Transfer Pricing – Benchmark cannot be applied on a global basis but has to be on a transaction basis ; Tribual explains Important Principles of Cost Plus, CUP and TNMM

ACIT Vs Tara Ultimo Private Limited (ITAT Mumbai)- The application of Cost Plus Method thus provides for (i) ascertaining the direct and indirect costs of property transferred, or services rendered, to the associated enterprises; (ii) ascertaining the normal mark up of profit over aggregate of direct costs and indirect costs in respect of same or similar property or services, or a series of transactions of same or similar property or services, to the unrelated enterprises; (iii) adjusting the normal mark up, or gross profit, for differences, if any, in the material factors (to give simple examples of such variations, these variations could be risk profile, credit period, market differences, nature of goods of services etc etc); (iv) applying the mark up or gross profit so arrived at on the aggregate of direct and indirect costs. The way this rule works, the benchmark gross profit is to be applied on each transaction with the AEs , while, for computing the benchmark, one could take into account a series of same or similar transactions. In other words, while setting the benchmark, one can take into account several transactions with unrelated enterprise on what can be termed as ‘global basis’, essentially in respect of same or similar property or services though, the benchmark so arrived at cannot be applied on the global basis i.e. the average of gross profit earned from same or similar transactions with AEs. The application of CPM has to be on transaction basis rather than on global basis, and this fundamental scheme of cost plus method is also evident from the plain wordings of Rule 10 B as well. Any other view of the matter will result in incongruities. For example, if our average mark up to unrelated enterprises is 20%, and we charge a mark-up of 2% in one transaction with AE and 38% in another transaction with the AE, both these transactions, by applying the mark up on global basis, will meet the test of ALP whereas in the first case, the mark up charged is certainly not a mark-up resulting in an ALP. In this particular case, for example, the normal mark up in transactions with has been computed at 16.3 1%, and the average of mark up on sales to AEs having been taken at 17.08%, entire sales to AEs has been taken at ALP, but, the mark up in the many cases is clearly less than benchmark. To give one example, at page 221 of the paper-book, margin of 14.15% (4 invoices), 13.95%, 13.81%, 14% ( 4 invoices), 14.14% ( 2 invoices), and 14.16% is given by assessee’s own computation, and, on the same page, on one invoice, the assessee has shown a margin as high as 27%. The cost plus method, therefore, has not been correctly applied. In any case, one of the most important input , i.e. diamond, has been imported at a price for which no ALP documentation is available and the price of imports have been taken into account in computation of costs as well. The costs of inputs have not been verified either. No efforts are made to show that the terms of sale to the AEs and all other relevant factors are materially similar vis-a-vis the transactions with independent enterprises. The CPM is applied by comparing gross profit on sales, whereas the method requires comparison of mark up on costs on transactions with AEs vis-à-vis mark up on costs on transactions with non AEs. In view of these discussions, the CIT(A) was in error in upholding assessee’s computation of ALP by cost plus method.

Full Text of the Judgement is as follows

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