2013 (9) TMI 120 - AT - Income Tax

Basis of selection of comparables in Transfer Pricing Held that - There is no legal binding precedence on the issue of selection of most appropriate method, selection of comparable companies, selection of comparables transactions for benchmarking etc. as these are fact based and vary from company to company - Law and the rules be applied first, arguments be based on them and broad proposition relied upon when situations warrant For choosing comparables, time should be devoted to the nature of the companies business operations, nature of transactions, FAR analysis - The logic or reasons behind selection of comparables for benchmarking and supporting the T.P. Study should be based on the Act and Rules rather than picking up orders of different benches on the ground that they are precedent, that too without reference to the facts and nature of transactions. Capping of adjustment in Transfer Pricing Transaction - Transfer pricing adjustment cannot exceed the total profits earned by the group Held that - Neither the Act nor the Rules provide for such capping of an adjustment. Such an exercise is not permissible under the Transfer Pricing provisions but also, it is not practical as the profits of the entire group are not subject to scrutiny of the Indian authorities. Multinationals have innumerous types of business and have multiple locations with multiple AEs and to lay down such a proposition would make the transfer pricing provisions unworkable. Under the Indian law, the T.P.O. is given a mechanism to determine ALP and make an adjustment. Such power is not subject to the acts of the assessee or it s A.E. in different jurisdiction. No Transfer pricing adjustment required as the assessee s income is liable to deduction u/s 10A Held that - Relying upon the judgment in the case of Aztec Softwar 2007 (7) TMI 50 - ITAT BANGALORE , the contention of the assessee is rejected Transfer Pricing adjustment to apply. Adjustment in Transfer Pricing due to risk factor involved - Assessee has come out with this claim of being a captive service provider and hence an adjustment has to be given Held that - Any claim for adjustment, on the basis of risk or any other factors, has to be based on proper data and sound calculation. Ad hoc adjustments should not be granted as it becomes discretionary. The adjustment cannot be used to leverage the desired results, so as to prove or disprove the assessee s claim that its transactions with the AE are at arm s length Rejected the claim of the assessee on the ground that the same is not supported by proper data and material Decided against the Assessee. Principle of consistency in Transfer Pricing adjustment - TPO has not made any adjustment in the earlier years and on the principle of consistency no adjustment should be made in the current year Held that - Transfer Pricing Officer in the A.Y.2005-06 has not exercised his mind in the lines and in the manner in which the TPO has done in this year - The material available with the TPO in the current year is vastly different to the material available with the TPO in the earlier year. In such circumstances, the principle of consistency does not hold water Decided against the Assessee. Comparables for Transfer Pricing to be internal of external comparables only - Whether internal comparables has to be taken and if not as to whether the selection of comparables, when external comparables are taken, is correct or not For application of internal comparables, the assessee argued that under the rules the margin of the single transaction has to be compared to the margin of another transaction, or at best the group of similar transactions and under those circumstances, the volume is not criteria for rejecting the internal comparables. Reliance was placed on Rule 10B(1)(e) - The Revenue relies on Rule 10B(2)(d) Held that - Requirement of transaction margins being compared at a transaction level or at the level of a class of similar transactions, does not warrant comparing miniscule transactions with large transaction for the purpose of benchmarking. Benchmarking of transactions at the transaction level does not warrant ignoring the principle or concept of materiality. The facts and circumstances of each case has to be seen. At the same time reliance placed by the learned DR on Rule 10B(2)(d) is not correct as the same does not apply to the factual situation. This Rule refers to external conditions and not to the miniscule nature of the comparable uncontrolled transactions. Rule 10B(1)(e) relied upon by the assessee also does not come to its rescue as the Rule does not lay down as to which transaction can be taken as a comparable uncontrolled transaction for the purpose of benchmarking the net profit margin with the controlled transaction. Thus the reasoning of both the parties on the issue does not fit into the facts of this case and has to be rejected. In the present case, in the assessment year 2007-08, the assessee has uncontrolled comparable transactions with third parties in export segment to the tune of 15% of total turnover - It has uncontrolled transactions with the third parties in the domestic sector to the tune of 10% of the total turnover. Thus the uncontrolled transactions are significant part of total turnover of the assessee. The argument of the TPO for both the years is that the comparable is miniscule in nature and fails on the comparability of volumes or scale of operation. This argument and finding of the TPO is factually incorrect for the A.Y. 2007-08. 15% of the total turnover is sufficient sample which can be used for the purpose of benchmarking, provided the transactions are functionally comparable. Even domestic uncontrolled transactions are about 10%. In case domestic transactions are functionally comparable these transactions can be used for benchmarking Internal comparables can be taken for the purpose of computation of Transfer Pricing adjustments, provided the nature of transactions and the functions in these transactions has been examined.

