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 Services (FTS), was justified. It emphasized the need to benchmark these transactions separately and rejected the use of RBI-approved rates for determining the Arm's Length Price (ALP). The Tribunal favored the Comparable Uncontrolled Price (CUP) method for determining the ALP, criticizing the incorrect approach of the Transfer Pricing Officer (TPO) in comparing expenses to sales ratios. The matter was remitted for fresh determination of ALP, with directions to allow the tax credit claimed by the assessee.

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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.

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