The relevant market condition for testing a transaction under CUP is that of the market where the goods are sold and not the place of origin of the goods

Brief of the case: - The Delhi bench of the Income-tax Appellate Tribunal [“The Tribunal”] recently pronounced its ruling in the case of Clear Plus India Private Limited v. DCIT [ITA NO. 3944/DEL/2010], wherein it upheld the transfer pricing methodology adopted by the taxpayer to benchmark its export sale by the application of internal comparable uncontrolled price [“CUP”] method, adopting its associated enterprise [“AE”] as the tested party. The revenue’s contention to use Transactional Net Margin Method [“TNMM”] was rejected as in view of the Tribunal minor aberrations in the application of CUP method do not warrant its abandonment.

Facts of the case:- The taxpayer, a subsidiary of M/s Advantage Asia, USA [“the AE”], is engaged into manufacture of wind-shield wipers in Noida SEZ and entitled to tax holiday benefits under section 10A of the Income-tax Act, 1961 [“the Act”]. The AE procures comparable automobile wipers from the taxpayer as well as from an independent Chinese supplier [“Chinese supplier”] for resale in the USA and sells them under the same brand.

During the relevant assessment year, the taxpayer exported wipers to its AE [“subject transaction”] and benchmarked the same with the application of internal CUP method, adopting the AE as the tested party since the quality of Chinese and Indian purchases was comparable. Since the AE paid a higher price in the subject transaction in comparison to Chinese purchases, it was concluded that the arm’s length principle was satisfied.

However, the Transfer Pricing Officer [“TPO”] rejected CUP method in favour of TNMM on the pretext that the comparability of the two transactions could not be established with reasonableness and accuracy. Further, the conditions prevailing in the market were held to be dissimilar. The TPO selected four comparables (without carrying out any detailed FAR analysis) and made an upward adjustment to the total income of the taxpayer. While making adjustment, he failed to take into account the notional interest on interest-free loan granted by the AE and also, did not grant the benefit of +/- 5% range to the taxpayer.

The Appellant approached the Dispute Resolution Panel [“DRP”], which also confirmed the stand of the TPO.

The aggrieved taxpayer filed an appeal before the Tribunal, seeking endorsement of CUP method. Further, it submitted an application for admitting additional evidence, which contained results of quality test reports conducted by an independent organization of Indian and Chinese wipers.

Ruling of the Tribunal

The Tribunal, while upholding the application of CUP method by the taxpayer, held as under:

• The additional evidence could not be admitted since such tests were conducted after more than four years of the accounting period and thus, lacked contemporaneous comparability;
• CUP method should be preferred over any other method when it can be reliably applied. On the facts of the case, the Tribunal held CUP as the most appropriate method. The change of method to TNMM in the instant case was held to be erroneous. Further, minor aberrations in the application of CUP method do not justify its complete rejection.
• The Tribunal also held that where the foreign AE is adopted as the tested party, the relevant market conditions will be those prevailing in the territory of sale (i.e. USA) since the buyer will be concerned with price and quality in the end-market rather than economic conditions in China and India.
• In order to arrive at the decision, the Tribunal placed reliance upon the rulings in SNF (Australia) Pty. Ltd. v. Commissioner of Taxation (2010) FCA 635and Serdia Pharmaceuticals (India) Private Limited v. ACIT in I.T.A. Nos.2469/Mum/06, 3032/Mum/07 and 2531/Mum/08.

The case was restored back to the file of AO to determine the arm’s length price by adopting CUP method. The taxpayer was instructed to furnish data of AE for Chinese and Indian purchases.

Conclusion :- CUP method, being a direct method, provides the most reliable measure of arm’s length price and should be preferred over any other method when it can be reliably applied. Further, for the application of CUP method, 100% comparability is not required and minor aberrations in its application do not justify its complete rejection. The relevant market to test a transaction under CUP is the market where the goods are sold and not the place of origin of goods.

Related posts:

1. Arms’ length testing for distributors – transaction prices vis-a-vis financial results
2. Sale of identical goods to non-AEs cannot be taken as comparable under CUP, if there are significant differences in quantity sold, geography and cust
3. In order to determine the arm’s length price of the international transaction, the arm’s length margin should be applied only on the international transaction
4. A transaction cannot be held bogus for the mere fact that Assets sold by Assessee if not found with buyer
5. ‘Market rate’ for inter divisional notional transfer price cannot be based on rate determined by the Regulator