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Facts
The assessee, Kennametal India Limited, is in the business of manufacturing mining tools and other metal products. The appeal challenges an order raising a transfer pricing adjustment of INR 10,60,65,735/- for the assessment year 2017-18. The assessee disputes various aspects of the transfer pricing adjustment, including the selection of comparables and the method of computation.
Held
The Tribunal considered various grounds related to the exclusion and inclusion of comparable companies, the computation of operating margins, and the restriction of transfer pricing adjustments. Several issues were remitted to the AO/TPO for fresh examination. Notably, the Tribunal directed that transfer pricing adjustments should be restricted to AE-related transactions and that certain other incomes should be included in the operating income.
Key Issues
The primary issues revolve around the correct determination of arm's length price (ALP) for international transactions, including the selection and rejection of comparable companies, the method of calculating operating margins, and the scope of transfer pricing adjustments.
Sections Cited
143(3), 144B, 92CA, 92C, 92B, 92(1)
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Income Tax Appellate Tribunal, “C’’ BENCH: BANGALORE
Before: SHRI CHANDRA POOJARI & SHRI KESHAV DUBEY
PER CHANDRA POOJARI, ACCOUNTANT MEMBER:
This appeal by assessee is directed against order of DCIT Circle-4(3)(1), Bangalore dated 30.3.2022 passed u/s 143(3) r.w.s. 144B of the Income Tax Act, 1961 (in short “The Act”). The assessee has raised following grounds of appeal: “Assessment Order passed by the learned Assessing Officer is bad in law 1.1. The Appellant submits that the order of the Assessing Officer ("AO") is bad in law and facts on account of the grounds raised as below.
2. Transfer Pricing The grounds mentioned hereinafter are without prejudice to one another.
2.1 The Learned AO, Learned Transfer Pricing Officer ("Learned TPO") and Hon'ble Dispute Resolution Panel ("Hon'ble DRP") grossly erred in determining an adjustment of INR 10,60,65,735/- with respect to the international transaction entered by the Appellant u/s 92CA of the Income-tax Act, 1961 ("the Act").
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 2 of 38 2.2 The Learned AO/ Learned TPO/Hon’ble DRP erred in rejecting the TP documentation maintained by the Appellant by invoking provisions of sub- section (3) of 92C of the Act. 2.3 The Learned AO/ Learned TPO/ Hon'ble DRP erred in rejecting comparability analysis carried in the TP documentation and in conducting a fresh comparability analysis by introducing various filters while determining the Arm's Length Price ("ALP"). 2.4 The Learned AO/ Learned TPO/ Hon'ble DRP erred in not considering the financial data of the preceding two years in case of the comparable companies wherein the data for the current year is unavailable, while determining the ALP. 2.5 The Learned AO/ Learned TPO/ Hon'ble DRP erred in applying different financial year ending filter while selecting the comparable companies. 2.6 The Learned AO/ Learned TPO/Hon'ble DRP erred in the manner of computing the related party transaction filter for selecting the comparable companies. 2.7 The Learned AO/ Learned TPO/ Hon'ble DRP erred in accepting companies that ought to have been rejected as comparable to the Appellant as they failed to qualify the comparability criteria: • Lunar Enterprises Private Limited • T Square Tools Private Limited • Marshall Machines Limited • Hind Tools (India) Private Limited Swanand Sales and Services Private Limited • • Mitsubishi Heavy Industries India Precision Tools Limited • Aashapuri Engineering Private Limited Lokesh Machines Limited • • Ind-Sphinx Precision Limited • United Drilling Tools Limited Emkay Taps and Cutting Tools Limited • Groz Engineering Tools Limited • 2.8 The Learned AO/ Learned IPO/ Hon'ble DRP erred in rejecting the below companies that ought to have been accepted as comparable as they qualified the comparability criteria: • Birla Precision Technologies Limited • Jainex Aamcol Limited • Frick India Limited The Learned AO/ Learned TPO erred in computing the operating margin of 2.9 the comparable companies selected retained in the final order post the directions of the Hon'ble DRP in determination of ALP.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 3 of 38 2.10 Without prejudice to the above, the Learned AO/ Learned 'TPO/ Hon'ble DRP erred in not appreciating that transfer pricing adjustment, if any, should be restricted to the proportionate value of cost of international transactions of the Appellant. 2.11 The Learned AO/ Learned TPO/ Hon'ble DRP erred in computing the operating margin of the Appellant in the Final order/ TP order. 2.12 The Learned AO/ Learned TPO/ Hon'ble DRP erred in not considering provision of bad and doubtful debts as operating in nature while computing the margins of the comparable companies. 2.13 The Learned AO/ Learned TPO/ Hon'ble DRP ought to have allowed the appropriate adjustment towards working capital between the Appellant vis-å- vis the comparable companies.
2.14 The Learned AO/ Learned TPO/Hon’ble DRP erred in considering the loss/gain arising from fluctuation in foreign exchange as operating in nature. Interest on Delayed Receivables 2, 15. The Learned AO/ Learned TPO erred in not giving effect to the directions of the Hon'ble DRP with respect to the fact that the trade payables to AES was greater than trade receivables and hence the net interest position should be arrived at post setting off the payables with receivables. 2.16 Without prejudice to the above, the Learned AO and Learned TPO grossly erred in determining an adjustment of INR with respect to interest on delayed receivables u/s 92CA of the Act thereby: a. Erred in not considering that receivables cannot be considered as an international transaction and it does not fall within the purview of capital financing as stated by Section 92B of the Act. b. Erred in not appreciating the fact that the Act provides for taxing only real income whether received or accrued under the normal provisions. c. Erred in not appreciating the fact that transfer pricing adjustment cannot be made on a hypothetical and notional basis unless there is material on record that there has been under charging of real income. d. Erred in imputing interest on delayed receivables without giving cognizance to the fact that the primary transaction of manufacturing has been tested by the Learned TPO and the receivables are arising out of the primary transaction itself.
The appellant craves leave to add, alter, rescind and modify the grounds herein above or produce further documents, facts and evidence before or at the time of hearing of this appeal. For the above and any other grounds which may be raised at the time of hearing, it is prayed that necessary relief may be provided.”
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 4 of 38
2. Assessee raised additional grounds of appeal
before us. However, these grounds were not pressed and accordingly, the same are dismissed as not pressed.
3. Facts of the case are that the Assessee, a subsidiary of Kennametal Inc, USA is engaged in the business of manufacturing of mining tools, metal castings, fixtures and jigs, forming, machines for special purpose and products made of hard metals. The products manufactured by the Assessee are supplied to various industries such as construction, mining, general engineering and machine tools.
3.1 During the previous year relevant to the assessment year 2017-18, the Assessee entered into certain international transactions with its Associated Enterprises (‘AEs’). Upon a reference being made by the Assessing Officer to the TPO, the TPO vide an order dated 25.01.2021 determined an adjustment of Rs. 13,35,74,012/- towards the manufacturing segment. Additionally, the TPO determined a TP adjustment of Rs. 15,80,901/-, being interest on delayed receivables. Initially, a draft assessment order dated 31.05.2021 came to be passed by the Assessing Officer (‘AO’ for short), in which the aforesaid TP adjustment was incorporated. Aggrieved, the Assessee filed its objections before the DRP which, vide its directions dated 24.02.2022 granted partial relief to the Assessee. Pursuant to the DRP directions, the Assessing Officer passed a final assessment order dated 30.03.2022 in which the aggregate TP adjustment was reworked to Rs. 10,60,65,735/-. Aggrieved by the final assessment order, the Assessee has preferred the above appeal before us.
