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Honda Motorcycle & Scooters India Pvt. Ltd., Plot No.01, Sector-03, IMT Manesar, Gurgaon. Vs. ACIT, Circle-1(1), Gurgaon.
April, 14th 2015
        IN THE INCOME TAX APPELLATE TRIBUNAL
             DELHI BENCHES : I : NEW DELHI

BEFORE SHRI R.S. SYAL, AM AND SHRI GEORGE GEORGE K., JM

                        ITA No.1379/Del/2011
                       Assessment Year : 2006-07


Honda Motorcycle & Scooters        Vs. ACIT,
India Pvt. Ltd.,                       Circle-1(1),
Plot No.01, Sector-03,                 Gurgaon.
IMT Manesar,
Gurgaon.
PAN : AAACH7467D

  (Appellant)                              (Respondent)

            Assessee By        :    Shri Vijay Iyer, CA
            Department By      :    Shri Judy James, Standing Counsel


         Date of Hearing               :   30.03.2015
         Date of Pronouncement         :     .04.2015


                                   ORDER
PER R.S. SYAL, AM:
     This appeal by the assessee is directed against the final order passed

by the Assessing Officer u/s 143(3) read with section 144C of the Income-
                                                             ITA No.1379/Del/2011


tax Act, 1961 (hereinafter also called `the Act') on 14.02.2011 in relation

to the assessment year 2006-07.

2.   The first two grounds of the appeal are general, which do not require

any separate adjudication.

3. Ground no. 3, through various sub-grounds, is an assail to the making

of addition of Rs.19,53,79,302/- on account of transfer pricing adjustment.

Briefly stated, the facts of the case are that the assessee is a deemed public

limited company which was incorporated in India on 20.8.1999 as a

subsidiary of Honda, Japan. The assessee is engaged in the business of

manufacture and sale of motorcycles and scooters in India. Honda, Japan

provides necessary technology and support to the assessee for

manufacturing two-wheelers in India.        The manufacturing activity is

undertaken by the assessee and the goods so manufactured, namely, two

wheelers, are largely sold in India to unrelated parties and some part of the

total sale is exports made both to Associated enterprises (AEs) and non-

associated enterprises (non-AEs).     The assessee reported the following




                                      2
                                                                          ITA No.1379/Del/2011


fourteen international transactions with Honda and its other offshore

affiliates:-

S.No.   Nature of transaction      Method     used       by Value       of Value       of
                                   assessee                 Transaction    transaction
                                                            Received       Paid
                                   Method         PLI

1.      Purchase of Motorcycle, TNMM              OP/Sales                    18,48,17,733
        Scooter Parts, Consumables
        and other supplies
2.      Export of scooters and CUP/               OP/Sales    140,37,12,904
        scooter parts
                               TNMM

3.      Purchase of fixed assets   TNMM           OP/Sales                    21,37,15,816

4.      Payment        of   export CUP/           ---                          7,44,24,255
        commission                  TNMM
5.      Payment of royalty          CUP/          ---                         57,26,60,430
                                    TNMM
6.      Payment of technical CUP/                 ---                         18,88,50,000
        know-how fee                TNMM
7.      Payment of technical CUP/                 ---                         2,42,24,247/-
        assistance fee              TNMM
8.      Authorised test support fee CUP/          ---                            9,39,717/-
                                    TNMM
9.      Service fee                 CUP/          ---                            28,87,498
                                    TNMM
10.     Owner's manual charges      CUP/          ---                            34,13,309
                                    TNMM
11.     Prototypic Development      CUP/          ----                           69,05,820
                                    TNMM
12.     Reimbursement            of CUP/          ---                            21,74,230
        expenses                    TNMM
13.     Warranty on scooters        CUP/          ---                          1,89,59,146
                                    TNMM
14.     Recovery of expenses        CUP/          ---           4,64,06,214
                                    TNMM




                                              3
                                                                            ITA No.1379/Del/2011


4.        Certain comparables instances were given in respect of the above

twelve international transactions on which the assessee substantively

applied the Comparable Uncontrolled Price (CUP) method to show that

these were at arm's length price (ALP). The demonstration of such

international transactions at ALP under the CUP method was further

corroborated with the Transactional Net Margin Method (TNMM). In

respect of the remaining two international transactions on which TNMM

was applied, the assessee showed these to be at ALP with the help of the

analysis of five comparable companies with their respective profit margins,

as under : -

     S.No.     Name of companies                     Year ended            Operating
                                                                           profit/sales (%)
     1.        Kinetic Motor Company Ltd.            30.09.2005                       (15.51)
     2.        LML Limited                           31.03.2005                       (20.60)
     3.        TVS Motor Company Ltd.                31.03.2006                          7.64
     4.        Majestic Auto Ltd.                    31.03.2006                          4.75
     5.        Kinetic Engineering Ltd.              30.09.2005                        (9.84)

               Average (OP/Sales%)                                                    (6.71)


     Average of OP/Sales % of comparable companies                -6.71%
     OP/sales of the assessee company                             7.16%




                                              4
                                                              ITA No.1379/Del/2011


5.   In view of the fact that its adjusted OP/Sales of 7.16% was more than

that of the average of the comparables at (­) 6.71%, the assessee claimed

its international transactions at ALP.      In calculating its own ratio of

Operating Profit /Sales at 7.16%, the assessee adjusted its profit margin by

reducing 56% of fixed operating overheads for three months from the total

operating costs by treating them as non-operating, on the premise that

there was strike in its factory during this period.

