Section 92C – Support services cannot be recharacterized as trading transaction and cost of sales to be excluded while computing Arm’s Length Price (“ALP”); No adjustment to be made where the difference between ALP and price charged is within ±5%.
Facts:
The Taxpayer, an Indian Company, was a wholly owned subsidiary of a Japanese Company (“JCo”). JCo was a general trading company) in Japan playing an important role in linking buyers and sellers of wide range of products. The Taxpayer was engaged in the business of providing support services to various group entities of JCo. The Taxpayer was a facilitator for the transactions entered into by JCo and its group entities.
During the relevant financial year, the Taxpayer had entered into various transactions, which included provision of services, purchase of goods (including capital goods), reimbursement of expenses (payments and receipts) and receipt of interest. The Taxpayer used Transactional Net Margin Method (“TNMM”) as the most appropriate method and used ‘Berry Ratio’ as the Profit Level Indicator (“PLI”) for benchmarking the transaction. It calculated the Berry Ratio by taking into account operating profit and operating expenditure. The Taxpayer contended that its average berry ratio was 1.34 as against 1.09 computed on the basis of the 20 comparables set out in the transfer pricing study and hence the transactions entered into were at arm’s length price.
The tax authority was of the view that data was to be used only for the relevant financial year and cost of sale should be included in the denominator of the PLI used and not the operating expenses.
As regards the support services, the tax authority held that it should be treated equivalent to trading and the income received therefrom should be considered as trading income and comparison should be made accordingly. However, the Taxpayer was of the view that Function, Asset and Risk (“FAR”) analysis of the service business is different from trading business. Hence, the Taxpayer approached DRP. DRP upheld the order of the tax authority. Aggrieved, the Taxpayer appealed before the ITAT.
Held:
Relying on judgment of Delhi High Court in Li & Fung India Pvt. Ltd. vs. CIT [361 ITR 85 (Delhi)], and in Mitsubishi Corporation India (P) Ltd vs. DCIT [ITA No. 5042/Del/11 dated 21.10.2014], it was held that it is impermissible to make notional addition in the cost base and then take into account the costs which are not borne by the Taxpayer. Thus, it was not correct on the part of the tax authority to include the cost of sales incurred by the Associate Enterprises (“AEs”) in respect of which the Taxpayer has rendered services and then to work out the profit for determination of the arm’s length prices1. Thus, Tax Authority was not right in including the cost of sales of AEs while determining ALP.
As per the provisions of section 92C, first the most appropriate method should be determined. Based on that, ALP should be determined by using various comparables. Further, when the difference between the ALP and the cost paid or charged is within the permissible range, no adjustment is required to be made.
Therefore as the margin was within the permissible range of 5%, the adjustment made to ALP was not sustainable and was to be deleted.
