2010 (11) TMI 565 - AT - Income Tax

Arms length price - Addition - Deduction u/s 80HHC - Rectification of mistakes - TNMM - the first appellate authority has not adjudicated on the submissions of the assessee on the application of TNMM but gave relief by examining the operating margin at entity level - it is clear that under Chapter X of the Income-tax Act, 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 - T.P.O. is not authorized to determine the net operational profits at the enterprises level and thereby determined the total income of the assessee, but that he shall determine only, the ALP of the international transaction is correct - they have conducted the transfer pricing study and arrived at the ALP by comparing the net profit margins realized by the enterprises from an international transaction, with the net profit margin of transaction of another enterprise of same class - whether the assessee in its transfer pricing study, has arrived at the ALP by comparing the net profit margin realized by the enterprises from each international transaction or the aggregate of a class of an international transaction, with the net profit margin realized by another similar entity on an international transaction or on a class of international transactions, as claimed by the assessee - If this exercise has been done by the assessee, then as the TPO has not contradicted these findings, the claim of the assessee that the transfer pricing study report issued under section 92E has to be accepted by the Revenue and no adjustment has to be made, will have to be accepted by the Assessing Officer - Appeal is allowed by way of remand

Issues Involved:
1. Legality of the addition of Rs. 61,84,483 under section 92CA(3).
2. Methodology for determining Arm's Length Price (ALP) under the Transactional Net Margin Method (TNMM).
3. Authority of the Transfer Pricing Officer (TPO) and the Assessing Officer (AO) in determining ALP and total income.
4. Admissibility and correctness of the transfer pricing study conducted by the assessee.

Detailed Analysis:

1. Legality of the Addition of Rs. 61,84,483 under Section 92CA(3):
The Revenue appealed against the order of the Commissioner of Income-tax (Appeals) [CIT(A)] directing the AO to delete the addition of Rs. 61,84,483 made under section 92CA(3). The CIT(A) found merit in the assessee's contention that the TPO had erroneously applied the operating profit margin of independent enterprises to the entire sales of the assessee, rather than to the international transactions only. The CIT(A) concluded that the pricing of the international transactions was at ALP and no adjustment was necessary.

2. Methodology for Determining Arm's Length Price (ALP) under TNMM:
The assessee, a manufacturer, importer, and exporter of diamonds, filed its return of income and was assessed under a partnership firm status. The AO referred the case to the TPO for determining the ALP. The TPO suggested adjustments based on the net margin realized by the enterprise from international transactions, comparing it with the net margin of comparable uncontrolled transactions. The CIT(A) and the Tribunal emphasized that under Chapter X of the Income-tax Act, the determination of ALP must be at the transaction level or the level of a class of transactions, not at the entity level or by taking overall industry averages.

3. Authority of the TPO and the AO in Determining ALP and Total Income:
The Tribunal clarified that the TPO is authorized only to determine the ALP of international transactions, not the total income of the assessee. The AO must compute the total income having regard to the ALP determined by the TPO. The Tribunal found that the TPO had overstepped his authority by determining the net operational profits at the enterprise level, which was beyond his jurisdiction. The CIT(A) should have explicitly ruled that the TPO's scope is limited to determining the ALP of international transactions.

4. Admissibility and Correctness of the Transfer Pricing Study Conducted by the Assessee:
The Tribunal noted that the assessee claimed to have conducted a transfer pricing study and applied TNMM at the transaction level, demonstrating that its international transactions were at ALP. However, the Tribunal found that neither the AO's nor the CIT(A)'s orders provided clear evidence of this study. The Tribunal set aside the issue to the AO for fresh adjudication to verify whether the assessee's transfer pricing study compared the net profit margins of individual international transactions or classes of transactions with those of comparable uncontrolled transactions.

Conclusion:
The Tribunal allowed the appeal for statistical purposes, directing the AO to re-examine the transfer pricing study conducted by the assessee. The AO must ensure that the ALP determination aligns with the legal requirements, focusing on transaction-level comparisons rather than entity-level or industry averages. The Tribunal emphasized the correct legal position that the TPO's role is limited to determining the ALP of international transactions, and the AO must compute the total income based on this determination.

← Previous Next →