ITAT Bangalore Bench Case regarding differences in activities of assessee and appropriate TP adjustment

2012-ITS-2918-ITAT-Toyota Kirloskar Motors (P.) Ltd. -Vs- Assistant Commissioner of Income-tax, Circle 12(3), Bangalore* , On. NOVEMBER 22, 2012

IN THE ITAT BANGALORE BENCH ‘B’

Toyota Kirloskar Motors (P.) Ltd.

v.

Assistant Commissioner of Income-tax, Circle 12(3), Bangalore*

GEORGE GEORGE K, JUDICIAL MEMBER AND JASON P. BOAZ, ACCOUNTANT MEMBER IT APPEAL NO. 828 (BANG.) OF 2010 [ASSESSMENT YEAR 2003-04]

NOVEMBER 22, 2012

Bottom line:- There may be variations/differences in activities of both assessee and comparables from year to year requiring appropriate TP adjustment

Padamchand Khincha for the Appellant. D. K. Gupta and Ajit Kumar Jain for the Respondent.

ORDER

Jason P. Boaz, Accountant Member – This appeal by the assessee-company is directed against the order of the Commissioner of Income Tax (Appeals)-IV, Bangalore dated 31.3.2010 for Assessment Year 2003-04.

2. The facts of the case, in brief, are as under :

2.1 The assessee-company (hereinafter referred to as ‘the assessee’) is an Indian company engaged in the manufacture and trading of automobiles – namely, passenger cars (Corolla) and Multi Utility Vehicles (Qualis). The major shareholder of the assessee is Toyota Motor Corporation, Japan (hereinafter referred to as ‘TMC’) with 74% foreign equity participation and Kirloskar Systems India Ltd ;with 26% holding. The assessee imports components for manufacture of automobiles from TMC and other group companies. TMC provides the assessee with technical know-how for which it is paid royalty and fees for technical assistance received.

2.2 The assessee filed its return of income for Assessment Year 2003-04 on 27.11.2003 declaring a loss of Rs.6,21,90,723. Along with the return of income the assessee filed the report as required under section 92E of the Income Tax Act, 1961 (herein after referred to as ‘the Act’). The return was processed under section 143(1) and the case was taken up for scrutiny by issue of notice under section 143(2) of the Act. The Assessing Officer referred the case to the Transfer Pricing Officer (TPO) under section 92CA(1) of the Act for conducting the Transfer Pricing audit to determine the Arms Length Price (ALP) in respect of the following international transactions of the assessee in the relevant period :

A. Manufacturing Segment
Sl. No.

International Transaction

Amount Rs.
1.

Purchase of components

362,51,10,000
2.

Sale of prototypes

33,73,008
3.

Purchase of capital goods

6,72,44,889
4.

Royalty Paid

37,57,21,640
5.

Software License Fees Paid

20,13,533
6.

Technical Assistance Fees Paid

12,58,42,778
7.

Trading & Development paid

19,94,075
8.

R & D paid

2,51,875
9.

Sales Promotion expenses paid

25,95,608
10.

Other expenses paid

1,40,448
11.

Return of recks received

23,49,817
12.

Expenses reimbursed at cost

10,56,914

B. Trading Segment
Sl.No.

International Transaction

Amount Rs.
1.

Purchase of automobiles & spares for resale.

44,27,00,000

2.3 The T.P. documentation of the assessee was prepared on a consolidated basis (at the entity/entreprise level), without segmentation between the manufacturing and trading/distribution business. The TPO called for segmental bench marking analysis, separately for manufacturing and distribution, which was provided by the assessee without prejudice to its contention that the assessee’s transactions had to be considered on an aggregated basis. In response to the economic analysis and bench marking study of the segmented financials of the assessee, the TPO issued a show cause notice to the assessee rejecting the customs duty and excise duty adjustments and making an operating expense adjustment. The TPO proposed an adjustment of Rs.196.09 Crores and required the assessee to show cause as to why the import prices of materials imported by the assessee from Associated Enterprises (AEs) should not be reduced to this extent.

2.4 The TPO, after considering the submissions filed by the assessee passed an order under section 92CA of the Act on 7.3.2006 computing the ALP of foreign transactions and proposing an adjustment of Rs. 196.09 Crores. This figure was arrived at by adopting the Transaction Net Margin Method (TNMM) after making adjustment of the profits of comparable companies on account of differences in ‘Operational efficiency’ and depreciation. In TNMM, the operative margin before depreciation has been compared. The TPO has opined that the margins were lower because of the fact that the price paid for the purchase of components from AE’s overstated. The adjustment was made to restate the purchase price at a lower figure than the reported figure by a sum of Rs.196.09 Crores. On receipt of the TPO’s order under section 92CA of the Act, the Assessing Officer passed the order of assessment for Assessment Year 2003-04 under section 143(3) of the Act on 28.3.2006 wherein –

(i) T.P. adjustment of Rs.196.09 Crores was made on account of the proposed adjustment to the ALP by the TPO.

(ii) The Assessing Officer also disallowed expenditure amounting to Rs.9,03,028 incurred on software, holding it to be capital in nature and allowed depreciation thereon.

2.5 Aggrieved by the order of assessment for Assessment Year 2003-04 dt.28.3.2006, the assessee went in appeal before the CIT (Appeals)-IV, Bangalore. The assessee also filed a letter seeking rectification under section 154 of the Act of the order of assessment including the TPO’s order under section 92CA of the Act. In the rectification application, the assessee contended that the international transactions of purchases with related parties constituted only 37% of the total purchases and therefore the adjustment under section 92CA of the Act on account of high material cost should have been restricted to the percentage of material purchased from Associated Enterprises (AE’s). The TPO vide order dt.31.8.2006 rejected the assessee’s rectification application. Aggrieved by the TPO’s order dt.31.8.2006 rejecting the rectification application under section 154 of the Act, the assessee filed an appeal before the CIT (Appeals).

2.6 The CIT (Appeals) disposed off the appeals against both assessment under section 143(3) dt.28.3.2006 and the order under section 154 of the Act by a common order dt.31.3.2010 upholding the adjustments made by the TPO. The learned CIT (Appeals) also directed the Assessing Officer/TPO to examine other items of expenditure incurred by the assessee such as capitalized value of car, discarding of dies and moulds of old models, loss on sale of assets and amortization of technical fees; whether these expenses are operating expenses or extraordinary expenses to be excluded from operating cost. In respect of expenditure incurred on software licenses, the learned CIT (Appeals) directed the Assessing Officer to ascertain the true nature of the software licenses and decide the question of deductibility of the said expenditure in the light of the decision of the Special Bench of the Delhi Tribunal in the case of Amway India Enterprises v. Dy. CIT [2008] 21 SOT 1 (Delhi)(SB).

3.0 Aggrieved by the order of the CIT (Appeals)-IV, Bangalore for Assessment Year 2003-04 dt.31.3.2010, the assessee is now in appeal before this Tribunal. The assessee initially filed elaborate grounds that were narrative and argumentative. However, subsequently it filed revised grounds of appeal on 21.9.2011 which are reproduced as under :

“A. The lower authorities (the learned Assessing Officer, learned Transfer Pricing Officer and learned Commissioner of Income Tax (Appeals-IV) have erred in

1. passing the order disregarding the principles of natural justice.

2. making a reference to Transfer Pricing Officer for determining arm’s length price.

3. not appreciating that the charging or computation provision relating to income under the head “Profits & Gains of Business or Profession” do not refer to or include the amounts computed under Chapter X and therefore addition under Chapter X is bad in law.

4. not appreciating that there being no disallowance under section 40A(2) for purchase of parts and components, adjustment under Chapter X ought not to be made.

5. passing the order without demonstrating the appellant had motive of tax evasion.

6. making transfer pricing adjustment for the year under consideration, although, the method adopted, the associated enterprises, the nature of transactions and the comparables were same as in the earlier years or subsequent years in which no similar adjustment had been made.

7. not appreciating that the value of the imported components having been accepted by the Customs Tribunal, the same therefore deserves to be accepted by the Income Tax Authorities also.

8. considering data which was not available to the appellant at the time of complying with the TP documentation requirements.

9. adopting a flawed methodology and process in arriving at the ALP.

10. not appreciating that the trading and manufacturing segments are intertwined and inter-related warranting a “Combined Transaction Approach” in arriving at the arm’s length price.

11. making a flawed adjustment on account of operational efficiencies in arriving at the ALP.

12. not excluding excise duty in sales and material cost while computing arm’s length price.

13. not appreciating that a customs duty adjustment was required to be made in order to put all comparables on a level playing field.

14. not considering cash PLI which is an accepted parameter of determining arm’s length price.

15. not making adjustment for various extraordinary expenses incurred while computing arm’s length price.

16. not making proper adjustment for enterprise level and transactional level differences between the appellant and the comparable companies.

17. not appreciating that the law does not compel adopting many (or any minimum) companies as comparables and that the appellant could justify the price paid/charged on the basis of any one comparable only.

18. not allowing the benefit of the +/- 5% range as per the proviso to section 92C(2).

B. The learned CIT (Appeals)-IV has erred in restoring the following matters to the file of AO/TPO without appreciating that under section 251 CIT (Appeals) cannot restore the matter back to AO/TPO :

(a) computation of ALP restricting the adjustment to purchase of components from associated enterprise;

(b) treatment of extraordinary items like loss on sale of assets, amortization of technical fees, discarding of old dies and moulds and commission income; and

(c) determining the nature of software license purchased.

The appellant submits that each of the above grounds/sub-grounds are independent and without prejudice to one another.

The appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before or at the time of hearing of the appeal, so as to enable the Income-tax Appellate Tribunal to decide the appeal according to law.”

4.1 T.P. analysis of the assessee.

For the year under consideration, the assessee was engaged in the manufacture of passenger cars and also in trading/distribution of passenger cars, (Camry) and spares. In the T.P. analysis, the assessee adopted the TNMM as the most appropriate method and carried out the T.P. analysis at the entity level merging both the trading and manufacturing segments (Combined Transaction Method). Using the ‘Prowess” database, the assessee selected the following seven companies as comparables whose business activity was classified as ‘commercial vehicles and passenger cars’ :

(i) Ashok Leyland Ltd

(ii) Bajaj Tempo Ltd.

(iii) Eicher Motors Ltd.

(iv) Hindusthan Motors Ltd.

(v) Mahindra & Mahindra Ltd

(vi) Swaraj Mazda Ltd.

(vii) Tata Engineering & Locomotive Company Ltd. (TELCO).

The data utilized in the assessee’s T.P. analysis pertained to Financial Year 2000-01 and 2001-02. The assessee adopted cash profit to sales as the Profit Level Indicator (PLI) and operating profit to sales as additional PLI and made adjustments for excise duty and customs duty while computing the ALP. Since the cash profit margin and operating margin as worked out by the assessee at 8% was higher than that of the comparable companies, the assessee contended that its international transactions were at arm’s length.

