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Date of decision : 12 November 2010
2010-TII-54-ITAT-DEL-TP
IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH 'A' NEW DELHI
ITA No.1433/Del/2009
Assessment Year: 2004-2005
ABHISHEK AUTO INDUSTRIES LTD
1, UNDER HILL LANE, CIVIL LINES, DELHI
PAN NO:AAACA2837J
Vs
DEPUTY COMMISSIONER OF INCOME TAX
CIRCLE-1(1), NEW DELHI
R P Tolani (JM) and B C Meena (AM)
Dated: November 12, 2010
Appellants Rep by: Shri Pradeep Dinodia, R K Kapoor & Ms Pallavi Dinodia
Respondent Rep by: Shri Ashok Pandey, CIT-DR
Income tax - Sections 92B, 92C, 92CA(1), Rule 10B(1)(e) - Transfer
Pricing - Whether payment of royalty and knowhow fee under an
agreement can be ignored by the Revenue while doing the TP
analysis - Whether Sec 92 of Chapter X has no application for
domestic transactions - whether adjustment can be made only to the
international transactions and not transactions at the enterprise
level which include domestic transactions - Whether comparability is
most efficient when it involves the transactions of the tested party
itself.
The assessee company is engaged in manufacturing of car seat belts
in technical collaboration with M/s. Takata of Japan. Assessee
imports CKD kits from Takata and then carries out a manufacturing
process by adding certain indigenous raw materials and finishes the
car seat belts. This manufacturing process is carried out with the
technical know-how received from Takata. The finished seat belts
are then supplied to the car manufacturers such as Maruti, Honda,
Tata etc.
The assessee had international transactions with Takata in respect
of purchase of raw materials, purchase of machines, payment of
royalty and technical know how and interest on loan. On a reference,
the TPO did not draw any adverse inference relating to purchase of
machinery and payment of interest. However, with respect to
payment of royalty and knowhow, he held the same to be nil in view
of the fact that no transfer of technology or know how has taken
place, that the price of know how and royalty is bundled in the price
charged for the supply of material and the fact that expenses have
been incurred on expatriates which the assessee was under no
obligation to incur. As for the purchase of raw materials, the
assessee had submitted that the raw materials components are not
available with any other supplier because these are developed by
Takata Group and hence, it was difficult to ascertain arm's length
price of these products. The assessee therefore submitted
comparative analysis of Gross Profit rates of various types of seat
belts manufactured from the materials supplied by other suppliers,
which are being supplied by the assessee company to its parties visà-vis seat belts manufactured from the materials supplied by the
foreign collaborators. Assessee claimed that it is earning a higher
rate of gross profit on the seat belts manufactured from the
materials under transfer pricing purview as compared to the seat
belts manufactured from the materials supplied by the other
suppliers. So, it was argued that the price paid for the material
imported from the foreign collaborator, may be accepted by the tax
authorities. It was submitted that the assessee procured the
materials from its foreign collaborator under agreement of
collaboration and this material could not be obtained from any other
source. The A.O, however, was of the opinion that TNMM was the
right method for transfer pricing analysis. He used the assessee as
tested party and took the Profit Level Indicator as the ratio of net
margin computed in relation to sales. The TPO identified six
companies to be comparable companies and based on the data,
worked out their net operating margins at 9.21% on the average. As
the assessee's net operating margin on overall basis was 4.56%, the
AO made a downward adjustment of the purchase. Aggrieved, the
assessee preferred appeal to the CIT(A) who however, enhanced the
addition in respect of international transactions to 10.74% average
operating margin using updated data.
Aggrieved, the assessee appealed to the Tribunal. It was pleaded
that CIT (A) had erroneously added Rs.1.10 crores on account of
technical fee as the same was never debited to profit and loss
account as such and was actually capitalized by the assessee. By
allocating entire payment of technical know-how fee of Rs.1.10
crores to AE segment, CIT(A) computed the PLI from AE segment at
1.86% and from non-AE segment at 2.88%. It was pointed out that
the margin in the AE transactions is much higher than the margins in
its local business. As per revised chart furnished by assessee by
excluding the capital payment of Rs.1.10 crores which has been
capitalized in its books of accounts under the Companies Act as well
as under the Income Tax Act, the operating profit of sales in the AE
transaction segment would be 10.495% as against 2.88% in the
totally domestic segment in which there is no international
transaction .Moreover, the net margins worked out by CIT(A) in the
six companies are not correct and as per data filed which is collected
from ROC , the margins are much lower than the one calculated both
by the TPO and the CIT (Appeals).
