2016 (4) TMI 377 - AT - Income Tax

Transfer Pricing Dispute Resolved: TNMM Upheld, Depreciation Issue Remanded for Further Review

The Tribunal partly allowed the assessee's appeals and dismissed the revenue's appeal. It upheld the TPO's use of TNMM over CPM for transfer pricing, ... Cost Plus Method (CPM) - Transactional Net Margin Method (TNMM) - Most Appropriate Method (MAM) - Arm's Length Price (ALP) - comparability analysis - contemporaneous data - Rule 10B adjustments - working capital adjustment - profit level indicator (PLI) - remand for verificationCost Plus Method (CPM) - Transactional Net Margin Method (TNMM) - Most Appropriate Method (MAM) - comparability analysis - Arm's Length Price (ALP) - Validity of rejection of CPM and adoption of TNMM as the MAM for determination of ALP for AY 2008-09 - HELD THAT: - The Tribunal upheld the orders below in rejecting CPM as the MAM and in adopting TNMM. The Tribunal observed that the assessee was not a contract manufacturer performing limited-risk job-work but an independent manufacturer purchasing raw material and selling finished goods to AEs and others. Material variations in cost components between the assessee and proposed comparables (including differences in depreciation methods) meant CPM could not be regarded as the most appropriate method in the facts of the case. Reliance on the co ordinate bench decision in GE Medical Systems was considered inapposite because that decision turned on the assessee being a contract manufacturer and on functional dissimilarity of comparables in that case; those facts did not apply here. Accordingly the Tribunal found no error in the TPO/AO/CIT(A) in applying TNMM as MAM.Rejection of CPM and adoption of TNMM as MAM upheld; ground decided against the assessee.Contemporaneous data - Arm's Length Price (ALP) - Use of current-year (contemporaneous) data versus multi-year data for comparables - HELD THAT: - The Tribunal applied the mandate of the transfer pricing rules that, as far as possible, data relating to the financial year in which the international transaction occurred should be used and that only in exceptional circumstances data of not more than two prior years may be considered if they reveal facts influencing transfer pricing. The assessee did not demonstrate that current year data failed to reflect correct uncontrolled comparable prices. Hence the Tribunal dismissed the plea for multi year data.Ground rejected; current-year (contemporaneous) data requirement affirmed.Rule 10B adjustments - depreciation - remand for verification - Claim for adjustment on account of differential depreciation (and related fixed-asset usage costs) - HELD THAT: - The Tribunal found that a comparison based on depreciation alone is inadequate. Any adjustment for differential depreciation must consider composite expenditures related to use of fixed assets (depreciation, maintenance, lease rentals, etc.) and the ratio of such composite expenditure to turnover. The TPO and CIT(A) had not examined or quantified these aspects. Given the absence of decision at TPO/CIT(A) level on this specific composite analysis, the Tribunal set aside the issue to the record of the TPO/AO for comparative analysis and computation of an appropriate adjustment.Issue remanded to TPO/AO for working out comparative composite cost-of-asset usage and for granting appropriate adjustment under Rule 10B.Working capital adjustment - Rule 10B adjustments - Whether the CIT(A) was justified in directing the TPO/AO to grant working capital adjustment - HELD THAT: - The Tribunal held that where the TPO changes comparables or method, the assessee is entitled to seek adjustments such as working capital adjustment. The CIT(A) had directed the TPO to grant the working capital adjustment following Tribunal precedent; the Tribunal found no error in that direction but clarified that the assessee must furnish relevant details and quantification for the TPO to compute the adjustment.CIT(A)'s direction to grant working capital adjustment upheld; assessee to furnish requisite particulars to TPO.Tolerance range - Arm's Length Price (ALP) - Application of the +/- 5% tolerance proviso to Section 92C(2) (consequential relief) - HELD THAT: - The Tribunal observed that entitlement to the +/-5% tolerance is consequential upon the outcome of ALP re determination. It directed the Assessing Officer/TPO to consider the proviso depending on the result of the re determination of ALP following adjustments/remand.Directed AO/TPO to consider the proviso to Section 92C(2) after re determination of ALP; issue left for computation on remand.Comparability analysis - remand for verification - Admissibility and functional comparability of General Optics (Asia) Ltd. as a comparable - HELD THAT: - The Tribunal found that the TPO had included General Optics (Asia) Ltd. without discussing functional comparability or inviting objections from the assessee. The assessee produced material indicating the company's products and markets are industrial/defence/space applications rather than personal care ophthalmic lenses. Given the absence of any substantive examination by the TPO, the Tribunal admitted the assessee's additional ground and set aside the comparability issue to the Assessing Officer/TPO for proper examination, verification and decision after considering the assessee's objections.Issue remanded to AO/TPO for fresh examination of functional comparability of General Optics (Asia) Ltd.Profit level indicator (PLI) - comparability analysis - remand for verification - Use of different Profit Level Indicators (PLIs) by the TPO for mass production and reference