IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : I : NEW DELHI
BEFORE SHRI R.S. SYAL, AM AND SHRI A.T. VARKEY, JM
ITA No.3883/Del/2010
Assessment Year : 2006-07
Claas India Pvt. Ltd., Vs. DCIT,
A-39, First Floor, Circle-3(1),
New Friends Colony, New Delhi.
New Delhi.
PAN: AAACE0762A
(Appellant) (Respondent)
Assessee By : Shri S.P. Singh, CA,
Shri Manomeet Dalal, Advocate &
Shri Vishnu Goel, Advocate
Department By : Shri Amrendra Kumar, CIT, DR &
Ms Y. Kakkar, Sr.DR
Date of Hearing : 10.08.2015
Date of Pronouncement : 12.08.2015
ORDER
PER R.S. SYAL, AM:
This appeal by the assessee arises out of the final order dated
15.6.2010 passed by the Assessing Officer (AO) u/s 143(3) read with
ITA No.3883/Del/2010
section 144C of the Income-tax Act, 1961 (hereinafter also called `the
Act') in relation to the assessment year 2006-07.
2. The first two grounds are general which do not require any specific
adjudication. The ld. AR did not press these grounds as well. These
grounds, therefore, stand dismissed.
3. Ground no. 3 has three parts. The first part is against some of the
aspects relating to the computation of the Profit Level Indicator (PLI),
being, the Operating Profit/Total Cost (OP/TC) of the assessee.
4. Briefly stated, the facts of the case are that the assessee was
established as an Indian company in 1990 as a wholly owned subsidiary
of a Claas KGaA mbH, Germany. Until 31.8.2002, the assessee was
known as Escorts Claas Ltd., with 60:40 joint venture between Escorts
India Ltd., and Claas, Germany. Thereafter, the entire shareholding was
acquired by Claas, Germany. The assessee's main activity is
manufacture and sale of harvester combines in India and export of
harvester combines and engine harvester combines and engine related
products, licensed by Claas Group. The assessee manufactures two
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types of harvester combines, namely, wheel based and track based.
Certain international transactions were reported by the assessee
including purchase of raw materials and components; sale of harvesters
and spare parts; Import of computer; payment for services; and
allocation of cost. To demonstrate that its international transactions
were at arm's length price (ALP), the assessee applied the Transactional
Net Margin Method (TNMM) as the most appropriate method with the
Profit Level Indicator (PLI) of Operating Profit/Total Cost (OP/TC). All
the international transactions were aggregated and a combined OP/TC
was computed. The first dispute is against the Advances written off,
Fixed assets written off and Loss on foreign exchange, treated by the
TPO as operating costs as against non-operating costs claimed by the
assessee.
5. We have heard the rival submissions and perused the relevant
material on record. The first item is `Advances written off' amounting
to Rs.1,56,007/-. This amount finds place under Schedule-B
(Administrative and other expenses) in the assessee's Profit and loss
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account. The assessee treated this amount as non-operating in the
calculation of its OP/TC. The TPO held it to be an operating cost. On a
pertinent query, it was admitted by the ld. AR that the Advances so
written off were given in relation to trading items. Like debts becoming
bad from the sale of goods assuming the character of operating cost, the
advances given in relation to trading items, becoming non-recoverable,
also cannot be considered as anything other than an item of operating
cost. In our considered opinion, such amount has rightly been
considered as an operating cost.
6. In so far as the Fixed assets written off are concerned, we find that
the amount of Rs.3,84,196/- is distinct from the amount of depreciation
claimed by the assessee at Rs.1.45 crore. This represents a loss on the
fixed assets which has been written off. The purchase of fixed assets is
capital expenditure. As such, the amount of fixed assets when written
off, otherwise than by depreciation, falls for consideration as an item of
non-operating cost. We, therefore, accept the assessee's contention for
treating this sum of Rs.3,84,196/- as non-operating.
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7. The third item is loss on foreign exchange amounting to
Rs.31,22,119/-. On a pertinent query, it was admitted by the ld. AR that
this loss relates to trading transactions.
