2012 (8) TMI 1246 - AT - Income Tax

AO referral to TPO upheld; RPM rejected, TNMM affirmed; contemporaneous comparables sustained; turnover-filter remanded; s.92C(2) +/-5% applied.

ITAT Delhi upheld the AO's reference to the TPO as valid. RPM was rejected and TNMM affirmed as the most appropriate method. Use of ... Arm's length price - Reference to Transfer Pricing Officer under section 92CA(1) - Resale Price Method (RPM) versus Transactional Net Margin Method (TNMM) as most appropriate method - Comparability and selection of comparables (including turnover filter) - Use of current year data versus multiple year data for comparability - Applicability of amended proviso to the arm's length range (Finance Act, 2009) - Initiation of penalty proceedings not being appealable - Mandatory levy of interest under sections 234B and 234DReference to Transfer Pricing Officer under section 92CA(1) - Validity of the Assessing Officer's reference to the Transfer Pricing Officer - HELD THAT: - The Tribunal considered whether the AO recorded reasons in the draft order to show it was 'expedient and necessary' to refer the matter to the TPO. The DRP's view - that formation of a prima facie opinion by the AO suffices and that CBDT instruction acts as a guideline but does not oust AO's discretion - was held to be consistent with judicial precedents (e.g., Sony India and Coca Cola decisions cited by DRP). The assessee did not place any material to controvert the DRP's findings. On this basis the reference to the TPO was held to be within the AO's discretion and not vitiated for lack of reasons. [Paras 3, 4]Objection to the reference to the TPO dismissed; reference held valid.Use of current year data versus multiple year data for comparability - Permissibility and correctness of using multiple year data instead of current year data for comparability - HELD THAT: - TPO rejected the assessee's use of prior years' data and applied current year margins, relying on Rule 10B(4) and a body of decisions holding that current year data is to be used unless justification for multiple year data is shown. The DRP affirmed the TPO, noting that the assessee had not shown how earlier years' data affected current year profitability or that contemporaneous data was unavailable. The assessee placed no contrary material before the Tribunal. The Tribunal found the approach consistent with precedents and declined to interfere. [Paras 5, 6, 7]Assessee's claim for use of multiple year data dismissed; current year data approach upheld.Resale Price Method (RPM) versus Transactional Net Margin Method (TNMM) as most appropriate method - Whether RPM was the appropriate method or whether the TPO was justified in rejecting RPM and adopting TNMM - HELD THAT: - TPO concluded RPM was inapplicable because gross-level measures did not capture GSA and other selling/marketing expenses and because comparable-product and accounting inconsistencies undermined RPM; TNMM (using OP/sales) was adopted as most appropriate. The DRP reviewed the TPO's reasons and concurred that the assessee's search methodology and functional profile warranted rejection of RPM. The assessee did not present materials before the Tribunal to rebut the DRP/TPO reasoning. The Tribunal therefore declined to interfere with rejection of RPM. [Paras 8, 9, 10]Rejection of RPM and adoption of TNMM upheld.Comparability and selection of comparables (including turnover filter) - Arm's length price - Appropriateness of selected comparables and whether a turnover filter should be applied (remanded for fresh consideration) - HELD THAT: - TPO selected a set of comparables after re-running the search and applied filters; DRP upheld TPO's findings on search defects in the assessee's methodology and accepted the TPO's comparables. At the Tribunal stage the sole substantive contention advanced was that a turnover filter should have been applied - an issue not raised before TPO/DRP. The Tribunal observed authorities permitting fresh pleas and noted that TPO/DRP had not examined turnover-filter issues. In the interests of fairness and because the point had not been considered below, the Tribunal set aside the DRP/AO order on this limited aspect and directed the DRP/AO to re-examine comparables applying the turnover filter, allow the assessee opportunity, and pass a speaking order; other findings on comparability remain undisturbed. [Paras 11, 16, 17]Matter remitted to DRP/AO to recompute ALP after applying turnover filter and re-examining comparables; fresh speaking order to