Sony India vs. DCIT (ITAT Delhi)

Where the Transactional Net Margin Method (TNMM) was accepted as the method for determining the Arm’s Length Price and the taxpayer was taken as a tested party and the Operating profit margin on sales had been chosen as the profit level indicator and disputes arose as to how the operating profit had to be computed and what parties had to be taken as comparables, HELD

(i) Under Rule 10B (2) (c) the comparability of an international transaction with an uncontrolled transaction has to be judged with reference to the contractual terms. Accordingly, the actual transaction, as entered into between the parties, has to be considered and the authorities have no right to re-write the transaction unless it is held that it is sham or bogus or entered into by the parties in bad faith to avoid and evade taxes.

(ii) Where the assessee had received moneys towards reimbursement of advertisement expenses under an agreement with the Associated Enterprise and the genuineness of the same was not disputed, the TPO was not justified in treating the said funds as a windfall and bounty. The same had to be treated as a part of the normal operating profit of the assessee and could not be ignored in computing the comparable margins.

(iii) Other amounts received by way of reimbursement of cost, provision written back, balances written back, interest received from customers and other miscellaneous revenue receipts also constitute a part of the operating profit and could not be ignored in computing the operating profit.

(iv) Statutory levies paid to the State Govt. had to be ignored in computing the operating profits of the taxpayer as other enterprises taken into account by the TPO were not subjected to such levy.

(v) For purposes of determining what parties should be considered for purposes of comparison under Rule 10B (3), what is to be judged is the impact of the related party transaction vis-à-vis sales and not just profit since profit of an enterprise is influenced by large number of other factors. The facts and circumstances surrounding the company in question that should determine its status as a comparable and not its financial result. The cumulative effect of all factors have to be considered.

(vi) While comparing controlled and uncontrolled transactions or enterprises, one has to look for the differences and whether such differences are likely to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonable accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonable accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) have to be rejected.

(vii) The proviso to s. 92C (2) consists of two limbs. Under the first limb, where, through the Most Appropriate Method, more than one price is determined, the arithmetic mean of such price has to be taken to be the Arm’s Length Price in relation to the international transaction. The second limb gives “an option” to the taxpayer to take Arm’s Length Price which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean. This option is applicable even to cases where the taxpayer intends to challenge the Arm’s Length Price taken as arithmetic mean and determined through the Most Appropriate Method. The argument of the Revenue that where the difference is much more than 5%, then the taxpayer cannot have the benefit of the said provision, particularly where the taxpayer has not accepted such arithmetic mean, is not correct.

See Also: E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)