Adjustment for variation in closing stock necessary for correct application of TNMM

Brief of the case:                              

ITAT Licknow in the case of ACIT vs. M/s Rahman Industries Ltd. held that

• Adjustment for variation in closing stock is necessary for the correct computation of Operating cost thereby correct application of Transaction Net Margin Method (TNMM).
• Resale price method for computing ALP cannot be used in case of exporters

Facts of the case:

The assessee company has entered some international transactions for the relevant AY. The AO referred those cases to Transfer Pricing Officer(TPO) to ascertain whether the transfer price as taken is in line with the Arm Length Price(ALP).The TPO audited the transactions and after considering the assessee’s responses proposed an adjustment of Rs. 2,23,73,153.

The adjustments were made because the TPO rejected the method of computing the ALP adopted by the assessee . The AO accepted the adjustments and made addition to the total income accordingly. The assessee challenged the addition before the CIT(Appeals) , who deleted the addition made by holding that the method adopted by TPO was incorrect and also pointing out some apparent mistakes from the TPO’s order. Aggrieved by the said order revenue preferred an appeal before the tribunal.

Contention of the Revenue:

The learned counsel for the revenue contended that the TPO was right in rejecting the Comparable Uncontrolled Price (CUP) method adopted by the assessee because the assessee applied the method by comparing the prices of similar category of products instead of identical products and there also the basis of categorization was price range. Thus, he applied the most suitable methods having regard to the facts of the case.

Further, the Profit Linked Index (PLI) of the assessee as worked out by the TPO was 1.23% much lower than industry average 8.11%.Thus, the addition is justified because of the huge variation.

Contention of the Assessee:

The AO referred the case to TPO without even providing an opportunity to be heard , thus, the reference itself bad in law. Further, the TPO adopted two different method for two different AYs – Resale Price Method (RSM) for AY 2007-08 and Transaction Net Margin Method (TNMM) for AY 2008-09.

Assessee challenged the adoption of RSM for AY 2007-08 and submitted that RSM not applicable to 100% exporters and applies in case of imports or in case where the Associated Enterprise is engaged in in purchase and distribution of goods or services back to back. Even further, the TPO while working out the PLI made following errors:

i) failed to consider the adjustment on account of variation of closing stock in Total expenses.

ii) wrongly taken Export sale to AE as Rs. 32,96,77,862/- instead of Rs. 30,48,35,492/-.

In respect of AY 2008-09, if these errors are rectified, then the PLI would come to 9.56% which is more than industry average (8.11%), hence no requirement of making adjustments even if the method chosen by the assessee was rejected.

In respect of AY 2007-08, if the TNMM is applied then PLI of the company is 7.45% whereas industry average is 8.22%, thus the variance is within permissible variance of 5%

Decision of the ITAT:

The TPO has incorrectly adopted the RSM method for AY 2007-08 , as the same is not applicable for the exporters and only suitable in case of importers. Further, in respect of AY 2008-09, the TPO applied TNMM but failed to consider the adjustment in respect of variation in closing stock, lead to incorrect operating cost and incorrect PLI. TPO also made typographical error in using figure of the export sale to AEs.

Since in both AYs the PLI is either more than industry average or in permissible variation limit, the additions made to the total income are not justified and bad in law.

Therefore, the appeal filed by revenue is dismissed.