Pentair Water India (P.) Ltd. v. Addl. CIT

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The Tax Publishers2014 TaxPub(DT) 3518 (Panaji-Trib) : (2014) 164 TTJ 0502 : (2014) 107 DTR 0051 Pentajr Water India (P) Ltd. v. Addl. CIT INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALP operatings profit vis-a-vis rendering of services to AE as also to local units--The assessee was engaged in manufacture of fibre glass pressure vessel used for water treatment. It has set up a division in the year 1998-99 for providing in-house support engineering services in the field of product quality assurance, designing and product development. The said division is internally named as CDR Division. The AO made addition under the transfer price provision on information technology based engineering design services transaction to the assessee's AEs. The assessee is having two operational segment; manufacturing of water treatment component and IT-based engineering design services. Major revenue was derived by the assessee (92.65 per cent) from manufacturing division and balance (7.35 per cent) from CDR division. The TPO has suggested addition on the international transaction of the CDR division consisting of engineering support services rendered to the assessee's AEs abroad. The assessee has shown operating margin @ 12.49 per cent (operating profit/operating cost) but the TPO had increased the same to 29.83 per cent on the ground that the transaction with the AE was not at ALP. The assessee went in appeal before CIT(A). CIT(A) after considering the submission of the assessee and the various decisions in respect of the comparables directed the AO to compute the transfer pricing adjustment by taking the operating margin of the comparables @ 22.92 per cent. *Held:* The operating margin @ 12.50 per cent while in fact if the notional revenue was worked out in respect of the services rendered to the assessee's Goa plant at the same rate at which services were rendered to the AE abroad, the operating profit would have come @ 14.16 per cent. On an average the revenue has been received from the AE abroad @ Rs. 608 as the CDR unit has spent 1,80,064 hrs. while to the Goa unit, the services were rendered for 2,680 hrs. If the said 2,680 hrs. are taken into consideration, the revenue from the entire division in India would have been Rs. 16,29,003 as such notional revenue in respect of Goa plant should also be considred while computing the net operating profit excluding depreciation. In this case the TPO has computed the profit margin of the CDR unit, which was rendering the services not only to the associated concerns outside India but also to the other units of the assessee company, by taking the revenue received from the export of services to the associated concerns and without taking any revenue into consideration in respect of the services rendered by the CDR unit of the assessee to the other unit in Goa. The TPO has considered the total operating costs of the CDR unit which has been incurred by the unit not only in respect of services rendered to the associated concerns outside India but also in respect of services rendered to the unit in India and on that basis the operating profit was worked out. It is not denied in this case that the CDR unit was rendering services not only to the AEs outside India but also was rendering services to the other divisions of the assessee company. No nominal value has been assigned in respect of the services rendered by the CDR unit to the Indian division. The CDR unit has rendered services to the AE units abroad for 1,80,064 hrs. while in respect of Goa plant, services was rendered for 2,680 hrs. The average revenue received by the CDR unit from the AEs abroad comes to Rs. 608/hour. When the total revenue received from the AEs abroad is Rs. 10,94,49,682, if Tribunal apply the same rate in respect of the services rendered to Goa plant, the nominal revenue which should have been credited to CDR unit and debited to the Goa plant comes to Rs. 16,29,003. In Tribunal opinion, while computing the true profit of a particular division, it is necessary that the value should be assigned in respect of services received by the other unit and it should be taken as part of the revenue of that particular unit. In this case, Tribunal noted that the TPO has taken the total operating cost of the CDR unit which consists of the cost not only in respect of the services rendered to the AEs but also in respect of the services rendered to the Goa plant by the CDR unit. Since the total cost of the CDR unit has been taken, therefore, the notional revenue in respect of Goa plant should also be considered while computing the net operating profit. Thus, the correct operating profit in the case of the assessee from CDR unit, will be 14.16 per cent. This operating profit ratio is based on the profit which has been computed after charging depreciation. Tribunal noted that there is no dispute so far method of determining the ALP is concerned. In fact, for charging depreciation to the P&L a/c there are different prevalent recognized methods of depreciation. Some assessee opt for straight line method, some opt for written down method and some opt for sum of digit method or even replacement cost method. Selection of each method will affect the rate and quantum of depreciation even if the nature of the asset is the same and ultimately, the net profit derived by the company will vary. For determining the fair and true profit, it is appropriate that the effect of the depreciation must be excluded out of the operating profit for determining the operating profit ratio. Therefore, the best way of computing the operating profit, will be to compute the profit before depreciation in respect of each of the company. This will take out the inconformity or the variation in the profit level of the comparables arising due to adoption of different method of charging depreciation. [Para 6.4] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2014 TaxPub(DT) 3518 (Panaji-Trib) : (2014) 164 TTJ 0502 : (2014) 107 DTR 0051

