2014 (12) TMI 467 - AT - Income Tax

Transfer pricing adjustment - Determination of ALP of international transactions - Sale of stitched bond fabric - Evaluation of a taxpayer s separate and combined transactions Held that - Assessee rightly contended that under CUP approach, same period transactions ought to be compared so that correct benchmarking takes place - export sales rates in the month of March-2007 have increased drastically - for a correct benchmarking, transactions of March-2007 ought to have been ignored - sales to non-Associated Enterprises after 2-2-2007 should have been ignored - there are no. of instances wherein, the prices charged to the Associated Enterprises party are higher than prices charged to the non-Associate Enterprise party - Though yearly average is a good and reasonable indicator for benchmarking under the CUP approach, a transaction based benchmarking approach should not be rejected, and especially in such cases where, rejection of a transaction-based benchmarking may lead to some distortion - like has to be compared with like - In fact, natural process of benchmarking itself calls for ignoring that period when, supplies are not made either to Associated Enterprises party or non-Associated Enterprises party - Further, if March-07 supplies are removed from the yearly benchmarking average, even yearly average rates become comparable and within the permissible 5% variation scope as follows thus, the additions made by the TPO is set aside Decided in favour of assessee.

Summary

Issues:
1. Transfer Pricing adjustments made by the tax authorities.
2. Benchmarking of sales transactions with associated enterprises.
3. Rejection of adjustments sought by the appellant.
4. Application of arm's length principle in international transactions.
5. Evaluation of benchmarking methods.

Transfer Pricing Adjustments:
The appeal challenged the ACIT's decision to refer the case to the TPO without forming an opinion under section 92C(3) of the ITA, 1961. The DRP upheld the addition to the appellant's income on the sale of finished goods to AE parties as proposed by the TPO. The appellant contested the lack of appreciation for benchmarking sales transactions to AE parties under various approaches, highlighting the distorted picture due to unequal comparisons. The appellant also objected to the lack of independent assessment by the DCIT in passing the order under section 143(3) r.w.s. 144C.

Benchmarking of Sales Transactions:
The appellant, engaged in manufacturing stitch bonded fabric, conducted international transactions with AE and non-AE parties. The pricing of stitched bond fabric was based on factors like petroleum price, yarn price, and global market conditions. The appellant made adjustments for selling and marketing expenses and credit risk during the benchmarking process. However, the TPO rejected the benchmarking, leading to proposed additions to the appellant's income. The DRP reduced the adjustment but did not grant other adjustments sought by the appellant.

Rejection of Adjustments:
The appellant's requests for adjustments related to marketing functions, working capital difference, and volume discount in the transfer pricing of international transactions were rejected by the DRP. The appellant argued for a more rational transaction-based approach to benchmarking, emphasizing the fluctuating nature of market prices and the lack of fixed prices.

Application of Arm's Length Principle:
The appellant's representative argued for a transaction-by-transaction comparison under the CUP approach, highlighting the need to ignore certain periods for correct benchmarking. The appellant's detailed benchmarking, supported by OECD commentary, demonstrated instances where prices to AE parties were higher than non-AE parties. The appellant's approach was deemed more appropriate than the yearly average method, leading to the allowance of the appeal and the direction to delete the additions proposed by the TPO and sustained by the DRP.

Evaluation of Benchmarking Methods:
The judgment emphasized the importance of comparing like transactions and the need for transaction-based benchmarking in certain cases to avoid distortion. The court upheld the appellant's submission, noting the comparability of prices charged to AE and non-AE parties and the potential distortion in yearly average rates. The judgment concluded by allowing the appeal and directing the revenue to delete the proposed additions.

This detailed analysis of the judgment highlights the key issues, arguments presented by the appellant, decisions of the tax authorities, and the court's reasoning in allowing the appeal based on the application of the arm's length principle and appropriate benchmarking methods.