2018 (10) TMI 1785 - AT - Income Tax

Tribunal adopts TNMM with 'Berry ratio' for arm's length price in transfer pricing case.

The Tribunal concluded that the Transactional Net Margin Method (TNMM) with 'Berry ratio' as Profit Level Indicator (PLI) was the most appropriate method ... TP Adjustment - selection of MAM - CUP or TNMM - whether the higher standard of comparability required under the CUP method are met or not? - HELD THAT:- As been brought to our notice that from the Assessment Years 2011-12 to 2018-19 under the MAP agreement it has been agreed that TNMM should be the most appropriate method to determine the ALP of the international transaction of the indent keeping into the fact that assessee is a low risk service provider and there is no change in FAR right from Assessment Years 2003-04 to 2018-19. Once TNMM has been accepted under the similar FAR, we do not find any reason to deviate by adopting some other method. Otherwise also we have held that CUP method cannot be applied and other methods admittedly are incapable of capturing the true arm’s length result and therefore, we hold that TNMM should be taken as a most appropriate method for benchmarking the said transaction. What should be the base for computing the PLI? - Profit derived by the assessee is mainly depended on its operating expenditure as the value of goods does not enter in its financial. As a low risk service provider, it seeks to obtain adequate return on its operating expenses as the operating expenses incurred represents the value added carried on by the assessee. The operating expenses adequately and sufficiently represents the functions performed and the risk undertaken by the assessee. Thus, we hold that the ‘berry ratio’ should be accepted as the most appropriate PLI for taking as base under TNMM while determining the ALP of the Indian transaction for all the five years under appeal. Accordingly, we remand the matter back to the file of the TPO to examine and benchmark the international transaction by adopting TNMM as the most appropriate method by taking ‘berry ratio’ as PLI. The assessee has to substantiate its margin by bringing comparable uncontrolled transactions to demonstrate that its commission earned in this segment is at arm’s length; and the TPO shall examine the same and decide accordingly. Needless to say that TPO shall give due and effective opportunity to the assessee to substantiate its ALP as per direction given above. Disallowance of claim of expenditure incurred under the head ‘legal and professional’ charges and addition on account of bad debts and deposits written off - HELD THAT:- These expenses have been incurred as per the details given above. It is quite apparent that these are routine expenditure incurred during the regular course of business and nowhere has it been alleged by the Assessing Officer that these are for non business purpose and are not related to the assessee’s business. Once similar addition has been deleted in the earlier and subsequent year which has attained finality then no addition could be made here, accordingly the same is deleted. Claim of deduction of deposit written off, it has been brought to our notice that assessee has not written off any such deposit in the instant year, albeit the same was debited in the Assessment Year 2006-07 and that was claimed in the same year only and the Assessing Officer has completely misunderstood and has taken the figure from the P&L account of Assessment Year 2006-07 and has been understood to have been claimed and Assessment Year 2007- 08. In fact DRP has directed the Assessing Officer to delete the same if the same has not been debited and yet the Assessing Officer has not carried out the direction of the DRP. Accordingly, we hold that the addition made by the Assessing Officer is unjustified on facts and same is directed to be deleted. Issues Involved:1. Determination of arm's length price (ALP) for indenting transactions between the assessee and its associated enterprises (AEs).2. Applicability of Transactional Net Margin Method (TNMM) versus Comparable Uncontrolled Price (CUP) method.3. Use of 'Berry ratio' as Profit Level Indicator (PLI) under TNMM.4. Disallowance of legal and professional charges.5. Addition on account of bad debts and deposits written off.Issue-wise Detailed Analysis:1. Determination of ALP for Indenting Transactions:The primary issue revolves around determining the ALP of indenting transactions between the assessee and its AEs for various assessment years. The Tribunal had to examine the similarity of indent AE transactions to ensure high comparability under the CUP method. The assessee argued that the transactions with AEs and non-AEs were dissimilar in terms of product categories, volumes, values, and geographical locations. The Tribunal noted that there were significant differences in the products and volumes transacted with AEs and non-AEs, making it inappropriate to use the average commission rate of non-AE transactions as a benchmark for AE transactions.2. Applicability of TNMM versus CUP:The Tribunal had to decide whether TNMM or CUP was the most appropriate method for determining the ALP. The Tribunal observed that CUP requires a high degree of similarity between controlled and uncontrolled transactions, which was not present in this case due to differences in products, volumes, and geographical locations. Consequently, the Tribunal rejected the CUP method and accepted TNMM as the most appropriate method, considering the assessee's consistent use of TNMM in previous years and the agreement under the Advance Pricing Agreement (APA) for subsequent years.3. Use of 'Berry Ratio' as PLI under TNMM:The Tribunal had to determine the appropriate PLI under TNMM. The High Court had permitted the use of 'Berry ratio' in situations where the value of goods is not directly linked to profits, and profits are mainly determined by operating expenses. The Tribunal noted that the assessee acted as a low-risk service provider with minimal financial risk and no significant asset deployment. Therefore, the 'Berry ratio' was deemed appropriate as it adequately represented the functions performed and risks undertaken by the assessee.4. Disallowance of Legal and Professional Charges:The Tribunal addressed the disallowance of legal and professional charges amounting to Rs. 3,72,560. The assessee argued that these were routine business expenses incurred during the regular course of business. The Tribunal noted that similar expenses had been allowed in previous and subsequent years and found no basis for the disallowance. Consequently, the Tribunal deleted the disallowance.5. Addition on Account of Bad Debts and Deposits Written Off:The Tribunal examined the addition of Rs. 2,56,257 on account of bad debts and deposits written off. The assessee clarified that no such deposit was written off in the relevant assessment year, and the amount was mistakenly taken from the previous year's profit and loss account. The Tribunal directed the deletion of this addition, as it was not justified on the facts presented.Conclusion:The Tribunal concluded that TNMM with 'Berry ratio' as PLI was the most appropriate method for determining the ALP of indenting transactions. The disallowance of legal and professional charges and the addition on account of bad debts were deleted. The matter was remanded to the TPO to benchmark the international transactions using TNMM and 'Berry ratio'. The appeals were partly allowed for statistical purposes.