We reject the learned Departmental Representative’s contention that adjustment arising our of ALP has to be made on the entire turnover instead of restricting the same to the international transaction with the A.E. This again is against the spirit of law as envisaged in section 92 which provides that “any income arising from an international transaction shall be computed having regard to the ALP”.
Thus, the ALP has to be on international transaction and not in relation to assessee’s entire sales/turnover. The second proviso to section 92C, though brought in statute by the Finance Act, 2009, w.e.f. 1st October 2009, provides that “if the variation between ALP so determined and the price at which international transaction has actually been undertaken shall be deemed to be the ALP”, however, the same is indicative of the preposition that the ALP is to be determined only on international transaction.
This, inter-alia, means that the statute itself provides that the adjustment arising out of ALP should be with regard to international transaction and not on the entire turnover of the assessee. The transfer pricing mechanism revolves around international transaction where it has to be seen whether such transactions are at arm’s length price or not. The presumption is that transactions with the independent parties are always at arm’s length price, however, it is with regard to related parties i.e., A.Es, only one has to see whether such a transaction is at arm’s length. The profit margin from the international transaction with the A.E. has to be seen in relation to the uncontrolled transaction with the independent parties. What is to be compared is the international transactions of the assessee with its related parties and not for its entire transaction with non-related parties also. Therefore, ALP has to be seen only with regard to international transaction with A.Es and not on the entire turnover/sales.
IN THE ITAT MUMBAI BENCH ‘K’
Ratilal Becharlal & Sons
v.
Joint Commissioner of Income-tax, Range – 18(3)
IT APPEAL NO. 7876 (MUM.) OF 2011
Assessment Year 2007-08
Date of Pronouncement – November 7, 2012
ORDER
Per Bench – The present appeal preferred by the assessee, is directed against the final impugned assessment order dated 21st October 2011, which has been passed in pursuance of the directions given by the Dispute Resolution Panel-II (for short “DRP”) under section 144C(5) of the Income Tax Act, 1961 (for short “the Act”) for the quantum of assessment for A.Y. 2007-08.
2. In grounds no.1 to 6, the assessee has challenged the addition/adjustment of Rs. 3,70,87,177, towards Arm’s Length Price (for short “ALP”) in respect of its transactions with Associate Enterprises (for short “A.E”) amounting to Rs. 49,8100,499, during the year.
3. Brief facts of the case are that the assessee is a partnership firm engaged in the business of manufacturing and sale of cut and polished diamonds, which are being exported. During the year, the assessee had gross sales of Rs. 464,90,63,687, as against this, the sales to A.E. amounted to Rs. 49,81,00,499. The assessee had disclosed its net profit to the cost ratio of 4.86%. The profit level indicator (for short “PLI”) was worked out by taking net profit before tax and excluding non-operating expenditure like debtors written-off, final cost and non-operating income. The final profile of the assessee vis-a-vis the A.E. transactions and non-A.E. transaction and the net profit during the year were as under:-
Particulars
A.Es (Rs.)Total (Rs.)Sales (A) 49,81,00,499
Non A.Es (Rs.) 4,15,09,63,188
Sales (Rs.) 4,6,490,63,687
Operating Expenses * (B) excluding non-operating expenses (debtors written-off) financial costs (interest and finance charges)
47,50,24,604
3,95,86,58,237
4,43,36,82,841
Net Profit (C) (A-B)
2,30,75,895
19,23,04,951
21,53,80,846
Net profit as a % of expenses (C/B)
4.86%
4.86%
4.86%
4. Since the assessee had international transactions with the A.E. for more than Rs. 15 crores, the matter was referred to the Transfer Pricing Officer (for short “TPO”) under section 92CA(1) for determining the ALP of the international transactions. In the T.P study report, the assessee has adopted “Transactional Net Margin Method” as most appropriate method for determining its ALP of international transaction. It had used six comparable companies for bench marking its ALP on international transactions. However, out of six, the TPO rejected three comparables on the ground that their related party transactions were either more than 15% or turnover was more than Rs. 1,500 crores. Thereafter, the TPO introduced his set of fresh nine comparables to bench mark the ALP of international transaction of the assessee. The arithmetic mean of the PLI of the 12 comparable companies (three of assessee and nine of TPO) worked out to 5.34%.
5. Before the DRP, the assessee had made detail objections which were rejected and the order of the TPO for adopting the comparable companies and the margin of 5.34% so arrived at were upheld.