4. The ld. A.R. submitted as follows:
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 5 of 38 4.1 On Transfer Pricing Adjustments:
DETAILS OF THE ASSESSEE’S INTERNATIONAL TRANSACTIONS Particulars Amount in Rs. Outcome of the TP Order Purchase of raw materials Rs.88,34,79,258/- and components Sale of finished goods Rs.79,56,41,613/- Payment of royalty Rs.2,36,95,784/- Adjustment of Rs. 13,35,74,012/-. IT Allocation Charges Rs.15,87,21,057/- Commission Income Rs.1,10,28,815/- Reimbursement of Rs.1,57,53,815/- Expenses paid/payable Accepted to be at Recovery of expenses Rs.5,04,06,544/- arm’s length Purchase of finished goods Accepted to be at Rs.135,20,41,513/- for trading arm’s length. 4.2 MANUFACTURING SEGMENT A. ANALYSIS OF THE TP STUDY OF THE ASSESSEE AND THE TPO:
A.1 Net mark-up on cost earned by the Assessee as computed by the TPO:
Operating Revenue * Rs. 393,09,70,000/- Operating Cost Rs. 373,47,35,629/- Operating Profit (Op. Revenue – Op. Cost) Rs. 19,62,34,371/- Operating/Net mark-up (OP/OR) 4.99% Note: The TPO excluded an amount of Rs. 2,64,23,000/- being other income, from the operating revenue. If the said sum is included, as done by the Assessee in its TP study, the Assessee’s margin would stand at 5.06%. A.2 Comparison of the TP studies done by the Assessee and TPO:
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 6 of 38 Assessee TPO Methodology adopted TNMM TNMM Profit Level Indicator OP/OR OP/OR (PLI) Database used PROWESS & PROWESS CAPITALINE NEO Comparables selected 15 28 Period for which data FYs 2014-15 to 2016- FYs 2014-15 to used 17 2016-17 A.3 Filters applied by Assessee in its TP study:
Step Description 1. Companies with net sales more than 1 crore – selected.
2. Companies which have positive net worth – selected.
3. Companies with manufacturing income to sales greater than 50% – selected.
4. Companies which have related party transactions in excess of 25% of total sales – rejected.
5. Companies which were functionally comparable – selected.
6. Companies having extraordinary event during the year of study- rejected 7. Companies having losses in all the year under consideration - rejected 8. Companies reporting abnormal fluctuating margins – rejected 9. Companies with significant intangibles – rejected. A.4 Comparables selected by Assessee and the range of weighted average of OP/TR of comparable companies:
Sl. No. Name of the company Weighted Unadjusted average (in %) 1. Birla Precision Technologies Ltd. -0.81 2. Kulkarni Power Tools Ltd. -2.08 3. Stanley Black & Decker India Pvt. Ltd. -3.47 4. Yuken India Ltd. 1.14 5. Kirloskar Brothers Ltd. 2.14 6. Akar Tools Ltd. 2.37 7. Jainex Aamcol Ltd. 5.84
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 7 of 38 8. Shanthi Gears Ltd. 6.96 9. Cenlub Industries Ltd. 7.41 10. Dynamatic Technologies Ltd. 8.02 11. Lakshmi Machine Works Ltd. 9.60 12. Roto Pumps Ltd. 10.08 13. Solitaire Machine Tools Ltd. 10.46 14. W P I L Ltd. 13.48 15. Lokesh Machines Ltd. 14.84 35th Percentile 2.37 Median 6.96 65th Percentile 8.02 NOTE: Out of the 15 comparables selected by the Assessee, the TPO accepted the 4 companies highlighted above, viz. Dynamatic Technologies Ltd., Lakshmi Machine Works Ltd., Solitaire Machine Tools Ltd., and Lokesh Machines Ltd. and rejected the other 11.
A.5 Filters applied by the TPO:
Step Description 1. Companies having different financial year ending (i.e., not March 31, 2016) or data of the company does not fall within 12-month period i.e., 01-04-2015 to 31-03-2016 - excluded.
2. Companies whose income was less than Rs. 1 Crore - excluded.
3. Companies whose manufacturing income is less than 75% of its total operating revenues - excluded.
4. Companies which have more than 25% related party transactions of the sales - excluded.
5. Companies having positive net worth- selected. A.6 Comparables selected by TPO and the median of weighted average of PLIs of the companies:
Sl. Name of the Company Mark-up on Total No. Costs (WC–unadj) (in %) 1. Ralli Engineering Ltd. 0.95 2. Matrix Tools & Metaplast Pvt. Ltd. 1.46 3. Swalka Tools and Machines Pvt. Ltd. 3.15 4. A A C K Technocraft Toolings Pvt. Ltd. 4.18 5. Electronica India Ltd. 4.43 IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 8 of 38 6. Vishwa C N C Technologies Pvt. Ltd. 5.45 7. Sunikh Components Pvt. Ltd. 5.60 8. Esab India Ltd. 6.34 9. Total Tools & Equipments Pvt. Ltd. 6.35 10. Dee Tee Industries Pvt. Ltd. 7.65 11. Lunar Enterprise Pvt. Ltd. 7.83 12. I T L Industries Ltd. 7.95 13. Dynamatic Technologies Ltd. 8.02 14. Lakshmi Machine Works Ltd. 8.29 15. T Square Tools Pvt. Ltd. 8.49 16. Marshall Machines Ltd. 8.72 17. Hind Tools (India) Pvt. Ltd. 8.97 18. Swanand Sales & Services Pvt. Ltd. 9.20 19. Vekaria Engineering Works Pvt. Ltd. 9.71 20. Samatha Technologies Pvt. Ltd. 10.63 21. Mitsubishi Heavy Inds. India Precision 11.41 Tools Ltd.
Solitaire Machine Tools Ltd. 11.64 23. Aashapuri Engineering Pvt. Ltd. 11.77 24. Lokesh Machines Ltd. 12.79 25. Ind-Sphinx Precision Ltd. 17.32 26. United Drilling Tools Ltd. 24.50 27. Emkay Taps and Cutting Tools Ltd. 30.56 28. Groz Engineering Tools Pvt. Ltd. 32.27 35th Percentile 7.65 Median 8.39 65th Percentile 9.71 A.7 Computation of arm’s length price by the TPO and the adjustment made:
Taxpayer’s operating revenue Rs. 393,09,70,000/- Arm’s Length Margin determined by the TPO 8.39% Arm’s Length Cost (ALP) @ 91.61% of Operating Rs. 360,11,61,617/- Revenue Operating Cost Rs. 373,47,35,629/- Adjustment to ALP Rs. 13,35,74,012/- 4.3 DIRECTIONS ISSUED BY THE DRP:
Briefly, the ld. A.R. submitted the directions issued by the DRP as follows:
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 9 of 38 (i) The DRP directed the exclusion of I T L Industries Ltd., Vekaria Engineering Pvt. Ltd., and Samatha Technologies Pvt. Ltd.
(ii) The DRP directed the TPO to compute the margin of Lokesh Machines Ltd. by taking only the figures of the components division.
(iii) The remaining contentions with respect to inclusion and exclusions of comparables, computation of operating margin and restriction of the adjustment to the value of the international transactions, were rejected.
4.4 LIST OF COMPARABLES POST THE DRP’S DIRECTIONS:
On giving effect to the above directions issued by the DRP, the ld. A.R. submitted the final list of comparables as follows: Sl. Name of the Company No.
Ralli Engineering Ltd.
Matrix Tools & Metaplast Pvt. Ltd.
Swalka Tools and Machines Pvt. Ltd.
A A C K Technocraft Toolings Pvt. Ltd.
5. Electronica India Ltd.
6. Vishwa C N C Technologies Pvt. Ltd.
7. Sunikh Components Pvt. Ltd.
Esab India Ltd.
Total Tools & Equipments Pvt. Ltd.
Dee Tee Industries Pvt. Ltd.
Lunar Enterprise Pvt. Ltd.
12. Dynamatic Technologies Ltd.
13. Lakshmi Machine Works Ltd.
14. T Square Tools Pvt. Ltd.
15. Marshall Machines Ltd.
16. Hind Tools (India) Pvt. Ltd.
Swanand Sales & Services Pvt. Ltd.