6.   The Transfer Pricing Officer (TPO) rejected Kinetic Motor Company

Ltd., LML Ltd. and Kinetic Engineering Ltd. from the list of comparables

because of non-availability of their relevant data for the year ending

31.03.2006. Apart from retaining the other two companies, namely, TVS

Motor Company Ltd. and Majestic Auto Ltd., the TPO expanded the list of

comparables by also including Bajaj Auto Ltd. This company was included

in the list of comparables for the reason that the assessee itself treated this

company as comparable in the immediately preceding year, but chose to

ignore the same for the year in question. Average of the Profit Level

Indicator (PLI) of these three companies, being, the rate of Operating


                                       5
                                                            ITA No.1379/Del/2011


profit/Operating Revenue, was computed at 7.44%.         In computing the

assessee's percentage of Operating profit/Operating revenue, the TPO

rejected the assessee's point of view of reducing total operating costs by

the proportionate operating costs incurred for three-months strike period.

That is how, he computed the assessee's operating profit margin at 0.32%

by, inter alia, including the amount of depreciation as part of operating

cost, which was not considered by the assessee in its original calculation.

A transfer pricing adjustment of Rs.19,53,79,302 was computed by

applying the differential profit rate of 7.12% (7.44% minus 0.32%) on the

total value of all international transactions reported by the assessee at

Rs.274,40,91,319. In other words, the TPO applied Transactional Net

Margin Method (TNMM) on entity level of the assessee by considering all

the reported fourteen international transactions in one go. This was done in

contrast to the assessee determining the ALP of twelve international

transactions by considering the Comparable Uncontrolled Method (CUP)

as the most appropriate method, and of the remaining two international

transactions of Purchase of Motorcycle, Scooter Parts, Consumables and

other supplies at Sr. no. 1 and Purchase of Fixed assets at Sr. no. 3 by
                                     6
                                                            ITA No.1379/Del/2011


considering the TNMM as the most appropriate method. The assessee

remained unsuccessful before the Dispute Resolution Panel (DRP). This

eventually led to the making of addition of Rs.19.53 crore on account of

transfer pricing adjustment by the Assessing Officer (AO) in the final order

passed u/s 143(3) read with section 144C of the Act. The assessee is

aggrieved against the making of addition of Rs.19.53 crore and odd.

7.1. We have heard the rival submissions and perused the relevant

material on record.   It is observed that the assessee reported fourteen

international transactions and determined the ALP of twelve of such

transactions by applying the CUP as the most appropriate method, which

was also corroborated with the help of the TNMM. The remaining two

international transactions were shown at ALP under the TNMM. The TPO

proceeded to determine the ALP of all the fourteen transactions in a

combined manner by applying the TNMM on entity level. In doing so, he

took the declared value of all the fourteen international transactions at

Rs.274.40 crore and applied the difference between profit margin of the

comparables and that of the assessee, as computed by him, for proposing


                                     7
                                                            ITA No.1379/Del/2011


transfer pricing adjustment of Rs.19.53 crore. In resorting to the TNMM

for all the fourteen international transactions, the TPO did not mention

any reason worth the name as to why the ALP of twelve international

transactions was not determined by him as per the CUP method, which

was considered and applied by the assessee as the most appropriate

method.   The primary question which falls for our consideration and

determination is as to whether the approach adopted by the TPO in

determining the ALP of all the fourteen international transactions under the

TNMM on a combined level is correct, when the assessee applied the CUP

as the most appropriate method on twelve international transactions.

7.2. Section 92(1) of the Act provides that: `Any income arising from an

international transaction shall be computed having regard to the arm's

length price.' The procedure for computation of arm's length price has

been set out in section 92C. Sub-section (1) of section 92C provides that:

`The arm's length price in relation to an international transaction shall be

determined by any of the following methods, being the most appropriate

method, having regard to the nature of transaction or class of transaction or


                                      8
                                                                ITA No.1379/Del/2011


class of associated persons or functions performed by such persons or such

other relevant factors as the Board may prescribe'. Five specific methods

have been enshrined in this provision apart from one general method,

being : `Such other method as may be prescribed by the Board.' Out of the

five specific methods, the first one is Comparable uncontrolled price

(CUP) method and the fourth one is Transactional net margin method

(TNMM). A bare reading of section 92C(1) brings out that: (i) the ALP is

required to be determined of `an' international transaction; and (ii) the

ALP of such an international transaction is to be determined by applying

the most appropriate method out of the prescribed methods which, inter

alia, include CUP and TNMM. The first ingredient is that the ALP should

be determined in relation to an international transaction.             The term

`international transaction' has been defined in section 92B to mean            : `a

transaction between two or more associated enterprises, either or both of

whom are non-residents, in the nature of purchase, sale or lease of tangible

or intangible property, or provision of services, or lending or borrowing

money, or any other transaction having a bearing on the profits, income,

losses or assets of such enterprises, .....'.   It is discernible from the above
                                        9
                                                             ITA No.1379/Del/2011





