ITAT Kolkata Deletes ₹79.79 Lakh TP Adjustment on Pass-Through AE Purchases

Solex Chemicals Private Limited Vs DCIT (ITAT Kolkata)

When AE Is Only a Pass-Through, CUP Beats TNMM: No TP Adjustment Where Credit Notes Eliminate the Entire Mark-up

The Kolkata Bench of the ITAT has deleted a transfer-pricing adjustment of ₹79,79,861 on purchases of raw materials routed through an Associated Enterprise. The Tribunal found that the AE was merely a pass-through entity, the actual supplier was an unrelated Chinese company, the products and quantities on both sides were identical, and the entire provisional mark-up appearing in the AE’s invoices was neutralised through credit notes. Therefore, the assessee’s international transaction was effectively carried out at the same price charged by the independent supplier, making the Comparable Uncontrolled Price method more appropriate than the TNMM adopted by the TPO.

Solex Chemicals Pvt. Ltd. was an MSME and a wholly owned subsidiary of Endura S.P.A., Italy. It manufactured active ingredients used in household insecticides for preventing vector-borne diseases such as malaria & chikungunya. Since its incorporation in 2008, its turnover had generally remained below ₹25 crore, except during the relevant assessment year.

The assessee required two specialised raw materials—Prallethrolone and Chrysanthemic Acid Chloride D+Trans. These materials were supplied by a Chinese manufacturer which enjoyed an exclusive position in relation to the products. Since the assessee placed relatively small orders, the Chinese supplier was reluctant to directly supply the materials or extend the credit terms available to the Italian parent company.

Endura S.P.A. therefore facilitated the procurement. The goods were physically shipped by the Chinese supplier directly from Shanghai to the assessee at Kolkata. The transaction followed a bill-to/ship-to arrangement: the Chinese supplier invoiced Endura, while Endura raised corresponding invoices on the assessee.

The assessee reported these purchases as international transactions in Form No. 3CEB and adopted the CUP method for benchmarking. According to it, the price charged by the unrelated Chinese supplier to Endura provided a direct uncontrolled comparable for determining the arm’s-length price of the identical goods supplied through Endura to the assessee.

The invoices raised by Endura initially included an additional amount of USD 25 per unit in the case of Prallethrolone and USD 11 per unit for Chrysanthemic Acid Chloride. The assessee explained that this additional amount had been included for customs-duty valuation. It was subsequently reversed through credit notes issued by Endura. Consequently, the assessee ultimately paid only the amount charged by the independent Chinese supplier, without any mark-up being retained by the AE.

The transactional data supported this explanation. The total quantity purchased was 28,420 kilograms. Endura’s gross invoices aggregated to USD 27,69,900. However, credit notes of USD 5,11,420 were issued, reducing the net purchase price to USD 22,58,480. This was exactly the amount charged by the unrelated Chinese suppliers to Endura for the same quantity of goods.

The TPO nevertheless rejected the CUP method and adopted the Transactional Net Margin Method as the most appropriate method. Based upon a set of chemical and agrochemical companies selected as comparables, the TPO proposed a transfer-pricing adjustment of ₹79.79 lakh.

The assessee objected that the TPO had rejected CUP without issuing a proper show-cause notice explaining why its Form No. 3CEB or transfer-pricing study was incorrect. The same procurement arrangement had been followed for over ten years, and no adjustment had been made in the earlier or subsequent years.

The assessee further argued that the companies selected under TNMM were functionally incomparable. Many were large enterprises having turnovers ranging from ₹100 crore to ₹1,000 crore. They manufactured finished crop-protection products, possessed valuable brands and intangibles, operated through retail and wholesale distribution networks and carried on businesses in multiple segments. In contrast, the assessee was a small-scale manufacturer of intermediate ingredients having only industrial use.

