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17-09-2018, IKA India, Section 92, 133(6), 92B, 92C, Tribunal Bangalore
This appeal is by the assessee against the order of CIT(Appeals)-3, Bengaluru dated 12.09.2017 for the assessment year 2012-13.
2. The assessee is engaged in the business of manufacture and trading of laboratory and processing equipment. The assessee imports products from IKA Group for sale in the domestic market and also undertakes manufacturing operations locally to export the products to IKA Group. In addition, the assessee also provides research and development services and marketing and technical support services to Group companies.
3. The Assessee filed its return of income on 28 November 2012, declaring a taxable income of Rs.1,03,08,770. The following were the international transactions entered into by the assessee with its Associated Enterprise (AE) during the relevant previous year:-
4. In view of the provisions of section 92 of the Income-Tax Act, 1961 [“the Act”], income from an international transaction had to be determined having regard to the arm’s length price (ALP). The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO accepted that all international transactions carried out by the assessee was at arm’s length, except the international transaction of export of finished goods by the assessee to its AE. The dispute raised in this appeal which is one of the subject-matter of this appeal is with regard to this international transaction. For the purpose of establishing the ALP of its international transaction with its AE, the assessee filed a Transfer Pricing (TP) study.
The assessee chose the Transactional Net Margin Method ("TNMM") as the most appropriate method. In order to identify companies which are comparable to the assessee, search was conducted on Capitaline database (a database compiled and managed by Capital Market Publishers) for obtaining publicly available financial information of companies in India engaged in similar business activity as the assessee.
The Profit Level Indicator (PLI) chosen for the purpose of comparison of assessee’s profit margin with that of comparable companies was Operating Profit to Operating Cost (OP/OC). For the companies identified as comparables, operating margin was computed using the financial data pertaining to FY 2011-12 which was available to the assessee at the time of complying with the transfer pricing documentation requirements. The operating margin of the assessee was adjusted for under-utilization of capacity during FY 2011-12 as compared to the comparables. The adjusted net margin of the assessee was determined as 12 97 percent on operating cost and 11.48 percent on operating revenue. The operating margins of the comparable companies were adjusted to account for differences in the level of trade receivables and trade payables of the comparable companies vis-a-vis the assessee.
5. In connection with the international transaction of finished goods, the above analysis yielded a set of 3 comparables with arithmetic mean of the adjusted net margins of the comparable companies being 6.59% on operating revenue and 7.08% on operating cost. As the assessee’s net margin of 11.48% on operating revenue and 12.97% on operating cost was greater than operating margin earned by the comparables, the assessee claimed that the international transaction of export of finished goods was to be considered to be at arm's length in accordance with the Indian transfer pricing regulations.
6. The list of 3 comparables chosen by the assessee were :-
7. As already stated, the TPO accepted the price paid or received by the assessee in all the international transactions as at arm’s length, except theinternational transaction in relation to the manufacturing activity with its AE. The learned TPO did not accept the economic analysis undertaken by the assessee and conducted a fresh economic analysis. The TPO rejected 2 companies out of 3 companies selected as comparables by the assessee in the TP Study. The TPO on his search of the database chose 4 new companies and selected the following 5 companies as the final set of comparables with unadjusted margin of 8.21% on operating revenue:-
The TPO considered foreign exchange gain/losses as non-operating in nature while computing the operating margin of the comparable companies. However, he considered the foreign exchange gain/losses as operating in nature while computing the operating margin of the assessee. The TPO did not make suitable adjustments to account for differences in the working capital position of the assessee vis-à-vis the comparable companies. The TPO also did not make suitable adjustments to account for under-utilized capacity of the assessee vis-a-vis the comparable companies. The TPO computed addition to the total income consequent to determination of ALP as follows:-
“8.3 In view of the discussions made above, the TPO rejects the claim of adjustments on account of Capacity utilization, working capital, and Risk adjustment in the case of the taxpayer and proceeds to make adjustment u/s 92CA of the Income-tax Act, 1961 using the set of 5 uncontrolled comparables as above with average PLI (OP/OC%) of 8.21% as under:
11. Therefore an adjustment of Rs.1,50,66,817/- is made u/s 92CA of the income-tax Act, 1961 in the case of the taxpayer in respect of its international transactions of Manufacturing Segment.”
8. Aggrieved by the order of the TPO whose directions were incorporated in the order of assessment of the AO, the assessee preferred appeal before the learned CIT(A). The assessee filed detailed submission on 27 June 2017 and various additional submissions on 03 August 2017 and 29 August 2017, before the learned CIT(A) to justify the arm's length nature of the manufacturing activity undertaken by the assessee.
9. The CIT(A) did not provide any relief to the assessee on the transfer pricing matter. The approach of the CIT(A) while disposing assessment, in determining the ALP of the assessee in relation to the manufacturing activity with its AE can be summarised as below:-
• The CIT(A) directed the TPO to re-compute the operating margins of the Assessee and the comparable companies.
• The CIT(A) directed the AO/TPO to follow a consistent approach in treatment of foreign exchange fluctuation by considering the same as operating in nature for the Assessee and the comparable companies.
• In respect of the other grounds, the CIT(A) primarily agreed with the TPO's approach and did not appreciate the Assessee's submission.
• In addition to the above, the CIT(A) directed the TPO to recompute the ALP and TP adjustment on the entire manufacturing segment instead of restricting the adjustment to AE transaction.
10. Aggrieved against the order passed by learned CIT(A), the Assessee has prefer ed an appeal before the Tribunal on the following grounds of appeal
Grounds of general nature
Ground 1: The order of the learned CIT(A) is based on incorrect interpretation of law and facts and therefore is bad in law;
Grounds of appeal relating to transfer pricing matters
Ground 2: The learned CIT(A) has erred in making an addition to the total income of the Appellant on account of adjustment in the arm's length price ("ALP") relating to the manufacturing activity entered into by the Appellant with its Associated Enterprises ("AEs") thereby holding that the international transactions do not satisfy the arm's length principle envisaged under the Income Tax act, 1961 (the "Act");