2018 (4) TMI 688 - AT - Income Tax

Adjustment made by TPO w.r.t. license fee and management fees - Held that - No merit in the analysis carried out by the TPO by benchmarking the licence fee. In fact assessee by aggregation of transactions in the TP study had benchmarked the arm s length price of all the transactions by comparing operating profit / operating cost at the entity level was 25.49% as against the non-AE it was 5.26 % . The comparability analysis in the TP study carried out by the assessee by aggregation of transactions adopting TNMM as the most appropriate method has not been examined by either of the authorities below who have merely concentrated merely on the issue of aggregation / segregation of transactions. The CIT (A) has mechanically accepted the results of the assessee to be at arm s length by accepting the operating profit / operating cost of the assessee as 25.49% as against non-AE at 5.26%. In that view of the matter, we deem it appropriate to remand the issue to the file of the CIT (A) for examining the correctness of the ALP at the entity level by applying the TNMM as the most appropriate method by aggregating the transactions. The CIT (A) is directed to take the remand report from the TPO in this regard and afford the assessee adequate opportunity of being heard in the matter. Management fees addition - comparability analysis in the TP study carried out by the assessee by aggregation of transactions adopting TNMM as the most appropriate method has not been examined by either of the authorities below who have merely concentrated merely on the issue of aggregation / segregation of transactions. The CIT (A) has mechanically accepted the results of the assessee to be at arm s length by accepting the operating profit / operating cost of the assessee as 25.49% as against non-AE at 5.26%. In that view of the matter, we deem it appropriate to remand the issue to the file of the CIT (A) for examining the correctness of the ALP at the entity level by applying the TNMM as the most appropriate method by aggregating the transactions. The CIT (A) is directed to take the remand report from the TPO in this regard and afford the assessee adequate opportunity of being heard in the matter. Thus Ground of revenue appeal are allowed for statistical purposes.

Issues Involved:
1. Adjustment of license fee and management fees by the Transfer Pricing Officer (TPO).
2. Determination of Arm's Length Price (ALP) for international transactions.
3. Aggregation of transactions for Transfer Pricing (TP) analysis.
4. Commercial expediency and benefit test for intra-group services.
5. Jurisdiction of TPO and Assessing Officer (AO) in determining ALP and service benefits.

Detailed Analysis:

1. Adjustment of License Fee and Management Fees by the TPO:
The TPO proposed adjustments by treating the license fee and management fees as NIL, arguing that these payments suppressed profit margins and shifted profits to the Associated Enterprise (AE). The TPO adopted the Comparable Uncontrolled Price (CUP) method instead of the Transactional Net Margin Method (TNMM) used by the assessee and issued a show-cause notice questioning the necessity and benefit of these payments.

2. Determination of Arm's Length Price (ALP) for International Transactions:
The TPO's approach was to benchmark the license fee and management fees separately, concluding that these should be NIL. The assessee argued that these fees were intrinsic and interlinked with the main transaction of manufacturing and exporting pharmaceutical formulations, and hence, should not be benchmarked separately. The CIT(A) upheld the assessee's approach, noting that the operating profit margin was higher than that of comparable companies, indicating that the transactions were at arm's length.

3. Aggregation of Transactions for Transfer Pricing (TP) Analysis:
The CIT(A) and ITAT supported the aggregation of transactions, citing that closely linked transactions should be analyzed together. This approach is consistent with the OECD guidelines and Indian TP provisions, which allow for the aggregation of transactions emanating from a common source. The ITAT referenced the Delhi High Court's judgment in Sony Ericsson Mobile Communication India (P.) Ltd. v. CIT, which permits the aggregation of transactions for TP analysis.

4. Commercial Expediency and Benefit Test for Intra-Group Services:
The TPO questioned the commercial expediency and benefit of the license fee and management fees, suggesting that no tangible benefit was derived from these payments. However, the ITAT emphasized that the benefit test should be viewed from the taxpayer's perspective and that the TPO cannot question the commercial wisdom of the taxpayer. The ITAT cited various judgments, including EKL Appliances and Dresser Rand, which held that the necessity or prudence of an expenditure is not for the revenue authorities to decide.

5. Jurisdiction of TPO and Assessing Officer (AO) in Determining ALP and Service Benefits:
The ITAT clarified that the TPO's role is to determine the ALP of international transactions and not to decide whether a service was necessary or beneficial for the taxpayer. This distinction was highlighted in the case of Dresser-Rand India Pvt. Ltd. v. Additional Commissioner of Income Tax, where it was noted that the AO, not the TPO, should determine the factual existence and benefit of services under Section 37 of the Income Tax Act.

Conclusion:
The ITAT remanded the issue to the CIT(A) for a detailed examination of the ALP at the entity level by applying the TNMM method and aggregating the transactions. The ITAT directed the CIT(A) to obtain a remand report from the TPO and provide the assessee with an adequate opportunity to be heard. The appeals filed by the revenue were allowed for statistical purposes, emphasizing the need for a comprehensive analysis of the aggregated transactions and the correctness of the ALP determination.

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