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Income Tax Appellate Tribunal, KOLKATA BENCH “C” KOLKATA
Before: Shri N.V.Vasusdevan & Shri Waseem Ahmed
आदेश /O R D E R
PER Waseem Ahmed, Accountant Member:-
This appeal by the Revenue is arising out of order of Commissioner of Income Tax (Appeals)-X, Kolkata dated 04.04.2006. Assessment was framed by ITO Ward-10(2), Kolkata u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) vide his order dated 30.03.2005 for assessment year 2002-03. Grounds raised by Revenue are reproduced below:-
1. That under the fact and circumstances of the case, the CIT(A) has erred in holding that the assessee company maintained all prescribed information and documents and computed its income from international transactions having regards to an arm’s length price. His finding is completely without any basis.
ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 2 2. That under the fact and circumstances of the case, the CIT(A) has erred in holding that the price charged by the se company to its international associated enterprise in respect of international transactions was at arm’s length. Thus his holding to delete the addition on account of transfer pricing adjustment is not correct.
3. That under the fact and circumstances of the case, the CIT(A) has erred in holding that the assessee’s adopted method of pricing was the most appropriate method. His holding was not correct in view of OECD’s Transfer Pricing guidelines for Multinational enterprises and Tax Administrations.
4. That under the fact and circumstances of the case, the CIT(A) has erred in concluding that if the arm’s length net profit margin was 12% and the assessee company earned a profit of 7.37% it is within acceptance limit. Actually, the tolerance limit of 5% is on “Price” and not on profit as per section 92C thus, the CIT(A) has erred in ordering deletion of transfer pricing adjustment of Rs.49,84,545/- from the total income.
5. That under the fact and circumstances of the case, the CIT(A) has erred in holding the addition of Rs.33,54,034/- as deemed dividend income of the assessee company not sustainable as per law. His decision is in apparent variance to the decision of the apex court in the case of P. Sarada Vs. CIT reported in 229 ITR 444 and of the Madras High Court in CIT Vs. P.K.Abubucker reported in 259 ITR 507.”
The effective ground no. 1 to 4 are inter-connected and hence same is clubbed together for the sake of convenience is that Ld. CIT(A) erred in deleting the addition made by TPO on account of transfer pricing adjustment.
Facts in brief as culled out from the records are that the assessee in the present case is a private limited company and engaged in the business manufacturing of garments which are sold in national and international market. The assessee during the year had International transaction with its Associated Enterprises (for short AE) namely M/s Udare Limited London, UK. The assessee during the year made the export of goods worth of Rs. 9,19,87,333/- to its associated enterprises. The assessee submitted form 3CEB in relation to international transactions as required under section 92(E) of the Act. The assessee used the cost plus method for determining the Arm Length Price (for short ALP) with AE and arrived to the aforesaid figure of Rs. 9,19,87,333/-. During the proceedings u/s 92CA of the Act the TPO asked the assessee to ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 3 provide detailed working of ALP including the documents and data which had been relied for using the cost plus method. But the assessee failed to submit the working the details as desired by the TPO. In the absence of information for the reliability of the ALP worked out by the assessee, the TPO asked the assessee to provide necessary information and worked out the ALP using the Transaction Net Margin Method (for short TNMM) as under:- “9. Search of Comparables Using the cLine™ database, search of enterprises comparable to the assessee company was conducted in the following manner: INDUSTRY≥FACT SHEET≥≥ Manufacturing ≥≥ Textiles & Fabrics ≥≥ Textiles≥≥ Readymade Appeal All Companies 10713 Manufacturing 5684 Textiles & Fabrics 968 Textiles 892 Readymade Apparel 52 Data available for YE 22 March 03 Turnover between 10 8 Assessee’s turnover is 14 crores (aprox) To 50 crores during the relevant period and was appro- ximately the same in the year before that. It is for this reasons that the enterprises of almost same size with t/o between 10 to 50 crores were selected.
