2009 (5) TMI 600 - AT - Income Tax

Arms length price - 100 per cent EOU - Transactions with associated enterprises (AEs) - CUP or TNMM method - assessee submitted that it is neither practical nor desirable for the assessee company to directly deal with third party suppliers in UK-particularly when the assessee has an AE with several decades of experience in this line in UK - With regard to import of raw material from AEs the TPO noted assessee s stand that the Authorised Representative purchases raw material on behalf of the assessee and exports the same to the assessee company on bulk basis - although Chapter X has title Special provision relating to avoidance of tax and aim of various sections under Chapter X is to check avoidance of taxes diversion of income and funds by non-residents from India it is not necessary that AO must demonstrate such avoidance and diversion of tax before invoking provisions of ss. 92C and 92CA. - the transfer pricing provisions could not have been invoked on the facts of this case as the assessee did not have any tax avoidance motive is hereby vacated. Regarding method of computation of ALP - It is an undisputed position that the imports of raw material which mainly consist of copper and lead are charged by the AE on the basis of rates prevailing at London Metal Exchange. and certain mark up thereon - once it is not in dispute that the billing by the AE for raw materials supplied to the assessee is done on the basis of the London Metal Exchange prices plus certain mark up there is no further need of the internal comparables since London Metal Exchange being an independent organization entering into transparent and arm s length transactions with a number of other organizations provides the most reliable prices at which uncontrolled comparable transactions are entered into - assessee had offered the comparison of gross profit mark up margin of the assessee company on transactions with AEs with gross profit mark up margin of the assessee company on transactions with unrelated parties. which in our considered view. was a sufficient basis for determination of ALP under r. 10(1)(c) - Held that TNMM was indeed not the appropriate method of determining ALP on the facts of this case these comparables are no longer relevant. We decline to go into that aspect of the matter/issues as it is now purely academic aspect - Appeal is dismissed

Issues Involved:
1. Adjustment in Arm's Length Price (ALP)
2. Methodology for determining ALP
3. Relevance of the assessee being a 100% Export Oriented Unit (EOU)

Issue-wise Detailed Analysis:

1. Adjustment in Arm's Length Price (ALP):
The primary issue in this appeal is the ALP adjustment of Rs. 56,35,952 made by the Transfer Pricing Officer (TPO) and subsequently deleted by the Commissioner of Income Tax (Appeals) [CIT(A)]. The Revenue contends that the CIT(A) erred in allowing relief on the grounds that the unit being a 100% EOU negates the necessity for manipulating the assessee's income. Additionally, the Revenue argues that the CIT(A) improperly dismissed the ALP adjustment, which was based on comparable cases not rebutted during the appeal.

2. Methodology for Determining ALP:
The taxpayer, a 100% EOU, engaged in manufacturing and supplying components, used the Cost Plus Method and Comparable Uncontrolled Price (CUP) Method for ALP computation. The TPO, however, rejected these methods and adopted the Transactional Net Margin Method (TNMM), arguing that the taxpayer's loss in the relevant financial year indicated that the transactions were not at ALP. The TPO selected comparables from the prowess database dealing in 'connectors' and made an adjustment based on the average PBT/cost ratio of these companies. The CIT(A) disagreed with the TPO's approach, noting that the taxpayer had adequately explained the losses due to increased material consumption and lower capacity utilization, and found the comparables adopted by the TPO unsuitable.

3. Relevance of the Assessee Being a 100% Export Oriented Unit (EOU):
The Revenue challenged the CIT(A)'s reasoning that the taxpayer, being a 100% EOU, had no incentive to manipulate prices. The Revenue cited the Aztec Software & Technology Services Ltd. case, asserting that tax exemption does not preclude the application of transfer pricing provisions. The taxpayer, however, relied on the Philips Software Centre (P) Ltd. case, which suggested that transfer pricing provisions should not apply to entities claiming benefits under Section 10A of the Act. The Tribunal, aligning with the Aztec Software case, upheld that transfer pricing provisions apply regardless of tax exemption status, thus vacating the CIT(A)'s conclusion on this point.

Detailed Analysis:

Adjustment in ALP:
The TPO's adjustment was based on the premise that the taxpayer's loss in the relevant year indicated non-ALP transactions. The TPO noted a significant increase in the material consumption ratio and inferred that the taxpayer should have passed on the increased costs to its AE. The CIT(A) found the taxpayer's explanations for the loss reasonable and noted that the TPO's comparables were not truly comparable. The Tribunal agreed with the CIT(A) that the ALP adjustment was not justified, emphasizing the need for reliable comparables and appropriate methods.

Methodology for Determining ALP:
The Tribunal emphasized that the selection of the most appropriate method for determining ALP must be based on the nature of the transaction and the availability of reliable data. The taxpayer's use of the Cost Plus and CUP methods was deemed appropriate given the nature of the transactions and the availability of London Metal Exchange prices as a reliable benchmark. The TPO's reliance on TNMM was considered inappropriate as it did not adequately address the specifics of the taxpayer's transactions. The Tribunal highlighted that traditional methods should be preferred unless they are unworkable, and the TPO failed to demonstrate the fallacies in the taxpayer's methods.

Relevance of the Assessee Being a 100% EOU:
The Tribunal clarified that the applicability of transfer pricing provisions is not contingent on the taxpayer's tax exemption status. The Tribunal rejected the CIT(A)'s reasoning that the taxpayer had no incentive to manipulate prices due to its EOU status, aligning with the Aztec Software case. The Tribunal upheld that transfer pricing adjustments are valid irrespective of tax exemption, provided the transactions are not at ALP.

Conclusion:
The Tribunal dismissed the Revenue's appeal, upholding the CIT(A)'s deletion of the ALP adjustment but disapproving the reasoning related to the taxpayer's EOU status. The Tribunal emphasized the importance of selecting the most appropriate method for ALP determination and the need for reliable comparables, ultimately supporting the taxpayer's use of the Cost Plus and CUP methods.

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