4.2 T.P. Analysis of the TPO

The TPO on examination of the assessee’s T.P. Study accepted TNMM as the most appropriate method and also the comparables selected by the assessee. The TPO, however, did not accept the following aspects of the T.P. Study carried out by the assessee.

(i) Combining the manufacturing and distribution functions and applying TNMM at the entity level.

(ii) Use of earlier year’s data against the mandatory use of current year as per the Act.

(iii) Exclusion of customs and excise duty while computing the cost of goods sold.

(iv) No adjustments made for the differences in the relative operational efficiency levels and depreciation costs between the assessee and the comparable companies considered by it.

The TPO accordingly carried out a fresh analysis of the comparable companies considered by the assessee using the current year’s data i.e. for F.Y. 2002-03 and separate evaluation of the manufacturing and distribution segments. In respect of the manufacturing segment, the TPO considered customs and excise duty by the assessee as part of cost of goods sold. Based on this analysis the TPO accepted the price charged by the assessee in its international transactions in the distribution segment. In regard to the manufacturing segment, upon comparison of ratio of material costs to sales, the TPO observed that the cost of materials came to around 85% of sales of the assessee as against 73% in the case of comparable companies. Even if customs duty and excise duty were excluded, the assessee’s material costs stood at 74% of its sales as against 64% of sales in the case of comparables. The TPO then proceeded to compare the operating efficiency levels of the assessee vis-à-vis the comparable companies and noted that the operating efficiency of the assessee at 14% was much higher than 22.57% of the comparable companies. Thus, the TPO made an adjustment for differences therein to nullify the effect of operative efficiency between the assessee and comparable companies. Simultaneously, the TPO also made a depreciation adjustment to nullify the effect of differences in the relevant levels of depreciation between the assessee standing at 5.8% on sales and that of comparable companies at 2.78% of sales had on the profits. As per the adjustments made out above, the TPO arrived at the arithmetical mean margin of 7.56% on sales, when compared to the assessee’s margin of (-) 4.56% on sales. Based on the above, the TPO proposed an adjustment of Rs.196.09 Crores towards raw material purchased from A.E’s.

4.3 We have heard both parties, carefully perused and considered the orders passed by the TPO under section 92CA of the Act, the order of assessment for Assessment Year 2003-04 dt.28.3.2006, the grounds of appeal raised, the order of the learned CIT (Appeals), written submissions filed and the judicial decisions relied upon and proceed to dispose off the grounds of appeal raised by the assessee.

Violation of principles of natural justice.

5. In support of the grounds raised at A-1, the learned counsel for the assessee has contended that the Assessing Officer had erred in passing the order disregarding the principles of natural justice by passing the order at the fag end of the limitation period; in a hurried manner and without affording proper opportunity of being heard and therefore the order of assessment is bad in law and liable to be quashed. We have also heard the learned Departmental Representative and perused the record. We find no merit in the claim of the assessee that the Assessing Officer had not afforded the assessee adequate opportunity of being heard. No evidence has been brought on record before us by the assessee to establish the violation of the principles of natural justice by the Assessing Officer as claimed and we therefore reject this ground raised by the assessee as infructuous.

6.1 Reference to TPO

In the ground of appeal at A-2, the learned counsel for the assessee argued that the Assessing Officer has erred in making a reference to the TPO for determination of ALP of the international transactions entered into by the assessee, as a reference could be made to the TPO only in circumstances where the Assessing Officer considers it necessary or expedient to do so. It was contended by the learned counsel for the assessee that on the facts and in the circumstances of the case, the Assessing Officer has not demonstrated that the conditions necessary for reference were satisfied and as such the reference to the TPO has been made in a routine and mechanical manner without application of mind is bad in law and the assessment order based on such reference is liable to be quashed. It was further contended that the CIT has erred in according approval for making a reference to the TPO to determine the ALP of international transaction in a routine and mechanical manner which is bad in law.

6.2 The learned Departmental Representative relied on the CBDT’s Circular No.3 of 2003 as per which it is mandatory to refer all cases, where the aggregate value of international transactions exceed Rs.5 Crores. As the aggregate value of international transactions exceed Rs.5 Crores in the instant case, the learned Departmental Representative submitted that the Assessing Officer had correctly made a reference to the TPO to determine the ALP. Similarly, the Commissioner of Income Tax in order to approve the making of reference to the TPO had to only satisfy three things based on Form 3CEB submitted by the assessee namely; (i) whether there are AE’s; (ii) that there are international transactions and (iii) whether the aggregate value of international transactions exceed Rs.5 Crores during the relevant period.

6.3 In the decision of a co-ordinate bench of this Tribunal in the case of Tally solutions (P.) Ltd. v. Dy. CIT [2011] 48 SOT 110 / 14 taxmann.com 19 (Bang.), it was observed that :

“There is nothing in section 92CA to suggest that the Assessing Officer should hear the assessee or record reasons before making a reference to the TPO nor is there anything to suggest that the Assessing Officer should ask the assessee whether he should himself proceed to determine the arm’s length price or should involve the TPO for this purpose. The reference is a step in the collection of material which might be useful for making assessments. No violation of any civil rights of the assessee is involved here. Mere reference does not tantamount to any adverse assessment or use of adverse material. Moreover, by virtue of Board Instruction No.3 of 2003 dt.20.5.2003 the CBDT decided that whenever the aggregate value of international transactions exceeds Rs.5 Crores, the case should be picked up for scrutiny and reference under section 92CA be made to the TPO.

Thus, it is mandatory for the Assessing Officer to refer all the cases whenever the aggregate value of international transactions is more than Rs.5 Crores. These instructions are binding on all Assessing Officers. In these cases, there is no need for the Assessing Officer to make a prima facie opinion, except that he/she needs to examine the 3CEB Report to see the aggregate value of international transactions. In the instant case, as the aggregate value of international transactions based on 3CEB Report filed by the taxpayer before the Assessing Officer, exceeded Rs.5 Crores, he referred the case to the TPO. Therefore, we see no infirmity in referring the matter to the TPO without forming “a considered opinion”. In the light of the above reasoning, the first legal point raised by the assessee, namely, the reference to the TPO by the Assessing Officer without forming “a considered opinion” does not stand the test of law and cannot be sustained, therefore this plea of the assessee is rejected. It is ordered accordingly.”

Respectfully following the decision of the co-ordinate bench of this Tribunal in the case of Tally Solutions Pvt. Ltd. (supra), we hold that there is nothing in section 92CA to suggest that the Assessing Officer should hear the assessee or record reasons before making a reference to the TPO and therefore in the instant case there is no infirmity in the action of the Assessing Officer in referring this case to the TPO. Accordingly this ground of the assessee is dismissed.

Approval of Commissioner of Income Tax

7.1 Regarding the approval of the Commissioner of Income Tax, since the word ‘approval’ is not defined under the Act, we have perused various judicial pronouncements. The Hon’ble Apex Court in the case of Vijayadevi Navalkishore Bhartia v. Land Acquisition Officer [2003] 5 SCC 83, held :

“What is provided under the proviso to section 11(1) is that the proposed award made by the Collector must have the approval of the appropriate Government or such officer as the appropriate Government may authorize in that behalf. In our opinion, this power of granting or not granting previous approval cannot be equated with appellate power. Black’s Dictionary, 6th Edition, defines “approval” to mean an act confirming, notifying, asserting, sanctioning or consenting to some act or thing done by another. In the context of an administrative act, the word “approval” in our opinion, does not mean anything more than either confirming, ratifying, assenting, sanctioning or consenting. It will be doing violence to the scheme of the Act if we have to construe and accept the argument of the learned counsel for the respondents that the word ‘approval’ found in proviso to section 11(1) of the Act under the scheme of the Act amounts to an appellate power. On the contrary, we are of the opinion that this is only an administrative power which limits the jurisdiction of the authority to apply its mind to see whether the proposed award is acceptable to the Government or not. In that process for the purpose of forming an opinion to approve or not to approve the proposed award, the Commissioner may satisfy himself as to the material relied upon by the Collector but he cannot reverse the finding as if he is an Appellate authority for the purpose of remanding the matter to the Collector as can be done by an Appellate authority; much less can the Commissioner exercising the said power of prior approval give direction to the statutory authority in what manner he should accept/appropriate the material on record in regard to the compensation payable. If such a power of issuing directions to the Collector by the Commissioner under the provision of law referred to hereinabove is to be accepted then it would mean that the Commissioner is to examine the said power to substitute his opinion for that of the Collector’s opinion for the purpose of fixing compensation, which in our view is opposed to the language of section 11 of the Act.”

7.2 In the case of Kailash Moudgil v. Dy. CIT [2000] 72 ITD 97 (Delhi) (SB) the issues before the Hon’ble Tribunal of Delhi was whether the Commissioner is required by law to give an opportunity of hearing to the assessee before giving approval for block assessments and also whether the Commissioner is required by law to record his reasons in writing while approving the order of the Assessing Officer. The Tribunal held as under :

“10. ¦¦ Then, what is the role of the Commissioner while granting approval to the assessment order prepared by the Assessing Officer and putting it before him for approval. We have already seen what is meant by ‘approval.’ The word ‘approval’ means to be satisfied with, to sanction officially, to ratify, to pronounce good, think or judge well of; admit the propriety or excellence of; to be pleased with; distinguishable from ‘authorise’, meaning to permit a thing to be done in future. Therefore, the ordinary meaning of the word approval can never be synonymous to satisfaction which is derived from out of judicial proceedings. On the other hand, it means that the Commissioner is administratively satisfied with the assessment. It means to confirm, ratify, sanction or consent to some act or thing done by another, to sanction officially. The meaning of the word ‘approval’ does not carry any meaning of authorization. In order to satisfy himself, the Commissioner can go through the assessment and after going through, he can confirm, ratify, sanction or give consent or give sanction officially. Therefore, the intendment of the word ‘approve’ is only to give official sanction and nothing more. There is no scope that the word ‘approve’ admits of any judicial proceedings. There is no question of Audi alteram partem rule to apply. We are inclined to think that under the facts and circumstances and the set up in which proviso under 158BG was obtaining, ‘approve’ means exercise of administrative authority.”

7.3 The Hon’ble Apex Court in the case of Sant Lal Gupta v. Modern Co-op. G.H. Society Ltd. (Civil Appeal No.9439 of 2003, dated 18-10-2010) approved its earlier decision in the case of Vijayadevi Navalkishore Bhartia (supra) and held that approval means confirming, ratifying, assenting, sanctioning or consenting to some act or thing done by another. Though the decision of Vijayadevi Navalkishore Bhaatia (supra) was rendered in the context of Land Acquisition Act, the same would be equally applicable to administrative approvals under the Income Tax Act, 1961. As held by the Hon’ble Apex Court (supra), the power of approval is only an administrative power and limits the jurisdiction of the authority i.e. the Commissioner, to apply its mind to see whether the proposal sent by the Assessing Officer is acceptable or not. In the context of section 92CA(1) of the Act, the word ‘approval’, in our opinion, does not mean anything more than confirming, ratifying, assenting, sanctioning or consenting. It will be doing violence to the scheme of the Act if we have to construe and accept the ground raised by the learned counsel for the assessee that the word approval amounts to an appellate power and thereby the Commissioner would have to give detailed reasons for approval. Further, in view of the decision of the Hon’ble Apex Court (supra), the Commissioner cannot go beyond the material placed before him by the Assessing Officer like records of assessment, Form 3CEB etc. Therefore, in our view, the approval of the Commissioner to the Assessing Officer’s proposal for making a reference to the TPO as per section 92CA(1) of the Act is an administrative approval based on appraisal of Form 3CEB which contains information on international transactions entered into and the quantum of such transactions, suffers from no legal infirmity once the aggregate value of such international transactions exceed Rs.5 Crores in the relevant period. Therefore, we dismiss this ground raised by the assessee.

