Case Law Article 34 – Arm’s Length Principle

Case Law Article 34 – Arm’s Length Principle

Comparable Uncontrolled Price Method

Judgements

Case: AT and S India Pvt Ltd vs DCIT Circle111 03082016 ITAT Kolkata

Note: CUP method provide the most direct comparison for the purpose of determining the arm’s length price of international transactions and is to be preferred over the other profit based methods

Assessee was a Private Limited Company and engaged in the manufacturing business of Printed Circuit Board (PCB). The Assessee was a subsidiary of a company. The Assessee during the year had international transactions with its Associated Enterprises (AE) for supplying the PCB manufactured by it. The Assessing Officer after having the approval from the Commissioner made reference to the Transfer Pricing Officer (TPO) under Section 92CA(1) of the Act to determine the Arm’s Length Price (ALP) in respect of international transactions reported in the audit report in form 3CEB as submitted by the Assessee. The Assessee, for the year under consideration has undertaken various international transaction inter-alia export of PCB for a value to its AE which is under dispute. The Assessee was characterized as full-fledged manufacturer which assumes significant business risk associated with its manufacturing activity and on the contrary the AE could be characterized as routine distributor. Accordingly the Assessee selected the TNMM as most appropriate method in relation to tested party i.e. AE in the instant case and found companies of foreign countries for the comparables to determine the ALP. Finally the TPO has rejected the AE as tested party and treated the Assessee as tested party. The TPO treated the TNMM as most appropriate method and PLI as operating profit on sales. An upward adjustment was made by the TPO for the export of PCB to its PE. On appeal, the DRP made adjustment by using Transactional Net Margin Method (TNMM) method instead of Comparable Uncontrolled Price (CUP) Method.
The tax authority held that the AE could not be treated as tested party because its accounts are based on foreign GAAP which was different from Indian GAAP. Accordingly the method of accounting, allocation of costs, recognition of revenue etc. differ for making the comparison. The Assessee had rightly been treated as tested party. The Assessee had submitted back to back invoices and on which no adverse comment had been passed by the lower authorities on its genuineness. It was also observed that the financial distribution segment report of AE submitted by the assessee was rejected by the TPO without assigning any specific reasons and defects in the report. The CUP method provide the most direct comparison for the purpose of determining the arm’s length price of international transactions and is to be preferred over the other profit based methods. Accordingly in the instant case internal CUP method should be preferred over the external CUP method. Hence, the CUP Method (internal) was the most appropriate method in determining the arm’s length price of the international transaction involving export of PCBs by the Assessee to AE.

Case: Lenovo India Pvt Ltd vs The Deputy Commissioner of Income Tax Circle 411 21032022 ITAT Bangalore

Note: TPO to replace the TNMM with CUP as most appropriate method

For the year under consideration, the assessee filed its return of income. The TPO observed that the assessee also imported parts and components from third parties. The assessee chose Comparable Uncontrolled Price (CUP) as the Most Appropriate Method (MAM) for determining ALP. Assessee compared the price paid for import of parts and components from unrelated persons with the price paid for import of parts and components to the AE. In its Transfer Pricing Analysis, the assessee considered itself as assuming most of the risks including market risk, inventory risk, credit and collection risk, forex risk, warranty and idle capacity risk. Based on the functions and risks performed, the assessee characterized itself as a full-fledged manufacturer for its manufacturing activity. The TPO did not accept the TP analysis by assessee for the reasons given in the show cause notice. He rejected the CUP method adopted by the assessee to its Manufacturing Segment and applied the TNMM as the MAM and determined ALP which resulted in an adjustment. Hence, present appeal. The tax authority held that the Tribunal in earlier assessment year direct the TPO to apply CUP as the MAM and determine ALP after due opportunity of being afforded to the Assessee. Therefore, in view of settled position, direct the TPO to replace the TNMM with CUP as most appropriate method.

Case: Bausch and Lomb Eyecare India Pvt Ltd vs Addl CIT Range2 23052014 ITAT Delhi_

Head Note: If no data is available for comparability purposes then CUP method cannot be applied.

Comparable uncontrolled price method cannot be considered as the most appropriate method since, comparable uncontrolled price method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. However, no such data is available for comparability purposes. The TPO while proposing such an adjustment did not identify any unrelated comparable transactions for application of comparable uncontrolled price method and arbitrarily considered the arm’s length price as nil, thereby, proposing an adjustment amounting to the total value of reimbursements.

Resale Price Method

Judgements:

Case: Sava Medica Ltd. vs. ACIT, Central Circle 2(1) (30.08.2021 – ITAT Pune)

The assessee was a part off group which was engaged in the business of manufacturing, importing and exporting pharmaceutical drugs etc. It filed a return declaring loss. A search action was taken up in group of companies including the assessee. Pursuant to such search, a notice under Section 153A was issued calling the assessee to file return for the year under consideration. The assessee filed a letter stating that the return originally filed for the year may be treated as a return in response to notice under Section 153A of the Act. The assessee reported an international transaction of Sale of finished goods in Form 3CEB. After taking prior approval of the Competent authority, the AO made a reference to the Transfer Pricing Officer (TPO) for determining the Arm’s Length Price (ALP) of the international transaction. TPO made adjustment to the international transaction and as a consequence of the adjustments, income of the assessee shall be increased. The draft order incorporating the transfer pricing adjustment of equal amount was notified by the TPO. The assessee assailed various facets of the transfer pricing addition before the Dispute Resolution Panel (DRP), which gave certain directions. The AO passed the impugned order, giving effect to the directions of the DRP, by making the transfer pricing addition. Hence, present appeal.

