Dy. CIT v. Ge Be (P) Ltd. - Taxpublishers.in

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The Tax Publishers2014 TaxPub(DT) 2051 (Bang-Trib) : (2014) 164 TTJ 0040 : (2014) 103 DTR 0033 Dy. CIT v. Ge Be (P) Ltd. INCOME TAX ACT, 1961 --Transfer pricing--Computation of ALPMost appropriate method--As a general rule a cost plus method (CPM) is the most appropriate method in the case of contract manufacture, provided certain adjustments are made for the difference in marketing and selling functions, on the basis of actual expenses incurred by the companies as stipulated in rule 10B(1)(c). The assessee's contention of using TNMM as an alternate approach or method is not in tune with the Indian Transfer Pricing Rules, even though it may be permissible as per OECD Guidelines. As per the Indian Transfer Pricing Rules, the assessee is to select one method as the most appropriate method. The Indian Transfer Pricing Rules do not give any scope or leverage to use different transfer pricing methods. [Para 44] The method can be changed only if there are any changes in the facts, functionalities or availability of data. Assuming that there could be situations where an assessee may be required to change its chosen most appropriate method for the same year between the time of his transfer pricing study and the assessment/appellate proceedings, such a change can happen only if there are any changes in facts, functionalities or availability of data. [Para 45] In the instant case, the assessee has not made out any case or adduced any evidence to demonstrate that there has been any change in the facts, functionalities or availability of data. Nor is it the assessee's case that any of these have been taken wrongly in the transfer pricing study that warrant a change of method has become necessary. The only reason for seeking change of method is that the comparables chosen by the TPO are different from that chosen by the assessee and that the functional profile of the comparables are different. While the aspect of functional difference has been discussed in the later part of the order, can conclude here that the change of method sought by the assessee is not in tune with the Indian Transfer Pricing Rules, which finds support in the UN Transfer Pricing Manual. [Para 46] In the case of a contract manufacturer, most appropriate method is CPM. The UN Practical Transfer Pricing Manual for Developing Countries, 2012, lays down selection of most appropriate method. [Para 47] A careful perusal and analysis of the assessee's submissions before the CIT(A) clearly place the assessee's stated position as one that accepts CPM as the most appropriate method, provided certain adjustments are made for the differences in the marketing and selling functions, based on the actual expenses incurred by the companies. Therefore, it is before the Tribunal that the assessee has changed its stand, stating that TNMM is the most appropriate method and that it would be absurd to consider CPM to be the most appropriate method. TNMM was broached as an alternative approach only during the appellate proceedings. As already held, the concept of alternate approach or use of more than one method is not recognized in Indian Transfer Pricing Rules. The Indian Transfer Pricing Rules recognize use of only one methodâ€”the most appropriate method. Based on the discussions in the pre para of this order, CPM is the most appropriate method in this case. [Para 47] Assessee's arguments proceed on purely theoretical basis without citing as to how the required data of direct and indirect costs of production of the property in the case of the comparable companies chosen by the TPO are not available. No specific instance as to how in the case of comparable companies chosen by the TPO, indirect costs of production have been taken at the net profit level. The other argument was that the assessee is a contract manufacturer and the comparable companies selected should also perform a function performed by a contract manufacturer. If comparable companies perform functions beyond that of a contract manufacturer then they are not comparable. This argument is again general in nature without any particulars on the three comparable companies chosen by