PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER : In this appeal filed by the assessee, it assails the directions given by the DRP and the pursuant adjustments carried out in its income by the Assessing Officer, based on the order of the Transfer Pricing Officer. Apart from this, assessee has also raised a few grounds on issues other than transfer pricing.

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2. Facts apropos are that assessee, a company engaged in supply of assembly, front-end module, cockpit, rear chassis, front chassis, etc., is 100% subsidiary of one M/s Hyundai Mobis, Korea, also referred as Mobis Korea. It was incorporated in India in July, 2005. As per the assessee, its commercial production started only on 27th January, 2007. Assessee had international transactions with M/s Mobis Korea on account of purchase of raw materials, purchase of capital equipment, payment of royalty, payment of technical services fee and payment of guarantee fee. Assessee had filed return for impugned assessment year on 31.10.2007 declaring a total income of ` 12,17,671/-. Since assessee had international transactions of value exceeding the prescribed limit, Assessing Officer made a reference to Transfer Pricing Officer (TPO).

3. For the transactions in the nature of purchase of raw materials from its associate enterprise, assessee had adopted Transaction Net Margin Method (TNMM) for evaluating the pricing, whereas, for purchase of capital equipments, payment of royalty, reimbursement of travel and accommodation expenses and payment of guarantee fee, assessee had adopted Comparable Uncontrolled Price (CUP) method. TNMM was also followed for evaluating the technical

I.T.A. No. 2112/Mds/11 3 services fee paid. The dispute before us, insofar it relates to transfer pricing is confined to determination of arm's length price of raw materials and material parts purchased from associate enterprise, for which TNMM was adopted.

4. Assessee had filed a TP study based on a set of comparables identified on a search conducted on 15.2.2007 in Prowess & Capital Line data bases. Since the search for the comparables itself was conducted during the currency of the relevant previous year, obviously the data used for ALP analysis was not contemporaneous. Benchmarking was done based on results of eight comparable companies for various financial years ending 1st April, 2004 to 15th February, 2007. TPO at the outset itself rejected this data for a reason that it was not in accordance with Rule 10B(4) of Income-tax Rules, 1962. Certain adjustments carried out by the assessee for negative working capital and disabilities due to first year of its operation, were also not accepted by the TPO. The TPO thereafter proceeded to make a search by herself in the Prowess and Capital Line data base. She identified fourteen number of comparables based on certain filters which, according to her, were necessary to select companies, in a similar business situation as that of the assessee. In the process, she rejected companies having sales more

I.T.A. No. 2112/Mds/11 4 than ` 1 Crore, companies which had suffered loss, companies with dissimilar products and companies having related party transactions.

5. Assessees main argument before TPO was that its capacity utilization was only 5.47% since it started commercial operation only on 26.1.2007. As per the assessee, this called for an adjustment on the operating margin. As per the TPO, no adjustment could be made on the margins of the tested party. Assessee had also required a 5% adjustment for its negative working capital, when compared to the substantial positive working capital of the comparables. But, the TPO was of the opinion that no data was provided by the assessee for arriving at the 5% adjustment sought by it. As per the TPO, just because assessee was in its first year of operation, did not mean that it was necessary to incur a loss. TPO also noted that assessees expenditures were mostly on variable costs and hence, utilization of capacity did not have any material effect. She computed the arithmetic mean of PLI of comparable companies at 5.18% of sales. Adopting such PLI to the sales effected by the assessee, the TPO arrived at the ALP of the operating cost. Therefrom she deducted the actual non-AE cost of raw materials and arrived at ALP value of the AE purchases. Difference was determined at ` 9,58,60,522/- and recommendations to this effect was given to the Assessing Officer.

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6. Assessing Officer proceeded to frame a draft assessment order based on the recommendations of the TPO. In such draft assessment order, Assessing Officer proposed an addition of ` 9,58,60,522/- for the arm's length price adjustment. In addition to this, there were certain other additions as well. These were for income arising out of an invoice raised subsequent to the end of relevant previous year, disallowance of amortization cost of lease hold land, disallowance of payment made for acquiring software licence and reimbursement of expenses for non-deduction of tax at source.

7. Assessee elected to move the DRP against proposed draft assessment. Objections of the assessee on the TP adjustment proposed could be summarized as under:-

(i) TPO had conducted a fresh analysis and in the process, adopted a new set of comparables without cogent reasons and without rejecting the transfer price documentation of the assessee.

(ii) TPO considered companies with controlled transactions also as comparables.

(iii) TPO adopted data which were not contemporaneous.

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(iv) TPO did not make required adjustments under Rule 10B for difference in start-up expenses, depreciation, Customs Duty and capacity utilization.

(v) TPO did not grant 5% safe harbour range available to it under proviso to Section 92C(2) of the Act.