Mitsubishi Heavy Inds. India Precision Tools Ltd.
Solitaire Machine Tools Ltd.
Aashapuri Engineering Pvt. Ltd.
Lokesh Machines Ltd.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 10 of 38 22. Ind-Sphinx Precision Ltd. 23. United Drilling Tools Ltd. 24. Emkay Taps and Cutting Tools Ltd. 25. Groz Engineering Tools Pvt. Ltd.
4.5 FINAL ASSESSMENT ORDER:
The AO passed the final assessment order in which the TP adjustment stood reworked at Rs. 10,60,65,735/- (Rs. 10,44,84,834/- being towards manufacturing segment).
4.6 GROUNDS OF APPEAL BEFORE THIS HON’BLE TRIBUNAL:
Briefly, the ld. A.R. submitted the grounds in the appeal which are being pressed as follows: a) The TPO erred in selecting companies like T Square Tools Pvt. Ltd., Swanand Sales and Services Pvt. Ltd., Mitsubishi Heavy Industries Precision Tools Limited, Ind-Sphinx Precision Ltd., United Drilling Tools Ltd., Emkay Taps and Cutting Tools Ltd., and Groz Engineering Tools Ltd. in the final list of comparables; (Ground No. 2.7). b) That the TPO erred in not including Birla Precision Technologies Ltd., and Jainex Aamcol Ltd., in the final list of comparables; (Ground No. 2.8) c) The TPO erred in not restricting the TP adjustment to the proportionate value of cost of international transactions of the Assessee; (Ground No. 2.10) d) The TPO erred in not including certain income like lease rentals etc., and export incentives which was part of operating income, while computing the operating margin of the Assessee; (Ground No. 2.11)
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 11 of 38 5. Now coming to the main ground No.1.1, this ground is general in nature, which does not require any adjudication.
6. With regard to ground Nos.2.1 to 2.6, ld. A.R. made no argument and hence not considered for adjudication.
In ground No.2.7, at the time of hearing, the ld. A.R. for the assessee has limited its argument for exclusion of following 7 comparables only: (a) T Square Tools Pvt. Ltd. (b) Swanand Sales and Services Pvt. Ltd. (c) Mitsubishi Heavy Industries Precision Tools Limited (d) Ind-Sphinx Precision Ltd. (e) United Drilling Tools Ltd. (f) Emkay Taps and Cutting Tools Ltd. (g) Groz Engineering Tools Ltd.
a) T Square Tools Pvt. Ltd. (T Square): - Functionally dissimilar 7.1 He submitted that T Square is engaged in sale of engineering goods in nature of foundry tooling, pattern equipments, PDC dies and machine parts. The Company is also a service provider of CNC Machining services.
- Different operational model 7.1.1 He submitted that the Company earns income as a “job-work entity” which is not comparable to a routine manufacturer like Assessee since job work entity performs the required activity on an agency basis and does not undertake any risk. The goods are usually supplied by the principal who owns the rights to the products that are to be manufactured and the principal also provides instructions with respect to the work to be done by the job-work entity. Upon completion of the same, the goods are sold back to the principal and IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 12 of 38 the processing charges are earned as income by the job-work entity. Therefore, this operational model cannot to be compared to the model of the Assessee who is a routine and licensed manufacturer undertaking risk.
Pertinently, this company was rejected in the Assessee’s own case by the DRP in the assessment year 2018-19.
7.1.2 Further, he placed reliance on the decision of the Mumbai Bench of this Hon’ble Tribunal in the case of Hope India Polishing Works (P.) Ltd. v. DCIT (reported in [2015] 54 taxmann.com 195 (Mumbai – Trib.)), wherein the Hon’ble Tribunal held that an entity undertaking job work is not comparable to a manufacturing entity (para 5).
- Fails manufacturing income filter.
7.1.3 He submitted that the Company’s income from manufacturing activity is 73.75% and therefore, the Company fails manufacturing income filter of 75% as applied by the TPO.
Particulars 2017 Income from engineering goods Rs. 2,77,78,243/- Total income from operations Rs. 3,76,67,143/- % on revenue 73.75% 7.1.4 Therefore, he submitted that T Square is not comparable to the Assessee and ought to be excluded from the final list of comparables.
7.2 The ld. D.R. submitted that the assessee has requested for exclusion of this company based on the following reasons functionally different Fails manufacturing income filter
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 13 of 38 7.2.1 He submitted that as per the Annual report of the company , the company is into manufacture of Pattern equipments, dies, Press tools, rubber moulds and plastic moulds. The assessee is also into manufacturing of tools hence functionally similar. From the Annual report it is seen that the revenue is from sale of engineering goods and hence, its passes the manufacturing income filter In view of the above discussion the objection of the assessee is to be rejected. 7.3 We have heard the rival submissions and perused the materials available on record. In this case, in the assessment year 2018-19, the ld. DRP vide order dated 14.6.2022 itself has excluded it from the list of comparables by observing as under: “12.0 Grounds of Objections No. 11:T Square Tools Pvt. Ltd.— should be rejected 11.1 T Square Tools Pvt. Ltd. ("T Square" or "the Company") is functionally dissimilar hence should be rejected 11.2 The Company is fails manufacturing income filter applied by the learned TPO 12.1Panel: The assessee has requested for exclusion of this company based on the following reasons functionally different Fails manufacturing income filter As per the Annual report of the company, the company is into manufacture of Pattern equipment, dies, Press tools, rubber moulds and plastic moulds. From the Annual report, it is seen that this company has revenue from sale of engineering goods and also job work. Since the operational model is different and also due to the non-availability of the breakup of the revenue from manufacturing activity and job work for the year ending 31/3/3018, we are of the opinion that this company is not comparable. Since the company is functionally different, the TPO is directed to exclude this comparable. Hence the objection of the assessee is allowed.” 7.3.1 Further, in the case of Hope India Polishing Works (P) Ltd. v. DCIT reported in (2015) 54 taxmann.com 195 (Mumbai Trib) wherein observed as under: 5. We have heard the rival submissions and perused the material before us. We find that during the year under consideration the assessee was doing job work for its parent company only, that the AO had referred the international transaction to the Transfer Pricing Officer (TPO), that in the study report the assessee had furnished comparables of seven entities, that all other entities were trading in diamond and were also exporting the goods manufactured by them, that assessee was the only entity who had carried out Job work only, that TPO had not brought on record any entity that was doing only job work, that he made some adjustment in the comparables furnished by the assessee. In these circumstances, the basic issue before us is what can be the most appropriate method to determine the ALP for the transactions carried out by the assessee with the AE. It is found that the assessee was getting rough diamonds from the AE and after processing them was sending back to the AE, that it was entitled to recover processing charges only.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 14 of 38 We find that the assessee had filed a letter on with regard to the directions issued by the TPO on, but he had not considered the same. From the facts available on record it is evident that the assessee is only a job worker or a contract manufacturer who is entitled for processing charges based on its cost incurred and not based on the value of material supplied by its AE. In such a situation, the comparables chosen by the assessee of the fullfledged independent manufacturers cannot be prima facie considered for the purpose of comparability analysis. We have compared the audited accounts of the assessee for the current years with the accounts for the last year. It is found that the total income returned by the assessee for last year was Rs.(-)l .94 lakhs, whereas during the year under consideration, it had filed a return showing income of .58 Crores. On a query by the bench, it was explained that because of the fluctuation in foreign exchange rate, the assessee had suffered heavy losses. We find that while comparing the case with other entities the assessee/TPO had not taken into consideration about the fluctuation in the foreign exchange rates and the resultant effect on their profits/losses. Besides, it is not known that whether factor of under utilisation of capacity was existing or not in the comparables chosen by the assessee. In our opinion, to decide the Transfer Pricing matters similar or almost similar comparables have to be adopted. It is said that an apple has to be compared with an apple only and not with the cabbage. As the comparables adopted by both the parties-the assessee and the TPO- are not according to the establishing principles of Transfer Pricing, so we are of the opinion that in the interest of justice, matter should be restored back to the file of the TPO for fresh determination of Transfer Pricing issue. He is directed to find out some entities that are doing job work only or are mainly engaged in doing job work. After obtaining relevant data for bench marking the transactions, he should decide the issue afresh. He would afford a reasonable opportunity of hearing to the assessee.” 7.3.2 In view of the above decision of the Tribunal, we remit this issue to the file of AO/TPO to re-appraise this comparable and to decide afresh whether it is suitable comparable or not. Ordered accordingly. b) Swanand Sales and Services Pvt. Ltd. (Swanand): - Fails the positive net worth filter.
