The order of the Bench was delivered by
Challa Nagendra Prasad, Judicial Member - This appeal is filed by assessee against the order of Assistant Commissioner of Income Tax, Company Circle-II(2), Chennai dated 28.10.2011 passed under section 143(3) read with section 144C(13) of the Act on the directions of the Dispute Resolution Panel.
2. Ground No.1 of the grounds of appeal of the assessee is a general ground agitating the addition of Rs. 7,18,00,000/- based on the provisions of Chapter X of the Act and Rs. 4,52,00,000/- based on the other provisions of the Act to the assessee's total income.
3. Ground Nos. 2 to 9 of the grounds of appeal of the assessee are as under:—
"On the facts and in the circumstances of the case and in law, the Transfer pricing officer and the Assessing Officer under the directions issued by the Dispute Resolution Panel:
2. Erred in law and facts in disregarding Transfer pricing documentation report prepared based on the segmental approach and the separate books of accounts for the transfer pricing analysis.
3. Erred in law and facts in adopting entity level approach without considering the functional dissimilarity between the business segments of the Appellant.
4. Erred in facts in placing reliance on the erroneous figures/expense percentages on segmental revenue and erred in facts in ignoring the reason for difference in proportion of common expenses allocated between segments while concluding that the segmental accounts has been prepared incorrectly by way of inappropriate allocation of common expenses.
5. Erred in issuing direction by arbitrarily directing the learned AO alone for reconsidering the deduction under section 10B of the Act without issuing any direction to the learned TPO for considering the segmental accounts as recomputed by the learned AO.
6. Erred in confirming the action of the learned TPO in disregarding the segmental approach adopted by his predecessor in the transfer pricing assessment for AY 2005-06 although the facts were the same in the relevant AY 2007-08, thereby disregarding the principles of consistency.
7. Without prejudice to the grounds above, erred in attributing the losses in the domestic transactions to that of the international transactions of the assessee.
8. Erred in law in disregarding the multiple year approach adopted by the assessee.
9. Erred in not granting reasonable and adequate opportunity to the Appellant for producing separate books of accounts before issuing the directions under section 144C(6) of the Act and the order passed under section 143(3) of the Act, being passed in violation of the principles of natural justice is liable to be quashed or alternatively set aside."
4. Brief facts are that the assessee, an Indian company, engaged in the business of providing switches and cable management solutions in global market for commercial as well as domestic applications. The assessee filed return electronically on 30.10.2007 declaring loss of Rs. 1,35,87,570/-. The case was selected for scrutiny, notice under section 143(2) of the Act was issued on 21.7.2008 and the Assessing Officer made a reference to the Transfer Pricing Officer under section 92A(1) in respect of international transactions entered into by the assessee with its Associated Enterprises. The Transfer Pricing Officer passed an order dated 28.10.2010 under section 92CA(3) of the Act determining the arm's length price of Associated Enterprise sales at Rs. 29.87 crores as against Rs. 22.35 crores reported by the assessee and made upward adjustment of Rs. 7.52 crores on the Associated Enterprise sales. Based on the Transfer Pricing Officer's order, the Assessing Officer passed draft assessment order on 31.12.2010 under section 143(3) read with section 144C(1) of the Act making addition of Rs. 7.52 crores towards upward adjustment on determination of arm's length price with Associated Enterprise. Assessing Officer in his draft assessment order also proposed to disallow provision for discount of Rs. 4.12 crores treating the said provision as contingent and not an accrued liability. It was also proposed to exclude expenses of Rs. 40,51,870/- incurred in foreign currency towards travel from export turnover while computing deduction under section 10A of the Act.
5. The Transfer Pricing Officer subsequently passed an order dated 24.02.2011 revising the upward adjustment of purchase price on determination of arm's length price with Associated Enterprise of the assessee at Rs. 7.18 crores as against Rs. 7.52 crores made in the order dated 28.10.2010.
