2016 (5) TMI 796 - HC - Income Tax

Transfer pricing adjustment - application of cash profit to operating cost as Profit Level Indicator under Transactional Net Margin Method for determining Arm s Length Price - CIT(A) deleted the addition - Held that - The entire purpose of determining the ALP is to ensure that there is no Base Erosion and Profit Shifting. The tax proceedings are not adversarial in nature and there can be no estoppal in pointing out the correct facts before the Appellate Authority particularly when all facts are on record. This very objection as urged by the Revenue before us was raised before the Tribunal viz. that the ratio of cost profit to operating cost was urged for the first time in appeal before the CIT(A). However as the impugned order records all the materials/details relevant to determine the TNMM on application of ratio of cash profit to operating cost was on record before the Assessing Officer. No fresh documents were brought on record before the CIT (A). It was only on the basis of documents which were already on record and were subject matter of examination by the TPO. Thus the TPO in his remand report found that in the facts of this case the ratio of cash profit to operating cost to determine the ALP was correctly raised by the respondent-assessee. Therefore question no.(i) as framed does not give rise to any substantial question of law. Applicability of principle of res judicata - Held that - The ratio of cash profit/operating cost in application of the TNMM method was infact accepted by the TPO itself for Assessment Years 200708 and 200809. Thus it is an acceptable ratio while applying the TNMM method. In any case on facts as obtained from the remand report of the TPO, the Authorities under the Act i.e. the CIT (A) as well as the Tribunal have for the subject assessment year found that the ratio of cash profits to operating cost is appropriate to determine the ALP.

Summary

Issues:
1. Whether the Tribunal was correct in upholding the deletion of transfer pricing adjustment by applying cash profit to operating cost as Profit Level Indicator?
2. Whether the principle of res judicata can be applied in Income Tax proceedings based on findings of a later assessment year?

Analysis:

Issue 1:
The respondent, an IT-enabled services provider, applied the Transactional Net Margin Method (TNMM) to determine the Arm's Length Price (ALP) of its transactions with Associated Enterprises (AEs) for the Assessment Year 2005-06. The Transfer Pricing Officer (TPO) found an adjustment of ?10.38 crores necessary, which was added to the respondent's income by the Assessing Officer. The respondent appealed to the CIT (A), arguing that the method of charging depreciation on fixed assets distorted the comparison with selected comparables. The CIT (A) accepted the respondent's method of using the ratio of cash profit to operating cost as the PLI and deleted the adjustment based on the TPO's remand report. The Tribunal upheld this decision, noting that the Revenue itself used the same ratio for subsequent assessment years. The Court found that all relevant facts were on record before the Appellate Authority, and as no new documents were presented, the objection raised by the Revenue did not give rise to a substantial question of law. Therefore, the appeal on this issue was dismissed.

Issue 2:
The Revenue argued that the principle of res judicata should not apply to tax matters and that the ratio of cash profit to operating cost accepted for later assessment years should not be applied to the subject assessment year. However, the Tribunal found the ratio acceptable for the subject assessment year based on the remand report of the TPO. The Court agreed with the Tribunal's findings, stating that the Revenue's objection did not raise a substantial question of law. Therefore, the appeal on this issue was also dismissed.

In conclusion, the High Court dismissed the appeal under Section 260A of the Income Tax Act, 1961, challenging the Tribunal's order regarding transfer pricing adjustments for the Assessment Year 2005-06. The Court found no merit in the Revenue's contentions and upheld the decisions of the lower authorities, emphasizing the importance of using appropriate methods to determine Arm's Length Price in international transactions.