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Income Tax Appellate Tribunal, “C” BENCH : KOLKATA
Before: Hon’ble Sri N.V.Vasudevan, JM & Shri M.Balaganesh, AM]
IN THE INCOME TAX APPELLATE TRIBUNAL “C” BENCH : KOLKATA [Before Hon’ble Sri N.V.Vasudevan, JM & Shri M.Balaganesh, AM] I.T.A No. 201/Kol/2012 Assessment Year : 2007-08 D.C.I.T., Circle-12 , -vs.- M/s. J.J.Exporters Ltd. Kolkata Kolkata [PAN : AAACJ 6722 H] (Respondent) (Appellant) For the Appellant : Shri G.Mallikarjuna, CIT(DR) For the Respondent : Shri R.N.Bajoria, Shri A.Gupta & Shri S.Jhajharia, AR Date of Hearing : 04.05.2017. Date of Pronouncement : 12.05.2017. ORDER Per N.V.Vasudevan, JM This is an appeal by the Revenue against the order dated 25.11.2011 of C.I.T.(A)-XII, Kolkata relating to A.Y.2007-08.
Ground No.1 raised by the revenue reads as follows :- “1. That on the facts and in the circumstances of the case the CIT(A) has erred in deleting the addition u/s. 36(1)(iii) made on the basis of Auditor's certificate in the form 3CD. “
The Assessee is a company engaged in the business of manufacture and export of silk fabrics. In the course of assessment proceedings the AO noticed from col.17(l) of the Form 3CD of the Tax Audit Report which deals with amount inadmissible under the proviso to Section 36(1)(iii) of the Income Tax Act, 1961 (Act), the auditor had certified as follows: “Rs.14,60,01,802.60 (including depreciation as per Income Tax Act) income of which exempted u/s 10B”
2 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 According to the AO, since the auditor had certified the aforesaid amount inadmissible, the amount should have been added back to the total income, which has not been done. According to the AO proper reply was not given by the AO to a show cause notice issued by him in this regard. Therefore, the AO added a sum of Rs.14,60,01,802.60 to the total income as expenses disallowed as stated in the tax audit report.
Before CIT(A), the assessee pointed out that it had two units which were 100% Export Oriented Undertakings and the income arising from which are fully exempt u/s 10B and such exemption of income from such units are being regularly allowed to the Assessee ever since which such undertakings began manufacturing or producing articles and such deduction/exemption was allowed on the basis of similar Tax Audit Report. The Assessee pointed out that as per the audited accounts of such 100% Export Oriented Undertakings for the year ended 31 .03.2007 relevant to assessment year 2007-08, expenditure of Rs.14,60,01,802.60 which comprises of Cost of manufacturing of goods and other Establishment expenditure and other expenditure incurred in connection with export of the goods manufactured and Depreciation in respect of Plant & Machinery used in production of such goods, was debited in the profit and loss account. Profit of Rs. 1,62,59,986/- of the two units for exemption u/s.10B of the Act was arrived at after debit of those expenses and set off of losses for earlier years was arrived in those Units and such profit was claimed exempt in terms of section 10B of the Act being the Profit from 100% Export Oriented Undertakings. The AO has also allowed such exemption.
It was pointed out to the CIT(A) that the sum of Rs.14,60,01,803/- disallowed u/s.36(1)(iii) of the Act by the AO comprised of expenditure in connection with purchases of Raw. Materials, manufacturing expenses, depreciation etc. for EOUs and could not be treated as expenditure disallowable in terms of section 36(1 )(iii) which applies in respect of payment of interest on loan borrowed for the purposes of business. 2
3 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 The AO has not disputed that any loan had been borrowed for the purpose other than business and hence the entire disallowance is not only wholly bad, illegal and uncalled for but such disallowances had been made under complete mis-conception and without proper appreciation of the Tax Audit Report and without proper appreciation of the facts and circumstances of the case.
