2016 (8) TMI 1351 - AT - Income Tax

Transfer pricing addition - aggregation of all the international transactions including royalty for the purpose of determining the ALP - MAM selection - Held that - In the present case the purchase and raw-material from AE consist of Rs. 123 Crores as against the total purchases of Rs. 623 Crores. The export components to the AE is only Rs. 20, 89, 409 which is insignificant in comparison to the total sale of the assessee. Therefore the TNMM cannot be applied as MAM for determining the ALP of royalty payment in question but we find that neither the TPO nor the assessee was able to find such uncontrolled comparable case where an identical intangible has been transferred by the party to a non-related party against the payment of royalty. Thus in such a situation the TNMM being the residual method which has to be applied as MAM for determining the ALP. We find that in a number of cases the Tribunal has taken this view by considering the peculiar facts where a comparable price is not available for the purpose of applying the CUP method. In the case on hand it was brought to our notice that the TPO has accepted the TNMM as MAM for determining the ALP in respect of the royalty payment being aggregated transaction along with the other international transactions of the assessee. Therefore keeping in view of the facts and circumstances of the case we do concur with the view of the CIT (Appeals) on this issue. Accordingly the appeal of the revenue is dismissed. Comparable selection criteria - functional similarity - Held that - The assessee is engaged in the manufacturing of textiles machines for textile manufacturers in India - assessee has bench marked its international transactions on consolidated basis by considering the purchases royalty payment sales as composite international transactions by applying TNMM at enterprise level thus companies functionally dissimilar with that of assessee need to be deselected from final list.

Issues Involved:
1. Aggregation of international transactions for determining the Arm's Length Price (ALP).
2. Justification and benefit test for royalty payment.
3. Application of Transactional Net Margin Method (TNMM) versus Comparable Uncontrolled Price (CUP) method.
4. Inclusion and exclusion of comparable companies for ALP determination.
5. Application of turnover filter for selecting comparables.
6. Correct computation of profit margin for comparables.
7. Transfer pricing adjustment for non-associated enterprise transactions.
8. Standard deduction under proviso to Section 92C(2) of the Income Tax Act, 1961.
9. Imposition of interest under Sections 234B, 234C, and 234D of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Aggregation of International Transactions for Determining ALP:
The primary issue in the revenue's appeal was whether the royalty payment should be aggregated with other international transactions for determining the ALP. The Tribunal upheld the CIT (Appeals)'s decision to aggregate the transactions, noting that the royalty was integral to the assessee's manufacturing activities. The Tribunal emphasized that the TNMM method, being a residual method, was appropriate in the absence of comparable uncontrolled prices for the royalty payment.

2. Justification and Benefit Test for Royalty Payment:
The TPO had questioned the justification for the royalty payment, determining its ALP as NIL due to the lack of demonstrated benefits. However, the CIT (Appeals) found that the assessee had provided sufficient evidence, including the agreement with the AE, to justify the royalty payment. The Tribunal agreed, stating that the TPO's role was to determine the ALP, not to assess the benefit derived from the transaction.

3. Application of TNMM versus CUP Method:
The revenue contended that the CUP method should be used for the royalty transaction. The Tribunal, however, supported the CIT (Appeals)'s use of TNMM, citing the lack of comparable uncontrolled prices for the royalty payment. The Tribunal referred to previous decisions, including the case of M/s. Toyota Kirloskar Motors P. Ltd., to reinforce that TNMM was appropriate in such scenarios.

4. Inclusion and Exclusion of Comparable Companies for ALP Determination:
The assessee and the revenue disputed the inclusion of certain comparables. The Tribunal directed the exclusion of Lakshmi Machine Works Ltd. due to its significantly higher turnover, which provided it with economies of scale not comparable to the assessee. For Lohia Starlinger Ltd., the Tribunal upheld its inclusion, applying a tolerance range of five times the assessee's turnover. The Tribunal also directed the TPO to verify the correct profit margin for Nesco Ltd.

5. Application of Turnover Filter for Selecting Comparables:
The Tribunal criticized the TPO's turnover filter of Rs. 1 crore to Rs. 200 crores, suggesting that a more flexible approach was needed. The Tribunal applied a multiple of five times the assessee's turnover as an upper and lower limit for selecting comparables, ensuring a more reasonable comparison.

6. Correct Computation of Profit Margin for Comparables:
The Tribunal addressed the assessee's concern regarding the incorrect profit margin considered for Nesco Ltd. The Tribunal directed the TPO to verify and consider only the segmental data of Nesco Ltd.'s engineering division, ensuring accurate computation of the profit margin.

7. Transfer Pricing Adjustment for Non-Associated Enterprise Transactions:
The assessee contended that the CIT (Appeals) erred in making transfer pricing adjustments for non-associated enterprise transactions. The Tribunal directed the TPO to consider adjustments only for international transactions with the AE, excluding non-associated enterprise transactions from the adjustment computation.

8. Standard Deduction under Proviso to Section 92C(2) of the Income Tax Act, 1961:
The Tribunal upheld the CIT (Appeals)'s decision to grant the assessee a standard deduction of 5% from the ALP under the proviso to Section 92C(2), rejecting the revenue's contention against it.

9. Imposition of Interest under Sections 234B, 234C, and 234D of the Income Tax Act, 1961:
The Tribunal did not specifically address the imposition of interest under Sections 234B, 234C, and 234D, as the primary focus was on the transfer pricing adjustments and the methods used for determining the ALP.

Conclusion:
The Tribunal dismissed the revenue's appeal and partly allowed the assessee's appeal, directing the TPO/A.O. to recompute the ALP by applying the TNMM method, excluding non-associated enterprise transactions, and ensuring accurate computation of profit margins for comparables. The Tribunal emphasized the need for a reasonable approach in selecting comparables and justified the aggregation of transactions for determining the ALP.

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