2016 (6) TMI 1005 - AT - Income Tax

Tribunal favors CUP method over RBI rates in transfer pricing case

The Tribunal held that the segregation of international transactions for transfer pricing, specifically the payment of Royalty and Fees for Technical ... Transfer pricing adjustment - arm's length price - aggregation of international transactions - comparable uncontrolled price method - transactional net margin method - selection of comparables - RBI approval and arm's length determination - deduction under section 80IC and applicability of TP provisions - rule of consistency - remand for fresh determinationAggregation of international transactions - transactional net margin method - transfer pricing adjustment - Segregation of royalty and fees for technical services from other international transactions for determining ALP - HELD THAT: - The Tribunal held that aggregation is permissible only where transactions are closely linked or form part of a package deal intended to be accepted together. The Agreements between the assessee and its AE specifically related to licence/technical know-how and management services and did not refer to imports or other international transactions; royalty/FTS were payable as a percentage of value addition (net ex-factory sale price reduced by bought-out and landed cost of imports), not simply linked to imports. Cross-subsidisation by combining unrelated transactions under entity-level TNMM is impermissible; section 92(1) and section 92(3) principles require each international transaction to be considered on its own merits. Consequently, the TPO was justified in segregating the royalty and FTS transactions for separate benchmarking. [Paras 5]Segregation of the royalty and fees-for-technical-services transactions from other international transactions is upheld and aggregation under TNMM is rejected for these transactions.Comparable uncontrolled price method - arm's length price - Appropriateness of the CUP method to determine ALP of the segregated royalty and FTS transactions - HELD THAT: - Having held that the transactions must be benchmarked separately, the Tribunal accepted that the CUP is the most appropriate method for such transaction-specific benchmarking because it compares the price paid for services in uncontrolled transactions directly and operates at a micro/transactional level. The TPO's choice of CUP as the most appropriate method in the facts of the case is therefore approved. [Paras 6]CUP is the most appropriate method for determining the ALP of the royalty and FTS transactions in the present circumstances.Comparable uncontrolled price method - selection of comparables - arm's length price - Validity of the TPO's implementation of the CUP method, including selection of comparables and computation of benchmark - HELD THAT: - Under Rule 10B(1)(a) the CUP requires identification of the price charged or paid in comparable uncontrolled transactions and adjustment for material differences; the emphasis is on comparison of prices paid for services. The TPO instead computed a ratio of royalties/FTS to sales for two selected comparables (0.56%) and applied that percentage to the assessee's sales, failing to compare actual prices for services. This approach was erroneous because (a) it compared ratios to sales rather than prices paid for services, and (b) the assessee paid royalty/FTS on 'value addition' (net ex-factory sale less bought-out/landed costs), so comparison with a sales-based ratio is unsound. Further, objections regarding the chosen comparables (Havells India Ltd. and Autometers Alliance Ltd.) - such as related-party royalties and significant in-house R&D - were not addressed and other potential comparables were not considered, denying adequate opportunity to the assessee. [Paras 7]While CUP is appropriate, the manner of its application by the TPO is flawed; the benchmarking and selection/application of comparables cannot be upheld and require reassessment.RBI approval and arm's length determination - arm's length price - Whether rates approved by the Reserve Bank of India conclusively establish arm's length nature of royalty/FTS payments - HELD THAT: - The Tribunal relied on the Delhi High Court's reasoning in Nestle India to hold that RBI permission under foreign exchange regulations serves a different regulatory purpose and does not preclude tax authorities from examining reasonableness or ALP. RBI sets broad maximum permissible rates applicable across industries; the actual commercial rate depends on product-specific complexity and other factors. Thus, RBI approval has at best persuasive value and cannot be treated as conclusive proof of ALP for transfer pricing purposes. [Paras 8]RBI-approved rates do not automatically constitute arm's length price; they are only of persuasive value and subject to transfer-pricing scrutiny.Deduction under section 80IC and applicability of TP provisions - arm's length price - Whether availability of deduction under section 80IC prevents application of Chapter X transfer-pricing provisions or alters allowance of deduction on TP additions - HELD THAT: - The Tribunal held that neither the existence of tax incentives under section 80IC (or similar provisions) nor the deductibility of profits exempts an assessee from computing income from international transactions at arm's length; section 92(1) and section 92C mandate ALP determination irrespective of statutory deductions. Moreover proviso to section 92C(4) expressly precludes allowance of deductions (including those under Chapter VIA) in respect of income by which total income is enhanced on account of TP adjustments. The Tribunal followed the Special Bench precedent in Aztech Software that exemptions do not bar applicability of TP provisions and rejected the assessee's contention. [Paras 9]Availability of deduction under section 80IC does not bar TP adjustments and deductions are not allowable in respect of income increased by TP additions.Rule of consistency - transfer pricing adjustment - Whether the assessee could invoke consistency because a similar TP issue for AY 2010-11 