be passed.Applicability of amended proviso to the arm's length range (Finance Act, 2009) - Whether the amended proviso to the arm's length range (Finance Act, 2009) applies to the case - HELD THAT: - DRP applied the CBDT corrigendum and the Memorandum to the Finance Bill, 2009, holding that the amendment applied to cases pending with the TPO on or after 01.10.2009. DRP noted authorities where benefits of a 5% margin were not treated as a standard deduction. The Tribunal accepted DRP's reasoning that the amended proviso (clarificatory in nature) applies as the TPO's order was passed after 01.10.2009 and declined to interfere. [Paras 12]Amended proviso applied; DRP/TPO's application of the amended proviso sustained.Initiation of penalty proceedings not being appealable - Appealability of mere initiation of penalty proceedings under section 271(1)(c) - HELD THAT: - The Tribunal noted that mere initiation of penalty proceedings is not itself appealable and accordingly dismissed the ground challenging initiation of penalty proceedings without considering the merits of any penalty order. [Paras 18]Ground challenging initiation of penalty proceedings dismissed as not appealable.Mandatory levy of interest under sections 234B and 234D - Challenge to levy and computation of interest under sections 234B and 234D - HELD THAT: - The assessee made no submissions on the interest point before the Tribunal. The Tribunal observed the levy of interest under these sections is mandatory by law and supported by apex court authority; in absence of submissions the ground was dismissed. [Paras 19]Challenge to interest levy dismissed; interest under sections 234B and 234D sustained as mandatory.Final Conclusion: The appeal is partly allowed for statistical purposes: objections to the reference to the TPO, the use of multiple year data, rejection of RPM, application of the amended proviso, initiation of penalty and interest were dismissed; however, on the discrete issue of applying a turnover filter to selection of comparables the Tribunal set aside the DRP/AO order and remitted the matter to the DRP/AO to re-examine comparables, apply the turnover filter, allow the assessee opportunity and pass a speaking order, and to recompute the ALP accordingly. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer's reference to the Transfer Pricing Officer under section 92CA(1) was valid in the absence of detailed reasons in the draft assessment order (i.e. what constitutes 'expedient and necessary'). 2. Whether the Resale Price Method (RPM) was the most appropriate method for benchmarking the distribution (trading) transactions, or whether the Transactional Net Margin Method (TNMM) should be applied instead. 3. Whether use of multiple-year (earlier years') comparable data is permissible vis-à-vis mandatory use of current-year comparables for determination of arm's length price under the Rules (Rule 10B/10D), particularly where current-year data was not available to the taxpayer at the time of preparing TP documentation. 4. Whether the comparables chosen by the TPO/DRP (including companies with brand presence and diversified product ranges) were functionally comparable and whether the search methodology and filters applied by the TPO were appropriate and adequately disclosed. 5. Whether a turnover filter (or similar quantitative filter) must be applied to exclude comparables with materially different scale (turnover) and whether the Tribunal may entertain this new plea raised for the first time on appeal. 6. Whether the amended proviso to section 92C(2) (Finance Act 2009) - permitting a +/-5% range - applied to the appraisal of arm's length margins for the relevant year. 7. Whether initiation of penalty proceedings under section 271(1)(c) and levy of interest under sections 234B and 234D were infirm. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Validity of reference to TPO under section 92CA(1) Legal framework: Section 92CA(1) permits AO to refer matters to TPO where it is 'expedient or necessary' to determine ALP; CBDT instruction acts as guideline. Judicial authorities examine whether prima facie opinion suffices. Precedent treatment: Decision(s) accepting that AO's prima facie satisfaction is sufficient and CBDT instruction is a guideline, not a fetter on discretion. Interpretation and reasoning: The DRP and the Court relied on the established line that formation of a prima facie opinion by the AO is adequate and that CBDT instruction (monetary thresholds) guides rather than supplants