6. The assessee filed its objections before the Dispute Resolution Panel (in short "DRP") in respect of upward adjustment of Rs. 7.52 crores towards international transactions with its Associated Enterprise and the other disallowances i.e. in respect of provision for discount and excluding foreign travel expenses from export turnover and not excluding the same from total turnover while computing deduction under section 10A of the Act. The DRP by its order dated 28.9.2011 passed under section 144C(5) sustained the Transfer Pricing Officer's addition of Rs. 7.18 crores in respect of transfer pricing adjustment. The DRP also sustained disallowance of provision for discount and exclusion of travel expenses incurred in foreign currency from export turnover and not excluding the same from total turnover while computing deduction under section 10A of the Act. The Assistant Commissioner of Income Tax passed final assessment order dated 28.10.2011 under section 143(3) read with section 144C(13) giving effect to DRP's order by making upward adjustment of purchase price of Rs. 7.18 crores on determination of arm's length price with Associated Enterprise of the assessee . The Assistant Commissioner also disallowed provision for discount of Rs. 4.12 crores and excluded foreign travel expenses incurred in foreign currency from export turnover without excluding the same from total turnover and computed deduction under section 10A of the Act.
7. The learned counsel for the assessee Mr. Sunil Moti Lala submits in respect of the addition of Rs. 7.18 crores made towards upward adjustment in respect of international transaction with Associated Enterprise on export of goods, that the assessee is in the business of providing switches and cable management solutions for commercial as well as domestic applications. The assessee is having broadly two activities manufacturing and trading. The learned counsel submits that the manufacturing activity is further divided into two parts one into contract manufacturing (i.e. export) wherein the assessee manufactures goods for its Associated Enterprises and the other is local manufacturing, wherein the assessee manufactures goods for sale in domestic markets.
8. The counsel submits that the assessee exported finished goods aggregating to Rs. 22.35 crores in respect of its contract manufacturing segment and the Transfer Pricing Officer has computed the arm's length price sales at Rs. 29.53 crores and thus the Transfer Pricing Officer has made adjustment of Rs. 7.18 crores to contract manufacturing segment. The learned counsel submits that the Transfer Pricing Officer and DRP rejected the segmental reporting made by the assessee in respect of its transactions with AE and non-AE sales. The counsel submits that the Transfer Pricing Officer and DRP are not correct in adopting the entity level approach to perform the transfer pricing analysis by disregarding the segmented analysis maintained by the assessee.
9. The counsel for the assessee submits that the net cost plus margin in respect of its contract manufacturing segment was 20.89% and in the local manufacturing segment it was (9.87%) and since the margin in respect of contract manufacturing segment was more than the local manufacturing segment by following the internal TNMM, the assessee claimed that its contract manufacturing and export sales to be at arm's length price (in short "ALP"). However, the Transfer Pricing Officer rejected the internal TNMM and selected external comparables and arrived at the comparable margin at 8.87% and this margin of 8.87% was compared with the entity level margin of 1.08% of the assessee ignoring the segmental report results where net cost plus margin of the assessee in contract manufacturing segment was 20.89% which is more than 8.87% i.e. margin of external comparables arrived at by the Transfer Pricing Officer and in such circumstances, the Transfer Pricing Officer should not have made any upward adjustment as the net cost plus margin of the contract manufacturing segment is much more than the profit margin of the external comparables adopted by the Transfer Pricing Officer.
10. The counsel submits that the external comparables adopted by the Transfer Pricing Officer has been accepted by the assessee. The counsel submits that the Transfer Pricing Officer has erred in comparing the external comparable's margin of 8.87% with 1.08% margin which is entity level margin of the assessee and this approach is wrong. The counsel submits that the Transfer Pricing Officer should have compared the margin of contract manufacturing segment with that of the margin of the external comparables arrived and this is the right approach. Counsel submits that if this is done, no upward adjustment would require as the reported margin of the contract manufacturing segment of the assessee was 20.89% which is more than the margin of 8.87% of the external comparables arrived by the Transfer Pricing Officer.
