2011-VIL-735-ITAT-HYD

Income Tax Appellate Tribunal HYDERABAD

ITA No.1626/Hyd/2010

Date: 30.06.2011

ST. JUDE MEDICAL INDIA PVT. LTD.,

Vs

THE DCIT, CIRCLE 3 (2) , HYDERABAD

Appellant by : S/Shri. R. Vijayaraghavan & Others
Respondent by : Shri V. Srinivas, DR (CIT)

BENCH

SHRI G.C. GUPTA, VICE PRESIDENT AND SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER

JUDGMENT

PER CHANDRA POOJARI, A.M.

This appeal preferred by the assessee is directed against the order passed u/s 143(3) r.w.s. 144C of the Income Tax Act, by the DCIT, Circle 3 (2) – Hyderabad dated 25.10.2010 and pertains to the assessment year 2006-07.

2. The assessee raised the following grounds in its appeal:

1. That the order of the DCIT, Hyderabad is in pursuance of the directions of the Dispute Resolution Panel is contrary to law, facts and circumstances of the case.

2. Transfer pricing adjustments:

2.1 That the DRP erred by not accepting the price of international transaction of purchase of medical devices of Rs. 35,61,05,687 shown by the assessee and determining the arm’s length price at Rs. 42,11,11,027 and thereby making transfer pricing adjustment of Rs. 6,50,05,340/- to the total income of the assessee.

2.1.2 : That the DRP erred in rejecting the economic analysis undertaken by the assessee in accordance with the provisions of the IT Act, read with IT Rules, 1962 and consequently making adjustment u/s 92CA of the Act to the total income of the assessee.

Without prejudice to the above, the assessee submitted that DRP has not properly appreciated the submissions of the assessee that the TPO had not considered proper comparables and not applied the proper adjustments to arrive at the ALP, more specifically :

2.2.1 : That the DRP erred in the confirming the action of the TPO by rejecting the comparables selected by the assessee in accordance with the provisions of the Act read with the Rules.

2.2.2. That the DRP erred in rejecting multiple year data of comparable companies ad adopted by the assessee and using data for the financial year 2005-06 only in determination of ALP.

2.2.3: That the DRP erred in ignoring the key requirements of functional comparability under the Act read with Rules by confirming the TPO’s consideration of companies having manufacturing operations as comparable companies without appreciating the fact that the assessee is into trading activities only.

2.2.4: That the DRP ought to have appreciated that the TPO had computed gross margins of the alleged comparable companies incorrectly.

2.3 Resale price method(RPM)

2.3.1 That the entire approach/methodology adopted by DRP for computing the ALP under RPM is not as per the provisions of rule 10B(b) and therefore, the computation of ALP of Rs. 42,11,11,027 is not correct.

2.3.2: That the DRP have erred in confirming the order of the TPO wherein purchase price was taken as base to determine ALP under RPM, instead of resale price of such purchases without appreciating that as per rule 10B(b), the resale price as reduced by the normal gross profit is similar uncontrolled transaction and other adjustments should be considered as ALP for the international transactions.

2.4 Arm’s Length range of 5%

2.4.1. That the DRP erred in not granting the benefit of +5% of the profit margin determined in the case of comparable companies as prescribed under the proviso to section 92C(2).

2.4.2. That the DRP erred by rejecting the contention of the assessee that if the difference between ALP and value of international transaction of the assessee exceeds 5% of the ALP, the TP adjustments can be made only with respect to the remaining differential amount after considering the benefit of 5% range.

2.5 others:

2.5.1. That on the facts and circumstances of the case, the adjustments of 1% of ALP given on account of start up company/economic differences is not sufficient

2.5.2. That the DRP erred in ignoring the fact that the valuation of the import of goods by the assessee from the AE was accepted by the custom authorities of India in terms of Custom Valuation Rules, 1988.

2.5.3 That the DRP erred in holding that gross profit margin of 16.84% of the assessee is not reliable.

3. Other adjustments:

3.1.1. That the DRP erred in disallowing the amount of Rs. 47,250 paid to Karnataka VAT authorities on behalf of the assessee’s customer without appreciating that the payment is not penal in nature.

3.1.2: The DRP erred in imposition of interest under section 234B section 234C and section 234D.