Having heard the parties, the Tribunal held that:
+ it is a settled proposition of the law that legally binding
agreements between unrelated parties cannot be disregarded
without assigning any cogent reasons thereto. In this case it has not
been imputed that agreements were ingenuine or sham, rather they
are duly approved by RBI and other regulatory agencies. It is also a
settled proposition that commercial transactions are in the domain
of the businessman and Income Tax Department cannot intervene in
realm of intricacies of commercial expediencies involved in these
arrangements. In this case if the assessee had not entered into joint
venture agreement with Takata, it would not have been able to make
any sales whatsoever using their technology and raw material and
the machines supplied by them. The very existence of this business
in AE segment depended upon the joint venture agreement. In such
circumstances, the TPO and the CIT (Appeals) were not correct in
disregarding this agreement without assigning any cogent reasons;
+ the TPO in his order has accepted the international transactions of
purchase of machinery from the AE, however, an inference has been
drawn that assessee was competent to make independent use of
such machinery. Assessee has met this finding that machineries
were imported to manufacture the assembly line for manufacturing
of seat belts for which the technical know-how fee and foreign
technicians were also deputed by the AE. Whenever international
transactions of such nature are undertaken, it is a combination of
technical know-how, royalty, technical assistance through the
deputation of expat employees on the rolls of the person obtaining
the technical know-how. There is merit in assessees submissions
that merely by importing machinery, it cannot be said that the
assessee would become competent to make use of such machinery;
+ the provisions of Chapter X Section 92C deal with international
transactions only and not with transactions which have no
international cross border element at all. Therefore, the basis of
making the adjustments on the enterprise level is not correct. What
should have been taken is the sale to domestic parties using Takata
technology and Takata raw material . The segment that was to be
looked at was the international segment, that is, domestic sale using
foreign technology and foreign raw material;
+ the best comparability can be of the transactions of the tested
party itself. If the tested party without the use of the imported
technology and imported raw material can make additional margins,
then it would be a case which may require an adjustment, but in this
case the international transactions have demonstratively boosted
the profits . As per calculations of the CIT (Appeals), as corrected by
an error on account of technical know-how fee which was not
claimed as revenue expense, the segment which did not have the
benefit of foreign technology and foreign raw material had an
operating profit to sales margin at 2.88%, whereas the segment
which had this benefit had a margin of 10.49%. It is obvious that
the transactions are at arm's length and no adjustments are called
for;
+ taking external comparables as given by the TPO and the CIT
(Appeals) and by looking at the average PLI calculated by the CIT
(Appeals) in his order of 10.74% and if it is reduced by 5% thereof,
it will come to 10.20. This will be the PLI after adjustment as per the
Proviso to Section 92C. This, in any case, is less than the PLI of the
Takata transactions of the assessee which is 10.49%. Therefore
even if the work done by the authorities below is upheld and adjust
it by 5% and then compare it with the international transactions, the
PLI of the tested party is higher than the PLI worked out by the TPO
and the CIT(Appeals).
Assessee's appeal allowed
Cases followed
Electrobug Technologies Ltd. v. ACIT
Development Consultants v. DCIT
Sony India Pvt. Ltd. v. DCIT
(2010-TII-39-ITAT-DEL-TP)
(2008-TII-03-ITAT-KOL-TP)
(2008-TII-08-ITAT-DEL-TP)
Customer Services India (P) Ltd. v. ACIT
(2009-TII-08-ITAT-DEL-TP)
ORDER
Per: R P Tolani (JM):
This is assessee's appeal. Following grounds are raised:"1) On the facts and the circumstances of the case and in law, the Ld.
CIT(A) has erred in confirming the following actions of the Ld. Assessing
Officer
(a) Making an addition of Rs.3,18,89,975/- on account of Difference in
“Average net operating margin” of the comparable companies as against the
assessee's “Net operating margin”, using the TNMM method for determining
the Arms Length Price.
AND
(b) In applying such difference to make an adjustment on the Total sales of
the assessee, including Non-international transactions, whereas Section 92
is applicable only to international transactions, as given in Section 92B of the
Income Tax Act, 1961, while completely ignoring the submissions repeatedly
made by the assessee in this regard.
2) On the facts and the circumstances of the case and in law, the Ld. CIT(A)
has erred in confirming the action of the Ld. Assessing Officer in holding that
the amount paid to the ASSESSEE for royalty and technical now how should
be Nil.
3) On the facts and the circumstances of the case and in law, the Ld. CIT(A)
has erred in confirming the action of the Ld. Assessing Officer in applying the
TNMM method, whereas the Cost plus method was the most appropriate
method for determining the Arms Length Price and also ignoring the Internal
Comparable between International and Non-International transactions for
the Cost plus method submitted by the assessee.
4) On the facts and the circumstances of the case and in law, the Ld. CIT(A)
has erred in ignoring and in not giving the assessee the benefit of the fact
that No adjustment has been made in the assessee's Transfer pricing
assessment for the next Asst. Year, 2005-06, where the facts and
circumstances were absolutely the same.
5) The order of the Ld. CIT(A) is bad in law and on the facts of the case and
is based on the surmises and conjectures only and without considering the
facts and submissions made.”
2. Brief facts are that the assessee company is engaged in manufacturing of
car seat belts in technical collaboration with M/s. Takata of Japan. Assessee
imports complete knock down Kits (CKD) from Takata and then carries out a
manufacturing process by assembly on these CKD Kits, by adding certain
indigenous raw materials and finishes the car seat belts. This manufacturing
process by assembly is carried out with the technical know-how received
from Takata. The finished seat belts are then supplied to the car
manufacturers such as Maruti, Honda, Tata etc.
2.1. The Assessing Officer referred the assessee's case to Transfer Pricing
Officer (TPO) for determination of Arm's Length Price (ALP) under sec.
92CA(1) of the Income-tax Act, 1961. Before TPO the assessee submitted
comparative analysis of Gross Profit rates of various types of seat belts
manufactured from the materials supplied by other suppliers, which are
being supplied by the assessee company to its parties vis-à-vis seat belts
manufactured from the materials supplied by the foreign collaborators.
