2015 (10) TMI 2790 - AT - Income Tax

TP Adjustment - Determination of ALP under TNMM - MAM selection - Accurate adjustments if CUP method is followed - HELD THAT - There are a number of differences in the international transaction and the non AE export rates considered by the TPO for comparability analysis. As put forth by the assessee, these differences, inter alia, include impact due to adopting simple average instead of weighted average, quantity based price variation, quality based price variation, analysis cost absorption based price variation, market based price variation, key customer based price variation, forward contract based price variation etc. These differences materially affect the computation of ALP of the international transaction. Even though the assessee has computed the adjustments to be given for these differences, the same will not make the Internal CUP as the most appropriate method. Reasonably accurate adjustments cannot be made to eliminate these differences. Internal CUP fails to be a most appropriate method on the basis of facts and circumstances of the case and law applicable. DRP as to how TNMM is the most appropriate method. As rightly observed by the DRP, TNMM requires establishing comparability at a broad functional level. It requires comparison between net margins derived from the operation of the uncontrolled parties and net margin derived by an associated enterprise on similar operation. The assessee in the present case has chosen comparables in the similar industry under the TNMM. The DRP had directed the TPO to make comparability analysis under the TNMM and subsequently the TPO has not determined any TP adjustment thereby concluding that the international transactions are at ALP even under the TNMM. As concluded that the TNMM is the most appropriate method. The assessee has relied on various decisions in support of the proposition that accurate adjustments should be given if CUP method is followed. Regarding adjustments to be given under the internal CUP. Since it is held that TNMM is the most appropriate method on the basis of facts and circumstances of the case and law applicable, the decisions relied on and the assessee s cross objections are not being dealt.

Summary

Issues Involved:
1. Determination of the most appropriate method for Arm's Length Price (ALP) - Transactional Net Margin Method (TNMM) vs. Comparable Uncontrolled Price (CUP) method.
2. Adjustments and considerations under the CUP method.
3. Appropriateness of comparables selected by the assessee under TNMM.

Detailed Analysis:

Issue 1: Determination of the Most Appropriate Method for ALP
The primary issue revolves around whether the Transactional Net Margin Method (TNMM) or the Comparable Uncontrolled Price (CUP) method is the most appropriate for determining the Arm's Length Price (ALP) of international transactions. The Transfer Pricing Officer (TPO) initially rejected the TNMM adopted by the assessee and applied the internal CUP method, comparing export invoices of products with similar technical specifications. The TPO's approach was based on the belief that the assessee exported similar products to both Associated Enterprises (AEs) and non-AEs.

The Dispute Resolution Panel (DRP), however, found significant differences between the transactions compared by the TPO, such as huge time gaps, different geographical locations, and varying quantities. The DRP concluded that these differences made it impossible to make reasonable adjustments to the internal CUP adopted by the TPO and determined that TNMM was the most appropriate method based on the facts and circumstances of the case.

Issue 2: Adjustments and Considerations under the CUP Method
The TPO proposed adjustments based on the internal CUP method, which the assessee contested on several grounds:

- Quality Differences: The TPO acknowledged material differences within the same grade but deemed them 'miniscule.' The assessee demonstrated significant quality variations, such as differences in solubility and color, which materially affected pricing.
- Timing Gaps: The TPO compared transactions with significant time gaps, ranging from a single day to 260 days, without accounting for price differences due to these gaps.
- Geographical Differences: The TPO compared exports to different geographical locations without considering price fluctuations based on demand and supply in those regions.
- Quantity Variations: The TPO's analysis on quantity-based price variations was flawed. The assessee provided instances where smaller quantities were sold at lower prices as part of larger consignments, and larger quantities were sold at higher prices due to smaller shipments.

The DRP found that these differences materially affected the comparability of transactions, making the internal CUP method inappropriate. The TPO's rejection of the weighted average of comparable prices in favor of a simple average was also contested by the assessee, who argued that this resulted in excessive TP adjustments.

Issue 3: Appropriateness of Comparables Selected by the Assessee Under TNMM
The DRP directed the TPO to examine the comparability analysis of the comparables selected by the assessee under TNMM. The TPO subsequently found no adjustment required under section 92CA, leading to the deletion of the TP adjustment in the final assessment order.

The DRP emphasized that TNMM requires establishing comparability at a broad functional level, comparing net margins derived from the operations of uncontrolled parties with those derived by an associated enterprise on similar operations. The assessee had chosen comparables in the similar industry under TNMM, and the DRP found this method to be the most appropriate based on the material on record.

Conclusion
The Tribunal upheld the DRP's findings, concluding that the TNMM is the most appropriate method for determining the ALP of the international transactions in question. The revenue's appeal against the deletion of TP adjustment and the assessee's cross objections were both dismissed. The Tribunal's decision emphasized the importance of accurate adjustments and comparability in transfer pricing analysis, ultimately favoring the TNMM over the internal CUP method due to the significant differences in the transactions compared by the TPO.