No transfer pricing adjustment where TNMM wrongly applied to enterprise-level operating margins; exclude non-operational income under s.92F(ii)

ITAT, Mumbai - AT dismissed the Revenue appeal, upholding the CIT(A)'s decision that no transfer pricing adjustment was warranted. The Tribunal found the TPO and AO erred in applying TNMM to enterprise-level operating margins rather than net profit margins from the international transaction(s) as required by s.92F(ii); non-operational income should have been excluded, which would have reduced the margin variation below 5% under the CBDT guidance. The AO's application of TNMM was therefore incorrect.

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Issues:
Transfer Pricing Adjustment under section 92CA(3) of the Income-tax Act, 1961.

Analysis:
The appeal was filed against the order of the CIT (Appeals)-XVII, Mumbai for the assessment year 2004-05. The assessee, a partnership firm engaged in import and export of diamonds, entered into an international transaction with a related entity. The assessee adopted the CUP method for determining the arm's length price, but the TPO rejected this method and suggested an adjustment under the Transaction Net Margin Method (TNMM). The Assessing Officer concurred with the TPO's recommendation, leading to an addition of Rs. 44 lakhs. The first appellate authority, however, deleted this addition, stating that no adjustment was necessary as per the Board's Circular, as the price variation was less than 5 percent after excluding non-operational profits. The Revenue appealed this decision, arguing that the addition should not have been deleted.

The learned DR contended that the rejection of the CUP Method was not challenged, and the TNMM was erroneously applied by the CIT (Appeals) by not excluding the highest comparables. The Assessing Officer's authority to adopt gross margins at the enterprise level under TNMM was also questioned. On the other hand, the assessee's counsel argued that even under the Assessing Officer's method, errors existed as non-operational profits were not excluded, leading to a variation below 5 percent. The counsel also disputed the Assessing Officer's approach of taking profits at the enterprise level under TNMM, stating it was contrary to the Act.

The Tribunal analyzed the provisions related to arm's length price and transactional net margin method (TNMM). It emphasized that TNMM requires comparing net profit margins from international transactions and not operational margins of enterprises as a whole. Citing a precedent, the Tribunal held that TNMM focuses on the net profit margin realized from international transactions, not overall operational margins. Consequently, it concluded that both the TPO and the Assessing Officer erred in applying TNMM. The Tribunal upheld the CIT (Appeals) decision to delete the addition, albeit for different reasons, and dismissed the Revenue's appeal.

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