Pallavi Dinodia, for the Assessee. Krishna Kumar Mishra, for the Revenue.

This appeal by the assessee arises out of the final Assessment order dated 21-10-2019 passed by the Assessing Officer (AO) u/s.143(3) (of Income Tax Act, 1961) r.w.s. 144C(13) (of Income Tax Act, 1961) (hereinafter also called ‘the Act’) in relation to the assessment year 2015-16.

2. The only issue pressed before the Tribunal is the transfer pricing addition of Rs.13,10,50,362/- made by the AO. Succinctly, the factual matrix of the case is that the assessee is engaged in providing lighting solutions to the automotive industry, i.e. two wheelers and commercial vehicles. Return of income was filed declaring total income at Nil. Thirteen international transactions were reported in Form No. 3CEB.

The AO made a reference to the Transfer Pricing Officer (TPO) for determining the Arm’s Length Price (ALP) of the international transactions. The assessee applied a combined Transactional Net margin method (TNMM) as the most appropriate method in respect of eight transactions. The TPO did not dispute the correctness of the method and restricted himself only to the five international transactions under the `Manufacturing Activity’ for benchmarking. The remaining three international transactions of Purchase of Assets; Sale of Assets; and Sale of tools and moulds under the TNMM were not disturbed by the TPO. He made certain alterations to the comparables chosen by the assessee and finally shortlisted six companies as comparable with Profit level indicator (PLI) of weighted Operating Profit (OP)/Operating Revenue (OR) having Median at 2.40%. Thereafter, he applied such Median to the total operating revenue of the assessee for working out transfer pricing adjustment of Rs.13,10,50,362/-. The AO notified draft order with such an adjustment. No reprieve was provided by the Dispute Resolution Panel (DRP) which led to the passing of the final assessment order with the transfer pricing addition of Rs.13.10 crore. Aggrieved thereby, the assessee has approached the Tribunal.

3. We have heard the rival submissions through Virtual Court and gone through the relevant material on record. The ld. AR pressed only one issue, namely, the making of transfer pricing adjustment on entity level rather than the transactions with the Associated enterprises (AEs). It is a matter of record that out of total thirteen international transactions, the assessee applied the TNMM in respect of eight transactions; the CUP method in respect of three; and OM in respect of the remaining two. The TPO restricted himself only to the five international transactions relating to ‘Manufacturing activity’, tabulated at page three of his order, namely, Import of components for manufacture, wiring harness, plastic and related – Rs.1,14,74,722/-; Sale of Finished goods – Rs.9,37,66,308/-; Royalty charges – Rs.11,56,48,118/-; Consulting services – Rs.1,43,88,579/-; and Designing & Product Development Charges – Rs.10,88,47,390/-. He computed 2.40% as arm’s length margin (OP/OR) of the comparables and then proposed the transfer pricing adjustment of Rs.13.10 crore in para 12.1 of his order in the following manner:

As per Assessee As per ALP Particulars Amount (Rs. Particulars Amount (Rs. Operating Income 3266594915 Operating Income 3266594915 Operating Cost 3319246999 Operating Cost 3188196637 Operating Profit (52652084) Operating Profit 78398278 PLI (OP/OR) PLI (OP/OR) 2.40 Adjustment 13,10,50,362/-

4. Before delving into core of the controversy, it is pertinent to mention that the international transactions relating to balance sheet items do not per se offer a base for transfer pricing adjustment directly, as these are neither considered as the operating costs or operating revenue. Their ALP determination assumes significance only for the purpose of allowing depreciation etc. over the period. Out of total eight international transactions reported by the assessee under the TNMM, the TPO has himself left out three transactions of Purchase and sale of assets and also Sale of tools and moulds. He did not determine their ALP, thereby impliedly accepting them at ALP. He has considered only five items as set out supr.

5. The ld. AR submitted that the fifth transaction in the TPO’s table, namely, `Designing & Product Development Charges’ of Rs.10,88,47,390/- is a balance sheet item, which was taken as an Intangible asset, going straight to the Balance sheet through the Schedule of Fixed Assets and, as such, was neither debited to the Profit and loss account nor taken as a component of Operating costs. Our attention was invited towards Schedule of Fixed Assets at page 107 of the paper book, wherein there is a figure of Rs.15,02,23,827/- under the main column of `Intangible assets’ and sub-column of `Design charges’. The ld. AR contended that the international transaction of Design and Product Development Charges at Rs.10.88 crore is a part of Rs.15.02 crore. This was attempted to be demonstrated with the help of Note No.34 to the Financial statements, a copy given at page 120 of the paper book, where a sum of Rs.10,88,47,390/- has been shown as “Design Charges” (Intangible Assets). This figure of Rs.10.88 crore in the Notes to Financial statements matches with the figure of international transaction of Design and Product Development Charges. However, it is not clear as to whether or not the value of international transaction of Rs.10.88 crore is a part of figure of Rs.15.02 crore shown under the head “Intangible Assets” in Schedule to the Fixed Assets. The AO/TPO is hereby directed to ascertain the correctness of the claim of value of international transaction of Rs.10.88 crore as forming part of the total figure of Rs.15.02 crore reflected in the Schedule of Fixed Assets shown under the head “Intangible Assets”. In case, such a contention is found to be correct, then the value of this international transaction will go out of the reckoning for the purposes of transfer pricing adjustment as discussed infra.

