2014 (11) TMI 1299 - AT - Income Tax

Transfer pricing remanded to tax officer for fresh benchmarking using job-worker comparables, considering FX and capacity utilization

Hope India Polishing Works Pvt. Ltd. Versus DCIT, 8 (2), Mumbai.

ITAT DELHI remanded the transfer-pricing issue to the TPO for fresh determination, finding that the comparables used by both sides were inappropriate. The ... TP Adjustment - international transaction entered in to by the assessee with its Associated Enterprise (AE) - Comparable selection - assessee is only a job worker or a contract manufacturer who is entitled for processing charges based on its cost incurred and not based on the value of material supplied by its AE HELD THAT:- We find that while comparing the case with other entities the assessee/TPO had not taken into consideration about the fluctuation in the foreign exchange rates and the resultant effect on their profits/losses. Besides, it is not kwown that whether factor of under utilisation of capacity was existing or not in the comparables chosen by the assessee. In our opinion, to decide the Transfer Pricing matters similar or almost similar comparables have to be adopted. It is said that an apple has to be compared with an apple only and not with the cabbage. As the comparables adopted by both the parties-the assessee and the TPO-are not according to the establishing principles of Transfer Pricing, so we are of the opinion that in the interest of justice, matter should be restored back to the file of the TPO for fresh determination of Transfer Pricing issue. He is directed to find out some entities that are doing job work only or are mainly engaged in doing job work. After obtaining relevant data for bench marking the transactions, he should decide the issue afresh. He would afford a reasonable opportunity of hearing to the assessee. We further find that in the case of Twilight Jewellery (P.) Ltd. [2014 (4) TMI 200 - ITAT MUMBAI] in almost similar circumstances, the Tribunal had remitted back the matter to the file of the TPO for fresh adjudication. ISSUES PRESENTED AND CONSIDERED 1. Whether the Transfer Pricing Officer's adoption of Operating Profit / Value Added Cost (OP/VAC) as the Profit Level Indicator (PLI) and consequent upward adjustment to processing charges is appropriate where the assessee applied Cost Plus Method (CPM) using Operating Profit / Operating Cost (OP/OC) and functioned as a job-worker/contract processor. 2. Whether the comparables used for benchmarking are appropriate where the assessee is a pure job-worker (processing on material supplied by an associated enterprise) but the selected comparables are full-fledged traders/manufacturers, and whether capacity-utilisation and other Function-Assets-Risks (FAR)-linked adjustments ought to have been made. 3. Whether, on the material before the Tribunal, the proper remedy is to adjudicate the transfer-pricing issue on merits or to remit the matter to the Transfer Pricing Officer for fresh benchmarking with suitable comparables and consideration of relevant adjustments (including responses to TPO note-sheet directions). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Appropriateness of PLI: OP/OC (assessee) v. OP/VAC (TPO) Legal framework: The arm's-length price for international transactions is to be determined by applying the most appropriate method and PLI consistent with the functions performed, assets employed and risks assumed. Under CPM for a contract processor/job-worker, PLI should reflect the relationship between operating profit and an appropriate cost base (whether operating cost or value-added cost) that aligns with the nature of services rendered. Precedent treatment: The Tribunal noted earlier decisions in the assessee's own appeals for prior years where similar methodology was considered; the decision also referred to a Tribunal remand in analogous circumstances (referred case) where matter was remitted for fresh benchmarking. Interpretation and reasoning: The Tribunal finds on facts that the assessee was a pure job-worker entitled only to processing charges based on costs incurred and not on the value of materials supplied by the associated enterprise. Thus, benchmarking that includes comparables whose margins are computed on a cost base inclusive of material purchases creates a misalignment. The TPO's adoption of OP/VAC implicitly treated cost of material as part of value-added cost for comparables, whereas for a contract processor the proper cost base would normally exclude material supplied by the AE. The Tribunal also observed that the TPO did not appear to consider the assessee's response to a note-sheet seeking justification for excluding cost of material and thus did not address the assessee's rationale for OP/OC. Ratio vs. Obiter: Ratio - Where the taxpayer is a job-worker/contract manufacturer receiving