2015 (5) TMI 644 - AT - Income Tax

Transfer pricing adjustment - most appropriate method - Held that - Pertinently, bifurcation of assessee's financial results into manufacturing and trading segment was done only in the course of proceedings before the TPO and so far as the segment of Trading activity is concerned the TPO accepted the position that it was at arm's length price and no addition has been proposed. The addition in question has been made only with regard to the Manufacturing segment. DRP/AO determining the arm's length price of the international transactions pertaining to the manufacturing segment of the appellant, by comparing with external comparables when functionally similar internal comparables are available to determine the arm's length price under the internal Transactional Net Margin Method which is more reliable - Held that - The present case internal comparison of the operating margins using internal TNM Method is liable to be upheld in order to compute arm's length for the international transactions of purchase of raw material and components from associated enterprises as well as sales of finished goods effected to the associated enterprises. On the basis of the aforesaid benchmarking, the profitability of international transactions under the associated enterprises segment computed at 3.25% is higher than the profitability of transactions under the Third parties segment computed at 2.80%. Hence, the international transactions entered with the associated enterprises under the Manufacturing segment on account of purchase of raw material and components and also sales are consistent with the arm's length price and no transfer pricing adjustment is thus required to be made. - Decided in favour of assessee. Disallowing the expenditure incurred on lease rentals for use of Vehicles and Computers - Held that - The dispute for the assessment year 2003-04 as relied to make disallowance was still not final and therefore the matter may be set-aside to the file of the Assessing Officer with the directions to decide the issue in the light of the ultimate decision with regard to such dispute in the assessment year 2003-04. The learned Departmental Representative appearing for the Revenue has not contested the aforesaid factual matrix and has also not opposed the plea of the assessee for remanding the issue back to the file of the Assessing Officer - restore the matter back to the file of the Assessing Officer who shall consider the claim of the assessee in conformity with the ultimate decision on this aspect in the assessment year 2003-04. - Decided in favour of assessee for statistical purposes.

Issues Involved:
1. Transfer Pricing Adjustment
2. Selection of Comparables
3. Use of Data for Transfer Pricing Analysis
4. Internal vs. External Transactional Net Margin Method (TNM Method)
5. Disallowance of Lease Rental Expenditure
6. Initiation of Penalty Proceedings

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment:
The primary issue revolves around the addition of Rs. 5,21,97,453/- made by the Assessing Officer (AO) on account of transfer pricing adjustment while computing the arm's length price of the international transactions of the assessee. The AO, following the directions of the Dispute Resolution Panel (DRP), determined that the international transactions did not satisfy the arm's length principle as envisaged under the Income-tax Act, 1961. The assessee had entered into international transactions with its associated enterprises and applied the Transactional Net Margin Method (TNM Method) to determine the arm's length price. The AO, however, rejected the approach adopted by the assessee and made an adjustment.

2. Selection of Comparables:
The assessee contended that the AO erred in selecting certain external comparables which were not functionally comparable and in rejecting certain comparables that were functionally comparable. The AO adopted a set of 11 comparable cases, whose arithmetic mean of operating margin was determined at 14.57%, while the operating margin of the assessee in the manufacturing segment was 1.57%. The AO's approach in selecting comparables was challenged by the assessee as it led to an incorrect set of comparables being chosen.

3. Use of Data for Transfer Pricing Analysis:
The AO used data which was not available to the assessee at the time of conducting the transfer pricing analysis. The assessee argued that the AO's use of such data was unfair and penalized the assessee for an act that was impossible to perform. The AO did not allow the use of multiple-year data as prescribed under Rule 10B(4) of the Rules, which was another point of contention.

4. Internal vs. External Transactional Net Margin Method (TNM Method):
The major point of difference was whether to use internal or external TNM Method for benchmarking the international transactions. The assessee argued for the internal TNM Method, stating that the profitability from transactions with associated enterprises was higher than the profitability from transactions with third parties. The AO, however, rejected this approach. The Tribunal found that the internal comparables had a more direct and closer relationship to the tested transactions and upheld the plea of the assessee, stating that the internal TNM Method was more appropriate for benchmarking.

5. Disallowance of Lease Rental Expenditure:
The AO disallowed the expenditure incurred on lease rentals for vehicles and computers, amounting to Rs. 12,14,618/- and Rs. 3,30,371/- respectively, by treating the expenditure as capital in nature. The assessee argued that if the expenditure was to be treated as capital in nature, depreciation under Section 32(1) of the Act should have been allowed. The Tribunal restored the matter back to the file of the AO to consider the claim of the assessee in conformity with the ultimate decision on this aspect in the assessment year 2003-04.

6. Initiation of Penalty Proceedings:
The assessee contended that the AO erred in initiating penalty proceedings under Section 271(1)(c) of the Act on the premise that the assessee furnished inaccurate particulars of income. The Tribunal did not provide a detailed analysis on this issue, as the primary focus was on the transfer pricing adjustment and related grounds.

Conclusion:
The Tribunal allowed the appeal of the assessee partly. It upheld the plea of the assessee regarding the use of the internal TNM Method for benchmarking the international transactions, thereby negating the need for the transfer pricing adjustment of Rs. 5,21,97,453/-. The issues related to the selection of comparables and the use of data were rendered academic due to the decision on the internal TNM Method. The matter of disallowance of lease rental expenditure was remanded back to the AO for reconsideration in light of the decision for the assessment year 2003-04. The initiation of penalty proceedings was not adjudicated in detail.

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