CORNELL OVERSEAS P LTD.,NEW DELHI vs. DCIT, NEW DELHI

This is an appeal filed by the assessee against the order of the ld Assessing Officer dated 26.09.2014 for the Assessment Year 2006-07.

The assessee has raised the following grounds of appeal:- “1) Ld Dispute Resolution Panel , Id AO and Id TPO erred in including the abnormal loss of Rs 2,40,79,629/- in the cost of consumption of Raw Material for the purposes of calculation of Normal Gross Profit Mark -Up over Cost. The abnormal loss is purely during the course of normal manufacturing operations and does not constitute/is not attributable to any international transaction between assessee co. and its AE. This has led to the total disallowance of Rs 2,80,09,153/- on account of difference in arm's length price. 2) Entire Transfer Pricing order is based on the false understanding of TP laws and regulations as applicable in India. 3) Ld Dispute Resolution Panel, Id AO and Id TPO erred in eliminating loss making companies from the comparables and has recomputed the average gross mark-up by using only heavy profit making companies. The Id. TPO has not adopted any scientific methodology in selecting the comparables and in determination of arm's length margin. 4) The Ld. AO has not followed the directions given by the Ld. Dispute Resolution Panel w.r.t. to the selection of certain companies which were not incurring persistent losses. The Ld, AO has finalized the draft assessment order without considering the above directions.

The 1st ground of appeal of the assessee is against not considering the loss of Rs. 2 407 9629 as the abnormal cost of consumption of raw material for the purpose of calculation of normal gross profit markup over cost. According to the appellant, abnormal losses purely during the course of normal manufacturing operations and does not constitute and not attributable to any international transaction between the assessee and its associated enterprise. Accordingly, appellant has submitted that this disallowance of Rs. 2 80, 09153/– has resulted in to difference in arm’s length prices. Mainly the difference has arisen because of the computation of profit level indicator at 18.23% by the assessee and computed by the Ld.

The Ld. authorized representative submitted before us that in January 2006 one of the biggest buyer of the assessee declared itself bankrupt and assessee decided to not to sell goods to this party. As a result export orders from this buyer were taken as cancelled. On receiving the news of this bankruptcy inventory revaluation exercise was taken by the assessee to identify raw material/ semi finished goods which was purchased and was to be developed for the above buyer. Since the product was specifically for that buyer , items were revalued at present realisable scrap value on account of cancellation of export order for which company had incurred expenses like cost of fabric, printing charges etc which are also embedded in cost of semi finished goods. Therefore, the revaluation of inventory by assessee leads to loss of Rs. 2.4 crores. The closing inventory was further sold as scrap to third-party by the assessee in the next year as contended by the appellant. Therefore, for the year under consideration, assessee has debited this loss on revaluation of inventory, but has not considered the same while computing PLI as it as an abnormal loss. The appellant further submitted that undisputedly the cost plus method have been taken by the assessee which has been accepted by the revenue. Therefore, comparison of normal gross profit markup of the Assessee Company and uncontrolled comparables is required to be made. He further stated that gross profit markup can be normal only when the revenue and cost considered for determination of this PLI are also normal and not affected by the abnormal item/ extraordinary item and not subject to any abnormal circumstances. Therefore, he stated that abnormal loss in accordance with the Indian accounting principle means that loss that is so serious that it threatens the viability of the enterprise and such losses are to be ignored for the purpose of comparison of profit level indicator in the plus method. He therefore submitted that while calculating the PLI of the assessee the above cost Page 6 of 10 needs to be removed. To support his contention he submitted that according to the rule 10 C which deals with the methodology to be applied in applying the cost plus method, the amount of normal gross profit is required to be computed and same is comparable. Therefore, his submission was that that the above loss on the valuation of inventory is an abnormal expenditure charged to the profit and loss account which needs to be excluded. It was further the submission of the Ld. authorized representative that the Ld. Transfer pricing officer has failed to consider the difference between the TNMM method and the cost plus method. To buttress his claim, He further relied upon the decision of the assistant Commissioner of income tax versus MSS India private limited [32 SOT 132 ( Pune)] . He further submitted that the contention of the Ld. Transfer pricing officer that the loss incurred by the appellant on account of diminution in value of the inventory should have been recovered from the associated enterprises is also against the accepted business practices. He further submitted that the trend of the raw material consumption shown by the assessee in the past year will also justify the claim of the assessee that during the year the consumption of raw material 61.24% over total income as compared to average consumption of 54% in the past 3 years. This itself shows that the assessee has incurred abnormal cost. He further referred to the decision of Skoda auto India private limited versus assistant Commissioner of income tax [30 SOT 319 (Pune)] wherein it was held that extraordinary circumstances beyond the assessee’s control are required to be eliminated for the purpose of computing the PLI. He further referred to the decision of the assistant Commissioner of income tax versus Fiat India private limited (2010 – TII – 30 – ITAT – MUM– TP). He referred to the commentary of OECD Transfer pricing guidelines 2009 and submitted that the transaction between the parties should be compared of like conditions. The losses on account of account of cancellation of export orders due to the bankruptcy of the buyer is outside the control of the assessee and cannot be labeled as any arrangement to evade the taxes. Therefore, his contention was that that for the working of the PLI of the assessee above cost of Rs. 2.40 crores incurred by the assessee in revaluation of the inventory on account of cancellation of the export order due to the bankruptcy of the one of the buyer of the company shall be excluded for working of the PLI.

