2013 (11) TMI 468 - AT - Income Tax

Tribunal Rejects TPO's Adjustments, Emphasizes Accurate Analysis

The Tribunal allowed the assessee's appeals, rejecting the TPO's adjustments and criteria for comparables. The Tribunal emphasized the need for accurate ... Addition on account of adjustment in Transfer Pricing sale Transaction – Held that:- As per the CA's certificate provided by the assessee, being certificate dated 3.4.2013, when we consider all 15 sale transactions of the assessee with its 'AE', the average profit margin of total sales of the 'AE' works out to 11.68%. This is admitted position of the fact that the profit margin of the comparable adopted by the TPO and the assessee i.e. IDA was 11.94%, and hence, the aggregate profit margin of the 'AE' is within the limit of ± 5% of the profit margin of the comparable i.e. IDA, and therefore no addition is called for in this year, even as per the basis adopted by the AO/TPO, i.e. 'AE' as a tested party, and IDA as comparable - When no addition is justified, even as per the basis adopted by the AO and the TPO, therefore, the entire addition made by the AO in respect of sales effected by the assessee to the 'AE' of Rs.2,65,37,704/- is deleted – Decided in favor of Assessee. Addition on account of adjustment in Transfer Pricing purchase transaction - Addition of Rs.3,68,986/- made by the AO and the TPO out of which Rs.1 lakh addition was confirmed by the learned CIT(A) – Held that:- when the same material, which is purchased by the assessee from the 'AE' is sold to the same 'AE', and profit margin on such purchase and sale to the 'AE' is considered for working out the addition in the profit of the assessee, no separate addition in respect of purchases can be made, because, once the value of purchase is reduced for making the adjustment as per the TP rules, the margin on its sale to the 'AE' will further go up, and therefore, this addition is not sustainable in the facts of the present case – Decided in favor of Assessee. Selection of a company as a comparable – Domestic segment as comparable for a company of export segment – Held that:- The companies chosen for comparision do not have any export business for the year under consideration whereas the assessee company has full-fledged export business. The functions, risks and assets are entirely different – Hence, the chosen company cannot be considered as a comparable company for determining the ALP - Moreover, the Delhi Bench of the Tribunal in the case of Mentor graphics [2013 (5) TMI 49 - DELHI HIGH COURT] held that the ALP should be determined by taking results of a comparable transaction in comparable circumstances – Therefore, from the reasoning above, the chosen companies will not be in the final list of comparables. Reliance have been placed upon the judgment in the case of ITO v. CRM Services India (P.) Ltd [2011 (6) TMI 398 - ITAT DELHI ], wherein it was held that territory of the business is a material factor in deciding comparability of the cases. The assessee renders services in USA while Shreejal Info Hubs Ltd. renders services in India. This fact alone is sufficient to exclude this comparable. Selection of a company as a comparable – Turnover criteria – Held that:- Relying upon the judgment in the case of DCIT v. Indo American Jewellery Ltd. [2010 (5) TMI 530 - ITAT, MUMBAI], it is held in the instant case that use of turnover criteria is an important comparability factor, even if the search process carried out by the assessee is considered. Selection of tested party – Held that:- 'AE' is having the intangible in the form of supplier list, and the 'AE' is developing the market by participation in tenders and bears all types of risks. The data of the assessee-company is easily available, and the same are reliable data whereas the data of the 'AE' is complex data and it cannot be more reliable, as compared to the assessee, and considering all these facts, as compared to its 'AE', the assessee should be treated as tested party in the present year as the least complex party is the assessee-company in comparison to its 'AE' – Decided in favor of Assessee. Applicability of precedent decisions in Transfer Pricing issues - Applicability of the Tribunal decision cited by the learned DR of the Revenue – Reliance have been placed upon the case of Interra Information Technologies (India) (P.) Ltd. [2013 (9) TMI 120 - ITAT DELHI], wherein it has been held that while adjudicating the TP issues that there is no legal binding precedence on the issue of selection of most appropriate method, selection of comparable companies, selection of comparables transactions for benchmarking etc, as these are facts based and vary from company to company. Hence this Tribunal decision cited by the learned DR of the Revenue in fact does not help the Revenue – Decided in favor of Assessee. Selection of comparables – Four comparables selected - The arithmetic mean margin of these four comparables comes to 4.27% - Held that:- Assessee-company has to be considered as tested party - Working of the profit margin of the assessee-company, which is 5.29% being gross profit margin on COGS and 1.15% is the operating profit margin on operating revenue and 1.16% is operating profit margin on operating cost – Comparison of these margins of the assessee-company with arithmetic mean - Average of these