Air tech Private Limited Vs. Deputy Commissioner of Income Tax, New Delhi for Assessment Year 2006- 07, ITA No. 3591(DEL)/2010)
Executive Summary- The Delhi bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of Airtech Private Limited (Appeal no. ITA 3591 Del )/2010) on documentation aspect of transfer pricing (TP). The Tribunal held that contemporaneous TP Documentation was to be maintained by the taxpayer annually as the transaction was separate and was influenced by changing market dynamics.
Facts- Airtech Private Limited (“Taxpayer”) is engaged in production of metal bed steads out of a factory in Sahibabad. The Taxpayer sold all the goods manufactured by it to its wholly owned subsidiary company in the United Kingdom. The company had a long standing understanding with the subsidiary company to sell the goods at a cost plus fixed fee basis per unit in Indian currency. The Assessing Officer (AO) had conducted a transfer pricing scrutiny in the year 2002-03 and had accepted that the international transactions of the Taxpayer in that year adhered to the arm’s length principle laid down under the Indian Regulations. Further, the I.R.S., U.K. had also analysed the arm’s length nature of the international transactions of the subsidiary company for the FY 2000-01 and had not drawn any adverse inference. Accordingly, the Taxpayer argued that it was not required to maintain any transfer pricing documentation as per the proviso to Rule 1 0D(4) of the Income Tax Rules, 1962. This proviso carved out an exception to Rule 1 0D of the Income Tax Rules, 1962 and held that fresh documentation was not necessary where a transaction continued for more than one year, unless there was a significant change in the nature or terms of the international transaction.
The Transfer Pricing Officer (TPO) disagreed with the Taxpayer’s contention and made a TP adjustment to the arm’s length price of the international transactions of the Taxpayer by adopting a transactional net margin method (TNMM) analysis using two external comparables.
Being aggrieved by the said transfer pricing order, the Taxpayer filed its objections before the Dispute Resolution Panel (DRP). Before the DRP, the Taxpayer objected to the TP addition and sought certain economic adjustments. However, the DRP did not find any clear methodology in the adjustments sought by the Taxpayer and upheld the order of the TPO.
Ruling of the Tribunal
Subsequently, the Taxpayer appealed before the Tribunal. During the course of the proceedings, the Taxpayer argued that the AO as well as the U.K. I.R.S. had accepted the arm’s length nature of the international transactions for an earlier year and that there was no change in the nature or basis of the transactions since then. Accordingly, it was submitted that the Taxpayer was not required to maintain any documentation as per the proviso to Rule 10D (4) of the Income Tax Rules, 1962. Also, the two comparable companies selected by the TPO were engaged in manufacturing of different products. Moreover, one of the comparable company’s financials was not reliable as it had shown extraordinary growth during the year and the annual report stated that the company was engaged in diversified activities.
The Revenue, on the other hand contended that the Taxpayer had not maintained any documentation. Accordingly, in the absence of any economic analysis undertaken by the Taxpayer, TNMM was adopted to determine the arm’s length price of the international transactions of the Taxpayer.
In this regard, the Tribunal inter alia held the following:
• In the case of the Taxpayer, each transaction of sale was a separate transaction and the Taxpayer had not shown any agreement with the AE that suggested the arrangement subsisted over years and was binding in nature. Given the fact that the marketing dynamics keep varying periodically, a margin charged in an earlier year cannot be taken as a fair margin for the future. In any case, the foreign exchange fluctuation should also be taken in to account. Accordingly, the proviso to Rule 1 0D(4) was not applicable to the facts of the Taxpayer and it was required to maintain the TP Documentation
• The Tribunal observed that the U.K. I.R.S. acceptance of the arm’s length price was conditional in nature and subject to foreign exchange fluctuation. As the Taxpayer’ s pricing of the international transactions had remained static in rupee per unit terms, a determination of the arm’s length price by the AO was called for
• The com parables brought forward by the revenue were dealing in different product lines.
Accordingly, the case was restored back to the AO to obtain data on comparable companies in similar line of business to determine the arm’s length price
The ruling clarifies that absence of change in intra- group arrangements will not by itself justify non-maintenance of contemporaneous annual documentation unless it can be shown that the market dynamics have also remained constant. The ruling also highlights the importance of having robust intra- group contracts in place to document the terms and obligations inter-se.