definition of international transaction given in section 92B that it refers to

`a transaction' between two or more associated enterprises. The term

`transaction' has been defined in section 92F(v) and also in Rule 10A(d)

of the Income-tax Rules, 1962. The Rule defines the term `transaction' to

include: `a number of closely linked transactions.' On going through the

above provisions, it becomes palpable that the arm's length price is

essentially determined on transaction-by-transaction approach for each

international transaction separately; and for that purpose, a transaction in

singular also includes plural for closely linked transactions.        In other

words,   where the transactions are not closely linked, then their ALP

should be determined separately for each international transaction and such

determination of ALP for `an' international transaction as per section

92C(1) is done as per the most appropriate method, being one of the

methods given in the provision. To put it simply, each international

transaction is viewed separately and independent of other international

transactions for determining its ALP by using one of the given methods,

which is the most appropriate method having regard to the nature of

transaction or class of transaction or functions performed, etc.           It is
                                      10
                                                               ITA No.1379/Del/2011


impermissible to combine all the international transactions for determining

their ALP in a unified manner when such transactions are diverse in nature.


7.3. Adverting to the facts of the instant case, we find from the nature of

international transactions reproduced above that these include Purchase of

spare parts; Export of scooters and scooter parts; Purchase of fixed assets;

Payment of export commission; Payment of royalty, technical knowhow

fee, technical assistance fees; Payment of Authorized test support fee; and

Reimbursement expenses, etc.        By no standard,       the above fourteen

international transactions can be considered as closely related to each

other, so as to fall for consideration as a single international transaction. It

can be noticed from the assessee's Transfer Pricing study report and also

Audit report in Form No. 3CEB that it claimed twelve out of the total

international transactions at ALP by using the CUP as the most appropriate

method. The TPO, without assigning any reason as to why the CUP

method could not be applied, went ahead by determining the ALP of all the

international transactions under TNMM on a consolidated manner.




                                       11
                                                           ITA No.1379/Del/2011


7.4.   It goes without saying that it is the assessee who knows best about

the most appropriate method for a particular international transaction

undertaken by him. It is his prerogative to initially choose the most

appropriate method for each international transaction having regard to the

nature of transaction and all other relevant factors and then determine its

ALP. Having chosen a particular method as the most appropriate method

for determining the ALP of an international transaction, it then becomes

obligatory for the assessee to satisfy the AO/TPO that the method so

chosen by him is, in fact, the most appropriate method and further that the

data required for the determination of ALP under such a chosen method, is

properly available. Then, comes the turn of the AO/TPO to satisfy himself

that not only the correct method has been applied by the assessee but also

that proper data for determination of ALP under such method has also been

made available. If the Officer gets satisfied on the above aspects, the

matter ends. If, however, the Officer comes to a conclusion that either the

method employed by the assessee for determining the ALP is not the most

appropriate method or that the method is appropriate, but the necessary

data for computation of the ALP under such method is not available, then,
                                    12
                                                             ITA No.1379/Del/2011


it is open to him to disregard the method employed by the assessee or the

data so produced and substitute it with the correct data, and if the requisite

correct data is not available, then, with another suitable method, being the

most appropriate method. To put it simply, first choice is always of the

assessee to choose a particular method as the most appropriate method. It

is only if the Officer is not satisfied with such choice, that he can reject

such a method and proceed to determine the ALP under another more

appropriate method.     However, before applying another method, it is

incumbent upon the Officer to give some plausible and convincing reasons

for rejecting the method selected by the assessee. The Officer cannot

arbitrarily reject the assessee's choice of method and substitute it with

another method, which he considers as the most appropriate method.


7.5. Reverting to the facts of the instant case, we find that the assessee

chose CUP as the most appropriate method in respect of twelve

international transactions, but, the TPO simply brushed aside the assessee's

choice of the most appropriate method and proceeded to determine the

arm's length price of all the fourteen transactions under the TNMM,


                                      13
                                                            ITA No.1379/Del/2011


without giving any reason whatsoever, much less any cogent and rational

reasons, for discarding the assessee's choice of method. Such a course of

action adopted by the TPO is unknown to the law. Without expressly

rejecting the assessee's contention about the applicability of the CUP as

the most appropriate method in respect of twelve international transactions,

the TPO could not have proceeded to determine the ALP of these twelve

international transactions also under the TNMM.                Under such

circumstances, we have no option but to set aside the impugned order and

remit the matter to the file of AO/TPO for determining the ALP of the

twelve international transactions, firstly, under the CUP method as was

substantively chosen by the assessee as the most appropriate method. It is

only if the TPO comes to the conclusion that either the CUP method is not

appropriate to such international transactions or that the data provided by

the assessee is not proper or is inadequate, that he can resort to some other

method, of course, after confronting the assessee with his reasons for the

proposed rejection of the CUP method. We want to make it clear that we

have eschewed from undertaking the exercise of checking the applicability

or otherwise of the CUP method to such twelve international transactions
                                     14
                                                           ITA No.1379/Del/2011


or examining the availability or suitability of the data of comparable

uncontrolled transactions given by the assessee. In other words, the entire

exercise has been left open to be done by the TPO as per law.