The comparables also included companies engaged in fertilisers, seeds, biological products, aquaculture inputs, animal and human healthcare products, warehousing, trading & export activities. Some had substantial related-party transactions, while reliable segmental results were unavailable in other cases. The assessee contended that these fundamental differences made their margins unsuitable for benchmarking its limited manufacturing activity.

The DRP upheld the use of TNMM but directed the TPO to verify computational errors in operating revenue and to pass a speaking order after examining the functional profiles of the comparables. However, the Tribunal found that these directions had been complied with only routinely and mechanically. For example, certain companies were retained merely because they operated broadly in the chemicals sector, without addressing the assessee’s detailed objections regarding product differences, scale, intangibles and business models.

There was another significant computational defect. The TPO had failed to consider operating revenue of approximately ₹1.09 crore, comprising foreign-exchange gains, revaluation gains, insurance claim, recovery of guest-house and freight charges and compensation received through supplementary invoices. Although the DRP had directed verification, the error was not properly rectified. If this revenue were included, the assessee’s profit would increase to approximately ₹1.23 crore, eliminating the basis for any TP adjustment even under the profitability analysis.

The ITAT held that the AE performed no value addition in relation to the goods. The materials moved directly from the independent Chinese supplier to the assessee, and the AE merely facilitated procurement and credit. The additional amount appearing in its invoices was completely reversed through credit notes. Thus, no mark-up was ultimately paid to the AE.

The Tribunal concluded that the assessee had effectively transacted with an unrelated supplier, although the purchases were routed through its AE. The uncontrolled purchase invoices, AE invoices, quantities & credit notes provided direct evidence of the actual price. In these circumstances, no adjustment to the arm’s-length price was called for. The AO was directed to delete the entire TP adjustment of ₹79,79,861.

Author’s Comments

The ruling reinforces the accepted hierarchy that where reliable direct price evidence is available, CUP ordinarily provides a more direct and reliable measure of ALP than a broad profit-based method such as TNMM. The Revenue cannot discard an exact product-to-product and invoice-to-invoice comparison merely to benchmark a small manufacturer against large, diversified chemical companies.

The decision also recognises commercial substance. Routing a purchase through an AE does not automatically mean that the AE has added value or earned a margin. Here, the identical quantity travelled directly from the independent supplier to India, while the invoices and credit notes demonstrated that the final cost exactly matched the supplier’s price.

Equally important is the Tribunal’s criticism of routine compliance with DRP directions. A direction to examine functional comparability requires a speaking and reasoned analysis, not a generic observation that both entities operate in the chemical sector. Transfer pricing must follow the actual transaction. Where the documents reveal a pure pass-through arrangement with zero retained mark-up, an artificial profit adjustment cannot survive.

FULL TEXT OF THE JUDGMENT/ORDER OF ITAT KOLKATA

This appeal filed by the assessee is against the order of the National Faceless Assessment Centre, Delhi [hereinafter referred to as ‘Ld. ‘AO’] passed u/s 143(3) r.w.s. 144C(13) r.w.s. 144B of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) for AY 2021-22 dated 22.10.2024.

1.1 The Registry has informed that the appeal is barred by limitation by 8 days. The assessee has filed a petition for condonation of delay for 17 days explaining the reasons that the authority to file the appeal was with the Managing Director of the assessee company, who suffered a serious eye disease rendering him with temporary loss of sight and requiring complicated surgery. He was advised complete rest and had to defer all official activities until recently being declared fit to attend to duties. After perusing the same, we are satisfied that the assessee had a reasonable and sufficient cause and was prevented from filing the instant appeal within the statutory time limit. We, therefore, condone the delay and admit the appeal for adjudication.

2. The assessee is in appeal before the Tribunal raising the following grounds of appeal:

“1. Because the order of the Ld. AO/DRP/TPO is bad in law, on facts and circumstances of the case.

2. Because the order of the Ld. AO/DRP/TPO is passed in violation of the principals of natural justice as it fails to consider the Transfer Pricing report and revised form 3CEB filed by the assessee and hence the order is illegal, bad in law and void ab initio.

