Assessee to follow one of the methods prescribed and demonstrates that international transactions entered with associated enterprise are at arm’s leng

Citation : ITA No. 925/Mum/06, Assessment Year: 2002- 03,

M/s Star lite Vs. DCIT

Court :ITAT Mumbai

It is mandatory for the assessee to follow one of the methods prescribed in Section 92C of the Income Tax Act, 1961 read with Rule 10B of the Income Tax Rules, 1962 and demonstrate that the international transactions entered with the associated enterprise are at arm’s length.

Tribunal Ruling: It is mandatory for the assessee to follow one of the methods prescribed in Section 92C of the Income Tax Act, 1961 read with Rule 10B of the Income Tax Rules, 1962 and demonstrate that the international transactions entered with the associated enterprise are at arm’s length. [M/s Star lite – I.T.A. No 925/Mum/2006]

Facts:

M/s Starlite (‘Appellant’) is a partnership firm engaged in business of import, manufacture and export of diamonds and jewellery. During the assessment year 2002-03, appellant had exported polished diamonds. The Assessing Officer (‘AO’) referred the case to the Transfer Pricing Officer (‘TPO’) for determination of the arm’s length price (‘ALP’) under section 92CA(3) of the Income Tax Act, 1961 (‘Act’).

The appellant in its transfer pricing study report contended that none of the methods prescribed was adopted for the purpose of bench marking the international transaction due to the impossibility of adopting one of the methods prescribed under section 92C of the Act. TPO in its letter to the appellant contended that, where no method was possible to apply, then the appellant may justify its international transaction using Transactional Net Margin Method (‘TNMM’) as prescribed under section 92C of the Act.

Based on the search conducted by the TPO for identifying comparable companies determined the arm’s length margin at 9.57 per cent on sales and made an adjustment of INR 1.69 crores.

On appeal to the Commissioner of Income Tax (Appeals) [‘CIT(A)’], CIT(A) ignored the objection of appellant for the use of TNMM as the most appropriate method by the TPO for determining the ALP of the international transaction, qualitatively rejected two companies from the set of comparable companies selected by the TPO and determined the arm’s length profit margin at 5.46 per cent on sales. As the operating profit margin of the appellant was within +/- 5 per cent of the arm’s length profit margin of the comparable companies, CIT(A) deleted the addition made by the TPO.

Aggrieved by the order of the CIT(A), both assessee and revenue preferred an appeal before the Income Tax Appellate Tribunal (‘Tribunal’)

Observation and decision of the Tribunal

• Tribunal agreed with the findings of the TPO and held that under the Indian Transfer Pricing Provisions, it is mandatory for an assessee to determine the ALP for the various international transactions entered into by it in accordance with any one of the methods prescribed under the Act. Claiming that none of the methods can be applied does not absolve the assessee of its statutory duty in determining ALP as per the law;

• As per section 92F of the Act r.w. Rule 10B of the Income Tax Rules, 1962, Tribunal held that TNMM requires the comparison of the net margin realized by an enterprise from an international transaction(s) and not comparisons of operating margins of the enterprises. Relying on the decision of UCB India Pvt. Ltd. (121 ITD 131) rendered by the same bench, Tribunal held that section 92C read with Rule 10B(1)(e) deals with TNMM and it refers to the net profit realized by an enterprise or the class of international transactions or class of such transactions, but not operational margins of the enterprise as the whole;

• Tribunal observed that TPO had not applied the TNMM as contemplated under the Act and thus, set aside the order of the TPO for fresh adjudication with the direction to the TPO that adjustments, if any, arising due to the computation of the ALP should be restricted only to the international transaction and not to the entire turnover of the appellant which included transactions with third parties as well.

Our View:

Under the Transfer Pricing Regulations (TPR), any income or allowance for any expenses arising from an international transaction shall be computed having regard to the ALP. The ALP cannot be determined merely on the basis of the methods prescribed under section 92C(1) r.w. Rule 10B. The application of the methods hinges on the functional and economic analyses,which are the cornerstones of transfer pricing. Transfer pricing is not an exact science. Therefore, it may not be necessary that methods prescribed under the TPR are the only means for determining the arm’s length nature of the controlled transaction. The dynamic nature of business may not always allow the application of the specified methods for bench marking unique transactions. We believe that the arm’s length standard, which is the foundation of transfer pricing law in India and throughout the globe, is flexible enough to absorb the vicissitudes of business and is not straight jacketed by only methods specified in law. Thus, this decision should be read with the facts of the case and may not have universal application for all unique transactions.

However, Tribunal has correctly reiterated the philosophy that while applying TNMM as the most appropriate method, the evaluation should be restricted to the international transactions and not to the entire turnover of the assessee.

NF