2017 (4) TMI 1094 - AT - Income Tax

Transfer pricing addition - purchases from AE were inflated - Held that - The assessee cannot be said to have maintained a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transaction or a record of the actual working carried out for determining the arm s length price, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any. Thus, it is unambiguous that the assessee did not undertake any transfer pricing analysis in the manner prescribed. In such circumstances, the TPO was fully justified in holding that the assessee did not maintain any worthwhile documentation or undertake any valid transfer pricing study. All the points taken note of by the ld. CIT(A) in deleting the transfer pricing addition lack valid reasoning and suffer from certain inconsistencies. We, therefore, hold that the impugned order deleing the transfer pricing addition made by the AO, cannot be sustained. Sub-clause (i) deals with the computation of the net operating profit margin realised by the enterprise from an international transaction in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. Sub-clause (ii) provides that the net operating profit margin realised by a comparable uncontrolled transaction should be computed having regard to the same base as that taken in sub-clause (i) for the assessee. In the formula for calculating the profit margin under rule 10B(1)(e) under sub-clauses (i) and (ii), there can be any denominator, such as, costs incurred or sales effected or assets employed or to be employed. However, the numerator is uniform, which is, net operating margin. In fact, the numerator is operating profit and not the net profit as has been taken by the TPO in making transfer pricing adjustment. Whereas, operating profit is the excess of operating revenue over the operating costs, net profit is the excess of revenue over all costs, both operating and non-operating. The Hon ble Supreme Court in DIT (I.T.) vs. Morgan Stanley and Co. (2007 (7) TMI 201 - SUPREME Court) has held that operating profit from the international transaction is compared with the operating profit margin of the comparables under the TNMM. Thus the addition based on the transfer pricing adjustment, on the strength of net profit as numerator in contrast to operating profit , cannot be upheld. The same is required to be corrected accordingly. Thus in fitness of the things if the impugned order is set aside and the matter is remitted to the file of AO/TPO for a fresh determination of the ALP of the international transaction.

Summary

Issues Involved:
1. Deletion of transfer pricing addition amounting to ?74,70,729/- made by the Assessing Officer (AO).

Detailed Analysis:

1. Deletion of Transfer Pricing Addition:

Facts of the Case:
The assessee, a private limited company engaged in manufacturing auto parts and components, reported three international transactions: Purchase of material worth ?6,78,21,310; Royalty paid for providing technical know-how worth ?35,88,664; and Technical fee paid for providing technical assistance worth ?10,96,337. The Transfer Pricing Officer (TPO) disputed only the international transaction of 'Purchase of material' from its Associated Enterprise (AE), F-Tech, Japan. The TPO applied the Transactional Net Margin Method (TNMM) to determine the arm's length price (ALP).

TPO's Determination:
The TPO selected seven comparable companies and determined the average net profit margin at 9.87%. The assessee's net profit margin was calculated at 4.25%. By applying the average PLI of comparables to the assessee's total sales and job work, the TPO determined an additional net margin and proposed a transfer pricing adjustment of ?74,70,729/-.

CIT(A)'s Deletion of Addition:
The CIT(A) deleted the addition based on several reasons:
- The absence of unrecorded transactions or undisclosed facts reflecting the assessee's intent to avoid tax.
- The CIT(A) argued that the transfer pricing provisions do not prescribe comparing the net profit margin of the organization as a whole.
- Exclusion of five companies with higher turnover from the comparables.
- Consideration of the net profit margin of Unit-2 alone, which deals with the manufacturing and sale of automobile components.
- Comparison of the assessee's profit margin with that of its AE, which was found to be lower.
- Exclusion of depreciation on ED plant capitalized during the year.

Tribunal's Analysis and Conclusion:
- The Tribunal noted that the assessee did not apply any recognized method to demonstrate that the international transaction was at ALP and did not maintain the required documentation.
- The Tribunal disagreed with the CIT(A)'s reasoning that the absence of unrecorded transactions or intent to avoid tax negates the need for transfer pricing analysis.
- The Tribunal found the CIT(A)'s exclusion of companies with higher turnover unjustified, citing the Hon'ble Delhi High Court's ruling that high or low turnover is not a criterion for exclusion.
- The Tribunal observed that the CIT(A) incorrectly assumed that all imports from AE were utilized only in Unit-2.
- The Tribunal rejected the CIT(A)'s comparison of the assessee's profit margin with that of its AE.
- The Tribunal disagreed with the CIT(A)'s exclusion of depreciation on the ED plant, noting the lack of clarity on its exclusive use for job work.

Tribunal's Decision:
- The Tribunal set aside the CIT(A)'s order, finding the deletion of the transfer pricing addition unsustainable.
- The Tribunal remitted the matter to the AO/TPO for fresh determination of the ALP of the international transaction, emphasizing the need for a reasonable opportunity of hearing for the assessee.

Outcome:
The appeal was allowed for statistical purposes, and the order was pronounced in the open court on 10.03.2017.