Transfer Pricing – Initial burden is upon the assessee to prove the reasonableness of the method followed by the assessee-company

Cherokee India Pvt. Ltd. Vs. ITO

ITAT Mumbai

ITA. No. 825/Mum/2010

Assessment year: 2005- 2006

ORDER

PER D. MANMOHAN, V.P.

1. Assessment made by the Assessing Officer under section 143 (3) of the Act read with section 92C(4) of the I.T. Act for the assessment year 2005- 2006, having been confirmed by the learned CIT(A), assessee is in appeal before us. Though several grounds were urged before us, all the grounds are directed against the correctness of the transfer pricing adjustment made by the TPO as against the profit/losses declared by the assessee under Transactional Net Margin Method (hereinafter referred to as “TNMM”).

2. Facts of the case are as follows :- Assessee-company was set up in Santacruz Electronics Export Processing Zone (SEEPZ). This was incorporated on 25-1-1984 as a wholly owned subsidiary (99.95%) of Cherokee International, USA. The prime goal of the company was to act as a subsidiary to its parent company (hereinafter referred to as “Associated Enterprise” or “AE”). The object of the company was to manufacture various magnetic components like transformers, inductors, printed circuit boards etc., and to export the same to AE.

 2.1. In the year under consideration assessee exported finished goods worth Rs.15,91,07,755/-. The assessee however incurred loss of Rs. 13.2 lakhs during the year. Operating loss of the assessee as a percentage of sales works out to 0.93%.

2.2. The case of the assessee was that 95% of the raw materials were received from AE free of cost i.e., without payment of custom duty as provided in the EXIM policy. Balance is sourced, by the assessee, locally or through imports. Title to the goods vests with AE throughout the manufacturing process. It was also contended that the production schedule is given by the AE and assessee does not own any manufacturing intangibles nor do they conduct any independent research and development activities. Under the circumstances, it was contended, on the exports made to the AE a mark-up of 6% is charged to the expenditure/ standard cost incurred by the assessee. The ‘standard cost’ is based on an estimate of the cost likely to be incurred during the year. In the process, it takes into account the future volumes and other factors to a reasonable extent. Since the products are priced based on estimate of time involved in conversion of raw material into finished goods and estimated cost, any variation due to inefficiencies or capacity utilisation will lead to under-absorption of overheads and such under-absorption will lead to some overheads which will be saddled on the entity without being transferred on to the selling price of finished goods. Under the circumstances, as against the estimated profit of Rs. 62 lakhs (based on the earlier year’s figures) the assessee-company incurred a loss of around Rs. 13 lakhs. It was contended that there were justifiable factors for incurring the loss which is more to do with economics rather than with an object to avoid tax.

2.3. Since it is a transfer pricing case, in view of the provisions of section 92CA of the Act, the case of the assessee was referred to TPO (The Transfer Pricing Officer) for computation of ALP (Arms Length Price) in relation to the international transactions. The Transfer Pricing Officer in turn, issued a questionnaire to the assessee-company and requested to submit detailed explanations to support the arms length price computed in this case.