Transfer pricing treatment of cost plus remuneration in crossborder sourcing upheld; court rejects TPO's FOBbased imputation, rules for TNMM affirmed

Challenge concerned whether a costplus remuneration of 5% on FOB exports to an associated enterprise was arm's length under the TNMM. Court found TNMM the appropriate method and held the taxpayer's 5% costplus reflected functions performed, assets used and risks assumed, while the TPO's imputation of income based on a fixed percentage of unrelated vendors' FOB was legally unsupportable. The TPO ignored relevant comparables and prior years' acceptance of TNMM, failed to apply TNMM adjustments within its framework, and did not provide a reasoned, speaking order; result: decision in favour of the assessee.

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Issues: Whether the Transfer Pricing Officer/AO/ITAT could, while applying the Transactional Net Margin Method (TNMM) under Rule 10B(1)(e), broaden the cost base by including costs of unrelated thirdparty manufacture and apply a markup on FOB value of exports to determine the assessee's arm's length price.

Analysis: Rule 10B(1)(e) requires computation of the tested party's net profit margin with reference to costs incurred, sales effected or assets employed by that enterprise; TNMM compares the tested party's net margin with comparable internal or external margins and adjustments, if any, must be made within the TNMM framework. The statutory scheme (Sections 92-92F and Section 92C) mandates selection of the "most appropriate" method and confines the AO/TPO to intervene only on specified grounds. FAR analysis and transfer pricing documentation are relevant to assess functions, assets and risks, but enhancement of the tested party's cost base by imputing unrelated thirdparty manufacturing/export costs falls outside the textual mandate of TNMM under Rule 10B(1)(e). Application of an FOBbased markup by imputing thirdparty costs amounts to introducing an alien adjustment not authorised by the Act/Rules; findings about risk exposure must be supported by objective record evidence before rejecting the assessee's TNMM computation.

Conclusion: The TPO/AO/ITAT's approach of including thirdparty manufacturing/export costs into the assessee's cost base and applying a markup on FOB value is contrary to Rule 10B(1)(e) and the transfer pricing provisions; the impugned adjustment is therefore set aside and the questions of law are answered in favour of the assessee.

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