subsequent year in the case of assessee, cannot

be the sole basis for deleting the additions in the year under consideration, as

the CIT(A) has not called for any remand report from the AO/TPO on this

count. The ld. DR also objected the use of multiple year data. It is submitted

that the case law relied on by the ld. CIT(A) are not applicable in the present

case. The ld. DR also objected that no advantage can be given to the assessee

on the premise that the law of Transfer Pricing was at the initial stage, being

newly introduced in the statute. The ld. DR, therefore, submitted that the

order of the AO/TPO should be restored.

authority.

entire material available on record. A perusal of the impugned order shows

that the ld. CIT(A) has given favour to the assessee observing as under :-

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“12.1. Ground No. 12.1 deals with the objection of the appellant for reference made to the TPO by AO u/s 92CA(1) of the IT. Act, 1961. I have carefully examined this issue and also considered the submissions made by the appellant and all other relevant material placed on record. The issue has been adequately dealt with by the Hon’ble Special Bangalore Bench in the case of M/s Aztec Software & Technology Services Ltd. vs. ACIT, Circle-11(1), Bangalore in ITA No. 584, 585/Bangalore/2006 dated 12.06,2007.

12.2. It has been held by the Tribunal that a combined reading of the provisions of section 92C and 92CA of the Act reveals that these provisions can be invoked by the AO for determining the ALP of International Transactions. The AO himself can proceed to determine the ALP where he finds the existence of the circumstances specified in clauses (a) to (d) of subsection 3 of section 92C of the Act. On the other hand, if the AO considers it necessary or expedient to refer the determination of ALP to the TPO, the same can be done under section 92CA (1) of the Act.

12.3 It has further been held by the ITAT that the AO is not required to demonstrate the existence of the circumstances set out in clauses (a) to (d) of sub-section (3) of section 92C of the Act before referring the case to the TPO for the following reasons :

(i) Proceedings under section 92C and 92CA are quite independent of and distinct from each other and the proceedings under section 92CA(1) of the Act are not dependent on the proceedings under section 92C(3) of the Act

(ii) The provisions of section 92C(3) of the Act confers powers on the AO to determine the ALP himself where the circumstances mentioned in clause (a) to (d) of the sub section exist. In such cases, the AO is not bound to refer the case of the assessee to the TPO. On the other hand, the AO may refer the case of the assessee to the TPO if he considers it necessary or expedient to do so.

(iii) The expression "necessary" or "expedient" is quite distinct from and independent of the circumstances mentioned in section 92C(3).

12.4. Another contention made by the appellant is that the AO is required to record a finding to justify the presupposition of avoidance of tax through the International Transactions, before making reference to the TPO. This contention of the appellant is also not correct and the same has been held to be so by the ITAT's Special Bangalore Bench in the case of M/s Aztec Software

12 ITA No.4374/Del./2011

& Technology Services Ltd. vs. ACIT, Circle 11(1), Bangalore in ITA NO. 584, 585/Bangalore/2006 dated 12.06.2007.

12.5. It has been further held by the ITAT at Para 22 of the order mentioned supra, that it is not necessary for the AO to demonstrate tax avoidance and diversion of tax before invoking provisions of section 92C and 92CA of the Act. Hon'ble Delhi High Court in the case of Sony India Pvt. Ltd. 288 ITR 52 has also upheld this view.

12.6. From the above discussion, I hold that reference made by the AO to the TPO is not bad in law and accordingly TPO's order is not void ab-initio. There is no need to establish the motivation to manipulate "Transfer Pricing". Ground No. 12.2 to 12.10 are taken together and adjudicated.

12.7. The appellant is engaged in the business of manufacturing, marketing and selling of wristwatches, spare parts and also provision of after sales services for these products.

During FY 2001-02 (relevant to the captioned AY), the appellant had engaged in the following international transactions.