3. Because the Ld. AO/DRP/TPO erred in law, facts and circumstances in selecting Transactional Net Margin Method [TNMM] as the most appropriate method as against the Comparable Uncontrolled Method (CUP) adopted by assessee.

4. Because the Ld. AO/DRP/TPO erred in law, facts and circumstances in selecting non-comparable companies as comparable without considering appropriate filters.

5. Because the Ld. AO/DRP/TPO erred in law, facts and circumstances in as much as she failed to make necessary adjustments to the operating profit (OP) to operating revenue (OR) as required under Rule 10D of the Income Tax Rules so far as these are necessary to determine correct OP/OR for comparison with the OP/OR of assessee company.

6. Because Ld. AO/DRP/TPO erred in law, facts and circumstances in as much as she incorrectly computed the operating revenue at Rs. 23,82,81,256.00 as against the correct operating revenue of Rs. 24,92,18,064. for the year ended 31.03.2021.

7. Because the Ld. AO/DRP/TPO erred in law, facts and circumstances in making an adjustment of Rs. 79,79,861.00 towards transfer pricing adjustment.

8. Because for the facts and circumstances warranting, the assessee craves leave to alter, amend, withdraw any ground or grounds of appeal.”

3. Brief facts of the case are that the assessee had filed the return of income for the AY 2021-22 on 23.12.2021 declaring total income at ₹68,04,260/-. The return was selected for complete scrutiny to investigate international transactions, and the Ld. AO referred the matter to the Technical Unit/Transfer Pricing Officer (TPO) for determination of the arm’s length price (ALP). The Ld. TPO rejected the Comparable Uncontrolled Price method adopted by the assessee, and selected the Transactional Net Margin Method (TNMM) as the most appropriate method, and proposed the transfer pricing adjustment of ₹79,79,861/- in respect of the purchase of raw materials. Aggrieved with the draft assessment order of the Ld. AO, the assessee filed objections before the Ld. Dispute Resolution Panel (‘DRP’), who upheld the application of the Transactional Net Margin Method and the filters applied by the Ld. TPO, and also directed the Ld. AO to verify and rectify any computational errors regarding operating revenue while confirming the inclusion and exclusion of specific comparables based on their functional profiles. Accordingly, the Ld. DRP decided the objections of the assessee and directed the Assessing Officer to incorporate the findings of the DRP in respect of various objections suitably in the final order and also enclose a copy of the Ld. DRP’s directions as annexure to the final order. The TPO passed the order giving effect to the direction of Ld. DRP, which has been incorporated in the assessment order, and thereafter the assessment order dated 22/10/2024 was passed after making an addition on account of adjustments as proposed by the Ld. TPO at ₹79,79,861/- and the total income was assessed at ₹1,47,84,121/- under section 143(3) r.w.s. 144C(13) r.w.s. 144B of the Act.

4. Aggrieved with the order of the Ld. AO, the assessee has filed the appeal before the Tribunal.

5. Rival contentions were heard and the submissions in the form of paper book filed have been examined. The Ld. AR submitted that the assessee is an MSME and a wholly owned subsidiary of an Italian company called Endura S.P.A. and its maximum turnover had never exceeded ₹25 Crore since 2008 when it was incorporated, except in the impugned A.Y. The assessee manufactures ingredients for household insecticides for prevention of vector-borne diseases like chikungunya and malaria etc. and purchases raw material being active ingredients which are two in numbers and are supplied by a Chinese supplier, who is the exclusive supplier of the products. It was submitted that an adjustment was made on account of purchases from AE, Endura S.P.A., which is merely assisting the assessee for getting the ingredients from the Chinese supplier as the assessee gives small orders and the supplier was reluctant to supply the material and allow credit purchase as was available to the AE. It was also stated that in fact, the assessee had received the material directly from the Chinese supplier, no value addition was actually done by the AE and the transactions were billed to ship and the goods were shipped from Shanghai to Kolkata; however, for the purpose of customs duty, a nominal amount was specified in the bill by the supplier. Endura S.P.A. raised invoices after including a margin of $25 for the purpose of customs duty for Pralletrolone and $11 for Chysanthemic Acid Chloride for the purpose of payment of customs duty, which was later adjusted by issuance of credit notes so that the mark up element was excluded for the material costs of purchase by the assessee. The assessee makes the payment of the cost to its AE, excluding the additional amount added, which in turn makes payment to the Chinese supplier and receives credit notes for the difference in the amount billed and the amount paid.