Final Selection Kitex Garments Ltd Samtex Fashion Ltd Wearology Ltd
Results of these enterprises as obtained from cLine™database are as below:- Co_Code Co_Name Rs in crores FX to SALES PBITM (Mar’03) (Mar’03) Net Sales PBIT (Mar’03) (Mar’03) 1 4621 Kitex Garments Ltd. 14.73 2.38 49% 16.16% 2 4274 Samtex Fashion Ltd 32.25 4.41 93% 13.67% 3 2604 Wearology Ltd 18.34 0.97 78% 5.78% MEAN 11.87%
In view o the above, PBIT3 margin or the Operating Profit (OP) margin in the assessee’s case is adopted as 11.87 12% ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 4 10. Following transfer pricing adjustment is made to the assessee’s profits with regard to the international transactions with the associated enterprise on the basis of arm’s length operating profit margin (PBITM):
REFERENCE X Net profit P&L a/c 539,788 Y Interest costs (In relation to P&O a/c 8,287,782 paid of 9192576-In relation to recd. 904794) Z PBIT as shown in P&L a/c X+Y 8,827.570
Arm’s length Operating Profit 12.00% Margin on Sales (PBITM) A Total Cost as claimed E-Z 1,38,716,572 (excluding interest) B Arm’s length OP/Cost ratio PBIM 13.64% (100-PBITM) C Adjusted profit A x B 18,915,896 D Adjusted total income on A + C 157,632,468 credit side E Total income shown on credit P&O a/c 147,544,142 side F Value of AE transactions 3CEB report 91,987,333 (exports) G Third party transactions on E + F 56,556,809 55,556,809 credit side H Adjusted value of AE D – G 102,075,659 transactions (exports) I 95% of Adjusted value of AE H x 95% 96,971,876 transactions (exports) S Adjustment on account of I – F 4,984,543 export to AE
Based upon above computation, a sum of Rs.49,84,543/- is to be added as transfer pricing adjustment.”
Aggrieved, assessee preferred an appeal to Ld CIT(A). Before Ld. CIT(A) assessee submitted that the TPO has not considered all the details submitted at the time of hearing for working out ALP of International Transaction. The assessee demonstrated that the entire procedure how the goods are exported to the AE right from the idea of inception of the product that the AE wishes to import and up to the time of delivery of the product along with the functions performed by the Assessee and AE, risk assumed, assets employed, number of employees and overall gross profit margin.
Regarding the tax rate in India and UK, the assessee submitted that effective tax rate for the year in India after claiming the benefit under section 80HHC of ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 5 the Act is 10.50% whereas the Tax rate in UK is 19%. Accordingly it cannot be a basis for rejecting the ALP of the assessee.
The TPO has selected three companies for the comparison but none of them have identical pattern. There is huge and significant difference in export turnover and profit margin. So the data of these companies cannot be relied upon for the ALP of International Transaction of assessee. Besides The TPO has also failed to consider the income of aforesaid three companies which are directly connected with the export e.g. Duty drawback. The assessee has these incomes which are directly connected with the export business but the TPO failed to consider the same while working out the ALP.
The TPO has determined the ALP using the Transaction Net Margin Method (for short TNMM) @ 12% and has made adjustment of 5% as required for adjusting the value of export to M/s Udair, UK. After adjusting the variation of 5% from the ALP then it comes 7% and the assessee has declared ALP 7.37%. In view of this the ALP declared by the assessee of international transactions is clear and appropriate and do not require any adjustment.
The ld. CIT(A) accordingly has deleted the addition by observing that the assessee was to fulfill certain conditions for working out the ALP in terms of Circular No. 12 of 2001 dated 23.8. 2001 as under:- “i) The income from the international transactions should be computed having regard to arm’s length price. ii) Assessee should keep and maintain prescribed information and document for the period prescribed by the Board and should furnish the same within 30 days, to the Assessing Officer/CIT(A) from the date of their requisition by a duly served notice or within the extended period. iii) The assessee entering into an international transactions is also required to furnish an audit report in Form No.3CEB by a Chartered Accountant within the ‘due dates’. As apparent from above, in case an assessee has computed its income from the international transactions having regard to an arm’s length price adopting the prescribed method appropriate and well-suited in its case, has kept and maintained the prescribed information and documents, has furnished the ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 6 same to the concerned authorities and has also filed / furnished audit report in the prescribed form by a CA, no further action in this regard appears to have been called for or warranted as failure on the part of an assessee its obligations will attract penal provisions under the Act. In the instant case, in my considered view, the app has fulfilled all the required obligations as per law and facts of the case. The appellant has computed the income from international transactions with M/s Udare Ltd having regard to arm’s length price (alp) at Rs.9,19,87,333/-, has maintained the prescribed information and document to support the computation of arm’s length price, the transactions value including the quantity sold in the process and has also duly furnished an audit report in the prescribed Form No. 3CEB by a qualified Charted Accountant within the prescribed due date – 31st October containing all the required details and figures in respect of the said international transactions. The AR of the appellant company has also furnished copies of its final audited accounts, its segmented profit analysis, audited final accounts of associated enterprise M/s Udare