The CIT(A) agreed with the submissions made on behalf of the Assessee and was of the view that even if disallowance u/s. 36( 1 )(iii) of the Act, 1961 is to be made then the profits derived from the eligible 100% EOUs shall increase to that extent and on such enhanced profit deduction u/s. 10B of LT. Act had to be allowed. In that view of the issue, the CIT(A) held that the disallowance if held to be proper would have no effect since assessee is 100% eligible EOU. Hence the disallowance/addition to taxable income made by the AO was deleted by the CIT(A). 7. Aggrieved by the order of CIT(A) the revenue has raised ground no.1 before the Tribunal. 8. The ld. DR relied on the order of AO. The ld. Counsel for the assessee relied on the order of CIT(A). 9. We have considered the rival submissions and perused the material on record. The material on record shows that clause (l) of col.17 of the Tax Audit Report gave the following particulars :-
“(l) Amount of deduction inadmissible in terms of Rs.14,001,802.60( including Section 14A in respect of the expenditure incurred depreciation as per income Tax In relation to income which does not form part Act) income of which exempted Of the total income u/s 10B “
This was the starting point of enquiry by the AO. Since there was an international transaction and the provision of section 92 were applicable in the case of the assessee, the AO passed a draft assessment order date 27.12.2010 u/s 143(3) of the Act. On
4 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 27.12.2010 the assessee filed a letter before the AO in which the assessee had specifically pointed out as follows :- “In the Tax Audit Report the amount disallowable u/s 36(1)(viii) has been shown at Nil. Further under the earlier column regarding disallowance u/s 14A wrongly an amount of Rs.14,60,01,802.60 was shown. Actually, this amount represented the expenses incurred from the gross receipts eligible unit u/s 10B. Since only the net amount i.e. a net profit after deduction was claimed u/s 10B, no further amount was disallowable u/s 14A in respect of the above claim, an addendum issued by the Auditor is enclosed herewith which will clarify the whole position.”
The corrigendum issued by the auditor to the tax audit report in column (l) was as follows :- CORRIGENDUM In reference to our Tax Audit Report signed dated 30th day of October, 2007 for the financial year 2006-07 (Assessment year 2007-08) of J.J.Exporters Ltd. Of 23C, Ashutosh Choudhary Avenue, Kolkata 700019 in Clause 17(l), it should be read as follows :
“Amount of deduction in admissible in terms of Section 14A in respect of the expenditure incurred in relation to income which does not form part of total income – Rs. NIL”
As against Rs.14,001,802.60 (including depreciation as per Income tax Act) which was stated in our above mentioned report as clarifica5tory in nature however there is no further disallowance due to exemption taken of Business Profit u/s 10B. The above expenditure of Rs.146,001,002.00 was already considered for arriving of Business profit u/s 10B. So disallowance u/s 14A should be treated as Nil.”
Since the draft assessment order has been passed on 27.12.2010 this letter was not considered by the AO. Even in the proceedings before CIT(A) attention of CIT(A) was not drawn to this letter. The revenue authorities have therefore proceeded on an erroneous assumption that the Tax audit report refers to disallowance of interest u/s 36(1)(iii) of the Act whereas in reality disallowance was done in the context of section 14A of the Act .
5 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 10. It is also clear from the corrigendum issued by the tax auditor to col.(l) 17 to the tax audit report that since the interest expenditure and depreciation mentioned in col. 17(l) of the tax audit report was expenditure in relation to section 10B unit which in deals with income exempt from tax, there was no disallowance u/s 14A of the Act which was necessary to be made. In other words, these expenses were not claimed as deduction against income which is chargeable to tax under the Act. With this clarificatory facts, we uphold the order of CIT(A). The conclusion of the CIT(A) in effect is that since the amount of Rs. 14,60,01,803/- has not been claimed as an expenditure in computing income of the assessee chargeable to tax. His further conclusion is that the said sum was claimed as deduction only in arriving at the profits of 10B unit which was not chargeable to tax and therefore can be no effect on the determination of the total income of the assessee. We agree with these conclusions and therefore dismiss ground no.1 raised by the revenue. 11. Ground Nos. 2 and 3 raised by the revenue read as follows :- “2. That on the facts and in the circumstances of the case the CIT(A) has erred m deleting upward adjustment amounting to Rs.10,83,00,000 / - without appreciating the fact that the assessee itself compared the profit at enterprise level.
That on the facts and in the circumstances of the case, the CIT(A) has erred m deleting upward adjustment amounting to Rs.10,83,000/- though the assessee failed to provide the comparable profit at transactional level.”
We have already seen that the assessee is in the business of manufacture and export of silk fabrics. During the previous year relating to A.Y.2007-08 the assessee entered into international transaction with M/s. Spin International Corporation USA (hereinafter referred to as “SPIN”) which was a 100% subsidiary of the assessee. The transaction between the assessee and SPIN was an international transaction . The arms length price (ALP) of the said transaction had to be determined as required under the provision of section 92 of the Income Tax Act, 1961 (Act). The transaction in question was a transaction of sale of silk fabric for a sum of Rs.23,63,20,140/- by the assessee to SPIN.
