ITAT: ALP between AE and non AE Transcation

Recently on 20th March
2013 in the case of Cybertech Systems
and Software Ltd. ITAT bench rejected assessee's argument that separate ALP
computation not required since non-AE transaction was similar to AE transaction.

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The assessee has raised various grounds
of appeal, but in sum and substance, the entire issue revoives around Transfer
pricing adjustment of Rs.2,44,94,134/- made by the TPO while determining the
arms length price in respect of internationals transaction undertaken with its
Associate Enterprise (AE). Corollary to this issue, assessee has also raised
alternative grounds that firstly, the functional return earned by AE i.e. 12%
of the contract price from the customers is functionally comparable to similar
return of 12% earned by third party non-AE on similar nature of transaction,
therefore, its margin is at ALP; secondly, 12% of the contract price retained
by AE has resulted into loss to AE and, therefore, assessee's profit margin
should be taken at arm's length; thirdly, based on segmental details of AE and
non-AE Internal Transaction Net Margin Method (TNMM) should have been accepted,
as operating margin of total cost earned by the assessee for its AE
transactions is more than operating margin earned on all contracts with similar
transaction with third party; fourthly, while applying external TNMM, the
search process/filters criteria applied by the TPO are improper and has also
objected to the various comparables taken by the TPO.

ITAT observed that, the
application of proposed arm's length requires comparison of conditions in a
controlled transaction with the condition of uncontrolled transaction and for a
difference between the situations, reasonable adjustment of profit can be made
to offset the effect of such difference, if any. Thus such a comparability
analysis has to be carried out to compare the controlled transaction with the
conditions of uncontrolled transactions and then only the arm's length price
can be determined. Once the determination of arm's length price is triggered,
it has to be determined by following any of the prescribed methods under the
statute i.e. prescribed in section 92C of the Act read with Rule 10B. There is
no other way ALP can be examined in transfer pricing mechanism. It is not the
actual price but the price which is applied or proposed to be applied,
following comparability analysis based on any of the prescribed method. Thus ALP
determination must be made by following prescribed methods and not by any other
way.

Further the bench also rejects assessee's
stand that separate ALP computation not required since non-AE transaction was
similar to AE transaction.

The bench also rejected, contention
of Id counsel that once AE has been incurring losses on the margin retained by
it i.e. 12% of the contract price, then assessee's income from such transaction
should be considered at arm's length, because there is no shifting of profits.
Such contention cannot be upheld. Firstly, the details of the margin of the AE
and its expenses are not subject matter of comparability analysis as it is not
the tested party and secondly, assessee's controlled transaction with its AE
has to be judged from the conditions of uncontrolled transaction with
independent parties and then it has to be seen that they are at arm's length.
Whether the AE is incurring losses or profits, cannot be the guiding tool for
arriving at ALP with regard to its transaction with AE. Hence, reject this
contention of Id counsel.

However ITAT bench on "whether
under TNMM method, internal comparable should be taken first or not". Under
TNMM, arm's length price is determined by comparing the operating profit to an
appropriate base i.e. cost, sale, assets of the tested party with the operating
profit of an uncontrolled party engaged in comparable transaction. It compares net margin of profit earned in
uncontrolled transaction by an independent entities against those achieved in
related party transaction. In comparing profit or margin, the comparables are
chosen having functional comparability and these comparables may be internal
comparables or external comparables.

ITAT relied on (2012) TaxCorp
(INTL) 4431 (MUMBAI-TRIB.) accepts assessee's contention that internal TNMM
preferable over external TNMM where segmental data available.