M/s. Steer Engineering Pvt. Ltd., Bengaluru V. Deputy Commissioner of Income-tax, Circle-6(1)(2), Bengaluru

ITA 2071/BANG/2018

• Counselvise Citation: [2022] 105 COUNSELVISE.COM (IT) 3732 (ITAT-BANGALORE)
• Duration Of Justice: 3 year(s) 10 month(s) 6 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 26-04-2022
• Appeal Filed By: Assessee
• Order Result: PartlyAllowed
• Bench Allotted: B
• Assessment Year: 2012-2013
• Appeal Filed On: 20-06-2018
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: NARENDRA JAIN
• Keywords: Depreciation; Transfer pricing; Opportunity of being heard; International transaction; Fair market value; Right to appeal
• Section: 13; 22; 92CA

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL “B” BENCH : BANGALORE BEFORE SHRI N. V. VASUDEVAN, VICE PRESIDENT AND MS. S. PADMAVATHY, ACCOUNTANT MEMBER ITA No.2071/Bang/2018 Assessment Year : 2012-13 M/s. STEER ENGINEERING PRIVATE LIMITED, No.290, 4 th Main, 4 th Phase, Peenya Industrial Area, Nagawara, Bengaluru – 560 058. PAN : AABCS 8840 E Vs. DCIT, Circle – 6(1)(2), Bengaluru. APPELLANT RESPONDENT Assessee by :Shri.Narendra Jain, Advocate Revenue by:Mrs. Susan D. George, CIT(DR)(ITAT), Bengaluru. Date of hearing:18.04.2022 Date of Pronouncement:27.04.2022 O R D E R Per N. V. Vasudevan, Vice President :. V. Vasudevan This is an appeal by the Assessee against the order dated 26.03.2018 of CIT(A), Bengaluru-6, in relation to A.Y.2012-13. 2. The first issue that needs to be adjudicated in this appeal is with regard to the correctness of determination of Arm’s Length Price (ALP) in respect of international transactions of sale of extruders and parts and elements of extruders manufactured by the Assessee to it’s Associated Enterprise (AE), (i) Steer Japan Corporation, Japan, (ii) Steer America Inc., USA and (iii) Steer China Corporation, China. ITA No.2071/Bang/2018 Page 2 of 33 3. The Assessee was incorporated in the year 1993 as a private limited company under the provisions of the Companies Act, 1956 with liability limited by shares. The Assessee manufactures Extruders and Parts and Elements for Extruders. M/s Steer Japan Corporation (hereinafter referred as "Steer Japan" for brevity) and M/s Steer America Inc (hereinafter referred as "Steer America" for brevity) are both 100% subsidiaries of the Assessee and act as distributors in Japan and America respectively for the products manufactured by the Assessee. Steer China Corporation (hereinafter referred as "Steer China" for brevity) manufactures full range of extrusion lines, twin screw compounding extruders and CNC Wire EDM machines. During the relevant previous year, Steer China operated as distributor for products manufactured by the Assessee. Steer China is a wholly-owned subsidiary of Chindia Company Limited, Hong Kong (hereinafter referred as "Chindia" for brevity) which is a wholly owned subsidiary of Steer Engineering Private Limited. Chindia is an investment company. 4. There is no dispute that (i) Steer Japan Corporation, Japan, (ii) Steer America Inc., USA and (iii) Steer China Corporation, China, were associated enterprise(AE) within the meaning of the term as defined in Sec.92A(1) of the Income Tax Act, 1961 (Act). In terms of Sec.92(1) of the Act, the any income arising from an international transaction shall be computed having regard to the arm’s length price. Section 92F(ii) of the Income Tax Act defines 'arm's length price' as “a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.” The term associated enterprises in uncontrolled conditions. Unrelated Persons; Section 92A, the persons said to be unrelated if they are not associated or deemed to be associated enterprise. Uncontrolled Conditions are that conditions which are not controlled or suppressed or moulded for achievement of a predetermined result. Section 92C( 1) of the Act provides that the arm's length price in ITA No.2071/Bang/2018 Page 3 of 33 relation to an international transaction shall be determined by any of the following methods, being the most appropriate method(MAM), having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribed, namely :— (a) comparable uncontrolled price method (CUP);(b) resale price method;(RSPM)(c) cost plus method;(CPM)(d) profit split method;(PSM)(e) transactional net margin method(TNMM);(f) such other method as may be prescribed by the Board. By virtue of the provisions of section 92CA(1), the Assessing Officer, with the previous approval of the Pr Commissioner / Commissioner is empowered to refer to the Transfer Pricing Officer (TPO) the computation of the arm’s length price of an international transaction or specified domestic transaction entered into by an assessee over whom the Assessing Officer exercises jurisdiction. The TPO, after due enquiry and opportunity of being heard, shall by order in writing determine the ALP in relation to the international transaction in accordance with provisions of section 92CA(3) and send a copy of his order to the Assessing Officer (AO) and to the assessee for finalization of assessment order. Section 92C(2) provides that the variation between the ALP and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been under taken shall be deemed to be the ALP. The AO passes a draft order of assessment against which, the Assessee has a right to file objections before the Dispute Resolution Panel (DRP) u/s.144C of the Act. Under section 144C(5), the Dispute Resolution Panel (DRP) shall issue the directions, as it thinks fit, for the guidance of the AO to enable him to complete the assessment after considering report of TPO. The AO passes a final assessment order on the basis of directions of the DRP. In case the Assessee chooses not to filed objections before the DRP to the draft assessment order within the time required u/s.144C of the ITA No.2071/Bang/2018 Page 4 of 33 Act, the AO passes a final assessment order. The Assessee has a right of appeal against the said order to the CIT(A), which course the Assessee has adopted in the present case. 5. During the previous year, the Assessee entered into the following international transactions with its AE: Sl. No Name of Associated Enterprises Nature of Transactions Value (INR) 1 Steer Japan Corporation Sale of Extruders / Parts and Elements of Extruders 124,631,529 2 Steer America Inc Sale of Extruders / Parts and Elements of Extruders 167,037,028 3 Steer China Corporation Sale of Extruders / Parts and Elements of Extruders 4,091,356 4 Steer China Corporation Purchase of parts and elementsofextruders 6,148,295 5 Steer China Corporation Purchase of Fixed Assets 9,137,883 6Steer China CorporationPurchase of Intangible Assets32,991,505 7 Steer Japan Corporation Commission on sales 13,891,128 8 Steer America Inc Commission on sales 140,536,066 9 Chindia Company Ltd, Hong Kong Interest received / receivable 811,791 Total 499,276,581 The Assessee filed a transfer pricing study justifying