8.1 In respect of the ground raised at A-3, the learned counsel for the assessee argued that the authorities below have erred in not appreciating that the charging or computation provisions relating to income under the head ‘Profits & Gains from Business or Profession” do not refer to include amounts computed under Chapter X of the Act and therefore the additions under Chapter X are bad in law. It was also contended that there is no amendment to the definition of the term ‘income’ to include amounts computed under Chapter X of the Act.

8.2 On the other hand, the learned Departmental Representative submitted that section 92(1) of the Act makes it very clear that income or expense arising out of an international transaction is to be computed having regard to the ALP.

8.3 On a careful consideration of the submissions made on this issue, we are of the view that the T.P. provisions in Chapter X of the Act are special provisions and section 92(1) thereof mandates that any income arising from an international transaction shall be computed having regard to the arm’s length price (ALP). The Explanation to section 92(1) clarifies that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the ALP. As these are anti-avoidance provisions of the Act, and also special provisions to protect the tax base of the country from being eroded, they will over-ride all other provisions of the Act. We, therefore, see no merit in this ground raised by the assessee that the definition of ‘income’ under the Act is not amended to include the T.P. adjustments as income and accordingly dismiss this ground.

9. In support of the grounds raised at A-4, the learned counsel for the assessee submitted that when there was no disallowance under section 40A(2) of the Act for purchase of spare parts and components, adjustments under Chapter X of the Act ought not to be made. In this regard, as held in para 8.3 of this order (supra), we are of the view that Chapter X being brought in as anti-avoidance measures to protect the tax base of the country, then provisions thereof would over-ride the other provisions of the Act, including section 40A(2). The Explanation to section 92(1) of the Act clarifies that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the ALP and therefore the disallowance is made under section 92(1) and not under section 40A(2) of the Act. We, therefore, finding no merit in the arguments put forth by the assessee that disallowance even for TP adjustments require to be made under section 40A(2) of the Act, dismiss this ground of the assessee.

10.1 In support of the ground raised at A-5, the learned counsel for the assessee argued that the authorities below have erred in passing the orders making the TP adjustment and thereby enhancing the assessee’s income without demonstrating that the assessee had motive for tax evasion or that the profits of the assessee were diverted elsewhere or that there has been any erosion in the base of taxable income in India. The main arguments of the learned counsel for the assessee is that the assessee did not intend to transfer/shift profits outside India and thus the TPO ought not to have made any adjustment without establishing that the assessee shifted profits outside India. The learned Departmental Representative’s submissions were also heard.

10.2 We have heard both sides on this issue. We have perused the decision of the ITAT, Pune Bench in the case of Asstt. CIT v. MSS India (P.) Ltd. [2009] 32 SOT 132 (Pune) wherein the Tribunal discussed both the decisions of the co-ordinate benches of the Bangalore Bench in the cases of – (i) Aztech Software Technology Services Ltd. v. Asstt. CIT [2007] 107 ITD 141 / 15 SOT 49 / 162 Taxman 119 (Bang.)(SB) and (ii) Phillips Software Centre (P.) Ltd. v. Asstt. CIT [IT Appeal No. 218 (Bang.) of 2008, dated 26-9-2008]. The Tribunal was of the view that the decision of the Special Bench of the Tribunal in the case of Aztech Software Technology Services Ltd. (supra) would prevail and held that it is not necessary for the TPO to demonstrate tax avoidance and diversion of income for invoking the provisions of section 92C and 92CA of the Act. In the case of Coca Cola India Inc. v. Asstt. CIT [2009] 309 ITR 194 / 177 Taxman 103 (Punj. & Har.), the Hon’ble Punjab & Haryana High Court dealt with the matter of anti-avoidance and T.P. in detail and held that it is not necessary for the Assessing Officer/TPO to demonstrate that profits are shifted out of India in order to determine the arm’s length nature of any international transaction.

In para 52 of the judgment their Lordships have held that –

“¦¦ The income arising from international transactions is to be computed having regard to arm’s length price as per the guidelines laid down in section 92C of the Act by adopting one of the laid down methods, at the discretion of the competent authority¦.”

In para 53 of the said judgment their Lordships have held that :

“53. We do not find any ambiguity or absurd consequence of application of Chapter X to persons who are subject to the jurisdiction of taxing authorities in India nor do we find any statutory requirement of establishing that there is a transfer of profits outside India or that there is evasion of tax. Only condition precedent for invoking provisions of Chapter X is that there should be income arising from international transaction and such income has to be computed having regard to arm’s length price.”

In para 54 of the said judgment, their Lordships have held that –

“54. We, thus, do not find any merit whatsoever in the contention that provisions of Chapter X cannot be made applicable to parties which are subject to the jurisdiction of the tax authorities in India, without there being any material to show transfer of profits outside India or evasion of tax between the two parties¦¦”

Respectfully following the decisions of the Hon’ble Punjab & Haryana High Court in the case of Coca Cola India Inc (supra) and of the ITAT, Pune Bench in the case of MSS India Pvt. Ltd. (supra) and of the Bangalore ITAT, Special Bench in the case of Aztec Software Technology Services Ltd. (supra), we do not find any merit in the ground raised that no T.P. adjustment could be made in the assessee’s case without there being any material or finding by the TPO to show that there was transfer of profits outside India or evasion of tax in India and therefore dismiss this ground raised by the assessee.

11.1 In the ground raised at A-6, it has been submitted that the TPO made a T.P. adjustment for the year under consideration, although the method adopted, the AE’s, the nature of transactions and the comparables were same as in earlier years or subsequent years in which no similar adjustment was made.

11.2 In this regard, after consideration of the submissions, we are of the view that the determination of ALP is a factual matter and there would certainly be variations/differences in the activities of both the assessee and comparables from year to year and therefore in the fact situation the TPO on examination of the material placed before her found differences leading to the TP adjustment. Moreover, as res judicata is not applicable for income tax proceedings, as the TPO, based on the material available with her could find that in the relevant period there are major differences between the assessee and the comparable companies mainly on account of better operational efficiency of the assessee. We, therefore, dismiss this ground as being devoid of any merit.

USE OF MULTIPLE YEAR DATA

12.1 In support of the ground raised at S.No.8, the learned counsel for the assessee contends that the authorities below have erred in determining the ALP using F.Y. 2002-03 data of comparables which was not available to the assessee at the time of complying with the TP documentation requirement. It was further submitted that the TPO/learned CIT(Appeals) have erred in not appreciating that under the relevant rules, data pertaining to a period not being more than two years prior to the relevant financial year may also be used in comparability analysis.

12.2 The arguments of the assessee have been carefully considered. In respect of the assessee’s claim that the authorities below had erred in determining the ALP on the basis of data of the comparable companies pertaining to F.Y. 2002-03 which was not available to the assessee at the time of T.P. documentation, we are of the view that such non-availability will not dispense with the mandatory requirements of Rule 10B(4) of Income Tax Rules, 1962 (hereinafter referred to as ‘the Rules’) for using the data of the current financial year in conducting comparability analysis and in determining the ALP in accordance with section 92C(1) and 92C(2) of the Act. In this view of the matter, the TPO is both empowered and also duty bound to determine the ALP using such contemporaneous data for this purpose even if it is not available to the assessee in the public data bases at the time of preparation of its report on the T.P. study. We, therefore, hold that there is no infirmity in the action of the TPO by using data at the time of the transfer pricing audit, though the same was not available to the assessee at the time of preparation of statutory T.P. documentation.

12.3 The learned counsel for the assessee contended that the TPO erred in not appreciating that under the relevant rules, multiple years data pertaining to period of not more than two years prior to the relevant period may be used in the T.P. documentation. The submissions made are carefully considered with reference to the action of the TPO.

We find that as mandated by rule 10B(4) of IT Rules, 1962, the TPO used data pertaining to the current year i.e. Financial Year 2002-03. We are also of the view that the TPO/CIT(Appeals) had rightly rejected the assessee use of multiple year data as the assessee failed to demonstrate before them how such data pertaining to the prior years had an influence or bearing on prices in the current financial year. Multiple year data may be used in case there is any effect in the case of the assessee or of the comparables on their profitability. The assessee has failed to establish how the use of multiple year/prior years data influenced the determination of transfer prices in relation to the transactions being compared. In our considered opinion the use of earlier years data was not warranted in the facts of the instant case and we find that the TPO aptly used only data of the relevant financial year and therefore uphold her action.

13.1 In the ground raised at S.No.9, it is submitted that the TPO adopted a flawed methodology and process in arriving at the ALP. On perusal of the material on record, we find that the TPO had rejected the assessee’s T. P. documentation mainly on three points –

(i) the assessee did not use data of the relevant financial year 2002-03

(ii) the assessee did not make any adjustments to account for the material differences in operating efficiency and depreciation and

(iii) the assessee claimed unwarranted adjustments towards customs duty and excise duty.

When the TPO is bound to ensure that the data used for determining ALP in correct and reliable, it is but natural that the TPO can reject documentation and information that is unreliable and incorrect. Further, the TPO is empowered to gather such information as is useful in determining the ALP. As the TPO has afforded sufficient opportunity to the assessee for rebuttal and considered the arguments put forth in her order, we find no infirmity with the procedure adopted by the TPO in modifying the assessee’s T.P. documentation, conducting her own T.P. analysis and in arriving at her own conclusions.

14. Segmentation between Manufacturing and Trading Operations.

14.1 In support of the grounds raised at A-10, 16 & 17, the learned counsel for the assessee has submitted that the authorities below have erred in concluding that the trading and manufacturing segment are distinct without appreciating that both the segments are intertwined and inter-related warranting a ‘Combined Transaction Approach’ in arriving at the ALP. It is submitted that in the relevant period, the assessee was engaged both in manufacture of passenger cars (viz. Corolla and Qualis) and also in trading/distribution of passenger cars (viz. Camry) and spare parts and components. It is submitted that the T.P. analysis performed by the assessee at Entity/Enterprise level using the ‘Combined Transaction Method’ was for the following reasons :

(i) that its various activities were inter-twined and inter-related as a part of the trading activities were as a result of manufacturing activities including warranty commitments;

(ii) the data in the public domain was available only at the entity level and was not detailed enough to make a comparison of results at the transaction level; and

(iii) in the peculiar circumstances involving various types of transactions entered into, it was not possible to split the financial data to arrive at the net result from particular transactions.