8.   Now, we are left with the remaining two international transactions,

viz., `Purchase of motorcycles, scooter parts, consumables and other

supplies' worth Rs.18,48,17,733/- given at Sl. no. 1; and `Purchase of

fixed assets' worth Rs.21,37,15,816/- given at Sl. no. 3. The assessee

applied the TNMM as the most appropriate method for showing that these

transactions were at the ALP. The TPO also applied the same method.

Thus, there is no dispute as regards the application of TNMM as the most

appropriate method. The quarrel is on two major aspects of the

determination of ALP under this method, being, first, the determination of

the operating profit margin of the assessee and second, exclusion/inclusion

of some companies as comparable.


9.   Firstly, we espouse the determination of the operating profit margin

of the assessee, which has two disputed aspects, namely, not allowing of



                                    15
                                                            ITA No.1379/Del/2011


deduction for the abnormal operating costs for the three months period of

strike; and improper grant of depreciation allowance.


10.1. The assessee determined its adjusted OP/sales at 7.16% by reducing

the total operating costs by a sum of Rs.2391.57 lacs. This amount of

Rs.23.91 crore was computed by initially taking the actual fixed operating

costs incurred for three months of strike from June to August, 2005. Such

costs were reduced by 56% towards improper utilization of capacity on

account of decline in the turnover to actual amount of Rs.277 crore as

against the estimated turnover which ought to have been during normal

working of these three months at Rs.493 crore. The TPO refused to reduce

the said sum of Rs.23.91 crore from the total operating costs in working

out the assessee's profit rate. The ld. AR vehemently argued that the strike

during these three months period of June to August, 2005 crippled the

functioning in the factory and, as such, it was essential to reduce the

operating costs with the proportionate decline in the turnover during this

period. Au contraire, the ld. DR. strongly supported the impugned order.




                                     16
                                                             ITA No.1379/Del/2011


10.2.   We are not inclined to accept the contention urged on behalf of the

assessee. On a specific query from the Bench, it was stated that the strike

commenced on 27.6.2005 and came to an end on 1.8.2005. This shows

that the assessee's action in proportionately reducing the operating costs

for the three months period is wholly inappropriate because the so-called

strike continued only for a period of one month and five days. It is further

discernible that the assessee computed the amount of abnormal fixed costs

at Rs.23.91 crore by applying 56% to the total operating costs incurred

during this period of three months.        This 56% was determined by

considering the ratio of actual sales during these three months to the

normal sales during such period. Prima facie, going by the assessee's own

version, it should have been in the ratio loss of sale to the normal sales and

not actual sales to normal sales.     The ld. AR candidly conceded this

position during the course of hearing before us. Be that as it may, we find

that there is no warrant for reducing any amount/percentage of the

operating costs for these three months period from the total operating

costs. If we accept the contention of strike, then there should be some

corresponding reduction in costs as well. The assessee has not
                                      17
                                                             ITA No.1379/Del/2011


demonstrated that the operating expenses during the month preceding and

succeeding these three months were at any higher level. Apart from that,

we find from the Chart of month-wise production placed on page 471 of

the paper book that production for the month of May, 2005 stood at 57063,

that of June at 32217, July at 14853, August at 44173, September at

60225, November at 54597 and December, 2005 at 39170. It is patent that

that the average production during these three months period at 30415 is

quite close to the normal production during December, 2005 at 39170.

Even during the normal working, the production is fluctuating and not

static. Further, the assessee has not shown the figures of production during

the corresponding three months of the preceding year to show any

deviation during these three months. We fail to appreciate that if at all

there was a strike, then how there could be any production at all? In view

of the foregoing reasons, we are satisfied that the assessee was not justified

in reducing operating expenses with a sum of Rs.23.91 crore, by treating it

as abnormal fixed costs.




                                      18
                                                                  ITA No.1379/Del/2011


10.3.      There is another vital reason for not allowing the deduction as

claimed by the assessee.        This is the mandate of Rule 10B(e), which

contains the modus operandi of determining the ALP of an international

transaction under the TNMM, as under:-

        "(e) transactional net margin method, by which,--
              (i) the net profit margin realised 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 realised 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 realised by the enterprise and referred
        to in sub-clause (i) is established to be the same as the net profit
        margin referred to in sub-clause (iii) ;
              (v) the net profit margin thus established is then taken into
        account to arrive at an arm's length price in relation to the
        international transaction."