the price received as at Arm’s Length adopting TNMM as the MAM for determination of ALP and chose two comparable companies. The profit level Indicator (PLI) adopted for the purpose of comparing Assessee’s profit margin with that of comparable uncontrolled transactions was Operating profit which was arrived at by reducing from the operating revenues the Operating Cost. ITA No.2071/Bang/2018 Page 5 of 33 Operating Revenues = Revenues from operating activities i.e. sale of parts and elements of extruders including foreign exchange gains and miscellaneous income but excluding non recurring and non operating income [i.e., interest, dividends, profit on sale of investment, profit on sale of assets, and other non recurring income]. Operating Cost = Total Cost including foreign exchange losses but excluding extraordinary expenses, non-recurring expenses, non-operating expenses, [i.e., profit / (loss) on sale of fixed assets, amortisation of preliminary expenses, any interest payments, etc.], fringe benefit tax, provision of income tax and deferred tax. Operating Profit = Operating Revenues - Operating Cost 6. The Assessee chose comparable companies engaged in sale of identical products as that of the Assessee to unrelated parties. The net operating margins of the comparable companies so chosen by the Assessee in it’s Transfer pricing analysis, for the financial year 2011-12 based on the above PLI along with the operating revenues, operating cost and operating profit is tabulated below: Sl. No. Name of the Company Operating Revenue Operating Cost Operating Profits Average Unadjue d Mar (%) 1 Kabra Extrusion Technik Ltd 1,902,883,000 1,814,029,00088,854,000 4.90% 2 Rajoo Engineers Ltd 781,159,786 727,279,635 53,880,151 7.41% Arithmetic mean 6.16% On the basis of the above, the arithmetic mean of net operating margins on comparable companies was 6.16 per cent. ITA No.2071/Bang/2018 Page 6 of 33 7. Computation of operating margin of Steer India: The net operating margin of the Steer India based on the financial statements for financial year 2011-2012 keeping the above PLI was tabulated by the Assessee in it’s TP analysis as given below: Particulars Total (INR) Operating Revenues: Revenue from operations 787,483,935 Other operating income 13,838,634 Total 801,322,569 Operating cost: Material consumption 269,861,504 Manufacturing and Operating Expenses 443,542,009 Bank Charges 5,411,760 Depreciation 37,626,304 Total Operating Cost 756,441,577 Operating Profits 44,880,992 Net Operating Profit/Operating Cost 5.93% 8. Since the operating profit margin of the Assessee was within the arm’s length range of comparable companies, the Assessee claimed that the price received in the international transaction was at Arm’s length. The second provisio to Sec.92C(2) provides that if arm’s length price determined and price at which the international transaction has actually been undertaken does not exceed such percentage of the latter, as may be notified by the Central Government in the Official Gazette in this behalf, the price at which the international transaction [or specified domestic transaction] has actually been undertaken shall be deemed to be the arm’s length price. The variation in ITA No.2071/Bang/2018 Page 7 of 33 this case between the price at which the comparable companies carried out the transaction and the price charged by the Assessee in the transaction with AE was within the permissible range and hence the Assessee claimed that the international transaction was carried out at Arm’s length price. 9. It can be seen from the computation of Assessee’s operating profit that the Assessee compared its operating profit at entity level by comparing the operating revenue from sale to AE as well as non AE. The operating profit of the two comparable companies were also arrived at by comparing operating revenue from sale to AE as well as non AE. In this regard there is no dispute that the operating revenue of both the two comparable companies were taken at the entity level and that the two comparable companies also had transaction within the country (domestic sales) and outside the country i.e., international sales but they were to unrelated parties. As far as the Assessee is concerned it had sales within the country (domestic sales) with unrelated parties and sales outside the country of which part of it was with related parties and part was with foreign parties who were unrelated. The quantum of foreign sales of the Assessee with related parties out of the total foreign sales of Rs.43,54,22,715 was only Rs.29,57,59,913/-. The following chart would show the break up of domestic and international sales of the Assessee and the comparable companies. Sl. No. Particulars Domestic Sales and its % of total sales International Sales and its % of total sales Total Sales Annexure 35, 20,61,220 43, 54,22,715 1 1 Appellant (45%)(55%) 78,74,83,935 47.01 61,005 34,22,24,399 2 2 RojooEngineers (58 '%)(42%) 81,23,85,404 ITA No.2071/Bang/2018 Page 8 of 33 3 Kabra 60,19,00,000 (32%) 130,09,84,000 (68%) 190,28,84000 3 10. The reasons given by the Assessee for choosing the operating profit at the entity level was that the Assessee Manufactures Extruders and Parts & Elements for Extruders. M/s Steer Japan and M/s Steer America act as distributors in Japan and America respectively for the products manufactured by the Assessee. During the year under consideration, Steer China also operated as a distributor for products manufactured by Assessee in China apart from performing manufacturing activity for part of the year. The transactions of sale and purchase of extruders and parts and elements of extruders, commission on sales, purchase of fixed assets and services received were considered as closely linked transactions. Therefore, the Assessee evaluated the international transactions by adopting Combined Transaction approach at entity level. This was for the following reasons: i. The transactions between the Appellant and its associated enterprises are two ways i.e. purchase as well as sale. ii. The comparable transactions are also available only at the entity level and not at individual transaction level; and iii. The net profit at an entity level would broadly justify the intrinsic value of all the underlying transactions particularly when the organization views them as interdependent and integrated whole. Therefore, the Assessee submitted that due to the nature of transactions, performing transfer pricing analysis at entity level is the most appropriate way to benchmark the international transactions. ITA No.2071/Bang/2018 Page 9 of 33 11. The TPO however did not accept the plea of the Assessee. He proceeded to perform a fresh TP analysis with respect to manufacturing activity based on segmental analysis i.e. bifurcation of the financial statement into international and domestic segment. The TPO held that the Assessee’s transactions with