Assessee claimed that it is earning a higher rate of gross profit on the seat
belts manufactured from the materials under transfer pricing purview as
compared to the seat belts manufactured from the materials supplied by the
other suppliers. Assessee company filed statutory audit report pleading that
since it earned considerable profits by selling the seat belts procured from
outside India as compared to the selling of seat belts manufactured in India,
so the price paid for the material imported from the foreign collaborator,
report may be accepted by the tax authorities.
2.2. The assessee procured the materials from its foreign collaborator under
agreement of collaboration, this material could not be obtained from any
other source. The company had fixed its sale prices after taking into
consideration the cost of materials and the higher rate of gross profit in
comparison to the other types of seat belts.
2.3. The TPO however, did not agree with the assessee's working and made
the additions by adopting net operating margin of 9.21% by holding that
comparable enterprises performing broadly similar functions, operations and
risks by following average working:Sl.No. Name of the
Company
1.
Clutch Auto
Ltd.
2.
Net sales
during
F.Y.2003-04
(in crores)
Net
operating
profit F.Y.
2003-04 (in
crores)
Net
Operating
profit
margin (%)
75.30
7.13
9.46
NRB Beadings
Ltd.
210.95
31.95
15.14
3.
Rane (Madras)
Ltd.
201.66
23.39
11.58
4.
Sona Kaya
Steering
Systems Ltd.
281.47
20.20
7.17
5.
Talbros
Engineering
Ltd.
22.95
1.51
6.57
6.
Bharat Gears
Ltd. (Auto
Motive
Segement)
92.69
4.95
5.34
Average
9.21%
2.4. As the appellant's net operating margin on overall basis was 4.56% as
against 9.21% for the comparables adopted by the TPO, accordingly AO
made a downward adjustment by Rs.3,18,89,975/- to the international
transaction.
3. Aggrieved, the assessee preferred first appeal where the detailed
submissions were made. The CIT(A) however, enhanced the addition in
respect of international transactions to 10.74% average operating margin by
following observations:“15. In view of the above discussion, I hold that the following 6 comparables
chosen by the TPO are correct for making comparability analysis for
determining the arm's length price for the international transactions
comparing payment for raw material, royalty and technical know-how.
15.1. The average operating margin of the following comparables is 10.74%,
the details of which were communicated to the appellant vide this office
letter dated 20.01.2009, during the appellate proceedings. Therefore the
same is considered for determining the arm's length price of the
international transaction.
S.No.
Name of the Company
Net Operating
profit margin
(%)
1.
Clutch Auto Ltd.
6.73
2.
NRB Beadings Ltd.
27.05
3.
Rane (Madras) Ltd.
13.12
4.
Sona Koyo Steering Systems Ltd.
12.40
5.
Talbros Engineering Ltd.
-0.22
6.
Bharat Gears Ltd. (Auto Motive
Segement)
5.34
Average
10.74
Computation of the Arm's Length Price of the International transaction is
arrived at as under:
Net sales of the appellant (as per TPO's
order)
Rs.68,76,63,661
Net operating profit (as per TPO's
order)
Rs. 3,14,43,848
Average Net operating margin of the
comparables
Net Operating margin the appellant
should have earned.
Downward adjustment required to the
international transaction relating to raw
material, royalty and technical knowhow
10.74%
Rs.7,38,55,057 (10.74%
of Rs.687663661)
Rs.4,24,11,209
(Rs.7,38,55,057 minus
Rs.3,14,43,848)
15.2 Since already held that the TPO was correct in holding the value of
international transaction for royalty and technical know-how to be NIL,
hence no separate adjustment is made for it and it is deemed to be included
in the overall adjustment of Rs.4,24,11,209 determined above. Accordingly,
the total taxable income of the assessee needs to be enhanced by this
amount.”
4. Aggrieved, the assessee is in appeal before us. An additional ground of
appeal has been filed requesting that the figure of Rs.3,18,89,975/- is
actually Rs.4,24,11,209/- as the CIT (Appeals) has made enhancement to
the addition made by the A.O. Assessee took the figure of Rs. 3,18,89,975/inadvertently as against Rs.4,24,11,209/- as finally retained by CIT(A). The
learned DR has no objection to the same consequently we permit to amend
this figure at Rs.4,24,11,209/-.
5. Ld. Counsel for assessee Shri Dinodia adverted to the Transfer Pricing
reports filed by assessee and TPO and contends that assessees working of
Arms Length Price ALP was based on following disclosures:
“1.1 The assessee Abhishek Auto Industries Limited (AAIL) is engaged in
manufacturing safety seat belts for automobiles and is supply to OEM's like
Maruti Udyog Ltd., Honda Siel Cars India Ltd., Tata Motors Ltd., Swaraj
Mazda and Hindustan Motors Ltd. AAIL has a technical & financial
collaboration with Takata Asia Pte Ltd., Singapore. This collaboration
provides technology for new seat belts coming. AAIL is also doing business
of Window regulators (Power & manual) for Cars and supply to Tata Motors
and Hindustan Motors. AAIL buys seat belt components from Takata,
assemble them and sell to Honda and Maruti Udyog. AAIL's total equity
capital is 13,00,000 shares, of which 70% is being held by Indian
Shareholders and balance 30% is held by Takata's group.
1.2 The major international transactions reported in Form No.3CEB are as
under:
S.No.
Description of
transaction
Method
Value (in Rs.)
1.
