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Income Tax Appellate Tribunal, DELHI BENCHES : I-2 : NEW DELHI
Before: SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM
We find that there is not much discussion in the order of the TPO about the functional profile of Kusalava International Ltd. The TPO simply excluded this company from the list of comparables by observing that it has entered into a phase of losses. In the immediately next para on the same page No.15, the TPO has remarkably observed as under:-
“In the like manner as the assessee has proposed above fresh comparables I also propose some new comparable in equal numbers from my search from having similar line of product. After inclusion of the fresh comparables of the assessee as well as of the dept the position of the margin shoots to 10.80 detailed as under :-
India Nippon Electricals Ltd. 120.23 9.74 8.88 Lucas TVS 958.29 8.34 7.70 Auto Ignition Ltd. 132.89 10.97 9.88 Varroc Engineering 629.22 13.90 12.21 Hi Tech Arai 151.44 21.46 17.67 Varroc Engineering 629.22 13.90 12.21 Asco India Ltd. 53.56 69.29 40.93 Perfect Circle India Ltd. 76.97 2.32 2.27 Rane Engine Valve Ltd. 198.41 4.54 4.34 Auto Gallon Industries Ltd. 9.02 4.19 4.02 KUSALAVA International 83.26 -1.32 -1.33 Mean 10.80
Since, new comparables proposed by the assessee are rejected, I am also not going to use fresh comparables proposed by me.”
A careful perusal of the above recording by the TPO divulges that apart from three companies finally selected as comparables out of the assessee’s original list of five comparables, the TPO neither considered Kusalava International Ltd., as proposed by the assessee, as comparable nor the other seven companies included in the above Table selected by him as comparable on fresh search. This stand was taken by the TPO for not considering any fresh comparables proposed either by the assessee or searched by him. Once we accept the contention advanced on behalf of the assessee and proceed to consider Kusalava International Ltd. as comparable, which was put forth by the assessee during the course of the proceedings before the TPO, it is, but natural that we should also consider the other seven companies selected by the TPO as comparable in the fresh search which were excluded because he was not entertaining any fresh comparables. If we accept the objection of the ld. AR for considering only Kusalava International Ltd. as comparable and ignoring those seven selected by the TPO and incorporated in his order, it would distort the overall comparability and amount to blowing hot and cold in the same breath. Obviously, this cannot be permitted. Once we are proposing to consider the comparability or otherwise of Kusalava International, it is just, fair and equitable to also consider the other seven companies selected by the TPO from the angle of comparability.
A line of distinction needs to be drawn between the cases in which the TPO ignores some companies on the basis of some logical reasons after referring to them as comparable in his order and the cases in which the TPO does not refer to any new company as comparable. Whereas in the first set of cases, there is full justification for directing the consideration of such companies as comparable on parity, of course, after due opportunity to the assessee, in the second set of cases, there can be no rationale in requiring the TPO to once again initiate a fresh process of search for finding out new companies in the circumstances as are prevailing before us. Extantly, we are covered under the first situation in which the TPO referred to seven new companies as comparable in his order but ignored them on the touchstone of parity in not considering any new company as comparable including those proposed by the 9 assessee. Once, the assessee has assailed the non-inclusion of its company, namely, Kusalava International, which it is also lawfully entitled to and we accept such contention, then simultaneously the other seven companies originally selected by the TPO should also be taken up for consideration. We hold accordingly. In our opinion, considering the comparability of these seven companies does not amount to making out a new case by the AO/TPO because these seven companies were specifically taken note of by the TPO as comparable in his order.
Turning to the merits of comparability, we find that there is not much discussion in the TPO’s order about the functional profile of Kusalava International Ltd., on one hand and other seven companies viz., Varroc Engineering, Hi Tech Arai, Varroc Engineering, Asco India Ltd., Perfect Circle India Ltd., Rane Engine Valve Ltd., Auto Gallon Industries Ltd., on the other. Under such circumstances, we deem it befitting to set aside the impugned order and remit the matter to the file of TPO/AO for considering the comparability or otherwise of Kusalava International Ltd. and other seven companies afresh, after allowing a reasonable opportunity of being heard to the assessee.
Apart from the inclusion of the Kusalava International Ltd., the ld. AR also pressed for the inclusion M/s Design Auto System in the list of comparables. It was fairly admitted that this company was not chosen by the assessee as comparable either before the TPO or before the DRP.
Referring to the Annual report of this company, it was argued that the same was functionally similar. The ld. DR opposed the inclusion of this company in the list of comparables.
In an earlier para, we have restored for fresh consideration of Kusalava International Ltd. and seven other companies to the TPO after allowing due opportunity to the assessee. While carrying out this exercise, the TPO is also directed to consider the comparability or otherwise of Design Auto Systems and then deal with it accordingly.