We have carefully considered the rival contentions. The Cost Plus Method is used to determine the appropriate price to be charged by a supplier of property or services to a related purchaser. The price is determined by adding to costs incurred by the supplier an appropriate gross margin so that the supplier will make an appropriate profit in the light of market conditions and functions performed. We agree with the contention of the appellant that if the costs which are not related to sale of the goods which are exported same cannot be considered as the direct cost/ indirect cost while working out the normal gross profit of the appellant. Therefore, in nutshell, if there are extraordinary costs which are beyond the control of the assessee and which are not related to the sale of the goods, then such costs are required to be excluded. We also draw support from the safe harbour rules wherein it provides that operating expenses means the cost incurred in the previous year by the assessee in relation to the international transaction during the course of its normal operations, including depreciation and amortisation expenses relating to the assets used by the assessee, but it does not include extraordinary expenses. The contention of the assessee is that it has incurred an extraordinary expenditure by valuation of the inventory which was for a specific product and to a specific customer orders which were cancelled and therefore the inventory of finished goods and semi finished goods with respect to that order was written off. However, on looking at the balance sheet of the company, We could not find out in the profit and loss account itself or in the schedules attached thereto relating to the profit and loss account where such extraordinary expenditure have been specifically shown which is a requirement of the accounting standard. Furthermore analysis of the Page 8 of 10 transfer pricing study report submitted by the assessee, It is noted that the company selling approximately 70% of export sales to its associated enterprises. However, there are 3 concerns to whom the goods are being sold namely in USA, Canada and Hong Kong. These 3 companies are selling this product through approximately 115 retail outlets and about 3000 wholesale customers. It was also mentioned that One of the biggest customers of the assessee declared itself as bankrupt under Chapter 11 of the US courts in January 2006 and therefore the company was unable to recover Rs. 2.7 crores against which goods were already exported to US company. Therefore the company which purchased and developed material for this buyer specifically had no alternative use otherwise, all such items were revalued at its present realisable value or scrap price and as a result of this, the gross profit ratio reduced significantly. It was also stated that there were cancellation of export orders for which the company had incurred expenses like cost of fabric printing charges etc and such impact was to the extent of Rs. 2.4 crores. Therefore it is apparent that the assessee has incurred certain costs which are extraordinary in nature. However, the claim of the assessee is half-hearted as assessee has not furnished the details of the cancellation of order and what are the materials, which were procured by the assessee against which order of the buyer who got bankrupt. Further, there are no details available that what the realisable value of those materials is and how the valuation loss of Rs. 2. 4 crores were determined. According to the Ld. transfer pricing officer, the claim of the assessee was also rejected for the reason that the assessee is not only supplying goods to the party would failed but also supplying goods to 3 other associated enterprises. It has not been shown by the assessee that Raw material was purchased by the assessee for the supply is to be made to that party. Agreeing with the contention of the assessee that extraordinary cost/ abnormal cost cannot be included in the cost for working PLI of the assessee, but assessee has prove first about the actual loss incurred leading concrete evidences. In view of this, we set aside this issue to the file of the Ld. transfer pricing officer/assessing officer to examine with respect to quantity, price and quality or specification of the material revalued with respect to the material which was purchased or designed by the assessee specifically for that buyer who cancelled the orders and gone bankrupt. The Page 9 of 10 appellant is also directed to furnish all this information to justify its claim and also to show the nature and extent of extraordinary loss incurred by the assessee with evidences. In view of this ground No. 1 and 2 of the original grounds of appeal