11. The counsel further submits that the reason given by the Transfer Pricing Officer and the DRP for rejecting the segmental results is that the assessee did not report segmental results in financial accounts, expenses are apportioned on AE and non-AE sales. The assessee's company trading account accounts only 23% of its total sales and further there is no segmentation of trading and manufacturing activity in its financial statements and the segmentation has been done in line of trading and manufacturing only for the purpose of transfer pricing and therefore segmental results cannot be accepted. Placing reliance on the decision of co-ordinate bench of this Tribunal in the case of 3i Infotech Ltd. v. ITO [2013] 35 taxmann.com 582 (Chennai), the counsel for the assessee submits that non-reporting of segmental results in the audited financial accounts cannot be a basis for rejecting the segmental results of the assessee.
12. The counsel further submits that the Transfer Pricing Officer and the DRP accepted the segmental reports for computing deduction under section 10B of the Act for the assessment year under consideration. He further submits that such segmentation approach had been accepted as an ideal approach for the operations undertaken by the assessee in the previous assessment year i.e. 2006-07 and there have been no difference in the operations of the assessee from the financial years 2005-06 to 2006-07. The counsel submits that since there are no change in the facts and circumstances, following the principle of consistency segmentation result/reports of the assessee have to be accepted in the assessment year 2007-08 also. Counsel referring to compilation of judgments-III furnished and placing reliance on various decisions including the decision of Hon'ble Supreme Court in the case of Radhasoami Satsang v. CIT [1992] 193 ITR 321/60 Taxman 248 submits that in the absence of any material change in facts, a different view than taken in earlier years could not be taken. He further submits that in the current assessment year i.e. 2007-08, the Transfer Pricing Officer and DRP having accepted the segment results for computing relief under section 10A of the Act, the said segmentation approach should not have been rejected in determining the ALP of sales of Associated Enterprise.
13. The counsel for the assessee referring to page 67 of the paper book further submits that DRP has directed the Assessing Officer to examine the segmental results for contract manufacturing segment for computing relief under section 10B of the Act and the Assessing Officer has accepted the segment reports and the submissions of the assessee before him vide letter dated 28-10-2011 in respect of segmentation results claiming deduction under section 10B of the Act.
14. The counsel further submits that TNMM does not permit comparison of margins on any entity-wide basis, only margins from the international transaction or a class of international transaction can be compared. Without prejudice to the above, the counsel submits that if segmental data of AE transaction is not available, the adjustment made on the basis of the entity level margin on the total turnover should be restricted to the proportion of AE sales to total turnover. However, ALP has to be determined only for the international transaction and hence segmental data and the margin as per the AE segment ought to be compared/considered for computing ALP. The counsel further submits that if the segmental data and the margin of the AE segment (i.e. 20.89%) is accepted and even if internal TNMM adopted by the assessee is rejected, and the margin of comparables selected by the Transfer Pricing Officer is considered (i.e. 8.87%), the resultant transfer pricing addition would be Nil.
15. The learned CIT Dr. Mr. P.B. Sekaran supported the order of the DRP and the Assessing Officer in making upward adjustment of Rs. 7.18 crores to the AE sales. Referring to the letter dated 29.10.2013 submitted in the course of hearing, the CIT DR submits that segmental results though accepted for the assessment years 2005-06 and 2006-07, it cannot be accepted for the assessment year 2007-08 as the allocation of expenses between contract manufacturing segment and local/domestic segment are not done scientifically and the assessee has not offered any satisfactory reason for this abnormal allocations, especially in respect of 'other expenses' allocated to local/domestic sales segment which are at 67% and in respect of contract manufacturing segment which are at 5.2%. The Departmental Representative submits that in any event the allocation is not properly done and the segmental reports have to be examined and for this purpose, this matter should go back to the Assessing Officer for verification.
16. In reply, the counsel for the assessee submits that DRP has already sent back to the Assessing Officer to verify the segmental reports/results for the purpose of computing deduction under section 10B of the Act. The Assessing Officer has examined segmental results vis-à-vis allocation of expenses to segments and accepted the segmental reports/results and computed the relief under section 10A and therefore, counsel submits there is no need for sending back the issue to the file of Assessing Officer for verification and analysis once again. The counsel for the assessee referring to the table extracted in the letter dated 29.10.2013 submitted by the CIT DR before us with respect to allocation of expenses to manufacturing segment submits that the allocation of expenses were accepted for computing relief under section 10B of the Act.