                                         19
                                                            ITA No.1379/Del/2011


10.4.    Sub-clause (i) in the determination of ALP under TNMM is the

computation of net operating profit margin realized by the assessee from

an international transaction.   Sub-clause (ii) is the computation of net

operating profit margin realized by an unrelated enterprise from a

comparable uncontrolled transaction. Sub-clause (iii) provides that the net

profit margin realised by a comparable company, determined as per sub-

clause (ii) above, `is adjusted to take into account the differences, if any,

between the international transaction and the comparable uncontrolled

transactions, ..... which could materially affect the amount of net profit

margin in the open market.' It is this adjusted net profit margin of the

unrelated transactions or of the comparable companies, as determined

under sub-clause (iii), which is used for the purposes of making

comparison with the net profit margin realized by the assessee from its

international transaction as per sub-clause (i). Sub-rule (2) of Rule 10B

provides that the comparability of an international transaction with an

uncontrolled transaction shall be judged with reference to certain factors

which have been enumerated therein. Rule 10B(3) states that an

uncontrolled transaction shall be comparable to an international
                                     20
                                                             ITA No.1379/Del/2011


transaction, if either there are no differences between the two or a

`reasonably accurate adjustment can be made to eliminate the material

effects of such differences.' When we read sub-clauses (ii) & (iii) of Rule

10B(1)(e) in juxtaposition to sub-rules (2) & (3) of rule 10B, the position

which emerges is that the net operating profit margin of the comparable

companies calls for adjustment in such a manner so as to bring both the

international transaction and comparable cases at the same pedestal. In

other words, if there are no differences in these two, then the net operating

profit margin of the comparable companies should be considered as a

benchmark. However, in case there is some difference, then such

difference should be ironed out by making suitable adjustment to the

operating profit margin of the comparables. That is the way for bringing

both the transactions, namely, the international transaction and the

comparable uncontrolled transaction, on the same platform for making a

meaningful and effective comparison. The above analysis overtly

transpires that the law provides for adjusting the profit margin of

comparables on account of the material differences between the

international transaction of the assessee and comparable uncontrolled
                                     21
                                                            ITA No.1379/Del/2011


transactions. It is not the other way around to adjust the profit margin of

the assessee. In other words, the net operating profit margin realized by

the assessee from its international transaction is to be computed as such,

without adjusting it on account of differences between its international

transactions and the comparable uncontrolled transactions.                 The

adjustment, if any, is required to be made only in the profit margin of the

comparables, and that too, by demonstrating some difference between

international transaction of the assessee and comparable uncontrolled

transactions. The assessee in the instant case has failed to bring on record

any material to show that the profit of the comparable companies was not

hit by any untoward incident. Such southwards adjustment in the

assessee's own operating costs and the resultant northwards movement in

its own profit rate, is impermissible under the law.       In view of the

foregoing reasons, we uphold the view taken by the TPO in rejecting the

claim of the assessee for reduction of the so-called abnormal operating

costs from the total operating costs.




                                        22
                                                            ITA No.1379/Del/2011


11.1.    Now, we take up the second issue of adjustment to the operating

profits of the assessee by the amount of depreciation. The ld. DR submitted

that depreciation ought not to have been allowed to the assessee. We fail

to appreciate this contention for the reason that depreciation is an integral

part of the operating costs. Even though the assessee initially did not

consider the amount of depreciation allowance as a part of the operating

cost, but the TPO, in our considered opinion, was right in including the

amount of depreciation as an element of operating cost.

11.2.   The ld. AR submitted that the assessee charged depreciation in its

Profit and loss account on straight line method at the rates higher than

those prescribed under Schedule XIV of the Companies Act, whereas the

comparable companies charged depreciation at the rates specified in the

Schedule, necessitating adjustment in the operating profit margin, thereby

requiring an upward increase in the amount of depreciation of the

comparables and the resultant reduction in their operating profit margins.

11.3.    Schedule XIV to the Companies Act provides for rates of

depreciation on various assets under different blocks, both on written down

                                     23
                                                           ITA No.1379/Del/2011


value method and straight line method. We appreciate that sub-clause (iii)

of Rule 10B(e) provides that the net profit margin realized by a

comparable company, determined as per sub-clause (ii) above, is adjusted

to take into account the differences, if any, between the international

transaction and the comparable uncontrolled transactions, which could

materially affect the amount of net profit margin in the open market. It is

this adjusted net profit margin of the comparable companies, as determined

under sub-clause (iii), which is used for the purpose of making comparison

with the net profit margin realized by the assessee from its international

transaction as per sub-clause (i).

11.4.    There can be no dispute on the principle that calculation of

`Operating profit' as envisaged under Rule 10B(1)(e) embraces cumulative

effect of all the items of income and expenses which are of operating

nature. Ordinarily, there can be no question of considering each item of

such operating expenses or income in isolation de hors the other expenses

to claim adjustment on the ground of such expenditure or income of the

assessee on the higher side seen individually or as a percentage of other


                                     24
                                                             ITA No.1379/Del/2011


operating expense/incomes in comparison with its comparables. The

reason is obvious that when we consider the operating profit margin, the

effect of all the individual higher or lower items of expenses or incomes

gets subsumed in the overall operating profit margin, ruling out the need

for any adjustment on comparison of one-to-one items resulting into the

determination of the operating profit margin. One company may have

taken a building on rent for carrying on its business, in which case, it will

pay rent which will find its place in the operating costs. For the purposes of

making comparison, one cannot contend that the payment of rent by one

enterprise in comparison with a non-payment of rent by another, should be

neutralized by giving proper adjustment from the operating profit of the

comparable. The manifest reason is that the other enterprise may have its

own office premises and in that case, the amount of depreciation on such

premises will also form part of its operating cost. When we consider the

operating profit of the first enterprise which is paying rent and then

compare it with the second enterprise which is not paying any rent but is

claiming depreciation on its own premises, the overall effect of rent in one

case gets counterbalanced with depreciation on premises of the other.
                                      25
                                                            ITA No.1379/Del/2011