Held:

Validity of adjustment on sale of finished goods:

(i) Resale Price Method applies where an Indian entity purchases goods from its foreign/AE and then resells the same. The entire mechanism in the subsequent sub-clauses of Rule 10B(1)(b) is a consequence of this foundational fact. If the international transaction is not that of purchase by an Indian entity, then the RPM cannot be applied. Here was a case in which the assessee sold goods to its AE in the international transaction rather than purchasing the same. In fact, the purchases for such a resale were made from non-AEs. In such a scenario, this tribunal could not countenance the DRP’s direction to apply the RPM for the ALP determination of the international transaction of Sale of finished goods to the AEs. [26]

(ii) Once the application of the PSM had been ruled out by the DRP and rightly so and then there could be no hitch in accepting the assessee’s contention of applying the TNMM as the most appropriate method in the facts and circumstances of the case. In fact, the DRP also directed to apply the TNMM for the next two years in which the international transactions are sale of manufactured goods to the AEs. [27]

(iii) Assessee had came out with a contention that if the TNMM was to be applied, then its original ALP determination in the Transfer pricing study report should be accepted without remitting the matter to the AO. This tribunal could not concur with this contention because the working done by the assessee in this regard had not been vetted either by the TPO or the DRP. The TPO rejected such a method and went ahead with the PSM and the DRP suggested the RPM. Hence veracity of the calculations made by the assessee under TNMM had yet to pass through the eyes of the authorities below. Under these circumstances, set aside the impugned order and remit the matter to the file of the AO for a fresh determination of the ALP of international transaction of Sale of finished goods under the TNMM as per law. [28]

Case: Airport Retail P. Ltd. vs. DCIT, Cir 8(1) (09.01.2019 – ITAT Mumbai)

Assessee company is in the business of retail trade and operation of duty free shops at airports in India. The assessee had entered into an international transactions within the meaning of Section 92B of the 1961 Act with its Associated Enterprises(AE) Transfer Pricing Officer computed Arms Length Price of international transactions entered into by the assessee with its AE by selecting most appropriate method(MAM) as prescribed under section 92C IT Act to compute the income from international transaction having regard to Arms Length Price(ALP). Assessee submitted before the TPO that the RPM measures the value of functions performed and is ordinarily appropriate in cases involving the purchase and resale of tangible goods/services in which the buyer/seller does not add substantial value to the goods by physically altering them. TPO under section 92CA(3) IT Act led to the additions being made by the AO vide adjustment to ALP of the international transactions entered into by the assessee with its AE. Aggrieved by same appellant is before Tribunal.

Held:

From the assesses own case it is ordered to re-compute ALP of international transaction of import of finished goods entered into by assessee with its AE i.e. Alfa Group of entities by following RPM. Rule of consistency need to be followed. Appeal Allowed. [9]

Case: RFS India Telecom Pvt Ltd vs ACIT Circle211 11112020 ITAT Delhi

Case
Direct Taxation – Arm’s length price of international transactions – Computation of – Most appropriate method for – Present appeal filed by assessee is directed against order of AO relating to Assessment Year 2012-2013 – Whether DRP/TPO erred in rejecting Resale Price Method (RPM) applied by appellant and instead applied TNMM as most appropriate method – Held, if comparables selected by TPO are considered, then also margins of assessee are higher or fall within +/-5% of final comparable companies selected by TPO – DRP was not justified in rejecting RPM method followed by assessee – Impugned order of TPO set aside – Appeal allowed. [15]

Facts:

Assessee is a company which is wholly owned subsidiary of Radio Frequency System, GmbH (RFS Germany). RFS India is a stated to be primarily engaged in the business of trading of telecom network equipments mainly base station antennas, cables and accessories and other associated services and pre and post sales support services in relation to the telecom products. Assessee electronically filed its return of income for A.Y. 2012-13 on 30.09.2012 declaring loss of Rs. 10,89,39,514/-. The case was selected for scrutiny and notice u/s. 143(2) dated 20.09.2013 was issued and served upon the assessee. Thereafter, notice u/s. 142(1) along with questionnaire was issued and served on the assessee. AO has noted that during the year assessee entered international transactions with its AEs and accordingly made reference to TPO u/s. 92CA(3) to determine the arm’s length price of the International transactions. The TPO vide order dated 20.01.2016 passed u/s. 92CA(3) proposed adjustment of Rs. 1,73,97,217/- to the income of the assessee on account of international transactions. After considering the adjustment proposed by TPO, AO in the Draft Assessment Order dated 16.03.2016 proposed addition of Rs. 1,73,97,217/-. The assessee filed objections against the proposed addition before the Hon’ble DRP who vide order dated 19.12.2016 upheld the adjustment proposed by TPO/AO. Thereafter, AO passed an order u/s. 143(3)/144C/92CA(4) vide order dated 31.01.2017 and determined the total income at Rs. 75,60,413/-. Aggrieved by the order of AO, pursuant to the directions of DRP, assessee is now in appeal.