6. Before us, the learned Counsel for the assessee, by way of preliminary ground, submitted that even if arithmetic means of operating profit margin of 12 comparable companies arrived at 5.34% is applied on assessee’s international transaction, then the same falls within the safe harbour of +/- 5% in view of the proviso to section 92C(2). His furtehr objection was that the adjustment arising out of ALP should not have been made on the entire turnover of the assessee, instead it should have been restricted to international transactions with the A.E., because sales to non-A.E. comprised of 89% of the entire sales. To demonstrate that the ALP determined by the TPO and as shown by the assessee falls within +/- 5%, the learned Counsel submitted the following working which for the sake of ready reference is reproduced herein below:-
Particulars
A.Es (Rs.)
Non A.Es (Rs.)
Total (Rs.)
Sales (A)
49,81,00,499
41,509,63,188
4,64,90,63,687
Operating Expenses * (B)
47,50,24,604
3,95,86,58,237
4,43,36,82,841
Net Profit (C) (A-B)
23,075,895
19,23,04,951
21,53,80,846
Net profit as a % of expenses (C/B)
4.86%
4.86%
4.86%
Arms Length Profit Level Indicator (PLI) determined by the Tax authorities
5.34%
5.34%
5.34%
Arms Length Profit with PLI of 5.34%
2,54,51,635
21,21,03,383
23,75,55,018
Arm’s Length Sales as computed by tax authorities
50,20,74,018
4,18,40,76,846
4,68,61,50,864
Difference in transactions price and arm’s length price
39 73,519
3,31,13,658
3,70,87,177
Range of Arms Length Sales considering 5% variation from ALP
+5%
527,177,718.58
-5%
476,970,316.81
7. Further, the learned Counsel, in support of his contentions that adjustment of ALP has to be made on international transaction with A.Es only and not on entire turnover, referred and relied upon the following case laws:-
• Petro Araldite P. Ltd., ITA no.3531/Mum./2009;
• T. Two International P. Ltd., ITA no.5644/Mum./2008, Tera Jewels Exports P. Ltd. ITA no.5646/Mum./2008 and Tara Ultimo P. Ltd.;
• Huntsman Advanced Materials (I) P. Ltd., ITA no.8237/M./2010;
• SMCC Construction India Ltd., ITA no.4333/Del./2009.
8. Besides this, he also made detail submissions on the merits of various comparable companies adopted by the TPOs and the adjustment made in ALP.
9. On the other hand, the learned Departmental Representative, relying upon the order of the TPO as well as the directions of the DRP submitted that the international transaction of the assessee were on income side as well as on expenditure side and the assessee has bench marked its international transaction at the entity level. He submitted that the ALP of the transaction with A.E. has to be computed as per the provisions of the Act and the law does not required computing of ALP of the transaction with independent parties because there is an inherent presumption that the transaction with independent parties should always be at ALP. So, the transactions with the independent parties are at arm’s length and the margin of the assessee’s company is down because of the transaction with the A.E. Therefore, margin from the independent transaction and international transaction cannot be computed separately unless the margin is applied on the entity level. He submitted that the adjustment made by the TPO is justified. On the basis of his argument, he also gave his computation of ALP in the following manner:-
Figures in Rs.
Total
A.E Transaction Non-A.E. Transaction
Sales of the assessee since non-A.E. transactions are at arm’s length hence apply the arm’s length margin i.e., 5.34% to arrive at the cost
4,64,90,63,687
A
49,81,00,499
4,15,09,63,188
Cost
4,44,85,95,846
B
50,80,57,410
3,94,05,38,436
Apply the arm’s length margin on the cost used to earn the A.E. sales
C
2,71,30,266
Arm’s length price of sales made to the A.Es
D=B+C
53,51,87,676
Difference of ALP and the price at which the international transaction has taken place
E=D-A
3,70,87,177
95% of Arm’s Length Price
50,84,28,292
10. We have carefully considered the rival contentions of the parties, perused the material available on record with regard to the preliminary objection raised by the learned Counsel. Admittedly, the assessee’s net profit to the cost ratio with its A.E. transactions was at 4.86% and also for the entire turnover. The TPO, after taking set of 12 comparables to bench mark the ALP of international transactions of the assessee, has taken the arithmetic mean of PLI of 12 comparables at 5.34%. We have to basically examine as to whether the adjustment in ALP, falls within safe harbour of +/- 5% or not. Section 92C provides that the assessee’s ALP along with price in relation to international transactions shall be determined by following any of the methods, being the most appropriate method having regard to the nature of transaction and the most appropriate method should be applied for determining of ALP. The proviso to section 92C(2) provides that where more than one price is determined by the most appropriate method, the ALP shall be taken to be the arithmetical mean of such price or at the option of the assessee a price which may vary from arithmetic mean by an amount not exceeding 5% of such arithmetical mean. The basic philosophy and concept behind the proviso is that in transfer pricing, there cannot be exact determination of ALP as there are lot of factors and variables in coming to a proper judgment. The use of range of 5% in the results reduces the effect of difference in the controlled and un-controlled transactions. The CBDT, vide Circular no.12/2001 dated 23rd August 2001, laying down the guidelines for applying the newly introduced transfer pricing regime stated as under:-
“However, this is a new legislation. In the initial years of its implementation, there may be room for different interpretations leading to uncertainties with regard to determination of arm’s length price of an international transaction. While it would be necessary to protect our tax base, there is a need to ensure that the taxpayers are not put to avoidable hardship in the implementation of these regulations.”