It was submitted by the learned counsel for the assessee that inspite of the assessee demonstrating the unified nature of the manufacturing and trading segments, the TPO had modified the T.P. analysis by segmenting the manufacturing and trading operations. It was submitted that the learned CIT (Appeals) concurred with the view of the TPO that the activities of manufacturing and trading segments were different and distinct each having its own functions, assets and risks. It is submitted that the learned CIT (Appeals) had further held that the import of components for manufacture of passenger cars and import of Camry passenger car for distribution is a distinct class of transaction and requires separate analysis. In support of his conclusion, the learned CIT (Appeals) relied on the decision of the Tribunal in the case of Star India Pvt. Ltd. v. Asstt. CIT IT Appeal Nos. 3585 & 3846 (Mum.) of 2006, dated 28-5-2008 Mumbai and UCB India (P.) Ltd. [2009] 30 SOT 95 (Mum.).

14.2 Before us, the learned counsel for the assessee submitted that to determine whether the prices charged/paid in international transactions entered into by the assessee are at arm’s length, a T.P. method may be applied to each transaction separately on to a group of transactions. Reliance was placed on para 3.9 of the OECD T.P. Guidelines 2010, which provide that a ‘Combined Transaction Method’ can be adopted in case the transactions are closely linked or continuous and cannot be adequately evaluated on their individual basis. In such a situation, the learned counsel for the assessee submits that, rather than assessing the arm’s length terms of the transactions individually, these different international transactions could be better evaluated together if they are closely linked or continuous. This, it is submitted, is also in accordance with Rule 10A (d) of the Rules which define “transaction” to include a number of closely linked transactions and does not mandate that the transactions should be identical or similar. The learned counsel for the assessee submitted that the assessee’s trading and manufacturing segments are closely linked and interdependent since a part of the trading activity were a result of the manufacturing activity, including warranty commitments.

14.3 An automobile manufacturer has to inevitably engage in trading activities given the fact that it has to provide after sales support to its customers and so is the case with the assessee also. It was further submitted that even the comparable companies are engaged in both manufacture and trading activities. In support of this proposition, the assessee provided the following details in tabular form:

In case of comparables
Name of the Company

Page No. of Annual Report

Purchase of finished goods (In Crores) (a)

Total Operating Cost & Depreciation (In Crores) (b)

Percentage of a/b
Ashok Leyland

38

58.33

3012.4

1.94
Eicher Motors

20

29.86

646.48

4.62
Mahindra & Mahindra

66

108.37

4,570.99

2.37
Swaraj Mazda

27

13.47

398.98

3.18
Tata Motors

30

360.77

10,553.49

3.42

In the case of assessee
Assessee

23

122.02

1,804.53

6.76

The learned counsel for the assessee also invited our attention to the relevant extracts from the Annual Reports of the comparable companies submitting that though purchase of traded goods are separately stated therein, the sales figure in some companies are the aggregate of trading and manufacturing items. For eg., in the case of Tata Motors on page 7 of the Annual Report, a cumulative figure of Rs.10,604.04 Crores is stated as ‘sale of products and services’. Similarly, in the case of Mahindra & Mahindra Ltd, page 65 of the Annual Report gives a single figure of sales – manufactured and traded goods. It is submitted that due to lack of details in the public domain, it is not possible to have segmental analysis of comparables. The learned counsel for the assessee also submitted that for Assessment Year 2004-05, the TPO accepted the T.P. analysis of the assessee without segmenting the results between trading and manufacturing segments. Based on the above, the learned counsel for the assessee submitted that segmentation of its results between trading and manufacturing was not called for and is bad in law.

14.4 The learned Departmental Representative supported the orders of the learned CIT (Appeals) in upholding the action of the TPO in taking the segmental break up of trading and manufacturing operations. The learned Departmental Representative submitted that”

(i) the two activities of manufacture and trading are distinct; each with their own functions, assets and risks involved and therefore cannot be clubbed together and requires to be analysed separately as per Rule 10C(2)(a).

(ii) the tax payers argument that both trading and manufacturing segments are closely linked is without basis as the completely built units CBU’s are sold independently of the sale of manufactured vehicles and the pricing in the trading activity is not dependent on the pricing of the manufactured passenger vehicle. Thus the purchase and sale of CBU’s (Camry) are to be independently analysed from the manufactured vehicle.

(iii) with respect to the assessee’s arguments that even the comparable companies are engaged in manufacturing as well as trading activities, the learned Departmental Representative submitted that the trading activities of the comparables is minimal and are in respect of spares only where the assessee sells manufactured cars also and therefore entity level margins should be adopted.

(iv) With respect to the assessee’s contention that the support functions and marketing set up is common, the learned Departmental Representative submitted that one has to look at the important functions and not support functions.

(v) The learned Departmental Representative relied on para 2.78 of the OECD Guidelines in support of the proposition that it would be inappropriate to apply TNMM to entity level margins.

The learned Departmental Representative submitted that both segments, i.e. Trading and manufacturing being distinct and different, therefore the segmental level T.P. analysis carried out by the TPO is correct and ought to be upheld.

14.5 The learned counsel for the assessee in rejoinder submitted that :

(i) In respect of the learned Departmental Representative’s submission that the assessee’s trading segment comprises only of trading in CBU’s, the learned counsel for the assessee submitted that its trading segment is not just confined to trading in CBU’s but also includes purchases and sales of spare parts and components which comprises almost 50% of the trading activity.

(ii) With respect to the learned Departmental Representative’s submissions that the trading activity in the case of the comparables is minimal and below threshold and entity level margins are required to be adopted, the learned counsel for the assessee submits that then on a parity of reasoning, in the assessee’s case also margins need to be computed at entity level.

(iii) In respect of the learned Departmental Representative’s submission that the trading activity of the comparables is mainly in trading of spares and not in CBU’s, the learned counsel for the assessee drawing our attention to the extracts of the Annual Reports of the comparable companies contended that their trading activities are not confined to spares alone but to other items also and in such circumstances to single out the assessee alone for evaluation of trading activity results separately is inappropriate.

(v) The learned counsel for the assessee strongly argued that when the learned Departmental Representative had accepted that both the assessee as well as the comparable companies are engaged in trading in spares, comparison of segment profits of the assessee with enterprise/entity level results of the comparable companies would be incorrect.

(vi) With respect to the learned Departmental Representative reliance on paras 2.78 of the OECD guidelines to support the proposition that it would be inappropriate to apply TNMM at entity level margins, the learned counsel for the assessee submits that the observations in para 2.78 are made in the context wherein a company is engaged is a variety of controlled transactions which are not closely linked. However, in the assessee’s case the transactions are closely linked and inter-related and therefore the reliance placed by the learned Departmental Representative is without basis.

(vii) Drawing our attention to Para 2.90 of the OECD guidelines, the learned counsel for the assessee submitted that after sales support services on sales are to be considered as closely linked to purchase transactions even if after sales service or sales are with own related parties. In the case of the assessee, the learned counsel for the assessee submits, the sale of spares is closely linked to its manufacturing efforts and therefore they ought to be evaluated together.

Briefly, the learned counsel for the assessee relying on earlier submissions made, argued that both the trading and manufacturing activities of the assessee being closely inter linked, they should be evaluated together at the entity/entity level using the ‘Combined Transaction Approach.’

14.5.1 We have heard both sides at length and perused and carefully considered the material on record. The assessee is engaged in the manufacture of passenger cars and also trading/distribution of passenger car model ‘Camry’ and spare parts and components. In the relevant period, the assessee had entered into various international transactions with AE’s. The learned counsel for the assessee submitted that the assessee carried out its T.P. Study documentation at the entity/enterprise level using the ‘Combined Transaction Approach’ and not at the segmental level, for the reason that its trading and manufacturing activities are closely inter-linked. It was also submitted that part of the trading activities were as a result of the manufacturing activities including warranty commitments. The learned counsel for the assessee also submitted that the data regarding comparable transactions were available only at entity/enterprise level and not at the individual level and that therefore the adoption of the combined transaction approach is correct. On the other hand, the learned Departmental Representative contends that functionally, assets and risks of both segments being different, therefore the combining or merging of both segments is inappropriate. The learned Departmental Representative also submitted that though the comparable companies have minimal trading activities, those are confined to spare parts only and not CBU’s as in the case with the assessee. The learned counsel for the assessee countered this by submitting that even in the assessee’s trading segment, 50% of sales is from sale of spare parts.

14.5.2 Taking into consideration the submissions made and the facts and circumstances of the case, we agree with the submissions of the learned counsel for the assessee. While it is true that function, assets and risks of the trading and manufacturing segments generally differ, however circumstances may warrant combining both of them. It is only in the specific facts of the case that the combining of both segments is advisable. In the instant case of the assessee, the sale of spare parts is triggered as a result of the manufacturing activities, including warranty commitments. Therefore, we are of the view that it would not be in the fitness of things for the sale of spare parts and components to be considered in isolation from the sale of manufactured vehicles. This view is supported by the OECD T.P. Guidelines, 2010, relied on by the assessee. This view is also buttressed by the fact that the comparable companies are also trading in spare parts and components. On a overall consideration, it can be concluded that trading in spare parts is closely inter-linked with the manufacturing segment of the assessee. We are of the view that no meaningful purpose would be served in segregating the trading and manufacturing segments, particularly when the assessee and the comparable companies are at par with regard to the nature and scale of combined activities. Needless to add that this finding/decision by its very nature has to be case-specific and year-specific as the decision is based on the facts and circumstances of this particular case and of this particular year and is not to be construed as laying down the principle in this regard. We, therefore, direct the Assessing Officer/TPO to compute the ALP at the entity/enterprise level by combining the trading and manufacturing segments.

OPERATING EFFICIENCY ADJUSTMENT

15.1 In the grounds raised at A-11, the learned counsel for the assessee argued that in the comparability analysis, the authorities below have erred in making an adjustment on account of operational efficiency without appreciating that the same does not constitute either functions performed or risks assumed or assets employed and therefore is not an adjustment contemplated under the law. The learned counsel for the assessee submitted that the TPO observed that Rule 10B( 3 ) provides for adjustment of difference between the assessee and the comparables. The TPO was of the view that in case of manufacturing concerns like automobile sector, operating margins are affected by four factors namely, (1) sales price; (2) material cost; (3) operative efficiency and (4) Depreciation. It is submitted that the TPO observed that 86% of the assessee’s international transactions related to the material cost segment and therefore its arm’s length conditions needed to be examined. The TPO also observed that operating efficiency and depreciation have an impact on profitability. It was submitted that in this context, the TPO analysed the ratio of operating expenses (including depreciation) to sales of the assessee at 14.04% vis-à-vis that of the comparables at 22.57% and concluded that since the assessee has a high degree of operative efficiency, the difference in operating efficiency needs to be nullified and proceeded to make the said adjustment for operating efficiency. It was submitted that the learned CIT (Appeals) sustained the TPO’s action holding that operating efficiency is an enterprise level adjustment and therefore is required to be carried out to eliminate material effect of differences in operational efficiency of the assessee vis-à-vis the comparables.