The assessee had reported the transactions with AE under international transactions and Form No.3CEB was filed. No other transaction is part of the litigation. It was submitted that no show cause notice was issued by the Ld. TPO as to how the report on Form No. 3CEB was incorrect either in value or in respect of the method of valuation adopted. The Ld. TPO issued a notice on 1st September, 2023. In the TP study carried out by the assessee, CUP method has been applied. The supplier is an independent party effectively except for the fact that the supplies are being routed through the AE. The Ld. TPO applied TNMM as against CUP method applied by the assessee and no show cause notice was issued for rejecting the CUP method which had been followed since more than 10 years in the past. There were purchases from the same party in earlier and subsequent years and no adjustment has ever been made, it was submitted. Our attention was also drawn to page 147 of the paper book for explaining the transactions of 28420 Kg from Endura SPA and equivalent 28420 Kgs of Prallethrolone and Chrysant Acid Chloride D+Trans supplied by Jiangsu Yangnong Chemical Co. Ltd. to Endura SPA for amount of $22,58,480 while the expenditure incurred by the assessee for purchases from Endura SPA works out to the same amount of $22,58,480 if Credit Notes of $5,11,420 are considered from the gross amount of $27,69,900 billed by Endura SPA to the assessee and is Annexure-1 of the Transactional Analysis of the Purchase of Goods as per Para 4.2.1 of the Transfer Pricing Report filed by the assessee and the same is extracted as under:

SOLEX CHEMICALS LIMITED
DATA FOR THE FINANCIAL YEAR 2020-21

COMPARATIVE STATEMENT OF PURCHASES FROM ENDURA SPA AND
SALE BY ENDURA SPA TO SOLEX

1. SALE OF ENDURA TO SOLEX

2. PURCHASE OF ENDURA

6. Our attention was also drawn to page 83 of the paper book being the order u/s 92CA(3) of the TPO and the comparables adopted and it was submitted that no scrutiny assessment u/s 143(3) of the Act was done either in the earlier or in the subsequent years and the Ld. TPO has also included a government company HIL for carrying out the TP study. The Ld. AR in the alternative submitted that the turnover of ₹1.09 Crore was not considered and if the same is considered as per the directions of the DRP, there would be no variation and no adjustment on account of arm’s length price would be required. The calculation is at page 75 of the paper book and it was stated that the profit would increase by ₹1.09 Crore if the same is considered and the overall profit would be ₹1.23 Crore. The working is as under:

Statement 3.3.1
STATEMENT OF OPERATING REVENUE NOT CONSIDERED BY LD. TRANSFER PRICING OFFICER
FOR THE YEAR ENDED 31ST MARCH, 2021

Table: Operating Revenue Details

7. It was submitted that the Ld. DRP’s directions had not been complied with and although the expenses had been considered but the revenue had not been considered. Our attention was also drawn to para 6.1 of the order of the Ld. TPO which relates to the consideration of credit notes.

8. The Ld. CIT(DR) relied upon the orders of the Ld. AO and the Ld. CIT(A) and submitted that the same may be upheld.

9. We have considered the written submissions made, gone through the facts of the case and perused the record and the order of the Ld. CIT(A). At this juncture, it would be relevant to peruse the Transfer Pricing Submission & Analysis made before the Ld. DRP by the assessee as extracted hereunder:

“3.i) Assessee company is engaged in the business of manufacturing active ingredients using raw materials “Prallethrolone” and Chroisanthemic Acid Chloride which are imported from China through its Associate Enterprise, Endura, SVA.

