2023 (3) TMI 706 - AT - Income Tax

Tribunal directs adjustments for comparability in transfer pricing appeal

The Tribunal partially allowed the appeal, remitting various issues back to the AO/TPO for reconsideration with specific directions to ensure proper ... Transfer pricing adjustment - arm's length price - comparability adjustments - foreign exchange fluctuation - operating v. non operating treatment - customs duty adjustment - depreciation adjustment - capacity utilization adjustment - working capital adjustment - restriction of transfer pricing adjustment to international transactions - remand to TPO/AO for fresh considerationForeign exchange fluctuation - operating v. non operating treatment - transfer pricing adjustment - Whether losses on account of foreign exchange fluctuation should be treated as operating in nature for the purpose of transfer pricing comparability and ALP determination. - HELD THAT: - The Tribunal noted that the TPO treated the entire foreign exchange fluctuation loss as operating in nature but that the matter required detailed analysis as to whether the fluctuation during the relevant year was abnormal and what effect it had on operating margins of the tested party and comparables. Relying on its earlier order in the assessee's own case for AY 2012-13, the Tribunal observed that these aspects were not properly analyzed by the TPO/DRP and that the issue should be examined afresh by the TPO with appropriate analysis of the nature and effect of the foreign exchange fluctuations. [Paras 5]Issue remitted to the TPO for fresh consideration and analysis on the lines directed by the Tribunal.Customs duty adjustment - comparability adjustments - transfer pricing adjustment - Whether an adjustment on account of customs duty/surcharge incurred by the assessee should be allowed in the comparability analysis for determination of ALP. - HELD THAT: - The Tribunal considered precedent from co ordinate Benches which held that where higher import content is necessitated by circumstances beyond the tested party's control, customs duty differences may materially affect margins and merit adjustment. Noting judicial guidance (including Gates Unitta and other Bench decisions) and that earlier authorities did not examine the matter in the light of those principles, the Tribunal directed that the AO/TPO examine the claim afresh and eliminate any material difference, ensuring adjustments are made only where such differences are likely to materially affect the net profit margin. [Paras 6]Issue remitted to the AO/TPO for fresh consideration and adjustment, if any, in accordance with the Tribunal's directions and precedents.Depreciation adjustment - comparability adjustments - Whether depreciation differences between the tested party and comparables require an adjustment in the computation of operating margins for ALP determination. - HELD THAT: - The Tribunal observed that where depreciation policies or rates differ between the tested party and comparables, a reasonable depreciation adjustment may be required. Citing the Tribunal's earlier decision in the assessee's own case and other precedents, the Tribunal found that there was no proper analysis on record and directed the AO/TPO to re examine the depreciation policies of the assessee and comparables and allow suitable adjustment if differences are demonstrated. [Paras 7]Issue remitted to the AO/TPO for fresh consideration and, if substantiated, a reasonable depreciation adjustment to be made.Capacity utilization adjustment - comparability adjustments - Whether adjustment for under utilisation of installed capacity should be made in computing the arm's length margin. - HELD THAT: - The Tribunal reiterated settled law that under utilisation of capacity impacts per unit cost and net margins and that adjustments are permissible where reliably ascertainable. The Tribunal referred to Rule 10B and multiple precedents, and directed the AO/TPO to follow the established methodology including use of powers under section 133(6) (to collect relevant data of comparables) and to grant capacity utilization adjustment after obtaining and sharing requisite information with the assessee. [Paras 8]Issue remitted to the AO/TPO for fresh adjudication following the Tribunal's directions on capacity utilization adjustment.Working capital adjustment - comparability adjustments - Whether working capital differences between the tested party and comparables should be adjusted in the TNMM analysis for ALP determination. - HELD THAT: - Relying on detailed Tribunal guidance and OECD principles, the Tribunal held that working capital adjustment is a recognised comparability adjustment and, where properly computed, ought to be allowed. The Tribunal noted that the TPO had accepted the assessee's working and that the CIT(A) erred in denying the adjustment; it directed the AO/TPO to allow working capital adjustment as per actual on the final set of comparables and to follow the methodology outlined in the Tribunal's precedents. [Paras 9]Issue remitted to the AO/TPO with direction to allow working capital adjustment as per the Tribunal's established approach.Restriction of transfer pricing adjustment to international transactions - arm's length price - Whether the transfer