Cost Plus Method benchmarking rejected on pass-through raw kit costs, functional dissimilarity, and remand for fresh arm's length determination.

Raw kits supplied by the associated enterprise for assembly and re-export were treated as pass-through material costs, so they were excluded from the assessee's Cost Plus Method cost base because the assessee earned profit only on value-addition services. Astra Microwave Component Ltd. was held not to be functionally comparable since it operated as a full-fledged manufacturing and marketing company, unlike a captive unit performing limited processing for the same enterprise. With the retained comparable rejected, no reliable arm's length benchmark remained; the transfer pricing adjustment was therefore set aside and the matter remitted for fresh arm's length price determination under the appropriate method.

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Issues: (i) whether the purchase cost of raw kits received from the associated enterprise was to be included in the assessee's cost base for applying the Cost Plus Method; (ii) whether Astra Microwave Component Ltd. was a functionally comparable uncontrolled company for benchmarking the international transactions; and (iii) whether the transfer pricing adjustment could be sustained on the basis of the material on record.

Issue (i): whether the purchase cost of raw kits received from the associated enterprise was to be included in the assessee's cost base for applying the Cost Plus Method.

Analysis: Rule 10B(1)(c) requires determination of direct and indirect costs of production and then application of a gross profit mark-up. The raw kits were supplied by the associated enterprise for assembly, partial testing, and re-export back to the same enterprise. The consideration for the kits was treated as a pass through cost, and the assessee's remuneration was only for the value addition services performed on those kits. In such a case, the material cost did not represent a cost on which the assessee earned profit and was therefore excluded from the profit computation.

Conclusion: The raw kits cost was correctly excluded from the assessee's cost base and revenue base for Cost Plus Method benchmarking, in favour of the assessee.

Issue (ii): whether Astra Microwave Component Ltd. was a functionally comparable uncontrolled company for benchmarking the international transactions.

Analysis: Comparability under the transfer pricing rules requires a close functional match. The assessee operated as a captive unit receiving kits from its associated enterprise, carrying out limited value addition, and returning the goods to the same enterprise. Astra Microwave Component Ltd. was found to be a full-fledged manufacturing and marketing concern with materially different functional characteristics. On that basis, it could not serve as a reliable comparable for the assessee's controlled arrangement.

Conclusion: Astra Microwave Component Ltd. was not a proper comparable and was directed to be excluded, in favour of the assessee.

Issue (iii): whether the transfer pricing adjustment could be sustained on the basis of the material on record.

Analysis: Once the only retained comparable was excluded, no reliable comparable uncontrolled transaction remained for a valid arm's length price determination. Sections 92(1) and 92C(1) mandate computation of international transaction income having regard to the arm's length price under an appropriate method. In the absence of usable comparable data, the existing adjustment could not be sustained and the matter required fresh determination by the Transfer Pricing Officer/AO under law, first under the chosen method and, if necessary, under the next suitable method.

Conclusion: The transfer pricing adjustment was set aside and the matter was remitted for fresh arm's length price determination, partly in favour of the assessee.

Final Conclusion: The transfer pricing addition did not survive in its existing form, and the controversy was sent back for a fresh benchmarking exercise after rejecting the retained comparable.

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