(vi) TPO failed to consider the valuation made by the Customs authority as a properly comparable value for accepting the arm's length price of the international transaction of the assessee.

(vii) TPO did not make the required adjustments to the results of the comparable cases before making a comparison with assessees results.

(viii) TPO failed to consider functional differences like the start-up expenses incurred by the assessee and huge import content of 98.55%.

(ix) TPO had selected as comparables, companies which were already in existence and running for more than a decade.

(x) TPO cherry-picked fourteen number of companies as comparables in a pre-determined manner without making a detailed analysis as required under Rule 10B(2) of the Act.

(xi) Out of the comparables selected by the Assessing Officer, M/s JBM Auto Ltd., M/s Jaya Bharat Maruti Ltd. and M/s Sanden Vikas (India) Ltd. had substantial related party transactions exceeding 25%.

(xii) TPO selected companies like Automotive Coaches and Components Ltd., Endurance Systems (India) Pvt. Ltd., Neel Metals Products Ltd., which were not manufacturing products comparable to that of the assessee.

(xiii) TPO did not confine the adjustment on account of alleged difference in arm's length operating profit, to the proportionate AE transactions.

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(xiv) TPO did not recognize need for considering multiple year data for arriving at the profit level indicator.

8. On the additions proposed by the A.O. for items other than international transactions, objections of the assessee before DRP were as under:-

(i) A.O. included income of ` 5.34 Crores arising out of an invoice raised in subsequent year, ignoring that assessee had accounted such income in the subsequent assessment year. A.O. made the above addition though a right to claim such income came to be vested on the assessee only on issuing the invoice.

(ii) TPO had wrongly presumed that assessee had amortized cost of lease hold land, and incurred an expenditure of ` 3,26,500/-.

(iii) TPO failed to appreciate that assessee had not purchased any right in the software acquired from M/s Autoever Systems Corporation, Korea, and M/s Wipro India Ltd. but had only made purchase of Shrink-Wrapped software and thus there was no necessity for deduction of tax of the payments.

(iv) A.O. erred in proposing disallowance of ` 6,50,000/-, which was reimbursement of expenses, on which there was no necessity to deduct tax at source.

(v) A.O. erred in holding that assessee had excess depreciation on account of adjustment on notional gains on exchange fluctuation with the cost of the assets.

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9. The DRP, after considering the above objections of the assessee, held as under, with regard to transfer pricing adjustments proposed by the A.O.:-

(i) TP study done by the assessee was correctly rejected by the TPO. TP study was done much before the end of the year and the data collated by the assessee was for period preceding to the relevant previous year.

(ii) Multiple year data could not be considered unless data for contemporaneous year was found to be unreliable for some valid reasons.

(iii) Against eight companies considered as comparables by the assessee, TPO had considered 14 companies and assessee had not per se objected to any of the selections made by the TPO.

(iv) Assessee should have conducted the search after the end of the relevant previous year and not in February, 2007 and by doing so, it had itself placed in a position whereby the data selected by it were out of time.

(v) Assessees argument that adjustment was required for idle capacity was acceptable and idle capacity adjustment of 30% was to be done by the A.O.

(vi) Assessees claim for adjustment for negative working capital on its results could not be demonstrated and hence, no adjustment was required for this.

(vii) Assessees claim that there was significant import content in its purchases, much higher than that of comparables, could not be considered as a unique phenomenon. If imports required payment of Customs duty, indigenous purchases attracted various domestic taxes.

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(viii) Assessees claim that adjustment for start-up expenses were required, was not demonstrated by it.

(ix) There was no requirement for any adjustment with regard to fixed overheads, since adjustment recommended for idle capacity would take care of this.

(x) Assessees claim that Customs valuation should be taken as arm's length price, could not be accepted since Custom authorities scrutinized the value of goods for suspected undervaluation, whereas, TPOs endeavour was to find whether there was any overvaluation. Customs valuations rules were very different from transfer pricing rules and hence, would not be amenable for a comparison.

(xi) Safe harbour as claimed by the assessee at 5% under proviso to Section 92C(2) could not be given, since amendment introduced by the Finance (No.2) Act, 2009 had come into effect from 1.10.12009 and assessees assessment was completed after the said date. As per the DRP, position was explained in Corrigendum to Circular No.5 of 2010 dated 30.9.2011 issued by CBDT.

(xii) Assessees claim that TPO had attributed the shortfall in profits entirely to its international transaction without taking the proportionate turnover relatable to raw material imported from associate enterprise, could not be accepted, since cost variation relating to non-AE transaction were passed on to unrelated parties.

10. On issues other than transfer pricing, the DRP held as under:-

(i) Invoice raised in the subsequent year was only for difference between estimated price and final price, for sales already effected to M/s HMI. Under the matching principles of mercantile system of accounting, income stood accrued to the assessee.

