Interest being non-operating income & other non-operating expenses to be excluded from computing ALP – Del HC


Marubeni India Pvt. Ltd. v DIT (ITA 1042/2011 dtd 25.04.2013) Delhi High Court

Background:

The assessee is a private limited company incorporated in India under the Companies Act, 1956. It is a 100% subsidiary of Marubeni Corporation, Japan(MCJ). It carries on mainly two types of business – agency and market research business.

The assessee filed a return of income on 31.10.2002 declaring “nil” income for AY 2002-03. In the course of the assessment proceedings, the assessee’s case was referred to the transfer pricing officer (TPO). The TPO proposed an addition of Rs 2,60,49,881/- on the ground that the commission and service fees received by the assessee from MCJ did not represent arm’s length price. The TPO treated the interest income of Rs 1.72 crores received by the assessee as non-operating income. Because of this treatment accorded to the interest, the profits of the companies which were taken for comparison purposes were found to be more than the profits earned by the assessee. The TPO was further of the view that in respect of the services rendered by the assessee, it should be remunerated on a cost-plus basis and the total costs should be made the basis of computing its earnings and not merely the commission and fixed feespaid to it. 

Further, the assessee’s contention that the expenses relating to the closure of the business were abnormal expensesand cannot be considered relevant while arriving at the ALP in respect of the international transaction was also rejected by the TPO.

Assessee’s contentions:

§ The short term interest of Rs 1.72 crores received was on account of a treasury function which represented its core functionand, therefore, ought to have been taken as operating income.

§ Excluding the interest revenue from the computation of the ALP was not appropriate since the cost for earning the interest income was built into the operating costof the assessee.

§ The parking of the surplus funds in interest bearing securities was an integral partof the assessee‟s operations.

§ The treasury functions of the assessee included cash management, management of bank accounts, data management, financial planning and foreclosing with cash plus financial management, etc.

§ In the alternative and without prejudice, all the costs associated with the earning of such interest income should be segregatedand if that was not done those costs would continue to be part of the agency and market research business which would present an untrue picture of the entire operations.

§ With regard to the abnormal expenses, its Indian business was being run as a totally independent unitwith authority to the management in India to take decisions regarding closure of the offices in India.

§ The payment of compensation for closure of the Indian units was an abnormal item of expense and therefore, ought to have been excluded from the operating costswhile arriving at the ALP of the international transaction.

CIT(A)’s order:

§ The interest income cannot be considered as the assessee‟s operating income.

§ The commission rates and the fees by which the assessee was remunerated were in no way related to the interest earnings of the assessee.

§ If interest is included as part of the operating revenue, it would amount to computing the return on investment which would be wholly inappropriate.

§ With regard to the abnormal expenses, the decision was taken at the behest of the associated enterprises and therefore, for transfer-pricing purposes the assessee must be compensated by them and accordingly the costs of closure are not to be excludedfor computing the operating expenses.

ITAT’s order:

§ The business profile of the assessee shows that the earning of interest income was only the result of investment of the surplus funds and was not a primary income-generatingactivity;

§ The nature of the services provided by the assessee to its holding company was to render marketing support servicesand facilitation by providing information.

§ The TPO and the CIT (Appeals) were rightin, therefore, segregating the stream of interest income from the other services rendered by the assessee which were its core activities.

§ If interest is included as part of the operating income that would result in an inappropriate Profit-Level Indicator (PLI) in the case of a service provider, such as the assessee.

§ With regard to the abnormal expenses, since the assessee is a captive unit of its associated enterprise, it was actually the latter which undertook the entire risk, that the associated enterprise was paying the assessee at the rate of cost plus 10% that if the Indian units are closed then the operating costs would correspondingly be reduced and therefore, the compensation paid would form part of the operating costs and would thus be relevant for arriving at the ALP.

HELD:

§ The Tribunal has rightly noted that the fact that the memorandum of association gave powers to the assessee to earn interest by making investments is relevant only for the purpose of determining the appropriate head of incomeunder section 14 of the Income Tax Act, 1961 under which the interest would fall to be assessed.

§ It has been rightly observed by the Tribunal that such a consideration is not relevant for the purpose of determining the operating incomeof an assessee for the purposes of transfer pricing regulations.

§ With regard to the question of abnormal expenses, the assessee is being compensated by a fee or commission which has no connection with the costs incurred.

§ Having regard to the nature and manner in which the assessee is remunerated for its services, the payment of compensation to the Indian units on their closure would represent abnormal costs which have to be excluded in the determination of the ALP.

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