2016 (11) TMI 202 - AT - Income Tax

Transfer pricing adjustment - MAM - TNMM - comparability - Held that - It is an admitted fact that the assessee entered into international transaction with Moriseiki, Japan and to determine the arm s length price, the assessee adopted TNMM method as most appropriate method in accordance with OECD Guidelines, and the operating profit/operating cost was considered as profit level indicator. The AO was of the view that the assessee ought to have earned gross profit rate of 38.09% on the direct sales made by the HO in India and 50% of that gross profit was attributable to the assessee. In the present case, it is an admitted fact that in the subsequent year, the DRP considered the TNMM as the most appropriate method and worked out the arithmetic mean margin at 5.60% on the basis of 5 comparables while the assessee had calculated the average margin on the basis of 13 comparables at 5.84% and since the facts in the year under consideration are similar to the facts involved in the subsequent year as there was no change in the functions, utilization of assets and risk profile of the assessee. Therefore, the ld. CIT(A) rightly held that the action of the AO was not sustainable because he on the one hand had accepted TNMM and also used profit split method for attribution of profit on the international transaction at 50 50 ratio. In our opinion either of the two methods could have been used and not both, therefore, the ld. CIT(A) was fully justified in holding that the action of the AO was not sustainable in the eyes of law. In the present case, when the AO himself accepted that the transaction was benchmarked under the provision of Section 92 of the Act, so there was no need to attribute the profit separately to the assessee PE. Since, there is no change in the facts for the year under consideration vis- -vis subsequent year, the ld. CIT(A) rightly restricted the adjustment to the international transaction at ₹ 54,37,717/-. We do not see any infirmity in the impugned order passed by the ld. CIT(A). - Decided against revenue

Summary

Issues Involved:
1. Attribution of profits to the Permanent Establishment (PE) in India.
2. Determination of the arm’s length price using the Transaction Net Margin Method (TNMM).
3. Appropriateness of the AO’s method of profit attribution and the comparables used.

Issue-wise Detailed Analysis:

Attribution of Profits to the Permanent Establishment (PE) in India:
The core issue in the appeal was whether the profits arising from the sales made by the head office (HO) in Japan should be attributed to the PE in India and taxed accordingly. The Assessing Officer (AO) argued that the PE in India was fully involved in the sales transactions, including taking orders, deciding prices, and maintaining stock, and thus, profits from these sales should be attributed to the PE. The AO relied on the India-Japan tax treaty and the decision of the Hon’ble Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd., which emphasized that income directly or indirectly attributable to the PE should be taxed in India.

Determination of the Arm’s Length Price Using the TNMM:
The assessee argued that the transactions between the PE and the HO were at arm’s length, as demonstrated by their Transfer Pricing (TP) documentation using the TNMM. The AO, however, did not accept this contention, stating that the transactions were not part of the TP study. The AO used the gross profit rate of the HO in Japan to determine the profits attributable to the PE in India, attributing 50% of the gross profit to the PE.

Appropriateness of the AO’s Method of Profit Attribution and the Comparables Used:
The AO’s method of attributing 50% of the gross profit to the PE was challenged by the assessee, who argued that the AO did not use any comparables to fix the margin. Instead, the assessee provided a set of 13 comparables in their TP study, which showed an average margin of 5.84%. The Commissioner of Income Tax (Appeals) [CIT(A)] accepted the assessee’s comparables and adjusted the profit attribution accordingly, reducing the addition made by the AO. The CIT(A) also noted that the AO had used both the TNMM and the profit split method, which was not permissible. The CIT(A) concluded that TNMM was the most appropriate method, as it was used in the subsequent year and approved by the Dispute Resolution Panel (DRP).

Conclusion:
The Tribunal upheld the CIT(A)’s decision, agreeing that the AO’s approach of using both TNMM and the profit split method was not sustainable. The Tribunal found that the CIT(A) was justified in using the average margin of 5.84% from the comparables provided by the assessee to determine the arm’s length price, resulting in an adjustment of ?54,37,717/-. The appeal of the department was dismissed, affirming that the transaction between the PE and the HO was at arm’s length, and no further profit attribution was necessary.