7.4. The ld. A.R. submitted that the net worth of the Company was in negative in the earlier two years. Since, for comparability analysis, the information for three years is to be considered, the Company fails net worth filter.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 15 of 38 7.4.1 The ld. D.R. submitted that the assessee has requested for exclusion of this company based on the following reasons: Fails networth filter He submitted that the company passes networth filter based on the Annual report of the company for the ending 31.3.2017 and hence, it passes the filter applied by the TPO. Hence, the objection of the assessee is to be rejected. 7.4.2 We have heard the rival submissions and perused the materials available on record. The main contention of the assessee’s counsel is that it fails positive networth filter and cannot be considered as a comparable. In our opinion, it is appropriate to remit the issue to the file of AO/TPO to once again analyse financials of this comparable and if it passed the positive networth filter, then only be considered as comparable. Ordered accordingly. c) Mitsubishi Heavy Industries India Precision Tools Ltd. (Mitsubishi): - Functionally dissimilar 7.5 The ld. A.R. submitted that the Company is engaged in the business of manufacturing gear cutting tools and broaches. The manufactured goods sold by the Company include gear hobs, gear shaping and shaving cutters and broaches which are not comparable to hard metal products manufactured by the Assessee. Therefore, he submitted that Mitsubishi ought to be excluded from the final list of comparables.
7.6 At the time of hearing, the ld. D.R. submitted that this is not challenged before the ld. DRP. Hence, it need not be considered for adjudication.
7.7 We have heard the rival submissions and perused the materials available on record. The ld. A.R. was unable to show how it was dealt by ld. DRP and there was no challenge of this comparable before ld. DRP
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 16 of 38 and the ld. A.R. not able to demonstrate why assessee failed to challenge this comparable before lower authorities. Hence, this ground is dismissed. d) Ind-Sphinx Precision Ltd. (Ind-Sphinx): - Functionally dissimilar 7.8 The ld. A.R. submitted that Ind-Sphinx is primarily engaged in the manufacture of PCB routers, PCB tools for micro machines. The Company derives 94.52% of its revenue from PCB drills, router & tools for micro machines, which are sold mostly to customers and work on a B2C model. The Assessee on the other hand predominantly caters to domestic automobile industry (B2B) and manufactures machine tool and hard metal products. Therefore, this company is not functionally comparable to the Assessee.
- No segmental information available 7.8.1. He submitted that the Company also provides software development and other services and other services in addition to the sale of products. No segmental information for sale of products and sale of services is available to ascertain the actual margins of the Company. Therefore, he submitted that Ind-Sphinx ought to be excluded from the final list of comparables.
7.9 The ld. D.R. submitted that the assessee has requested for exclusion of this company based on the following reasons:
Functionally different Substantial income from export sales 7.9.2 He submitted that the comparable company is into manufacturing of PCB tools, tools for metal core PCBS. Hence, it is functionally similar. As regards the substantial income from export, the TPO has not applied the export sales filter, only the functional
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 17 of 38 similarity/dissimilarity are being considered in this ground of objection. Since the company is functionally similar, objection raised by the assessee is to be rejected.
7.10 We have heard the rival submissions and perused the materials available on record. The main contention of the ld. A.R. is that this comparable is not functionally comparable and it is undertaking diversified activities like manufacture of PCB routers, PCB tools, for micro machines along with software development and other services for the sale of produce like segmental information and also increased R&D existence. In our opinion, these facts to be required to be examined at the end of AO/TPO. Accordingly, this issue is remitted to the file of AO/TPO for reconsideration. e) United Drilling Tools Ltd. (United Drilling): - Functionally dissimilar 7.11. The ld. A.R. submitted that the Company is primarily engaged in the manufacture and sale of casing pipes, wireline wrenches, gas lift valves and stabilizers. Further, the Company is engaged in the global oil and gas industry with a license from American Petroleum Institute. The principal business activity of the Company is casing pipe. The Company is engaged in sale of products as a dealer and distributor, which shows that this company is a retailer.
- Presence of patents and intangibles 7.11.1 He submitted that United Drilling has patented some of its products and technologies which indicate that it is a full-fledged risk bearing entity and proprietary manufacturer of its products. The Assessee on the other hand undertakes manufacturing and does not own any patents/trademarks. The presence of patents also contribute to an increased recognition and quality among customers which in turn result in difference in terms of pricing and margins earned. Therefore, the IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 18 of 38 functional profile of the Company is different from the functional profile of United Drilling. Therefore, he submitted that United Drilling ought to be excluded from the final list of comparables.
7.12 The ld. D.R. submitted that the assessee has requested for exclusion of this company based on the following reasons:
Functionally different Substantial income from export sales 7.12.2 He submitted that the comparable company is into manufacture of oil field drilling, production and exploration tools and equipments. Hence, it is functionally similar. As regards the substantial income from export, the TPO has not applied the export sales filter, only the functional similarity/dissimilarity are being considered in this ground of objection. Since the company is functionally similar, objection raised by the assessee is to be rejected.
7.13 We have heard the rival submissions and perused the materials available on record. The main contention of the ld. A.R. is that its function is dissimilar to assessee’s case and it is engaged in manufacture and sale of casing pipes, wireline wrenches. It also engaged in Global Oil and Gas Industries with the license from American Petroleum Institute and it also owns patents and intangibles. In our opinion, these facts to be required to be examined at the end of AO/TPO. Accordingly, this issue is remitted to the file of AO/TPO for reconsideration.
Emkay Taps and Cutting Tools Ltd. (Emkay):
- Functionally dissimilar 7.14 The ld. A.R. submitted that the Company is engaged in the business of manufacture of taps and cutting tools and production of power through windmill unlike Assessee whose operations are restricted
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 19 of 38 to metal tools and parts. Therefore, the company is functionally dissimilar and ought to be rejected.
Pertinently, this company was rejected by the DRP in the Assessee’s own case for the assessment year 2018-19 (refer page 14).
- Difference in operational model 7.14.1 He submitted that the Company operates on a subcontracting model as the Company has 31% of its income from ‘job- work income’. The Company earns income as a “job-work entity” which is not comparable to a manufacturer like Assessee, since job work entity performs the required activity on an agency basis and does not undertake any risk. Further, the annual report of Emkay Taps does not have segmental financials which would clearly bifurcate between the results from manufacturing and job work activities. Therefore, the Assessee is unable to determine the impact of such job work expenses on the overall profitability of Emkay and thus, submits that Emkay should be rejected as a comparable.
7.14.2 He placed reliance in this regard on the decision of the Mumbai Bench of this Hon’ble Tribunal in the case of Hope India Polishing Works (P.) Ltd. v. DCIT (supra), wherein the Hon’ble Tribunal held that an entity undertaking job work is not comparable to a manufacturing entity (para 5).
- Different industry 7.14.3 He submitted that the Company serves the automobile and electrical industry. Further, the product base of Emkay is more in the nature of taps and cutting tools which are more related to the electrical goods industry. On the other hand, the Assessee is engaged in the automobile sector and manufactures machine tools and hard metal products.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 20 of 38 7.14.4 At the outset, the Assessee submitted that this company was rejected on the grounds of functional dissimilarity by the DRP in the assessment year 2018-19 in the Assessee’s own case. As the functional profile of the company has not undergone any changes from assessment year 2017-18 to assessment year 2018-19, the same should be considered for assessment year 2017-18 and the company should be rejected. Therefore, he submitted that Emkay ought to be excluded from the final list of comparables.
