2015 (1) TMI 699 - AT - Income Tax

Transfer pricing adjustments - arms length price - Assessee considered Transactional Net Margin Method ( TNMM ) as Most Appropriate Method and selected Operating Profit to Total Cost ( OP/TC ) margin as Profit Level Indicator - selection of comparables - whether to include the results of M/s Dolphin Medical Services Ltd. or not? - Held that - Results of Dolphin should not be excluded, as Dolphin is functionally acceptable comparable, whereby, the resultant PLI shall fall within safe harbor of /-5 and no adjustment shall be required. Risk adjustment - Held that - We direct the revenue authorities to delete the addition made on contract research and development segment, made at ₹ 2,04,84,562/-. TNMM method selection - Held that - The assessee as well as the AE operates in a perfectly competitive market and the assessee does not have exclusive access to the factors that may result in the location specific advantages. As a result, there is no super profit that arises in the entire supply chain. Thus there is no unique advantage to the assessee over competitors. We are basing our opinion on the fact that the revenue authorities were not able to substantiate the adjustments made either from the present day scenario or any authenticated and globally material.Thus, once the TNMM method is accepted as method of considering assessee as a tested party then any benefit/advantage accruing to AE is irrelevant if the PLI is within the range of comparables. TPO has based his computation on a method, which is not ascribed by the provisions of the Act. Adjustment on account of location savings - Held that - No doubt, clause (f) of section 92C(1) says, such other method as may be prescribed by the Board . For adoption of this method, the TPO has to take care that the method has to be prescribed by the Board, which can do so through relevant Rules. Even relevant Rules do not talk about the method adopted by the revenue authorities. This, in unison with the decision of the coordinate Bench on incorrect method of computation, we are of the view that the TPO/AO and DRP erred in making the adjustment on account of location savings. We, therefore, set aside the order of the DRP and direct the AO to delete the addition. Direction to the revenue authorities to make adjustments, taking into account the safe harbor range of /- 5% - Held that - Since the safe harbor range has been allowed by the legislature itself, the revenue authorities are bound to follow the same.Since we have set aside the order of the DRP, we, direct the AO to consider the safe harbor zone and compute the income accordingly. Disallowing interest income of ₹ 2,10,65,566/- for the purposes of computing deduction u/s 10B - Held that - In such a situation where the incomes sought to be taxed are intrinsically connected to the business of the assessee and also that provisions falling under section 10A & 10B form a code within the code, we are of the opinion that no disallowance is called for. We therefore, set aside the order of the DRP and direct the AO to compute the deduction, taking into account the interest income as well as sale scrap as business income. - Decided partly in favour of assessee.

Issues Involved:

1. Determination of Arm's Length Price (ALP) for international transactions.
2. Rejection of comparables by Transfer Pricing Officer (TPO).
3. Adjustment on account of location savings.
4. Inclusion of interest income for computing deduction under Section 10B.
5. Initiation of penalty under Section 271(1)(c).
6. Set-off of unabsorbed depreciation against profits of eligible units.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for International Transactions:

The assessee, a wholly owned subsidiary of a US-based company, engaged in contract manufacturing and R&D services, justified its ALP using the Transactional Net Margin Method (TNMM). The assessee identified comparable companies and computed mean profit margins, arguing that its transactions were within the arm's length range. The TPO, however, altered the comparables and computed a higher mean profit margin, leading to an adjustment of Rs. 1.93 crores.

2. Rejection of Comparables by TPO:

The TPO rejected four of the comparables provided by the assessee, citing reasons such as different functional profiles and related party transactions. The TPO selected new comparables, resulting in a higher mean profit margin. The ITAT found that the TPO did not provide sufficient reasons for rejecting the comparables and emphasized the importance of functional similarity over quantity. The ITAT included Dolphin Medical Services Ltd. as a comparable, which brought the assessee's margin within the permissible range, thus eliminating the need for adjustment.

3. Adjustment on Account of Location Savings:

The TPO made adjustments for location savings, arguing that the transfer of manufacturing to India resulted in cost savings. The TPO allocated these savings between the assessee and its AE, leading to a significant adjustment. The ITAT, however, found that the TPO's calculations were based on assumptions and not supported by reliable data. The ITAT emphasized that the assessee operated in a competitive market and did not have exclusive access to location-specific advantages. The ITAT concluded that location savings should not be separately adjusted if local comparables are used, and directed the deletion of the adjustment.

4. Inclusion of Interest Income for Computing Deduction under Section 10B:

The AO excluded interest income and income from the sale of scrap from the computation of deduction under Section 10B, treating them as income from other sources. The ITAT, relying on judicial precedents, held that such incomes, being intrinsically connected to the business, should be included in the computation of business income for Section 10B purposes. The ITAT directed the AO to include these incomes in the computation.

5. Initiation of Penalty under Section 271(1)(c):

The assessee's objection to the initiation of penalty proceedings under Section 271(1)(c) was deemed premature by the ITAT, and hence, the ground was rejected.

6. Set-off of Unabsorbed Depreciation Against Profits of Eligible Units:

The department argued that unabsorbed depreciation of another eligible unit should be set off against the profits of the Goa unit before allowing deduction under Section 10B. The ITAT, following the decision of the Bombay High Court in the case of Black & Veatch Consulting Pvt Ltd., held that such set-off is not permissible. The ITAT rejected the department's grounds and upheld the DRP's order allowing the deduction without set-off.

Conclusion:

The ITAT partly allowed the assessee's appeal, directing the deletion of adjustments made on account of location savings and inclusion of interest income for Section 10B deduction. The department's appeal was dismissed, upholding the DRP's order on the set-off issue. The penalty proceedings under Section 271(1)(c) were deemed premature.

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