2015 (11) TMI 185 - AT - Income Tax

Transfer pricing adjustment - selection of most appropriate method - TNMM or CUP or CPM - Held that - The prices on which the assessee has sold the same products to resident associated enterprises cannot be taken as benchmark for ascertaining the arm s length price of its similar sale transaction with the non-resident enterprises. Once we come to the conclusion that necessary inputs for ascertaining the ALP under CUP are not available, there cannot be any occasion to apply the same. In the assessment year 2008-09, the TPO himself abandoned the CUP method and resorted to cost plus method. CPM is not a residuary method in the sense that if every other method of ascertaining the arm s length price fails, CPM can be applied on the basis of imperfect data. If at all there is a residuary method, or what is termed as the method of last resort, it is transactional net margin method. TNMM has almost become the default method for taxpayers in recent years.The key advantage of the TNMM is that there is often available data in the public domain about the net profits that comparable independent businesses earn from their trading activities in comparable markets with other third parties. As such, the TNMM often proves easier to apply than, say, the Cost Plus or RPM methods, and TNMM is less sensitive to minor differences in the products being sold. It is also important that the data for application of CPM, as collected by the TPO, was not in public domain and this has been done by collecting information under section 133(6). Such a data could not have been available to the assessee. All shortcomings being equal in the application of the methods of determining the ALP, as at best is the case of the authorities below, the method to be preferred is the method for which necessary inputs are available in the public domain Authorities below indeed erred in not applying the TNMM for ascertaining the arm s length price of assessee s transactions with the associated enterprises. We direct the AO/TPO to compute the ALP on the basis of the transactional net margin method. With these directions, we remit the matter to the file to the assessment stage for fresh determination of arm s length price. - Decided in favour of assessee for statistical purposes.

Issues Involved:

1. Determination of the most appropriate method for ascertaining the arm's length price (ALP) of exports made by the assessee to its associated enterprises (AEs) abroad for the assessment years 2007-08 and 2008-09.
2. Validity of the Comparable Uncontrolled Price (CUP) method applied by the Transfer Pricing Officer (TPO) for the assessment year 2007-08.
3. Validity of the Cost Plus Method (CPM) applied by the TPO for the assessment year 2008-09.
4. Appropriateness of the Transactional Net Margin Method (TNMM) as proposed by the assessee.

Detailed Analysis:

1. Determination of the Most Appropriate Method for Ascertaining ALP:

The primary issue was to determine the most appropriate method for ascertaining the arm's length price of the exports made by the assessee to its associated enterprises abroad. The assessee contended that the Transactional Net Margin Method (TNMM) was the most appropriate method, while the authorities below argued for the Comparable Uncontrolled Price (CUP) method for the assessment year 2007-08 and the Cost Plus Method (CPM) for the assessment year 2008-09.

2. Validity of the CUP Method for Assessment Year 2007-08:

The TPO applied the internal CUP method to ascertain the arm's length price. The TPO noted that the assessee sold the same products to associated enterprises in India and used these prices as benchmarks. However, the Tribunal observed that the CUP method requires comparable uncontrolled transactions, which are defined as transactions between enterprises other than associated enterprises. The Tribunal found that using prices from transactions with associated enterprises, even if resident in India, did not meet the criteria for an uncontrolled transaction as defined under Rule 10A. Therefore, the Tribunal concluded that the necessary inputs for applying the CUP method were not available, rendering the application of the CUP method inappropriate.

3. Validity of the CPM for Assessment Year 2008-09:

For the assessment year 2008-09, the TPO applied the Cost Plus Method (CPM) after rejecting the TNMM proposed by the assessee. The Tribunal noted that the DRP conceded that appropriate data for the application of CPM was not available, yet approved its adoption because the data for TNMM was also deemed inadequate. The Tribunal criticized this approach, stating that CPM is not a residuary method to be applied on the basis of imperfect data. The Tribunal emphasized that TNMM should be preferred when necessary inputs are available in the public domain, as it often proves easier to apply and is less sensitive to minor differences in products.

4. Appropriateness of the TNMM:

The Tribunal highlighted the advantages of TNMM, noting that it is typically applied when two related parties engage in a continuing series of transactions and one party controls intangible assets. TNMM is often more reliable when data on gross margins are less consistent due to accounting differences. The Tribunal concluded that the authorities below erred in not applying TNMM for ascertaining the arm's length price and directed the AO/TPO to compute the ALP using TNMM. The Tribunal remitted the matter to the assessment stage for fresh determination of the arm's length price, allowing the assessee to present further arguments on the application of TNMM.

Conclusion:

The Tribunal set aside the application of CUP and CPM by the authorities below and directed the AO/TPO to use TNMM for determining the arm's length price. The matter was remitted back to the assessment stage for fresh determination, with instructions to consider the assessee's arguments and issue a speaking order in accordance with the law. The appeals were allowed for statistical purposes.

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