7.15 The ld. D.R. submitted that it is functionally comparable to the assessee’s case.
7.16 We have heard the rival submissions and perused the materials available on record. The main contention of the ld. A.R. is that this comparable has been excluded by ld. DRP itself in assessment year 2018-19 and on the same reason, this is to be excluded as it is functionally not comparable. He also relied on the earlier order of the Tribnal in the case of Hope India Polishing Works (P.) Ltd. v. DCIT (reported in [2015] 54 taxmann.com 195 (Mumbai – Trib.). In our opinion, it is not included in assessment year 2018-19 by ld. DRP. Hence, this issue requires to be relooked at the end of TPO/AO. Hence, it is remitted to the file of AO/TPO for reconsideration. . f) Groz Engineering Tools Ltd. (Groz): - Functionally dissimilar 7.17 The ld. A.R. submitted that Groz is in the business of manufacturing engineering goods, power handling equipments, professional hand tools and engineering equipments, for business and domestic use. These are inherently not comparable to the machine tools manufactured by the Assessee. Further, such tools are in the nature of small tools like hammers, plyers, taps, dies and other miniature products which are not related to the machine tools manufactured by the Assessee. This is evident from the website extracts produced along
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 21 of 38 with the present synopsis. The products manufactured by this company are sold more in the B2C model, as opposed to the products of the Assessee which are in the B2B segment. Therefore, this company is not comparable.
- R&D activities:
7.17.1 He submitted that the Company also has an in-house technology research and development wing, which is continuously working towards more efficient Engineering tools production, improved processes and better designs. Therefore, he submitted that Groz ought to be excluded from the final list of comparables.
7.18 The ld. D.R. submitted that the assessee has requested for exclusion of this company based on the following reasons:
Functionally different Substantial income from export sales 7.19 He submitted that the comparable company is into manufacturing of fuel pumps, machine tools, accessories and Engineering Tools. Therefore, ld. DR submitted that the company is functionally similar. As regards, the export sales, the TPO has not applied export sales filter, only the functional similarity/dissimilarity is being considered in this ground of objection. Since the company is functionally similar this ground of objection is to be rejected.
7.19.1 We have heard the rival submissions and perused the materials available on record. The main contention of the ld. A.R. is that this company is functionally dissimilar to the assessee’s case as it manufactures engineering goods, small tools and works on B2C model. In our opinion, it is appropriate to remit this issue to the file of AO/TPO to undertake fresh study with reference to functionality. Ordered accordingly.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 22 of 38 8. In ground No.2.8, the assessee wants inclusion of following two companies as comparables: (a) Birla Precision Technologies Ltd. (b) Jainex Aamcol Ltd. a) Birla Precision Technologies Ltd.(Birla):
8.1 The ld. A.R. submitted that the company came to be rejected by the TPO for the reason that the same fails the persistent loss filter. The DRP upheld the action of the TPO for the reason that the Company is functionally dissimilar. At the outset, he submitted that this filter was not applied by the TPO, and therefore the exclusion of this company on this count is wholly erroneous and unsustainable. In any event, he submitted that the company has not incurred losses in all three years under consideration. It is submitted that the company in fact had profits for 2 out of 3 years. A summary of the computation of margins is provided below, for reference:
FY 2015- Particulars FY 2016-17 FY 2014-15 16 Operating Revenue – 11,987.72 11,910.1 11,387.66 A Total Operating 14,079.38 11,144.96 10,416.07 expenditure – B Operating profit (A- -2,091.66 765.14 971.59 B) Margin on sales -17.45% 6.42 8.53 (OP/OR) Weighted Average Margin - Unadjusted on sales -1.01% 8.1.1 Since the company has profits in two out of the three years under consideration, the Company ought to be included in the final list of comparables. Undisputedly, the company is comparable to the Assessee. Moreover, the Company has been accepted in the final list of comparable companies by the TPO in Assessee’s own case for the assessment year 2014-15 (para 9 at pages 8-9 of the order). Further, it is submitted that the Company also passes all the filters selected by IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 23 of 38 the TPO. In this regard, he placed reliance on the decision of the Hon’ble Bombay High Court in the case of CIT v. Welspun Zucchi Textiles Ltd. (Order dated 06.01.2017 passed by the Hon’ble Bombay High Court in (pages 2-7). In view of the above, he submitted that Birla ought to be included in the final list of comparables.
8.2 The ld. D.R. submitted that the assessee has requested for inclusion of this company based on the following reasons:
Functionally comparable Passes persistent loss filter
He submitted that this comparable is engaged in the manufacture of 4 divisions, tool holder division, Foundry and Machining division, precision components and cutting tools. So it is into diversified business, it has significant export revenues and has many joint ventures with many Multi national companies engaged in similar line of business. Hence, he submitted that it is functionally different from the assessee. It also fails the persistent losses filter as it has recorded losses in the FY 2017-18, 2016-17 and 2015-16. Accordingly, he submitted that the plea of the assessee to include this comparable is to be rejected.
8.3 We have heard the rival submissions and perused the materials available on record. The main contention of the ld. A.R. is that this company is earning profit in 2 years out of 3 assessment years functionally comparable. More so, in the assessment year 2014-15, the ld. TPO himself has included this company as a comparable. For this purpose, he relied on the judgement of the order of the Tribunal in the case of CIT Vs. Welspun Zucchi Textiles Ltd. dated 6.1.2017 passed by the Hon’ble Bombay High Court in ITA No.1286/2014. In view of this, we remit this issue to the file of ld. AO to reconsider the same in the light of above observations.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 24 of 38 b) Jainex Aamcol Ltd.(Jainix):
8.4 The ld. A.R. submitted that the company came to be rejected by the TPO for the reason that the same fails the persistent loss filter. The DRP upheld the action of the TPO for the reason that the Company is making loss for 2 out of 3 years. At the outset, he submitted that this filter was not applied by the TPO, and therefore the exclusion of this company on this count is wholly erroneous and unsustainable. In any event, he submitted that the company has made profits in all three years under consideration, the details of which are as under:
Particulars FY 2016-17 FY 2015-16 FY 2014-15 Operating 152,286,427 130,551,940 141,183,541 Revenue – A Total Operating 143,706,559 124,149,560 132,580,838 expenditure – B Operating profit 8,579,868 6,402,380 8,602,703 (A-B) Margin on sales 5.63% 4.90% 6.09% (OP/OR) Weighted Average Margin - Unadjusted on 5.56% sales Pertinently, it is submitted that the Company has been accepted in the final list of comparable companies by the TPO in Assessee’s own case for the assessment year 2014-15 (para 9 at pages 8-9).
8.4.1 Further, he submitted that the Company also passes all the filters selected by the TPO. In view of the above, he submitted that Jainex ought to be included in the final list of comparables.
8.5 The ld. D.R. relied on the orders of the lower authorities.
8.6 We have heard the rival submissions and perused the materials available on record. The ld. A.R. submitted that the company is making profit in all assessment years and it has been accepted as comparable in assessment year 2014-15. Hence, in our
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 25 of 38 opinion, if AO/TPO accepted it as comparable in the assessment year 2014-15, it is to be considered as comparable in AY 2017-18 also. Ordered accordingly. 9. Next ground No.2.9 is general in nature, which does not require any adjudication.