8. We find merit in the contention raised on behalf of the assessee
about the inclusion of foreign exchange gain/loss in the operating
revenue/costs of the assessee as well as that of the comparables. When
we advert to the nature of such foreign exchange gain earned by the
assessee, it has been admitted by the ld. AR that the same is in relation
to the trading items emanating from the international transactions. When
the foreign exchange loss directly results from the trading items, we fail
to appreciate as to how such foreign exchange fluctuation loss can be
considered as non-operating.
9. The Special Bench of the Tribunal in ACIT Vs Prakash I. Shah
(2008) 115 ITD 167 (Mum)(SB) has held that the gain due to fluctuations
in the foreign exchange rate emanating from export is its integral part
and cannot be differentiated from the export proceeds simply on the
ground that the foreign currency rate has increased subsequent to sale
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but prior to realization. It went on to add that when goods are exported
and invoice is raised in currency of the country where such goods are
sold and subsequently when the amount is realized in that foreign
currency and then converted into Indian rupees, the entire amount is
relatable to the exports. In fact, it is only the translation of invoice value
from the foreign currency to the Indian rupees. The Special bench held
that the exchange rate gain or loss cannot have a different character from
the transaction to which it pertains. The Bench found fallacy in the
submission made on behalf of the Revenue that the exchange rate
difference should be detached from the exports and be considered as an
independent transaction. Eventually, the Special Bench held that such
exchange rate fluctuation gain/loss arising from exports cannot be
viewed differently from sale proceeds.
10. In the context of transfer pricing, the Bangalore Bench of the
Tribunal in SAP Labs India Pvt. Ltd. Vs ACIT (2011) 44 SOT 156
(Bangalore) has held that foreign exchange fluctuation gain is part of
operating profit of the company and should be included in the operating
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revenue. Similar view has been taken in Trilogy E Business Software
India (P) Ltd. Vs DCIT (2011) 47 SOT 45 (URO) (Bangalore). The
Mumbai Bench of the Tribunal in S. Narendra Vs Addtl. CIT (2013) 32
taxman.com 196 has also laid down to this extent. In view of the
foregoing discussion, we are of the considered opinion that the amount
of foreign exchange gain/loss arising out of revenue transactions is
required to be considered as an item of operating revenue/cost, both of
the assessee as well as comparables. We, therefore, hold that the AO
was justified in considering forex loss as operating cost as against the
assessee's claim of non-operating cost.
11. The second component of the first ground is against the
computation of transfer pricing adjustment in respect of transaction with
Associated Enterprises (AEs) and non-AEs. Computation of the arm's
length price (ALP) by the TPO on the penultimate page of his order
divulges that he took total costs at Rs.54,72,86,629/-. By applying
arithmetic mean of the comparables at 12.25%, he proposed a transfer
pricing adjustment of Rs.3,12,57,833/-. The ld. AR contended that no
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transfer pricing adjustment is possible in respect of transactions with
non-AEs.
12. It is uncontroverted, as is also apparent from the TPO's order, that
the transfer pricing adjustment has been made by considering the total
costs incurred by the assessee in respect of transactions with the
associated enterprises (AE) and non-AEs. An addition towards transfer
pricing adjustment is made by comparing the assessee's profit rate from
the international transaction with that of comparable uncontrolled
transactions. Under the TNMM, the process is simple in initially finding
out the operating profit margin of the assessee and then the average
adjusted operating profit margin of comparable cases. Such adjusted
profit margin of the comparables constitutes benchmark margin, which
is then compared with the operating profit margin from the assessee's
international transactions with its AE. It is not permissible to make
transfer pricing adjustment, by applying the average operating profit
margin of the comparables, on the assessee's universal transactions
entered into with both the AEs and non-AEs. As the entire exercise
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under Chapter-X is confined to computing total income of the assessee
from international transactions having regard to the arm's length price,
there is no scope for computing income from non-international
transactions having regard to the ALP. As the TPO has computed the
transfer pricing adjustment qua all the transactions carried out by the
assessee with reference to the base of `total costs', also inclusive of
costs relevant for transactions with non-AEs, we vacate the impugned
order on this issue and restore the matter to the file of the TPO/AO for
recalculating the amount of addition of transfer pricing adjustment by
taking into consideration the international transactions only under this
segment, to the exclusion of transactions with non-AEs. Needless to say
the assessee will be allowed a reasonable opportunity of being heard.
