2018 (7) TMI 734 - AT - Income Tax

TPA - ALP Determination - MAM selection - rejecting RPM method - CUP method adoption - Held that - Revenue has accepted the method in subsequent years i.e. AY 2011-12 to 2013-14. In view of the above given facts and circumstances, we are of the view that the Revenue should adopt the CUP method for benchmarking the international transaction as it is doing consistently in subsequent years. Since we have held that CUP is the most appropriate method in the case of the assessee, we not consider RPM. The AO is directed accordingly.

Summary

Issues Involved:
1. Transfer pricing adjustment of ?5,02,05,493 by rejecting the Comparable Uncontrolled Price (CUP) method and applying the Transactional Net Margin Method (TNMM).
2. Rejection of Resale Price Method (RPM) despite AO's initial proposal to adopt it.
3. Selection of comparable companies by AO without proper criteria and justification.
4. Use of internal comparables for RPM application.
5. Computation of arm's length price (ALP) using TNMM without considering all facts and circumstances.
6. Inconsistency in CIT(A)'s approach regarding product comparability.
7. Adjustment based on sales rather than purchase transactions.
8. Absurdity in the adjustment amount exceeding the value of international transactions.
9. Transfer pricing adjustments applied to entire turnover instead of restricting to transactions with associated enterprises.

Detailed Analysis:

1. Transfer Pricing Adjustment and Method Rejection:
The primary issue revolves around the CIT(A) confirming the AO's adjustment of ?5,02,05,493 to the international transactions of purchase of finished goods for distribution. The AO rejected the CUP method, which the assessee used for benchmarking, citing the lack of stringent and absolute comparison required by Indian Transfer Pricing Laws. The AO also rejected the internal RPM due to differences in product comparability and reliability issues with unaudited segmental financials. Consequently, the AO applied the TNMM, selecting three companies for benchmarking, which resulted in the disputed adjustment.

2. Rejection of Resale Price Method (RPM):
The assessee contended that the CIT(A) erred in not accepting the RPM, which the AO initially proposed. The CIT(A) observed that the assessee had rejected RPM in the transfer pricing study report. However, the assessee argued that RPM should be considered, emphasizing that strict product comparability is not warranted for RPM, as per OECD guidelines. The assessee highlighted that the gross margins from sales of products purchased from AE were higher than those from non-AE, supporting the RPM application.

3. Selection of Comparable Companies:
The AO's selection of comparable companies without proper criteria and justification was contested. The CIT(A) upheld the AO's approach, despite the assessee's argument that the selected comparables were functionally different. The assessee specifically pointed out the profit margin of Hawkins Cookers Ltd. (19.3%) as an example of inappropriate comparability.

4. Use of Internal Comparables:
The assessee argued that internal comparables should be preferred over external ones for RPM application. The CIT(A) rejected this, citing differences in product comparability. The assessee maintained that the products from both AE and non-AE belonged to the same category, and internal comparables should be considered.

5. Computation of ALP Using TNMM:
The CIT(A) confirmed the AO's computation of ALP using TNMM without considering all relevant facts and circumstances. The assessee argued that the AO's approach was flawed, as it did not account for the specificities of the assessee's business and transactions.

6. Inconsistency in CIT(A)'s Approach:
The CIT(A) was inconsistent in rejecting internal RPM due to product comparability issues while proposing TNMM despite product dissimilarity. The assessee highlighted this inconsistency, arguing that the same standard should apply to both methods.

7. Adjustment Based on Sales:
The assessee contended that the adjustment was erroneously based on sales rather than the purchase transactions, which was the actual international transaction under scrutiny.

8. Absurdity in Adjustment Amount:
The adjustment amount of ?5,02,05,493 exceeded the value of the international transactions (?3,85,26,535), leading to an absurd situation where the associated enterprise would effectively pay the assessee for selling goods. The assessee argued that this was a non-arm's length situation.

9. Transfer Pricing Adjustments to Entire Turnover:
The AO applied transfer pricing adjustments to the entire turnover of the assessee, instead of restricting them to the value of international transactions with the associated enterprise. The assessee argued that this was incorrect and led to an inflated adjustment.

Tribunal's Decision:
The Tribunal considered the arguments and evidence presented. It noted that in subsequent years, the RPM method was accepted by the TPO for the assessee. The Tribunal found that the assessee had justified the ALP using RPM, with gross margins from AE transactions being higher than those from non-AE transactions. The Tribunal referred to OECD guidelines, emphasizing that strict product comparability is not required for RPM. The Tribunal also acknowledged the Supreme Court's decision in a similar case, where CUP was accepted in subsequent years.

Conclusion:
The Tribunal directed the AO to adopt the CUP method for benchmarking the international transactions, as consistently done in subsequent years. The appeal was allowed for statistical purposes, and the AO was instructed to verify the figures in the segmental financials provided by the assessee. The Tribunal did not consider RPM further, as CUP was deemed the most appropriate method. The order was pronounced on 04-07-2018.