6. Having held that the international transactions in the nature of balance sheet items do not give a platform for the direct transfer pricing adjustment except indirectly affecting depreciation claim etc., now we espouse a situation in which the TNMM has been applied on an aggregate basis and the international transactions involved therein are in the nature of both expenses and revenue. This is the situation under consideration inasmuch as out of the remaining four transactions (after exclusion of Design and Product Development Charges of Rs.10.88 crore) in the table of the TPO, three are in the nature of expenses, namely, Import of components, Royalty and Consulting services and one in the nature of revenue, namely, Sale of finished goods.

7. The TNMM - whether on segregate or aggregate approach of international transactions - contemplates only one calculation of ALP. Naturally, there can be a solitary PLI, which can be either w.r.t. operating revenue or operating costs and in no case both of them. Thus, under the combined TNMM approach of certain international transactions of both revenue and expense items, the transfer pricing adjustment can be made by considering either the expense items, such as import of material, other operating costs, cost of services availed on one hand or the revenue items such as sales, consideration for services rendered on the other. Normally, when the expense items are taken up for benchmarking under the TNMM, then PLI of (OP)/(OR) of the comparables is adopted. Such PLI is applied to the Operating revenue of the assessee to find out the ALP of the costs, which is then compared with the actual costs incurred to the AE for ascertaining if any transfer pricing addition is warranted. Per contra, if the international transactions of revenue nature are to be benchmarked, then normally PLI of OP/OC of comparables is taken. Such PLI is applied to the Operating costs of the assessee to find out the ALP of the revenue, which is then compared with the actual revenue received from the AE for finding out quantum of transfer pricing addition, if any.

8. From the Table reproduced above, it can be seen that in the extant case, the TPO has proceeded with the PLI of OP/OR of the comparables to benchmark the international transactions in the nature of operating expenses of the assessee for proposing the transfer pricing adjustment. He took Median margin of comparables with weighted average of OP/OR at 2.40%, which was applied to the total Operating Revenue of the assessee at Rs.326.65 crore to work out arm’s length Operating Cost of the assessee at Rs.318.81 crore and the corresponding Operating Profit at Rs.7.83 crore. By reducing the arm’s Length Operating costs at Rs.318.81 crore from the actual operating costs of the assessee at Rs.331.92 crore, the TPO worked out the amount of transfer pricing adjustment at Rs.13.10 crore. It is evident from the above working that the transfer pricing adjustment has been made at the entity level.

9. The case of the assessee, with which we concur, is that the transfer pricing adjustment ought to have been restricted to the international transactions rather than the entity level transactions. Section 92 (of Income Tax Act, 1961) is the first section of the Chapter-X containing special provisions relating to avoidance of tax. Sub- section (1) of section 92 (of Income Tax Act, 1961) provides that: `Any income arising from an international transaction shall be computed having regard to the arm’s length price’. Thus it is graphically clear that the ALP and the consequential transfer pricing adjustment are contemplated only in respect of the international transactions and not the entity level transactions. The TPO, in the instant case computed transfer pricing adjustment in respect of entity level transactions and then forgot to restrict it to the international transactions. We have noted above that in a case of combined TNMM, when there are international transactions of the income as well as expenses nature, the transfer pricing adjustment can be made only by considering either the expenses or the incomes. Out of the balance four international transactions under the `Manufacturing activity’ taken by the TPO, three transactions are of expense nature and one is of income nature. As the TPO took the PLI of OP/OR, naturally, the transfer pricing adjustment as per his version could have been in respect of the international transactions of expenses items and he has also proceeded with the costs base rather than the revenue. However, after finding out the amount of entity level transfer pricing adjustment accordingly, the TPO should have gone further by restricting it to the transactions with the AEs by ascertaining value-wise percentage of such transactions to the total operating costs of the assessee and then applied such percentage to the amount of the entity level transfer pricing adjustment.

10. The ld. AR has placed on record a computation of value of the international transactions in the `Manufacturing activity’, warranting adjustment towards expenses, at Rs.14.15 crore and also the percentage of such costs to total operating costs of the assessee at 4.26%, thereby working out the proportionate transfer pricing adjustment at Rs.55,87,148/-. This calculation has not passed through the eyes of the AO/TPO. Under these circumstances, we set aside the impugned order and restore the matter to the file of the AO/TPO for verifying the correctness of the above figures given by the ld. AR and then deciding the issue afresh in conformity with our observations. Needless to say, the assessee will be allowed reasonable opportunity of hearing in such fresh proceedings.

11. No other ground was pressed by the ld. AR. Such grounds, ergo, stand dismissed as ‘not pressed’.

12. In the result, the appeal is partly allowed for statistical purposes. Order pronounced in the Open Court on 16th February, 2021.

Sd/- Sd/-

(S.S. VISWANETHRA RAVI) (R.S.SYAL)

JUDICIAL MEMBER VICE PRESIDENT

Pune; Dated : 16th February, 2021