Held:

If the comparables selected by the TPO are considered then also the margins of the assessee are higher or fall within +/-5% of the final comparable companies selected by TPO. Considering the totality of the aforesaid facts, we are of the view that DRP was not justified in rejecting the RPM method followed by assessee. We therefore, set aside the order of TPO (pursuant to the directions of DRP) to compute the ALP by following the TNMM method. Thus the ground of appeal of the assessee is allowed. [15]

Cost Plus Method

Judgements

1.Case: DCIT, Circle-6(1) Vs. Deepak Industries Ltd. IN THE ITAT, KOLKATA BENCH, KOLKATA

Facts:

The assessee had three manufacturing units. The unit was eligible for deduction. The assessee had been claimed deduction which had been accepted by the revenue in the scrutiny assessment. The assessee had specified domestic transactions between two units during the year and accordingly the AO referred the matter to TPO after obtaining due approval for determining the arms length price of the said specified domestic transactions. The TPO passed an order in relation to specified domestic transactions proposing arm’s length price adjustment by rejecting Cost Plus Method followed by the assessee and adopting TNMM as MAM(Most Appropriate Method) for benchmarking the said transactions between the eligible unit and non-eligible unit. The TPO compared the net profit margin of the two units and calculated the arm’s length adjustment and applied the same on specified transactions thereby were proposing TP adjustments. The assessee followed the cost plus method (CPM) to bench mark the specified domestic transactions and accordingly filed the transfer pricing documents before the TPO showing that the assessee had followed the cost plus method to determine the arm’s length price of the transactions between Unit the auditor of the assessee in Form 3CEB has wrongly stated that TNMM method was considered to bench mark the said transactions between unit. The assessee followed cost plus method (CPM) for which direct and indirect cost were considered based on costing records CAS-4 and gross profit margin was added thereto towards margin. In the appellate proceedings, the Commissioner allowed the appeal of the assessee on this issue by upholding the CPM as most appropriate method.

Held:

Deletion of adjustment on domestic transactions:

The assessee had maintained cost records CAS-4 which were duly certified by the CA in respect of direct and indirect cost and the gross profit margin is also available. Therefore the CPM had to be the most appropriate method as the eligible unit was a contract manufacturer and procuring semi-finished goods from unit besides doing contractual job for the said non eligible unit. Assessee’s net profit as a whole during the year which was better and much higher than other comparables. Therefore considering these facts which show the net margin of the assessee being better than the comparable industries, price as determined by the assessee was at ALP. On the other hand, there was no merit of the submissions of the department that the assessee was not a contract manufacturer which were incorrect observations on the part of the TPO/AO. As regards the argument of the department that the assessee itself followed TNMM method as mentioned in Form 3CEB, the same was a mistake as the assessee in the TPSR mentioned CPM as MAM correctly and also placed the documents justifying and corroborating the fact that the assessee had followed CPM for benchmarking the domestic transactions between eligible unit and non-eligible unit. It was also observe that OECD guidelines, UNTP manual & ICAI guidance Note also refer to CPM to be applicable where the semi-finished goods are transferred & job work was done. Therefore, upheld the order of Commissioner.

2.Case: Dow Chemical International Private Limited Vs. Income Tax Officer-14(1)(3) IN THE ITAT, MUMBAI BENCH, MUMBAI

The assessee adopted Cost Plus Method (CPM) taking profit level indicator (PLI) as gross profit/sales and gross profit was arrived after considering direct and indirect cost of production. The assessee worked out PLI of its manufacturing segment. The assessee chosen comparables, but taken operating profit/operating income as PLI and computed mean PLI of comparables and accordingly, the assessee was of the view that the transactions of purchase of raw material and finished goods were at arm’s length. The TPO rejected the CPM method as most appropriate method for determination of arms length price. According to the TPO, the application of CPM requires gross margins both for the tested party and the comparables. The TPO found that assessee was a loss-making concern and had incurred selling & distribution and administration expenses and therefore to avoid comparability at entity level, the assessee was trying to benchmark the transactions on GP/sales. The TPO also rejected the CPM method because of non-availability of gross profit margin details in respect of the comparables. The TPO also observed that in immediately preceding assessment year, the DRP rejected the CPM method and applied TNMM as most appropriate method. The TPO also rejected the argument of the assessee of applying CUP method in view of Independent Chemical Information Service (ICIS) data. According to the TPO the import prices on various indices/markets as reported in ICIS data fluctuate on hourly basis and therefore the assessee’s attempts to benchmark the transactions with non-contemporaneous data, vitiates the whole benchmarking process. The TPO applied TNMM as most the appropriate method using operating profit/operating revenue as PLI. The PLI of the manufacturing segment of the assessee was worked out. The TPO, accordingly computed the transfer pricing adjustment. The DRP also rejected the objection of the assessee for not considering CPM as most appropriate method. Hence, present appeal.

Held:

Selection of CUP as most appropriate method:

The exercise of examining comparability has already been carried out by the TPO in remand during DRP proceedings, wherein the TPO had rejected the comparability on the ground that geography and volume of the transactions was not available in the database. The Assessing Officer or the TPO had authority to call for complete information of the transactions of import of raw materials and export of finished goods from the Custom Authorities including invoices of import or export having details of geography and volume. The TPO may also remove the related party transactions from the relevant information. Assessing Officer in earlier assessment year had carried out exercise for comparing the international transactions of the assessee with the uncontrolled transactions available in TIPS data base and that too after the order of the DRP for year under consideration. Thus, appropriate to restore the matter to the AO/TPO for comparing the TIPS data with the international transactions of the assessee under CUP method of comparability as most appropriate method.

Profit Split Method

Judgements

1.Case: Satellite Television Asian Region Limited and Ors. Vs. DDIT (International Taxation)-2(1) and Ors. IN THE ITAT, MUMBAI BENCH, MUMBAI

The Assessee had adopted the profit split method as the most appropriate method to determine the arm’s length price. For this purpose, the assessee has aggregated all its transactions with the other channel companies and determined the global profits. These profits were compared with profits earned by certain comparable companies engaged in the telecasting activity. The assessee determined the profit margin of eight companies, identified by the assessee. After making various adjustments, the assessee determined a profitability rate to which extent it increased its profits by making a suo moto transfer pricing adjustment and these profits were then divided amongst the channel companies and assessee. However, the TPO rejected the three comparables of the assessee on the basis that the turnover of these companies was less than ten percent of the assessee’s turnover. After excluding three companies, the TPO had calculated the comparable margin. In the proceeding before DRP, the action of TPO had been upheld. The Assessee was further aggrieved against determination of higher profitability for advertisement receipts. Hence, present appeal.

