2012 (12) TMI 93 - AT - Income Tax

Determination of arm s length price - rule of consistency Held that - External comparable prices for the impugned assessment year 2006-07 supplied by the assessee, when accepted by the Assessing Officer for the assessment year 2007- 08, must be accepted for that year in view of the absence of material facts and also in view of the rule of consistency - rule of consistency is relevant to Income-tax matters and Assessing Officer cannot be ignore the same - appeal filed by the assessee is allowed for statistical purposes

Issues Involved:
1. Confirmation of the Transfer Pricing Officer's (TPO) order by the Dispute Resolution Panel (DRP).
2. Rejection of two comparable companies by the DRP/TPO.
3. Emphasis on functional comparability over product comparability.
4. Inconsistent application of product criteria for selecting comparable companies.
5. Consideration of only one company as comparable without adjustments for material differences.
6. Rejection of additional comparables fulfilling closer product comparability criteria.
7. Classification of Preliminary expenses, Donation, and Interest expense as operating in nature.
8. Non-application of the amended proviso to section 92C of the Act for A.Y. 2006-07.
9. Violation of principles of natural justice by not providing the opportunity to submit evidence.
10. Failure to meet preconditions for making a reference to the TPO and not providing an opportunity of being heard.

Detailed Analysis:

1. Confirmation of the TPO's Order by the DRP:
The appeal was directed against the order passed by the Assessing Officer (AO) dated 25th October 2010, pursuant to the directions issued by the DRP dated 29th September 2010. The assessment order was passed under section 143(3) read with Section 144C of the Income-tax Act, 1961. The main addition in the appeal was a transfer pricing adjustment of Rs. 2,68,77,839/-.

2. Rejection of Two Comparable Companies:
The DRP/TPO erred in rejecting two comparable companies, Gadage Mahalaxmi and Handicrafts & Handloom, based on incorrect facts. Gadage Mahalaxmi was excluded on the ground that it derived only rental income, and Handicrafts & Handloom was rejected as it primarily dealt in silver and gold jewelry.

3. Emphasis on Functional Comparability:
The DRP/TPO was criticized for not placing higher reliance on functional comparability vis-a-vis product comparability while applying the Transactional Net Margin Method (TNMM) as the most appropriate method.

4. Inconsistent Application of Product Criteria:
The DRP/TPO applied product criteria inconsistently while selecting comparable companies. For instance, companies dealing in different products like plywood, particle board, and veneers were rejected, while Gratex Industries, dealing in decorative paper and similar products, was accepted.

5. Consideration of Only One Comparable Company:
The TPO considered only Gratex Industries as comparable, with an OP/TC of 8.26%. After giving credit to the margin earned by the assessee, the difference in the Arm's Length Price (ALP) was found to be 6.81%, resulting in an adjustment of Rs. 2,68,77,839/-.

6. Rejection of Additional Comparables:
The DRP/TPO erred in rejecting additional comparables that fulfilled the criterion of closer product comparability. The assessee suggested using comparables selected by the TPO in subsequent years (2007-08 and 2008-09), which had operating margins ranging from -27.16% to 9.10%.

7. Classification of Expenses as Operating in Nature:
The DRP/TPO erred in considering Preliminary expenses, Donation, and Interest expense as operating in nature while computing the operating margins of the assessee.

8. Non-application of Amended Proviso to Section 92C:
The DRP/TPO erred in not directing the TPO to allow an upward variation of 5% in determining the arm's length price, as the amended proviso to section 92C of the Act was not applicable to A.Y. 2006-07.

9. Violation of Principles of Natural Justice:
The TPO violated the principles of natural justice by not providing the assessee an opportunity to submit evidence to support the arm's length nature of international transactions.

10. Failure to Meet Preconditions for TPO Reference:
The AO erred in not meeting the preconditions for making a reference to the TPO under section 92 CA (1) of the Act and in not providing an opportunity of being heard before referring the transfer pricing issues to the TPO.

Conclusion:
The ITAT, considering the principle of consistency and the decision of the co-ordinate Bench of Pune ITAT in the case of Brintons Carpets Asia P. Ltd. vs. DCIT, restored the issue to the file of the AO for redetermination of the arm's length price. The AO was directed to re-compute the arm's length price based on comparables selected by the TPO in subsequent years, where suitable comparables were found and applied. The appeal was allowed for statistical purposes only.

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