foreign subsidiaries are in the international segment and therefore considered international sales segment for benchmarking purpose. Thereafter the TPO drew international and domestic segments by allocating expenditure between international and domestic sales in the ratio of turnover. In respect of "Business promotion" and "Marketing exhibition" expenses the TPO allocated them on the basis of actual. The TPO thereafter drew segmental Profit & Loss acc (i.e. domestic and international segment) as follows: Domestic segment International segment Entity level Allocation Sales (OR)35,20,61,220 43542271578,74,83,935 Actuals Costof material Consumed 11,3084822 13,9861746252946568 Ratio of sales Increase/decre ase of Inventory and WIP 75,62,16093,52,7761,6914,936 Ratio of sales Employee benefit expenses 6,35,89,613 7,86,46,756 142236369 Ratio of sales Bank charges24,19,436 29,92,324 54,11,760 Ratio of sales Depreciation 1,68,21,592 2,08,04,712 3,7626,304 Ratio of sales ITA No.2071/Bang/2018 Page 10 of 33 Business promotion, marketing and exhibition 29,06,85016,7061704 169968554 Actuals Other operating expenses 5,94,91,506 7,35,87,202 13,30,78,708 Ratio of sales Total Operating cost 265875979 492307220 758183199 Operating Profit 86185241 -56884505 29300736 OP/OC -13.06% 12. According to the TPO, tested party should be selected first and thereafter the comparable companies have to be searched. Therefore, entity level margin of the Assessee cannot be adopted just because the segmental information of the comparable companies in not available. The TPO thereafter observed that the Assessee’s expenditure on business promotion is very high in international segment. The TPO also observed that the comparables selected i.e. Kabra Extrusion Technik Ltd and Rajoo Engineers Ltd. do not have segmental similar to that of the Assessee and they are the only companies who are comparable to the Assessee in terms of their functions. The TPO also observed that export revenue filter of 75% cannot be adopted in the Assessee’s case because, no comparables (Kabra Extrusion Technik Ltd's export revenue is 68% and Rajoo Engineers Ltd export revenue is 42%) will get selected and therefore export revenue filter of 25% is appropriate in the case of the Appellant. The TPO justified the allocation keys adopted by him. The TPO held that apportionment of cost based on revenue is valid as the Assessee himself had adopted entity wide analysis for benchmarking international transactions. The TPO also held that actual allocation of sales & marketing expenditure is valid as sales and marketing expenses are mainly incurred for earning revenue from international segment. Based on the above, learned ITA No.2071/Bang/2018 Page 11 of 33 TPO computed an adjustment u/s 92CA for manufacturing segment at Rs. 5,92,37,627/-. Following is the relevant extract of the TP Order: “4.1 The adjustment to international transactions is determined as under: Mean PLI of comparables A 6.16% Operating cost of tested party B49,23,07,220 Arms length Operating Revenue C = (100+A)% of B52,26,33,345 Operating Revenue of tested party D 43,54,22,715 DifferenceE = C—D 8,72,10,630 International transactions as part of Operating Revenue F 29,57,59,913 Ratio of international transaction in OR G = F/D 67.92% Adjustment to international transaction H = G% of E 5,92,37,627 4.2 Above adjustment of INR 5,92,37,627 is the adjustment to international transactions of taxpayer relating to sale to AEs.” 13. Before the CIT(A), the Assessee contended: (i) that the TPO in determing the profit margin has refused to recognise foreign exchange gain as part of the operating profit whereas in the comparable companies, foreign exchange gain was treated as operating in nature, thereby resulting in skewed comparability analysis. The Assessee relied on judicial pronouncements wherein it was held that foreign exchange fluctuation to the extent it relates to the international transaction has to be regarded as part of ITA No.2071/Bang/2018 Page 12 of 33 operating profit by relying on the decision of Delhi high court in the case of Prl.CIT Vs. Ameriprise India TS 174-HC2016 (del) TP. (ii) The Assessee challenged the basis of allocation of expenditure as done by the TPO, contending that due to the nature of transactions, performing transfer pricing analysis at entity level is the most appropriate way to benchmark the international transactions. It was submitted that the methodology adopted by the TPO was incorrect because in the case of the comparables selected by the TPO, the TPO was unable to bifurcate the financial statement based on the ratio of turnover. Yet the TPO considered the margins at entity level of comparables for benchmarking the Appellant’s international transactions. It was contended that when it is not possible to draw segmental in case of comparables and their margins are adopted at entity level, the only option left is to benchmark the international transactions of the Assessee at entity level. It was contended that the TPO has allocated all expenses except sales & marketing expenditure on the basis of turnover. In this regard, it was submitted that the TPO failed to appreciate that the export and domestic markets have different dynamics, different functions and different risks. Therefore, assuming that the cost of goods sold (COGS) and other expenses will be same for both domestic and international transactions is without basis. Also, product profile/quality/nature varies for domestic and international transactions. Sales price, COGS and gross profit will therefore be different for both international and domestic markets. Therefore, the TPO’s action of allocating all expenses on the basis of turnover was incorrect. Attention of the CIT(A) was drawn to note 25.9 of audited financial statement wherein only geographical split of revenue is provided. However actual profit from each geography is not given. This reflects that the Assessee as well statutory auditor are of the view that profit from reach geography cannot be computed with reasonable accuracy and they view them as single segment. In such circumstances arbitrary ITA No.2071/Bang/2018 Page 13 of 33 allocation of expenses by the TPO is bad in law and hence to be rejected. Relevant extract of the Annual Report is given below: It was further contended that the TPO has bifurcated expenses based on the ratio of turnover. However, the TPO has failed to appreciate that the basis for apportionment also included international transactions with AE’s which itself is a tainted transaction. The TPO by allocating expenditure based on turnover, which has tainted transactions has therefore computed tainted segmental. The TP adjustment based on such tainted segmental is therefore bad in law. Therefore, the action of the TPO of drawing segmental based on turnover is incorrect and without basis. 