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(ii) Though deduction of tax for royalty payment would not apply to off-the-shelf software, the agreement entered by the assessee with M/s Autoever Systems Corporation, Korea and M/s Wipro Ltd. would show that what was acquired were customized softwares, specially designed for assessee. Hence, tax was required to be deducted at source.

(iii) Disallowance of ` 3,26,500/- proposed on amortization of leasehold land was justified in the facts and circumstances of the case.

(iv) Assessees argument that there was no excess claim of depreciation of assets, was to be accepted. Based on the above directions, a final assessment order was framed by the Assessing Officer.

11. Before us, assessee has taken eight grounds on transfer pricing adjustment. These grounds are reproduced hereunder:- (1) Erred on facts and in the circumstances of the case and in law by confirming the proposed addition of ` 14,39,29,461 [i.e. ` 7,68,97,012 based on the provisions of Chapter X of the Income-tax Act, (the Act) and ` 6,70,32,449 based on the other provisions of the Act] to appellants total income. (2) Erred in law by upholding / confirming the action of the TPO in not satisfying any of the conditions prescribed under Section 92C(3) of the Act before making an adjustment to the income of the appellant. (3) Erred in law in upholding / confirming the action of the TPO in denying the benefit of variance of 5 percent from the arithmetic mean as provided in proviso to Section

I.T.A. No. 2112/Mds/11 11 92C(2) of the Act, while computing the adjustment to the total income of the appellant. (4) Erred on facts and in the circumstances of the case in upholding / confirming the action of the TPO in failing to take due cognizance of the order of the customs authority accepting the arm's length nature of the international transactions of appellant within its affilitates. (5.1) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in disregarding the benchmarking analysis and comparable companies selected by the appellant based on the contemporaneous data in the transfer pricing documentation maintained as per Section 92D of the Act read with Rule 10D of Income-tax Rules, 1962 (the Rules). (5.2) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO of conducting a fresh benchmarking analysis using non contemporaneous data to substitute the analysis performed by the appellant. Further, erred in law in selecting the comparable companies having controlled transactions. (5.3) Erred in law in upholding / confirming the action of the TPO in computing the arm's length price using single-year margin of the comparable companies as against three-year weighted average margin of the comparable companies as enumerated in Rule 10B(4) of the Rules. (6.1) Erred on facts and in the circumstances of the case and in law in ignoring the economic commercial circumstances prevailing in the appellants business during the year in which the appellants business was in operation only for two months and was in the nature of a start-up. Further, erred in adopting a biased premeditated approach to make a transfer pricing adjustment by completely ignoring the transfer pricing approach documented by the appellant.

I.T.A. No. 2112/Mds/11 12 (6.2) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in not allowing suitable economic adjustment as provided under Rule 10B of the Rules, to account for the difference between international transactions and the comparable uncontrolled transactions selected by the learned A.O./TPO. Erred in not allowing adjustment for the following: working capital, Customs duty and, One-time start-up expenses. (7) Erred on facts and in the circumstances of the case and in law in upholding / confirming the action of the TPO in making adjustment on the shortfall in the margin of the appellant on total transactions (i.e. controlled as well as uncontrolled) instead of applying the shortfall in the margin only to controlled transactions. (8) Erred on facts and in the circumstances of the case and in law in initiating penalty proceedings under Section 271AA on pretext of non-compliance of Section 92D(1) read with Rule 10D.

12. Learned A.R. admitted that first two grounds raised by the assessee were general in nature.

13. In support of ground No.3, learned A.R. submitted that under proviso to Section 92C(2) assessee was entitled to the benefit of 5% safe harbour range.

14. In support of ground No.4, learned A.R. submitted that valuations done by the Customs authorities under Customs Valuation

I.T.A. No. 2112/Mds/11 13 Rules, 2007 were good comparisons. According to him, Customs authorities would not have accepted the declared value as per the invoice, for the raw materials and material parts imported by the assessee from its associate enterprise, unless they were satisfied that the prices were not influenced by the relationship. As per learned A.R., Rule 3(3) of Customs Valuation Rules, 2007 was not considered by any of the authorities below. According to him, a benefit conferred by one Department of Government could not be taken away by another Department of the Government, as held by Hon'ble jurisdictional High Court in the case of PRP Granites (221 CTR 371). Therefore, as per learned A.R., the prices at which assessee purchased raw material and material parts from associate enterprise were at arms length.

15. In support of Ground No.5, learned A.R. submitted that comparable companies selected by the assessee were based on best available contemporaneous data, but, still rejected by the TPO. TPO without giving adequate reasons for rejecting such contemporaneous data, resorted to a fresh benchmarking analysis. Assessee had appropriately considered three-year weighted average margin of comparable companies which gave a more representative result than single-year margin. Assessee had only very small value addition on

I.T.A. No. 2112/Mds/11 14 the raw material purchased. Assessee could not be compared with other companies, which were having substantial value addition on the material purchased.

