2011 (1) TMI 151 - AT - Income Tax

Transfer Pricing - Arms length price - Resale price method - importing rough diamonds from abroad and selling the same in India - business of trading (no value addition) - The Transfer Pricing Officer passed an order under section 92CA (3) and held that the imports made from the assessee s Associated Enterprise is not in accordance with the transfer pricing guidelines and held that arms length price adjustment is required to be made to the imports - Held that The A.O. himself states that he find some merit and force in the submission of the assessee but in view of the directions of the T.P.O. and as the assessment is getting time barred he made the addition in question. The submission of the assessee that the T.P.O. is not authorised to determine the net operational profits at the enterprises level and thereby determine the total income of the assessee but that he shall determine only the ALP of the international transaction is correct. Resale price method - neither the Transfer Pricing Officer nor the CIT(A) have held that this is not the most appropriate method. The only ground for rejecting resale price method adopted by the assessee is that the comparables are wrongly chosen - Held that As the assessee is a trader without value addition to the goods we find force in the submission of the assessee that resale price method is the most appropriate method for determining the ALV with respect to AE transaction. - as the comparables given by the assessee i.e. Flawless Diamonds and Professional Diamonds are not in the business of purchase and sale of rough diamonds it would have to set aside of the issue to the file of the Assessing Officer for fresh adjudication so as to enable both the assessee as well as the Assessing Officer to undertake a fresh exercise by finding out appropriate comparables and adopting resale price method. Variation upto 5% - The second proviso to s. 92C(2) (as substituted by F (No. 2) Act 2009 w.e.f 1.10.09) clearly shows that if the difference is less than 5% then the actual price paid should be considered as arm s length price. The Transfer Pricing Officer as well as CIT(A) have clearly observed that difference in respect of these two items is 4% and therefore same has to be reckoned in terms of second proviso.

Issues Involved:
1. Appropriateness of the Resale Price Method (RPM) for determining Arm's Length Price (ALP).
2. Validity of comparables used by the assessee and the Transfer Pricing Officer (TPO).
3. Application of the Transactional Net Margin Method (TNMM) by the TPO and CIT(A).
4. Adjustment of ALP based on gross vs. net purchases.
5. Determination of ALP for international transactions only.

Detailed Analysis:

1. Appropriateness of the Resale Price Method (RPM) for Determining ALP
The assessee consistently followed the Resale Price Method (RPM) to determine the ALP, which had been accepted in previous assessment years. The Transfer Pricing Officer (TPO) and the Commissioner of Income Tax (Appeals) [CIT(A)] did not provide cogent reasons to reject the RPM. The Tribunal noted that the RPM is suitable for the assessee's business model, which involves trading without value addition. The Tribunal stated, "The only ground for rejecting resale price method adopted by the assessee is that the comparables are wrongly chosen." Hence, the method itself was not disputed, but the comparables used were.

2. Validity of Comparables Used by the Assessee and the TPO
The TPO and CIT(A) rejected the comparables provided by the assessee, namely M/s. Flawless Diamonds and M/s. Professional Diamonds, on the grounds that these entities were involved in diamond cutting and polishing, not trading in rough diamonds. The Tribunal found this rejection to be valid but noted that the CIT(A) had inconsistently used these comparables along with others to determine the operating margins. The Tribunal emphasized the need for fresh comparables that are more appropriate for the RPM.

3. Application of the Transactional Net Margin Method (TNMM) by the TPO and CIT(A)
The TPO and CIT(A) applied the TNMM, which the assessee argued was incorrectly used. The Tribunal agreed, stating, "Law does not permit determination of ALP of international transactions, by comparing operating margins at entity levels, or by taking overall industry level averages." The Tribunal held that the TNMM should only be applied to international transactions, not at the entity level, and thus, the application of TNMM by the TPO and CIT(A) was struck down as illegal.

4. Adjustment of ALP Based on Gross vs. Net Purchases
The CIT(A) made adjustments based on gross purchases, which the assessee contested, arguing that adjustments should be based on net purchases (i.e., purchases minus returns). The Tribunal agreed with the assessee, stating, "If purchases are held to be having arms length price of 'X', then purchase returns should also be taken at that 'X' rate." Therefore, the Tribunal directed that the ALP should be determined only for the net purchases of Rs. 94 lakhs, not the gross amount.

5. Determination of ALP for International Transactions Only
The Tribunal emphasized that adjustments should be made only for international transactions. The Tribunal cited the case of DCIT v. M/s. Ankit Diamonds, stating, "The determination of ALP of an international transaction has to be only at the transaction level or at the level of a class of transactions." The Tribunal directed that the ALP should be determined for the net international transaction of Rs. 94 lakhs and that if the variance is less than 5%, no adjustment should be made.

Conclusion
The Tribunal allowed the appeal for statistical purposes and set aside the issue to the file of the Assessing Officer (AO) for fresh adjudication. The AO was directed to determine the ALP for the net transaction of Rs. 94 lakhs, considering the appropriate comparables and using the RPM. If the variance is less than 5%, no adjustment should be made. The Tribunal concluded, "In the result, appeal of the assessee is allowed for statistical purposes."

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