Article 34 – Arm’s Length Principle Case Law

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.

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