Petro Araldite (P.) Ltd. v. Dy. CIT

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The Tax Publishers2013 TaxPub(DT) 1329 (Mum-Trib) : (2013) 154 TTJ 0176 : (2013) 086 DTR 0233 Income Tax Act, 1961 --Transfer pricing--Computation of ALP Selection of comparables--Assessee-company was engaged in manufacture of 'speciality chemicals'. Its main product was Epoxy Resins. Chemicals manufactured by it were used in industries operating in paints, Assessee followed transactional net margin method (TNMM) to benchmark its international transactions in a composite way for all such transactions taken together. It adopted Profit Level Indicator (PLI) as operating profit/sales, which was shown at 4.20 per cent. Assessee selected four comparable cases to benchmark its international transactions. TPO did not find any of cases selected by assessee as comparable for reasons given in his order. Initially, he selected more number of comparable cases but finally short-listed four cases for benchmarking. *Held* Partly not sustainable. As regards comparables were concerned speciality chemical manufactured by assessee could not be said to be comparable with those manufactured by DIKL. That apart, DIKL was also manufacturing bulk drugs and acting as project consultants. Thus, DIKL could not be considered as comparable case. Also, list of chemicals manufactured by SCL was quite long. There was a predominant difference in functional profiles. SCL was, therefore, rightly excluded from final list of comparables drawn by TPO. Further, in case of MIL, it was mainly engaged in sale of inks and other intermediates, besides manufacture of certain speciality chemicals and no bifurcation of profits on segmental level was available from annual accounts of MIL, thus, it was also not comparable because assessee was engaged solely in manufacturing of speciality chemicals. Morever, company PIL was involved in acquisition and demerger of a unit of another company during relevant year it could not be selected for comparable. Therefore, this case was also to be excluded from the eventual list of coparables. DIKL is also partly engaged in manufacture of specialty chemicals, being the same line in which the assessee is involved, apart from manufacturing bulk drugs and acting as project consultants. However, it is pertinent to mention that specialty chemicals have a variety of kinds with different ingredients, qualities, compositions and costs. Such different chemicals satisfy the needs of a range of industries as per their respective requirements. It can be noticed from the assessee's transfer pricing study that the specialty chemicals manufactured by it are used in Paint industries, civil engineering application, Structural composites, Electrical insulation material, Adhesive and Tooling material, whereas the specialty chemicals manufactured by DIKL are basically used in textile filaments and yarns. One fail to appreciate as to how the specialty chemicals manufactured by the assessee can be said to be comparable with those manufactured by DIKL. The chemicals manufactured by both the assessee and DIKL cater to the needs of altogether different types of industries. The TPO discussed three products of DIKL, namely, Trimetazidine, Tramadolc and Carboprost tramethamine as different. Nowhere any finding has been given that the other products of DIKL are similar to those manufactured by the assessee. We have noticed from the assessee's transfer pricing study that DIKL is engaged in manufacture of specialty chemicals which are used in the entirely different industries with no resemblance whatsoever to those which use the specialty chemicals manufactured by the assessee. Other than that, DIKL is also in manufacturing bulk drugs and project consultants. It is beyond our comprehension as to how this case can be considered as comparable with the assessee. [Para 8] The first and the foremost factor of relevance is the functional comparability. Once functional profile of two cases is found to be similar, then comes the question of examining the assets employed and risks undertaken by such functionally comparable cases. If the other case is functionally incomparable, that goes out of the reckoning at the very threshold. A case is said to be functionally comparable if it is in the same activity of business. If the activity of such case is by and large similar to the assessee's case with some minor exceptions here and there, then also we can include such a case in the list of comparables provided the incomparable part of the functional profile of the other case is not such so as to have damaging influence over its overall profit rate. But if the other case is largely different in the functional profile, but comparable part is minimal, such case cannot be considered as comparable. The main factor to be taken into consideration is the comparability of two cases. It is no doubt true that the TNMM is tolerant to functional differences between two cases to some extent, but at the same time the broader functional dissimilarities cannot be overlooked in selecting comparables. In view of the foregoing discussion, we are of the considered opinion the case of DIKL cannot be considered as a comparable one. [Para 9] One more factor which needs to be accentuated is the selection of number of comparable cases. The most appropriate method for determining ALP in the extant case is admittedly TNMM. Rule 10B(1)(e)(ii) provides that 'the net profit margin realized 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. Section 