materials from an AE, PLI selection must reflect that status; adoption of OP/VAC without addressing why OP/OC is inappropriate is unsound. Obiter - Comments on exchange-rate fluctuation effects and historical losses, while relevant to comparability, operate as contextual observations supporting remand rather than standalone holdings. Conclusion: The Tribunal concluded that OP/OC could be the appropriate PLI for a pure job-worker and that the TPO's unexplained shift to OP/VAC without addressing the assessee's submissions was not satisfactorily justified. This supports remand for reconsideration with suitable comparables and cost-base treatment. Issue 2 - Appropriateness of comparables; need for FAR and capacity-utilisation adjustments Legal framework: Comparability analysis requires selection of comparables that are similar on functions, assets and risks (FAR). Relevant quantitative and qualitative adjustments (including for capacity utilisation and other structural differences) must be made where differences materially affect margins. Precedent treatment: The Tribunal relied on its own past decisions in similar fact patterns where remand was ordered to identify closer comparables (and on a cited Tribunal decision in analogous circumstances remitting the matter for re-benchmarking). Interpretation and reasoning: The Tribunal found the assessee's activities were limited to job work for the AE (processing of supplied rough diamonds), whereas the comparables relied upon by both the assessee and TPO were predominantly trading/manufacturing entities engaged in broader operations and exports. The TPO had not demonstrated existence of comparables engaged solely in job work nor made adequate FAR or capacity adjustments. The Tribunal also noted lack of clarity on whether the comparables suffered under-utilisation of capacity and that the assessee had asserted under-utilisation of its own capacity (44.08%) which impacted its margin computation-an assertion that had not been properly considered by the TPO. Ratio vs. Obiter: Ratio - Comparables must be similar in FAR and operational profile (job-work v. full-scale manufacturing); absence of such comparability or of necessary adjustments undermines the benchmarking. Obiter - The Tribunal's analogy 'an apple has to be compared with an apple' is illustrative but not a freestanding legal test. Conclusion: The comparables used were not prima facie appropriate. The TPO must identify entities primarily engaged in job work (or closely similar FAR) and make/consider necessary adjustments (including capacity-utilisation) before computing arm's-length margins. Issue 3 - Remedy: Whether to decide on merits or remit to TPO Legal framework: Where benchmarking is fundamentally flawed because of inappropriate comparables or unexplained methodological choices, remand to the TPO for fresh determination while affording the taxpayer opportunity to be heard is an appropriate corrective procedure. Precedent treatment: The Tribunal referenced a prior Tribunal remand decision in an almost identical fact situation supporting the course of remittal rather than final adjudication on the present record. Interpretation and reasoning: Given that (a) the assessee's status as a job-worker implies a different cost base and comparable set, (b) the TPO did not record/consider the assessee's response to queries on exclusion of material cost, and (c) neither party produced clear job-work comparables nor satisfactorily addressed capacity-utilisation and FAR differences, the Tribunal held that adjudication on the existing record would not serve justice. The TPO is better placed to obtain additional data, identify appropriate job-work comparables, make necessary adjustments, and re-compute the arm's-length price after giving a reasonable hearing. Ratio vs. Obiter: Ratio - Where benchmarking contains fundamental defects of comparability or unaddressed methodological issues, the correct remedy is remand to the TPO for fresh determination with opportunity to present and consider relevant data. Obiter - Observations regarding exchange-rate fluctuations and historical losses are supportive factors but do not replace the need for fresh benchmarking. Conclusion: The Tribunal remitted the transfer-pricing issue to the TPO for fresh adjudication, directing the TPO to identify suitable job-work comparables, obtain relevant data (including capacity-utilisation), make appropriate FAR and other adjustments, and afford a reasonable opportunity of hearing to the assessee. Ancillary observations 1. Grounds not pressed (including the challenge to TPO jurisdiction based on monetary limits) were dismissed as not pressed and not adjudicated. 2. Interest under sections 234B/234D and other ancillary grounds were not decided on the merits in the impugned order and thus not determined in the Tribunal's order of remand.