10. With regard to ground No.2.10, the ld. A.R. submitted that the TPO, while computing the TP adjustment has erred in proposing an adjustment on the entire expenses in the manufacturing segment, which includes transaction with unrelated parties, without limiting the same to the value of the international transactions. The value of international transactions of the Assessee in terms of cost is 28.37% of the total cost in the manufacturing segment, the breakup of which is as under:
Particulars Amount (INR) Purchases of raw materials and components 883,479,258 Payment of Royalty 23,695,784 Payment of IT charges 158,721,057 Total Expenses 1,065,896,099 Total Operating cost 3,756,978,000 % of international transactions to operating cost 28.37% 10.1 Therefore, he submitted that the TP adjustment, if any, ought to be restricted to the value of the international transaction. Further, the TPO in the TP order in Assessee’s own case for the assessment years 2014-15 (refer pages 9 and 10 of the order) and 2018-19 (refer page 21 of the order) has restricted the TP adjustment to the proportion of cost of international transactions to total operating cost. In any event, the TP adjustment, if any ought to be restricted to the value of international transactions. Reliance in this regard is placed on the decision of this Hon’ble Tribunal in the case of Continental Automotive Components (India) Pvt. Ltd v. ACIT (Reported in [2022] 139 taxmann.com 187 (Bangalore – Trib.)
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 26 of 38 10.2 In view of the above, he submitted that the TP adjustment in the manufacturing segment, if any, ought to be restricted to the proportionate value of international transaction to total operating cost.
10.3. The ld. D.R. relied on the orders of lower authorities.
10.4. We have heard the rival submissions and perused the materials available on record. Similar issue came for consideration before this Tribunal in the case of M/s. Continental Automotive Components India Pvt. Ltd. in IT(TP)A No.280/Bang/2021 for the AY 2016-17 dated 6.2.2023 wherein held as follows:
51. We notice that the coordinate bench in assessee’s own case has considered the identical issue and held that – 73. In this regard, we find that identical issue has been decided by the Tribunal in the case of Ika India Pvt. Ltd., (supra) and the Tribunal held as follows: “44. Section 92(1) of the Act provides as under:-
"Any income arising from an international transaction shall be computed having regard to the arm's length price".
Section 92B defines the term "international transaction" 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. Subsection (1) of section 92C stipulates that:- "The arm's length price in relation to an international transaction shall be determined by any of the following methods ............. ".
It is the plea of the assessee that addition by way of transfer pricing adjustment is mandated only in respect of transactions between two or more AEs. The profit from comparable transactions of the assessee with non-AEs is one of the subtle and most reliable modes for IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 27 of 38 determining ALP of the international transactions. The Act does not contemplate an addition by way of TP adjustment in respect of transaction with non-AEs.
The TPO determined addition to total income, consequent to determination of ALP only in relation to international transaction i.e., transactions with AE in the export of finished goods segment by considering the value of international transaction at Rs.3,31,50,982 which is the value of export of finished goods by the assessee to its AE and not on the total sales in the finished goods segment of Rs.39,19,74,355 (vide para 8.3 of the TPO’s order).
The Hon'ble Bombay High Court in the case of Phoenix Mecano (India) Private Limited [ITA No. 1182 of 2014], had to deal with the following question of law suggested by the revenue:- Whether on the facts and in the circumstances of the case, the Hon'ble Tribunal was correct in directing the AO to restrict the determination of the ALP to transactions with the AE rather than on the entire turnover of the Company. Whether on the facts and in the circumstances of the case and in law, the Hon'ble Tribunal was correct while issuing the above directions without appreciating the observations of the DRP that there was no segmental audit of the transactions of AE and non AE and therefore there was no method whereby the AO could come to a fair determination of ALP by only restricting to transactions with AE."
The Hon’ble Bombay High Court on the above questions of law held as follows:-
“5. With the assistance of the learned counsel for respective parties, we have considered the submissions and the judgment of the Tribunal. The Tribunal in para 7 of its order has observed as under:- "7. We have heard both the parties and their contention have carefully been considered. So far it relates to grievance of the assessee that the TP adjustment can only be applied to international transactions of the assessee with the AE and it cannot be applied at entity level, the issue is found to be covered by the aforementioned decision of the Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. (supra). Therefore, we hold that determination of arms length price should be restricted only to international transaction of the assessee with its AE. It was pointed out that the figures are available with the AO, details of which has also been filed before us at page 170 of the paperbook. Therefore, we direct the AO to take only the international transactions of the assessee with its AE IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 28 of 38 for the purpose of determining arms length price. We direct accordingly."
6. The Tribunal has held that the figures are available with the Assessing Officer, the details of which has also been filed with the Tribunal at page 170 of the paperbook. It would be clear that the details of the international transaction are specifically made available and therefore the apprehension of the department as such is misplaced. ……..
Considering the provisions of Section 92 of the Income Tax Act, so also the reasoning adopted by the Tribunal suggesting that separate figures of international transaction are available, so also the order referred above. No substantial question of law arises for consideration. As such the appeal is dismissed with no costs." (Emphasis supplied) 51. The Hon'ble Mumbai Tribunal in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 7032/Mum/2011] held that the ALP can only be determined on the value of international transaction alone and not on the entire turnover of the assessee at entity level. This decision was further upheld by the Hon'ble Bombay High Court in the case of Thyssen Krupp Industries India Pvt. Ltd. [ITA No. 2201 of 2013], which held as below:-
"2. .............. (a) Whether on facts and the circumstances of the case and law, the Tribunal was justified in law in restricting the Transfer Pricing (TP) adjustment only to the transaction between the Associated Enterprises (AEs.)? 3. ........... ……….. (e) We find that in terms of Chapter X of the Act, redetermination of the consideration is to be done only with regard to income arising from International Transactions on determination of ALP. The adjustment which is mandated is only in respect of International Transaction and not transactions entered into by assessee with independent unrelated third parties. This is particularly so as there is no issue of avoidance of tax requiring adjustment in the valuation in respect of transactions entered into with independent third parties. The adjustment as proposed by the Revenue if allowed would result in increasing the profit in respect of transactions entered to with non-AE. This adjustment is beyond the scope and ambit of Chapter X of the Act.
In the above view, as the provisions of the Act in respect of transfer pricing are self evidence, Question No.(a) as proposed does not give rise to any substantial question of law. Thus not entertained.” The ITAT Bangalore in the case of Kirloskar Toyota Textile Machinery Pvt. Ltd. v. ACIT [IT(TP)A No.1401/Bang/2010 held as under:-
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 29 of 38 “Taking into consideration of these factors, we accept the first fold of submission made by the learned counsel for the assessee and direct the Assessing Officer to confine the adjustment, qua the purchases made by the assessee from the AE. To be more specific, the adjustment is to be made only to the purchases made from the AE ….. (emphasis supplied) The CIT(A) in exercise of his powers of enhancement of income took the view that the ALP has to be determined on the basis of the entire sales in the finished goods segment including transactions with Non- AE also. The reasoning adopted by the CIT(A) for doing so was as follows:- “10.0 While examining the working of ALP in the case of Assessee, it was observed that the TPO has reduced the adjustment proportionately by holding that only 8.46% of revenue of the Assessee is from AE. She accordingly adopted 8.46% of the operating revenue and 8.46% of the Operating cost for purpose of the determination of ALP. However, this method is not the correct approach as the ALP determination should have been based on the entire operating revenue and entire operating cost. Since this change in method would have amounted to enhancement of the income of the Assessee, so opportunity of being heard was given to the Assessee vide order sheet entry dated 11.08.2017, as to why the proportionate reduction done by the TPO should not be disregarded. The Assessee sought time to file written submissions and the same was allowed. The Assessee filed written submissions vide letter dt 29.08.2017. The same have duly been considered and the issue is being decided as follows:
10.1 In the case under consideration, the Assessee is selling its product to AE as well as to non AEs, for the manufacture of which, part purchases are from AEs and remaining from the non AEs. The TPO has considered OP/OR for purpose of computation of the ALP as the quantum of sales to AE are lesser than the purchase from AE and thus lesser controlled. When a product is sold, only overall profit margin is recorded without any data as to what would be the profit in relation to purchases from AE. So this cannot be presumed that the profit percentage earned in relation to costs related to AE transactions as well as non-AE transactions was same. Since costs are common to the products ultimately sold by the Assessee, and the same includes AE transactions, so it is always possible that the margin of profit percentage vis-a-vis costs related to AE transaction is not the same as profit margin on costs related to non-AE transactions but ultimately overall certain profits are being shown. Further, the transactions with non-AEs can be presumed to be at arm's length as there is no reason to earn lesser profit. But in case of transactions with AEs, there is always a likelihood of earning lesser profits as transactions are controlled and decisions are influenced by AE. Thus the overall profits
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 30 of 38 on account of transactions with AE as well as non-AE gets suppressed.”
