2023 (2) TMI 1273 - AT - Income Tax

ITAT directs AO/TPO/DRP to apply TNMM instead of PSM for royalty adjustment in transfer pricing matters

M/s. Toyota Kirloskar Auto Parats (P) Ltd. Versus The Asst. Commissioner of Income-tax LTU, Circle-2 Bangalore

The ITAT Bangalore directed the AO/TPO/DRP to apply TNMM instead of PSM for royalty adjustment in transfer pricing matters. The assessee successfully ... TP Adjustment - royalty adjustment - MAM - royalty adjustment has been made separately by applying profit level method (PSM) whereas the assessee contested that the TNMM should be applied by the revenue authorities - HELD THAT:- As relying on own case for the AY 2017-18 [2022 (6) TMI 1462 - ITAT BANGALORE] we direct the AO/TPO/DRP for applying TNMM as most appropriate method as decided in the previous assessment year cited supra. Needless to say that the assessee shall be given reasonable opportunity of being heard and assessee is directed not to seek unnecessary adjournment for early disposal of the case. Issues Involved:1. Transfer Pricing2. Rejection of Transfer Pricing Documentation3. Manufacturing Segment4. Benchmarking of Payment of Royalty5. Corporate TaxDetailed Analysis:1. Transfer Pricing:The learned AO, TPO, and DRP determined an adjustment of INR 85,30,90,000/- to the Arm's Length Price (ALP) of the appellant's international transactions with its Associated Enterprises (AEs) under Section 92CA of the Income-tax Act, 1961.2. Rejection of Transfer Pricing Documentation, Computation of Appellant's Operating Margin, and Use of Various Filters:- The AO/TPO/DRP rejected the TP documentation maintained by the appellant by invoking provisions of sub-section (3) of 92C of the Act.- They rejected the comparability analysis undertaken in the TP documentation and conducted a fresh comparability analysis by introducing various filters.- The AO/TPO/DRP erred in treating foreign exchange as operating in nature and considering export incentives as non-operating in nature.- The AO/TPO did not appreciate the treatment of excise duty for computation of the appellant's operating margin.- They selected companies only if data pertaining to FY 2017-18 was available in public databases, leading to a narrower comparable set.- They applied different financial year ending filters and rejected comparable companies that failed the manufacturing income filter of 75 percent, leading to a narrower comparable set.- They applied a persistent loss filter and adopted an erroneous approach in computing the related party transaction filter.3. Manufacturing Segment:- The AO/TPO/DRP did not adjudicate upon the reasons for rejection of comparable companies forming part of TP Documentation prepared by the appellant.- They did not consider that certain companies were selected by the AO/TPO in the appellant's own case in previous assessment years.- They did not reject certain companies from the list of comparable companies and rejected companies that ought to have been accepted on grounds such as functional similarity and companies qualifying applied filters.- They did not consider that Hindustan Hardy Limited was selected by the TPO in the appellant's own case in the set of comparable companies for AY 2015-16 and AY 2016-17.- They did not consider certain companies in the final set of comparable companies which had been accepted by the DRP in the appellant's own case in previous assessment years.4. Benchmarking of Payment of Royalty Separately and Incorrect Application of Residual PSM:- The AO/TPO/DRP disregarded the Transactional Net Margin Method (TNMM) analysis performed by the appellant to justify the arm's length nature of the payment of royalty transaction.- They did not understand that the appellant had adopted TNMM for benchmarking the royalty transaction as it is closely interlinked with the manufacturing operations.- They did not follow the Tribunal's order in the appellant's own case for previous years where TNMM for royalty transaction was upheld.- They stated that the royalty transaction is not linked to the manufacturing activities without appreciating that the appellant is a licensed manufacturer needing the licensed technology to manufacture its products.- They disregarded the aggregation of transactions and stated that unrelated transactions cannot be clubbed.- They computed the percentages of purchase and sale to AEs incorrectly, leading to an incorrect approach for aggregation of transactions.- They adopted Profit Split Method (PSM) for benchmarking the royalty transaction and erroneously concluded that both the appellant and AE make valuable contributions.- They considered Residual PSM and ignored the fact that the appellant does not make any unique contribution to the licensed technology.- They assigned arbitrary weights to the functions performed by the appellant vis-à-vis the Associated Enterprises without carrying out a detailed FAR analysis and applied an ad-hoc 50:50 profit split without logical reasoning.- They determined the royalty rate at 0.335% on sales without any logical basis.- They proposed an adjustment against royalty payment twice.5. Corporate Tax:- The AO erred in levying interest under sections 234B, 234C, and 234D of the Act.- The AO initiated penalty proceedings under Section 274 read with section 270A of the Act without appreciating that the appellant has not furnished any inaccurate particulars of income.- The AO failed to appreciate that a mere difference of opinion between the appellant and the AO would not amount to furnishing of any inaccurate particulars of income.- The AO failed to appreciate that the additions made are on items that are sub-judice, and hence, no penalty can be levied on such contentious adjustments.Judgment:- The Tribunal dismissed ground No.1 as not pressed.- Grounds 2 to 11 were considered academic in nature and did not require adjudication.- Grounds 12 to 17 and 29 became infructuous after rectification orders passed by the revenue authorities.- For grounds 18 to 28, the Tribunal directed the AO/TPO/DRP to apply TNMM as the most appropriate method, following the decision in the appellant's own case for previous assessment years.- Grounds 30 and 31 were consequential in nature.- The appeal was partly allowed for statistical purposes.