16. In support of ground No.6, learned A.R. submitted that lower authorities ignored the date on which assessee had commenced its commercial operation. It was only on 26.1.2007 and therefore, assessee was a start-up concern. Assessee had operations for two months alone. Comparing the result of a two months old company with other well-entrenched companies, was not logical. Comparables chosen by the assessee were unjustly rejected. DRP itself had admitted that product-to-product comparability was not required in TNMM. In the companies selected by the TPO, atleast three were having related party transactions exceeding 20%. Further, according to learned A.R., adjustments were required to be made to the margin since assessee was having negative working capital. Substantial Customs duty was paid by the assessee. Imported raw material consumed by the assessee relatable to the AE itself came to 27% of its total cost. As per the learned A.R., adjustments were required to be carried out for off-setting excess expenditure incurred by the assessee for starting its operations, before making a comparison. In any case, according to him, Assessing Officer having made an

I.T.A. No. 2112/Mds/11 15 income addition of ` 5.34 Crores for an invoice raised in subsequent year, it ought have been considered while working out the profit margin, before attempting a comparison.

17. In support of ground No.7, learned A.R. submitted that the difference on account of PLI should not have been applied directly to the total transactions of the assessee. The shortfall in margin, if any, ought have been restricted to the controlled transactions. According to him, the arm's length prices of the AE purchases were worked out by the TPO by applying the PLI on the total sale, for arriving at the arm's length operating cost and thereafter deducting the non-AE cost.

18. Learned A.R. did not press ground No.8.

19. In support of his contention that filtering process adopted for selecting the comparable should take care of all essential factors, learned A.R. relied on the decision of co-ordinate Bench of this Tribunal in the case of M/s California Software Co. Ltd. v. ACIT in

I.T.A. No. 1842/Mds/2011 dated 27th August, 2012.

20. In support of his contention that working capital was a factor to be considered for transfer pricing analysis, learned A.R. relied on the

I.T.A. No. 2112/Mds/11 16 decision of Pune Bench of this Tribunal in the case of Demag Cranes & Components (India) (P) Ltd. v. DCIT (2012) 144 TTJ 320.

21. In support of his contention that where imported raw materials were substantial, adjustment for Customs duty had to be done, while making a comparison, learned A.R. relied on the decision of Pune Bench of this Tribunal in the case of Skoda Auto India (P) Ltd. v. ACIT (2009) 122 TTJ 699.

22. In support of his contention that adjustment while applying TNMM could be carried out only on turnover relatable to the purchases from an associate enterprise, learned A.R. relied on the decision of Delhi Bench of this Tribunal in the case of IL Jin Electronics (I) (P.) Ltd. v. ACIT (2010) 36 SOT 227.

23. In reply, learned D.R., at the outset, submitted that assessee had endeavoured to make a comparison with results of eight companies based on a search conducted on 15.2.2007. Data of comparable companies related to a financial year as early as 2004-

05. Contemporaneous data of selected comparables was never considered by the assessee. Therefore, the A.O. was justified in applying Rule 10B(4) and selecting a set of comparables by searching the Prowess and Capital Line data base. In any case, as

I.T.A. No. 2112/Mds/11 17 per learned D.R., assessee had at no point of time objected to the comparables selected by the DRP. TPO had selected 14 comparables having similar manufacturing line and out of these, atleast three companies, namely, Automotive Stampings & Assemblies Ltd., Axles India Ltd. and Subros Ltd. were common in the list considered by both the parties. Assessee selected eight companies under Prowess search and Nil companies from Capital Line database. One of the filters adopted by the assessee, while arriving eight comparables, was exclusion of start-up companies. By this filter, assessee itself had excluded 61 companies. Having itself excluded the start-up companies from the list of possible comparables, assessee could not now turn back and say that it should be given adjustment for being a start-up. Further, as per learned D.R., assessee could never demonstrate that three companies out of fourteen selected by the TPO had related party transaction exceeding 26%. The impact of negative working capital on the profitability, if any, requiring an adjustment, was never demonstrated by the assessee. Assessee had simply made 5% adjustment citing idle capacity, negative working capital and start-up difficulties. Of this, DRP had given considerable relief for idle capacity, and assessee could not be aggrieved any further.

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24. Vis--vis the Customs duty adjustment, learned D.R. submitted that assessee could not demonstrate that comparables were not having similar imports. Even otherwise, if the purchases were made within India, assessee would have had to pay excise and other taxes.

25. As for the claim of the assessee that addition of ` 534 lakhs made on its revenue for invoicing done in succeeding year, if upheld, then corresponding adjustment was required to be made in the profit margin also, learned D.R. had no serious objection.

