Transfer pricing: TNMM found tested party PLI 10.49% exceeds adjusted external average 10.20%, addition of Rs.4.24cr deleted

ITAT, Delhi held that under TNMM the tested party's PLI (10.49%) exceeded the adjusted external average PLI (10.20% after 5% proviso), and the international transactions demonstrably boosted profits; technical know-how/assistance justified higher margins. Consequently the addition of Rs. 4,24,11,209 made by the lower authorities was deleted and the appeal allowed, with the AO directed to give effect to the deletion.

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Issues Involved:
1. Addition on account of difference in "average net operating margin" using TNMM for determining ALP.
2. Adjustment on total sales including non-international transactions under Section 92B of the IT Act.
3. Determination of royalty and technical know-how payments as nil.
4. Appropriateness of TNMM versus cost-plus method for determining ALP.
5. Consistency of transfer pricing assessments across different assessment years.

Detailed Analysis:

1. Addition on account of difference in "average net operating margin" using TNMM for determining ALP:

The Assessing Officer (AO) referred the case to the Transfer Pricing Officer (TPO) for determining the Arm's Length Price (ALP) under Section 92CA(1) of the IT Act, 1961. The TPO adopted the Transactional Net Margin Method (TNMM) and selected six comparable companies to calculate an average net operating margin of 9.21%. The TPO made an adjustment of Rs. 3,18,89,975 due to the difference between this margin and the assessee's margin of 4.56%. The CIT(A) further enhanced the adjustment to Rs. 4,24,11,209 by updating the operating margin to 10.74%.

2. Adjustment on total sales including non-international transactions under Section 92B of the IT Act:

The assessee argued that adjustments should only apply to international transactions and not to the total sales, as Section 92 is applicable only to international transactions. The Tribunal accepted this argument, noting that only international transactions should be considered for ALP adjustments. The Tribunal cited various judgments supporting this view and directed that the base for adjustments should be the sales to domestic parties using Takata technology and raw material, amounting to Rs. 12.74 crores.

3. Determination of royalty and technical know-how payments as nil:

The TPO determined the ALP for royalty and technical know-how payments as nil, arguing that no transfer of technology or know-how had taken place and that these costs were bundled in the price of materials. The Tribunal disagreed, noting that the agreements were genuine, duly executed, and approved by regulatory authorities. The Tribunal emphasized that commercial transactions should not be disregarded without cogent reasons and that the TPO's findings were incorrect.

4. Appropriateness of TNMM versus cost-plus method for determining ALP:

The assessee contended that the cost-plus method was more appropriate for determining the ALP. However, the CIT(A) and TPO considered TNMM as the most appropriate method. The Tribunal noted that the internal comparable method showed higher margins for AE transactions compared to non-AE transactions, indicating that the international transactions were at arm's length. The Tribunal found that the TNMM was appropriately applied but adjusted the margin to account for the safe harbor rule of +/-5%, concluding that no adjustments were necessary.

5. Consistency of transfer pricing assessments across different assessment years:

The assessee argued that no adjustments were made in subsequent years (AY 2005-06 and AY 2006-07) under similar circumstances. The Tribunal took note of this consistency and found it relevant in supporting the assessee's case. The Tribunal emphasized that legally binding agreements should not be disregarded and that the business expediency should be respected.

Conclusion:

The Tribunal concluded that the addition of Rs. 4,24,11,209 made by the CIT(A) should be deleted. The Tribunal directed the AO to delete this addition, emphasizing that the transactions were at arm's length and no adjustments were required. The appeal was allowed in favor of the assessee.

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