PCIT Vs Audco India Ltd. (Bombay High Court)
Summary: The Bombay High Court, in PCIT Vs Audco India Ltd., dismissed the Revenue’s appeal under Section 260A of the Income-tax Act, 1961, challenging the Income Tax Appellate Tribunal’s order dated 16 December 2015 for Assessment Year 2004-05. The dispute involved two separate transfer pricing adjustments arising from the export of industrial valves and valve kits to associated enterprises in the United States. The principal questions were whether the arm’s length price could be determined by selectively comparing transactions favourable to the Revenue and whether prices charged in controlled transactions with other associated enterprises could constitute reliable comparables. The Court upheld the Tribunal’s findings on both questions and concluded that neither issue raised a substantial question of law.
On the first issue, the assessee, a joint venture between Larsen & Toubro Limited and Audco Limited, exported industrial valves to its associated enterprise, L & T LLC, USA, and also supplied similar products to unrelated customers and distributors in the United States. The Transfer Pricing Officer selectively identified transactions where prices charged to the associated enterprise were lower than those charged to unrelated customers and made an upward adjustment, disregarding transactions where associated-enterprise prices were higher. The Commissioner of Income Tax (Appeals) rejected this selective approach and adopted an aggregated comparison of associated-enterprise and non-associated-enterprise transactions. On aggregation, the difference between the arm’s length price and the actual transaction price fell within the then-applicable 5% tolerance under Section 92C of the Income-tax Act. The Tribunal upheld the deletion, and the High Court observed that the Revenue could not establish any flaw in the aggregated approach.
The second issue concerned exports of finished valves and valves in kit form to Flow Serve Sulphur Spring, USA. The Transfer Pricing Officer had made adjustments of Rs.8,79,23,415 and Rs.1,44,93,984 respectively, amounting to Rs.10,24,17,399 in aggregate. The assessee had relied on BHEL and KSB Pumps as comparables for determining a cost-plus margin of 15%, but the TPO did not accept these comparables and instead used higher profit margins earned on supplies to other associated enterprises situated in different countries. The Commissioner (Appeals) held that prices charged to associated enterprises operating in different geographical markets could not provide an appropriate basis for determining the arm’s length price of supplies to Flow Serve in the United States. The Tribunal agreed, finding a fundamental error in the TPO’s reliance upon controlled transactions rather than comparable uncontrolled transactions.
The High Court examined the statutory scheme under Chapter X of the Income-tax Act, particularly Section 92, Section 92F(ii) and Rule 10A(d) of the Income-tax Rules, 1962. It observed that arm’s length price represents a price applied or proposed to be applied between persons other than associated enterprises in uncontrolled transactions. Consequently, prices charged to one associated enterprise could not ordinarily be used as uncontrolled comparables for determining the arm’s length price of transactions with another associated enterprise. The Court further emphasised the requirement of geographical and country-specific comparability, noting that the TPO had ignored differences between markets in which the transactions occurred.
The Court held that the Tribunal’s approach was consistent with the statutory transfer pricing provisions. In relation to sales to L & T LLC, the aggregated comparison of sales to associated and unrelated parties, including the arithmetic mean and the applicable 5% tolerance, disclosed no legal infirmity. In relation to Flow Serve, the use of transactions with other associated enterprises as comparables was contrary to the statutory requirement of uncontrolled transactions, while the failure to account for geographical differences further undermined the adjustment. The Revenue’s proposed questions therefore did not give rise to any substantial question of law. Both questions were declined, and the appeal was dismissed without costs.
The ruling reinforces that transfer pricing benchmarking must be based on a consistent and legally permissible comparability analysis rather than selective transactions producing higher adjustments. It also distinguishes aggregation of comparable transactions with associated and unrelated enterprises from the impermissible use of controlled transactions as uncontrolled comparables. The decision is relevant to international transfer pricing disputes involving the selection of appropriate comparables, the assessment of geographical market differences and the determination of arm’s length prices. The statutory reasoning must, however, be understood in the context of the law applicable to AY 2004-05, particularly the tolerance provisions of Section 92C.