In the background, the Board has decided the following:
“(i) The Assessing Officer shall not make any adjustment to the arm’s length price determined by the taxpayer, if such price is up to 5% less or up to 5% more than the price determined by the Assessing Officer. In such cases the price declared by the taxpayer may be accepted.”
This concept was given statutory form in the Finance Act, 2002, by providing the proviso to section 92C(2). Thus, the statute itself recognises that if the variation between ALP so determined and the price at which international transaction has been undertaken variation of arithmetic mean should be within tolerable range of +/- 5%.
11. The application of +/- 5% to the ALP can be demonstrated by way of following illustration:-
Non A.Es
Total
Operating expenditure attributable to A.E. – sales
Rs. 100
Net profit of assessee from A.E. – sales
Rs. 4.51
Operating profit % of the assessee
4.51%
A.E. sales
Rs. 104.51
If AE PLI as determined by the TPO is taken at 5.34% then arm’s length sales would be.
Rs. 105.34
Thus, the difference in transaction price and ALP would be Rs. 105.34 (-)Rs. 104.51 =
0.83
Range of AE sales considering 5% variation from ALP
+5% of Rs. 105.34
Rs. 110.61
-5% of Rs. 105.34
Rs. 100.07
Thus, +/- 5% range falls between Rs. 100.07 to Rs. 110.61 and accordingly, Rs. 104.51 is within the range.
12. Now, going by the computation as submitted by the learned Counsel, we find that the A.E. sales as computed by the TPO, after applying 5.34% comes to Rs. 50,20,74,018, whereas assessee’s sales to A.E. is Rs. 49,81,00,499. Going by safe harbour of 5% variation, +5% comes to Rs. 52,71,77,719 and -5% comes to Rs. 47,69,70,317. Thus, the assessee’s ALP falls within safe harbour of +/-5% of the ALP determined by the Assessing Officer. Insofar as the calculation submitted by the learned Departmental Representative is concerned, we do not find any merits in the said calculation in view of our analysis given above.
13. Further, we also reject the learned Departmental Representative’s contention that adjustment arising our of ALP has to be made on the entire turnover instead of restricting the same to the international transaction with the A.E. This again is against the spirit of law as envisaged in section 92 which provides that “any income arising from an international transaction shall be computed having regard to the ALP”. Thus, the ALP has to be on international transaction and not in relation to assessee’s entire sales/turnover. The second proviso to section 92C, though brought in statute by the Finance Act, 2009, w.e.f. 1st October 2009, provides that “if the variation between ALP so determined and the price at which international transaction has actually been undertaken shall be deemed to be the ALP”, however, the same is indicative of the preposition that the ALP is to be determined only on international transaction. This, inter-alia, means that the statute itself provides that the adjustment arising out of ALP should be with regard to international transaction and not on the entire turnover of the assessee. The transfer pricing mechanism revolves around international transaction where it has to be seen whether such transactions are at arm’s length price or not. The presumption is that transactions with the independent parties are always at arm’s length price, however, it is with regard to related parties i.e., A.Es, only one has to see whether such a transaction is at arm’s length. The profit margin from the international transaction with the A.E. has to be seen in relation to the uncontrolled transaction with the independent parties. What is to be compared is the international transactions of the assessee with its related parties and not for its entire transaction with non-related parties also. Therefore, ALP has to be seen only with regard to international transaction with A.Es and not on the entire turnover/sales.