We have heard the rival submissions. The ld. counsel for the assessee reiterated submissions made before the CIT(A) that transaction with non- AE cannot be subject matter of determination of ALP because section 92 clearly speaks of determination of ALP only in respect of transactions with AE. He also referred to certain decisions of the Tribunal for the proposition that section 92 of the Act is not applicable to non-AE transactions. These decisions have already been extracted in the earlier paragraphs. The ld. DR relied on the order of the CIT(Appeals).
52. We have considered the rival submissions. The reasoning of the CIT(A) for considering the entire sales in manufactured finished goods segment for determination of ALP is that certain components and raw materials used in manufacture of finished goods are also sourced from AE and there is a possibility of the cost of such component having been bargained at a price which is not at arm’s length. This presumption of the CIT(Appeals) is without any basis. He has not demonstrated with actual figures as to how there would be impact on profit margin on sale of finished products to AE because of purchases of some components from AE. He has given examples which are imaginary figures. Apart from this, the TPO has accepted that purchase of raw material and components by the assessee from its AE is at arm’s length. Therefore, the basis on which the CIT(A) proceeded to apply the ALP test for transactions with non-AE is neither correct on facts nor permissible in law. As rightly contended by the assessee, section 92 of the Act can be applied only in respect of international transactions i.e., transactions with AE.
In view of the above transfer pricing provisions and various judicial precedents, we hold that the transfer pricing adjustment should be restricted only to the AE related transactions of the assessee.” 74. The facts and circumstances of the case in this appeal on this issue is identical to the case decided by the Tribunal in the case of IKA (supra). The reasoning of the CIT(A) in this case and the case of IKA (supra) are also identical. Therefore the decision rendered in the case of IKA (supra) squarely applies to the present case. Therefore, the adjustment on account of determination of ALP has to be restricted only to that part of the transaction with AE and not the entire value of the manufacturing segment as was done by the revenue authorities.
Respectfully following the above decision we direct the AO/TPO to restrict the adjustment on account of determination of ALP only to that part of the IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 31 of 38 transaction with AE and not the entire value of the manufacturing segment. It is ordered accordingly.” 10.4.1 Further, it was also brought to our notice that in assessment year 2014-15 and assessment year 2018-19, the ld. TPO has restricted the TP adjustment to the proportionate of cost of international transaction to total operative cost. Being so, taking a consistent view, we direct the ld. AO to restrict the TP adjustment to the proportionate value of cost of international transaction only. Ordered accordingly.
11. With regard to ground No.2.11 the ld. A.R. submitted that the TPO, while computing the margin of the Assessee erred in not considering other income of Rs. 2,64,23,000/- which comprises of lease rentals, commission on order-based sales, facility charges from fellow subsidiary, support services charges from fellow subsidiaries and export incentives. While the Assessee had included the same in the computation of margin in its TP study, the TPO had reduced the same. Pertinently, it is submitted that the TPO reduced the other income from the operating income, while taking in the operating cost base, the costs incurred by the Assessee in earning the other income. He submitted that the above income is operating in nature and ought to be included in the operating income.
11.1 As regards the lease rentals, he submitted that during the year, the Assessee had received lease rentals from its fellow subsidiary Kennametal Shared Services Private Limited (“KSSPL”) for leasing its business premises. The costs relating to depreciation, repair and maintenance cost and upkeep costs of the premises and machinery were initially incurred by the Assessee and was forming part of Assessee’s cost base in its profitability statement. Therefore, he submitted that the relevant lease rental/ recoveries should also be suitably factored (either to be included in revenue or excluded from cost base, as appropriate) while computing the operating profit
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 32 of 38 of Assessee, for transfer pricing purposes. This would also be in line and consistent with the ‘matching concept’ as laid out in the generally accepted accounting principles.
11.2 As regards the facility and support charges, it is submitted that the Assessee operates a canteen facility at its office premises which was also provided to the employees of its fellow subsidiary company i.e., KSSPL. The expenses relating to this canteen facility was incurred by Assessee. In addition, the Assessee had recovered certain expenses from KSSPL towards central functions like finance, human resources, legal and administration, warehouse and logistics management support, which were driven centrally by the Assessee on behalf of KSSPL. In this connection, the Assessee has cross charged the applicable allocable costs to KSSPL.
11.3 Considering the above, he submitted that the cost towards the above services were initially incurred by the Assessee and was forming part of Assessee’s cost base. Therefore, he humbly submitted that the relevant revenue/ recoveries should also be suitably factored (either to be included in revenue or excluded from cost base, as appropriate) while computing the operating profit of the Assessee, for transfer pricing purposes.
11.4 As regards the export incentives, he submitted that the nature of export incentives was directly relating to the manufacturing and sale of products which was forming part of the profit and loss account. Such export incentives were covered under the Merchandise Exports from India Scheme (MEIS) and Duty Drawback Scheme (DBK). Under MEIS, the Assessee is entitled for a certain percentage of incentives on the FOB value of Exports which shall vary in accordance with the notification issued by the Government of India. As such incentives earned are directly related and arising out of the manufacturing activity of the Assessee, therefore, the amount of IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 33 of 38 export incentives should be considered as operating in nature. Reliance in this regard is placed on the following decisions:
- CIT v. Welspun Zucchi Textiles Ltd. (Order dated 06.01.2017 passed by the Hon’ble Bombay High Court in - Reitzel India Private Limited v. DCIT (Reported in [2020] 119 taxmann.com 401 (Bangalore – Trib.); 11.5 As regards the commission on order-based sales, he submitted that the Assessee has a dedicated sales team whose predominant role is to expand the sales portfolio of the Assessee. As part of this role, the sales team also assists its group entity, i.e., Kennametal Stellite Inc., in the sale of products manufactured and sold to independent customers. As part of this activity, the sales team had incurred certain cost in relation to the sale of products made by Kennametal Satellite Inc., which were closely connected to the primary activity of manufacturing and sale of machine tools. Considering the overall nature of activity and the quantum to the total operations, the said activity is forming part of the manufacturing segment’s cost. Therefore, he humbly submitted that the relevant commission income should also be suitably factored (either to be included in revenue or excluded from cost base, as appropriate) while computing the operating profit of the Assessee, for transfer pricing purposes. This would also be in line and consistent with the ‘matching concept’ as laid out in the generally accepted accounting principles. 11.6 The ld. D.R. relied on the orders of lower authorities.
11.7 We have heard the rival submissions and perused the materials available on record. In case of lease rental income has been received from the leasing of the same premises, which is used for the assessee’s business on which the assessee claimed as an expenditure charged to P&L account. The lease rental received on the same premises to be netted with the payment of the lease rent. Ordered accordingly.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 34 of 38 11.7.1 In respect of receipt from canteen facility and support services offered to the other than employees to be netted out of the expenditure incurred towards providing canteen facility. Ordered accordingly.
11.7.2 With regard to export incentive received by the assessee as held by the Tribunal in the case of CIT v. Welspun Zucchi Textiles Ltd. (Order dated 06.01.2017 passed by the Hon’ble Bombay High Court in wherein held as under: “4. Regarding question (ii):- (a) The TPO while arriving at the ALP for the export of bathrobes and towels had excluded the DEPB benefit and depreciation while arriving at the operating profits and total cost respectively of the respondent for the purposes of application of the TNMM method to arrive at ALP. This exclusion of DEPB benefit from profit and depreciation from costs, was done only while arriving at the profits of the respondent assessee and not while arriving at the profit margin of the comparables.
