2012 (11) TMI 1094 - AT - Income Tax

TPA - ALP determination - comparable selection - Held that - Assessee is engaged in the business of providing contract pharmaceuticals Research & Development services, thus companies functionally dissimilar with that of assessee need to be deselected from final list. As already seen in the earlier part of this order, if the six companies (including IDC India Ltd. and Mindtree Ltd.) is taken as comparables, the operating margins on cost (unadjusted) is 10.22%. The assessee s operating margin on cost is 13.17% which is much above the arithmetic mean of the comparables. In the given circumstances, we are of the view that the price at which the assessee rendered services to its AE has to be considered as at arms length and no adjustment on account of arms length price (ALP) ought to have been made. We accordingly hold that the addition made by the Assessing Officer by way adjustment to ALP deserves to be deleted.

Summary

Issues Involved:
1. Incorrect interpretation of law by the AO and DRP.
2. Discrepancy between assessed total income and returned income.
3. Addition due to adjustment in the arm's length price (ALP) of international transactions.
4. Rejection of the economic analysis undertaken by the assessee.
5. Use of financial year 2006-07 data by the AO/TPO.
6. Rejection of companies with different accounting years.
7. Rejection of companies with foreign exchange earnings less than 25% of revenues.
8. Rejection of a comparable company due to persistent operating losses and acceptance of super profit-making companies.
9. Use of unreasonable comparability criteria.
10. Incorrect computation of working capital adjustment.
11. Failure to adjust for differences in risk profiles.
12. Non-application of +/- 5% benefit under proviso to section 92C.

Detailed Analysis:

1. Incorrect Interpretation of Law by AO and DRP:
The assessee argued that the AO and DRP misinterpreted the law, rendering their order legally flawed. The Tribunal did not specifically address this issue separately but implicitly considered it while evaluating the correctness of the AO/TPO's actions.

2. Discrepancy Between Assessed Total Income and Returned Income:
The AO assessed the total income at Rs. 7,96,29,650 as against the returned income of Rs. 16,12,489. This discrepancy arose primarily due to the adjustment in the ALP of international transactions, which the Tribunal addressed in detail.

3. Addition Due to Adjustment in ALP:
The AO/TPO made an addition of Rs. 8,41,59,983 to the total income of the assessee due to an adjustment in the ALP of international transactions. The Tribunal scrutinized the comparables used by the AO/TPO and found that several companies selected by the TPO were not functionally comparable to the assessee's activities. The Tribunal excluded these companies and recalculated the arithmetic mean margin, concluding that the assessee's operating margin was above the recalculated mean, thus negating the need for any adjustment.

4. Rejection of Economic Analysis by the Assessee:
The AO/TPO rejected the economic analysis undertaken by the assessee, conducting a fresh analysis. The Tribunal found that the TPO's rejection of certain comparables was not justified, and the economic analysis provided by the assessee was more appropriate.

5. Use of Financial Year 2006-07 Data:
The AO/TPO used financial year 2006-07 data, which was not available in the public domain when the assessee complied with the transfer pricing documentation requirements. The Tribunal did not specifically address this issue but implicitly considered it while evaluating the comparables and the overall approach of the TPO.

6. Rejection of Companies with Different Accounting Years:
The AO/TPO rejected companies with different accounting years. The Tribunal did not specifically address this issue separately but considered the functional comparability of the companies in its analysis.

7. Rejection of Companies with Foreign Exchange Earnings Less Than 25% of Revenues:
The AO/TPO rejected certain companies for having foreign exchange earnings less than 25% of revenues. The Tribunal did not specifically address this issue separately but considered the overall comparability of the companies.

8. Rejection of a Comparable Company Due to Persistent Operating Losses:
The AO/TPO rejected Neeman Medicals International (Asia) Ltd. due to persistent operating losses. The Tribunal found that Neeman Medicals was not consistently loss-making and should be included as a comparable. This inclusion significantly affected the recalculated arithmetic mean margin.

9. Use of Unreasonable Comparability Criteria:
The AO/TPO used unreasonable comparability criteria. The Tribunal found that the criteria used by the TPO were not appropriate, leading to the exclusion of several companies from the comparables list.

10. Incorrect Computation of Working Capital Adjustment:
The AO/TPO incorrectly computed the working capital adjustment. The Tribunal did not specifically address this issue separately but considered the overall approach and calculations of the TPO.

11. Failure to Adjust for Differences in Risk Profiles:
The AO/TPO did not make suitable adjustments for differences in the risk profile of the assessee vis-`a-vis the comparables. The Tribunal implicitly considered this while evaluating the overall comparability and the appropriateness of the adjustments made by the TPO.

12. Non-application of +/- 5% Benefit Under Proviso to Section 92C:
The AO/TPO computed the ALP without giving the benefit of +/- 5% under the proviso to section 92C of the Act. The Tribunal found that since the assessee's operating margin was higher than the recalculated arithmetic mean, the issue of applying the +/- 5% benefit did not arise.

Conclusion:
The Tribunal concluded that the adjustment made to the ALP by the AO/TPO was not justified. The Tribunal directed that the addition made by the AO be deleted, allowing the appeal of the assessee. The Tribunal's decision was based on a detailed analysis of the comparables and the functional profile of the assessee, ensuring that the ALP determination was accurate and fair.