14. Thus, in our conclusion, we hold that in the present case, the value of international transaction of the assessee falls within safe harbour of +/- 5% of the ALP determined by the TPO. Accordingly, on this preliminary ground alone, the adjustment of Rs. 3,70,87,177 made towards ALP by the Assessing Officer is uncalled for and the same is hereby deleted. Thus, grounds no.1 to 6, raised by the assessee are allowed.
15. In ground no.7, the assessee has challenged disallowance of expenditure on computer software.
16. The DRP, on assessee’s objection, has observed and held as under:-
“3. Objection no.2: Objection number 2 pertains to the A.O. having erred in making a disallowance of legal and professional charges paid for software consulting by erroneously holding that the same was towards development of software. Without prejudice, it was argued that in not allowing depreciation on the same, if the same was in the nature of software. It is submitted by the assessee that a sum of Rs.372361 was shown as legal and professional fee towards software consultancy charges paid to various parties. In so far as the payments to Systems and Software Enterprises of rupees 140000 was concerned this was for AMC for existing software and therefore allowable revenue expense. In so far as the payments to Gunvantrai Kaku and Nirav Kaku are concerned these were for maintenance of software and the other recharges (in 2 party names) were in the nature of software maintenance and not for development of any new software. Assessee states that the AO has mistakenly construed that the amount debited were arising out of an agreement for development of software and also erred in treating monthly consultation fee as expenses on development of software.
3.1 Submissions made have been considered. We find that the assessee’s argument of AMC for maintenance of software is reasonable. We accordingly, direct the AO to verify the bills/payment vouchers in respect of the disallowance under this head. If it is found that the payment is rot for development or up gradation of the software but in the nature of AMC/maintenance then such expenditure would be considered allowable as revenue expenditure. Remaining expenditure, if any, would be capitalized and depreciation allowed as per Income Tax Rules.”
17. Before us, the learned Counsel for the assessee submitted that the assessee had debited a sum of Rs. 3,72,361 to legal and professional fees towards software consultancy charges paid as under:-
Systems & Software Enterprises
Rs. 140,000
Nirav Kaku
Rs. 150,040
Gunvantrai Kaku
Rs. 37,821
Subodh Chogle
Rs. 37,500
Keshavkant Dwivedi
Rs. 7,500
18. He clarified that the assessee uses various software for its operations and was also in the process of getting new software. The payments made to Systems and Software (“S&S”) were towards maintenance of existing software. S&S was also developing other software and the payments made for that purpose were shown as advances given. The payments to Nirav and Gunvantrai Kaku were also monthly charges paid for maintenance of software. The other charges were also in the nature of software maintenance and were not for the development of any new software. The expenses have to be looked at in line with the general distinction between capital and revenue to decide whether the expenses were towards creation of new software or towards regular maintenance of existing software. The Assessing Officer has merely treated the entire sum as being in the nature of expense incurred on creating software.
19. On the other hand, the learned Departmental Representative relied upon the DRP’s directions.
20. After having carefully considered the rival contentions of the parties, and the findings of the DRP, we find that insofar as the directions on account of AMC for maintenance of software given by the DRP is concerned, the same appears to be very reasonable and no interference is called for. However, with regard to the other expenditure, the Assessing Officer is directed to verify this contention of the assessee in the light of the decision of the Special Bench of the Tribunal, Delhi, rendered in Amway India Enterprises v. DCIT, [2008] 111 ITD 112 (Del.). Thus, this ground is partly allowed for statistical purposes.
21. In ground no.8, the assessee has challenged the disallowance of depreciation on laptop purchased.
22. After hearing both the parties, we find that the assessee, before the Assessing Officer as well as before the DRP,
submitted that it has purchased a laptop worth Rs. 98,696, through credit card, however, no other evidences were produced like purchase invoice, etc. The assessee was also required to produce other circumstantial evidences like warranty details, etc. The assessee, however, could not file any such evidence. In view of these facts, the DRP rejected the assessee’s objection. Before us also, the learned Counsel for the assessee could not produce evidence for purchase of laptop. Thus, in view of the reasons given by the Assessing Officer, we do not find any merit in the contention of the assessee and the same is dismissed. Thus, ground no.8, is dismissed.
23. In the result, assessee’s appeal is partly allowed for statistical purposes.
CAclubindia
