2015 (10) TMI 1747 - AT - Income Tax

Transfer pricing adjustment - rejecting the methodology followed by the assessee for benchmarking of international transactions - TNMM v/s CUP method - Held that - The associate enterprises segment also includes controlled transactions, wherein material imported had been used for manufacturing geysers / water heaters, which in turn, were sold both to associate enterprises and non-associate enterprises. All these above said explanations have been rejected by the TPO/DRP without any basis, wherein similar explanation has been accepted by the TPO itself in all the other years. The conduct of the business and the products manufactured are identical in the year under consideration, when compared to the other years i.e. assessment year 2005-06, 2007-08, 2008-09 and 2010-11. In the entirety of the above said facts and circumstances, we are of the view that the adoption of TNMM method was the most appropriate method for benchmarking international transactions with its associate enterprises and we find no merit in the order of Assessing Officer in adopting CUP method to benchmark the international transactions with its associate enterprises. We hold that the TNMM method should be applied on aggregate basis for benchmarking international transactions of the assessee. Benchmarking international transactions with its associate enterprises on aggregate basis, TNMM method should be applied and since the margins declared by the assessee are higher than the margins declared by the comparables picked up by the assessee in its TP study report and consequently, the international transactions entered into by the assessee with its associate enterprises being at arm s length price, no addition is warranted in the hands of the assessee. Accordingly, we delete the addition. - Decided in favour of assessee.

Issues Involved:
1. Transfer Pricing Adjustment
2. Rejection of Benchmarking Analysis
3. Inappropriate Approach Adopted by the TPO
4. Incorrect Application of Cost Plus Method (CPM)
5. Disregard of Rule 10B(2) and Rule 10B(3)
6. Benefit of Variation/Reduction of 5%
7. Initiation of Penalty Proceedings

Detailed Analysis:

1. Transfer Pricing Adjustment:
The core issue in the appeal was the transfer pricing adjustment amounting to Rs. 6,82,60,528 made by the TPO and applied by the Assessing Officer. The assessee was aggrieved by the rejection of the methodology it followed for benchmarking international transactions, which had been accepted in preceding and succeeding assessment years.

2. Rejection of Benchmarking Analysis:
The TPO rejected the aggregation methodology followed by the assessee for its manufacturing activity without providing a cogent basis or establishing deficiencies in the documentation as required under section 92C(3) of the Income-tax Act, 1961. The TPO also rejected the TNMM as the "Most Appropriate Method" and the independent comparable companies selected by the assessee without providing cogent reasons.

3. Inappropriate Approach Adopted by the TPO:
The TPO selected the Cost Plus Method (CPM) as the "Most Appropriate Method" for benchmarking the international transactions of export of water heaters and spares, using internal comparables with controlled transactions. The TPO's approach did not appreciate the significant and material differences in functions, assets, and risks between the transactions.

4. Incorrect Application of CPM:
The TPO wrongly applied CPM, ignoring section 92C of the Income-tax Act, 1961 read with Rule 10B(1)(C) of the Income-tax Rules, 1962, which warrants comparison of "Normal Gross Profit Mark Up" on "Direct and Indirect Cost of Production." The TPO's calculation mechanism was faulty as it compared unadjusted "Gross Profit" to "Cost of Goods Sold" and stated that marketing functions represented by their operating expenses do not affect the gross profit margin.

5. Disregard of Rule 10B(2) and Rule 10B(3):
The TPO disregarded the comparability factors specified under Rule 10B(2) and the provisions contained in Rule 10B(3) that specify adjustments for differences between transactions that may materially affect the price. The TPO did not allow adjustments for significant and material differences in functions performed, assets employed, and risks assumed by the assessee.

6. Benefit of Variation/Reduction of 5%:
The TPO, pursuant to the directions of DRP, did not grant the benefit of the variation/reduction of 5% from the arithmetic mean as provided in the proviso to Section 92C(2) of the Act while determining the arm's length price for the adjustments made to the international transactions of the assessee.

7. Initiation of Penalty Proceedings:
The TPO proposed to initiate penalty proceedings under section 271(1)(c) of the Act without considering that the adjustment to transfer price was due to a difference of opinion regarding the application of selection criteria for comparable companies and the computation of arm's length price.

Judgment:
The Tribunal held that the TNMM method should be applied on an aggregate basis for benchmarking international transactions of the assessee. The Tribunal found no merit in the order of the Assessing Officer adopting the CPM method. The Tribunal emphasized the principle of consistency, noting that the TNMM method had been accepted by the TPO in preceding and succeeding years. The Tribunal also referenced similar cases like John Deere India (P.) Ltd. Vs. DCIT and M/s. Drilbits International P. Ltd. Vs. DCIT, where the TNMM method was upheld. Consequently, the Tribunal deleted the addition of Rs. 6,82,60,528 and allowed the appeal of the assessee.

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