6 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 This price had to be shown as a price which unrelated parties would also pay considering the nature and other features of the transaction of sale. To justify the price charged by the assessee, the assessee filed a transfer pricing study. The assessee chose transaction net margin method (TNMM) as the Most Appropriate Method (MAM) for the determination of ALP. The Profit Level Indicator (PLI) used for determination of ALP was operating profit/operating cost where operating profit was equal to total operating income minus total operating expenses. The assessee gave working of its PLI as follows :- Table
Particulars Total (Rs.)
Export (Net FOB) to Spin 23,63,20,140/- Cost of Goods Exported 16,97,09,276/- Gross Profit 6,66,10,864/- Gross Profit Margin on cost 39.25%
The assessee had chosen nine comparable companies for the purpose of arriving at the arithmetic mean of comparable companies. Out of the above 9 companies, four comparable companies had fluctuating operating profits. Therefore these companies were excluded. The assessee was therefore left with five comparable companies whose operating profit/operating cost was as follows :- Sl.No. Name of company Operating Profit/Operating Cost 1. Zenith Exports Ltd. 17.7% 2. Himatsingha Selde Ltd. 48.79% 3. Silktex Ltd. 14.19% 4. Silktex International Ltd. 15.98% 5. Eastern Silks Ind. Ltd. 42.70%
The arithmetic mean of the aforesaid comparable companies was 27.872%. The assessee made operating profit and operating cost was 39.25%. Since the assessee’s 6
7 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 profit margin was much more than arithmetic mean of the comparable companies chosen, the Assessee claimed that the international transaction was at arms length and therefore no addition whatsoever should be made by the TPO. 13. The TPO rejected all the comparables chosen by the assessee in its transfer pricing study except SilkTex Ltd whose operating profit to operating cost was 20.91%. The TPO arrived at the operating profit to operating cost of the Assessee at 17.26% as against the claim of the Assessee that its operating profit to operating cost was 39.25%. The reason for the difference was that the value of international transaction with the Associated enterprises by the assessee was only Rs.23,63,20,140/- and its cost of export sales was adopted by the Assessee by taking only the cost of sales of the goods exported of Rs. 16,97,09,276/-. The TPO took the sales of the Assessee at entity level and the cost of sales at the entity level, i.e., export sales and domestic sales. The TPO took the sales at Rs.89.94 Crores and operating cost at Rs.82.40 Crores at the entity level and arrived at a operating profit of Rs.7.54 Crores. The TPO worked out the profit margin of the Assessee as follows: PLI (Operating Profit/Total cost) X100 = 7.54 Cr./82.40 Cr. X 100 = 17.26%. The TPO applied 20.91% being the profit margin of the comparable company chosen by him on the operating cost of Rs.82.40 Crs. and came to a figure of Rs.99.62 crores as the price that the Assessee should have received from its AE for sale of silk fabrics. The Assessee received only a sum of Rs.88.79 Crores as its total sales. The TPO therefore arrived at a shortfall in ALP of Rs.10,83,00,000 (Rs.99.62 Crores – Rs.88.79 Crores). The TPO added a sum of Rs.10,83,00,000 to the total income of the Assessee as upward revision of ALP of international Transaction. The following were the relevant observations of the TPO in his order. “Determination of Arm’s length Price 15. To determine ALP, it would be appropriate to look at the datea a copy of which was also given to the assessee vide an order sheet entry dated 04.10.2010 during the course of TP proceedings. The data sheet is as given below : Table – V 7
8 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 Sl.No. Particula20.91%rs Tested party Comprabale Siltex J J Exports Ltd (Rs.) Ltd. (Rs.) 1. Sale of goods 88.79 31.97 2. Trading income 1.15 0.26 3. Operating Sales (1)+(2) 89.94 32.23 4. Raw material, stores & 51.65 13.91 spares 5. Power & water charges 3.8 1.79 6. Compensation to employees 10.7 3.91 7. Indirect taxes 0.13 0 8. Rent & Lease rent 0.77 0.25 9. Repair & maintenance 1.17 0.53 10. Outsourced manufacturing 7.71 1.44 jobs 11. Depreciation 6.47 3.66 12. Operating cost (4)to (11)] 82.40 25.49 13. Operating profit [(3)-(12)] 7.54 6.74 PLI (Operating Profit/Total 17.26% 20.91% cost) X100