Endura is an established name and engaged in business of manufacturing of formulation, insecticides for almost 50 years it enjoys substantial goodwill and higher credit ratings amongst international suppliers of Active Ingredients. Endura, Italy merely facilitated assessee to source the active ingredients (AI) from the Chinese supplier on credit terms of 150 days merely acting as an intermediary in between the international suppliers and the assessee company.

The foreign suppliers was a Chinese vendor and was unrelated to the assessee company as well as its AE, Endura and was therefore uncontrollable, independent party both the assessee and its AE.

The materials were shipped directly to assessee company at Indian destination port by the Chinese foreign supplier while the invoice was billed by them to Endura, the AE of the assessee implying that the transaction was billed to foreign AE of assessee while materials shipped to assessee company.

The AE, Endura Italy raised a back to back invoice on assessee company at its purchase invoice price (as raised y the Chinese supplier) and a mark up of USD 25 for Prallethrolone” and markup of USD 11 for Chroisanthemic Acid Chloride for the sole purpose of payment of customs duty on cost plus markup basis as required under the Customs Act.

Subsequently the said mark up of USD 25 and USD 11, as mentioned above, was reversed by issuance of credit note by the AE such that the effective purchase price are reduced and the actual price for purchase of supply to the assessee company was exactly equivalent to the price at which the Chinese vendor billed the same to the AE. In other words the materials were supplied (invoiced) by AE at same price at which the materials were supplied (billed) by the Chinese vendor to Endura, Italy.

ii) Thus, effectively the materials were supplied by Endura SPA to assessee at exact purchase price of purchase from Chinese foreign supplier. Even the terms and conditions of credit of 150 days by the AE to assessee was same as was available to Endura from the Chinese supplier. All other terms and conditions were same and on back to back basis between AE to assesse and Chinese vendor to Endura, Italy the holding company of the assessee and its AE.

It is emphatically pointed out that the Chinese vendor and Endura Italy, the holding company of the assesse are unrelated, independent parties . There the transactions of billing by the Chinese vendor to Endura, Italy w, were independent transactions between unrelated parties and a good comparison as the materials were identical, sources from the same place and under the same terms and conditions.

As the supply price by Endura to assessee was same as supply by the Chinese vendor who is the actual supplier of the said materials, Endura did not incur any additional costs nor assessee paid any markup to its AE.

The materials were shipped to assessee, directly by the original supplier and assessee completed the customs clearing formalities after payment of customs duty, freight and clearing and forwarding charges as applicable for any imports, whether or not from an AE.

iii) Considering the fact that the Chinese foreign supplier is an independent uncontrolled party unrelated to the AE Endura SPA or the assessee, Solex, that there was direct dispatch of goods from China to India by the original supplier, that there was no value addition by the AE, Endura, there was no change in geographical location of the supply and receipt, no change in product, no additional costs by AE, no markup imposed by AE and a clear indication that AE acted as an intermediary, the transactions between AE and the Chinese vendor who was an unrelated independent party, is a suitable External CUP and can therefore used for benc marking the transaction of purchase by assessee from its AE and the most appropriate method will only be CUP.

iv) Assessee applied the said CUP method as the Most Appropriate Method, considering the fact that the said transactions met all the features of the CUP method, that

– Transaction between AE and Chinese vendor were independent and unrelated party transactions;

– the product was exactly same;

– Terms and conditions were supply were same and identical to that of AE and original vendor and of AE and assessee;

– Credit period and other supply terms were same;

– No markup was paid by assessee to AE;

– No additional costs or functions were performed by the AE for supply to assessee.

– all relevant data and information to apply external CUP for comparison of its transactions with its AE weer available.

