2011 (7) TMI 177 - AT - Income Tax

Transfer pricing adjustment upheld under TNMM method for lack of substantiation, burden of proof on assessee.

The Tribunal affirmed the CIT(A)'s decision in a transfer pricing case, upholding the adjustments made by the tax authorities. The primary issue was the ... Arm length price - Transfer pricing adjustment - Profit/losses declared by the assessee under Transactional Net Margin Method ('TNMM') - Proof of - There is no dispute with regard to the method followed by the assessee except for the fact that the assessee has not proved satisfactorily as to why estimated 'standard-cost' has to be taken into consideration particularly when the transaction is with the principal who is holding 99.95 per cent control over the assessee-company - The main factor for disregarding the method followed by the assessee was due to non-furnishing of the so-called agreement with the AE - Since, we are in agreement with the detailed reasons given by the TPO/Assessing Officer as well as the CIT(A), held that the initial burden is upon the assessee to prove the reasonableness of the method followed by the assessee-company and in the absence of proving the same by producing any document/agreement with its principal highlighting the contractual terms of sharing cost, the learned CIT(A) was correct in holding that the special provisions of the Act have to be construed strictly and the method adopted by the tax authorities for making transfer pricing adjustments is reasonable in the circumstances of the case - Decided against the assessee. Issues Involved:1. Transfer Pricing Adjustment2. Correctness of Methodology (Transactional Net Margin Method - TNMM)3. Burden of Proof and Documentation4. Application of Cost-Plus Method vs. TNMM5. Justification of Mark-Up and Estimated CostsDetailed Analysis:1. Transfer Pricing Adjustment:The primary issue in the appeal was the correctness of the transfer pricing adjustment made by the Transfer Pricing Officer (TPO) against the profit/losses declared by the assessee under the Transactional Net Margin Method (TNMM). The TPO suggested an adjustment of Rs. 30,09,844, concluding that the assessee should charge a mark-up as per TNMM on the total cost incurred.2. Correctness of Methodology (TNMM):The assessee argued that TNMM was the most appropriate method for determining the arm's length price (ALP) of the international transactions. The TPO and Assessing Officer (AO) accepted TNMM as the correct method but questioned the application of a 6% mark-up on estimated costs rather than actual costs. The CIT(A) supported the TPO's view, noting that the method followed by the assessee was not justified due to the use of estimated costs, which led to a depressed cost base.3. Burden of Proof and Documentation:The assessee failed to produce the agreement with the Associated Enterprise (AE) that would substantiate the claim of a 6% mark-up on standard costs. The TPO and CIT(A) emphasized that the burden of proof was on the assessee to demonstrate the correctness of the method followed. The absence of documentation and failure to define 'standard cost' led to the conclusion that the assessee did not meet the required burden of proof.4. Application of Cost-Plus Method vs. TNMM:The CIT(A) observed that the cost-plus method would have been more appropriate for a contract manufacturer like the assessee, who should not bear business risks and should be compensated based on actual costs. The CIT(A) noted that the method followed by the assessee, which involved charging a mark-up on estimated costs, was not appropriate and led to necessary adjustments under TNMM.5. Justification of Mark-Up and Estimated Costs:The TPO and CIT(A) questioned the justification of using estimated costs instead of actual costs for applying the 6% mark-up. They highlighted that the assessee, being a contract manufacturer with 99.95% ownership by the AE, should have been compensated based on actual costs, even if it resulted in inefficiencies. The CIT(A) upheld the TPO's adjustment, noting that the transfer pricing regulations apply regardless of the intention behind setting the contract price.Conclusion:The Tribunal affirmed the CIT(A)'s order, agreeing that the initial burden was on the assessee to prove the reasonableness of the method followed. The failure to produce the agreement and substantiate the use of estimated costs led to the conclusion that the transfer pricing adjustments made by the tax authorities were reasonable. The appeal filed by the assessee was dismissed.