14. Without prejudice to above submissions, it was contended that the segmental adopted by the TPO in the TP Order contains several errors. It was pointed out that the revenue for the international segment is considered at Rs.43,54,22,715/- without appreciation that the fact that Rs.43,54,22,715/- contains both sales made to AE and non- AEs. It was pointed out that in Form 3CEB, sales made for the relevant previous year to AE was only Rs. 29,57,59,913/-. The AE ultimately sold these products to third parties. Therefore, considering whole of international segment for comparison is without basis. ITA No.2071/Bang/2018 Page 14 of 33 15. It was pointed out that the TPO has considered Rs. 16,99,68,554/- as business promotion and marketing & exhibition expenses and apportioned Rs. 16,70,61,704/- out of such expenses towards International Segment. It was pointed out that the Assessee has paid commission of Rs. 15,44,27,194/- to AEs which was part of sales and promotion expenditure. It was pointed out that the TPO’s observation that expenditure on business promotion was very high in international segment was incorrect because, the Assessee remunerated Steer America on cost plus 10% basis and Steer Japan at 35% of sale price forvarious serveries rendered by them. The Assessee explained the reasons for such basis for remunerating the AEs. 16. The Assessee pointed out that remuneration paid to Steer America was for the reason that Steer Group operates in a market comprising of Co-Rotating Twin Screw Extruders and Extruder Parts ranging 10mm to 125mm. The Assessee then, had a market share of about 60% in India, and about 12% worldwide. The Assessee is the only Indian company making Co-Rotating Twin Screw Extruders and is one of the Top 6 players in the world in Extruders and the Top player in Extruder parts. The Assessee has around 32 patents at various stages, and has its own in-house developed technology using which it competes against suppliers from Germany and Japan. Out of the 20,000 Co-Rotating Twin Screw Extruders that exist in the world, more than 4,500 are located in US alone. It was also the most competed market in the world. Over the last eight years, the Assessee has stayed invested in the US market in order to gradually build its market share and position in the US. During the relevant previous year, the Assessee held about 10% market share in US. Till 2009, US market grew in excess of 5% year on year (which is, about 250+ Extruders in a year). However, it added less than 100 Extruders each year over the last 5-6 years. In FY 2015-16 economic circumstances have improved and the business is showing an increasing trend. In the aftermarket (post sales) segment (Extruder ITA No.2071/Bang/2018 Page 15 of 33 Parts), the Assessee is consistently growing its market share in US using its ‘made-in- India’ Technology and is penetrating into being the ‘preferred supplier’ to the Top 25 Compounding Companies in the world. The Assessee tabulated below its sales trend and projection for sakes for US market: SALES TREND Financial Year Sales (INR Crs) 2011-12 16.70 2012-13 21.43 2013-14 33.32 2014-15 24.15 2015-16 50.03 PROJECTIONS FOR US MARKET INR Crores Sl.Particulars 2017-182018-192019-20 1 Sales 45.4250.3155.95 -Extruders 19.3121.2923.54 -Extruder Parts 26.1129.0232.41 17. The Assessee thus pointed out that from the above it can be observed that slowly but surely, revenue generated from the US market is improving and Assessee’s ITA No.2071/Bang/2018 Page 16 of 33 penetrating strategy in the US market is working. The Assessee submitted that the facts and economic circumstances unique to the Assessee’s business strategy should be appreciated. The business model of cost plus 10% is therefore to be accepted as at arm’s length. As detailed above, Steer America is remunerated at cost plus 10%. Steer America is exclusively engaged in distribution of products of the Assessee and does not provide any services to third parties. The costs incurred are with third parties. Therefore effectively, the AE is retaining a margin of 10% on cost for the services rendered. Steer America is rendering services in the nature of distributor. For such an activity, the Assessee submitted that 10% mark-up is at arm’s length. It was pointed out that the TP Order, the TPO has proposed comparables engaged in support services who are earning a margin of 13.51% on cost. Therefore, even by the TPO’s own standard, the margin earned by Steer America is fair and at arm’s length. 18. As far as payment of remuneration to Steer Japan concerned, the Assessee pointed out that Steer Japan has an office in Tokyo. Steer Japan distributes the Assessee’s products and also performs certain pre-sales and post-sales activities. Steer Japan has also commissioned a technology centre at Japan pursuant to which Steer Japan develops applications indigenously. The Assessee submitted that for the services rendered by Steer Japan, it was remunerated at 35% of the sales price. For the nature of services rendered, the service fee paid is fair and reasonable. Further the same has been accepted in earlier year by the TPO. 19. Thus the Assessee contended that the TPO’s statement that Assessee’s expenditure on business promotion was very high in international segment is incorrect and bad in law. 20. The Assessee submitted that the TPO erred in rejected the stand of the Assessee for adopting entity level margins of the Assessee for comparison with the entity level profit margin of the comparable companies. In this regard it was submitted that it was a ITA No.2071/Bang/2018 Page 17 of 33 manufacturer of Extruders and Parts & Elements for Extruders. Steer Japan and Steer America act as distributors in Japan and America respectively for the products manufactured by the Assessee. During the year under consideration, Steer China has also operated as a distributor for products manufactured by the Assessee in China apart from the manufacturing activity for part of the year. During the year under consideration, the Assessee entered into following transactions with AE’s: Sl. No.Nature of Transaction Amount 1 Sale of Parts and Elements of Extruders 29,57,59,913 2 Purchase of parts and elements of Extruders 61,48,295 3 Purchase of fixed assets 91,37,883 4 Purchase of intangibles 3,29,91,505 5 Payment of commission on sales 15,44,27,194 6 Reimbursement of sales promotion and other expenses23,26,538 7 Interest received 8,11,791 21. The transactions of sale and purchase of extruders and parts and elements of extruders, commission on sales, purchase of fixed assets and services received were considered as closely linked transactions. Therefore, the Assessee evaluated the international transactions by adopting Combined Transaction approach at entity level. Following are the important reason for benchmarking international transactions by considering Entity Level margins: a.The transactions between the Assessee and its associated enterprises are