2013 (8) TMI 735 - AT - Income Tax

Tribunal orders fresh Transfer Pricing study: focus on comparables, functional profile, and accurate adjustments

TCL Holdings (P.) Ltd. Versus Assistant Commissioner of Income-tax, Circle 3(3)

The Tribunal set aside the Assessing Officer's order and directed a fresh Transfer Pricing (TP) study by the Transfer Pricing Officer. The study should ... Transfer pricing adjustment - Rejection of comparables - loss making companies - Held that:- the comparables could not be rejected only on the ground of loss making. The cases of loss making companies are required to be further examined to find out if the loss had occurred during the normal course of business or because of some extraordinary factors which have affected the comparability of the transaction. Only in the later case the loss cases have to be excluded. No such exercise has been done - both assessee and TPO have applied TNMM method at entity level which is not correct. The adjustment is required to be computed only with respect to international transaction and not in respect of the entire business transactions - Merely because the assessee had made mistakes in computing the TP adjustment the authorities cannot follow the same blindly as they are duty bound to compute the adjustment correctly as per law. Because of the mistakes committed by both the sides TP adjustment has been made at Rs. 65.27 crore when the entire purchases from the AE was only Rs. 56.25 crore. It will not be appropriate to compare the margin of manufacturing companies to those of trading companies. - business profile of the assessee itself was not very clear. - it is appropriate that a fresh transfer pricing study be undertaken for selecting proper comparables after careful study of functional profile of the assessee so as to arrive at proper TP adjustment - Decided in favour of assessee. Issues Involved:1. Transfer Pricing (TP) adjustment in relation to transactions with Associate Enterprise (AE).2. Selection and rejection of comparables for TP study.3. Application of Transactional Net Margin Method (TNMM) at entity level versus transaction level.4. Exclusion of loss-making companies in TP adjustment.5. Computation of TP adjustment on total sales including local sales.6. Allocation of expenditure between international and local transactions.7. Discrepancies in financial data and functional profile of the assessee.Detailed Analysis:1. Transfer Pricing (TP) Adjustment in Relation to Transactions with Associate Enterprise (AE):The core issue in the appeal is the TP adjustment made by the Assessing Officer (AO) pursuant to the directions of the Dispute Resolution Panel (DRP). The assessee, engaged in trading consumer electronics, had entered into international transactions with its AE for purchasing goods. The AO referred the matter to the Transfer Pricing Officer (TPO) for determining the TP adjustment.2. Selection and Rejection of Comparables for TP Study:The assessee had applied the TNMM method and selected six comparables, which resulted in a weighted average operating profit on sales of -7.95% and operating cost of -6.84%. The TPO rejected these comparables, arguing that most were loss-making and conducted his own study with new comparables dealing in consumer electronics. The TPO's comparables resulted in an arithmetic mean margin of 2.23% after excluding loss cases. The TPO's rejection was based on the broad similarity of products and functional comparability.3. Application of TNMM at Entity Level Versus Transaction Level:The assessee argued that the TP adjustment should be made only concerning international transactions and not the entire business transactions. However, the TPO and DRP applied the TNMM method at the entity level, as the assessee had done in its TP study. The Tribunal noted that adjustments should be computed only for international transactions and not at the entity level. This misapplication led to an incorrect TP adjustment of Rs. 65.27 crore when the total AE purchases were only Rs. 56.25 crore.4. Exclusion of Loss-Making Companies in TP Adjustment:The TPO excluded loss-making companies from the comparables, which the Tribunal found inappropriate. The Tribunal emphasized that loss-making companies should not be rejected solely based on their losses. Instead, it should be examined if the losses occurred during the normal course of business or due to extraordinary factors affecting comparability. This examination was not conducted by the TPO.5. Computation of TP Adjustment on Total Sales Including Local Sales:The assessee objected to the TPO's approach of applying the Profit Level Indicator (PLI) on total sales, including local sales, arguing that the adjustment should be made only with respect to international transactions. The DRP upheld the TPO's approach, noting that the assessee had applied the TNMM method at the entity level. The Tribunal disagreed, stating that the adjustment should be transaction-specific.6. Allocation of Expenditure Between International and Local Transactions:The DRP observed that the assessee had not provided a basis for the allocation of expenditure between international and local transactions with supporting documents. This led to the rejection of the assessee's computation of internal margins for imported and local trading goods. The Tribunal acknowledged this issue and indicated that a proper allocation basis should be established.7. Discrepancies in Financial Data and Functional Profile of the Assessee:The Tribunal noted discrepancies in the assessee's financial data and functional profile. For instance, the total income figures and the margin percentages for comparables like Salora International differed between the assessee's and the TPO's records. The functional profile of the assessee, particularly regarding the import of Completely Built Units (CBUs), was unclear. These discrepancies necessitated a fresh TP study.Conclusion:The Tribunal set aside the AO's order and restored the matter to the AO/TPO for a fresh TP study. This study should involve selecting proper comparables after a careful examination of the assessee's functional profile and addressing the discrepancies and infirmities noted. The Tribunal emphasized the need for the TP adjustment to be computed correctly as per law, focusing on international transactions rather than entity-level adjustments. The appeal was allowed for statistical purposes.