2016 (5) TMI 1300 - AT - Income Tax

Reference to Dispute Resolution Panel - enhancement of transfer pricing adjustment - upward adjustment - Held that - Assessing Officer has not passed the assessment order in conformity with the direction of the DRP. In fact, the direction of the DRP was to the TPO. Therefore, the assessee has no occasion to file its objection to the subsequent order of the TPO dated 22.1.2014. When the TPO passed the order dated 22.1.2014, the Assessing Officer in all fairness ought to have given an opportunity to the assessee to file its objection. Such an opportunity was not given to the assessee. Moreover, the TPO was not empowered to pass any order subsequent to the direction of the DRP. The Assessing Officer is expected to pass an assessment order in conformity with the direction of the DRP without any intervention either by the TPO or by any authority. Therefore, there is a clear violation of the procedure prescribed u/s 144C of the Act. Moreover, as rightly submitted by the ld. Counsel for the assessee, the DRP made adjustment with regard to capacity utilization and customs duty adjustment without issuing any notice. This Tribunal is of the considered opinion that there was a clear violation of the principles of natural justice. Therefore, the matter needs to be reconsidered by the DRP. The direction of the DRP shall be specific and clear so that the Assessing Officer can implement the same without any intervention either by the TPO or any authority. Thus entire issue is remitted back to the file of the Assessing Officer. The Assessing Officer shall refer the matter once again to the DRP and the DRP shall pass a clear and specific order, if necessary, after calling for a remand report from the TPO.

Summary

Issues:
1. Upward adjustment of value of international transaction.
2. Application of Transactional Net Margin Method (TNMM).
3. Adjustment on account of working capital.
4. Customs duty adjustment.
5. Exclusion of forex fluctuation loss from operating income.
6. Capacity utilization adjustment.
7. Violation of principles of natural justice in making adjustments without notice.
8. Compliance with the procedure under Section 144C of the Income-tax Act.

Issue 1: Upward adjustment of value of international transaction
The appellant contested the upward adjustment of ?4,81,47,719 to the value of an international transaction. The Transfer Pricing Officer (TPO) had revised the Profit Level Indicator (PLI) and made adjustments, leading to the increase in profit margin. The Dispute Resolution Panel (DRP) directed the application of TNMM as the most appropriate method but further enhanced the adjustment without notice. The appellant argued against the additional adjustment, citing procedural irregularities and lack of opportunity to present objections.

Issue 2: Application of Transactional Net Margin Method (TNMM)
The TPO rejected the TNMM chosen by the assessee and revised the PLI, resulting in an upward adjustment. The DRP, however, accepted TNMM as the appropriate method but made further adjustments without prior notice. The appellant emphasized adherence to the method prescribed under the Income-tax Act and challenged the validity of additional adjustments made by the DRP.

Issue 3: Adjustment on account of working capital
The DRP directed the TPO to compute adjustments considering the working capital structure, specifically in cases where the assessee was buying from an associated enterprise (AE). The need for demonstrating extraordinary credit periods from the AE was highlighted, emphasizing the importance of adjusting for differences in working capital structures.

Issue 4: Customs duty adjustment
The DRP agreed with the TPO that no adjustment was necessary concerning customs duty. Citing a precedent from a Delhi ITAT case, the decision to exclude customs duty adjustment was supported, emphasizing the need for a comprehensive comparison of imported components and associated costs for accurate adjustments.

Issue 5: Exclusion of forex fluctuation loss from operating income
The DRP supported the exclusion of forex fluctuation losses from operating profits, considering the functions of treasury management not directly linked to manufacturing and distribution activities. The directive was to exclude forex losses from the PLI computation for both the assessee and comparables.

Issue 6: Capacity utilization adjustment
The appellant sought an adjustment based on capacity utilization differences compared to comparables. However, the Tribunal found the arguments unconvincing, noting the lack of a direct correlation between capacity utilization percentages and profits earned. The margin differences were deemed insignificant, leading to the rejection of the adjustment request.

Issue 7: Violation of principles of natural justice in making adjustments without notice
The Tribunal highlighted a violation of natural justice principles in making adjustments without issuing notices to the assessee. The lack of opportunity to present objections regarding capacity utilization and customs duty adjustments was considered a procedural flaw, necessitating reconsideration by the DRP.

Issue 8: Compliance with the procedure under Section 144C of the Income-tax Act
The Tribunal emphasized the importance of compliance with Section 144C, outlining the roles of the DRP and TPO in directing assessments. The failure to adhere to the DRP's directions and the subsequent intervention by the TPO were deemed as violations of the prescribed procedure, requiring a clear and specific order from the DRP for assessment completion.

In conclusion, the Tribunal allowed the appeal for statistical purposes, setting aside the previous orders and remitting the entire issue back to the Assessing Officer for reconsideration, emphasizing adherence to procedural fairness and compliance with the Income-tax Act's provisions.