Purchase of Raw Material
None
8,27,84,638/-
2.
Purchase of machines
None
33,27,876/-
3.
Payment of Royalty
None
16,09,505/-
4.
Fee for Technical Knowhow
None
1,10,00,000/-
5.
Interest on loan
None
10,26,843/-
Purchase of Raw Material
“During the previous year, certain transactions for purchase of raw material
has been entered into with M/s. Takata Asia Pte Ltd. an associated
enterprise. These purchases have been made for specifically designed
product as per requirement of Car manufacturer, developed with the help of
technology provided by TAKATA”.
“The products can be consumed in particular cars only and raw material
required for assembling these products are to be sourced from Takata only.
The raw materials components are not available with any other supplier
because these are developed by Takata Group. Hence, it was difficult to
ascertain arm's length price of these product”.
Purchase of Machines
“During the previous year, certain transactions for purchase of Plant &
Machinery has been entered into with M/s Takata Asia Pte Ltd. an associated
enterprises (holding 30% shares in the company). These machines are
required for manufacturing of products designed and developed by Takata
and the machines are not available in the open market. Therefore it was
difficult to ascertain the arm's length price of these machines”.
Payment of Royalty and Know-how
“In 2000-2001, the company entered into a technical collaboration
agreement with Takata Asia Pte Ltd. for development of Safety Seat Belt for
various new models of car manufacturer. All the Government approvals have
already been obtained by the company. The technical fee and royalty
amount is being paid by the company as per agreement only. Hence, the
question of determining arm's length price does not arise”.
Interest on Loan
“The amount of US$218,000.00 was borrowed in 2002. The balance 70%
was contributed by Indian promoters. This project was very important for
the growth of the company and has resulted in doubling the turnover of the
company. To fund this project, the company explored bank finance also, but
the cost of bank borrowing was 14%. Therefore, the company opted for 8%
rate charged by TAKATA”.
5.1. The TPO however proceeded to determine the arm's length price on an
assumption that assessee has failed to do so, although the assessee in
response to his queries submitted the comparative G.P. ratio of AE. and nonAE segment during the course of hearing.
5.2. TPO with respect to royalty has failed to consider assessees categorical
submissions that:
a. The assessee has paid the technical fee and royalty amount as per
agreement only, hence the question of determining Arm's Length Price does
not arise. During the course of proceedings, the assessee has filed
photocopy of collaboration agreement, copy of profile of Takata, its AE.
b. A note on determination of ALP was also filed mentioning:
“We are engaged in manufacturing and supplying Safety Seat belts for
automobiles to all OEMs in India like Maruti Udyog Ltd., Honda Siel Cars
Ltd., Tata Motors Ltd., Hindustan Motors Ltd., and Sawarj Mazda Ltd.
In 2000, AAIL entered a technical collaboration with Takata Asia Pte Ltd.,
Singapore (previously known as Automotive Safety System Pte Ltd), a
subsidiary of Takata Corporation, Japan. Takata Asia also holds 30% equity
shares in Abhishek Auto Industries Ltd. (AAIL).
Takata has developed seat belt for HONDA SIEL CAR INDIA LTD and MARUTI
EXPORT MODEL. These are specifically designed seat belts for particular
Model of Car and can't be used in other Cars. Abhishek Auto, buys this
material from Takata and does some assembly work and supply to Honda
and Maruti. Initially, the prices are fixed according to purchase price from
Takata and later on foreign exchange fluctuations are adjusted by the Honda
and Maruti for these products.
Takata has developed seat belts for HONDA's all model and Maruti Export
Model. Their product is guaranteed by Takata. AAIL is only doing some
assembling work under the supervision of Takata's Japanese staff stationed
in AAIL. Any failure of product is the responsibility of Takata.”
5.3. Vide submissions dated 22-08-2006, assessee furnished a note on
functions performed as under:
“The technical collaboration is for technology for new models seat belt.
Whenever, any car manufacturer like Honda plans to launch a new model,
they give all specifications, drawing, design etc. to Abhishek and the same is
forwarded to Takata which has all R&D facility in house. Takata develops
seat belt suitable to Honda and gives final quotation of seat belt to Abhishk
which is forwarded to Honda. Once Seat belt and rates are approved by
Honda, production schedules are received from Honda on monthly basis.
Accordingly, AAIL procure the materials from Takata, assemble them in
India and supply to Honda.”
5.4. The TPO failed to consider assessees submissions and held that a formal
agreement between the appellant and the associated enterprise cannot be
the basis for determining the arm's length price of the transaction. Relying
on some judgments of US courts TPO held that:
“4.8 To, Sum up the arm's length price is ‘international transaction' of
royalty and know how is treated as Nil for the following reason which have
been discussed above.
(i) No transfer of technology or know how has taken place.
(ii) The price of know how and royalty is bundled in the price charged for
supply of material.
(iii) Expenses have been incurred on expatriates, which the assessee was
under no obligation to incur.”
5.5. The TPO there after held that the most appropriate method was the
Transaction Net Margin Method (TNMM) in accordance with Rule 10B(1)(e),
the Profit Level Indicator (PLI) would be the ratio of net margin computed in
relation to sales. He treated the appellant company as a tested party. The
TPO used the PROWESS data base to identify potential comparable
companies. After completing what he considered the appropriate screening
process, in par 5.7 he identified six companies to be comparable companies
and based on the data worked out their net operating margins at 9.21% on
the average.