15.2 The submissions of the assessee opposing the operational efficiency adjustment made by the TPO is as under :

“(i) Operating Efficiency Adjustment is not contemplated by law : The law contemplates an adjustment to be made for transaction level difference or an enterprise level difference. These differences can either be in the functions performed or assets employed or risks assumed. An operating efficiency does not fall within any of the parameters warranting an adjustment. The difference in operating expenses is neither a difference in transactions nor enterprises. An adjustment for operating efficiency is thus not contemplated under the law. The ratio of the Mumbai Tribunal judgment in the case of CAPITAL ASSETS Computer Associates Pvt. Ltd. v. Dy. CIT 2010-TIOL-68-ITAT-MUM, supports this argument.

(ii) Companies with different operating efficiency cannot be compared. If there are substantial differences in the performance of other companies, they cannot be chosen as a comparable at all. The differences may arise because of products manufactured, the scale of operations, assets employed etc. Assuming that operating efficiency could also be one of the relevant factors in choosing a company as comparable, if there exists a wide disparity in such efficiency, the concerned company must be discarded as a comparable, which has not been done by the TPO.

(iii) After adjustment comparables cannot be compared.

The impact of the operating efficiency adjustment as carried out by the TPO has resulted in startling effect. The financial results of some of the comparable companies before and after the adjustment are as under :

Name of the Company

Operating margins (As per financials) (Rs. in Crores)

Operating margins (After the operating adjustment) (Rs. in Crores)

Adjustment quantum (Rs. in Crores)

Hindustan Motors

(-) 37.12

69.48

106.60

Mahendra & Mahendra

(-) 72.74

378.29

451.03

Bajaj Tempo

(+) 4.48

89.09

84.61

The appellant submits that adjustments are of astronomical amounts keeping in view the actual performance. It converts loss making companies to highly profitable ventures. The comparison moves to a hypothetical analysis than an actual reality; such adjustments distort and accordingly invalidate the comparability analysis. Such startling results should have put the TPO on notice and he ought to have conducted further examination to test the veracity of his findings which has not been done. The appellant also submits that if there were to be such variations in the results before and after the operating efficiency adjustment, the companies cannot be adopted as comparables at all.

(iv) Inter dependency between material cost and operating expenses :

A holistic approach is required to be adopted in the comparative study or analysis. Business is a constituent of many factors. Many of these factors are interlinked. An examination of one without the other may therefore not be advisable.

The TPO has erred in not appreciating that operating efficiency is significantly influenced by the quality of materials used. For example, if a person manufacturing bricks uses a bad quality of clay, it is very likely that :

(a) the time consumed for the job would be longer;

(b) the quality of product (bricks) would suffer;

(c) wastages are going to be high;

(d) acceptance of the product by the customer is bound to suffer.

A good quality of clay on other hand would significantly reduce the above mentioned downsides. Operating efficiency and the quality of material used are thus interdependent. There is an interplay between them. One is inextricably linked to other. They cannot therefore be segregated. The approach of the TPO to segregate these components and thereafter draw adverse consequences against the appellant is faulty. The same needs to be disregarded. The correct approach would therefore be to reckon the operating costs and the material costs simultaneously and together.

To give another example, cutting wood with blunt axe would take longer when compared to sharp axe. The cost of blunt axe may be less but the labour would be high. Operating expenditure is thus dependent on the quality of the material and technology used.

This is more so incase of the appellant who follows Toyota Production System (hereinafter referred as “TPS” for short). TPS differs from the other modes of organizing production and performing the manufacturing management function. TPS seeks to continuously eliminate waste and non-value added work from an organization and provide value to the customer in terms of products and services. This is referred to as Lean Management, which enables an organization to employ fewer resources in manufacturing and management. TPS believes in greater degree of outsourcing :

In order to ensure that the components and the sub-systems are designed and manufactured to the highest standards TPS relies on organizations that are known to be good in design and manufacture of such sub-systems rather than doing it in-house. These components are sourced directly from the vendors and used in the final assembly line/process to ensure desired quality of the products produced. On the other hand, in case of comparables, materials are brought and the same component is fabricated “in-house”. Input material cost in such cases would indicate only the material cost. The materials purchased will undergo value addition by way of further processing in-house. Such processing costs are captured as operating expenses. In view of this intrinsic difference in functioning, the proportion of material cost in TPS is likely to be higher compared to others. It also implies that for the appellant, the price at which a supplier provided the components will include cost of material as well as the cost of conversion and classified as ‘material cost.’ The appellant in this regard relies on the Charts on page 26 & 27 of the Note.

The appellant therefore submits that in its case, material cost includes conversion or processing cost which in case of comparables are classified as manufacturing or labour cost. Therefore direct comparison of material cost of the appellant with that of the comparables would be incorrect.

Quality of material affects operational efficiency :

Under TPS, the organization benefits significantly by sourcing high quality inputs and thereby avoiding unnecessary expenditure in terms of rectifying any deviations from customer’s specifications. High quality raw material will typically require fewer number of inspections, fewer scrap and defects, lesser managerial supervision to ensure quality, lesser time to respond to customer requirement and so on. The TPS captures these aspects by its basic definition of various types of wastes inan organization. The appellant therefore submits that there is a strong relationship between the materials and operating expenditure. Correlation between them is negative since low material cost will lead to high operating expenditure.

The concept of variance anlaysis under standard costing assumes relevance in this context. The relevant portion of the download from the website was filed with the CIT (Appeals) (www.bpp.com/acca/downloads/sc/ATF57-Sc.pdf) (page 211 & 212 of case law compilation). The down load consists of an explanation of the interdependency between material and efficiency and the impact of variance thereunder. It is suggested therefore that the individual variances should not be looked at in isolation. The variances are inter-related, and much of it occurs only because the other variance occurred too. When two variances are interdependent (inter-related) one will usually be adverse and the other one favourable. For example, if cheaper materials are purchased for a job in order to obtain a favourable price variance, materials wastage might be higher and an adverse usage variance may occur. Similarly if the cheaper materials are more difficult to handle, there might be an adverse labour efficiency variance too.

The appellant further submits that the TPO’s conclusion regarding operating efficiency just looking profit and loss account (operating expenses incurred by the appellant) is incorrect. Operating efficiency is influenced by various factors like quality of assets (which form part of balance sheet), quality of material used for manufacture, manufacturing processes, employee morale, training of employees and many other factors. Therefore an adjustment confined solely to operating expenditure in the profit and loss account is without basis as also incorrect.

Based on all the above, the appellant submits that segregation of material cost and operating expenses is bad in law and liable to be rejected. If at all, they have to be aggregated for the purpose of comparison, on such aggregation, the appellant’s performance is better than those of comparables as extracted on page 336 of paper book. The table is extracted below :

Particulars

Appellant

Comparable Companies

Material cost

73.71

65.65

Operating cost

18.45

27.01

Total :

92.16

92.66

On the basis of the above, the operating efficiency adjustment as made by the TPO is to be deleted.”

15.3 The learned Departmental Representative made a forceful submissions in support of the operating efficiency adjustment.

(i) It was submitted that every function carried out by an enterprise is reflected in the cost debited to the profit and loss account and thus an enterprise operating more efficiently than another shows that it is performing the same or more functions at a lower cost.

(ii) With respect to the assessee’s submission that operating efficiency adjustment is not contemplated by law, the learned Departmental Representative contended that Rule 10B(3) permits reasonable and accurate adjustments to eliminate material effect on price or margin or costs.

(iii) The learned Departmental Representative relied on para 2.71 of the OECD T.P. Guidelines, 2010, which states that net profit indicators may be directly affected by forces like management efficiencies, individual strategies, etc. The learned Departmental Representative also cited section 1.482-5 of the US regulations dealing with the impact of factors like differences in management efficiency etc on the operating profit and provides that if material differences are there, the same should be eliminated.

(iv) With respect to the assessee’s contention regarding inter-dependence between operating efficiency and quality of material, the learned Departmental Representative has stated that the tax payer has not brought on record any material to prove its contention that in the case of comparables, this model is not being followed.

(v) With respect to the assessee’s contention that the Toyota Production System believes in greater degree of outsourcing, the learned Departmental Representative submits that nothing has been brought on record by the assessee to demonstrate that the comparables do not follow the same model.

(vi) With respect to the assessee’s reliance on experts opinion, the learned Departmental Representative submitted that the same is additional evidence and therefore cannot be considered at this stage of proceedings. If at all the experts opinion is to be considered, then this matter should be remanded to the file of the TPO for examination/rebuttal of the same.

15.4 In rejoinder to the learned Departmental Representative’s submission, the learned counsel for the assessee submitted as under :

(i) The law contemplates an adjustment to be made for transaction level difference or enterprise level difference in support of functions performed, or assets employed or risks assumed. It is submitted that the law does not contemplate an adjustment to the difference in costs for the same function performed as the TPO has attempted to do.

(ii) With respect to the learned Departmental Representative’s contention that the operating efficiency adjustment is in accordance with Rule 10B(3), the learned Departmental Representative submitted that to determine whether a difference exists, a holistic view requires to be taken and not just by limiting the examination to the profit and loss account and such an exercise has not been carried out by the TPO. Rather, the adjustment as carried out by the TPO has led to startling results distorting factual realities and are not warranted as per the provisions of Rule 10B(3).

(iii) With respect to the learned Departmental Representative’s reliance on 1.482 – 5 of the US Regulations to support the argument that management efficiency adjustment should be done, the learned counsel for the assessee submitted that the US Regulations merely state that use of statistical tool like inter-quartile range iron out differences like technical expertise or management efficiency and nowhere therein has any methodology been provided to make an adjustment for difference in operational efficiency. It was argued by the learned counsel for the assessee that reliance on foreign law/provision is not called for when no basis has been made out regarding its similarity/relevance to Indian T.P. Regulations which are detailed and self-contained.

(iv) With respect to the learned Departmental Representative’s contention that comparables can be adopted if reasonable and accurate adjustments can be made, the learned counsel for the assessee states if the operating efficiency of the assessee if far in excess of the other comparable companies, this disparity is sufficient to reject all the comparable companies adopted by the assessee and TPO as comparables for the T.P. Analysis.

(v) The learned counsel for the assessee submitted that on a perusal of the Annual Reports of the comparable companies various components like engines, transmission, etc are produced in-house as against the assessee who has outsourced the manufacture of such components or imports the same. Therefore, direct comparison of operating cost of the assessee with that of the comparables would be incorrect.

(vi) With regard to the learned Departmental Representative’s contention that the assessee is making consistent losses, the learned counsel for the assessee submitted that its sales and profits have increased substantially in the subsequent years of operation. (vii) The learned counsel for the assessee also submitted that based on the above submission, it is clear that the adjustment for operating efficiency as proposed by the TPO is bad in law. Further, no operating efficiency adjustment has been made in the earlier years or immediately succeeding years and this inconsistency in such adjustment is proof enough that the said adjustment is to be removed.

