Tuesday, February 24, 2009

Honeywell Ruling by Pune Tribunal

"Current year" financial data of comparables and only the expenses having nexus with operating profits to be considered for FAR Analysis. Though per OECD guidelines, it is permissible to take profit of similar transaction not only of period under consideration, but also for next or previous year or take average of such profit - This however is not permitted under Indian TP Regulations.


HONEYWELL AUTOMATION INDIA LTD
PAN NO : AAACT3904F
Vs
Dy COMMISSIONER OF INCOME TAX
CIRCLE 7, PUNE

FACTS
The taxpayer is engaged in the business of providing integrated automation and software solutions that increase productivity in industry, provide comfort in work environments, ensure safety & security of home and business premises. The company was incorporated as a joint venture between Tata Group and the Honeywell Group in 1988 and currently enjoys a good position in Indian automation and control industry. Subsequent to the year ended March 31, 2004, Tata Group sold its entire equity stake to the Honeywell Group resulting in the Honeywell Group acquiring a controlling stake in the company.

During the year under consideration, the taxpayer, as per its audit report disclosed six international transactions with its associated enterprises. Out of six, in case of five transactions, arm’s length principles have been accepted to be satisfied and accordingly no adjustments made under the transfer pricing regulations. The detail of such transactions is available at page 2 of the order of Transfer Pricing Officer (TPO).

The taxpayer in its audit report justified and supported prices paid to its associated enterprises (AE) for the raw material etc. used in System Integration Division under TNM Method. The Transfer Pricing Officer (TPO), to whom the case was referred, however, found, from the study of report, that taxpayer had bifurcated system integration division for computing operating profit in two sub-business segments namely IS-Infra and Balance Systems. Each of these segments was separately benchmarked by taking external comparables to prove arm’s length price. The TPO did not agree that suitable comparables were taken into consideration. He also rejected bifurcation into two sub-segments (profits) since sub-segments, according to the TPO, were part of business of rendering system integration activities and accordingly TNM Method could be applied to aggregated transactions for computing arm’s length profit. TPO carried fresh analysis after finding uncontrolled comparables and worked out mean margin of the operating profit of such comparables at 0.42% as against negative figure [ (-)0.84%] disclosed by the taxpayer as per its accounts. The TPO vide show cause notice dated November 9, 2006 asked the taxpayer why arm’s length profit be not computed by applying above ratio.

The taxpayer vide its replies dated 13.06.2006, 28.07.2006, 03.08.2006 and 15.11.2006 raised objections against above computation.

The taxpayer submitted that if profit margin of the companies mentioned by the taxpayer for the financial year ended March 31, 2004 was taken into account, it will be minus 0.82%. It was accordingly contended that there was no case for making adjustment under the transfer pricing.

The Transfer Pricing Officer (TPO), on due consideration of taxpayer’s objections, did not find any substance in them. He observed that system integration segment was the identified business unit and, therefore, operating profit of the said unit has to be taken into account for benchmarking. Similar results of comparables were taken into account for analysis after considering functions carried by them. It was not possible to bifurcate and take profit of sub-segments since what was comparable in each case, was systems integration activity for applying Transactional Net Margin Method. The TPO accordingly rejected the objections of the taxpayer.
After rejecting contentions of the taxpayer, the TPO made adjustment of Rs 282 lakhs as per the following calculations:

“The profit of the system integration segment is being computed as follows:
Gross Sales: 22050 lakhs
Operating Profit: -186 lakhs
Arm’s length operating profit margin: 0.42%
Arm’s length operating profit = 22050 lakhs * 0.42% = 93 lakhs
Profit to be added to total income – 189 lakhs – 93 lakhs = 282 lakhs.

On receipt of order of the TPO, the Assessing Officer (A.O) made assessment in conformity with the said order.

The addition made under the head “Transfer Pricing adjustments” was challenged by the taxpayer in appeal before the CIT (Appeals) and the main contention of the taxpayer that the A.O committed an error in the selection of the comparables was reiterated. The CIT (A) did not find any force in the contentions raised by the taxpayer. The Transfer Pricing adjustments were accordingly upheld. The taxpayer being aggrieved has brought the issue in appeal before the Income-tax Appellate Tribunal (ITAT).