5.6. The appellant's margins have been calculated by TPO in para 5.8 of his
order as under:“Computation of net operating margin of the assessee
5.8 From the balance sheet and P&L account filed by the assessee the
following emerges:
Net Sales :
Rs.68,76,63,661/-
Profit before tax :
Rs. 1,91,17,090/-
Other income :
Rs. 16,10,614/-
Financial expenses :
Rs.1,39,37,372/-
Net operating profit :
Rs.3,14,43,848/-
(Profit before tax – Other income + Financial expenses)
Net operating margin :
4.56%
Net operating profit at Arm's Length
margin =
9.21% of
68,76,63,661/= Rs.6,33,33,823/-.”
5.7. Ld. Counsel contends that TPO thus concluded in his order as under:
“5.9 Accordingly, at Arm's Length the assessee company was required to
obtain a net operating margin of 9.21% over sales which translates into
Rs.6,33,33,823/-. The net operating profit of the assessee is
Rs.3,14,43,848/- accordingly the value of ‘international transaction' related
to purchase of raw material and machines needs to be adjusted downward
by an amount of Rs.3,18,89,975/- which is the difference of net operating
margins at Arm's Length i.e. Rs.6,33,33,823/- and the net operating
margins of the assessee i.e. Rs.3,14,43,848/-.
5.10 Accordingly, the value of ‘international transaction' relating to
purchases of raw materials is determined at Rs.5,08,94,663/-.
6. In the earlier part of this order, the Arm's Length :Price of the
‘international transaction' related to payment of royalty and know how has
been determine at Nil Value. Accordingly, the net profit margin needs to be
re-adjusted to take into account the Nil value of royalty and know how
related expenses. The total expenses under these two heads of expenses re
Rs.1,26,09,505/-. Accordingly, the adjustment to the value of purchase of
goods is restricted to Rs.1,92,80,470/-. So that the cumulative adjustment
remains at Rs.3,18,89,975/-.”
5.8. TPO did not draw any adverse inference relating to purchase of
machinery and payment of interest.
5.9. In first appeal, the CIT (A) accepted facts that- the appellant was
performing full-fledged manufacturing activity and accepted the TPO's
comparables and that TNMM method is the most appropriate method,
however he changed the PLI of the comparables by up-dating the data which
brought the net operating margin to sale to 10.74%. Assessee supplied the
break up as under, which is placed on PB-I page 106:
2003-04
2003-04
2003-04
Total
Takata
Others
(In Rs.)
(In Rs.)
(In Rs.)
Mode of
Bifurcation
Operating
A Income
Sales
687,663,661
127,465,091
560,198,570
Total
687,663,661
127,465,091
560,198,570
559,732,341
95,274,997
464,457,344
Actual
Personnel
Expenses
9,140,467
881,520
8,258,947
Actual
Freight
Outward
4,194,340
196,743
3,997,597
Actual
Exchange
Difference
3,878,089
2,028,519
1,849,570
Actual
Bad Debts
Written Off
3,962,923
-
3,962,923
Actual
43,925
-
43,925
Royalty
1,689,980
1,689,980
-
Actual
Testing
Expenses
2,886,620
563,871
2,322,749
Actual
Other
Expenses
44,287,717
8,209,155
Operating
B Expenses
Raw
Material
Consumed
Loss on
Sale/
discarded
fixed assets
Total
36,078,562 Proportionate
629,816,402 108,844,785 520,971,617
Operating
C Profit
57,847,259
18,620,306
39,226,953
Operating
Profit as a
percentage
of
Operating
D Income
8.41%
14.61%
7.00%
Operating
Profit/Total
E cost
9.18%
17.11%
7.53%
5.10. CIT(A) made adjustments which are mentioned in his order as under:
“8.6 When the information given in the above table is compared with the
audited financial statements provided by the appellant it is found that the
total expenses allocated between the two segments was Rs.62,98,16,402
vis-à-vis the total expenses of Rs.67,01,57,185.
On the perusal of the schedule of the profit and loss account it is noticed
that the difference is on account of non-allocation of the following expenses:
a) Technical know-how payment made to Takata amounting to
Rs.1,10,00,000.
b) Depreciation amounting to Rs.2,64,03,411.
c) Finance expenses amounting to 1,39,37,372.
The above expenses also need to be allocated to both the segments either
on the basis of some allocation key or if they are directly attributable to a
particular segment.
8.7 On the perusal of the nature of the international transactions undertaken
by the appellant it is noticed that the payment of technical know-how fee is
for manufacturing Takata based products only. Thus the technical know-how
payment needs to be allocated to the segment pertaining to sales made of
Takata products.
The depreciation charged on the fixed Assets is to be allocated on the basis
of the turnover of these segments. As for the financial expenses, they
primarily pertain to interest expenses which are non-operating in nature.
However the bank charges of Rs.18,79,136 needs to be allocated to both the
segments on the basis of the turnover.
8.8 Based on the above, the revised segmental calculation of the internal
segments is provided below:
Particular
Expense
already
allocated
Total (in Rs.) Takata (in Rs.) Others (in
Rs.)
