2013 (9) TMI 195 - AT - Income Tax

Transfer pricing Adjustments - ALP - Preference in choosing comparable, be it internal or external - Held that - the application of proposed arm s length requires comparison of conditions in a controlled transaction with the condition of uncontrolled transaction and for a difference between the situations, reasonable adjustment of profit can be made to offset the effect of such difference, if any. Thus such a comparability analysis has to be carried out to compare the controlled transaction with the conditions of uncontrolled transactions and then only the arm s length price can be determined. Once the determination of arm s length price is triggered, it has to be determined by following any of the prescribed methods under the statute i.e. prescribed in section 92C of the Act read with Rule 10B. There is no other way ALP can be examined in transfer pricing mechanism. In this case, admittedly neither CUP method nor Cost Plus Method is applicable because in CUP, the price at which a controlled transaction is carried cut is compared to the price obtained in a comparable uncontrolled transaction. In CPM, ALP is determined by adding an appropriate gross profit margin to an AE s cost of producing products or services. None of the factors required in both the methods are existing for carrying out the comparability analysis in this case. The only method which could be said to be applicable for bench marking the margin of international transactions of the assessee, as admitted by both the parties before us can be TNMM. Once internal comparable was available, along with the segmental details, TPO was required to examine the same and carry out the comparability analysis. It is only when internal TNMM fails, the TPO can go into search for external TNMM because external comparable require lot of functionality test and adjustments - It is only when the internal comparable and its segmental details are not found to stand the test of comparability analysis, then external comparable s should be looked into. In such a situation, the TPO will carry out fresh search after taking into consideration all the assessee s objection and submission - All those contentions about search/filter criteria, comparable companies, can be raised before the TPO. Though this will be done only when analysis on internal TNMM is not workable at all - Restored this matter to the file of the AO to verify the segmental details of the AE as well as non-AE and carry out comparability analysis for arriving at the margin of both parties and, accordingly, determine the arm s length price Decided in favor of Assessee.

Summary

Issues Involved:
1. Transfer Pricing Adjustment.
2. Method for Determining Arm's Length Price (ALP).
3. Internal vs. External Comparables.
4. Set-off of Brought Forward Business Loss and Unabsorbed Depreciation.

Detailed Analysis:

Transfer Pricing Adjustment:
The primary issue revolves around a transfer pricing adjustment of Rs. 2,44,94,134/- made by the Transfer Pricing Officer (TPO) while determining the arm's length price (ALP) for international transactions undertaken with the assessee's Associate Enterprise (AE). The assessee's international transactions included software development, accounting, and technical support services with its AE, CyberTech Systems and Software Ltd. (CSSI). The assessee argued that the functional return earned by AE (12% of the contract price) is comparable to a similar return earned by a third party (Corliant Inc.), thus justifying its margin as being at ALP.

Method for Determining Arm's Length Price (ALP):
The TPO rejected the Cost Plus Method (CPM) used by the assessee for benchmarking, arguing that the cost of the product was not used for benchmarking the transactions. Instead, the TPO applied the Transactional Net Margin Method (TNMM), which led to an upward adjustment of Rs. 2,44,94,134. The assessee contended that the internal Comparable Uncontrolled Price (CUP) method should be used if CPM fails, and argued that internal TNMM should be applied as the operating margin of total cost earned by the assessee for its AE transactions is more than the operating margin earned on similar transactions with third parties.

Internal vs. External Comparables:
The TPO and the Dispute Resolution Panel (DRP) rejected the assessee's internal comparables, arguing that the assessee had not demonstrated the terms and conditions of the contracts with the third party, which are comparable to the transactions with AE. The TPO instead used external comparables, resulting in a higher margin. The Tribunal emphasized that internal comparables should be preferred over external comparables when segmental details are available, as they require fewer adjustments. The Tribunal restored the matter to the Assessing Officer (AO) to verify the segmental details of the AE and non-AE transactions and carry out a comparability analysis.

Set-off of Brought Forward Business Loss and Unabsorbed Depreciation:
The assessee contended that the AO had not set off brought forward business loss and unabsorbed depreciation against business income. The Tribunal directed the AO to allow the set-off in accordance with the provisions of law.

Conclusion:
The Tribunal allowed the appeal in part for statistical purposes. It directed the AO to verify the segmental details of the AE and non-AE transactions and carry out a comparability analysis. If internal comparables are not workable, the AO should then consider external comparables, taking into account the assessee's objections and submissions. The Tribunal also directed the AO to allow the set-off of brought forward business loss and unabsorbed depreciation as per the law.