Summary

Issues Involved:
1. Rejection of internal comparables for benchmarking international transactions.
2. Application of additional filters by the Transfer Pricing Officer (TPO).
3. Risk adjustment claims by the assessee.
4. Adjustment for low capacity utilization.
5. Consistency in the application of Transfer Pricing adjustments.
6. Disallowance of deduction under section 10A of the Income-tax Act.

Detailed Analysis:

1. Rejection of Internal Comparables for Benchmarking International Transactions:
The assessee argued that internal comparables should be used for benchmarking its international transactions, as these provide a higher degree of comparability. The TPO rejected this on the grounds that the revenue from unrelated parties was economically insufficient. The Tribunal found that for the assessment year 2007-08, the internal comparables were significant (15% of total turnover in export sales and 10% in domestic sales) and directed the TPO to consider these for benchmarking after a functional analysis.

2. Application of Additional Filters by the Transfer Pricing Officer (TPO):
The TPO applied additional filters such as wages to sales ratio, persistent losses, declining operating profit, and negative ROG-sales to select comparables. The assessee argued that these filters were applied inconsistently and were not based on functional analysis. The Tribunal noted that the TPO's approach was to achieve predetermined results and directed a fresh examination of internal comparables for the assessment year 2007-08. For the assessment year 2006-07, the Tribunal also directed a similar exercise for consistency, despite the internal comparables being less significant.

3. Risk Adjustment Claims by the Assessee:
The assessee claimed a risk adjustment of 5% on the grounds that it was a captive service provider. The TPO rejected this, arguing that the assessee faced various risks, including technological, governmental, and environmental risks. The Tribunal found that the assessee did not provide robust data to support its claim for risk adjustment and rejected the claim, emphasizing that adjustments should not be ad hoc and must be supported by proper data and sound calculations.

4. Adjustment for Low Capacity Utilization:
The assessee claimed an adjustment for low capacity utilization, but this was not included in its Transfer Pricing Study. The Tribunal found that the assessee did not provide sufficient details or data to support this claim and upheld the TPO's findings. The Tribunal emphasized that any adjustment claims must be supported by robust data and evidence.

5. Consistency in the Application of Transfer Pricing Adjustments:
The assessee argued that the TPO should follow the principle of consistency and not make adjustments if none were made in earlier years. The Tribunal found that the TPO in the earlier year had not exercised his mind in the same manner as in the current year and that the principle of consistency has its limitations. The Tribunal rejected this argument, noting that the subsequent TPO had gathered further material and conducted a different analysis.

6. Disallowance of Deduction under Section 10A of the Income-tax Act:
The assessee claimed deduction under section 10A for its Noida unit, which was denied by the AO following earlier assessment orders. The Tribunal noted that the assessee's claim had been allowed by appellate authorities in earlier years and upheld by the Delhi High Court. The Tribunal allowed the claim for deduction under section 10A for the current year as well.

Conclusion:
The Tribunal directed the AO/TPO to reconsider the internal comparables for benchmarking, rejected the claim for risk adjustment due to lack of robust data, and upheld the disallowance of adjustments for low capacity utilization. The Tribunal also allowed the deduction under section 10A, following the decision of the Delhi High Court. The appeals were allowed in part.