Tribunal favors TNMM over CPM for determining arm's length price in export transactions

The Tribunal determined that the Transactional Net Margin Method (TNMM) was more appropriate than the Cost Plus Method (CPM) for determining the arm's length price (ALP) of exports to associated enterprises. It found that the authorities erred in not applying TNMM and directed the Assessing Officer to reassess the ALP using TNMM, allowing the assessee to present additional arguments. The appeal was allowed for statistical purposes, with the decision pronounced on 30th October 2015.

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Issues Involved:

1. Determination of the most appropriate method for ascertaining the arm's length price (ALP) of exports to associated enterprises (AEs).
2. Validity of using internal Comparable Uncontrolled Price (CUP) method.
3. Appropriateness of using Cost Plus Method (CPM) versus Transactional Net Margin Method (TNMM) for determining ALP.

Issue-wise Detailed Analysis:

1. Determination of the Most Appropriate Method for Ascertaining the Arm's Length Price (ALP) of Exports to Associated Enterprises (AEs):

The primary contention revolves around whether the Transactional Net Margin Method (TNMM) or the Cost Plus Method (CPM) is more appropriate for determining the ALP of the exports made by the assessee to its AEs. The assessee argued for TNMM, while the authorities below preferred CPM.

2. Validity of Using Internal Comparable Uncontrolled Price (CUP) Method:

The authorities initially attempted to use the internal CUP method to determine the ALP by comparing prices at which the assessee sold products to its group entities in India. However, the Tribunal noted that for the CUP method to be valid, the comparable price must be from transactions between independent enterprises, as stipulated by Rule 10B(1)(a) and Rule 10A(a). Transactions with associated enterprises, whether resident or non-resident, do not qualify as "uncontrolled transactions." The Tribunal cited the case of Sabic Innovative Plastic India Pvt Ltd Vs DCIT to support this view, emphasizing that prices from transactions with associated enterprises cannot be used for ALP determination under the CUP method.

3. Appropriateness of Using Cost Plus Method (CPM) Versus Transactional Net Margin Method (TNMM) for Determining ALP:

The Tribunal observed that the DRP conceded the lack of appropriate data for applying the CPM but still upheld its use over TNMM due to similar data limitations for TNMM. The Tribunal criticized this approach, stating that CPM is not a residuary method to be used when other methods fail. TNMM, often considered the method of last resort, is generally preferable due to the availability of data in the public domain about net profits of comparable independent businesses. The Tribunal highlighted that TNMM is less sensitive to minor product differences and is usually applied with respect to broad comparable functions rather than specific transactions.

The Tribunal referred to the UN's Transfer Pricing Manual, noting that TNMM is typically applied when related parties engage in ongoing transactions, and one party controls intangible assets for which an arm's length return is not easily determined. TNMM is advantageous when data on gross margins are unreliable due to accounting differences, making net margins a more consistent profit level indicator.

Conclusion:

The Tribunal concluded that the authorities below erred in not applying TNMM for determining the ALP of the assessee's transactions with its AEs. It directed the AO/TPO to compute the ALP using TNMM and remitted the matter for fresh determination. The assessee was allowed to present additional pleas on the merits of TNMM application, which the authorities must address in a speaking order, ensuring a fair hearing.

Final Judgment:

The appeal was allowed for statistical purposes, with directions to the Assessing Officer to reassess the ALP using the TNMM method. This decision was pronounced in the open court on 30th October 2015.

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