2016 (5) TMI 867 - AT - Income Tax

Addition on account of transfer pricing adjustment - determination of the most appropriate method - non availability of comparable uncontrolled transaction - computation of adjusted gross margin of distributors - Held that - RPM is quite a useful method where the goods purchased by the Indian AE are sold without doing any value enahncement. We therefore approve the application of RPM as the most appropriate method. The term uncontrolled transaction has been defined in Rule 10A(a) to mean a transaction between enterprises other than associated enterprises whether resident or nonresident. When we substitute the definition of the term uncontrolled transaction in Rule 10B(1)(b)(ii) the relevant part would read that the resale price of the enterprise is reduced by the amount of normal gross profit margin accruing in a comparable transaction between enterprises other than the associated enterprises. ALP of an international transaction of purchase of goods is always determined on the basis of the gross profit margin on the resale price charged in a comparable transaction between enterprises other than the associated enterprises. It cannot be anything else. Only when some gross profit margin in comparable transaction between two independent enterprises is available sub-clause (ii) of Rule 10B(1)(b) works. The existence of a comparable uncontrolled transaction giving gross profit margin accruing from purchase and resale of similar goods is an essential condition for determining the ALP under RPM. Adverting to the facts of the instant case we find from the calculation of the ALP under RPM as extracted above that the TPO has taken arm s length margin of GP on sales at 50% which has been considered for determining the ALP of this international transaction at 4.24 crore leading to transfer pricing adjustment of 1.05 crore. This 50% arm s length gross profit margin on sales has been taken by the TPO on the basis of what the assessee stated before the Customs Authorities in a generalized manner. The TPO has not brought on record any comparable uncontrolled case and thus has not eventually determined gross profit margin from purchase and resale of similar goods in a comparable uncontrolled transaction. In the absence of availability of any comparable uncontrolled transaction we cannot approve the action of the AO in making such an addition as the same has not been done in the manner prescribed under the rule. As we have upheld the application of RPM as the most appropriate method and found the view point of the ld. CIT(A) in deleting addition to be untenable we consider it expedient to set aside the impugned order and remit the matter to the file of TPO/AO for a fresh determination of the ALP - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Deletion of addition on account of transfer pricing adjustment for the import of raw materials, components, and semi-finished goods.
2. Deletion of addition on account of transfer pricing adjustment for the import of finished goods.

Issue-wise Detailed Analysis:

1. Deletion of addition on account of transfer pricing adjustment for the import of raw materials, components, and semi-finished goods:

The primary issue in this appeal is the deletion of addition on account of transfer pricing adjustment concerning the import of raw materials, components, and semi-finished goods. The assessee, an Indian company, reported six international transactions categorized into three classes and applied the Transactional Net Margin Method (TNMM) and Comparable Uncontrolled Price (CUP) method accordingly. The Transfer Pricing Officer (TPO) rejected the TNMM for Class I transactions, arguing that aggregation of controlled and uncontrolled transactions was inappropriate and opted for the CUP method for the transaction of 'Import of raw materials, components, and semi-finished goods.'

The TPO observed that the raw materials imported by the assessee from its Associated Enterprise (AE) were purchased by the AE from third parties at lower prices and sold to the assessee at higher prices. The TPO determined the Arm's Length Price (ALP) by reducing the AE's profit margin of 11.75% from the transacted value, resulting in a transfer pricing adjustment of ?26,80,767/-. The CIT(A) deleted this addition, accepting the assessee's contention that the variation was due to the weighted average pricing methodology and supported by a certificate from Luxottica SPA, Italy.

The Tribunal noted that the CUP method is the most appropriate for determining the ALP of purchase or sale of goods if comparable uncontrolled instances are available. However, the TPO's application of the CUP method was flawed as it considered the AE's transactions with third parties in Italy, which cannot constitute a comparable uncontrolled transaction for an Indian assessee. The Tribunal emphasized that the CUP method requires comparing the price in a comparable uncontrolled transaction, not the profit margin. The Tribunal set aside the CIT(A)'s order and remitted the matter to the AO/TPO for fresh determination of the ALP under the CUP method as per law.

2. Deletion of addition on account of transfer pricing adjustment for the import of finished goods:

The second issue pertains to the deletion of addition on account of transfer pricing adjustment for the import of finished goods. The assessee benchmarked this transaction under the TNMM, showing a profit margin of 5.61% against 2.37% of comparables. The TPO rejected the TNMM, noting that the assessee sold the imported goods without value addition and applied the Resale Price Method (RPM) instead. The TPO determined the ALP by adopting a gross profit margin of 50% on sales, based on the assessee's submissions before Customs Authorities, resulting in a transfer pricing adjustment of ?1,05,57,553/-.

The CIT(A) deleted this addition, accepting the assessee's argument that the actual gross margin of distributors was around 37.50% after accounting for VAT/sales tax. The Tribunal found that the CIT(A) erred in considering only the payment part of VAT/sales tax without its receipt part, which neutralizes the impact on profit margin. The Tribunal also noted that the TPO did not bring on record any comparable uncontrolled transaction to justify the 50% gross profit margin.

The Tribunal upheld the application of the RPM as the most appropriate method but found the TPO's determination of the ALP flawed due to the lack of comparable uncontrolled transactions. The Tribunal set aside the CIT(A)'s order and remitted the matter to the AO/TPO for fresh determination of the ALP under the RPM as per law.

Conclusion:

The Tribunal set aside the CIT(A)'s order deleting the additions made by the AO on account of transfer pricing adjustments for Class I and Class II international transactions and remitted the matter to the TPO/AO for fresh determination of the ALP under the CUP method and RPM, respectively, as per law. The appeal was allowed for statistical purposes.