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2022 (5) TMI 1679 - AT - Income Tax


The core legal questions considered in this appeal pertain to the correctness and scope of Transfer Pricing (TP) adjustments made by the Assessing Officer (AO) and the Dispute Resolution Panel (DRP) under the Income-tax Act, specifically:
  • Whether the AO and DRP erred in not allowing adjustment for non-cenvatable basic customs duty paid by the assessee, given the significantly higher import content (85%) in comparison to comparable companies (16.10%).
  • Whether the customs duty paid by the assessee should be eliminated from the comparability analysis under the Transactional Net Margin Method (TNMM) due to its extraordinary nature and the initial year of operations.
  • Whether the AO/DRP failed to consider the detailed submissions and justifications provided by the assessee regarding customs duty adjustments.
  • Whether the customs duty cost could be recouped from customers, and if not, whether it qualifies as an extraordinary cost warranting adjustment.
  • Whether the TP adjustment should be restricted to international transactions with Associated Enterprises (AEs) rather than applied at the entire entity level, including third-party transactions.
  • Whether the procedural requirements under Section 144C of the Income-tax Act, including the role and powers of the DRP, AO, and Transfer Pricing Officer (TPO), and the principles of natural justice, were adhered to in the assessment process.

The first issue concerns the adjustment for basic customs duty paid by the assessee, which was not allowed by the AO/DRP. The legal framework involves the application of the TNMM under the Income-tax Act for benchmarking international transactions between the assessee and its AEs. The Tribunal's earlier orders and established precedents recognize that non-cenvatable customs duty, especially when incurred disproportionately due to higher import content, impacts the net margin and comparability. The Court noted that the assessee's import content was approximately 85%, significantly higher than the 16.10% for comparable companies, resulting in additional customs duty liability that was not recoverable from customers due to market-driven pricing.

The Court interpreted that such customs duty constitutes an extraordinary cost that should be adjusted to ensure comparability under TNMM. The Tribunal had previously allowed such adjustment for subsequent assessment years (AY 2011-12 and AY 2012-13) and the DRP had also granted similar relief for AY 2010-11. The AO and DRP's refusal to grant this adjustment for AY 2009-10 was found to be inconsistent with these precedents and the facts of the case. The Court emphasized that eliminating the customs duty impact is necessary to place the assessee and comparables on an equal footing for transfer pricing analysis. The submissions and detailed workings provided by the assessee were not adequately appreciated by the AO/DRP, which the Court found to be an error of appreciation.

Regarding the second issue on the scope of TP adjustment, the assessee contended that the adjustment should be limited to the value of international transactions with AEs and not applied at the entire entity level, which includes third-party transactions. The legal principle here is that transfer pricing adjustments under the Income-tax Act are intended to correct the arm's length price of international transactions with AEs and should not affect unrelated party transactions. The Court concurred with the assessee's submissions, relying on relevant Tribunal decisions, including a recent ruling involving a similar issue, which held that TP adjustments must be restricted to international transactions with AEs. The Court directed the TPO to verify and restrict the adjustment accordingly, as per the working submitted by the assessee.

The third issue relates to procedural compliance under Section 144C of the Income-tax Act, which governs the dispute resolution mechanism involving the DRP, AO, and TPO. The Tribunal's earlier order had highlighted that the DRP's directions must be clear and specific, and the AO must pass the assessment order in conformity with the DRP's directions without further intervention by the TPO or other authorities. The Court found that the procedure was violated when the TPO passed a subsequent order after the DRP's direction without providing the assessee an opportunity to be heard, thereby breaching the principles of natural justice. The Court reiterated that if further investigation is required, the DRP should call for a remand report from the TPO and then issue clear directions. The AO must then complete the assessment strictly in accordance with the DRP's directions. This procedural framework ensures fairness and adherence to statutory mandates.

In applying the law to the facts, the Court found that the AO and DRP failed to grant the customs duty adjustment despite the substantial evidence and prior decisions favoring such adjustment. The Court also found that the TP adjustment was incorrectly applied at the entity level rather than being confined to international transactions. The procedural lapses in the assessment process warranted remand and reconsideration by the DRP with proper adherence to Section 144C.

The Court treated the competing arguments by the revenue authorities, who justified the denial of customs duty adjustment and the entity-level adjustment, as lacking in appreciation of the unique facts of the case and established legal principles. The Court gave precedence to the principles of comparability, arm's length pricing, and procedural fairness.

Consequently, the Court allowed the ground relating to customs duty adjustment, directing the TPO to grant the adjustment consistent with earlier Tribunal rulings. It also allowed the ground restricting the TP adjustment to international transactions with AEs and remitted the matter for appropriate verification. The appeal was partly allowed accordingly.

Significant holdings from the judgment include the following:

"In such a case, the margins of the assessee would be hit by non-cenvatable portion of basic custom duty which would not make such significant impact for comparable entities. In such a case, the difference has to be nullified to make the comparable at par with the assessee."

"The direction of the DRP shall be specific and clear so that the Assessing Officer can implement the same without any intervention either by the TPO or any authority."

"The TP adjustment should be restricted to the value of international transactions entered with AEs and not at entity level which includes transactions with third parties."

"There was a clear violation of the principles of natural justice as no opportunity was given to the assessee to file its objection to the subsequent order of the TPO passed after the DRP's direction."

The core principles established are:

  • Transfer pricing adjustments must consider extraordinary costs like non-cenvatable customs duty to ensure fair comparability under TNMM.
  • Adjustments must be confined to international transactions with Associated Enterprises and should not be extended to unrelated party transactions.
  • The procedural scheme under Section 144C mandates that the AO must pass assessment orders strictly in conformity with the DRP's directions, without further orders from the TPO, ensuring the principles of natural justice are upheld.
  • DRP directions must be clear and specific, and if further investigation is needed, the DRP must call for remand reports rather than delegating powers to the TPO post-direction.

On the issues raised, the Court made the final determinations that the customs duty adjustment must be granted to the assessee as per prior Tribunal rulings; the TP adjustment should be limited to international transactions with AEs; and the matter be remitted for reconsideration by the DRP with proper adherence to procedural safeguards under Section 144C.

 

 

 

 

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