Similar is the position of a company having purchased new assets charging

higher amount of depreciation allowance in its books of accounts vis-a-vis

another comparable company using old assets with lower amount of

depreciation. No adjustment on account of difference in the amounts of

depreciation of two companies is called for when the operating profits are

determined because in the case of a company having purchased new asset,

there will be lower repair cost and vice versa.       The effect of all the

individual items of operating expenses and incomes culminates into the

overall operating profit margin. That is why, the legislature has provided

for comparing the ratio of `operating profit margin' to a similar base of the

assessee with that of its comparables, thereby dispensing with the need for

making any adjustment on account of higher or lower amount of individual

items of expenses and incomes.            Merely because the amount of

depreciation of one enterprise is more or less than the other, can never be a

ground for seeking adjustment. Such higher amount of depreciation may be

due to large scale of the company and host of other factors. By considering

percentage of operating profit margin under the TNMM of the assessee as

well as comparables, the higher or lower volume of two companies
                                     26
                                                            ITA No.1379/Del/2011





becomes immaterial and so is the quantum of depreciation. The nitty-gritty

of the matter is that no adjustment can be allowed simply for the reason

that one company has charged higher amount of depreciation vis-a-vis its

comparable companies.       Not only no adjustment on this score is

permissible, the assessee cannot also seek an exclusion or inclusion of a

company on the ground that the ratio of its depreciation to total expenses is

more or less in comparison with comparables. It is so for the reason that

such higher percentage of depreciation to total expenses is marginalized by

the lower percentage of repairs and other incidental costs of the assets and

vice versa.

11.5.   However, the position may be a little different when there is a

difference in the rates of depreciation charged by two companies on similar

category of assets. One company may adopt the policy of charging

depreciation on its assets in conformity with the rates prescribed in

Schedule XIV of the Companies Act and other company may adopt a

policy of charging depreciation at the higher rates or lower than those

prescribed under Schedule XIV. This can be demonstrated with the help of


                                     27
                                                             ITA No.1379/Del/2011


an example. Other things being equal, if the operating profit of company

A, after claiming depreciation of Rs.10 on the value of asset worth Rs.50

with rate of depreciation 20%, is Rs.100, the operating profit of company

B with everything same including the value of assets at Rs.50, but with

rate of depreciation 30%, will be Rs.95. It shows that the comparability is

jeopardized due to higher rate of depreciation charged by company B at

30% in comparison with lower rate of depreciation charged by company A

at 20%. In such a situation, although both the companies use similar type

of assets and everything else is also equal, but their respective operating

profit percentages undergo change due to higher or lower rate of

depreciation, thereby distorting their comparability. It is this difference in

the amounts of depreciation due to different rates of depreciation and not

due to different quantum of depreciation simiplicitor, which calls for

bringing both the companies at par.

11.6. Reverting to the facts of the extant case, we find that the TPO did

not have any occasion to consider this issue, because such an argument has

been advanced before us for the first time. In our considered opinion, the


                                      28
                                                            ITA No.1379/Del/2011


ends of justice would meet adequately, if we set aside the impugned order

to this extent also and send the matter back to the file of the TPO for

allowing adjustment to the operating profit margin of the comparable

companies, if there is some difference in rates of depreciation charged by

the assessee vis-à-vis these companies. In other words, the amount of

depreciation of the comparable companies on their assets shall be

recomputed under straight line method alone as per the rates at which the

assessee has provided depreciation. To clarify, if the comparables have

charged depreciation at a higher rate in comparison with the assessee on

some of its assets, then suitable reduction should be made in the amount of

their depreciation. The TPO should not equally hesitate to make adverse

adjustment, if warranted, which means that if the comparable companies

have charged depreciation at a lower rate in comparison with the assessee,

then suitable increase should be made to their amount of depreciation. In

doing so, the TPO should see if he can correctly deduce the amount of

depreciation on the above lines. If due to one reason or the other, such

precise calculation is not possible or the assessee fails to place it before

him, then no adjustment should be carried out in the calculation of the
                                     29
                                                           ITA No.1379/Del/2011


operating profits of the comparable companies. We, therefore, sum up our

conclusion on this aspect of the matter by holding that if the assessee as

well as the comparable companies are using the SLM and there is some

difference in the rates of depreciation charged by them vis-à-vis the

assessee, then suitable adjustment should be made to the profits of the

comparables.

12.1. Now, we take up the objection of the ld. AR on the question of the

comparables. It can be noticed from the factual matrix discussed above that

the assessee initially chose five companies as comparable, out of which

three were excluded by the TPO for want of the availability of their

necessary data. Apart from retaining two cases of the assessee's choice,

the TPO also included the case of Bajaj Auto Ltd., in the final list of

comparables.