17. Heard both sides. Perused the orders of lower authorities and the case law relied on. The reason given by the Transfer Pricing Officer and DRP for not accepting the segment results are that the assessee has not shown the same in the audited financial accounts and the segment reporting was done only for transfer pricing purposes. They have also stated that allocation of expenses between the contract manufacturing segment and non AE local/domestic segments are abnormal. In so far as the reason that the assessee has not shown the segmental report/results in audited financial accounts and therefore, such segmental results cannot be accepted for ALP has not been accepted by this Tribunal in the case of 3i Infotec Ltd. (supra). This Tribunal in the above cited case held that even though segmental reports are not show in audited financial accounts, they have to be accepted.
18. This Tribunal further held, in view of the decision of the Delhi Bench of the Tribunal in the case of Dy. CIT v. Stratex Net Works (India) (P.) Ltd. [2010] 42 SOT 395, that rate of profit achieved in other comparable cases are to be compared with profit level declared by the assessee in respect of its AE transactions after excluding domestic transactions. In the case of 3i Infotech Ltd. (supra) this Tribunal found that on comparing the profit achieved in other comparable cases to the profit level declared by the assessee in respect of the AE transactions, profit level declared by the assessee was more than the profit level in respect of comparable cases found by the Transfer Pricing Officer. Here, in case on hand, the net cost plus margin reported by the assessee in respect of its contract manufacturing segment stood at 20.89% and whereas the net margin of the external comparables selected by the Transfer Pricing Officer stood at 8.87%. The DRP on examining the segmental results prepared by the assessee observed in para 7.2 of the order as under:—
"It is very pertinent to observe here that the taxpayer generated revenues of Rs. 22.35 crores in its contract manufacturing segment with employee cost of Rs. 1.88 crores and depreciation cost of Rs. 18.50 crores, whereas it generated of Rs. 43.18 crores in its local manufacturing segment with employee cost of Rs. 5.24 crores and depreciation cost of Rs. 1.15 crores. Further, the taxpayer could not substantiate how other expenses of Rs. 0.59 crores and Rs. 24.01 crores were allocated to contract manufacturing segment and local manufacturing segment respectively. Further, the low employee cost combine with higher depreciation in the contract manufacturing segment indicates that the taxpayer did not apportion the employee cost to contract manufacturing segment appropriately. Thus, in these circumstances, the Transfer Pricing Officer has to reject the segmental results prepared by the taxpayer."
19. As could be seen from the above observations of the DRP, the Transfer Pricing Officer has rejected the segmental results prepared by the assessee, as the assessee could not substantiate as to how 'other expenses' were allocated to contract manufacturing segment and local manufacturing segment. It is also the observation of the DRP that low employee cost combined with higher depreciation in contract manufacturing segment indicates that the assessee did not apportion the employee cost to contract manufacturing segment appropriately. In this regard, we find that the figures adopted by the Transfer Pricing Officer/DRP in their orders in analyzing these facts and coming to the decision/conclusion to reject the segmental results of the assessee is wrong. For example in the above extracted para from DRP order the employee cost was taken at 1.88 crores as against the correct figure of 2.10 crores. Similarly, other expenses and depreciation was taken at 0.59 crores and 18.50 crores as against the correct figures of Rs. 1.88 crores and 0.58 crores respectively. The Transfer Pricing Officer in his order at page 9 has taken the figures of material cost, employee cost and other expenses at Rs. 2.10 crores, Rs. 1.88 crores and Rs. 0.59 crores as against the correct figures of Rs. 1.39 crores, Rs. 2.10 crores and Rs. 1.88 crores respectively for analysis. The Transfer Pricing Officer and DRP have taken wrong figures in respect of these expenses in analyzing and rejecting the segmental results. The figures taken by the Transfer Pricing Officer/DRP in respect of material cost, employee cost, other expenses, depreciation are not matching with the figures given by the assessee in segmental results appearing at page 138 of the paper book submitted before us. Apparently, the Transfer Pricing Officer/DRP have adopted wrong figures and analyzed with these figures and came to a conclusion that apportionment of expenses was not properly done and at the same time, we find that the assessee by letter dated 11.10.2010 submitted before the Transfer Pricing Officer in Annexure 'A' where segmental profitability was shown and it has mentioned in the Note that employee cost, other expenses and depreciation includes Direct Factory cost which is allocated between contract manufacturing and local manufacturing segments were based on the respective sales of the segments.
