2012 (5) TMI 414 - AT - Income Tax

Transfer pricing - arm s length price - Order of DRP u/s 144C - selection of comparable - According to the assessee, it is a small public limited company and cannot be compared with the companies whose turnover is large - held that - neither the assessee in its TP report nor the TPO in the TP order have spelt out the functions performed, risk borne and assets used by the assessee as well as associated enterprises. Function and risk assessment has not been performed between the assessee and the comparable companies. Any difference in the function and risk which will affect profitability ought to be identified and adjustment made to arrive at the ALP. Without analysis of the above, we are of the view that the choice of comparable companies itself would become questionable. Overall profitability cannot be taken as a yardstick but if transactions or set of transactions undertaken by the assessee and the comparable companies are substantially the same, there can be no objection to applying the overall profitability. However proper adjustments have to be made to the margin arrived at by the AO for any differences at transaction level between the transaction of the assessee and that of the comparable companies. Appeal allowed by way of remand.

Issues Involved:
1. Direction by the Dispute Resolution Panel (DRP) to make an addition under Section 92C(4) of the Income Tax Act, 1961.
2. Alleged arbitrary rejection of the appellant's claims by the DRP.
3. Establishment of Arms Length Price (ALP) and comparability of transactions.
4. Consistency in tax treatment across different assessment years.
5. Estimation of operating margin and corresponding addition.
6. Levy of interest under Section 234B of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Direction by the DRP to make an addition under Section 92C(4) of the Income Tax Act, 1961:
The appellant contested the DRP's directive to the Assessing Officer (AO) to add Rs. 1,71,28,081/- under Section 92C(4). The DRP upheld the AO's adoption of the Transfer Pricing Officer's (TPO) findings, which determined the Arm's Length Price (ALP) using the Transactional Net Margin Method (TNMM) instead of the Comparable Uncontrolled Price (CUP) method initially used by the appellant. The TPO found the appellant's operating margin of 10.16% to be lower than the average margin of 20.68% of comparable companies, leading to the proposed adjustment.

2. Alleged arbitrary rejection of the appellant's claims by the DRP:
The appellant argued that the DRP did not address the issues raised during the hearing and arbitrarily rejected their claims. The DRP's directions were claimed to be contrary to the law, as they did not consider the appellant's evidence and arguments adequately. The Tribunal noted that the DRP upheld the AO's draft assessment without substantial engagement with the appellant's contentions.

3. Establishment of Arms Length Price (ALP) and comparability of transactions:
The appellant argued that the transactions with Trigent Software Inc. (TSI) were at arm's length, as there was no margin retained by TSI. The TPO, however, rejected the CUP method due to geographical and contractual differences and adopted the TNMM. The TPO compared the appellant's operating margin with those of 20 other companies and found it lower, justifying the addition. The Tribunal observed that the TPO did not adequately consider the functions performed, risks borne, and assets used by the appellant and the comparable companies, which is crucial for a proper ALP determination.

4. Consistency in tax treatment across different assessment years:
The appellant highlighted that in earlier assessment years, similar pricing models were accepted by the Revenue without adjustments. The Tribunal emphasized the importance of consistency in tax treatment and noted that the TPO's deviation in the current assessment year was not justified without substantial reasons.

5. Estimation of operating margin and corresponding addition:
The TPO estimated the appellant's operating margin at Rs. 3,78,08,119/-, leading to an addition of Rs. 1,71,28,081/-. The Tribunal found that the TPO's approach of using overall operating profits of comparable companies without necessary adjustments was flawed. The Tribunal cited precedents where such methods were deemed inappropriate without considering functional and risk differences.

6. Levy of interest under Section 234B of the Income Tax Act, 1961:
The appellant contested the levy of interest under Section 234B amounting to Rs. 22,41,807/-. The Tribunal did not specifically address this issue in detail, as the primary focus was on the correctness of the ALP determination and the resultant adjustments.

Conclusion:
The Tribunal concluded that the determination of ALP was not done in accordance with the law. It set aside the impugned order and directed the AO to reconsider the objections raised by the appellant, determine the ALP after obtaining a fresh report from the TPO, and ensure proper adjustments for differences at the transaction level. The appeal was allowed for statistical purposes, and the addition related to local sales was directed to be deleted.

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