3. The Learned Authorized Representative for the assessee has submitted that the Assessing Officer has not taken into account the closing stock of unsold goods. The assessee has purchased from M/s Associate Enterprises, at Rs. 35.61 crores. The closing stock was Rs. 9.26 crores. The sale price realised was Rs. 33.56 crores. As a result, the company had made gross operating profit of Rs. 6.33 crores or 23.25% on the cost of goods sold. The TPO has taken operating profits as minus figure.

4. He further submitted that the assessee and the TPO had agreed that most appropriate method is resale price method. Under Rule 10B(1)(b) of Income Tax Rule 1962, for determining the ALP (arm length price) under the resale price method, the price at which the goods are sold is to be taken and from the resale price the average gross profit margin of comparable enterprises is to be reduced. The price so arrived at, is to be further reduced by the expenses incurred by the enterprise and also adjustment taken into account functional and other differences. The DRP arrived at the comparable gross margin at 29.51% and has made an adjustment of Rs. 2.71 crores towards marketing expenses and a further 3% adjustment on account of start up company and working capital adjustments.

5. He further submitted that both the TPO and DRP instead of following Rule 10B(1)(b), started with the gross purchase value from the AE and applied the gross profit margin. After making adjustment of marketing expenses and 3% adjustment and arrived at Rs. 42.11 crores as ALP. This amount again compared with the purchase price of in Rs. 35.61 crores and adjustment of Rs. 6.50 crores was confirmed by the DRP. There is no reference unsold stock, sale price or the profits made by the assessee. The method adopted by the DRP is against the provisions of the Act.

6. Without prejudicial to the assessee’s objections to the choice of comparables and other adjustments, the Learned Authorized Representative submitted that adopting percentage of GP and other adjustments adopted by the DRP and applying the correct method of computation under rule 10B(1)(b) there would be no adjustment required. Thus, if the patent mistakes made by the TPO/DRP are corrected and the figure adopted by the DRP is taken then there will be no adjustments is required.

7. Without prejudice to the contention of the assessee that the comparable companies taken by the TPO and the comparable of the company rejected by the TPO is not on the basis of the correct FAR analysis and comparable verticals, he submitted that consequently the GP rate adopted by DRP is on the higher side. The assessee is entitled to the benefit of 5% adjustments on the ALP arrived at on the basis of average profit margin.

8. On the other hand, the DR has submitted that the sale price of the goods sold to non AE i.e. Rs. 33,56,53,652/- should be adopted as resale price under the RPM, whereas the TPO has started the computation on the basis of the value of total purchase from the AE i.e. Rs. 35,61,05,687/-. The facts appear to be opposed to the assessee’s contention as recorded by the TPO. The operating profit is a minus figure i.e. (-) Rs. 67,21,027/-. The operating profit to cost ratio as well as operating profit to revenue ratio are negative. Further, the assessee company markets and sales the products in India mainly through distributors and only to a limited extent through direct sales to hospitals. He submitted that in view of this, there is difficulty in ascertainment of resale price on the basis of resale to unrelated enterprise. Thus, in the given factual matrix, the approach of the TPO is rational. The resale price can be determined by applying the determined rate of margin to the base of total value of international transaction i.e. purchase from AE. Further, what is at stake is the determination of ALP in respect of the entire value of international transaction which comprises of purchases from the AE to the extent of Rs. 35,61,05,687/-. Out of this total purchase, goods to the extent of Rs. 9,62,38,847/- constitute closing stock. Hence the assessee’s stand to do the bench marking exercise adopting the sales figure reflected in the P&L account i.e. Rs. 33,56,53,652/- is untenable as it ignores a substantial amount of purchase from AE represented by the closing stock as at 31.3.2006. Any bench marking exercise has to necessarily take the entire value of international transaction into account. This exercise has to be done at the enterprise level. Hence the assessee’s canvassing that the exercise should begin with the sales figure from the profit and loss account is preposterous.