20. It is not in dispute that Transfer Pricing Officer has accepted the segmental results of the assessee in the assessment years 2005-06 and 2006-07 on the contract manufacturing transactions with the AE for arriving at ALP while computing the relief under section 10A of the Act. The Transfer Pricing Officer/DRP has not given any reason as to why segmental results shall not be considered for determining ALP for transactions with AE having accepted very same segmental results of the assessee for the purpose of computing deduction under section 10B of the Act. In the above facts and circumstances, we do not find any valid reason for not accepting the segmental reports in determining the ALP on the AE sales for this assessment year i.e. 2007-08 having accepted the segmentation approach for the earlier assessment years i.e. 2005-06 and 2006-07 and especially when there is no change in the facts and circumstances of the case in the current year.
21. We also find that the Transfer Pricing Officer/DRP's approach in comparing external comparables margin of 8.87% with entity level margin of the assessee i.e. 1.08% is wrong, since segmental results are available and as per this the margin in contract manufacturing segment is 20.89% and this margin should have been compared with the comparable margin of 8.87% in determining the upward adjustment in AE sales. In our view since the net cost plus margin of the assessee in contract manufacturing segment is 20.89% which is more than the operating profit of 8.87% on the external comparables of the Transfer Pricing Officer, there is no need for any upward adjustment to be made on the AE sales of the assessee. Hence, we direct the Assessing Officer to delete the addition of Rs. 7.18 crores made towards upward adjustment of purchase price on determination of ALP with Associated Enterprise.
22. Ground no.10 of the grounds of appeal is with regard to disallowance of provision for discount. At the time of hearing, learned counsel for the assessee concedes that this issue is decided against the assessee by the co-ordinate Bench of this Tribunal in the assessee's own case for the assessment year 2005-06 in ITA No. 1925/Mds/2010 dated 30.06.2011. The counsel further submits that this Tribunal sustained the disallowance of provision for discount claimed as deduction by the assessee holding that it is unascertained and contingent expenses. However, the counsel submits that an additional ground was placed before the DRP submitting that the assessee during the assessment year 2007-08 had actually passed on Rs. 2,73,03,455/- as discounts to the customers and such discount which was passed on to the customers should be allowed as deduction. The counsel submits that DRP has not given any finding on such additional ground. The counsel places copy of assessment order for the assessment year 2009-10 dated 13.05.2013 passed under section 143(3) read with section 144C(3) and referring to para 3.4 of the order submits that the Assessing Officer allowed the provision on discounts actually passed on to the customers during the assessment year 2009-10. Therefore, he pleads that a direction be given to Assessing Officer to allow the actual discounts of Rs. 2,73,03,455/-passed on to the customers as deduction for the assessment year 2007-08 as was allowed in the assessment year 2009-10.
23. The Departmental Representative has no serious objection in directing the Assessing Officer to verify and allow the claim of the assessee in respect of actual discount passed on to the customers as deduction, as similar claim was allowed by the Assessing Officer in the assessment year 2009-10.
24. Heard both sides. Perused the orders of the lower authorities. As far as the claim of the assessee that provision for discount should be allowed as deduction is concerned, the issue is decided against the assessee by the co-ordinate Bench of this Tribunal in the assessee's own case for the assessment year 2005-06, wherein the Tribunal held as under:—
'6. We have considered the rival submissions and have found that the assessee can claim such a 'provision' only if it satisfies the following conditions:
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An enterprise has a present obligation as a result of a past event; |
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It is probable that an outflow of resources will be required to settle the obligation; and |
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A reliable estimate can be made of the amount of the obligation. |
7. In our opinion, these are general observations made by the Hon'ble Supreme Court in the case of Honda Siel Power Products Ltd. (supra). If the decision is read in toto, these conditions could be given effective meaning.