26. We have perused the orders and heard the rival submissions. There is no dispute that assessee had started its commercial production only on 26.1.2007. Or, in other words, it was in operation only for two months during the relevant previous year. There is also no dispute that against the installed capacity of 2,40,000 cars per annum, the actual production for the relevant previous year was 13,138. This is clear from Schedule 18 of audited final accounts. Thus, capacity utilization was only 5.47% during the relevant previous year. Argument of the assessee that the comparable cases selected by the TPO were all companies having a standing more than 10-20 years, appears true. But, assessee had by itself selected eight companies for comparison and while applying filters, this was one of

I.T.A. No. 2112/Mds/11 19 the criteria adopted by it. The search process done by the assessee is clear from its own transfer pricing documentation placed at paper- book 58 and 60, which reads as follows:- Summary of Search Process - Prowess Criteria and reason for usage No. of companies passing the criterion Total universe of companies available in Prowess as of February 15, 2007 9,801 Selected companies with sales greater than zero & the ratio of sales manufacturing to sales more than 90% over the aforesaid time period so as to capture all possible manufacturers 1,758 Selected companies classified under economic activity of Transport Equipment industry with a sub-classification of Automobile ancillaries Companies wholly or partly owned by Government of Co- operative society were removed to concentrate on profit oriented companies Companies having R&D expenditure more than 3% of sales were rejected to eliminate full-fledged manufacturers Companies having advertisement, marketing & distribution expenses to sales more than 3% were eliminated to focus on companies not earning on account of performing such functions Companies having Net fixed assets upon sales more than 50% were rejected to eliminate full-fledged manufacturers Companies with a positive net worth were included to exclude companies whose net worth had eroded Companies with sales turnover lesser than ` 1 Crore were selected to exclude startup companies Companies whose value added expenditure as a percentage of total cost greater than 20% were rejected to exclude high value adding companies

I.T.A. No. 2112/Mds/11 20 Qualitative companies that were functionally comparable and that did not have controlled transactions were selected Summary of Search Process CapitalinePlus Criteria and reason for usage No. of companies passing the criterion Total universe of companies available in CapitalinePlus as of February 15, 2007 13,887 Identified additional companies with positive sales over the time period under consideration were selected i.e. companies for which data was not available in Prowess Companies having the ratio of sales manufacturing to sales more than 90% were selected to primarily filter for manufacturing companies Selected companies classified in the Transport Equipment industry. Companies which are not wholly or partly owned by Government or Co-operative society were selected to concentrate on profit oriented companies Companies having R&D expenditure less than 3% of sales were selected to eliminate full-fledged manufacturers Companies having Net fixed assets upon sales more than 50% were rejected to eliminate full-fledged manufacturers Companies with a positive net worth were included to exclude companies whose net worth had eroded Companies with sales turnover more than ` 1 Crore were selected to exclude startup companies Companies whose value added expenditure as a percentage of total cost less than 20% were selected to exclude high value adding companies Qualitative companies that were not functionally comparable and that had related party transactions were eliminated

I.T.A. No. 2112/Mds/11 21 Assessee itself had excluded start-up companies having turnover less than ` 1 Crore while applying the filters. Having itself excluded start-up companies while doing its own comparative study, it cannot now turn back and say that adjustment should be made for its start- up nature.

27. Adjustments carried out by the TPO were on purchases made from its associate enterprise. The value of purchases from AEs came to ` 217082589/-. Total sales of the assessee for the relevant previous year came to ` 289794535/-. In the face of these figures, assessee cannot be considered as a mere start-up company, facing birth pangs.

28. Assessee at no point of time had objected to the comparables selected by the TPO. Claim of the assessee that multiple year data should be considered for a more representative analysis, could have been accepted if it was able to show that contemporaneous data had some deficiency rendering it not readily comparable. There was no such aspect pointed out. Just because the selected companies were old, would not by itself be a reason to reject the selection. Though assessees counsel submitted that loss making companies were unjustly excluded by the TPO, he was unable to point out which were

I.T.A. No. 2112/Mds/11 22 those companies which were excluded and what were the margin levels indicated by such companies. However, we find substantial strength in the grievance of the assessee that three of the companies selected by the TPO were having related party transaction in excess of 26%. This factor had not been addressed by any of the lower authorities. Comparisons have to be made with uncontrolled transactions and it is essential that entities having related party transactions are eliminated, in such comparison to the extent possible. If three out of the 14 companies, were having related party transactions in excess of 25%, as mentioned by the assessee, these had to be excluded.

