*connectedthinking pwc
Background
The Delhi Bench of the Income-tax Appellate Tribunal (“the Tribunal”) in the case of Chrys Capital Investment Advisors India Pvt. Ltd.1 (“the assessee”) held that non- operating income such as interest, dividends, share trading, etc. cannot be included as part of the operating income of comparables for the purpose of determining the arm’s length price (“ALP”). Further, the Tribunal held that where the reimbursement of expenses was considered as an operating cost, the same has to be including in the operating income.
1 CIT v. Chrys Capital Investment Advisors India Pvt. Ltd.
[2010-TII-11-ITAT-DEL-TP]
Facts
The assessee was engaged in the business of carrying out research and scouting activities for management companies to identify entrepreneurs and portfolio companies requiring assistance in the form of capital infusion, strategic direction and financial advice.
The approach adopted and contentions raised by the assessee, the Transfer Pricing Officer’s (“TPO”) approach and the Commissioner of Income Tax (“CIT(A)”) observations and ruling have been set out in the table below:
Non-operating income cannot be included as part of income towards determining Arm’s Length Price Tax & Regulatory Services
News Alert*
24 May, 2010
PricewaterhouseCoopers Issues Approach adopted
and contentions raised by the Assessee
TPO’s approach CIT(A) observation and ruling
Selection of comparables
The assessee adopted the Transactional Net Margin Method (“TNMM”) to benchmark its international
transactions selecting eight entities as comparable.
The TPO rejected three companies and introduced two new comparables.
The CIT(A) upheld the approach adopted by the TPO.
Profit Level Indicator (“PLI”) to be applied
The assessee adopted operating profit to operating revenue as the PLI.
The TPO substituted the PLI used by the assessee with operating profit as a percentage of operating cost.
The CIT(A) upheld the adoption of operating profit as a percentage of operating cost as the PLI.
Use of multiple year data
The assessee used multiple year data for the comparability analysis.
The TPO rejected use of multiple year data used by the assessee.
The CIT(A) upheld the TPO’s
approach.
Treatment of reimbursement of expenses
The assessee challenged the action of the TPO of treating
The TPO included the reimbursable expenses
The CIT(A) held that the TPO’s
discriminatory
Issues Approach adopted and contentions raised by the Assessee
TPO’s approach CIT(A) observation and ruling
the reimbursement of expenses as part of operating expenses and ignoring the same as income of the assessee.
incurred by the assessee as a part of operating cost, but at the same time did not consider the corresponding receipt of such expenses as part of operating income.
treatment was devoid of any logic and was against the principle of financial analysis;
accordingly treated the reimbursement as a part of income and expense.
Permissibility to include the non-operating income of comparables as part of operating income for determining the ALP
The assessee did not include non-operating income by way of interest, profit on sale of investment and income from money market operations, dividend, profit from share trading etc cannot form part of operating income.
The TPO included non-operating income as a part of operating income.
The CIT(A) agreed with the assessee and after detailed examination of the operating margins of the comparables excluded the income which was not operating in nature.
PricewaterhouseCoopers
On the basis of the above findings, the CIT(A) computed the operating margin (PLI) of the assessee at the rate of 14.14 per cent and determined the operating margin of comparables at 16.26 per cent. Since the assessee's margin was within the +/- 5%
range of the proviso to section 92C(2) of the Income Tax Act, 1961 (“the Act”), the assessee's international transaction was considered to be at arm’s length by the CIT(A), and accordingly, the addition made by the TPO were deleted.
Revenue’s contentions
The Revenue contended that the CIT(A) erred in disregarding the items of income in case of comparables which are operating in nature, resulting in an overall reduction of the average PLI of the comparables from 48.91 per cent to 16.26 per cent.
The Revenue further contended the CIT(A) also erred in holding that reimbursement of any item of operating cost as a part of the income.
Tribunal Ruling
On appeal of the Department, the Tribunal held that:
• Non-operating income cannot be included as part of operating income for comparison purposes.
• The CIT(A) rightly increased the income for corresponding receipt of expenses reimbursed; otherwise this would have led to distorted figures
Accordingly, the Tribunal upheld the CIT(A)’s order which held that on application of proviso to section 92C(2) of the Act, the assessee's international transactions were at arm's length and dismissed the appeal filed by the Revenue.
Conclusion
This decision by the Delhi Bench of the Tribunal rightfully excluded non-operating items such as interest, dividend, profit from share trading, etc. for the purpose of determining the operating margins in the case of the manufacturing and service industry. However, such income could be treated as operating income in cases of companies where investment activities or capital market operations are the primary source of income.
Further, the decision also provides guidance on the adoption of operating profit to operating cost as the PLI in case of a service provider and guidance on treatment of reimbursement of expenses while computing operating profits.
However, issues pertaining to selection of comparables and use of multiple year data still remain debatable as the Tribunal has not discussed nor provided guidance on the same.
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