9. The departmental representative further submitted the relevant provisions relating to resale price method under the IT Rule 10B stipulate a reduction of the normal gross profit margin accruing to the enterprises from the identified resale price to unrelated enterprise. A serious difficult posed in the case of the present assessee as regards normal gross profit, is that the assessment years under consideration i.e. 2006-07 happens to be the very first year of existence of the assessee company. It started its business operation only from August, 2005. Hence the business operation results are not available for the entire year, but only for a part of the year i.e. less than 8 months. Hence, the statutory idea of normal gross profit margin accruing to the enterprise would not be applicable here as the result relating to the very first year, that too, relating a part of the year cannot form a rational basis for ascertainment of normal gross profit margin an idea which presupposes a trend of result involving at least 2 to 4 years of business activity. This conclusion is reinforced by the assessee’s own conduct in the very first year of assessment as under:

i) The assessee’s return that in December 2005 it had estimated and paid an advance tax of Rs. 50 lakhs. This payment certainly presupposes estimate of taxable profits in the neighbourhood of more than Rs. 1.5 crores. But the assessee filed a return and a revised return claiming a refund of Rs. 44,37,755/-. Thus, it is evident that the divergence between December estimate for advance tax liability and the total income declared in the income tax return was unusually wide.

ii) Further, in the profit and loss account for the assessment years under consideration i.e. 2006-07 the assessee had debited a substantial amount of Rs. 88,63,870/- towards provision for product replacements. The assessee came to file a revised return for the assessment years 2006-07 declaring the said provision to be excessive by a substantial margin of Rs. 73,09,498/-. But this excess provision of Rs. 73.09 lakhs was written back only in the succeeding financial year i.e. 2007-08. This would evidently suggest unwarranted reduction of profit and profit margin for the assessment years 2006-07 which is under consideration.

iii) The overall business results as recorded by the TPO tend to be negative i.e. operating profit is negative, operating profit to cost ratio is negative, operating profit to revenue ratio is negative. The GP margin of 16.84% shown is not reliable. 10. He submitted that the basic approach adopted by the TPO towards computation of ALP appears to be rational in the given situation of facts as the entire value of international transaction has to be bench marked for ALP. The resale price can only be determined by applying the gross profit margin of 29.51% to the base figure of value of purchase from the AE and the computation of ALP is as under:

Purchase price from the AEs by the tax payer company as per 3CEB report	Rs.35,61,05,687
Add: Normal average GP margin on sales @ 29.51% of the independent comparables as worked out above Rs. 35,61,05,687 X 29.51%	Rs.46,11,92,475
Less: Marketing expenses incurred by the tax payer with the purchase of goods arm’s length Price	Rs.2,71,46,889 -------------------- Rs.43,40,45,586
Less; Adjustments 1) No adjustment is being given for functional differences as rightly contended by the TPO since the two comparables are functionally similar and one of which ahs been proposed and accepted by the tax payer
2) However, adjustment 1% of ALP is given on account of start up company, economic differences etc. (Rs.43,40,45,586 X 1%	Rs.43,40,455
3) Working capital adjustment at 2% on net ALP as done by the TPO (i.e. 42,97,05,131 X 2%	Rs.85,94,102
Adjusted arms length price as per the DRP	Rs.42,11,11,027

 

10.2 According to the DR, the price charged by the tax payer to its associated enterprises is compared to arms length price as under:

Adjusted arms length price worked above	Rs.42,11,11,027
Purchase price shown in the international transactions	Rs.35,61,05,687
Shortfall being adjustment u/s 92CA	Rs.6,50,05,340/-

 

11. He submitted that the addition at Rs. 6,50,05,340/- is justified.

12. We have heard both the parties and perused the materials available on record. We find force in the arguments of the assessee’s counsel. There is no dispute herein with regard to the fact that the entire purchases were made from M/s Associate Enterprises at Rs. 35.16 crores was not sold. There were unsold goods. The unsold goods cannot be considered in the assessment year under consideration for determining the arm’s length price. Only the goods that which was sold has to be considered for determining the ALP. After considering the purchase price from the AE in respect of the goods sold, the addition has to be made towards normal average GP margin on sales and thereafter deduction is to be made towards marketing expenses and other adjustments i.e., towards functional, economic differences and working capital at 3% of the ALP as determined by the DRP. Accordingly, with these directions, we set aside the order of the Assessing Officer and remit back the entire issue to the file of Assessing Officer to re-determine the ALP in accordance with Rule 10B(1) (b) of the IT Rules and thereafter compute the additions if any required to be made u/s 92C(A) with regard to the difference between ALP and purchase price of international transactions after giving adequate opportunity of hearing to the assessee.

13. The other grounds are not seriously pressed by the AR before us and hence dismissed as not pressed.

14. In the result, the appeal of the assessee is partly allowed for statistical purposes.

Order pronounced in the Open court on 30.6.2011

 

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