92C(2) provides that : The most appropriate method referred to in sub-section (1) shall be applied for determination of ALP, in the manner as may be prescribed'. First proviso to this provision provides : 'that where more than one price is determined by the most appropriate method, the ALP shall be taken to be the arithmetical mean of such prices'. These provisions make it amply manifest that the attempt should be to first find out a really comparable case and then in the alternative the endeavour should be to find out more than one comparable uncontrolled case, if these are available. There is no warrant in the relevant provisions that one must choose more than one case for benchmarking, even at the cost of comparability. If the number of comparable cases is more than one, then it is advisable to pick all such cases so as to iron out the peculiarities of a particular case. But, when the number of comparable cases is limited to one or more, then no futile attempt should be made to find out even some incomparable cases with a view to swell the list of comparables and ultimately distort the profit rate of the really comparable case(s). The crux of the matter is that the comparability cannot be sacrificed at any cost at any stage. [Para 10] The list of the chemicals manufactured by SCL, as given by the TPO, is found to be quite exhaustive as against only a few items shown by the assessee in its transfer pricing study as being manufactured by SCL. The position so stated by the TPO has not been controverted by the learned Authorised Representative. On the other hand, specialty chemicals manufactured by the assessee under the brand name of 'Araldite' are meant for use in the industries such as paint, civil engineering application, structural composites, electrical insulation material, adhesives and tooling material. From several items which are used in the chemicals manufactured by SCL, this Tribunal can find that the only common industry using the chemicals manufactured by the assessee and SCL, is paint industry. When one view the wide range of industries using chemicals manufactured by SCL in contrast to the limited range of industries using the chemicals manufactured by assessee, it can be observed that there is a' predominant difference in the functional profiles. The learned Authorised Representative could not point out the percentage of specialty chemicals manufactured and sold by the assessee for use in paint industries and such percentage in the case of SCL to demonstrate that it constituted main business in both the cases. Considering the test laid down above for selection of comparable cases, viz., if the other case being largely different in the functional profile, but comparable part is minimal, such case cannot be considered as comparable, there was no difficulty in upholding the impugned order in rightly excluding the case of SCL from the final list of comparables drawn by the TPO. [Para 13] Contention raised by Authorised Representative about the variation in percentage of related party transactions in the case of assessee and that of MIL is not properly demonstrated from the material on record. It is pertinent to note that the assessee requested the TPO to consider all of its international transactions as one unit and apply TNMM on entity level to benchmark them. While calculating the percentage of related party transaction at 52 per cent in the case of MIL, what the assessee has done is that it computed percentage of all its international transactions of sale of goods and services, royalty, reimbursement of expenditure, gain/loss on exchange rate fluctuation, other expenditure and purchase of goods and service with only the total net sales. It is but natural that the contents of the numerator and denominator must be similar. Finding a percentage of all types of the related party transactions with only sales on entity level, has vitiated such calculation. As such, this Tribunal is not inclined to accept the contention raised by learned Authorised Representative to reject the case of MIL on the question of variation in the percentage of related party transactions. [Para 15] However, from the annual accounts of MIL it is found that they are mainly engaged in the sale of inks and other intermediaries and are also in the business of manufacture of certain specialty chemicals. No bifurcation of profits on segmental level is available from such annual accounts of MIL. Since this party, apart from manufacturing some speciality chemicals, is also engaged in business of inks and earning processing income, the same cannot be compared with that of the assessee which is engaged in manufacture of speciality chemicals alone. It goes without saying that the comparison can be made with the comparables and not incomparables. As no segmental data of MIL dealing with the manufacture of specialty chemicals, more specifically which are manufactured by the assessee, is available, such a case cannot be included in the list of comparables. Therefore, the impugned order on this issue is set aside audit is ordered that the exclusion of this case is to be excluded from the list of comparables. [Para 16] As the case of PIL has acquisition and demergers during the relevant year, such a case cannot be included in the final list of comparables. In view of this decision, there is no need to look into the comparability or otherwise of the factual aspects of this case with that of the assessee. This case is directed to be excluded from the eventual list of comparables. [Para 18] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2013 TaxPub(DT) 1329 (Mum-Trib) : (2013) 154 TTJ 0176 : (2013) 086 DTR 0233

