2016 (3) TMI 815 - AT - Income Tax

Transfer pricing adjustment - whether the international transaction undertaken by the assessee were at Arm s Length as against the adjustment made by the AO? - adoption of PLI under the TNMM challenged - correctness of the ALP of the international transactions undertaken by the assessee under both the business models of Indenting as well as Trading - Held that - We have noticed that operating costs of a Commission agent are always exclusive of cost of goods sold, whereas a Trader has to have it as an essential element. Albeit a Trader can ascertain his operating profit margin as a percentage of VAE to be designated as any other base , but in our considered opinion that can not be described as a relevant base, so as to fall within the ambit of the expression any other relevant base as used in sub-clauses (i) and (ii) of rule 10B(1)(e). The corollary, which ergo follows, is that whereas any other relevant base under the TNMM in case of a Commission agent can be Value added expenses , which, in fact, represents his total operating costs alone, but in case of a Trader , it can be cost of goods sold plus other operating expenses, which represents his total operating costs and not Value added expenses to the exclusion of cost of goods sold. We, therefore, set aside the impugned order in comparing OP/VAE of the assessee on combined transactions under both the models with OP/OC of the comparables. Having disapproved the view taken by the ld. CIT(A), we need to judge the correctness of the ALP of the international transactions undertaken by the assessee under both the business models of Indenting as well as Trading , which are obviously distinct from each other. It can be seen that the assessee tried to demonstrate that its combined international transactions under both the models were at ALP by comparing its PLI of OP/VAE with OP/OC of comparables, which is an incorrect approach. In the like manner, the TPO, though compared the assessee s PLI of OP/VAE with OP/VAE of the comparables, but he also fell in error by jointly considering the international transactions of both the business models, namely, Indenting and Trading, under one umbrella. We thus hold that both the assessee as well as the TPO fell in error in considering the international transactions under both the models as of uniform character. It has been noticed supra that the ingredients of Operating costs under the Trading model are different from those under Indenting model. Ex consequenti, transactions under both the models are required to be benchmarked separately. We find that there is insufficient information available on record facilitating the determination of ALP of the international transactions under these two business models separately. We, therefore, set aside the impugned order and remit the matter to the file of AO/TPO for processing the international transactions of Indenting and Trading separately under Chapter X of the Act in consonance with our above analysis. Needless to say, the assessee will be allowed an adequate opportunity of hearing in such a de novo determination. - Decided in favour of revenue for statistical purposes.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for international transactions.
2. Selection of Profit Level Indicator (PLI) under the Transactional Net Margin Method (TNMM).
3. Differentiation between operating costs and value-added expenses (VAE).
4. Comparison of the assessee's PLI with that of comparables.
5. Treatment of transactions under different business models (Indent model and Buy-Sell model).

Issue-wise Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for International Transactions:
The primary issue in the appeal was whether the international transactions undertaken by the assessee were at Arm's Length Price (ALP). The assessee, a subsidiary of Agilent Technologies, Europe B.V., reported two international transactions. The Transfer Pricing Officer (TPO) accepted the transaction of 'Payment of interest on loan' at ALP but disputed the transaction of 'Facilitation of sales of Agilent products in India' with a transacted value of Rs. 76,54,27,667/-. The TPO made an adjustment of Rs. 8,35,41,898/-.

2. Selection of Profit Level Indicator (PLI) under the Transactional Net Margin Method (TNMM):
The assessee used the Transactional Net Margin Method (TNMM) with the Profit Level Indicator (PLI) of Operating profit/Operating cost (OP/OC) at 4.9%. The TPO observed that the assessee showed the profit margin on the basis of Operating Profit/Value Added Expenses (OP/VAE) at 13.96%. The TPO computed the assessee's operating profit margin at Rs. 5.20 crore by applying the PLI of 13.96% to the 'Value Added Expenses' incurred by the assessee. The TPO then benchmarked this against the comparables' OP/VAE of 36.38%, leading to the transfer pricing adjustment.

3. Differentiation between Operating Costs and Value-Added Expenses (VAE):
The TPO and the CIT(A) had differing views on the base for computing the PLI. The CIT(A) compared the assessee's OP/VAE with the OP/OC of comparables, concluding that the international transaction was at ALP. However, the tribunal noted that the net operating profit margin realized by the assessee must be compared with the comparables using the same base, as per Rule 10B(1)(e) of the IT Rules, 1962. It was emphasized that operating costs for a trader include the cost of goods sold, whereas for a commission agent, it excludes such costs.

4. Comparison of the Assessee's PLI with that of Comparables:
The tribunal found that the CIT(A)'s assumption that the TPO accepted the assessee's OP/VAE as equivalent to OP/OC of comparables was incorrect. The TPO had consistently used OP/VAE for both the assessee and the comparables. The tribunal highlighted that the numerator (operating profit) and denominator (cost base) must be identical for both the assessee and the comparables to ensure a rational comparison.

5. Treatment of Transactions under Different Business Models (Indent Model and Buy-Sell Model):
The tribunal noted that the assessee engaged in two distinct business models: Indent model and Buy-Sell model. The assessee claimed that under both models, it was merely a commission agent. However, the tribunal found evidence in the assessee's financial statements indicating substantial investment in stock and debtors, characteristic of a trading activity under the Buy-Sell model. The tribunal concluded that the assessee's transactions under the Buy-Sell model were not comparable to those under the Indent model and should be treated separately.

Conclusion:
The tribunal set aside the CIT(A)'s order, directing the Assessing Officer (AO)/TPO to separately benchmark the international transactions under the Indent and Buy-Sell models. The tribunal emphasized the need for consistency in the base used for computing the PLI and directed a de novo determination of the ALP, providing the assessee with an adequate opportunity for hearing. The appeal was allowed for statistical purposes.