Held:

Application of low turnover filter:

(i) The turnover filter must be applied not as a tool for cherry picking at a later stage but at the time of the search process and by applying a quantitative filter. It can not be one sided process to exclude companies after the qualitative level based on FAR analysis where no filter had been applied in the earlier. Consistency also requires that it could not be used to exclude it in an individual given year, when it had not been applied in earlier year and subsequent year. There could not be a pick and choose of comparables every year unless there were some material differences in facts and circumstances.

Determination of higher profitability

(i) As the combined net profit as per the PSM under Rule 10B(1)(d) of Rules had been found to be at arm’s length except for the exclusion of three companies for ten percent turnover filter applied by the TPO. On the present facts, all the international transactions in respect of the advertisement and distribution stream could not be separated. Therefore set aside the orders of lower authorities on this issue and restored the same back to AO/TPO for deciding afresh.

2.Case: Loreal India Private Limited Vs. DCIT IN THE ITAT, MUMBAI BENCH, MUMBAI

During the assessment proceedings, the AO found that the Assessee had entered into international transactions with its associated enterprises (AEs).For determining the Arm’s Length Price (ALP) of such transactions, he made a reference to the Transfer Pricing Officer (TPO), as per the provisions of Section 92 of the Act. During the TP proceedings, the TPO accepted all the international transactions to be at ALP except one and that was the AMP expenses. He held that the expenditure was on the higher side. He applied profits split method (PSM) to arrive at ALP. The TPO was of the opinion that the AMP expenditure incurred by the Assessee had resulted in creation of marketing intangibles for its AE, that it should have been compensated by its AEs to the extent of excess AMP incurred vis a vis comparable companies. Accordingly, he applied Bright Line Test (BLT) to determine the ALP of the AMP expenses. To determine the comparable to that of the Assessee the arithmetic mean of the AMP expenditure of the comparable was reduced to eight percent. In the DS, the TPO accepted two out of the four comparables selected by the Assessee, having average APL to sales ratio. He arrived at the markup on the excessive AMP expenses again based on set of comparable companies selected by him for calculating the ALP in respect of the services of brand building to the AE. Based on the above the TPO made AMP adjustments. After receiving the order of the TPO, the AO sent a draft assessment order to the Assessee proposing the adjustment made by the TPO. Aggrieved by the order of the AO, the Assessee filed objections before the DRP, whereby DRP dismissed objections filed by Assessee. Hence, present appeal.

Held:

Validity of Transfer Pricing Adjustment on AMP expenses:

The TPO had failed to prove that the real intention of the Assessee in incurring advertisement and marketing expenses were to benefit the AE’s. and not to promote its own business. The turnover of the Assessee proved that during the year under consideration the Assessee had done a reasonably good business, as state earlier. The resultant profit was offered for taxation. Therefore, transferring of profit, the basic ingredient to invoke the provisions of Section 92 of the Act, remains unproved. Considering the facts-like absence of an agreement between the Assessee and the AE’s. for sharing AMP expenses, payment made by the Assessee under the head AMP to the domestic parties, failure of the TPO prove that expenses were not for the business carried out by the Assessee, it was held the transaction in question was not an international transaction and that the TPO had wrongly invoked the provisions of Chapter X of the Act for the said transaction. With regard to the submissions of the AR that the issue of AMP should be restored back to the file of the AO, in view that AMP expenditure was not an international transaction and therefore not inclined to restore back the issue to the file of the AO. Therefore, additions made by the AO, including the mark-up adjustments, were directed to be deleted.

Transactional Net Margin Method

Judgements

1.Case: Topcon Sokkia India Pvt. Ltd. Vs. DCIT, Circle IN THE ITAT, NEW DELHI BENCH, NEW DELHI

Held:

Validity of Transfer Pricing Adjustment on AMP expenses:

The TPO had failed to prove that the real intention of the Assessee in incurring advertisement and marketing expenses were to benefit the AE’s. and not to promote its own business. The turnover of the Assessee proved that during the year under consideration the Assessee had done a reasonably good business, as state earlier. The resultant profit was offered for taxation. Therefore, transferring of profit, the basic ingredient to invoke the provisions of Section 92 of the Act, remains unproved. Considering the facts-like absence of an agreement between the Assessee and the AE’s. for sharing AMP expenses, payment made by the Assessee under the head AMP to the domestic parties, failure of the TPO prove that expenses were not for the business carried out by the Assessee, it was held the transaction in question was not an international transaction and that the TPO had wrongly invoked the provisions of Chapter X of the Act for the said transaction. With regard to the submissions of the AR that the issue of AMP should be restored back to the file of the AO, in view that AMP expenditure was not an international transaction and therefore not inclined to restore back the issue to the file of the AO. Therefore, additions made by the AO, including the mark-up adjustments, were directed to be deleted.