the TPO. [Para 49] The argument on behalf of the assessee by placing reliance on para 1.41 of the OECD Guidelines which provides that comparability even where products are different can be undertaken but the functions undertaken should be similar is not applicable in the present case as the TPO has considered both product as well as functional similarity of comparable. The difference in functions performed between the assessee and the comparable, if any, calls only for adjustments to be made, which in the present case can be quantified. Therefore, the claim of the assessee that the comparable chosen has to be rejected cannot be accepted. [Para 50] The argument on behalf of the assessee that Indian Accounting Standards do not give clear-cut requirement for disclosure of gross profits and therefore there will be difficulty in computation of the cost of production and gross profit is again an argument in the air without any specific instance having been pointed out referable to the three comparable companies chosen by the TPO. In any event such differences as laid down in para 2.46 of the OECD Transfer Pricing Guidelines, where the accounting practices differ in the controlled transaction and the uncontrolled transaction, appropriate adjustments should be made to the data used to ensure that the same types of costs are used in each case to ensure consistency. [Para 51] The argument on behalf of the assessee that a contract manufacturer does not perform functions like marketing, selling and distribution, the expenses on marketing, selling and distribution are expenses which will be relevant only when computing net profit and therefore those expenses are irrelevant while applying CPM. Similarity of functions to the gross profit level will only be relevant. In such cases it has to be demonstrated as to how lower net profit and higher gross profit takes a comparable company out of the comparability. Alternatively, it can be shown as to why the gross margin of the comparable company need to be reduced because of items which are required to be considered while determining the gross margin have been considered only for determining net margin in the case of comparable companies. In that event appropriate adjustment to the gross margin of the comparable companies can be made. [Para 52] It thus seen that the assessee has not been able to point out as to how CPM is not the most appropriate method in the present case. It can therefore be concluded that CPM, on the facts and circumstances of the present case, is the most appropriate method. [Para 53] It is however seen that the TPO has not given any weightage to the various aspects pointed out by the assessee which call for making appropriate adjustments to the margins of the comparable companies, as required under rule 10B(1)(c)(iii), (iv) and (v) of the Rules. The computation of adjustment at 8 per cent made by TPO is not backed by proper reasoning or rationale. The comparables selected by the TPO perform additional functions in the nature of selling and marketing thus evidencing functional differences with the appellant. This fact has been acknowledged by the TPO, but while giving adjustment, the TPO has computed the adjustment at an ad hoc figure of 8 per cent. In view of the difference in functions, the assessee is entitled to adjustments which are reliable and accurate, as stipulated in rule 10C(2)(e). If such adjustments are provided on actual basis, the difference in the functional profile with the comparable companies gets quantified as provided in rule 10B(1)(c)(iii) as applicable to cost plus method (CPM). In the absence of such adjustment, a mere application of CPM on comparables with different functional profile will not be in tune with the Transfer Pricing Rules. Therefore, as CPM is adopted as the most appropriate method, the assessee should be allowed adjustment on actual basis, which will be reliable and accurate, as stipulated in rule 10C(2). Needless to add, the TPO will afford opportunity of hearing to the assessee with leave to file detailed submissions in this regards, if necessary. [Para 54] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2014 TaxPub(DT) 2051 (Bang-Trib) : (2014) 164 TTJ 0040 : (2014) 103 DTR 0033