Income Tax Act, 1961

--Transfer pricing--Computation of ALP Selection of comparables--Assessee-company was engaged in manufacture of 'speciality chemicals'. Its main product was Epoxy Resins. Chemicals manufactured by it were used in industries operating in paints, Assessee followed transactional net margin method (TNMM) to benchmark its international transactions in a composite way for all such transactions taken together. It adopted Profit Level Indicator (PLI) as operating profit/sales, which was shown at 4.20 per cent. Assessee selected four comparable cases to benchmark its international transactions. TPO did not find any of cases selected by assessee as comparable for reasons given in his order. Initially, he selected more number of comparable cases but finally short-listed four cases for benchmarking. Held Partly not sustainable. As regards comparables were concerned speciality chemical manufactured by assessee could not be said to be comparable with those manufactured by DIKL. That apart, DIKL was also manufacturing bulk drugs and acting as project consultants. Thus, DIKL could not be considered as comparable case. Also, list of chemicals manufactured by SCL was quite long. There was a predominant difference in functional profiles. SCL was, therefore, rightly excluded from final list of comparables drawn by TPO. Further, in case of MIL, it was mainly engaged in sale of inks and other intermediates, besides manufacture of certain speciality chemicals and no bifurcation of profits on segmental level was available from annual accounts of MIL, thus, it was also not comparable because assessee was engaged solely in manufacturing of speciality chemicals. Morever, company PIL was involved in acquisition and demerger of a unit of another company during relevant year it could not be selected for comparable. Therefore, this case was also to be excluded from the eventual list of coparables.

DIKL is also partly engaged in manufacture of specialty chemicals, being the same line in which the assessee is involved, apart from manufacturing bulk drugs and acting as project consultants. However, it is pertinent to mention that specialty chemicals have a variety of kinds with different ingredients, qualities, compositions and costs. Such different chemicals satisfy the needs of a range of industries as per their respective requirements. It can be noticed from the assessee's transfer pricing study that the specialty chemicals manufactured by it are used in Paint industries, civil engineering application, Structural composites, Electrical insulation material, Adhesive and Tooling material, whereas the specialty chemicals manufactured by DIKL are basically used in textile filaments and yarns. One fail to appreciate as to how the specialty chemicals manufactured by the assessee can be said to be comparable with those manufactured by DIKL. The chemicals manufactured by both the assessee and DIKL cater to the needs of altogether different types of industries. The TPO discussed three products of DIKL, namely, Trimetazidine, Tramadolc and Carboprost tramethamine as different. Nowhere any finding has been given that the other products of DIKL are similar to those manufactured by the assessee. We have noticed from the assessee's transfer pricing study that DIKL is engaged in manufacture of specialty chemicals which are used in the entirely different industries with no resemblance whatsoever to those which use the specialty chemicals manufactured by the assessee. Other than that, DIKL is also in manufacturing bulk drugs and project consultants. It is beyond our comprehension as to how this case can be considered as comparable with the assessee. [Para 8] The first and the foremost factor of relevance is the functional comparability. Once functional profile of two cases is found to be similar, then comes the question of examining the assets employed and risks undertaken by such functionally comparable cases. If the other case is functionally incomparable, that goes out of the reckoning at the very threshold. A case is said to be functionally comparable if it is in the same activity of business. If the activity of such case is by and large similar to the assessee's case with some minor exceptions here and there, then also we can include such a case in the list of comparables provided the incomparable part of the functional profile of the other case is not such so as to have damaging influence over its overall profit rate. But if the other case is largely different in the functional profile, but comparable part is minimal, such case cannot be considered as comparable. The main factor to be taken into consideration is the comparability of two cases. It is no doubt true that the TNMM is tolerant to functional differences between two cases to some extent, but at the same time the broader functional dissimilarities cannot be overlooked in selecting comparables. In view of the foregoing discussion, we are of the considered opinion the case of DIKL cannot be considered as a comparable one. [Para 9] One more factor which needs to be accentuated is the selection of number of comparable cases. The most appropriate method for determining ALP in the extant case is admittedly TNMM. Rule 10B(1)(e)(ii) provides that 'the net profit margin realized 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. Section 92C(2) provides