*connectedthinking pwc
Overview
The Delhi Bench of Income-tax Appellate Tribunal (“the Tribunal”) in its recent ruling in the case of Toshiba India Pvt. Ltd.1 (“the assessee”) has held that cherry picking of comparables is not justified, and that an addition made in an arbitrary manner without cogent analysis and basis is against the transfer pricing law.
Facts
During the relevant assessment year, the assessee entered into two international transactions with its associated enterprises. One related to service charges and the other to reimbursement of expenses. For the purpose of transfer pricing analysis, the assessee adopted the Transactional Net Margin Method (“TNMM”) as the most appropriate method and after undertaking a detailed search process, selected eight comparable companies (“comparables”) to determine the arm’s length operating margin. The average operating margin of comparables was 9.89% as
1 ACIT v. Toshiba India Pvt Ltd. [2010-TII-14-ITAT-DEL-TP]
compared to the operating margin of 15.97% earned by the assessee. Based on a comparison of these operating margins, the assessee justified the arm’s length nature of its international transactions.
During the course of assessment proceedings, the assessing officer (“AO”) observed that three out of the eight comparables selected by the assessee had margins higher than the assessee, while one had a negative margin. On this basis, the AO formed a view that a correct and independent decision was required.
Accordingly, out of the companies which had been rejected by the assessee while undertaking the comparability analysis, the AO selected four different companies on a random basis on the ground that these companies had better margins than the assessee. In doing so, the reasons for which these companies had been rejected by the assessee were not taken into consideration by the AO. The reasons included insufficient description information, significant related party transactions and an exceptional year of operations. The AO, therefore, proceeded to arbitrarily make an upward adjustment of 5% to the operating margin of the assessee.
Cherry picking of companies is unjustified and so is an addition made in an arbitrary manner Tax & Regulatory Services
News Alert*
7June, 2010
PricewaterhouseCoopers
In an appeal before the Commissioner of Income tax (Appeals) (“CIT(A)”), the CIT(A) observed that the AO had cherry picked companies which had shown better results, without giving consideration to the assessee’s reasons for rejecting those comparables. The CIT(A) also observed that the AO had made an upward adjustment of 5% to the operating margin of the assessee in an arbitrary manner. Accordingly, the CIT(A) deleted the adjustment made by the AO.
Appeal before the Tribunal
The Revenue appealed before the Tribunal against the order of the CIT(A) by placing reliance on the AO’s order.
The assessee submitted the following contentions before the Tribunal:
• The assessee had selected comparables after undertaking a detailed comparability analysis and search process as per the relevant provisions of the transfer pricing law (i.e., section 92C of the Income-tax Act,1961 (“the Act”), read with Rule 10B and 10C of the Income-tax Rules, 1962 (“the Rules”)).
• There was no circumstance or reason that would warrant the AO to reject the analysis carried out by the assessee and instead undertake a fresh analysis.
• The AO cherry picked comparables, which was against the fundamentals / principles of the transfer pricing law.
• The AO erred in concluding that the four companies selected by him had margins higher than the assessee. On the contrary, the average net margin of the four comparables was in fact lower than that of the assessee.
• The benefit of 5% variation as per the proviso to section 92C of the Act was not provided by the AO.
Tribunal Ruling
The Tribunal agreed with the CIT(A) that the AO was unjustified in rejecting the arm’s length analysis carried out by the assessee. The Tribunal also agreed that the random selection of four comparables by the AO, without giving consideration to the reasons for their rejection as submitted by the assessee, amounted to cherry picking, and was also unjustified.
In addition, the Tribunal observed that the AO did not properly analyse or compute the results of those four comparables and merely stated that they had better results than the assessee. On the other hand, the assessee had provided a proper computation of the margins of those four comparables, which provided evidence that the AO’s action had no basis.
Further, the Tribunal agreed with the assessee’s plea that the benefit of 5% variation, as per the proviso to section 92C was not provided by the AO.
Accordingly, the Tribunal held that the addition made by the AO was arbitrarily made, which was not in accordance with the law.
Conclusion
Vide this ruling, the Tribunal has emphasised the significance of a comprehensive, detailed, systematic and precise search process, comparability analysis and arm’s length result computation. If the assessee had undertaken the above, then the onus shifts to the Revenue to counter and challenge in a manner which is not ad hoc or arbitrary.
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