Dy. CIT v. Ge Be (P) Ltd.

INCOME TAX ACT, 1961

--Transfer pricing--Computation of ALPMost appropriate method--As a general rule a cost plus method (CPM) is the most appropriate method in the case of contract manufacture, provided certain adjustments are made for the difference in marketing and selling functions, on the basis of actual expenses incurred by the companies as stipulated in rule 10B(1)(c).

The assessee's contention of using TNMM as an alternate approach or method is not in tune with the Indian Transfer Pricing Rules, even though it may be permissible as per OECD Guidelines. As per the Indian Transfer Pricing Rules, the assessee is to select one method as the most appropriate method. The Indian Transfer Pricing Rules do not give any scope or leverage to use different transfer pricing methods. [Para 44] The method can be changed only if there are any changes in the facts, functionalities or availability of data. Assuming that there could be situations where an assessee may be required to change its chosen most appropriate method for the same year between the time of his transfer pricing study and the assessment/appellate proceedings, such a change can happen only if there are any changes in facts, functionalities or availability of data. [Para 45] In the instant case, the assessee has not made out any case or adduced any evidence to demonstrate that there has been any change in the facts, functionalities or availability of data. Nor is it the assessee's case that any of these have been taken wrongly in the transfer pricing study that warrant a change of method has become necessary. The only reason for seeking change of method is that the comparables chosen by the TPO are different from that chosen by the assessee and that the functional profile of the comparables are different. While the aspect of functional difference has been discussed in the later part of the order, can conclude here that the change of method sought by the assessee is not in tune with the Indian Transfer Pricing Rules, which finds support in the UN Transfer Pricing Manual. [Para 46] In the case of a contract manufacturer, most appropriate method is CPM. The UN Practical Transfer Pricing Manual for Developing Countries, 2012, lays down selection of most appropriate method. [Para 47] A careful perusal and analysis of the assessee's submissions before the CIT(A) clearly place the assessee's stated position as one that accepts CPM as the most appropriate method, provided certain adjustments are made for the differences in the marketing and selling functions, based on the actual expenses incurred by the companies. Therefore, it is before the Tribunal that the assessee has changed its stand, stating that TNMM is the most appropriate method and that it would be absurd to consider CPM to be the most appropriate method. TNMM was broached as an alternative approach only during the appellate proceedings. As already held, the concept of alternate approach or use of more than one method is not recognized in Indian Transfer Pricing Rules. The Indian Transfer Pricing Rules recognize use of only one methodâ€”the most appropriate method. Based on the discussions in the pre para of this order, CPM is the most appropriate method in this case. [Para 47] Assessee's arguments proceed on purely theoretical basis without citing as to how the required data of direct and indirect costs of production of the property in the case of the comparable companies chosen by the TPO are not available. No specific instance as to how in the case of comparable companies chosen by the TPO, indirect costs of production have been taken at the net profit level. The other argument was that the assessee is a contract manufacturer and the comparable companies selected should also perform a function performed by a contract manufacturer. If comparable companies perform functions beyond that of a contract manufacturer then they are not comparable. This argument is again general in nature without any particulars on the three comparable companies chosen by the TPO. [Para 49] The argument on behalf of the assessee by placing reliance on para 1.41 of the OECD Guidelines which provides that comparability even where products are different can be undertaken but the functions undertaken should be similar is not applicable in the present case as the TPO has considered both product as well as functional similarity of comparable. The difference in functions performed between the assessee and the comparable, if any, calls only for adjustments to be made, which in the present case can be quantified. Therefore, the claim of the assessee that the comparable chosen has to be rejected cannot be accepted. [Para 50] The argument on behalf of the assessee that Indian Accounting Standards do not give clear-cut requirement for disclosure of gross profits and therefore there will be difficulty in computation of the cost of production and gross profit is again an argument in the air without any specific instance having been pointed out referable to the three comparable companies chosen by the TPO. In any event such differences as laid down in para 2.46 of the OECD Transfer Pricing Guidelines, where the accounting practices differ in the controlled transaction and the uncontrolled transaction, appropriate adjustments should be made to the data used to ensure that the same types of costs are used in each case to ensure consistency. [Para 51] The argument on behalf of the assessee that a contract manufacturer does not perform functions like marketing, selling and distribution, the expenses on marketing, selling and distribution are expenses which will be relevant only when computing net profit and therefore those expenses are irrelevant while applying CPM. Similarity of functions to the gross profit level will only be relevant. In such cases it has to be demonstrated as to how lower net profit and higher gross profit takes a comparable company out of the comparability. Alternatively, it can be shown as to why the gross margin of the comparable company need to be reduced because of items which are required to be considered while determining the gross margin have been considered only for determining net margin in the case of comparable companies. In that event appropriate adjustment to the gross margin of the comparable companies can be made. [Para 52] It thus seen that the assessee has not been able to point out as to how CPM is not the most appropriate method in the present case. It can therefore be concluded that CPM, on the facts and circumstances of the present case, is the most appropriate method. [Para 53] It is however seen that the TPO has not given any weightage to the various aspects pointed out by the assessee which call for making appropriate adjustments to the margins of the comparable companies, as required under rule 10B(1)(c)(iii), (iv) and (v) of the Rules. The computation of adjustment at 8 per cent made by TPO is not backed by proper reasoning or rationale. The comparables selected by the TPO perform additional functions in the nature of selling and marketing thus evidencing functional differences with the appellant. This fact has been acknowledged by the TPO, but while giving adjustment, the TPO has computed the adjustment at an ad hoc figure of 8 per cent. In view of the difference in functions, the assessee is entitled to adjustments which are reliable and accurate, as stipulated in rule 10C(2)(e). If such adjustments are provided on actual basis, the difference in the functional profile with the comparable companies gets quantified as provided in rule 10B(1)(c)(iii) as applicable to cost plus method (CPM). In the absence of such adjustment, a mere application of CPM on comparables with different functional profile will not be in tune with the Transfer Pricing Rules. Therefore, as CPM is adopted as the most appropriate method, the assessee should be allowed adjustment on actual basis, which will be reliable and accurate, as stipulated in rule 10C(2). Needless to add, the TPO will afford opportunity of hearing to the assessee with leave to file detailed submissions in this regards, if necessary. [Para 54]