2021 (9) TMI 341 - AT - Income Tax

Transfer Pricing Appeal Outcome: ALP Determination, TNMM Upheld

The Tribunal partly allowed the appeal for the A.Y. 2011-12, directing the AO to determine the Arm's Length Price (ALP) using the Transactional Net Margin ... TP Adjustment - selection of MAM - RPM or TNMM or Profit Split method [PSM] - assessee applied the TNMM for determining the ALP of the international transaction of 'Sale of finished goods' - TPO rejected such a method and applied the PSM - DRP has finally held that the RPM is the most appropriate method - assessee is in appeal challenging the correctness of the RPM as the most appropriate method - HELD THAT:- The entire mechanism in the subsequent sub-clauses of rule 10B(1)(b) is a consequence of this foundational fact. If the international transaction is not that of purchase by an Indian entity, then the RPM cannot be applied. Here is a case in which the assessee sold goods to its AE in the international transaction rather than purchasing the same. In fact, the purchases for such a resale were made from non-AEs. In such a scenario, we cannot countenance the DRP's direction to apply the RPM for the ALP determination of the international transaction of 'Sale of finished goods' to the AEs. Once the application of the PSM has been ruled out by the DRP and rightly so and further we have held hereinabove that the RPM is not the correct method to be applied, then there can be no hitch in accepting the assessee's contention of applying the TNMM as the most appropriate method in the facts and circumstances of the case. In fact, the DRP also directed to apply the TNMM for the next two years, which are part of this batch of appeals, in which the international transactions are sale of manufactured goods to the AEs. Assessee has came out with a contention that if the TNMM is to be applied, then its original ALP determination in the Transfer pricing study report should be accepted without remitting the matter to the AO. We cannot concur with this contention because the working done by the assessee in this regard has not been vetted either by the TPO or the DRP. The TPO rejected such a method and went ahead with the PSM and the DRP suggested the RPM. Hence veracity of the calculations made by the assessee under TNMM has yet to pass through the eyes of the authorities below. Under these circumstances, we set aside the impugned order and remit the matter to the file of the AO for a fresh determination of the ALP of international transaction of 'Sale of finished goods' under the TNMM as per law after allowing reasonable opportunity of hearing to the assessee. Operating cost base for computing the assessee's PLI - Expenses as brand building costs qualifying for exclusion - Assessee incurred Employee cost and Operating & administrative expenses in relation to its manufactured products, which were sold in the year under consideration both in the domestic market to non-AEs and in the foreign market to the AEs. In such a situation, the assessee cannot justify the exclusion by correlating the same with its impact in the years to come -AR admitted that these costs were not capitalized in the books of account but were taken as revenue expenses for the year under consideration. Once these costs are incurred for the year in question and claimed as deduction in entirety in this year alone, we fail to understand as to how these can be correlated with the sales to be made in future years without capitalizing them for accounting or tax purpose. Albeit the assessee claims to have incurred ₹ 10.94 crores for the A.Y. 2012-13 and ₹ 23.89 crores for the A.Y. 2013-14 as operating cost for the future years, but neither capitalized them in the accounts for the years under consideration nor included them in the operating costs base for any of the future years. If we accept the contention of assessee to exclude such expenses, then they will neither form part of operating cost base for the years under consideration nor in the future years though these have actually been granted deduction in the computation of total income for the years in question. As the so-called brand building exercise done by the assessee facilitated making of the sales in the years under consideration, we are in full agreement with the DRP that the expenses so carved out and excluded from the operating cost base were liable to be included back. Whether brand building expenses have no relation with the sale of finished goods to the AEs and hence should be excluded? - We again fail to appreciate as to how brand building exercise does not help in facilitating profit from sales to related parties. Every sale to the AEs has a corresponding manufacturing also. A good brand not only helps in accelerating revenue side by pushing sales across the board to the related and unrelated parties but also reins in economies