One profit level indicator of a comparable

HC: Tribunal was wrong in holding that if one profit level indicator of a comparable

Whether, in view of the first proviso to section 92C(2) of the Income-tax Act, 1961, the Tribunal was correct in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator of the taxpayer, then the transactions reported by the taxpayer is at an arm’s length price as contemplated in sections 92, 92C and other related provisions of the said Act?”

ITAT bench in the case reported in (2007) TaxCorp (TP) 2314 ruled in favour of assessee holding that TPO did not keep into account fact that most of business risk such as contract risk, market risk, credit risk, warranty risk, price risk, etc., were essentially borne by parent company and the fact that assessee did not own any valuable intangibles, parent had provided necessary intangible such as software and other proprietary tools and process to carry out software development. In selecting comparables, TPO chose transactions which included transactions with related parties and used had used data for financial year 2003-04 to verify transactions of financial year 2001-02 after prohibiting assessee to use data for any year other than financial year 2001-02. Futher ITAT also observed that  ld. TPO did not take into account specific characteristics of controlled transaction while searching for comparable and failed to apply FAR test to controlled or potentially comparable uncontrolled companies/transactions. Ld. TPO selected five companies for comparison, material on record did not show that TPO cared to know size of those companies and there was no mention of characteristics of companies selected and whether those companies had any intangible properties or what was ratio of fixed and operating assets carried out by TPO and whether those companies were also low risk companies like that of assessee. ITAT also held that analysis was necessary in terms of para 1.47 of OECD guideline which was not done and reliance on para 7.27 of OECD Guidelines by TPO was out of context. ITAT bench held that it could be concluded that since TPO did not apply mandatory provisions of rule 10B or guidelines issued by OECD on transfer pricing and assessee, on other hand, had carried out proper screening of comparable companies carrying business of software in India and exporting services and goods abroad and it took into account characteristics of its company in question for relevant assessment year and thereafter made selection of company after applying functional test with reference to assets employed and risk assumed by those companies, ALP determined by TPO was not sustainable, and, therefore, addition on that account was unjustified.

Revenue has appealed before Hon`ble high court against ITAT's ruling.

Hon`ble High court observed that the provisions of sub-section (3) of section 92C, provision makes it clear that if the assessing officer in the course of any proceeding of assessment, on the basis of material or information or documents in his possession, is of the opinion that any of the 4 conditions (a) to (d) stipulated in sub-section (3) are satisfied then, the assessing officer may proceed to determine the arm’s length price in relation to the international transaction in accordance with the provisions of sub-section (1) and sub-section (2) of section 92C on the basis of such material or information or documents available with him. Provided, of course, that an opportunity is given by the assessing officer to the assessee to show cause as to why the arm’s length price should not be so determined on the basis of material or information or document in the possession of the assessing officer. In other words, in the aforesaid circumstances the assessing officer may himself embark upon the determination of the arm’s length price. However, where the assessing officer considers it necessary to do so, he may with the previous approval of the commissioner, refer the computation of the arm’s length price to the Transfer Pricing Officer.

Hon`ble High court held that, the Tribunal had gone further and reduced the list of comparables to merely four as indicated in paragraph 46 of the impugned order. We do not think that it was the right approach to be adopted by the Tribunal. The Tribunal should have stopped at the point where it decided on facts that the comparables given by the respondent/assessee were to be accepted and those searched by the Transfer Pricing Officer were to be rejected. The only option then left to the Tribunal was to derive the arithmetical mean of the profit level indicators of the comparables which were accepted by it. In this case such comparables happen to be those of the respondent/assessee. The Tribunal, in selecting only one profit level indicator out of a set of profit level indicators had clearly erred in law.

The respondent/assessee’s case inasmuch as even if the arithmetical mean of the comparables as accepted by the Tribunal are taken into account, the profit level indicator would, whether the seven companies are taken into consideration or all eight companies are taken into consideration, be less than 6.99 % which is the profit level indicator of the respondent/assessee for the relevant year, that is, financial year ending 31.03.2002. We may also make it clear that the reference to the OECD guidelines by the Tribunal in the impugned order are in the context of the reliance placed by the Transfer Pricing Officer on the very same guidelines, in particular, to paragraph 3.27 thereof. In the present case, there are specific provisions of sub-rules (2) and (3) of Rule 10B of the said Rules as also of the first proviso to section 92C(2) of the said Act which apply. Therefore, the question of applying OECD guidelines does not arise at.

It is clear that the Tribunal was wrong in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator of the taxpayer, then the transaction reported by the taxpayer is at an arm’s length price. The proviso to section 92C(2) is explicit that where more than one price is determined by most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices. To this extent the appeal is allowed. However, as pointed out above, if this principle is applied to the comparables suggested by the assessee (which have not been rejected by the Transfer Pricing Officer), the arm’s length price suggested by the assessee would yet be acceptable in law.

Also Read: (2012) TaxCorp (TP) 0190, ITAT bench observed that In a Transfer Pricing matter, the Tribunal had to consider whether for purposes of making adjustment under Rule 10B (1)(e)(iii) ‘working capital’ constituted a ‘difference between the international transactions and the comparable uncontrolled transactions of between the enterprises entering into such transactions’ and if so whether the said difference ‘could materially affect’ the amount of net profit margin of relevant transactions in the open market.

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Rupesh Srivastava

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