ITAT Ruling: Transfer Pricing- Sec 92- While bench marking a controlled transaction, mere selling of an identical product to unrelated party is not sufficient for applying Comparable Uncontrolled Price (CUP) as the most appropriate method unless reasonable and accurate adjustments on account of economic and market differences can be arrived to determine the arm’s length price. [M/s Intervet India Private Limited – 2010-TIOL-240- ITAT-MUM].
Facts:
M/s Intervet India Private Limited (Intervet- India) was engaged in manufacturing and trading of animal health and veterinary products. The product range of Intervet- India included pharmaceutical products, feed additives, poultry vaccines, canine vaccines, Foot and Mouth Disease Vaccine, viral and Bacteria. Intervet- India was a wholly owned subsidiary of Intervet holdings B.V. Netherlands. Intervet Group entities were part of the Akzo Nobal Group a multinational group with headquarters in Netherlands.
During the year under consideration, Intervet- India undertook transactions with its Associated Enterprises (AEs) which include import of raw materials and finished goods, export of raw materials and finished goods, reimbursement and recovery of expenses and internal audit services.
Intervet- India used Transactional Net Margin Method (TNMM) as the most appropriate method to benchmark the international transactions undertaken with its AEs. The case was referred by the Assessing Officer (AO) to the Transfer Pricing Officer (TPO) for determination of the arm’s length price (ALP) for the international transactions entered into by Intervet- India with its AEs.
As regards the export transactions with AEs, the TPO observed that Intervet- India had exported five products to AEs and unrelated parties. In respect of four products, the price charged by Intervet- India were more or less similar to the price charged by it to the unrelated parties. However, in case of one product viz. Floxding 10% (50ml) the price charged to AE was much less in comparison to that charged to unrelated party. The sale price of Floxding 10% (50ml) to unrelated party was USD 3.66 per unit as compared to sale price of USD 1.17 per unit charged to AE. Intervet- India was asked why CUP should be applied in the instant case.
In reply Intervet – India submitted that if CUP method was to be applied, then reasonable adjustment is required to be made to arrive at a reasonable price. Intervet – India offered adjustments for high volume of sales to AE as compared to unrelated party, difference in credit period, credit risks and adjustments on account of annual and future business with AE and unrelated party. For this purpose, Intervet – India claimed 40 % adjustment to the price on the grounds that even in domestic the percentage of discounts varies directly with the volume of sales in the range of 25 to 40%.
The TPO after considering the arguments submitted by Intervet – India came to the conclusion that the adjustments sought by Intervet – India in respect of voluminous sales to AE were too high and concluded that 10 % was reasonable as against 40% claimed by Intervet – India. Further, TPO held that the adjustment of interest at 12 % per annum was reasonable as the interest rate during that year was around 12 % as compared to 18% per annum sought by Intervet – India. TPO allowed 5 % adjustment for the credit risk adjustment. However, for annual and future business adjustment, TPO rejected the claim of Intervet – India on the grounds that this was repetition of volume factor. The TPO concluded that except for the volume factor, credit period adjustment and credit risk adjustment, the international transaction were comparable considering the provisions of Rule 10B(2) of the Income tax Rules, 1962.
The TPO arrived at the conclusion that the transactions were comparable on the grounds that (i) Specific characteristics of the property transferred in both the cases were identical. (ii) Functions performed taking into account assets employed and risks assumed by the respective parties to the transactions were same except the Credit Risk discussed above, (iii) The delivery terms were same in both the cases. The payment terms differ for which necessary adjustment was made and (iv) The conditions prevailing in the markets in which the respective parties to the transactions operate can be considered as similar because the related entity was located in Thailand, and the unrelated party was located in Vietnam. Both the parties were located in the South East Asian Countries and therefore, the geographical areas of the countries appeared to be comparable. Further, the incidence of disease for which the medicine (Injectible Ampoule) was used was also most likely to be the same. In both the countries the retail prices were also similar.
Based on the above, TPO made an upward addition to the tune of Rs. 27,17,82 1 to the export made to its AE . On appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] partly allowed the appeal of Intervet – India by allowing further adjustment to the price on account of volume discount and the credit period.
Aggrieved by the order of the CIT(A), Intervet- India preferred an appeal before the Income Tax Appellate Tribunal (ITAT).
Assessee’s Contention before the ITAT:
- The TPO and CIT(A) have not taken into account all the adjustment factors while making adjustments in comparing the sale price to an AE and a third Party while adopting the CUP method.
- Thailand (where the AE is situated) and Vietnam (where the unrelated party is situated) have totally different market conditions. Thailand is dominated by Poultry Vietnam is dominated by Pigs and hence the needs are different.
- Market sizes of the two countries are not comparable. Size of the Thailand market is large compared to that of Vietnam.
- It was also submitted that in view of some defects in the vaccine, it was difficult to sell it at higher price in a competitive and developed, market like Thailand.
- Invert-India had pointed out before the CIT(A) that the sale price of vaccine by the AE in Thailand to an unrelated customer was only USD 2.90 and USD 3.14 which is less than the price of USD 3.66 charged by Invert-India for its sale to the unrelated party in Vietnam.
- The above factors would show that the market condition in Thailand is totally different from that prevailing in Vietnam.
Observation of the ITAT and Ruling:
- The ITAT observed that when there is a sale of identical product to an unrelated party, it (CUP) will form the basis of determining the ALP in respect of sales to an AE, but one of the essential prerequisite is that reasonably accurate adjustments are to be made to eliminate material factors affecting price, cost or the profit arising from such transaction. But at least all material factors should be considered in arriving at the adjustments.
- The ITAT found that the TPO and the CIT (A) have assumed similarity of markets and economic conditions and have made adjustments only for the volume discount, credit offered and a small adjustment of credit risk. They have, completely ignored the disparate economic land market conditions of Thailand and Vietnam and have made no adjustment for the same. Mere geographical contiguity of two countries need not mean similarity in economic or market conditions. How can the sale prices to wholesale agents in two different countries be comparable, when the sale price to the final user in one country is less than the sale price to the wholesale agent in another country, unless adjustment for the same has been considered. Thus, the adjustments merely for volume off take, credit period and credit risk, though material are not sufficient to make the sale price to AE in Thailand comparable with the sale to unrelated party in Vietnam.
- Thus, the ITAT has set aside the matter to the file of the CIT (A) for deciding the matter afresh after giving reasonable opportunity to Intervet- India to present their case.
Our View:
This judgement clearly brings out the importance of the most critical element of any transfer pricing analysis i.e. the use of comparable data for the purpose of bench marking the controlled transaction. Further, the standard of the comparable data while applying the CUP method is more stringent and need of similar economic relevant transactions is of paramount importance. The application of the CUP method for determining the ALP hinges upon one of its essential prerequisite that reasonably accurate adjustments are to be made to eliminate material factors affecting price, cost or the profit arising from such transaction. Transfer pricing is not an exact science and thus, there is no formal set of rules as to what constitutes reasonable accurate adjustments. However, at the same time it may also imply that where reasonable accurate adjustments cannot be arrived at, then CUP method cannot be used as the most appropriate method to determine the ALP for bench marking the international transaction between the AEs.
The Ruling of the ITAT has further emphasized that while analyzing a transaction between the AEs vis-à-vis unrelated party, a transaction is required to be evaluated from end to end perspective for the purpose of determining the arm’s length nature of such transaction.