2.Case: Vishay Components India Private Limited Vs. ACIT, Circle IN THE ITAT, PUNE BENCH, PUNE

The assessee was engaged in the manufacturing of electrical capacitors and resistors. A return was filed declaring total income at Nil. Certain international transactions were reported in Form No. 3CEB. The Assessing Officer (AO) made a reference to the Transfer Pricing Officer (TPO) for determining the Arm’s Length Price (ALP) of the international transactions. The TPO noticed that the assessee aggregated four major international transactions in the Manufacturing segment, namely, Export of Finished goods; Import of raw materials and components, Import of Finished goods for resale, and Receipt of Commission and applied the Transactional Net Margin method (TNMM) for demonstrating that such international transactions were at ALP. The assessee with Profit Level Indicator (PLI) of Operating profit/Operating cost worked out its Operating profit margin before depreciation, interest and taxes. Three companies were chosen as comparable with their average PLI of OP/OC on the basis of multiple year data. The TPO did not accept the assessee’s view point, inter alia, on the determination of the PLI on the basis of Operating profit before depreciation, interest and taxes. He worked out the Operating profit rate of the assessee, after depreciation but before foreign exchange loss. Out of the three comparables chosen by the assessee, the TPO retained two and added a new company in the list of comparables. He also did not approve the profit rate of comparables based on the multiple year data. In this way, he worked out the average PLI of the new set of comparables on single year basis. This was how, he proposed transfer pricing adjustment in this segment. The assessee could not convince the Dispute Resolution Panel (DRP) on its line of reasoning, which led to the impugned transfer pricing addition. The Assessee was further aggrieved against foreign exchange loss taken by Transfer Pricing Officer as non-operating. Hence, present appeal.

Held:

Validity of adjustment on manufacturing segment:

It was made clear that admittedly there was no dispute on the application of the TNMM as the most appropriate method and aggregation of the four sets of international transactions under the Manufacturing segment, which had been accepted by the TPO. In so far as the working out of the assessee’s own PLI was concerned, the assessee was aggrieved by the adoption of operating profit after depreciation. The Assessee fairly settled down to admit that difference on account of rates of depreciation on individual assets should be adjusted. It was held that the operating profit of the assessee and that of the comparables should be calculated after depreciation since depreciation was an integral part of the operating cost. It was further held that no adjustment could be allowed if there was difference just on account of the amount of depreciation or percentage of depreciation to a certain base. An adjustment could be allowed in the computation of profit of the comparables only if there was difference in the rates of depreciation as charged by the assessee and comparables on the same assets. [3]

Foreign exchange loss considered as operating:

The High Court in Pr. CIT Vs. B.C. Management Services Pvt. Ltd. had held that foreign exchange fluctuation in relation to trading transactions, prior to Safe Harbour Rules, should be treated as an operating item. Therefore, it was held that the amount of foreign gain/loss arising out of the revenue transactions should be considered as an item of operating revenue/cost, both for the assessee as well as the comparables.

Resale Price Method to be most appropriate method for determining ALP for international transaction, where goods purchased from Associated enterprises are sold as such to unrelated parties.

Ecolab Food Safety & Hygiene Private Limited Vs. Assistant Commissioner of Income Tax-9(2)(2), Mumbai reported in MANU/IU/0847/2019 decided in 26.07.2019.

Facts: In this case the assessee is engaged in the manufacturing and trading of cleaning, sanitizing, food safety and infection control products and services. The assessee imports finished chemical products from its Associated Enterprises (AEs) and exports the finished chemical products to its overseas Group entities. The assessee contended that functions performed by it is that of a trader and hence they have adopted Resale Price Method (RPM) for determining the Arm’s Length Price (ALP).

However, the Transfer Pricing Officer (TPO) rejected the RPM by contending that the assessee is not a pure trader but does subsequent value addition to the goods brought by the AE before selling the same to the end customers. The TPO contended that the RPM can be used where a product which has been purchased from A.E. has been sold to independent party without any significant value addition. Further, use of Resale Price Margin is justified in a situation where the assessee does not make significant value addition to the goods bought from the A.E. before selling them to independent enterprise. Accordingly, the TPO adopted Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and made the necessary adjustment.

Held: The Appellant Tribunal in this case, observed that assessee had engaged in importing products from its AEs for mere resale without any value addition thereon and accordingly, the assessee concluded that the international transaction of import of finished goods from its AE for resale was at arm’s length. Further, the audited financial statements that assessee is having both manufacturing segment as well as distribution segment. The break-up of revenue system of the assessee and the purchase of goods for re-sale and cost of materials consumed would go to prove that assessee is having separately manufacturing segment as well as distribution segment. Further, only for its distribution segment, the assessee had applied resale price method as most appropriate method.

The Tribunal relied upon the decision of this Tribunal in the case of M/s. Videojet Technologies (I) Pvt. Ltd., vs. ACIT in ITA No. 6956/Mum/2012 for A.Y. 2008-09 dated 28/05/2019, where it was concluded that ‘RPM is the best suited method for determining the ALP of an international transaction, in a case where the goods purchased by an assessee from its AE are thereafter resold without any value addition to unrelated parties’. On the other hand under the TNMM, the ALP is determined by comparing the operating profit related to an appropriate base i.e. cost or sale or assets of the “tested party” with the operating profit of an uncontrolled party engaged in comparable transactions. As such, under the TNMM, the net margin or operating profit achieved in related party transactions is compared against with those entered into between the independent entities. Accordingly, under the TNMM the major thrust is to derive the operating profit at the transactional level and to identify the operating expenses of both the tested party as well as the independent parties, which, thus, requires a lot of adjustments to arrive at the actual operating profit.

Therefore, it was held that the transaction of import of goods by the assessee from its AEs were only to be benchmarked and all the other functions carried out by the assessee having no nexus with the said import transactions. in RPM method focus is more on the functions rather than the similarity of products because product differentiation does not materially affect the gross profit margin. RPM is upheld as most appropriate method in case of assessee as against TNMM applied by TPO.

‘Availability, coverage and reliability of data necessary for application of the method’ is one of the crucial factors determining suitability of a method of determination of arm’s length price in a particular situation.

