Case Law Details

Case Name : Star Diamond Group Vs. Dy. Director of Income Tax (ITAT Mumbai)
Appeal Number : ITA No: 3923/Mum/2008
Date of Judgement/Order : 28/01/2011
Related Assessment Year : 2004- 2005
Courts : All ITAT (5383) ITAT Mumbai (1672)

TPO cannot reject TP method adopted by assessee on the ground that the comparables are wrongly chosen. Further the ALP has to be determined with respect to an international transaction and not at an entity level

Star Diamond Group Vs. Dy. Director of Income Tax (Mumbai Bench), ITA No: 3923/Mum/2008

Executive Summary

The Mumbai bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of branch of Star India Diamond Co. (Belgium) N.V. (Taxpayer), on transfer pricing issues arising from import of rough diamonds by the Taxpayer from its Associated enterprise (AE). The Tribunal ruled in favour of the Taxpayer stating that the determination of Arm’s Length Price (ALP) of an international transaction has only to be made with respect to international transaction and the adjustment cannot be made at entity level. Further without proper reasoning, the department cannot apply another method for determination of ALP. Further value of adjustment in the international transactions can be made on purchases net of returns to AE and not on gross international transaction value.


The Taxpayer is a branch office of Star Diamond Co. (Belgium) N.V. and is in the business of import of rough diamonds and selling in the local market. During the AY 2004-05, the Taxpayer has purchased rough diamonds from its Associate Enterprise (AE) worth Rs.5.62 crores. The Taxpayer had also returned rough diamonds purchased from the same entity worth Rs.4.68 crores since they were not suitable for sale. The Taxpayer has used Resale Price Method (RPM) to benchmark the above international transaction. The Transfer Pricing Officer

(TPO) rejected the RPM method and applied TNMM method. The TPO applied the operating margin of comparables to the entire turnover of the Taxpayer. Further the TPO calculated the adjustment on Gross Purchase value of international transaction.

Being aggrieved by the said transfer pricing order, the Taxpayer filed an appeal before the Commissioner of Income Tax – Appeals i.e. the CIT (A). The CIT (A) held that the RPM method adopted by the assessee, cannot be accepted for the reason that, two comparables cited by the Taxpayer are engaged in export of cut and polished diamonds and are not resellers of rough diamonds as claimed by the Taxpayer. After rejecting the RPM method adopted by the Taxpayer, the CIT(A) considered the arithmetical mean of the operating margins of three other comparables, along with the comparables cited by the Taxpayer and arrived at an average of 2.68%. Thereafter, he applied this percentage to the entire turnover of the Taxpayer, on the ground that operating profit margins is always arrived, at the entity level and cannot be segmented unless the margins of the external comparables are also segmented. He held that there is no provision for calculating profit only on sales of goods purchased from AE. Hence, he rejected the contention of the Taxpayer to calculate profit only on the sale of the goods purchased from the AE. Thereafter he also rejected the contention of the Taxpayer to consider net purchases, instead of gross purchases. The CIT(A) reduced the adjustment as made by the TPO as the profit margin of comparables as selected by CIT(A) earned a lower profit margin as compared to AO.

Ruling of the Tribunal

The salient aspects of the Tribunal’s order are as follows:-

•           The Tribunal accepted the contention of the Taxpayer and according to Chapter X of the Income-tax Act decided that the determination of ALP of an international transaction has to be only at the transaction level or at the level of a class of transactions. Law does not permit determination of ALP of international transactions, by comparing operating margins at entity levels, or by taking overall industry level averages.

•           Thus the Tribunal held that the order of the TPO as confirmed by the CIT(A) on the perceived application of TNMM method at entity level is illegal and hence needs to be struck down.

•           The Tribunal held that neither TPO nor CIT(A) has held that RPM is not the most appropriate method but they have rejected RPM method on the basis that comparables chosen by Taxpayer were wrong. As the Taxpayer was a trader who does not add any value to the goods and RPM method was accepted in the case of the Taxpayer in the earlier two Financial Years, hence the Tribunal held that RPM is the most appropriate method for determining arm’s length price.

•           The Tribunal was of the view that if the comparables are not found appropriate, then fresh comparables can be searched but the method adopted need not be rejected.

•           The Tribunal was of the view that if there is purchase as well as purchase return of goods to the AE, then value of net purchases (Purchase – Purchase Return) should be the value of international transaction. As the law permits determination of arm’s length price of an international transaction only, then arm’s length value should calculated on net purchase value and not on gross purchase value. In other words, the Tribunal held that the same yardstick has to be applied to both purchases and purchase returns.

• The Tribunal set aside the case to the AO and directed TPO/AO to arrive at ALP for net purchases only and directed the Taxpayer to submit a fresh TP Study in view of the peculiar facts and circumstances of the case as an exception. Further after relying on the decision of Tribunal in case of BASF India Limited and second proviso to s 92C(2), Tribunal directed TPO/AO that in case the difference is less than 5% no adjustment should be made.


The ruling emphasises that the ALP has to be determined with respect to an international transaction and hence any adjustment to the ALP proposed by the TPO cannot be made at the entity level. Further the ruling strengthens the view that the most appropriate method chosen by the Taxpayer cannot be rejected by the TPO without cogent reasons.

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