8. In the case of Metal Box Company of India Ltd. (supra), the Hon'ble Supreme Court has held as under:
"Contingent liabilities discounted and valued as necessary, can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into consideration. An estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit & loss account. This is recognized in trade circles and there is nothing in the Bonus Act which prohibits such a practice. Such a provision provides for a known liability of which the amount can be determined with substantial accuracy. It cannot, therefore, be termed a 'reserve'. Therefore, the estimated liability for the year on account of a scheme of gratuity should be allowed to be deducted from the gross profits. The allowance is not restricted to the actual payment of gratuity during the year."
9. In the case of Dy. CIT v. Beardsell Ltd. (supra), Hon'ble Jurisdictional High Court has held as under:
"Held, that if a debt had become irrecoverable the same could be written off and deducted from the profit of the business. A debt, the recovery of which was doubtful could not be termed to be an ascertained liability as mentioned under section 115J of the Act and could not be excluded from the book profits. Accordingly, the conclusion of the Tribunal in directing the Assessing Officer to rectify the alleged mistake of inclusion of the unascertained liability in the book profit could not be upheld."
10. Thus, it becomes evidentially clear that when the liability is ascertained and not quantifiable during the year and is simply a contingent based on estimates, the same cannot be allowed as deduction. In the given case, the assessee's version, as put forth in para 6.4 of the appellate order, clearly states that the only reason for creating a provision and not charging the same as an expenses is because of the fact that the exact quantification could not be undertaken for the various reasons. In our opinion, the basis for the provision is simply ad hoc and arbitrary. It depends on the facts of each and every case to come to a conclusion as to whether the liability is ascertained or unascertained one and it cannot be generalised. The discounts given to meet out a particular target to the Channel Partners and further discounts given to the customers are not specifically specified and nobody knows as to what would be the exact position when transactions take place. There is no past history of this assessee. Therefore, in these circumstances, we are unable to accept the version of the assessee. We, therefore, set aside the findings of the ld. CIT(A) and reverse the same. The grounds raised by the Revenue, in this regard, are allowed.'
25. The facts and circumstances being similar in the current assessment year also, respectfully following the said decision, we reject the ground of appeal of the assessee on this issue. However, in respect of the alternative claim of the assessee that deduction for discount actually passed on to the customers has to be allowed as deduction, we see that the Assessing Officer in similar circumstances, allowed the claim of the assessee for the assessment year 2009-10. Keeping in view of the same, we direct the Assessing Officer to grant deduction for the discount actually passed on to the customers during this assessment year after verification of the claim of the assessee. The assessee shall provide the details of discounts actually passed on to the customers during this assessment year and the same shall be verified by the Assessing Officer and decide accordingly after providing opportunity to the assessee.
26. Ground no.11 is in respect of recomputation of profits of the contract manufacturing unit by allocating expenses to the contract manufacturing unit on the basis of arm's length sales determined by the Transfer Pricing Officer.
27. Since we have deleted the upward adjustment of Rs. 7.18 crores made towards ALP of Associated Enterprise sales, the question of allocation of expenses to contract manufacturing unit on the basis of arm's length sales does not arise and this ground becomes infructuous, therefore, this ground is dismissed as infructuous.
28. The last issue in the grounds of appeal of the assessee is with regard to exclusion of travelling expenses incurred in foreign currency from export turnover and included in total turnover for computing deduction under section 10A of the Act. Similar issue has been decided in assessee's own case for the assessment year 2005-06 by the co-ordinate Bench of this Tribunal in ITA No.1925/Mds/2010, wherein the Tribunal following the Special Bench decision of Chennai Bench in the case of ITO v. Sak Soft Ltd. [2009] 30 SOT 55 held that such travel expenses incurred in foreign currency have to be excluded both from export turnover as well as from total turnover for the purpose of computing relief under section 10A of the Act. Respectfully following the decision of the Special Bench in the case of Sak Soft Ltd. (supra), we direct the Assessing Officer to exclude the travel expenses incurred in foreign exchange from export turnover as well as total turnover for the purpose of computing relief under section 10A of the Act.
29. In the result, the appeal of the assessee is partly allowed.
The order pronounced in the open court on 12th day of december 2013 at Chennai.