discretion. No contrary material was placed before the Tribunal to impeach exercise of discretion. Ratio vs. Obiter: Ratio - prima facie opinion by AO suffices for reference; instruction is a guideline. This is applied as binding reasoning. Conclusion: Reference to TPO was valid; ground challenging absence of detailed reasons dismissed. Issue 2 - Appropriateness of RPM versus TNMM for distribution segment Legal framework: Rule 10B(1)(b) describes RPM applicability; TNMM may be appropriate where functions performed include marketing/brand building and gross margins may not capture relevant expenses. Precedent treatment: DRP/TPO relied on both rule text and comparability considerations; decisions cited support choice of most appropriate method based on functional analysis. Interpretation and reasoning: TPO concluded RPM inappropriate because (inter alia) GSA/SG&A expenses (marketing, advertising, promotion, product launch) were not captured at gross margin level and because taxpayer performed marketing/brand-building functions (and paid royalty). DRP concurred that RPM's difficulties (inventory/cost accounting, differences in marketing, exclusivity/branding) made TNMM more appropriate. Taxpayer did not produce cogent rebuttal or evidence demonstrating that RPM yielded more reliable ALP given the facts. Ratio vs. Obiter: Ratio - method selection must follow functional analysis; where tested party performs significant marketing/brand-building and gross-level distortions exist, TNMM may be superior. DRP's concurrence on method selection is treated as operative ratio. Conclusion: Rejection of RPM and adoption of TNMM upheld; grounds challenging method rejected. Issue 3 - Use of current year data versus multiple-year data for comparables Legal framework: Rule 10B/10D and associated guidance emphasize contemporaneous (current-year) data for comparability; limited allowance for prior years' data only with justification. Precedent treatment: Several authorities (including jurisdictional High Court decisions cited) endorse use of current-year data; Tribunal decisions referenced support mandatory use of current-year margins absent specific justification for earlier years. Interpretation and reasoning: TPO and DRP held that multiple-year data was not justified because taxpayer failed to demonstrate how earlier years' data affected current-year profitability; case law supports use of contemporaneous data. Taxpayer did not advance convincing evidence to the contrary before the Tribunal. Ratio vs. Obiter: Ratio - contemporaneous/current-year data is the norm and required unless specific, demonstrable reasons justify use of earlier years' data. This was applied to validate TPO's reliance on current-year margins. Conclusion: Use of current-year data upheld; grounds relying on multiple-year data dismissed. Issue 4 - Selection of comparables, search methodology and functional comparability (including brand/diversification/RPT filter) Legal framework: Comparability analysis requires assessment of functions, assets and risks (FAR), product similarity, marketing/branding, and appropriate quantitative/qualitative filters; TPO must record search strategy and filters applied; taxpayer's search must be defensible. Precedent treatment: DRP/TPO relied on FAR analysis and accepted comparables that passed RPT filters and functional analysis. Tribunal jurisprudence recognizes need for functional comparability and that each year's comparability exercise is distinct. Interpretation and reasoning: TPO found deficiencies in taxpayer's search keywords (resulting in non- pharma and chemically-focused comparables) and re-ran search using industry-appropriate categories (e.g., drugs & formulations) and RPT filter (25%). Objections to inclusion of companies with brand/differentiation/diversified ranges were considered and addressed by analyzing segmental data (e.g., TTK) and marketing/R&D ratios. DRP reviewed TPO's reasoning, found TPO gave cogent reasons, and upheld the selected comparables. Taxpayer failed to rebut the TPO/DRP findings or produce alternate FAR evidence. Ratio vs. Obiter: Ratio - TPO/DRP's selection stands where search methodology aligns with functional profile and filters are applied and explained; mere prior acceptance of methodology in earlier years does not preclude fresh scrutiny. This holding is applied as ratio. Conclusion: TPO/DRP's comparable selection and search methodology sustained except insofar as turnover filter was not considered (see next issue); grounds attacking comparables