2013 (9) TMI 595 - AT - Income Tax

Transfer pricing ALP under TNMM: intra-group transactions can't be 'uncontrolled' comparables; wholly owned subsidiary benchmark rejected.

In determining ALP under s.92C read with rr.10A(a) and 10B(e) (TNMM), the Tribunal held that comparison must be made only with a 'comparable uncontrolled ... Transfer pricing adjustments - Adjustment of arm's length price (ALP) - uncontrolled transaction - Comparables relied on by the assessee differ in their risk and functional profile from that of the assessee and thus cannot be accepted as comparable – Held that:- What is an 'uncontrolled transaction' has been clearly defined under rule 10A(a) to mean 'a transaction between enterprises other than associated enterprises whether resident or non-resident'. A plain reading of the meaning given to the expression 'uncontrolled transaction' leaves no room for any doubt that it is a transaction between two non-associated enterprises. If the transaction is between two associated enterprises, it goes out of the ambit of 'uncontrolled /transaction' under rule 10A. When section 92C is read along with rules 10B(e) and 10A, it becomes abundantly clear that in computing the arm's length price under the transactional net margin method, a comparison of the assessee's net profit margin from international transactions with its associate enterprises has necessarily to be made with that of the net profit margin realised by the same enterprise or an unrelated enterprise from a comparable but definitely uncontrolled transaction, i.e., a transaction between non-associated enterprises. The arm's length price can be determined only by making comparison with a comparable uncontrolled transaction and not a comparable controlled transaction. Internal comparable, being the subsidiary company of the assessee company, be taken as comparable for computing the ALP for an international transaction – Held that:- Arm's length price represents the true value of transaction or profitability as will be there in the ordinary course without having any regard to the relationship between the concerns - Arm's length price of the transaction or the arm's length profit cannot be considered as benchmark for the purposes of making comparison in other cases – Legislature restricted the ambit only to uncontrolled transactions for computing the arm's length price in respect of international transactions between two associate enterprises - The basic purpose behind the transfer pricing provisions is to ensure that the multinational companies do not arrange their intra group cross border transactions in such a way as to reduce the incidence of tax in India. A multinational company, having concerns across the world, may resort to pricing the intra group transactions in such a manner that lower income gets offered in countries with high tax rates and higher income gets reflected in countries with lower tax rates, so that its overall tax liability is shrinked. Net profit margin realised from a transaction with an associate enterprise cannot be taken as a comparable being internal comparable for computation of the arm's length price of an international transaction with another associate enterprise even though the net margin from a transaction with associate enterprise is found and accepted at the arm's length price – Therefore, M/s. ICBC, a wholly owned subsidiary of the assessee are dismissed as comparable for computing price for international transaction. Issues Involved:1. Rejection of comparability analysis by the Transfer Pricing Officer.2. Deletion of addition by the Commissioner of Income-tax (Appeals).3. Inclusion of ICBC as a valid comparable.4. Adjustment of arm's length price.5. Consideration of controlled transactions for benchmarking.6. Reimbursement of expenses and mark-up adjustment.Issue-wise Detailed Analysis:1. Rejection of Comparability Analysis by the Transfer Pricing Officer:The Transfer Pricing Officer (TPO) rejected the external comparables provided by the assessee, citing that they differ in risk and functional profile from the assessee. The TPO noted that the assessee had not conducted a detailed FAR/comparability analysis and that reasonable accurate adjustments could not be made. The Commissioner of Income-tax (Appeals) (CIT(A)) found that the TPO's rejection of the comparables was not proper, as the TPO did not consider the segmental data provided by the assessee and rejected the comparables on an entity level basis.2. Deletion of Addition by the Commissioner of Income-tax (Appeals):The CIT(A) deleted the addition of Rs. 8,42,54,187 made by the Assessing Officer (AO) by holding that the transactions of ICBC, a wholly owned subsidiary of the assessee, are not comparable for benchmarking the international transaction of the assessee. The CIT(A) observed that ICBC had significant intra-associate enterprise transactions, which constituted 59% of its total revenues, and thus could not be considered a valid comparable.3. Inclusion of ICBC as a Valid Comparable:The TPO included ICBC as an internal comparable, despite the assessee's contention that ICBC had significant related party transactions. The TPO argued that since an unrelated party held a majority stake in JTS Contracting Co., the transactions with ICBC could be considered at arm's length. The CIT(A) disagreed, noting that ICBC's transactions with JTS Contracting Co. were related party transactions and that ICBC was functionally dissimilar to the assessee.4. Adjustment of Arm's Length Price:The TPO adjusted the arm's length price by adopting ICBC as a comparable and calculated the adjustment to the total income as Rs. 8,42,54,187. The CIT(A) rejected this adjustment, stating that the TPO's inclusion of ICBC was not appropriate due to functional dissimilarities and the availability of external comparables that were more appropriate.5. Consideration of Controlled Transactions for Benchmarking:The CIT(A) and the learned Accountant Member held that controlled transactions could not be used for benchmarking under the transactional net margin method (TNMM). The learned Judicial Member dissented, arguing that if a transaction with an associated enterprise is found at the arm's length price, it can be used as an internal comparable for another associated enterprise.6. Reimbursement of Expenses and Mark-up Adjustment:The assessee argued that the amount of reimbursements received from its associated enterprises should not form part of the cost base while computing the operating margin. The TPO included the entire reimbursements in the cost base and made an addition of 5% towards mark-up. The CIT(A) upheld the addition but noted that the TPO should not have made a flat 5% addition. The matter was restored to the AO for recomputation of the arm's length price adjustment in respect of mark-up costs.Conclusion:The appeal by the AO was dismissed, and the appeal by the assessee was partly allowed for statistical purposes. The cross-objection by the assessee was dismissed as infructuous. The matter was referred to a Third Member due to a difference of opinion between the learned Members on the issue of considering controlled transactions for benchmarking. The Third Member agreed with the learned Accountant Member, holding that controlled transactions could not be used for benchmarking under the TNMM.