ITAT upholds assessee's choice of Resale Price Method over TNMM for transfer pricing benchmarking of trading transactions

The ITAT Ahmedabad ruled in favor of the assessee regarding transfer pricing method selection. The DRP had rejected the assessee's use of Resale Price Method (RPM) for benchmarking international transactions involving both purchases and sales, arguing that various expenses incurred in India added significant value, making gross margin analysis inappropriate. However, the ITAT found the DRP's reasoning general and inadequate. The tribunal held that RPM was the most appropriate method for the trading transactions as demonstrated by the assessee, since the transactions were inter-linked and the assessee had proven arm's length pricing. The TPO was directed to reconsider and apply RPM instead of TNMM for benchmarking purposes.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal include:

- Whether the Assessing Officer (AO) erred in making an upward adjustment of INR 83,30,174 to the total income of the appellant on account of deemed international transactions related to sale of goods and in re-determining the Arm's Length Price (ALP).

- Whether the AO, Transfer Pricing Officer (TPO), and Dispute Resolution Panel (DRP) erred in disregarding the ALP determined by the appellant and rejecting the benchmarking analysis based on the Resale Price Method (RPM) without cogent reasons.

- Whether the goods sold under the arrangement of deemed international transaction attract the status of associated enterprise under section 92A and whether RPM is an appropriate method when transactions involve both purchase and sale from related parties.

- Whether the AO, TPO, and DRP erred in rejecting the appellant's contention that no further allocation of expenses (depreciation, advertisement, travelling, etc.) is warranted for a mere trading activity where no significant value-added functions are undertaken.

- Whether the AO, TPO, and DRP erred in disregarding corroborative analysis showing that gross margin earned from sales to parties covered under deemed international transactions is higher than margin earned from third parties.

- Whether the AO erred in not following DRP directions under section 144(5) to restrict the adjustment to the value of deemed international transactions, thereby acting contrary to section 144C.

- Whether the AO and TPO erred in computing the adjustment amount by incorrectly computing the operating margin of the tested party.

- Whether the AO erred in levying interest under sections 234B and 234D consequential to the aforementioned grounds.

- Whether the AO erred in initiating penalty proceedings under section 270A.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 & 2: Legality and correctness of upward adjustment and rejection of RPM benchmarking

The relevant legal framework comprises sections 92, 92A, 92B, 92C of the Income Tax Act, 1961, and Rules 10B, 10C, and 10D of the Income Tax Rules, 1962, which govern transfer pricing and determination of ALP for international transactions. The RPM is recognized as one of the prescribed methods for benchmarking under section 92C.

The appellant submitted that the TPO and AO erred in rejecting the RPM-based benchmarking analysis without providing cogent reasons, and that the ALP determined by the appellant should have been accepted. The appellant contended that the RPM was methodically applied in its Transfer Pricing Study Report and that no significant value addition warranted further expense allocation.

The DRP and TPO took the view that since the transactions involved both purchase and sale from related parties, the RPM was not appropriate. They also noted that the appellant incurred various expenses adding significant value, thereby invalidating the simple resale price margin analysis.

The Tribunal observed that the DRP's reasoning was general and did not adequately consider the appellant's demonstration that the transactions are inter-linked and that RPM is the most appropriate method for such trading transactions. The Tribunal found that the appellant's benchmarking analysis was methodical and that the RPM method was rightly selected for the transactions under consideration.

Consequently, the Tribunal directed the TPO to reconsider the RPM method and make adjustments accordingly, partly allowing grounds related to rejection of RPM and expense allocation (grounds 2, 4, and 5).

Issue 3: Status of goods sold under deemed international transactions and applicability of RPM

The appellant argued that goods sold under the arrangement of deemed international transactions do not make the transacting party an associated enterprise under section 92A, thus RPM should be accepted. The AO, TPO, and DRP rejected this contention.

The Tribunal did not explicitly rule on the status of associated enterprise under section 92A but implicitly accepted that the transactions fall within the ambit of transfer pricing provisions requiring ALP determination. The Tribunal emphasized that the transactions are interlinked and thus must be aggregated for benchmarking, supporting the use of RPM.

Issue 6: Compliance with DRP directions and rectification under section 154

The appellant contended that the AO failed to follow DRP directions under section 144(5) and section 144C(10) by initially making an addition of Rs. 4,59,51,095 instead of Rs. 83,30,174 as per DRP directions, and that the rectification order passed was suo moto and thus invalid.

The AO submitted that the rectification was made pursuant to the appellant's rectification application dated 19-07-2024, and hence was not suo moto.

The Tribunal held that since the rectification was made following the appellant's application, it could not be considered suo moto. Therefore, the appellant's reliance on precedents regarding suo moto rectification was misplaced. The Tribunal dismissed ground 6 relating to non-compliance with DRP directions.

Issue 7: Computation of operating margin

The appellant argued that the AO and TPO erred in computing the adjustment by incorrectly calculating the operating margin of the tested party. The Tribunal did not elaborate extensively on this ground but by implication, the direction to reconsider RPM benchmarking would involve recalculation of margins consistent with the method.

Issue 8 & 9: Levy of interest and penalty proceedings

The appellant challenged the levy of interest under sections 234B and 234D and initiation of penalty proceedings under section 270A as consequential to the disputed adjustments.

The Tribunal did not specifically address these grounds in detail, implying that these issues are dependent on the resolution of the primary transfer pricing adjustments and hence were not separately adjudicated.

3. SIGNIFICANT HOLDINGS

- "The DRP has considered the benchmarking adopted by the assessee as well as by the TPO as transactions conducted by the assessee i.e. purchase as well as sales are contended and hence it does not fit into the ambit of RPM and consequently because various expenses were incurred by the assessee in India which adds significant value to the sales and hence gross margin analysis cannot be at all as it is not a case simple re-sale."

- The Tribunal found this observation of the DRP to be general and held that "for the transactions related to purchase as well as sales the RPM method is the most appropriate method as demonstrated by the assessee."

- The Tribunal emphasized that "the deemed international transaction of sale of goods have to be aggregated for the purpose of benchmarking and thus the RPM is rightly selected method related to the transactions which are in the nature of trading for benchmarking international transactions."

- On rectification under section 154, the Tribunal held that "the assessee has filed the rectification application which cannot be held as suo moto rectification on the part of the revenue and therefore the decisions referred by the Ld. A.R. will not at all be applicable in the present case."

- The appeal was partly allowed, directing the TPO to reconsider the RPM method and make adjustments accordingly, while dismissing the ground related to non-compliance with DRP directions on rectification.

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