The ITAT observed, “In this complicated field of transfer pricing, the taxpayer has raised only a limited issue relating to exclusion of Wellwin Industry Ltd. as a comparable. All other objections raised before revenue authorities have been given up. Neither the selection of most appropriate method (TNMM), nor any parameters of selection have been challenged by the counsel for the taxpayer. As regards the question of not considering profit / losses of Wellwin Industry Ltd., for the period ending March 31, 2004, it is an admitted position that results of that enterprise for the relevant period are not available. The party after September, 2003 maintained accounts for 18 months and closed its account only on March 31, 2005. The company did not maintain separate accounts for the period March 31, 2004. The taxpayer did try to work out the alleged losses of the concern for the period ending March 31, 2004 on some basis by taking average of profits but was unable to show to the revenue authorities that figures so arrived at were correct and reliable for comparison.”

In the OECD guidelines, it is permissible to take profit of similar transaction or enterprises not only of the period under consideration, but also for next or previous year or take the average of such profit. This, however, is not permitted under the Indian Regulations on Transfer Pricing.

For the relevant financial year in which the international transaction took place, is to be considered for comparability analysis. Under the proviso, data for period not being more than two years prior to financial year in which international transaction was entered, may also be considered, if such data reveals facts which could have an influence on the determination of transfer prices. Under the proviso, there is no scope to consider data for a subsequent assessment year. The assessee has not been able to reveal any facts to bring the case within the above proviso. Admittedly, Wellwin Industry Ltd. in the period prior to the financial year under consideration had shown profit and same was taken into consideration for determining arm’s length price for the assessment year 2003-04. However, its accounts for the period ended 31.3.2004 are not available and, therefore, could not be taken for working mean margin of profit.

On these facts, ITAT did not find any error in the approach of revenue authorities in excluding Wellwin Industry Ltd. for a comparative analysis.

As regards the alternative contention of the taxpayer, Tribunal held that for finding operative profit margin of the taxpayer or other similar enterprises, under TNM Method, all receipts and disbursements shown in accounts for the relevant period are required to be scrutinised. Only items of receipt or expenditure having nexus with the operating profit/loss of the enterprises are to be taken into consideration. An item of receipt or expenditure, which has no direct connection with operating profit, is to be ignored. Further, relevant receipts and expenditure for the year ending 31.3.2004 are relevant and not future profit or loss of the subsequent year. It appears that to settle accounts with Tata Group, which withdrew from the enterprise after 31.3.2004, future losses were also provided in the accounts. Otherwise such provision of future losses, prima facie, had no connection with operating profit of the financial year.

The objection that such a claim was not made before the TPO or other revenue authority, cannot debar the taxpayer from raising this claim before the Income-tax Appellate Tribunal. Evidence of claim is available in the primary record considered by the revenue authorities. The matter can be considered and decided on the basis of material available on record and would cause no surprise to the opposite party.
In the case of National Thermal Power Co. Ltd. vs. CIT, the Supreme Court examined the question of powers of Appellate Tribunal relating to question raised for the first time before the Tribunal. The Supreme Court observed:

“There is no reason to restrict the power of the Tribunal under section 254 only to decide the grounds which arise from the order of the Commissioner of Income-tax (Appeals). Both the assessee as well as the Department has a right to file an appeal/cross-objections before the Tribunal. The Tribunal should not be prevented from considering questions of law arising in assessment proceedings, although not raised earlier. The view that the Tribunal is confined only to issues arising out of the appeal before the Commissioner (Appeals) is too narrow a view to take of the powers of the Tribunal.

Undoubtedly, the Tribunal has the discretion to allow or not to allow a new ground to be raised. But where the Tribunal is only required to consider the question of law arising from facts which are on record in the assessment proceedings, there is no reason why such a question should now be allowed to be raised when it is necessary to consider that question in order to correctly assess the tax liability of an assessee.”

Tribunal therefore, permitted the assessee to raise alternative ground of appeal on question of deduction of provision for future loss debited in the profit and loss account. The Tribunal opined that consideration of above debit entry is fundamental to computation of correct profit margin of the enterprise. As the question was not raised by the taxpayer before the revenue authorities and was neither examined by the taxpayer nor by TPO, ITAT set aside impugned orders and directed that above question be examined in accordance with law and profit margin of the taxpayer be determined as warranted by facts and circumstances of the case.

All relevant details be examined to finally decide the issue. In the interest of justice, the question of claim of deduction of provision of future loss is remitted to the file of the Assessing Officer / T.P.O. The same be examined and allowed in accordance with law. The alternative ground of appeal raised by the taxpayer is accepted, to the extent mentioned above.

No comments:

FAQ on GST

Find enclosed Compilation of FAQ’s on GST for your ready reference. This is only for educational and guidance purposes and do not hold an...