S.No Particulars Amount (In INR Crores)

1 Purchase of raw material, components and 11.28 spares

2 Sale of components 0.42

3 Purchase of finished watches 0.67

4 Sale of finished watches 1.30

5 Purchase of capital equipment 1.01

6 Reimbursement of expenses (Paid/payable) 0.34

7 Reimbursement of expenses 0.12 (Received/receivable)

Total 15.14

13 ITA No.4374/Del./2011

12.8. The appellant, in its TP documentation, applied the Transactional Net Margin Method (TNMMJ using Operating Profit ('OP/ Sales as the Profit Level Indicator (PLI) to corroborate the arm's length nature of all the above mentioned international transactions.

12.9. For the purpose of the said benchmarking analysis, the appellant considered itself as the tested party and accordingly identified comparable companies engaged in manufacturing wristwatches and their spare parts. While conducting the search for comparable companies, the appellant used PROWESS database for searching comparable companies in India. Since the appellant was unable to find sufficient number of comparables using the PROWESS database, the appellant searched for comparables companies in Asia / Australasia region using the One Source database. Using the said two databases, the appellant identified 11 comparables companies (2 using PROWESS database and 9 using One Source database), 11 comparables were used in total and mean OP/Sales margin of the comparable was calculated at 3.88%.

12.10. The arm's length average OP/ Sales margin of the 11 comparable companies worked out to 3.88 percent on sales. The arm's length average OP / Sales margin was arrived using data of multiple years (i.e. FY 1999-2000 and FY 2000-01) as data for FY 2001-02 was not available with the appellant at the time of undertaking the benchmarking exercise.

12.11. The Transfer Pricing Officer has rejected the comparable companies by saying that they are operating in a different geographical location. The two Indian companies which were there in the list of comparable were also rejected because the current year data were not available in respect of these companies. Thereafter, the TPO carried out a fresh search of comparables, selecting two comparable companies namely Titan Industries Ltd. and Kamla Dials 6s Devices Ltd. The comparable companies had a margin of 9/82% as against 0.22% of the appellant. As a result, the Arm's Length Price of the International Transaction was adjusted by an amount of Rs. 6.10.

12.12. The appellant has objected to the fresh search conducted by the TPO on the ground that both these companies have significant Related Party Transactions (RPT). In the case of Kamla Dials & Devices Ltd. the related party transaction is to the extent of 10% and in the case of Titan Industries Ltd. the RPT is to the extent of 37%. The appellant has also objected for the inclusion of Titan Industries Ltd. because of the size and scale of operation of this

14 ITA No.4374/Del./2011

comparable is really not comparable to the size and scale of operation of appellant.

12.13. The contention of the appellant is examined carefully. Respectfully following the judgment of the Hon'ble ITAT in the case of Sony India Pvt. Ltd. ITA No. 1189/Del/2007 and 820/Del/2007, the RPT above 10% to 15% is not a healthy comparable. Therefore, the Titan Industries Ltd. should be excluded from the list of comparable companies. As Kamla Dials & Devices Ltd. has RPT of 10% this can be kept as comparable companies in the present case.

12.14. The appellant has objected to the exclusion by TPO of foreign comparable used by the appellant in the original Transfer Pricing Study. The TPO in his order has objected to the use of foreign comparable on the ground that they are operating in different markets wherein the prevailing laws and government orders, cost of labor and capital, overall economic development, size of the market etc, are different He also observed that as the appellant is operating in India, Indian comparables should be chosen. He also contended that no reasonable and accurate adjustment can be made for these differences.

12.15. It is submitted by the appellant that in the subsequent years i.e. in the AY 2004-05, 2005-06, 2006-07 and 2007-08 the foreign comparables are used and was accepted by the TPO for determining the Arm's Length Price, In all those years appellant itself was the tested party. Some of the comparables used in subsequent years which was accepted by the Department were common even during the year under contention. Comparable companies used by the appellant during this year, Artfield Group Limited (now known as China Sonangol Resources Enterprise Limited), Eganagoldpfeil (Holdings) Mark (Holdings) Limited, National Electronics Holding Limited Fiyta Holdings Ltd. are accepted by the TPO as comparables in the assessment years starting from 2004-05 onwards. In the case of Shenshen Fiyta Holdings Ltd- even though it is accepted as a comparable company in the subsequent years, in this particular year it has extraordinary losses amounting to -31.94%. It will meet the end of justice if this extreme result company is eliminated from the list of comparable.

