Rule 10B of Income Tax Rules provides methodology for computation of ALP. Under TNMM, ‘net profit’ is used as benchmark for ALP computation. Rule 10B(1)(e)(i) provides for considering “net profit margin realised by the enterprise from an international transaction or SDT entered into with an associated enterprise”. Rule 10B(1)(e)(ii) provides for computation of ‘net profit margin in uncontrolled comparable transactions’. Therefore, while computing net margin realized by the enterprises (tested party as well as comparables) all incomes and expenses that are representative or comprised of business obligation should be considered.
Generally, Government grants export subsidies towards recoupment of revenue expenditure and to ensure that the Indian exporters are competitive in the global markets. Also, the subsidies are factored by all exporters while determining their sales price. The issue has come before the Courts is whether export incentive or subsidies received by the taxpayer can be considered as operating in nature while calculating the operating margins.
Cases wherein it is held that Export incentives are operating in nature
Welspun Zucchi Textiles Ltd v ACIT (2014) 108 DTR Del (376) : 30 taxmann.com 251 (Mum Trib) – The taxpayer was engaged in the manufacture of various types of bathrobes. The taxpayer had exported bathrobes to its AEs in Italy and benchmarked the same applying CUP method using internal comparables. The TPO rejected CUP Method and adopted TNMM as the MAM. While computing operating margin of the taxpayer, the TPO held that DEPB benefit received by the taxpayer was other income and it could not be considered as operating income for computing PLI. The taxpayer contended that DEPB benefit is inextricably linked with export sale and while negotiating the price with the AE/any party, the taxpayer takes into consideration the export benefits that would accrue to the taxpayer on export of such goods. Hence, while calculating the margins, DEPB and other export benefits should be considered as part of total sales. The TPO rejected the contention.
The CIT(A) held that DEPB benefit was not taken into consideration by the TPO for the purpose of working out the profit margin of the taxpayer whereas such benefit was taken into account in case of the comparables, while working out their profit margin. Thus, the benefit should be considered as a part of operating income of the taxpayer. The ITAT held that since nothing has been brought on record to controvert or rebut this finding of the CIT(A), DEPB benefit received during the year under consideration should be considered as part of the turnover of the taxpayer for working out the profit margin for determining ALP.
Followed in DCIT v Welspun Zuchhi Textiles Ltd [2013] 38 taxmann.com 243 (Mumbai – Trib.), Welspun Zuchhi Textiles Ltd v ACIT TS-50-ITAT-2014(Mum)-TP and Welspun Zuchhi Textiles Ltd v ACIT TS-72-ITAT-2014(Mum)-TP.
Department appeal has been dismissed by Bombay HC (ITA NO.1827 OF 2013). Further, Bombay High Court in CIT v Welspun Zucchi Textiles Ltd [2017] 77 taxmann.com 137 (Bombay) confirmed the above view and held that DEPB benefit is operating revenue includable in arriving at operating profit
DCIT V Indo Spanish Tasty Foods Pvt Ltd TS-118-ITAT-2016(Bang)-TP – the ITAT upheld the DRP view that freight subsidy should be considered as operating in nature.
Greenland Exports Pvt Ltd v DCIT TS-879-ITAT-2016(Chny)-TP – the ITAT held that duty drawback and export incentives should be considered as operating in nature.
Cummins India Ltd. v. DCIT [2019] 101 taxmann.com 325 (Pune – Trib.) – It was held that export incentives were to be considered as operating income while benchmarking international transactions of assessee.
FCI OEN Connectors Ltd. v. ACIT [2017] 77 taxmann.com 223 (Cochin – Trib.) – The ITAT held that export entitlements is nothing but realization of export sales and is closely linked to export and should be taken into account while computing operating profit
M/s. AB INBEV GCC Services India Pvt. Ltd v DCIT IT(TP)A No 792/Bang/2022 – Income earned from sale of SEIS scrips should be considered as operating in nature.
Other Decisions wherein same is adopted are as follows:
- Sami Labs Ltd v DCIT IT(TP)A No 186/Bang/2015
- Reitzel India Pvt Ltd v DCIT [2020] 119 taxmann.com 401 (Bangalore – Trib.)
- Carraro India (P.) Ltd. v. ACIT [IT Appeal No. 1629 and 1673 (Pune) of 2013, dated 19-1-2017]
- Behr India Ltd v ACIT [2017] 81 taxmann.com 46 (Pune – Trib.)
Contrary View – Export Incentives not to be considered as operating
Goodyear India Limited v DCIT (2013) 33 taxmann.com 507 (Delhi-Trib.) – The taxpayer was engaged in the business of manufacture and sale of automobile tyres, tubes and flaps in the brand name of ‘Goodyear’. The taxpayer had purchased goods from Goodyear South Asia Tyres P Ltd (GSATL) for export to its AEs. The taxpayer exported goods to its AE by adopting mark-up of 5 per cent on cost of goods sold. While computing the cost of goods sold for determining ALP, the taxpayer deducted export incentive.
The TPO held that export incentive could not be reduced from the cost of goods sold. The TPO observed that export incentives were benefits provided to the Indian taxpayer, which could not be transferred to the foreign entity. The TPO also referred to Global Transfer Pricing Policy of Goodyear Group, as per which, inter-company selling price was to be decided by considering 5 per cent mark-up on inventory and all applicable costs. The TPO observed that export incentives were available to the taxpayer only after trading exports were made. The TPO observed that cost as per Global policy of the group means cost in inter-company transfer before the goods and services are dispatched. The TPO therefore held that export incentives can never be adjusted to determine the cost of goods sold. Accordingly, the TPO computed the margin of 5 per cent without considering export incentive and proposed additions.
The ITAT held that reasoning adopted by the TPO has considerable cogency. The ITAT observed that the export benefits are given to the taxpayers to promote and stimulate the growth of exports of goods and services from India. They are meant to earn valuable foreign exchange for the country. Referring to Global Transfer Pricing policy of the Group, the ITAT observed that the very purpose of global transfer pricing is to provide a minimum amount of return to the members of global transfer pricing policy. The ITAT observed that future value of benefits which may be available in a few countries cannot be included as this will disturb the very basis/purpose or providing uniform return to each and every enterprise which is a member of global transfer pricing policy. The ITAT held that if India provides tax incentive or other incentive to compensate its taxpayers on the basis of the economic situation, then this benefit is available to Indian taxpayers and the same cannot be transferred or traded to other entity which is not located in India. This kind of shifting of economic and tax incentives offered to local company will disturb the fiscal structure of a country and will result in shifting of profits from one tax jurisdiction to other tax jurisdiction. The ITAT noted that economic and tax incentives offered to Indian entities are not meant to subsidize the entity in foreign jurisdiction.
The ITAT observed that if the taxpayer’s method of calculation of cost of goods sold is followed, it would tantamount to a claim of benefit, which has not yet accrued at the time of sale of goods, being treated as a component of cost of goods sold. The ITAT held that while determining the gross profits from sale of goods such incentives cannot be adjusted to determine the cost of goods sold.
Same view in Goodyear India Ltd [2016] 70 taxmann.com 67 (Delhi – Trib.).