Marubeni India Private Ltd vs. ACIT (ITAT Delhi)

Transfer Pricing: For TNMM, interest on surplus & abnormal costs to be excluded

The assessee, a subsidiary of a Japanese company, received commission for agency and market research services. For Transfer pricing purposes, the assessee adopted the Transactional Net Margin Method (TNMM) and chose the Operating Profit Margin on Operating Cost (OP/OC) as the PLI and treated itself as the tested party. As the assessee’s margins were higher than that of comparables (9% vs. 8.37%), the transactions were claimed to be at arms’ length. The TPO & CIT (A) held that in computing the Operating Profit (a) interest income and (b) abnormal costs had to be excluded. On appeal to the Tribunal HELD:

(a) Even if interest on surplus funds is assessed as “business income”, it has to be excluded in computing the ‘operating profits’ because if it is included, one is computing the “return on investment” which is an inappropriate profit level indicator for a service provider. As the PLI is the Operating Margin on Cost, neither the interest income nor interest expenses is a relevant factor. The essential element is the cost incurred for the operating activity which has to be taken into account;

(b) In computing the ALP, abnormal expenses which are not of a routine nature as well as those of a personal nature have to be excluded;

(c) Compensation for closure of certain units, though not a regular phenomena, has a direct link with the international transaction. The assessee was receiving certain charges at cost plus 10%. By closing down certain branches, the cost to the AE was reduced and so such receipts would always be considered as operating expenses. The cost of closure cannot be excluded in computing the operating expenses;

(d) The current year data should be used for comparison purposes and not the data of preceding two years;

(e) The argument that as the assessee did not take any financial risk while providing agency services and as it also did not have a patent etc, there must be an adjustment for the “functional and risk level difference” is not acceptable because no evidence as required by Rule 10D to show the risk born by comparables is shown. The assessee has to demonstrate “exact details, exhibiting the risk born by the comparable vis-à-vis the risk in running the assessee’s business” (Sony India 114 ITD 448 (Del) where a 20% adjustment was permitted distinguished);

(f) The argument that there is a “general recession” in the international market and so an adjustment should be made is not acceptable because the comparables adopted by the TPO takes into consideration the general factor available to the assessee vis-à-vis to the comparable in the market. No ad-hoc separate adjustment can be made for the general conditions of the market at the relevant point of time;

(g) The benefit of +/- 5% adjustment is not a ‘standard universal deduction’. This option is available only when assessee is computing the ALP and not when the AO/TPO is computing the ALP.