Low-risk distributor wins transfer pricing case using Berry ratio under TNMM over net cost plus method

ITAT DELHI ruled in favor of the assessee regarding transfer pricing adjustments in distribution operations. The tribunal held that the assessee, functioning as a low-risk distributor providing only logistics and administrative services without inventory maintenance or value addition, correctly applied Berry ratio as the profit level indicator under TNMM instead of the net cost plus margin method adopted by TPO. The tribunal found the assessee's approach reasonable since it excluded cost of goods from the denominator, similar to comparable companies. Consequently, transfer pricing adjustments for both distribution and manufacturing segments were deleted. Regarding interest under section 234A, the tribunal directed AO to verify if the return was filed within the extended deadline per CBDT Circular 1/2022, potentially exempting the assessee from delay-related interest charges.

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ISSUES:

Whether the Berry Ratio (Gross Profit/Value Added Expenses) is an appropriate Profit Level Indicator (PLI) for determining Arm's Length Price (ALP) of international transactions of a limited risk distributor engaged in distribution activities.Whether the Transactional Net Margin Method (TNMM) with Net Cost Plus Margin (Operating Profit/Operating Cost) as PLI is appropriate for benchmarking distribution segment transactions instead of Berry Ratio.Whether the Transfer Pricing Officer (TPO) and Assessing Officer (AO) erred in rejecting the 'Other method' applied by the assessee for benchmarking international transactions in the distribution segment.Whether the AO erred in making transfer pricing adjustments in the manufacturing segment contrary to directions of the Dispute Resolution Panel (DRP).Whether the AO erred in levying interest and initiating penalty proceedings under the Act.Whether working capital adjustments under Rule 10B(1)(e)(iii) and Rule 10B(3) should have been allowed to account for material differences between comparables and the assessee.Whether the DRP violated principles of natural justice by not adjudicating the issue of working capital adjustment.Whether interest under sections 234A and 234B of the Act was rightly levied considering the filing of returns within extended due dates.

RULINGS / HOLDINGS:

The Berry Ratio (Gross Profit/Value Added Expenses) is held to be the most appropriate PLI for the distribution segment of a limited risk distributor engaged in back-to-back trading with minimal functions and risks, as it "effectively captures all functions performed and risks undertaken by the Assessee" and excludes the cost of goods sold as a non-value-added expense.The application of TNMM with Net Cost Plus Margin as PLI for the distribution segment was rejected, as the assessee's limited risk profile and functional analysis do not justify inclusion of cost of goods in the PLI denominator.The 'Other method' adopted by the assessee for benchmarking distribution transactions is accepted, and the transfer pricing adjustment made by AO/TPO on this count is deleted.The AO erred in applying TNMM for the manufacturing segment contrary to the DRP's direction to apply the 'Other method'; accordingly, the adjustment made in the manufacturing segment is deleted.Interest levied under the Act is to be recalculated based on the income computed after giving effect to the Tribunal's order; penalty proceedings under section 270A are premature and dismissed.Adjustments under Rule 10B(1)(e)(iii) and Rule 10B(3) for material differences including working capital were not adjudicated by the DRP, constituting a violation of principles of natural justice; grounds relating to this issue are allowed.Interest under section 234A will not be charged if the return was filed within the extended due date as per CBDT Circular No.1/2022; interest under section 234B is consequential and to be computed after giving effect to the Tribunal's order.

RATIONALE:

The legal framework applied includes sections 92, 92C, 143(3), 144B, 144C(13), 234A, 234B, and 270A of the Income Tax Act, 1961, and Rule 10B(1)(e) and 10B(3) of the Income Tax Rules.The Tribunal relied on authoritative judicial precedents including Sumitomo Corporation India (P.) Ltd. v. CIT and Mitsubishi Corporation India (P.) Ltd. v. Dy. CIT, which recognize the Berry Ratio as appropriate for limited risk distributors with minimal functions and risks, where profits are linked to operating expenses rather than the value of goods sold.OECD Transfer Pricing Guidelines (2022) and United Nations Practical Manual on Transfer Pricing for Developing Countries (2021) were cited to support the applicability of the Berry Ratio in intermediary distribution activities where resale price and cost plus methods are unsuitable.The Tribunal emphasized the assessee's functional analysis, asset base, and risk profile, concluding that the assessee operates as a limited risk distributor with back-to-back purchase-sale contracts, no inventory holding, and no significant value addition.The DRP's directions to adopt transaction-by-transaction approach and reject TNMM for manufacturing segment were binding; AO's contrary application of TNMM was held erroneous.The Tribunal recognized that Rule 10B(1)(e) allows flexibility in selecting the relevant base for computing net profit margin, including the Berry Ratio, which is a ratio of gross profit to operating expenses.The Tribunal held that failure of the DRP to adjudicate working capital adjustment issues violated principles of natural justice, warranting relief to the assessee.Interest and penalty issues were considered in light of procedural compliance and statutory provisions, with directions to recompute interest post-order and dismissal of premature penalty proceedings.

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