Benchmarking guarantee processing fees using TNMM upheld, transfer pricing adjustment deleted under consistency principle

The ITAT Mumbai held that the assessee's benchmarking of international transactions relating to processing fees from guarantees using TNMM as the most appropriate method was correct. The tribunal relied on its coordinate bench decision in the assessee's own case and noted that identical transactions were previously accepted by the TPO until AY 2012-13. Applying the consistency principle established in Radhasoami Satsang, the tribunal directed deletion of the transfer pricing adjustment made by the TPO, as there was no change in facts and circumstances from earlier years. The assessee's appeal was allowed.

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1. ISSUES PRESENTED and CONSIDERED

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

• Whether the determination of the arm's length price (ALP) of the international transaction relating to processing fees received on account of guarantees issued by the assessee to Indian companies based on counter-guarantees from overseas branches was correctly computed by the Assessing Officer (AO) and Dispute Resolution Panel (DRP).
• Whether the rejection of the Transactional Net Margin Method (TNMM) adopted by the assessee and the adoption of the External Comparable Uncontrolled Price (CUP) method as the Most Appropriate Method (MAM) for benchmarking the guarantee fee transaction was justified.
• Whether the final assessment order passed under section 143(3) read with section 144C(3) of the Income-tax Act, 1961 (the "Act") is valid if passed beyond the prescribed timelines under section 153 of the Act.
• Whether the initiation of penalty proceedings under section 270A of the Act for under-reporting of income was justified.
• Whether the levy of interest under section 234A of the Act was proper.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Determination of ALP of processing fees on guarantees issued based on counter guarantees from overseas branches

Relevant legal framework and precedents: The ALP determination is governed by the transfer pricing provisions under the Income-tax Act, 1961, specifically sections 92 to 92F and Rule 10B of the Income Tax Rules. The methods prescribed include CUP, TNMM, and others, with the MAM to be selected based on reliability and comparability. The Tribunal relied on its own earlier coordinate bench decisions in the assessee's own case for AY 2012-13 and 2013-14, which dealt with identical facts and held that TNMM was the appropriate method in such circumstances. The Tribunal also referred to judicial precedent from the Hon'ble Bombay High Court and this Tribunal's decision in Asian Paints Ltd. regarding the inapplicability of CUP when reliable data is unavailable.

Court's interpretation and reasoning: The Tribunal examined the nature of the transaction wherein the assessee, a branch of an overseas bank, issued guarantees to Indian beneficiaries based on back-to-back counter guarantees from its overseas associated enterprises (AEs). The Tribunal noted that the assessee merely provided administrative or secretarial services related to processing the guarantees and did not bear any credit or foreign exchange risk, as the overseas AE fully indemnified the assessee. The Tribunal held that, given the absence of risk and the nature of the services, the assessee was the least complex entity and thus the tested party for benchmarking.

Key evidence and findings: The assessee submitted detailed documentation including swift messages evidencing the back-to-back guarantees and the processing fees charged. The AO and Transfer Pricing Officer (TPO) had rejected the TNMM method and comparables used by the assessee, instead adopting an external CUP method based on data collected from seven banks under section 133(6) of the Act. The TPO benchmarked the guarantee fee at 1.3% (1.8% median rate less 0.5% adjustment), whereas the assessee charged an average of 0.33%. The AO made an upward adjustment of INR 2,25,13,339.

Application of law to facts: The Tribunal found that the CUP method was not appropriate due to the lack of reliable comparable data, the generic and incomplete nature of information obtained under section 133(6), and the inability to make adjustments for differences as required under Rule 10B(1)(a). The Tribunal emphasized that the assessee's functions were limited to administrative processing with no risk assumption, making TNMM the more reliable and appropriate method. The Tribunal also highlighted consistency with previous years' accepted methodology and the principle of consistency as upheld by the Supreme Court.

Treatment of competing arguments: The Department argued in favor of CUP based on market data from other banks, contending that the fees charged by the assessee were below ALP. The assessee countered that the data was incomplete, not publicly available, and not comparable due to differences in risk profiles and functions. The Tribunal accepted the assessee's arguments, noting the absence of risk borne by the assessee and the support service nature of the transaction.

Conclusions: The Tribunal held that TNMM was the Most Appropriate Method for benchmarking the guarantee fee transaction and that the adjustment made by the AO/TPO using CUP was unsustainable. The Tribunal directed deletion of the transfer pricing adjustment of INR 2,25,13,339 and allowed grounds 1 and 2 raised by the assessee.

Issue 2: Validity of final order passed beyond the timelines prescribed under section 153 of the Act

Relevant legal framework: Section 153 prescribes the time limit for passing assessment orders. The issue was whether the final order passed under section 143(3) read with section 144C(3) was time-barred.

