2016 (4) TMI 478 - AT - Income Tax

Transfer pricing adjustment - transfer pricing adjustment has been calculated by reducing the actual gross receipts of the assessee from its AE at ₹ 116.95 crore ( Costs incurred at ₹ 108.89 crore plus 8% markup at ₹ 8.06 crore) from the amount of profit margin calculated by the TPO at ₹ 176.14 crore (by applying 6% on FOB value of goods exported at ₹ 2935.69 crore) - Held that - Under no circumstance, the amount of transfer pricing adjustment can be calculated by picking up profit margin of the assessee or comparables and then comparing it with the price charged by the comparables or the assessee, as has been done in the extant case. Such calculation of the transfer pricing adjustment by the TPO has resulted into landing in a piquant situation, in which ideal profit has been compared with the actual price charged for the purposes of making a transfer pricing adjustment, which is patent incorrect. We have noted above that the assessee applied the TNMM under which the ALP can be determined by comparing the adjusted profit margin realized by comparables as per subclauses (ii) and (iii) with the realized profit margin of the assessee as per sub-clause (i) of Rule 10B (1)(e). As the TPO has computed ALP of the international transaction with the help of a method unknown to law, which calculation is again flawed because of making comparison of profit with the gross revenue , we cannot countenance the same. The right course for the TPO was to compute assessee s profit margin realized under the TNMM as per Rule 10B(1)(e)(i) from its annual accounts without any adjustment and then compare it with the adjusted net operating profit margin of the comparables with the same base. This would have led to the determination of ALP of this international transaction. In view of the foregoing discussion, we are satisfied that the action of the AO/TPO in making/proposing addition/adjustment on account of transfer pricing, cannot be upheld for the reason that the shifting of the base on which markup has been applied has been turned down by the Hon ble Delhi High Court in assessee s own case; the mechanism followed by the TPO for calculating the transfer pricing adjustment has no legal legs to stand on; and further the assessee s profit margin is at ALP under the TNMM on the basis of figures mentioned in the TPO s order, whose correctness has not been disturbed by the TPO. Ex consequenti, the addition is hereby deleted. - Decided in favour of assessee

Summary

Issues Involved:
1. Addition of ?59.19 crore on account of transfer pricing adjustment.
2. Application of Transactional Net Margin Method (TNMM).
3. Determination of Arm’s Length Price (ALP).
4. Substitution of cost base with FOB value of exports.
5. Comparison of profit margins with comparables.
6. Legal conformity of TPO’s methodology.

Issue-Wise Detailed Analysis:

1. Addition of ?59.19 crore on account of transfer pricing adjustment:
The appeal by the assessee challenges the addition of ?59.19 crore made by the Assessing Officer (AO) based on transfer pricing adjustment. The AO, following the Transfer Pricing Officer (TPO)'s recommendations, added this amount to the assessee’s income for the assessment year 2009-10.

2. Application of Transactional Net Margin Method (TNMM):
The assessee, an Indian subsidiary of a Mauritius-based company, applied TNMM as the most appropriate method for determining the ALP of its international transaction involving the provision of buying services. The assessee’s Profit Level Indicator (PLI) was calculated at 8% of the total costs incurred. The TPO accepted TNMM but changed the base for markup calculation from ‘costs incurred’ to ‘FOB value of exports’.

3. Determination of Arm’s Length Price (ALP):
The TPO determined the ALP by applying a 6% markup on the FOB value of goods exported, resulting in a net operating income of ?176.14 crore. After subtracting the operating income shown by the assessee at ?116.95 crore, the TPO proposed a transfer pricing adjustment of ?59.19 crore. This approach deviated from the prescribed method under Rule 10B(1)(e) of the Income-tax Rules, 1962.

4. Substitution of cost base with FOB value of exports:
The TPO replaced the cost base with the FOB value of exports for calculating the markup. This substitution was contested by the assessee and was found to be inconsistent with the provisions of the Income-tax Act and the Rules. The Hon’ble Delhi High Court in previous cases involving the assessee had rejected such substitution, stating that it was not supported by the IT Act or Rules.

5. Comparison of profit margins with comparables:
The TPO failed to determine the profit margin of comparables correctly. Instead of comparing the net profit margin realized by the assessee with that of comparables, the TPO derived a revised compensation amount, which was not a valid profit rate of any uncontrolled transactions/comparables. This flawed methodology led to an incorrect transfer pricing adjustment.

6. Legal conformity of TPO’s methodology:
The Tribunal noted that the TPO’s methodology was not in accordance with the law. The TPO’s approach of comparing the actual gross receipts of the assessee with the net operating income was incorrect. The valid comparison should have been between the profit margins of the assessee and the comparables. The Tribunal emphasized that the correct procedure under TNMM involves comparing the adjusted net operating profit margin of comparables with the realized profit margin of the assessee.

Conclusion:
The Tribunal concluded that the TPO’s calculation of the transfer pricing adjustment was flawed and not in conformity with the prescribed methods. The assessee’s profit margin at 8% was within the permissible range of the comparables' profit margin at 9.30%, necessitating no transfer pricing adjustment. The addition of ?59.19 crore was deleted, and the appeal of the assessee was allowed.

Order Pronounced:
The appeal of the assessee was allowed, and the order was pronounced in the open court on 23rd March, 2016.