four companies worked out at 4.27% - Arithmetic mean is within the range of (+/-)5%, and hence, no Transfer Pricing adjustment is called for – Decided in favor of Assessee. Issues Involved:1. Selection of tested party.2. Selection of comparable entities.3. Transfer Pricing adjustment.4. Economic characterization and functional analysis.5. Rejection of tested party by TPO.6. Risk and asset analysis.7. Adjustments for differences in FAR (Functions, Assets, and Risks).8. Comparability of IDA Foundation.9. Use of consolidated financial statements.10. Turnover differences.11. Related party transactions.12. Export earnings filter.13. Loss-making comparables.14. Application of +/-5% price range benefit.Detailed Analysis:1. Selection of Tested Party:The TPO selected the AE (MPAS) as the tested party, considering MPL (assessee) as more complex due to its substantial investments and involvement in purchasing, inspecting, and processing drugs/formulations. The assessee argued that MPL should be the tested party as it performs limited functions, bears minimal risks, and has readily available and reliable data. The Tribunal found that the AE was sourcing materials from Indian suppliers for over three decades and that MPL was set up merely as a logistics platform. The Tribunal concluded that MPL is the least complex entity and should be the tested party.2. Selection of Comparable Entities:The TPO selected IDA Foundation as a comparable entity. The assessee initially included IDA in its comparables but later argued that IDA, being a not-for-profit organization, is not comparable. The Tribunal agreed with the assessee, noting that IDA's surplus does not indicate a profit motive and that its objectives are charitable. The Tribunal thus excluded IDA as a comparable.3. Transfer Pricing Adjustment:The TPO made an upward adjustment based on the gross margins of MPAS compared to IDA Foundation. The Tribunal found that even if MPAS were considered the tested party, no adjustment was justified as the profit margin of MPAS was within the +/-5% range of IDA's margin.4. Economic Characterization and Functional Analysis:The TPO characterized MPL as a service provider, which the Tribunal found incorrect. MPL's activities were akin to those of a wholesale trader, performing routine functions with minimal risks. The Tribunal emphasized that MPL's role is limited to receiving, packing, and dispatching goods as per AE's instructions.5. Rejection of Tested Party by TPO:The TPO's rejection of MPL as the tested party was based on its perceived complexity and intangible assets. The Tribunal found no factual basis for these claims, noting that MPL did not develop intangibles and that its operations were financed by AE.6. Risk and Asset Analysis:The Tribunal found that MPL bears minimal risks, as its inventory is financed by AE, and it operates in a risk-mitigated environment. The AE bears significant risks, including market, credit, product, and financial risks.7. Adjustments for Differences in FAR:The TPO did not make necessary adjustments for differences in FAR between MPL and its comparables. The Tribunal noted that adjustments should account for working capital and risk profile differences, which were not considered by the TPO.8. Comparability of IDA Foundation:The Tribunal excluded IDA Foundation as a comparable due to its not-for-profit status and different economic objectives. The Tribunal emphasized that comparables should have similar economic profiles and objectives.9. Use of Consolidated Financial Statements:The TPO used consolidated financial statements for comparability, which the Tribunal found inappropriate. The Tribunal noted that consolidated statements include diverse business activities and geographical markets, making them unsuitable for comparability.10. Turnover Differences:The TPO rejected comparables with high or low turnover. The Tribunal found this criterion irrelevant in MPL's case, as turnover differences do not significantly impact profitability in wholesale trading.11. Related Party Transactions:The TPO rejected comparables with significant related party transactions. The Tribunal agreed with excluding Zydus Pharmaceuticals due to high related party transactions but accepted other comparables after verifying their independent operations.12. Export Earnings Filter:The TPO applied an export earnings filter, rejecting comparables with low export sales. The Tribunal found this filter irrelevant for MPL, as its activities do not involve typical export risks and functions.13. Loss-Making Comparables:The Tribunal held that loss-making comparables should not be excluded solely based on losses. The Tribunal accepted comparables with occasional losses, provided they met other comparability criteria.14. Application of +/-5% Price Range Benefit:The Tribunal found that MPL's profit margin was within the +/-5% range of the comparables' margins, making any transfer pricing adjustment unnecessary.Conclusion:The Tribunal allowed the assessee's appeals, rejecting the TPO's adjustments and criteria for comparables. The Tribunal emphasized the need for accurate functional analysis and appropriate selection of tested parties and comparables. The Tribunal's decision was based on detailed examination of MPL's operations, risks, and economic profile, ensuring compliance with transfer pricing regulations.