62,98,16,402
10,88,44,785
52,09,71,617
Details Allocation of expenses not done by the appellant
Depreciation
Bank Charges
:Payment of
Transfer
Total
Expenses
Sales
Operating Profit
2,64,03,411
48,94,126
2,15,09,285
18,73,136
3,48,315
15,30,820
1,10,00,000
1,10,00,000
-
1,62,42,441
2,30,40,105
66,90,98,948
12,50,87,226
54,40,11,722
68,76,63,661
12,74,65,091
56,01,98,570
1,85,64,713
23,77,865
1,61,86,848
1.86%
2.88%
OP/Sales
If the above segmental computation is to be considered for the purpose of
benchmarking the international transaction of the appellant then the margin
earned by the appellant from the AE business is lower than the margin
earned by the appellant in the domestic business, hence if the appellant's
submission is to be considered then the transactions of the appellant would
not adhere to the arm's length standard.”
5.11. Ld counsel contends that in para 8.6 CIT (A) has found comparison of
financials with internal comparable in para 8.5, a difference of Rs.4.03
crores was noted on account of which this difference had arisen, i.e.
(a) Technical know-how fee
Rs.1.10 crores.
(b) Depreciation
Rs.2.64 crores.
(c) Financial Expenses
Rs.1.39 crores.
This becomes
Rs.5.13 crores
5.12. It is pleaded that CIT (A) has erroneously added Rs.1.10 crores on
account of technical fee as the same was never debited to profit and loss
account as such and was actually capitalized by the assessee. Therefore in
any case difference may be attributed to only of items (b) and (c) above. By
allocating entire payment of technical know-how fee of Rs.1.10 crores to AE
segment, CIT(A) computed the PLI from AE segment at 1.86% and from
non-AE segment at 2.88%. This according to ld counsel is incorrect as the
appellant never claimed payment of technical know-how fee of Rs.1.10
crores in its profit and loss account since the same was capitalized.
5.13. Even though CIT(A) rejected internal comparable and held that in the
absence of internal comparable, TNMM is the most appropriate method by
following observations in para 8.9 of his order:“Hence in the absence of any internal comparable TNMM is the most
appropriate method to compare the company wide margins earned by the
appellant with external comparables undertaking similar manufacturing
activities.”
5.14. In view of the above calculations, the CIT (Appeals) enhanced the
addition as calculated by him on page 25 para 15.1 of his order to
Rs.4,24,11,209/-.
5.15 Ld. counsel canvassed following points before us:
A. Written agreements which are duly executed by parties based on
commercial expediency cannot be disregarded without giving any cogent
reasons reliance is placed upon the following judgments:i) Azadi Bachao Andolan – 263 ITR 706 SC =
(2003-TII-02-SC-INTL);
ii) CIT v. Gillette Diversified Operations (Pvt) Ltd. [2010] 324 ITR 226 (Del)
= (2010-TIOL-396-HC-DEL-IT)
(iii) CIT v. Walfort Share & Stock Brokers (P) Ltd. [2010] 233 CTR 42 (SC) =
(2010-TIOL-47-SC-IT)
(iv) Sony India v. DCIT [2008] 114 ITD 448 (Del) (relevant para 100, page
520) = (2008-TII-08-ITAT-DEL-TP)
No finding has been given that agreements are non-genuine or sham.
The agreements have been duly approved by the Ministry of Commerce,
Department of Industrial Policy and Promotion, SIA, of 2 nd December 2000
wherein the foreign collaboration agreement was approved by the
Government of India including the payment of royalty and lump-sum
technical know-how fee. The business with Takata and the sale of seat belts
could not have taken place at all without this joint venture agreement with
Takata Japan. This duly executed and approved agreement lays the
foundation stone of the business and whether the appellant should conduct
his business at all and whether it should enter into a joint venture
agreement at all is the decision of the businessman. The TPO cannot step
into intricacies of business expediency and hold that assessee need not have
entered into this agreement at all and, therefore, not paid any technical
know-how fee or royalty to Takata i.e. the A.E.
B. Findings that royalty was being paid in the purchase price of the raw
material was incorrect as the formula for payment of royalty was net of
imported raw material purchased and for this references is made to the
calculations for payment of royalty which are contained in paper book at
page 69 demonstrating that out of the sale amount total landed cost of
material has been reduced and on the net selling price royalty has been
calculated at 5% of the net selling price. Therefore, the TPOs action to
completely disregard the royalty paid is not incorrect.
C. OECD Guidelines and US case law are based on the domestic law of the
countries they represent whereas as far as India is concerned Chapter X
dealing with international transactions and transfer pricing is a complete
code in itself and therefore there is no need for any external aids in
interpretation of the Indian statute. The judges of the Apex Court and
various other High Courts and the Tribunals specifically dealt with almost
every situation in Indian perspective and the law in India is well settled on
most of the propositions involved in this case. Royalty agreement duly
executed and approved by the Government of India should not have been
disregarded completely by the authorities below. D. Ld counsel supports his
case on the of assessment orders in assessees own case for subsequent
years, i.e. assessment year 2005-06 and 2006-07 along with TPO's orders
which show that the TPO as well as the AO have accepted the existence of
this joint venture agreement and have not proposed any additions either on
account of royalty payment or on account of purchase of raw materials in
the subsequent years.
D. Only international transactions are covered by Chapter X on transfer
pricing regulations and the transactions which have no international
transaction element are not amenable to adjustments and for this
proposition he has cited the following authorities:(i) IL Jin Electronics v. ACIT [2010] 36 sot 227 (relevant para on page 230)
= (2010-TII-07-ITAT-MUM-TP).