12.16. The appellant's business model is unchanged from year to year. The nature of the business continues to be the same in the subsequent years as well. Therefore, in order to have a better comparability analysis in this year also the foreign comparable should be accepted. This view is in consistent

15 ITA No.4374/Del./2011

with the decision of the Hon'ble ITAT, Mumbai in the case of M/s NGC Network India Pvt. Ltd. ITA No, 5307/Mum/2008 wherein the Hon'ble Tribunal held that since the comparables and method of computation of ALP by the taxpayers had been accepted by the Department in subsequent years, these have to be adopted for the purpose of computation of Transfer Prices for the year in question.

12.17. As a result of this exercise, the following comparables are to be used for benchmarking purposes. The OP/ Sales of the comparables for the current year are taken as below: s. Company Name Operating Profit / Sales FY 200 1-02 No 1 Artfield Group Limited (now known 1.97% as China Sonangol Resources Enterprise Limited) 2 Eganagoldpfeil (Holdings) Limited 0.80%

3 National Electronics Holdings 2.33% Limited 4 Peace Mark (Holdings) Limited 7.22% 5 Kamla Dials & Devices Limited 10.63% Average 4.59% +5% 9.36% -5% -0.18% 12.18. As per the order of the TPO, the appellant's margin is determined at 0.22% which is not under dispute. Therefore, the appellant is within proviso to section 92C(2) of the I.T. Act, 1961. Since the transaction of the appellant is at arm's length, no addition made on this account by AO/ TPO is sustained. The rest of the grounds mentioned become academic, since the international transaction of the appellant is at arm's length and therefore they are not adjudicated separately. Ground No. 13 is general in nature and therefore needs no adjudication.”

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CIT(A) has given relief to the assessee on the ground that in the assessment

year 2004-05, 2005-06, 2006-07 and 2007-08, some of the common foreign

comparable companies are used and accepted by the TPO for determining the

Arm’s Length Price of the international transactions and in those years, where

the assessee itself was the tested party. It is also observed that the business

model is unchanged from year to year and the nature of business continues to

be the same in the subsequent years as well. We, however, find that the

contention of the ld. DR can also not be said to be without any logic that

geographical locations, different markets & the prevailing laws and

government orders, cost of labour and capital, overall economic development,

size of the markets etc. also impart an important role in the test of

comparables. Before considering the foreign comparables in the instant case,

the ld. CIT(A) has also not called for any remand report from the Assessing

Officer/TPO to examine as to under what circumstances, the foreign

companies were considered as appropriate comparables in the subsequent

years and under what circumstances, the AO/TPO excluded the same from the

final set of comparables in the year under consideration. We, therefore,

consider it appropriate in the interest of justice that the matter should go back

to the ld. CIT(A) for deciding the issue afresh after seeking remand report

17 ITA No.4374/Del./2011

from the Assessing Officer/TPO on the comparability test of foreign

companies applied by them in the subsequent years and excluded in the year

under consideration. In case it is found that common comparables referred to

by the ld. CIT(A) are considered as appropriate in the subsequent years under

the identical facts and circumstances of the case having similar FAR analysis,

then the assessee deserves relief on this issue, no doubt, it for the assessee to

demonstrate the above fact. Otherwise, the ld. CIT(A) shall decide the issue in

accordance with law keeping in view various norms of comparability tests, as

enumerated by the ld. DR above. Needless to say, the assessee shall be given

reasonable opportunity of being heard. Accordingly, the appeal of the Revenue

is allowed for statistical purposes.

Dated : 22.12.2016 *aks/- Copy of order forwarded to: (1) The appellant (2) The respondent (3) Commissioner (4) CIT(A) (5) Departmental Representative (6) Guard File By order Assistant. Registrar Income Tax Appellate Tribunal Delhi Benches, New Delhi