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
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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
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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%
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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
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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
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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
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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
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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
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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
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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.
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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,
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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,
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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
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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
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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.
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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
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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.
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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."
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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
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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
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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.
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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
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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
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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.
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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.
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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
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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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