2014 (4) TMI 932 - AT - Income Tax

Tribunal upholds CIT(A)'s decision on arm's length pricing, emphasizing transparency and natural justice.

The tribunal upheld the CIT(A)'s decision to delete the adjustment made by the AO under Section 92CA(3) of the Income Tax Act. It found that the ... Deletion of adjustment u/s 92CA(3) of the Act – Selection of comparables – Held tha:- While finalising the ALP,TPO had added two new comparables i.e. FEL and MIL to the eight comparables adopted by the assessee, that because of the inclusion of the two companies variation in operating margin arose, that the operating margin was within the range of 5% of the arithmetic mean of the operating margin of the comparable companies – the TPO had not given any reason as to why he was including FEL and MEL in the list of comparables - He did not give any notice to the assessee for inclusion of two new variables. Basic principles of natural justice demand and expect that assessees should be heard, before fastening tax-liability to them - It is not known as how did the TPO arrive at the conclusion that FEL and MEL could be compared with the other companies for arriving at operating margin. Similarly, it is also not known as whether both the companies were in the same line of business or not. If the TPO had some definite information, he should have brought it on record and should have confronted the assessee with it - It would have given a chance to the assessee to defend itself - By not affording an opportunity to the assessee, TPO had taken a unilateral decision and such decisions cannot be endorsed - TPO had not found any defect in TP Study carried out by the assessee - TPO had not discussed the reason for not accepting the operating margins of AIL, though the said company was in the same business - If the average operating margin shown by the assessee is compared with AIL, it is clear that same was within the +/-5% of the margins/transactions and was allowable as per the rules - while considering the basic data of AIL had ignored vital factors that have been highlighted by the FAA - FAA had correctly held that international transactions entered in to by the assessee were at arm's length and that no adjustment was required – Decided against Revenue. Issues Involved:1. Deletion of adjustment made under Section 92CA(3) of the Income Tax Act.2. Selection of comparables for determining the arm's length price (ALP).3. Consideration of Transfer Pricing Officer's (TPO) reasons for rejecting comparables selected by the assessee.Issue-Wise Detailed Analysis:1. Deletion of Adjustment Made Under Section 92CA(3):The Assessing Officer (AO) challenged the deletion of an adjustment amounting to Rs. 82,52,119 made under Section 92CA(3) of the Income Tax Act by the Commissioner of Income Tax (Appeals) [CIT(A)]. The AO contended that the CIT(A) failed to appreciate the facts of the case. The assessee-company, engaged in importing, assembling, and distributing weighing machines, had reported various international transactions. The TPO determined the arm's length price (ALP) and recommended an adjustment, which the AO incorporated into the total income of the assessee. The CIT(A), however, deleted this adjustment, leading to the AO's appeal.2. Selection of Comparables for Determining ALP:The CIT(A) was criticized for taking Avery India Ltd. (AIL) as the only comparable case, ignoring two other comparables adopted by the TPO. The TPO had initially identified eight comparables and reworked the operating margins, but the CIT(A) found discrepancies in the TPO's approach. The CIT(A) noted that the TPO did not provide detailed parameters for arriving at the operating sales, costs, and margins of the comparables, thus conducting the scrutiny in an opaque manner. The CIT(A) also pointed out that the TPO failed to issue a show cause notice to the assessee before rejecting the margins and adopting additional comparables, Flex Engineering Ltd. (FEL) and Manugraph India Ltd. (MIL), which was against the mandate of law.3. Consideration of TPO's Reasons for Rejecting Comparables Selected by the Assessee:The TPO included two additional comparables, FEL and MIL, without providing reasons or issuing a notice to the assessee. The CIT(A) held that these companies were engaged in different lines of business compared to the assessee. FEL's substantial income was from job work related to the oil and gas sector, and MIL was also not comparable. The CIT(A) found that the TPO failed to consider various factors like provisions written back, bad debts recovered, and other operating nature expenses. The CIT(A) concluded that the operating margin of AIL, based on audited financial statements, was correct and lower than the assessee's margin. Therefore, the international transactions were at ALP, and no TP adjustment was required.Judgment:The tribunal heard the rival submissions and perused the material. It found that the TPO added two new comparables, FEL and MIL, without providing reasons or notice to the assessee, which violated the principles of natural justice. The TPO did not find any defects in the Transfer Pricing Study carried out by the assessee and failed to discuss the reasons for not accepting AIL's operating margins. The tribunal confirmed the CIT(A)'s order, holding that the international transactions were at arm's length and no adjustment was required. Consequently, the appeal filed by the AO was dismissed.Conclusion:The tribunal upheld the CIT(A)'s decision to delete the adjustment made by the AO under Section 92CA(3), emphasizing the importance of transparency, adherence to natural justice principles, and proper consideration of comparables in transfer pricing cases. The tribunal found that the TPO's inclusion of additional comparables without proper justification and notice was flawed, and the assessee's transactions were indeed at arm's length. The appeal by the AO was dismissed, affirming the CIT(A)'s order.