In the instant case, as other income of the assessee is excluded from the net profit, the other income of comparable companies should also be excluded from their net profit and the full data of the comparables should also be provided to the assessee.
Kem Tron Technology (P) Ltd. v CIT
ITAT, Ahmedabad
ITA No. 356 (Ahd.) of 2008
Assessment Year: 2004-05
D.K. Tyagi, JM and A.K. Garodia, AM
Decided on: 17 June 2011
Counsel appeared:
J.P. Shah for the appellant
S.A. Bohra for the respondent
Order
D.K. Tyagi, JM
1. This appeal by the assessee has been preferred against the order dated 7-12-2007 of CIT(A)-V,
Baroda for the assessment year 2004-05. The assessee has taken the following grounds of appeal:
"1.00 On the facts and in the circumstances of our appellant case as well as in law, the
Hon'ble Commissioner of Income-tax (A)-V, BRD had erred in confirming the Order of ld.
Asstt. Comm. of Income-tax, Circle 1(2), BRD on account of upward adjustment in
international transaction on the plea that similarly placed companies have better margin as
compared to your appellant's company.
1.01 Your appellant says and submits that the Hon'ble CIT(A) had erred in not considering
the other income, mainly consisting of export incentives for the purpose of calculating margin
with other companies whose net profits are comprising of the other income.
1.02 Your appellant further says and submits that the Hon'ble CIT(A) had erred in not
considering the plea of your appellant that data furnished by the ld. A.O. in respect of various
companies is not comparable with that of your appellant company on various reasons
furnished during the course of assessment proceedings as well as before the Hon'ble CIT(A),
BRD., the principal reason being the companies whose data are furnished by the ld. A.O. are
not similarly placed companies.
1.03 Your appellant says and submits that the Hon'ble CIT(A), BRD had erred in not taking
any cognizance of the submission made by your appellant in respect of data submitted for
2. The brief facts of the case are that during the assessment proceedings, the A.O on perusal of P and
L account of the assessee found that the assessee has declared a gross profit of Rs.18,86,446 against
export sales of Rs.2,82,70,233. This sale was entirely made to its principal holding company. The
gross profit ratio comes out to 6.67% and the net profit of the business has been worked out at
Rs.9,22,281 which is 3.26%. The A.O. was of the view that there was a transaction with the related
concern as the holding company has 98% shareholding of the assessee company. He also observed
that the profit of the assessee becomes a negative figure if other income of Rs.18,28,677 is reduced
from the net profit declared. The other income comprised of interest income and income by way of
export incentive. He concluded that in these circumstances, net profit will become negative i.e. (-
)3.21%. Invoking the provisions of section 92C(3), the A.O. issued a show cause notice. The A.O.
pointed out that the profit of business ensuing to the assessee did not appear to be the coefficient of
the turnover of the business of international transaction carried out by the assessee during the year
with its associate enterprises. As the operating margin appears low, the A.O. proposed to make
upward adjustment in the ALP by treating the instances of similarly placed companies and made
upward adjustment after allowing the assessee reasonable opportunity to rebut the objection of the
department. The A.O. stated that the assessee has not been able to prove in terms of documents that
the transaction between the assessee company and its principal was at arm's length price. The details
on the basis of which the revenue held that there was a case to disturbed the ALP had been culled out
from prowess software which was a reliable data.
3. Before CIT(A), assessee company filed written submission which have been summarized by the
Ld. CIT(A) as under:
"The appellant has inter alia submitted that the company had entered into sales transaction
with AE and on that transactions being export sales, the Government of India had given
incentive in the form of DEPB licenses, which are accounted as other income. The Assessing
Officer while calculating the margins had not considered the incentive and had made
calculation after ignoring the incentive only. The appellant further argues that during the
course of assessment proceedings they had submitted before the Assessing Officer, that the
appellant had sold certain items at a higher price compared to the other suppliers from Turkey
and China. However, as argued by the appellant, the Assessing Officer has not considered the
same while framing the assessment order. The appellant argues that the Assessing Officer had
selected the net transaction margin method and for that purpose had selected certain
companies from India. The appellant further argues that during the course of assessment it
was submitted that the companies which are selected by the Assessing Officer are not
comparable with that of appellant company due to various reasons, main reason being the size
of the company, infra structure, turn over of the company, and full data of the company, being
not provided to the appellant company. It was contended by the appellant that the comparison
can be made when there exist similar situation but no comparison can be made with the
companies when they are not similar and this fact was also explained to the Assessing Officer
in details during the assessment proceedings. The appellant further argues that while
calculating net margin the Assessing Officer has ignored the other income while data
provided of other companies, it appears that they are inclusive of other income and the
appellant was ignorant about this fact. It is also submitted by the appellant that the Assessing
Officer has not taken cognizance of the detailed working of FAS Analysis even though it was
submitted by the appellant."
4. The submissions of the assessee were sent to the A.O. for his comments. The A.O. filed a remand
report on which assessee's counter comments were also obtained by Ld. CIT(A). After taking into
consideration the submissions of the assessee, remand report by the A.O. and counter comments of
the assessee on A.O.'s remand report, Ld. CIT(A) upheld the upward adjustment in the price adopted
for international transaction made by the assessee with its associate concern by observing as under:
"6. I have carefully considered the facts of the case, the arguments of the Assessing Officer
and the arguments of the learned Authorized Representative. The Assessing Officer in this
case has adopted the net margin method to make an up-ward adjustment in the price adopted
for International transaction made by the appellant with its associated-concern. This
adjustment made by the Assessing Officer is justified and according to Law for the following
reasons:
6.1 The appellant is almost a 100% subsidiary of the foreign enterprise. The parent company
holds 98% of the total number of shares of the appellant. Therefore, the principal company is
in a vantage position to dictate or determine the sale price made by the appellant. Secondly,
the parent company is the only buyer of the customized components sold by the appellant
company. In such a situation it has to be seen whether the Indian enterprise is selling its
products to foreign enterprise at arm length price. The Assessing Officer has correctly found
that the appellant is not making any profit in its entire operation with the parent company.
