2014 (11) TMI 132 - AT - Income Tax

Tribunal orders Transfer Pricing Officer to reevaluate issues using specified methods

Danisco (India) Pvt. Ltd. Versus ACIT Circle 10(1) New Delhi

The Tribunal allowed the appeal for statistical purposes, directing the Transfer Pricing Officer to reevaluate the issues according to specified ... Transfer pricing adjustment – Computation of ALP – Addition made on entire transaction - Assessee contended that the addition on the entire transactions under taken by the assessee, irrespective of the fact that during the year, the assessee has also under taken transactions with unrelated treaties which are not subject to transfer pricing – Held that:- The assessee was established in 1998 as a 100% subsidiary of Danisco A/S Denmark - Danisco India is engaged in the business of manufacturing and trading of food additives - The manufacturing business in respect of food flavours and the trading business is for products for falling under the category of food ingredients – assessee rightly contended that the methodology adopted by the TPO has been to arrive at the deficiency in the operating profits of the assessee vis-à-vis the comparables and attribute the entire differential only to the prices accordingly - TPO has conveniently ignored that the purported deficiency in the profits of the appellant is also a function of several other normal third party business expenses incurred by the assessee during the year - in the manufacturing activity the majority of the raw material was purchased from unrelated third parties - TPO has himself has noted only 12.5% of purchases are from related parties - about 87.5% of the purchases of raw material are from unrelated parties and hence these transactions were outside the purview of transfer pricing examination - in respect of purchase of traded goods, a small portion of the same was purchased from unrelated entities. Selection of comparables – Economic adjustment claim denied – Computation of margins erroneous – Held that:- Assessee rightly contended that there was error in rejecting 4 comparable companies selected by the assessee in its transfer pricing document - three of the comparables namely Ashok Alco Chem, Gayatri Star Chem and Kothari Ferment has been rejected on the ground that they have negative net-worth - there is no correlation between net worth and profitability of a company - The fact that two of these 3 companies had positive margins clearly shows the absence of this correlation - loss and profit are normal incident of business and the law as provided in section 92C(2) provides for taking an arithmetic mean of more than one ALPs is meant to take into account profit and loss making companies - almost half of the revenue of the assessee have been derived from trading as evident from the segmental accounts - the predominant international transaction is import of traded goods - choice of manufacturing companies as comparables for the assessee company having both trading and manufacturing operations is fundamentally flawed and contrary to the standards of comparability laid down in Rule 10B(2) of I.T. Rules 1962 - TPO ought to have used the segmental accounts furnished by the assessee to examine the trading and manufacturing activities separately - Separate set of comparables should have been chosen for the trading segment. Furthermore for trading Resale Price Method (RPM) widely acknowledged as the most appropriate method for distributors ought to have been used. Failure to consider the supplementary analysis carried out by the assessee using resale price method (RPM) for determining the arm’s length price (ALP) of the import transactions – Held that:- Assessee rightly contended that in the trading segments the assessee imports the ingredients from associated enterprise(s) and resells them to its customers in India through its distribution chain - In its transfer pricing documentation the assessee had conducted a company as a whole approach and applied TNMM as the most appropriate method to benchmark its international transfer - the assessee in its transfer pricing documentation had also conducted a secondary analysis in form of resale price method for the trading transactions undertaken by it - under the trading segment the assessee merely imports the ingredients and resells it further to unrelated parties - in respect of the international transaction of import of furnished goods, wherein the assessee merely acts a reseller / distributor it has applied RPM while comparing the gross profit margin from the sale of such imports in the domestic market with the gross profit margin earned by the comparable companies from the similar transactions - The international transaction of import of finished goods from the AEs for distribution in India would appropriately be benchmarked applying RPM as defined at Rule 10B (1) by comparing - the gross profit margins from the transactions of resale of similar products sourced from unrelated parties the gross margins earned by the comparable companies is 17.86% while that earned by assessee is 50.01%. Thus the international transactions undertaken by the assessee with respect to its trading segment are at arm’s length as defined by the Indian Transfer Pricing regulations - there was substance in the contentions of the assessee and the matter is to be remitted back to the TPO for his fresh consideration and decide the issue afresh after affording opportunity of being heard to the assessee and discussing their submissions in the order and reasons, if any for not agreeing or agreeing with them – Decided in favour of assessee. Issues Involved:1. Validity of the order passed by the Assessing Officer.2. Jurisdictional error in referring the matter to the Transfer Pricing Officer (TPO).3. Addition to income by re-computing the arm's length price of international transactions.4. Application of Transaction Net Margin Method (TNMM) and related issues.5. Ignoring supplementary analysis using Resale Price Method (RPM).6. Denial of sufficient opportunity to be heard.7. Selection of data for comparability.8. Denial of the benefit of 5% margin.9. Validity of initiation of penalty proceedings under section 271(1)(c).Detailed Analysis:Ground No. 1:The ground was considered general in nature and did not require independent adjudication.Ground No. 2:The appellant did not advance any argument for this ground. The issue of the validity of reference to the TPO without recording reasons was decided against the assessee based on the Tribunal's decision in the case of Aztec Software and Technology Services Ltd. vs. ACIT. This ground was rejected.Grounds No. 3 to 6:Ground No. 3:The assessee objected to the manner of transfer pricing adjustment. The TPO made an addition on the entire transactions, including those with unrelated entities. The assessee, a subsidiary of Danisco A/S Denmark, engaged in manufacturing and trading of food additives, reported international transactions in Form No. 3CEB. The TPO rejected the comparables chosen by the assessee and made an adjustment of Rs. 3.61 crores. The DRP upheld this adjustment.Ground No. 4:The assessee contested the selection of comparables and denial of economic adjustments. The TPO rejected four comparables selected by the assessee and denied economic adjustments for administrative expenses without providing an opportunity for the assessee to be heard. The TPO also erred in computing the operating margin by misclassifying certain items as non-operating.Ground No. 5:The assessee argued that the TPO and DRP ignored the supplementary analysis using RPM for trading transactions. The RPM was considered appropriate as the assessee acted as a reseller without adding value to the products. The gross margin analysis showed that the assessee's transactions were at arm's length.Ground No. 6:The assessee claimed a violation of natural justice due to inadequate opportunity to present its case. The TPO made adjustments without allowing the assessee to respond, and the DRP issued a summary order without examining the assessee's contentions.Tribunal's Decision:The Tribunal found substance in the assessee's submissions and set aside the matter to the TPO for fresh consideration. The TPO was directed to:a) Apply RPM for trading transactions if no value addition was made.b) Use TNMM only for manufacturing transactions.c) Select appropriate comparables without negative net worth and persistent losses filters.d) Allow economic adjustments for administrative expenses.Grounds No. 7 and 8:The appellant did not advance any argument for these grounds, and they were rejected as not pressed.Ground No. 9:The ground questioning the validity of penalty proceedings under section 271(1)(c) was considered premature and rejected.Conclusion:The appeal was allowed for statistical purposes, with directions for the TPO to reconsider the issues as per the Tribunal's guidelines. The order was pronounced in the open court on 29th April 2014.