Transfer pricing ruling upholds TNMM for specified domestic transactions under Section 92, limits expense adjustments, remands finance allocation

ITAT Delhi upheld application of TNMM by AO/TPO for determining arm's length price of specified domestic transactions, holding that comparison of the eligible unit's margin with margins of comparable companies selected by the assessee was proper and that margins of other eligible units (being related party transactions) could not be used as comparables. It rejected the assessee's plea for invoice-based verification, as CUP was not the adopted method. The Tribunal held AO/TPO unjustified in making adjustment to allocation of common/head office expenses and directed exclusion of such expenses from the quantum of specified domestic transactions. On allocation of finance cost, the matter was remanded to AO/TPO to identify non-unit-specific interest and reallocate it among units, granting the assessee opportunity of hearing.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether the method adopted by the Assessing Officer/Transfer Pricing Officer for determining the arm's length price of specified domestic transactions of the eligible unit, by applying a profit-level comparison akin to the Transactional Net Margin Method, was valid and in accordance with section 92C of the Act.

1.2 Whether, in view of the directions of the Dispute Resolution Panel, the Assessing Officer/Transfer Pricing Officer was required to verify invoices and apply the Comparable Uncontrolled Price method for inter-unit transfer of raw material, packing material and consumables.

1.3 Whether the Assessing Officer/Transfer Pricing Officer was justified in making transfer pricing adjustment on the specified domestic transaction relating to allocation of common/head office expenses to the eligible unit, despite the Dispute Resolution Panel's finding that such allocation was at arm's length.

1.4 Whether allocation of finance cost to the eligible unit, while computing its profit margin for transfer pricing purposes, was justified and, if not, how such finance cost was required to be identified and allocated.

1.5 Whether levy of interest under sections 234B and 234C of the Act required separate adjudication.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Validity of method adopted to determine arm's length price of specified domestic transactions

Interpretation and reasoning

2.1 The assessee benchmarked specified domestic transactions of inter-unit purchases by applying the Comparable Uncontrolled Price method, comparing prices of goods procured from third-party suppliers with prices charged in inter-unit transfers.

2.2 The Transfer Pricing Officer rejected this approach and, using comparables selected by the assessee itself, applied an entity-level profit comparison (average margin of 2.90%) to the eligible unit's operating revenue, treated the difference between the arm's length profit and the actual profit of the eligible unit as "excess profit", and then attributed a proportion of such excess profit to specified domestic transactions based on the ratio of specified domestic transaction expenses to total operating expenses.

2.3 The assessee argued that: (i) CUP was the most appropriate method and had not been shown to be inaccurate; (ii) the Assessing Officer/Transfer Pricing Officer adopted an ad hoc method not recognised under section 92C; and (iii) margins of company-level comparables could not be used against a single-product eligible unit.

2.4 The Tribunal noted that: (i) the issue of challenging the method had neither been raised before the Dispute Resolution Panel nor adjudicated by it and no additional ground was raised; (ii) in giving effect to the Dispute Resolution Panel's directions, the Assessing Officer/Transfer Pricing Officer computed the eligible unit's margin excluding the impact of excise duty and sales tax and compared it with average margins of comparables chosen by the assessee; and (iii) the approach followed by the Assessing Officer/Transfer Pricing Officer was in substance an application of the Transactional Net Margin Method, under which minor functional/vertical variations at entity level are permissible.

2.5 On the contention that only margins of eligible units of comparable companies should be compared, the Tribunal held that margins of exempt units of other assessees would generally relate to related-party/exempt transactions and would not constitute independent uncontrolled transactions suitable for arm's length comparison.

Conclusions

2.6 The method adopted by the Assessing Officer/Transfer Pricing Officer, applying a TNMM-type comparison of the eligible unit's margin with margins of comparables and computing adjustment therefrom, was upheld as a valid and appropriate method under section 92C.

2.7 The plea to mandate use of CUP and to reject the method adopted as ad hoc was rejected.

Issue 2 - Necessity of invoice-wise verification and application of CUP method in light of Dispute Resolution Panel's directions

Legal framework (as discussed)

3.1 The Dispute Resolution Panel had: (i) rejected the assessee's arm's length price determination under CUP in respect of purchases of packing material, raw material, and stores & spares; (ii) accepted the apportionment of head office expenses as arm's length; and (iii) directed the Assessing Officer/Transfer Pricing Officer to examine invoices for inter-unit transfers and compare with third-party purchases to give specific findings.

Interpretation and reasoning

3.2 The assessee argued that the Assessing Officer/Transfer Pricing Officer did not properly comply with the Dispute Resolution Panel's direction to examine invoices, and sought restoration of the matter for detailed verification to substantiate that inter-unit transfers were at the same or higher prices than third-party purchases.

3.3 The Tribunal noted that, in the final computation, the Assessing Officer/Transfer Pricing Officer had implemented the Dispute Resolution Panel's key direction by excluding the effect of excise duty and sales tax from the eligible unit's operating profit and then applying a TNMM-based margin comparison for specified domestic transactions.