Once export incentive and other income are taken out, there is a loss of about 3.21%.
Therefore, the conclusion of the Assessing Officer that the pricing of the product is not at
arm's length price is a logical and defendable conclusion.
6.2 As has briefly already discussed the appellant is manufacturing a part or components of a
product for the parent company. For this no direct comparable are available. Neither the
appellant is able to find one. Therefore, the only logical way is to adopt net margin method to
determine whether appellant is making any profit in this transaction. The Assessing Officer
has precisely done the same thing.
6.3 The objection of the appellant that for calculating net margin, other income should have
been taken into account is not correct as these incomes are not strictly related to the
transaction. Courts of Law have already held that export incentives cannot form part of
business profit although in different context. Export incentives are to be taken as other income
for the purpose of 80HHC. Export incentive could be incidental to export activities, but this is
not a factor of the cost.
6.4 The net margin adopted by the Assessing Officer at 3.768%, from the available
International Comparables, is again a fairly reasonable margin. Appellant has cited cases
where companies have also incurred losses, that argument is not tenable, because the background
of those cases are not given and appellant company also did not face any adverse or
extraordinary circumstances to warrant a negative margin.
7. In view of the above, I am in complete agreement with the Assessing Officer that transfer
price between the Associated Enterprises is to be suitably altered for determining correct
profit for the Indian Enterprise i.e. appellant company. The upward adjustment made by the
Assessing Officer amounting to Rs.19,72,697 in the ALP and consequential addition made is
upheld and the appeal on this ground is dismissed."
5. Further aggrieved, now the assessee is in appeal before us.
6. At the time of hearing Ld. counsel for the assessee reiterated the submissions made before the Ld.
CIT(A) and further argued that Ld. CIT(A) has erred in confirming the action of the A.O. on account
of upward adjustment in international transaction on the gourd that similarly placed companies have
better margin as compared to the assessee company. The companies which were selected by the A.O.
are not comparable with the assessee company as the size of the company, infrastructure, turnover and
full data of the company was not provided to the assessee company to rebut the findings of the A.O.
Most of the companies referred for comparison with the assessee company were not even dealing in
the goods in which assessee company deals. Ld. counsel for the assessee further argued that Ld.
CIT(A) was wrong in not considering the other income of the assessee company mainly consisting of
export inventive for the purpose of calculating margin money with the other companies whose net
profit is including other income also. To be fair to the assessee, the other income of those companies
should also be excluded from the net profit of those companies while comparing with the results of
the assessee company. Ld. Counsel for the assessee also argued that the authorities below also ignored
the data submitted by the assessee before them for comparison purpose for calculating the net margin
of the five similarly placed companies without giving any cogent reasons. It was also argued by the
Ld. Counsel for the assessee that in the subsequent years i.e. assessment years 2005-06, 2006-07 and
2007-08, though a reference under section 92(c)(1)(a) of the Act for the computation of arms length
price in relation to international transaction was made to TPO but no such adjustment was made by
the TPO in those assessment years. Concluding his arguments, Ld. Counsel for the assessee submitted
that upward adjustment of net price international transaction was uncalled for in this case therefore,
addition made in this case may kindly be deleted.
7. Ld. D.R. on the other hand relied on the orders of authorizes below.
8. We have heard both the parties and perused the material on record. We find that the assessee
company is a private limited company whose 98% shares are held by M/s. Kem-Tron Technologies
Inc. USA. The assessee is engaged in the business of manufacturing equipments and machinery parts
and components of solid operating equipments and parts used in oil and gas filled machinery. The
assessee does not supply any complete component but only spare parts are being manufactured and
supplied through its holding company.
9. As the assessee's major sales in international market related to associate enterprise section 93E was
applicable and a report in Form 3CEB was duly filed along with the return of income by the assessee.
The A.O. invoking the provisions of section 92C(3) of the Act made addition of Rs.19,72,697 by
making upward adjustment in international transaction with the associate enterprise on the ground that
similarly placed companies had better margins as compared to the assessee company. While doing so,
the A.O. took the net profit of the assessee company at (-) 3.21% instead of 3.26% shown by the
assessee, excluding the other income of Rs.80,28,677 from net profit declared by the assessee. A.O.
while holding that similarly placed companies had better margin as compared to assessee company,
has not done the same exercise i.e. other income of those companies had not been excluded from their
net profit, which according to us, is not proper. We further find that full data of the companies with
which assessee's profit margin was compared, was not provided to the assessee company. On the
other hand, the data of five companies which were engaged in the similar type of business, provided
by the assessee to the A.O., was totally ignored for no cogent reason. We are therefore, of the
considered opinion that the matter requires fresh adjudication by taking the average of net profit
shown by the companies considered by the A.O. while making this upward adjustment and the
companies on which assessee has placed reliance to show that transaction between the assessee
company and its principal was at arm's length price. While doing so, similar figures of all the
companies should be taken into consideration. In case, other income of the assessee is excluded form
the net profit, the other income of comparable companies should also be excluded from their net
profit. With these observations, the matter is restored back to the file of the A.O. for fresh
adjudication after giving opportunity of being heard to the assessee.
10. In the result, the appeal of the assessee stands allowed for statistical purposes.
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