ITAT Mumbai Clarifies TP Methods, DDT Treaty Relief & MODVAT Treatment in Kansai Nerolac Case

The Income Tax Appellate Tribunal, Mumbai Bench, issued a consolidated order in the case of Kansai Nerolac Paints Limited Vs DCIT for Assessment Years 2012-13 and 2013-14. Multiple connected appeals were heard together – two by the assessee and two by the Revenue – as the underlying issues were common.

AY 2012-13 was treated as the lead year, and the Tribunal’s conclusions for that year were applied, mutatis mutandis, to AY 2013-14. The assessee is engaged in the manufacture of paints and varnishes, with no change in the nature of business during the relevant years.

Below is a structured summary of the key findings of the Tribunal on:

  • Transfer pricing (exports to AE and interest on delayed receivables)
  • Disallowance under Section 40(a)(ia) for director’s commission
  • Additional depreciation under Section 32(1)(iia)
  • Rate of tax on DDT vis-à-vis DTAA
  • Treatment of unutilized MODVAT/CENVAT credit under Section 145A
  • TP on royalty and disallowance under Section 14A for AY 2013-14

1. Transfer Pricing – Export of Water-Based Paints to AE (AY 2012-13)

1.1 Facts and TP Positions

The assessee exported water-based paints worth Rs. 1,02,54,000 to its Associated Enterprise, Kansai Paints Philippines Inc..

  • The assessee benchmarked this international transaction using Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM).
  • Contribution margin (sales minus direct costs) was adopted as the Profit Level Indicator (PLI), determined segment-wise by comparing:
    • Contribution margin on sales to non-AEs in the domestic market, and
    • Contribution margin on exports to the AE.
  • On this basis, the assessee computed the Arm’s Length Price (ALP) of exports at Rs. 26,11,447.

The Transfer Pricing Officer (TPO):

  • Rejected TNMM,
  • Applied Comparable Uncontrolled Price (CUP) Method,
  • Compared average per-unit domestic selling price to non-AEs in India with the export price to AE,
  • Treated domestic prices as CUP for exports, and
  • Proposed a TP adjustment of Rs. 8,88,796.

1.2 Assessee’s Arguments

The assessee contended that:

  • Domestic sales and export sales are carried out in distinct economic and commercial environments.
  • Differences exist in:
    • Markets (India vs Philippines),
    • Functions and risks,
    • Pricing structure,
    • Volume and trade terms, and
    • Credit and other contractual conditions.
  • In the absence of any comparable uncontrolled export transaction, domestic sales cannot be used as CUP without appropriate adjustments.
  • TNMM, using contribution margin on domestic sales to non-AEs as the PLI, is the proper benchmarking approach in such circumstances.

The assessee further relied on a prior order of the ITAT Mumbai in its own case in ITA No. 3384/Mum/2014, where a closely similar TP issue on exports of paints to AE had been decided in its favour. The earlier order, in turn, referred to and followed the decision in Dow Chemicals International (P.) Ltd. v. DCIT (2021) 126 taxmann.com 312 (Mum-Trib.), which held that:

Domestic sales to non-AEs cannot automatically serve as CUP for export transactions absent strict comparability, particularly when geographical market differences materially affect pricing and no appropriate export comparables exist.

1.3 Revenue’s Stand

The Departmental Representative (DR):

  • Supported the TPO’s use of CUP,
  • Relied on the orders of the lower authorities,
  • But could not point out any uncontrolled export comparables or distinguish the facts from the earlier ITAT order in the assessee’s own case.

1.4 Tribunal’s Ruling on Export TP Adjustment

The Tribunal:

  1. Noted that the facts were materially identical to those in the earlier years in the assessee’s own case.
  2. Reiterated that CUP requires strict comparability, including:
    • Similar geography,
    • Similar market conditions,
    • Similar functions and risks, and
    • Similar contractual terms.
  3. Observed that the TPO simply contrasted domestic prices with export prices without any adjustment for:
    • Market/geographic differences,
    • Volume/credit terms, or
    • Other commercial parameters.

Relying on the earlier coordinate bench decision (and Dow Chemicals International (P.) Ltd. v. DCIT), the Tribunal held that:

  • CUP was wrongly applied,
  • TNMM adopted by the assessee was valid, and
  • The TP adjustment of Rs. 8,88,796 was unsustainable.

Result: The adjustment on export of water-based paints to AE was deleted, and Grounds 1(a) and 1(b) of the assessee were allowed.

2. Notional Interest on Delayed Realisation of AE Receivables (AY 2012-13)

2.1 Background

The assessee exported three consignments aggregating to Rs. 1,02,54,000 to its AE in the Philippines. There were delays of 11, 19, 21 and 22 days in the receipt of export proceeds.

The TPO:

  • Treated the delay as a separate international transaction,
  • Applied prime lending/base rate of SBI as CUP,
  • Calculated notional interest of Rs. 56,377,
  • Proposed a TP adjustment on that basis.

2.2 Assessee’s Position

The assessee relied on the ITAT order in its own case (ITA No. 3384/Mum/2014) where:

  • The Tribunal accepted that delay in AE receivables is an international transaction,
  • Held that such delay is akin to extension of a loan or credit facility to AE,
  • Applied the principle laid down by Bombay High Court in Tecnimont (P.) Ltd. (2018) 96 taxmann.com 223, and
  • Directed that benchmarking should be done based on LIBOR (being foreign currency credit) rather than domestic PLR.

In that earlier order, ITAT also held that:

Interest on delayed receivables from AE should be computed at LIBOR + 100 basis points after granting a reasonable credit period.