two ways i.e. purchase as well as sale. These transactions are linked and interdependent; b.In the peculiar circumstances of the operations involving various types of transactions entered into, towards achievement of a common goal, it is not ITA No.2071/Bang/2018 Page 18 of 33 possible to split the financial data to arrive at the net result from particular and individual transaction; c.The data in the public domain is not detailed enough to permit a comparison of the results at the transaction level; d.The comparable transactions are also available only at the entity level and not at individual transaction level; and e.The net profit at an entity level would broadly justify the intrinsic value of all the underlying transactions particularly when the organization views them as interdependent and integrated whole. It was thus submitted that due to the nature of transactions, performing transfer pricing analysis at entity level is the most appropriate way to benchmark the international transactions. The Assessee pointed out that the Income Tax Rules, 1962 (Rules) provide that “closely linked transactions” can be evaluated together. Rule 10A(d) of the Rules, defines “transaction” to include a number of closely linked transactions. Linked means something which is connected. The definition does not provide that the transactions should be identical or similar. Once the transactions are connected, they can be evaluated together. The Organisation for Economic Co-operation and Development in its Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter referred as “OECD Guidelines” for short) refers to this approach. Para 3.9 of the OECD TP Guidelines, 2017 provides that ideally, in order to arrive at the best approximation of fair market value, the arm’s length principle should be applied on a transaction by transaction basis (“Separate Transaction” approach). However, the OECD Guidelines provide that a “Combined Transaction Approach” can be adopted in case the transactions are closely linked or continuous and they cannot be evaluated adequately on an individual basis. In such a situation, rather than assessing the arm's length terms of the transactions individually, these transactions could be evaluated together using the most appropriate method. The relevant observations of the OECD are as below: ITA No.2071/Bang/2018 Page 19 of 33 “3.9 Ideally, in order to arrive at the most precise approximation of arm’s length conditions, the arm's length principle should be applied on a transaction-by- transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include: a) some long-term contracts for the supply of commodities or services, b) rights to use intangible property, and c) pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing of manufacturing know-how and the supply of vital components to an associated manufacturer; it may be more reasonable to assess the arm's length terms for the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method. A further example would be the routing of a transaction through another associated enterprise; it may be more appropriate to consider the transaction of which the routing is a part in its entirety, rather than consider the individual transactions on a separate basis. See example 26 of the Annex to Chapter VI.” 22. The Assessee also relied on para 2.73 of Australian Tax Office (ATO) Taxation Ruling 97/20 on International Transfer Pricing which provides that: “Ideally, dealings between associated enterprises should be priced on a transaction by transaction basis. However, it is also recognised that if it is impractical to assess individual transactions (e.g., if such an approach would not address all the relevant aspects of the dealings between the parties that affect comparability), it may be more appropriate to consider a combination of transaction”. In Para 2.74 it has been observed as follows: “Dealings between associated enterprises in a particular product may involve separate transactions for the product, the intangibles associated with the product, technical advice, management services and any other related matters. ITA No.2071/Bang/2018 Page 20 of 33 In dealings with independent parties, these various aspects may be rolled into a package deal with all the associated costs being included in the transfer price of the product. The various aspects may need to be considered together to account properly for the costs and to prevent double counting. If the independent dealings being considered as possible comparables cannot be disaggregated, it would generally be appropriate to group all the relevant transactions between associated enterprises so comparability to the uncontrolled party package deal transaction can be properly determined.” 23. The Assessee relied relied on the decision in the case of Cummins India Ltd. v Addl CIT [2015] 53 taxmann.com 53 (Pune - Trib.). Therelevant extracts of the tribunal decision is as below: “26. In view of the ratio laid down by Pune Bench of the Tribunal in Demag Cranes & Components (India) Pvt. Ltd. v. DCIT (supra), it is held that where number of transactions are closely linked transactions, then the same can be aggregated and construed as a single transaction for the purpose of determining the arm's length price. In case, there is close link exists between the different transactions, the same should be treated as composite transaction and appropriate method should be applied to work out the transfer pricing analysis. Where two or more transactions emanate from common source being an order or contract or an agreement or an arrangement, then such transactions could be said to be closely linked as the nature, characteristic and terms of such transaction substantially flow from the said common source.” 24. It was submitted that the Assessee is a manufacturer of extruder and parts of extruder and the AE’s act as distributor for such extruders and parts outside India. The products manufactured by the Assessee are being sold to AE, who in turn sell them to third parties. For remunerating the AEs for rendering distribution services, the Assessee has paid commission, which is part of business promotion expenses. In case of third party sales the Assessee performs similar functions. It manufacturers extruders and elements of extruders and sells directly to third parties/distributors. All the activities of the Assessee ITA No.2071/Bang/2018 Page 21 of 33 have similar functions and assets. These activities are governed by the same set of risk. These had therefore been grouped as single business segment and the TP analysis was conducted at entity level under combined transaction approach. In this regard it was pointed out that the Assessee had only one business segment which is the business of manufacturing extruders and wire EDM’s machines including spares which constitutes a single business segment and hence business segments have not been reported. It was therefore submitted that the segmental P&L account considered by the TPO was not appropriate. The Assessee therefore submitted that transfer pricing analysis should be conducted at entity level. 