(b) Being aggrieved, the respondent assessee filed an appeal to the CIT(A). In appeal, the CIT(A) by an order dated 2nd November, 2012 held that both the DEPB as well as the depreciation are part of the operating income/expenses respectively. Thus, they have to be taken into account while arriving at the operating profit and total cost before determining the margin on adoption of TNMM method. (c) Being aggrieved, the Revenue carried the issue in appeal to the Tribunal. By the impugned order, the Tribunal held that so far DEPB benefit is concerned, the issue arose for consideration before it in the case of respondent assessee itself for Assessment year 2005-06 and 2007-08 and the Tribunal held that the same has to be included for the purposes of arriving at operating profit for the application of TNMM method. This on the basis that comparison should be made on like to like and similar to similar. So far as the depreciation is concerned, the impugned order of the Tribunal adopted the same reasoning which it had applied while holding that DEPB benefit is includable in arriving at the net profit in its order in the earlier assessment years 2005-06 and 2007-08 in the subject assessment year with regard to claim of depreciation. Therefore, the DEPB was includable in arriving at the operating profit and depreciation was includable while arriving at the total costs of the respondent assessee as the same is not excluded in arriving at the profits of the comparable companies.
(d)We find that so far as exclusion of DEPB benefit in arriving at the operating profit of the respondent assessee is concerned, the order of the Tribunal for the assessment years 2005-06 and 2007-08 were appealed by the revenue to this Court. Mr. Suresh Kumar, learned Counsel appearing for the Revenue very fairly states that this very issue was raised by the Revenue in its appeal before this Court for the earlier assessment years being Income Tax Appeal No.1827 of 2013 relating to AY 2005-06 and Income Tax Appeal No.171 of 2014 relating to AY 2007-08. However, this Court by orders dated 22nd September, 2015 for AY 2005-06 and 1st July, 2016 for IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 35 of 38 AY 2007-08, dismissed the Revenue’s appeal. In the above view, the issue with regard to the exclusion of the DEPB benefit stands concluded by virtue of order of this Court against the Revenue and in favour of the respondent assessee.”
11.7.3 In view of the above judgement of Hon’ble Bombay High Court, we direct the AO/TPO to include the export incentive received as part of business income of the assessee. Ordered accordingly. 11.7.4 Regarding commission receipt it is directed from the primary business activity of the assessee for which the assessee used its sales team and earned the same and to be treated as business income of the assessee. Ordered accordingly.
12. At the time of hearing, ground No.2.12 was not pressed and hence, this ground is dismissed as not pressed.
13. With regard to ground No.2.13, the ld. A.R. submitted that during the year under consideration, the Assessee had receivables arising from the sale of machine tools and machine products to its AEs. The receivables are on account of regular business transactions. Similarly, the Assessee also had outstanding payables to its AEs. In this regard, neither the Assessee charged any interest on the outstanding payables, nor paid any interest on the receivables.
13.1 In this regard, he submitted that the lower authorities erred in making the adjustment towards outstanding receivables. The Assessee submitted that the inclusion in the Explanation to Section 92B of the Act of the expression ‘receivables’ does not mean that every item of ‘receivables’ appearing in the accounts of an entity, which may have dealings with foreign AEs would automatically be characterized as an unsecured loan leading to benefit the AEs. The intent behind including the above clause within the ambit of Section 92B of the Act is to penalize the taxpayers who do not repatriate the money for an indefinite period and not to automatically characterize any debit balance in the books of accounts from the AEs as an IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 36 of 38 unsecured loan. Further, an outstanding balance cannot be treated as a loan or borrowing as it is not an independent transaction which can be viewed on standalone basis. The Assessee submitted that element of interest comes in only with respect to an indebtedness created out of a loan transaction. In view of the above, the ld. A.R. submitted that the delayed receivables cannot be treated as an independent international transaction.
13.2 In any event, he submitted that the said amounts were outstanding with the AEs as well as Non-AEs for a period exceeding the credit period purely because of business reasons. He submitted that the Assessee has not charged any interest for the receivables outstanding even from Non-AEs, which is apparent from the financial statements. He placed reliance in this regard on the decision of the Hon’ble Bombay High Court in case of CIT V. Indo American Jewellery Ltd. (Order dated 08.01.2013 passed by the Hon’ble High Court of Bombay in ITA(L)No. 1053/2012) (para 5) wherein the Hon’ble High Court upheld the decision of Hon’ble Tribunal in deleting the notional interest on trade receivables considering the fact that the taxpayer has not charged the interest in case of trade receivables from both AEs as well as Non-AEs.
13.3 Moreover, he submitted that the Assessee had outstanding payables to its AEs, the impact of which the lower authorities failed to consider. Pertinently, the Assessee has not paid any interest on the payables. He submitted that the Assessee had payables far in excess of the receivables, the details of which are as under:
Particulars INR Balance of trade receivables as on Rs. 10,83,54,534/- 31.03.2017 Balance of trade payables as on 31.03.2017 Rs. 33,21,43,825/-
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 37 of 38 13.4 He submitted that while the DRP had directed the TPO to consider the same, the TPO failed to take the same into consideration, in clear defiance of the DRP’s directions. He submitted that the interest on delayed receivables, if any, ought to be computed after taking into consideration the outstanding payables. In this regard he placed reliance on the decision of the Hon’ble High Court of Delhi in the case of PCIT v. McKinsey Knowledge Centre India Pvt. Ltd. (Order dated 12.10.2021 passed in ITA No. 146/2020). If done so, the adjustment determined on this account will be deleted.
13.5. The ld. D.R. relied on the orders of the lower authorities.
13.6 We have heard the rival submissions and perused the materials available on record. Similar issue came for consideration before Hon’ble Delhi High Court in the case of PCIT Vs. M/s. Mckinsey Knowledge Centre India (P) Ltd. in dated 12.10.2021, wherein held as under:
“11. Having heard learned counsel for the parties, this Court is of the view that the first proposed question of law by the Department is squarely covered in favour of the respondent-assessee vide this Court’s order dated 9th August, 2018 in ITAS No.590/2017 and 82/2018 for Assessment Year 2011-12 and Assessment Year 2012- 13 wherein this Court had dismissed the appeal filed by Income Tax Department/appellant on the exclusion of ABCL from the list of comparables, as functions performed by ABCL as a fund manager were wholly different from that of the respondent and also with a totally different risk profile.
This Court is also of the opinion that under no transfer pricing norm, principle or evaluation of any "benefit" can there be a one-sided adjustment taking into account delayed invoices while at the same time ignoring invoices/payment received in advance. Consequently, factually there can be no notional computation of 'delayed receivables' only ignoring the receivables received in advance.
A perusal of paper book reveals that most of the invoices/receivables had been paid significantly in advance. When the period for which the amounts of receivables received in advanced enjoyed by the respondent is seen vis-a-vis the amount receivable beyond sixty days, it is apparent that the respondent has received, significantly -more advance rather than outstanding receivable beyond sixty days.
IT(TP)A No.506/Bang/2022 Kennametal India Limited, Bangalore Page 38 of 38
14. Consequently, on the facts and circumstances of the case, the notional interest relating to alleged delayed payments in collecting receivables from the AES is uncalled for as in fact, there are no outstanding receivables as the amount received in advance far outweigh the amount received late.
15. The question as to whether in a given case transfer pricing adjustment on 'delayed receivables', could apply even to a debt-free company or not, hence does not arise on facts and is left open.”
13.6.1 In view of the above judgement, we remit this issue to decide the same afresh in the light of above judgement of Hon’ble Delhi High Court.
At the time of hearing, ground No.2.14 was not pressed and hence, this ground is dismissed as not pressed.
With regard to ground Nos.2.15 & 2.16, this issue required to be considered by the ld. AO while granting working capital adjustment. Ordered accordingly.
In the result, appeal of the assessee is partly allowed for statistical purposes.
Order pronounced in the open court on 15th May, 2024