Ltd., copies of invoices drawn on the associated enterprise (AE) and detailed write up on the functional, risk factors, assets employed analysis etc in its own case and those of its AE M/s Udare Ltd. Regarding the manufacturing risks assumed both by the appellant company and its associate enterprise M/s Udare Ltd., it would e worthwhile to discuss in details and at length. The appellant prepares samples / designs in small quantity and sends the same with checksheet to Udare Ltd for its approval or comments. When and after M/s Udare’s comments are received, the final samples are prepared by the appellant company and sent to AE for ultimate/final approval before bulk purchase of materials and production have been made. Only on / after obtaining final approval and order from Udare Ltd mass procurement and production mere made by the appellant as per the requirements of its AE. Certain minimum risk may be involved at sampling designing stage as the same may be rejected or not approved by the AE as they are. At the stage of sampling and the procedures followed immediately thereafter, there is no bulk procurement of materials and mass production of goods which are liable to be rejected or discarded at later stage. Bulk purchase and production, processing and dyeing process are undertaken by the appellant as per the requirements of and as per approved samples by Udare Ltd. this was followed by asking and shipment on due time. Bills were raised on Udare Ltd and payments were also received on due time. The role of the appellant company is confined only to reparation of few samples, obtaining final approval of the buyer and thereafter procuring materials and producing goods in bulk as per the buyer’s requirements and to the extent of orders placed by it for manufacturing of the goods. Therefore, I am of the view that there was no high manufacturing risk assumed by the appellant in view of the very fact that the purchases and manufacture process were undertaken on the basis of and as per the committed and guaranteed orders and requirements of Udare Ltd. (AE). There may be high manufacturing risk in the appellant’s other manufacturing activities but so far as the risk in respect of its international transactions is concerned the risk factor will be minimum in view of fact and reasons discussed above. Once approved and placed orders, the chance of rejection of the manufactured goods as per approved samples and designs by Udare Ltd is remote. M/s Udare Ltd., which undertakes marketing ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 7 and distributing activities of the goods manufactured by the appellant company faces much higher risk as the same may be rejected by the customers and clients for being not upto their liking. In that event M/s Udare Ltd will have to sell the goods at much lower rate and lower profit margin. This element is not thee in the case of the appellant company as Udare Ltd., is the only Associate Enterprise (AE) with which it has international transactions and their transactions have been preceded by prior approval and guaranteed orders of the buyer. Moreover, the no/ of employee and the value of assets employed or to be employed are also not the sole criteria to determine the risk factors to be assumed by the parties in international transactions. If the addition made and determined by the TPO is taxable in India, the consequential effect would be that the appellant could get the benefit of 70% deduction in respect of export profits and the tax would be only on 30% of the added amount and, the tax rate would also be 10.5% which is less than 19% in UK. It appears that these aspects have not been taken into consideration. There is no definite finding and indication that one of the methods adopted by the appellant company has not determined the true picture of the international tan with its lone Associated Enterprise (AE) M/s Udare Ltd. I also decline to reinforce the presumption that the appellant has assumed higher manufacturing risks than its associated enterprise in view of factual positions discussed earlier in this regard. In my view, the appellant has satisfied the required conditions as per law and facts of the case. In view of above, I find the determination and the consequential addition of Rs.49,84,543/- as transfer pricing adjustment is not strictly in conformity with the requirements of the provisions of section 922CC or Rule 10B & 10C of the Act and accordingly the same is directed to be deleted.”
Being aggrieved by this order of Ld. CIT(A) Revenue is in appeal before us.
We have heard rival contentions and perused the materials available on record. Before us Ld. AR has submitted declaration of the auditor on the stamp paper of Rs.10 duly notarized on dated 27.7.2012 stating that the assessee maintains its administrative office in Chennai and the relevant working of ALP could not be received from the Chennai office before passing the order u/s 92CA(3) of the Act. Accordingly the TPO observed that the auditors has not carried out an exercise to determined the ALP on the basis of cost plus method as claimed in form number 3CEB. The ld. AR submitted that necessary working for determining ALP was carried out in the year under consideration and in the subsequent assessment years on the basis of cost plus method. In the subsequent years the ALP was accepted which was prepared on the basis of cost plus method and no adjustment has been ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 8 made by the TPO. The ld. AR also submitted the orders of the TPO for the subsequent years which are placed on record. The ld. AR also submitted that the ALP has been determined by the auditors on well accepted principles applicable in the case of the assessee. He relied on the order of ld. CIT(A). On the other hand, Ld DR vehemently relied on the order Assessing Officer and he left the issue to the discretion of the Bench.