Pentajr Water India (P) Ltd. v. Addl. CIT

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALP operatings profit vis-a-vis rendering of services to AE as also to local units--The assessee was engaged in manufacture of fibre glass pressure vessel used for water treatment. It has set up a division in the year 1998-99 for providing in-house support engineering services in the field of product quality assurance, designing and product development. The said division is internally named as CDR Division. The AO made addition under the transfer price provision on information technology based engineering design services transaction to the assessee's AEs. The assessee is having two operational segment; manufacturing of water treatment component and IT-based engineering design services. Major revenue was derived by the assessee (92.65 per cent) from manufacturing division and balance (7.35 per cent) from CDR division. The TPO has suggested addition on the international transaction of the CDR division consisting of engineering support services rendered to the assessee's AEs abroad. The assessee has shown operating margin @ 12.49 per cent (operating profit/operating cost) but the TPO had increased the same to 29.83 per cent on the ground that the transaction with the AE was not at ALP. The assessee went in appeal before CIT(A). CIT(A) after considering the submission of the assessee and the various decisions in respect of the comparables directed the AO to compute the transfer pricing adjustment by taking the operating margin of the comparables @ 22.92 per cent. Held: The operating margin @ 12.50 per cent while in fact if the notional revenue was worked out in respect of the services rendered to the assessee's Goa plant at the same rate at which services were rendered to the AE abroad, the operating profit would have come @ 14.16 per cent. On an average the revenue has been received from the AE abroad @ Rs. 608 as the CDR unit has spent 1,80,064 hrs. while to the Goa unit, the services were rendered for 2,680 hrs. If the said 2,680 hrs. are taken into consideration, the revenue from the entire division in India would have been Rs. 16,29,003 as such notional revenue in respect of Goa plant should also be considred while computing the net operating profit excluding depreciation.

In this case the TPO has computed the profit margin of the CDR unit, which was rendering the services not only to the associated concerns outside India but also to the other units of the assessee company, by taking the revenue received from the export of services to the associated concerns and without taking any revenue into consideration in respect of the services rendered by the CDR unit of the assessee to the other unit in Goa. The TPO has considered the total operating costs of the CDR unit which has been incurred by the unit not only in respect of services rendered to the associated concerns outside India but also in respect of services rendered to the unit in India and on that basis the operating profit was worked out. It is not denied in this case that the CDR unit was rendering services not only to the AEs outside India but also was rendering services to the other divisions of the assessee company. No nominal value has been assigned in respect of the services rendered by the CDR unit to the Indian division. The CDR unit has rendered services to the AE units abroad for 1,80,064 hrs. while in respect of Goa plant, services was rendered for 2,680 hrs. The average revenue received by the CDR unit from the AEs abroad comes to Rs. 608/hour. When the total revenue received from the AEs abroad is Rs. 10,94,49,682, if Tribunal apply the same rate in respect of the services rendered to Goa plant, the nominal revenue which should have been credited to CDR unit and debited to the Goa plant comes to Rs. 16,29,003. In Tribunal opinion, while computing the true profit of a particular division, it is necessary that the value should be assigned in respect of services received by the other unit and it should be taken as part of the revenue of that particular unit. In this case, Tribunal noted that the TPO has taken the total operating cost of the CDR unit which consists of the cost not only in respect of the services rendered to the AEs but also in respect of the services rendered to the Goa plant by the CDR unit. Since the total cost of the CDR unit has been taken, therefore, the notional revenue in respect of Goa plant should also be considered while computing the net operating profit. Thus, the correct operating profit in the case of the assessee from CDR unit, will be 14.16 per cent. This operating profit ratio is based on the profit which has been computed after charging depreciation. Tribunal noted that there is no dispute so far method of determining the ALP is concerned. In fact, for charging depreciation to the P&L a/c there are different prevalent recognized methods of depreciation. Some assessee opt for straight line method, some opt for written down method and some opt for sum of digit method or even replacement cost method. Selection of each method will affect the rate and quantum of depreciation even if the nature of the asset is the same and ultimately, the net profit derived by the company will vary. For determining the fair and true profit, it is appropriate that the effect of the depreciation must be excluded out of the operating profit for determining the operating profit ratio. Therefore, the best way of computing the operating profit, will be to compute the profit before depreciation in respect of each of the company. This will take out the inconformity or the variation in the profit level of the comparables arising due to adoption of different method of charging depreciation. [Para 6.4]