2015 (7) TMI 291 - AT - Income Tax

Addition made to the price to the international transaction - Determination of arm s length price - CIT(A) deleted addition - Held that - Out of the total revenue earned by the parent company from India activity, it has transferred 76% of the revenue to the Appellant and has incurred about 20.6% of the revenue towards sales, marketing, general and administration allocable to India operations. In other words, it retains only 3.38% of the revenue which it has earned from India operations and which is the operating profit. Whereas, the Appellant has earned an operating profit of 6.63%.In respect to the finding of the TPO that the parent company is only preferring the functions of marketing and the tax payer performs all other functions, is not correct. A perusal of the chart of the ld CIT(A) clearly reveals that the parent company is exposed to Market Risk, service liability risk, technology risk, credit risk and price risk and the parent company is engaged in Research and Development (R&D) of new process/ service. So we concur with the ld CIT(A) that TPO has incorrectly stated parent company is only performing the functions of marketing. We take note that during the course of the appellate proceedings before the ld CIT(A), the assessee had filed a copy of the, transfer pricing audit conducted by the Internal Revenue Service, Department of the Treasury US. The assessee was audited by Internal Revenue Service- International Division US for the calendar years 2003, 2004 and 2005. The arithmetical mean of the weighted averages of the comparable companies as compiled by the assessee and as also referred to and accepted by the TPO in his order is 10.25%. Since the assessee s operating margins falls within ( 1) 5% of the arithmetical mean of comparable prices, Ld. CIT(A) has rightly held that the assessee s International Transactions with its associated enterprises during the year to be at Arm s Length. Consequently the addition of ₹ 3,00,60,788/-made to the price of international transaction was directed to be deleted by the ld CIT(A). For the reasons enumerated above by the ld CIT(A), she rightly deleted the addition made by the Assessing Officer on account of difference in arm s length price of ₹ 3,00,60,788/-. In the background of the aforesaid discussions, the impugned order of Ld. CIT(A) does not need any interference on our part, hence, we uphold the same - Decided against revenue.

Summary

Issues Involved:
1. Deletion of addition to the price of the international transaction.
2. Determination of arm's length price (ALP) using multiple year data versus single year data.
3. Comparison of the functions and risks between the assessee and its parent company.
4. Acceptance of comparables and rejection criteria by the Transfer Pricing Officer (TPO).

Issue-wise Detailed Analysis:

1. Deletion of Addition to the Price of the International Transaction:
The Revenue's appeal contested the deletion of Rs. 3,00,60,788 added by the Assessing Officer (AO) to the income of the assessee. The AO had enhanced the total income of the assessee based on the TPO's determination of the arm's length price (ALP) for international transactions. The CIT(A) deleted this addition, and the Tribunal upheld the CIT(A)'s decision, agreeing that the assessee's international transactions were at arm's length.

2. Determination of Arm's Length Price (ALP) Using Multiple Year Data Versus Single Year Data:
The TPO used current year data to determine the ALP, rejecting the multiple year data used by the assessee. The assessee argued that multiple year data mitigates the effects of business cycles and economic distortions, providing a more accurate reflection of the market reality. The CIT(A) agreed with the assessee, noting that multiple year data was used in previous years and should be used to determine the ALP due to the recurring nature of the projects and consistent billing rates. The Tribunal upheld this view, stating that the TPO's deviation from using multiple year data was arbitrary and unreasonable.

3. Comparison of the Functions and Risks Between the Assessee and Its Parent Company:
The TPO contended that the parent company performed only marketing functions while the assessee performed all other functions, leading to an imbalanced profit retention. The CIT(A) and the Tribunal found this assertion incorrect, noting that the parent company also faced significant risks, including market, service liability, technology, credit, and price risks, and was involved in research and development. The parent company retained only 3.38% of the revenue from Indian operations, while the assessee earned an operating profit of 6.63%, indicating a fair distribution of profits relative to the functions and risks borne by each entity.

4. Acceptance of Comparables and Rejection Criteria by the Transfer Pricing Officer (TPO):
The TPO rejected certain comparables based on nil or low foreign exchange earnings, which the CIT(A) found inconsistent as the TPO included some companies with similar earnings in his comparables list. The CIT(A) accepted the comparables provided by the assessee, noting that the arithmetic mean of the weighted averages of the comparable companies was 10.25%, and the assessee's operating margins fell within the permissible range of +/- 5% of this mean. The Tribunal upheld the CIT(A)'s decision, affirming that the assessee's international transactions were at arm's length and the addition made by the AO was rightly deleted.

Conclusion:
The Tribunal dismissed the Revenue's appeal, upholding the CIT(A)'s decision to delete the addition of Rs. 3,00,60,788 to the price of the international transaction. The Tribunal agreed with the use of multiple year data for determining the ALP, recognized the fair distribution of profits relative to the functions and risks between the assessee and its parent company, and accepted the comparables used by the assessee. The Tribunal found no need to interfere with the CIT(A)'s order, concluding that the assessee's international transactions were at arm's length.