From the aforesaid discussions, we find that the assessee has determined ALP using the cost plus method but failed to submit the necessary the working for the same at the time of assessment under section 92CA of the Act. Therefore the TPO opined that the auditor of the assessee has not carried out any working in determining the ALP. So the TPO adopted the TNMM method and worked out the ALP in the case of the assessee. However before us the learned AR admitted that the assessee failed to produce the working in support of its claim in the determination of the ALP prepared using the cost plus method as the administrative office was located in Chennai. We further find from the records that in the subsequent assessment years the assessee has determined the ALP on the basis of cost plus method and the same was accepted by the TPO. Now in our considered view and in the interest of natural justice and fair play we are inclined to restore this file to TPO for fresh adjudication as per law after giving opportunity to the assessee. Needless to mention that assessee should co-operation at the appropriate stage.
Next issue raised by Revenue in its appeal in ground number 5 is that learned CIT(A) erred in deleting the addition made by AO for Rs.33,54,034/- as deemed dividend income of the assessee.
The assessee was holding the equity shares of Magnum Fashions Pvt. Ltd. and Magnum Cottons private Limited, carrying voting power more than 10% in both the companies. These companies were having the accumulated ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 9 profit in the books of accounts as on 31.03.2002 for Rs.19,36,858/- and Rs.14,17,176/- respectively. The assessee had received advances from these companies for an amount of Rs.25.34 lakhs and 25.66 lakhs respectively. Accordingly the AO opined that the said advance comes within the definition of deemed dividend income in terms of the provisions of section 2(22)(e) of the Act to the extent of accumulated profits and sought the clarification from the assessee. In response to the notice the assessee submitted that the money receipt does not represent the advance as per the provisions of section 22(2)(e) but the said money represents the advance against the transaction for this sale of flats to the above companies. However the AO disregarded the claim of the assessee by holding that the intention of the legislature behind the insertion of section 2(22)(e) of the Act is to bring the accumulated profit under the net of tax in the cases where companies passed on the benefit of undistributed profit to the share holders of the company without paying the taxes. Accordingly the advance received by the assessee falls under the provisions of section 2(22)(e) of the Act which gives the artificial definition of the dividend. In the instant case there was no the registered agreement for the sale of the properties and the same was not executed till the date of passing the order. Moreover the assessee has been showing the said flats as part of the balance sheet. It was also envisaged that the purpose for starting the process for sale of the flats was to settle the loan liability of the bank but instead of that the advance is used for the business purpose. On getting the verification it was revealed that both the flats were internally connected and was occupied by the common director all the three above stated companies. Accordingly the AO held that the transactions was framed to escaped from the applicability of section 2(22)(e) of the Act. So the advance received was treated as deemed dividend as per section 2(22)(e) of the Act and added to the total income of the assessee.
Aggrieved, assessee preferred an appeal to Ld.CIT(A) deleted the addition made by AO by observing that in the instant case the advance was ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 10 received against the sale of the property as per the agreement dated 06.09.2001 and 24.8.2001 accordingly the question registering sale deed whether executed or not does not matter in the provisions of TP Act 1882. The AO has also not doubted the validity and genuineness of the agreements for the sale of the flats. Accordingly the payments of sale price for the flat of the assessee made by the aforesaid companies cannot be treated as dividend income as per section 2(22)(e) of the Act as it does not represent the repayable advance or loans but the full value of consideration for the flats.
Being aggrieved by this order of Ld CIT(A) Revenue is in appeal before us.
We have heard the rival contentions and perused the materials available on record. Before us Ld. AR submitted paper book which is running pages 1 to 38 and stated that relied on the order of the Ld. CIT(A). On the other hand Ld. DR relied in the order of AO. From the aforesaid discussion, we find that the AO has treated the advance received by the assessee against a sale of properties as deemed dividend because assessee was holding the equity shares of the company, carrying voting rights more than 10%. However from the facts of the case we find that the money received by the assessee was representing the sale of the flats and therefore we conclude that the advance received by the assessee was not on returnable basis. The advance representing against the consideration for the sale of the flats is out of the purview of the provisions of section 2(22)(e) of the Act. In holding so we are putting our reliance in the decision of Hon'ble Bombay High Court in the case of CIT v. Nagindas M Kapadia (1989) 177 ITR 393 (Bom) wherein Hon'ble court has held that only the payments and advances to the extent of accumulated profits could be treated as loans or advances within the meaning of Sec.2(22)(e) and this was what the Tribunal had done and, therefore, the Tribunal was right in holding that only Rs.28,500 and Rs.10,000 could be treated as deemed dividend in the assessment years 1968-69 and 1969-70.
ITO Wd-10(2), Kol. v. Magnum Clothing (P) Ltd. Page 11 11. In this view of the matter and relying the judgment of Hon'ble Bombay High Court in the case of (supra) Naginds M Kapadia (supra) we do not find any reason to uphold the order of Ld. CIT(A). This ground of Revenue’s appeal is dismissed.