Executive Summary- The Mumbai bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of Monsanto Holdings Private Limited Vs. Dy. Commissioner of Income Tax Range – 8(2) (Mumbai Bench), ITA No: 9130/Ml/2010 , on transfer pricing issues arising from international transactions entered by the Taxpayer with its Associated enterprises (AEs). The Tribunal ruled in favor of the Revenue stating that Resale Price Method (RPM) cannot be applied based on expected gross margin. Application of RPM is required to be based on examination of audited accounts and consequent computation of actual profit margin.
In its transfer pricing documentation report prepared for the FY 2005-06, the Taxpayer had adopted RPM as the most appropriate method to determine the arm’s length price of its international transactions with its AEs which resulted in no adjustments to be made to the transfer prices.
However, the Transfer Pricing Officer (TPO) despite of accepting the fact that RPM is the most appropriate method to determine the arm’s length price in the current case, observed that the Taxpayer in its computation of gross margin had used expected gross profit margin which was a notional / vague figure. Hence, the TPO rejected the RPM approach followed by the Taxpayer and adopted Transactional Net Margin Method (TNMM) to determine the arm’s length price which led to an adjustment of Rs. 9.86 crores.
Being aggrieved by the said transfer pricing order, the Taxpayer filed an appeal before the Dispute Resolution Panel (DRP). The DRP observed that the TPO was unable to apply the RPM since during the assessment proceedings the audited accounts of com parables were not made available to the TPO by the taxpayer for the purpose of computation of actual gross profit margin. The DRP in its order had directed that since the audited accounts were now available, the TPO can examine the same and based on the audited accounts can accordingly determine the arm’s length price on application of RPM.
The final assessment order reflected the same adjustment which was proposed in the draft assessment order and the direction of the DRP was not carried out. Aggrieved by the final assessment order, the Taxpayer filed an appeal with the Tribunal.
Ruling of the Tribunal
The salient aspects of the Tribunal’s order are as follows:-
• The Tribunal observed that the Assessing Officer (AO) / TPO despite the direction of DRP, was not able to apply RPM since the audited financial accounts of the comparable companies along with the computation of gross profit margin was not made available to the AO / TPO by the Taxpayer.
• The Tribunal ruled that transfer pricing adjustment should be based on actual profit margin after examination of audited accounts and not on expected gross margin which is a notional figure.
• The Tribunal based on the above observations held that the determination of actual adjustments on adoption of RPM will not be clear and definite in the absence of the relevant audited financial accounts.
The ruling though has not provided a definite conclusive view on the correct approach towards application of RPM but to a certain extent it provides clarity and guidance to taxpayers and tax administration on the computation of gross profit margin based on actual accounts while applying the RPM. The ruling provides support that the most appropriate method should be applied since data was available at the time of DRP order. However the ruling does not discuss any arguments on why net margins based on unaudited accounts computed under the TNMM are justified. Also, the ruling is significant in respect of its support and stress on the timely submissions of relevant details to be made by the taxpayer when called for by the tax authorities during the litigation proceedings.