29. Coming to the aspect of adjustment pleaded by the assessee for negative working capital, no doubt, in the case of Demag Cranes & Components (India) (P) Ltd. (supra), it was held that adjustment had to be granted for eliminating material effects, if any, arising out of difference in working capital between tested party and comparables. Nevertheless, we find from the said decision that the plea regarding adjustment for working capital was first raised before DRP and the DRP had decided the issue without realizing that this was never adjudicated by the TPO. As per the assessee, it was having negative working capital as against substantial positive working capital enjoyed

I.T.A. No. 2112/Mds/11 23 by the comparables. If the assessee is able to demonstrate that negative working capital had effected its margins, adjustment should have been made. Assessee has indeed filed before the DRP, margins of comparables adjusted for difference in working capital, but at no point of time it had given any reason why such adjustments were required. Assessee had made adjustment on inventories, debtors and creditors, which in its opinion, reflected the difference in working capital, based on OECD guidelines. Just because assessee relied on OECD guidelines, would not mean that the adjustment made by it were required, unless the impact could be demonstrated. Such a demonstration was never done by the assessee. Here it will be relevant to have a look at the narration given by the assessee with regard to the adjustment carried out for working capital, as appearing in its transfer pricing documentation. This reads as follows:- To elaborate, the adjustment is made by adding the debtor adjustment to sales and by adding creditor adjustment and subtracting inventory adjustment from Cost of Goods Sold for each comparable company. Here, the prime-lending rate was used as the appropriate cost of capital because it can be determined with reasonable accuracy and is the best available estimate of the cost of capital. For this purpose, the prime-lending rate of 12.50% for the year 2007, 10,80% for the year 2006 and 10.89% for the year 2005 published in CMIE and Reserve Bank of India publications were considered.

I.T.A. No. 2112/Mds/11 24 What were the debtor adjustment and creditor adjustment and how these were relevant have not been demonstrated by the assessee. We are thus of the opinion that the assessee has not been able to justify the adjustments that were required to be made on account of negative working capital.

30. Coming to the adjustment for Customs duty, assessee itself has mentioned in its objection before the DRP that total raw material imported from the associate concern constituted only 27% of its total cost. As per the assessee, cost of components consumed by AE was 27% of the total cost of ` 370633638/- incurred, whereas, the remaining cost related to unrelated domestic suppliers. No doubt, in the case of Skoda Auto India (P) Ltd. (supra), it was held by Pune Bench that higher import content of raw material was a factor to be considered while doing the ALP analysis. Nevertheless, it is also mentioned therein that higher import content of raw material itself did not warrant an adjustment in operating margins. For getting the benefit of any such adjustment, assessee should be able to demonstrate that higher import content was necessitated by any extraordinary circumstance beyond its control. Assessee had endeavoured to make a 5% adjustment to its total cost for off-setting the leverage derived on account of negative working capital and for

I.T.A. No. 2112/Mds/11 25 taking care of under utilization of capacity. Nevertheless, there was no empirical data ever provided by the assessee to support the figure of 5% arrived by it.

31. As to the claim of the assessee that valuations made by the Customs authority on the import of raw material for the purpose of levy of Customs duty should be taken as a proper comparable, we do not find any merit. This is for the reason that, as pointed out by DRP, valuation by the Customs authority is as per Customs Rules, which are not relevant for the purpose of transfer pricing under income-tax rules. Further, the purpose of valuation by the Customs authority is to determine undervaluation and by its very nature, this would not fit with the scheme of transfer pricing analysis under the Income-tax Act. Decision of Hon'ble jurisdictional High Court in the case of PRP Granites (supra) strongly relied on by the learned A.R., was in relation to a claim for exemption under Section 10B, based on an approval granted by Ministry of Commerce under Section 14 of the Industries (Development and Regulation) Act, 1951, to which CBDT was a party. On the other hand, in the case before us, CBDT had nothing to do with the valuations done under Customs Valuation Rules, 2007.

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32. The associate enterprise from which assessee purchased the raw materials was M/s Hyundai Mobis Korea, whereas, sales effected was to M/s Hyundai Mobis India. Assessee, therefore, had a captive buyer of its product and there was no reason for it to show lower than the industrial working results. However, there is substantial justification in the argument of the assessee that TP adjustment should have been restricted to controlled transactions. In this, assessee is supported by the decision of co-ordinate Bench of this Tribunal in the case of IL Jin Electronics (I) (P.) Ltd. (supra). Relevant para 15 of the order is reproduced hereunder:-

15. The assessee has also taken one alternative ground out of the total raw materials consumed by the assessee for manufacturing print circuit boards, only 45.51 per cent of the total raw materials were imported through assessees associate concerns, and, therefore, any adjustment, if any called for, can only be made to the 45.51 per cent of the total turnover, and not to the total turnover of the assessee. After considering the facts of the case, we do not find any difficulty in accepting the contention of the assessee that at best only 45.51 per cent of the operating profit can be attributed to imported raw material acquired from assessees associate concerns. In the present case, the Assessing Officer has calculated the operating profit on the entire sales of the assessee, which in our considered opinion, is not justified, when it is admitted position that only 45.51 per cent of raw material has been acquired by the assessee from its associate concerns for the purpose of manufacturing items. The assessee has stated that the operating profit if applied to 45.51 per cent of the turnover would come to ` 35,52,573 as against operating profit of ` 24,35,175 booked by the assessee, and the difference thereof would only be called for

