2016 (4) TMI 204 - AT - Income Tax

Tribunal rules in favor of assessee on transfer pricing adjustments and disallows Rule 8D for 2005-06 assessment.

The Tribunal dismissed the Revenue's appeal and partly allowed the assessee's cross-objection for statistical purposes. The key points were the proper ... Transactional Net Margin Method (TNMM) - Profit Level Indicator (net profit margin) - Comparability under Rule 10B - Applicability of Rule 8D for disallowance under section 14A - Remand to Transfer Pricing Officer for fresh verificationTransactional Net Margin Method (TNMM) - Profit Level Indicator (net profit margin) - Comparability under Rule 10B - Validity of transfer pricing adjustment based on comparison of gross margins instead of net profit margins under TNMM in respect of exports of manufactured IC engines - HELD THAT: - The Tribunal upheld the CIT(A)'s conclusion that TNMM requires comparison of net profit margins and not gross margins. The CIT(A) applied Rule 10B(e) and relied on OECD guidance to hold that gross margin comparison (as undertaken by the TPO/AO) is not envisaged under TNMM; gross margins are pertinent to CUP/resale price/cost plus methods while TNMM compares net profit indicators. The TPO/AO's adjustment, computed by comparing gross margins of domestic sales with exports to associated enterprises, was therefore held unsupported by the legal provisions and deleted. The Tribunal found no infirmity in the CIT(A)'s reasoning and dismissed Revenue's grounds challenging that deletion. [Paras 3, 29]Adjustment based on gross margin comparison was deleted; CIT(A)'s order upholding net margin comparison under TNMM is upheld and Revenue's grounds on this issue are dismissed.Applicability of Rule 8D for disallowance under section 14A - Whether Rule 8D could be applied for A.Y. 2005-06 to compute disallowance under section 14A - HELD THAT: - The CIT(A) followed the Bombay High Court decision in Godrej & Boyce to hold that Rule 8D cannot be applied retrospectively and is prospective with effect from A.Y. 2008-09 onward; accordingly the disallowance computed under Rule 8D for A.Y. 2005-06 was not sustainable. The Tribunal agreed that Rule 8D is not applicable to the assessment year in question but, on facts, held that some disallowance was warranted and, considering the totality, directed a notional disallowance of a modest amount to meet the ends of justice. [Paras 33, 35]CIT(A)'s deletion of the Rule 8D based disallowance for A.Y. 2005-06 is accepted in principle; on merits Tribunal allows part relief and directs a limited disallowance (administrative adjustment) to meet the ends of justice.Remand to Transfer Pricing Officer for fresh verification - Comparability under Rule 10B - Export of IC engines by LHP Division - whether the adjustment confirmed by CIT(A) required fresh consideration - HELD THAT: - The Tribunal found that the assessee had made detailed submissions before the TPO regarding comparability (exports to AEs versus exports/non AE and domestic sales) which were not properly considered by the lower authorities. In view of incomplete consideration of the assessee's factual/material submissions, the Tribunal directed that the matter be remitted to the TPO to give the assessee another opportunity to demonstrate arm's length pricing for LHP Division exports and for fresh verification by the TPO. [Paras 46]Ground in cross objection relating to LHP Division exports is allowed for statistical purposes and remitted to the TPO for fresh consideration and verification.Final Conclusion: The Revenue's appeal is dismissed; the CIT(A)'s deletion of the TP adjustment based on gross margin (while applying TNMM) is upheld; the disallowance under section 14A computed by applying Rule 8D is not sustained for A.Y. 2005-06 though a limited disallowance is directed in place of the deleted amount; the LHP Division export adjustment is remanded to the TPO for fresh consideration. Appeal dismissed; cross-objection partly allowed for statistical purposes and partly remanded. Issues Involved:1. Delay in filing the appeal by the Revenue.2. Transfer Pricing Adjustment on export of manufactured IC Engines.3. Disallowance of expenses for earning exempt income under Section 14A.4. Adjustment to the value of international transactions in respect of export of IC engines by the LHP Division.Detailed Analysis:1. Delay in Filing the Appeal by the Revenue:The Revenue's appeal was delayed by 87 days. The Departmental Representative explained the reasons for the delay, and after hearing both sides, the delay was condoned.2. Transfer Pricing Adjustment on Export of Manufactured IC Engines:The TPO made an adjustment of Rs. 8,23,19,580/- based on the difference in gross margin between domestic sales and export sales to AEs. The assessee argued that the adjustment was against transfer pricing provisions and that the domestic and export markets were significantly different. The CIT(A) deleted the adjustment, noting that TNMM requires comparison of net profit margins, not gross margins, and that the TPO's method was not supported by the legal provisions. The Tribunal upheld the CIT(A)'s order, agreeing that net profit margins of controlled transactions should be compared with those of uncontrolled transactions.3. Disallowance of Expenses for Earning Exempt Income Under Section 14A:The AO disallowed Rs. 40,36,560/- under Section 14A, applying Rule 8D. The CIT(A) deleted the disallowance, holding that Rule 8D is prospective and not applicable to the assessment year 2005-06. The Tribunal agreed with the CIT(A) but held that some administrative expenses must have been incurred for earning the exempt income. It directed a disallowance of Rs. 2 lakhs, partially allowing the Revenue's appeal.4. Adjustment to the Value of International Transactions in Respect of Export of IC Engines by the LHP Division:The TPO made an adjustment of Rs. 78,72,507/- based on the difference in operating margins between exports to AEs and sales to third parties. The CIT(A) upheld the TPO's adjustment, stating that the assessee did not provide specific facts to support its arguments. The Tribunal found that the lower authorities had not properly considered the assessee's submissions and remitted the matter back to the TPO for reconsideration, allowing the assessee's ground for statistical purposes.Conclusion:The Tribunal dismissed the Revenue's appeal and partly allowed the assessee's cross-objection for statistical purposes. The key points were the proper application of TNMM for transfer pricing adjustments and the inapplicability of Rule 8D for the assessment year 2005-06.