(ii) DCIT v. Starlight
2010–TII–28–ITAT-MUM-TP.
(iii) Twinkle Diamond v. ACIT 2010–TII–09–ITAT-MUM–TP.
(iv) Addl. CIT v. Tej Diem [2010] 130 TTJ 570 (Mumbai) = ( 2010-TII-27-ITATMUM-TP).
5.16. It will be seen that the operating profit on sales for the international
transactions with TAKATA give a PLI of 10.495% which is higher than both
the workings by the TPO of 9.21% and by the CIT (Appeals) of 10.74% - 5%
= 10.27 for which he has invoked the safe harbour rule. Since the lump-sum
transfer of royalty has been capitalized by the appellant in the fixed assets
and depreciation thereon has been claimed CIT(A)'s table will have to be reworked after excluding the amount of Rs.1.10 crores on account of technical
know-how fee. Ld. Counsel furnished the revised working which is placed on
record, the same is as under:
Particular
Total (in Rs.) Takata (in Rs.) Others (in
Rs.)
Expense
already
allocated (A)
62,98,16,402
10,88,44,785
52,09,71,617
Details Allocation of expenses not done by the appellant
Depreciation
2,64,03,411
48,94,126
2,15,09,285
18,73,136
3,48,315
15,30,820
NIL
NIL
-
2,82,76,547
52,42,441
2,30,40,105
Total
65,80,92,949
Expenses (C =
A+B)
11,40,87,226
54,40,11,722
68,76,63,661
12,74,65,091
56,01,98,570
2,95,70,712
1,33,77,865
1,61,86,848
10.495%
2.88%
Bank Charges
:Payment of
Transfer
Total (B)
Sales ( D )
Operating Profit
(E = D – C)
OP/Sales
5.17. Ld counsel canvassed third proposition that in accordance with the
transfer pricing regulations ± 5% should be allowed as per Proviso 92C of
the Income Tax Act and for this proposition he has relied upon the following
authorities:(i) Electrobug Technologies Ltd. v. ACIT [2010] 37 sot 270 (Del.) =
(2010-
TII-39-ITAT-DEL-TP)
(ii) Development Consultants v. DCIT [2008] 23 SOT 455 (Del.) (Relevant
para on page 457) = (2008-TII-03-ITAT-KOL-TP)
(iii) Sony India Pvt. Ltd. v. DCIT [2008] 114 ITD 448 (Del.) (relevant page
571 para 163.4) = (2008-TII-08-ITAT-DEL-TP)
(iv) Customer Services India (P) Ltd. v. ACIT
2009–TIOL–424–ITAT-Delhi =
(2009-TII-08-ITAT-DEL-TP)
5.18. The next proposition canvassed by Mr. Dinodia is with regard to
internal CUP as the comparable method for testing the appellant's
transactions with its associated enterprise. It is pointed out that paras 8.5
and 8.8 of the CIT (Appeals) order show that the margin in the AE
transactions by the appellant is much higher than the margins in its local
business. As per revised chart furnished by assessee by excluding the capital
payment of Rs.1.10 crores which has been capitalized by the appellant in its
books of accounts under the Companies Act as well as under the Income Tax
Act, the operating profit of sales in the AE transaction segment would be
10.495% as against 2.88% in the totally domestic segment in which there is
no international transaction. In both these segments, the product
manufacturing processes are the same. In the other segment the turnover is
Rs.56.02 crores as against turnover of Rs.12.74 crores in the AE segment.
All the sales of the appellant company are to domestic, non related parties
only, there is no export sales. The only difference in the Takata segment is
the use of technology of Takata and the raw material is also imported from
them. Normally in a transfer pricing regulation, this should be tested on the
fact that where Takata transactions are leaving a lower operating profit than
the non- Takata transactions and in this case the operating profit in Takata
transactions is much more than the transactions in the non- Takata
transactions. Therefore, according to ld. counsel, this internal comparable
available in the appellant company itself should not have been disregarded
by the TPO and the CIT (Appeals).
5.19. The next proposition is that the net margins worked out by CIT(A) in
the six companies on page 24 of order are not correct, as per data filed
which is collected from ROC by the appellant, the margins are much lower
than the one calculated both by the TPO and the CIT (Appeals). A revised
working of 3 comparable companies is furnished (annexure ‘C') on record, it
supports assessee.
6. Ld. CIT D.R. Shri Ashok Pandeny in reply relied upon the orders of the
TPO and the CIT (Appeals) and alternatively pleads that if new data with
regard to the comparables is to be taken into account, then the matter
should be restored back to the file of the TPO to re-work the margins of the
comparables as per data collected from the ROC and filed by the appellant
during the course of hearing.
7. In rejoinder Mr. Dinodia submitted that on the same set of comparables,
the TPO and the AO have accepted both the royalty as well as purchase of
raw materials to be at arm's length price for assessment year 2005-06 and
assessment year 2006-07. Copies of TPO's orders as well as the assessment
orders have been filed in the paper book. There is no point of sending the
matter back because even if revised data is not considered and the error
committed by CIT (Appeals) in working out the margins on AE segment and
non-AE segment is corrected by removing the amount of Rs.1.10 crores of
technical know-how fee, the results show that the assessee's transactions
are at an arm's length and no additions are required to be made because AE
segment gives margin of 10.495% and non-AE segment gives margins of
only 2.88%. An appeal should not be set aside in routine manner as it
results in multiplicity of proceedings and in this case the mistakes being
manifest can be corrected without taking the efforts of further set aside.
