2015 (7) TMI 477 - AT - Income Tax

Transfer Pricing Adjustment - CIT(A) restricted addition - selection of comprables - Held that - CIT(A) had followed the ratio laid down in the case of Global Ventedge P. Ltd. (2009 (12) TMI 668 - ITAT DELHI ) wherein held that adjustment on account of arm s length price of international transactions cannot exceed the amount received by the associated enterprise from the customer and the actual value of international transactions, i.e., the amount received by the assessee in respect of international transactions. This decision was affirmed by both Hon ble High Court and Hon ble Supreme Court and his ratio was followed in subsequent decisions as submitted earlier and, therefore, the order of Ld. CIT(A) on this issue is reasonable and we do not find any reason to interfere with this finding of Ld. CIT(A) - Decided against revenue. TPO - Computation of Operating Profit Margin of the appellant - Held that - There is force in the argument of Ld. Counsel for the assessee that while calculating operating cost, the abnormal cost incurred on account of start-up should be excluded. Following the same parity of reasoning in the cases cited by him and keeping in view that the judgement of ITAT co-ordinate Bench in the case of Transwitch India (2012 (5) TMI 314 - ITAT DELHI) affirmed by Hon ble Delhi High Court. Therefore, respectfully following the decision of Hon ble High Court, we direct TPO / A.O. to adjust operating cost by excluding abnormal cost incurred on account of start-up company like salary, rent and depreciation. This matter is restored to the file of TPO/A.O. to re-determine the operating cost on the above lines to arrive at operating profit.- Decided in favour of assessee for statistical purposes.

Issues Involved:
1. Transfer Pricing Adjustment (TPA) for the Assessment Year 2003-04.
2. Restriction of TPA to gross revenue receipts by the associate enterprises from its customers.
3. Adjustment of operating profit and selection of comparables.
4. Adjustment for idle capacity and start-up costs.

Detailed Analysis:

1. Transfer Pricing Adjustment (TPA) for the Assessment Year 2003-04:
The primary issue in the cross appeals filed by the assessee and the Revenue pertains to the TPA determined by the Transfer Pricing Officer (TPO) for the Assessment Year 2003-04. The TPO computed an adjustment of Rs. 17,03,05,993 based on the arm's length operating profit to the total cost ratio of 13.56%, derived from eight comparable companies.

2. Restriction of TPA to Gross Revenue Receipts by the Associate Enterprises from its Customers:
The CIT(A) restricted the TPA to Rs. 1,19,60,457, which was the amount retained by the associated enterprises from the gross revenue received from end customers. The CIT(A) held that the adjustment computed by the TPO cannot exceed the net amount retained by the associated enterprises. This decision was based on the principle that the adjustment on account of arm's length price of international transactions cannot exceed the amount received by the associated enterprise from the customer and the actual value of international transactions.

3. Adjustment of Operating Profit and Selection of Comparables:
The assessee contended that the approach of taking a weighted average of its operating margins over a period of five years was in conformity with OECD guidelines for start-up companies. The TPO, however, considered only the data for the relevant financial year. The CIT(A) upheld the TPO's approach but restricted the adjustment to the amount retained by the associated enterprises. The Tribunal affirmed this decision, citing precedents where adjustments were limited to the actual value of international transactions.

4. Adjustment for Idle Capacity and Start-Up Costs:
The assessee argued that as a start-up enterprise, it incurred extraordinary expenses and underutilized capacity, which should be adjusted while computing the operating margins. The Tribunal found merit in this argument and directed the TPO/A.O. to adjust the operating cost by excluding abnormal costs incurred due to the start-up phase, such as salary, rent, and depreciation. The Tribunal cited several cases where adjustments for idle capacity and start-up costs were allowed, emphasizing the need for accurate adjustments to reflect true operating margins.

Conclusion:
The Tribunal upheld the CIT(A)'s decision to restrict the TPA to Rs. 1,19,60,457, the amount retained by the associated enterprises, and directed the TPO/A.O. to adjust the operating cost by excluding abnormal start-up costs. The Tribunal's decision was based on established precedents and the principle of ensuring that the TPA does not exceed the actual value of international transactions. The appeal filed by the Revenue was dismissed, and the appeal filed by the assessee was partly allowed for statistical purposes.

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