Court's interpretation and reasoning: Since the Tribunal decided the appeal in favor of the assessee on merits, it left this issue open for adjudication. No detailed analysis or decision was rendered on this ground.

Conclusions: Ground no. 3 was left open for adjudication.

Issue 3: Initiation of penalty proceedings under section 270A of the Act for under-reporting of income

Relevant legal framework: Section 270A provides for penalty for under-reporting of income in income tax proceedings.

Court's interpretation and reasoning: Since the appeal was allowed on merits and the transfer pricing adjustment deleted, the penalty proceedings based on the adjustment were consequential and not independently adjudicated.

Conclusions: Ground no. 4 was consequential and not decided.

Issue 4: Levy of interest under section 234A of the Act

Relevant legal framework: Section 234A imposes interest for delay in filing return of income.

Court's interpretation and reasoning: As with penalty, since the substantive appeal was allowed, the interest levy was consequential and not independently considered.

Conclusions: Ground no. 5 was consequential and not decided.

3. SIGNIFICANT HOLDINGS

The Tribunal's crucial legal reasoning is encapsulated in the following verbatim excerpt from the coordinate bench decision relied upon:

"At the outset, we find that overseas branches of ANZ have clients who require guarantees to be issued to the beneficiaries in India. Since the beneficiaries are situated in India, the overseas branches of ANZ are situated in India. The overseas branches of ANZ request the assessee to provide such guarantees to the beneficiaries and in turn provide a back to back inter-bank guarantee / indemnity to assessee to cover any financial liability that assessee may incur in connection with guarantees issued to Indian beneficiaries on behalf of overseas ANZ branches. This is the prime function / activity carried out by the assessee with regard to the impugned international transaction. In case where the client of the overseas branch defaults and the guarantee would be invoked then, under the back to back guarantee issued to assessee, the overseas branch would make payments to assessee which would onward then make the payment to the beneficiary in India."

"Hence, from the aforesaid modus operandi, it could be concluded that assessee acts as a beneficiary bank i.e. issue guarantee in India on behalf of clients of overseas branches of ANZ based on the counter guarantee issued by such overseas ANZ branches. Since assessee is acting as the beneficiary, the entire risk of discharging the bank guarantees is borne by overseas ANZ branch issuing the counter guarantee. The assessee merely provides support service in connection with processing of the guarantees, typing out the guarantee agreement based on swift message received and issuing the said agreement to the beneficiary. The aforesaid functions performed by the assessee are not disputed by the lower authorities."

"When assessee is fully protected by overseas counter guarantee, we are unable to comprehend ourselves as to how CUP method could be applied therein as it would be impossible to make adjustment for the differences as per Rule 10B(1)(a) of the Income Tax Rules. In effect, we find that assessee is merely providing secretarial services or which can be loosely called as carrying out administrative functions. It is not in dispute that the assessee does not bear any risk in its books as it is fully protected by overseas counter guarantee / indemnity."

"Given these undisputed facts, it would be appropriate to consider assessee as the tested party as it would be the least complex entity and its profitability could be reliably ascertained. Admittedly, the transaction which requires to be benchmarked is the receipt of processing fees by the assessee for the guarantees issued by rendering the aforesaid secretarial services. Hence, what is to be looked into is under similar terms and conditions and under similar circumstances what is the guarantee fee charged by the third party comparables from their AEs. This is what precisely assessee has done in the instant case."

"Hence, when the data under CUP method is not available and data of margins under TNMM is readily available, then it would be appropriate to apply TNMM method as the Most Appropriate Method (MAM) in the facts and circumstances of the instant case."

Core principles established include:

• The appropriateness of TNMM as the Most Appropriate Method when CUP data is unavailable or unreliable, especially where the tested party performs only low-end administrative functions without bearing risk.
• The necessity to consider the actual functions, assets, and risks borne by the tested party in selecting the transfer pricing method.
• The importance of consistency in transfer pricing positions across assessment years, in line with the principle upheld by the Supreme Court.
• The inadmissibility of using incomplete, generic, or non-public data obtained under section 133(6) of the Act for CUP benchmarking without adequate adjustments.
• The recognition that a back-to-back guarantee transaction where the tested party is fully indemnified by overseas AEs involves negligible risk, thus rendering high guarantee fees charged by unrelated parties not comparable.

Final determinations on each issue are:

• Grounds 1 and 2: Allowed. The transfer pricing adjustment based on CUP method was deleted, and TNMM was held to be the appropriate method.
• Ground 3: Left open for adjudication as the appeal was allowed on merits.
• Grounds 4 and 5: Consequential in nature and not adjudicated.

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