segments for AY 2009 10 - HELD THAT: - The Tribunal noted that the TPO applied OP/Sales PLI consistently for mass production (and as used in AY 2008 09) but used OP/Operating Cost PLI for the reference segment without adequate justification. The Tribunal found no material showing that differing PLIs were necessary to avoid distortion, and that the process and material differences between segments did not justify using different PLIs. Accordingly, the matter was set aside to the TPO to apply a uniform PLI (consistent with mass production and prior year) and re determine ALP.TPO directed to re determine ALP using a uniform PLI; issue remanded for fresh application of consistent PLI.Prior period expenses - Claim for disallowance of prior period expenses (AY 2008 09) - HELD THAT: - The assessee did not press the ground relating to prior period expenses during hearing. In the absence of argument or plea for adjudication, the Tribunal declined to entertain the ground.Ground dismissed as not pressed.Final Conclusion: The Tribunal partly allowed the assessee's appeals and dismissed the revenue appeal. CPM was rightly rejected and TNMM upheld as MAM; contemporaneous (current year) data requirement affirmed; working capital adjustment direction of CIT(A) sustained (subject to assessee furnishing particulars); issues of depreciation adjustment, functional comparability of General Optics (Asia) Ltd., application of uniform PLI, and consequential application of the +/-5% tolerance proviso were set aside to the TPO/AO for fresh examination and computation. Issues Involved:1. Assessment and reference to Transfer Pricing Officer (TPO) legality.2. Comparability analysis and selection of Most Appropriate Method (MAM) for Transfer Pricing.3. Use of erroneous data by AO/TPO.4. Non-allowance of appropriate adjustments by AO/TPO.5. Variation of 5% from the arithmetic mean.6. Disallowance of prior period expenses.7. Initiation of penalty proceedings.8. Relief and additional grounds.Detailed Analysis:1. Assessment and Reference to TPO Legality:The assessee challenged the legality of the assessment and reference to the TPO, arguing that the AO did not issue a show cause notice as per the proviso to section 92C(3) of the Income-tax Act, 1961. The AO also failed to record an opinion that conditions in section 92C(3) were satisfied, and the TPO did not demonstrate that the motive was to shift profits outside India. The Tribunal did not find merit in these arguments and upheld the actions of the AO/TPO.2. Comparability Analysis and Selection of MAM for Transfer Pricing:The assessee, engaged in manufacturing plastic ophthalmic lenses, used the Cost Plus Method (CPM) for benchmarking its international transactions, arguing that it was more of a job work than full-fledged manufacturing. The TPO rejected CPM and adopted the Transactional Net Margin Method (TNMM) as MAM, finding that the assessee was not a contract manufacturer but purchased raw materials and independently carried out manufacturing. The Tribunal upheld the TPO's decision, noting that the CPM was not appropriate due to variations in cost components and the nature of the assessee's business activities.3. Use of Erroneous Data by AO/TPO:The assessee contended that the AO/TPO used non-contemporaneous data and did not apply multiple-year data. The Tribunal emphasized the mandate of Rule 10B(4), which requires using current year data unless it does not reflect the correct uncontrolled comparable price. The assessee failed to demonstrate that the current year data was inadequate, leading to the dismissal of this ground.4. Non-Allowance of Appropriate Adjustments by AO/TPO:The assessee sought adjustments for differences in accounting practices, depreciation, research and development expenditure, and capacity under-utilization. The Tribunal focused on the depreciation adjustment, noting that the assessee's depreciation expenses were higher due to the straight-line method. The Tribunal remanded the issue to the TPO/AO for a comparative analysis of depreciation costs and other related expenses, directing an appropriate adjustment.5. Variation of 5% from the Arithmetic Mean:The Tribunal acknowledged this as a consequential benefit, directing the AO/TPO to consider the 5% variation depending on the outcome of the re-determination of the ALP.6. Disallowance of Prior Period Expenses:The assessee did not press this ground during the hearing, leading to its dismissal.7. Initiation of Penalty Proceedings:The Tribunal did not specifically address this issue in detail, focusing on the substantive grounds of the appeal.8. Relief and Additional Grounds:The assessee raised additional grounds, including the rejection of General Optics (Asia) Ltd. as a comparable, and claims for depreciation and capacity utilization adjustments. The Tribunal admitted the additional ground regarding General Optics, remanding the issue to the AO/TPO for examination of functional comparability. For the working capital adjustment, the Tribunal upheld the CIT(A)'s direction to the TPO, emphasizing the need for the assessee to provide relevant details and quantification.Separate Judgments:No separate judgments by different judges were mentioned; the order was delivered collectively by the Tribunal.Conclusion:The appeals of the assessee were partly allowed, and the appeal of the revenue was dismissed. The Tribunal upheld the TPO's adoption of TNMM over CPM, dismissed the use of erroneous data ground, and remanded the depreciation adjustment issue for further analysis. The Tribunal also directed consideration of the 5% variation and admitted additional grounds for further examination.