2018 (6) TMI 468 - AT - Income Tax

Tribunal Orders Fresh ALP Analysis for Transfer Pricing Dispute

The Tribunal set aside the matter to the AO/TPO for a fresh adjudication on both issues regarding the exclusion of Celestial Labs Ltd. and inclusion of ... Comparability analysis in transfer pricing - functional analysis (FAR) in selection of comparables - exclusion of outlier comparables due to abnormal/super normal profits - Transactional Net Margin Method (TNMM) and Profit Level Indicator (PLI) - remand for de novo adjudication by AO/TPOComparability analysis in transfer pricing - functional analysis (FAR) in selection of comparables - exclusion of outlier comparables due to abnormal/super normal profits - Transactional Net Margin Method (TNMM) and Profit Level Indicator (PLI) - Whether M/s. Celestial Labs Ltd. should be excluded from the comparable set for benchmarking the assessee's product development services - HELD THAT: - The Tribunal examined the TPO's inclusion and the CIT(A)'s exclusion of Celestial Labs Ltd. The authorities below did not undertake a detailed, year specific functional and financial analysis of Celestial Labs vis a vis the tested party, nor did they sufficiently analyse the audited financials to determine whether the high PLI for the year under consideration was attributable to extraordinary events (notably the IPO and related items) or to the ordinary operations comparable to the assessee. Because Celestial is a listed entity with public financials and the IPO in the relevant period could have distorted profitability (for example, IPO related expenses and interest on escrow), the Tribunal held that adopting the reported PLI without excluding or adjusting for extraordinary IPO related items was not justified. The Tribunal therefore set aside the conclusions of the authorities and directed that the AO/TPO undertake a fresh, detailed analysis of Celestial Labs' functional profile and financial statements for the impugned year, exclude or adjust for the impact of extraordinary items as appropriate, admit the assessee's evidences, and re adjudicate the comparability on merits in accordance with law. [Paras 5]Set aside and remitted to AO/TPO for de novo analysis and adjudication with directions to admit evidence and adjust for extraordinary IPO related items before deciding comparability.Comparability analysis in transfer pricing - functional analysis (FAR) in selection of comparables - adjustment of Profit Level Indicator (PLI) for extraordinary events - Whether M/s. Tonira Pharma Ltd. should be included in the comparable set for benchmarking the assessee's product development services - HELD THAT: - The Tribunal found that the TPO's exclusion of Tonira on account of having effluent treatment/waste disposal systems was not a valid basis, as such facilities are commonly required by law and not indicative of functional dissimilarity. However, the audited financials showed that Tonira's reported loss for the year incorporated exceptional items and the impact of an extraordinary event (attachment of inventories and disallowance of clearances at its Ankleshwar unit), and the parties had differed on which loss figure ought to be used for PLI computation. Given these facts, the Tribunal concluded that the selection or rejection of Tonira as a comparable requires a deeper analysis of the audited statements, segregation of exceptional/extraordinary impacts, and fresh adjudication by AO/TPO after admitting relevant evidence and affording proper opportunity to the assessee. [Paras 5]Set aside and remitted to AO/TPO for de novo analysis and adjudication, with directions to examine exceptional items, admit evidence and decide comparability on merits.Final Conclusion: The Revenue appeal is allowed for statistical purposes; the Tribunal has set aside the contested comparability conclusions regarding Celestial Labs Ltd. and Tonira Pharma Ltd. and remitted both issues to the AO/TPO for fresh de novo adjudication after detailed FAR and financial analysis, adjustment for extraordinary items where warranted, admission of the assessee's evidence and compliance with principles of natural justice. Issues Involved:1. Exclusion of Celestial Labs Ltd. from the comparables for determining the ALP.2. Inclusion of Tonira Pharma Ltd. in the final set of comparables for determining the ALP.Issue-wise Detailed Analysis:1. Exclusion of Celestial Labs Ltd. from the comparables for determining the ALP:The Revenue's primary contention was that the CIT(A) erred in excluding Celestial Labs Ltd. from the comparables on the grounds of abnormal profit levels and different functional profiles. The CIT(A) had directed the exclusion of Celestial Labs Ltd., noting that the company reported an abnormal profit margin of 87.94% and was involved in different functional activities compared to the assessee. The TPO had included Celestial Labs Ltd. as a comparable, asserting that it was engaged in clinical research, which aligned with the assessee's product development activities.The Tribunal observed that the financial data of Celestial Labs Ltd. indicated significant profits in the years preceding the assessment year, but a deeper analysis of the financial statements was necessary to understand the reasons behind the abnormal profits. The Tribunal noted that the company had undergone an Initial Public Offering (IPO) during the relevant period, which could have influenced its profitability. The Tribunal directed the AO/TPO to re-examine the financial statements of Celestial Labs Ltd., excluding the impact of the IPO and other extraordinary events, to determine its appropriateness as a comparable.2. Inclusion of Tonira Pharma Ltd. in the final set of comparables for determining the ALP:The Revenue challenged the CIT(A)'s decision to include Tonira Pharma Ltd. as a comparable, arguing that it was a loss-making company with a negative PLI of (-)16.90%. The CIT(A) had directed the inclusion of Tonira Pharma Ltd., stating that the presence of waste disposal systems was not a valid reason for exclusion and that the company was otherwise functionally comparable.The Tribunal noted that Tonira Pharma Ltd. had faced extraordinary events, including the attachment of its inventory by the Excise and Customs Department, which affected its profitability. The Tribunal emphasized that the impact of such extraordinary events should be excluded when computing the PLI for benchmarking purposes. The Tribunal directed the AO/TPO to re-evaluate the financial statements of Tonira Pharma Ltd., excluding the impact of the extraordinary events, to determine its suitability as a comparable.Conclusion:The Tribunal set aside the matter to the AO/TPO for a fresh adjudication on both issues. The AO/TPO was directed to provide the assessee with a proper opportunity to present evidence and arguments. The Tribunal emphasized the need for a detailed analysis of the financial statements of both Celestial Labs Ltd. and Tonira Pharma Ltd., excluding the impact of extraordinary events, to accurately determine their comparability for computing the ALP of the international transactions. The appeal of the Revenue was allowed for statistical purposes.