2016 (6) TMI 1005 - AT - Income Tax

Tribunal favors CUP method over RBI rates in transfer pricing case

Gruner India Pvt. Ltd. Versus DCIT, Circle-10 (2), New Delhi

The Tribunal held that the segregation of international transactions for transfer pricing, specifically the payment of Royalty and Fees for Technical ... Transfer pricing adjustment - whether the segregation of these two transactions of payment of Royalty and Fees for technical services from the other international transactions, is justified? - Held that:- When we consider more than one separate transaction under the combined umbrella of TNMM on an entity level, it is quite possible that a probable addition on account of transfer pricing adjustment arising from one international transaction may be usurped by the income from the other international transaction giving higher income on transacted value. That is the reason for which the legislature has provided for determining the ALP of each international transaction separately from the others. As the international transactions of payment of royalty and fees for technical services are separate transactions and not closely linked with the other transactions with which the assessee has merged them, we cannot permit such merger or aggregation for the purpose of the determining their ALP on entity level under TNMM. We, therefore, reject this contention raised on behalf of the assessee. Thus the TPO was justified in segregating the international transactions of payment of royalty and fees for technical services from other international transactions as these are not linked with import of raw material etc. from its AE. The assessee’s contention in this regard is, ergo, repelled. Selection of the most appropriate method - Held that:- As fairly settled through a catena of decisions that the CUP is the most appropriate method to determine the ALP of an international transaction because it seeks to compare the price charged or paid for property transferred or services rendered provided proper comparables are available. It is under this method alone that the price charged or paid is directly compared with the price charged or paid in an uncontrolled comparable transaction. Rest of the four specific methods seek to make comparison of the price charged or paid indirectly through the medium of normal profit arising in a comparable uncontrolled transaction. Further, the CUP method is a transaction specific method which strives to determine the ALP of an international transaction on a micro level, thereby lending more credibility to the ALP of a transaction. As such, we hold that the CUP is the most appropriate method for determining the ALP of these transactions under the present circumstances and the TPO was justified in applying the CUP as the most appropriate method. Determination of ALP under CUP method - Held that:- We approve the application of the CUP as the most appropriate method in the given circumstances for determining the ALP of the international transaction of royalty and fees for technical services, but, the manner of selection of comparables also cannot be upheld. Whether rate of Royalty/FTS approved by RBI is always at ALP ? - Held that:- hat we need to do in a transfer pricing analysis is to find out a comparable case engaged in the same line of business. The rate of royalty for use of technical know-how of industrial equipments cannot be considered as comparable with that of electronic goods. Even within the overall electronic goods segment, there can be different products or components and the technical know-how required for components cannot be compared with the electronic goods on the whole. In our considered opinion, at best, the rate of royalty approved by the RBI has a persuasive value in the process of determination of ALP of Royalty for a particular case and cannot be considered as conclusive.We, therefore, refuse to accept the payment of royalty and fees for technical services at ALP simply on the ground that it was paid at the maximum rate stipulated by the Reserve Bank of India. Whether the TP provisions apply when deduction is available under the Act ? - Held that:- The eligibility of the assessee to deduction u/s 80IC of the Act does not operate as a bar on determining the ALP of international transaction undertaken by it and further the enhancement of income due to such transfer pricing addition cannot be considered for allowing the benefit of deduction under this section. Rule of Consistency - Held that:- For the year under consideration, the TPO has separated the international transactions of payment of royalty and fees for technical services from other international transactions by treating the remaining at ALP under the TNMM. There is a sea change in the approach adopted by the authorities in the preceding year vis-à-vis the current year. The fact that the TPO proceeded on a wrong premise in the preceding year without considering the international transactions of royalty and fees for technical services as separate from the others, cannot give a licence to the assessee to claim that the same wrong approach be repeated in the subsequent years as well. In an earlier part of this order, we have approved the action of the TPO in segregating these two international transactions from the remaining transactions and determining their ALP separately. Under such circumstances, the assessee cannot seek deletion of addition on the principle of consistency because of a completely changed scenario in the instant year. Such a rule of consistency, if at all, could have been pleaded if the TPO in the preceding year had also segregated such two transactions and benchmarked them same separately under the CUP method, which the DRP would have overturned. Since no such exercise was done by the TPO in the preceding year when the proceedings went on an altogether different line, we cannot approve the argument of the ld. AR for accepting these two international transactions at ALP. Thus we set aside the impugned order and remit the matter to the file of AO/TPO for a fresh determination of the ALP of the international transaction of payment of royalty and fees for technical services 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.