2013 (3) TMI 666 - AT - Income Tax

Determination of appropriate method and amount of ALP - rejection of comparables offered by the assessee - Addition of management fees to TP adjustments - Held that - CUP method is not separately applicable for management fee transactions - TNMM applied on the enterprise level is a most appropriate method - the revised set of ten comparables submitted by the assessee in reply to the show-cause notice is the correct set to be used for comparability analysis - directed to TPO to adopt the ten comparables while computing the comparable margins to arrive at the ALP for the TNMM Held that - the management services fee was paid to the AE in connection with setting up of a new factory - the expenditure cannot be considered as operating expenses - does not constitute operational expenses hence same should be excluded while computing the operating profits of the assessee - directed to make no transfer pricing adjustment with respect to management fees and also recompute PLI by excluding the management fees Whether sale of scrap considered as operating income - Held that - The scrap material has come from the core manufacturing activity of the assessee - Hence it needs to form part of the operational income - recompute the margin of the assessee by including sale of scrap as operating income - Decided in favor of assessee Disallowing the benefit of range of /-5% while determining the ALP - Held that - Assessee shall not be entitled to exercise its option of /-5% if the variation between the arithmetical mean and the price at which such transaction has actually been undertaken exceeds 5 per cent of the arithmetical mean - Decided against assessee Disallowing the provision of agency commission u/s 37 - Held that - This commission payment accrues to the assessee company on incidence of sale and deferment of the payment of agency commission does not render the commission to be contingent in nature - AO Is directed to verify this aspect as to whether the liability of payment of commission to agents has arisen during the relevant AY and decide in accordance with law - Remanded back

Issues Involved:
1. Adjustment in transfer pricing provisions.
2. Rejection of comparables by TPO.
3. Computation of operating profit (OP) and operating profit to sales ratio (OP/Sales).
4. Treatment of management services fees.
5. Inclusion of income from the sale of scrap in operating income.
6. Application of filters for comparability analysis.
7. Benefit of +/- 5% range as per Section 92C(2) of the IT Act.
8. Disallowance of provision for agency commission under Section 37 of the IT Act.

Detailed Analysis:

1. Adjustment in Transfer Pricing Provisions:
The appeal by the assessee was against the adjustment of Rs. 2.76 crores made by the Dispute Resolution Panel (DRP) under transfer pricing provisions for the assessment year 2007-08. The assessee, a manufacturer of specialty chemicals, had filed a return of income and subsequently revised it, declaring a loss and book profit. The Assessing Officer (AO) referred the matter to the Transfer Pricing Officer (TPO) to determine the appropriate method and amount of Arm's Length Price (ALP) for international transactions totaling Rs. 16.53 crores.

2. Rejection of Comparables by TPO:
The TPO rejected the comparables offered by the assessee and selected two new comparable companies, arriving at an OP/Sales ratio of 14.43%. The TPO determined the Profit Level Indicator (PLI) of the taxpayer at 5.1%, leading to an adjustment of Rs. 2.76 crores for purchases from international transactions.

3. Computation of Operating Profit (OP) and Operating Profit to Sales Ratio (OP/Sales):
The assessee argued that certain extraordinary expenses, including management fees, should be excluded from the margin computation as they were one-off payments for setting up a new plant. The TPO had rejected this claim, treating the ALP of management fees as nil. The DRP, however, disagreed and enhanced the disallowance to Rs. 2.76 crores, reverting the PLI of the assessee back to 5.1%.

4. Treatment of Management Services Fees:
The TPO examined the management services fees of Rs. 1.54 crores paid by the assessee to its Associated Enterprises (AEs) and found that the assessee did not prove the services rendered. The DRP concluded that the CUP method was not applicable for management fee transactions and that all international transactions should be aggregated for comparison. The DRP deleted the adjustment of Rs. 1.54 crores made by the TPO for management services fees but restored the adjustment for purchases from AEs.

5. Inclusion of Income from Sale of Scrap in Operating Income:
The DRP directed that income from the sale of scrap should be treated as operating income. The assessee contended that the AO did not follow the DRP's directions properly. The Tribunal agreed with the assessee and directed the TPO to include the sale of scrap as operating income while computing the margin.

6. Application of Filters for Comparability Analysis:
The Tribunal found that the filters used by the TPO, including a turnover filter of Rs. 5-35 crores and zero export revenue filter, were applied incorrectly. The Tribunal directed the TPO to rework the comparables by applying a turnover filter range of Rs. 1-200 crores and not excluding companies with zero export revenue. The revised set of ten comparables submitted by the assessee was to be used for comparability analysis.

7. Benefit of +/- 5% Range as per Section 92C(2) of the IT Act:
The Tribunal dismissed the assessee's ground for allowing the benefit of +/- 5% range as a standard deduction, relying on the decision of the Co-ordinate Bench of the Tribunal and the retrospective amendment of Section 92C(2A) by the Finance Act, 2012.

8. Disallowance of Provision for Agency Commission under Section 37 of the IT Act:
The assessee argued that the provision for agency commission was based on sales income and in line with Accounting Standard 1 (AS-I). The AO had disallowed the amount, treating it as a provision. The Tribunal directed the AO to verify whether the liability for payment of commission to agents had arisen during the relevant assessment year and decide accordingly.

Conclusion:
The appeal was partly allowed for statistical purposes. The Tribunal directed the TPO to rework the ALP by applying the correct filters and excluding management fees from the PLI computation. The TPO was also directed to make transfer pricing adjustments only to the international transactions of the assessee in the ratio of international transactions to total operating expenses. The AO was directed to verify the liability for agency commission and decide as per law.

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