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2022 (5) TMI 1679 - AT - Income TaxTP Adjustment - TPO not allowing the differential adjustment for basic customs duty - as argued percentage of imported goods consumed by Doowon India is 85% as against 16.10% by comparable companies of the case - HELD THAT - The assessee is dependent on its AE for raw material and bulk of raw material is imported by the assessee from its AE. The import constitutes more than 85% of raw material cost which is approx. 16% for comparable entities. 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. Accordingly this adjustment should have been granted to the assessee to make the margins comparable. Tribunal in assessee s own case for AY 2011-12 2017 (1) TMI 1690 - ITAT CHENNAI has allowed this adjustment. We direct TPO to grant this adjustment. The ground thus raised stand allowed. Assessee plea adjustments if any should be restricted to the value of international transactions and not at the entity level which is inclusive of AE and non-AE transactions - AR has filed a working to submit that the upward adjustment computed in this manner should have been Rs.481.47 Lacs. Concurring with the submissions of Ld. AR we direct Ld. TPO to verify the same and restrict the adjustment to the value of international transactions in the manner as worked out by Ld. AR. This ground stand allowed for statistical purposes.
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:
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:
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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