(viii) With respect to the expert opinion introduced as additional evidence, the learned counsel for the assessee submitted that the admission of the same is within the power of the ITAT.

15.5.1 We have heard both parties and carefully considered the rival submissions.

We are concerned here with a unique and unusual adjustment made by the TPO and upheld by the learned CIT (Appeals). The TPO has made the operating efficiency adjustment by bringing the operating expenditure of the comparables at par with that of the assessee. The TPO has concluded that the assessee is very efficient as its operating expenses are lesser when compared to that of the comparable companies. Briefly, the TPO has equated operating efficiency to operating expenditure. Before the learned CIT (Appeals) detailed submissions were made on this issue and a remand report was called for thereon. The learned CIT (Appeals) however was of the view that since these submissions were not filed before the TPO during the assessment proceedings they could not be entertained at the appellate stage. Before us apart from the submissions made, expert opinion has been filed on this issue by the assessee which was not available before the TPO. In these circumstances, it is in the fitness of things and in the interest of equity and justice that this matter of operating efficiency adjustment be remanded back to the file of the TPO for re-examination.

15.5.2 While remitting this issue to the file of the TPO, it appears that there is merit in the arguments made by both the sides. However, in order to resolve the issue of operating efficiency, there should be a fresh examination carried out of the inter-play of the following three aspects while computing this adjustment :

(i) the inter-play between the material cost and other operating costs of the assessee and comparable companies due to the functional differences between them;

(ii) the operational efficiency; and

(iii) the price charged in controlled transaction.

It appears from the record that the TPO has only considered the aspects at (ii) and (iii) but not (i) above. Thus the issue of adjustment for operating efficiency, if any, is remitted to the file of the TPO for re-examination in the light of the expert opinion filed by the assessee. The TPO is directed to afford adequate opportunity to the assessee to be heard and to file written submissions/details and to pass a reasoned order thereon. The TPO would also be free to counter the expert opinion filed by the assessee with another experts opinion.

16. Admission of Additional Evidence

We notice that Rule 29 of the ITAT Rules permit additional evidence to be admitted under the following circumstances :

(i) To enable the ITAT to pass an order.

(ii) If it is for any substantial cause.

(iii) In the event of a situation where the income tax authorities have decided the case without affording the assessee sufficient opportunity to adduce evidence either on points specified or not specified by them.

It is held in the case of CIT v. Salig Ram Prem Nath [1989] 179 ITR 239/ 45 Taxman 322 (Punj. & Har.) that in order to do substantial justice, the ITAT is vested with the requisite authority to admit additional evidence. In the factual matrix of the case, we find that the assessee had made submissions on the said matter on which the experts opinion is now filed. The expert opinion is filed and available with the Department for subsequent years in the assessee’s case as submitted by the learned counsel for the assessee. We also notice that the learned Departmental Representative while opposing the admission, argued on the fallacies and short comings of the experts opinion. In view of all of the above, and of the paramount consideration for the effective disposal of this appeal, for which reason the ITAT can admit additional evidence, we in the interest of equity and justice admit the experts opinion for being considered in the disposal of this ground of appeal.

17. Excise Duty Adjustment

17.1 The ground raised at A-12, challenges the non-exclusion of excise duty in sales and material cost by the TPO while computing ALP without appreciating that variable excise duty structure effects the material cost and thereby margins. It is submitted by the learned counsel for the assessee that while computing the margins for comparison purposes, the assessee had excluded both excise duty and customs duty both for the comparables and itself. It is further submitted that the TPO rejected this adjustment made by the assessee on the grounds that as per section 145A of the Act, the cost is the amount spent to bring the goods to the present location and condition and this would include excise duty and that no independent enterprise would agree for a purchase price without taking into account the duty structure. The learned CIT(Appeals), it is submitted, upheld the action of the TPO as he was of the view that excise duty has no material impact on profitability and that comparable companies have to incur certain direct costs/expenses which are not required to be borne by the assessee.

17.2 With respect to the excise duty adjustment, the learned counsel for the assessee submitted that excise duty levy is uneven across manufacturers and therefore the margin on sales ought to be calculated excluding excise duty. It was contended that from an accounting prospective also, excise duty is a ‘pass through cost’ and hence financial statements are typically prepared net of excise duty and profitability is arrived at accordingly. The learned counsel for the assessee further argued that in the relevant period, the assessee manufactured only passenger cars for which the excise duty rate was at 32%, whereas the comparable companies had a different product mix which could include commercial vehicles and/or engine components for which excise duty was at 16%. Therefore, the comparables being subjected to excise duty at rates different from that of the assessee excise duty ought to be excluded for computing comparable margin on sales between them. It was also contended by the learned counsel for the assessee that inclusion of excise duty skews the gross profit. It was forcefully argued by the learned counsel for the assessee that in the succeeding years, the margins have been computed by the TPO excluding excise duty and therefore submitted that for the year under consideration also, the computation be made on the basis of net sales (i.e. After excluding excise duty) and also excise duty be excluded from operating costs also.

17.3 The learned Departmental Representative supported the orders of the authorities below on this issue. The learned Departmental Representative argued that the accounting treatment of an item for the purpose of financial accounting would not be a determinant factor how that particular item should be treated for computing the operating cost for the purpose of transfer pricing. The learned Departmental Representative contended that excise duty is an integral part of operating cost and is also embedded in sales and therefore should be considered as part of cost as well as revenue. The learned Departmental Representative further contended that if the assessee wants to exclude excise duty from cost, then the same should also be excluded from sales so that comparability analysis could be at the same level between the assessee and the comparable companies. Thus the margin may be computed either on gross sales (excluding excise duty in cost as well as sales) or on net sales (including excise duty in cost as well as sales.)

17.4 The learned counsel for the assessee in rejoinder contends that the learned Departmental Representative had submitted that excise duty should be removed from both costs and revenues and that was precisely what the assessee is requesting i.e. that excise duty be excluded from both sales and operating costs as had been done by the assessee when computing the margins. In this view of the matter, the learned counsel for the assessee submitted that excise duty adjustment as carried out by the assessee ought to be accepted.

17.5 We have heard both parties on the issue of excise duty adjustment and perused the material on record. On careful consideration of the same, we are of the view that the assessee’s ground on excise duty adjustment needs to be allowed. The assessee collects excise duty as levied by the Central Government and there is no profit element involved in collecting the same and remitting it to the Government. Excise duty is a ‘pass through cost’ and financial statements are prepared net of excise duty and based on this the profitability is worked out. TP regulations are based on the actual margins and ‘pass through’ items like excise duty are not to be considered while computing margins as is also the case with the comparable companies. The learned Departmental Representative too did not appear to have serious objections to the exclusion of excise duty in arriving at the margins. In view of this, we direct the Assessing Officer/TPO to perform the TP comparability analysis excluding excise duty from sales as well as costs for both the assessee and the comparable companies so as to maintain consistency/parity and to compute the margins accordingly.

18. Customs duty adjustment

18.1 In the grounds raised at A-7 and 13, it is contended that the authorities below have erred in not appreciating that a customs duty adjustment was made in order to put the assessee and the comparables on a level playing filed. It is submitted that as the assessee’s import component of raw-material at 53% in the relevant period is high, the corresponding customs duty expense is proportionately greater leading to lower profits. In comparison to the assessee who is in a start up phase, the learned counsel for the assessee contends, the comparable companies are established players in the automobile market and have negligible import content due to indigenization of materials required for production. In these circumstances, the learned counsel for the assessee argues that the assessee’s having to pay the higher customs duty component it would put the assessee at a disadvantage when compared with the other comparable companies as customs duty impact profit margins. It is submitted that as the import component increases, the material cost as a percentage of sales also increases and thereby leads to a reduction in profit margins. In view of the above, the assessee submitted that the adverse effect of customs duty warrants its exclusion so as to bring the assessee and the comparables on par. The learned counsel for the assessee relied on the decision of the ITAT, Pune in the case of Skoda Auto India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 319 and submitted that the proposition of customs duty adjustment is also supported by this decision.

18.2 Per contra, the learned Departmental Representative supported the findings of the authorities below and submitted that customs duty is paid on the parts and components imported from its AE’s and so forms a part of the cost of purchase of the raw material. The learned Departmental Representative submitted that the decision of whether to import or purchase locally is a commercial decision. As the method adopted is TNMM, which is tolerant of minor functional differences ,adjustments cannot be made for each and every item of expenditure. For example, the Annual Report of Tata Motors Ltd says that there is a consumption of steel and its cost may be due to an increase in steel prices. Then its cost also should be adjusted for this increase of steel prices, as such type of expenditure is not substantial in the case of the assessee. The learned Departmental Representative contended that the assessee is selling Toyota Brand vehicles in India and has established its business knowing well that customs duty is required to be paid on imports of vehicles to India in semi-knocked down (SKD) condition. The learned Departmental Representative further argued that the comparable companies like Tata Motors etc pay excise duty as well as sales tax on the inputs used by them in the manufacture of commercial or passenger vehicles which the assessee does not bear in a significant way. The learned Departmental Representative relied on the decision of Sony India Pvt. Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi) in support of the proposition that customs duty adjustment should not be given. In the said decision, it was held that the import of components in a commercial decision made by the assessee consciously taking into account all the commercial consideration including the obvious benefits of better quality which is bound to translate into higher selling price of the product. With respect to the learned counsel for the assessee’s reliance on the decision of Skoda Auto (P.) Ltd. (supra), the learned Departmental Representative submitted that the said decision was not applicable to the facts of the assessee’s case, as the main argument before the ITAT was that it was the first year of the assessee’s operations and complete facilities ensuring reasonable indigenous raw-material contract was not in place and therefore it had to sell cars with such high import contents, while the normal selling price of the car was computed in the light of the cost as would apply when the complete facilities of regular production was in place. It is also submitted by the learned Departmental Representative that the Tribunal concurred with the findings in the Sony India decision (supra) and held that higher import content by itself does not warrant an adjustment, as it is a commercial decision. Further, in the Skoda Case, the Tribunal has given a clear finding that it is an assembler of cars whereas the comparable companies were manufacturers. In the case of the assessee, the learned Departmental Representative submits, it is a full fledged manufacturer with sufficient localization as evidenced by the local sourcing of 60% of its material consumption. The learned Departmental Representative also pointed out that in the case of Skoda ( supra), it was the first year of operation and it was claimed that for want of local vendors it was found to import to the extent of 98.55% whereas the assessee is in its third year of operation and is in the business of manufacturing of passenger cars in India since 1999. It is thus submitted by the learned Departmental Representative that no adjustment is required on customs duty paid by the assessee.

