2017 (4) TMI 962 - AT - Income Tax

Transfer pricing adjustment - whether RPM should be considered as most appropriate method or not? - Held that - It is quite ostensible that in case of a distributor, wherein the goods are purchased from AE and resold to other independent entities without any value addition, then resale price method should be reckoned as MAM. One of the main reason given by the TPO as well as the DRP is that the assessee is a full-fledged/full risk distributor and performing host of functions, therefore, RPM should not be taken us the MAM, because all these functions required huge cost which may not represent correct gross profit margin. We are unable to appreciate such proposition, because in a comparable uncontrolled transactions scenario, a normal distributor will undertake all kind of functions which are related to sales of the product. The functions like market research, sales and marketing, ware-housing, inventory control, quality control etc. and also risk like market risk, inventory risk, credit risk etc all are undertaken by any distributor for sale of products. No comparable instances have been brought either by the TPO or by the Ld. DRP that the other distributors are not performing such functions. What is important is to see is, whether there is any value addition or not on the goods purchased for resale? If there is no value addition and if the finished goods which are purchased from AE are resold in the market as it is, then gross profit margin earned on such transaction becomes the determinative factor to analyse the gross compensation after the cost of sales. Thus, we hold that under the facts of the present case, RPM should be held as MAM. Huge variation in the gross profit margin of the two products distributed by the assessee and, therefore, under the RPM same cannot be clubbed together, because it will not yield proper arm s length result - Held that - As already clarified by the assessee before the authorities below as well as before us that, assessee has separately worked out the gross profit margin for both the items distributed and even then the assessee s gross profit margin is higher than the comparables. However, in order to examine whether the gross profit margin for both the products are at arm s length margin or not vis-a-vis the comparables, we are of the opinion that for the limited purpose of benchmarking the gross margins of the comparables selected by the assessee for both the products, i.e., automotive components and medical equipment should be separately benchmarked; and if on comparison it is found that the gross profit margin of these comparables chosen by the assessee as well as accepted by the Department are within the arm s length range, then no adjustment should be made. With this limited direction the matter is remitted back to the TPO/AO only to verify the gross margins of the comparable companies.

Issues Involved:
1. Adjustment to income on account of the difference in the arm's length price of international transactions.
2. Appropriateness of Resale Price Method (RPM) vs. Transactional Net Margin Method (TNMM) for benchmarking international transactions.
3. Aggregation of medical and automotive trading segments for determining the arm's length price.
4. Determination of arm's length price based on ad-hoc allocation methodology and segmental profitability.
5. Appropriateness of disregarding cash profits as a profit level indicator while applying TNMM.
6. Disregarding adjustments for extraordinary expenses incurred by the assessee.
7. Initiation of penalty proceedings under section 271(1)(c) of the Act.
8. Charging of interest under sections 234B and 234C of the Act.

Detailed Analysis:

1. Adjustment to Income on Account of Difference in Arm's Length Price:
The assessee, a subsidiary of a Japanese company, engaged in the distribution of automotive and medical diagnostic equipment, disclosed transactions with its associated enterprise (AE) and benchmarked these using the Resale Price Method (RPM). The Transfer Pricing Officer (TPO) rejected RPM and applied the Transactional Net Margin Method (TNMM), resulting in an upward adjustment of ?3,63,80,656/-. The Dispute Resolution Panel (DRP) confirmed the TPO's approach.

2. Appropriateness of Resale Price Method (RPM) vs. Transactional Net Margin Method (TNMM):
The assessee argued that RPM is the most appropriate method for a distributor who resells products without any value addition. The TPO and DRP contended that RPM is unsuitable due to the different gross margins from automotive and medical equipment segments and the assessee's full-risk distributor status. The tribunal, referencing judicial pronouncements and OECD guidelines, held that RPM is appropriate for the assessee's distribution activities, emphasizing that product differentiation does not materially affect gross profit margins under RPM.

3. Aggregation of Medical and Automotive Trading Segments:
The TPO aggregated the medical and automotive segments, leading to the rejection of RPM. The tribunal noted that the assessee provided separate gross profit margins for both segments, which were higher than the comparables. The tribunal directed the TPO/AO to separately benchmark the gross margins of the comparables for both segments.

4. Determination of Arm's Length Price Based on Ad-hoc Allocation Methodology and Segmental Profitability:
Given the tribunal's decision that RPM is the most appropriate method, the issues related to ad-hoc allocation and segmental profitability under TNMM were rendered academic and dismissed for statistical purposes.

5. Appropriateness of Disregarding Cash Profits as a Profit Level Indicator:
This issue became moot following the tribunal's decision to apply RPM instead of TNMM.

6. Disregarding Adjustments for Extraordinary Expenses:
This issue also became academic due to the tribunal's preference for RPM over TNMM.

7. Initiation of Penalty Proceedings under Section 271(1)(c):
The tribunal dismissed this ground as premature.

8. Charging of Interest under Sections 234B and 234C:
This ground was dismissed as consequential.

Conclusion:
The tribunal allowed the appeal in part, holding that RPM is the most appropriate method for the assessee's distribution activities. The tribunal remitted the matter back to the TPO/AO to verify the gross margins of the comparables for both automotive and medical equipment segments separately. The remaining grounds were either dismissed as academic or premature. The order was pronounced on 18th April 2017.

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