I.T.A. No. 2112/Mds/11 27 to be made as addition to the profit shown by the assessee. We, therefore, direct the Assessing Officer to modify the assessment and make the adjustment only to the extent of difference in the arm's length operating profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the assessee. Therefore, to this extent, the addition made by the Assessing Officer and further confirmed by the CIT(A) is reduced. We order accordingly. Thus, if assessees purchase of raw material from associate enterprise is 27% of the total raw material purchase, then the adjustment for ALP has to be restricted to 27% of the total turnover.

33. Coming to the aspect of + 5% safe harbour limits, this is no more res integra, in view of the decision of Special Bench in the case of M/s IHG IT Services (India) Pvt. Ltd. v. ITO (I.T.A. No. 5890/Del/2010 dated 30.4.2013). The Special Bench was constituted to consider whether prior to the insertion of the second proviso to Section 92C(2), the benefit of 5% tolerance margin as prescribed under provisio to Section 92C(2) for the purposes of determining the arm's length price of an international transaction is allowable as a standard deduction in all cases, or is allowable only if the difference is less than 5%. In the meanwhile, the second proviso to Section 92C(2) was amended by the Finance Act, 2012 with retrospective effect from 1.4.2002. The assessee claimed, relying on Piagio Vehicle P. Ltd. v. DCIT that even after the retrospective amendment

I.T.A. No. 2112/Mds/11 28 by the Finance Act, 2012, it was entitled to the benefit of adjustment of + 5% variation while computing the ALP. It was also argued that the amendment was unconstitutional. The Special Bench held that there was a controversy on whether the + 5% tolerance adjustment was a standard deduction or not. After the retrospective amendment to the second proviso to Section 92C by the Finance Act, 2012 with retrospective effect from 1.4.2002, it is evident that if the variation between the arm's length price and the price at which international transaction was actually undertaken does not exceed the specified percentage, then only the price at which the international transaction has actually been undertaken shall be deemed to be arm's length price. Thus, the benefit of tolerance margin would be available only if the variation is within the tolerance margin. Once the variation exceeded the tolerance margin, then there would be no benefit even up to tolerance margin. Then, the ALP as worked out under Section 92C(1) shall be taken as ALP without any benefit of tolerance margin.

34. Based on the above discussion, grounds raised by the assessee on transfer pricing are disposed of as under:- Ground Nos.1&2 being general in nature, are dismissed. Ground Nos.3, 4, 5.1, 5.3, 6.1 & 6.2 are dismissed. Ground No.5.2 is partly allowed viz. insofar as it concerns exclusion of three comparables having controlled transactions. Ground No.7 is allowed for statistical purposes. Ground No.8 is dismissed as not pressed.

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35. Accordingly, Assessing Officer shall re-work the adjustment required to the pricing of the international transactions by restricting such adjustment to the turnover proportionate to purchase of raw materials from associate enterprise, after excluding the three comparables having related party transactions exceeding 25%.

36. Now we take up the assessees grounds which are not related to transfer pricing.

37. Vide ground No.9, grievance raised by the assessee is that a sum of ` 5,34,00,000/- added to its income despite the invoice having been raised in the succeeding year.

38. Facts apropos are that related party transactions reported by the assessee showed that it had made sales of ` 34.31 Crores to M/s Hundai Motor India Limited (HML). However, the Profit & Loss account reported a figure of ` 28.97 Crores only. Assessee was required to explain why such sum should not be added to its income both for computing total income and book profit income. Reply of the assessee was that supplementary invoice of ` 5.34 Crores was not raised on HML during the relevant previous year and hence could not be considered as income. However, Assessing Officer was not impressed. According to him, Annual Report of the assessee clearly

I.T.A. No. 2112/Mds/11 30 mentioned sales to M/s HML was ` 34.31 Crores. Assessee was following mercantile system of accounting and hence this income should have been accounted in the relevant previous year. He, therefore, proposed an addition of ` 5.34 Crores, which was confirmed by the DRP.

39. Now before us, learned A.R. submitted that the annual report gave only an analysis of corporate margins. According to him, supplementary invoice was raised on 30th June, 2007. It was duly accounted in financial year 2007-08 also. Unless and until the invoice was issued, the party would not have paid. Related party transactions given in the audited final accounts at Schedule 18, did not show such amount as income of the relevant previous year.

