2011 (6) TMI 386 - AT - Income Tax

Tribunal directs re-examination of transfer pricing issues with external comparables & economic adjustments

Brintons Carpets Asia (P.) Ltd. Versus Deputy Commissioner of Income-tax, Circle 1(1), Pune

The Tribunal allowed the appeal for statistical purposes, directing the AO/TPO to re-examine the issues, adopt external comparables, consider economic ... Transfer pricing adjustment - external comparables v/s domestic comparables - unadjusted operating margin of the export segments with 91.14% of the total annual sales of the assessee is -13.57 per cent thus lower operating margin is due to labour unrest and therefore, the capacity of the company was under-utilized - Held that:- Assessee is entitled to economic adjustments in the circumstances of under capacity utilization of the company. Of course, such adjustments must be restricted to fixed cost/overheads only. In the instant case, the Assessing Officer/TPO did not have the occasion to go into the period or the extent of the labour unrest, break up of the claimed adjustments amounting Rs. 7.32 crores (rounded off), fixed cost versus the variable cost etc. as they summarily rejected the external comparables in view of their preference to the operating profits of the domestic segment of the carpets. Therefore and consequently, this key issue has to be set aside to the files of the TPO/Assessing Officer for fresh examination.TPO/AO shall pass a speaking order in this regard. External comparable v/s domestic comparable - the revenue authorities or the DRP deliberated on the acceptability of the six comparable furnished by the assessee summarily dismissing the assessee's submissions in this regard. The same is not proper that the Assessing Officer/TPO have not find mistake with the six external comparable filed by the assessee. They merely held that the domestic comparables are to be relied as the labour related problems are common to both export and domestic segments. In fact, considering the facts relevant to the subsequent assessment year where the Assessing Officer/TPO accepted the six external comparable for the purpose of the TNMM, the assessee conveyed no objection for going to the files of the Assessing Officer/TPO in this regard - Rule of consistency - assessee contested that the external comparable prices for the AY 2006-07 when accepted by AO for that assessment year must be accepted for this year in view of the absence of material facts - Held that:- It is a settled law that the principle of res judicata is inapplicable to Income-tax matters. However, the same is true as long as the facts of different in different assessment years. Otherwise, the rule of consistency is relevant to Income-tax matters and Assessing Officer cannot be ignore the same. There ought to be uniformity in treatment and consistency when the facts and circumstances are identical. Applicability of the provisions of section 10B & 93C(2) - Held that:- these issues should go to the files of the Assessing Officer as they are dependent on the outcome of the key issues set aside above - appeal decided in favour of assessee for statistical purpose Issues Involved:1. Rejection of benchmarking approach in transfer pricing.2. Use of domestic segment for benchmarking.3. Economic adjustment due to labor unrest.4. Differences in functional, asset, and risk (FAR) profile.5. Adjustment percentage for FAR differences.6. Transfer pricing adjustment despite tax holiday benefits.7. Applicability of the +/- 5% range under section 92C(2).8. Initiation of penalty proceedings under section 271(1)(c).Detailed Analysis:1. Rejection of Benchmarking Approach in Transfer Pricing:The assessee challenged the rejection of its benchmarking approach in the transfer pricing study, which led to a transfer pricing adjustment of Rs. 161,98,390. The Assessing Officer (AO) and the Dispute Resolution Panel (DRP) held that the international transaction of 'Export of carpets' did not satisfy the arm's length principle. The Tribunal noted that the AO/TPO summarily dismissed the external comparables provided by the assessee without proper reasoning.2. Use of Domestic Segment for Benchmarking:The AO/DRP compared the export segment with the domestic segment, which the assessee argued was inappropriate because the domestic segment involved controlled transactions and was not comparable. The Tribunal observed that the AO/TPO's approach lacked consistency, as they accepted external comparables in the subsequent assessment year. The Tribunal emphasized the need for consistency and ruled that the AO should adopt external comparables for the current year as well.3. Economic Adjustment Due to Labor Unrest:The assessee argued for economic adjustments due to labor unrest, which affected production and profitability. The Tribunal agreed that the AO/TPO did not adequately consider the impact of labor unrest on the export segment. The Tribunal directed the AO/TPO to examine the period and extent of labor unrest, the breakdown of costs, and the necessity of adjustments for underutilization of capacity.4. Differences in Functional, Asset, and Risk (FAR) Profile:The Tribunal noted the significant differences in the FAR profile between the export and domestic segments. The AO/TPO failed to make necessary adjustments to eliminate these differences. The Tribunal directed the AO/TPO to consider these differences and make appropriate adjustments.5. Adjustment Percentage for FAR Differences:The assessee contested the adjustment percentage for FAR differences, arguing that the AO/TPO's stance of a 44.54% adjustment was not granted. The Tribunal directed the AO/TPO to re-examine the adjustments and ensure they are reasonably accurate.6. Transfer Pricing Adjustment Despite Tax Holiday Benefits:The assessee claimed that there was no motive to manipulate transfer prices due to tax holiday benefits under section 10B. The Tribunal directed the AO to consider this aspect in the reassessment.7. Applicability of the +/- 5% Range Under Section 92C(2):The AO/DRP did not grant the benefit of the +/- 5% range as per the proviso to section 92C(2). The Tribunal directed the AO to re-evaluate this in light of the explanatory circular issued by the CBDT.8. Initiation of Penalty Proceedings Under Section 271(1)(c):The assessee challenged the initiation of penalty proceedings for furnishing inaccurate particulars of income. The Tribunal directed the AO to reconsider this issue based on the outcome of the reassessment.Conclusion:The Tribunal allowed the appeal for statistical purposes, directing the AO/TPO to re-examine the issues, adopt external comparables, consider economic adjustments due to labor unrest, and ensure consistency in their approach. The AO was instructed to pass a speaking order considering all relevant factors and judgments.