Supreme Court Update: The Supreme Court subsequently dismissed the Revenue’s Special Leave Petition against the Bombay High Court judgment without giving independent reasons. Read Controlled Transactions Cannot Determine Arm’s Length Price: SC Declines Interference.
FULL TEXT OF THE ORIGINAL JUDGMENT/ORDER OF BOMBAY HIGH COURT
1. The Appeal under Section 260-A of the Income Tax Act, 1961 (the Act), challenges an order dated 16th December, 2015 passed by the Income Tax Appellate Tribunal (the Tribunal). This Appeal relates to Assessment Year 2004-05.
2. The revenue has urged the following questions of law for our consideration:
“(A) Whether in the facts and circumstances of the case and in law was the Tribunal justified in upholding the order of CIT (A) benchmarking international transactions of sale of Valves to its Associated Enterprise (AE) viz. one L & T LLC by aggregating all its transactions with the A.E. and comparing it with aggregation of all comparable Non AE transactions?
(B) Whether on the facts and circumstances of the case and in law was the Tribunal justified in law in upholding the order of CIT (A) deleting the Transfer Pricing Adjustment on export of Valves (Rs.8,79,23,415/-) and Valves in Kit form (Rs.1,44,93,984) to its AE in USA viz. Flow Serve Sulphur Spring (Flow Serve) by holding the benchmarking of international transactions by comparing controlled (AE) transactions with uncontrolled (Non-AE) transactions?”
3. The respondent is joint venture company between L & T Limited and Audco Limited. The respondent is engaged in manufacture and sale industrial valves. It sells its valves to group companies and also to others.
4.Re-Question (A)
(a) During the assessment proceedings, the Assessing Officer noticed that the respondent had sold valves to its A.E. i.e. one L & T LLC, U.S.A.. On a reference the Transfer Pricing Officer (TPO) computed the arms length price (ALP) of the sale of valves to L & T LLC. This the TPO did after recording the fact that the respondent was exporting finished valves not only to its A.E. one L & T LLC, USA for sale in the U.S. market but also other distributors and customers in USA. The TPO thereafter shortlisted only those transactions where the prices charged to the A.E. was less than that charged to unrelated parties in USA. On the above basis alone he made an upward revision/adjustment in respect of the price charged by the respondent to its A.E. i.e. L & T LLC, USA. On the basis of the above order of the TPO, the final assessment order was passed by Assessing Officer.
(b) Being aggrieved on the above transfer pricing adjustment the respondent challenged it in appeal before the Commissioner of Income Tax (Appeals)(CIT (A)). In appeal the CIT (A) allowed the appeal of the respondent holding that during the year various standard valves were supplied not only to its AE i.e. L & T LLC, USA but also to others i.e. non AE entities in USA. The CIT (A) found that in some cases the respondent charged higher rate from its AE and in other cases lesser than those charged to non AE’s. However he was of the view that the AE and non AE transactions are to be separately aggregated, then the difference on aggregation of transactions is to be determined to decide the ALP. The CIT (A) found that if the above exercise is done then the difference between ALP and the price at which it sold to AE was less than 5% as provided in Section 92C of the Act. Therefore, the addition on account of sales of valves to L & T LLC, USA made by the Assessing Officer was deleted.
(c) Being aggrieved with the order of the CIT (A) the revenue carried the issue in appeal to the Tribunal. The Tribunal upheld the order of the CIT (Appeals). It found the respondent’s claim was based on aggregation of sales of valves to AE’s and compared it with aggregation of sales to non A.E.. It found that the TPO was doing the comparison on selective basis i.e. only selecting those transactions where the price charged to A.E. is less than the price charged to non A.E. and enhancing its ALP. The Tribunal in the impugned order concluded that the most logical approach is to aggregate all the transactions made during the year with the AE and with non AE separately and thereafter determine the ALP of the respondent’s transactions with the A.E.. The difference between the prices charged to A.E. and non A.E. being within the tolerance limit of 5% as held in the order of the CIT (A) was found correct. Thus, dismissed the appeal of the Revenue.
