2015 (3) TMI 613 - HC - Income Tax

Correctness of the ITAT s order - directing the AO/TPO for fresh determination of the addition originally made on account of Arm s Length Price, which was specified in the course of the proceedings - Held that - Question of law urged in both the appeals does not arise since it already stands settled in the previous order reported in 2014 (1) TMI 501 - DELHI HIGH COURT - pertaining to the present assessee wherein held that there is no legal authority under the Income Tax Act, 1961 or the Rules to broaden the cost base in that manner. Consequently, the ITAT directed a remission of the matter to the AO for redetermination of the cost base. The TPO s reasoning to enhance the assessee s cost base by considering the cost of manufacture and export of finished goods, i.e., ready-made garments by the third party venders (which cost is certainly not the cost incurred by the assessee), is nowhere supported by the TNMM under Rule 10B(1)(e) of the Rules. Having determined that (TNMM) to be the most appropriate method, the only rules and norms prescribed in that regard could have been applied to determine whether the exercise indicated by the assessee yielded an ALP. The approach of the TPO and the tax authorities in essence imputes notional adjustment/income in the assessee s hands on the basis of a fixed percentage of the free on board value of export made by unrelated party venders. Appeal dismissed.

Summary

Issues:
1. Correctness of ITAT's order directing fresh determination of addition on account of Arm's Length Price.
2. Interpretation of cost base for determining Arm's Length Price.
3. Applicability of Li and Fung India Pvt. Ltd. judgment on the present case.
4. Settlement of the question of law in previous order.

Analysis:

1. The Revenue challenged the ITAT's order for fresh determination of the addition on account of Arm's Length Price for the Assessment Years 2007-08 and 2008-09. The key question was the correctness of ITAT's directive to the AO/TPO for reassessment based on the increased cost base of total cost incurred. The High Court observed that the TPO's directions were acted upon by the AO using the enhanced cost base, which was not in line with the legal provisions. The ITAT referred to the Li and Fung India Pvt. Ltd. judgment, emphasizing that there is no authority to broaden the cost base as done in this case. Consequently, the ITAT remanded the matter to the AO for redetermination of the cost base in accordance with the Li and Fung India Pvt. Ltd. judgment.

2. The High Court highlighted the basis on which the TPO's directions were implemented by the AO, focusing on the increased cost base for determining the Arm's Length Price. The Court noted that the cost base was expanded beyond permissible limits, as established in the Li and Fung India Pvt. Ltd. case. The judgment clarified that the cost base should be determined based on the functions performed and costs incurred by the assessee, not by unrelated third-party vendors. The Court emphasized that the net profit margin for the Transfer Pricing Method should be calculated with reference to the costs incurred by the assessee, in line with Rule 10B(1)(e) of the Income Tax Rules.

3. The High Court reiterated the findings of the Li and Fung India Pvt. Ltd. judgment, emphasizing the proper application of the Transactional Net Margin Method (TNMM) for determining the Arm's Length Price. The Court emphasized that the TNMM should consider the relevant factors of the enterprise in question, i.e., the assessee, and not unrelated third parties or associated enterprises. The judgment clarified that the TNMM does not support imputing notional adjustments or income based on costs incurred by third-party vendors. The Court upheld the principles established in the Li and Fung India Pvt. Ltd. case, emphasizing the textual mandate for determining the Arm's Length Price.

4. The High Court concluded that the question of law raised by the Revenue did not stand as it was settled in the previous order related to the present assessee. Therefore, the Court dismissed the appeals, affirming the decision of the ITAT for a fresh determination of the addition on account of Arm's Length Price based on the correct interpretation of the cost base in accordance with the Li and Fung India Pvt. Ltd. judgment.