18.3 The learned counsel for the assessee in rejoinder has reiterated his submissions that import of parts and components was necessary because it was the start up phase and it needed to adhere to the global quality standards, for which the Toyota Group is renowned. Localisation of such high quality raw material and product take time due to several factors. The assessee manufactures Toyota Vehicles using technology provided by Toyota Motor Corporation and is required to ensure global Toyota standard with regard to quality of parts used and finished goods, therefore, high quality of inputs become a pre-requisite. It is the quality of vehicles turned out by the Toyota group that ensures its pre-eminence in the automobile industry. In the relevant period, it is submitted that, the assessee was in its start-up-phase and the localization process had commenced whereby after identification of vendors/OEM’s the assessee involves itself to ensure that the quality and standard is maintained. The learned counsel for the assessee submitted that in such a scenario where the sale price is market driven, a higher import cost (through a differential discharge of duty) is bound to depress profits. It is submitted by the learned counsel for the assessee that in such a scenario, the automobile industry being sensitive and inflexible, in order to eliminate the impact of margins due to duty differentials, the impact of customs duty has to be eliminated.

18.4 We have heard both sides and considered the submissions made by both of them. The crux of the issue is whether the customs duty adjustment made by the assessee in its T.P. study needs to be allowed or rejected. After careful consideration of the facts advocated and the proposition put forward, we are of the view that all the points raised by the assessee and revenue have not been fully evaluated by the TPO in arriving at the decision to reject the assessee’s customs duty adjustment, some of which are the following :

(i) The assessee is in the early stage of activities (3rd year of operation) with a high import content of 40 – 50% which would be much less than that of the comparables and local sourcing of about 50%. However, in this period the Toyota Qualis was the best selling multi-purpose with a 40% market share in 2002-03. In the light of these facts, the TPO should examine the applicability of the decision in the case of Sony India Pvt. Ltd. (supra) that if the tax payer company has purchased imported components after payment of customs duty at a higher price than indigenous components, this decision must have been taken by it consciously taking into account all the commercial considerations including the obvious benefits of better quality which is bound to reflect or translate into a higher selling price of the product which hardly leaves any scope for adjustment to the profit margin of the comparables on this issue.

(ii) No doubt, a higher import content of raw-material does not warrant an adjustment in operating margins as was held in Sony India Pvt. Ltd. case (supra), but what is to be really seen is whether the high import content was necessitated by circumstances beyond the assessee’s control.

(iii) Whether the higher customs duty component on account of imports impacts the profit margins of the assessee, putting it at a disadvantageous position, vis-à-vis the comparable companies who would be paying more of central excise duty, sales tax etc.

(iv) Whether if the sale price is market driven, a higher import duty cost through a differential discharge of duty is bound to depress profits and the import of customs duty would have to be eliminated through adjustment to maintain the impact on margins ?

In these factual circumstances, we remand the matter, of examining the necessity of whether customs duty adjustment is to be allowed, as claimed by the assessee, to the file of the TPO. The TPO is directed to examine the contentions of the assessee on customs duty adjustment in a holistic perspective also keeping in mind the observations made by us (supra) and in the light of the decision of the ITAT, Pune in the case of Skoda Auto (P.) Ltd.’s case (supra) relied on by the assessee and the case of Sony India Pvt. Ltd.’s case (supra) relied on by revenue.

19.1 In the ground raised at A-14, the assessee has contended that the authorities below have erred in not considering cash PLI (Profit Level Indicator) or PBDIT (Profit Before Depreciation, Interest and Tax) to sales which is an accepted parameter of profit margin for determining ALP. The learned counsel for the assessee submitted that the TPO compared the ratio of depreciation to sales of the assessee (5.58% of sales) with that of the comparables (2.78% of sales) and adjusted the difference in depreciation of each of the comparables to the level of the assessee at 5.58% of sales. The learned counsel for the assessee submitted that the cash PLI is an accepted ratio for determining ALP as per para 1.44 of OECD T.P. Guidelines and which has been accepted by the ITAT, Delhi in Schefenacker Motherson Ltd. v. ITO [2009] 123 TTJ 509 . The assessee also relied on the decision of the Hyderabad Tribunal in the case of Qual Core Logic Ltd. v. Dy. CIT [2012] 22 taxmann.com 4/ 52 SOT 574 wherein it has been held that where depreciation of the tax payer was high when compared to comparables, profits should be considered without depreciation. In view of this the learned counsel for the assessee submitted that the TPO’s adjustment for depreciation should be eliminated from the comparability analysis.

19.2 The learned Departmental Representative supported the orders of the authorities below on this issue and submitted that when depreciation forms part of the considerations while fixing the price, as in the case of manufacturing a car, depreciation cannot be eliminated from the comparability analysis. It was further submitted that as fixed assets drive the revenues of a manufacturing concern and also the depreciation cost is a significant one, which is considered while fixing the price of a car, then depreciation effect cannot be eliminated by excluding depreciation while comparing profitability of the assessee with that of the comparables. The learned Departmental Representative further contended that in the case of new companies depreciation would be higher as compared to an old enterprise, but the expenses on repairs and maintenance would be lower in a new enterprise as compared to an older one and therefore the depreciation along with expenses on repairs and maintenance takes care of the age factor of the assessee vis-à-vis the comparable companies. It is argued that in asset – intensive manufacturing concerns like the assessee, exclusion of depreciation distorts the comparability analysis and therefore cash PLI or PBDIT is not the appropriate PLI. In support of this proposition the learned Departmental Representative placed reliance on the decision of the ITAT, Mumbai in the case of Fiat India (P.) Ltd. v. Dy. CIT [IT Appeal No. 1848 (Mum.) of 2009, dated 30-4-2010].

19.3 In rejoinder the learned counsel for the assessee submitted that the learned Departmental Representative’s contention that depreciation is one of the consideration for fixing the price and therefore cannot be eliminated from the comparability analysis is without basis as the TPO had analysed that the sales price is market driven. The learned counsel for the assessee relied on para 136 of OECD Draft Guidelines on Transactional Profits Method to submit that since depreciation charges are susceptible to differences in accounting treatment and may materially distort the comparison in in an asset intensive industry, therefore cash PLI would be appropriate in the facts and circumstances of the case. The learned counsel for the assessee also relied on the decision of the ITAT, Hyderabad in the case of Qual Core Logic Ltd. (supra) wherein it was held that where depreciation of tax payer was high when compared to comparables, profits should be considered without depreciation. In these circumstances, the learned counsel for the assessee sought that cash PLI or PBDIT to sales should be accepted as the parameter of profit margin for determining ALP.

19.4.1 We have heard both parties and carefully perused and considered the material on record including the judicial decisions cited on both sides. There are varying opinions among experts whether depreciation should be taken into account for working out profits of an enterprise. One view is that it is not revenue deduction at all. As per that view, depreciation is only an annual loss in the cost/value of the capital assets due to factors like age of assets, their usage etc. and therefore allowance of depreciation, being capital in nature, should find no place in the computation of profits. The opposite view is that depreciation, though a capital loss, needs to be deducted, to replace the value of assets to the extent it has depreciated. Be that as it may, in the present case, ALP of the transactions to be determined by comparing the profits of the assessee with that of the comparable companies. There are no express statutory provisions which indicate that deduction for depreciation is a must. Depreciation, which can have varied basis and is allowed at different rates, is not an expenditure which must be deducted in all situations. It has no direct bearing or connection on price, cost or profit margin of international transactions. It can therefore be held that depreciation can be taken into account or disregarded in computing profit, depending on the context and purpose for which profit is to be computed.

19.4.2 In the case of Schefenacker Motherson Ltd. (supra) of the ITAT, Delhi, the issue of whether depreciation can be excluded for comparison has been discussed at length and it was held in para 22 thereof that –

“¦ The basic issue involved was whether the cost paid or charged for international transactions was at arm’s length or not. The factors which go to influence price, cost or profits are/were relevant for computing profit and not depreciation having no direct connection with price or profit but responsible for wide differences. The case of revenue is not clear. If depreciation is not leading to any difference, its exclusion is immaterial. If it is leading to differences, then differences are required to be adjusted, as required by the IT regulations. There is no way to dislodge the claim of the tax payer. The context and purpose of legislation and facts of the case overwhelmingly approve adoption of cash profit only.”

This case was relied upon by the assessee in support of its proposition that cash PLI or PBDIT is the appropriate PLI.

19.4.3 We find that the above finding of the Tribunal was given as the case of revenue was not clear and the TPO had rejected cash PLI without assigning any reasons. Subsequently, the Mumbai, ITAT, in the case of Fiat India Pvt. Ltd. (supra) held that in an asset intensive industry where assets are the key drivers, excluding depreciation would not lead to any meaningful outcome and PBIT and not PBDIT is to be taken for computing PLI. The assessee in the instant case is also similarly in the asset-intensive industry of automobile manufacturing like the assessee in the cited case (supra), where depreciation is a significant cost, which no prudent businessman would ignore while pricing a passenger car. In such an instance, when the price is determined by considering the depreciation cost, excluding depreciation from the profits for comparison under TNMM distorts the comparability analysis. We are therefore of the opinion that in view of the finding of the Mumbai ITAT in the case of Fiat India Pvt. Ltd. (supra) in which the assessee therein is in the asset intensive automobile industry, as is the assessee in the present case, that cash PLI or PBDIT to sales is not the appropriate PLI and also note that the TPO has given depreciation adjustment for differences in relative level of depreciation cost with reference to sales. We, therefore, dismiss this ground raised by the assessee. Adjustments for differences

20.1 In the grounds raised at A-15, the assessee contends that the authorities below have erred in not making adjustment for various extra-ordinary expenses incurred while computing the ALP. The learned counsel for the assessee contended that for a meaningful TNMM analysis, the results of comparable companies need to be adjusted for transaction level differences or enterprise level differences.

20.2 The learned counsel for the assessee submits that in the relevant period there was a global increase in steel prices and simultaneously a fall in the value of the rupee vis-à-vis the US dollar. As a result thereof, the assessee would have to incur higher rupee costs for its imports and the rupee depreciation resulted in higher custom duty payments on imported components whereas the comparable companies did not suffer a similar impact.

We have considered the submissions of the assessee and are of the view that they do not have merit on this issue for the simple reason that the comparable companies also suffer the impact of increase in steel prices as is borne out by the Annual Report of Tata Motors wherein this aspect is highlighted. In this view of the matter, we hold that no adjustment is required on this issue.

20.3 It is submitted by the learned counsel for the assessee that the assessee is part of a world renowned multi-national organization and as part of its global image has made substantial investments in establishing dealership networks, implemented global standards of office layout and thereby secured the highest satisfaction for both customers and dealers.

We have carefully considered the submissions and find no merit in the claim for making any adjustment on this count. The assessee has failed to demonstrate that comparables do not invest in setting up dealership network. “Even otherwise TNMM is tolerant to minor functional differences and hence no adjustment is required for this difference in operation.

20.4 It is submitted by the learned counsel for the assessee that in the case of the assessee the technology belonged to the AE and therefore research and development activity was not assumed by the assessee and hence the assessee was insulated from certain risks. In these circumstances, it is submitted that it is natural that the profit margins of the assessee are lower than that of the comparables who assume the full range of functions and risks and have full fledged assets.