25. On the adoption of PLI as done by the TPO, the Assessee pointed out that the TPO’s observation in his order that tested party should be selected first and thereafter the comparable companies have to be searched and therefore, entity level margin of the Assessee cannot be adopted because the segmental information of the comparable companies in not available. It was submitted that the contention of the TPO is incorrect and not in accordance with the rules prescribed by the Board. Following is the relevant extract of Rule 10B(2) of Income Tax Rules: (2) For the purposes of sub-rule (1), the comparability of an international transaction or a specified domestic transaction with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; ITA No.2071/Bang/2018 Page 22 of 33 (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 26. Rule 10B(2) of the Income Tax Rules provide that for application of Transfer Pricing methods, it is important to ensure that comparability exists between comparable companies selected and international transactions undertaken by the taxpayer. Rules has also spelt out that Geographical locations are one of the important comparability criteria’s. If the comparability criteria’s do not tally, then such uncontrolled comparable companies cannot be compared to the taxpayer. It was pointed out that the TPO has completely disregarded the above aspects. The TPO has stated that Tested Party should be selected first and comparables have to be searched later. The TPO has not appreciated that both the Assessee and TPO has selected the same tested party i.e. the Assessee. The Assessee has benchmarked the international transactions considering entity wide margins for the following reasons: Only two comparables i.e. Kabra Extrusion Technik Ltd and Rajoo Engineers Ltd. are available in public database whose functions, risks and assets are similar to the Appellant [This is also accepted by the TPO in para 3.7 of the TP Order] Both the comparables also have domestic sales and international sales, similar to the Appellant. Tabulated below is the details of domestic and international sales made by the Assessee and comparables during the year under consideration: [This is also accepted by the TPO in para 3.7 of the TP Order] ITA No.2071/Bang/2018 Page 23 of 33 Sl. No. Particulars Domestic Sales and its % of total sales International Sales and its % of total sales Total Sales Annexure 1 Appellant 35,20,61,220 (45%) 43,54,22,715 (55%) 78,74,83,935 1 2 Rojoo Engineers 47,01,61,005 (58%) 34,22,24,399 (42%) 81,23,85,404 2 3 Kabra 60,19,00,000 (32%) 130,09,84,000 (68%) 190,28,84,000 3 For both the comparables and the Assessee segmental bifurcation between domestic and international sales segment is not available. [This is also accepted by the TPO in para 3.7 of the TP Order] 27. It was pointed out that both the comparables and the Assessee are engaged in manufacture and sale of extruders and parts of extruders. Both the comparables and the Assessee have similar kind of exposure to international market. Their functional activity, product profile and markets in which they operate are all same/ similar. Therefore, the Assessee compared its entity level results with that of the comparables. The TPO has disregarded this important aspect and has compared the Assessee’s international sales segment with comparables entity wide margins, which constitute both domestic and international segment. Therefore, the action of the TPO is bad in law. 28. The Assessee relied on the decision in the case of M/s. Toyota Kirloskar Motors (P.) Ltd. v ACIT [2012] 28 taxmann.com 293 (Bang). In this case, the taxpayer was ITA No.2071/Bang/2018 Page 24 of 33 engaged in the manufacture of passenger cars and also trading/distribution of passenger car model ‘Camry’ and spare parts and components. In the relevant period, the taxpayer had entered into various international transactions with AEs. In its study, the taxpayer combined both the trading and manufacturing segments and computed ALP under TNMM adopting combined transaction approach. The taxpayer contended that even the comparables have trading of spare activity and level of its trading activity and that of comparable is same. The ITAT observed that while it is true that function, assets and risks of the trading and manufacturing segments generally differ; however, circumstances may warrant combining both of them. It is only in the specific facts of the case that the combining of both segments is advisable. In the instant case, the sale of spare parts is triggered as a result of the manufacturing activities, including warranty commitments. Therefore, it would not be in the fitness of things for the sale of spare parts and components to be considered in isolation from the sale of manufactured vehicles. The ITAT held that on an overall consideration, it can be concluded that trading in spare parts is closely inter-linked with the manufacturing segment of the taxpayer. The ITAT held that no meaningful purpose would be served in segregating the trading and manufacturing segments particularly when the taxpayer and the comparable companies are at par with regard to the nature and scale of combined activities. 29. On the observations of the TPO that export revenue filter of 75% cannot be adopted in the Assessee’s case because, no comparables (Kabra Extrusion Technik Ltd’s export revenue is 68% and Rajoo Engineers Ltd export revenue is 42%) will get selected and therefore export revenue filter of 25% is appropriate in the case of the Assessee, the Assessee submitted that Rule 10B(2) and 10(3) of the Rules provide that, if uncontrolled comparable companies do not meet the comparability criteria or if the functional ITA No.2071/Bang/2018 Page 25 of 33 differences cannot be adjusted then such uncontrolled comparable companies cannot be selected. 30. The CIT(A) however without discussing the contentions as above and without giving any reasons whatsoever upheld the order of the TPO by observing that the TPO’s order is self explanatory on the issue and that the Assessee has not been able to meet the TPO order in his arguments and submissions during appeal proceedings. Aggrieved by the order of the CIT(A), the Assessee is in appeal before the Tribunal. 