(d) Mr.Suresh Kumar, learned counsel appearing in respect of the appeal submits that the approach adopted by the TPO was correct approach. However, he is not able to point any flaw in the approach of the CIT (A) and the Tribunal in adopting the aggregated approach in the present facts. Thus, the view taken by the Tribunal of determining the ALP of sales to AE on the comparison of the aggregation of AE and non AE transactions (taking its arithmetical mean) does not call for any interference.
(e) Therefore, question No.1 as proposed does not give rise to any substantial question of law. Thus, not entertained.
5.Re:Question No. B
(a) During the assessment proceedings on a reference to the TPO, it was noted that the respondent had exported finished valves and valves in kit form to its AE i.e. Flow Serve Sulphur Spring (Flow Serve) USA and also its group companies across the globe. It was also found that finished valves and kits supplied to Flow Serve was unique in nature. It was found that sales to Flow Serve U.S.A. were at a loss. The respondent had during the proceedings before TPO placed reliance upon two comparable companies viz. BHEL & KSB Pumps to determine the transfer pricing adjustment at cost of production plus 15%. However, the TPO found that supply of valves and kits to other group companies was at a higher price. Therefore, the TPO adjusted the profit margin (average) of similar supplies made to group companies (AEs) to enhance/revise the sales price of valves and kits sold to M/s Flow Serve, U.S.A. The Assessing Officer passed an Assessment Order in terms of the TPO’s directions resulting in enhancement of Rs.8.79 crores (valves) and Rs.1.44 crores (kits).
(b) Being aggrieved by the order of the Assessing Officer on the above issue, the respondent filed an appeal to the CIT (A). By order dated 27th October, 2012 the CIT (A) held that the two comparables viz. BHEL and KSB Pumps were not accepted by the TPO without establishing, how and why they were inappropriate. It further held that selection of profit margins of the respondent’s transactions with Flow Serve with sales made/prices charged by the assessee to its A.E.’s in other countries cannot be the basis for determining the ALP of sales made to other AE’s in different countries. This as they are in different geographical location i.e. different from the USA, thus not comparable. Therefore, allowed the appeal of the respondent assessee.
(c) The revenue being aggrieved, filed an appeal of the Tribunal. The impugned order of the Tribunal held that TPO had clearly made a fundamental error in determining the ALP of sales of vales and kits made to Flow Serve by comparing its margin with other sales by the respondent to its AEs in different parts of the world. The Tribunal held that in terms of the provision of the Act the comparison to determine the ALP cannot be done by comparing the prices charged to other AE’s i.e. controlled transactions. The Tribunal further held that the transfer pricing adjustment of transactions with AEs in USA has to be done/arrived at by making comparisons with uncontrolled parties in USA. In the aforesaid circumstances, impugned order of the Tribunal dismissed the revenue’s appeal, upholding the CIT (A)’s order.
(d) We note that Chapter X of the Act is a special provision relating to avoidance of tax. Section 92 deals with computation of income from international transaction having regard to ALP. It provides any income arising from the international transaction shall be computed having regard to the ALP. The ALP is defined under Section 92F(ii) of the Act to mean a price which is applied or proposed to be applied in transactions between persons other than AE’s in uncontrolled transactions. This is further supported by Rule 10A(d) where uncontrolled transaction has been defined as a transaction between enterprises other than with A.E’s. whether resident or non-resident. In view of the above clear position in law, the TPO ought to have arrived at the ALP of the respondent’s sale to its A.E.viz. Flow Serve by only comparing it with uncontrolled transaction of sale to in USA. Thus the approach of the TPO is contrary to the clear provisions of law. Besides as held by the Tribunal the comparison has to be region /country specific, which in this case, the TPO has completely ignored.
(e) Therefore, the view taken by the Tribunal does not call for any interference as it is in accordance with the self evident provisions of law. Thus, this question as proposed does not give rise to any substantial question of law. Thus, not entertained.
6. Accordingly, Appeal dismissed. No order as to costs.