13. The third component of this ground is against not considering
operating profit margin from internal comparables in computing the
ALP of international transactions. The ld. AR was fair enough to
concede that this issue was not taken up before the TPO. However, our
attention was drawn towards the objections taken before the Dispute
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Resolution Panel, relevant part of which is available on page 82 of the
paper book, contending that the internal comparables be also taken into
consideration. The direction given by the DRP is silent on this issue.
14. Clause (i) of Rule 10B(1)(e) stipulates that the net profit margin
from an international transaction with an AE is computed in relation to
cost incurred or sales effected or assets employed etc. Clause (ii) is
material for the present purpose. It provides that the net profit margin
realized 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. On splitting clause (ii) into
two parts, it divulges that the reference is made to internal and external
comparables. One part of clause (ii) refers to 'the net profit margin
realised by the enterprise .... from a comparable uncontrolled transaction'
and the other part talks of 'the net profit margin realised .... by an
uncontrolled enterprise from a comparable uncontrolled transaction'. It
transpires that whereas the first part refers to the profit margin from
internal comparable uncontrolled transactions, the second part refers to
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profit margin from an external comparable uncontrolled transaction.
Thus it is discernible that what is to be compared under this method is
the profit from a comparable uncontrolled transaction. The word
'comparable' may encompass internal comparable as well as external
comparable. There is a signal in the rule itself as to preference to be
given to internal comparable uncontrolled transactions vis-à-vis external
comparable uncontrolled transactions. It is because the delegated
legislature has firstly referred to the net profit margin realized by the
enterprise (internal) from a comparable uncontrolled transaction and,
thereafter, it points out towards the net profit margin realized by an
unrelated enterprise (external) from comparable uncontrolled
transaction. Thus where a potential comparable is available in the shape
of an uncontrolled transaction of the same assessee, it is likely to have
higher degree of comparability vis-a-vis the comparables identified
amongst the uncontrolled transactions of third parties. The underlying
object behind the computation of the ALP of an international transaction
is to find out the profit which such enterprise would have earned if the
transaction had been with some third party instead of related party.
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When the data is available showing profit margin of that enterprise itself
realized from a third party, it is advisable to have recourse to an
internally comparable uncontrolled transaction. The reason is patent that
the various factors having bearing on the quality of output, assets
employed, input cost etc. continue to remain, by and large, same in case
of an internal comparable. The effect of difference due to such inherent
factors on comparison made with the third parties, gets neutralized when
comparison is made with internal comparable. Ex consequenti, it follows
that an internal comparable uncontrolled transaction is more noteworthy
vis-a-vis its counterpart i.e. external comparable. However, the caveat is
that the internal transaction sought to be compared with should, in fact,
be comparable in a proper manner. Various Benches of the Tribunal
have repeatedly held that internal comparables should be preferred over
external comparables, if these are actually comparables. The Mumbai
bench of the tribunal in Gharda Chemicals Ltd. vs. DCIT (2010) 130
TTJ (Mumbai) 556 has held that internal comparables should be
preferred over the external comparables. Similar view has been taken by
the Pune Bench of the Tribunal in ACIT vs. MSS India (P) Ltd. (2009)
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123 TTJ Pune 657. Since this issue was not taken up before the TPO
and the DRP has not given any finding on specific objection taken
before it in this regard, we are of the considered opinion that the ends of
justice would meet adequately if the impugned order on this score is set
aside and the matter is restored to the file of the TPO/AO with a
direction to decide this issue afresh, as per law, after allowing a
reasonable opportunity of being heard to the assessee.
15. The only other ground which survives in this appeal is against
confirmation of disallowance of Rs.72,92,082/- on account of expenses
incurred for improving the existing product.
16. Both the sides are in agreement that the facts and circumstances of
this ground are mutatis mutandis similar to ground no. 3 of the
assessee's appeal for the AY 2005-06. Vide our separate order passed
for the said earlier year, we have accepted the assessee's claim in this
regard by relying on an earlier order passed by the Tribunal in the
assessee's own case for the AY 2007-08. This ground is, therefore,
allowed. In view of our decision on ground no. 3 in favour of the
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assessee, ground no. 4 taken up in the memorandum of appeal, has
become infructuous. The same is therefore, dismissed.
17. In the result, the appeal is partly allowed.
The order pronounced in the open court on 12.08.2015.
Sd/- Sd/-
[A.T. VARKEY] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 12th August, 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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