2024 (9) TMI 739 - HC - Income Tax

TPO cannot reject internal comparables based solely on transaction size when determining arm's length pricing

THE COMMISSIONER OF INCOME TAX- INTERNATIONAL TAXATION -2 Versus LUMMUS TECHNOLOGY HEAT TRANSFER BV

Delhi HC upheld ITAT's decision rejecting TPO's arm's length price adjustment. TPO incorrectly rejected internal comparables solely based on transaction ... TP Adjustment - Comparability selection - attribution of profits between the respondent assessee and the foreign Associated Enterprise [“AE”] - TPO appears to have been influenced by the sheer size of the transaction set which was undertaken between the respondent assessee and its foreign AE, thus taken the view that internal comparables would not be acceptable - HELD THAT:- ITAT held if the size of the uncontrolled transaction is too small, it may provoke an inquiry by the TPO to ensure that it is not a contrived transaction outside the normal course of business or with regard to other significant factors surrounding smallness of such transaction. However, in our considered view, in none of these cases, a comparable can be rejected on the basis of its size per se. In this view of the matter, the authorities below were clearly in error in rejecting the internal comparable, i.e. profitability of assessee's transactions with Non AEs, on the ground that the volume of business with non AEs was too small vis-a-vis business with AEs. As also bearing in mind entirety of the case, the assessee was quite justified in adopting internal TNMM and comparing the profit earned on its transactions with AEs with profit earned with Non AEs. Accordingly, the ALP adjustment deserves to be deleted. ​​​​​​We find no justification to interfere with the view as expressed. As decided in Sony Ericsson Mobile Communications India P. Ltd [2015 (3) TMI 580 - DELHI HIGH COURT] identification of the potential comparables is the key to the transfer pricing analysis. As a sequitur, it follows that the choice of the most appropriate method would be dependent upon the availability of potential comparable keeping in mind the comparability analysis including befitting adjustments which may be required. As the degree of the comparability increases, extent of potential differences which would render the analysis inaccurate necessarily decreases. Attribution of profits between the assessee and foreign Associated Enterprise (AE) - Following the principle of consistency, we find no justification to entertain these appeals on the issue of attribution. They consequently fail and shall stand dismissed. Issues:1. Transfer pricing adjustment and attribution of profits between the assessee and foreign Associated Enterprise (AE).Analysis:1. The primary issue in the appeals pertains to the transfer pricing adjustment and the attribution of profits between the respondent assessee and its foreign AE for Assessment Years 2009-10 and 2007-08. The Transfer Pricing Officer (TPO) had sought to make adjustments based on the size of the transaction set between the parties.2. The Income Tax Appellate Tribunal (ITAT) considered the matter and referred to a previous assessment year's decision where it was held that for computing the arm's length price under the Transactional Net Margin Method (TNMM) based on internal comparables, it is not necessary for the net profit computations to be based on audited books of accounts. The ITAT concluded that the TPO erred in rejecting the segmental accounts and internal comparables based on size differences alone, as long as the net profits from controlled transactions were equal to or higher than uncontrolled transactions.3. The judgment further highlighted the importance of functional analysis in transfer pricing, emphasizing the need for comparability analysis between controlled and uncontrolled transactions. The choice of the most appropriate method depends on the availability of potential comparables and the extent of adjustments required for accurate analysis.4. Regarding the issue of attribution, the court noted the principle of consistency in previous decisions favoring the respondent assessee for AYs 2006-07 and 2008-09. As the Revenue Department had only filed an appeal on the transfer pricing issue for AY 2009-10, the court found no justification to entertain the appeals on the attribution issue, leading to the dismissal of the appeals.5. In conclusion, based on the decisions rendered on the transfer pricing adjustment and attribution issues, the appeals were dismissed, and it was acknowledged that the questions raised in another related appeal would not survive in light of the judgment.