2019 (1) TMI 2080 - AT - Income Tax

TPO to redetermine ALP only for assessee's international transactions; if within ±5% no TP adjustment (Sec.92C)

ITAT Mumbai directed the TPO to re-determine ALP confined to the assessee's international transactions (not entire turnover); if the revised ALP falls ... TP Adjustment - international transactions with the AEs - Claim of the assessee that in case of transfer pricing proceedings the ALP determined by the assessee has to be seen only with regard to its international transactions with the AEs and not on its entire turnover/sales - HELD THAT:- We find issue is squarely covered by the order of the Tribunal in the case of Hindustan Unilever Ld. [2012 (12) TMI 458 - ITAT MUMBAI] as observed by the Tribunal that in the course of transfer pricing proceedings the ALP determined by the assessee has to be seen only with regard to its international transactions with the AEs and not in respect of its entire turnover/sales. We find that the aforesaid order of the Tribunal had thereafter been affirmed by the Hon’ble High Court of Bombay in the case of CIT-1, Mumbai Vs. Hindustan Unilever Ltd. [2016 (7) TMI 1245 - BOMBAY HIGH COURT] We restore the matter to the file of the TPO with a direction to re-determine the ALP of the assessee by confining himself only to the international transactions and not the entire turnover/sales of the assessee. In case the ALP on the basis of the aforesaid working is found to be within the safe harbour range of +/- 5%, then no adjustment shall be made in the hands of the assessee. Insofar the contention of the ld. D.R that the assessee had neither allocated the costs amongst its various services on a scientific basis nor produced any data from which the basis adopted for the allocation of the expenses could be discerned is concerned, the same does not find favour with us. Admittedly, the TPO had observed that the assessee had neither allocated expenses on a scientific basis nor produced the basis adopted by it for such allocation. However, there is nothing discernible from the records which could persuade us to conclude that the TPO had ever called upon the assessee to place on record and justify the basis of allocation of expenses adopted by it. Rather, it is the contention of the ld. A.R that the TPO had never called upon the assessee to furnish any further evidence inspite of being informed about the methodology that was adopted for allocation of expenses by the assessee, vide its letter dated 08.08.2011. D.R could not rebut the aforesaid contention of the assessee. Apart therefrom, we find that the allocation of the expenses had been supported by the assessee on the basis of a certificate of a chartered accountant, wherein the latter had certified that the allocation of the costs was in accordance with the generally accepted accounting principles and the applicable accounting standards issued by the Institute of Chartered Accountant of India. Be that as it may, in terms of our aforesaid observations we are not inclined to subscribe to the adverse inferences that were drawn by the TPO as regards the methodology of allocation of costs adopted by the assessee, without calling upon the latter for any justification of such allocation in the course of the proceedings before him. The Ground of appeal No. 2 raised by the assessee before us is allowed in terms of our aforesaid observations. Disallowing the claim of deduction of the assessee in respect of an amount that was “written off” as irrecoverable u/s 36(1)(vi) r.w.s. 36(2) - In our considered view the claim of deduction of the assessee towards “bad debt” had been declined by the lower authorities on the ground that the assessee had not offered the said amount as its income in the earlier years. Assessee had not only rebutted the aforesaid observations of the lower authorities, but had also placed on record the date wise details of certain “debts” which are claimed to have been offered as income by the assessee in the preceding years viz. F.Y.2005-06 and F.Y. 2006- 07 Aforesaid unsubstantiated claim of the assessee cannot be summarily accepted on the very face of it and the same in all fairness requires to be revisited by the A.O for making necessary verifications. We thus for the limited purpose for making necessary verification as to as to whether the amount or any part thereof, as claimed by the assessee as “bad debt” u/s 36(1)(vi) r.w.s 36(2) of the I.T. Act had earlier been shown as its income, or not, therein restore the matter to the file of the A.O. We may herein observe that to the extent the contention of the assessee is found to be in order, the claim of “bad debt” raised by the assessee to the said extent shall be allowed by the A.O. The Ground of appeal No. 3 is allowed for statistical purposes. ISSUES PRESENTED AND CONSIDERED 1. Whether the Arm's Length Price (ALP) determination in transfer-pricing proceedings must be confined to international transactions with associated enterprises (AEs) rather than the taxpayer's entire turnover. 2. Whether the Transfer Pricing Officer's (TPO) rejection of the taxpayer's choice of methods (Comparable Uncontrolled Price (CUP), Cost Plus/Cost Plus Method (CPM), and Transactional Net Margin Method (TNMM) at segmented level) and adoption of TNMM applied at the entity level was justified given the taxpayer's accounting and allocation of costs. 3. Whether the comparable set and arithmetic mean profit level indicator adopted by the TPO to compute the ALP were appropriate, including rejection of specific comparable(s) as not functionally comparable. 4. Whether amounts shown as advances written off (claimed as deduction under section 36(1)(vi) read with section 36(2)) qualify for deduction where the taxpayer asserts they were earlier offered as income in prior years. 5. Whether initiation of penalty proceedings under section 271(1)(c) is amenable to adjudication at the present appellate stage (prematurity). