2017 (2) TMI 1012 - AT - Income Tax

Transfer pricing adjustment - TPO made an adjustment taking in to consideration the OP/OC for AE segment at 23% 26%(-)3%,an allowance for delay in receivables and after sales services and other efforts made under the non-AE business - Held that - Fairness demands that the assessee as well as the revenue authorities should avoid arbitrariness, while determining ALP of an IT. Both should use some reasonable data to prove that IT is above board. Adhoc adjustments, in our opinion, goes against the basic concept of TP. In the case under consideration 3% and 8% allowance was given by the TPO and the DRP. But,how they arrived at those figures is not known. The reasons for adopting a certain percentage does not find place in their orders. They have not discussed as to what was the material that gave them the basis for allowing 3% and 8% adjustment on account of delay in receivables and after sales services and considering the factors like bulk manufacturing orders received from AE.s and geographical locations . But, both the authorities have not cited the instances where an independent assessee,in similar circumstances,had claimed that adjust -ment on account delay in receivables geographical factors etc. was approximately 3% or 8%. No judicial forum has adopted the said percentage on account of delay in receivables/ bulk manufacturing/ geographical location. Even if they had some material supporting their stand,same has not been brought on record. Thus, the order passed by them is a non-speaking order and it falls under the category of an order passed without assigning reasons. Such orders cannot be endorsed. A comparable cannot and should not be rejected only on the basis of loss suffered by it for a particular year. A persistent loss making comparable can be excluded. But, in the case under consideration,the comparable had not suffered loss year after year. After admitting that internal TNMM could not have been applied straight away, the DRP should have deliberated upon the issue of determination of ALP in a more rational manner. But,it just adopted the easiest route- an ad hoc allowance. It is a fact that more than 60% of the sales turnover of the assessee is with non- AE.s and the profit ratios of non-AE.s and AE.s cannot be same. Besides, the assessee had entered in to an agreement with its AE for supply of goods and working capital adjustment is required to be made. All these factors would affect the ALP of the transactions. Considering all we are of the opinion that the matter needs further verification and investigation thus we are restoring the matter to the file of the TPO/AO to decide the issue afresh. While determining the ALP, he should consider the data of the companies who are engaged in such activities that are similar or closer to the activities of the assessee and the turnover with the AE.s and Non-AE.s should be of similar volumes. In short,some reasonable comparables should be selected after considering the FAR analysis of such comparable and only then exercise of determining ALP should be completed. Effective ground of appeal is decided in favour of the assessee in part.

Summary

Issues Involved:
1. Upward adjustment to the total income of the assessee.
2. Application of Transfer Pricing (TP) methods and determination of Arm's Length Price (ALP).
3. Comparability analysis and selection of comparables.
4. Adjustments for functional and risk differences.

Detailed Analysis:

1. Upward Adjustment to the Total Income of the Assessee:
The primary issue in the appeals was the upward adjustment of ?14.13 crores to the total income of the assessee. The Assessing Officer (AO) made a reference to the Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) of the international transactions with Associated Enterprises (AEs). The TPO proposed an addition of ?27.31 crores, which was partly upheld by the Dispute Resolution Panel (DRP). Consequently, the AO completed the assessment determining the income of the assessee at ?50.99 crores.

2. Application of Transfer Pricing (TP) Methods and Determination of Arm's Length Price (ALP):
The assessee, a 100% subsidiary of a Japanese company, engaged in manufacturing injection stretch blow-moulding machines, entered into various international transactions with its AEs. The TPO used the Transactional Net Margin Method (TNMM) to determine the ALP, considering Profit Level Indicator (PLI) as Operating Profit/Operating Cost (OP/OC). The TPO found that the net cost plus margin (14.01%) shown by the assessee was higher than the margin of comparable companies (12.64%), indicating that the international transactions were at arm's length. However, the TPO directed the assessee to submit segmental profit and loss accounts, leading to an adjustment based on the AE segment's OP/OC.

3. Comparability Analysis and Selection of Comparables:
The assessee argued that the AE and non-AE segments had different functional and risk profiles, and internal TNMM should not have been applied. The DRP rejected one of the comparables provided by the assessee on the ground that it was loss-making, stating that contract manufacturers could not incur losses. The DRP granted an adjustment of 8% for bulk manufacturing orders and geographical factors, reducing the addition to ?14.13 crores. The assessee contended that the AE segment should be compared with companies engaged in similar contract manufacturing activities, and the non-AE segment included controlled transactions like royalty and purchase payments.

4. Adjustments for Functional and Risk Differences:
The DRP and TPO provided adjustments for various differences deemed existent between the AE and non-AE segments. The assessee argued that the revenue authorities failed to appreciate the distinct business models and risk profiles of the segments. The DRP held that internal TNMM could not be applied straight away and that adjustments for functional and risk differences were necessary. The DRP directed the AO/TPO to work out the amount of adjustments accordingly, considering the peculiar facts and circumstances of the case.

Conclusion:
The Tribunal found that the orders of the TPO and DRP lacked a clear basis for the adjustments made. It was noted that the assessee's arguments regarding the different business models and risk profiles were not properly considered. The Tribunal restored the matter to the file of the TPO/AO for fresh determination of the ALP, directing them to consider reasonable comparables and the functional and risk analysis of such comparables. The appeals filed by the assessee and the AO were partly allowed, and the matter was remanded for further verification and investigation.

Order Pronouncement:
The order was pronounced in the open court on 04th January, 2017, with both appeals being partly allowed and the matter remanded to the TPO/AO for fresh determination.