2014 (9) TMI 266 - AT - Income Tax

Determination of Arm s length price TNM method rejected and CUP method invoked - Addition of international transaction of export of finished goods to AE Held that - The adoption of CUP method is to be treated as the most appropriate method for the purposes of comparability analysis is liable to be upheld relying upon Serdia Pharmaceuticals (India) (P.) Ltd. v. ACIT 2010 (12) TMI 60 - ITAT, Mumbai - though the transfer pricing legislation does not prescribe a particular order of preference for the methods for determining the arm s length price, but the selection of most appropriate method essentially requires the methods to be ranked on a rational basis - the CUP method has been rightly selected as the most appropriate method in order to determine the arm s length price of the international transactions of export of finished goods to the associated enterprises. There is nothing in the phraseology of Rule 10B(3) of the rules to suggest that the adjustment to an uncontrolled transaction is permissible only under the TNM method and not to the other methods enumerated in Rule 10B(1) of the rules - even in relation to the present situation whereby the comparability analysis has been carried out by adopting the CUP method, the adjustments to the uncontrolled comparable transaction which are permissible and justifiable in law and on facts of the case, in order to facilitate comparability of the international transaction with the uncontrolled comparable transactions deserve to be allowed so far as adjustments proposed by the TPO on account of the international transaction of export of finished goods to the associated enterprises is concerned, it shall be scaled down to ₹ 36,91,536/- as against ₹ 71,01,810/- determined by the TPO Decided partly in favour of Assessee. The comparable transaction picked-up by the TPO, namely, agreement between assessee and Henkel USA is a transaction between two related/associated enterprises and therefore it is a controlled transaction and not an uncontrolled transaction - Such a transaction undertaken between two controlled entities, in our view cannot be considered as a comparable uncontrolled transaction , as envisaged in clause (a) of sub-rule (1) of rule 10B of the Rules - the adjustment made by the TPO by considering the agreement between Henkel USA and assessee as an arm s length price for the international transaction has to fail - the addition made by the TPO is to be set aside. The entire purpose of the transfer pricing analysis is to compute the income arising from an international transaction, having regard to its arm s length price - The international transaction in question, relates to import of raw materials by the assessee from its associated enterprises - what is expected of the TPO is to consider the transactions of import of raw materials by the assessee from its associated enterprises in its entirety - as factually demonstrated by the assessee, TPO has ignored certain transactions of import of raw materials from the associated enterprises where the prices charged by the associated enterprises were lower than the prices charged by the non- associated enterprises - TPO has picked up only those transactions where the prices charged by the associated enterprises are higher in comparison to prices charged by the third parties, without considering the reasons for the same - the approach of the TPO is quite flawed and is not justified. In the tabulation, assessee has explained reasons which prevailed with it to make imports from the associated enterprises of the 5 products, though the prices charged by associated enterprises were higher than the prices charged by the non-associated enterprises - The circumstances canvassed by the assessee have not been found to be lacking in bonafides by the TPO the action of the TPO is set-aside and the matter is remitted back for re-computation of the arm s length price by taking into consideration the international transaction of import of raw materials from the associated enterprises in its entirety and not merely in relation to 5 products and leaving out the other 5 products which are also imported from the associated enterprises Decided in favour of Assessee.

Summary

Issues Involved:
1. Adjustment to the value of international transactions.
2. Rejection of the aggregation approach.
3. Rejection of Transactional Net Margin Method (TNMM) for benchmarking export of finished goods.
4. Rejection of TNMM for benchmarking import of raw materials.
5. Rejection of TNMM for benchmarking drop shipment commission.
6. Transfer pricing adjustment without giving the benefit of +/- 5% as per section 92C(2).
7. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Adjustment to the Value of International Transactions:
The assessee challenged the adjustment of INR 78,43,090/- to the value of international transactions made by the DCIT based on the directions of the DRP. The transactions in question pertained to the import of raw materials, export of finished goods, and drop shipment commission. The TPO proposed this adjustment to align the transactions with the arm's length price.

2. Rejection of the Aggregation Approach:
The DCIT rejected the aggregation approach used by the assessee in its Transfer Pricing Study Report, which grouped transactions related to import of raw materials, export of finished goods, and import of packing materials under 'manufacturing activity'. The DCIT did not provide reasonable justification for this rejection. The assessee argued that these activities were closely linked to the manufacturing process and should be aggregated for comparability analysis under the TNMM method.

3. Rejection of TNMM for Benchmarking Export of Finished Goods:
The DCIT rejected the TNMM method for benchmarking the export of finished goods and instead applied the Comparable Uncontrolled Price (CUP) method. The TPO found that the export prices to associated enterprises were significantly lower than the prices charged to third parties. The assessee argued that differences in functions, risks, and geographical locations were not considered, and adjustments should be made for sales & marketing functions and credit risk. The Tribunal upheld the use of the CUP method but allowed adjustments for sales & marketing functions and credit risk, reducing the adjustment from INR 71,01,810/- to INR 36,91,536/-.

4. Rejection of TNMM for Benchmarking Import of Raw Materials:
The DCIT rejected the TNMM method for benchmarking the import of raw materials and applied the CUP method, resulting in an upward adjustment of INR 5,11,870/-. The assessee argued that the imports were made due to business contingencies and urgent requirements, and the TPO only considered transactions where the prices charged by associated enterprises were higher. The Tribunal remanded the matter back to the TPO for re-computation, instructing to consider the entire international transaction of import of raw materials.

5. Rejection of TNMM for Benchmarking Drop Shipment Commission:
The DCIT rejected the TNMM method for benchmarking drop shipment commission and applied the CUP method, resulting in an adjustment of INR 2,29,410/-. The TPO compared the commission rates with those charged by Henkel USA, an associated enterprise. The Tribunal found this approach flawed as it did not consider an uncontrolled transaction and directed the deletion of the adjustment.

6. Transfer Pricing Adjustment without Benefit of +/- 5%:
The assessee contended that the DCIT erred by not allowing the benefit of the +/- 5% range as per the proviso to section 92C(2) of the Act. However, this issue was not specifically adjudicated in the provided judgment text.

7. Initiation of Penalty Proceedings under Section 271(1)(c):
The assessee challenged the initiation of penalty proceedings under section 271(1)(c) on account of the transfer pricing adjustment. This issue was not specifically adjudicated in the provided judgment text.

Conclusion:
The Tribunal partly allowed the appeal. It upheld the use of the CUP method for benchmarking export of finished goods but allowed adjustments for sales & marketing functions and credit risk. The adjustment for drop shipment commission was deleted as it was based on a controlled transaction. The matter of import of raw materials was remanded back to the TPO for re-computation. The Tribunal did not specifically adjudicate on the benefit of the +/- 5% range and the initiation of penalty proceedings.