31. We have heard the rival submissions. The learned counsel for the Assessee reiterated submissions made before CIT(A). It was submitted that the Assessee has one single business segment of manufacture of Extruders and its parts. He submitted that the allocation of expenses on the basis of turnover as done by the TPO was erroneous because the domestic and export markets have different dynamics and profit from each geography cannot be computed with accuracy. Comparable data is also available only at the entity level. The operating profit of the Assessee has been compared with the entity level profit of the comparables, though the comparable companies were also having export as well as domestic sales. In the given circumstances entity level comparison would be more appropriate. In this regard it was submitted that when the business segment is single business segment with same workforce, plant and when the entire business activity is integrated, segmentation would disturb the functional integrity and therefore comparison at the entity level would be more appropriate. It was also pointed out that the Assessee’s domestic and international sales were in the ratio of 45% and 55% and the comparable companies Rajoo and Kabra were also 58% and 42% and 32% and 68% respectively and therefore comparison at the entity level would be appropriate. Reliance was placed on the following decisions wherein in identical circumstances, entity ITA No.2071/Bang/2018 Page 26 of 33 level profits were taken for comparison purposes viz., Toyota Kirloskar Motors 28 taxmann.com 293 (Bang.) and DCIT Vs. JDSU Indian Pvt.Ltd. (2018) 93 taxmann.com (Delhi-ITAT). It was submitted that entity level TNMM comparison was accepted in the earlier years by the revenue i.e., for AY 2009-10 to 11-12 and therefore applying the rule of consistency, it should be accepted this year also. If international segment of the Assessee is to be compared, then comparables should pass 75% export turnover filter. It was submitted that turnover cannot be adopted for allocating all costs. Export and domestic markets have different product mix, different packing and documentation requirements and different cost of Goods sold. Alternatively it was submitted that the export sales to AE was only Rs.29.57 crores and the segmentation and operating profit margin of only export sales should be taken for the purpose of comparison both in the case of the Assessee as well as the comparables. It was submitted that in any event foreign exchange fluctuation gain has to be treated as part of the operating profit. The learned DR reiterated the stand of the revenue as contained in the order of the TPO. 32. We have given a careful consideration to the rival submissions. The issues that arise for consideration on determination of ALP on sale of extruders and parts by the Assessee to it’s AE are: (i) Whether the profit margins for the purpose of comparison of Assessee’s profit margin with that of the comparables has to be arrived at the entity level as was done by the Assessee or that part of the export sale to AE and non-AE as was done by the TPO or that part of the export sale to AE alone as was canvassed by the Assessee by way of an alternate plea. (ii) If the action of the TPO is justified in choosing Assessee’s profit margin on export sale to AE and non AE, whether the manner of apportionment of expenses to the domestic and export sales was correct. ITA No.2071/Bang/2018 Page 27 of 33 (iii) Whether foreign exchange gain has to be treated as part of the operating profits for the purpose of comparison of Assessee’s profit margin and that of the comparable companies. (iv) If the profit margins are taken on that part of the Export sale to AE and Non-AE, whether the filter of 75% export sale has to be applied and thereby the two comparable companies which are admittedly comparable companies available for comparison, will fail the test of comparability due to absence of 75% export sales and therefore has to be regarded as not comparable. 33. On the first issue, we find that there is no dispute in the present case that TNMM is the MAM. Rule 10B(1) (e) of the Rules provides the manner of determination of ALP under TNMM and it reads thus: (e)transactional net margin method, by which,— (i)the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction]entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii)the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii)the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv)the net profit margin realised by the enterprise and referred to in sub- clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v)the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction[or the ITA No.2071/Bang/2018 Page 28 of 33 specified domestic transaction]; Rule 10A(d) defines transaction to include “a number of closely linked transactions”. In terms of Rule 10B(1)(e) (i) of the Rules, the net profit realized by an enterprise from an international transaction has to be ascertained first. The Assessee in it’s Transfer Pricing study at page-12 paragraph 4.5.5 has given reasons for choosing profit margin of Assessee at entity level for the purpose of comparison. It has been stated therein that the transactions of sale and purchase of extruders and parts and elements of extruders, commission on sales, purchase of fixed assets and services received were considered as closely linked transactions. Therefore, the Assessee evaluated the international transactions by adopting Combined Transaction approach at entity level. This was for the following reasons: i. The transactions between the Appellant and its associated enterprises are two ways i.e. purchase as well as sale. ii. The comparable transactions are also available only at the entity level and not at individual transaction level; and iii. The net profit at an entity level would broadly justify the intrinsic value of all the underlying transactions particularly when the organization views them as interdependent and integrated whole. The TPO rejected the plea of the Assessee as above for the reason that tested party should be selected first and thereafter the comparable companies have to be searched. Therefore, entity level margin of the Assessee cannot be adopted just because the segmental information of the comparable companies in not available. There were 9 international transactions the Assessee had with it’s AE’s. The three international transactions of sale of extruders and parts and accessories were with steer America, Steer Japan and Steer China. Steer China Corporation (hereinafter referred as "Steer China" for brevity) manufactures full range of extrusion lines, twin screw compounding extruders and CNC Wire EDM machines. During the relevant previous year, Steer China ITA No.2071/Bang/2018 Page 29 of 33 operated as distributor for products manufactured by the Assessee. The Transfer Pricing Study is silent as to how the transactions between the Assessee and its associated enterprises are two ways i.e. purchase as well as sale and how they are interlinked. Admittedly as per para 4.5.6 of the TP Study the transaction of purchase of intangibles and interest received from Chindia were benchmarked separately. The three international transactions are of purchase of extruders and parts from Steer China and payment of commission to Steer Japan and Steer America. The other international transaction is of purchase of fixed assets from Steer China. As to how these international transactions are interlinked and interdependent is not spelt out in the TP study. By it’s very nature, these transactions appear to be independent. We also find that in the transfer pricing study at page 29 paragraph 8.11, the Assessee has given reasons as to why CUP method was not suitable in its case. It has been stated therein that the extruders parts and elements are manufactured based on specific order. The products are unique and not comparable to others. The terms and conditions and the economic circumstances under which the Assessee sells extruders parts and elements to AE are materially different from the comparable uncontrolled transactions. We are therefore of the view that the question of adopting the profit margins at the entity level based on the submissions made by the Assessee before the CIT(A) cannot be accepted. 