12.2.   The ld. AR contended that the assessee included Kinetic Motor

Company Ltd., LML Ltd., and Kinetic Engineering Ltd., in the list of

comparables which were excluded by the TPO on the ground that the data

for these three companies for the year ending 31.3.2006 was not available

                                    30
                                                             ITA No.1379/Del/2011


at that time. It is vivid from the assessee's Transfer pricing study report as

well as its reproduction on page 4 of the TPO's order that the data of these

three companies was not given for the year ending 31.3.2006. Whereas the

data for Kinetic Motor Company Ltd. and Kinetic Engineering Ltd. was

given for the year ending 30.9.2005, the assessee provided data of LML

Ltd. for preceding year ending 31.3.2005. It is obvious that in the absence

of the relevant data for the year ending 31.3.2006, these companies were

liable to be excluded. Primarily, we are in agreement with the TPO in so

far as the rejection of the data other than the relevant financial year is

concerned.     The Special Bench of the Tribunal in the case of Aztec

Software and Technology Service Ltd. (2007) 107 ITD 141 (Bang) (SB)

has held that the current year's data should be preferred over the multiple

years' data.    Rule 10B(4) read with Rule 10D(4) also supports this

proposition. As such, we approve the view taken by the TPO in using only

the current year's data.

12.3.    The ld. Counsel for the assessee contended that though at the

material time the relevant data for the current year of these three


                                      31
                                                             ITA No.1379/Del/2011


companies was not available, but, now the assessee can produce the

relevant data. We find from the TPO's order that he has excluded these

three companies only for the non-availability of the data for the current

year. The otherwise comparability of these companies is not in dispute.

Under such circumstances, we set aside the impugned order and direct the

TPO to consider the comparability or otherwise of these three companies

on the basis of the data which now assessee claims to be available. In

other words, if the assessee successfully gives the relevant data of these

companies for the year in question, without any distortion of their Annual

accounts, then, these companies should be considered as comparable. In

any other eventuality, these companies should be excluded.


12.4.   As regards the consideration of Bajaj Auto Ltd. as comparable by

the TPO, we find that the viewpoint of the Revenue in treating this

company as comparable, is perfectly in order. It is clear that the assessee

itself chose Bajaj Auto Ltd. as one of the comparables for the immediately

preceding year. Once a company is considered as comparable in an earlier

year and there is nothing to justify shift from such stand, no change can be

                                     32
                                                             ITA No.1379/Del/2011


permitted in so far as inclusion of such company in the list of comparables

for the succeeding year is concerned. The ld. AR argued that Bajaj Auto

Ltd. was mainly involved in the sale of three wheelers, whereas the

assessee was exclusively dealing in two wheelers. We have perused the

Annual accounts of this company, a copy of which has been placed on

record by the ld. AR. It is manifest from such Annual accounts that the

sales of two wheelers is roughly 90% of total sales of this company. In

view of the fact that the assessee itself treated Bajaj Auto Ltd., as

comparable for the preceding year and the contention about the pre-

dominant sale of this company in the three wheeler segment has turned out

to be incorrect, we see no justifiable reasons in overruling the view taken

by the TPO in considering Bajaj Auto Ltd. as comparable, which is hereby

affirmed. This contention of the ld. AR on this aspect is repelled.

13. Our above directions will facilitate the computation of profit margin

of the assessee and those of comparables.

14.   Now, we come to the remaining two international transactions,

namely, Purchase of motorcycle/scooter parts amounting to Rs.18.48 crore

                                     33
                                                              ITA No.1379/Del/2011


and Purchase of fixed assets amounting to Rs.21.37 crore, which the

assessee benchmarked by using TNMM as the most appropriate method.

As such, there can be no argument on the inapplicability of the TNMM on

these transactions because the TPO also did not deny the application of

TNMM as the most appropriate method. As such, we direct the TPO to

determine ALP of the first transaction of the Purchase of motorcycles and

scooter parts, etc. in the light of the operating profit margin of the assessee

and that of comparables as determined in the light of our above directions.

If the difference between two margins breaches the safe harbor rule, then,

the addition on account of TP adjustment should be made.

15.1.   Coming to the international transaction of Purchase of fixed asset,

it is seen that the assessee recorded it at Rs.21.37 crore and showed it as

ALP under the TNMM.            We have laid down the mechanism for

computation of ALP of such transaction under the TNMM by directing the

way in which the profit margin of the comparables and the assessee should

be computed. The TPO should apply the recalculated profit margin of the

assessee and comparables to the value of this international transaction. If


                                      34
                                                              ITA No.1379/Del/2011


the result crosses the permissible percentage, then the additional amount

would go to affect the value of fixed assets.


15.2.   It is noted that the TPO proposed the transfer pricing adjustment on

this score by considering the value of the transaction and then applying the

differential profit rate of 7.12% on such value. In other words, the addition

has been made on the value of international transaction of the purchase of

fixed assets. The ld. AR contended that the TPO was not justified in

proposing the transfer pricing adjusting w.r.t. the value of purchase of

fixed assets. It was argued that only the depreciation element of such

adjusted value of the international transaction of purchase of fixed assets

would call for adjustment to the operating profits.


