2011 (9) TMI 453 - AT - Income Tax

Transfer Price - Calculation of Arm Length Price - Assessee selected Transactional Net Margin Method(TNMM) - Profit level Indicators were determined by dividing operating Income with Operating Cost - only dispute between the parties is inclusion of other income in the operating income of comparables and exclusion of miscellaneous expenses - Held that - assessee has accepted almost all the objections of the Learned DR - Determination of Arm Length price is not a mathematical formula rather scientific mechanism - we are of the view that some element of guess work estimation is always involved for determining the ALP of international transactions. The arithmetic mean of the comparables is 6.84% in the first analysis and 5.63% in the second analysis extracted supra. The average profit margin shown by the assessee is 1.96% which is within the tolerance band of /- 5%. Thus appeal of revenue was dismissed.

Summary

Issues Involved:
1. Deletion of addition made by the Assessing Officer concerning the arm's length price of international transactions.
2. Determination and computation of the arm's length price using the Transactional Net Margin Method (TNMM).
3. Inclusion and exclusion of specific incomes and expenses in the operating income and operating cost of comparables.
4. Adjustment for employee costs and the concept of idle capacity.
5. Application of the tolerance band provided under section 92C of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Deletion of Addition Made by the Assessing Officer:
The revenue's primary grievance was that the CIT(Appeals) erred in deleting an addition of Rs. 55,78,476 made by the Assessing Officer. This addition was based on the arm's length price of international transactions conducted by the assessee with its associate enterprises, as recommended by the Transfer Pricing Officer (TPO).

2. Determination and Computation of Arm's Length Price Using TNMM:
The assessee, engaged in software development services, used the Transactional Net Margin Method (TNMM) to determine the arm's length price of its international transactions. The TPO accepted the TNMM method and the profit level indicator (PLI) used by the assessee, i.e., operating profit/operating cost. The TPO considered four out of six comparables selected by the assessee and calculated the arm's length price, resulting in an addition of Rs. 55,78,476.

3. Inclusion and Exclusion of Specific Incomes and Expenses:
The dispute centered around the inclusion of other income in the operating income and the exclusion of miscellaneous expenses from the operating cost of comparables. The TPO included stock adjustment in both operating income and cost, while the assessee included it only in the operating cost. The CIT(Appeals) and the tribunal found that the exact details of expenses could not be ascertained precisely, leading to some element of estimation in determining the arm's length price.

4. Adjustment for Employee Costs and Idle Capacity:
The assessee argued for an adjustment of Rs. 1.12 crores in operating costs due to higher employee costs, which was rejected by the TPO. The CIT(Appeals) did not delve into this issue but focused on the comparative analysis, concluding that the profit margin shown by the assessee was within the tolerance band.

5. Application of the Tolerance Band Under Section 92C:
The CIT(Appeals) and the tribunal concluded that the profit margin shown by the assessee, 1.96%, was within the tolerance band of +/- 5% as provided under section 92C of the Income-tax Act. The arithmetic mean of the comparables was 6.84% in the first analysis and 5.63% in the second analysis, both within the acceptable range. Therefore, no adjustment was required.

Conclusion:
The tribunal upheld the CIT(Appeals)'s decision, dismissing the revenue's appeal. The tribunal found that the assessee's profit margin was within the tolerance band, and the adjustments made by the TPO were not warranted. The tribunal emphasized that determining the arm's length price involves some estimation and that the results shown by the assessee were reasonable and within the statutory limits.