DCIT vs. BP India Services Pvt Ltd (ITAT Mumbai)

Transfer Pricing: Important principles of “Comparable Uncontrolled Transaction” explained

The assessee, engaged in providing support and advisory services to BP group companies, entered into international transactions with its AEs pursuant to which it made payments for “business support services”. The assessee adopted the TNMM and claimed that the transactions were at ALP on the basis that its profit rate compared favourably with the comparables. In the list of comparables were two entities which had suffered a loss. There were also two other companies with high profit margin. The TPO excluded the loss making companies from the comparables on the ground that they were having a different “functional & product profile” as compared to the assessee. In appeal, the CIT (A) held that the loss making concerns could not be excluded. He also upheld the alternate argument that if the loss making companies were excluded, the high profit companies also had to be excluded. On appeal by the department, HELD reversing the CIT (A):

(i) Under Rule 10B(1)(e)(ii), “the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transaction is computed having regard to the same base;” The term “uncontrolled transaction” is defined in Rule 10A(a) to mean “a transaction between enterprises other than associate enterprises, whether resident or non-resident”. The result is that in applying the TNMM, the net profit margin realized from a comparable uncontrolled transaction is to be taken into consideration. The conditions require that a case should not only be comparable but also have uncontrolled transactions. These twin conditions need to be cumulatively satisfied. If a case is only comparable but has controlled transactions or vice-versa, it falls outside the ambit of the list of comparable cases;

(ii) Further, Rules 10B (2) & (3) set out the circumstances with reference to which the comparability of an international transaction with an uncontrolled transaction has to be judged. The decisive factors for determining inclusion or exclusion of any case in/from the list of comparables are the specific characteristics of services provided, assets employed, risks assumed, the contractual terms and conditions prevailing including the geographical location and size of the markets, costs of labour and capital in the markets etc. The fact whether the comparable has a higher or lower profit rate has not been prescribed as a determinative factor to make a case incomparable. This is because profit is not a factor in itself, but a consequence of the effect of various factors. Only if the higher or lower profit rate results on account of the effect of factors given in rule 10B (2) read with sub-rule (3), that such case shall merit omission. If however such extreme profit rate is achieved because of factors other than those given in the rule, then such case would continue to find its place in the list of comparables;

(iii) On facts, the two loss making companies, though excluded by the TPO for being functionally different, were not eligible to be taken as comparables because the whole/ majority of the transactions were from related/ controlled parties. The transactions were not “uncontrolled transactions” and so the prescription of Rule 10B (1)(e)(ii) r.w. Rule 10A(a) failed. The alternate argument that if the loss making companies are excluded, the high profit companies should also be excluded is not acceptable. As stated above, the question of inclusion or exclusion from the list of comparables under Rule 10B (2) & (3) has to be determined on the basis of factors like characteristics of services provided, assets employed, risks assumed, contractual terms and conditions prevailing including the geographical location etc and not only on the basis of high or low profit rate (Quark Systems 132 TTJ (Chd) (SB) 1 explained).