II. WORKING CAPITAL ADJUSTMENT 10. The next issue raised by the ld. AR is about not granting of working capital adjustment. The assessee requested for allowing working capital adjustment which was refused by the TPO. The assessee remained unsuccessful before the DRP as well. Now the same is challenged before us.
We have heard the rival submissions and perused the relevant material on record. We are not inclined to accept the view canvassed by the authorities that the working capital adjustment cannot be allowed because the assessee failed to demonstrate that the difference in the working capital deployed was making a difference in the margin earned by the assessee and comparables. On the contrary, the ld. AR has drawn our attention towards the details furnished by the assessee for claiming working capital adjustment. It is vivid that the working capital adjustment is restricted to inventory, trade receivables and trade payables. If a company carries high trade receivables, it would mean that it is allowing its customers relatively longer period to pay their dues, which will result into higher interest cost and the resultant low net profit.
Similarly, by carrying high trade payables, a company benefits from a relatively longer period available to it for paying back the dues to its suppliers, which reduces the interest cost and increases profits. In order to neutralize the differences on account of carrying high or low inventory, trade payables and trade receivables, as the case may be, it becomes eminent to allow working capital adjustment so as to bring the case of the assessee at par with the other functionally comparable entities. We, therefore, agree in principle with the grant of working capital adjustment.
The view taken by the Dispute Resolution Panel for not allowing such an adjustment that the assessee did not furnish necessary details is not tenable since the assessee did furnish the necessary details, which have been adverted to during the course of proceedings before us.
However, since such details qua the grant of such an adjustment have not been examined because of refusal to grant such adjustment at the threshold, we are of the considered opinion that it would be fit and proper to set aside the impugned order on this issue and send the matter back to the file of the AO/TPO for computing and allowing working capital adjustment, if any, available to the assessee in the light of our above discussion. Once it is held that such an adjustment is allowable qua all the comparables, then it should be carried out whether it favours or disfavors the assessee. It goes without saying that the assessee will be allowed an opportunity of hearing in such fresh determination of the working capital adjustment, if any.
III. T.P. ADJUSTMENT ONLY FOR INTERNATIONAL TRANSACTIONS.
The next challenge of the ld. AR was against the computation of transfer pricing adjustment in respect of transaction with Associated Enterprises (AEs) and non-AEs. Computation of the arm’s length price by the TPO on the last page of his order divulges that he took Operating profit amounting to Rs.4,42,38,699 at a margin of 8.82%. This has been calculated by the TPO on entity level figures of the assessee, including those concerning unrelated transactions. By applying the arithmetic mean of the comparables at 8.82%, the TPO proposed a transfer pricing adjustment of Rs.2,74,69,498/-. The ld. AR contended that no transfer pricing adjustment is possible in respect of transactions with non-AEs.
It is uncontroverted, as is also apparent from the TPO’s order, that the transfer pricing adjustment has been made by considering the total sales effected by the assessee in respect of transactions with the associated enterprises (AE) and non-AEs. An addition towards transfer pricing adjustment is made by comparing the assessee’s profit rate from the international transaction with that of comparable uncontrolled transactions. Under the TNMM, the process is simple in initially finding out the operating profit margin of the assessee and then the average adjusted operating profit margin of comparable cases. Such adjusted profit margin of the comparables constitutes benchmark margin, which is then compared with the operating profit margin from the assessee’s international transactions with its AE. It is not permissible to make transfer pricing adjustment, by applying the average operating profit margin of the comparables on the assessee’s universal transactions entered into with both the AEs and non-AEs. As the entire exercise under Chapter-X is confined to computing total income of the assessee from international transactions having regard to the arm’s length price, there is no scope for computing income from non-international 15 transactions having regard to the ALP. As the TPO has computed the transfer pricing adjustment qua all the transactions carried out by the assessee with reference to the base of ‘total sales’, also inclusive of sales made to non-AEs, we vacate the impugned order on this issue and restore the matter to the file of the TPO/AO for recalculating the amount of addition of transfer pricing adjustment by taking into consideration the international transactions only to the exclusion of transactions with non-AEs. The assessee will be allowed a reasonable opportunity of being heard. Our this view is fortified by a recent judgment of the Hon’ble jurisdictional High Court in CIT VS. Keihin Panalfa Ltd. (2016)
381 ITR 407 (Del). Similar view has been taken in CIT VS. Thyssen Krupp Industries India P. Ltd. (2016) 381 ITR 413 (Bom).
To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment and remit the matter to the file of AO/TPO for fresh determination of the ALP of the international transaction in consonance with our above observations/directions, after allowing due opportunity of hearing to the assessee.
In the result, the appeal is allowed for statistical purposes.
The order pronounced in the open court on 11.05.2015.