(all figures in Rs.crores taken from Prowess database for FY 2006-07)
The PLI of the comparable Siltex Ltd is 20.91%. This PLI (OP/TC) of 20.91% for the tested party can be used to compute mean of ALP. Based on this, ALP would be Rs.82.40 Cr. X (1+0.2091)= Rs.99.62 crores. Thus the adjustment required is Rs.10.83 crore in sales. Thus ALP of export is Rs.34,46,20,140/-. No benefit of +/- variation of 5% is given because no more than one ALP has been computed. Hence, the adjustment required to be made to the transaction is as below :-
Sl.No. Nature of transaction Amount received by assessee (Rs.) 1. Sale of Silk Fabric 23,63,20,140/- 2. Total 23,63,20,140/- Arm’s length Price 34,46,20,140/- Upward Adjustment Required Rs.10,83,00,000/-
Upward adjustment required in the amount received by the assessee would therefore be Rs.10,83,00,000/- on the basis of above Arm’s Length Price determination. The revenue of the assessee for FY 2006-07 would Rs.34,46,20,140/- instead of Rs.23,63,20,140/-.” 8
9 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08
Aggrieved by the action of TPO the assessee preferred appeal before CIT(A). The principal contention of the assessee before CIT(A) without prejudice and without in anyway accepting the validity of upward adjustment of ALP of Rs. 10,83,00,000 was that the TPO has applied the PLI of the comparable without appreciating the fact that only the controlled "international transaction" has to be compared with uncontrolled transaction and adjustment has to be made only to the "controlled international transaction" and not otherwise. The Assessee relied on the decision of the Hon'ble Mumbai Tribunal in the case of ACIT (Mum.) v. T. Two International Pvt. Ltd. (ITA No. 5645/Mumbai 04-05 order dt. 23.2.2010 wherein the Hon'ble Tribunal had remanded the matter back to the CIT(A) with the direction to apply the net profit rate on the controlled sale only. The Assessee pointed out that PLI of 20.91% if applied to international transaction then the same has to be considered with reference to the cost of the sale transaction with the AE i.e. 16,97,09,276/-, as such, the ALP in such a case would be as follows: - 16,97,09,276 X (1 + .2091) = 20,51,95,486/-. Hence, the mean ALP in such a case. would be Rs. 20,51,95,486/- only. Since the sale value of the international transaction is Rs. 23,63,20,140/- which is much higher than the mean ALP of Rs. 20,51,95,486/-, the same should be considered as at Arm’s Length price.
The Assessee also submitted that it had transactions worth Rs. 23,63,20,140/- with the AE (Associated Enterprise - SPIN Inc. ) on which it has earned gross profit margin on cost @ 39.25%. The TPO/ AO has applied PLI of the comparable selected by him i.e. Silk Tex Ltd. @ 20.91%. The TPO/AO then compared such PLI of the comparable with the PLI of the Assessee as a whole i.e., at the entity level, which is approximately 8.38%. The Assessee contended that such comparison of the company as a whole and that of the comparable itself is bad since Rule 10B provides comparability 9
10 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 of "international controlled transaction", with an "uncontrolled transaction" only. On such premises, the Assessee contended that it is only the margin of the transaction with the AE. which should be compared with the comparable (Internal or External). 16. The CIT(A) agreed with the submission of the Assessee and he held that sec. 92F (ii) and Rule 10B(1)(e) which deals with arm’s length price & transaction net margin method, clearly envisages that net profit margin realized by an enterprise from an international transaction or a cluster of such transaction that has to be taken up for comparison and not operating margin to the enterprises as a whole, which has to be considered for the purpose of comparison. He therefore upheld that contention of the Assessee. The CIT(A) also found that the proposition canvassed by the Assessee has been accepted in the following decisions rendered by various benches of ITAT viz., (i) UCB India Pvt. Ltd. v. ACIT (2009) 121 JD 131 (ii) Addl. CIT v. Tej Diam (20) 0) 37 SOT 341 (Mum) (iii) DClT v. Starlite (2010) 40 SOT (41) (Murn) (iv) Avisek Auto Ltd. v. DCIT, Delhi-ITA No. 1433-De1/2009 dt. 12.11.20-10 (v) IIjin Electronics Pvt. Ltd. v. ACIT (2010) 36 SOT 227 Following the ratio laid down in the aforesaid decisions, the CIT(A) deleted the additions made by the AO.