The submissions of the assessee have been carefully considered. We find that the assessee is also a full fledged manufacturer performing the functions, bearing all the risks and employing assets just as other comparables undertake their manufacturing activities and hence no adjustment is called for on this count.

20.5 The learned counsel for the assessee submits that, the assessee is in a start up phase (third year of operation) whereas the comparable companies are well established, with some having operations over six decades. It is submitted that at the start up stage, market acceptance is yet to gain ground; technology is in the stage of absorption and the workers would be in the process of gearing up to the technicalities involved in manufacturing especially when Kaizer and JIT (Just-in-time) concepts are involved.

The submissions of the assessee have been carefully considered. In our view, the excise duty adjustment as recommended by us and the re-examination of the customs duty adjustment directed by us would neutralize the differences, if any and therefore no separate adjustment is required to be made.

21. PLI Computation

The assessee submits that the TPO has erred in rejecting the following while computing margins.

(i) Commission Income

(ii) Provision for Warranty Costs

(iii) Marketing Expenses

21.2 Commission Income

It is submitted that the assessee helps the AE in processing enquiries for automobiles manufactured by them and also renders other services in the course of and for the purpose of selling the vehicles of the AE’s. For these services, the assessee earns a commission. It is contended that since these services are rendered in the course of its business operations, the said commission income should be regarded as operating income.

We have considered the assessee’s submission carefully. We are in agreement with the TPO’s action in excluding commission income for the reason that the commission income earned by the assessee is not derived from out of the assessee’s business operations of manufacture and sale of passenger vehicles or the sale of spare parts and components. Admittedly, it is earned from incidental activities for rendering other services to the AE’s and therefore its inclusion in operational income would lead to a distortion therein.

21.3 Provision for Warranty Costs

The learned counsel for the assessee submits that when the assessee sells its vehicles to various customers, they have an attached warranty condition. In the event of a faulty design or manufacture, defects arise which were not originally visualized. It is submitted that in the relevant period, the assessee noticed a defect in the exhaust system of the automobiles manufactured by it. Apprehending that there would be increased expenditure to rectify these defects, the assessee made a special one time provision of 15.90 Crores towards warranty costs. The learned counsel for the assessee contended that the same being an unusual expenditure and also non-recurring, it ought not to have been included in the operating costs which was what the TPO did. It was further submitted that in the succeeding years, in the assessee’s own case, the TPO had accepted that warranty provision is not operating expenditure and excluded it from operational costs. The learned Departmental Representative submitted that warranty adjustment is not called for on the ground that it is part of the operating expenditure and integral to the tax payers business. This was rebutted by the learned counsel for the assessee stating that the warranty provision is a special, extra-ordinary, one time provision made in the relevant period and therefore it should be excluded while computing operating margins.

We have heard both parties and carefully considered the material on record. In normal business operations of the kind the assessee is involved in namely, manufacture and sale of passenger cars, warranty would be attached and will form part of operative expenditure. However, in the instant case, from the facts on record, it is clear that the special warranty provision of Rs.15.90 Crores to warranty costs was a special, one time provision made to overcome the defects in the exhaust system of the automobile manufactured by it in the relevant period. In that sense, it is clearly an extra-ordinary expense of a non-recurring nature and in that view of the matter requires to be excluded from operating costs. In view of this factual matrix, we direct that the one time special warranty provision, arising out of an extra-ordinary viz. manufacturing defect in exhaust of passenger vehicle in the relevant period should be considered as non-operating expenditure.

21.4 Marketing Expenses

It is submitted by the learned counsel for the assessee that during the year under consideration the assessee had introduced a new vehicle and in order to promote the launch and sales of this vehicle incurred substantial marketing expense of Rs.10.19 Crores. It is contended that these expenses being special one time expenses, not associated with the ordinary business activities of the assessee, the same is to be excluded while arriving at the operational costs. The learned Departmental Representative submitted that for the relevant period, the marketing expenditure of the comparable companies is 4.72% which is higher than that of the assessee at 2.89% inspite of launch of a vehicle. It was further submitted that all the comparable companies and the assessee were automobile manufacturers and year on year would be bringing out new models for which marketing expenses would be incurred in the normal course of business and therefore there is no need for adjustment for marketing expenses.

We have heard both parties and carefully considered the material on record. It is a matter of record that even though the assessee claims extraordinary marketing expenses were incurred on launch of a passenger vehicle, its marketing expenditure at 2.89% is less than that of the comparable companies which is 4.72%. It is common knowledge that the comparable companies also in the automobile industry would be launching new models/vehicles at regular intervals, for which they too, just like the assessee, would be incurring marketing expenses to promote their products. In these circumstances, we are of the opinion that these marketing expenses for launch of new vehicles are part and parcel of the normal business operations of the assessee and the comparable companies and therefore would comprise a part of the operational expenses. From an accounting perspective, it is generally perceived that marketing expenses have an impact on revenues over a period of time. However, in the assessee’s case we find that all the marketing expenses have been incurred and claimed in the relevant period only. In view of the facts and circumstances as discussed above, we are of the opinion that the marketing expenses incurred by the assessee for launch of a new passenger vehicle in the relevant period, is incurred in the normal course of its business operations and forms part of its operating expenditure. In this view of the matter, the assessee’s claim is rejected.

22. Adjustment for AE Transactions

22.1 It is submitted that the assessee’s imports from AE’s constituted 37% of the total purchase cost of the year. The learned counsel for the assessee submitted that the TPO erred in applying the modified PLI for all transactions of purchase of components including purchases from Non-AE’s and this resulted in the making of an adjustment in respect of transactions with Non-AE’s also.

In this regard, the assessee placed reliance on the decision of the Delhi Tribunal in the case of I l Jin Electronics (I) Pvt. Ltd. v. Asstt. CIT [2010] 36 SOT 227 . It is submitted that in the cited case the assessee was engaged in the manufacture of printed circuit boards. Out of its total purchases, 45.51% thereof was from AE’s. On the facts of the case, the Tribunal held that adjustment can be made only to the extent of 45.51% of the turnover. The learned counsel for the assessee pointed out the relevant observation of the Tribunal in para 15 of its order which reads :

“¦¦¦ After considering the facts of the case, we do not find any difficulty in accepting this contention of the assessee that at best only 45.51 of the operating profit can be attributed to imported raw material acquired from the assessee’s associate concerns¦¦.”

The learned counsel for the assessee also relied on the decision of the co-ordinate bench of this Tribunal in the case of Genysys Integrating Systems (India) (P.) Ltd. v. Dy. CIT (ITA No.1231/Bang/2010) wherein it was held that TP adjustment should be restricted to AE transactions only. The learned counsel for the assessee submitted that the above proposition that TP adjustments should be restricted to transactions with AE’s only is further supported by the following judicial precedents –

(i) Global Vantedge (P.) Ltd. v. Dy. CIT [2010] 37 SOT 1 (Delhi)

(ii) Dy. CIT v. Startex Networks (India) (P.) Ltd. [IT Appeal No. 3640 (Delhi) of 2007, dated 30-4-2010]

(iii) Asstt. CIT v. Wockhardt Ltd. [2011] 45 SOT 138 (URO)/ 10 taxmann.com 207 (Mum.)

(iv) Addl. CIT v. Tej Diam [2010] 37 SOT 341 (Mum.)

(v) Abhishek Auto Industries Ltd. v. Dy. CIT [IT Appeal No. 1433 (Delhi) of 2009, dated 12-11-2010]

(vi) Dy. CIT v. Ankit Diamonds [2011] 43 SOT 523/ 9 taxmann.com 37 (Mum.)

(vii) Asstt. CIT v. T Two International (P.) Ltd. [2008] 26 SOT 583 (Mum.).

The learned counsel for the assessee submits that the TP adjustment, if any, should be restricted to transactions with AE’s only.

22.2 On a perusal of the order of the learned CIT(Appeals), at para 7.31 thereof, we find that the CIT(Appeals) has held that the ALP adjustment has to be restricted to the extent of import/purchases from AE’s only and cannot be extended to purchases made from Non-AE’s and has remitted the matter back to the file of the TPO for computation of the same. Since this issue is not disputed before us, we decline to adjudicate thereon or interfere therein.

23. Benefit +/- 5% Safe Harbour

23.1 In the ground No.5 on Safe Harbour – the assessee has sought the benefit of +/- 5% as set out under the proviso to section 92C(2) of the Act citing several judicial decisions in support of this proposition. Prior to the amendment made by Finance (No.2) Act, 2009 and the Finance Act, 2012, the proviso to section 92C(2) of the Act provided that the ALP would be taken to be the Arithmetical Mean (AM) or at the option of the assessee, a price which may vary from the A.M. by an amount not exceeding 5% of such A.M. Thus, the ALP was +/- 5% of such A.M. Thus, the ALP was +/- 5% from the A.M. This issue is more of an academic nature and case laws cited by the assessee are not applicable to the facts of the case, as the IT Act, 1961 has been amended with retrospective effect from 1.4.2002 by the introduction of a clarificatory amendment in which the section 92C (2A) was inserted, which as per the Finance Act, 2012 reads as follows :

“(2A) Where the first proviso to sub-section (2) as it stood before its amendment by Finance (No.2) Act, 2009 (33 of 2009), is applicable in respect of international transactions from an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso.”

23.2 The new section 92C(2A) mandates that if the arithmetical mean price falls beyond +/- 5% from the price charged in the international transactions, then the assessee does not have any option referred to in section 92C(2). Thus, as per the above amendment, it is clear that the +/- 5% variation is allowed only to justify the price charged in the international transactions and not for adjustment purposes. The aforesaid amendment has settled the issue and accordingly the 5% benefit is not allowable in the assessee’s case. The various judicial decisions cited pertain to the period prior to the retrospective amendment in section 92C(2A) of the Act and are not applicable to the facts of the assessee’s case. In view of the amendment brought about therein by Finance Act, 2012, this ground raised by the assessee is not maintainable and is accordingly dismissed.

24.1 In the grounds raised at B, the assessee submits that the learned CIT(Appeals) erred in setting aside the following matters to the file of the Assessing Officer/TPO without appreciating that under section 251 of the Act, the CIT(Appeals) cannot set aside the matter to the file for (i) computation of ALP restricting the adjustments to purchase of components from AE’s only and (ii) Treatment of extra-ordinary items like loss on sale of assets, amortization of technical fees, discarding of old dies and moulds.

24.2 In this regard, a perusal of the learned CIT(Appeals)’s order and para 7.3.1 on page 40 thereof indicates that the learned CIT(Appeals) has given a clear finding that the ALP adjustment is to be restricted to the extent of purchase of components from its AE’s and has consequently only directed the TPO to compute the ALP adjustment, if any, in accordance with his finding and for this purpose to make necessary verification in the matter. In this view of the matter, we do not find any reason to hold that the learned CIT(Appeals), in directing the TPO to recompute the ALP adjustment, has exceeded his jurisdiction under section 251 of the Act and therefore decline to interfere therein.

25. In the result, the assessee’s appeal is partly allowed.