Shindengen India Pvt. Ltd. vs. The Deputy Commissioner of Income Tax, Circle 6(1)(1)- ITAT Bangalore) : MANU/IL/0303/2021 decided on 31.08.2021.

Facts: The assessee i.e. Shindengen India Pvt. Ltd. (SIPL) is a wholly owned subsidiary of Shindengen Electric Mfg Co., Ltd, Japan. During the year under consideration, the assessee was engaged in the trading of power system products & electrical components for two wheelers. The dispute in this appeal is with regard to the determination of Arm’s Length Price (ALP) in respect of the international transaction of purchase of stock-in-trade by the assessee from its Associated Enterprises (AEs). The assessee aggregated and benchmarked the transactions of purchase of consumables, raw materials, stock-in-trade and capital assets by selecting Cost Plus Method (CPM) as Most Appropriate Method (‘MAM’) and the overseas AE as tested party.

Transfer Pricing Officer’s contention:

The TPO conducted a fresh benchmarking analysis in respect of the international transaction of purchase of stock-in-trade using Comparable Uncontrolled Price Method (‘CUPM’) disregarding the benchmarking analysis carried out by the assessee in respect of purchase of consumables, raw materials, stock-in-trade and capital assets by selecting Cost Plus Method (CPM’) as Most Appropriate Method (MAM’) and the overseas AE as tested party.
The TPO compared the prices at which stock-in-trade were purchased by SIPL with the prices at which they were sold to third parties and considered the differential gross margins for application of CUPM. Those gross margins were applied on the sale prices of SIPL to arrive at the Arm’s Length Price (ALP’) of purchase of stock-in-trade effectively using Resale Price Method (RPM) while claiming to have applied the CUPM. As a result, TPO computed adjustment and made addition to the value of international transaction of purchase of stock-in-trade.

Further, the TPO rejected the Transfer Pricing analysis of the Assessee.

Issue:

Whether the action of the TPO in applying margins under CUP method based on difference in purchase and sale price of the assessee is correct.
Why the purchase price is not accepted at ALP when the very same purchases were held to be not influenced by the relationship existing between the assessee and AE by the Special Valuation Branch of Customs

Whether method of computation of ALP by applying CUP as MAM is correct.

Held: It was held that a method for determining arm’s length price, to be held as a ‘most appropriate method’ (MAM), should be best suited to the facts and circumstances of each particular transaction” and a method and “which provides the most reliable measure of arm’s length price of the international transaction”. Further, “the availability, coverage and reliability of data necessary for application of the method” is one of the crucial factors determining suitability of a method of determination of arm’s length price in a particular fact situation. Similarly, it is also important to determine whether accurate adjustments can be made for the differences between the international transactions and the comparable uncontrolled transactions, and unless such adjustments can be made the related method cannot be said to be most appropriate method. Determination of ALP on the basis of facts and circumstances and as per the requirements of the relevant statutory provision is mandatory and cannot be accepted owing to default

Transactional Profit methods to be applied only when standard or traditional methods i.e. Comparable uncontrolled price method, resale price method or Cost plus method cannot be reasonably applied

Assistant Commissioner of Income Tax – 7(2) Vs. Sonata Software Ltd. reported in MANU/IU/1463/2012 decided on 29.08.2012 (ITAT Mumbai)

Facts: In this case, the assessee has entered into various International transaction with its Associated Enterprise Offshore Digital Service Inc (ODSI), in the previous year relevant to the assessment year under consideration. The assessee has adopted the cost plus method (CPM) for determining the Arm’s Length Price (ALP) in respect of the transaction relating to the service by the assessee to ODSI. However, the Transfer pricing officer (TPO) has not accepted the ALP method adopted by the assessee and made an adjustment in the income of the assessee by adopting Transactional Net Margin Method (“TNMM”) for determining the ALP. The assessee aggrieved by the decision of TPO filed appeal before the CIT(A) and the appeal comes out in favour of assessee.

Revenue’s Contention: The revenue contended that the CPM method adopted by the assessee was not appropriate on the facts of the case as these averages did not factor in the difference in the skill sets/level of employees engaged in performing work for the AE and Non-AE. Further, TNMM Method is the most appropriate method for determining the ALP in respect of the transaction entered by the assessee with its AE ODSI.

Assessee’s Contention: The assessee contended that the law does not provide any hierarchy of method to be adopted in the determination of ALP. Further, relying on decision of the Hon’ble Supreme Court in the case of Radhasoami Satsang v. CIT MANU/SC/0061/1992, submitted “that internal comparables are more reliable than the external comparables and therefore CUP/CPM method are more appropriate as they are direct and use internal data for comparison”.

Further, pointed out that the comparables used by the TPO for the application of TNMM method, the TPO has included 5 such companies where either two are cases of super profit or super turnover, and such high turnover companies cannot be taken as comparables. Also, pointed out that if these high turnover and high profit company are removed from the comparables, list adopted by the TPO the average would come to the same as shown by the assessee in its international transaction.

Held: Where an assessee has followed one of standard methods of determining ALP, such a method cannot be discarded in preference over transactional profit methods, unless revenue authorities are able to demonstrate fallacies in application of standard methods. The transaction profit method should be applied only when standard or traditional methods are incapable of being properly applied in the facts of the case because while traditional methods seeks to compute the prices at which international transactions would normally be entered into by the associated enterprises but for their interdependences and relationships, transactional profit methods seek to compute the profits that the tested party would normally earn on such transactions with unrelated parties. Further, relying on the decision of ITAT, Pune Bench in the case of Asstt. CIT v. MSS India (P.) Ltd. MANU/IP/0008/2009, held that while there is no particular order or priority of methods which the assessee must follow and no method can invariably be considered to be more reliable than others, TNMM and Profit Split Method (PSM) are treated as methods of last resort which are pressed into service only when the standard methods i.e. CUP Resale Price Method (RPM) and Cost Plus Method (CPM) cannot be reasonably applied.