was decided in its favour by the DRP - HELD THAT: - The Tribunal observed there is no res judicata in income-tax proceedings; moreover the approach adopted by the TPO in the preceding year differed materially (the TPO had not segregated the royalty/FTS transactions in AY 2010-11). A change in approach by authorities in the subsequent year (after appropriate reassessment of the factual matrix) cannot be nullified by invoking consistency where the factual treatment differs. Accordingly, prior-year DRP outcome on a differently conducted exercise does not preclude a different result in the year under consideration. [Paras 10]Consistency argument rejected; prior-year decision does not preclude reassessment where factual and methodological approach differs.Remand for fresh determination - transfer pricing adjustment - Remand to AO/TPO for fresh ALP determination and verification of tax credit claim - HELD THAT: - Given the Tribunal's findings that CUP is the appropriate method but that the TPO's implementation (benchmark computation and comparable selection) was flawed, the matter is set aside and remitted to the AO/TPO for fresh determination of the ALP of royalty and FTS in accordance with the Tribunal's directions, allowing the assessee a reasonable opportunity of hearing. Separately, the claim for credit of tax amounting to the stated figure is directed to be verified by the AO and allowed wholly or in part if paid and not adjusted. [Paras 11, 12]Matter remitted to AO/TPO for fresh determination of ALP of royalty and FTS in accordance with the Tribunal's observations; AO to verify and allow tax credit claim if substantiated.Final Conclusion: Impugned assessment order set aside; segregation of royalty and FTS transactions upheld; CUP accepted as the appropriate method but TPO's application and choice of comparables found flawed. Matter remitted to AO/TPO for fresh determination of ALP (with hearing) and for verification/allowance of the claimed tax credit. Appeal allowed for statistical purposes. Issues Involved:1. Segregation of international transactions for transfer pricing.2. Selection of the most appropriate method for determining Arm's Length Price (ALP).3. Determination of ALP under the Comparable Uncontrolled Price (CUP) method.4. Applicability of RBI-approved rates for Royalty/Fees for Technical Services (FTS) as ALP.5. Applicability of transfer pricing provisions when deductions are available under the Income Tax Act.6. Rule of Consistency in transfer pricing adjustments.Issue-wise Detailed Analysis:I. Segregation of International Transactions:The primary issue was whether the segregation of the transactions of payment of Royalty and FTS from other international transactions was justified. The Tribunal held that the transactions of payment of Royalty and FTS were independent and not closely linked with other transactions like import of raw materials. Thus, these transactions should be benchmarked separately. The Tribunal referred to the judgments in Sony Ericson Mobile Communication India Pvt. Ltd. vs. CIT and Knorr Bremse India P. Ltd. vs. ACIT, which emphasized that unrelated transactions cannot be aggregated for determining ALP.II. Selection of the Most Appropriate Method:The Tribunal considered whether the CUP method was appropriate for determining the ALP of Royalty and FTS. It was concluded that the CUP method is the most appropriate method for such transactions because it directly compares the price charged or paid in an uncontrolled comparable transaction. The Tribunal emphasized that CUP is a transaction-specific method that provides more credibility to the ALP.III. Determination of ALP under CUP Method:The Tribunal found that the TPO's method of determining ALP by comparing the ratio of expenses to sales was incorrect. The correct approach should involve comparing the price paid for services in comparable uncontrolled transactions. The TPO's selection of comparables, Havels India Ltd. and Autometers Alliance Ltd., was also questioned. The Tribunal noted that the assessee's objections regarding the comparables were not addressed, and an opportunity should have been given to consider or exclude other companies.IV. Applicability of RBI-approved Rates for Royalty/FTS as ALP:The Tribunal rejected the argument that the rates approved by the RBI should be considered as ALP. It referred to the judgment in CIT vs. Nestle India, which clarified that RBI approvals are for regulating foreign exchange and not for determining the reasonableness of expenses under the Income Tax Act. The Tribunal held that RBI-approved rates have persuasive value but are not conclusive for determining ALP.V. Applicability of Transfer Pricing Provisions when Deductions are Available:The Tribunal dismissed the argument that transfer pricing provisions should not apply to transactions where deductions under section 80IC are available. It referred to section 92C(4) and the proviso, which clearly state that the ALP must be determined for international transactions, and no deduction under Chapter VI-A shall be allowed for the enhanced income due to transfer pricing adjustments. The Tribunal also cited the Special Bench decision in Aztech Software and Technology Services Ltd. vs. ACIT, which supports the application of transfer pricing provisions irrespective of deductions.VI. Rule of Consistency:The Tribunal rejected the contention that the TPO should follow the same approach as in the previous assessment year (2010-11), where no segregation was done. It was noted that the approach in the current year was different, and the TPO had rightly segregated the transactions of Royalty and FTS. The Tribunal held that the rule of consistency cannot be applied when the approach and facts of the case have changed.Conclusion:The Tribunal set aside the impugned order and remitted the matter to the AO/TPO for fresh determination of the ALP of the international transactions of payment of Royalty and FTS. The AO was directed to verify and allow the credit for the tax amount claimed by the assessee. The appeal was allowed for statistical purposes.