34. The next part of the first issue is as to whether the profit margin of export sale including sale to AE and non AE or only export sale to AE ought to have been considered by the TPO. On this aspect we find that the revenue for the international segment is considered at Rs.43,54,22,715/- without appreciating the fact that Rs.43,54,22,715/- contains both sales made to AE and non-AEs. Perusal of Form 3CEB shows that sales made for the relevant previous year to AE was only Rs. 29,57,59,913/-. The AE ultimately sold these products to third parties. Therefore, considering whole of ITA No.2071/Bang/2018 Page 30 of 33 international segment for comparison is without basis. We therefore hold that the sale and proportionate expenses relatable to sale to AE alone has to be considered to arrive at the profit margin of the Assessee for the purpose of comparison of Assessee’s profit margin. Similar exercise has to be carried out by the TPO with regard to the two comparable companies and the profit margin of the two comparable companies has to be arrived at by identifying expenses relatable to export sale to AE and for this purpose the TPO may exercise his powers u/s.133(6) of the Act and call for the required details from the the comparable companies. 35. The second issue of manner of apportionment of expenses, in our view the basis of apportionment as adopted by the TPO is just and fair and calls for no interference. The Assessee has not given any other manner of apportionment except to say that expenses attributed to the export sale are not proper. In our view the Assessee is in knowledge of its own affairs and should be in a position to justify a better manner of apportionment rather than simply contend that the basis of apportionment by the TPO was unfair. 36. On the third issue regarding foreign exchange gain to be treated as part of the operating profits for the purpose of comparison of Assessee’s profit margin and that of the comparable companies, we agree with the plea of the Assessee. Foreign exchange fluctuation to the extent it relates to the international transaction has to be regarded as part of operating profit and the decision of Delhi high court in the case of Prl.CIT Vs. Ameriprise India TS 174-HC2016 (del) TP supports the plea of the Assessee in this regard. 37. On the last issue viz., application of filter of 75% export sales, we find that the Assessee’s export turnover is also less than 75% and the comparables also have export ITA No.2071/Bang/2018 Page 31 of 33 turnover of less than 75%. The TPO has reasoned that export revenue filter of 75% cannot be adopted in the Assessee’s case because, no comparables (Kabra Extrusion Technik Ltd's export revenue is 68% and Rajoo Engineers Ltd export revenue is 42%) will get selected and therefore export revenue filter of 25% is appropriate in the case of the Assessee. As we have already Rule 10B(1)(e) of the Rules, do not prescribe any fixed filters. An element of flexibility is always inbuilt in the rules. The idea is to get data for comparison. The Assessee’s transaction with AE has to be compared with that of an uncontrolled transaction. The net profit margin referred to in the uncontrolled transaction has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market. In such circumstances, the reasoning of the TPO in applying export turnover filter at 25% of the turnover is proper and calls for no interference. The two comparable companies which are admittedly comparable companies available for comparison, cannot be excluded on the basis of a filter which has no relevance to the factual scenario in the present case. 38. We direct the TPO to determine the ALP in accordance with the directions contained in this order after affording the Assessee opportunity of being heard. 39. The next issue that needs to be adjudicated in this appeal is with regard to correctness of determination of ALP in respect of provision of Corporate Guarantee by the Assessee to its AE. The law is by now well settled that providing corporate guarantee to AE is an international transaction and the provisions of Sec.92 of the Act are applicable to such transactions. The Assessee had given a gurantee in favour of SBI, Shanghai for a cash credit facility availed by Steer China in a sum of Rs.2,18,00,000. ITA No.2071/Bang/2018 Page 32 of 33 The Assessee did not charge any commission from Steer China for providing such guarantee and hence the TPO determined the ALP by obtaining credit rating and relevant interest rate of corporate bonds from CRISIL at arrived at 0.925% as the appropriate rate at which the Assessee ought to have charged guarantee commission from the AE. By applying the said rate on the sum for which guarantee was extended the AO arrived at a sum of Rs.2,01,650 as the ALP of the international transaction of providing guarantee and the same was added to the total income of the Assessee and the action of the TPO was confirmed by the CIT(A). The limited prayer before the Tribunal is to adopt 0.5% as the appropriate rate and that too on the sum utilized by the AE from and out of the sum of Rs.2.18 crores extended as credit limit to the AE and the submission so made is based on the decisions of ITAT rendered in the case of Associated Capsules Pvt. Ltd. Vs. ACIT (2020) 121 taxmann.com 103(Mumbai-Trib). We are of the view that the prayer so made based on the decision cited is acceptable. We accordingly direct that the ALP be determined at 0.5% of the credit limit utilized and not that what is sanctioned. We hold and direct accordingly. 40. In the result, appeal of the Assessee is partly allowed. . Pronounced in the open court on the date mentioned on the caption page. Sd/- (S. PADMAVATHY) Sd/- (N.V. VASUDEVAN) Accountant MemberVice President Bangalore, Dated: 27.04.2022. /NS/* ITA No.2071/Bang/2018 Page 33 of 33 Copy to: 1.Appellants2.Respondent 3.CIT4.CIT(A) 5.DR 6. Guard file By order Assistant Registrar, ITAT, Bangalore.