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Confine ALP determination to international transactions with AEs Legal framework: Transfer pricing provisions require ALP determination for international transactions with AEs; adjustments under section 92CA relate to such international transactions. Precedent treatment: The Tribunal's earlier decision that ALP must be applied only to AE transactions and not to entire turnover is noted and has been affirmed by the High Court in subsequent decisions relied upon by the taxpayer; these precedents were treated as binding on the Tribunal in the present matter. Interpretation and reasoning: The Court observed that the legal mandate and binding precedents establish that benchmarking and ALP computation must be confined to the international transactions with AEs. The TPO's exercise on entire turnover therefore conflicted with settled law. Ratio vs. Obiter: Ratio - the principle that ALP determination in TP proceedings applies only to international/AEs transactions is applied as binding ratio; references to authorities are followed not distinguished. Conclusion: Matter restored to TPO to re-determine ALP confined to international transactions; if ALP so computed lies within ±5% safe harbour, no adjustment to be made. Issue 2 - Choice of TP method and application of TNMM at entity level / rejection of taxpayer's methodology Legal framework: Transfer pricing regulations prescribe selection of Most Appropriate Method (MAM) based on nature of transaction, availability of data, and ability to reliably determine comparables; allocation of costs and maintenance of segmental accounts affect method selection. Precedent treatment: Tribunal and High Court authorities on method selection and entity-level application of TNMM (as cited in proceedings) were considered; however, the Court focused on procedural fairness in TPO's approach. Interpretation and reasoning: The TPO rejected taxpayer's CPM/CUP applications on grounds that service costs were not identifiable and that expense allocation was not scientific; TPO then applied TNMM at entity level because activities were interlinked. The Tribunal found no evidence that the TPO asked the taxpayer to justify or furnish further materials on allocation, despite the taxpayer having provided a methodology and a Chartered Accountant's certificate and a Schedule R disclosure. The Tribunal held that adverse inference about allocation methodology could not be drawn without affording opportunity to the taxpayer to justify the allocation; consequently the TPO's summary rejection was procedurally improper. Ratio vs. Obiter: Ratio - TPO must call for and consider explanations/evidence on cost allocation before rejecting a taxpayer's method; procedural fairness is essential in method acceptance/rejection. Obiter - discussion that services' costs are hard to segregate supports TNMM choice but is not determinative given procedural lapse. Conclusion: Ground challenging TPO's application of TNMM at entity level and rejection of taxpayer's benchmarking/allocation methodology allowed; matter remitted to TPO to re-determine ALP confined to AE transactions and after giving taxpayer an opportunity to justify allocation and methodology. Issue 3 - Selection and treatment of comparables; arithmetic mean PLI Legal framework: Comparable selection must be based on functional comparability; profit level indicators (PLI) from comparables are mathematically aggregated (with possible trimming) to derive ALP benchmark. Precedent treatment: No departure from established approach of rejecting non-functionally comparable entities and computing mean PLI; Tribunal accepted TPO's rejection of specifically identified comparable as not functionally comparable. Interpretation and reasoning: The TPO excluded a listed comparable on functional grounds and adopted an arithmetic mean of remaining comparables (19.75%) to compute entity-level margin. The Tribunal did not disturb the rejection of that particular comparable but held that the ALP so computed must be applied only to AE transactions; consequently the mathematical computation is to be revisited by the TPO when confining benchmark to AE transactions. Ratio vs. Obiter: Ratio - rejection of non-functionally comparable entity is permissible; Obiter - the specific averaging and its numeric effect are contingent on scope (AE transactions only) and may change when re-computed. Conclusion: Comparable exclusion upheld; however, profit margin application must be reworked when ALP computation is confined to AE transactions by TPO on remand. Issue 4 - Deduction for advances written off under section 36(1)(vi) read with section 36(2) Legal framework: Post-01.04.1989, deduction for bad debts under section 36(1)(vi)/36(2) requires that the debt be written off as irrecoverable in the accounts; it is not necessary to prove absolute irrecoverability beyond the book write-off. Precedent treatment: The Tribunal relied upon the Supreme Court dicta that writing off in the accounts suffices for the claim (citing general principle from TRF Ltd. decision as persuasive in submissions). Interpretation and reasoning: The A.O disallowed the claim because he was not satisfied that the amounts had been earlier offered as income; the taxpayer produced partial evidence (details evidencing that part of the amount had been offered in prior years) and the Tribunal found the tax authority's rejection to be without adequate verification. Given that the taxpayer has placed material warranting verification, the Tribunal held that the claim should be re-examined by the A.O, who must verify whether the amounts (or part thereof) had earlier been shown as income; allowance to follow if verified. Ratio vs. Obiter: Ratio - where taxpayer writes off debts in books and produces prima facie evidence that parts were earlier offered as income, the claim should be verified by A.O rather than summarily rejected; the evidentiary standard is a book write-off supported by records and prior offer evidencing nexus. Obiter - the extent to which each item is allowable is fact-specific and for assessment authority to determine on remand. Conclusion: Ground allowed for remand to A.O for verification of earlier income offer and to allow deduction to the extent substantiated; decision remitted for fresh examination. Issue 5 - Initiation of penalty proceedings under section 271(1)(c) Legal framework: Penalty proceedings are distinct quasi-criminal proceedings and may be initiated by A.O; appellate adjudication of penalty initiation may be premature in absence of a concluded penalty order. Precedent treatment: The Tribunal treated initiation (as distinct from imposition) as not ripe for adjudication on merits at appellate stage. Interpretation and reasoning: The Court observed that only initiation of penalty proceedings had occurred and no penalty order had been passed; since initiation alone does not attract substantive relief, challenge at this stage is premature. Ratio vs. Obiter: Ratio - appeals against mere initiation of penalty proceedings are premature and thus not maintainable on merits; factual review may be appropriate only after imposition. Conclusion: Ground dismissed as premature. Overall Disposition The appeal is allowed in part: transfer-pricing adjustments set aside for reconsideration by the TPO confined to international transactions with AEs (giving taxpayer opportunity to justify cost allocation and methodologies); advances written off remitted to A.O for verification and allowance to the extent substantiated; challenge to mere initiation of penalty proceedings dismissed as premature.