otherwise dismissed. Issue 5 - Turnover filter: admissibility, timing and remand Legal framework: Turnover (scale) may be a relevant comparability filter but cannot be applied in isolation; comparability is multi-factorial. Tribunal has power to entertain new pure legal pleas under established authorities, but factual filters raised for first time require opportunity to be examined by fact-finding authority. Precedent treatment: Conflicting decisions cited by parties - some Tribunal/High Court decisions exclude oversized comparables; others hold turnover filter not a general rule. The Tribunal may remit issues not examined below for fresh decision after giving parties opportunity. Interpretation and reasoning: The turnover-filter plea was not raised before TPO/DRP; neither did the AO/TPO/DRP examine turnover filter. The Tribunal recognized competing authorities and that turnover may be relevant but must be examined with other comparability factors. Given the issue's factual character and absence of prior adjudication below, the Tribunal exercised discretion to remit the matter to DRP/AO for re-computation applying turnover filter (if appropriate), with directions to conduct a speaking, reasoned decision and give the taxpayer opportunity to respond. Ratio vs. Obiter: Ratio - where a new factual/factual-legal contention (turnover filter) not considered below is raised on appeal, the Tribunal may remit to the fact-finding authority for consideration rather than decide it for the first time; this remedial direction is binding on remand. This is an applied holding (ratio for remand practice). Conclusion: Matter remitted to DRP/AO to re-examine comparables with turnover filter application (if warranted) and to pass a speaking order after affording opportunity to taxpayer; related grounds partly allowed for statutory remand only. Issue 6 - Applicability of amended proviso to section 92C(2) (+/-5% safe harbor) Legal framework: Finance Act 2009 amended proviso; CBDT memoranda and corrigenda indicate application to cases pending with TPO on/after 01.10.2009. Precedent treatment: DRP relied on explanatory memorandum and CBDT corrigendum and on Tribunal decisions holding that 5% benefit not available where price lies beyond that range and that amendment is clarificatory with retrospective effect. Interpretation and reasoning: Since TPO passed order after 01.10.2009 and statutory clarification/corrigendum applied, amended proviso was held applicable. Further, Tribunal/ITAT precedents indicate that 5% is not a blanket deduction where margins fall outside the prescribed range. Ratio vs. Obiter: Ratio - amended proviso applies to cases pending with TPO after 01.10.2009; 5% benefit is not an absolute standard deduction where comparables' range is exceeded. Conclusion: TPO/DRP's application of amended proviso sustained; taxpayer not entitled to proviso benefit in this case. Issue 7 - Penalty under section 271(1)(c) and interest under sections 234B/234D Legal framework: Initiation of penalty proceedings is not appealable at assessment stage; levy of interest under sections 234B/234D is generally mandatory where conditions exist. Precedent treatment: Jurisprudence cited establishes mandatory nature of interest provisions and limits on appellate remedy against mere initiation of penalty proceedings. Interpretation and reasoning: Ground challenging initiation of penalty proceedings dismissed as non-appealable; taxpayer made no submissions contesting interest calculation and interest provisions are mandatory per precedent. Ratio vs. Obiter: Ratio - initiation of penalty is not an appealable order; mandatory interest under relevant sections stands unless specifically contested with substantive grounds. Conclusion: Penalty initiation ground dismissed; interest under sections 234B/234D sustained. OVERALL CONCLUSION The Tribunal upholds the validity of reference to TPO, the rejection of RPM and adoption of TNMM, the use of current-year comparables, the TPO/DRP's search methodology and selected comparables (other than the turnover-filter point), and the applicability of the amended proviso to section 92C(2); penalty initiation ground dismissed and interest upheld. The sole substantive relief granted is a remand to the DRP/AO to re-examine comparables applying a turnover filter (if appropriate), with a direction to pass a speaking order after allowing the assessee an opportunity to be heard. Appeal is otherwise dismissed/partly allowed for statistical purposes in accordance with these directions.