8. We have carefully perused the record and considered the submissions of
both the parties. It is a settled proposition of the law that legally binding
agreements between unrelated parties cannot be disregarded without
assigning any cogent reasons thereto. In this case it has not been imputed
that agreements were non genuine or sham, rather they are duly approved
by RBI and other regulatory agencies. It is also a settled proposition that
commercial transactions are in the domain of the businessman and Income
Tax Department cannot intervene in realm of intricacies of commercial
expediencies involved in these arrangements. In this case if the assessee
had not entered into joint venture agreement with Takata, it would not have
been able to make any sales whatsoever using their technology and raw
material and the machines supplied by them. The very existence of this
business in AE segment depended upon the joint venture agreement which
has been duly approved by the Government of India in accordance with law.
In such circumstances, we are of the view that TPO and the CIT (Appeals)
were not correct in disregarding this agreement without assigning any
cogent reasons except challenging the commercial need for such
arrangement which is in the domain of the businessman and not of the
Revenue authorities.
8.1. We have observed that the TPO in his order has accepted the
international transactions of purchase of machinery from the AE however an
inference has been drawn that assessee was competent to make
independent use of such machinery. Assessee has met this finding that
machineries were imported to manufacture the assembly line for
manufacturing of seat belts for which the technical know-how fee and
foreign technicians were also deputed by the AE. Whenever international
transactions of such nature are undertaken, it is a combination of technical
know-how, royalty, technical assistance through the deputation of ex-pat
employees on the rolls of the person obtaining the technical know-how.
There is merit in assessees submissions that merely by importing
machinery, it cannot be said that the assessee would become competent to
make use of such machinery. Technical know-how and technical assistance
was needed for the use of machinery under the normal circumstances.
8.2. It has not been disputed that provisions of Chapter X Section 92C deal
with international transactions only and not with transactions which have no
international cross border element at all. Therefore, the basis of making the
adjustments on the enterprise level by taking Rs.68.76 crores as the base is
not correct. What should have been taken is the sale to domestic parties
using Takata technology and Takata raw material amounting to Rs.12.74
crores. The segment that was to be looked at was the international segment,
that is, 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 transactions have to be looked at has also been approved
by various Benches of the Tribunal which have been cited by the appellant
and are not disputed by the learned CIT (DR) and no contrary judgment has
been cited before us on this proposition. We, therefore, accept this second
proposition also that only international transactions are to be taken into
account while calculating the arm's length price.
8.3. Similarly, the next proposition i.e. as per Proviso to 92C to adjust net
margin with ± 5% is also well settled by various Tribunal judgments which
we respectfully concur with, this proposition also has not been challenged by
the learned D.R. and while making adjustments based on statistical analysis
some sort of safe harbour percentage must be there before making any
additions. Respectfully following the judgments of the Tribunals, we accept
this plea of the assessee.
8.4. The next proposition of using internal comparables also in our view
helps the case of the assessee, to take it outside the scope of making any
adjustment. Apart from relying on the judgments cited by the appellant, in
our opinion, the best comparability can be of the transactions of the tested
party itself. If the tested party without the use of the imported technology
and imported raw material can make additional margins, then it would be a
case which may require an adjustment, but in this case the international
transactions have demonstratively boosted the profits of the appellant. As
per calculations of the CIT (Appeals), as corrected by an error on account of
technical know-how fee which was not claimed as revenue expense, the
segment which did not have the benefit of foreign technology and foreign
raw material had an operating profit to sales margin at 2.88%, whereas the
segment which had this benefit had a margin of 10.49%. It is obvious that
the transactions are at arm's length and no adjustments are called for.
8.5. Taking external comparables as given by the TPO and the CIT (Appeals)
and by looking at the average PLI calculated by the CIT (Appeals) in para
15.1 of his order of 10.74% and if we reduce 5% thereof, it will come to
10.20%, i.e. 10.74 - 5% = 0.537. If this is reduced from 10.74, it will come
to 10.20. This will be the PLI after adjustment as per the Proviso to Section
92C. This, in any case, is less than the PLI of the Takata transactions of the
appellant which is 10.49%. Therefore even if we uphold the work done by
the authorities below and adjust it by 5% and then compare it with the
international transactions, then again there is no need, in our opinion, to
make any adjustment as the PLI of the tested party, i.e. the appellant, is
higher than the PLI worked out by the TPO and the CIT(Appeals).
8.6. The alternate plea of ld. D.R. about setting aside the issue is not worthy
of acceptance. Even if we ignore the ROC data mistakes and comparables
are clear and glaring. We have dealt with all the angles and assessment
cannot be set aside unless there are adequate reasons to do so.
8.7. In view of all the foregoings, we have no hesitation in holding that the
addition of Rs.4,24,11,209/- made by the CIT (Appeals) deserves to be
deleted. A.O. is directed to delete the this addition.
9. In the result the appeal is allowed.
(Order pronounced in open court on 12.11.2010.)
(DISCLAIMER: Though all efforts have been made to reproduce the order
correctly but the access and circulation is subject to the condition that
Taxindiainternational (TII) is not responsible/liable for any loss or damage caused
to anyone due to any mistake/error/omissions.)