2016 (3) TMI 718 - AT - Income Tax

Transfer pricing adjustment - Berry ratio selected as most appropriate method for determining the ALP - Held that - Considering the facts of the case we are in total agreement with the view of the Revenue on the issue of accepting Berry ratio as the most appropriate method for determining the ALP in the case of the assessee as the contention of the Revenue that the assessee is indulging in value added service to its AEs along with distribution activities is unquestionable. Since the Tribunal on several occasions has accepted the Berry ratio, the contention of the Ld. A.R. that the same cannot be applied as per Rule 10B(1C) of the Rules, is not acceptable. In the case of the assessee company it was not a routine purchase and sale transactions but immense activities were performed in order to bring awareness of the existence of the AE s products and the AE. Therefore, the contention of the Ld. A.R. that Resale Price Method is most appropriate method cannot be accepted.We also make it clear that since the assessee had incurred abnormal expenses for specific activities conducted by the assessee for the predominant benefit of the assessee s AEs, the decisions cited by the Ld. A.R. are rejected because in those cases only routine expenses were incurred unlike the case of the assessee. - Decided against assessee Non providing adjustments on account of differences in working capital - Held that - DRP agreed with the view that adjustments has to be granted for eliminating material effects, if any, arising out difference in working capital between the tested party and comparables. It was the contention of the assessee that it was having negative working capital as against substantial positive working capital enjoyed by the comparables. Ld. DRP observed that the assessee has not demonstrated as to how the negative working capital of the assessee has affected its margin. Since the assessee was not able to justify the adjustments that were required to be made on account of negative working capital the Ld. DRP did not give effect to working capital adjustments. Before us also the Ld. A.R was not able to justify its stand on working capital adjustments in the case of the assessee with any tangible materials on record. Therefore, we do not have any other option but to reject the claim of the assessee - Decided against assessee Adjustments on account of foreign exchange fluctuations - Held that - since the Tribunal on the earlier occasion has already recognized adjustments towards foreign exchange fluctuations, the same ratio has to be applied in the case of the assessee. Accordingly, we hereby direct the Ld. Assessing Officer to make adjustments on account of foreign exchange fluctuations in the case of the assessee. - Decided in favour of assessee

Summary

Issues Involved:
1. Rejection of the Resale Price Method (RPM) as the Most Appropriate Method (MAM) and acceptance of Berry ratio as the MAM.
2. Not providing adjustments on account of differences in working capital.
3. Adjustments on account of foreign exchange fluctuations.

Detailed Analysis:

1. Rejection of the Resale Price Method (RPM) as the Most Appropriate Method (MAM) and acceptance of Berry ratio as the MAM:
The assessee applied RPM, arguing it is suitable where the reseller does not add substantial value to the product. However, the TPO rejected RPM for several reasons:
- The assessee provided value-added services to its AEs.
- The cost of these services was substantial and interlinked with distribution functions.
- The functions assumed by the assessee were manifold and disproportionate to the remuneration received.
- The contractual terms were not appropriately set to benchmark transactions using RPM.
- Comparables selected by the assessee were not truly comparable without analyzing value-added costs.
- The assessee incurred high costs such as advertisement and warranty, indicating higher risks and necessitating higher margins, which were not reflected.
- The market research activities were not maintained as a separate segment with proper apportioning of overheads.

The TPO adopted the Berry ratio, considering it suitable for routine distributors and service providers, ensuring that the distributor earns a return commensurate with the distribution service performed. The DRP upheld this view, noting that the RPM is not suitable where the reseller adds substantial value to the product. The DRP also found that the Berry ratio was appropriate, as it evaluates the return on value-added expenses, aligning with the functions performed by the assessee.

The Tribunal agreed with the Revenue, noting the significant expenses incurred by the assessee on advertisement and marketing, which were disproportionate to the profits earned. The Tribunal emphasized that the assessee's activities were closely interlinked with the distribution of the AEs' products, justifying the use of the Berry ratio to determine the ALP. The Tribunal also highlighted that the Berry ratio is recognized in various jurisdictions and by the OECD guidelines, making it a suitable method in this case.

2. Not providing adjustments on account of differences in working capital:
The assessee argued that the TPO did not provide working capital adjustments, which materially affected its profit. The DRP acknowledged that adjustments should be made for eliminating material effects arising from differences in working capital but noted that the assessee failed to demonstrate how its negative working capital affected its margin. The Tribunal upheld this view, as the assessee could not justify its claim for working capital adjustments with tangible materials.

3. Adjustments on account of foreign exchange fluctuations:
The DRP opined that derivative losses/gains are independent of the services rendered and are determined outside the parameters of the service provider's actual business. The DRP also noted that the essence of transfer pricing is to reflect terms as if the transaction occurs between unrelated parties, and costs arising from future uncertain exchange rate movements are non-contractible. However, the Tribunal recognized that adjustments for foreign exchange fluctuations are acknowledged in transfer pricing matters, as per Accounting Standards-11 and previous Tribunal decisions. The Tribunal directed the Assessing Officer to make adjustments for foreign exchange fluctuations in the assessee's case.

Conclusion:
The Tribunal partly allowed the assessee's appeal, upholding the use of the Berry ratio for determining the ALP and rejecting the claim for working capital adjustments. However, the Tribunal directed adjustments for foreign exchange fluctuations, recognizing their impact on the assessee's purchase price and profit margin.