Transfer pricing adjustments under TNMM must be restricted to international transactions only, not entire manufacturing segments

ITAT Mumbai ruled that when TNMM is applied as the Most Appropriate Method for transfer pricing adjustments, the adjustment should be restricted to international transactions only, not applied at the entity level across the entire manufacturing segment. The Tribunal followed HC precedents establishing that TPO cannot make adjustments to the complete manufacturing activity segment. Additionally, the assessee was granted the benefit of the +/-5% tolerance range under Section 92C(2) proviso. After applying this tolerance range, no adjustment remained, confirming the transaction was at arm's length. The assessee's appeal was allowed.

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Issues Involved:

1. Whether the CIT(A) erred in deleting the disallowance/adjustment made by the Transfer Pricing Officer (TPO) by upholding the CUP method over the TNMM method for A.Y. 2010-11 and 2011-12.
2. Whether adjustments should be applied to international transactions only or at the entity level.
3. The applicability of the +/- 5% tolerance range under Section 92C(2) for determining the Arm's Length Price (ALP).

Detailed Analysis:

1. Methodology for Determining ALP:

The primary issue was whether the CIT(A) erred in deleting adjustments made by the TPO, who applied the Transactional Net Margin Method (TNMM) instead of the Comparable Uncontrolled Price (CUP) method adopted by the assessee. The TPO had previously applied TNMM in earlier years (A.Y. 2005-06 to 2007-08), which was upheld by the ITAT. However, the assessee argued that the CUP method had been consistently accepted in subsequent years, including A.Y. 2006-07 to 2009-10, and the High Court had confirmed the ITAT's decision for A.Y. 2005-06 and 2006-07. The Tribunal noted that the issue had been consistently discussed and resolved in favor of the assessee in previous orders, acknowledging the CUP method as a valid approach for benchmarking transactions.

2. Scope of Adjustments:

The Tribunal examined whether adjustments should be made at the entity level or restricted to international transactions. The TPO had made adjustments based on the entire segment of manufacturing activities, which the Tribunal found inappropriate. The Tribunal emphasized that adjustments should be restricted to international transactions only, aligning with the decisions of the Bombay High Court in similar cases. The Tribunal reiterated that the TPO was not justified in making adjustments to the entire segment of manufacturing activity, and such adjustments should be confined to the international transactions of import of goods.

3. Application of +/- 5% Tolerance Range:

The Tribunal addressed the issue of applying the +/- 5% tolerance range under Section 92C(2) for determining the ALP. It was argued that if the adjustments were restricted to international transactions and the tolerance range was considered, the transactions would fall within the permissible limits, negating the need for adjustments. The Tribunal accepted this argument, directing the TPO to apply TNMM but restrict adjustments to the international transactions and grant the benefit of the tolerance range. The Tribunal's decision was based on prior judgments, including those of the Bombay High Court, which had established that adjustments should only be made concerning international transactions and not the entire entity's operations.

Conclusion:

The appeals of the Revenue were dismissed, and the cross-objections of the assessee were allowed. The Tribunal concluded that no adjustments were necessary for the years in question, as the transactions were within the arm's length range when considering the +/- 5% tolerance. The Tribunal's order reaffirmed the consistent application of the CUP method for the assessee's transactions and restricted the scope of adjustments to international dealings, aligning with established legal precedents.

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