2016 (5) TMI 40 - AT - Income Tax

Tribunal rules in favor of assessee, finding arm's length international transactions.

The tribunal allowed the appeal filed by the assessee, ruling that the international transactions were at arm's length based on the correct gross margin ... Transfer Pricing - determination of Arm's Length Price - Appropriateness of Pricing Method - Resale Price Method versus Transactional Net Margin Method - Comparable selection and FAR analysis - Use of contemporaneous data and post-study data by the TPO - Duty to exclude manifestly incorrect comparable data - Role of TPO and Dispute Resolution Panel in TP adjustmentsTransfer Pricing - determination of Arm's Length Price - Appropriateness of Pricing Method - Resale Price Method versus Transactional Net Margin Method - Comparable selection and FAR analysis - Duty to exclude manifestly incorrect comparable data - Whether the TPO/DRP were justified in rejecting entity-level benchmarking under TNMM, applying RPM to trading transactions and making an upward TP adjustment based on the comparables used - HELD THAT: - The TPO separated the assessee's trading transactions (purchase and sale of finished goods) from other international transactions and applied RPM, selecting a set of comparables whose reported gross margins were taken at very high values. The DRP upheld the TPO. The Tribunal examined the comparable data and found glaring computational discrepancies in the gross margins taken for several comparables (notably HPCL and IOCL), producing an inflated average gross margin (31.68%). Using the correct reported gross margins produces an average of 19.35%, which is lower than the assessee's gross margin of 28.45%. The Tribunal held that where comparable data are manifestly incorrect, they cannot be allowed to stand to justify a TP adjustment; applying correct comparable margins shows the assessee's transactions to be at arm's length. The Tribunal did not adjudicate issues relating to total turnover versus turnover with the AE and related contentions. [Paras 5]TP adjustment set aside; transactions found to be at arm's length and appeal allowed.Final Conclusion: The appeal is allowed: the upward transfer-pricing adjustment based on the TPO/DRP's comparables is set aside because the comparables' gross margins were manifestly misstated and, on correct figures, the assessee's gross margin exceeds the comparables' average, demonstrating arm's-length pricing. Issues Involved:1. Determination of Arm's Length Price (ALP) for international transactions.2. Selection of the most appropriate method for benchmarking transactions.3. Comparability analysis and selection of comparable companies.4. Application of +/- 5% range for ALP determination.5. Rectification of errors in Transfer Pricing Officer's (TPO) computations.Detailed Analysis:1. Determination of Arm's Length Price (ALP) for international transactions:The assessee, engaged in trading marine and protective paints, filed a return declaring total income at Rs. Nil. The Assessing Officer (AO) found that the assessee had entered into international transactions and referred the matter to the TPO for determining the ALP. The TPO identified several international transactions including the purchase and sale of finished goods, purchase of SAP license, commission income, advance received, cost-sharing expenses, and reimbursement of expenses. The TPO initially adopted the Transactional Net Margin Method (TNMM) as the most appropriate method and conducted a search to identify comparable companies.2. Selection of the most appropriate method for benchmarking transactions:The TPO observed that the assessee had imported and sold protective and marine coatings and aggregated these transactions with other international transactions, benchmarking them using TNMM. However, the TPO opined that the Resale Price Method (RPM) was more appropriate for benchmarking the purchase and sale of finished goods, as the assessee was a trader and RPM focused on gross margins. The TPO conducted a fresh search and identified new comparables for benchmarking.3. Comparability analysis and selection of comparable companies:The TPO selected eight comparables, including companies engaged in manufacturing lubricating oil, grease, and other unrelated businesses. The assessee objected, arguing that the TPO had used incorrect comparables and erroneously computed the gross margin of comparable companies at 31.68%. The DRP upheld the TPO's approach, stating that the RPM was the most appropriate method and that the TPO had used contemporaneous data to benchmark the transactions.4. Application of +/- 5% range for ALP determination:The assessee argued that even if the correctness of the method adopted was not challenged, the gross margin earned by the assessee (28.45%) fell within the +/- 5% range of the TPO's computed average of 31.68%. The tribunal found that the assessee's gross margin was indeed within the permissible range and thus, the international transactions were at arm's length.5. Rectification of errors in Transfer Pricing Officer's (TPO) computations:The tribunal noted significant discrepancies in the gross margin figures reported by the TPO and those computed by the assessee for certain comparables. The TPO had reported abnormally high margins for companies like Hindustan Petroleum Corporation Ltd. (64.20%) and Indian Oil Corporation Ltd. (48.46%) compared to the correct margins of 6.88% and 9.6%, respectively. The tribunal criticized the DRP for not addressing these glaring mistakes and concluded that the correct gross margin of the comparables was 19.35%, which was lower than the assessee's margin of 28.45%. Therefore, the transactions were deemed to be at arm's length.Conclusion:The tribunal allowed the appeal filed by the assessee, ruling that the international transactions were at arm's length based on the correct gross margin figures. The order was pronounced in the open court on 27th April 2016.