2017 (7) TMI 806 - AT - Income Tax

Non-granting of tolerance band of /(-) 5% from the arm s length price (ALP) in accordance with the proviso to section 92C(2) - Held that - After making certain adjustments to make it compatible with the international transaction, the adjusted price is taken as arm s length price in respect of property transferred or services provided in the international transaction. Thus it can be noticed that what is determined under this method is the price. When we refer to plus minus 5% of the value determined under this method as per proviso to section 92C(2), it inevitably refers to the figure determined under this method, which is price and not profit embedded in the price. If an assessee has sold goods to its AE worth ₹ 100 and the ALP in respect of such goods sold under CUP method is say ₹ 103 or ₹ 98, then no adjustment is required because it is within 5% of ₹ 100, being the price at which goods were sold to associated enterprises in the international transaction. Irrespective of the fact whether the profit component in the sale value of ₹ 100 is ₹ 4 or ₹ 8 or ₹ 10, it is, in fact, the comparison of the price charged or paid for property transferred which is the subject matter of proviso to section 92C(2). Thus it can be seen that the plus minus 5% is required on the value of international transaction, being the purchase price in the instant case and not on the profit element in such transactions. We, therefore, direct that -5% should be given effect in the calculation of the transfer pricing adjustment from the international transaction, if any. It is however, clarified, that this -5% is not a standard deduction. This benefit is to be given only if the ALP falls within -5% range of the price and not otherwise.

Summary

Issues Involved:
1. Non-granting of tolerance band of +/- 5% from the arm’s length price (ALP) as per the proviso to section 92C(2).
2. Transfer pricing adjustment for international transactions, specifically the purchase of raw materials and components from associated enterprises (AEs).

Detailed Analysis:

Issue 1: Non-granting of Tolerance Band of +/- 5% from ALP
Background: The assessee contended that the tolerance band of +/- 5% from the ALP, as stipulated in the proviso to section 92C(2), was not granted.

Legal Provisions: Section 92(1) mandates that any income arising from an international transaction must be computed with regard to the ALP. Section 92B(1) defines "international transaction" as a transaction between two or more associated enterprises. Section 92C(1) outlines methods for determining the ALP, and the proviso to section 92C(2) allows for a tolerance band of +/- 5% from the arithmetical mean of the ALP.

Tribunal's Analysis: The Tribunal emphasized that the ALP serves as a benchmark for comparison with the price charged or paid by the assessee in international transactions. The proviso to section 92C(2) aims to provide flexibility, stating that if the actual transaction price falls within a 5% range of the ALP, no adjustment should be made. The Tribunal clarified that the 5% tolerance should be applied to the price of the transaction rather than the profit margin embedded in the price. For example, if the ALP is determined to be ?103 or ?98 for goods sold at ?100, no adjustment is necessary as it falls within the 5% range.

Conclusion: The Tribunal directed that the +/- 5% tolerance band should be applied to the price of the international transaction. This benefit is not a standard deduction but should be applied only if the ALP falls within the 5% range of the transaction price.

Issue 2: Transfer Pricing Adjustment for International Transactions
Background: The Revenue challenged the relief granted by the CIT(A) regarding the transfer pricing adjustment for the purchase of raw materials and components from AEs.

Facts: The assessee, a 100% Indian subsidiary of a Japanese company, reported international transactions including the purchase of raw materials and machinery. The TPO determined the ALP for raw materials at ?4.65 crore against the declared value of ?5.77 crore, resulting in a proposed adjustment of ?1.12 crore. The CIT(A) reduced this adjustment to ?23 lakh.

Tribunal's Analysis: The Tribunal noted that the TPO's adjustment was based on entity-level figures, including transactions with both AEs and non-AEs. The Tribunal referred to sections 92 and 92B, which stipulate that transfer pricing adjustments should only apply to transactions between AEs. The Tribunal upheld the CIT(A)'s approach of restricting the adjustment to AE transactions, citing the jurisdictional High Court's ruling in CIT vs. Keihin Panalfa Ltd.

Manner of Relief by CIT(A): The CIT(A) calculated the adjustment by apportioning the total operating profit based on the ratio of costs associated with AE transactions to total operating costs. However, the Tribunal found flaws in this method, particularly the inclusion of costs unrelated to raw material purchases in the denominator. The Tribunal proposed a more accurate method, focusing on the utilized raw material purchased from AEs versus non-AEs.

Conclusion: The Tribunal set aside the CIT(A)'s order and remitted the matter to the AO/TPO for recalculating the adjustment based on the correct apportionment method. The assessee should be given an adequate opportunity to present necessary figures.

Final Judgment:
Both appeals were allowed for statistical purposes, with directions for recalculating the transfer pricing adjustment and applying the +/- 5% tolerance band as appropriate. The order was pronounced in the open court on 03.03.2017.