Aggrieved by the order of CIT(A) the revenue has raised ground nos. 2 and 3 before the Tribunal. The ld. DR relied on the order of AO/TPO. The ld. Counsel reiterated the submissions as were made before CIT(A). 18. We have considered the rival submissions and we are of the view that order of CIT(A) does not call for any interference. Section 92F(ii) lays down that "'arm's length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. " Sec.92(v) defines “transaction” to include " an arrangement, undertaking or action in concert,- 10
11 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 (A) whether or not such arrangement, understanding or action is formal or in writing; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding." .. Rule 10B sub-clause (e) deals with Transaction Net Margin Method as follows:- (e) transactional net margin method, by which,- “(i) the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; , (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause( 1) is established to be the same as the net profit margin referred to in sub-clause (ii); (v) the net profit margin established is then token into account to arrive at an arm's length price in relation to the international transaction." 19. It is clear from the statutory provisions especially Rule 10B( e) (i) to (iii) that it is only the international transaction that has to be compared with uncontrolled transaction and not the transaction undertaken by the entity as a whole. Hon'ble Mumbai ITAT in the case of UCB India (P) Ltd. V. ACIT (2009) 121 ITD 131 had held that sec, 92C read with Rule 10B(l) (e) deals with the Transactions Net Margin Method and it refers to only net profit margin realized by an enterprise from an international transaction or a 11
12 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 class of such transactions but not operating margins of enterprises as whole. This view was re-iterated by the Hon'ble Mumbai ITAT ‘L ‘ Bench in the case of Addl. CIT v. Tej Diam as reported in [2010] 37 SOT 341 (Mum) and wherein tribunal held that the margin of the international transaction can only be compared with uncontrolled transaction and not otherwise. This view was also followed in following decisions as well: (a) DCIT v. Starlite (2010) 40 SOT 401 (Mum) (b) Decision of Delhi Tribunal in the case of Avishek Auto Ltd. v. DClT, Delhi, Circle - 1 (1 ) in ITA No. 1433/Del/2009· for A.Y 2004-05 order dt. 12.11.2010 ) the Hon'ble Tribunal while affirming the aforesaid judgment of Mumbai Tribunal in the case Of UCB India (F) Ltd. v. ACIT (supra) observed at page 8.2 of such order as :
"It has not been disputed that provisions of chapter X of sec. 92C deal with international transaction only and not with transaction which . have no international cross border element at all. Therefore the basis of making the adjustments on the enterprise level by taking 68.66 crores is not correct which should have been taken to sell to domestic parties, using Takata technology & Takata raw material using foreign technology and foreign raw material. The segment that was to be looked at was international segment, i.e. domestic sale, using foreign technology and foreign raw. material. As given by the appellant, the operating profit margin on AE sales Is 10.49% whereas in the domestic sales segment it is only 2.88%. Proposition that only international transaction have to be looked at has else been approved by various benches of the Tribunal which have been cited by the appellant and are not disputed by the Ld. CIT(R) and no contrary judgment has been cited before us on this proposition. We, therefore, accept also that only international transactions are to be taken into consideration while calculating the arm's length price." (c) DCIT, Ward 16(3) v. Twinkle Diamond in ITA No. 5033/ Mum/ 07 for A.Y 2004- 05 order dt. 30.04.2010. (d)ACIT v. T. Two International P. Ltd. & DCIT v. Tarajewels Exports P. Ltd. & ACIT v. Tara Ultimo P. Ltd. in ITA No. 5644, 5645 & 5646/ Mum/ 08 order dt. 29.2.2010. (e) IIjin Electronics Pvt. Ltd. v. ACIT (10) 36 SOT 227
13 ITA No.201/Kol/2012 M/s. J.J.Exporters Ltd. A.Yr.2007-08 20. It is not disputed by the TPO that the net profit margin earned by the Assessee from the controlled international transaction was 39.25% in comparison to the average net profit margin earned by the comparables chosen by the Assessee at 27.072%. If one were to proceed on the basis of the comparable selected by the TPO and apply its profit margin of 20.91%, the Assessee’s profit margin of 39.25% is higher. Hence the comparison of the net profit margin of the international transaction of the Assessee in comparison to the net profit margin of the comparables is much better and the addition so made by the TPO & AO is wholly wrong and incorrect and was rightly deleted by the CIT(A). 21. For the reasons given above ground nos. 2 and 3 raised by the revenue are dismissed. 22. In the result the appeal by the revenue is dismissed. Order pronounced in the Court on 12.05.2017. Sd/- Sd/- [M.Balaganesh] [ N.V.Vasudevan ] Accountant Member Judicial Member
Dated : 12.05.2017. [RG PS]
Copy of the order forwarded to:
M/s. J.J.Exporters Ltd., 23C, Ashutosh Chowdhury Avenue, Kolkata-700019. 2. D.C.I.T., Circle-12, Kolkata. 3. CIT(A)-XII, Kolkata 4. C.I.T.-IV, Kolkata. 5. CIT(DR), Kolkata Benches, Kolkata.