15.3.   Section 92B gives the meaning of an `international transaction'.

Sub-section (1) provides that : `For the purposes of this section and

sections 92, 92C, 92D and 92E, "international transaction" means a

transaction between two or more associated enterprises, either or both of

whom are non-residents, in the nature of purchase, sale or lease of tangible

or intangible property, or provision of services, or ........'. The Explanation
                                      35
                                                             ITA No.1379/Del/2011


below sub-section (2) inserted by the Finance Act, 2012 w.r.e.f. 1.4.2002

clarifies, for the removal of doubts that-- (i) the expression "international

transaction" shall include-- (a) the purchase, sale, transfer, lease or use of

tangible property including building, transportation vehicle, machinery,

equipment, tools, plant, furniture, commodity or any other article, product

or thing. In view of the above plain and unambiguous language of the

provision read with its Explanation, it is abundantly clear that the purchase

of fixed asset is also an international transaction. The moot question is

whether the difference in the value of such international transaction and its

ALP would call for making a transfer pricing adjustment. In our

considered opinion, the answer to this question has to be given in negative.

The main substantive provision of the Chapter­X of the Act is section 92,

which provides through sub-section (1), that any income arising from an

international transaction shall be computed having regard to the ALP. To

put it simply, section 92 is not a charging but a procedural provision for

recomputing the income arising from an international transaction having

regard to its ALP. Before applying the mandate of this provision, it is of

utmost importance that there should be some existing income chargeable to
                                      36
                                                             ITA No.1379/Del/2011


tax, which is sought to be recomputed having regard to its ALP. If there is

an international transaction which in itself gives rise to income that is

chargeable to tax, then its ALP shall constitute a basis for making of

addition on account of difference between the assigned value and ALP of

such international transaction as per the relevant provisions. But if there is

an international transaction in the capital field, which does not otherwise

give rise to any income in itself, then even though its ALP may be

computed in consonance with the provisions, but no adjustment can be

made for the difference between the declared value and the ALP of such

international transaction. At the same time, it does not mean that the

computation of the ALP of such an international transaction in the capital

field is just a ritual and should not be embarked upon. In fact, such a

computation is necessary because of the impact of such a transaction of

capital nature on the transactions of its revenue offshoots. In our present

context, the international transaction of purchase of fixed assets is required

to be benchmarked as per the most appropriate method. The application of

the ALP, if required, will give rise to the recomputation of the revised

value of the purchase of fixed assets. Such an increase in the value of the
                                      37
                                                             ITA No.1379/Del/2011


fixed assets, being a capital transaction in itself, will not give rise to any

addition towards transfer pricing adjustment, but the depreciation on such

assets, being a revenue offshoot of the capital transaction, will be required

to be recomputed on such revised value. Ergo, we set aside the addition

made by the TPO due to the determination of the ALP of the international

transaction of purchase of fixed assets and direct that the depreciation on

such fixed assets be computed on the adjusted value, if permissible, as per

the relevant provisions. Needless to say, the assessee will be allowed a

reasonable opportunity of being heard in such fresh proceedings.

16.1.     Ground no. 4 of the assessee's appeal is against allowing

depreciation on Moulds used in plastic goods factory at Rs.1.35 crore as

against Rs.2.37 crore claimed by the assessee.

16.2.   Briefly stated, the facts of this ground are that the assessee claimed

depreciation @ 30% and 50% on moulds used in plastic goods factories.

The AO restricted such rate of depreciation to 15% by considering the

view taken by him in earlier years. The assessee is aggrieved against the

reduction in the amount of depreciation due to application of a lower rate.


                                      38
                                                              ITA No.1379/Del/2011


16.3.   After considering the rival submissions and perusing the relevant

material on record, it is noticed that the AO reduced the depreciation rate

on plastic moulds by following the view taken by him in the preceding

years. Neither the ld. AR nor the ld. DR could specifically point out the

fate of such addition in the earlier years, inasmuch as whether the assessee

accepted such addition or if assailed, then the final view taken by the

Tribunal in the preceding years on this issue. As such, we set aside the

impugned order on this issue and remit the matter to the file of AO for

deciding it in conformity with the final view taken in the earlier year.

17.1.   The last effective ground is against the disallowance of Sales tools

expenses amounting to Rs.1,00,22,142/-. The assessee claimed deduction

for the above sum as Sales tools expenses on account of auto spare parts

traded. Following the view taken in the earlier years, the AO disallowed

this amount.

17.2.    We have heard the rival submissions and perused the relevant

material on record. It is observed that position on this issue is again similar

to that of the immediately preceding issue inasmuch as neither the ld. AR

                                      39
                                                                   ITA No.1379/Del/2011


nor the ld. DR is aware of the final position on this issue in the earlier

years. We, therefore, set aside the impugned order on this score and remit

the matter to the file of AO for deciding it in consonance with the final

view taken on it in earlier years.

18.       In the result, the appeal is allowed for statistical purposes.

          The order pronounced in the open court on 13.04.2015.

                Sd/-                                            Sd/-

[GEORGE GEORGE K.]                                    [R.S. SYAL]
 JUDICIAL MEMBER                                  ACCOUNTANT MEMBER


Dated, 13th April, 2015.
dk
Copy forwarded to:
     1.   Appellant
     2.   Respondent
     3.   CIT
     4.   CIT (A)
     5.   DR, ITAT

                                                        AR, ITAT, NEW DELHI.




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