2018 (6) TMI 169 - AT - Income Tax

TPA - comparable selection - functional dissimilarity - MAM - Held that - The assessee is engaged in business of procuring/importing lubricants in bulk from its parent company G. S. Caltex Corporation South Korea which holds 100% shares of the assessee company and selling in India to its customers after repacking in small packs of 910 ML to 210 ltrs thus companies functionally dissimilar with that of assessee need to be deselected from final list - the matter need to be set aside and restored to the file of the AO/TPO for re-adjudication by re-computing ALP for benchmarking international transactions of the assessee for import of lubricating oils from its AE on merits in accordance with law in accordance with our directions as outlined in this order.

Summary

Issues Involved:
1. Selection of Transfer Pricing Method (TNMM vs. Cost Plus Method)
2. Selection of Comparable Companies for Analysis
3. Calculation of Average OP/TC of Selected Companies
4. Consideration of Diversified Business Activities of Selected Companies
5. Adjustment for Extraordinary Costs in the First Year of Operation

Detailed Analysis:

1. Selection of Transfer Pricing Method (TNMM vs. Cost Plus Method)
The assessee adopted the Cost Plus Method for determining the Arm's Length Price (ALP) of its international transactions, arguing that it was appropriate given its status as a new company in its first year of business. The Transfer Pricing Officer (TPO) rejected this method, observing that the assessee effectively used the Comparable Uncontrolled Price (CUP) method by comparing prices charged by its Associated Enterprise (AE) to customers in other countries. The TPO favored the Transactional Net Margin Method (TNMM), citing the decision in Gharda Chemicals Ltd. v. DCIT, which indicated that TNMM is more suitable when there are significant differences in geography, product quality, and scale of operations.

2. Selection of Comparable Companies for Analysis
The TPO selected three comparables: Castrol India Ltd., Gulf Oil Corporation Limited, and Sah Petroleum Ltd. After considering the assessee's objections, Castrol India Ltd. was dropped, leaving Gulf Oil Corporation Limited and Sah Petroleum Ltd. The assessee argued that these companies were not suitable comparables due to their established presence in the market and diversified business activities. The Dispute Resolution Panel (DRP) upheld the TPO's selection, noting that the Caltex brand, associated with the assessee, is well-known and established, thus making the comparables appropriate despite the age and market presence differences.

3. Calculation of Average OP/TC of Selected Companies
The TPO calculated the average Operating Profit to Total Cost (OP/TC) of the selected companies as a whole, rather than isolating the lubricant segment. The assessee contended that this approach was flawed since the comparables were involved in diversified businesses. The DRP rejected this objection, stating that the major and substantial segment for both the assessee and the comparables was lubricant oil. The DRP also noted that the assessee failed to provide segmental data for the comparables.

4. Consideration of Diversified Business Activities of Selected Companies
The assessee argued that the selected comparables, Gulf Oil Corporation Limited and Sah Petroleum Ltd., were involved in other diversified businesses, which made them unsuitable for comparison. The DRP dismissed this argument, emphasizing that the primary business of these companies was lubricating oil. The DRP also pointed out that the assessee did not provide sufficient evidence to show that the comparables were significantly engaged in other segments.

5. Adjustment for Extraordinary Costs in the First Year of Operation
The assessee claimed that extraordinary costs incurred in the first year of operation, such as infrastructure setup and hiring new employees, negatively impacted its OP/TC. The tribunal acknowledged that such costs should be considered and adjusted for when computing the Profit Level Indicator (PLI). The tribunal directed the authorities to allow adjustments for these extraordinary costs and to re-compute the ALP accordingly.

Conclusion:
The tribunal upheld the adoption of the TNMM method by the TPO and DRP, given the significant differences in geography, product quality, and scale of operations. The tribunal also concurred with the selection of Gulf Oil Corporation Limited and Sah Petroleum Ltd. as comparables, noting that the primary business of these companies was lubricating oil. However, the tribunal directed the authorities to consider adjustments for extraordinary costs incurred by the assessee in its first year of operation and to re-compute the ALP accordingly. The appeal was allowed for statistical purposes, and the matter was remanded to the AO/TPO for re-adjudication.