(Oct 19, 2016)
Simultaneous Application Of Two Methods For Benchmarking An International Transaction Is Not Permitted In India TP Regulations
Mori Seiki Co. Ltd. [“the taxpayer”/ “the HO”], operating as a Branch office of Mori Seiki- Japan in India [“India BO”], is primarily engaged in selling machine tools manufactured by the HO in India. During the assessment year under review, the taxpayer provided marketing, sales, post sales, technical and consumer support services to the dealer network of its associated enterprise [“AE/ the HO”] and benchmarked the same by applying Transactional Net Margin Method [“TNMM”].
During assessment proceedings, the assessment officer [“AO”], by relying the terms of the agreement between the HO and its India BO held that the India BO is not only involved in selling of machines manufactured by the HO in India but also participates in determination of price of machines with the HO and thus, is exposed certain crucial business risks. Based on functional, assets and risk [“FAR”] analysis of the India BO and, the AO concluded that the taxpayer constituted a Permanent Establishment [“PE”] and accordingly, by applying the provisions of Rule 10(ii) of Income-tax Rules, 1962, attributed 50% of the gross profit arising from the sales generated from India.
Further, in relation to receipt of commission by India BO from the HO for provision of aforesaid services, the AO, on the ground that since no efforts were made by taxpayer to carry out any FAR analysis, determined the arm’s length price [“ALP”] by applying TNMM using operating margin of comparables at 20% and accordingly made further addition of INR 21.50 lakhs.
The aggrieved taxpayer filed an appeal before the Commissioner of Income tax (Appeals) [“CIT(A)”] who restricted the addition made by the AO amounting to INR 1.42 Cr. to INR 54 lakhs by rejecting AO’s simultaneous application of TNMM and Profit Split Method [“PSM”] for the attribution of gross profit at 50:50 ratio for the same international transaction. The same is not permitted in law either. Aggrieved Revenue authority filed an appeal before the Income Tax Appellant Tribunal [“the ITAT”/ “the Tribunal”].
The ITAT’s Adjudication
- On application of TNMM in subsequent years
The ITAT was in consonance with the CIT(A) in holding that in subsequent year, the Dispute Resolution Panel has considered applied TNMM using Net Cost Plus Margin [“NCPM”] of 5.60% while the taxpayer computed the NCPM of 5.84% for benchmarking similar transaction during the year under review. The ITAT opined that the since the facts during the year under consideration are similar to the facts in the subsequent year on account of identical FAR, therefore, the CIT(A) has rightly applied the NCPM of 5.84% to work out the ALP adjustment.
- On using TNMM and PSM for the same international transaction
The ITAT held that CIT(A) was justified in rejecting the approach of the AO of accepting TNMM and also using PSM for attribution of profit on international transaction at 50:50 ratio on the grounds that either of the two methods could be used and not both for benchmarking the transaction under review. The Tribunal also observed that the lower authorities failed to appreciate the fact that when once the transaction benchmarked under the provisions of Section 92 of the Income Tax Act, 1961 is approved, then there is no need to attribute the profits separately to the taxpayer’s PE. In the light of the same, the Tribunal dismissed the appeal of the Revenue and concluded that CIT(A) is justified in restricting the adjustment to INR 54 lakhs.