2015 (11) TMI 1527 - AT - Income Tax

Transfer pricing adjustment - most appropriate method to be applied for bench marking the transaction relating to sale of metro trains - Held that - As a methodology under the TNMM the standard of comparability is relaxed relative to the other methods and requires similarity of functions. This finds support even in the OECD guidelines which provides that where exact comparables (in terms of product or price) are not available TNMM is the most preferred methodology in analyzing transactions (at the net level) as it is more tolerant to differences between the tested party and comparable uncontrolled transactions. The use of TNMM method allows comparability of the functions rather than strictly focusing on product/service comparability as in the case of CPLM Resale Price Method and CUP. Thus TPO finally held that TNMM method shall be used for benchmarking transaction pertaining to passenger and bogie segment. Thus Ld. TPO has rightly applied the TNMM as most appropriate method by looking into the aspect that the assessee was unable to justify with documentary evidence the comparability on the issue of quality of the product or service contractual terms level of market geographical market in which the transaction takes place date of transactions intangible property associated with the sale foreign currency receipt alternatives realistically available with the buyer and the seller. Aggregating the transaction pertaining to sale of metro train sets with other international transaction in the Mainline division and testing the overall margin of the division under the Transactional Net Margin Method - Held that - TPO has rightly excluded the consortium supply value/cost revised segmental of BEML. The consortium agreement clearly reveals that both are similar and the consortium formed by the assessee with AE is functionally comparable with MRMB consortium. The activities undertaken by the assessee in the PGR & BOG division with respect to RS2 contract was similar those carried out by BEML in its Railway Customer Segment with respect to RS3 contract. Therefore Ld. DRP s finding is set aside herewith and BEML is allowed as comparable in assessee s case. While deciding the comparables Ld. TPO has not taken into consideration the proper information related to the free of cost material provided by the Railways to Titagarh Wagons Ltd. as well as to Texmaco Ltd. and thus the said information is necessary to take into account the functions performed assets employed and risks assumed ( FAR ). Ld. DRP in his finding also has directed Ld. TPO to take these aspect while allowing the said comparables. There is no doubt that these two companies are having the major role in supplying coaches to the Indian Railway and these are proper comparables if all the aspects are taken into consideration including the free of cost material value. Therefore Ld. TPO is directed to take into account 30% additional cost base to account free of cost material and revised the OP/TC margin of 13.65% for determining the arm s length margin as claimed by the Assessee. The companies operating on negative margins is an industry reality and companies incurring persistent losses cannot be accepted as comparable. The negative margin earned by these companies is reflective of the industry. This company i.e. Bharat Wagon & Engineering Co. Ltd. was rightly rejected by the Ld. TPO stating that the company was earning persistent losses over the past several years. The finding of Ld. TPO is right as this company was persistently incurring losses over the past several years. As relates to Braithwaite & Co. Ltd. it is properly rejected by Ld. TPO because the Annual Report for A.Y. 2010-2011 was not available and thus the Profit Margin and the relevant deciding factors for comparability will be lacking if the said company is taken as comparable. Therefore Ld. TPO s findings are just and proper. Modification of the Profit Level Indicator (PLI) i.e. Operating Profit/Operating Revenue (OP/OR) used by the Assessee for benchmarking with Operating Profit/Operating Cost (OP/OC) - Held that - Popularly used ratios include operating profit / sales operating profit / total cost gross profit / operating expenses operating profit by capital employed etc. The choice of the appropriate ratio must be done keeping in mind the characterisation and the nature of business of the tested party as well as the nature of comparables selected and the quality of information available. In present case Ld. TPO after taking into consideration all factors decided that the Profit level indicator which has to be used for benchmarking the captioned transaction has to be Operating Profit /Operating Cost. Operating Profit Margin by subtracting selling general and administrative (SG&A) or operating expenses from a company s gross profit number we get operating income. Thus it needs to be looked into and as per the submissions made by Ld. AR OP/Sales has to be taken into consideration by the revenue as the untainted base of the Profit Level Indicator (PLI). Ld. TPO is directed to consider the same and give finding to that effect. Intra group services - when AEs transact with each other for the purpose of transfer pricing they must replicate the dynamics of market forces as there is no concept of free lunch in business dealings. Thus Ld. DRP rightly held that the benefit test which is well recognized by OECD and other developed countries Tax regime have to be seen for allowing the payment in case of Intra-Group Services. The expected benefit must be sufficiently direct and substantial so that an independent entity in similar circumstances would be prepared to pay for it. If no benefits have been provided (or was expected to be provided) then the services cannot be charged for. Since the assessee just explained in generic nature about the benefits vis- -vis the intra-group services payment to its AEs therefore we uphold the orders of Ld. DRP and Ld. TPO.