pricing adjustment must be confined to transactions with associated enterprises (i.e., international transactions) rather than being applied to the assessee's entire turnover. - HELD THAT: - The Tribunal admitted the additional ground and relied upon its earlier rulings (and authority cited) that Section 92 applies only to international transactions with associated enterprises and that benchmarking/TP adjustments should be restricted to AE related transactions. The Tribunal directed the AO/TPO to reconsider the adjustment in light of this principle. [Paras 11]Issue remitted to the AO/TPO for reconsideration, with directions to restrict TP adjustment to AE related international transactions.Final Conclusion: The appeal is partly allowed for statistical purposes. Several disputed comparability adjustments (foreign exchange treatment, customs duty, depreciation, capacity utilisation, working capital) and the scope limiting TP adjustments to AE transactions are remitted to the AO/TPO for fresh consideration in accordance with the Tribunal's directions and applicable precedents. Issues Involved:1. Transfer Pricing Adjustment2. Rejection of TP Documentation3. Economic Analysis Disregard4. Foreign Exchange Fluctuation Losses5. Custom Duty and Surcharges Adjustment6. Purchase Price Adjustment7. Depreciation Exclusion8. Capacity Utilization Adjustment9. Working Capital Adjustment10. Risk Difference Adjustment11. Limitation of TP Adjustment to International TransactionsDetailed Analysis:1. Transfer Pricing Adjustment:The appeal challenges a transfer pricing adjustment of INR 5,67,47,747/- under section 92CA of the Income-tax Act, 1961, related to international transactions for AY 13-14. The Tribunal noted that the Ld. DRP did not provide certain reliefs, leading to the adjustment by the TPO.2. Rejection of TP Documentation:The AO, TPO, and DRP erred in rejecting the TP documentation maintained by the appellant under sub-section (3) of 92C of the Act. The Tribunal did not specifically adjudicate this issue as it was deemed general in nature.3. Economic Analysis Disregard:The authorities disregarded the economic analysis performed by the appellant in the TP documentation. This issue was also considered general and did not require specific adjudication.4. Foreign Exchange Fluctuation Losses:The appellant argued that losses due to foreign exchange fluctuations should be treated as operating in nature if they are in the revenue field and non-operating if related to earlier years or reinstatement. The Tribunal remitted this issue to the TPO for reconsideration, referencing a similar decision in the appellant's case for AY 2012-13.5. Custom Duty and Surcharges Adjustment:The appellant sought adjustments for custom duty expenses, arguing that these were significantly higher compared to comparable companies. The Tribunal referred to the decision in Continental Automotive Components India Pvt. Ltd. and remitted the issue to the AO/TPO for fresh consideration, emphasizing the necessity of adjustments for custom duty to ensure proper comparability.6. Purchase Price Adjustment:The appellant sought adjustments for purchase price differences due to forex fluctuation. The Tribunal remitted the issue to the TPO for reconsideration, highlighting the need for a proper comparability analysis that factors in the import component and forex fluctuation.7. Depreciation Exclusion:The appellant contended that different depreciation rates adopted by companies should be considered, and depreciation should be excluded while computing operating margins. The Tribunal remitted the issue to the AO/TPO for fresh consideration, referencing a prior decision that emphasized the need for reasonable depreciation adjustments.8. Capacity Utilization Adjustment:The appellant argued for adjustments due to underutilization of capacity, being in its third year of operations. The Tribunal upheld the necessity of such adjustments, citing several precedents, and remitted the issue to the AO/TPO with directions to obtain relevant data from comparable companies under section 133(6) of the Act.9. Working Capital Adjustment:The appellant sought working capital adjustments. The Tribunal, referencing a decision in Huawei Technologies India (P.) Ltd., directed the AO/TPO to allow working capital adjustments based on actual data from the final set of comparables.10. Risk Difference Adjustment:The appellant argued for adjustments to account for differences in risks borne by the appellant and comparable companies. This issue was not specifically adjudicated as it was considered general in nature.11. Limitation of TP Adjustment to International Transactions:The appellant raised an additional ground that TP adjustments should be restricted to international transactions alone. The Tribunal admitted this ground and remitted the issue to the AO/TPO for fresh consideration, referencing a decision in Continental Automotive Components India Private Limited, which emphasized that TP adjustments should be limited to AE transactions.Conclusion:The Tribunal allowed the appeal partly for statistical purposes, remitting several issues back to the AO/TPO for fresh consideration with specific directions to ensure proper comparability and adjustments in line with judicial precedents.