that : The most appropriate method referred to in sub-section (1) shall be applied for determination of ALP, in the manner as may be prescribed'. First proviso to this provision provides : 'that where more than one price is determined by the most appropriate method, the ALP shall be taken to be the arithmetical mean of such prices'. These provisions make it amply manifest that the attempt should be to first find out a really comparable case and then in the alternative the endeavour should be to find out more than one comparable uncontrolled case, if these are available. There is no warrant in the relevant provisions that one must choose more than one case for benchmarking, even at the cost of comparability. If the number of comparable cases is more than one, then it is advisable to pick all such cases so as to iron out the peculiarities of a particular case. But, when the number of comparable cases is limited to one or more, then no futile attempt should be made to find out even some incomparable cases with a view to swell the list of comparables and ultimately distort the profit rate of the really comparable case(s). The crux of the matter is that the comparability cannot be sacrificed at any cost at any stage. [Para 10] The list of the chemicals manufactured by SCL, as given by the TPO, is found to be quite exhaustive as against only a few items shown by the assessee in its transfer pricing study as being manufactured by SCL. The position so stated by the TPO has not been controverted by the learned Authorised Representative. On the other hand, specialty chemicals manufactured by the assessee under the brand name of 'Araldite' are meant for use in the industries such as paint, civil engineering application, structural composites, electrical insulation material, adhesives and tooling material. From several items which are used in the chemicals manufactured by SCL, this Tribunal can find that the only common industry using the chemicals manufactured by the assessee and SCL, is paint industry. When one view the wide range of industries using chemicals manufactured by SCL in contrast to the limited range of industries using the chemicals manufactured by assessee, it can be observed that there is a' predominant difference in the functional profiles. The learned Authorised Representative could not point out the percentage of specialty chemicals manufactured and sold by the assessee for use in paint industries and such percentage in the case of SCL to demonstrate that it constituted main business in both the cases. Considering the test laid down above for selection of comparable cases, viz., if the other case being largely different in the functional profile, but comparable part is minimal, such case cannot be considered as comparable, there was no difficulty in upholding the impugned order in rightly excluding the case of SCL from the final list of comparables drawn by the TPO. [Para 13] Contention raised by Authorised Representative about the variation in percentage of related party transactions in the case of assessee and that of MIL is not properly demonstrated from the material on record. It is pertinent to note that the assessee requested the TPO to consider all of its international transactions as one unit and apply TNMM on entity level to benchmark them. While calculating the percentage of related party transaction at 52 per cent in the case of MIL, what the assessee has done is that it computed percentage of all its international transactions of sale of goods and services, royalty, reimbursement of expenditure, gain/loss on exchange rate fluctuation, other expenditure and purchase of goods and service with only the total net sales. It is but natural that the contents of the numerator and denominator must be similar. Finding a percentage of all types of the related party transactions with only sales on entity level, has vitiated such calculation. As such, this Tribunal is not inclined to accept the contention raised by learned Authorised Representative to reject the case of MIL on the question of variation in the percentage of related party transactions. [Para 15] However, from the annual accounts of MIL it is found that they are mainly engaged in the sale of inks and other intermediaries and are also in the business of manufacture of certain specialty chemicals. No bifurcation of profits on segmental level is available from such annual accounts of MIL. Since this party, apart from manufacturing some speciality chemicals, is also engaged in business of inks and earning processing income, the same cannot be compared with that of the assessee which is engaged in manufacture of speciality chemicals alone. It goes without saying that the comparison can be made with the comparables and not incomparables. As no segmental data of MIL dealing with the manufacture of specialty chemicals, more specifically which are manufactured by the assessee, is available, such a case cannot be included in the list of comparables. Therefore, the impugned order on this issue is set aside audit is ordered that the exclusion of this case is to be excluded from the list of comparables. [Para 16] As the case of PIL has acquisition and demergers during the relevant year, such a case cannot be included in the final list of comparables. In view of this decision, there is no need to look into the comparability or otherwise of the factual aspects of this case with that of the assessee. This case is directed to be excluded from the eventual list of comparables. [Para 18]