and efficiencies on the cost side - economies in terms of relatively cost-effective purchases of quality raw material and efficiencies in terms of having good and satisfied work force preferring to stick with an established and reputed brand thereby adding the value. Thus we do not countenance the contention that brand building exercise has no impact on the profitability from sales made to related parties. The position which finally emerges is that neither the Employee Cost and Operating and administration expenses have any relation with the 'brand building' nor even genuine brand building expenses can be excluded from the operating cost base on the facts and in the circumstances of the case. Thus the contention of the Ld. AR for reducing the operating cost base with the expenses of ₹ 10.94 for the A.Y. 2012-13 and ₹ 23.89 crores for the A.Y. 2013-14 is repelled. To sum up, we hold that the DRP rightly ordered the inclusion of such costs in the operating cost base for computing the assessee's PLI for both the years under consideration. Assessee's Additional ground contending that the reference made by the AO to the TPO for the second international transaction, without granting opportunity of hearing to the assessee - HELD THAT:- For the two years instantly before us, again the ALP determination by the TPO is confined to the only reported international transaction of sale made to the AEs. Unlike in the case of OIE, there is no second transaction referred by the AO to the TPO. Following the raison d'etre given for the preceding year, the additional grounds for these two years are also dismissed. Issues Involved:1. Transfer Pricing Adjustment2. Application of Transfer Pricing Methods (TNMM, PSM, RPM)3. Validity of Reference to TPO4. Determination of Arm's Length Price (ALP)5. Inclusion of Operating Costs in PLI CalculationDetailed Analysis:Transfer Pricing Adjustment:The assessee contested the addition of Rs. 37,78,910 made by the AO for the A.Y. 2011-12. The TPO initially determined the adjustment based on a previous order in the case of Anagha Pharma Ltd. The DRP later modified this adjustment to Rs. 37,78,910. For A.Ys. 2012-13 and 2013-14, the AO made transfer pricing adjustments of Rs. 4,34,17,316 and Rs. 7,76,19,272 respectively, based on the TPO's application of the PSM, which was later directed by the DRP to be determined under the TNMM.Application of Transfer Pricing Methods:The TPO used the Profit Split Method (PSM) for determining the ALP, which was later contested by the assessee. The DRP directed the application of the Resale Price Method (RPM) for the A.Y. 2011-12, but the Tribunal found that RPM was not appropriate as the assessee was selling goods to its AE rather than purchasing. The Tribunal ruled that the Transactional Net Margin Method (TNMM) was the most appropriate method for determining the ALP for the A.Y. 2011-12. For A.Ys. 2012-13 and 2013-14, the DRP directed the application of TNMM, which was accepted by the Tribunal.Validity of Reference to TPO:The Tribunal addressed the issue of the AO referring the international transaction to the TPO without granting an opportunity of hearing to the assessee. It was argued that the AO made the reference based on a search action and subsequent findings. The Tribunal found that the AO's reference was valid for the only reported international transaction of sale made to the AE, and no second transaction was referred to the TPO, thus dismissing the additional ground raised by the assessee for all three years.Determination of Arm's Length Price (ALP):The Tribunal found flaws in the application of the PSM by the TPO, including the incorrect allocation of residual profits and the failure to include the assessee's profit/loss in the combined profit calculation. The Tribunal directed the AO to determine the ALP using the TNMM for the A.Y. 2011-12 and upheld the DRP's application of TNMM for A.Ys. 2012-13 and 2013-14.Inclusion of Operating Costs in PLI Calculation:The Tribunal addressed the issue of the assessee excluding certain operating costs from its PLI calculation, arguing that these were brand-building expenses with future benefits. The Tribunal found that these costs were ordinary operating expenses and should be included in the operating cost base for the years under consideration. The Tribunal upheld the DRP's inclusion of these costs in the operating cost base for computing the assessee's PLI for both years.Conclusion:The Tribunal partly allowed the appeal for the A.Y. 2011-12 for statistical purposes, directing the AO to determine the ALP using TNMM. The appeals for A.Ys. 2012-13 and 2013-14 were dismissed, upholding the DRP's application of TNMM and the inclusion of operating costs in the PLI calculation. The additional grounds raised by the assessee regarding the validity of the reference to the TPO were also dismissed.