As the AE did not charge any markup from the assessee, and entered into the transactions at the same value as with the unrelated independent Chinese vendor, the same ought to be considered as at ALP.

Copy of the invoice raised by original Chinese supply to AE and the invoice and credit note raised by AE to the assessee is attached marked as 4.2.1.

Ld. TPO wrongly assumed that the transaction between the original Chinese supplier and the AE of assessee were between related party and hence rejected the method adopted by assessee.

v) Contrary to the above, Ld. TPO based here bench marking on TNMM as MAM. When there was direct evidence and availability of data for determining ALP of the transactions, ignoring the same and moving on to the more complex method was incorrect and contrary to the scheme of law.

The onus is on the revenue to show that the CUP method is not the appropriate method.

vi) Rule 10B(1)(a) of the Income-tax Rules “the Rules”) provides that for application of CUP, the price charged or paid for services provided in a comparables uncontrolled transaction or a number of such transactions are to be compared with price charged from international transaction undertaken by the enterprise (tested party) from the international transaction undertaken with an associated enterprise.

The CUP seeks to provide a direct estimate of the price the parties would have agreed to, had they resorted directly to an open market alternative to the controlled transaction. The results derived from applying CUP method generally will be the most direct and reliable measure of an arm’s length result for the controlled transaction.

The OECD guidelines also provide in paragraph 2.7 that “…….Where it is possible to locate comparable uncontrolled transactions, the CUP method is the most direct and reliable way to apply the arm’s length principle. Consequently, in such cases the CUP Method is preferable over all other methods.

…..

4.1 In selecting the comparables and determining the benchmarking ratio of Operating Profit/Operating Revenue, Ld.TPO did not consider the fact that comparable selected were operating in different segments, there substantial difference in scale of operations, the comparable were operating in different segments, were using intangibles. In particular the following broad category of difference can be identified in respect of each of the comparable company selected by the Ld. TPO to show that the selected company are un-comparable to the assessee company.

ii. Considering that the comparables selected by the Ld TPO are operating mainly in crop protection chemicals which is a end use product meant for sales to retail and wholesale customers as compared to assessee who is engaged in manufacturing of industrial products being Artificial ingredients for manufacturing of end use product and requires further value addition. Such value additions enables comparable companies to earn higher margins as the product is a final product .
Some of the selected company are operating is very high scales with turnover exceeding Rs. 100 Crores to Rs. 1000 Crores as compared to assessee’s turnover of less than Rs. 25 Crores not only for the year but since its incorporation.
The impact of such difference in scale of operations makes the companies uncomparable.”

10. Apparently, these objections were not considered and the directions of the Ld. DRP were either not complied with by the TPO or have been complied routinely and as an illustration, the response of the Ld. TPO in the last column for selection of comparables is as extracted as under:

Transfer Pricing Panel Observations & Comparables Analysis

11. Thus, considering the past history of the case and the fact that the AE was only a pass through entity and not an entity through which the transactions were being carried out and the additional amount added in the bill was only for the purpose of customs duty valuation as was submitted and which could not be controverted by the Ld. DR; so that the correct custom duty could be paid and for the amount added, credit notes were being received by the assessee from the AE, therefore, the Bench was of the view that on the facts of the case, no adjustment on account of ALP was called for as the assessee had effectively caried out transactions with an unrelated party, though through the AE. This is also supported by the fact that in case the Ld. DRP’s direction relating to the revenue of ₹1.09 Crore is also to be considered, which has not been complied with, then the overall profit of the assessee increases by this amount requiring no further adjustment. Hence, Ground Nos. 4, 5, 6, 7 and 8 are allowed and we direct the Ld. AO to delete the adjustment made on account of TP adjustment on the purchase of raw material through the AE. Other grounds being general in nature are not adjudicated.

12. In the result, the appeal filed by the assessee is allowed.

Order pronounced in the open Court on 15th September, 2026.