Therefore, held that in this case CUP/CPM adopted by the assessee is the most appropriate method for computing the ALP.

Arm’s Length Price shall be calculated or determined after considering nature of transaction between parties.

Tally Solutions (P.) Ltd. Vs. Respondent: Deputy Commissioner of Income Tax, Circle 12(4), Bangalore reported in MANU/IL/0143/2011 decided 26.09.2011 (IN THE ITAT, BANGALORE BENCH, BANGALORE)

Facts: The assessee is engaged in the business of software development, marketing and sales of Tally Brand Financial Accounting and Management Software. The assessee has Associated Enterprises (AE) in UK, Dubai and other countries. In Dubai’s AE, the assessee has 40% shareholding. During the year under dispute, the assessee sold intellectual property right (IPR) held by it including patent, copy rights and trade marks to Tally Solutions FZLLC, Dubai (Tally Dubai). The Transfer pricing officer (TPO) has adopted adopted non-statutory method i.e. Excess Earning Method (EEM) for valuating IPR and not Comparable Uncontrolled Price Method (CUP), which was method not known to law. The assessee contented that the ALP in relation to an international transaction has to be determined only with reference to the prescribed method.

Held: It was held that sale of IPR was not routine transaction involving regular purchase and sale. The assessee itself admitted that there was no comparable. The TPO had used an established method (EEM), since there were no comparables available with reference to IPR sold by Assessee. However, it could be stated that TPO had applied only CUP method, EEM was used only to arrive at CUP price, price at which Assessee would have sold in an uncontrolled condition. Therefore, issue that TPO had adopted method of valuation of IPR which was not method prescribed under Act or Rules was not correct.

Further, no infirmity was found in adoption of said method for simple reason that relevant data was available with reasonable accuracy, closing in on real valuation of software product. Moreover, valuation under method mainly revolved around discounted cash flow (DCF) analysis which was known to economists for times immemorial. Therefore, TPO used reasonable well accepted method of valuation of intangibles including software products.

Thus, excess earning method adopted by TPO to arrive at ALP was correct. Hence, Assessee’s contention that ALP should be computed based on actual sales and not projection adopted by TPO was dismissed.

Transactional Net Margin method (TNMM) to be appropriate method to compute arm’s length price when Comparable uncontrolled price method (CUPM) could not be applied in case of payment of royalty to the Associated Enterprises.

Dow Agrosciences India Private Limited Vs. ACIT, Range-14(1)(2) and Ors. (ITAT, MUMBAI BENCH, MUMBAI) reported in MANU/IU/0015/2021 decided on 11.01.2021

Facts: The assessee company is engaged in the business of manufacturing and trading of pesticides, agro chemicals and seeds. The assessee entered into international transactions with its Associate Enterprises in respect of the transaction of payment of royalty. For this, the assessee has adopted TNMM to ascertain the arm’s length price, however, the Officer rejected the method adopted by the assessee and made adjustments in the ALP by adopting CUP method.

Held: The benchmarking of the royalty paid by the assessee to its AE could not have been carried out by selecting the royalty agreement.

Although it was held that as the royalty paid by the assessee to its AE was approved by the Government of India and RBI, vide their respective approvals and was also in conformity with the rates prescribed in the Press Note, therefore, no infirmity did emerge from considering of the same for benchmarking the royalty paid by the assessee to its AE using CUP method, however, for the sake of completeness we shall deal with the sustainability of the secondary analysis carried out by the assessee following TNM method. The assessee had carried out a secondary analysis to ascertain the arm’s length price of the royalty paid to its AE by applying the TNM method. As stated by the assessee, since the royalty transaction is clearly linked to the manufacturing activity, it had, therefore, analyzed the same alongwith the manufacturing transaction using a combined transaction approach. As the margin earned by the assessee from the manufacturing activity (after considering the amount of expense on royalty payment) was much higher than the margins earned by the other comparables, the margin earned from the manufacturing activity was held to have met the arm’s length test. Accordingly, the assessee had concluded that the royalty payment being the operating cost for the manufacturing segment was at arm’s length. On a perusal of the orders of the lower authorities, it was found that they had accepted the benchmarking analysis applying the TNM method for all other transactions. The CUP method could not be applied as the TPO had not been able to find a similar transaction which could be compared with the transaction of the assessee company. As regards the remaining methods, viz. Resale Price Method (RPM), Cost Plus Method (CPM) and Profit Split Method (PSM), the same were not applicable to the transaction under consideration i.e. payment of royalty by the assessee to its AE. As such, since comparable transactions could not be found under the CUP method AND RPM, CPM & PSM were not applicable on the prevalent facts, therefore, the transaction of payment of royalty by the assessee to its AE had rightly been benchmarked by the assessee by applying the TNM method. As the net margin of the assessee company is shown to be higher than the margin of the comparables, therefore, the adjustment made by TPO/DRP on the said count also could not have been sustained.

Therefore, the transfer pricing adjustment made by the AO/TPO as regards the royalty paid by the assessee company to its AE could not be sustained and was liable to be vacated.