40. Per contra, learned D.R. supported the orders of authorities below.

41. We have perused the orders and heard the rival submissions. It is not disputed that the invoice was raised by the assessee on the party, only on 30th June, 2007. Irrespective of the method of treatment given in the books of accounts, unless and until the invoice is raised, a customer will not be legally bound to pay. Assessee will get a legal right to claim the sum only after raising the invoice. Even

I.T.A. No. 2112/Mds/11 31 if it was price difference for sales made during the relevant previous year, unless and until the invoice was raised, assessee could not make any claim from M/s HMIL. No doubt, mercantile system of accounting requires matching concepts to be satisfied. But, matching concepts cannot be extended to mean that assessee could be fastened with an income which has not accrued to it. It has also been held by Hon'ble Apex Court as early as in 1954 in E.D. Sassoon & Company Ltd. v. CIT (26 ITR 27) that the point of accrual of income has to be seen from the date on which a legal claim could have been legitimately made on such income. Admittedly, here, the invoice was raised on 30th June, 2007. Legal claim for such income accrued, and was vested on the assessee only on that date. The said amount could have been considered as income only for the relevant previous year ending 31st March, 2008. The addition, made for the relevant previous year, therefore, stands deleted. Since the addition is deleted, no adjustment is required for this, while making the TP analysis, to arrive at arm's length price of the raw materials purchased by the assessee from its associate enterprise.

42. Ground No.9 of the assessee stands allowed.

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43. When ground No.10 was taken up, learned A.R. submitted that he was not pressing the same. Hence, this ground is dismissed as not pressed.

44. Vide ground No.11, assessee is aggrieved on disallowance made under Section 40(a)(i) and 40(a)(ia) of the Act for non- deduction of tax at source on payments made for acquiring certain software.

45. Facts apropos are that Assessing Officer had found that assessee had acquired a software license from M/s Autoever Systems Corporation, Korea for ` 80,71,622/- and another software license for ` 13,34,327/- from M/s Wipro Ltd., India. Assessee had not deducted tax at source on both the above payments. Assessing Officer was of the opinion that former was covered under Section 40(a)(i) and the latter was covered under Section 40(a)(ia) of the Act. Disallowance was proposed for both these amounts. Though assessee submitted before the DRP that these were Shrink- Wrapped or copyrighted packaged software. According to it, while purchasing such software, there were no royalty whatsoever involved. These were outright purchase of software and hence tax deduction

I.T.A. No. 2112/Mds/11 33 under Section 194J was not required. This argument did not find any favour with DRP.

46. Now before us, learned A.R. submitted that Section 40(a)(i) and Section 40(a)(ia) both mandated deduction of tax at source on royalty payments. However, according to him, the term royalty mentioned in these Sections had to be given the same meaning in Explanation 2 to clause (vi) of sub-section (1) of Section 9 of the Act. Relying on the said Explanation, learned A.R. submitted that the payments made by the assessee did not fall within the said Explanation. According to him, Explanation 4 inserted by Finance Act, 2012 with retrospective effect from 1.6.76 had no effect whatsoever for construing the meaning of the term royalty mentioned in Explanation 2. In support of this, learned A.R. relied on the decision of Mumbai Bench of this Tribunal in the case of Sonata Information Technology Ltd. v. DCIT in

I.T.A. No. 1507/Mum/2012 dated 7.9.2012.

47. Per contra, learned D.R., strongly supporting the orders of authorities below, submitted that Explanation 4 was a clarificatory amendment for removal of doubts and hence, it applied to Explanation 2 as well.

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48. We have perused the orders and heard the rival submissions. No doubt, royalty mentioned in Section 40(a)(i) and 40(a)(ia) has to be assigned the meaning given in Explanation 2 to clause (vi) of sub- section (1) of Section 9 of the Act. None of the authorities below have verified this issue in the proper perspective. They were also not having the benefit of the elucidation of the law in this regard by higher authorities. The A.O. had held that the tax had to be deducted by the assessee for payment made to software purchase, but, was not done. Neither he, nor the DRP had looked into the aspect whether the payments made were in respect of Shrink-wrapped software or towards right to use software and whether Section 40(a)(i) and 40(a)(ia) stood attracted. We are, therefore, of the opinion that this issue requires a fresh look by the A.O. We set aside the orders of authorities below and remit this issue back to the file of the A.O.

49. Ground No.11 stands allowed for statistical purposes.

50. When ground No.12 is taken up, learned A.R. submitted that he was not pressing this ground.

51. Ground No.12 is dismissed as not pressed.

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52. In the result, appeal of the assessee is partly allowed for statistical purposes. Order was pronounced in the Court on Wednesday, the 14th of August, 2013, at Chennai. sd/- sd/- (S.S. Godara) (Abraham P. George) Judicial Member Accountant Member Chennai, Dated the 14th August, 2013. Kri. Copy to: (1) Appellant (2) Respondent (3) Secretary, DRP, Chennai (4) TPO-V, Chennai-34 (5) D.R. (6) Guard file