2013 (5) TMI 49 - HC - Income Tax

Arms length price determination - selection of comparable - Whether the finding of the Tribunal that if any one margin of a comparable, in a given set of comparables is lower than the margin of the taxpayer, then the transactions are at arm s length, is correct as per Section 92C(2) - Held that - Tribunal had reduced the list of comparables to merely four which is not a right approach to be adopted by the Tribunal. The Tribunal should have stopped at the point where it decided on facts that the comparables given by the respondent/assessee were to be accepted and those searched by the Transfer Pricing Officer were to be rejected. The only option then left to the Tribunal was to derive the arithmetical mean of the profit level indicators of the comparables which were accepted by it. In this case such comparables happen to be those of the respondent/assessee. The Tribunal, in selecting only one profit level indicator out of a set of profit level indicators had clearly erred in law. However, in the facts of the present case that would not make any difference to the respondent/assessee s case inasmuch as even if the arithmetical mean of the comparables as accepted by the Tribunal are taken into account, the profit level indicator would, whether the seven companies are taken into consideration or all eight companies are taken into consideration, be less than 6.99 % which is the profit level indicator of the respondent/assessee for the relevant year, that is, financial year ending 31.03.2002. Also the reference to the OECD guidelines by the Tribunal in the impugned order are in the context of the reliance placed by the Transfer Pricing Officer on the very same guidelines. In the present case, there are specific provisions of sub-rules (2) and (3) of Rule 10B of the said Rules as also of the first proviso to section 92C(2) of the said Act which apply. Therefore, the question of applying OECD guidelines does not arise at all. Thus it is clear that the Tribunal was wrong in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator taxpayer, then the transaction reported by the taxpayer is at an arm s length price. The proviso to section 92C(2) is explicit that where more than one price is determined by most appropriate method, the arm s length price shall be taken to be the arithmetical mean of such prices. To this extent the appeal is allowed. However, as pointed out above, if this principle is applied to the comparables suggested by the assessee (which have not been rejected by the Transfer Pricing Officer), the arm s length price suggested by the assessee would yet be acceptable in law. There shall be no orders as to costs.

Issues Involved:
1. Correctness of the Tribunal's finding regarding arm's length price determination under Section 92C(2) of the Income-tax Act, 1961.
2. Rejection of comparables by the Transfer Pricing Officer (TPO).
3. Use of data for the relevant financial year.
4. Functional Asset Risk (FAR) analysis and criteria for selecting comparables.

Detailed Analysis:

1. Correctness of Tribunal's Finding on Arm's Length Price:
The central issue was whether the Tribunal correctly held that if one profit level indicator (PLI) of a comparable is lower than that of the taxpayer, then the transactions are at arm's length. The Tribunal observed that if any one margin of a comparable is lower than the taxpayer's margin, the transactions are at arm's length. This interpretation was challenged, and the court found it incorrect. The proviso to Section 92C(2) mandates that where more than one price is determined, the arm's length price should be the arithmetical mean of such prices. Thus, the Tribunal erred in not adopting the arithmetical mean of the prices determined by the most appropriate method.

2. Rejection of Comparables by the TPO:
The TPO rejected the comparables submitted by the taxpayer without specific elimination for each comparable. The TPO provided general reasons such as differences in turnover, non-use of relevant financial year data, and differences in product profiles. The court noted that the TPO did not indicate how each comparable failed to meet the criteria. The Tribunal found that the TPO's rejection of comparables was not justified as he did not provide specific reasons for each rejection and instead used broad criteria.

3. Use of Data for the Relevant Financial Year:
The TPO used data from the financial year 2003-04 instead of the relevant year 2001-02, which was against the provisions of Rule 10B(4) of the Income-tax Rules, 1962. The Tribunal emphasized that only data from the relevant financial year or two preceding years should be considered. The use of data from a subsequent year was deemed erroneous.

4. Functional Asset Risk (FAR) Analysis and Criteria for Selecting Comparables:
The Tribunal criticized the TPO for not conducting a proper FAR analysis and for using criteria such as low employee cost and a wide turnover range (Rs.50 lakhs to Rs.100 crores) which were not appropriate. The Tribunal held that the TPO should not have rejected the taxpayer's comparables without a detailed analysis and should have only conducted a fresh search if the taxpayer's comparables were insufficient or had deficiencies.

Conclusion:
The court concluded that the Tribunal erred in its interpretation of the proviso to Section 92C(2) by not adopting the arithmetical mean of the prices. However, the comparables suggested by the taxpayer, which were not rejected by the TPO, showed that the taxpayer's transactions were at arm's length. The appeal was allowed to the extent of correcting the Tribunal's interpretation, but the arm's length price suggested by the taxpayer was still acceptable in law. No orders as to costs were made.

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