Methods of determination of arm’s length prices have to be essentially implemented in a reasonable and pragmatic manner so as to achieve its laudable objectives without any collateral damage

Toll Global Forwarding India Pvt. Ltd. vs. Deputy Commissioner of Income Tax (ITAT Delhi) reported in MANU/ID/0890/2014 decided on 18.11.2014

Facts: The Assessee, along with its associated enterprise, offers multi modal transportation services to business to business shippers through global freight forwarding services. The profits earned, after deducting transportation costs, by the Assessee and its Associate Enterprises or independent third party business associates, in respect of import and export of cargo were shared in a equal ratio. In the transfer pricing report submitted by the Assessee, the Assessee had adopted the Comparable Uncontrolled Price (CUP) method for determining the arm’s length price. However, the A.O. rejected the said method and proceeded to adopt Transactional Net Margin (TNMM) method. On appeal, DRP confirmed the method of TNMM as adopted by AO to determine arm’s length price. Hence, present appeal.

Held: It was held that:

the stand taken by the authorities that CUP could not be applied in such cases, because of non availability of data in terms of comparable amount having been charged for the same service, loses its relevance.
Further, Adopting a pedantic approach in the determination of arm’s length price, which serves letter of the law but leads to the conclusion diametrically opposed to the spirit of the law, had to be deprecated. The methods of determination of arm’s length prices had to be essentially implemented in a reasonable and pragmatic manner so as to achieve its laudable objectives without any collateral damage.

It appears that under any method of determining the arm’s length price, that price paid for the controlled transactions was the same as it would have been, under similar circumstances and considering all the relevant factors, for an uncontrolled transaction, the price so paid could be said to be arm’s length price. Therefore, business model said to had been adopted by the Assessee, in principle, meets the test of arm’s length price determination under Rule 10BA of Income Tax Rules as well.

The business model, as was admittedly prevalent in the line of business activity of the Assessee and as was followed by the assessee, thus indeed satisfied the test for determination of arm’s length price.
Therefore, arm’s length price of services rendered to, or received from, the associated enterprises, which was computed on the basis of thebusiness activity as was the industry norm and as had been employed by the Assessee for computing similar services to the independent enterprises, was at arm’s length. Accordingly, impugned arm’s length price adjustment stand deleted.

Change in transfer pricing method in the same year can be done only in case of change in facts, functionalities or availability of data.

Dy. CIT Vs. Ge Be (P) Ltd. (ITAT Bangalore) reported in MANU/IL/0127/2013 decided on 06.12.2013

Facts: The assessee is a joint venture between GE Mauritius Ltd. and Bharat Electronics Ltd. (BEL). The assessee is engaged in the business of manufacture of x-ray and CT tubes, HV tanks, detectors, parts and accessories for medical diagnostic imaging equipment, distribution of tubes, parts and accessories and provision of engineering services to its AE as contract manufacturer. The assessee adopted the Cost Plus Method as the most appropriate method for determining the ALP. The assessee identified 19 comparables and claimed that the consideration received by the assessee from its AE in respect of international transaction was more than the arithmetic mean of the comparable companies chosen by the assessee and therefore the price received by the assessee on sale of manufactured products is at arms length, therefore no adjustment needs to be made.

Transfer Pricing Officer’s contention: The TPO was of the view that the comparables selected by the assessee in its transfer pricing study related to automobile parts manufacturers. He was of the view that the industry segment vastly differs from that of the assessee which was manufacturer of medical equipment. Moreover, there were manufacturers of medical equipments, who were not taken as comparables by the assessee. Therefore, held that the assessee has not chosen comparables using an objective, consistent, logical and transparent criteria. Accordingly, rejected the comparables chosen by the assessee in its transfer pricing study. Thereafter, the TPO on his own identified 4 comparable companies which were in the business of manufacture of either surgical equipment, medical equipment or pacemakers.

Assessee’s contention: The assessee then claimed that TNMM should be adopted as the most appropriate method instead of CPM. The only reason for seeking change of method is that the comparables chosen by the TPO are different from that chosen by the assessee and that the functional profile of the comparables are different.

Further, the assessee contended that the they are contract manufacturer and the comparable companies selected should also perform a function performed by a contract manufacturer. If comparable companies perform functions beyond that of a contract manufacturer then they are not comparable.

Held: The assessee’s contention of using Transactional Net Margin Method (TNMM) as an alternate approach or method is not in tune with the Indian Transfer Pricing Rules, even though it may be permissible as per OECD Guidelines. The assessee is to select one method as the most appropriate method. The Transfer Pricing Rules do not give any scope or leverage to use different transfer pricing methods. The method can be changed only if there are any changes in the facts, functionalities or availability of data. Assuming that there could be situations where an assessee may be required to change its chosen most appropriate method for the same year between the time of his transfer pricing study and the assessment/appellate proceedings, such a change can happen only if there are any changes in facts, functionalities or availability of data.

In the instant case, the assessee has not made out any case or adduced any evidence to demonstrate that there has been any change in the facts, functionalities or availability of data. Nor is it the assessee’s case that any of these have been taken wrongly in the transfer pricing study that warrant a change of method has become necessary.

The only reason for seeking change of method is that the comparables chosen by the TPO are different from that chosen by the assessee and that the functional profile of the comparables are different. In the case of a contract manufacturer, most appropriate method is Cost Plus Method. The Assessee’s arguments proceed on purely theoretical basis without citing as to how the required data of direct and indirect costs of production of the property in the case of the comparable companies chosen by the TPO are not available. No specific instance as to how in the case of comparable companies chosen by the TPO, indirect costs of production have been taken at the net profit level.

Further, it is held that since the assessee has not been able to point out as to how CPM is not the most appropriate method in the present case. It can therefore be concluded that CPM, on the facts and circumstances of the present case, is the most appropriate method. Therefore, as CPM is adopted as the most appropriate method, the assessee should be allowed adjustment on actual basis, which will be reliable and accurate.

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