2012 (10) TMI 404 - AT - Income Tax

Adjustments made to the purchase price of imports from Associated Enterprises - rejection of CUP method claimed by the assessee - CIT(A) deleted the addition - Held that - The assessee had furnished proper details to show comparable transactions of Non-AE parties which match with the transaction of the assessee with its AE. Persuing the chart reproduced from the order of CIT(A) it was observed that the rate of diamonds per carat varies between Rs. 38, 561/- to Rs. 98, 499/-. It was the submission of assessee that the transaction compared being in the immediate vicinity of the transaction entered into by the assessee with its AE is sufficient to prove that the price charged by its AE was comparable with price charged by Non-AEs. However he could not produce details about the quality of the diamond mentioned with reference to invoices. Therefore CIT(A) has wrongly accepted the CUP method and TPO was right in observing insuffciant details were furnished to prove the justification of applicability of CUP method. As the ALP can be worked out only with respect to international transaction of the assessee with its AE it is just and proper to restore this issue to the file of AO with a direction to verify the aforementioned calculations submitted by the assessee after giving the assessee reasonable opportunity of hearing and if the aforementioned calculations are correct then the difference being within the safe harbour of /- 5% no addition with regard to ALP should be made - in favour of revenue by way of remand.

Issues Involved:
1. Deletion of adjustment to the purchase price of imports from Associated Enterprises (AEs).
2. Use of Comparable Uncontrolled Price (CUP) Method for determining Arm's Length Price (ALP).
3. Application of benchmarked operating profit ratio to sales turnover corresponding to purchases from AEs.
4. Interpretation of "net profit margin" under Rule 10B of Income Tax Rules.
5. Impact of 'capital base' on operating profit.
6. Comparability of selected entities by the Transfer Pricing Officer (TPO).
7. Acceptance of ALP working based on three entities or industry average by the assessee.

Detailed Analysis:

1. Deletion of Adjustment to Purchase Price:
The revenue contested the deletion of Rs. 2,58,00,000/- made to the purchase price of imports from AEs by the CIT(A). The TPO had initially made this adjustment due to discrepancies in the comparability data provided by the assessee.

2. Use of CUP Method:
The CIT(A) accepted the CUP method for determining ALP, which the TPO had rejected due to inadequate documentary evidence. The assessee argued that sufficient data and one-to-one comparison were provided, including import invoices and bills of entries attested by Customs Authorities. The CIT(A) found that the application of the CUP method placed the AE transactions within the +/- 5% range, thus no adjustment was needed.

3. Application of Benchmarked Operating Profit Ratio:
The CIT(A) accepted the assessee's plea that the benchmarked operating profit ratio should apply only to the sales turnover corresponding to purchases from AEs, not the total turnover. This was a significant point of contention, as the TPO had applied the ratio to the entire turnover.

4. Interpretation of "Net Profit Margin" under Rule 10B:
The CIT(A) held that the "net profit margin" for Rule 10B should be determined after allowing for costs, including interest. The TPO's approach of excluding interest costs was found to be inconsistent with Rule 10B.

5. Impact of 'Capital Base' on Operating Profit:
The CIT(A) considered the 'capital base' as materially affecting operating profit, contrary to the TPO's findings. The TPO had argued that the diamond industry is not capital-intensive and that the assessee did not incur interest costs while comparables did.

6. Comparability of Selected Entities:
The CIT(A) disagreed with the TPO's selection of comparables, finding that the seven entities chosen by the TPO were not comparable to the assessee. The TPO had selected entities with sales between Rs. 50 to Rs. 100 crores, while the assessee's turnover was Rs. 57.27 crores.

7. Acceptance of ALP Working Based on Three Entities:
The CIT(A) accepted the working of ALP as done by the assessee, which was based on three entities or an industry average of four entities. The TPO had rejected this approach, citing insufficient comparability data.

Conclusion:
The tribunal examined the submissions and evidence provided by both parties. It found that the CIT(A) had wrongly accepted the CUP method due to insufficient details about the quality of diamonds. However, the tribunal agreed with the CIT(A) that the determination of ALP should be limited to international transactions with AEs and not extended to Non-AEs. The tribunal directed the AO to verify the calculations submitted by the assessee and, if correct, to refrain from making any adjustments as the difference would fall within the safe harbour of +/- 5%. The appeal was allowed for statistical purposes, with the matter remanded to the AO for verification.

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