3.4 The Tribunal further recorded that the Dispute Resolution Panel had already rejected the CUP-based ALP determination for purchases (raw material, packing material, stores and spares) and accepted only the apportionment of head office expenses as arm's length.

3.5 Having upheld TNMM as the most appropriate method for determining the arm's length price of specified domestic transactions, the Tribunal reasoned that invoice-level price comparison, relevant to CUP, was no longer material to the computation of adjustment under TNMM.

Conclusions

3.6 Verification of individual invoices, as requested by the assessee, was held unnecessary once TNMM was applied as the governing method.

3.7 The request to restore the issue to the Assessing Officer/Transfer Pricing Officer for invoice verification was rejected, and the ground dismissed.

Issue 3 - Adjustment on specified domestic transaction of allocation of common/head office expenses

Interpretation and reasoning

4.1 The assessee had itself allocated common/head office expenses of Rs. 9,14,01,671 to the eligible unit. The Dispute Resolution Panel explicitly noted that the same figure was adopted by the Transfer Pricing Officer and, therefore, no further direction was required on this issue, implying acceptance of such allocation as arm's length.

4.2 While computing the eligible unit's margin and the resultant transfer pricing adjustment, the Assessing Officer/Transfer Pricing Officer nevertheless applied the excess-margin effect to all specified domestic transactions, including the transaction relating to allocation of common/head office expenses, notwithstanding the Dispute Resolution Panel's finding.

4.3 The Tribunal observed that, once the Dispute Resolution Panel had accepted the allocation of common/head office expenses as being at arm's length, the Assessing Officer/Transfer Pricing Officer could not disturb or adjust that particular specified domestic transaction while giving effect to the Dispute Resolution Panel's directions.

Conclusions

4.4 The adjustment in respect of the specified domestic transaction relating to allocation of common/head office expenses of Rs. 9,14,01,671 was held to be unjustified.

4.5 The Assessing Officer/Transfer Pricing Officer was directed to exclude Rs. 9,14,01,671 from the total specified domestic transaction base of Rs. 29,82,52,633 considered for transfer pricing adjustment.

Issue 4 - Allocation of finance cost to the eligible unit while computing profit margin for transfer pricing purposes

Interpretation and reasoning

5.1 The Assessing Officer/Transfer Pricing Officer allocated finance cost of Rs. 65,28,298 to the eligible unit out of total finance cost of Rs. 11,81,89,903, on the basis of an allocation key, for purposes of computing the eligible unit's operating margin.

5.2 The assessee contended that: (i) the eligible unit had sufficient internal funds and substantial accumulated profits; (ii) no borrowed funds were utilized by the eligible unit and, in fact, an amount was receivable by the unit from the head office; (iii) no fresh borrowings were raised during the year and existing loans related to other units; and (iv) in earlier years, similar allocation of interest to eligible units had been disallowed by the Tribunal in the context of section 80-IB/80-IC computations.

5.3 The Department argued that: (i) common/head office expenditure, including interest-bearing funds, was incurred for the overall business; (ii) some portion must necessarily have benefitted the eligible unit; and (iii) earlier decisions pertained to computation of deduction under section 80-IB and not to transfer pricing of specified domestic transactions.

5.4 The Tribunal accepted that interest specifically relatable to particular loans used for particular non-eligible units need not be allocated to the eligible unit. However, neither the Assessing Officer nor the assessee had undertaken any exercise to correlate specific loans and related finance cost with specific units.

5.5 In absence of such correlation, the Tribunal considered it necessary to segregate: (i) finance cost directly attributable to particular units; and (ii) residual/common finance cost not linked to any specific unit, for rational allocation across all units.

Conclusions

5.6 The issue of allocation of finance cost, and the quantum to be allocated to the eligible unit, was remanded to the Assessing Officer/Transfer Pricing Officer to:

(a) identify finance cost directly relatable to specific units and exclude such cost from common allocation; and

(b) allocate only the residual/unattributable finance cost among all units, including the eligible unit, on an appropriate allocation key, and thereafter recompute the eligible unit's margin and corresponding transfer pricing adjustment.

5.7 The assessee was placed under an express onus to demonstrate, with evidence, the unit-wise nexus of particular loans and interest expenditure; wherever such nexus was not demonstrated, related interest was to form part of the common pool for allocation.

5.8 This ground was allowed for statistical purposes with directions as above.

Issue 5 - Charging of interest under sections 234B and 234C

Interpretation and reasoning

6.1 The assessee challenged the levy of interest under sections 234B and 234C as a separate ground.

6.2 The Tribunal noted that the levy of such interest was consequential in nature, dependent on the final assessed income after giving effect to its directions on transfer pricing and related issues.

Conclusions

6.3 No separate adjudication on merits of interest under sections 234B and 234C was undertaken; the ground was dismissed as infructuous, the levy being consequential to the final computation of income.

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