Summary

Issues Involved:
1. Determination of the most appropriate method for benchmarking international transactions.
2. Inclusion and exclusion of comparable companies for Transfer Pricing analysis.
3. Modification of the Profit Level Indicator (PLI) for benchmarking.
4. Computation of Transfer Pricing adjustment.
5. Arm's length nature of intra-group services.

Issue-wise Detailed Analysis:

1. Determination of the most appropriate method for benchmarking international transactions:
The assessee contended that the Comparable Uncontrolled Price (CUP) method should be used for benchmarking the sale of metro trains to its Associated Enterprise (AE), Bombardier Transportation Germany (BTG). The Transfer Pricing Officer (TPO) rejected this, stating that the CUP method requires high comparability standards, which were not met due to differences in geographical markets, contractual terms, and other factors. The TPO and Dispute Resolution Panel (DRP) concluded that the Transactional Net Margin Method (TNMM) was more appropriate due to the interlinked nature of the transactions and the inability to evaluate the sale of metro trains individually. The Tribunal upheld this decision, emphasizing the need for a high degree of comparability under the CUP method, which was lacking in this case.

2. Inclusion and exclusion of comparable companies for Transfer Pricing analysis:
The TPO included Texmaco Infrastructure & Holdings Ltd. and Titagarh Wagons Ltd. as comparables, while excluding BEML Limited due to differences in consortium agreements and the nature of transactions. The Tribunal reversed the exclusion of BEML, noting that its "Railway Customer" segment was functionally comparable to the assessee. The Tribunal directed the TPO to include BEML as a comparable after excluding consortium supply values/costs. For Titagarh Wagons Ltd., the Tribunal instructed the TPO to account for "free of cost" supplies from Indian Railways, adjusting the OP/TC margin to 13.65%.

3. Modification of the Profit Level Indicator (PLI) for benchmarking:
The TPO used Operating Profit/Operating Cost (OP/OC) as the PLI, while the assessee argued for Operating Profit/Operating Revenue (OP/OR). The Tribunal directed the TPO to reconsider using OP/OR as the PLI, taking into account the revenue as the untainted base of the PLI.

4. Computation of Transfer Pricing adjustment:
The assessee claimed an error in computing the TP adjustment on the entire sale and cost of the Mainline division, including third-party transactions. The Tribunal directed the TPO to restrict the TP adjustment to AE sales and costs.

5. Arm's length nature of intra-group services:
The TPO determined the arm's length price for intra-group services to be Nil, citing a lack of evidence for the necessity and benefit of the services. The DRP upheld this, emphasizing the need for contemporaneous documentation and cost-benefit analysis. The Tribunal agreed with the TPO and DRP, noting the absence of detailed evidence and supporting documents to substantiate the intra-group services' benefits and costs. The Tribunal upheld the TPO's decision to benchmark these services separately rather than aggregating them under TNMM.

Conclusion:
The Tribunal's judgment upheld the TPO's and DRP's decisions on several key issues, including the use of TNMM for benchmarking, the inclusion of specific comparables, and the separate benchmarking of intra-group services. The Tribunal provided detailed instructions for revisiting certain aspects, such as the PLI modification and the computation of TP adjustments, ensuring a thorough and fair analysis of the assessee's international transactions. The appeal was partly allowed for statistical purposes.