Tribunal clarifies price tolerance band for international transactions & remits transfer pricing adjustment for recalculation

The Tribunal directed that the +/- 5% tolerance band should be applied to the price of international transactions, clarifying that it should be based on the transaction price rather than profit margin. Regarding transfer pricing adjustments for raw materials purchased from associated enterprises, the Tribunal set aside the CIT(A)'s order and remitted the matter for recalculation based on a more accurate apportionment method. Both appeals were allowed for statistical purposes, with directions for recalculating the transfer pricing adjustment and applying the tolerance band.

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Issues Involved:
1. Non-granting of tolerance band of +/- 5% from the arm’s length price (ALP) as per the proviso to section 92C(2).
2. Transfer pricing adjustment for international transactions, specifically the purchase of raw materials and components from associated enterprises (AEs).

Detailed Analysis:

Issue 1: Non-granting of Tolerance Band of +/- 5% from ALP
Background: The assessee contended that the tolerance band of +/- 5% from the ALP, as stipulated in the proviso to section 92C(2), was not granted.

Legal Provisions: Section 92(1) mandates that any income arising from an international transaction must be computed with regard to the ALP. Section 92B(1) defines "international transaction" as a transaction between two or more associated enterprises. Section 92C(1) outlines methods for determining the ALP, and the proviso to section 92C(2) allows for a tolerance band of +/- 5% from the arithmetical mean of the ALP.

Tribunal's Analysis: The Tribunal emphasized that the ALP serves as a benchmark for comparison with the price charged or paid by the assessee in international transactions. The proviso to section 92C(2) aims to provide flexibility, stating that if the actual transaction price falls within a 5% range of the ALP, no adjustment should be made. The Tribunal clarified that the 5% tolerance should be applied to the price of the transaction rather than the profit margin embedded in the price. For example, if the ALP is determined to be Rs. 103 or Rs. 98 for goods sold at Rs. 100, no adjustment is necessary as it falls within the 5% range.

Conclusion: The Tribunal directed that the +/- 5% tolerance band should be applied to the price of the international transaction. This benefit is not a standard deduction but should be applied only if the ALP falls within the 5% range of the transaction price.

Issue 2: Transfer Pricing Adjustment for International Transactions
Background: The Revenue challenged the relief granted by the CIT(A) regarding the transfer pricing adjustment for the purchase of raw materials and components from AEs.

Facts: The assessee, a 100% Indian subsidiary of a Japanese company, reported international transactions including the purchase of raw materials and machinery. The TPO determined the ALP for raw materials at Rs. 4.65 crore against the declared value of Rs. 5.77 crore, resulting in a proposed adjustment of Rs. 1.12 crore. The CIT(A) reduced this adjustment to Rs. 23 lakh.

Tribunal's Analysis: The Tribunal noted that the TPO's adjustment was based on entity-level figures, including transactions with both AEs and non-AEs. The Tribunal referred to sections 92 and 92B, which stipulate that transfer pricing adjustments should only apply to transactions between AEs. The Tribunal upheld the CIT(A)'s approach of restricting the adjustment to AE transactions, citing the jurisdictional High Court's ruling in CIT vs. Keihin Panalfa Ltd.

Manner of Relief by CIT(A): The CIT(A) calculated the adjustment by apportioning the total operating profit based on the ratio of costs associated with AE transactions to total operating costs. However, the Tribunal found flaws in this method, particularly the inclusion of costs unrelated to raw material purchases in the denominator. The Tribunal proposed a more accurate method, focusing on the utilized raw material purchased from AEs versus non-AEs.

Conclusion: The Tribunal set aside the CIT(A)'s order and remitted the matter to the AO/TPO for recalculating the adjustment based on the correct apportionment method. The assessee should be given an adequate opportunity to present necessary figures.

Final Judgment:
Both appeals were allowed for statistical purposes, with directions for recalculating the transfer pricing adjustment and applying the +/- 5% tolerance band as appropriate. The order was pronounced in the open court on 03.03.2017.

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