2022 (2) TMI 1446 - AT - Income Tax

TP Adjustment - adoption of appropriate PLI for benchmarking and determining the arms length nature of the international transactions undertaken by the assessee company with its associated enterprises - Applying Berry Ratio with OP/VAE as PLI under TNMM disregarding the manufacturing activities of the assessee - assessee has adopted Gross Profit Margin/Cost of Production as the PLI whereas the TPO has applied Operating Profit/Value Added Expenses as an appropriate PLI for benchmarking the international transactions with the associated enterprises. HELD THAT - In the light of above OECD and UN guidelines and domestic jurisprudence for the applicability of appropriate PLI or for that matter Berry ratio in the instant case what is therefore relevant to determine is the profile of the assessee company in terms of functions performed assets employed and related risk undertaken by it. In this regard we refer to the Transfer Pricing Report submitted by the assessee before the Transfer Pricing Officer wherein the profile of the assessee company has been described it is relevant to note that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the fact rather there is an categorical affirmation that the assessee is engaged in the business of manufacture and export of colored stones and studded jewellery and has manufacturing units in Jaipur and Mumbai. It has the necessary manufacturing set up with requisite assets and infrastructure in place which are employed. The associated enterprises perform substantial part of marketing sales and distribution functions. The assessee takes all types of risk such as inventory risk credit collection Risk product risk manpower risk market risk (to limited extent) technology risk general business risk and foreign exchange risk. Therefore we donot find any infirmity in assessee being classified as a manufacturer performing all the entrepreneurial functions. It is again noted that the TPO while issuing the show cause notice as well as while proposing the adjustment as well as the DRP has not disputed the functions performed the assets employed and the risk undertaken (nature and extent thereof) by the assessee while carrying out its business of manufacture and export of colored stones and studded jewellery. Moving further if we look at the international transactions undertaken by the assessee which are subject matter of examination before us the same relates to import of gems stones rough diamonds and other raw material from its associated enterprises as well as export of gems stones and studded jewellery to its associated enterprises. For the purposes the assessee has considered the Cost Plus Method as the most appropriate method for determining the arms length and has adopted Gross Profit/COP as the appropriate Profit Level Indicator and accordingly has carried out the benchmarking analysis with independent third party comparables. The assessee thereafter carrying out the search procedure for independent comparable companies and selecting the comparables has determined yearly average gross margin of 8.95% of cost of production (GP/COP) and given its GP/COP of 15.62% has determined its sales transactions to its associated enterprises which constitute 88.34% of total sales at arm s length. The TPO however has not agreed with the PLI so adopted by the assessee company and has adopted OP/VAE as the appropriate PLI. The reasoning adopted by the TPO is that as the assessee is purchasing from related parties and selling to related parties both cost and revenue sides are tainted and in such a scenario OP/COP will not be an appropriate PLI and OP/VAE has then been adopted by him. The DRP has upheld the reasoning so adopted by the TPO drawing reference to the decision of Sumitomo Corporation ( 2016 (7) TMI 1055 - DELHI HIGH COURT where use of berry ratio in certain situations has been upheld even though the Income Tax Act doesn t specifically provide for either the Berry ratio or the bright line test. We therefore find that in the facts of the present case the approach adopted by the TPO is bereft of the factual position of the assessee in terms of functions performed the assets employed and risk undertaken while carrying out its manufacturing and export activities and the approach so adopted is also not in consonance with the approach so suggested by OCED and UN and the decisions of the Hon ble Delhi High Court and the Coordinate Benches and therefore the adoption of berry ratio as an appropriate PLI is not justified in the instant case. Cost Plus Method as the most appropriate method confirmed for determining the arms length and Gross Profit/COP as the appropriate Profit Level Indicator Selection of comparables and application of the PLI (i.e. Gross Profit margin / Cost of production) - Taking into consideration the comparables so selected by the TPO where the median OP/COP comes to 12.90% and given that the assessee has reported OP/COP of 13.51% we find that the assessee s transactions with its associated enterprises meets the arms length requirements and no adjustment is warranted. Therefore following the approach so suggested by OECD/UN transfer pricing guidelines the transfer pricing adjustment is hereby directed to be deleted. Decided in favour of assessee.

Summary

Issues Involved:

1. Assessment of total income.
2. Transfer pricing adjustment.
3. Rejection of economic analysis in TP documentation.
4. Rejection of Cost Plus Method (CPM) and application of Berry ratio.
5. Violation of Rule 10B(2) by rejecting certain comparables.
6. Application of new filters and introduction of new comparables.
7. Correct computation under Berry Ratio.
8. Benefit of proportionate adjustment.
9. Denial of natural justice.
10. Levy of interest u/s 234A/234B/234C.
11. Initiation of penalty proceedings u/s 274 r/w 271(l)(c).

Summary:

Assessment of Total Income: The assessee contested the assessment of total income at INR 57,36,47,429 against the returned income of INR 28,11,30,040.

Transfer Pricing Adjustment: The Transfer Pricing Officer (TPO) proposed and the Assessing Officer (AO) confirmed a transfer pricing adjustment of INR 29,25,17,385 for international transactions with Associated Enterprises (AEs), which was upheld by the Dispute Resolution Panel (DRP).

Rejection of Economic Analysis in TP Documentation: The TPO, AO, and DRP rejected the economic analysis carried out by the assessee in its Transfer Pricing (TP) documentation prepared in compliance with Section 92D of the Act read with Rule 10D of the Rules.

Rejection of Cost Plus Method (CPM) and Application of Berry Ratio: The TPO rejected the Cost Plus Method (CPM) considered by the assessee as the Most Appropriate Method (MAM) and applied the Berry ratio with Operating Profit/Value Added Expenses (OP/VAE) as the PLI under the Transactional Net Margin Method (TNMM). The DRP upheld this application.

Violation of Rule 10B(2) by Rejecting Certain Comparables: The TPO, AO, and DRP were found to have violated Rule 10B(2) by rejecting certain functionally comparable companies identified by the assessee in its TP documentation.

Application of New Filters and Introduction of New Comparables: The TPO, AO, and DRP introduced new filters and comparables without sharing the entire search process with the assessee.

Correct Computation under Berry Ratio: The TPO, AO, and DRP disregarded the assessee's submissions for considering the correct computation of OP/VAE under the Berry Ratio for the assessee as well as the alleged comparable companies.

Benefit of Proportionate Adjustment: The TPO, AO, and DRP did not allow the benefit of proportionate adjustment to the assessee, restricting the adjustment to the value of international transactions.

Denial of Natural Justice: The TPO did not provide an opportunity for hearing/responding to the show-cause notice proposing the impugned transfer pricing adjustment, and the DRP rejected the assessee's objections on this ground, denying the principle of natural justice.

Levy of Interest u/s 234A/234B/234C: The AO erred in levying interest under section 234A/234B/234C of the Act.

Initiation of Penalty Proceedings u/s 274 r/w 271(l)(c): The AO erred in initiating penalty proceedings under Section 274 read with Section 271(l)(c) for concealment/furnishing inaccurate particulars of income.

Decision:

The Tribunal found that the TPO's adoption of the Berry ratio was inappropriate given the assessee's manufacturing activities. The Tribunal upheld the use of the Cost Plus Method (CPM) with Gross Profit/Cost of Production (GP/COP) as the appropriate PLI. The transfer pricing adjustment of Rs 29,25,17,385/- was directed to be deleted, and the appeal of the assessee was allowed.